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Asbury Automotive Group (NYSE:ABG)

Q4 2007 Earnings Call

February 21, 2008 10:00 am ET

Executives

Keith Style - Vice President of Finance and Investor Relations

Charles R. Oglesby - President and Chief Executive Officer

Gordon Smith - Senior Vice President and Chief Financial Officer

Analysts

Edward Yruma - J.P. Morgan

John Murphy - Merrill Lynch

Rick Nelson - Stephens Inc.

Rod Lache - Deutsche Bank

David Lim - Wachovia

Matt Nemer - Thomas Weisel Partners

Joe Amaturo - Buckingham Research

Operator

Good day, everyone and welcome to the Asbury Automotive Group’s Quarterly Earnings Results Conference Call. Today’s call is being recorded. At this time for opening remarks and introduction, I would like to turn the call over to the Vice President of Finance and Investor Relations, Mr. Keith Style.

Keith Style

Thank you. Good morning, everyone, and thanks for joining us today. As you know, this morning we reported our fourth quarter and full year 2007 earnings. The press release is posted to our website at www.asburyauto.com. If you don’t have access to the Internet or would like a copy of the release faxed or e-mailed to you, please contact Gail Falotico at our corporate office. Gail could be reached at 212-885-2520.

Before we start, I’d like to remind everybody that the conference call today will include some forward-looking statements that are subject to certain risks and uncertainties, which are detailed in the company’s 2006 10-K report, as well other filings with the SEC.

In addition, certain non-GAAP financial measures, as defined by the SEC, may be discussed in this call. To comply with the SEC rules, reconciliations of non-GAAP financial measures have been attached to this morning’s release.

The purpose of today’s call is to discuss Asbury’s fourth quarter and 2007 results and our guidance for 2008. With us today are Charles Oglesby, our President and CEO, and Gordon Smith, our CFO. Following their comments we will be happy to take your questions.

Now I would like to turn the call over to Charles Oglesby.

Charles R. Oglesby

Thanks, Keith. And good morning everyone. I appreciate you joining us on our call today. This morning we reported fourth quarter adjusted EPS from continuing operations of $0.39 compared to $0.43 a year ago. These results exclude non-core items as disclosed in the tables attached to our earnings release, including $0.03 charge in the quarter for legal claims arising in the 2003 and prior, and $0.03 net benefit from non-core items in the fourth quarter of 2006.

For the year, adjusted EPS from continuing operations, excluding non-core items, increased 8% to $2.09. We believe that an 8% increase in a year as challenging as 2007 illustrates the fundamental resilience of the automotive retail model.

The fourth quarter was a transition period for us as we adjusted the business to prepare for the weaker retail environment we are projecting for 2008. In the face of a challenging retail market, we acted decisively in addressing the three largest cost of automotive retailing: inventory, advertising and personnel.

We reduced our comp store used-inventory levels $16 million, or 13%, from the third quarter. As planned we cut our comp store advertising spend 10%, and perhaps most importantly we adjusted our organizational structure, positioning the business to deliver a 3% reduction in a comp store personnel expense in 2008.

These efforts impacted our operational performance for the quarter. Specifically, our focus on reducing used-vehicle inventory put pressure on our used retail margins, which were down a 130 basis points to 10.8%, as we retail out of existing inventory. In addition, we took $1.2 million in incremental wholesale losses compared to last year.

However, all these adjustments were necessary and have positioned us well as we enter 2008, and we will make further adjustments as necessary to respond to the market as the year unfolds.

Turning to the results for the quarter, we knew throughout the second half of the year that the retail environment was getting more difficult. However, we did not anticipate the extent of the weakness in our Southeastern markets, particularly, in Florida, which provides approximately 30% of our revenue.

Our total revenue for the quarter declined 2%, with the 9% decline in comp store retail vehicle revenue being partially offset by our strong performance in F&I and parts and service, as well as the addition of our 2007 acquisitions.

Our gross margin remained steady at 15.6%, with the shift towards higher-margin businesses offsetting compression in our retail vehicle margins. As anticipated, our heavy truck business declined from last year when changes in the emission standards drove sales volumes. This decline impacted the bottom-line by $0.01 of EPS.

In the new light-vehicle business, we did not have the benefit of the strong incentive programs that we saw in the fourth quarter of 2006; particularly, the Honda and Nissan programs that had significant impact on our unit volumes and margins last year.

Against these difficult comps, light vehicle comp store unit sales declined 3% and margins were down 70 basis points for the quarter. Manufacturer programs influenced the pace of our new vehicle business throughout the year, impacting unit volume and gross margin from quarter-to-quarter.

However, our new light vehicle margin for the year was down only 20 basis points to 7.5%. The slower sales pace in December of ‘07, which was off 12%, led to a nine-day increase in DSI to 69 days, and a 6% increase in comp store light vehicle inventory from the end of 2006. We have been working, and we’ll continue to work, with our OEM partners to control our new vehicle inventory levels.

