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Asbury Automotive Group, Inc. (NYSE:ABG)

Q3 2013 Earnings Conference Call

October 22, 2013 10:00 AM ET

Executives

Ryan Marsh - Treasurer

Craig Monaghan - President and CEO

Scott Krenz - SVP and CFO

Michael Kearney - EVP and COO

Analysts

Rick Nelson - Stephens, Inc.

John Murphy - Bank of America

Bill Armstrong - CL King

Brett Hoselton – KeyBanc

Rod Lache - Deutsche Bank

Jamie Albertine - Stifel Nicolaus & Co.

Brett Jordan - BB&T Capital Markets

Ravi Shanker - Morgan Stanley

presentation

Operator

Good day and welcome to the ABG third quarter 2013 earnings call, today's conference is being recorded and at this time I would like to turn the conference over to the treasurer, Mr. Ryan Marsh. Please go ahead.

Ryan Marsh

Thanks Camille, and good morning to everyone, welcome to Asbury Automotive Group's third quarter 2013 earnings call. Today's call is being recorded and will be available for replay later today. The press release detailing Asbury's third quarter results is 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'll open up the call for questions and I'll be available for any follow up questions you might have later in the day.

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 are 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 further 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 10K for the year ended December 2012, any subsequently filed quarterly reports on form 10Q and our earnings release that we issued earlier today. We expressly disclaim any responsibility to update forward looking statements. My pleasure to hand our call over to our President and CEO, Craig Monaghan.

Craig Monaghan

Good morning everyone and thanks for joining us. We are pleased to report record third quarter results. Adjusted EPS from continuing operations increased 26% for the third quarter. Our stores continued to maximize sales and service opportunities across all business lines while controlling expenses. Revenues were up 17% and gross profit was up 16%. We improved our cost structure, reducing SG&A as a percent of gross profit by 120 basis points. We achieved record third quarter income from operations with an adjusted margin of 4.3%, placing us among the leaders in our industry. We acquired and successfully integrated three franchises with approximately $115 million of run rate revenues and we redeemed the remaining $143 million of our seven and five eights (ph) bonds. Our third quarter results demonstrate the dedication and determination of our associates across the organization.

With that I'll turn the call over to Scott.

Scott Krenz

Thank you, Craig. Our third quarter adjusted EPS of $0.91 reflect the earning powers of our business. This quarter's adjusted results exclude debt redemption costs of $4.2 million after tax or $0.14 per diluted share and a non-cash real estate related charge resulting from the purchase of a previously leased property of $1.3 million after tax or $0.04 per diluted share.

The debt costs are related to the redemption of the remaining $143 million, 7 and 5/8senior sub notes. The real estate charge is reported in the other operating expense line in our income statement. There were no adjustments to last year's third quarter results. Our SG&A as a percentage of gross profit continues to improve to 70.9%, a 120 basis points lower than the prior year period. A focus on cost discipline and ongoing productivity improvement continues to be part of our core operating culture, excluding rent expense which we view as a financing decision. Our SG&A as a percentage of gross profit ratio was 67.3%. During the third quarter, we spent $14 million on CapEx, we're anticipating CapEx in the range of $45 to $50 million for all of 2013 as we continue to execute our plan to upgrade our stores, expand service capacity, and invest in technology.

For 2014, we are budgeting CapEx of $60 million. This breaks down to approximately $45 million associated with our existing capital plan, $15 million associated with the acquisitions that we made in July of 2013, and the relocation of one of our franchises from a leased facility into a new owned facility effectively the same as a lease buy out.

As is our custom, CapEx numbers exclude the lease buyouts and real estate investments. In the quarter, we spent $19 million purchasing a property we had previously leased. We anticipate $2 million in annualized rent savings from that transaction. We continue to evaluate other opportunities to buy out leases. Year to date, we have spent $33 million in lease buyouts with a cumulative $3.5 million in annualized rent savings. We now own approximately 66% of our dealership facilities.

We have been taking advantage of a low interest rate environment, and by the end of 2013, we will have significantly improved our balance sheet. In doing this, we will have accomplished three objectives; fund our acquisition and lease buyout activities while maintaining our financial flexibility, extend our maturities, the earliest material maturity is now 2020, and lower our overall cost of debt.

