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Asbury Automotive Group Inc. (NYSE:ABG)

Q3 2009 Earnings Call

October 29, 2009; 10:00am ET

Executives

Charles R. Oglesby - President & Chief Executive Officer

Craig T. Monaghan - Senior Vice President & Chief Financial Officer

Michael Kearney - Chief Operating Officer

Ryan Marsh - Treasurer

Analysts

Rick Nelson - Stephens

Rod Lache - Deutsche Bank

John Murphy - Bank of America Merrill Lynch

Operator

Good day and welcome everyone to Asbury Automotive Group quarterly earnings results conference call. Today’s call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to the Treasurer, Mr. Ryan Marsh. Please go ahead sir.

Ryan Marsh

Thank James and good morning to everyone. Welcome to Asbury Automotive Group’s third quarter 2009 earnings call. Today’s call is being recorded and will be available for replay later today. As you know the press release detailing Asbury’s third quarter results was issued earlier this morning and is now posted on our website at www.AsburyAuto.com.

Participating with us today are Charles Oglesby, our CEO; Craig Monaghan, our CFO and Michael Kearney, our COO. As always, at the conclusion of our remarks we will open up the call up for questions and I will be available in my office afterwards to address any follow up questions you might have.

Before we begin, I must remind you that the discussions today are likely to contain forward-looking statements. Forward-looking statements are statements other than those which are historical in nature. All forward-looking statements are subject to significant uncertainties and natural results may differ materially from those suggested by the statements.

For information regarding certain of the risks that may cause actual result to differ, please see our filings with the SEC from time to time including our Form 10-K for the year ended December 2008. Any subsequently filed quarterly reports on Form 10-Q and on our earnings release issued earlier today. We expressly disclaim any responsibility to update forward-looking statements.

With that said, I will hand the call over to Charles.

Charles Oglesby

Thanks, Ryan and good morning to everyone and thanks for joining us today. We’re pleased to announce third quarter and continued operations of $0.29 per diluted share, up 38% versus prior year results despite a 12% decreases in revenues over the same period.

Our third quarter results were reduced $0.02 per share by non-core charges which Craig will discuss in more detail later. This improved financial performance reflects what we believe is a temporary boost from the government’s Cash for Clunkers program combined with the benefits of the dramatic expense reductions we have achieved over the past year.

This quarter with a SAR of $14.1 million in August and $9.2 million in September tested the impact of our ongoing restructuring efforts on the flexibility of our employees to capture the sales on the upside and maintain cost savings on the downside. Each of our employees have been instrumental in successfully navigating a litany of changes during the most difficult of times.

The elimination of our regional management structure, the relocation of our corporate headquarters, the ongoing conversion of all stores to a new DMS and a common chart of accounts, the centralization of payroll processing, significant debt reduction and bank commitments and restating our cost base for today’s sales environment. We are asking a lot of our employees and they continue to deliver.

And now I’ll hand the call over to Craig.

Craig Monaghan

Thanks Charles. Asbury has made great strides in maximizing cash flow, preserving liquidity, improving working capital and monetizing the balance sheet over the last year. In addition, we have delivered over $100 million of SG&A expense reductions and while accomplishing all of this, we were still able to invest in our infrastructure to drive future efficiency and profitability.

In terms of our infrastructure investments I would like to provide the following updates. We’re 70% complete with the consolidation of payroll processing, which we expect to finish by the end of this year. We are 59% complete with the conversion of our stores to the Arkona DMS. Our goal is to complete the DMS conversion by next summer. We are also 50% complete with the conversion of all of our stores to common chart of accounts which we expect to complete in the middle of 2010.

The company has made tremendous progress on these infrastructure initiatives with respect to the speed and quality of implementation. Especially, when you consider the disruptions of our concurrent corporate relocation and restructuring activities. This is a direct reflection of the caliber of Asbury’s employees I couldn’t be more appreciative of the hard work and commitment.

I would like to discuss a couple of housekeeping items. In this quarter, we incurred a $0.02 charge stemming from $0.04 of the DMS transition and restructuring cost. This was partially offset by $0.02 tax benefit. Our $0.06 discontinued operations loss is primarily related to an accounting charge on vacated leases.

With respect to CapEx, we’ve spent $6.1 million year-to-date and on track to achieve the $10 million target we set for 2009. We’re targeting a CapEx budget of $25 million for 2010. The company’s financial position continues to improve with total available liquidity on September 30 of approximately $205 million. Including $34 million of cash and borrowing facility availability of $171 million. We currently have nothing drawn under other the [Inaudible] or J.P. Morgan facilities.

Finally, I would like to conclude by highlighting the fact that over the last 12 months, we have paid down 12% or $75 million of our non-core planned debt. We have no significant debt maturities scheduled on 2012. At this point, we believe that maximizing cash flows from our existing operations and opportunistically paying down debt are the best ways to balance risk and enhance investor returns.

Now, I would like to turn the call over to Michael Kearney, our COO, to provide some operational highlights for the quarter. Michael?

Michael Kearney

Thanks Craig. The automotive retail industry experienced sequential strength in the third quarter over the second quarter, with a SAR of $11.5 versus $9.6 million. We believe third quarter new vehicle sales performance was a temporary uptick driven in a large part by the Federal government’s Cash for Clunkers program. Following a strong August SAR of $14.1 million the September SAR dropped back to $9.2 million which is more inline with the sales levels we have experienced from most of 2009.

New light vehicle retail unit sales were down 11% in the third quarter versus last year, which is generally inline with the broader industry. Our luxury sales were softer than our other segments, primarily because most of the luxury cars were not eligible for the Cash for Clunkers program. Additionally, luxury sales were impacted by tight inventory levels at some of our luxury stores during this period.

Speaking of inventory, on a same store basis, our new light vehicle inventory is down $93 million or 26% since June. With our days supply around 46 as of September 30th. These record low inventory levels combined with the buzz generated from the Clunker program helped us produce strong or new light vehicle retail gross margins, which are up versus prior year at 7.4%.

However, we are at a point where thin inventory levels are potentially impacting showroom traffic and sales volume. Simply stated, our new vehicle inventory was too low at the end of the quarter. For the first time in over two years, many of the factories are targeting production increases in the fourth quarter, which should enable us to adjust our inventory levels over the next quarter.

Asbury’s used light vehicle unit sales were down 5% from the third quarter last year, but up 1% sequentially over the second quarter. Margins remained relatively stable at 11.5%. We ended the quarter with $72 million of used light vehicle inventory, our 44 days supply.

Finance and insurance for vehicle retail for the quarter was $888, down 9% year-over-year due to tighter lending standards and lower advance rates. On a sequential basis, however, S&I per vehicle retail has improved 9% from $817 in the second quarter, primarily as a result of improved product sales and broadening of advanced rates.

In our parts and service businesses, revenues declined 8% and gross profit declined 7% from the third quarter of 2008. The gross margin for the third quarter was 50% flat compared to the prior year. The year-over-year gross profit decline was driven primarily by reduced warranty work, as well as less internal preparation work associated with the reduction in new and used vehicle sales volumes.

Although traditional customer pay and wholesale parts were down year-over-year, over the last four quarters we have seen a slight increase in customer pay which includes internal prep work and wholesale parts, offset by small reduction in warranty. On a same store basis, the company’s parts and service operations remain relatively stable this year with gross profits holding steady at approximately $79 million in the first and second quarter and $77 million in the third quarter of 2009.

Before passing the call back to Charles, I would like to briefly summarize the impact of the Cash for Clunkers program on Asbury. We sold 33,000 new vehicles as a direct result of this program, and we have collected all of the money due to us from the government.

Considering our brand mix, and the fact that a great majority of our luxury cars were not eligible under the Clunkers program, we are very pleased with these results. And considering the vehicles that customers were trading in for Clunker deals we anticipate only a moderate pull forward impact on future new vehicle sales.

Special mentioned in facts are due to our great dealership teams that hustled and worked tirelessly to make this program a success for us. The fact that less than 1% of the deals we submitted it Clunkers deals did not qualify. The testimony to the diligence and the persistence of these dealership teams. Thank you very much for making it happen.

With that, I will hand the call back to Charles to conclude our prepared remarks. Charles?

Charles Oglesby

Thanks, Michael. Going forward, we will continue to pursue operational excellence by focusing on the outstanding mix of dealerships we already owned. Our operational restructuring goal is greatly enhanced by our geographic concentration and density within the markets we operate. We’re fully engaged in numerous internal projects, several of which Craig highlighted earlier that are critical for establishing Asbury’s foundation for future growth.

Over the near term, we intend to live within our operating cash flow and pay down debt while adhering to a disciplined capital spending budget. We strongly believe this is the best path for Asbury in order to create maximum value for all our stakeholders in today’s economy.

Now, I’ll turn the call back to the operator and we will take your questions. Operator?

Question-And-Answer Session

(Operator Instructions) Your first question comes from Rick Nelson - Stephens.

Rick Nelson - Stephens

On October trends maybe has a length to September, both new and used cars as well as where your inventories is at today, I know you mentioned your 46 days supply at the end of the quarter, and when do you anticipate you will be fully stocked from an inventory standpoint?

Michael Kearney

Rick, this is Michael. I will answer that one. First part of that multi part question. October on the new side is marginally better than the rate that we saw in September. I would say used is up marginally, again over that, fixed operations is also up.

In terms of inventories on the new side, we are rebalancing our inventory, in terms of both make and model mix, trim level mix and unit numbers pretty much in generally across the board with all the manufacturers. Used car inventory was at the high number at the end of September, we are managing that inventory back down very quickly this month to our guidelines and well on our way there.

Rick Nelson - Stephens

Michael, can you also speak to geographic areas of strength and weakness and I guess comments on Florida would be particularly of interest?

Michael Kearney

In the quarter Florida participated along with the rest of the country of course in the Clunkers program which we had concentration of the brands down there that did very well for us. So Florida performed very well, the Mid Atlantic states did well, Texas performed again very strong in that program.

So, I would say most of the geographic regions performed in-line with the overall. We are not, I don’t want to say not concerned about where we are, but looking where we came from we feel much better about Florida than we did 12 months ago.

Rick Nelson - Stephens

Some of the dealers are talking about the price erosion that we’ve seen at auction the past couple of weeks. Do you take that says anything about demand for used car is potentially slowing?

Michael Kearney

Rick, it’s Michael again. I’ll answer that in two pieces, and you are correct on what you’re hearing. First, we saw an erosion of the sale rate at the auctions which then is almost always followed by erosion in the pricing. I think what we are seeing is that some of that is in fact seasonality, it’s happening a little bit later this year than it has in the past.

We usually see that early September, we are seeing it now in October and I think it reflects the general, seasonal reduction in used car volume this time of year, but we anticipate that seasonality change in the first quarter of 2010 as done in the past.

Rick Nelson - Stephens

Demand, its that what you see it and not covered at strength for used cars relative to September.

Michael Kearney

Yes, that’s correct.

Rick Nelson - Stephens

Just one final question if I could, some of other dealers are talking about steeping up the acquisitions pays, it sounds like you guys are still in debt pay down mode. I’m wondering how you evaluate those two alternatives.

Charles Oglesby

Rick, this is Charles. We are very comfortable with the balance, the mix of our portfolio. We like our geographical locations and we are very fortunate right now that we can be opportunistic in whatever we want to add to the density that we have in these geographies.

We feel like that’s an advantage for us that we have in this market place and is that density. So we actually have the ability where there is paying down debt in the left the right, the yield that passes through our filter process comes to us. We have the ability to purchase it as well from the manufactures well as all ability.

So on a go forward basis, getting our balance sheet right and being selective on the what we add to our portfolio and continuing to work on our operational initiatives is what we feel is the best way to navigate this company to the position we wanted to be in the future. So we don’t have to buy anything, but if something that’s out there that we really like, we have the ability to do it.

Rick Nelson - Stephens

On pricing skill, how do you compare the acquisitions from..?

Charles Oglesby

The pricing, it’s always kind of fun to watch the pricing in the market place. The ones that are cheap, no body wants and the ones that are sill very desirable, great locations have done the job in the past, they are still pretty robust in what they want for the returns on them. Again fortunate for us, it’s been able to buy opportunistically with everything that goes through our filter process. So the good stores are sill high, I think they always will be and stores again nobody wants them, nobody wants.

Craig Monaghan

Hey Rick, this is Craig. I’d just add that we’re fortunate to be in a position where we are generating cash, with tremendous liquidity and in a sense, buying back debts such a return threshold for us and buying back debt is attractive, if acquisitions are more attractive, obviously that’s something that you consider, but paying down debt when we feel like we’re in a situation where we are valued on EBITDA, the debt repurchase is an obvious and easy to calculate return threshold.

Operator

Your next question comes from Rod Lache - Deutsche Bank.

Rod Lache - Deutsche Bank

I had a couple of questions, first on the new margins which were obviously pretty strong. Do you sense that there was some benefit there from just the pace of activity during Cash for Clunkers and just more or broadly in longer-term, it sounds like you guys and others are planning to keep inventories relatively low.

Do you think that has kind of a longer term implications for what the profitability of the new car business would be like on a gross profit level?

Michael Kearney

Rod this is Michael. I think couple of things came into play for the margins, one of them is the fact that we did have a lot of showroom activity, a lot of buzz, lot of people showing up to buy cars so that was part of it. The other part was again supply and demand, these inventories were tighter. So I think that’s reflected in the margins.

I think as on go forward as we restock, we are viewing this as the new world in inventories, the levels that we want to maintain are the levels that we hope that will continue to reflect these margins on a go forward basis.

Rod Lache - Deutsche Bank

So you basically are saying that you think that these kinds of margins are sustainable?

Michael Kearney

I think so, yes.

Rod Lache - Deutsche Bank

In the parts and service business, could you just give us little bit more color on what’s happening there with the same-store sales changes. At this point, what is the customer pay percentage versus warranty percentage and when you look at customer pay?

Do you have any sense at this point how that kind of breaks down, is there a very large percentage that’s relatively new the past four year, vehicles that you guys typically capture in your customer pay, would there be any negative implication just because, obviously that population of three or four year old vehicles is going to decline just because sales have declined recently?

Michael Kearney

Again, this is Michael. Rod I’ll try to answer that multi part question in pieces. I’ll give you the observational stuff and then get into the numerics. I think what we are all seeing in the industry is, in the warranty side particularly, as a reflection of the drop in new vehicle sales in the last 18 months.

As you know most of the warranty work is done in the first 36, and a vast majority of it is in the first 18. So I think all of us are seeing that. In terms of the customer pay fees generally, we are seeing more maintenance work done than probably in the past as making up a bigger piece of our business, and we’re also seeing consumers continuingly holding off on the very large part of the repair work postponing it if they possibly can if it’s not safety related. So I hope that answers that part of the question.

Charles Oglesby

Just kind of put it in perspective, customer pay would represent about 70% of our parts and service business, warranties only about 15% and just kind of following up with what Michael said is that we have seen the warranty business decline.

So I don’t have the ratio on front of me, but if we are to go back three, four quarters you would see even longer than that, six quarters you’d see a steady deterioration on warranty. So maybe we’re down from 17% or 18% to the 15% a day.

Our customer paid business has felt some pressure, but nowhere near as much pressure, in fact over the last three or four quarters customer pay is basically flat on a dollar basis.

Rod Lache - Deutsche Bank

On the customer pay, I don’t know if it’s possible to give us this level of debts, but is a disproportionate amount of the customer pay for you relatively newer vehicles or is it fairly spread out across you guys are getting a fair number of five, six, seven year old vehicles that’s part of the customer pay as well?

Michael Kearney

That’s somewhat of brand specific answer. If you take BMW for instance, they have maintenance built in to the price of the car, so the customers will bring the cars in for the period of which the maintenance covers which is 48 and 48, so we will see that spectrum in there.

We have a number of Honda vehicles where we traditionally see the Honda customer bringing the car back in on the regular scheduled maintenance program similar to Nissan and Toyota, and then we have of course the Lexus brands where those customers have been very low. So I don’t have quantitative numbers in front of me, but I gave you that qualitative answer to that question.

Craig Monaghan

One of the things that I think we are looking forward to in future, and you probably have noticed and have heard this is the certified pre old vehicles are continuing to grow on the used vehicles sales side, and that is almost like new vehicle customers coming back in, there is a period of time that they are still loyal to the franchise dealer where they bought the vehicles.

So I think that in the future some of the customer pay or warranty that we have lost for whatever reasons, that these cars will start coming back to our dealerships as well for some of the maintenance side. So, I think that’s a part of the future that we are looking forward.

Rod Lache - Deutsche Bank

You are feeling pretty good about the outlook for the customer pay business looking forward?

Craig Monaghan

Personally I do. I mean, I think that we are positions ourselves well with not all of the initiatives that we are doing. Customer loyalty is a big part of that business, so they want to come back and see the value in doing business with a franchise dealer instead of the independent dealers.

Because years ago, the independents were wearing us out, and finally as we learned from a franchise standpoint to compete in that arena we all for a lot more value now than the independents do, and I think that we have the opportunity in our sales channel to educate the customer along those lines, so that they want to come back to us. So we’re very positive about the future with the fixed side of the business.

Operator

(Operator Instructions) Your final question comes from John Murphy - Bank of America Merrill Lynch.

John Murphy - Bank of America Merrill Lynch

You mentioned that the inventory, the low levels of inventory were restraint on demand or constraint on demand in the quarter. If you had more inventories to sell, how much higher do you think sales would have been? I mean just a little bit or a lot, what’s the magnitude of the pressure there?

Michael Kearney

John, this is Michael. That’s almost like asking me how high is high. That is a good question. Let me answer it in a little bit of a general way. When the inventories on the new side particularly get down to the levels that they were down to, the mix, the trim level mix and the color mix of the inventory also gets pressured. It’s not the ideal mix; it’s not the perfect inventory.

So, not only is it the number of vehicles available for sale which impacts how many we can sell, it’s the variety what’s on the grocery shelf that we can sell. So, I couldn’t really give you a number as to how much, I can just tell you that it was restrained we had numerous request for cars we just couldn’t fill the orders and the program of course ran out, but it was restrained, I just can’t quantify that number.

John Murphy - Bank of America Merrill Lynch

Then I’m going to ask you another tough one and ask you how high are high again. On credit availability, we are hearing a varied degree of answer of, it’s a big problem or it’s not a problem at all. What are you seeing as far as credit availability to the consumer loan to value ratios now a lot lower, so it’s tougher to get guys financed? What are you seeing there on that side? How much of a pressure do you see on demand from that?

Michael Kearney

John, this is Michael again. I’ll answer that in a trending way. Credit availability is a general response is better today than it was six months ago. The advance rates which is obviously the amount of money that could be lend against both of the new car and the used car side, the advanced rates have improved.

As far as the criteria and the specifications or the stiffs as we put for the consumer that’s out there, they have been relaxed a little bit and the way that the lenders tear the buyers scoring that has relaxed. So it is not where it was 24 months ago, but it is definitely better than it was six or nine months ago, and we’ve seen that as a nice gradual trend pretty much across the line for particularly the last three months.

John Murphy - Bank of America Merrill Lynch

I’m asking another similar question on leasing, I mean what are you seeing on the leasing front, is that using more leasing coming back to the market because that must be an important factor for you guys given your mix.

Michael Kearney

John, that’s a good question and it, is important to us of course. It is pretty much brand specific and driven by captives. Our captive partners particularly in the Highlands and the Asian imports have been pushing leasing continuously it’s been very strong there. We’ve seen residual values improve marginally again, but we have seen a greater participation from a number of our OEM partners in the leasing area. We are very pleased with that and we hope that will continue to sustain this over the next period.

John Murphy - Bank of America Merrill Lynch

Then lastly just on what do you see in the pricing environment, obviously it sounds like there is some non conventional players aka Toyota potentially ramping up some incentives in advertising spend. Are you seeing that in the market and would that at all put your gross margins at risk as we look into the fourth quarter?

Michael Kearney

John, this is Michael again. Good observation, Toyota is ramping up they are marketing substantially, General Motors of course is having a nice presence in the marketplace again and we are seeing a ramping up of new car inventories.

I can’t address the incentives, they change so quickly and I couldn’t and I wouldn’t want to predict what the manufacturers will do. We are hopeful that the inventories and their production will stay inline or more inline with the demand than they have in the past. So we are taking the position that we will manage our new car inventory to that level and as I stated earlier, I think we can maintain these margins.

John Murphy - Bank of America Merrill Lynch

Actually, just the last question, when you look at the cost savings you have achieved to-date it’s a 100 million, you went through a number of the actions that you’re taking and some of them are only half way done and some of them are 70% done. How much do you think you will ultimately really achieve here? Is there an update to your cost savings forecast? And how much of that do you think will be really structural going forward.

Charles Oglesby

I would answer that by saying that, the vast majority of the savings have been realized to-date, and we have done a lot of heavy lifting as you will recall the corporate staff in down by 25%, we eliminated six regional management offices, the guys out in the stores have done a tremendous job, that to a large extent is behind us.

I think what you will see going forward is continued productivity improvements, but those will come from these much heavier investments DMS chart of accounts, we are trying to move a lot of work we do into a paperless environment. We are trying to use many more web based functions within the store, but those will take time to play out.

I think if I were in your shoes for planning purposes, and let me be short range here if I could, we are looking at SG&A in the fourth quarter somewhere probably in the low 80s, 82% or so and that’s down about 150 basis points from where it would have been a year ago on a comparable basis.

Charles Oglesby

With that as our last question, we want to thank everyone for listening today and any certainly any follow up or future thought, you certainly can give Ryan Marsh a call and we appreciate everyone being a part of this today. Thank you.

Operator

That concludes today’s conference call. Thank you for your participation.

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