Turning to used vehicles, as you may recall in 2006, we made a strong push into the subprime market for used vehicles and were very successful in driving profitability gains from that business, and we also benefited from the aggressive finance programs of certain lenders.

The tighter standards being applied today by subprime lenders have weighed on our used vehicle performance, driving comp store unit sales declines of 13%, the majority of which is directly attributable to the decline in our subprime business, which now makes up only 20% to 25% of our used vehicle sales.

Turning to F&I, we have continued to achieve record results, generating $1,057 in F&I income per vehicle retailed. Our menu-driven process ensures that all of our customers are offered a complete line of our products during the buying experience.

As always, we continue to focus on process improvements in all of our dealerships, especially those operated in the bottom third. In addition, we continue to work with our suppliers on pricing improvements for the products we sell to our customers.

Moving to parts and service, we continued our steady performance with comp store gross profit in the quarter of 3%. Peeling back the data our progress in the high-margin customer pay business, where gross profit was up 4.5%, has been partially offset by the continued decline in warranty, which was off 6.2% for the quarter.

In 2007, we added 55 service bays to our fixed capacity. In addition, we have five projects coming online in 2008, which will add an additional 95 bays. Our investment in these state-of-the-art facilities will continue to pay dividends over the long-term as they enable us to better serve our customers.

SG&A as a percentage of gross profit increased 140 basis points for the quarter to 79%, excluding non-core items. Excluding rent increases, which were largely driven by CapEx financing decisions, our SG&A ratio was up only 70 basis points.

This increase reflects the de-leveraging impact on our cost structure from the decline in vehicle sales volumes. As I discussed earlier, we have reduced our advertising spend by 10% on a comp store basis. Personnel expense responded well, down 7% on a comp store basis, or $5.6 million.

For the full year the SG&A ratio was up only 30 basis points to 76.8%, adjusted for non-core items, and excluding rent, the SG&A ratio improved 10 basis points from 2006. Interest expense for the quarter was down $1.7 million as a result of our debt refinancing earlier in the year, and floor-plan expense for light vehicles was stable with last year on a comp store basis, with slightly higher inventory levels offsetting the benefit from interest rates.

Turning to the balance sheet, our financial position remained strong. At the end of the year, we had $53 million in cash and our debt-to-total capital ratio stood at 4% to 4.9%. Our average cost of debt is 6.6%, and we have $125 million of that available for general purposes or acquisitions under our line of credit. Our cash plus credit line totaled $178 million at year-end, providing plenty of capacity to fund our growth over the coming years.

Now I’d like to turn the call over to Gordon to discuss our guidance for 2008.

Gordon Smith

Thanks, Charles, and good morning, everyone. As our press release notes, we have established an initial guidance range for 2008, diluted EPS from continuing Ops between $1.80 and $2.00 per share.

From a high level, our performance in 2008 will be driven by a soft retail vehicle market, both new and used. Focusing on the new vehicle business, we are forecasting U.S. unit sales in the range of $15.3 million to $15.5 million.

In addition, we expect new vehicle margins will come under pressure, especially as the industry faces growing inventory levels of mid-line import brands, and decline 20 to 40 basis points.

With respect to the used business, as Charles mentioned, the lending terms today compared to 2006 and the beginning of 2007 are tighter. In addition, manufacturing standards on new vehicles are likely to pull more of the traditional used vehicle buyers into the new vehicle market.

These factors will continue to drag on our used vehicle performance, particularly in the first half of the year when we expect low double-digit declines in unit volumes versus our very strong performance in the subprime business in the first half of 2008.

For the year, we expect that unit volumes will decline between 5% and 8% on a same-store basis, and gross margins to continue at the level we experienced in the second half of 2007.

Turning to expenses, with the forecasted drop in the retail business, it will be difficult to regain any fixed-expense leverage. As Charles discussed in his comments on the fourth quarter, we have been and we’ll continue to focus on the three largest costs of automotive retailing: advertising, personnel and inventory, specifically used.

We are budgeting for our gross advertising spend to decline 5% to 10% on a same-store basis this year. We expect that our efforts in the fourth quarter to align our organizational structure to the retail environment will deliver personnel expense reductions of up to 3% in 2008.

Salesperson compensation will most likely increase as a percentage of retailed vehicle gross, with margin pressure on new and used vehicles. But F&I compensation, as the percentage of F&I income, will continue to decline due to our focused programs in this area.

Rent will increase between 5% and 7% on a same-store basis, depending on the completion dates of our growth CapEx projects during 2008.

With respect to our DMS conversion to Arkona, we project that savings from lower licensing fees will be offset by conversion costs in 2008, with the significant savings starting in 2009. Overall, based on our current retail forecast, we expect our SG&A ratio to increase between a 100 and 150 basis points in 2008.

Floor-plan expenses will benefit from the sharp decline in the fed fund rate and, assuming there is no further disruption in the credit markets, we are forecasting that LIBOR will average 3.3% for the year. Keep in mind, though, we swapped $150 million of our floating rate floor-plan debt for fixed through November of 2008.

