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Asbury Automotive Group, Inc. (NYSE:ABG)

Q1 2008 Earnings Call Transcript

April 24, 2008 2:00 am ET

Executives

Keith Style – VP, Finance and IR

Charles Oglesby – President and CEO

Gordon Smith – SVP and CFO

Analysts

John Murphy – Merrill Lynch

Rick Nelson – Stephens, Inc.

Edward Yruma – JPMorgan

Deron Kennedy – Goldman Sachs

Rich Kwas – Wachovia Securities

Matt Nemer – Thomas Weisel Partners

Operator

Good day everyone and welcome to the Asbury Automotive Group quarterly earnings results conference call. Today's call is being recorded. At this time for opening remarks, I would like to turn it over the Vice President of Finance and Investor Relations, Mr. Keith Style. Please go ahead sir.

Keith Style

Thank you. Good afternoon everyone and thanks for joining us today. As you know this morning, we reported our first quarter 2008 earnings. The press release is posted to our Web site at www.asburyauto.com. If you do not have access to the Internet or would like a copy faxed or emailed to you, please contact Michelle Ransamouge [ph] at our corporate office. Michelle can be reached at 212-885-2530.

Before we start today, I would like to remind everyone that our conference call today will include some forward-looking statements that are subject to certain risks and uncertainties, which are detailed in the company's 10-K report, as well as 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.

With us today are Charles Oglesby, our President and CEO; Gordon Smith our CFO; and we also have Michael Kearney, CEO of our Mid-Atlantic region with us today. Following our prepared remarks, we will be happy to take your questions.

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

Charles Oglesby

Thanks Keith and thanks for everyone for joining us today. For the first quarter, we reported EPS from continuing operations of $0.35 compared with adjusted EPS from continuing operations of $0.44 in the first quarter of 2007. During the quarter, the industry experienced an 8% reduction in new vehicle sales and turned in a SAR of approximately 15.2 million.

For Asbury, weakness in our key Florida and California markets, which we estimate were down 17% and 15% respectively, resulted in a 10% decline in same store new vehicle unit sales. We experienced headwinds in used vehicles as well, with a more challenging environment for sub prime financing. And our parts and service operations experienced weather disruptions in several of our local markets during March, resulting in relatively flat same store sales.

To say the least, we had our challenges this quarter, especially against the strong operational results we enjoyed across all of our business lines in the first quarter of last year. However with our cost reduction initiatives firmly in place, we were able to deliver better than anticipating savings in personnel and advertising, keeping us on pace with our EPS guidance range for 2008 of $1.80 to $2 per share.

When you look at the array of negative factors that are facing our economy and the automotive retail industry, it is easy to lose sight of the resiliency of this business. There are two things we know about this industry. One, every period of decline in new retail sales is followed with a strong rebound in the market, and two, the business model can be adjusted to meet the current market.

The first premise has been proven throughout the history of automotive sales in the U.S. and the second is being proven by Asbury as we work our way through the current rough patch in terms of customer confidence and what appears to be at least a mild recession in the overall economy.

Our new vehicle business was under pressure during the quarter in both sales volume and gross margin. New unit sales industry wide came in below our planning range of 15.3 million to 15.5 million SAR for 2008. And with our exposure to the Florida and California markets, our overall sales were a little softer than the industry. The remainder of our markets were generally in line with the overall industry trends, with the exception of Texas where the market remains relatively strong.

Our new light vehicle gross margin was 6.9%, down significantly from a 7.7% a year ago. We experienced margin pressure across all brands, which is generally the case as competition for sales increases, with less business available in the marketplace.

In addition, we saw changes in each brand segment that added to our overall margin decline. In luxury, there was a shift in sales away from high margin luxury vehicles toward lower margin entry level products. In mid-line imports, manufacturing incentives that added to gross margin and overall profitability a year ago, were down significantly. And in the domestic brands, we saw a shift away from higher grossing trucks and SUVs towards more fuel efficient lower grossing cars.

