Penske Automotive Group Inc (PAG) 2007 Q2 法說會逐字稿

Ladies and gentlemen, good afternoon, and welcome to the Penske Automotive Group second quarter 2007 earnings conference call. A press release which details Penske Automotives second quarter results was released this morning and is posted on the company's website that can be viewed at, www.penskeautomotive.com. The call today is being recorded and will be available for replay approximately one hour after completion through August 7, 2007. Please refer to Penske Automotive's press release dated July 19, 2007, about specific information about how to access the replay. I would now like to introduce Mr. Tony Pordon, Senior Vice President of Penske Automotive Group. Sir, please go ahead.

Thank you, John. Good afternoon everyone. Welcome to the Penske Automotive Group's second quarter 2007 conference call. Joining us today for the call are Roger Penske, our Chairman, Bob O'Shaughnessy, the Senior Vice President and Chief Executive Officer and [J. D. Carlson], the Controller. At the conclusion of our remarks today, we will open the call up for questions. We will also be available by phone to answer any follow up questions that you may have later today. Before we begin I would like to remind that you statements made on this call may include forward-looking statements regarding Penske Automotives future reportable sales and earnings growth potential. We caution you that 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 from these predictions.

These forward-looking statements should be evaluated together with additional information about Penske Automotive Group which is contained in our filings with the Securities and Exchange Commission, including our 2006 annual report on Form 10(K). During this call we may be discussing certain nonGAAP financial measures such as adjusted income from continuing operations and adjusted EPS from continuing operations related to our operations for the six-month period ended June 30, 2007. We believe this nonGAAP disclosure would improve the comparability of Penske automotives financial results from period to period.

At this time I would like to introduce Roger Penske, the Chairman of Penske Automotive Group.

Thank you, Tony. Good afternoon, everyone, and thanks for joining us today. As most of you know we changed the name of our business to the name of Penske Automotive Group 2007. Our shares are still traded on the New York stock exchange, but have a new ticker symbol, PAG. Despite the corporate name change all of our dealerships have retained their existing names due to the strong brand equity they enjoy in the current markets where they're positioned.

Turning to results for the second quarter, our business model continued to perform well despite challenging industry conditions. Our dealership delivered strong top line growth across each of our area businesses with overall revenue increasing 19.2% during the quarter. Same store retail revenue growth was 8.5% in the second quarter paced by a 13.1% growth in our high line dealerships. Same store retail revenue grew 2.5% in the United States and 22.8% in our international market. During the quarter same store growth was favorably impacted by exchange rates. If you exclude the impact of exchange rates our overall same store growth was 5.4% including a 13.5% increase in our international operations.

Let me just review the components of same store increase. New vehicle reported was 6.3%. If you exclude foreign exchange it's 4.2%. Used vehicle revenue was 14.9% reported. Excluding FX, 10.1%. Service and parts reported up 6.6%. Excluding foreign exchange was up 4.1%. Finance and insurance up 7%, we reported, and excluding foreign exchange 4.9%. Again overall retail revenue in the U.S. was up 2.5%. International up 22.8%. A total of 8.5%. In total, changes in foreign exchange rates resulted in $100 million increase in Q2 revenues and a $0.01 per share increase in Q2 EPS.

Our second quarter results also include $900,000 in costs for Smart distribution and another $1.9 million pretax reduction in amounts we recorded under our satellite radio program with Sirius. In total for the quarter income from continuing operations increased 8.1% to $39.3 million and related earnings per share increased 10.5% to $0.42. Net income increased 10% to $40.4 million and related earnings per share increased 10.3% to $0.43.

Our results continue to showcase the strength of our business model and the diversification provided by our premium luxury brand mix and our international operations. As expected we experienced margin pressure on both new and used vehicles which contributed to a decline in our gross margin versus Q2 of last year. On the good news side, some of the margin decline was offset to the continuing growth of our worldwide service and parts business by an increase in our finance and insurance per vehicle retail.

For the balance of 2007 we continue to see a low 16.3 million unit in the U.S. for the continued market share shift to foreign nameplates. In the U.K. the introduction of some new products from Audi, BMW and Mercedes Benz should help mitigate existing margin pressure. Just to give you some background in the U.K. for the quarter, we were up 27% in the U.K. on BMW. The market was up 5%. For Audi we were up 6%, the market was up 4%, for Land Rover, we were up 8%, the market was up 2%, and Mercedes Benz, we were down 10%, the market was up 3%. And that was really based on availability of vehicles.

Turning to specifics to our performance in the second quarter, retail unit sales increased 12.1% to 78,300 units, new up 8.3%, used up 20.1%. Our certified preowned units were 39% of total used for the quarter. Our revenue increased 19.2% as reported at $3.4 billion, and to give you the specifics, new vehicle up 15.6%, used up 31.2%, F&I up 15.3%, and service and parts up 16.4%. Average selling prices of new and used vehicles also increased during the quarter. New was up $2,261 to almost $35,600, used was up $2,600 per unit to $30,800.

Looking at our revenue mix for the quarter, United States was 63%, international 37%. On a worldwide basis foreign and premium nameplates represented 95% of total revenues including 65% for our premium luxury brands. U.S. big three contributed 5% on a worldwide basis and in the U.S. the big three was 7% of our revenue. To get more specific on our brand mix you can refer to the selected data sheet that we contained -- was contained in our press release this morning.