We estimate that bottom-line impact of interest rate relief for 2008 will be approximately $0.15 of EPS, including the impact of floor-plan loaner vehicles obligations and overnight investment.

We will continue to benefit from our 2007 debt refinancing and share repurchases. The debt refinancing will add $0.04 to EPS on a year-over-year basis during the first half of the year, primarily in the first quarter. And the share repurchase will continue to provide a lift to EPS through September, also adding a total of about $0.04.

We project our effective tax rate to be between 37.8% and 38.3% in 2008, compared to 36% in 2007. This increase is driven by prospective changes in the tax law in the states we operate, as well as the one-time benefits in 2007.

Also we expect our weighted average diluted shares outstanding for the year to approximate 32.5 million shares, assuming no share repurchase in 2008. At the end of the year we had 980,000 shares available for repurchase under our approved programs.

We will continue to monitor our share repurchase activity versus our debt covenants, which limit the amount of capital we will return to shareholders in the form a dividend and share repurchase. As of December 31, 2007, this limitation stood at $18.4 million and it will increase in 2008 by 50% of net income, less the dividend and any share repurchase.

Turning to our capital investment plan, we are forecasting total capital expenditures of $55 to $65 million, including $15 million of maintenance CapEx. The remaining investments in growth projects will total between $40 and $50 million, of which 60% to 70% will be financed through sale/leaseback transactions.

On the acquisition front, we intend to pursue our annual target of acquiring $200 million in revenue, adding two to three high-quality franchises to our portfolio. We expect that the F&I business will achieve another year of record PVR levels, largely due to pricing adjustments and operating improvements.

Finally, fixed operations will continue its steady growth, in what is forecast to be a difficult retail environment, and we will continue to grow at a steady pace of 4% to 5%.

With that, I will turn the call back over to Charles for some concluding remarks.

Charles R. Oglesby

Thanks, Gordon. Overall, 2007 was a year of many accomplishments for Asbury. Operationally, we have partnered with Arkona and DealerTrack to develop a fully integrated software solution for our dealership operations that will dramatically reduce expenses and deliver efficiency gains in the years ahead.

Today, we have successfully transitioned 10 stores to the Arkona DMS system in 2007. In the acquisitions arena, we acquired $350 million in annual revenue, obtaining approval to acquire seven different brands.

With respect to the balance sheet management, we refinanced our long-term debt, reduced our annual debt service over 20% to approximately $29 million.

Finally, we returned capital to our shareholders, repurchasing 2.3 million shares for a total cost of $57 million. And most importantly, we have positioned the company to outperform the market.

As we enter a year that many believe will be a challenging automotive retail environment, we remain committed to our long-range plan, focusing on process and efficiency improvements in our existing operation, driving modest revenue growth of 2% to 4% through acquisitions, and returning capital to our shareholders in the form of a dividend.

Our balance growth and income model, and primarily the dividend payment, was established with a strong cash flow of our operations in mind and was designed to deliver in all economic conditions.

And with respect to our acquisitions, I am pleased to announce that we are just a week away from closing on a Toyota franchise in the Atlanta market that we estimate will add $100 million in annual revenue.

In conclusion, I believe the market in 2008 will provide Asbury with an opportunity to prove that the automotive retail model delivers in all market conditions. It comes down to execution. And for Asbury, the odds for long-term growth are in our favor. We believe the strength of our brand mix and our geographic locations are significant advantages that will fuel our future growth.

Today, Florida’s economy is obviously weak, but we believe that over the next few years it will return to its longer term trend line. In fact, the U.S. Census Bureau projects that the population of Florida will grow 28% by the year 2020, compared to the projected growth of the U.S. population of just 11% over the same period.

While there will be occasional macro-economic factors that impact our retail growth trends, our job is to make sure that we succeed in good times and bad, relying on the staying power of our parts and service business, and making changes to the expense structure during slower retail environments.

At Asbury, we are building a culture of high-performance teams, and I am confident that with our talented workforce and leadership, we can look forward to the challenges ahead and prove the resilience of our business.

And with that I will turn it over to the operator to answer any questions.

Question-and-Answer Session

Operator

We will go and take our first question from Edward Yruma - J.P. Morgan.

Edward Yruma - J.P. Morgan

Can you give us a quick update on your subprime exposure on the new vehicle front as well? And have you seen any reduction in credit availability?

Charles R. Oglesby

The subprime really hasn’t impacted the new vehicle at same rate that it has the used vehicles for us. The availability of credit in the subprime has certainly tightened down because the lenders are crossing the t-s and dotting the i-s.

As we mentioned earlier, the subprime market for us, we actually started in ‘05 and ‘06 with those initiatives and announced it in first quarter of ‘07. It had been about 30% of our used vehicle sales, and maybe we pushed it beyond that in first quarter of ‘07. So with that decline, and with the decline in the subprime lending underwriting rules, that is what has slowed down the progress we have made in the used vehicle side.

