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Group 1 Automotive Inc. (NYSE:GPI)

Morgan Stanley Retail & Restaurant Conference

April 05, 2013 10:40 am ET

Executives

John C. Rickel - Chief Financial Officer, Chief Accounting Officer and Senior Vice President

Analysts

Ravi Shanker - Morgan Stanley, Research Division

Ravi Shanker - Morgan Stanley, Research Division

Let's get started. We're very happy to have Group 1 here with us. CFO, John Rickel, and Kim from IR.

John, let's...

John C. Rickel

Thank you.

Ravi Shanker - Morgan Stanley, Research Division

So I thought we'll just kick off with -- just your broad thoughts of the SAAR so far. We're running at about 15.3 million for the first quarter of the year, relatively in line with your expectations. Better or worse?

John C. Rickel

It is. We came out with our fourth quarter call with an expectation of 15.3 million to 15.5 million for this year. And so far, we seem to be kind of right within that bandwidth unlike some of the other kind of software retailers, restaurants, where you've heard some talk about maybe softness around the payroll tax increases. We really haven't seen that in the automotive space. That's kind of consistent with what we saw last year. Last year ran 14.5 million, and you didn't really see the variability around the election and the fiscal cliff. And we really attribute a lot of that to just where -- the point where the pent-up demand is, is at such a level that people need to get cars. The age of the U.S. car park right now is pushing 11 years old, which is about the oldest it's been since World War II. And that really is providing a real underpinning for the demand that the macro factors don't seem to be shaking the way that maybe some of the other segments might have seen. So, so far so good.

Ravi Shanker - Morgan Stanley, Research Division

That's a great point, or because a lot of people a couple of years ago were showing us what broad macro was trending at and the unemployment rate, and saying this is what is traditionally done. But then we also -- we saw that the pent-up demand could dislocate that traditional relationship. How far do you think this can go? I mean, do you think the SAAR can push 17 million again, 18 plus million, even as we get through this? Or -- and come back down to a more normalized trend level? Or do you think we'll kind of stay at this level for a while?

John C. Rickel

Well, no. I think it's going to continue to build slowly. With the age of the car park, it's going to take a few years to begin to bend that line down. Our view is that a normalized trend in this space really needs to be about 16.5 million. And then you obviously need a few years above trend to make a trend line. That's kind of the way it works. You have a number of years that were below, you're going to have to have a few years above. If you go back, the prior peak was in 2000. We got to 17.4 million. 2001 was 17.1 million. And for most of the 2000s, it was in the -- either low 17s or high 16s. So I think you are going to have to see some years above trend, whether or not it gets as ever as high as 18 million, don't know. But I think you certainly could see some years that certainly get back into the 17 million levels. If you think about it, the U.S. is still a growing population unlike a lot of parts of the world. There's another 10 million licensed drivers that are coming into the park over the next couple of years, which should say that this next peak ought to be higher than the peak before. I mean, that's been the cycle for the last couple of go rounds. You go back prior to 2000, the prior peak was in, what, '86 when it got to 16 million and change? You go back to '78 and it got to 15.8 million. So the U.S. is much, much bigger than those years, so you would think that the next peak should be bigger than those.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And coming back to 2013, you said the first quarter was pretty much consistent with your full year expectation. Do you think that the fourth quarter is going to be pretty steady at this level? Or do you think once we do get maybe past the sequestration some way or the other or when we get to the second half of the year, do you expect an elevated exit rate for the year?

John C. Rickel

Yes, I think there's a potential that it grows slowly across the year. I mean, clearly, there has been a lot of noise around the first quarter. So I think there is an opportunity that it will still strengthen slowly as the year goes on. To get to our 15.5 million, you'd have to have that.

Ravi Shanker - Morgan Stanley, Research Division

Sure. And we have been kind of stuck in this low- to mid-15s range for a few months now. What do you think we need to get out of this? Just macro needs to settle down? Or do you think we need to see [indiscernible].

John C. Rickel

Macro to settle down.

Ravi Shanker - Morgan Stanley, Research Division

What about credit availability? Because that's been one of the big drivers of getting from, say, a mid-12s to the range we are at right now. Do you see a lot of room there for that to grow?

