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Executives

Roger Penske - Chairman

Robert O’Saughnessy – Executive Vice President and Chief Financial Officer

J.D. Carlson – Controller

Anthony Pordon – Senior Vice President

Analysts

Saul Rubin - Silverstone Capital

Jonathan Chin

Sid Wilson - Kevin Dann & Partners

Scott Stember - Sidoti & Co

Rich Kwas - Wachovia

Rex Henderson - Raymond James

Matt Fassler - Goldman Sachs

N. Richard Nelson - Stephens

John Murphy - Merrill Lynch

Matt Nemer - Thomas Weisel Partners

Penske Automotive Group Inc. (PAG) Q2 2008 Earnings Call July 30, 2008 2:00 AM ET

Operator

Good afternoon ladies and gentlemen and welcome to the Penske Automotive Group second quarter 2008 earnings conference call.

The call today is being recorded and will be available for replay approximately one hour after completion through August 13, 2008. Please refer to Penske Automotive’s press release dated June 4, 2008 for specific information about how to access the replay.

I would now like to introduce Mr. Tony Pordon, Senior Vice President of Penske Automotive Group.

Anthony Pordon

Thank you John, and good afternoon everybody.

A press release detailing Penske Automotive Group’s second quarter results was released this morning, and it’s posted on our website at www.penskeautomotive.com.

Participating on the call today are Roger Penske, our Chairman; Bob O’Shaughnessy, our Chief Financial Officer; and J.D. Carlson, our Controller. At the conclusion of our remarks, we will open up the call for question. We will also be available by phone to answer any follow-up questions that you may have.

Before we begin, I would like to remind you that statements made in this conference call may include forward-looking statements regarding Penske Automotive’s future reportable sales and earnings growth potential.

We caution you that these statements are only predictions, which are subject to risks and uncertainties, including those relating to general economic conditions, interest rate fluctuations, changes in consumer spending, and other factors over which management has no control.

Our actual results may vary materially from these predictions. These forward-looking statements should be evaluated together with additional information about Penske Automotive, which is contained in our filings with the Securities and Exchange Commission, including our 2007 Annual Report on Form 10-K.

At this time, I would like to turn the call over to the Chairman of Penske Automotive, Roger Penske.

Roger Penske

Thank you, Tony, and good afternoon everyone. Thanks for joining us this afternoon.

Looking at the results for the second quarter, PAG’s model performed well despite industry challenges we all are aware of at this point. During the quarter, we faced several business headwinds: rising gas prices, declining consumer confidence in the U.S. and the U.K.-pressured new and used car vehicle sales also.

In fact, in the U.S. overall industry sales declined 12%, and in the U.K. new vehicle registrations declined 2.5%. I think despite these challenges our results continue to showcase the strength of our business model diversification.

Looking at the highlights for the quarter, the retail 78,472 new and used units in Q2, and that’s about 1% up versus last year. Total revenue was $3.4 billion. Gross margin improved to 14.9% versus 14.6% in the second quarter of last year.

Income from continuing operations was up 1% to $40.5 million and related EPS was up 2% to $0.43 per share.

Turning to the specifics for the quarter, new unit sales declined 1.7%. However, we had great momentum on our used unit sales remain strong, and they were up 4.9%. The other end average selling prices of new and used vehicles declined approximately $1,000 on new down to $34,500, and used was down approximately $1,600 to $29,000.

With the total revenue flat compared to last year, new vehicle revenue was minus 4.4%, used was flat, F&I was up 1.1% and service and parts overall was up 3%. On a same store basis worldwide, we decreased 5.9% and breaking it out the U.S. was down 6.8% and international was down 4.4%.

If you look at the revenue for same store, our new vehicle was down 8.7%; used vehicle down 2.8%, service and parts up 1%, and finance and insurance down 3.5%. There was no foreign exchange impact in the quarter at all.

Our revenue mix in Q2 was consistent with last year. 63% of the revenue was in the United States, and 37% was international. On a worldwide basis, foreign and premium nameplates represented 95% of our total revenues, including 63% from our premium brand mix. The Big 3 in the U.S. contributed the remaining 5%.

Looking at our specific brand mix and percentages, you can look at our press release and the specific data that was provided there this morning. During the quarter, our operating income was 65% and international was 35%, and that was consistent with last year.

Looking at the gross margin, I talked about earlier, margin increased from 14.6% to 14.9% during the quarter. New margins by the way remained stable at 8.4% despite lower selling environment.

Used margin decreased slightly from 8.0% to 7.8%, down 20 basis points. F&I increased $5 per unit to $968. Our service and parts business continued to perform well also with margins of 56.1% compared to 56% in the first quarter of this year.

Moving on to SG&A, SG&A to gross profit was 79.5% compared to 78.2% in Q2 last year. On a same store basis, SG&A was down $5.8 million in the quarter, or 1.5%, so we made good traction within the same store group.

SG&A declined 130 basis points from 80.8% reported in the first quarter. The tax rate for the quarter was 35.2% compared to 37.1% last year. We currently expect the annualized effective tax rate to be between 35% and 36% for the entire year.

Looking at the balance sheet, total vehicle inventory was $1.7 billion, which is down $33 million compared to March. On a same store basis, total vehicle inventory was down $56 million compared to March; new was down $4 million. The good news is our used was down $52 million.

In the U.S., our vehicle inventory really is in pretty good shape. Earlier this week, I asked the team to give me really a break out in three categories, pickup trucks, specifically pickup trucks and SUVs and passenger cars. We’re only sitting with 10% of our inventory in pickup trucks; 40% in SUVs, and 50% in passenger cars.

