Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Group 1 Automotive Inc. (NYSE:GPI)

Q3 2008 Earnings Call

October 28, 2008; 10:00 am ET

Executives

Earl Hesterberg - President and Chief executive Officer

Randy Callison - Senior Vice President of Operations and Corporate Development

John Rickel - Senior Vice President and Chief Financial Officer

Pete DeLongchamps - Vice President of Manufacture Relations and Public Affairs

Lance Parker - Vice President and Corporate Controller

Analysts

John Murphy - Merrill Lynch

Rick Nelson - Stevens Company

Scott Stember - Sidoti & Company

Matthew Fassler - Goldman Sachs

Richard Kwas - Wachovia

Matt Nemer - Thomas Weisel Partners

Operator

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Group 1 Automotives third quarter earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) I would now like to turn the conference over to Pete DeLongchamps, Vice President of Manufacture Relations; please go ahead, sir.

Pete DeLongchamps

Thank you [Makaela] and good morning everyone and welcome to the Group 1 Automotive 2008 third quarter conference call. Before we begin, I’d like to make some brief remarks about forward-looking statements and the use of non-GAAP financial measures.

Except for historical information mentioned during the call, statements made by management of Group 1 are forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

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

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

I’d now like to turn the call over to our president and CEO, Mr. Earl Hesterberg; Earl.

Earl Hesterberg

Thank you Pete and good morning everyone. In a moment, I’ll turn the call over to our CFO, John Rickel, who will provide Group 1’s detailed financial results. After he has finish, I will address guidance and then open up the call for questions.

Before I turn the call over to John, let me begin by telling you what we observed during the quarter. The third quarter started off looking like a continuation of the second quarter, with the challenging but manageable overall selling environment; then came September. First, hurricane Gustav made its way towards the New Orleans area, leading to mass evacuations that resulted in more than a one week loss of business, including the typically busy Labor Day weekend.

Then on September 13, hurricane Ike descended on the Houston metropolitan area. Evacuations began on the tenth, with most businesses in preparation for the storm. Even though our team was able to get all nine of the Houston area stores up and running by September 17 and the five Beaumont stores back in business a couple of a days later, the public was not out shopping for vehicles again until late in the month due to power outages, gasoline shortages and traffic issues.

The Houston and Beaumont stores account for approximately 20% of Group 1’s revenues and an even larger percentage of our profits. We estimate that the two weeks worth of business we lost as a result of this storm’s effects negatively impacted our earnings by approximately $0.15 per diluted share for the quarter.

I want to take this opportunity to thank our people for the outstanding job they did in getting us back in business so quickly. The level of dedication showed continues to demonstrate the quality of our most important asset, our employees.

In addition, to the impact of the two hurricanes and the already challenged automotive selling environment, the conditions worsened when the country became focused on the financial crisis that began unfolding in mid September. The uncertainty this has created has significantly reduced consumer confidence and negatively impacted customer traffic in our dealership showrooms. In addition, we have also seen lenders further tighten credit standards.

The majority of customers we are seeing, we are still able to get loans placed; however, we are seeing some level of lender turn downs, higher down payment requirements for most customers due to reduced loan-to-value ratios and increased interest rates that are leading some customers to reject the financing offered.

One of the positive things that occurred over the last few weeks is that gas prices have fallen to under $3 a gallon. This along with increased manufacturing incentives has helped improve sales of new and used trucks and SUVs. A major shift in car versus truck sales that we have been observing is beginning to stabilize.

For the third quarter, 56% of our new vehicle unit sales were cars. This is up slightly from last year’s 55%, but is down from 62% in the second quarter. It appears that the recent economic crisis will impact virtually all of the United States; however, so far in October, we are seeing business return to near pre-storm levels in Houston, but we do not anticipate a large replacement spike like we saw following hurricane Katrina, a significantly fewer vehicles appear to have been destroyed in this storm.

If you recall we mentioned on the second quarter call that we were hopeful that California had begun to stabilize, but with the increased credit pressures, that reversed and traffic continued to soften this quarter. One of the bright spots this quarter was our parts and service business which continued to show positive same store growth. This is a key part of the auto retailing model and an area that has held up well in prior slowdowns, the continued positive performance reinforces our confidence in the business model.

We put a lot of time and effort in improving efficiencies and capacity in our parts and service business, particularly since the gross profit generated here covers approximately 70% to 80% of our total fixed costs. Our new parts and service facility at Beverly hills Mercedes Benz which gets us 108 service base at that site and our newer collision center with nine paint booths for three of our selling call dealerships here in Houston, came on-stream during the quarter. We have several similar investments which will provide more capacity later this year or early next year.

Third quarter total parts and service sales increased 6. 9% with a 1.1% increase on a same-store basis. We estimate the hurricane impact reduced the same-store revenue results by more than a full percent and point. Gross profit was up 2. 3%, as we experienced improvements in all areas of this business.

Another area of focus has been our finance and insurance business. The improvements we have made continued to grow our profit for retail unit, which increased $27 from the same period a year ago to $1066 per unit.

With the exception of our parts and service business, it is clear that our revenues have and will in the near term decrease substantially. Therefore since October 1, we have implemented additional significant cost cuts in our ongoing operating structure. On an annual basis going forward, we expect these actions to generate approximately $35 million in savings. John will comment further on these actions.