John C. Rickel

Well, no. Credit availability is basically back to wide open. We're seeing credit availability back to what it was really in kind of 2006, 2007 across all the spectrum. What the banks figured out was that, that paper has performed the best for them in the portfolio, and it really gets back to consumers are actually pretty smart. They recognize pretty early on that your house might be difficult to foreclose upon, but people will come get your car with a hook, and you can't -- you really can't get around in most parts of the U.S. without a car, so people prioritize their car payments above everything else. And as the banks have looked at their -- the repossession rates, the losses on the portfolio, the automotive papers performed quite well. They're all anxious obviously to put money to work to grow their assets, their earning assets. So kind of the first best choice for them right now is automotive paper. We've got banks every day that are wanting to expand their business with us.

Ravi Shanker - Morgan Stanley, Research Division

Right. And we have reality TV shows about car repossessions, but not about foreclosures.

John C. Rickel

Yes.

Ravi Shanker - Morgan Stanley, Research Division

So just moving from, say, the volume of SAAR, the quality of SAAR, one of the other things that's been surprising us recently is just how resilient the transaction price has been, and it just keeps grinding up in your records. Has that -- is that something that's surprised you? And do you think there's any further legs there?

John C. Rickel

Well, I think it has been a positive. Clearly, it's hard to say quarter-to-quarter, but I think as you look over the next couple of years, I think you're going to have to continue to see transaction prices go up. One of the things that are going to go with the expanding Cap A requirements in the U.S. is significant additional technology and cost in the vehicles to be able to deliver those Cap A requirements. That's ultimately going to drive higher transaction costs. The OEMs are going to have to take pricing, and it's going to pass through.

Ravi Shanker - Morgan Stanley, Research Division

Right. And one of the more recent factors in this space has been the yen going from 78 to 96 or so. How do you think the J3 OEMs will react to that? I mean, have you seen anything happen already on the pricing side or the content side? How do think that evolves?

John C. Rickel

Well, I think, over time, it'll be positive for the space. Give them more ammunition. But if you think about it, when it went from -- in the '90s to the '70s, they didn't massively price. They were basically eating it in their margin. So now that it's kind of gone back the other way, I think it's given them a little relief on the margin side. But it wasn't like they had to massively pull back out of the space or significantly priced when the yen had strengthened so much. So while I think it will be mildly positive, big companies like that -- I spent 21 years at Ford. I'm certain they had -- at least a portion of that exposure must have been hedged. So there's some period of time where you've got to let the hedges roll off to get to kind of the true benefit of it. And the question about content, it takes a while to add content to a car. You don't go out and do that overnight. First of all, you want to make sure that the exchange rate holds. Because once you put the content it, it's tough to get it out. If they start to get comfortable, then I think you could see equipment content levels begin to come up over a 1-year or 2-year timeframe. Those normally aren't done on a quarter-to-quarter basis. I think what you will see, if they start to get more comfortable with their margins, is a desire for a bit more share. And the first place you'll see that is in more advertising dollars. You'll see more presence on TV, more in print and on the Internet. And then the next place that they will attack is with their finance companies, their captive finance companies. In particular, Toyota's is very, very strong. You'll see it in the form of subvented leases and subvented financing offers.

Ravi Shanker - Morgan Stanley, Research Division

All right. We're starting to see I think Mitsubishi commercials in primetime offer that [ph] how long. So that's the first sign of that.

John C. Rickel

There you go.

Ravi Shanker - Morgan Stanley, Research Division

But irrespective of whether they choose to do this with either batting their margins or more advertising, or adding more content, or even just blatant discounting, are you fairly agnostic to what approach they take?

John C. Rickel

Yes, reasonably agnostic. As long as it's basically good for the consumer and is driving traffic and more sales volume, we're happy with that. We're basically 60% J3 exposure. So we think we're well positioned to benefit from this.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And speaking of the J3, I'd say that they -- they did a great job last year in getting back some of the share they lost from the tsunami. But I don't think they're quite back there yet.

John C. Rickel

Correct.

Ravi Shanker - Morgan Stanley, Research Division

And there has been recent talk of Toyota kind of saying that the Camry is kind of struggling a little bit in terms of share, I mean, obviously not in terms of sales, and they think that they may lose some share this year. Where do you think the J3 are in terms of share? I mean, what do you think they need to do? Is it finally about product? Is there a perception issue? What do you think gets them back to close that gap?