If you look at the U.K., really our inventory is pretty much flat at ₤149 million, and that’s consistent of what we had at the beginning of the year. We’re going into a registration month so we’d look at some build up. We would expect that to come down after September.

On a used car basis, in the U.K., we’re really flat again at ₤100 million or $200 million, and we expect that to be down to ₤75 million by the end of the quarter. More than 40% of our new truck inventory obviously is related to our domestic Big 3 franchises.

The balance would be Toyota Tundra and Titan trucks from Nissan. As you know, they’ve been out plant closing or strong incentives on those businesses. Again only $80 million in total in trucks.

We expect all of our vehicle inventory to decline in the second half of the year as we’ve announced production cuts, which will help us better align our supply with demand. At the end of the quarter, our worldwide days inventory was 68; used was 35.

Moving onto CapEx. Gross year-to-date CapEx was $117 million. Sale lease proceeds for the first six months were $20 million. As a result, net CapEx for six months was $97 million.

We are currently planning to close transactions that would generate approximately $100 million of proceeds before the end of the year, subject to obviously market conditions. As a result, we are currently projecting net CapEx of approximately $50 million for 2008.

Looking at our leverage as of June 30, we had $1.1 billion of non-vehicle debt; $750 million of senior subordinated notes at a blended rate of 5.65%; $375 million at 3.5% to convert and $375 million at 7.75%. Another $310 million under our credit agreements with an average rate of 5%.

As of June 30, we had approximately $370 million of availability under all of our credit agreements both domestically and internationally. Our debt-to-capital ratio was 42% compared to 39% at the end of June.

We have $1.6 billion in floor plan notes outstanding. We have swaps that convert $300 million of our floor plan to fixed at an effective rate of 4.65% through January of 2011, with the remaining $1.3 billion approximately 50% is in the United States. When you include the $1.6 billion of floor plan, 40% of our debt was fixed with an average rate of 5.1% with maturity of 4.6 years, which puts us in real good shape.

Looking at acquisitions, year-to-date, I think we’ve already reached our guidance that we had guided earlier. During the first six months, we’ve had estimated annual revenue of $415 million.

Breaking that out acquisition is $200 million in the U.S.; $215 million internationally. We’ve also divested of 11 franchises with estimated annual revenue of $325 million; $255 in the U.S. and $70 million internationally.

We continue to evaluate transactions obviously that come to us, basically looking for any acquisitions which we think would be opportunistic as we go forward over the next six to twelve months.

Let me quick talk about our smart distribution business. During the quarter we delivered over 7700 fortwos to our dealer network, bringing the total wholesale deliveries for the year to 12,646 units. We’ve increased really our availability, and we’ll wholesale between them 24,000 and 27,500 vehicles in 2008.

During the quarter, we reported $98 million in smart revenue and the smart business contributed $0.07 in earnings per share. Smart fortwo continues to receive significant media coverage, as you know, and has earned an outstanding reputation against our customer base who have taken delivery to date.

I’d also like to point out that the 2008 fortwo was awarded the highest rating from the Insurance Institute for Highway Safety for front and side crash worthiness, the best of all ratings from any cars.

The IIHS coupled with today’s higher gas prices have led to continued strong consumer interest. In fact, we received 20,000 new reservations over the Internet in May and June and are on pace to receive over 7,000 here in the month of July.

Obviously I’m excited about smart, and I believe it’s going to continue to be a key differentiator for us at Penske Automotive.

Let me take a quick note on guidance. We updated our guidance in the press release this morning. As noted, we currently estimate our annual income from continuing operations to be in the range of $1.54 to $1.60 per share, and our guidance was based on 95 million total weighted shares outstanding.

Before I close the call, I want to talk a little bit about share repurchase. In February we announced it. I believe our shares represent a great value, however, we did not purchase any shares under this program in the second quarter, due to restriction within our internal securities trading policy.

We will continue to monitor the market and expect to make purchases opportunistically, as we said before, subject to market conditions and our trading policies.

In summary, I’m pleased with the company’s operating performance during the second quarter. Although the vehicle market was challenging, our brand mix and diversified structure allowed us to achieve earnings growth in the second quarter.

While we expect the macro economic challenges facing us to continue in the second half, I believe that the diversification provided by our geographic footprint, our import luxury nameplate brand mix, certainly smartUSA, and our investment in Penske Truck Leasing will put us in a position to maintain earnings growth throughout the balance of the year.

At this time, let me open it up for any questions, and thanks for joining us this afternoon.

Question-and-Answer Session

Operator

Our first question is from the line of Matt Nemer - Thomas Weisel Partners.

Matt Nemer - Thomas Weisel Partners

The first question is on the U.K. Can you give us a sense for what your guidance assumes for this coming September registration month, and then any changes that you’re thinking about to the cost structure over there before we get to September?

Roger Penske

As I said in the market their registrations were off 2.5% for the quarter that would be Q2. I know inflation has gone up to 3.8% over there. We’ve seen certainly some softness in our super premium luxury; people even canceling some of the Porsches and Ferraris.

That’s obviously giving us some guidance in where the market will go over the next six to twelve months. Certainly from our perspective, we probably have hair cut our U.K. guidance probably about 20% based on that as we look at the guidance for the balance of the year that would include Q3.

Certainly from a cost saving and offense, we’re looking at 6 to 10% reduction in head count, as we go forward, which we have about 5000 people there. I think that our average the cost of our people is probably $150 million. So there’s a chance for a decent savings there. Also, as we said earlier on the call, we’re reducing our inventory, down on used cars to a target of $75 million, down from a $100 million.