Now let’s turn to inventories. As I said the hurricanes significantly impacted our September unit sales, so our new vehicle day supply numbers are not meaningful. I will focus instead on absolute levels. On a unit basis, we saw substantial improvements from the second quarter in our domestic and luxury inventories, as well as in our truck inventories with total inventory decreasing 1157 units or about $67 million from our June 30, 2008 levels.

Compared to the third quarter of 2007, we improved our domestic inventory by about 8%. Our inventory mix improved as well with cars accounting for 44% of the units and trucks at 56% of the inventory, which is down from 63% at the end of the second quarter 2008. I just want to note that our Foreign Dodge pick up inventory is well positioned to receiving the new 2009 F150 and ram models respectively.

Noting our used vehicle inventory, our supply of used vehicles at quarter end stood at 31 days supply with a good balance between car and truck Mick. We are satisfied at this level as we head into the fourth quarter.

Turning to the third quarter brand mix, Honda, Nissan, BMW and Mercedes Benz, all increased their share of our new vehicle unit sales. Toyota Sun and Lexus accounted for 34% of our sales, followed by Honda Acura with 15% and Nissan with 14%. Ford came in fourth at 10% of our new vehicle unit sales, falling from 13% in the third quarter 2007. Rounding out the mix was BMW Mini with 9%, Mercedes Benz with 6% and Chrysler and GM each accounting for 5% of our new vehicle unit sales.

Import brands held steady at 57% of our unit sales from the prior year period, while luxury brand sales grew 560 basis points to account for 25% of our new vehicle unit sales. In total, import and luxury brands contributed 82% of our unit sales at the end of the third quarter 2008, with domestics accounting for 18%.

Now let me update you on our corporate development activities. In the third quarter we disposed off five franchises with 12 month annual revenues of $17.7 million. These dispositions include four domestic franchises that we disposed of in late July and a Volkswagen franchise in Kansas that we terminated on August 31. We did not complete any acquisitions during the third quarter, but during the first half of the year we did acquire five franchises with $90.2 million in estimated annual revenues.

During the currents environment, we do not expect a complete any additional acquisitions during the remainder of the year. We will continue to review opportunities as they are presented to us and we will only pursue those that fit our stringent criteria and add value for our shareholders. I will now ask John to go over our financial results in more detail.

John Rickel

Thank you Earl and good morning everyone. For the third quarter 2008, our net income from continuing operations was $9.4 million or $0.42 per diluted share excluding the impact of the asset impairment charges, lease terminations and bonds redemption gains recognize during the quarter. On a comparable basis net income from continuing operations decreased 57.3% from $22.1 million in the third quarter a year ago and earnings per diluted share were down 55.8% from $0.95 per diluted share.

As we indicated in our press release on October 10 2008, results for this quarter were negatively impacted by hurricanes Gustav and Ike, which made landfall near New Orleans, Louisiana on September 1 and near Houston Texas on September 13, 2008 respectively. We estimate that the impact on the quarter of the business lost as a result of these storms was approximately $0.15 per diluted share outstanding. In addition, in reviewing the third quarter we identified triggering events indicating a potential impairment of our indefinite life intangible assets, in other words goodwill and franchise rates, which required us to perform an interim valuation of the book value of these assets compared to their estimated fair market value.

In addition, impairment triggers were also identified relative to certain other assets, causing us to evaluate their caring values as well. As a result, we recognized a $30.2 million after-tax impairment charge during the third quarter of 2008, primarily related to a write-down of our domestic brand franchise evaluations as well as real estate associated with some domestic franchise terminations. We did not identify an impairment of our recorded goodwill.

Including the impact of these non-cash impairments, we realized a $20.6 million net loss for the quarter or $0.91 per diluted share. Our third quarter consolidated revenues decline $191.4 million or 11.8% to $1.4 billion compare to the same period a year ago. Our new vehicle business declined $145.4 million or 14.2%. In addition, our used vehicle retail and wholesale sales declined $26 million and $26.2 million respectively.

Revenues from our financial and insurance business decreased $6 million reflecting the impact of lower new and used retail volumes. As a partial offset, our parts and service business increased $12.2 million or 6.9%. Our consolidated gross margin improved 50 basis points to 16% in the third quarter of 2008, compared to the same period a year ago. This improvement was more than explained by the shift in revenue mix on a year-over-year basis towards our higher margin segments.

The partial offset was a decline in the margins of several of our businesses. Margins were lower in our new and used vehicle businesses declining 40 and 20 basis points respectively. In addition, margins in our parts and service business declined 240 basis points to 53.2%, reflecting faster growth in our wholesale parts and collision businesses where margins are lower on a relatively basis. Even though margins were down in parts and service, with the growth we achieved, gross profit generated by our parts and service business increased 2.3% to $100.3 million.

Although we reduced our consolidated SG&A expenses by $4.3 million in absolute terms, SG&A expense as a percent of gross profit increased 540 basis points from 77% in the third quarter of 2007, 82.4% in 2008 and as a result of the decline in gross profit, $21.7 million or 8.6% to $229.6 million.