John C. Rickel

Well -- I mean, they did lose a couple of points of share around the inventory shortages in 2011. They got most of that fixed. They -- and they didn't have full year availability until really the end of the first quarter of last year -- or in the first quarter of 2012. So they are now well positioned on inventory. But I think they are still down a bit, and I think their view is that they want to continue to grow share. They've always been kind of growth-oriented. And I think you will see them get a bit more aggressive as the year goes on, whether it's...

Ravi Shanker - Morgan Stanley, Research Division

On price?

John C. Rickel

Well, either on price or the -- I think they'll use the finance companies. That tends to be how they attack.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And specifically, for you -- not just for you, but you and the other dealers have said that the profitability on the J3 brand is probably a little bit soft compared to the D3 and, obviously, the luxury brands. Do you think that's changed over -- I mean, a, why is that the case? And b, do you think that changed over time?

John C. Rickel

Yes. The reason it's the case -- it goes back a bit historically. The Japanese and, once again, Toyota and Honda in particular, have been much better about the level of dealers in the country. Right? If you take a look, Toyota's got 1,200 and GM for market share that's not significantly better at this point, has got at least double, almost triple those levels. Right? So with the Japanese dealers, you always had more throughput per dealer. The trade-off is you take a little bit less margin on each individual unit, but the dealership is actually a lot more profitable because you're spreading that volume over a lot lower fixed cost. That's basically the way they're structured. So as you grow those volumes, there are a little bit less dollars per unit but the overall profitability of the individual dealerships is better.

Ravi Shanker - Morgan Stanley, Research Division

So it's not like a cyclical or product-related issue? It's just structural based on the [indiscernible].

John C. Rickel

It's structural to the business. Right.

Ravi Shanker - Morgan Stanley, Research Division

Got it. I mean, just shifting to the broader dealer group, and one of the themes that came out of the 4Q earnings was new vehicle margins across the group have been kind of in decline for many years now. And I think there has been a trend recently of a lot of dealers trying to maybe gain share by cutting new vehicle margins to try and get that back in the other segments over time. And one of the things we heard was the dealers saying that this year, maybe that stops, maybe you see a little more discipline, and so margins and new kind of stay flat or even improve this year. Where do you guys shake out of that? And have you seen signs of that already? And what really drives that improved discipline?

John C. Rickel

Well, actually, we've talked about this for the last couple of quarters. I think we're into a kind of a plateau level. If you go back to -- prior to the inventory shortages in second half of 2010, we were running about $1,900 a copy on new vehicles. And obviously, 2011 benefited pretty significantly from the inventory shortages. Margins went up. And then if you look -- once you got through with that, the last couple of quarters in 2012, we were kind of around that level. That's why we've pointed people to look more sequentially than year-over-year because of the distortion on a year-over-year basis. But we're comfortable with that $1,900 per unit. We think that's right when you think about dollars per unit. People get a little too focused on margin percentages. But we try to sell into that range, and I think that's what we're comfortable at looking for, for this year.

Ravi Shanker - Morgan Stanley, Research Division

And do you think there'll be other dealers that are kind of thinking this similar way? Or do you think people should try to gain share?

John C. Rickel

Well, I mean, there's certainly -- with all of the back-end money, the F&I profitability, there is an incentive to move the metal. And that's why we're not aggressively trying to drive the $1,900 up. We're comfortable that, that's the right balance of trade between what you make on the front end and the opportunity. Because you don't get the opportunity to sell that finance and insurance unless you make the sale upfront. So we think that's the right trade-off for us.

Ravi Shanker - Morgan Stanley, Research Division

And speaking of F&I, I mean, do you think the numbers in that segment across the group are sustainable, just given the push from the banks to expand availability, maybe a little more competition for sub-prime? Do you think those numbers stay up at current elevated levels?

John C. Rickel

Well, what we've suggested for modeling and for us is around 12 to 12 50 a unit. That's actually a little bit less than what we've run the last couple of quarters. I do think there's a little bit of out-earning going on right now in the F&I arena, and that's because the cost of money is so low on an absolute basis. It's a little bit easier to put a markup on the loans. And I think at some point, rates have to start to go back up. And when that happens, you're probably a little constrained, which is why we've been guiding people to that 12 to 12 50. As long as we can continue to outperform there, we're going to continue to do everything we can. But I do think that's the portion of the model right now that's probably benefiting from lower interest rates as it's a little easier right now to get the markup on those loans.