We’ll also reduce our demonstrators over there. We have a lot more demonstrators for our sales people for used, so we’ll cut those back by 10%. We’re also doing the traditional looking at any of the marketing activities that are taking place as we go forward.

So number one, we’ll look at people costs. We’ll look at inventory costs, and obviously any other marketing costs associated with the balance of the year. I think the real test will be how does the September registration month really activate the market or deactivate it as we see this over the next 60 days, so we’ll keep you stay tuned.

Matt Nemer - Thomas Weisel Partners

Okay great. And then just turning to this topic of leasing, any sense for what impact reduced leasing would have for your premium brands, not that we’ve seen any significant announcements there. But if they pull back on leasing, what do you think would happen to both sales and potentially profit per unit?

Roger Penske

First, on the Big 3, I think they have a different picture than the domestic or the foreign nameplates do, because their credit ratings and the ability for them to securitize leases.

I think the offense they’re taking probably is prudent for them, maybe as dealers we might not like it. But I think long term it’ll probably work out well for them because what’ll happen is they’ll put the money at the customer or at the dealer level, and they’ll know what the transaction costs them on a day-to-day basis.

Conversely, as we look at the premium luxury, and we look at Toyota Financial and we look at BMW and Mercedes, there is no question that their credit ratings are certainly higher. In fact, I think Toyota is an AAA. They’ve obviously been very active in leasing, and I think their residuals have not taken the hitch that maybe some of the Big 3 have.

I think what’s going to happen is I see more finance penetration, because obviously the customer in this case won’t be paying cash. I think today about 25 to 30% of our customers pay cash and the other ones are either leasing or are actually buying on a lease payment program, their vehicles.

With that happening I think that we’ll end up with maybe more reserve on our finance contracts we’ve had in the past, because on leases, you have a difficult time sometimes selling the extended products that we have in the future.

Today leasing is 33% of our total mix. I think you got to stay tuned on that. I can’t really tell the impact. There has been some pushback I think at BMW right now as far as leasing. I think they’re just looking at their overall portfolio.

But typically we get the benefit of those lease cars, because they come back to the dealership when we sell those as pre-owned certified. So that program’s worked out pretty well for us. I think you’ll see that continuing with all the premium luxury brands.

Matt Nemer - Thomas Weisel Partners

Okay. Then lastly, can you give us any early sense of what you’re thinking in terms of capital expenditures for 2009? And then on top of that, it seems like you’re generating at least $150 million in free cash per year, and I’m just wondering how you prioritize the uses for that cash?

Roger Penske

The good news is that the big campuses that we have invested the heavy money in over the last two years are complete. I would think that you’d see anywhere from 30 to 40% reduction in our gross CapEx as we went into 2009.

Basically then what we’re going to do is also look at projects that could even be pushed off further six months. Obviously some of that will be involved with discussions with the OEM, not that we won’t continue on them.

But from a cash perspective, share buyback will obviously be a key at the top of the list at least at today’s share price. We’ll continue to pay our dividends, and we can do debt repayment.

We have uses for our cash and I think that we’re going to also have an opportunity to look at some acquisitions, but they’ll have to be strategic in markets where we already have scale.

Matt Nemer - Thomas Weisel Partners

Great. Nice job of keeping earnings flat in a down market.

Operator

The next question is from Rich Kwas - Wachovia.

Rich Kwas - Wachovia

Good afternoon, Roger. Regionally speaking, some or the other retailers have talked about Florida getting precipitously worse here in the second quarter. What are you seeing in terms of your dealerships, and what’s your outlook for the rest of the year for Florida and some other parts of the country?

Roger Penske

I think our toughest markets right now are Arizona and Phoenix, and then you’d have to say South Florida. We don’t have a lot of concentration there. But it certainly was down when you look even in the foreign nameplates, we were down in Florida.

Obviously down more in new, probably down about 20%, and then used was only down less than 3%. On the other hand, we go to Southern California, our used business is up 5%, and the new car business was down around 10%.

Northern California on the other hand was up 3% on new cars. So we’re seeing some stabilization in Northern California; might be the high tech areas there that’s driving that, I don’t know.

Certainly when you look at Florida, you’re looking at housing and so many other things, and there’s no question that we’re seeing that impact in Arizona, which we have over $1 billion worth of sales in the Phoenix area. I’d have to probably go along with the statement that Florida is softer at the moment.

Rich Kwas - Wachovia

Okay. Parts and service I think you were up a little bit and customer pay was up a little bit. What are you seeing on customer pay? Are you seeing a pull back on the bigger ticket repairs and maintenance, any discernible trend there?

Roger Penske

Our parts and service up 1%. The one thing that we’re seeing is that warranty is reducing. So that’s a little bit of a headwind for us because that’s labor hours and parts that we’re selling. That would be the only thing I’d see.

Obviously people will do what they have to but with the extended warranties that we’ve sold, we’re getting some benefit of those at this point. But there are some delayed service, but I would say, where they might only do safety required items; tires, alignment, and things like that.

But my big concern is that this warranty, we saw it in the domestics probably back 2.5 years ago where all of the sudden the quality got so much better that the warranty went down, and we had bays available. Right now we’re running about 70% utilization of our bays across the country.

Again, when you look at margin, we’re at 56.1%. We’re up a tenth of a point for the quarter. I wouldn’t think that we’re in any downward slide. Our e-mail capture is key for us today.

We’re really penetrating our database, and there are probably a lot of loyalty programs because we’ve got to market to that customer because ultimately that’s the base that’s going to buy new and used cars from us.