Consolidated floorplan interest expense decreased 282,000 or 2.4% in the third quarter 2008, to $11.2 million as compared with the same period a year ago. This decrease was primarily attributable to a 144 basis point decline in our weighted average floor plan interest rate, including the impact of our interest rate swaps. This was substantially offset by $173. 5 million increase in our weighted average borrowings.

Other interest expense increased $1.5 million to 26.4% or $7. 2 million for the third quarter 2008, as our weighted average borrowings of other debt increased to $147.2 million.

Our weighted average interest rate increased five basis points. The increase in weighted average borrowings primarily reflects the continued execution of our strategy dealing more with the real estate associated with our dealership operations, as well as the outstanding borrowings under the acquisition line of our credit facility, which we were able to pay down by $35 million during the third quarter.

The increase in interest expense from the mortgage facility and acquisition line was partially offset by the redemption of $28.3 million of our senior subordinated notes over the past 12 months.

Manufacturers interest assistance, which we record as a reduction of new vehicle cost of sales at the time the vehicles were sold was 65.7% of total floor plan interest costs for the third quarter of 2008, a 21.3 percentage point decline from the 87% level of coverage experienced in the third quarter a year ago.

The decline stems primarily from the impact of our $550 million of fixed rate swaps that we had in place at September 30, 2008 and a weighted average interest rate of 4.7%. We reflect the monthly contract settlement of these swaps as a component of floor plan interest expense.

Now turning to same store results; in the third quarter, we had revenues of $1.4 billion, which was a 15.9% decline from the same period a year ago. Significantly lower customer traffic coupled with tighter lending standards, particularly reduced loan to value levels, plus our same store new vehicle unit sales to decline 18.2% and our new vehicle revenues to decline $182 million or 17.9% in the third quarter.

We estimate the hurricane impact lowered these results by approximately two percentage points. We continue to experience lower demand for trucks and other less fuel efficient vehicles, in addition soft economic conditions, particularly in our California and South Eastern markets persisted.

As a result for the three months ended September 30, 2008 our same-store new truck unit sales declined 20% from the third quarter of 2007 and new car unit sales declined 16.8% for the same period. Particularly in light of the impact the two hurricanes during the third quarter, we believe that our results are at least consistent with the retail performance of the brands that we represent in the markets that we serve.

In our retail used vehicle business same store sales slipped 13.9% or $39.8 million on a 11.1% fewer units. Most of this decline is explained by lower sales in markets that are traditionally strong truck markets. As with new vehicle sales, we estimate the hurricane impact lowered our used vehicle results by approximately two percentage points.

Overall our same-store unit sales of used retail trucks declined 15.9%, while used car sales declined 7.1%. In addition, tighter underwriting guidelines reducing loan to value ratios and requiring more money down have negatively impacted our retail used vehicle sales and margins.

We continue to focus on improving our used vehicle business, utilizing technology to enhance our selling and inventory management processes. As a result, our used vehicle business mix continues to shift towards used retail sales and away from less profitable wholesale sales. Our wholesale used vehicle sales were down $28.6 million or 34.4% compared with same period a year ago. Over the pass two months, we’ve seen a small rebound in auction values for pickup trucks and SUVs which has helped wholesale office from $104 in the third quarter of 2007 to $63 per unit this quarter.

Despite the more challenging economic environment, our fixed operations remain robust for the third quarter third quarter of 2008, with the same store revenues increasing $1.9 million or 1.1% to $176 million. We estimate that the hurricane took more than one percentage point off of our parts and service results this quarter.

The revenue improvement was driven by a 3% increase in our warranty related sales, a 3.9% increase in collision business and a 2.6% improvement in our wholesale parts sales. Partially offsetting these improvements was a decline of less than 1% in our customer paid parts and service revenues.

Production and retail volume more than explained a $7 million decline in our same-store F&I revenues to $45.3 million in the third quarter of 2008 compared to the same period a year ago. However, our F&I revenue for retail unit improved $31 in the third quarter of 2008 to $1072 per retail unit, partially offsetting the impact to the decline in retail units.

Same-store gross margin improved 50 basis points in the third quarter 2008 to 16%, reflecting the favorable shift in our business mix. Our total used vehicle margin remained flat while our parts and service margin declined 230 basis points to 53.3% and our new vehicle margin decline 40 basis points to 6.3%. New and used retail and gross profit per retail unit declined 6.1% to $1888 and 10.2% to $1822 per unit respectively.

On the new vehicle side of the business, improvements in the same-store car margins and gross profit for retail units were more than offset by margin and profit declines in our truck segment. Same-store margins and profit per retail unit were down in the aggregate for our domestic, import and luxury lines.

We continue to experience margin pressure in our retail used vehicle business, which declined 90 basis points from the same period a year ago to 10.7%. The decrease was primarily on the car side as reduced loan to value levels pressured margin.

We experience some offset from used truck margins as gas prices declined during the quarter. A combination of reduced wholesale losses and a continued reduction in wholesale mix allowed us to maintain total used vehicle margins at 8.6%.

In the parts and service area for the quarter, we experienced positive margin improvements in warranty segment as well as our wholesale part segment. However, our same-store parts and service gross margin declined from 55.6% in the third quarter of 2007 to 53.3% in the comparable period of 2008. As a result of the decline in the margins from our customer pay parts and service segment as well as the mix shift reflecting faster growth in our wholesale parts inclusion businesses where margins are lower on a relative basis.

