Penske Automotive Group Inc (PAG) 2008 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Penske Automotive Group first quarter 2008 earnings conference call. The call today is being recorded and will be available for replay approximately one hour after completion through May 6, 2008. Please refer to Penske Automotive's press release dated April 9, 2008 for specific information about how to access the replay.

I'd now like to introduce Mr. Tony Pordon, Senior Vice President of Penske Automotive Group. Sir, please go ahead.

John, thank you and welcome everyone.

As John indicated, our press release detailing our first quarter results was released this morning and is posted on our website at www.penskeautomotive.com. Participating on the call today will be Roger Penske, our Chairman; Bob O'Shaugnessy, our Chief Financial Officer; and J.D. Carlson, our Controller. At the conclusion of our remarks we will open the call up for questions and will be available by phone to answer any further questions you may have.

Before we begin today I'd like to remind you that statements made in this conference call may include forward-looking statements regarding Penske Automotive's 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 rates 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 on our filings with the Securities and Exchange Commission, including our 2007 annual report on Form 10-K.

During this call we will be discussing certain non-GAAP financial measures, such as adjusted income from continuing operations and adjusted earnings per share from continuing operations. Adjusted first quarter 2007 earnings exclude the $12.3 million, or $0.13 per share, sub - redemption charge we recorded in the first quarter of 2007. We believe such non-GAAP disclosure improves the comparability of our financial results from period to period, and is useful in understanding our financial performance.

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

Thank you, Tony, and good afternoon everyone, and thanks for joining us this afternoon.

The first quarter was a great way to start the year, as our business posted solid overall revenue and earnings growth. Like many sectors of the retail environment the first quarter was challenging, particularly as it relates to new vehicle sales here in the U.S. While the new vehicle market continued to struggle, our results certainly showcased the strength of our business model and the benefit provided by our brand mix and diversified revenue streams. The recently completed registration period in the U.K. highlighted the strength of that market, as registrations increased during the period and contributed to our success in the first quarter.

During the quarter, retail sales units increased 2.6% to 72,461 units. New was up 1%, used was up 5.3% and total revenue increased 4% to $3.2 billion. On a same store retail revenue basis, it decreased 2.3%. We were down 4.8% in the U.S. and internationally we were up 1.4%. The decrease and the softness is in both the premium and volume foreign businesses here in the U.S., particularly in Arizona, California and Florida. Just for a couple of data points, Arizona and California were down between 18 and 20% on new, Florida was down 10%, and we were up about 3% on used in those markets. So even though we had deterioration in the new side, we had some pick up in used. As a result, overall same story retail revenues declined 5.5%, due to an 8.9% decline in revenue in the U.S. Overall, while the new vehicle market was challenging, same store used retail revenues increased 2.2%, including 3.6% growth in the U.S., as we continued to implement programs to enhance our used vehicle operations.

Our service and parts business held steady, generating same store growth of 1.1%. We had a 5.5% same store growth in F&I, despite the softness in the U.S. market due to the continued growth of this business overseas. Due the impact of exchange rates, overall retail same store revenues declined 3.1%, including a .4% decline in our International operations. In total, changes in exchange rates resulted in a $25 million increase to revenues and less than $0.01 per share benefit to the EPS in the first quarter.

Interesting, average selling prices in new and used declined, with $35,900 down $100 on new for the quarter, and used was down almost $700 to $29,800. Our revenue mix was - in the first quarter was internationally was 40%, United States was 60%, and that was the same as it was in 2007.

On a worldwide basis, foreign premium nameplates represented 94% of total revenues, including 65% from premium brands. The big three contributed 6%, consistent with the first quarter last year. If you took the U.S. alone, the big three was 8% of our revenue. If you want to look at specific brand mixes, you can see our press releases put out this morning, which gives you more specifics. During the quarter our operating income was 46% in the U.S. and 54% internationally.

Turning to gross margin, the overall gross margin for the quarter increased 43 basis points to 15.4%. New margins in fact remained stable at 8.4% despite the slower selling environment, and used margins increased from 7.8% to 8.4%. We had a $76 increase per unit in F&I to $1,036. The good news is our service and parts continued to perform well, as our margins improved 50 basis points to 56%. You may have noted that our SG&A as a percentage of gross increased 74 basis points to 80.8% in the first quarter. This can be largely attributed to the deleveraging of our expenses in the U.S., as same store gross profit declined 3.6% due mainly to the weakness in the new vehicle market in the United States. Our tax rate for the quarter was 35.8 compared to 34.3 last year. If we look at it for the balance of the year, we think our annualized tax rate will be approximately 35 to 36%.

Moving on to the balance sheet, total vehicle inventory was $1.7 billion which is up $137 million compared to December, and on a same store basis vehicle inventory was up $122 million compared to December. Breaking that out, it was $97 million new and $25 million used. At the end of the quarter our worldwide days supply of inventory was in solid shape, 51 days on new and 33 days on used. If you go back and look at that, at the end of the year we were at 59 days, so we've really come down since 12/07, and we were 43 days on used. If you go back to a year ago, we were up 10 days in inventory on new, 41 to 51, and used is really 31 to 33. So not much increase in used. So we think our inventories are in pretty decent shape. The United States, in - our used inventory for the quarter was 30 days.

