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Asbury Automotive Group, Inc. (NYSE:ABG)

Q4 2012 Earnings Conference Call

February 19, 2013 11:00 ET

Executives

Ryan Marsh - Treasurer

Craig Monaghan - President and Chief Executive Officer

Michael Kearney - Executive Vice President and Chief Operating Officer

Scott Krenz - Senior Vice President and Chief Financial Officer

Analysts

Rick Nelson - Stephens

John Murphy - Bank of America/Merrill Lynch

Scott Stember - Sidoti & Company

Bill Armstrong - CL King & Associates

Rod Lache - Deutsche Bank

James Albertine - Stifel

Brett Hoselton - KeyBanc

Ravi Shanker - Morgan Stanley

David Kelley - BB&T Capital Markets

David Whiston - Morningstar

Operator

Good day everyone, and welcome to the ABG Fourth Quarter 2012 Earnings Conference Call. Today’s call is being recorded. At this time, I would like to turn the conference over to the Treasurer, Ryan Marsh. Please go ahead sir.

Ryan Marsh - Treasurer

Thanks, Vikki and good morning to everybody. Welcome to Asbury Automotive Group’s fourth quarter and year-end 2012 earnings call. Today’s call is being recorded and will be available for replay later today. The press release detailing Asbury’s fourth quarter and year end results was issued earlier this morning and is posted on our website at asburyauto.com.

Participating with us today are Craig Monaghan, our President and CEO; Michael Kearney, our Executive Vice President and COO; and Scott Krenz, our Senior Vice President and CFO. At the conclusion of our remarks, we will open up the call for questions and I will be available later for any follow-up questions that you might have.

Before we begin, I must remind you that the discussion during the call today is likely to contain forward-looking statements. Forward-looking statements are statements other than those which aren’t historical in nature. All forward-looking statements are subject to significant uncertainties and actual results may differ materially from those suggested by the statements.

For information regarding certain of the risks that may cause actual results to differ please see our filings with the SEC from time-to-time, including our Form 10-K for the year ended December 2011, any subsequently filed quarterly reports on Form 10-Q, and our earnings release issued earlier today. We expressly disclaim any responsibility to update forward-looking statements.

It is now my pleasure now to hand the call over to our President and CEO, Craig Monaghan.

Craig Monaghan - President and Chief Executive Officer

Good morning everyone and thanks for joining us. We are pleased to report record fourth quarter and full year results. EPS from continuing operations increased 31% for the quarter and adjusted EPS from continuing operations increased 49% for the year. Over the last three years, we have grown our adjusted EPS at a compound annual growth rate of over 50%. The investments we have been making in our business are clearly paying off.

Our new vehicle unit sales significantly outperformed the industry increasing 21% due to the strength of our brand portfolio and excellent sales execution. Revenues were up 15% and gross profit was up 11%. We improved our cost structure reducing SG&A as a percentage of gross profit by 230 basis points and we achieved record income from operations with a margin of 4% placing us among the leaders of our industry. In light of where we were just a few short years ago, I could not be more proud of what our team has achieved.

Now, I’ll turn it over to Scott.

Scott Krenz - Senior Vice President and Chief Financial Officer

Thank you, Craig. Our fourth quarter results of $0.72 demonstrate the strong operating leverage we have built into the company. The quarter’s results again include no adjustments for non-core items. We continued to make progress with our cost structure and continued to focus on future productivity enhancements.

SG&A to gross profit margin was 72.2% for the quarter, a 230 basis point improvement compared to the prior period. Excluding the rent expense, which we view as a financing decision, our 2012 SG&A as a percentage of gross profit ratio was 67.7%. Our cash flow generation during the fourth quarter allowed us to continue investing in our business and to support our ongoing share repurchase program. During the fourth quarter, we spent approximately $47 million investing in our business, buying out leases, and repurchasing our common stock.

For all of 2012, we invested approximately $111 million in CapEx, lease buyouts or real estate investments, and share repurchases while still decreasing our leverage levels. With respect to CapEx, we spent $57 million for the year. We are budgeting at approximately $45 million of CapEx for 2013 as we continued to upgrade our stores, expand service capacity, and invest in important technology enhancements. As always, our CapEx numbers exclude lease buyouts and real estate investments. With respect to real estate, we purchased $13 million of real estate during the year in anticipation of future and lease maturities and we have acquired $18 million of previously leased properties. We are making excellent progress towards our goal of owning 75% of our facilities as we now own approximately 60%.

During the year we raised $66 million through mortgages, primarily with our captive finance partners. To take advantage of the current low rate environment and given the amount of unencumbered real estate on our balance sheet, we will consider mortgaging more of our properties during 2013. We ended the year with a total debt to adjusted EBITDA leverage level of 2.4 times. This puts us at the low end of our peers and prides – provides us with significant financial flexibility. During the fourth quarter we have repurchased $8 million of our common stock or 249,000 shares. For the full year we have spent $23 million to repurchase 836,000 shares of our common stock. This represents around 3% of our outstanding shares.

We have $15 million remaining under our authorization and we will continue returning capital to our shareholders in 2013. We ended the year with total liquidity of $233 million which includes $214 million under our revolving credit lines, $6 million in cash and $13 million available in floor plan or offset accounts. We continue to execute our plan of allocating capital in a balanced and disciplined manner to improve our operations, increase ownership of our facilities, grow our company and return capital to shareholders on an ongoing basis.