In these challenging economic conditions, we continue to focus on reducing costs. As a result, we lowered same-store SG&A expenses by 5.8% to $179.8 million in the third quarter of 2008. While we did not fully offset to decline in same-store gross profit that we experienced this quarter and as such same-store SG&A as a percent of gross profit increase 620 basis points in the third quarter 2008 to 82.8%. We estimate that hurricane Ike negatively impacted this ratio by nearly 200 basis points.

Given the further slowdown we’ve experienced as the quarter progressed and our view is that the overall economy is not likely to improve in 2009, we have been actively working to further reduce our cost. To date our team has identified additional incremental cost reductions that we estimate will reduce our costs by approximately $35 million on an annualized basis.

Included in this total is $21 million of personnel cost reductions, $11 million of reduced advertising spending and $3 million of other costs, primarily lower outside service costs. We are in the process of implementing these reductions and should have most in place by the end of this year.

Same-store floor plan interest expense decreased 4.7% or 524,000 to $10.7 million in the third quarter of 2008, with 135 basis point decline in floor plan weighted average interest rates including the impact of our interest rate swaps was partially offset by an increase in our weighted average borrowings of $135 million.

Higher weighted average borrowings reflect higher vehicle inventory levels from the comparable period a year ago, although vehicle inventory at the end of the third quarter of this year was down $77.5 million from the second quarter 2008 levels. We would anticipate continuing to lower inventory over the coming months.

Now turning to liquidity and capital structure; we had $42.2 million of cash-on-hand as of September 30, 2008. In addition to cash-on-hand, we use our floor plan offset account to temporary invest excess cash. These immediately available funds totaled an additional $6.5 million at quarter end.

As I previously stated, we used available cash during the quarter to repay $35 million of borrowings on our acquisition line leaving $15 million outstanding at September 30, 2008. This gives us $317 million of available borrowing capacity under this facility after considering the $18 million of letters of credit outstanding.

With regards to our real estate investment portfolio, we completed the construction of the Beverly Hill Mercedes Benz service facility during the third quarter and began operations in the state of the art shop which we own. In total, we own $390 million of land and buildings at September 30, 2008. To finance these holdings, we’ve utilized our mortgage facility and executed borrowings under other real estate specific debt agreements.

As of September 30, 2008, we had borrowing outstanding of $180.4 million under our mortgage facility with $54.6 million available for future borrowings. In addition we had $38.7 million of borrowings outstanding under other real estate related debt agreements.

As to the stability of our capital structure, we do not have any near-term liquidity pressures. Except for the Ford floor plan facility, we face no significant debt refinancing decisions until March 2012 when our revolving credit and real estate facilities expire.

Our Ford floor plan facility is an evergreen arrangement that renews annually in December. We’ve engaged Ford Motor Credit Company in conversations regarding the renewal of this facility in December 2008 and at this time, do not have any reason to believe that the facility will not be renewed. However, if we are unable to agree with Ford’s unacceptable terms of the renewal, we have the necessary capacity within our revolving credit facility to absorb this floor plan financing requirement. Further, our 8.25 senior subordinated notes mature on 2013 and our 2. 25 convertible notes are not put able until 2016.

We’ve updated financial covenant calculations within each of our debt agreements and as of September 30, 2008 we are in compliance with all such covenants. As a result of a net loss recognized for the third quarter, we currently have $3.4 million available through restricted repayments under the covenants of our 8.25 senior subordinate notes. On a quarterly basis going forward, this available amount will increase by 50% of our consolidated net income.

Our total long term debt-to-capitalization ratio, excluding real estate debt totaled 37% at September 30, 2008. This was down from 39% at June 30, 2008, primarily as a result of the $35 million repayment on the acquisition line that I mentioned earlier, as well as the repurchase of $9.7 million of our 8.25 senior subordinated notes during the quarter.

With regards to our capital expenditures for the third quarter, we used $12. 2 million to construct new facilities, purchase equipment and improve existing facilities. This amount excludes the purchase of land and existing buildings. We estimate that our capital expenditures for the full-year, including the purchase of land and existing buildings will be $55 million.

Although we are confident in our balance and our ability to meet our covenants under a wide range of economic scenarios, we believe it’s prudent to continue to further strengthen our balance sheet. As a result, we are closely reviewing all planned future capital spending and working closely with our manufacturer partners in this area. As a result we anticipate 2009 capital spending will be down significantly from this year’s level.

In addition, we are also reviewing all additional uses of cash for opportunities, including as Earl mentioned lowering our acquisition target in 2008. Our top priority at this time is to use the cash we generate to further strengthen our balance sheet by paying down debt. We believe our present financing arrangements are valuable assets that we intend to protect.

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

Earl Hesterberg

Thanks, John. Now let me address our guidance. As I stated in our press release earlier this morning, we are suspending our 2008 full year guidance. It’s difficult enough during normal business conditions to provide valid earnings guidance. Given the unprecedented market volatility, rapidly changing consumer confidence and a shifting lending environment, it is impossible to predict near-term vehicle industry sales levels and therefore impossible to provide any meaningful estimates at this time. We will address 2009’s full year guidance when we announce our fourth quarter earnings in February.