Rich Kwas - Wachovia

Okay. And then finally in terms of real estate ownership versus sale-leaseback, what are your current thoughts there? And if you were to go the real estate route, how long would it take you to transition to that?

Roger Penske

It’s interesting. We followed what some of our peers have done in the market. Obviously, we’re looking at it the same time. There are some of the sale leaseback providers, who today have decided to liquefy some of their portfolio.

Opportunistically, we’ll look at those and see that they make any reason that we might move those to mortgages. I really want to look at that carefully.

We’ve got about $100 million right now that’s earmarked for sale-leaseback U.S. and domestically, and we probably will move on that. But we’ll look again as we go forward, we’ll balance a line of credit from the standpoint of mortgages.

I think there are some benefit from the standpoint overall cash flow over a longer period of time, and I think we’ve got to weigh that for any short-term cash requirements we might want to have. Because I think it’s got to be important to keep our balance sheet liquid here as we go over the next twelve months.

Rich Kwas - Wachovia

Great, thanks that’s all I had.

Operator

Our next question comes from the line of John Murphy - Merrill Lynch.

John Murphy - Merrill Lynch

You mentioned cost cutting efforts that you were potentially implementing in Europe. I was just wondering if there might be anything in the U.S. that you’d consider in the face of the weakening environment?

Roger Penske

Number one, we saw the SG&A come down about $5 million plus during Q2. What we’re going to do is we’ll go out and look at all the locations and I know they’ve done this in the U.K.; what they’ve really done is put a non hire in. So what happens is you’re going to have to try to look and see can you retrain some people to take over a job.

We run about a 30% attrition rate/turnover in our business. So that gives us some ability to trade out some of the people. We’ll look at our people obviously. We’re going to be sure that our comps have grossed all the variable composition from the standpoint of paid plans they’re working. As the elevator goes up, they make more money; if it comes down they’ll be impacted just like the company is. But in our advertising, we’re going to target a percent reduction. Everybody’s talking about that.

I think it’s more mix, and we didn’t have to get comfortable with whether it’s Internet, whether it’s going to be electronic or newspaper. But from the standpoint of purchasing with the Penske truck lease, we’ve got a tremendous opportunity to piggyback all of their purchasing synergies, and we look at phone and things like that.

There’s a huge opportunity that we pretty much operate on a region-by-region or area-by-area. Those are all activities that are in place today and we’re on offense. I don’t want to give you a number; I think that what we would do as we got toward the end of the year, we’d say this is already in place; these are the run rates that we’re seeing and just like we saw in Q2, the SG&A down and same store. What we want to be able to do is identify that for you as we go forward.

John Murphy - Merrill Lynch

Roger, on the inventory levels, the mix seems like it’s a little bit out of line, essentially with the sales in the market on pickups and SUVs being 50% of your inventory. Do you see the need to work that down aggressively as we step forward, and how much help are you getting from the automakers to fix that inventory user imbalance?

Roger Penske

I use the category of pickup trucks, and then I had passenger cars and then I had all other, and that was in SUVs. Some of those SUVs would be shown as cars in normal. There is so much crossover back and forth. I just want to see where it was on truck.

I think we’re in pretty good shape, because our inventory is down on a worldwide basis, down significantly. To me if you look at the volume foreign; June versus March we’re down $32 million. But where we’ve got some increases really when you look at Toyota and Lexus, we’re out $31 million. Believe me, with a truck plant shut down and with Toyota taking some schedule out, I think that we’re going to be in good shape.

When we look at the same store basis, we’re down $56 million, $4 million on new and $52 million on used. I don’t think that we’re in any trouble. I’ve looked at it. We really have the ability with our systems to look at it on a daily basis.

The U.K. as I’ve talked about they’ve got about £300 million of inventory and it’s flat since at the beginning of the year, and that will come down after the registration month. Their used car business will be down another £25 million, which is $50 million, and used cars is a good 35 days now. We don’t have any other new initiatives that we haven’t had in place in the past.

The good news is when you look at the U.K., 80% of our business is on consignment on new cars. If the world came to the end, and we’re not expecting this, we’d have the ability to put those cars back to the manufacturers.

I certainly don’t want on this call to indicate that I’m doing that. But that’s the safety valve we have here. Then as we see Mercedes and BMW, really their plants in the international side are down during the month of August, we’ll sell down some of those inventories which have creeped up on us over the last couple of months.

We can’t get enough small cars. We’re selling everything we have; the day’s supply is minimal.

John Murphy - Merrill Lynch

And then lastly, Roger, on the success of smart, it’s actually much better than we thought it was going to be. Do you think there’s any possibility to replicate that distribution model, potentially with new brands as we step forward in the next two or three years when the U.S. market stabilizes and there might be other brands that want to enter or potentially even reenter the U.S. market?

Roger Penske

I would say this, is that we’d have our hand up. Obviously, other people will too, to take on that role as a distribution partner. We’re not just looking at the U.S. We have a couple of markets in Eastern Europe and even Asia-Pacific that we’re looking at today that we might be able to step in with a distribution model.

We’re not yet to talk about those, but we see those as opportunities. I think with a reputation we’ve gotten through the smart distribution here and the way we’ve handled it, we could be on the top of the list.

Again I don’t have anything to report. But certainly that’s an opportunity. We’re seeing more and more people looking at this model and seeing that it worked on a longer term basis. Because today, I think, U.S. based entrepreneurial management might take some cost out of what I call the routine typical distribution process, from the standpoint of being able to get the vehicle to the market, working with the dealers and taking really costs out of the supply chain.

John Murphy - Merrill Lynch

Great, thanks a lot Roger.