I will now hand the call over to Michael to discuss our operational highlights.

Michael Kearney - Executive Vice President and Chief Operating Officer

Thank you, Scott. I would like to remind you that everything I will be covering with respect to operational highlights will pertain to same store retail performance. New vehicle revenues and gross profit increased 20% and 11% compared to the prior year. Our new vehicle sales were up over 21% easily outpacing the industry growth rate of 12%. Our new vehicle margins for the quarter were 6.2%, down 50 basis points reflecting both increased competition and rising inventory levels with our mid-line imports. On a sequential basis our new vehicle margins were essentially flat compared to the third quarter. We do not anticipate significant new vehicle margin erosion from current levels in 2013, but we are closely watching our new inventory levels.

Before moving on to our used vehicle sales performance, I want to highlight the fact that our total front-end gross profit yield that is new and used vehicle gross profit per vehicle sold plus our F&I per vehicle sold are $3170 for the full year 2012, has been increasing since 2009 and is $3 shy of our all-time high of $3173 we set in 2007. We have offset the effect of deteriorating new margins by enhancing our F&I production. We increased used vehicle revenues 5% over the fourth quarter last year as we continued to refine our Asbury 1 to 1 program.

Margins improved 10 basis points to 9.1% compared to the prior year period as a result of a greater supply of trade-in vehicles, as our new sales volume grew 21%. Our used to new sales ratio was 67% for the quarter as the market reacted favorably to both increased availability of new product competitive pricing and marketing and growing consumer and dealer incentives. We believe the supply of attractive pre-owned vehicles will improve throughout 2013 as we move further away from the class of new vehicle sales in 2009 and 2010 time period and the increase in leasing we saw in late 2010. We ended the fourth quarter with $95 million of used vehicle inventory or 35 days supply on a trailing 30-day basis.

Our finance and insurance business remained strong. It remains a strong source of earnings growth for us. Our consistent message and practice is that the disciplined execution of F&I sales processes and training creates solid, reliable growth in results. Fourth quarter F&I revenues grew 22% compared to the prior period. F&I per vehicle retail for the quarter was $1,251, up 9% year-over-year.

In the fourth quarter, our parts and service revenues grew 2% and gross profit grew 6% compared to the fourth quarter of 2011. Parts and service gross margin for the quarter was 58.2%, up 190 basis points compared to the prior year. The year-over-year gross profit improvement was driven primarily by the 11% increase in reconditioning work as well as the 5% increase in customer pay. I would also like to highlight that our gross profit from warranty work increased 4% over the prior period. This is due in part to recent recall volumes in some of our major brands as well as the recovery of our units in operation from 2010, 2011, and 2012. We believe we can continue to grow our parts and service business in a mid-single digit range while maintaining our current margins through our ongoing customer retention programs.

We made great progress on the National Tire sales program we launched last year growing our tire sales by 70% in 2012. Again, this program is designed to retain our current customers and providing incentive to all of our customers to return to our dealerships. Our tire sales goals for 2013 are aggressive and point to our commitment to long-term customer retention. Considering the increasing average age of vehicles in the U.S., the attractive financing rates and terms available to consumers, and a strong pipeline of new products coming from all of our manufacturing partners, we believe we are well positioned as we enter 2013.

Finally, I want to extend my appreciation to all of our associates in the field. You are doing an outstanding job adapting to the constantly changing retail environment. Your balanced energy and innovation are inspiring, I can’t thank you enough.

With that, I’ll hand the call back to Craig to conclude our prepared remarks. Craig?

Craig Monaghan - President and Chief Executive Officer

Thanks Michael. Continuing Michael’s thoughts regarding 2013, we expect the recovery of automotive sales to continue in 2013 due to the current age of the vehicle fleet, extremely attractive financing rates, and the availability of exciting new products. Our planning assumption for 2013 SAAR is 15 to 15.5 million units, which represents a continued recovery from the 2012’s 14.5 million units.

Taking these factors into account, we are targeting 10% EPS growth for 2013. As a result of the dedication and innovation of everyone at Asbury throughout the financial crisis and recovery, we believe we have positioned our company to outperform the industry. We believe our strong brand portfolio, attractive geographic locations, and proven ability to execute will allow us to grow across all business lines. In addition to our organic growth opportunities, our strong operating performance will allow us to fund other incremental growth opportunities as well as return capital to our shareholders.

Let me reiterate our three-year capital allocation outlook that I shared with you at the conclusion of our third quarter earnings call, which is based on a modestly improving economy, favorable interest rates, and a SAAR approaching approximately 16 million units by 2015. CapEx of $35 million to $45 million per year, a significant reduction from our 2012 CapEx spend. Lease buyouts of $10 million to $20 million per year as we approach our goal of owning 75% of our stores. Share repurchases of $25 million to $30 million in our ongoing share repurchase program with additional amounts on an opportunistic basis, and finally, the acquisition of $400 million to $600 million of additional revenues.