Our operating income for the quarter in the United States was 64%, internationally 36%. We were all pleased to see that our geographic earnings were consistent with our sales, demonstrating the strength of our business in the U.S. and international markets. In total for the quarter operating income increased 11% to $93.4 million. And as I mentioned income from continuing operations for the quarter increased 8.1% to $39.3 million and related earnings per share increased 10.5% to $0.42 per share.

Let's talk about gross margin. Overall gross margin in the quarter decreased from 15.1% to 14.7%. Let me give you a little color on margin -- on the margin decline. We saw a change in mix of our overall revenue to a greater proportion of lower margin used vehicles internationally. In fact, the percentage of used vehicle revenue of our total revenue at PAG increased 220 basis points versus Q2 last year, and used margin declined 70 basis points. If you look at both U.S. and international, in fact in the U.S. our margin was 10.3%, up 40 basis points, and internationally we were at 6.1%, down 90 basis points, a significant impact. In the U.K. used margins were affected by the sale of preregistered vehicles sold as used from the previous quarter. The new vehicle margin side we declined 50 basis points, 70 basis points in the U.S. and only 20 basis points internationally.

Product supply, I think from certain OEMs, affected these grosses. For example grosses on Honda Accord, they have a new car coming out in October were impacted as dealers pushed to hit the aggressive targets by the end of our September quarter, as you know Honda represents 13% of our overall revenue. Good news is average gross per transaction on new increased by $50 to $2,971 per unit. On the positive side our service and parts business continued to perform well with margins improving 110 basis points to 56.2% as many of our new shops are getting traction. In addition F&I increased $27 per unit to $967 despite a $24 decrease relating our Sirius agreement. Our tax rate for the quarter was 37%.

Moving on to the balance sheet, total vehicle inventory was $1.5 billion, which is up $109 million compared to the year end 2006. On a same store basis vehicle inventory was up $35 million compared to 2006. In fact, new vehicle was up $37 million. Our used vehicle same store was down $2 million. I'm pleased that the improved returns on our inventories -- on our vehicle inventories were able to generate same store vehicle sales growth of 8.8% with consistent inventory levels. The end of the quarter our worldwide day supply is in great shape, new at 50 days, used at 34, and in the U.S. new vehicle supply is 49 days, versus 64 days supply in the U.S. market overall. Our used was at 36 days.

Looking at our CapEx at the end of the quarter, we continue to fund our Capital Expenditures through sale lease-back transactions. Gross CapEx year to date is $73 million which compares to a gross CapEx for the entire year of 2006 of $225 million. Year to date sale lease-back proceeds are approximately $76 million. In 2007 we expect net Capital Expenditures to be approximately $50 million and gross expenditures between $140 million and $150 million; $75 million less than the previous year.

Turning to Penske Automotive's leverage, we had $847 million of nonvehicle debt at the end of the quarter, $750 million of senior subordinated notes with a blended rate of 5.625%. We had $97 million under our foreign credit agreement outstanding at a blended rate of 6.2% at the end of the quarter. We had no outstandings under our U.S. credit agreement and, as a result, we had approximately $413 million of availability under our credit agreements on a worldwide basis. As of June 30, our debt to capital was 39%, down from 48% at the end of 2006. The 42% of our $2.4 billion of debt including floor plan debt was figured with an average interest rate of 5.7% and an average maturity of 5.2 years.

Let me talk a little bit about our acquisitions during the quarter. During the second quarter we completed the acquisition of six franchises that we expect to generate approximately $400 million in annualized revenue These included the classic group in Austin, Texas, which operate Honda, Toyota, Scion and Hyundai franchises and two Audi stores located in Nottingham and [Lester], England, that are a natural fit with our business footprint in the Midlands area in the UK which will move into new facilities in 2008 and 2009. The good news is these facilities are being built by Audi in the UK and leased back to Penske Auto Group at Sytner. We continue to divest franchises that do not meet our return requirements, location strategy or where we feel we have mandated CapEx requirements aren't warranted. Year to date we're divested 10 franchises that generated an estimate of $215 million in annualized revenue. As a result our net annualized acquired during 2007 was $185 million.

Looking at earnings guidance, we updated our guidance in our press release this morning. We currently expect third quarter earnings from continuing operations to be in the range of $0.40 to $0.44 per share and we continue to expect earnings from continuing operations to be in the range of $1.40 to $1.50 per share for the year including expenses related to smart. One point is our annual guidance does not include the $0.13 per share we -- charge we incurred when we called our high yield notes in March.

Let me make a few points on our smart distribution business before we get on to questions. We continue to make great progress in billing the smart distribution network. There continues to be a lot of excitement around this vehicle. We have selected our dealers and will announce their locations during the third quarter. We currently expect approximately 70 dealers will be operational in 2008.

During the second quarter we launched the smart road show which consists of three teams visiting locations around the U.S. between May and November. During the road shows consumers can experience the Fortwo at various unique venues, participate in our street drivers and attend prospective dealer events. These teams have completed over 120 separate events since the road show began and we've conducted more than 19,000 test drives. In total, the teams have engaged more than 25,000 potential customers and have gained valuable information about our customer base. In fact when we ask the question, are you interested in smart, 91% of the people say they could see themselves driving a smart vehicle.