To complete our plan, we’re in the process of finalizing and expect to close several additional mortgages in the fourth quarter. Including these fourth quarter mortgages, we expect to leverage to be near the lower end of our 2.5 to 3 times target range and total debt to be somewhat higher than where we began the year. We estimate our average cost of debt will have fallen from around 7.2% at the beginning of the year to 6.7% at year’s end.

During the third quarter, we repurchased $8 million of our common stock or 160,000 shares. Year-to-date, we’ve repurchased $20 million or approximately 500,000 shares and are on pace to repurchase $25 million to $30 million for the year. We have $30 million remaining under our Board authorization and plan to continue returning capital to our shareholders.

Over the last 10 months, we have acquired five franchises representing approximately $175 million of annualized revenues, well on track to achieve our previously announced goal of adding $500 million in acquisition revenue by 2015.

We ended the quarter with total liquidity of $272 million, which includes $235 million under our revolving credit lines, $1 million in cash, and $36 million available in floor plan offset accounts.

During our third quarter earnings call last year, we shared our 3-year capital allocation plans through 2015. Today, we would like to update that plan through 2016. We are planning our business around a slowly improving economy, a favorable financing environment, and a modestly improving SAAR of around 16 million over the course of the next three years.

Based on that, we expect core CapEx of $35 million to $45 million per year, excluding future acquisitions, lease buyouts of approximately $10 million per year as we work towards owning 75% of our real estate, acquisition of an additional $500 million of annualized revenue over the next 3 years. To be clear, this is in addition to acquisitions we completed in 2013, and finally, return of capital to our shareholders by repurchasing $25 million to $30 million of our common stock per year in an ongoing share repurchase program with additional share repurchases possible on an opportunistic basis.

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

Michael Kearney

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 during the third quarter. Our new vehicle revenues and gross profit increased 10% and 7% compared to the prior year. Our new vehicle unit sales were up over 7%, basically in line with the industry. Although our new vehicle margins for the quarter were essentially flat compared to last year at 6.1%, down 10 basis points, the increase in volume more than offset that margin decline. On a sequential basis, our new vehicle margins did improved slightly by 10 basis points. I believe new vehicle PVRs will continue to remain stable at about $2000 a unit.

We ended the third quarter with $574 million of new vehicle inventory or 77 days' supply on a trailing 30-day basis. We're comfortable with our new vehicle inventory levels, but we continue to watch these and our OEM production very closely as we go into the fourth quarter. We increased used vehicle unit sales 25% over the third quarter of last year realizing the benefits of phase II of our Asbury one-to-one program. Although margins decreased 80 basis points to 8.6% compared to the prior year period, the substantial increase in volume more than offset the margin decline. This resulted in an 18% increase in used vehicle gross profit. Our used to new sales ratio was 81% for the quarter as our stores continue to refine their pre-owned acquisition strategy.

We view average one-to-one program as an important engine for future profit growth as we continue to see the impact our earnings from these gross profits. We are generating increases not only in used vehicle department but also the F&I and parts of service departments as well.

We have expanded our purchasing in pre-owned acquisition program to ensure that we maintain an adequate supply of these vehicles. We will keep the levels necessary for our continued growth in this sector.

We ended the third quarter with a $121 million of used vehicle inventory or 37 day supply on a trailing 30 day basis. Our strategy and practice within the F&I segment of our business remains the same. Disciplined execution of F&I sales processes and training create solid, reliable growth in results.

Third quarter F&I revenues grew 20% compared to the prior period. F&I per vehicle retail for the quarter was $1,305 up 5% year-over-year. The lending environment remains favorable.

In the third quarter our parts and service revenue grew 6% and gross profit grew 11% compared to the third quarter of 2012. Parts and service gross margin for the quarter was 60.9% up 270 basis points compared to the prior year. The year-over-year gross profit improvement continues to be augmented by 30% increase in reconditioning work. Our customer pay grew 5% and we experienced a 17% increase in warranty work.