I am excited about Asbury’s future and remain encouraged by the recent positive momentum from three consecutive quarters as well our full year record profits in what is still an uncertain economy. In closing, I want to thank each of our employees. Our record results and momentum are a direct result of your dedication and hard work. I’d now like to turn the call back to the operator and we’d be happy to take your questions. Operator?

Question-and-Answer Session

Operator

Yes, thank you. (Operator Instructions) And we’ll take the first question today from Rick Nelson with Stephens. Please go ahead.

Rick Nelson - Stephens

Thank you. Good morning and congratulations. Just to be clear on that 10% EPS growth target that does not incorporate acquisitions or share buybacks?

Craig Monaghan

Good morning, Rick. No, it doesn’t, we will, it does incorporate the share backs that we committed to and I just spoke about a moment about that $25 million to $30 million a year. So, it does contemplate that. But we are not dependent on acquisitions in order to hit that 10% target. We’re looking for acquisitions, don’t get me wrong. We’ve got a number of things, conversations are ongoing, but we think we’ve got a number of different levers that we can pull to get to that 10%.

Rick Nelson - Stephens

Alright, got you and I know it was a year ago, you were targeting 200 basis points in SG&A leverage over two years, which you achieved in a year and curious have you have SG&A targets for 2013 or the next couple of years?

Craig Monaghan

Yeah, Rick, I’ll jump in there and Scott may want to follow-up, but we – I think we’re very happy with what we’ve achieved. There is still a lot of work to be done. I feel like we’ve got our core infrastructure in place with the DMS, the CRM. We’ve got some very good reporting tools in place now as well. But there is still a lot of work to be done on shared services. Our shared service operations are just coming to life. I think this is a very important year for us in that regard. It will ultimately drive even more savings, but I don’t think we are at a point right now to quantify that.

Scott Krenz

I think you said it well, Craig. We have – we never let, we never let up on this Rick. In our environment you’re constantly vigilant by costs and we have made it part of our day-to-day life. I think we’ve changed it from being a project, which it was originally to be in just part of our day-to-day fabric in this company and we are constantly focused on driving down costs. And as Craig said as we can always see more to come. There is always improvements we can make and we’ll continue to focus on it.

Rick Nelson - Stephens

Okay. And I noted your SAAR forecast $15 million to $15.5 million. As you look at three segments your business, luxury, mid-line import and domestic where would you see the fastest year-over-year growth in 2013?

Michael Kearney

Rick, it’s Michael, I think if you look at our portfolio I think the mid-line import will be the biggest piece of that. Again if you look at those particular manufactures and a reaction from the post-tsunami or the tsunami recovery, you will see that they are expanding their lineup of product as well as substantial marketing push. And you can see it in the gains in market share in the last 12 months. So, I would say that with this company in particular, we’d see most of that from the mid-line imports.

Rick Nelson - Stephens

Okay, got you. Thanks a lot and good luck.

Charles Oglesby

Thanks, Rick.

Operator

Next is John Murphy with Bank of America/Merrill Lynch.

John Murphy - Bank of America/Merrill Lynch

Good morning guys.

Charles Oglesby

Good morning, John.

John Murphy - Bank of America/Merrill Lynch

Just a follow-up on the SG&A, as we look at the flow through to operating income of the gross profit increase in 2012 was about 85%. Obviously, there was a lot of cost cutting that you guys were really focused on, but it dropped through about 36% in the fourth quarter and so that the rule of thumb, we’ve kind of thought about is 30% to 40% flow through gross increase to the operating income line. Is that something you think is a reasonable range as we think about our estimates for 2013?

Craig Monaghan

We target internally and I think we’ve said consistently that we target something about 40% or 50% flow through and that continues to be where we focus ourselves, we’ve been tending to be at the high end to that range, which is we feel good about and we’ll continue to trying to do that, but that 40% to 50% is really what you should think about over the long-term.

John Murphy - Bank of America/Merrill Lynch

And that’s on a same store basis.

Craig Monaghan

Yes, correct.

John Murphy - Bank of America/Merrill Lynch

Okay, great. Then a second question on the UIO, I mean, you increased your parts and service by about 2% in the fourth quarter, but it sounds like you are expecting and this doesn’t make sense, the backlog of UIOs will increase and that will drive parts and service same-store comps into that, I think you are saying the mid-single digit range, is that the kind of phenomenon you think is really going to begin in the first half of 2013 or is it going to be more second half of 2013? And it does sound like this will probably run for a couple of years I just wanted to get your perspective on that?

Michael Kearney

Hey John this is Michael. The way I’ll look at it and going back to the ‘08/09 time period, I think you are probably pretty close on that. I don’t think this is a first quarter happening although we are seeing more people come into our shops than we have in prior months. But I think it ramps up over the next few years, I think the age of vehicles are reflected in the trade-ins we are seeing. I think that adds more the units in operation. And I think some of the internal work we have done are tire and our wiper program, which is really geared to retain customers and to go back and get some of our orphan customers. I think when you put all those together we feel confident about this growth rate that we projected. And I think we’ll see this run nicely over the next 24, 36 months.

John Murphy - Bank of America/Merrill Lynch

Okay, it’s helpful. And then just lastly as you are transitioning the more real estate ownership and you are using captive finance subs to underwrite the mortgages. I was just curious what kind of rates are you getting on those mortgages, are those significantly below market, and what is the term meaning that the duration of the years of those mortgages?