Ravi Shanker - Morgan Stanley, Research Division

Sure. Shifting gears a little bit, talk about one of your -- a surprising new initiative for you was UAB, right, the acquisition you made in Brazil. I think you're, what, 2 months off post-close so far. How is that going? Any surprises, good or bad?

John C. Rickel

Well, we closed at the end of February, so this is really -- we've had 1 month. And based on 1 month, so far so good. It was an opportunity for us to go into a growing market. Brazil is the fourth largest auto market in the world. The dealer network down there is a little less sophisticated. They're not really strong players. They tend to not be really well capitalized. We were fortunate we found kind of the premier platform within the market, which we're going to try to build from, but we think there's going to be a lot of opportunities to not only kind of grow with the market. If you look at the projections over the next 5 to 10 years, Brazil could be, instead of 3.8 million, could be pushing 6 million. And then the brands that we're aligned up with down there are brands that are growing share in that market. So we really like what the potential is for the operations down there.

Ravi Shanker - Morgan Stanley, Research Division

Sure. Obviously, Brazil is one of the fastest-growing markets in the world, so it makes a lot of sense to be there. But you've also heard from some of the other -- not dealers but some of the suppliers and the OEMs who have started sounding more cautious when they talk about Brazil. We had a couple of suppliers say that, "We want customers to pull us in. We don't want to go in there actively because we just don't know." So, a, what -- how much visibility -- or how much confidence do you have that you will -- that this current level of growth is sustainable? And b, how do you hedge in case -- it's obviously a very volatile market with a lot of legislative changes. How do you hedge against that volatility?

John C. Rickel

Well, it certainly is more volatile, and there's a lot of that you can't hedge. That's the trade-off for the higher growth potential, is there's going to be a little more volatility in the earnings. Obviously, it's still a smaller portion of our company. So you've got kind of the U.K. and the U.S. results to more than offset it. But we do think there is huge growth potential. It is going to vary from quarter-to-quarter. It's the nature of the developing market. I think longer term, the macro piece is -- it's hard to argue. It's a population of 200 million. Right now, you're looking at about 150 cars per thousand of population down there. Mexico is around 250 per thousand. Russia is 280 per thousand. U.S. is somewhere in the order of about 850 per thousand. So there's obviously a huge amount of runway to go on, filling out the car park down there. They don't have really good public alternatives for transport. So if you're going to get around, you ultimately need a car. And if you look at the growth of the middle class that is exploding in Brazil, we think the macro trend is hard to argue about. But what happens from any quarter-to-quarter, even from any year-to-year, is going to be a lot more volatile.

Ravi Shanker - Morgan Stanley, Research Division

Sure. And when do you think we start seeing the famous Group 1 cost efficiencies work their way through the UAB system? And how much can that help boost the margins in that business?

John C. Rickel

Well, the interesting thing is the operation that we picked up down there, UAB, is very well driven, very well run. We're not seeing huge amounts of excess cost at the operating level. Clearly, where they were constrained was their balance sheet. They've grown that company very rapidly and were very stretched on the balance sheet side. So part of what we did when we did the acquisition is we paid off all of their non-floor plan debt, which will significantly help. That was constraining the business. Basically, where they were on the balance sheet, they weren't able to hold as many used cars as what would be optimal. When they took cars for trade-in, they were liquidating a lot of them pretty quickly to raise cash. We've been able to fix that pretty rapidly. They were incurring late fees, things like that, that you won't have now that you've got a more stable balance sheet, and should be able to negotiate even better deals on the floor plan now that they've got a solid balance sheet. So I think most of the near-term cost is going to be more balance sheet-driven than operating because they're pretty good operators.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And do you think you need more scale in the region? I mean are there going to be more active [indiscernible]...

John C. Rickel

Oh, sure. We wouldn't have gone down there just for 18 dealerships. So I think, over time, you'll definitely see us build that platform out.

Ravi Shanker - Morgan Stanley, Research Division

Again, big groups? Are there groups with this scale? Or do you think there's going to be more...

John C. Rickel

It'll probably be more onesie twosies. The other thing that's really an opportunity down there, given the brands that we're aligned with, is they're still doing open points. And we've already had a number of the manufacturer partners approach us about opening additional dealerships. So we think there's going to be an opportunity to also grow via open points.