Moving on to CapEx, our gross CapEx in the quarter was approximately $49 million. Sale lease-back proceeds were $4 million for the quarter. As a result, our net CapEx in the quarter was $45 million. In 2008 we expect to complete sale lease-back transactions that will result in net capital expenditure of approximately $50 million in 2008. However, based on the impact of the recent turmoil in the credit markets, we may delay these transactions until more favorable rates become available.

Looking at our leverage, we had $844 million of non-vehicle debt consisting of $750 million of senior subordinated notes at a blended rate of 5.625%. We had $91 million drawn under our foreign credit agreements at a blended rate of 5.7%. We had no outstandings under our U.S. credit agreement at the end of the quarter. As a result, we had approximately $375 million availability under our credit agreements, and we have considerable equity in our vehicle inventory also, approximately $80 million at the end of the quarter. As of March 31, our debt to capital ratio was 37%.

We had $1.7 billion in floor plan notes outstanding at the end of the quarter. We have slots that convert to $300 million of our floor plan at a fixed effective rate of 465 through January of 2011, with the remaining $1.4 billion, approximately 50%, in the U.S. When you include the $1.7 billion in floor plan, 46 -- 43% of our debt was fixed, with an average interest rate of 5.1% and an average maturity of 4.8 years. So we are in great shape.

Looking at acquisitions, we did not complete any acquisitions during the quarter. However, in April we completed the purchase of an Audi business in the U.K. and a Toyota Scion business in the U.S. We expect these on an annualized basis to generate about $115 million in annualized revenue. And we sold off one franchise during April, which would reduce that revenue to a net revenue annualized of $30 million.

Turning to our Smart distribution business, as you know we began selling the Smart Fortwo in January. We also expect to have 74 Smart centers doing business in 2008. We currently project the dealership network will consist of 28 exclusive Smart centers - that's parts, service and sales - 33 shop and shop centers inside Mercedes Benz facilities, and 13 stand-alone sales centers which will share MB Service facilities. 68 of those dealerships are in operation today. Eight of the Smart retail outlets are owned and operated buy PAG. In Q1 we delivered wholesale 4,913 units to the retail network. We continue to estimate 20 to 25,000 wholesale deliveries in 2008, and the earnings per share contribution we think will be somewhere between $0.08 and $0.12. We certainly are excited about the Smart business. We believe our timing is right. This is another key differentiator for us, as we look at the Penske automotive model.

Looking to guidance, we provided guidance in our press release this morning. We currently expect second quarter earnings from continuing operations to be in the range of $0.45 to $0.47 per share, and we continue to expect earnings from continuing operations to be in the range of $1.63 to $1.71 for the year. Our guidance is based on 95 million weighted shares outstanding.

Let me just make a note on our share repurchase program. Before I close the call I wanted to address the share repurchase program that we announced in February. To date we have not purchased any shares under this program. We will continue to monitor the market and we'll make purchases at prices we think are appropriate, and subject to our open trading windows.

In summary, we had a great quarter. I was pleased with the performance of our business in a difficult operating environment. As I indicated at the beginning of the call, our results continue to showcase the strength of our business model and the diversification provided by our premium luxury brand mix, our international operations and our Smart distribution business.

Thanks for your attention. I look forward to talking to you and we will open the call now.

(OPERATOR INSTRUCTIONS) First, we'll go to do line of Edward Yruma with JPMorgan. Please go ahead.

Thanks for taking my question, and congratulations on a good quarter, Roger.

Thank you.

Can you give more color on the performance of Inskip and Turnersville? Have these ramped as quickly as you might have expected, given the weak vehicle environment?

I would say the good news is Inskip, you know, we have completed all of the construction. We have got our management team in place, and I think that we were positive in the first quarter. I think that we'll see an upward trend as we go into the second, third and fourth quarter of the year. We are still under construction in Turnersville. We are adding an open Audi point there, and we expect to finish that up at the end of the year. And again, I would say that they are still not generating the EBIT that we are forecasting obviously as we go forward, when you think about San Diego and think about Scottsdale 101, it takes a couple of years to get them in a position where they will produce solid results. But at this point, they are certainly not a drag on earnings.

Got you. Have there been any surprises to date in terms of the Smart vehicles that you retailed, in terms of the models that people prefer and the level of accessorization?

Let me say this. We had expected the inexpected model, the Pure, would be 10 to 11% of our brand mix. It's running 3 to 4%, and the interesting thing is that as people configure their car, we are looking at anywhere from $1,000 to $1,100 more content. So that's positive. I think the average selling price for the first quarter is right around $15,000, which is positive for us, and I think that it's unique when you think about today's new vehicle environment that we are able to sell this brand into a tougher market, but I think the vehicle itself with the fuel economy, that's certainly metro favorable from the standpoint of size, and I think the residuals will be great as we go forward. We delivered, I think I said in my comments, we wholesaled 4,900 units in the first quarter.