Operator

Our next question is from the line of N. Richard Nelson - Stephens.

N. Richard Nelson - Stephens

Thank you for taking my question. Just want to follow up on smart car. You talk about $0.07 contribution; about $0.10 year-to-date, and your prior guides have been $0.08 to $0.12 on contribution of this year. You’ve got to be thinking about some bigger numbers for this year...

Roger Penske

Yes I think you should look at $0.18 to $0.20, though we have the month of August, we get no production, and there is a change or I don’t know what going from 2008 to 2009 we’ve not experienced that with these guys.

One of the benefits we’ve had is that there are logistics that we set up is probably 15 days faster than we had expected. So that’s given us more vehicles into the market, and we’re going to expect remember we had said 20,000 to 25,000. What we’re saying now probably 24,000 to 27,500.

We’re seeing from the standpoint, we got certainly less marketing costs because you’ve seen the Internet action we’ve had. We talked about the orders we’re getting through the Internet. As we’ve rolled out the product, our logistics costs are coming in lower. Again, we talk about marketing; personnel costs are certainly in line.

One thing that we’d never talked about was mix. In smart, we had figured that 10% would be the cheapest car that was available to the public. That particular vehicle carried the lowest margin for us. What’s happened is that mix has gone from 5% in our model to 10%.

And again when you look at the Coupe, it’s at 60% and the Cabriolet is at 35% and that’s that inexpensive car that we thought would be 10 down to 5. We’re then getting bigger margin on those other cars.

Plus, as the customers have an opportunity now on their own to go into the Internet and actually inspect their vehicle, we’re seeing at least $1000 per vehicle more in content, which gives the dealer and the distributor more profitability.

Those are all certainly to give us a little more margin, and I think that will ensure us the opportunities as we go forward.

N. Richard Nelson - Stephens

Given the strong demand there, how do you see supply and unit potential for next year?

Roger Penske

Everybody asks me that question. I’m not sure how many to bring in. I don’t want to break the bubble here, that’s the big problem. I want to have at least 2 less than we need. But I’d like to see probably the run rate in the 30,000 to 32,000, to be realistic.

I think we’re running at those rates today. If we look at the wholesaling it’s 7,700. So that’s more than 2,500 a month. So that’d be 30,000. I think there’s some stretch there. If you were to looking at for the future, I think that’s probably the right thing.

The other thing that’s turned out to be a real plus for us is, we use the Penske Truck Leasing S.O.S, and we really have a connection with our customer now. If we see any units getting down on a daily basis, we’re able to take tech calls from the technicians in the field. It’s really worked out for us.

We get the number of customer calls on just some things or questions they want to get answered. They were doing a CSI contract and all of our customers we have their email capability because that’s how they ordered their car. We’re getting probably a 65% return on our CSI, and we’re seeing about 96 to 97% satisfied or extremely satisfied.

What we’re doing is going back to those ones that are not. We’re really being able to go back to those people and finding out what their issues are on an individual basis. I think that it’s key.

We’re getting about 250 calls per day, into our customer call center. So that’s another plus. We’re really taking these early adopters, and they’re becoming our marketing sales people in the marketplace for us.

N. Richard Nelson - Stephens

Great, thank you for that. Margins in new cars are stable on a year-over-year, but I’m not certain given the mix of international/U.S. exactly what’s happening...

Roger Penske

Tony said we’re down 100 in the U.S. and we were up 100 internationally. On the used car basis, the margins, we were, from a gross perspective, down really 250 in the U.S. and about 200 internationally.

But the point here is with less volume and with the focus on growth, it’s probably the first word I talk to people about is turnover, the second is gross. Quite honestly we’re managing to gross, and with the less people coming in the door and most of our sales people domestically are working on a commission basis they’ve got to go for gross.

I think that’s the key, and obviously the other piece of that is to be sure that we’re putting the right number on the used cars. So there’s real focus there right now.

N. Richard Nelson - Stephens

And I wanted to ask about the divested dealerships. Is there a market especially for the domestic stores today, and what valuations are you are looking at on the outside sales?

Roger Penske

I think if you look at our discontinued operations for the first six months, we’ve had a negative impact of $600,000. So we’re able to market these stores, some with a plus and some with a minus. But overall we’ve had $300 million in stores, and 11 stores we’ve divested, only with $600,000 negative.

We’re able to get the value out of the stores that we’re selling, and certainly we’re seeing some multiples come down on the new sales. We’ve done a pretty much a 50/50 between international and domestic. So we’re going to be really very opportunistic as we go forward.

I think there’ll be less pressure on multiples as we go into the market on stuff we might buy. But I’m sure you’ve talked to the other peer group. There is many people calling us.

In fact, if we keep our powder dry, I think the fallout is going to be really positive for us. Once this thing turns you might see some very attractive purchasing opportunity. People got to look at CapEx for these manufacturers, they need bigger facilities. They’ve got to move, or they’ve got personal situations that they want to solve from the standpoint of who would take over the businesses.

I think there is going to be quite a movement of these franchises; plus the good news is from a domestic standpoint that there is no question they’re getting a lot of action on reducing the number of points. Just today there’s twice as many domestic stores as there are foreign nameplates for roughly the same amount of volume.

Lots and lots of different pieces here. I think certainly with our case where there’s capital available, we’re in a position that we can take advantage of those when they come to us. We’ve had internationally; we’ve had some of the brands come to us already and offer us.

I had a fax today from Toyota saying there’s a real opportunity in Europe that they want me to talk to them about. So those are the things that are coming out of the sky today.

N. Richard Nelson - Stephens

Very good. Thank you and good luck.