Gordon Smith

In addition to that, Ed, on a new side what we are seeing is that the OEMs are stepping to the plate and, while I can’t directly correlate it, I’ll give you a statistic. In December this year, typically the OEMs account for about 50% of our retail financing business; in December it was 55%. So to the extent there is a little bit of weakness in the bank side of the market, for new vehicle sales, the OEMs look to be stepping to the plate and covering that void.

Edward Yruma - J.P. Morgan

Got you. So does that 20% to 25% of your current used exposure subprime, is that already reflective of the reduction availability, or does that go to some number that’s lower and that’s the number that’s assumed in your used guidance? Thank you.

Charles R. Oglesby

No, that’s a number that we are comfortable maintaining as a part of our business. The subprime market actually is even growing today with a lot of the impact of credit markets last year on consumers. So that market is always there. It takes three pieces to be successful in that market. One is the appropriate inventory. Two, having a dedicated staff for that market, and then three, credit availability.

Disruption in any of those areas disrupts that market. So, we actually were positioned well, the first inclination was when inventory started to tighten down and getting more expensive, and then as credit tightened down, that created the decline in that market.

So at some point in time, it will come back, but I don’t believe that we will move that strong as far as the retail portion of our business. We will probably maintain it at 20% to 25%.

Gordon Smith

What’s so important here is that, we are annualizing this, and the first half of the year, as I said in the script, we are expecting low double-digit declines in the used business and that’s primarily as a result of anticipating that softer subprime business, and that’s principally at first half this year.

Edward Yruma - J.P. Morgan

Got you. Thank you very much.

Operator

We will go and take our next question from John Murphy - Merrill Lynch.

John Murphy - Merrill Lynch

I was just wondering if you could talk about the different markets that you are in outside of Florida, and really how much of the aggregate weakness you could attribute to Florida and if there were any other markets that were particularly strong?

Gordon Smith

We had declines in all regions with the exception of Texas. Texas was strong, and particularly South Texas, the Houston area. With the subprime strength that we had in our Arkansas, Mississippi areas, they declined as well. The Carolinas appear to be relatively stable or flat, and Atlanta about the same. California is still a challenge; we are off slightly in California.

Charles R. Oglesby

And that’s only 5% of our market.

Gordon Smith

Right.

John Murphy - Merrill Lynch

Okay. And then if we think of the used business, some of your competitors have similar brand mixes and were able to do very well in the used vehicle business recently. And I am just wondering, given your very strong brand mix, there might be an opportunity to side step some of the subprime and focus more on the CPO market to offset the weakness. I am just wondering what you might be able to do there in the short-term and potentially even in the long term?

Charles R. Oglesby

I agree with you. The majority of our decline has been because of a shift away from subprime business. We absolutely see growth in the CPO market. The manufacturers are getting stronger in that market. It’s a great part of our business. We like it, getting the inventory; it’s good for our service business; it’s good for the customer.

So really we are getting more into normal retail ranges. We saw an opportunity in ‘05 and ‘06 in the subprime market, and so we actually accelerated taking advantage of those markets. So we are probably more, even though the comps are high and it looks as if we are declining, we are actually normalizing the used vehicle operations.

John Murphy - Merrill Lynch

Okay. Then if we think about acquisitions, particularly in the market that are weak right now, like Florida, are there better opportunities for you to make acquisitions and is that why we are seeing this above-target $350 million rate in the last year and the ramp-up going forward? Or are the valuations coming down and there is better opportunities in those markets?

Charles R. Oglesby

We are very fortunate in that what we look for in our growth model is $200 million or so in revenue. So we can be very selective in what we add to from a strategic stand point. In Florida, the marquee franchises, wherever they are, generally are the same franchises that most people want to have. And so the valuations, for the most part, multiples are not coming down there. So we make a strategic decision as to how it fits with our long-term growth plan as to what to purchase.

Right now, Florida would be a filter process for us whether or not we would want to grow more in that market today. It would be a very strategic decision and for a marquee franchise we actually would want to add to our portfolio.

We added $350 million in revenue last year because we had the opportunity to do that. We had not been in the acquisition market for quite a while and, once we opened the pipe up, we had the opportunities to do that and the ability to do it, and so we accelerated more than what our model normally calls for, last year.

This year, we expect to do at least $200 million. We don’t have any plans necessarily to go beyond that unless it’s a strategic purchase and we see the value in it. So we are fortunate again that our growth model involves two to four deals, or about $200 million in revenue a year.

Gordon Smith

I just think, just to add to that, we are still very bullish on the Florida markets in the long run. However, when you look at the business on a portfolio basis, our preference would be to add to the other regions as opposed to Florida, which is our largest concentration.

It’s the same thing a bank tries to do with its portfolio diversification. It’s the same thing in our business. We have our portfolio of dealerships that I think we want to take advantage of the high-growth areas, and there are other high-growth areas that we would like to add to rather than in Florida. But, as Charles said, if we find an outstanding dealership in that market, we would absolutely do it.