Before we begin the Q-and-A I wanted to say something about Randy Callison. A couple of weeks ago, we announced that Randy has decided to retire at the end of year so he can spend more time with his family. Randy has served as our Senior Vice President of Operations and Corporate Development since mid 2006. It was his service in corporate development that had the biggest impact on the company.

He’s been involved in nearly every acquisition and disposition that Group 1 completed since 1996, before the company went public. He was also instrumental in seeing Group 1 through the structural reorganization I implemented after I joined the company in 2005 and for that, I’m very grateful. I as well as all the employees who worked with him over the years will miss him, but we all wish he and his family well.

That concludes our prepared remarks. In a moment we’ll open the call up for Q-and-A. Joining me on the call today are Randy Callison, who is joining us for his last earnings call; John Rickel, our Senior Vice President and Chief Financial Officer; Pete DeLongchamps, our Vice President of Manufacture Relations and Public Affairs and Lance Parker our Vice President and Corporate Controller.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John Murphy - Merrill Lynch.

John Murphy - Merrill Lynch

John, you guys did some work on your coverage at the beginning of this year. We worked with the banks to get some more head room or your max leverage covenants and I was just wondering if we went into some tougher times next year which it looks like we are heading into, if there might be the need to rework some of your covenants, how that process worked earlier this year and if you think the banks will be willing to work you and how you would work through that process?

John Rickel

John, this is John Rickel. At present we really don’t anticipate needing to rework the covenant, so it’s kind of point one. We’ve looked at it under a variety of scenarios and are comfortable [inaudible] that we are performing.

To your second point though, we do think that if situation would worsen materially or something unexpected would occur, the banks have shown a willingness to have those discussions, but recognize there’s a price involved which is why we are very focused right now on continuing to work on the business, deliver the results and really work on strengthening the balance sheet, because I really don’t want to have to go do that if we don’t have to and right now we don’t anticipate it.

John Murphy - Merrill Lynch

And then on SG&A, we look at your program to a cut $35 million and that’s great. I was just wondering also as times get tougher and we think about SG&A, if you could just paint a little more color around what portion of SG&A is variable and what portion is fixed and as we go forward, if things get tougher, is it going to be more personnel and advertising cuts or there are other areas that you might be able to get into a little bit deeper in the cost curve?

Earl Hesterberg

John it’s Earl. I don’t want to imply that we believe that $35 million is enough at this moment. Personally I think that we’re going to need to go deeper than that. We’re trying to get a fix for the current sales travel rate, which until we have a month of data in October and then maybe into November, it’s hard to tell where the current true sales rate is in the industry, but I don’t think we’re sized properly yet.

This is about our fifth round of cuts for some our dealerships, such as our like the California dealerships, whereas we’ve just started to cut in Houston and some of the other areas, but when we look at our personnel related, which is about 60% of total SG&A, probably around half of that is truly variable. You have benefit costs and you have to have a certain level of management and a certain level of pay that’s not completely variable in terms of relating to gross profit generated.

Then with advertising, it’s highly flexible and very responsive, but there is a certain level of advertising we need to do to just maintain awareness and nowadays in particular, you have to have a constant web presence or electronic media presence, so that’s about the best I can answer that question at the movement.

John Murphy - Merrill Lynch

And Randy on your last conference call not to let you get away I heard an analyst ask you a tough question. You’ve seen the acquisition environment for quite sometime now. I was just wondering what you think it looks like right now. Currently a lot of companies are sort of cash draft to your capital draft and they are not able to make advantages acquisitions in an environment like this. Are there advantages acquisitions or cheap acquisitions to be made out there and it’s just a tough time because there’s not a lot of capital available or are we just looking at a lot of Dodge’s out there that are up for sale in the dealership network?

Randy Callison

Thanks John, this is Randy. There are some reasonably priced domestics which isn’t what we’re looking to add to our portfolio. There is still a gap between what sellers want for input and highline and what buyers are willing to pay. That’s probably going to come down at some point in ’09. I think this is the right time for the publics to be kind of quite on acquisitions and wait for that gap to strengthen.

John Murphy - Merrill Lynch

Okay, so you think prices still need to come down quite a bit and to more realistic levels?

Randy Callison

I do. On the desirable franchises the important highlight, demands are reasonable right now and someone wanted to go that direction.

John Murphy - Merrill Lynch

And then just one last question as far as the demand weakness that you guys are seeing in your dealerships, there’s a big debate on how much of it is because of credit tightness and how much it is just really fundamental weakness and it’s a very tough thing to parse out. In your opinion of what you’re seeing in your dealerships, how much is just because of fundamental weakness in the economy and the fact that unemployment is rising, consumer confidence is falling of a cliff and how much of it is actually because consumers can’t get credit to buy the vehicles?

Earl Hesterberg

John, this is Earl. The vast majority of the issue is customer traffic from the overall lack of confidence and the economic disruptions. We chatted here among our group, and we kind of see it is being about 80% of traffic issue and 20% a lending issue. That’s not scientific, but that is our feel based on our field input.

Operator

Your next question comes from Rick Nelson - Stevens Company.