Got you. One final follow-up. Can you give us a little bit of color around acquisition multiples, particularly in the U.K.? Thank you.

The multiples in the U.K. have always been less than the U.S., and they continue to be the same. I can't say today whether they're 30 or 40% less. It depends on the particular situation. But typically, we've not seen, we've not seen an increase other than if we are trying to buy something that would be close in our own markets, you might pay a little more for that. But typically the multiples are pretty much the same.

Got you. Thank you.

Our next question is from Rick Nelson with Stevens. Please go ahead.

Hi, Rick.

Good afternoon, Roger. The Smart distribution, I have a question about the gross margin. You reported a 15.9% gross margin in the first quarter. How should we think about that as we move forward, if the mix stays similar? Would it in fact be similar? And what are the costs below that gross margin line?

I think we probably got a little bit of a bump in the first quarter because of the parts that we delivered out to fill up the network. That was one shot that we get in the first quarter. We won't get - that will be a continuing basis, and as we get units in operation, that will certainly grow over the next two or three years, which will be certainly a benefit for us and for the dealers. The other question was -- repeat that for me, would you please?

The cost below the margin, what are the major costs?

Well, we have normal SG&A. We have marketing costs. We have our people costs, travelling, and I think that we had guided $0.08 to $0.12 and we made $0.02 in the quarter. And we don't really break out the SG&A to run this business, and we show it overall.

And then there were 5,000 units?

4,913, I think, to be exact, was what we wholesale -- we would expect to be in the 6,000 range for the next - 6,000, 6,500 for the next three quarters. However, we've got the month of August where the plant is shut down and we have model changeovers, so I'm not sure what kind of impact that will make. So I am pretty comfortable between 20 and 25,000.

Thank you. And can you comment on April trends, maybe as they relate to what you saw in March? Are you seeing much change in the business?

Well, I think that we certainly saw March better than January and February, because you know where we are located in many cases. I think used car business seems to be better because we've concentrated a lot on selling the car retail rather than wholesaling it, but I would say that the trends are probably pretty much the same as we come out of March into April.

And the U.K. market has been pretty resilient. It hasn't seen the big declines of the U.S. market. What does your crystal ball suggest there?

I'm not sure my crystal ball, but I can say that the market in the U.K. was up I think .7% and the expectations from the auto association there, they are estimating a flat market in 2008. So we feel pretty good about that. And when you think about our premium luxury, I know there's been lots of pressure on premium luxury in the U.S. You know, 95% of all of our business internationally is premium luxury, and we have not seen the margin pressures to date. In fact when you look at our new car margins, they were in good shape for the quarter.

Just a question about the CapEx requirements that a lot of the OEMs are putting out there for the dealers, particularly the imports and some of the luxury doors. Where do you stands in terms of - are those mostly behind you now at this point or...?

Well, you know, we have, as you know, probably - and I would have to go back and get the right number, but I think acquisitions have generated 5 or $6 billion of our revenue over the last 5 or 6 years, so we've had a consistent number of acquisitions. And every case, as we buy a store, the OEM looks at the facility, and part of our agreement as we would take it over would be to meet the current CI requirements. So we made a lot of those investments. I know there's some brands which are pushing hard now, specifically Mercedes Benz with Autohaus, we probably have a 7 to $9 million estimate for what we have to do. But the good news, on the other side of that we will get additional $400 per car which supports that. So I think when you're all done, you are going to be even money, the cash flow that you will get from the cars, and that will be retroactive back to the beginning of this year. You obviously can't get that money until you've met the criteria. The benefit will be to the customer and also the environment your employees work in, and we will be meeting the brands standards. We met Autohaus in every single case in the U.K. So we've been building this consistently in our acquisitions in the U.K. So we're okay with it.

I know a lot of the - many of the dealers I've seen in automotive news or, are complaining about the costs. Obviously it's something we have to look at and what we would do is probably look at either an acquisition or an existing dealership and if the CapEx did not give us a return that we would expect, meaning more service bays, and give us the margin we want we would, we would probably dispose of it. Also as you start to look at margins now, there's the front-end margin and the back-end margin and much of this back-end margin, there's a compliance requirement which requires CI or you won't get that margin, and that's on top of the - so much per car, in the case of Mercedes. So it's a mixed bag, and I think each one of us have to work through our own situation and it's unfortunate there's been many times where people have made significant investments and have to turnaround and meet a new CI standard. We've run into that, I wouldn't say a number of times but a few times, and it's somewhat disappointing. But on the other hand I think we have to move on.

Okay. Thanks a lot and good luck.

Thank you.

Next we'll go to the line of Matt Nemer with Thomas Weisel Partners. Please go ahead.