As you know we launched the $99 reservation program during the first quarter and the response has exceeded our expectations. We now have more than 26,000 reservations. We continue to believe the distribution of smart is another means of differentiating Penske Automotive Group.

In summary, before I open up for questions, I'd like to take a moment to recognize our U.K. employees for their outstanding efforts. As you may know Sytner is the third largest dealer group in the U.K. market representing 132 franchises and employing over 4,700 people. Over time Sytner has invested in a culture design to create motivated, well-trained, satisfied employees and where customer satisfaction is our number one priority. Due to this dedication of our key people working at Sytner; Sytner was recently named one of the best 100 companies to work for in the United Kingdom. In addition, Sytner was recently named dealer group of the year in the United Kingdom by the Motor Trade Magazine. These achievements recognize the success and contributions of each employee in our Sytner organizations. I want to pass on my congratulations to Managing Director, Gerry Nieuwenhuys and the entire team at Sytner for their great accomplishments. I appreciate you joining our call today, and I would like to open it up for questions at this time. Thank you.

(OPERATOR INSTRUCTIONS) Our first question is from the line of Matt Nemer with Thomas Weisel Partners. Please go ahead.

Good afternoon, everyone.

Hi, Matt.

My first question, Roger, is on the newer campuses. Can you give an update on the progress at Turnersville, Inskip, and then maybe even perhaps Fort Dunlap.

Number one when we look at Inskip and Turnersville we are down to the last facility. In Turnersville we are just finishing Cadillac and Hummer showroom -- sales showroom. We have the service facility completed. That will complete Turnersville. And for the second quarter they broke even which is we think quite good based on the higher cost base they have as they go on to their new campus environment. At Inskip, all facilities are complete except the Bentley showroom and the super premium showroom which will be completed at the end of the third quarter. And for the quarter Inskip had $1 million EBT, which was a significant gain over the previous year. We think that when you look at the service and parts piece of this that in both cases in Turnersville our service and parts gross is up 25%. So that's going to continue to drive profitability. And service and parts gross is up almost 10% at Inskip.

Okay. Great. Looking at the used vehicle margin situation in the UK, I realize that your ASPs were a lot higher and that impacts the margin rate. Your dollars per unit looked relatively flat and I'm wondering is the preregistration activity continuing or what can we expect on a dollar per unit profit in the back half of the year?

Well, I -- maybe I can't talk specific dollar per unit, but I can tell you this, we had no prereg vehicles going into Q3 which will make a big difference from the standpoint of that decline in margin. I think you'll see a lower selling price due to the fact that the, obviously the prereg vehicles are all at new vehicle prices.

Okay. And looking at SG&A can you give any more detail on any of the components of that, for example, compensation as a percent of gross profit or advertising in the quarter?

Well, as you know our goal is to drive compensation as a percentage of gross down 100 basis points. We are halfway there for the, through the first six months and our advertising per unit is down about $24 per unit.

Okay. And my last question is, given your performance relative to the rest of the group, I think your operating income was up 11%. Your sales beat the rest of the group by 1,000 basis points. Your operating income is the highest growth in the group; your stock price doesn't seem to reflect that. Have you considered looking at the share -- a share repurchase -- more share repurchase activity?

Well, there is lots of discussion about share repurchase. I think you first have to take a look at our company. We've had some share repurchase over the last five or six years. We've really grown the business through acquisition and same store, and I think at the end of the day, our board will look at this from time to time and if we think it's opportunistic for the shareholder we'd go ahead and make maybe a share buy-back. But at the present time we have a number of acquisitions in the pipeline and we will have to look at those to determine whether share buy-back is the best thing for the company long-term.

Okay. Nice quarter. Thank you, Roger.

Thanks, Matt.

Next, from the line of Rick Nelson with Stephens. Please go ahead.

Thanks, good afternoon.

Hi, Rick.

I'm sure you made some acquisitions here recently in the U.K., the two Audi dealerships and I guess classic prior to that. Can you talk about pricing of acquisitions in the U.S. and the U.K. and the pipeline, is it more UK focused or more U.S. focused?

I would say from a pure revenue standpoint the U.S. revenue will be much higher through classic. They are in Round Rock where Dell is and we've got a number of 75 dealership for Honda in that area and also I think the 1/10 or 1/12 of Toyota. So we see that as a big opportunity for us. Multiples, if you look at multiples today in the U.S. I think for the volume foreign they are four to five times. For the premium luxury they are probably five to seven. And in the UK we see these numbers probably at 50% to 60% of this. The Audi was terrific for us. It's right in our home backyard with Lester in Nottingham. These are significantly large Audi dealers. It gives us 10 Audi stores in the UK, the leading retailer for Audi and we see the product line there having great traction. In fact in some months they've outsold BMW and Mercedes. So pipeline today, really would be probably more weighted towards the U.S.

And your target had been $350 million for the year. You're already at $400 million.