Rick Nelson – Stevens Company

I wanted to follow-up on the expense cuts that you have in place, the $35 million. How much of that do you see coming here in the fourth quarter and how will that sort of layout over the next 12 months?

John Rickel

Rick, this is John Rickel. We started implementing most of the plan. Now obviously you don’t get it all at the start of the quarter, but we think by the end of this year, those cuts should basically be in place. So you get a portion of it this quarter and then you should get the annualized effect next year.

Rick Nelson – Stevens Company

Okay. The service and parts strike, I know you talked about capacity additions driving that but is there any operational changes that are going on that are also driving that good number?

Earl Hesterberg

Rick, this is Earl. I think that a lot of what we are realizing is the focus we put on this over the last year or two, but also the benefit of moving our brand mix toward these import and luxury brands which have the growing units and operation and so there’s a lot of things on the good side a ledger in the parts and service business these days, in the units operation, that wave from the brands like Toyota and BMW and Honda, that have grown, CPO business, certified pre-owned which types people back to us, complexity of vehicles, selling 35%, 35% extended service contracts, there’s a lot of good things on the positive side of the parts and service ledger.

Now, I wouldn’t say there aren’t a couple things on the negative side. Clearly people been driving less miles and there’s some cost pressure, not everyone is going do accept every repair presented to them in the service drive these days, so there’s a little economic pressure in the parts and service business two, but it seems to me that the factors on the positive side of the ledger outweigh those negative factors at least at the moment, at least based on what we’ve seen today.

John Rickel

A big difference is regional. I know you have lot of exposure in Texas

Earl Hesterberg

We’re really not seeing a big differential across the country.

Rick Nelson – Stevens Company

And the asset impairments, have you identified the dealerships that those are related to?

John Rickel

Internally we have, Rick. This is John Rickel. They primarily impairments of the domestic franchise value.

Rick Nelson – Stevens Company

And one final question John; on the covenants, the two ratios, I guess one is interested in is the leverage ratio and the fixed charge coverage; do you have those numbers through the third quarter?

John Rickel

Yes, we do. Give me just a second; total leverage 4.07, at the end of the third quarter and fixed charge coverage ratio 1.37. Those are also, Rick, posted on the website as part of our Investor Presentation; they are in the road show.

Operator

Your next question comes from Scott Stember - Sidoti & Company.

Scott Stember - Sidoti & Company

Thanks all for qualifying the traffic versus lending issues, but on the side of lending issues, obviously this has gotten a lot of press lately, could you quantify that maybe just a ballpark percentage of deals that are actually getting killed because of increased cash down or just people just not meeting the finance requirements?

Earl Hesterberg

That’s more difficult Scott for me. I mean we’ve seen some turndowns. In this kind of market, when there is less traffic, some of the traffic out there is very poor quality traffic. They seem to stay in the market regardless of economic conditions. I would have to believe that flat turndowns are still 10% or below the market, but I have no scientific data on that.

Scott Stember - Sidoti & Company

Okay and John you mentioned the breakup of parts and service comps, what was the warranty work versus the customer pay?

John Rickel

Yes, that the warranty work was up 3% and customer pay was down less than 1% on same-store basis.

Scott Stember - Sidoti & Company

And what was the collision?

John Rickel

Collision was up 3.9%.

Scott Stember - Sidoti & Company

Okay and just generally speaking, looking at 2009, I know you guys are not giving guidance yet, but with the level of cost cuts you’re talking about, obviously you guys are planning to be quite profitable in 2009 I imagine, right?

Earl Hesterberg

That’s our goal. You’ve received some kind of guidance with those questions, but we’re here Scott, we’re here; that’s what we get up everyday for, is to stay solidly profitable. We really need to get some trend line data on where the industry is traveling. I’ve read the analyst reports for where they believe October is going to come in but I’m really interested to give that data next week.

Scott Stember - Sidoti & Company

I only bring it up just given that unfortunately there’s a common belief that dealers won’t make money at all next year, so I just wanted to throw that out there.

Peter DeLongchamps

That possibility certainly still exists that retailers can be profitable in this type of environment.

Scott Stember - Sidoti & Company

And just last, I mean obviously, it sounds like your capital structure’s in tact, the dividend is safe, right?

John Rickel

Well, this is John Rickel. That’s something for the Board to address.

Operator

Your next question comes from Matthew Fassler - Goldman Sachs.

Matthew Fassler - Goldman Sachs

A few questions here; first of all, can you quantify the revenues associated with the divested sales, the divestitures rather?

John Rickel

Yes, this is John Rickel. That, it was about $18 million on a trailing 12 month basis.

Matthew Fassler - Goldman Sachs

Only $18 million of revenues?

John Rickel

Correct.

Matthew Fassler - Goldman Sachs

Okay. Just a couple other questions as we begin on some of the issues for the quarter. You touch about Ike, the increase of the hurricane impact and the aggregate increase in the SG&A to gross profit ratio by about 200 basis points. Was that primarily because of the loss of sales in gross profit dollars or is that SG&A dollars as well that increased because of your efforts to deal with the storms?

Earl Hesterberg

Matt, this is Earl. It was lot of sales, but by the same token during that period our large volume dealerships remained staffed up, so we head our normal expense load at the large Houston and Beaumont dealerships without the sales coming in for at least two weeks. So it ends up getting you from both sides of the equation.