In the heavy truck business, we again faced difficult comparisons on new vehicle units. In 2006, we acquired a substantial amount of inventory, before the emissions standards changed, which we subsequently sold during 2007. As we've discussed on our previous calls, we performed a full review of this business in 2007 and positioned it for a lower gross profit environment. And despite the retail sales decline, the bottom line performance delivered according to our internal forecast.

Turning to used vehicles, our guidance for 2008 assumed unit sales in the first half would experience a low double digit decline. Our focus on sub prime customers, which peaked in the first quarter of last year, together with the aggressive lending practices of certain lenders at that time, left us with difficult comparisons to overcome in 2008. In the first quarter of 2007, almost 35% of our used unit volumes were driven by sub prime financing, driving our ratio of used cars to new cars retailed to the highest levels in our history, reaching 0.68 used to new.

In contrast, our sub prime sales this quarter made up less than 25% of our total used vehicle sales and our used to new ratio returned to a more normal first quarter level of 0.62. Our used unit volumes for the quarter were slightly below our planning levels. However, the adjustments we made to our used inventory in the fourth quarter of 2007 improved our inventory turns and delivered better than anticipated gross margin, essentially compensating for the weakness in volumes.

In fixed operations, the quarter started off with a normal pace of business, with same store gross profit growth of 3% to 5% in each of the first two months, generally in line with our planning levels. However in March, several of our regions, including Texas, Arkansas, Atlanta, and St. Louis, experienced weather conditions that caused disruption in the parts and service business. On average, we estimate that our operations in these markets lost three to four days of fixed business due to blizzards, rain, and flooding, and heavily impacting our results for the quarter.

Lastly, our finance and insurance business continues to deliver excellent results posting F&I PBR of $1,060, a 12% increase from a year ago, and we expect a similar level of F&I PBR over the remainder of 2008. On the technology front, we made significant progress in working with DealerTrack to convert more of our dealership management systems to their Arkona software. To date, we have converted 18 dealerships. Our conversions are on schedule and we are more than satisfied with the support and training we have received from DealerTrack. We expect to begin seeing reduced licensing fees associated with the new DMS system in the second half of 2008. Once the core DMS is in place throughout the organization, we will begin to tap the efficiency improvements that will be available with the new software.

In the current economic environment, the results we delivered in the first quarter would not have been possible without our decisive approach to reducing expenses. As I said on our last call, we cut once and cut deep, and I am proud of our regional management teams' efforts in reducing our cost structure and delivering the expense savings our organization needed.

Now, I would like to turn the call over to Gordon to go over our expenses in further detail. Gordon?

Gordon Smith

Thanks Charles and good afternoon everyone. For the quarter, our SG&A as a percentage of gross profit increased 330 basis points to 80.6%. The increase reflects the deleveraging impact of our cost structure from the decline in vehicle sales volume. Our same store SG&A was down 6.2% or $10.7 million from a year a go. As Charles mentioned, at the end of 2007, we reviewed our expenses with a focus on personnel and advertising in particular.

To ensure that our cost structure was appropriate for our forecasted gross profit levels, our approach was decisive, yet surgical, so that it would result in the least amount of disruption on our retail performance. We reduced our personnel cost by 2% to 3%, or about $10 million in annualized costs. Those cutbacks combined with the natural flex of our pay plans as gross profit declined enabled us to deliver a $5.1 million or 6% reduction in same store personnel expenses for the quarter.

We took a similar approach to advertising. Our goal was a 5% to 10% reduction for 2008. But with the softer retail environment, we adjusted our plans even further, specifically in traditional media and bought same store advertising down 15%, keeping our advertising PBR constant with last year at $305 per vehicle. Meanwhile, we continue to expand our fixed operation advertising programs and Internet activities.

All of our regions contributed to our cost reduction initiatives. However, these efforts were particularly important in offsetting the weakness in Florida and California. For the quarter, Florida contributed 30% of our overall revenue and California contributed 4%, so more than one-third of our revenue was derived from very soft markets.

In Florida, our same store retail units were up almost 20% from a year ago, and as you would expect in this environment, our same store gross profit in Florida was down more than 15%. However, due to the strong flow-through from our expense cuts, operating income declined 35% or about $0.10 per share.