Charles R. Oglesby

We’d like where our portfolio is. We are really in a great position and we can make great decisions on a go-forward basis. We really don’t need to reposition our portfolio in any way.

John Murphy - Merrill Lynch

And then just lastly, on the service-bay add, I was just wondering if you could ballpark where capacity utilization is in your current service bays. It sounds like you added 55 in ‘07, plans for another 95 in ‘08 and how fast those stalls ramp up, if they are put in as flat stalls and then equipped later, just really the cap-utilization and how we progress from the flat stall to the fully utilized stall in these remaining 150 million stalls?

Gordon Smith

The fix guys will tell you that, and fix guys by their very nature are traditionally very conservative. They will tell you that it takes three years to fully utilize the new bays. Our experience though, it’s somewhat dependant on the store and where it is from when we add the bays. But typically, it’s more like 40% utilization in the first year. And by the end of the second year, you’re pretty much up to speed. So, it does depend, but, in a lot of our stores that we have done in the past, they come up to speed pretty quickly.

John Murphy - Merrill Lynch

But in your existing stalls, what do you think your cap utilization, roughly − 60% 70%?

Gordon Smith

I’d say 75% to 80%.

Charles R. Oglesby

And that will be case by case.

John Murphy - Merrill Lynch

Okay, great. Thank you very much.

Operator

Moving on, we will take our net question from Rick Nelson - Stephens Inc..

Rick Nelson - Stephens Inc.

If you were to achieve your EPS targets as you have outlined, where do you see free cash flow for the year and leverage which you’d be comfortable with?

Gordon Smith

The thumb sketch of that is take that income and add about $5 million to that. That $5 million is, add depreciation and subtract out maintenance CapEx. That’s how I define what free cash flow is. The only other change from that would be what happens to working capital, principally used inventory.

As you’ll notice when you get the K, our 2007 cash flow was $80 million, right around that number, which is a little higher than the calculation I gave you, and that’s the result of lowering our used inventory. So I would think it would be a little higher than the thumb sketch I just gave, maybe another $5 million or so. So that’s a quick way of figuring out our cash flow.

Rick Nelson - Stephens Inc.

Thank you for that. And how about the leverage, Gordon?

Gordon Smith

I am not looking to increase the leverage this year. It will come down slightly, probably into the high 43s to the 44 range. So it’s slightly lower than it is today.

Rick Nelson - Stephens Inc.

Okay. You quantified the impact of lower rates on floor-plan interest expense. Do you anticipate, or are you seeing any changes on assistance?

Gordon Smith

The only change we are seeing was GM did increase its number of pre-days, I believe that went from 60 to 90. That’s the only one we saw. The foreign plates, principally the mid-line, they are a fixed-dollar amount and they haven’t changed that and we haven’t seen anything from Chrysler or Ford yet. But GM changed, I believe, in December.

Rick Nelson - Stephens Inc.

Okay. Charles, you are halfway through the first quarter now. I am wondering if there is any comments or color changes that you are seeing particularly as it relates to luxury cars?

Charles R. Oglesby

What we are experiencing, I would say, would be consistent with SAR levels right now, Rick. I think when you saw the sales release this last month that some of the luxury makes were down. Really wasn’t surprised by that, and a lot of cases I think that could be a mix issue; and in some of our markets, weather-related issues as well.

So I think it’s too early to tell. Everyone has some sort of impact from the economic climate that we’re in, and the luxury buyer may elect to be cautious, but they have always shown to withstand whatever economic situation is going on. So we are still expecting that market to be good this year.

Gordon Smith

Yes. As you know, Rick, that January is probably the slowest month of the year. So it’s hard to glean anything from that. I think it’s fair to say February saw some increased incentives from the OEMs. So there is some reaction going on, and it seems like February is a little bit better than January. But, sequentially, it’s still off from previous years.

Rick Nelson - Stephens Inc.

Right, thank you. Good luck.

Operator

Our next question comes from Rod Lache - Deutsche Bank.

Rod Lache - Deutsche Bank

There was not much of a sequential decline in floor plan and other interest, and the inventory was actually up, based on the disclosure you made in your release, sequentially. Was that acquisition or we just didn’t see the LIBOR impact falling through, could you just elaborate on that?

Gordon Smith

One, first and foremost, we really lag a month behind the interest rate. Our floor plan resets on the fifth of every month. The second and probably the biggest impact that cost us a minimum a penny in the fourth quarter, was the LIBOR spread to the Fed funds rate. As you are aware, that probably hit one of the record highs; specifically in December, it was like 90 basis points spread when the spread LIBOR to Fed funds is typically 9 basis points.

So those are the two issues that we faced in the fourth quarter. And then January we saw some relief as the spread did come back in a little bit. But for us, the rate was in the high 4s in the January, and then we will see the true impact when the credit spreads come closer to normal, as they are not quite there, there is still a 20 basis point, I believe, spread right now.