Operator

Our next question is from the line of Matt Fassler - Goldman Sachs.

Matt Fassler - Goldman Sachs

Couple of questions. Lot of the QC ones have been answered. Your used business from a sales perspective was quite resilient especially in a couple markets. What’s your sense about what customers are thinking about used versus new these days when they’re thinking about a car? Are you surprised by how the traffic has held up?

Roger Penske

I talked to George Brochick yesterday, and we were talking about Land Rover in North Scottsdale. How the new was down, but used was up. These used vehicles, you can take a two-year-old vehicle that you pay $18,000 for and sell it for $22,000 or $23,000, and the new one is over $50,000. There’s some real bargains out there from the standpoint of some of these premium luxury.

One of the things that we’ve done is we’ve got a term around here, ‘retail first.’ So we’re really looking at is just trying to retail our used cars. They won’t all be certified obviously, and we will put probably a six-month warranty for the customer.

But there’s no question that from the standpoint our transaction price in the U.S. is dropped probably about $1,300 because we’re going more this retail first selling lower cost of sell.

We’ve looked at the CarMax model and then some of the other peer group who are really have a lower cost of sale. Obviously, with our large premium luxury component, it’s probably hard to drive it down, but we’re seeing a reduction in the selling price about $1,300 in the U.S. and about $2,000internationally.

But we are pushing the used because the good news is what people don’t realize that if we can increase our new and used by 7%, we’re also getting some internal gross profit through the shops because we’re doing some routine maintenance and upgrading these vehicles before we retail them. It’s a business we’re in.

Then of course, we have the finance subsidiaries, which will finance those on a non-recourse basis for us which keeps us in the game.

Matt Fassler - Goldman Sachs

Fair enough, and that’s very helpful. Then my second question; your parts and service held in quite well versus Q1. We’ve seen probably a little more industry weakness in parts and service than we’ve seen in some time.

I think not for you, but for a couple of your peers that might have been the biggest surprise of the quarter. How do you manage your parts and service cost structure differently in this environment given that you had bulked up and invested so aggressively over the past...

Roger Penske

I think we’re getting the benefit of the scale we already have. We’re now since we’ve got the bricks and mortar, we’re really looking into how we can penetrate this customer base. We casually would send out a mailer every four or five months. But now we have a dedicated group of people, who are calling customers, e-mailing customers on a daily basis to drive more parts and service.

We extended our hours. We’re working very hard to complete with the Quick Lubes and some of these alignment and tire places. We’re selling a lot more tires today. In fact, the service writers are compensated on tire sales. I think that’s key.

We reduced the tech turnover, which certainly helps us so we’re getting more productivity through the shops. It’s a customer base out there, which we own. We probably have not done the best job really cultivating that, so we’re going to continue.

The one negative is that the quality is so good on the cars coming through now, that warranty is down. We get some benefit because of CPO, certified pre-owned, the OEM has provided us with the warranty coverage, so that’s going to drive some of that CPO business back into the shop.

But I’m not at all concerned. I think with 70% utilization, we’ve got a couple of projects in Austin, where we’re building a bigger service capability, where we need it. But generally when you look at the major markets, you certainly look at California and San Diego; we look at Phoenix, we look at Inskip; we look at Turnersville, and we look at Fayetteville, out in Arkansas, where we have these campuses.

We won’t spend anymore money on those places other than just maintenance CapEx over the next two or three years. It will give us the chance to really get the benefit of what we spend.

Matt Fassler - Goldman Sachs

That’s very helpful thank you so much.

Operator

Our next question is from the line of Rex Henderson - Raymond James.

Rex Henderson - Raymond James

Good afternoon. I wanted to shift the focus away from some of the questions on the top line. Look at the cost line. You did a pretty good job on SG&A. I’m just wondering where those SG&A savings was. Some of it must have been adjusted in variable cost related to lower sales. But were there some fixed and structural costs that come out too, and where are the opportunities for that?

Roger Penske

You’re going to have some variable cost down, but I think you look down through the lines, it’s hard to say one particular area. But other expense, which is a cadre of legal and insurance and other things; services and things like that. We were down significantly. And our rent expense was up.

We were able on a same store basis, get the 1.5% even with a kick up in our rent. These are all small bites, and we can say we’ll reduce advertising by 20%. Our advertising quite honestly if you look at it for the quarter was pretty much flat. We see an opportunity to take that down even further as we go into the next quarter.

Rex Henderson - Raymond James

And if we continue to see weakness in the market or maybe even further weakness than we’ve seen so far in unit sales, where would you start looking to take costs out?

Roger Penske

The human capital side would be the first one. Remember, we have a variable comp basis, but you still have even though you’ve got variable comp, you’ve got a certain amount of fixed costs and benefits that go with that.

I think you try to decide what are the minimal sales that you expect people to sell by brand, and you try to right size your ship with that. And you can do that pretty quickly.

Then through the attrition, I mentioned it earlier, we’ll be able to take people out. But we’re going to look at that ASP, and I can tell you that we’re not going to sit around. To me that’s probably the first place, because with head count, you have costs.

Rex Henderson - Raymond James

Okay. Second question, I want to focus on the F&I business. I would think that with the shift in mix away from new and towards used, there would be some more F&I opportunities here. F&I was okay, but it wasn’t up much, so I just wondered whether you think that your F&I has got some opportunities to grow more aggressively in the back half of the year?

Roger Penske

Remember, if I sell a used car, the cost of sale is probably half of what it is on a new car. I might have unit sales up, but if the selling price for the used car is less than a new, you’re going to see you won’t get the finance reserve you would on new.