This is no doubt that the housing crisis continues to weigh on the overall economy in Florida and California, and we are expecting that the softness in these retail markets to continue throughout 2008, although on a comparable year to year basis, our results should start to look considerably better in the second half. And one last item on SG&A we incurred approximately $0.5 million or about $0.01 of EPS in costs related to the conversion of our stores to the Arkona DMS in the quarter. Our tax rate for the quarter was 38% at the midpoint of our planning range for 2008 and up slightly from last year's first quarter rate of 37.7%.

Turning to the balance sheet, our cash balance was $26 million as of March 31, down $27 million from year end, as a result of acquiring a Toyota store in Atlanta, as operating cash flow was up 55% compared to a year ago, to $25.7 million. Our debt to total capital ratio remained relatively constant at 44.7% and our average cost of debt is currently about 6.6%, with no principle amounts due under our subordinated debt until 2012 and nothing outstanding on our existing revolver.

As Charles mentioned, we brought down used inventory substantially at the end of 2007, and our used inventory levels are almost 25% below March of last year. Our used vehicle DSI stands at 45 days, and we will continue working to align our inventory to meet the demand of our local markets. Optimally, we would like reduce our used vehicle DSI to 35 days.

Looking at new vehicle DSI, we currently stand at 77 days. With our brand mix, we would like to see those numbers closer to 65 days. However, with the one month look-back we use in our DSI calculation and a usually weak retail month in March, inventory levels were up, especially relative to the lower sales pace. In total, our new light vehicle inventory was up 54 million or 11% on a same store basis from last March.

Breaking down new inventory by market segment, at the end of march, luxury inventory stood at 77 days, up from 53 days a year ago. Midline import brands increased to 67 days from 55 days. Finally, domestic inventory increased to 107 days from 77 days last March.

I would like to remind everyone that our floor plan rates are LIBOR based. So with the disruptions during the quarter in the debt markets, we have not yet seen the full benefit of the interest rate reductions. The fed funds rate is down 300 basis points since last March, yet our average LIBOR rate for the period of 3.6% was down just 170 basis points compared to a year ago and generally in line with our planning levels.

Floor plan expenses was down a little over 20% on a same store basis or $2.4 million. Currently, the spread between fed funds and LIBOR is about 65 basis points, significantly higher than the historical average of 10 basis points. And our current forecast assumes that LIBOR rates will stay at about 2.9% for the remainder of 2008. Also keep in mind that we have a swap in place to fix 150 million of our floating rate debt through November of this year.

Finally with respect to portfolio management, we divested three stores during the quarter, including two value brands and a domestic brand that were under the same roof. As always, we continue to evaluate the bottom 10% of our stores for potential divestiture, and capital redeployment opportunities.

With that, I would like to turn the call back to Charles for some concluding remarks. Charles?

Charles Oglesby

Thank you, Gordon. Before I turn to closing remarks, I want to make everyone aware of more severe weather that impacted our operations in April, this time in the form of a tornado that directly hit two of our dealerships in Jackson, Mississippi. We are currently evaluating the financial impact of the destruction, as well as the disruption in operations, and estimate that the total financial impact could be as much as $0.03 of EPS for the quarter.

In conclusion today, I would like to reiterate our commitment to our long term growth strategy and reassure our shareholders that we remain very confident in our positioning in the marketplace, in terms of both our brands and locations. During the quarter we saw further migration of consumer demand towards affordable fuel efficient vehicles, as gas prices continue to rise, and macroeconomic conditions worsened. These broad changes and customer preference are moving directly towards Asbury's sweet spot. During the quarter, 60% of our new vehicle sales came from our midline import brands, which offer the widest range of fuel efficient cars in the industry.

We also remain confident in the long term growth prospects of our regional markets. While Florida and California are obviously underperforming at the moment, we have no doubt that their strong growth will resume. As we noted in this morning release, most of our dealerships are in markets with populations growing faster than the national average in 2007, and long term projections still call for these markets to grow significantly faster than the nation as a whole.