Good afternoon. My first question was just following up on Rick's question about the U.K. retail environment. Obviously the media is painting a pretty negative picture there, and I'm just wondering if you can give us more flavor on the mix of vehicles that are being sold over there and just customer behavior in the U.K.

Well, we have such a strong market share in the U.K. in the premium luxury, when you think about the 15 BMW, 15 Mercedes, we have many stores with all of the BMW, which obviously is a plus with gas prices the way they are. We are the largest Bentley dealer. We have 11 Audi stores, 4 Porsche stores, 6 Lexus stores. And we are in markets where we really have many of those brands or multiple brands in one particular geographical area. And I don't feel that on the retail side that we will expect a decline, and that's what the NADA people in the U.K. are saying today. Now 2007 was the sixth highest year for the market, and overall we had a good quarter, and I think that we are doing a lot of blocking and tackling. We really have not made - our acquisitions are - this Audi store, we end up being in a cluster of Nottingham, Derby, and Leicester. So these are positive for us. So we really have the benefit of scale in a particular market.

And we've activated - our used car business is even greater in the U.K. I think used car business will continue to be good. We haven't been pushed on preregistration by BMW like some of the other manufacturers, which has given us the benefit of giving us higher margins. And I think we have to look at margins there, and we have to look at same store and we have to grow our parts and service.

And if we stay on that kind of a mission, I think that we are going to be fine for 2008 now. They are hoping there might be another reduction in the discount rate. We've had 50 basis points this year, which obviously helps lease rates. And when you look at our overall business, Matt, almost 70% of all the PAG's business is either financed or leased. Obviously interest rates along with residual values really tell you what your rates are going to be, and I think that at the present time with lower interest rates we might be getting the benefit on the car side. I haven't seen it yet on the housing side.

Great. And then on the used car business, you picked up quite a bit of momentum in your central region using some software and processes, and I'm just wondering how that's going and what the timeline might be for rolling that out nationwide?

Well, we have -- there's a number of products out there, we have - First Look has been our favorite, and I think what [Ramanod] in the central region has really jumped on that program, and when you look at our used to new ratio, a year ago we were at roughly .5, .55, and we are almost at .8 now during the first quarter. And the returns, if you take new - used vehicle revenue or gross profits, you take F&I, that's wholesale, we are probably up 100 basis points in profitability. And I think that when you look at the increase year-over-year, we've had a substantial 15 or 16% increase in unit sales. And at the end of the day, one thing that we've been following is that we've been able to sell cars at a lower margin - I mean, a lower price point, and we are down probably $1,000 in the central region from 15,000 to 14. So we are really selling everything that we trade. We are doing safety checks and reconditioning, which is one thing you get in these softer markets where maybe your new car customer isn't coming in. That internal gross profit goes a long way covering some of your fixed costs.

Got it. And then just more of a housekeeping question, but do you have the SG&A to gross profit, excluding any changes in rent expense? Just trying to get a sense for how much that may have changed the ratio?

I think if you take rent out we were roughly 72, 72.2 in - last year, and we are up about 40 basis points this year.

And then last question, on Smart, can you give us an update on what you are seeing from churn rates as these cars are actually hitting dealerships and the sales professionals are calling customers, at what type of churn are you seeing?

Well, I think, I think the great news is that we are sitting today with about a 19% cancellation rate from the point that we make the $99 reservation, and I think that's key, when we are sitting today with 52,000. And we went out to the market about a month ago and indicated to all reservation owners that they could go online and check the availability when they might expect to be able to receive their car within a 90-day period. We didn't see a big disconnect and people drop out. And quite honestly, today we got 37,000 people who have an idea of when their car is going to be delivered. And with a 19% dropout, I said we would be doing a great job if we held half of them. When you think we had no salespeople, we had no dealers. So it just shows you the power of the Internet. So to date 5% of the orders, as I said earlier, are the Pure, that's the smaller version of the Coupe, 62% is the Coupe that has more equipment on it, the higher value, and, of course, the balance would be the convertible, 32%. So again I think this is a situation where people are concerned about the price; you know, at the end of the day I think people want the car and want as much content as they can get. In fact, leather seat, heated seats, et cetera. So we have reservations in all 50 states at the moment.

Congratulations and thanks again.

Thanks.

Next, we'll go to the line of Rich Kwas with Wachovia. Please go ahead.

Good afternoon, Roger. Following up on Smart, what are the number of reservations you have right now? What is the number?

52,000-plus as of, we ran it this morning. 52,757, Tony tells me, to be exact. And that's - that's net of what have we've delivered already, too. And net of anything that has fallen out at least prior to delivery. We get some fallout obviously when the cars end up hitting the ground, but that's part of the 19%.

And then in terms of the gross profit, gross margin for new vehicles, you were flat year over year, you said there hasn't been really any deterioration internationally. What are your expectations, given that a fair number of dealers have pretty high inventory levels on the luxury side? Do you expect grosses to hang in there here in the U.S. going forward over the next couple of quarters?