Craig Monaghan

This is Craig. I will take the first shot. What I’d like to do is speak to the relationship with our captive finance partners. When the downturn hit us in late ‘08 our captive finance partners really stepped up and were tremendously helpful to us and we are continuing that relationship today. I point out that our revolver is majority controlled by our captive finance partners. And they have got a very strong appetite for these properties today, and we are happy to move in that direction, Scott can give you some of the details.

Scott Krenz

Yeah, I underscore that our captive finance partners that the manufacturing partners in general have been extremely supportive of our business. This is just one area where they have been supportive of it. They continue. We benchmark this. They offer very competitive rates with the market. Those rates will vary by the manufacturing by the properties involved. So, it’s hard to pin down one, but they are very competitive rates. This is a low rate environment. We have seen tenure on these things anywhere from 10 to 20 years in some cases. And to us just this is the area whereas we try and lock in this low rate environment that we are currently in, it makes the most sense to be a little more aggressive in what we are doing.

John Murphy - Bank of America/Merrill Lynch

Okay, great. And just one, yeah.

Craig Monaghan

Can I just come back on that on a second and to us this is a no-brainer. We can take out leases that are in the high single-digit to double-digit rates and refinance them with mortgages that are much longer duration that Scott said in the mid and the low mid-single digit rate. So, it’s – and it’s with our partners. So, it’s something we feel very strong about and we are very aggressive in going after these.

John Murphy - Bank of America/Merrill Lynch

It sounds like it makes a lot of sense. Just one follow-up on that though the relationship with automakers that you have, it sounds like it’s getting a little bit stronger and broader relative to sort of the skeptical relationship that may have existed 5 to 10 years ago. Do you agree with that and does that open up more opportunities as far as acquisitions getting larger maybe a loosening of the framework agreements? I am just trying to understand, because it does seem like there is a tightening of the relationship it is getting better and better with the larger public groups?

Craig Monaghan

Yeah, this is Craig again. I would say as an industry and certainly speaking to Asbury as well, I do think these relationships have dramatically improved over time. I think our manufacturing partners really do view us as partners. We all understand that if we want to continue to grow we have to do a good job for the manufacturers. We’ve got to have great TSI. We’ve got to do a good job on the market share side. We’ve got to have facilities that are attracted to our customers. And we have been making as an industry we’ve been making those commitments, I think we have been rewarded for making those commitments. And it’s – I think it’s turning more into a win-win relationship than what it may have been in the past.

John Murphy - Bank of America/Merrill Lynch

Okay. But could it go so far as to losing some of the framework agreements or that hasn’t been in the discussions at all more recently?

Craig Monaghan

I think what we are seeing is, well, let me put it this way, we haven’t rewritten any framework agreements or willing to make exceptions, if I could and give us a little more wittily way than what might be strictly written into a framework agreement and enabling us to get things done.

John Murphy - Bank of America/Merrill Lynch

Okay, that’s very helpful. Thank you very much.

Operator

We will now go to Scott Stember with Sidoti & Company.

Scott Stember - Sidoti & Company

Good morning.

Craig Monaghan

Good morning Scott.

Michael Kearney

Good morning Scott.

Scott Stember - Sidoti & Company

Can you guys talk about on the used side, I think one of the reasons for the gross profit advance or lease gross margin advance in that segment was for that are self sufficiency of products, can you talk about how that could improve even more as we see more cars coming off of lease and the supply at auctions continued to improve?

Michael Kearney

Yes, Scott this is Michael. I think as we saw particularly in December with a very large increase in our new volume, we started to see quite a bit more trade-ins coming in. And as we pointed out earlier with the improving sales over the last 24 months we are seeing quite a bit more trades coming to the stores. When you couple that with the program that we put in place a few years ago the way that we handled those trades and how we moved those amongst our stores, how we value them, I think we will continue to see little more products out there. I think we’ve got more leases coming off of cycle. We have got some more daily rental products coming off cycle. So, our view is that margins are stable at the present time availability of product is a lot better and we think that will continue as long as the new car sales continued to grow at the rate it which they have been growing.

Scott Stember - Sidoti & Company

And just going back on the new cars side it sounds as if on a sequential basis that things have at least stabilized in the 10% growth target that you have for 2013, what are your assumptions for the new cars side as far as gross profit?

Craig Monaghan

It’s Craig I will jump in I think what Michael said earlier is that we think new vehicle margins should be stable from this point forward and that’s what we have got baked into our plans.

Scott Stember - Sidoti & Company

Got you and lastly can you just talk about how sales have been so far in the first quarter?

Michael Kearney

Yeah, this is Michael, this all was up obviously in January and the word outs from the experts is that it is the same in February. I would say that we have product available for us to sell and for the most part Mother Nature has been cooperative, so it’s turning in to be a decent way to start 2013.

Scott Stember - Sidoti & Company

Got you, that’s all I have. Thank you.

Craig Monaghan

Thank you

Operator

We’ll now go to Bill Armstrong with CL King & Associates.

Bill Armstrong - CL King & Associates

Good morning. With the units in operation growth industry wide, would that have more of a positive impact on your warranty business or your customer pay business, will there be any major difference between the two?

Michael Kearney

Bill it should have and I think we will have a larger impact on the customer pay side. But I think what you will see in the industry that we have experienced a little bit of this is the slowing of the rate of decline of the warranty work. The cars are made so much better than they used to be all the manufacturers have substantial quality programs out there, so I think it will slowdown the rate of the decline in warranty and we never can predict recalls, we deal with them as they occur. But I think the biggest impact on those cars coming out of the warranty period and into the true maintenance period is from the customer pay side both parts and labor.

Bill Armstrong - CL King & Associates

Got it, okay. And then also in the fourth quarter you had very strong 21% new unit comp, used units comps were only 1%, I was wondering if you could just flush out why there was such a big disparity?

Michael Kearney

Yeah Bill this is Michael again so if you go back to the fourth quarter of ’11 and particularly with our portfolio, we were very much constrained on the inventory side, a number of our J3, J6 brands had not fully recovered yet from the Tsunami, so that we were very tight on the inventory. And we go full cycle one year we had adequate products, we had new products, we had of course what we think are great locations anyway and we were able to capitalize with a number of our brands with substantial volume increases when you compare those two periods.

Bill Armstrong - CL King & Associates

Okay, great. Thank you.

Operator

And we’ll now go to Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank

Good morning everybody. Can you hear me?

Craig Monaghan

Yeah. Good morning Rod.

Rod Lache - Deutsche Bank

I have just one near term question and one kind of longer term, just near term I was hoping you can elaborate on what’s giving you the confidence in the flattening of margins in the new business. And on a longer term basis at some point interest rates start to move up and I was hoping you might be able to take a minute and talk about how that affects your business? Is specifically maybe in the F&I area if rates pickup in the next year or so, do you face pressure on markups and additional product sales or is there enough for improvement in underperforming stores that it wouldn’t be that noticeable?

Michael Kearney

So, Rod this Michael I’ll take the short-term problem, short-term question. So, what gives us confidence is that it’s really two pieces to that, I think we all experienced a substantial push in market share grab this last 18-month period. And I think that we are seeing a little bit of that stabilization at least from our portfolio. We had substantial market share gains throughout ‘12. And from our point of view, we are outperforming national growth in a number of our brands. So, I feel as if we are seeing a little bit of stabilization from that side of it. The other part of it is that there is some fundamental economics that we all have to address is that there has to be a margin level at which we all feel comfortable that we can maintain profitability at the store pay our associates, and at the same time, show return to everyone. So, I think we are all there in my view. And I think that’s why I feel more the confident about stabilization of that. To the longer term problem, I’ll turn it to question I’ll turn it over to Craig and let him answer that one.

Craig Monaghan

Thank you, Michael. Rod, you raised a great point with interest rates. Interest rates over the long-term will impact us in two different ways. Our floor plan is floating rate. So, as rates go up we’ll see the pressure on floor plan, they can go up somewhat before we hit our floor plan floors. So, we pay rates that are already above the rates obviously the trade-in market today. So, we’ll feel an impact there. And then our customers are going to feel an impact, and it could create some pressure for us in our F&I offices, very difficult for us to quantify that. But what I would point out is the same point that we talked about a little earlier, there is quite a bit of disparity between what our best stores do in F&I and what our opportunity stores do in F&I, and those spreads can be well in excess of $600 per vehicle retail on average. And that’s what we just keep coming back to how do we get the people who were in the lower quartile back to the median. And if we can do that, there is – there is still plenty of opportunity to go.

Rod Lache - Deutsche Bank

Okay. And can you just elaborate that this – on the first part you mentioned the floor plan, there is also reimbursement from the automakers, does that typically correlate perfectly with the rates that you are paying?

Craig Monaghan

No, it does not necessarily. And we can let Ryan Marsh jump in here a little more color, I’ll give a big picture, but the manufacturers traditionally have had varying programs. There were some manufactures who would tie to the floor plan offset to rate. There are others who would just give you a fixed dollar amount. The imports tended to be more on the fixed dollar amount program. And as you know we are much, we are heavy import. Ryan, do you have anything you want to add to that?

Ryan Marsh

I think you got it right, I mean it’s a dollar amount, has no linkage to our actual floor plan facility, and they are the two independent animals.

Craig Monaghan

So, part of the answer to the question of rising rates is you’ve got to turn your inventory even faster, but that’s….

Rod Lache - Deutsche Bank

Okay.

Craig Monaghan

That’s what it will force and that’s what you will see happen.

Rod Lache - Deutsche Bank

Okay. And just one last point on this question, can you just give us the sense of – when you are doing $1,250, over $1,200 a vehicle in F&I, what percentage of that is the markups that you are allowed to get, is that the bulk of it or is that how does that work exactly and is that a part that moves up and down over time?

Michael Kearney

So, Rod this is Michael. So, the biggest impact on our PVR is the sale of mechanical breakdown and the sale of prepaid maintenance. So, that is the pricing and the margin of those is very much vehicle-dependent as you can imagine. It would be a different price and spread on a $22,000 cars opposed to a $75,000 car. We have internal policies where we cap rate spreads and so the vast majority of our income comes from the sale of products.

Rod Lache - Deutsche Bank

Okay, see, you would probably see the rate spreads would stay the same, but it might be a little bit more challenging in other words to sell some additional products and maintain relatively consistent monthly payments, is that sort of the message?

Michael Kearney

Yeah, I think that’s a fair – as rates go up and retail rates seem to have always lagged the wholesale rates. But as they do go up, it impacts the monthly payment which in fact is the – that’s the single identifier of moving product out.

Rod Lache - Deutsche Bank

Okay, great, thank you, I appreciate it.

Operator

Next is James Albertine with Stifel. Please go ahead.

James Albertine - Stifel

Great, thanks for taking my question and congratulations on a solid quarter. I wanted to take a quick step back here on used very quickly, overall the metrics were actually pretty sound I think and your revenue per unit went up, gross profit was down a little bit less than we expected. But if we would look back at the wholesale business there and you think about your long-term outlook, the – I think it was 27% increase in the same-store used vehicle wholesale revenues. Do you look at that as an opportunity or is that just a function of the market and sort of what’s coming in off-trade at this point?

Michael Kearney

Well, James that’s a good question, I’ll answer it in the opportunity part of it and I’ve said I think a number of times on number of calls even the SAAR in the 14, 15, and 16 range, there is about 40 plus million used card retailed in the United States and the dealer – the dealer body, the franchise, the dealer body accounts for about a third of those sales. So, I was looking at the opportunity that there is a lot more business for all of us to get out there and put under our umbrella as opposed to the other two-thirds, that’s part of that answer. I think the other answer again is that as we continue to refine our internal program, the way that we hold on to trades – the way that we market trades do our trade walks, I think we get better and better with that – we have Phase II going in this year. And I think we’ll continue to capitalize on the age of the product that’s coming out, the new products that’s out there and the improvement in economy will take more trades, have to buy less at auctions and have a more and better products available at a nice price band at all of our stores.

James Albertine - Stifel

I appreciate the detail on that and then just moving to one of the comments you made on the service side, I think if I heard you correctly, you talked about expanding service capacity as one of your opportunities and I think uses of CapEx in the year ahead. Can you just elaborate on that a little bit, I mean, is that fundamentally expanding base – expanding diagnostic systems and investments in base or is it personnel or technology driven just wanted to get more color?

Craig Monaghan

Jim, that’s – it’s Craig, I’ll just jump in, that’s – that is part of our ongoing capital program, we’re going to spend about $45 million this year. We spent about $60 million last year upgrading our stores and those upgrades will typically include in expansion of our service base. I will give you an example. We are just in the process of completing a very significant rebuild of a Hyundai store in Florida. And that includes not only a redesigned showroom, but I want to say I don’t know the exact number, but we are essentially doubling number of service base in that store and when Scott was talking about that expansion that’s really what we are speaking to.

James Albertine - Stifel

Okay, if I can just sneak one more and very quickly you just, I know you’ve talked about it before, it sounds like from an M&A standpoint, it makes more sense to think about building up the scale that you have. So, expanding with an existing market to may be contiguous market just want to get your sense of is the market more or less sort of rationale now from a seller standpoint maybe by brand if you can get into that level granularity whether it’s luxury, mid-line import, mid-line domestic what you are seeing from that side of it? And then I’ll leave it to the next caller, thanks.

Craig Monaghan

That’s a great question. Well, first of all, I would say that our footprint is pretty big. We consider a store anywhere from – anywhere in Southeast United States game, so that covers us from I mean as you know we are in New Jersey all the way to Florida and all the way up to Texas. So, we’ve got a lot of ground where we can go hunting. I would say broadly speaking that the - I think sellers are feeling pretty good about the recent run they have had, and I wouldn’t even consider it in any sense the imagination at a hot market for car stores. But that said there are people who are willing to talk I feel like lot of the transactions that people that we are talking today are more relationship type opportunities.

And we are talking to people that we have known for sometime who maybe reaching a point in their career and their lives, where they think it might be time to sell. And those things move at whatever pace the seller wants them to move, we can’t force them, but we have a number of those conversations that are underway right now. Some of them are luxury. Some of them are midline import, I’d say primarily. And we just need to see where they go. One thing I will say though is I maybe come back to, we are very happy with the Volkswagen and Bentley store that we bought in December. Those stores are performing above our expectation and we set some pretty steep hurdles there. So, those seem to be going well and we are optimistic that we will be able to get others done as well.

James Albertine - Stifel

Great, I appreciate the detail. Congratulations again and best of luck in 2013.

Craig Monaghan

Thank you.

Operator

And we’ll now go to Brett Hoselton with KeyBanc.

Brett Hoselton - KeyBanc

Good morning gentlemen.

Craig Monaghan

Good morning, Brett.

Michael Kearney

Good morning, Brett.

Brett Hoselton - KeyBanc

I wanted to circle back to the SG&A and so your throughput obviously has been very, very good this year. So, congratulations well done there. It sounds like your longer term target is kind of that 40% to 50% range, you kind of did 59% based on my calculations, I know that’s not same store, but 59% in fourth quarter, so very good. How do we think about that trending over the next two, three, four quarters is do you see it kind of a slow one-year reversion to that 40% to 50% range or do you see look we are probably going to be in that 40% to 50% range because of difficult comps than the first quarter?

Michael Kearney

Lot of things can impacted on a short-term period to period basis. And we tend to just wash that out over longer term and think of that 40% to 50% range. We have been running in certainly closer to the 50% than the 40%, and we try hard to stay there, but predicting it period to period is really difficult, because single large one-time events often get in there. And so we just moved that out in our thinking and I would urge everybody else to do that, just think in terms of that 40% to 50% over the long-term.

Craig Monaghan

And Brett, it’s Craig, I just jump in and say that we have to work at that. We have to – it doesn’t happen all by itself. Probably, the natural rate I think is someone lower. So, we’ve got to be identifying ways to be more productive, and it’s the combination of if you would leverage just doing more business combined with some of the initiatives that we have underway to be more productive that enable us to get to that 40% to 50%. But like Scott said it’s I think it’s more likely to be lumpy than any type of a smooth projection.

Brett Hoselton - KeyBanc

And then you obviously went through a significant amount of change in terms of you’ve seen very nice improvement in your SG&A leverage and so forth, so my question here is as I look at some of your opportunities you’ve already talked about F&I a bit, but I am wondering also in the used car side, I think those are kind of two areas that you are targeting F&I and used cars, can you talk a little bit more on the used car side. How do you see yourselves improving maybe your performance on the used car side just in terms of unit sales gross profit that sort of thing?

Craig Monaghan

And Brett, it’s Craig. Let me start and then maybe Michael can take over. And you referenced where we have been and I think if I could I’d say that the organization has spent a lot of energy in building out basic systems and basic processes, infrastructure. And that’s consumed a lot of our energy. It was only a year or so ago that we have finished getting all these stores on a common DMS. I would argue that we are just really learning to be pretty good at using a rather sophisticated CRM. But now that we are if you would we played a lot of defense and I feel like we are starting to play some offense. And as we play offense and we get better with these tools as we get better online as we get better with the web, as we get more sophisticated in understanding the value of our customers where they come from, how we communicate with them as we start to actually track activities with the customers, I think it gives us an opportunity to be more aggressive in pursuing organic growth within the stores. With that I would like to give it to Michael.

Michael Kearney

Yeah, so – and just to add on to that, if you take our philosophy in use which is same philosophy on F&I. We always have a bottom third and we have already identified a number of stores that are not facility constrained and they are location constrained, it’s more a matter of individual philosophy that needs to be adjusted in those stores. We just take those stores and bring them up to the median of our other stores, we have a substantial amount of used car volume throughout 2013. So, again there is no magic potion, no magic bullets on this, it’s applying our developed processes and applying them perhaps a little bit more intensely to the bottom third, maintaining what the rest of the stores are doing. And I think from that we get used car volume lift we are anticipating.

Brett Hoselton - KeyBanc

Okay. And let me move – dove down into a little bit deeper. As you look at your bottom third and you compare them to your top third let’s say can you give us some examples of maybe the one, two or three best practices that the top third is doing that you think you can implement at that bottom third to see that improvement.

Michael Kearney

So, I will give you one of them just real quick. So, in the very best of the best the trade walks are done religiously everyday. Those involve not only the used car manager, but all of the sales associates as well as the service department. Those trades are evaluated and within an hour, an hour and a half time period the decisions on to whether to keep the trade, to put it through shop at a wholesale trader might – right there on the spot. The stores that perhaps have a little more learning to do don’t do that religiously they may do on the four days out of the week. They may only do it with small amount of staff, but we have proven to ourselves over and over again when that particular practice occurs the buying becomes deeper, the enthusiasm becomes larger within that dealerships. We have a better, cleaner inventory. We have more sales staff excited about that inventory and then we just sell more cars out of that process.

So, that’s one of them right there and without getting into a whole lot more detail another one is truly the practice of how they – how the trades themselves are evaluated on the dollar basis, we have a scoring system and we talk about how we actually what you would call purchase the trade from the consumer. The smarter you are doing that and more aggressive you are within specific brands, the better your buying ability, if you will, becomes and our best stores do an outstanding job of that. And the bottom third again are little more education mode, but it’s my job to educate them and that’s again why we feel very confident about the next 24 months.

Brett Hoselton - KeyBanc

Great. Thank you very much gentlemen.

Craig Monaghan

Thanks Brett.

Operator

And the next question is from Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley

Good morning everyone. I had a couple of follow-ups. One on new and one of parts and services, you said earlier that you are seeing increased competition on the new side, I am assuming this was the grab for market share that you had referenced at some point of the call, just wanted to check I mean what makes you believe or what gives you the confidence that that’s going to recede in 2013 especially is it because the OEMs are getting more involved or is it more of a realization from the dealers that this is not healthy or what’s driving that?

Michael Kearney

Yeah, Ravi this is Michael I think the point I was trying to make is that as the mid-line imports recovered from the tsunami. There was a substantial – they had substantially gained market share again. And that availability of product and the push for market share causes very competitive pricing environment. I think they will all continued to go after more and more market share but the rate at which they are, my belief is the rate at which they think they can obtain that market share has become more rationale. I think some of the pricing practices are being looked at by number of the manufacturers. They deemed that some of those practicing practices were not helpful to the dealer body. And I think that they are being reevaluated. So, that gives me the confidence that we will be able to hold that margin a little bit. So, I think that the competitiveness is never going to go away, but I think there is also some view amongst the dealer body that there is a margin level at which we have to maintain to continue to support again our sales associates and maintain the inventory levels that the manufacturers want us to care.