Ravi Shanker - Morgan Stanley, Research Division

That's very interesting. And just coming back to the broad M&A environment in the U.S., I mean, obviously, there's been a lot of talk and speculation that you have real estate planning, a lot of existing single owners who are ready to transition. And that's supposed to happen over the next couple of years. Any changes at all you've seen in -- post the tax structure on Jan 1? And has there been more of a pipeline come in? Has there been any movement in valuation at all?

John C. Rickel

Well, there are a lot of deals floating around. We did over $700 million of acquired revenues last year. There, I think, continues to be great opportunities in the U.S. You have to be careful. We kick a lot of tires to find deals that makes sense. We're looking for acquisitions that basically return 15% to 20% pretax returns on a discounted cash flow basis. So there's a range of expectations out there on pricing. There's a lot that are very proud of their assets and certainly want to be rewarded very strongly for them, and those we walk away from. But we've been able to find enough good deals to fill up our requirements, and I think we'll be able to see that going forward. I think the thing we're a little surprised about was that the estate tax and kind of the taxation change actually didn't drive even more activity. We picked up a couple in December. We picked up a really nice Ford store in Georgia that was really around that. We completed an acquisition in Kansas City with a large Kia that were around that. But we were actually surprised there wasn't even more.

Ravi Shanker - Morgan Stanley, Research Division

Have you announced anything this quarter so far?

John C. Rickel

Not in the U.S.

Ravi Shanker - Morgan Stanley, Research Division

None in the U.S. In the U.K.?

John C. Rickel

Yes. U.K., we closed 4 stores there, and we -- the Brazil deal.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And -- I mean, this is obviously something that a lot of the big public dealers are talking about. So do you think in the next, say, 5 years, there's going to be a transformational change in the market share of the top 10 dealers in the U.S. if you do see a broad level of consolidation? Or do you think it's not going to be enough to move the needle?

John C. Rickel

Well, I think you'll see it continue to move up. I don't know if it's transformational. I don't know if you go from kind of 10% of all the dealerships today to 20% or 30%. But I think it could certainly be 15% in that time frame. You're already starting to see a real differential. Most of our competition are the smaller dealerships. Right? I mean, we don't really face off against the other publics in most of the markets. So 90% of the dealerships out there are the smaller mom and pops. And if you take a look, the NADA returns for that group last year averaged about 2% return on sales. We were at 3.3%. So I mean, there's some -- already some significant gap opening up kind of between the groups that have scale, that have the ability to redeploy their used vehicles, that have the ability to leverage some of the back-office cost versus kind of what the single-point dealers are doing. And I think that's going to be the fuel that will add pace to this as we go forward.

Ravi Shanker - Morgan Stanley, Research Division

And if you do see that level of consolidation going from 10% to 15%, maybe 20%, does that change your economics any way? I mean, do you think that'll help drive margins higher? How do you think the OEMs react to that?

John C. Rickel

Well, the OEMs have started to get incrementally more comfortable. I wouldn't tell you that they love the public ownership model uniformly. But I think they've gotten incrementally more comfortable. They certainly saw the value during the downturn, of what a well-capitalized partner can do for you. We certainly have been able to demonstrate with some of the partners what we're able to do on turnaround situations. Volkswagen, that's why we've partnered with them. So they've seen kind of the value that we bring. So I think the OEMs have gotten incrementally more comfortable. It's hard to see this having a big effect on gross margins, but I do think, as you continue to add scale, there is an opportunity to continue to drive kind of SG&A as a percent of gross down and ultimately drive further expansion in operating margins.

Ravi Shanker - Morgan Stanley, Research Division

Sure. And speaking of SG&A, you guys have been -- I think you really led the industry in SG&A leverage improvement over the last couple of years. You had a bit of a hiccup in the last quarter.

John C. Rickel

We did.

Ravi Shanker - Morgan Stanley, Research Division

Can you just talk a little bit more about that, what steps you're taking? I mean, you put in place a number of measures to fix that immediately. So when do we start seeing that improvement over time?

John C. Rickel

Well -- I mean, you'll start to see a bit of it in the first quarter. And we're comfortable that by kind of the start of second quarter, we should be back to our normalized run rate. Our normal metric is for each incremental same-store gross profit dollar, and I emphasize same-store because as you're doing acquisitions, obviously they bring a fixed cost load with them. So you're not going to have the same leverage there immediately. But on a same-store basis, $0.50 on each dollar should flow through to the bottom line. And the only exception is for the growth items we've talked about. We've got about 750,000 per quarter in the first quarter and the second quarter around 3 growth initiatives, and that tails off to 500,000 the third and the fourth. But -- with the exception of that kind of growth cost that we'll be adding in, we should be kind of back to that run rate starting the second quarter.