Matthew Fassler - Goldman Sachs

But, not allowed at extraneous expenses above the beyond…

Earl Hesterberg

No, not extraneous. Not significant extraneous expenses.

John Rickel

This is John Rickel. We get have some minor things, generators we has to rent, fuel for those sort of things, the primary impact was the fact that we had the expenses and we paid our people even though the stores were shutdown. So it’s more the lack of revenue than any extra incremental expenses.

Matthew Fassler - Goldman Sachs

Great, if you look at the lower floor plan rates that you discussed overall, including your swaps, can you just remind us what the swaps looked like a year ago and what the effective floor plan rate was? I should say, not the effective floor plan rate, I mean with the gross floor plan rate, with regard to the impact of swaps.

John Rickel

Yes, this is John Rickel, give me just a second now.

Matthew Fassler - Goldman Sachs

I can ask Randy while you dig that up? As you talk about the multiples that buyers are looking to pay and sellers are looking for etc., I guess there’s a point in time when the multiples were probably below where the publics were trading. I would imagine that the private market such as it exists as now, [Inaudible] above where the publics are trading on the EBITDA basis?

John Rickel

I think that’s absolutely correct.

Matthew Fassler - Goldman Sachs

And are you seeing any transactions happening or are those prices simply prices on paper, but there’s no liquid market at this point?

John Rickel

Matt yes, I’m seeing very little transactions. There are some deals for sale, but someone who’s had great memories for good numbers. So, they want the highest price paid, that kind of last deal multiple. So, those deals are out there on the market, but I’m not seeing any transaction.

Matthew Fassler - Goldman Sachs

Also another question about the changing environment and this one is probably for Earl. You’re F&I per vehicle retails was still up in the third quarter, some of the financing issues that you’re discussing I would think would weigh on F&I a little bit. Is it your expectations that you can continue to grow that line or would you think that it would start to finally see some pressure given tighter financing?

Earl Hesterberg

It’s Earl. I don’t see a lot of upside per unit from where we are. I believe there is a little bit, but we are starting to perform at a very high level there, so I believe your assessment is accurate.

Matthew Fassler - Goldman Sachs

And John, any cleanup on that last question?

John Rickel

Yes, this is John Rickel, back to your question on the swaps. If you go back to kind of the same period a year ago, the kind of the weighted average interest rate would have been around about 6.7%, thereabouts.

Matthew Fassler - Goldman Sachs

And this quarter?

John Rickel

This quarter, the average rate including the swaps was about 5.25.

Matthew Fassler - Goldman Sachs

What, if you were to ignore swaps and just apples-to-apples which you have been versus last year?

John Rickel

Would have been about 3. 9.

Matthew Fassler - Goldman Sachs

And did that change a lot over the course of the quarter and how does that look if you could into the first part of Q4?

John Rickel

I mean, it’s based on LIBOR. So as you saw in LIBOR was striking all over the place during third quarter. We have seen LIBOR obviously begin to come off in the last few weeks. So, really that kind of depends on what you think is going to happen with LIBOR.

Matthew Fassler - Goldman Sachs

And we should use three month LIBOR for that exercise.

John Rickel

One month LIBOR.

Operator

Your next question comes from Richard Kwas – Wachovia.

Richard Kwas – Wachovia

John, on customer pay margin, is there much you can do to try to improve the margin in the business right now?

Earl Hesterberg

This is Earl, Rich. No, I think there’s not a lot we can do and some of that floats based on individual customer pay brands mix from quarter-to-quarter, but we’ll probably want to do even more aggressive promoting, I would think through this type of environment. So I think that, I’d sacrifice a half point or point of margin to keep business in the shops these days.

Richard Kwas – Wachovia

Okay and then in terms of regional trends here, with oil declining how much impact do you expect that to have in the Texas market over the next several months?

Earl Hesterberg

This is Earl, again. Tm me the biggest factor is it could help a little bit on the launch of these new full-sized trucks that Ford and Dodge are offering. There’s some real brands loyal people in Texas and Oklahoma and people who need a truck for their vocation or life-style and that I guess is a little better chance to get some earlier adaptors into those new trucks. I don’t think it’s any type of panacea, but it is certainly better than what it was looking like 45 or 60 days ago.

Richard Kwas – Wachovia

Okay and then in terms of the acquisitions divestitures John, Earl. I know you are not giving guidance for February, but should we think about that in terms of the acquisition market not doing much next year that will be relatively neutral or maybe a net divestiture, either you’ll be a net divestiture next year?

John Rickel

Well based on where we sit right now, that would be my opinion, but we all know it’s a dynamic market, but as we sit here now, I would think it would have to be a good opportunities, just an overwhelming opportunity for us to acquire something in the near-term.

Richard Kwas – Wachovia

And then on the mortgage debt front, John do you have any restrictions with your covenants on moving towards more ownership? Do you feel any of your covenants are going to restrict your ability to covenants are going to restrict your ability to convert to more real estate taking out more mortgage debt?

John Rickel

I mean it’s the covenants that we’ve been talking about. Certainly the total leverage ratio and to some degree the fixed charge ratio will govern what we can do as well as kind of the overall capacity of the mortgage facility, we kind of balance all three of those things.