Well, I think we are looking at, I think when we gave that you information in the past it was the net revenue. So we've had 10 divestitures during year to date who have generating $215 million. So we are probably net at $185 million at this point.

Thanks for that. And just if we could get a general outlook or crystal ball what you see for the U.S. market and the U.K. market as we approach the second half.

Well, I can only -- let me just tell you look internationally, we have continued to outpace the markets internationally with the brands that we represent. We have a registration month in September which comes up obviously at the end of the quarter which will be key for our business and the moment the business in the month of July seems to be -- seems to be good. Also we will have the X5 which has sold out for the balance of the year and we are just now getting the C class on an international basis. So that should help I think sustain there and we have the benefit obviously of the strong Audi business.

Looking at the U.S., you see it as well as I do, I think that there is pressures on margins. Certainly we have it on the Accord because it's the run out of a model year. Honda decided to have this challenge. They've kind of reengineered it so it ends up in September. So we are all trying to beat our number or get to our number, so that has some impact of margins from the standpoint of the U.S. We see the Tundra truck gaining some traction. In fact, some of the incentives have come off that.

We've had no inventory in Mercedes Benz. I'd have to say that in the second quarter we've been way off. In fact in Washington at Tyson's we have the lowest inventory for Mercedes we've had in five years. A lot of this has to do with the C class. And certainly gas prices are always going to be something that are going to modulate the consumer opinion probably on a temporary basis. But overall we think that our brands are in good shape.

Inventory will be the toughest thing. BMW is tight. The interesting thing is we can sell BMW cars, we don't have them and then we will obviously sell the truck and SUVs and those give us lower margins, so that's had some dampening effect on margins as we go forward. But overall we see our guidance from $0.40 to $0.44 in-line with our expectation.

Thank you. Congrats.

Thanks.

Our next question is from the line of Rich Kwas with Wachovia. Please go ahead.

Hi, Rich.

Hi, Roger. SG&A when you look at the drivers of that you mention you were halfway on the compensation side. Assuming that you get to that in 2007, what's the next driver on SG&A on the comp side, and how are you balancing reducing costs with maintaining the best possible portfolio of people that you can have?

When I look at our business, and I'm looking, we were fortunate in our space we have a number, we have public retailers, so I keep looking at this SG&A number and is it a percent of revenue, obviously the percent of gross profit on a revenue basis we are in line with our peers. I think that we have also from the standpoint we've done the amount of sale lease backs, we probably have 60 or 70 basis points, which typically is in our rent factor and it would be either a depreciation and in interest.

So overall I think that we are going to continue to drive this number down. From a comp perspective one thing that the industry probably -- we didn't really probably manage it the best one as our margins go down we have to be sure that our comp goes up and as it goes up we want to reward our people. And in some cases pay plans; you have so many locations. We don't have a consistent matrix for every brand and therefore we have to do it market by market and there are some things in markets that would change those. So we have to manage those closer and I would have to say that we've been able to get metrics that we are managing to now throughout the network and I think we will see, we will get that 100 basis points from the standpoint as comp as a percent of gross profits. So we will continue in that area.

The other thing would be advertising. We are not sure today the traditional TV, radio, etc., newspaper advertising is the way you want to go long-term because if you use smart as an indicator, we haven't run an ad yet, we haven't run a radio commercial, it's all been internet based, internet connection. So I think we are going to get the benefit as the manufacturers continue to move more of their advertising into the internet those leads they are going to get then they are going to pass through the dealer in a particular area where you have the zip codes. And I think that's going to make a huge difference for us as we have scale in many of these markets.

Also when you look at the smart customer, we've asked them on the road show, how do you want to be contacted and 62% said, we want you to contact us by e-mail. So this e-mail capture, the internet, CRM systems, I think that's just going to drive our SG&A down as we get more efficient. Because I can send an e-mail blast out and blast out on a service special and get overnight response that hasn't cost me a nickel. So it's very efficient. So, I think that will be a big driver for us.

And then on service gross margin, 56.2% very strong. How do you see, what are the swing factors there going forward? Is this sustainable? Were there any one time issues that really drove the margin?

You look at it, we've grown this 53%, 54%, 55%, 56%, and I think what's happening we are getting more efficient in the service department by getting these bays filled which are driving gross profit. And we don't have -- we have the overhead -- the fixed overhead already there from the standpoint of our people. And warranty is down. And we typically don't make the margin on warranty parts that we make on customer labor. And typically if your door rate is $120 per hour, your warranty rate might only be an effective labor rate might only be $100. So there's a much -- so you are closing that gap.

And to me the other thing that's specific, we are getting out of the wholesale parts business where you are selling parts for 15% and 20% margin. We want to focus on having efficient parts departments, lower inventories and just taking care of our own shop which is helping us drive margin.

Then the upsell, we are training our people in the service drive to upsell the customer and in many cases we are selling a full service maintenance package at the time we sell the car, so we get the benefit of those consumable services that typically you go to some other provider.

Also I think the way we've designed our shops we are getting the real efficient platforms. We are using Saturdays. We have Sundays open for service in some markets and I think this will get us better efficiencies overall. So, I don't see the margin going down overall unless the manufacturer would decide to cut margins for something vis-a-vis parts, but that's only a portion of our margin.

And then finally what was the split on customer pay versus warranty this quarter growth?

I don't have that number but just from history it's probably 65% customer pay and 35% warranty. I can tell you that every single manufacturer including -- especially the domestic, the quality is much, much better. In fact, some of our bigger shops we have to hustle where we've had domestic and now that the quality is so much better to fill those hours with other work. Also I think if you look at our strategy on body shops, we've had the opportunity to grow these big shops. We have probably 10 shops in the U.S. that do almost $1 million a month and that's high margin for us, also.

Okay. Thank you, Roger.

Thanks.

Our next question's from Jonathan Steinmetz from Morgan Stanley. Please go ahead.

Jonathan, how are you?

Doing well, thanks. How are you, Roger?

Good.

Just a couple follow-ups here. Your comments on some of the margin degradation on the U.S. side and I guess reference to Honda and some of the main line sort of import brands. Do you have there's any type of secular trend here in terms of lower margins on these brands or you think this is just a function of product life style or inventory? And if there is any change, does it change your strategy meaning you have to go for a little more volume at the expense of margin and just sort of push the asset turns?

I think, typically you go through a new product cycle where you get new models outdrive higher margins. Obviously the Accord, it's the backbone of Honda and when they came out with this program and gave us incentives, obviously it's driving dealers to meet those targets. So I think it's, individually you would have to look at the brands. When you look at the Tundra, obviously it started out they've got some incentives on that. We've got traction with that -- with that production today and they are pulling those incentives back. But I don't think there's a trend of overall lower margins. I think if you are going to want to be the leader in volume in a particular market you are going to have to sell on -- probably sell on price.

We tend to a better job on our CRM, or customer relationship management, so we can on a contact basis and also are looking at some of this internet business to be sure we are managing it properly. We don't want to be sure we don't drop the customer from an internet intercept to a manager then to a salesman. We want to manage it all the way through the end. We find we get more gross profit. And then we are trying to accommodate that customer on trade and we have an opportunity to maybe by a trade. We also have a chance to do finance and insurance. So in the past it's been, let's come in and by a car for cash and move on. We are trying to get more share of wallet, I would call it, if you can.

I think that residual values and interest rates are really always going to make a consumer look -- if we have cars which are -- the presumption is the relationship is good on fuel economy, the perception is the fuel economy you will see some [flight] to those vehicles as we have the hybrids, now the diesels are coming to be an important part. So I don't think there's a trend -- a secular trend that we see high volume foreign is going to lose any margin as we go forward.

There's going to be a competitive situation, but the nice thing, remember you have to go back to one more very important point and that's units per dealer and location. And as long as we see these foreign nameplates with less dealers you will see the volume and you will see the ability for the dealer to make a return because they are not competing with 48 other competitors in a major city. And I think the good news is we see the domestic OEMs driving that dealer account down. When you look at the market is 50/50 today from the standpoint of take fleet out in the U.S., there is 6,500 foreign nameplate dealers and there's roughly 15,500 domestic. So there's probably a little more pressure on the domestic side, but in talking to the domestic marketing guys they have a good program to reduce count.

So and you've given us a lot of granular data which I appreciate, but have you looked at the domestic side if you were to ex Honda out would the margins be sort of neutral there or is there still pressure?

There's some pressure, yes, there's some pressure, but nothing I would say is worrisome as far as we've concerned.

Okay, and then finally on the CapEx side you talked about some of the reduction and then some of the acquisitions where there will be low CapEx spend related to it. Do you think you guys when I think out towards '08, '09, '010, do you think your CapEx has sort of sustainably come down now that the big campuses are over and some of the big spending could be over?

Well I guess it's all related to acquisition. We've grown the business and when you grow it we have commitments on CapEx. When you look at Round Rock and Austin we mind spend $5 million to $7 million there to upgrade the service department and add a center for PDI, the Audi and the UK there's no CapEx there. There's some CapEx required at Ryland which we bought earlier in the year. But I think we can see a number as we go into 2008, '09, probably hopefully on a gross basis approaching $100 million so that would be down $125 million from 2006.

Okay. Thank you. Thank you very much.

Our next question is from John Murphy with Merrill Lynch. Please go ahead.

Hi, Roger. How are you?

Good.

I think most of that short-term questions have been covered here, but maybe if we could hit two longer-term strategic questions. First how are you doing on your framework agreements? Are you bumping up against the ceiling anywhere in any region or with any of the automakers out there right now?

I would say Lexus has always been the one at the present time that we have -- we have a limit on. But the rest of the manufacturers I think we are in good shape. One of the things that's a prerequisite as a public company today is your CSI. And we do have some CSI metrics that you have to make in order to be able to be approved as you go forward, and I think that's a good one because that's based on customer satisfaction on the sales side and customer satisfaction on the service side. So we are in good shape. We are going to continue to grow and I think that the framework agreements are pretty realistic at this point.

Other than Lexus you are not running into anything specifically in any region?

We had one situation with Acura in California where we had three stores in one region which we divested in one which was just based on that particular market when we had [Cushing/Stevens].

Okay. And then on capital commitments it seems like there's increasing pressure from all automakers, but particularly some of the Japanese makers for facelifts and facility enhancements over time. Is that correct and might be that be somewhat of a drain on capital going forward?

Well, the good news is that's what we've been doing for the last five, six years. And I think people that have not had the image one or image two or image three programs are going to have to face those. But in every acquisition we've done, I think you've seen many of them, Turnersville, Inskip, Washington, San Diego, northern California, Florida, all those areas we stepped up and done the CapEx, Atlanta, we've done that on an ongoing basis. We spent $1.2 billion, almost $1.3 billion. We've done the same thing in the U.K. And I think that's given us the ability to higher better people and that's the reason we are growing that business, because they had no service capability to speak of and now it's a big focus.

And then just lastly on parts and service, are you selling tires in any of your stores right now? And is that potentially an opportunity going forward as you try to take share from the local repair shops?

Let me say that's a good point. I didn't mention it when I had the previous question. We are in the tire business. You walk in to Turnersville today, every one of those drive-throughs probably has 50 to 100 tires in it. Part of the upsell with a service rider today in all of our stores.

Are you carrying additional inventory for that or are you partnering with some --

No, dealer tire seems to be the natural focus because they have access to all of the makes, Michelin, GoodYear, Uniroyal, Pirelli, whatever it might be, Bridgestone, and what you do is you order through dealer tire and you carry a certain amount and they are delivered through a local contact. Many of the OEMs now because of their purchasing power from the OEM level give us the benefit of that leverage so we get lower tire costs which we then pass on to our customer.

Is that a relationship that PAG has with dealer tire or is that a relationship at the automaker level?

We have a relationship separate and in many cases, but that's really driven by the OEM. It's not a special situation that we have. We have all the other auto nation and others would have the same opportunity.

Great. Thanks a lot, Roger.

Our next question from Scott Stember with Sidoti. Please go ahead.

Scott, how are you?

Good. Yourself?

Good.

Just most of my questions have been answered already. Can you talk about sales strength throughout the quarter? It seems like most of your competitors, April was weak, at least in the United States could you talk about how it trended?

Well, it seems that we've come off a quarter, March we said we had to get back on and pedal a little harder in the first months, but I think that we had a good, solid quarter. Obviously the last month of the quarter is key from the standpoint of our final numbers, but when I look at July, early statistics on July. I see our BMW business is going to be real strong. I happened to talk to our brand manager today, the U.K., I was there last week, they see July, a good month for them. Obviously, August is always critical because it's just before the registration month. But I see a market at least with our brands and our diversity here to be pretty decent. And we talked -- no one has asked me the question about California or Florida.

We had the same impact in California, probably when you look at northern California, we were off probably about 10%. Now we take LA out of the Southern California piece, we really are in good shape. We were only off about 5%. We had some stores up 20%, BMW and Mercedes stores were up and the domestics in LA were down about 25%, 30% so we did feel that impact.

Then in Florida, overall in Florida we had one store which we changed the management from an earnings perspective was in great shape, but if you take that store out we were down only about 4% on the new side. We had a little more deterioration on used.

As far as the differentiation between the sales growth and the U.K. which was up a lot more than in the United States it sounds like you guys are taking a lot of share in the brands. Is there anything else in the parts and service business or S&I that can point to the out performance?

I think the -- we are all from a standpoint of F&I we are using the [e-menu] which has given us good controls from the standpoint of standards and pricing in that particular area. There is a lot more focus in the UK on other than just finance. The good news is when we take on these acquisitions typically they've got, they really don't have focuses or processes in F&I, so we are getting the benefit of good bump right away as we walk into those stores in the U.K. and I think, I think overall our brand mix is differentiating us also.

That's all I have. Thank you.

Next we go to Rex Henderson with Raymond James. Please go ahead.

Thanks for taking my call. A couple of questions. I wanted to return to same-store sales. Did you give us unit same store sales in the U.S. and the UK? I don't remember it. Maybe I missed it.

Yes, overall our unit on the new side was up about, just about 1% if you look at it total; up 7.6% internationally and down 1.7% in the U.S. But again you've got to look at a mix on that as we change our mix primarily to premium luxury.

Okay. And kind of on that topic, on the import midlines, we've had some reports of some weakness in those on a same store sales basis. And did you see that as well?

I think we were flat, maybe up 1% on a same store basis.

All right. That's it. Those are all my questions. Thank you.

Okay. Good.

Paul Dorf with [Las Asset Management]. Please go ahead.

I think maybe, it's me, Carl Dorf.

Carl. I'm sorry.

Hi, Roger. The question I have is related to cash flow. I was very happy to see that CapEx will be down $75 million this year, maybe another $50 million going on after that. Could you possibly translate that to me in terms of how close or would you be in a positive cash flow by the end of the year or how close to it with that kind of reduction in expenditures? And exclude the purchases of new companies from that because I understand obviously you are going to have to finance that.

We had $225 million of EBT and you add back your amortization and depreciation of about $50 million; that would be $275 million. Our CapEx net, let's say is going to be somewhere in the neighborhood of say $50 million. So on a pretax basis, before any acquisitions now, we would be sitting about $225 million, and we have our dividends that have to come out of there and there is some changes in working capital that flow through the business.

So there is no question that we've got a business here that has a strong cash flow capability. And the good news is when we make these acquisitions where we have a goodwill payment. We floor plan our new and then typically own our used or maybe some floor planning of the current year and there's a minimal part's staff. I would say the largest parts inventory we have in any one store might be $700,000 or $800,000, because today most of the manufacturers are delivering either on an every day basis or every other day.

So I think that the model works for us and this gives us a chance to take some of that capital to pay back to the shareholders in dividends. And of course, we have got a tax rate of somewhere in the neighborhood of 37%.

Well, I guess that didn't specifically answer the question, Roger, because as I look at the cash flow statement from last year, and just that reduction on last year's statement of CapEx wouldn't leave you with positive cash flow even excluding acquisitions. So if I go through it looking at what else you are likely to be spending excluding acquisitions where would that leave you on a cash flow basis let's say at the end of the year?

Why don't I do this, Carl, why don't I have Bob O'Shaughnessy, rather than tying it together here on the call, have him give you a call and go through it exactly. So -- we don't have all of those numbers in front of us here.

I appreciate that.

Not a problem.

Thank you.

And with apologies, Mr. Dorf, next we go to the line of Edward Yruma with JP Morgan. Please go ahead.

Can you give me a quick update on your Austin dealerships? I know you recently acquired those in terms of the figured investment that might be necessary and your outlook for that market and maybe for Minneapolis as well. Thank you.

Well, let me say this. Let me take your second question first. Minneapolis has turned out to be a home run. We've opened that business. We added a brand new facility. We probably have 55% to 60% market share now with BMW, up from less than 50%. Our service gross profit is growing from about $400,000. It's touched over $700,000 already within the first year of opening the facility, and again, our new business is up probably 20%. And Mini, which we had in a facility in a shopping center is probably up 30%. So we see Minneapolis as a target market for us in the future to make additional acquisitions.

Conversely, as you look it's a Austin, we went into it with a BMW, grew that business, it's one of our top profit locations in the country for any brand, and we want to get more scale there and when you looked at the number -- 110th Toyota store, 75th Honda store and a big Hyundai store out in Round Rock, where Dell is, and these facilities were 90% CI compliant for the manufacturer. We are going to do some tweaking in the shop to get some productivity, in fact I am going down there at the end of the week, and I asked the employees for a top 10 things that they think we can do to make it -- that we can do more business. So I would say those acquisitions today are really right on track.

Got you. And also your more mature campuses, like Scottsdale have you given any thoughts to rotating some brands in or out of that complex? Thanks.

We are at the moment looking at today to take our Mini operation out of the BMW store and put it in a separate location. And that's going to give us more traction on Mini and give us more sales capability within the used car area at the second floor of BMW. That business is -- that whole campus is approaching on an average of over 3% on sales. We are always looking to maximize, obviously. We just moved Audi, by the way to Chandler, we're down on McDowell. We moved that business into the campus along with Lexus and Mercedes so we have a nice full campus. This was a former AutoNation, a big box used car operation. IKEA just moved right in next to us, it's on the 10 Freeway, with great visibility so we see that as a great investment.

Got you. Thank you very much.

We go to Jerry Marks with AutoRetailStocks.com. Please go ahead.

Hi, Roger. Just two questions. With the Honda program that you mentioned Accord that ends in September, how do you account for this? Do you assume that you are going to hit the target and you are going to book it in gross and you wait until you hit it and get a trueup?

Let me say this. We would never take it in until we earn it.

And then [it sounded like] they were a talking about 40% debt to cap is kind of ideal. You have now brought it down to 39%. Are you happy with this debt to cap level present a philosophical standpoint how do you kind of determine the optimal debt to equity mix?

Well, we've moved above that if we had an acquisition that required it but we see us driving that down overall. We said in that number at 40% was a pitch point for us, and I think that we make another acquisition we could bounce above that. But with the cash flow, we have hopefully we can pay that debt down.

Okay. And just to clarify you still have the philosophy of doing leases to pay back all of your debt to finance --

We have the ability to do a sale lease-back where we own the land in the building traditionally. We would do a sale lease back and those rates, in the U.K. or in the 5%, the mid 5's and here in the U.S. they are probably around seven. So there is still an attractive market out there for auto retail sale lease backs.

Great. Thanks. That's all I had.

Thanks.

And we'll go to Darren Kennedy with Goldman Sachs.

Hi, how are you? I have a quick question, a lot of them have been answered in a lot of detail today, but on the smart dealerships it sounds like you've chosen your dealerships. I'm just wondering with how many of them ended up being Penske dealerships as opposed to those belonging to other groups.

Well, based on the total final approval, we will probably be between 8% and 10%.

8% to 10% will be your own.

So it will be fixed at 6 to 7.

6 to 7 dealerships.

Yes.

Okay. And as you have gotten closer to actuality of seeing a lot of your bookings for this early reservations. Do you have any sense of how much you can contribute next year, any better sense you can share to us of how to model it?

Well, everybody is asking me that question.

Of course.