During the first quarter, we continued to execute against our strategy, selectively acquiring a high quality Toyota franchise and continuing to pay the dividend to our shareholders. We remain well positioned to execute tuck-in acquisitions to complement our organic growth and need only a small contribution from them to deliver against our growth objectives.

And finally, with our balanced retail and services business model, with revenues from four lines of business, and the flexibility to cut expenses to offset any weaknesses, we are well positioned to weather the current turbulence in the economic environment. And likewise when the market does return, we will be in position to take advantage of the retail opportunities.

And with that, we'd like to turn the call back to the operator, and take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We'll go first to John Murphy with Merrill Lynch.

John Murphy – Merrill Lynch

Good afternoon, guys. Just had a question on the new car margins and if you think this pressure is more structural and cyclical here? Also just on that, if you could just talk a little about your profit differential as the mix deteriorates from sort of the higher-end luxury and larger trucks towards these more fuel efficient vehicles, if there is a big swing factor there?

Charles Oglesby

Certainly under today's market conditions, where there is more inventory available than customers in some cases, it will have an impact on the margins. Everyone still wants to turn the inventory. The part of the financing arrangements with the customer that are cash, the cash position is a little bit less. So it structurally changes the deal a little bit. So, that combination of events, right now makes it unusually difficult on margins. We do expect it to return in the future as soon as this cycle returns to a more normal business. And as far as the luxury margins, the heavier luxury inventory is not in demand right now, so the margins are softer there. The newer products that are being introduced are still quite strong and the margins are holding, but they are at a lower level.

John Murphy – Merrill Lynch

If you think about the cost structure and the fixed cost structure and what you are able to do there, sounds like you cut pretty far so far. And I am just wondering if there is anything more you can do there in the face of potentially weaker sales, and as you implement DealerTrack, how much further you can go on these cost savings?

Charles Oglesby

John, we continue to manage the business to the market. There will always be more expense takeouts. We did do – as you know the greatest expense opportunities are the greatest cost in dealerships is inventory, personnel, and advertising. We did cut personnel and we did advertising. The one area right now that is glaring to us is our inventories, and we are working diligently right now to get our inventories down, so we can work on that expense reduction as well.

On a go-forward basis, we want to be very careful with our advertising adjustments in the future. We still know that we won't have the appropriate share in the marketplace of our voice. Personnel reductions, depending on what happens in the marketplace, whether or not we would go there or not. And then with the efficiencies, and what we look for with the gains with the Arkona and DealerTrack implementation is productivity gains. Because as you know, from an expense standpoint, you really have two ways to go with it, which is a direct expense reduction or an increase in productivity, so we will look for both of those areas to help put us where we want to be with our bottom line results.

John Murphy – Merrill Lynch

And then lastly, on the used car market, I am just wondering what you are seeing there. Clearly there is some pressure on profits. Just wondering if that is really a function of a lack of availability to these sub prime consumers, what you are seeing on showroom traffic if the credit market were to loosen up and some of these guys were able to get financing, would there be a real big uptick there? Just generally, what is the short term weakness in there, where there may potentially maybe some real recovery here in the near term?

Charles Oglesby

What certainly impacted us, John, was last year as an example versus this year, over 75% of the difference between our volume last year and this year is our loss in sub prime. The sub prime market actually has always been there. Actually it is growing more today. The ability for the lenders to service that market and having the right inventory for that market is not there as it has been in the past. In the past, the lenders were – they stretched their limits a little bit and the ability of the customer to have a little more cash down and certain inventory that came out of rental car companies was in place.

And again, a lot of those conditions have changed, so that changed that sub prime market. I do believe that whenever the lenders are able to have availability of capital to loan, that that will open that market up. I think that that is going to be an opportunity. And of course with our experience there, we at the appropriate time and appropriate way will be able to take advantage of that.

John Murphy – Merrill Lynch

Great, thank you very much.

Operator

We will go next to Rick Nelson with Stephens.

Rick Nelson – Stephens, Inc.

Thank you and good afternoon.

Gordon Smith

Hey, Rick.

Rick Nelson – Stephens, Inc.