As I say that, I think it’s come completely back at the end of February. So we’ll see the benefits starting February and throughout the rest of the year, assuming no further liquidity crisis hitting the market.

Rod Lache - Deutsche Bank

Okay. The $769 million in inventory at year end, was that affected at all by acquisition or no?

Gordon Smith

Yes. I’d have to get you the exact number; I don’t have it off the top of my head.

Rod Lache - Deutsche Bank

Okay. And can you possibly just give us a rough breakdown of your SG&A? How does that break down between advertising, personnel and lease?

Gordon Smith

Advertising for the fourth quarter was, and we disclose that in the K and the Qs, just for your information, but advertising as a total $166 million; advertising was $11 million; personnel cost was $77 million; F&I comp was $6 million and sales comp was $16 million.

Rod Lache - Deutsche Bank

Okay.

Gordon Smith

That was a big element.

Rod Lache - Deutsche Bank

Last question. Just any thoughts on these wholesale losses and how we should expect that to trend over the course of this year? Looks like it’s been a pretty tough market in that regard.

Charles R. Oglesby

Roughly, Rod, when we made the decision to reduce our inventory, we knew that in that market we expected wholesale losses. The retail market wouldn’t absorb all of the inventories, so we had to go to the wholesale market some. It impacted our retail margins and the wholesale side.

We want to keep our day supply down, and right now we still have more to go there. It’s not dramatic and I don’t expect it for the full year, but for a period of time, we still have some adjustments to go.

Gordon Smith

And we would like to get our inventory down to 35 days, and right now we are at 45 days. So we still have a ways to go. As you saw in the results, we have taken $3 million in the last two quarters. So I think the first quarter probably is going to be higher than it was in the first quarter of last year, which I believe was slightly positive. I think there was about $100,000 positive in the first quarter. I would expect that we’ll show a loss in the first quarter.

Rod Lache - Deutsche Bank

Great. Thank you.

Operator

Our next question will come from David Lim - Wachovia.

David Lim - Wachovia

Just wanted to ask, can you give us an idea about the sensitivity to future rate cuts?

Gordon Smith

Sure, per-quarter point it’s about $0.02 a share, annualized obviously; so it’s about $0.02.

And just to answer Rod’s question on how much of our inventory was on acquisitions, it’s about $50 million of the balance in that position.

David Lim - Wachovia

And can you also talk about import margin trends? Is the story continuing where you’re seeing continued pressure with import margins, in-line import?

Charles R. Oglesby

When you have excess supply, you always have margin pressure. For the year, actually we did well. The gross has held up. It was the fourth quarter when the market turned down and there was less foot traffic and there was more inventory that we experienced higher margins.

We look at that as remaining competitive in the marketplace. Whenever you have a situation like that we have got to do the things that are necessary, not only to meet the manufacturers’ objectives and serve our customers and our employees. So we do expect a little bit of margin pressure until the supplies level out.

David Lim - Wachovia

Are the Asian OEMs taking steps in order to help you whittle down that supply, or are they adding incentives? Can you speak to that if you would?

Charles R. Oglesby

Yes, normally that is what happens in the marketplace. Whenever you get this kind of supply, you can expect incentives to help pull the inventory or push it through. Or there will be reductions in production.

And this is in the case with Toyota, as an example. They would look at their production, as well as incentives (inaudible) production cuts. So there will be, one way the other, an opportunity to level out the inventory because it cannot continue to build, nor would we continue to take it and grow our inventories anymore.

David Lim - Wachovia

Charles, I find it interesting, Toyota and Honda, they have had that inventory bloat for a while, and we were thinking that they would have taken more of a proactive or assertive action earlier on, but it doesn’t seem to be that way. Are you seeing something else, or are they waiting to see if the economy turns? What’s your thought on that?

Charles R. Oglesby

When you look at Toyota and Honda and the imports expectation of what this year is going to be like, I believe they are expecting 16-plus SAR. So I am not sure they have quite adjusted yet to the current economic climate.

I think we all have an expectation that the impact of these rate cuts and a lot of the packages and things that are happening, once that starts there is the opportunity for movement in the marketplace upward toward the second half of the year. We are hoping for that, but we are not counting on it.

We certainly believe that in ‘09 would be a stronger year. I do believe that they would make the adjustment, one way or the other, either with incentives or a reduction in production, once they have a clearer picture as to what is going to happen in the marketplace. Historically, that’s been the way that they have handled it.

Gordon Smith

And just as a reminder, the mid-line imports are low-margin, high-volume business. And comparing it to the domestic, principally as a result of incentives that domestics have, the margins on the business typically are 100, even 150 basis points lower in the mid-line imports.

David Lim - Wachovia

Okay, that’s interesting. And, finally, I was just wondering how comfortable are you with your overall variable cost structure at this juncture? The sense that I am getting is that you are not comfortable, but I just wanted to see if you could add some color around that.

Gordon Smith

I think variable cost structure, to me, there are three pieces to the expense structure of any auto retailer. There is the piece of the business that is directly variable and that’s your commission-based income both on sales, F&I and then a part of the GM’s compensation and is variable. That accounts for 25% to 30% of the expense structure. And that will go up and down based on gross profit.

The other third, if you will, slightly more than a third, but the other third, is what I call semi-variable. That’s salary-type individuals, that’s advertising; the big components there. That, I think I have said that consistently, you have to take some action to take the cost out.

David Lim - Wachovia

Sure.

Gordon Smith

When we are talking about taking out the 3% of personnel, that’s an action to reduce the semi-variable cost in personnel. And then the other third is things like rent and some other pieces (e.g., insurance) that are, in my mind, fixed. So that’s how I look at it: a third, a third, a third is the quick and dirty on that. But that’s how you have to look at it.

So a third happens automatically; a third you have to take actions to do it, and as we have said in the third quarter, we said that if we saw the market continuing at the pace it was we were going to take action. And that’s what we did in the third quarter to reduce that semi-variable cost down to levels that are consistent with what we are seeing on the revenue side.

David Lim - Wachovia

Got you.

Charles R. Oglesby

I would say when we used the word that we ‘weren’t comfortable,’ I would want to rephrase that a little bit, that we feel like that we took some pretty decisive action. We knew that it would be distracting to our organization and that that action was necessary. It’s like ‘pay me now or pay me later.’ And we made the decision to do that in the fourth quarter, and particularly in December of last year. And so there was a distraction on our operating side while we were setting our company right for 2008.

So when you look at how comfortable you are with that, we feel like we are in the right place right now for 2008. And then, depending on where the market goes, we still have the ability to move with the market. We can take advantage of the upside and then, if there is a continued decline, we have the opportunity to adjust to that as well.

David Lim - Wachovia

Got it. I was referring to if your initiatives right now make you comfortable or not, and that’s the thought that I wanted to convey but…

Charles R. Oglesby

We wanted to cut once, cut deep and not have a Chinese torture drill every day and every month. That would drive an organization nuts.

David Lim - Wachovia

Got you, okay. Thank you very much. Appreciate it

Operator

We will take our next question from Matt Nemer - Thomas Weisel Partners.

Matt Nemer - Thomas Weisel Partners

So, my first question is on SG&A. I am just wondering the actions that you have taken, can you give us some color on the cadence of those? And what I am getting at is, have we seen the full impact of those actions in the fourth quarter or do we really see the full impact in the first, or is it more likely the second or the third?

Gordon Smith

I would say you saw relatively little of it in the fourth quarter; most of it happened relatively late. I would say that you are going to see I would say about 60% of it in the first quarter and a full 100% of it to start in the second quarter and beyond.

Matt Nemer - Thomas Weisel Partners

Okay, that’s helpful. And then, this is more of a housekeeping item, but can you remind me what the other operating income line is and your operating expenses? I don’t remember seeing that before.

Gordon Smith

Yes. It’s what used to be called other income. We got a request from the SEC to just to move it up into the operating income section. But it’s principally that and it’s basically other income that used to be down below that we had to move up.

Matt Nemer - Thomas Weisel Partners

Got it, okay. And then just going back to the subprime issue, DealerTrack had some interesting comments this week about lenders cutting off 4,000 to 5,000 dealers I think in the U.S. And I don’t know if those are franchise or independent, but I am just wondering if you can quantify or give some granularity to what’s happening from subprime lenders. I know that the documentation requests are more stringent but are you seeing lenders cut off specific stores?

Charles R. Oglesby

We haven’t experienced being cut off in any specific stores. Their underwriting criteria is definitely tighter. I am not sure that all of the lenders have the same amount of capital to put in the marketplace that they had before, and they are buying probably 50% of the contracts that they purchased in the past.

So, again, I think that that market, at some point, will come back as the credit availability or as the liquidity is there. But right now it certainly is a challenge. And again, we have reduced our retail levels to about 20% to 25% of our business, and we feel like so far with what’s happening in the marketplace we can maintain that.

Gordon Smith

And in fact, Matt, we actually got some letters from some of the ones that announced that they were pulling back a little bit and said that they were still supporting our car franchises. So it seems like that there is a little bit of flight to quality on their part and as the public dealers look like (inaudible) flight to quality.

Matt Nemer - Thomas Weisel Partners

That’s helpful. And then on that same topic, what are you seeing in terms of your charge-back experience on those contracts?

Gordon Smith

I would say up very slightly; I am talking 10 to 15 basis points. Once again, the charge-back is not for defaults. It’s when a customer decides they are going to payout the loan or something like that. We are not exposed on that side of it.

Matt Nemer - Thomas Weisel Partners

So, they’re prepays? It’s a higher prepay experience?

Charles R. Oglesby

Yes. And Matt when you talk about charge-backs, would you define that for me?

Matt Nemer - Thomas Weisel Partners

I mean, for some reason or another, the lender comes back to you and wants a piece of their commission back, either the documentation wasn’t filled out properly or the client prepays or something else?

Gordon Smith

Now once again, another fact, if there is documentation problems or something like that, there is a 90-day period that we’re exposed to. So we have seen a little bit and some of the lenders may be more diligent in their review of paperwork, but it’s not material.

Matt Nemer - Thomas Weisel Partners

Got it. And then last topic on subprime. Is that having any impact on your F&I PVRs, either positive or negative; the mix shift away from subprime?

Charles R. Oglesby

Yes. It has moved our number up because we have less subprime.

Matt Nemer - Thomas Weisel Partners

Can you explain that?

Charles R. Oglesby

The F&I income on subprime is lower and so, as we do fewer subprime deals, that will have the overall impact on our overall number. The primary F&I income is a higher retail margin business than the subprime business is. So we are making more on the primary, we are making less on subprime, we are doing fewer subprime deals. And so that moves that PVR number up a little bit.

Matt Nemer - Thomas Weisel Partners

Got it; it’s a mix shift. And then my last question is, as you look at your restricted payments basket, that’s the $18 million plus that you have in there now, are you inclined to protect that relative to future dividend payments, or do you think that you will be allocating that to share repurchases or something else?

Gordon Smith

We are committed to the dividend, and that restricted payments basket will be used principally to ensure that we can pay that dividend. Just to put it all in perspective for you, at the low end of our guidance which is $1.80, at a $1.80, that restricted payments basket would be the same at the end of the year end of 2008 as it is today. That’s the break-even point.

So you can do some math and you can see that, not that we are forecasting it, but we can take a significant deterioration in the business and still maintain the dividend and be within our covenants for a fairly lengthy period of time and any feasible barriers that you can come up with.

So it’s our first priority: share repurchase. While right now our stock is cheap and I would love to be out buying it, I think our view is that the dividend shows the market, in a consistent way, our commitment to our share owners. And that’s what we think and that’s what our Board thinks, and therefore we will continue to support that dividend.

Matt Nemer - Thomas Weisel Partners

Got it. That’s helpful, thanks, and nice job on the expense line.

Operator

Now it looks as though we have time for one further question. And our last question will come from Joe Amaturo - Buckingham Research.

Joe Amaturo - Buckingham Research

You stated that 20% to 25% of your business in used is characterized as subprime, could you just remind us what that was in 4Q ‘06 and where that was for the first half of ‘07?

Charles R. Oglesby

In 4Q ‘06 it was about 30%, and in first quarter of ‘07 we may have even pushed to 35%. We really took advantage of that opportunity. We don’t regret that decision because it really took advantage of what was in the marketplace. However, we are looking at a more balanced model now.

Joe Amaturo - Buckingham Research

Okay.

Gordon Smith

Just as a reminder, the subprime business is really our first-quarter heavy because of tax refunds. It’s how that business works, so first quarter is the heaviest and then it tails off throughout the rest of the year.

Joe Amaturo - Buckingham Research

Do you expect it to stay in this 20% to 25% range in ‘08?

Charles R. Oglesby

Yes, we can sustain it. That market is there; it’s a market we are prepared to manage through because again it takes three different pieces for that model to work. With the franchise mix we have, with the volumes that we have, that business is good business. So yes, we expect to maintain that.

Joe Amaturo - Buckingham Research

And then with respect to your used inventory, could you just tell us what percent is luxury vehicles?

Charles R. Oglesby

We will have to get back to you on that.

Joe Amaturo - Buckingham Research

Okay, then the last one. With respect to F&I per vehicle tracking and $1050, $1060, are you comfortable that you will be able to achieve that in ‘08?

Charles R. Oglesby

Yes, we believe that is very sustainable. We continue to work on the bottom third of our performers, and we are continuing to work with our providers as well for re-pricing reductions. And we’ve had a very nice continued strength and movement in our PVR, and we don’t see any reason at all that that would decline.

Gordon Smith

It’s one of those where, quite frankly, you get to one level and we feel like we are going for $1100 this year. Then once we get to $1100, we will try for $1200. So it’s a continual improvement kind of business; don’t want to push it too hard, don’t want to get it on the wrong side of the legal community in terms of pushing the envelope, but we feel we can consistently improve that business.

Operator

And with that I will turn the conference back over to Mr. Oglesby for any final closing comments.

Charles R. Oglesby

We certainly appreciate everyone’s attention today and for joining us. If I had something that I would like to leave everyone with, it would be to view Asbury as steady as she goes. We really like our growth and income model. We feel like we execute well, we respond to the market.

We’ve got, again, geographically and from a franchise mix we are right where we want to be. And we can be opportunistic with our acquisitions. So that would be the viewpoint we would like to leave everyone with, that we are steady as she goes. So with that, we thank everyone for participating today and we will talk to you later.

Operator

And that does conclude our conference. Again thank you all for your participation. We do hope you enjoy the rest of your day.

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Source: Asbury Automotive Group Q4 2007 Earnings Call Transcript
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