I'm surprised I didn't get it sooner. Basically, we hope that there will be a sales number with two on it, meaning we'll get a 20,000. Right now the impact is the number of vehicles that can be produced in (inaudible) because there's a lot of interest not only here in the U.S. but on a worldwide basis. We obviously that have that, the production number will be key. And we have not given an estimate to the Street at this point from the standpoint of how it might impact us from an EPS and net income because we are just getting all our costs. As we build out our systems, our logistics, we are just now finalizing our logistics providers. We are looking at the transportation costs for taking the vehicles across the country. And I think that we've got to look at dealer margin and financing. So those are things that we are just in the process of meeting with the providers in many of those cases right now, but hopefully we can give you more light on that as we end the third quarter.

Okay. There's -- I guess on the cost side, can you refresh my memory by what you said earlier, and also how that's what you see the seconds half in expenses for the roll-out, and how that's met your initial projections?

We have $900,000. I think we told everyone on the Street that it would be approximately $0.04 for the quarter -- for the year. So it's about $0.01 a quarter drag.

So it's been about that -- it's been about that.

It's been consistent, right. We will get a little more as we build up as we go into the auto shows in LA and the launch. As we move into -- we hope to deliver the first 3,000 vehicles in the first quarter then it will ramp up from there so we will have a little higher cost to carry in the first quarter as we add on some more people.

Okay. I guess I have one more question regarding Mercedes. As I look at the industry sales, I think it's the first full quarter that they've been down as long as I look back at least in the intermediate term. You guys had an up quarter and you said inventory is pretty tight, but you are expecting new brand -- new models in the second half to drive sales?

The C class, we've been out of C class for I don't know how long and I think that's really hurt us.

But had you an up quarter?

Yes, but when you look around -- remember we have some markets in LA where we were not, we had to move to San Diego specifically, where we had more product availability. But I was in Fairfield last week and they complained of the same thing, they have SUVs but don't have the cars. It's a mix problem right now, not problem but it's a mix. We are trying to keep these inventories down as interest rates have gone up and I think we got caught a little shorthanded in both probably in BMW and Mercedes the first six months.

And you see that improving to the second half? Or --

Based on our allotments have, and if the C class doesn't have any blips on the execution of initial manufacturing, I have seen it over in the UK, it's a great vehicle, it should really help us and those should be obviously higher margin vehicles for us.

Okay. Great. Thank you very much.

Thank you.

And next we go to the line of Mike Geoghegan with Bear, Stearns. Please go ahead.

Hi. That was pretty much my question on the smart car or the costs associated with that roll-out. But I guess can you confirm at this point we are not expecting any cost to be incurred after fiscal 2007. Is that correct?

Well, we will have the same -- we've got people cost. We have got road show costs. We've got Internet setting up our CRM. The whole backplane on smart one which is doing all this, handling all of this e-mail and connection with the customer, that's going to continue. Plus we are going to add people and an admin, which basically, we haven't sold any cars yet. So there's been a lot of costs associated with developing the CI capability. We are out talking to the dealers looking at their plans for their dealerships. We will have warranty and other things that we will have to deal with as we get into next year.

Okay. Well, but I guess what I'm getting at is the $900,000 going to be ongoing every year?

I would expect it to be $900,000 plus.

Okay. And then real simple, do you still have a sort of a rough target for 2/3, 1/3 U.S. versus international business?

I think we are 60 -- 66%/34% or 64% or 34%/66% now. I think we are going to let it really flow. I mean we had some acquisitions. We had big acquisitions last year with Ryland and [Jack]. We really this year to date we've had the Audi stores, there will probably be a couple divestitures which will drive the net revenue, and, of course, with the increases we have here in classic will be key.

I think one thing we might see in the third quarter is with the registration month you will see those sales pop up, because you've got March and September and I really -- sitting here I don't want to give you a bad number, but there might be some mix change because of the registration that would come back down at year end.

Okay. All right. Thank you very much.

And we'll go to Jim Henry, a freelance reporter. Please go ahead.

Hi. A couple of your competitors have cited the slump in housing as a factor in auto sales. I haven't heard you guys mention it, and I know you have a lot of other items on your agenda, but I trust that's something you guys see also, is it not?

Well, my -- if you just said, what were my concerns, the concern is the U.S. household fully leveraged, and in the past where you had the benefit of maybe some equity in the home and that drove credit for not only automotive but other personal purchases, that's something I'm looking at very carefully. I think the key thing is that as you look at our brand mix that we have the benefit of cars that are typically perceived to have better fuel economy and we don't have the concentration of competition around us. So the benefit of customer loyalty, you've seen the brand loyalty increase with some of the brands that we are carrying, and I think that's driving us to our continued same store growth. But the differentiation with international, we are up over there, that market is up slightly.

The fact that today we are seeing less fleet cars in the market is helping residuals which will help the customer, will lower payments, quite honestly, to the customer because you have more residual value in your vehicle. That can help you. I think used is strong, so as new vehicles become a situation where they are not affordable, you will be starting to see some growth in used. We've seen it, now we haven't -- we can't say that's a sustaining situation, but there's no question when housing is down and we see the four closures in -- even in Wayne County here in Detroit and some of the places around the country. It definitely has an impact on the consumer. But how I can tie it exact to the my business would be hard for me to do.

Mr. Penske, you have no further questions in queue.

Thank you. Thank you everybody for joining us. Talk to you next quarter. Bye-bye.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.