Richard Kwas – Wachovia

So you may not be as aggressive here in this environment as you have been in a little last few quarters?

John Rickel

I think that’s a fair assumption.

Richard Kwas – Wachovia

And finally a housekeeping question, what was your lease expense for the quarter?

John Rickel

I have to dig that out. I can send it to you separately Rich.

Operator

Your next question comes from Matt Nemer - Thomas Weisel Partners.

Matt Nemer - Thomas Weisel Partners

My first question is if we could just go back to the credit availability topic, what are you seeing in terms of credit availability by brand? We’ve obviously seen some pretty interesting advertising out of Toyota and GM on credit availability. I’m just wondering if you can give us some color on that.

Earl Hesterberg

Matt this is Earl. Toyota financial services continue to be well-funded and reasonably aggressive in the markets certainly compared to others. That said, all lenders including TFS, have tightened up some of the requirements.

Loan-to-values are not what they were a year ago or six months ago, which means down payment requirements were higher and this is one of the real factors across the board, because you end up with the people who can’t roll as much negative equity from a trading into a deal. People are required to come up with more down payments and those are the types of things that are killing more deals than just out right rejections.

That was the point Pete DeLong wanted me to make on the previous question, which I missed, and we’re seeing that across the board, but Toyota is out there, as you know well represented and they are well funded, but there are a lot of manufacturers who are not for example financing used vehicles that are not of their brand. You’ve read obviously about G-Max 700, beacon score requirement on new vehicles and so when we get into the domestics, it gets even tougher I think and independent banks have pulled back and so a lot of times that is manifesting itself in this stipulations as they require on the deal, which just either drives up down payments or monthly payments and makes it harder to sell.

Matt Nemer - Thomas Weisel Partners

Any major change with BMW financial or Daimler, the luxury brands?

Earl Hesterberg

No, that’s the biggest issue, particularly with BMW, they are trying to shift away from leasing. Their incentives are much more attractive now to traditional retail financing than leasing. So the luxury world is switching more as it being rates and lesser attractive lease payments, that’s my take.

Matt Nemer - Thomas Weisel Partners

And then my second question was on service and parts, you mentioned that customer pay was down a little bit less than 1% on the same-store basis. Can you give us anymore insight into what you’re seeing on the field in terms of either a change during the end of the quarter and then specifically is it people neglecting to do very expensive repair work and so your labor is down, but your parts are still high? Can you give us some more color there?

Randy Callison

This is Randy. Don’t forget the hurricane impact, because that had a huge impact on our customer paid business, but also people are more frugal with the money they are spending. So some of the higher margin maintenance business, they are declining this time around. That puts pressures on our margins, but they’ll be back and we’ll get to do that maintenance at another time. As far as the trend is over the quarter, I think other than the hurricane impact, it is about the same.

Matt Nemer - Thomas Weisel Partners

Okay and then turning to John’s comments on CapEx; you mentioned that ‘09 would be down significantly versus ‘08 and I guess, I’m wondering if you can get us little bit more color than that on the construction line. Is that a line that can potentially go to zero or close to zero, given where your stock is and your bonds? It seems like there would need to be a very high hurdle to complete a project verse buying in one of those other two parts your capital structure.

Earl Hesterberg

You’re right, Matthew, there is a much higher hurdle we need to look at now when we do these projects, but there are some projects from manufacturers and those are the ones we tends to be continuing at the moment, where there’s money involved in terms of reimbursement from the manufacturer and we have to calculate that in these financial evaluations. Nissan, General Motors; they actually pay a significant part of some of these facility actions. So that gives us over some of these hurdles, but that said there’ll be a dramatic need for us to decrease CapEx next year and I assume rough orders of magnitude will be somewhat around half.

Matt Nemer - Thomas Weisel Partners

And the manufacturer’s been relatively understanding of the reduction in some of these projects or I guess the delay in some of the projects?

Earl Hesterberg

It’s hard for me not to laugh when you ask that question Matt. I would say perhaps some, somewhat better than others. Some are better than others, Matt.

Matt Nemer - Thomas Weisel Partners

And then my last question is just back to the topic on capital allocation. I guess you’re restricted payments basket is down to just a couple of million dollars. Does it make sense given where your stock is to potentially change the dividends and kind of refocus on stock buy back or does it make more sense to potentially try to pay down as much of the quarter notes as you can so you can relieve some of the RP basket pressure. What are you thinking about the best capital allocation hear?

John Rickel

Matt, this John Rickel. As kind of as I said in my stated or in my prepared remarks, our number one in priority for cash is to continue to pay down debt and strengthen the balance sheet.

Operator

Thank you and at this time, I’d like to turn the call back over to Earl Hesterberg for any closing remarks.

Earl Hesterberg

Thanks all of you for joining us today. We’re looking forward to updating you on our fourth quarter earnings call in February. Thanks and have a nice day.

Operator

Ladies and gentlemen this concludes the Group 1 Automotive third quarter earnings conference call. If you would like to listen to a replay of today’s conference please dial 303-590-3000 or 800452236 with an access code of 11120953#. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Group 1 Automotive Inc Q3 2008 Earnings Call Transcript.

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts