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Asbury Automotive Group, Inc. (NYSE:ABG)

Q2 2010 Earnings Conference Call

July 27, 2010 10:00 AM ET

Executives

Ryan Marsh – Treasurer

Charles Oglesby – CEO

Craig Monaghan – CFO

Michael Kearney – COO

Analysts

Rick Nelson – Stephens Inc.

Dan (ph) – Deutsche Bank

John Murphy – Bank of America / Merrill Lynch

Operator

Good day and welcome to Asbury's Automotive second quarter financial results conference call. Just a reminder, today's call is being recorded.

At this time for opening remarks and introduction, I will turn the call over to Mr. Ryan Marsh. Please go ahead sir.

Ryan Marsh

Good morning to everyone. Welcome to Asbury Automotive Group's second quarter 2010 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 second 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 the call up for questions and I'll be available in my office afterwards to address any follow-up questions you might have.

Before we begin, I must remind you that the discussion during the call today is likely to contain forward-looking statements. Forward-looking statements are statements other than those which 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 information regarding certain of these risks that may cause actual results to differ, please see our filings with the SEC from time to time including our Form 10-K for the fiscal year ended December 31, 2009 and any subsequently filed quarterly reports on Form 10-Q. We expressly disclaim any responsibility to update forward-looking statements.

It is now my pleasure to turn the call over to Charles.

Charles Oglesby

Thanks, Ryan and good morning everyone and thanks for joining us today. Today we reported Asbury's second quarter income from continuing operations of $0.42, more than a two-fold increases versus $0.20 a year ago. These results were driven by a 13% increase in revenue and a reduction of 400 basis points in SG&A as percentage of gross profit. We saw double digit growth in new and used vehicle units. Parts and service gross profit is up 5% boosted by a 5% increase in customer pay, and finance and interest gross profit improved 35% with F&I per vehicle working back over $1000 a vehicle. Our operating income margin of 3.4% is a 31% increase over a year ago and sequentially is up 13% over this year's first quarter.

Asbury has covered a lot of ground in a short period of time with many of the initiatives we have put in place in order to improve our profitability regardless at the broadest SAR environment and a 11 million SAR is still a very depressed sales environment, yet Asbury continues to deliver healthy results. I am also very encouraged by the completion of our IT strategy review and the result plan to take us to the next level of productivity gains. Craig will fill you in on the details and I will turn the call over to Craig now.

Craig Monaghan

In the second quarter, Asbury delivered income from continuing operations of $0.42 per diluted share versus $0.20 in the prior year period. Last year results included a charge of $0.04 per diluted share due to expenses primarily associated with the company's relocation and restructuring activities. Our improved performance was primarily the result of a 13% increase in gross profit and 400 basis point decrease in SG&A as a% of gross profit.

This quarter in particular demonstrates our ability to flow through incremental changes in gross profit to operating income. While our gross profit increase 13% compared to the prior period, operating income jumped 46%. We were able to flow through 55% of the increase in gross profit to operating income as a result of our leader cost structure and discipline. While analyzing SG&A expense it is important to consider rent expense. Renting versus buying is a financing decision. Either you pay interest expense on a mortgage, repay rent expense with a lease. The expense however, it's different parts of the income statement and can potentially distort productivity analysis. If you will adjust our SG&A for rent expense, Asbury's SG&A as a% of gross profit was 70.5% in the second quarter. We embedded a new table to our standard press release that provides more visibility on our rent expense. We are maintaining our capital spending discipline in 2010, the CapEx target remaining at approximately $25 million roughly in line with our depreciation expense. We expect our effective tax rate to 38% to 40%.

With respect to discontinued operations, a majority of the $900,000 loss was linked to dark (ph) rents on vacated properties we no longer conduct operations. Absent non-recurring items, we anticipate incurring $0.02 to $0.03 loss per diluted share per quarter for the foreseeable future. Our financial condition remains strong with total available liquidity of approximately $260 million as of June 30, 2010. This includes cash and (inaudible) offset availability of $94 million as well as borrowing availability of $166 million. We have a strong capital base, liquidity and flexibility to retire debt, grow organically or grow through acquisitions.

As a result of the comprehensive IT strategy review we announced in the first quarter, we have decided to use ADP as our common DMS provider. We anticipate our first group of stores going live in October and completing the rollout companywide by the end of next summer. We do not anticipate any material financial charges or increased expenses as a result of this transition. Over the long-term we expect continued productivity improvements from these investments as we install a fully integrated state of the art suite of tools in all of our stores.

Our entire organization is extremely excited and energized as we prepare to enhance our IT infrastructure. We are looking forward to a quick, (inaudible) disruptive implementation. Now I would like to turn the call over to Michael to provide some operational highlights for the quarter. Michael?

Michael Kearney

Thanks, Craig. Everything I will be covering with respect to operational highlights will pertain only to our light vehicle retails business on a same-store basis. Our attractive brand mix of luxury and imports contributed to the 11% increase and same-store new vehicle unit sales. Luxury new unit sales were up 14% and midline import unit sales were up 9%.

Our general managers have been doing a fantastic job maintaining a disciplined nimble approach to running their stores during this uncertain market environment. Many of the initiatives we have touched on in prior calls are starting to take hold as demonstrated in this quarter's exceptional results, a particular note are our used car retail strategy and our F&I training program. I will refer to those within their respective segments.

Same-store new vehicle unit sales were up 11% in the second quarter versus last year while new vehicle revenues were up 16%. Generally speaking unit volumes increased across each of our brand segments consistent with overall U.S. vehicle sales. Increased unit sales were primarily the result of less stringent consumer lending standards, enhanced financing incentive programs by certain manufacturers and a favorable comparison with the weak economic environment we face in the second quarter of 2009.

In addition to the strong recovery in unit sales, new vehicle retail margins remain close to 7%. Inventory levels to continue to remain alive with consumer demand and preferences.

Looking ahead, we're very comfortable with our new vehicle inventory levels of 63 days.

We continue to see strength in used vehicle unit sales with a 13% growth compared to the prior period while maintaining gross margins around 11%. The used market continues to perform well due to relatively high demand and favorable pricing.

Asbury's used vehicle sales have grown significantly over the last quarter, a performance that substantiate our implementation of the Asbury 121 program. Our aggressive inventory management supported the increased unit volumes while keeping our day supply at approximately 34 at the end of the quarter.

The rebound and F&I we started to see last quarter has continued into the second quarter increasing 35% compared to the prior year. This improvement is due to the double digit growth and same store unit sales and magnified with a 17% jump in dealership generated F&I per vehicle retail to a $1005.

F&I continues to benefit from increased product sales, improved consumer credit, consisted rates from our lenders and our focus on training of our F&I personnel on best practices. This training program developed internally supports our general managers and F&I staff in all areas of the sales process. These are fantastic results and I'm extremely pleased with the progress of our F&I team and the work they've done over the last 12 months.

Revenues in our parts and service business were flat compared to the prior year period. This is the first quarter in seven quarters where we did not experience decline revenues. More importantly, however, gross profit increased 5% over the prior year period due a 5% increase in customer pay and increased volumes from the reconditioning of used vehicles.

We are encouraged by the increase in customer pay, which more than offset the decline we experienced in warranty. Companywide our customer pay RO account is up over 4% compared to last year. During the second quarter, customer pay represented 63% of our light vehicle parts and service gross profit while warranty comprised 15%.

This quarter we have decided to add a table to our press release that provides a more detailed breakout of our parts and service gross profit.

Before I close, I'd like to emphasize Craig's point on Asbury's IT strategy. I would like to emphasize that this is not just simply a DMS conversion. Our technology decisions will provide an invaluable suite of tools that will allow our sales and service teams to dramatically improve the customer experience by expediting the sales process and maximizing the life time value of our customers.

Other benefits for our stores include ease of use as well as enhanced reporting and improved process efficiencies. I'm very pleased with the operating performance and would like to extend my gratitude to everyone in the field. Thanks again for your excellent execution and dedication to our customers.

With that I'll hand the call back to Charles to conclude our prepared remarks. Charles?

Charles Oglesby

Thanks, Michael. We believe we're making progress in formulating the ideal large automotive retailer business model. In order to differentiate us it is critical to install a winning culture that leverages our scale while retaining the ability to respond quickly to changes and local area markets.

We run the business as a partnership with our general managers and treat them as entrepreneurs and leaders to run Asbury's dealerships while providing them with the benefits of our scale.

It is important to note that these benefits are not limited to simply pulling out cost. These benefits also include providing tools and frameworks for sharing best practices. While the pace of economic recovery remains uncertain we continue to invest in Asbury's future in order to make a positive impact on our customers, our employees, to communities we serve and our shareholders. Although the market has improved compared to last year, we believe it is prudent to continue operating conservatively. Despite the increased volatility in our sector, we will continue with our approach of speaking to our results. During this period of depressed SAR, Asbury has demonstrated its ability to improve profitably as well as the fact that the deal model works.

As we turn this corner we're now more prepared than ever to enter the creating value phase. I am very pleased with the progress to date that Asbury has delivered. Look into the future, we are seeing the pace of activity in the acquisition market strengthening and we have the capital to toy in order to take advantage of these more compelling opportunities.

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

Question-and-Answer Session

Operator

(Operator Instructions) We'll go first today to Rick Nelson with Stephens.

Rick Nelson – Stephens Inc.

Can you talk about the regional performance, strengths and weaknesses I'm particularly interested in Florida?

Michael Kearney

Rick, this is Michael. Florida has rebounded very well. Actually, most every part of our business in the southeast and east has done very well. We've seen increased in new used unit sales as well as profitability in all those markets pretty much across the east and southeast.

Rick Nelson – Stephens Inc.

Thank you for that. I am wondering if you could also comment on your biggest brand Honda. I know we saw some – their unit sales lagging the industry and why do you think that is and what's the future on hold for Honda.

Charles Oglesby

This is Charles. I'll make one comment on that and let Michael give a little more color on it. As you know Honda is one of our great partners. They are in between a little product right now compared to sort of the rest of the market. We are very bullish on the future with Honda. I mean we've been part of them a long time. We've seen the same thing happen in other points with Honda when they were out of step with the market for some of the products.

They've got some great products coming. It's a great brand and a lot of loyal customers. So I think that what we're seeing right now was just a temporary decline in the percentage of sales with Honda. We're very bullish on Honda for the future.

Michael Kearney

Rick, I would just add one piece to that. If you look at the Acura segment of the Honda business, they've experienced a 20% growth year-over-year in volume without any really new product, just product that was not available last year. So I think that's evident that the consumer is still very strong on the brand as we are as a company.

Rick Nelson – Stephens Inc.

When you look at the gross profit increase by segment, it looks like they've been aligned to domestic and luxury segments saw some very good growth and the midline imports were down. Is that driven by Honda or it has had other factors?

Michael Kearney

Rick, this is Michael again. I think it is driven to a certain extent by Honda. I think also if you look at the volumes that we've experienced with Nissan, which is a little bit lower margin business that contributes to that. We look at our midline – at our domestics particularly our Chevrolet and Ford Stores, we've seen nice increase in the vehicle grosses as well as the ability to have product available for sale this year versus the shortage of product that we all experienced in the domestic brands in the second quarter of last year.

Rick Nelson – Stephens Inc.

Any comments on what you're seeing to-date in July? We're hearing about a nice recovery in the industry.

Charles Oglesby

What we're experiencing is kind of a mirror of June. I think there's still some uncertainty in the marketplace. Again where we have positioned ourself is whatever happens in the marketplace we will do well; we will be profitable. We're looking forward to the day when consumer confidence comes back and we get back to the volumes of 13, 14, 15 SAR, which I believe will be there.

I don't think we're going to see the type of recovery personally in the second half that many people thought what happened earlier in the year. We've always said we're going to be conservative with our company and we know that we are prepared to be able to move with the market. So from our perspective we know that we can take advantage of – whatever way the market goes, we will be in good shape.

Operator

We will go next to Rod Lache from Deutsche Bank.

Dan – Deutsche Bank

Thanks for the additional disclosures. Really appreciate that. Wanted to focus a little bit on margins here. In the parking service business, on a company-wide basis margins were 52.3%. We haven't seen a number that high in a while. Can you – is there anything – was there anything in there that's not sustainable, kind of takeaways should we take from that type of number.

Michael Kearney

Hi Dan, this is Michael. I think, well I know this, I don't think this – I know what we are experiencing in the service department is a – customers that have higher mileage vehicles, and all the vehicles are starting to return to the shop. Along with that, we are seeing more of what we would call the major type repairs. Not just oil changes or your brake pads, but maybe rotors being replaced, tighten belts being worked on. We've experienced, at least in a number of regions a nice increase in the gross profit per customer (per repair). So, I think they are all contributing to that increased margin that you are seeing. And we believe this is a trend that will continue.

Charles Oglesby

Yes, maybe I can just harp in there behind Mike and then give you a little more color. We've been digging pretty hard into some of the underlying data within the fixed-cost business, and what we are finding, at least on a preliminary basis, is that the number of miles on a vehicle is growing substantially versus where they were three or four years ago. You go back into the 2007-2008 range, over 40% of the vehicles coming into our shops would have 30,000 or fewer miles on them. Today that number is down substantially. It's been replaced by much older vehicles.

The other thing that we are learning is that the, as you would expect, the dollars per RO on an older vehicle are substantially higher than the dollars per RO on a vehicle that's that got less than 30 miles – 30,000 miles, sorry. You put these two things together, and it may answer some of the questions of what we are seeing not just in our business but across the industry in this parts and service business this quarter.

Dan – Deutsche Bank

Yes, thanks a lot for that. Just a follow up a little bit, I mean, there's – there's been a concern about pressure on the customer pay business as, you know, there's a population of three to four year old vehicles or less goes down. But it sounds like you guys are getting your fair share of older vehicles that are out of warranty for kind of normal repair, for non-warranty repairs. Is that just what you are seeing?

Craig Monaghan

Older vehicles are becoming a much larger percentage of our total population.

Dan – Deutsche Bank

Got it. Got it. I understand.

Craig Monaghan

And it has been – and they have been growing as a percentage of our population consistently over the past, let's say, two years.

Charles Oglesby

You know Dan, just one little bit echo to that, this is Charles, is this is what we are supposed to do. Again, we go to the market to regain share that we lost to the independent. And as we are growing this segment of our business, that's what you are seeing with the dealer model out there. They are competitive in the marketplace, first as the independent. The consumer has had a lot of experience now with the independent. And with the growth not only in the customer service area of our business, but the value side of it, these customers are coming back in after the dealerships.

Dan – Deutsche Bank

Okay. Thanks a lot for all the color on that. And moving on to used vehicles, I am sorry, on the new margins, I did notice a sequential decline in the dollars per unit gross margin from kind of 2,200 range down to less than 2,100, you know, that's on a corporate basis. Are you guys seeing something in the fourth quarter or in the first quarter that was – is there anything you can chalk up the sequential decline there, should we be looking for margins like this going forward or back to what you guys were doing in the fourth quarter and the first quarter?

Michael Kearney

Dan, this is Michael again. I think, in the second quarter, we experienced a little bit of a makeshift in what we've available to sell. You know, that was a little different from what our standard mix is. We as you know, have a fairly large footprint in the luxury side, and there was some constraint of different models, particularly with brands that had – they are introducing new products. So, that's where we carry the higher margin. We also then saw a growth in some of our midline. So, I would expect that as the make – products within certain makes, particularly in the luxuries become more available as they did in the month of June, we will see at least a consistency in the margins that we produced for the last four quarters.

Michael Kearney

Thanks, Dan.

Operator

(Operator Instructions) We will go next to John Murphy with Bank of America / Merrill Lynch.

John Murphy – Bank of America / Merrill Lynch

Good morning guys.

Michael Kearney

Good morning, John.

John Murphy – Bank of America / Merrill Lynch

You've done obviously a great job on cost cutting and really streamlining the business in a really tough time, and when you adjusted that rent factor being at 70.5%, SG&A gross is really impressive. And but it does seem like there's was some more wood to chop and you are putting a common DMS in, that's, you know coming over essentially in the next 12 months. Is there a lot more cost cutting and efficiencies and operating leverage that you think you can gain over time even if we didn't have a real increase in the sales level at this point?

Craig Monaghan

Yes John, this is Craig. We believe there is. We are still behind the curve with respect to where some of our competitors are with systems and processes. And we think as we get caught up, that that will definitely bring additional productivity gains. I don't think you should expect to see those gains quarter-on-quarter. Right now, I feel like we are – we have chucked a lot of wood. We've made a lot of progress, we've made a lot of progress very quickly. I think you see it in the results. But now we are going to go through a period for about a year and we'll get more, for it will take time for these things to (tickle). But as we now build this new IT infrastructure, that will bring the next step function, if you would, of improvement in margins. But we would ask that you get us a little bit of time as we work over there. We are very excited about it. There are quite a few enhancements that's going to be happening across the stores.

As Michael said, it's much more than just the DMS. I mean, this project includes DMS, includes CRN, includes a lot of the processes within the stores themselves. We've got many, many people across our organization working on the design of these technologies and process. To a large extent, it's been led by our people of the stores. And we are going to hit four stores here on the 1st of October. We are very excited about it. We kind of view it as a giant (inaudible) when we roll into those stores, we are carving to provide them the most fully integrated set of tools that exist in any store anywhere. We've got great partners working with this and we think it will bring significant enhancements down the road.

Craig Monaghan

So, there's still a whole lot of wood chopping going on John.

John Murphy – Bank of America / Merrill Lynch

That's good to hear. And you do sound very enthusiastic and excited about it. So, that is also good to hear as well. If we look at what's happening in the first quarter and the second quarter for just your earnings to get real simple about this, you posted $0.42 in the second quarter, $0.27 in the first quarter. You know, if you were to look at that sort of on a seasonal basis, basically that's above 50% of your earnings, and sales are about flat through the course of the year.

So, we try to indicate, you are guys are on a pretty healthy run rate of close to $1.40 in earnings per share. And I am not trying to get – given those guidance here, but, I mean, is there anything weird or odd or unusual in the first half of the year, that would throw off any of the sort of the general, typical seasonality we would see in earnings pattern, if sales kind of stayed in this low-to-mid ($11 million of sales rate) for the remainder of the year.

Craig Monaghan

Now John, it's Craig again. It's – we are trying to be very transparent with our results. That' why we provide all these tables in addition to what you see in the Q. I would say now those numbers are clean. And you know the rule of thumb that you talk about, you know, earnings in the first half of the year, typically very similar to earnings in the second half of the year if the stars stay stable. And (inaudible) expectations.

Charles Oglesby

You know John, again this is Charles. What we have positioned our company is to be very nimble. We can move up and we have the ability to move down and still be very profitable. So, that's the key to how we have all of the work that we have done has placed us in this position. And that's really what we are enjoying right now.

John Murphy – Bank of America / Merrill Lynch

That's great. Then just lastly on inventory, sounds like you are in good shape. Is there any, sort of excess – pockets of excess or pockets of shortages, would you like more inventory, just where, you know, this inventory need to go through an adjustment process or you are just real good where you are right now and won't make too many changes at all.

Michael Kearney

John, this is Michael. You can always (inaudible) to have the perfect situation. There is always a particular model within any brand that we would like to have more, you know, I love to have more BMW 5 Series right now, the brand new one. But, and I would love to have more Mercedes D Class. But looking all over everything I am pleased with it. I don't think we have any issues, satisfied with the jobs done at the store with inventories that we've got. And I would say we are overall just satisfied with what we have got right now.

John Murphy – Bank of America / Merrill Lynch

Great. Thank you very much guys.

Operator

Ladies and gentleman, this concludes our question-and-answer session. I would like to turn it back to management for additional or closing remarks.

Ryan Marsh

We really do appreciate everyone visiting with us today. We are excited about what is going on with our organization, and we are really looking forward again, to next quarter with our results with you. Thank you very much.

Operator

Ladies and gentlemen, we thank you for your participation in today's conference. As a reminder, there will be a replay available for this conference beginning later this afternoon and running through August 3, 2010. You may access that replay by dialing 888-203-1112 or 719-457-0820 and entering the replay pass code of 3479884 followed by the pound key. Again, we thank you for your participation. Have a wonderful afternoon.

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

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