Similar to last quarter, we benefited from a couple of recall campaigns during this quarter and as I have stated in the past you can never predict recalls. We believe we can grow our parts and service business in a mid-single-digit range, while maintaining our current margins through our ongoing customer retention programs.

We closed on the acquisition of three franchises in July, these dealerships are fully integrated into our system and producing the expected level of sales and profits.

Finally, let me express my appreciation to all of our associates in the field as well as those in our support center. Our Company continues to grow on all aspects and our employees are producing best in class results in many areas. This is a direct result of your collective dedication and effort. again I thank you.

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

Craig Monaghan

Thanks, Michael. Listening to the execution that Scott and Michael just discussed you will understand that we are proud of our accomplishments this quarter. We have a great set of brands in great locations and most of all we have great people who have made these results possible. Taking stock of the current SAAR environment we recognize that there has been a flattening in the marketplace over the past few weeks. Whether or not that was driven by the uncertainty in Washington we can’t know. However, in a more stable SAAR environment we do expect that our business will return to normal seasonality with the second third quarters of the year contributing in a greater level of profitability than the first and fourth quarters.

Looking at the longer term when you consider the current age of the vehicle fleet extremely attractive financing rates and the availability of exciting new products we believe that auto sales will continue to improve over the coming years and that our proven ability to execute will allow us to continue to deliver attractive returns to our shareholders.

I would now like to turn the call back to the operator and we would be happy to take your questions, operator?

Question-and-Answer Session

Operator

(Operator Instructions) And we’ll take our first question from Rick Nelson with Stephens.

Rick Nelson - Stephens, Inc.

Asking about the used car performance, same-store sales have really accelerated the last couple of quarters. If you could point, Michael, to the drivers there and whether you think that type of growth is sustainable?

Michael Kearney

So, couple of things that we put in place I guess over a number of months and quarters have really come to fruition. First of all, we have put a lot more capital in the inventory itself. We are carrying a lot more product, and that spectrum of products that we have got out there we have broadened it dramatically. We have expanded reconditioning hours, whether it’s going into evenings or just over the weekends, we are getting our reconditioning work done a lot faster. We've expanded our used car buying teams. We are sending a lot less product to the auctions. We are keeping them at the individual stores. We are transferring them to other stores, so we are saving a lot of fees. We have got just a quicker availability of product, and it’s just a continuation of making trade acquisitions more quickly and more effectively at the dealership level.

So, I think that’s the first part. The second part, as I have discussed many times, it’s a very big market, used car market is essentially the way I look at it, 3 times the new car market. So I think there is substantial opportunity. Don’t know if we can continue to grow at this pace, but I just think there is a substantial opportunity out there, and we will just keep refining our processes.

Rick Nelson - Stephens, Inc.

F&I per unit also another record there, if you could comment on the sustainability and whether you are seeing any change as a result of the CFPB?

Craig Monaghan

Again as I have mentioned, there is always a bottom third -- I sound like a broken record, but there is always a bottom third of our business and we have a very, very disciplined and dedicated program to focus on those individuals as well as our internal certification program. We take some of the best off the sales floor, put them through a very rigorous certification and training program to put them in our F&I processes. So we will continue to do that. I think there is always an upside to that. We continue to focus on product sales. We continue to focus on retaining those customers. That way, we want to sell products of course that have substantial value to consumer as well as bring them back to our parts and service department. So, I think -- and we will continue to do that, we'll continue to grow that number.

As far as the CFPB, it's -- there is not a lot of clarity from our side of the picture, we've not really had any impact to speak off, I think it's wait and see from our standpoint, but at this point in time it's of no relevance to us right at this moment.

Rick Nelson - Stephens, Inc.

Thank you for that. Like to also follow up on the commentary about October, and curious if you have seen sales change since the government went back, I am sure that had some impact on consumer confidence.

Craig Monaghan

Hey Rick, it’s Craig, maybe I can jump in and take a shot at that. Clearly, the sales slowdown in September, and we started off in October essentially, I would say, at the same kind of pace. It certainly wasn't the same feeling in the stores that we had as we were working our way through the summer. I think the big question is was that a result of the uncertainty in Washington? Or are we as an industry moving back to what we have seen historically where there is a significant seasonality factor, in that the first and fourth quarters are typically much slower than the second and third quarters, and maybe it’s a combination of the two. That's the message that we wanted to get across is that we’re all aware that the SAAR slowdown in September, and we just wanted to point out that we may just be getting back to what has been normal for the last 10 years other than the recovery since the recession, and maybe that's where we’re headed. And Michael you might have something to add?

Michael Kearney

Yes, Rick again I don't want to make a big deal about the governmental issue, but consumer purchasing of hot aisle products is an emotional event. So they can be persuaded one way or other by news and events. But we don't put a lot of -- don't want to put a lot into that, I agree with Craig that I think haven't been in this for long, long time, we’re returning perhaps to some of the seasonality. But I’ll just finish it off by saying October is now running better than September end.

Rick Nelson - Stephens, Inc.

October is a small month, right, within the quarter it's very December heavy for you particularly for the premium luxury?

Michael Kearney

Yes. As you have seen evolve particularly over the last, I would say, four years, the luxury brand start their push now middle November, so BMW, Audi, Mercedes Benz, Lexus, Acura start their big push about the 15th of November, so it's a little back end weighted for the fourth quarter.

Rick Nelson - Stephens, Inc.

Thanks a lot, and good luck.

Operator

We'll take our next question from John Murphy, Bank of America.

John Murphy - Bank of America

Just a first question to follow up on Rick's question on the October sales numbers on what you are seeing, when you talk about sort of flattening out, I mean that could mean a lot of things, so I was just trying to understand it. SAAR last month was 15.2, but there is a lot of confusion on where the Labor Day landed. So if we looked at August and September together, we were sort of at 15.6 to 15.7 SAARs. That kind of -- not maybe put an exact fine point on it, but are you seeing sort of a mid-to-high 15 SAAR or you are seeing a low 15 SAAR for October, because there is pretty big difference there between whether it's a low 15 or mid-to-high 15?

Craig Monaghan

John, I will start and maybe Michael can follow up. We're not doubting into trying to quantify the SAAR in any given period. I think what we’re saying is that the traffic in the stores, the traffic in our websites certainly during the last two weeks, first week in October, we saw a significant slowdown relative to what we had seen in the prior two, three months. Like Michael said, its October started slow, but it has since started to show some improvement. But we’re very much in a -- let's see where it goes from here like we just said to Rick. The fourth quarter is all about the month of December, and we just don't have that much visibility into where we're headed.

John Murphy - Bank of America

Okay but this statement is relative to last couple of months as opposed to just September itself?

Craig Monaghan

Very much.

John Murphy - Bank of America

Then on the parts and service we're seeing improvement really across the broad in your categories there, just curious as we think about the backlog of cars growing in that business moving in the right direction even better than it may be has already, just trying to understand the SG&A dollars that would be tied to the growth in gross profit sales and gross profits in the parts and service business. so there are a lot of SG&A dollars that come in there or are SG&A dollars more associated with new and used vehicles sales.

Unidentified Company Representative

I think we don't quite understand the question, I mean a lot of our SG&A quite frankly is fixed, and then there is a very large people component. On the parts and service side a lot of the people expense is actually recognized before we just took the gross line.

Michael Kearney

This is Michael let me see if I can take the shot at it if it’s on the fixed side of the business since we don’t have a variable sales component to speak of our flow through once we get to a certain level of fixed is much better, I don’t know if that what’s you’re asking or not.

John Murphy - Bank of America

So yes, so basically I mean if you look at the company on average year, this quarter you were 70.9% SG&A to gross profit that actually might be as the same as the same store sales or the gross profit grows on the part and service side it would actually be a lot lower than that and the flow through would be a lot higher than what you’re seeing on the corporate average.

Michael Kearney

Yes, that’s correct.

John Murphy - Bank of America

Okay, good. And then just a last question on luxury, it outperformed quite significantly for you in the quarter. What are you seeing there from those buyers? I mean, they seem to be sort of desensitized to everything that’s going on right now. Is that something where you think that you’re seeing good showroom traffic and able to close people fairly easily?

Michael Kearney

So, John, this is Michael again. So I’ll answer in reverse. I don’t ever like to say that we close anything easily. it’s a lot of effort and a lot of work. I think there is two parts to the luxury increase in the third quarter. One is as you know the luxury brands have expanded their product offering. so I gave you a perfect example, the CLA with Mercedes has an opening price point of just below $30,000. So we’re bringing in buyers that perhaps two years ago would have never considered or been able to consider a Mercedes. we’ve got the one series with BMW and you know I can go on and on but we are seeing an expansion of the product.

I think there has been a substantial amount of new product brought along Audi, Acura, BMW, Mercedes it’s the cadence of that product in the last 18 months has been dramatic. And I think you’re right on the third point I would make I would agree with you. I think a lot of the buyers that are in the $50,000 to $90,000 MSRP range are somewhat shielded from the vagarities of the press and they are somewhat shielded from ups and downs in the economy so we’re seeing them return. Leasing is very attractive today. So I think all those put together account for the nice increase in luxury business we saw in the third quarter.

John Murphy - Bank of America

Okay, and truly just one last question. Along with that when you sale a luxury car almost all the time they have full lifecycle service contracts for the first four years, is that correct? And will that help out parts and service going forward and are you seeing them bleed down much more into the mass [indiscernible] like what we saw at Toyota care so that you are sort of really even more naturally capturing a greater portion of really the first three or five years of service from the luxury cars and from maybe even the mass market cars?

Michael Kearney

John, this is Michael again. So I think generally speaking the luxury brands have a much higher customer retention in the service department throughout the lifecycle I think that is a correct statement. Not all brands supply maintenance to the consumer. But of course we do sell maintenance for packages on the brands that work side included we do very well with those. But I think generally speaking all of the luxury brands have a very… a much higher retention in the service department than say the midlines of the domestics. Because of that yes we see nice growth and nice sustainable growth in the parts and service departments with those brands.

John Murphy - Bank of America

Great, thank you very much.

Operator

We’ll take our next question from Bill Armstrong with CL King and Associates.

Bill Armstrong - CL King

Good morning. One felt up part from service gross margins up nicely and strongly. Is that really due to mix or did you see margin improvement in any of the sub categories within parts and service?

Michael Kearney

Bill, this is Michael. We -- as a direct result of the substantial increase in used car business we’ve seen a substantial increase in our internal work where the margin is dramatically higher. it’s essentially 100% and it’s almost all labor.

Unidentified Company Representative

Let me -- it’s not a 100% because we charge more, it's a 100% because in the accounting we eliminate the revenue so for the internal work. So as we shift the mix we’ve seen the strong growth in the internal recondition has improved the overall margin for products and services.

Bill Armstrong - CL King

Okay, got it. And shifting to used vehicles your gross profit per vehicle was down year-over-year. What the -- even as volumes were up, what can you point out or call out on that?

Michael Kearney

So, Bill, this is Michael. again it’s a couple things one we’ve truly expanded the price band of vehicle that we’re carrying and especially in a lot of stores we are carrying a lot lower priced vehicles in our non-luxury stores. So that contributes to part of it. I think the other part of it is as we’ve grown the business, we’ve accelerated the pace in many of our stores. We have consciously accepted a lower gross profit margin so that we will move the vehicle faster in and out of the inventory that velocity contributes to the ability to sell more and more cars out of any one particular outlet. So I think that’s a natural part of that growth curve. that is the part that we focus on and we work on. It is something, it’s a conversation piece everyday but it is not and was not unexpected as we grew the volume.

Bill Armstrong - CL King

Okay and then finally on mid-line imports, we've been hearing that there have been some gross margin pressures stair-step incentives, looks like your gross margins were pretty solid probably up year over year, are you seeing any of those kind of pressures?

Michael Kearney

Bill, Michael again, you know, there is a particularly throughout the third quarter which was in the summer time. There were some incentives by manufacturer; it’s a model changeover incentive. There were some stair-steps, nothing I wouldn’t call dramatic, but we are seeing from all those brands a push for market share. We grew our market share in all of those brands over the third quarter, but we also focused on the ability to return a fair amount of profit to the stores. So I think the question is, there is pressure, there is absolutely pressure for market share out there, but I don’t believe there was any excess amount of incentive pressure that we saw in the third quarter.

Bill Armstrong - CL King

Got it, okay. Thanks very much.

Operator

We will take our next question from Brett Hoselton with KeyBanc.

Brett Hoselton – KeyBanc

Good morning, gentlemen. First just wanted to ask you a quick point of clarification; it’s interesting in talking to a number of clients in recent months, it appears as though there is the impression that warranty business carries with it lower margins and therefore as your warranty business grows faster maybe negative in terms of your margins, but my impression is through our family’s business that warranty carries with it higher margins and should actually be accretive to your margins as it grows faster. Which is correct? maybe you could just clarify that for good investment community?

Michael Kearney

Brett, this is Michael. What warranty business carries for us essentially the same margin as our customer pay business, so it does not carry anything less or anything substantially greater. So we do not consider it dilutive to our business at all and it’s -- I look at it the same way on a rate wise as our customer pay business.

Brett Hoselton – KeyBanc

And that is you think about the maintenance program as John referred to and where are those captured in your business, is it under warranty under customer pay again I’m referring to the maintenance programs in BMW or something all knows?

Michael Kearney

It is captured in the warranty piece of the business, the factory programs, if it’s a factor supply program.

Brett Hoselton – KeyBanc

And that is we think about the used car gross profit per unit, it sounds like you’re making a conscious decision to kind of maybe take a little bit lower gross profit; so therefore as you think about your gross profit per unit on the go forward basis, is this kind of reasonable expectation from where you should be at -- this quarter you’re in 1.7 billion or I mean $1700 per unit, is that kind of the new go forward rate for used car gross profit per unit or is there some expectation that things might get little worse or things might get little better?

Unidentified Company Representative

Well, you listen to the people that I have talked to in our departments they’ll tell you better not get any lower than this. I think that this is something that we’re going to stabilize internally. There may be some ups and downs to it, but this is -- we’re putting programs in place to try to return to a little bit higher number that what we’re seeing today, but we don’t want to take any emphasis off of the volume push either.

Brett Hoselton – KeyBanc

And then finally you’ve got a very good exposure to Honda that Honda seemed to have performed the industry in the third quarter quite nicely and I guess it seemed as though maybe regionally Honda maybe didn’t perform as well in your region and therefore you didn’t necessarily benefit from the outperformance that we saw nationwide, can you maybe speak to that a little bit?

Unidentified Company Representative

Yes, our Honda stores did very well in third quarter. We gained market share in our markets with Honda in the third quarter. We happened to be -- I don’t know if it’s recently -- I can’t tell you about other regions of the country that we don’t operate in because I don’t look at it, but we grew our Honda business in the third quarter and we saw market share gains.

Brett Hoselton – KeyBanc

Thank you very much gentlemen.

Operator

We will take our next question from Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank

Good morning, it’s Dan Galves for Rod. How you guys doing? I wanted to ask about sequentially SG&A spending, we noticed that gross profit was up about $3.5 million versus Q1, but SG&A was up over 5 million sequentially just was there anything specific you can call out that drove kind of an increase in spending and has there been any change to your view on the level of SG&A spending at kind of this particular gross profit level?

Scott Krenz

This is Scott. The answer is there is nothing particular to call out. We have always said that from period to period that could be a little lumpy, and we are just experiencing some of that. We continue to focus on initiatives within the company to improve productivity and to keep cost under control, certainly higher proportions of profit coming from areas likes parts and service and F&I help that number as well. So we would expect to something that’s more like the year-to-date as opposed to the single quarter here to be sort of the going forward rate and we'll continue to try and improve that.

Dan Galves - Deutsche Bank

Okay, that’s perfect, thanks. And just one other question, just to clarify on the parts and service margin, I think last quarter, you know when we first saw like a real kind of strong growth in recon and prep that seemed to drive the margin higher. I think you were talking about that you talked that the gross margin in Q2 was a bit unsustainable as kind of the growth rate in different parts of the parts and service business normalized or kind of come back together a bit. Now you are saying affecting mid-single digit growth with similar margins occurring, you now is saying that you don’t expect the gross margin in parts to normalize downward.

Michael Kearney

Dan this is Michael. I think as I mentioned earlier the growth rate of used cars, you know was substantial particularly in last two quarters. I think we will continue to grow our used car rate which drives a lot of the reconditioning work, but I wouldn’t want to say it anti, we can grow it to 25% of core. So I think that’s part of where we come up with the mid-single range growth in the fixed department.

Dan Galves - Deutsche Bank

And how about on the margin side, do you think that this kind of close to 61% level is sustainable?

Michael Kearney

I think 60% - 61%, yes I do.

Dan Galves - Deutsche Bank

Okay, great, and then just -- maybe one follow up on the used business. It sounds like most of your incremental units are coming from being a little more aggressive on trades. Are you also seeing better flow of lease returns in auction vehicles? What are you seeing in terms of kind of used car population and how that’s helping your used growth?

Michael Kearney

Yes, Dan this is Michael again. There is no question that with leasing, returning necessarily, we have started to return three years ago. We are seeing more leased turn-ins and that absolutely helps us. There is also more availability of some product at auctions but we are not buying as much at the auctions as we used to, because we are taking a much more aggressive stands in buying them at our trade desk. So I think that’s where we are seeing the biggest increase in our inventory availability. But there is no question the availability of leases particularly when we want to get into the certified pre-owned business, that availability helps us a lot.

Operator

We will take our next question from Jamie Albertine with Stifel Nicolaus.

Jamie Albertine - Stifel Nicolaus & Co.

Great, thanks and good morning guys and let me add my congratulations on this, what I think is a very solid quarter particularly in the used business. I wanted to ask you, given your relatively broad portfolio, you got some stores that are in markets where there were faster to recover, you’ve got other stores in markets that have been slower to recover; looking within your portfolio, do you see any key variances in the operating performance first at the stores that are in the kind of faster to recover versus slow to recover markets. And separately, do you see any key to incentive variances or manufacture approaches to each of those markets respectively?

Michael Kearney

Jamie, this is Michael. I will take a shot at that question. As far as geography goes, Florida very strong quarter, Texas very strong, but I would also point out that the Atlanta markets, because of the growth in used cars was very strong; our Mississippi market very strong. And then the Mid-Atlantic ones, again stable, not as the growth rate as strong as Florida, but I would say very stable.

As far as incentives, most of the incentives that we’re seeing, that we saw in the third quarter are broad brushed with the exception of perhaps in the Southeast with a couple brands particularly, as you know Southeast, Toyota is dominant in the Southeast and they have their own set up incentive, so they are a little bit different than say TMS or [indiscernible] states what have you, that’s really the only variances and regional incentives that I can recall.

Jamie Albertine - Stifel Nicolaus

And then just one final question, looking at your longer term plan out to 2016, could you provide us with any sort of color, even if it’s very broad at this stage, of what your perspective is on operating margin, expansion over that period, or if you're not willing to sort of put a point on that, maybe just by order of magnitude, how much of the expansion that I am assuming you are budgeting into your forecast are driven by existing stores versus sort of the 500 million in new store sales that you are looking to acquire over that period.

Craig Monaghan

Well Jamie, now it’s Craig, I will give that one a shot. Like Scott said our long range plan starts of in assumption that the stars going to be somewhere in the range of 16 million units over the course of next three years. And we -- so we think our new vehicle growth rate will be at those levels. we think we can continue to grow used vehicles probably somewhat faster than that but certainly not the levels that you've seen historically at least over the last couple of quarters. we talked about -- we feel we can get good solid single digit growth in parts and service, we'll continue to work on becoming more and more efficient with the way we run the business.

We still talk about internally wanting to get 40 or 50% pull through on an incremental dollar gross profit. Now it's a fundamentally that's what we're trying to do with the core business. And then Scott mentioned what we anticipate doing with the cash, because when we look at our strategic plan, it's essentially got two legs. One is we want to be outstanding operators and two we want to be outstanding allocators of capital, and Scott walked you through what we're looking to do there and we think the capital allocation fees can also bring tremendous incremental value when we put the two together we get very excited about our future.

Jamie Albertine - Stifel Nicolaus & Co.

So, if I'm hearing you right, just to clarify, the pressure on the business from a profitability perspective seems to be the new vehicle side of it right now and you're seeing outsize growth and the higher profit more dynamic parts of the business is particularly in use and obviously in parts and service which should help to enhance throughput, if I'm hearing you correctly.

Unidentified company representative

I think that's very true.

Operator

We'll take our next question from Brett Jordan with BB&T Capital markets.

Brett Jordan - BB&T Capital Markets

Good morning, question on our parts and service gross margin and pick up, has there been a benefit there's only decreasing focus on tires and I've noted that our strategy in the past it wasn't mentioned on this quarter's call. That's something that's maybe benefiting growth as a less focus category.

Michael Kearney

Brett, this is Michael, no actually to the contrary, we've expanded our tire business, we had a very nice tire contest. We've got a national fixed operations marketing media campaign that starts now which was a huge emphasis on tires. What we see, and what we've said for two years is that the sale of tires although it is a very low margin part of the business, brings with it increased service and parts customers and increased service and parts business, and some of that business is very high margin business. Alignments, all wheel alignments, rotation of tires, break work and maintenance, so we have not backed off the tire program at all again, to the contrary we've expanded it. We've expanded the marketing and the push of it and we view that as a customer retention tool.

Brett Jordan - BB&T Capital Markets

Okay great and then one question I guess as you talked about September and early October trend, was it equal sort of softening in new and used or did you see used remain strong and may be this is a consumer confidence issue that the buyer is trying to shift to a lower cost option.

Michael Kearney

Brett, this is Michael again, you know I hate to try to predict what the consumer will do after all these years I still hate to do it, but I will tell you, the used car business did not soften to the extent that the new car did.

Brett Jordan - BB&T Capital Markets

And I guess on used pricing then, would your expectation be that if we're seeing a slowing in sar that we're going to see pretty sustained high used vehicle pricing.

Michael Kearney

You know our vehicle pricing is more a function of what we put in the car and the market place in general so I don't necessarily think that will happen, no.

Operator

And we'll take our next question from Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley

Thanks good morning. If I can touch on the F&I business, you guys I think mentioned in your last earnings call that you're seeing some banks move to GAAP rates. Have you seen any movement from the banks this time, in the last quarter and also there's been some media reports about some dealers getting letters from the lenders, just pointing out some of the transactions in the past and some of the standards on lending, have any of your dealers received those letters?

Craig Monaghan

Ravi, it's Craig, I'll take a shot at that. I would say, historically the banks have also, have always had different forms of caps on the stores, whether that's interest rate caps or how much money they're willing to provide for the additional products that we sell in the stores, so I don't really feel like there's been any significant change in that part of the business.

We also have internal caps, same thing, not only on the rates but also on the pricing of the incremental products. Those things have not changed, we have seen a few letters from banks, a very few letters. But broadly speaking like Michael said earlier, we continue to do business very much along the lines of what we've done in the past, we've always been very careful, very conscious about that piece of the business, a big part of our audit program is geared towards our F&I offices to make sure that we're in compliance with the loan treating our customers fairly. Where this goes from now, I think we're very much in a wait and see and we really don’t have lot of clarity on what’s next.

Ravi Shanker - Morgan Stanley

And just a little bit of the used business, we saw some headlines come across before this call started about you potentially talking about exploring standalone stores for used car business much line another dealer announced yesterday. Can you elaborate on that a little bit more and is that in you capital plan, I’m sorry if you already addressed on that.

Michael Kearney

I guess we look at it this way, I think we demonstrated that we’ve got some pretty good used car people in this company, you’ve seen their results. We also, we spend lot of time looking at what our competitors do and where the opportunities in market and obviously the used car business is a very large opportunity, that while we’re taking advantage of part of it we’ve recognize it’s a $40 million to $45 million unit business out there and maybe there is an opportunity to do more. So, we do explore that, we are exploring it today, I think we’ve got an obligation given our availability of capital and expertise to explore that market but at this point we really don’t have anything meaningful to say, it’s something that we’re taking a look at.

I think that wraps up our questions for today. We appreciate your questions and look forward to talk to you again next quarter.

Operator

And that does conclude today’s presentation. Thank you for your participation.

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