If you look at the first quarter, on our new margins, we ran 7.7%, and that was down 20 basis points. So we saw some of the same pressure downward that the other dealers, they [probably] have seen in the quarter. On the other hand in the U.K., and I think this shows you the strength of our business model, we don't have the competitive pressure. At least we don't have it as I sit here today. We were up about 30 basis points and when you combine the two we were 8.4, which was flat year-over-year, which was a real benefit to us. And the average transaction price went down about $700 in the U.S. from $32,000 to 31. And quite honestly we are seeing the - because of our mix is so much premium luxury, we were up about $1,300 in average transaction price in the U.K. If you look at that overall. we were down $100. Then on a gross basis, we held our grosses nicely. Up 300 in the U.K., down 100 in the U.S. and basically flat. So I can't tell you that we are smarter than anybody else, but I think it's the diversification because a big piece of our premium luxury, 65%, a big piece of that's overseas that's given us the benefit.

That's helpful. Then on the used front, I know you're focused on shifting down gear in terms of the mix of vehicles, particularly in the central region. Are you seeing - aside from that, are you seeing any shift within used vehicles where somebody comes in and maybe thought they could afford a $20,000 used vehicle and maybe has to settle for something less than that, anything along those lines?

I think today, that's all about getting the person financed. And you have a sub-prime customer, which really is 10% of our business, and we have people who take that client on a non-recourse basis. The balance we are doing with the captive is probably 70% of our business, both new and used, is with captives, and the rest is with our preferred lenders, and we really have not seen any pressure. If someone has credit we are able to get them financed through the - either the traditional source would be the OEM captive or a preferred lender. I don't see us shifting. I'm not on the line that close, so I don't want to give you a bad fact here. But I think that what we are focusing on, when you look at the used car prices in the U.S., the average selling price is roughly $20,000, and the average selling price in the U.K. is $46,000. And that's because we are so much more weighted to premium luxury. And on the other hand, our margins, because of I think the commitment to used, and we are not being pushed to preregister a lot of demonstrators, we've been able to sell used cars, and our margins are up in the U.K. about 100 basis points, and we were down 40 here in the U.S. but overall up 60.

So I think at the end of the day we are in pretty good shape. You know, advanced rates, probably the amount they will advance the finance might put some pressure on people to put more down payment. But when you think about 70% of our business is financed, and a big portion of that is leased, and when you look at BMW, Audi, Lexus, Mercedes, most of those are on leases, and they have - today you really have to put your initial down payment down. They don't give you any 0% on those, unfortunately. But I think we are seeing same pressures as the consumer is seeing with commodity prices, the day-to-day stuff they buy. They have sticker shock with the fuel prices, and there's about $500 billion, I guess, that go through the adjustable rate mortgage portfolio, which will always have downward pressure.

The biggest problem that we face potentially in the U.S. is that if these rates are not reduced in these adjustable rate mortgages, it might take the equity values down in homes, and today I guess if we got maybe one or two out of ten are under water, that could hurt us because in many cases the credit rating is based on the value of the equity you have in your home. So all of that plays into the consumer's wallet today. So lots of levers.

Okay. Thanks, very helpful. Appreciate it.

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

Hi, John.

Hey, Roger, how are you? On the parts and service business, there was a little bit of slowing in same store sales. It was clearly a tough comp. I was wondering if there was anything going on there. And also on the margin, you had some expansion in margin, even though had you a slowdown there. Just wondering how we should think about - or how you think about the capacity utilization there, and if you need that growth to keep ramping up that margin?

We are about 70% utilization today, and that would be with a number - I think we have 3,800 bays and we've got plenty of room, and plus you can go to second shifts, we can go to six and seven-day shifts from the standpoint - I think you are seeing people today, if it's under warranty, they will bring it in but warranty as a percentage of the total sales is coming down, and maybe some of the larger tickets we are not seeing. But what we've done is, all of our service people obviously want the upsell, so we are getting into some of the dent repair, the wheel repair, where we usual had farmed that out, we are bringing that in-house and that's giving us some more margin. Lots of e-mail blasts going on. And I think we had fewer service days with Easter, Good Friday, I think that was a little bump. I don't know what the other public retailers saw, but we saw some softness in the market, certainly had fewer days in the U.K., so we got a little bit of both.

If you think about just the pricing environment, what you are seeing from the auto makers, and it sounds like even beyond just the Detroit three, that there's a little bit more pricing competition going on, or incentives I should say, from the auto makers. I was wondering what you were seeing there, in particular from Japanese and even on the luxury brands?

I think pressure is only being driven by too much inventory. I looked at our inventory before the call, and we are up 30 million from the end of March. Now March 31 and April 20, obviously we delivered a lot of cars here in the last couple of days, and when you look at that increase, Toyota Lexus is up 7 million, Honda Accura is up 12, BMW Mini is up 12. So out of 31 million, there it is, and you've got some ins and outs. Mercedes is up only $3 million. So I think the pressure on gross, I don't think there's anybody out there that wants to give these cars away ,but the OEMs are going to have to get rational and realize that too much stock, nobody makes money, and what happens is then we get into some distressed advertising, and all that does is lower prices and ultimately we get lower residual value. I think the lesser is in the OEMs hand to help us on this growth side.

Just lastly, on SG&A, it was up a little bit year-over-year. Just wondering if there's any opportunity there in the short run, or if there was anything that happened in the quarter that was sort of making - inflating that in any way abnormally?

I don't think so. I think that when you look at - I was kind of looking at SG&A because that's a hot topic across the people that cover our stock. And when you look at us at 12.5%, we are in good shape, and certainly when you look at our - as a percentage of gross profit it's a little bit higher. But when you look at the mix of business, we are only running parts and service about 11% of our total revenue, and that's the high-margin business. So I'm looking at 12.5%, do I want it to be less, we do, we have lots of programs. But you have to be careful. We are in a variable comp mode today, and when business gets a little tighter I think you've got to look at some of your paid plans, and there and there might be - and when margins are down and people are used to being paid on margin, you might support some of your sales team in order to be sure that they take enough money home. So there could be a little bit of cost there. But I don't have anything that - you know, I think our rents are decent. We are up obviously $4 million quarter over quarter. Some of that is due to acquisition. Some to CPI, and some to sale lease-back. But overall I feel we are in good shape.

Great. Thank you very much, Roger.

Next question, Scott Stember with Sidoti. Please go ahead.

Hey, Scott.

Hey, Roger. Can you guys dig into the customer pay of the parts and service a little bit better? What was customer pay versus the warranty work in the quarter?

You know, that's been running somewhere about, I think, 35% warranty, and the balance is in customer pay, and customer pay in the quarter was up 3 to 5%. I can't tell you what was international, and what was domestically. And we warranty continuing to come down. But one component of warranty, we have to remember, is on these full circle programs, where the OEM is providing some of the maintenance items, you pay that back through warranty claims. So I'm not sure how the accounting is being done on that at the moment. But we see warranty coming down, much better quality from the standpoint of all OEMs, both domestic and foreign nameplate.

Now would that higher customer pay work be responsible for the parts and service gross margin being up?

Yes, you would get more on the - exactly, that's a good point. We would expect to get more margin on parts on a customer RO versus say warranty.

Just to the interest expense line, in aggregate between quarter-over-quarter or year-over-year it's down about 15 percent. Could you talk about how much maybe lower rates contributed to that?

Well, obviously we are getting the benefit of the convert at 3.5%, which we didn't have in the previous year. That was probably the biggest factor.

That's all I have now. Thank you.

Okay, great. Thanks.

We will go to the line of Darren Kennedy with Goldman Sachs. Please go ahead.

Hi, there, I'm here with Matt Fassler, how are you?

Hi, Darren. Hi Matt.

I guess my questions actually are on Smart. The first one is about I guess the cancellations, I'm really not that worried about it, considering the manufacturing constraints or the amount you are - have shipped this year, you don't really seem that concerned about being able to sell through that, correct?

When I say cancellations that's from the original - someone putting a $99 deposit. That's the original reservation we've taken. We take it all the way down to delivering those cars, people that have dropped out are, it's 19%. So we are saying there's roughly a 75 to 80% stick rate on people who want the car. And I think it's about wait time. I mean if people think they have to wait 15 months to get one, we might lose some of those. But we went out in the market and told all the customers that they could go in, take their reservation number, go into our Smart One system, and it would tell them within 90 days when they would get the car, and we didn't see a big drop out that point.

Okay. Because I think somewhere in the press it was cited that you thought you could use more Smart cars from the manufacturer, but I didn't know if there was really any possibility of that. Are they all manufactured in one plant currently?

Well, just to put it in perspective, they are all built in Hambach, France. It's a Mercedes Benz plant. They have a capacity of somewhere between 130 and 140,000 vehicles, and they are at max production. So we are in competition with the other parts of the world. There's no question that this new model, the Smart Fortwo has been well received, and I think that we are going to work on trying to get more allocation in the next year. But -

Next year you are going to be facing an introduction in China as well. I just want to make sure I have it straight, right?

There certainly from our discussions, they're going to look at getting more efficiency out of the plant. They have not run at these levels in the past, and I think that we will get some benefit out of increased production, and they will give us a number that we will negotiate with them as we get further into the third quarter.

Okay. Great. And the final question around this, because I'm just trying to understand the growth trajectory as well as any lumpiness, I think at one point I looked at Canada and the roll-out of Smart there, and then I saw some numbers that really dipped and I think it was a model transition period. Is that something that's in your - looking out projections? I don't know if that's - if I have that right or something is going to be different in the U.S., in the way they roll that out?

They had the original Smart with the diesel in it. And the vehicle they are selling to date does not have a diesel. I think they waited about four months from the time they shut down the old model until they ramped it up. So they were really short of product. It's my understanding that their business is way up in Canada also on the current car; I wish I had that exact number. I will get Tony maybe to get it for you. But I know that Smart year-over-year is up substantially. Now take out the down year, when they did the conversion, but we'll have a month out of production in August when they take vacations, and there will be a model change-over that will impact us probably in the October, November time frame. But if you take our numbers and what we expect to wholesale, over 6,000 this quarter, and you take another 6,000 in the third quarter less the impact, I think we are - our 20 to 25,000 is realistic. But we will keep you posted.

Thanks, very helpful. Thank you.

We'll go to the line of Rex Henderson with Raymond James. Please go ahead.

Hello, Roger. I wanted to drill down a second on the parts and service margin again. I thought you were getting pretty consistent and pretty good growth on that margin line. I'm wondering, as you grow the used car business, how much of that improvement in the parts and service margin is attributable to the reconditioning profits that are booked in parts and service, and how much of that margin improvement is native to the customer pay business or the warranty business?

Well, let me talk about used cars. Obviously, there is a real benefit. We don't - we don't have a discounted internal rate today in our shops. If our sell rate is $95 per hour, that's what we charge on the reconditioning of a used car, and we get the appropriate parts mark up. So the more we can do, that's going to drive more overall gross profit and there won't be a decrease. I think what's happening with the new shops and the ability from the logistics perspective, getting vehicles in and out, that we are getting better productivity, which gives us a higher margin from our technicians. I can see today where we have shops that are 130, 140% efficiency, and that's going to help drive that margin.

Okay. So what you are saying then is, you think that it is native to the core business and not just a portion of or an effect of the used car business?

Well, I think the used car business is helping us build a total gross profit. I think in the central they were up $300,000 in the quarter just on internal gross profit. But I think that the units in operation, which we've been able to generate because of our same store growth over the last six years, is driving a bigger customer base. And that base today is coming into the dealership for their service. And I said earlier in the call, where we've had a dent doctor come in and take dents out, we're done that internally. They just set up a significant piece, shop in Scottsdale 101. We are doing wheel, a lot of these wheels, these fancy aluminum wheels get damaged. We are doing a lot of wheel repair. So those have margins obviously a lot higher than you would have on a normal coverage, when you have a time study service that's generated by the technician. So I think a lot of that is helping the mix.

We've got to grow this business in parts and service, and the good news is that with the complexity of the cars today, they've got to come back to the OEM dealer. I don't care if it's GM, Ford, Chrysler or any of the foreign nameplates. Unless we throw the customer out the door, which we are not doing, and there's a lot more CSI. a lot more follow-up today, e-mail blasts, we are using the Internet extensively to bring these customers back in. We are following up on service. So basically everywhere we can get some revenue - we do oil changes. That was always done by the Pennzoil guy or someone around the corner. That's a huge factor today, and there's real good margin in that, when you think about someone comes in for an oil change, maybe a $25 oil change and you can upsell and that gives us the -- the tire business, we've never been in the tire business. And today it's a big focus throughout all of our stores, and in fact we pay the service writer on the drive-thru a commission for tire sales.

One other thing on the parts and service business. Your same store sales in parts and service this quarter was 1.1%, which is - I think it's the lowest number I've seen since I've been covering the company, and several years back. I'm just wondering what your outlook is for the rest of this year? Do you think that number is good for the rest of this year or do you think you can back to more historic numbers?

If you break it out, we haven't broke it up before. We are up 2.5% in the U.S., down 1.5% internationally. And there are fewer days that we were open due to holidays, et cetera, in the U.K. Now I'll give you a better feel of that after we get through this quarter. But I don't see any deterioration. We had some big comps, I think it was double-digit comps last year, and obviously we will see how it - how it plays out during the Q2.

Okay. Thank you very much.

Yes.

We'll go to Jonathan Steinmetz with Morgan Stanley. Please go ahead.

Good afternoon, Roger. Can you hear me okay?

Yes, fine, thank you.

Okay. A lot of them have been asked but let me just follow up. I think you said something on CapEx projects, that if the rates don't become more favorable that there may be a few things that you defer. If that's true, if you could just elaborate on the dollar amount that sort of is in question here and maybe what some of those types of projects might be?

I think maybe I wouldn't, sorry, I wasn't very clear. I think what we meant is that we are looking at the rates. I think that there's activity out there, but there's not quite the competitive environment to give us maybe the rates we want. We then would look at having our lenders provide us with a real estate line of credit for mortgages. So we've not done that in the past. As you know we make our money on selling cars. I know there's lots of companies that are owning their own real estate. But when you are looking at 5.5% cap rates internationally, and we are in the 8% range today, you think about depreciation interest rates, it's off our balance sheet and it gives us some flexibility. If you've got a 5 or a 7 or a 10-year initial lease, it gives you the benefit of - some flexibility versus owning it yourself. So there's plusses and minuses. And we've used our capital in the past. And we have a debt to capital of 37% and I think you have to take everything into consideration. Where - we think we are positioned in the right direction. I think we will still be in this $50 million, maybe slightly higher depending on what happens with rates, as far as net CapEx for the year.

Okay. And then on this parts and service side, so I guess did you 2.5% comp in the U.S. Do you have any data on things like number of repair orders year-over-year or traffic count or anything like that? And I'm just trying to get a feel as to whether increases in commodity prices are actually beneficial in any real magnitude to this line item ,given that everything from the price of motor oil, any steel on hard parts, is all going up, is that at all a factor in growing revenue?

I looked at some data before the conference call. We are up about, in east and west - I don't have the information in the central but we were up about 10% in numbers of our ROs for the first quarter. We were down about 7% in warranty, in ROs. So again, a slight increase, the big question is hours per RO. That's a huge incentive to the service writer because he gets paid on that, and obviously if we get more scale and more dollars per RO, we get more efficient in the shop. So I think overall total RO is probably up slightly, but there's a shift now between warranty and customer pay.

Okay. And lastly I just I you were at 1,036 on F&I per vehicle. Just your thoughts going forward on that? Do you think there's a lot of latitude to drive that line item hire over the next couple of years? And if so, what would that come from?

I would say that at $1,000, we are probably - I wouldn't look for big growth there for a couple of reasons. The ability for us on leases now to sell a lot of these extra products, if someone leases a car for three years, they don't want an extended service contract. A lot of these extras because of the lease rates, people are being probably a little more prudent, and especially in the premium luxury we want to be sure that we are competitive, as people look at different mix of cars. One good thing is that's happened in the U.K. they have a personal contract purchase, a PCP, which is like a lease but it's a finance contract with a guaranteed residual, and we've really grown the business from 39% in 2006 to 53% this last quarter and that's given us some nice reserve. And we see that to be pretty consistent. But overall, at the end of the day we've got to be careful that when we do sell and add, it's a hard add, it doesn't get charged back to us if the car is sold or traded into someone else. So overall I think that you are going to see finance penetration continue going to up. We are up about 3 points this past quarter in the U.K.

Okay. Thank you very much.

Our final question is from the line of Tim [Secontine] with Northern Trust. Please go ahead. Tim, your line is open, please go ahead.

Sorry about that. I had it on mute. I just have one question, it's on the used business. I would say first of all I was definitely impressed with the margin expansion, because it's - just because I've been hearing a lot of number news about residual values, and I just kind of want to do get your thoughts on, is that a trend that's going to continue through the next couple of quarters or is that pretty much going to stay steady, or is there going to be any impact on - in the U.S. on, I'm guessing on these lower option rates?

I think what you have to look at type of vehicle. I think you've got some vehicles that are off the charts as far as - as high - as maintaining their residuals. I think the other thing is you take the BMW Full Circle program, we take a lot of those vehicles back ,and Audi is going into the same type of marketing, and I'm not sure today whether Mercedes is, they have a minimum number of vehicles you have to purchase in order to get some back end money. That's getting the dealers more involved. There's many more initiatives, whether it's a public dealership or private, to keep the used cars and get in the used car business, the CPO, 38% of our business was CPO for the quarter, and I think that's going to help residuals. If you got trucks and you have big SUVs I'm not sure there's anybody that is going to turn those around at the moment because of the fuel prices, but we've got a concept called Retail First. So we are trying to give ourselves the ability to sell these cars first. Well, maybe we won't make them certified pre-owned but in fact we will do a safety check, and then provide the consumer a 6-month warranty that he doesn't even pay for. So if there's anything that pops up that is unexpected, the customer is covered. So I think you have to look at residual values by model type, and certainly some of the smaller cars, better fuel economy cars are going to hold residuals. But the trucks and some of the higher horsepower engines might lose it, and I think it's a mixed bag personally.

So it's reasonable then for me to say that the luxury mix that you have and more retail in focus is what would drive this in the future?

I would think that not only our, but the people who are in similar business, because we have to become good used car operators. There's been - probably for the last 10 years because it was so easy to sell a new car on the foreign nameplate side, there really wasn't a big supply of used because people kept these cars. We are now having to get into the used business to get this ratio from .4, to .5, to 1, up into .6, .7. In the U.K., in many of our stores we sell more used more than we do new. We have to understand how to do that here. We are just not really focused on it. The margins are less on used than they are here, but I think the competition with the customer to get him in a vehicle and our ability to get all the margin front and back from the manufacturer, it's going to include a major focus on our used car products, and that's what we are trying to do and it's a little different OEM by OEM., but I think all of them have focused on that. That could only help us, because higher residuals will take the cost down for the consumer, whether it's a financed or leased product.

Okay. Thank you.

Thank you.

Mr. Penske, I will turn it back to you for any closing comments.

One other item, we were talking at the end talking about acquisitions, and we had $85 million we'll have net in revenue annualized. I said we had 115 gross less the 30 of the store we had exited from here in the quarter. So I just want to make a note on it. I gave you a wrong fact there. Thank you for joining us today and we will talk to you next quarter. Thanks.

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