Ravi Shanker - Morgan Stanley

Very helpful. And then on the parts and services side, you touched upon this couple of times on the call, but can you just help summarize when you look at getting to a mid-single digit growth rate in parts and services from the levels you currently are at while still holding margins, can you talk about the big moving pieces there, that does going to get you there?

Michael Kearney

Let me give you – without giving well our secrets, let me give you a philosophical point of view that we are embracing and have been embracing in that Craig touched on a little bit in terms of technology and on process we have in our industry and within our company have for a number of years a very strong, disciplined process involved in the selling and the marketing and the follow-up of new and used cars. We are just now embracing sophisticated technology and training with our people to enable us to do that same type of marketing and follow-up with our parts and service customers. We have not done this. I don’t think we have done it as an industry, but I can tell you how specific well have not done nearly the work in that area that we have in the front end. So, I feel confident as that expands and then as we continue to put in those programs that we will see the results that we have seen in the new and used car side of the business.

Ravi Shanker - Morgan Stanley

Got it. So, mostly process driven stuff, not such a change in the mix of the business something?

Michael Kearney

That’s correct yes.

Ravi Shanker - Morgan Stanley

Got it, thank you so much.

Operator

We’ll now go to Bret Jordan with BB&T Capital Markets.

David Kelley - BB&T Capital Markets

Good morning. This is actually David Kelley in for Bret. And thanks for taking my questions this morning. I think most have been answered. Just a quick follow-up on the parts and service side, if you look at the reconditioning segment, solid growth really the last two years and just wanted to get your thoughts on where we could be headed on reconditioning heading into 2013 given rebounding volumes on the used side, but possible decelerating growth on the new side?

Michael Kearney

So, David, this is Michael. I would say the majority of our reconditioning work occurs on the used car side. We, of course, do internal work and prep work on the new cars. We add accessories to them, but most of the reconditioning service, parts and service business, is on the used car side. As we continue to emphasize continued growth in used cars, I think that, that you will see that business remained very healthy for us. I think as the new car volume continues to grow at the rate that it’s growing, again we’ll have more availability for trades, with more availability for trades that falls into what we can do in terms of the reconditioning work. So, I feel pretty comfortable with the reconditioning levels that were out there, and that as we grow our used car business, we can continue having a substantial piece of our business in the reconditioning area.

David Kelley - BB&T Capital Markets

Okay, great, thank you. And then just one quick more granular question on the parts and service side as well, I think you mentioned the tire sales strong year at 2012 and not off of a small base as you guys continue to ramp that category, do you have any longer term goals whether it be on the sales or the unit side in your tire segment?

Michael Kearney

Let me see if I understand your question. So, we had 70% increase last year and we have an aggressive number for this year. We believe that there was again areas of our industry, our geography. So, we didn’t do as good a job I think as we became better at selling tires and marketing tires, we just get better. I think we do more of it. So, I don’t want to discuss a specific number for 2013, but it is an aggressive number and we believe that it is a – it’s a retention program, it’s not necessarily that we want to sell tires just to sell tiers. But as we have mentioned on some previous calls that for every dollar sales of tiers, we get long-term we get a fair amount of increased business both in parts and labor and other products. And we are beginning to see some of that.

David Kelley - BB&T Capital Markets

Alright great thanks for taking my question.

Operator

We’ll now go to David Whiston with Morningstar.

David Whiston - Morningstar

Good morning. One question on your comment to that you wanted to increase your mortgages on your own stores throughout this year. Obviously we don’t need to worry about recession in this industry anytime soon. But eventually we’ll have one, so would your goal be to have all of your stores encumbered over the next few years or do you want to leave a little flexibility even in the downturn?

Scott Krenz

Our goal as we said 75%, so not obviously it’s not a 100% of our stores. And I think as we would – flexibility we’re doing this because it’s a very competitive source of financing in a low rate environment. And by doing it principally with our captive manufacturing partners when a cycle changes and cycles inevitably do change, we are now financed by people who are we are very much aligned with in terms of what we want to do with the business. They have as much interest in keeping the store open as we do. And it makes the whole relationship much stronger and much easier to manage in those sorts of an environment which is one of the other reasons we’re doing it principally with mortgages.

David Whiston - Morningstar

Okay. Thanks.

Craig Monaghan

It’s Craig, I’ll just jump in and we’ve talked a lot about our captive finance partners. I think it’s important to say that we’ve also got some very good relationships with our banking partners as well. Those – the revolvers managed by our banking relationships and those are equally important to us. And they’ve also been with us for quite some time.

Craig Monaghan - President and Chief Executive Officer

And with that said, we don’t have anymore questions. I would like to thank you for your patience and spending your time with us today. I think this is the longest call that we’ve had in quite sometime. We are thrilled to talk to you, we enjoyed the questions, we enjoyed the interaction and hopefully we’ll get to see some of you on the road in the not too distant future and for those we don’t catch up with we look forward to talking to you again next quarter. Thanks again for your time.

Operator

And thank you very much. That does conclude our conference for today. I would like to thank you for your participation. And you may now disconnect.

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