Ravi Shanker - Morgan Stanley, Research Division

Do you think there's like a natural ceiling or -- actually, a natural trough of SG&A to gross? We've already gone from like a 10 million to 15 million SAAR. So going from 15 million to 17 million is not going to give you much.

John C. Rickel

Yes. As long as we are generating incremental gross profit dollars, we should be able to continue to leverage them. There doesn't appear to be a limitation on that.

Ravi Shanker - Morgan Stanley, Research Division

And where do you think your own number settles down at once you do get these new initiatives in place? And is that going to be like a step function, like a 100-basis-point improvement? Or is it going to be just back to your leads?

John C. Rickel

Depends -- if we get to -- let's call a trend. If we're into that 16.5 million, right? Because this is all a factor of gross profit dollars you're putting through the model. But at 16.5 million, we ought to be able to approach something in the low-70s for SG&As as a percent of gross, which would conversely drive an operating margin that's getting close to 4%.

Ravi Shanker - Morgan Stanley, Research Division

Got it. If anyone in the audience has any questions, please -- question over there?

Question-and-Answer Session

Unknown Analyst

Just a question on the Parts & Services aspect of your business, about $800 million in revenue. Are you guys doing anything to try and -- I see it grew 2% this year, but slow in the other parts of the business. What are you doing to try and keep that customer coming back to the services in your dealerships?

John C. Rickel

Sure. No, it's a great question because it really is the heart of the profitability of the model. Fourth quarter, we doubled that rate. We were kind of 4% same-store growth. There's some really favorable trends on a macro basis that will help us. If you look, the -- kind of the sweet spot for our business is the first 6 years of ownership of the car. Once they get beyond kind of 6 years of age, they start to funnel out of the dealership model. Oftentimes, cars have traded hands. And once that happens, you lose the relationship. As cars get older, people become a little more sensitive to repair cost. So one of the things that we've been battling for the last couple of years is -- you've actually had kind of the units in operation in that first 6 years have been declining with the decline in new vehicle sales. We think we passed through the inflection point kind of late last year, and we now, with the SAARs continuing to rebound, are starting to rebuild that 0- to 6-year bucket and starts to become a tailwind over the next couple of years. So that's one thing on a macro basis. And then specifically, we've been very focused on kind of the points of defection. If you take a look at our results, and this starts to really get into the details, but there is some accounting differences across the sector. Three of us basically eliminate internal work from the Parts & Service. So if you're reconditioning used cars or you're prepping your new cars, so we don't get the benefit of that, if you will, on revenue growth. But if you adjust for that, I'd tell you that we've been basically kind of the top of the sector for the last 3 or 4 years. It's an area we've put a lot of focus on. But on those points of defection, one of the things we've been very focused on over the last 2 years is tire sales. Tires themselves are really low-margin business. You get about an 8% margin. But the reason you sell them is to keep the rest of that business in the house because when that -- once that tire comes off, you get the shot at the rest of the business around the wheel. So the brakes, the rotors, struts, front-end alignments. Two years ago, we were selling about 2,000 tires a month at our stores. Last quarter, we averaged 20,000 tires a month. So it's things like that. We measure our kind of same-store loyalty whether or not you bought the car there and come back for service within 12 months, or if you had it serviced and have been back within 12 months. We've moved that loyalty up about 10 percentage points, and that's part of the reason why we've been leading the sector. We didn't have nearly the falloff in the Parts & Service business that the SAAR decline would have led you to believe. If you go back 2 years ago, the big short thesis on this space was that Parts & Service was going to fall off massively because of the decline in SAARs. And we were able to counteract that with the focus that we've put. Then the final thing that we're really excited about, that I think is going to separate us further from the rest of the pack, is we've launched in the fourth quarter -- it was one of the 3 growth initiatives -- an inbound service call center where basically, if you think about the model today, you call a dealership on a Monday or Tuesday morning, you want to talk to the service advisor to set your service appointment, they're out on the drive, writing up all the customers that have come in to drop their cars off. And oftentimes, you're either going to get voicemail or, if he hasn't cleaned out his voicemail, may not even pick up at all. It may just ring and ring and ring. Well, this is somebody that's calling to try to set an appointment with you, that you make a 51% or 52% margin on. You don't want to miss too many of those phone calls. So at the end of the fourth quarter, we had 20-some stores on the pilot. As we sit here today, we're up to like 54 of our stores are in this center. And basically, what this is allowing us to do is we've improved our live answer rate 20 to 25 percentage points, and each of those calls, about half of those, are -- to actually set an appointment. Each of those appointments is about 150 gross profit dollars. So we think this is a really exciting initiative that should allow us to continue to drive additional Parts & Service growth as we go forward. Yes?

Unknown Analyst

What is your attachment rate for service on a new car sale? And then on a separate question, if you look at -- interest rates are so low now. Is the leasing business even there anymore? Or how much of your business is leasing versus loans for new cars?

John C. Rickel

Sure. Well, on the first question, attachment rate, loyalty is about 60%. So about 60% of the customers that we sell a car to actually attach to the Parts & Service. There continues to be opportunity to move that up by -- things like convenience. People that have BMWs is a great example, 4 years inclusive service. They're going to go where somebody's going to be able to answer the phone and get them in quickly and take care of them. So it's really about improving our customer points of contact to help drive that. On leasing, we're actually seeing leasing rebounding nicely. If you went back to kind of '08 and '09, leasing almost shut down in the U.S. The OEM captive finance companies took big write-offs because of declining residual values. And then the bigger issue was most of them fund their balance sheet by securitizing the assets. And it's a lot easier to securitize a pure loan than it is a lease. With the lease, you still have the residual guarantee, which gives you a tail back into the OEM. And of course, '08, '09, nobody wanted to have any exposure to OEMs in this space. So basically, March 2010, when Toyota came out of their stop sale around the sudden acceleration, they used leasing to attack the market. And that kind of really jump-started it. I think we're about back to about 20% lease penetration. And that -- probably 20%, 25% is the right level for the market. We're reasonably agnostic between leasing and selling. You make a little less on the F&I because it's harder to sell an extended service contract. Somebody's only taking a 2- or 3-year lease, but they tend to turn those cars more often. And they're a great source of used vehicles for us. One of the things we've been struggling with over the last kind of year or 2 years is not getting in enough late-model, low-mileage cars for our used car business. So we're excited about that prospect as leasing continues to rebuild.

Ravi Shanker - Morgan Stanley, Research Division

I also wanted to ask you about the used car business because we should be seeing that supply of lease returns come back. The Manheim numbers came out this morning, it was like down 4.5% year-on-year, which is a pretty big move for the Manheim index. Where do you see that balance between supply and pricing going over time? And are you guys relatively agnostic where prices go, given that you're kind of acquiring and selling used?

John C. Rickel

Yes. We are agnostic on the price. We're kind of like a broker. We're turning our used vehicle inventory 12 times a year. We only hold about a 30-day supply. So as long as we're staying kind of current with market prices whether they're up or down, as long as they're moving in a reasonably stable level -- if you get big spikes, obviously it can get disrupt it. But in a gradual environment, we really don't care. It doesn't really impact us that much because we're reacting to it, and we're lowering our acquisition cost as the market comes down. Our view is you're going to continue to see Manheim come down a bit. It got to all-time record levels in June 2011 driven by the shortages in new vehicle sales. As those off-lease vehicle units begin to build, I think that's going to continue to put a bit of pressure. If the Japanese get a bit more aggressive because of the yen that we talked about, that will put pressure on the relativities. So it means that new car prices are too close to used that we'd anticipate you're going to see a gradual decline in used car prices across the year. But to us, that's not an issue.

Ravi Shanker - Morgan Stanley, Research Division

Sure. We're out of time, but let's squeeze one question in on the cash flow. What would be your top priorities for cash? I mean, you guys pay a dividend, you buy back stock. Obviously, M&A is...

John C. Rickel

Sure. First best is acquisitions. If we can find acquisitions to hit those 15% to 20% return hurdles, we think that's the first best use of cash. And then beyond that, we mix and match between dividends and share repurchase. We have a $50 million share repurchase authorization in place. And right now, we're paying $0.15 a quarter dividend. And we'll mix and match between those.

Ravi Shanker - Morgan Stanley, Research Division

Got it. Great. Thanks so much, John.

John C. Rickel

Well, thank you. Thank you for inviting us. Thank you for your attention.

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