Just wanted to follow up on the cost savings, the personnel and advertising expenses that you discussed, that came out, was that front-end loaded or did that sort of flow through the quarter and is more back-end loaded?

Gordon Smith

What I would say – this is Gordon, what I would say is that probably 75% of it was throughout the quarter, and the other 25% came through the quarter. On the advertising side, it was pretty much, it was a little bit more in March than as a percent in January, but January and February are lower advertising months anyway. So that was more back end loaded.

Rick Nelson – Stephens, Inc.

Got you. And (inaudible) per unit, the nice increase that we saw there, what is the driver?

Charles Oglesby

We have had nice increases really quarter by quarter in our finance PBRs. There are a number of things that contribute to that. One of the greatest things I think is the focus on our bottom third stores, where we continue to improve the productivity and the training and the skill set of the people in the dealership. Because that also relates to higher customer satisfaction, a better customer experience. So that is where a lot of it comes from. Some of it has on the PBR side, comes from a natural lift from the decline in our sub prime financing, some of our product penetrations, and then certainly some of the income that we receive from our preferred lenders, as well as our contract providers, so it is a combination. But overall, the bulk of it comes from the skill set improvement, in our finance managers.

Rick Nelson – Stephens, Inc.

Thank you for that, Charles. Just a question on acquisition pricing, you have made an acquisition here recently, can you comment on the environment there?

Charles Oglesby

Personally, I think right now, it is still pricey. Although we look at very specific deals as you know and strategic deals that fit for us, we have hurdles that we must be able to get over before we make an acquisition. I think right now the number of deals that we have been able to look at, we could load this room right now with them, because there are more deals that as we expected would become available. I don't know that the rationalization is in the seller's mind yet, as to what the market is. I think that that, at some point in time, will settle in. But right now, I think they are still a little pricey for us. But, there is more available deals out there.

Rick Nelson – Stephens, Inc.

And how do you approach these CapEx requirements that the OEMs are instituting? Mercedes Benz with Autohaus and Toyota has got their image requirements, how does that work in with your return on capital targets?

Charles Oglesby

We like to have good partnerships, good relationships with what we consider our OEM partners. And their requirements, as you know, seem to be increasing. Where it makes sense for us to do that, we absolutely will do it. But it must make sense for us from a business standpoint as well. It is a matter of managing those relationships in an appropriate way, that it is win-win for everybody. I think ultimately, at some point in time, and it depends on again the return hurdle, as to when it happens, ultimately I think that the manufacturers will get what they are looking for. But we need to put it on our time frame as well when we do that.

Rick Nelson – Stephens, Inc.

All right, thank you. Good luck.

Operator

We will go next to Edward Yruma with JPMorgan.

Edward Yruma – JPMorgan

Thank you for taking my question. Given the amount of structural costs that you've been able to take out of your stores, where does that lower your SAR break-even point, or at least where you would cross the $1.80 threshold on low end of your guidance?

Gordon Smith

I think that right now we have lowered our SAR expectation and the cost take-outs are in line with SAR – around probably in the 15 to 15.2 range as opposed to where we were, when we started this process at 15.3 to 15.5. So we lowered our SAR expectation and taken the commensurate amount of cost out.

Edward Yruma – JPMorgan

Got you. And given some of the weakness in some of your local Florida and California markets, do you feel as if you are losing share there, or are you basically holding or gaining share in those tough markets?

Charles Oglesby

I would say on an overall basis, in all of our markets, historically we have gained share in the marketplace. But if you look at it dealership by dealership, sometimes operationally, we have operational changes or improvements that we can make. But, on an overall basis, we are maintaining or gaining share. Last quarter, I mentioned on our call that we lost share in last quarter and it was what I believe is because of some of the distractions where we were doing these expense cuts and the organization itself was distracted from what we do on a day-to-day basis, was go to work, sell cars, take care of the customer, take care of our employees. So with that exception, we generally maintain or gain share in our markets.

Edward Yruma – JPMorgan

Got you. One final question if I may, I know you addressed the issue of sub prime within the used vehicle market, can you refresh our memories and let us know how much new vehicles are sub prime and whether you have seen some impact from credit availability from there as well? Thank you.

Charles Oglesby

I am sorry Edward, did you say on the new vehicle?

Edward Yruma – JPMorgan

Yes.

Charles Oglesby

Okay. What we notice is not really a lender pull back. But what is different in the marketplace is the structure of the deal, the trade in, or the lack of equity being upside down, that the customer is, and that it is – excuse me a second. I lost my train of thought here. I am sorry.

Gordon Smith

Your original question on sales, I think – we don't particularly track sub prime and new, but it is around 8% to 10% of our volume in new, is related to sub prime.

Charles Oglesby

Excuse me. Someone distracted me. That is why my brain went soft there for a minute. The question was on the financing renewal [ph] side. What we notice again is the deal itself is changing. So as the lenders look at the deal, they are not over-extending the loan requirements or the loans, as they did in the past, where they may give 110% loan approval to the customer, whereas now it is 90%. So other than that, where the deal has changed, the lenders are not pulling back, they're just tightened the box a little bit.

Edward Yruma – JPMorgan

Got you. Thank you very much.

Operator

We will go next to Deron Kennedy, Goldman Sachs.

Deron Kennedy – Goldman Sachs

Hello, it's Deron Kennedy here with Matt Fassler, how are you?

Charles Oglesby

Good, Deron.

Deron Kennedy – Goldman Sachs

Good. A lot of my questions have been answered. I was trying to pick apart the weakness you are seeing in used. And I think overall, I am surprised the gross margin has held up as well as it has, considering how steeply down the comps are. But, is there a way you can kind of break out the sub prime challenges in the markets where you took kind of a deeper dive last year versus overall weakness in the market?

Charles Oglesby

Most of the impact on sub prime was in three of our markets; Florida, Arkansas, and Mississippi. We know that we lost, as I mentioned, about 75% of our unit volume has been lost on the sub prime part of our business. We know we are very good in the used car aspect of the business. If you are going do anything in this business, you must be good on the used side. You got be able to dispose of the trade-ins. You've got to be able to know how to trade for them, as well as retail. We are good. As we said before, we really took advantage of an opportunity in the marketplace, so we don't feel that we have dropped off and one of the reasons that we were able to hold on to the margins, is because of the inventory repositioning and the reduction of inventory that we did last quarter of last year allowed us to have the type of inventory in the market that the market was looking for. And therefore, you can hold a higher margin on that. Again, it is a number of factors that determines performance in the used arena. So again, it's a number of factors, that determines performance in the used arena, and so we look at all of them.

Deron Kennedy – Goldman Sachs

Yes. I think I understand how you are really comparing against those three markets last year where comps were so high. Do you have any indicator you can give us same-store, maybe excluding the markets where you were pushing in sub prime?

Charles Oglesby

We can get back to you on that. I want to say off the top of my head though that we are probably equal to where we were, excluding the sub prime in our other markets. We will get back to you on that with a definite answer.

Deron Kennedy – Goldman Sachs

Thanks. And then lastly on the credit side, I was just wondering if you could talk about sub prime and overall lending conditions and what your outlook is for the consumer overall pull back has been affecting availability for shoppers in your store.

Charles Oglesby

In the sub prime or prime?

Deron Kennedy – Goldman Sachs

I guess if you could talk to both.

Charles Oglesby

Okay. Again as we have mentioned just a little earlier, the lenders, we have seen some pull out of the sub prime business, but there have been others, Chase, Bank of America, as an example that have expanded. They see the opportunity in that business and have expanded themselves there. Others have reduced.

In the prime sector, in our portfolio mix, we really – again Toyota Financial Credit, NEMAC, Honda Finance, all of these guys are still buying well. Other than a tightening of the deal, as I mentioned just a little while ago, the customer in some cases today is upside down and they're not over-extending some of the loans. So that is where we are not able to be as flexible as we were in the past. But, as far as cutting back, we are not sensing that any of the lenders are cutting back.

Deron Kennedy – Goldman Sachs

Okay. There is actually, I noticed one more comment you made about incentives being down in domestic brands. How are incentives trending in other brands, in imports and luxury, and what is your outlook for that?

Charles Oglesby

The incentives I believe that I was mentioning was the dealer incentives that we received last year, that really was where our improvement in gross margin was so dramatic. Today, the dealer incentives are not as strong as they were last year. So, I do expect, if inventories stay the way they are, we will see – there is production cuts or greater incentives. One way or the other, something must move the market.

Deron Kennedy – Goldman Sachs

Got it. Thanks for taking my questions.

Operator

We will go next to Rich Kwas with Wachovia.

Charles Oglesby

Hey, Rich.

Rich Kwas – Wachovia Securities

Hi, good afternoon guys. A question on average selling price. You mention that there has been a shift to cars on the new side, away from trucks. What are you seeing on the used side. Similar shift?

Charles Oglesby

Yes. The market today is more – anything that is fuel efficient is hot. High-end luxury cars are weaker, except for CPO. The CPO business is in all of our dealerships, is improving. It has always been good, but it is continuing to strengthen. And the shift – SUVs, as you know right now, and trucks to an extent, if that is where your inventory is, you are in trouble. And the same thing for trading for those. You have got be aware of where the market is to whenever you trade for any of that inventory.

Gordon Smith

I think more than ever, the consumer is really looking at the overall cost of ownership of the vehicle. So they are looking at not only gas prices, but maintenance requirements, and then ultimately the residuals they receive when they trade in the car. Those are the things that the consumer is looking for and quite frankly, that is midline imports, and as you know, that is the biggest segment of our business. So we are right in the sweet spot of where the consumer is looking for vehicles.

Rich Kwas – Wachovia Securities

Have you been able to gauge whether the financing environment has had an impact on the mix of used vehicles? Meaning, lenders are maybe a little more stricter with their guidelines, and the cash that is required to put down is a little higher, and there are a group of consumers out there that just don't have that, so they trade down and they accept a cheaper vehicle?

Charles Oglesby

Yes. You have been in our dealerships, I can tell. Those things are absolutely happening out there. There is a shift in the marketplace like that. A lender wants to be protected on what they are lending the money for. And the consumer today, I think that that is one of the keys. When you have a consumer coming in, they may have something in mind and if that is not available to them, it is the ability to move them to something else that can satisfy their needs, as well as the financing aspect of the business. That is it. I think the more successful an organization can do that, the better they can weather these type of market conditions.

Rich Kwas – Wachovia Securities

When you think about that trend, do you think that extends throughout the rest of this year? Are you expecting any kind of relief on that front in 2008?

Charles Oglesby

Rich, I think that it is going the be through this year. Unless something macroconomically changes, I think that is the way we have got think about our business right now. If it does shift, then that's great, we will be ready for that too. But I think right now, we've got to think in those terms.

Rich Kwas – Wachovia Securities

Okay. And then lastly on heavy truck, I think that you'll recall that Charles that you said that you thought mid year, the heavy truck market would stabilize. Is that still your current thinking?

Charles Oglesby

No. When we made that statement, we certainly had different information than we have today. So we are – we are expecting continued weakness in that market. However, because we have repositioned that business, and restructured it, and have really pulled the inventory down on both new and used, we are comfortable with what we will be able to do with that business for the rest of the year, even at these lower volumes.

Rich Kwas – Wachovia Securities

Okay. Great. Thank you.

Operator

(Operator instructions) We will go next to Matt Nemer with Thomas Weisel partners.

Matt Nemer – Thomas Weisel Partners

Good afternoon everyone.

Gordon Smith

Hi, Matt.

Matt Nemer – Thomas Weisel Partners

My first question is, looking at the Accord programs that you had last year, I think that one of those payments hit in March and I think there's another one at the end of the year. But, can you just give us a sense where you are cycling those payments?

Gordon Smith

In the first quarter, in general, and most of it is the Honda program relative to last year. Incentives are probably on the magnitude of $0.015 to $0.02 lower this year than last year. I would say last year, I think Honda was about 500,000 of that. A good portion of the lowered amounts from last year was the Honda program. As far as the cycling through, there was a small pick up in the second quarter. My recollection that was about 600,000 we took in the second quarter and the rest of that was in the third quarter, somewhere around $3 million range in the third quarter. A lot of that was offset with lower margins. So, there won't be that drastic a reduction in the third quarter as a result of not replicating that program.

Matt Nemer – Thomas Weisel Partners

Got it. And then on certified pre-owned, is it possible to break out what you are seeing there in terms of unit sales? Seems like there has been a pretty significant acceleration for the luxury brands at least, for CPOs.

Charles Oglesby

We are experiencing that. Matt. we don't have it broken out as to specific units. But we confirm, you are exactly right. We are seeing a – particularly in BMW, that there's a great value story there for the consumer. And of course, we know they find the value and the are, especially with BMWs.

Matt Nemer – Thomas Weisel Partners

How does that impact your margin dollars? Is it relatively neutral or is it a little bit dilutive? I am assuming that those are people trading down from a new to nearly new.

Charles Oglesby

Not necessarily. And actually, in the luxury line, we experience higher margins, generally on the used products. We haven't noticed yet that these people are trading down, that they are buying the CPO rather than buying new.

Matt Nemer – Thomas Weisel Partners

You think it is incremental volume?

Charles Oglesby

The CPO is incremental volume. I think that the luxury buyer is still a luxury buyer; they want new.

Matt Nemer – Thomas Weisel Partners

Got it. Okay. And then turning to parts and service, you mentioned that weather had an impact there. From a modeling standpoint, should we expect that to tick back up to the 3%, 4%, 5% range, as we get beyond the weather impact in the first quarter, and the second quarter.

Charles Oglesby

We noticed – our customer pay is up 1%, and our warranty is down 5%. Normally, we are up more than that on customer pay. The weather and our foot traffic slowdown happened about the same time, so we really don't have visibility yet as to whether or not this is a slow down and we know how much the weather impacted us. Normally, in my experience, whenever we have a disruption in the market, like we have right now, it will temporarily disrupt the whole organization, the parts and service will experience it to some degree. But what also happens is, as the lifestyle changes that the customer makes, they do get back in the cycle because they need their vehicle. They have got go to school, they have got go to work, they have got to buy groceries. They need the vehicle. So if in fact they are putting that off right now, it is just temporary. They will be back in the service departments.

Matt Nemer – Thomas Weisel Partners

Okay.

Gordon Smith

Matt, for modeling purposes, we have assumed for the rest of the year, that we will be at the low end of the range that you just said. Around 3%.

Matt Nemer – Thomas Weisel Partners

Got you. This is just a housekeeping question, but the restricted payments basket should be around 15 million right now, does that make sense?

Gordon Smith

13.2.

Matt Nemer – Thomas Weisel Partners

Okay. Then lastly, can you comment on any change in customer behavior that you have seen in the first few weeks of April relative to March?

Charles Oglesby

It is kind of hard to say, the SAR for April last year was strong at 16.2. I believe that – I don't think that we are going get to that level this year. We kind of anticipated15.3, 15.5. It has been less than that. And April, usually is the type of month that is starts off slow and finishes stronger because Easter is usually in April. Easter this year was in March. I don't know necessarily how much impact that had in March or not, but it certainly was something different. So it is hard to say whether or not it will strengthen or not. We are just continuing to do the things that we do on a day-to-day basis and take advantage of whatever opportunities we have out there.

Matt Nemer – Thomas Weisel Partners

Got it. Thanks so much for your time.

Operator

At this time, we have no further questions in the queue. I would like to turn the conference back to the speakers for any additional or closing remarks.

Charles Oglesby

Thank you everyone for joining us today. I would like to just continue to extend the comment that I ended our last call with, last quarter. We are steady as it goes and we are very comfortable that we are executing the model that we have. I am very proud of the people in the field during these difficult economic times and we will continue managing the business to the level that everyone is expecting from us. So, thank you for joining us today.

Operator

Ladies and gentlemen, this concludes today's conference. We appreciate your participation. You may disconnect at this time.

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Source: Asbury Automotive Group, Inc. Q1 2008 Earnings Call Transcript

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