But I think there’s more opportunity there and to me today with the cash upfront, on new you’ll drive some of that business to the new side because it’s really the down payment.

But overall when you look at our F&I, we were up for the quarter. Really up greater in the U.K. because we’re able to sell these personal lease contracts and we’ve got a much better I think system there that really now is matured to give us that.

But I also want to be careful to not point out that the customer today is so fragile and we can load him up with lots of extra products. The payments are going to get out of his range. Quite honestly, if this whole industry shifts to retail selling and not leasing, the credit responsibility really lies on the lessee or on the customer.

Today with the consumer being levered up, there could be some tension and some pressure to say wow, the credit scores are going down. Your equity in your home is going down. That could put some pressure on who we can finance. That signal is probably always out there. That’s why I think you’ll see used move up because people can only afford payments at a certain level.

Rex Henderson - Raymond James

Okay. Drilling down on the F&I, have you seen any increase in charge backs in F&I?

Roger Penske

In some stores where we have a little more responsibility for charge backs. But in certain markets, I would say, yes, but remember, we’re on non-recourse. I think after 90 days, it’s not across the board. We have no chargeback responsibility.

Rex Henderson - Raymond James

Okay.

Roger Penske

We’re on non-recourse, remember that. You never say 100% but I would say 98-99%, we’re on non-recourse. Obviously on all leases we’re not guaranteeing any residuals. So the manufacturer has that responsibility. We have none of that as a retailer.

Rex Henderson - Raymond James

Okay. Thanks.

Operator

Our next question is from the line of Rich Kwas - Wachovia.

Rich Kwas - Wachovia

Just a follow-up on Turnersville and Inskip, could you just give us an update on how things are trending at both those facilities?

Roger Penske

The good news is that in the month of June, Turnersville made $500,000, and Inskip made over $200,000 in June. We’ve seen them turn the corner. Their unit sales were up for the quarter in both cases. All the CapEx is done there. Now it’s at about getting down to business.

I would say in a challenging market, those guys did a good job. I think the management teams that we have in place there, with Peter Klein and Marcelo Opt in Inskip and Eric, these guys are doing a good job.

We’re in the used car business and down in Turnersville we’ve got an auto outlet where we’re selling vehicles, where we do our closed bid wholesaling. We’ve got a small retail outlet there for cars under $10,000, which we do on wholesale. That’s been opened up here in the last 30 days. Lots of offense. Again, Turnersville and Inskip are becoming destinations.

Rich Kwas - Wachovia

Okay and that’s pre-tax right?

Roger Penske

Yes.

Rich Kwas - Wachovia

Okay great; thanks so much.

Roger Penske

We don’t talk EBITDA here.

Operator

Our next question is from the line of Scott Stember - Sidoti & Co.

Scott Stember - Sidoti & Co

Can you talk about the U.K. maybe just drill down a little bit more current what we’ve seen last month, heading into August? Have things deteriorated in July?

Roger Penske

There is no question that we saw softness in May and June. April was pretty good even coming off the March registration month. And overall they were down 2.5% in registration.

It’s so difficult to really say what’s going to happen in September, but we have seen a deterioration in, what I said the super premium luxury, which is driving that. Used car prices are dropping over there the same as we’ve seen the books change here.

The inventory management is super critical both in the U.S and internationally. I would say that we’re in for some tougher times in the U.K. Frankfurt market seems to be decent. Mexico has been good for us. That’s obviously primarily Toyota.

The super premium luxury up in Hamburg and Bremen, where we have Ferrari, Maserati, Bentley, Lamborghini, Aston Martin; unfortunately there we’re carrying more inventory than we want in new inventory. There’s no issue with it, but we’ve just almost sold those as they’ve come off the truck.

As the manufacturers have been a little more aggressive to get more market share in those, we’ve probably carried more inventory. Probably we’ve got $10 million to $15 million more inventory in those stores in Hamburg and Bremen that we had last year. But we’re talking about small volumes and those will go through very quickly by the end of the model year.

Scott Stember - Sidoti & Co

Okay, and last question, on Penske Truck Leasing, has anything changed from a few weeks ago when you made the announcement with regards to 2008 guidance?

Roger Penske

No, we’re looking at $0.02 to $0.04 in this next quarter. We’ve had our team meeting last week on our corporate sales initiatives, the perfect teams have been together already. We see that as quite positive.

They ended up with a good first six months. It seemed to be on track. Remember in their business probably 65% of their business is contracted. Meaning it’s on either a three to five year lease or a logistics contract. So they don’t have the ups and downs that we would see in the retail business. It’s somewhat of a good guy for us.

And the only thing is now would be their rental business, and that’s obviously a small piece of that, and that’s the commercial rental, which is, typically 50% of commercial rental revenue comes out of the leased customer base.

So what you do, you lease a company 10 trucks, and if they need the extra trucks they get them from you and that would be commercial rental. That’s down somewhat obviously because the general economy is down.

But we looked at delinquencies in that business and quite honestly, they’re in line with expectations. The sales, there’s a number of more people looking at leasing their equipment because their own credit lines are being challenged and we have the opportunity to leverage our relationship with GE and our AAA credit in that particular company.

I see that as being a real positive. What we’re going to do is try to have an analyst and interested party meeting in Reading some time between now and the end of the year to do a deep dive in that business.

Scott Stember - Sidoti & Co

Thank you.

Operator

Our next question is from the line of Sid Wilson - Kevin Dann & Partners.

Sid Wilson - Kevin Dann & Partners

Most of my questions have been answered, but one question that I have, can you touch a little bit more about the change in leasing policy on BMW as it relates to your business? And how we should be thinking about this going forward given that BMW’s such a high percentage of your business?

Roger Penske

BMW, of course, remember with the bigger mix, we’ve probably got 8% or 9% here in the U.S. and 13% in the U.K. The U.K. as the biggest driver of the BMW business. Over there we don’t quite have the effect we have here.

I’d say, they’ve gone from 60 to 50%, but again now they’re putting some serious money on the customer and they’ve got a 0.9% buy down rate today, which is very attractive to many of the buyers.

Their residual values, they’ve been pretty realistic on those and then we have the opportunity to buy those vehicles and sell them as certified pre-owned. I don’t see anything there at the moment.

In our BMW stores, as I think about them in the month of June, I can’t go back for the full quarter just sitting here today. But they have all done quite well from the standpoint of their earnings on a relative basis. Mini is out of sight. It’s as strong as it’s ever been; a lot like smart.

Sid Wilson - Kevin Dann & Partners

Okay, thank you very much

Operator

Our next question is from the line of Jonathan Chin - [inaudible] Management Group.

Jonathan Chin

I want to ask you a question regarding the fact that we’re going to see smaller vehicles. Is that really going to affect parts and service?

Roger Penske

I would say that this mix change is not going to happen overnight, when you’re listening to these manufacturers. I would pose the question the other day, if fuel gets down to $2 what happens? Do we now retool trucks? This is a real changing time here when you are look at the oil prices.

I think that there is no question that the sophistication on the bigger cars drove more customer labor and labor hours. But I think it’s going to take us a long term before you see a big mix change and you’ll see that affecting your parts and service business. I don’t think it’s going to happen overnight.

Let’s just to take a quick check by BMW, you’ve got a 1 Series, 3 Series. You’ve got a C-Class. With Mercedes, they’re talking about an A and B coming over here. These are high tech vehicles, and you’re not going to be able to just take those to any gas station for them to work on.

So it could happen, and it’s a very good question. I don’t want to give you any data that will be misleading at this point. I don’t think we’re in the ninth inning yet and what the mix is going to be long term.

Jonathan Chin

Okay I appreciate that. And also if you could just comment on what type of buyers are coming into showrooms?

Roger Penske

I hope they’re real buyers. I think at the moment, you’ve got the group that still has money and they’re buying the premium luxury cars. You can see that. Today it’s off slightly. You’d expect that in the financial markets. We’re seeing some people not buying new Porsches and maybe expensive BMWs and Mercedes.

But people need transportation, that’s one thing. When you look at public transportation across the U.S, we have some, but there is a still a big gap from the standpoint of vehicle requirements. We’ve seen people not driving their vehicles maybe for pleasure. We see that at the NASCAR races, where there is some attendance slippage, and really people just can’t afford the fuel prices.

But, there’s still going to be a need for the guy who’s in the construction business that needs to buy a truck. He’s probably not going to buy one with a Lincoln interior in it anymore. He’s going to buy a regular work truck and we sell those. I think that’s still be an opportunity.

You’ve got your soccer mom that’s going to be using the SUV and buying the sport utility and minivan. We tend to shift so fast in emotion in this business. I’ve been around a long time. We’ve seen us go through some of these things where we couldn’t even get gas.

It seems to level out, and we’ll be fine because we’ve got this customer base who already have their cars. And the good news is that if they’re not going to trade them; we’re going to get more service and parts business, where we’ve got our highest margin.

Jonathan Chin

Very good, thank you very much.

Operator

Our last question is from the line of Saul Rubin - Silverstone Capital.

Saul Rubin - Silverstone Capital

Just a few questions here. Did you say what your gross CapEx would be for the year?

Roger Penske

The gross CapEx this year will be probably somewhere around $180 million.

Saul Rubin - Silverstone Capital

Okay. And then could you say that that could come down quite considerably next year?

Roger Penske

I think I made a comment that I thought it would be 60% of that. I would say somewhere in the $100 to $120 million gross CapEx. We’re going to look at that. That’s one lever that we can pull back.

Now we have some commitments we’ve given to the OEMs, and we’ll certainly talk to them about that. That doesn’t mean that we’re going to delete it. It means that we would push it off six to twelve months.

There’s some places where we know we need to do it, because it will help us in our business and our efficiencies and our profitability will move forward. But that is a lever that we can pull back, and we plan to do that not only here domestically, but internationally.

We look at project-by-project, and we have a review on that here over the next couple of weeks. We’ll be able to give you a much tighter number as we talk in the third quarter.

Saul Rubin - Silverstone Capital

Okay, great. Group 1 had their conference call yesterday and they talked about an accounting change that would affect 2009 pertaining to their convertible. I think you have a similar convertible?

Roger Penske

We have a 3.5%. We have to mark that under the accounting change. I think we’ve got to mark that to market. I’m not sure there’s two pieces of that, but it would increase our interest cost probably 300 basis points at least as we reflect on our financial statements next year. Bob’s saying, maybe slightly more.

Saul Rubin - Silverstone Capital

Okay, fine. That would be 300 basis points on that piece or overall?

Roger Penske

Today we’re 3.5%, we have another piece that’s just like it at 7 7/8%, so I think we’ve got to mark that to market. I’m not sure how at all it accounts right now. But we can give you that specifically at the next call.

Saul Rubin - Silverstone Capital

Okay, fine. And quickly back to Penske Truck Leasing deal, was it completed in the quarter? Is that in the balance sheet?

Roger Penske

Usually there’s a one-line investment. We have 9% increase. So it would below the line in our investment line. The same we have our other joint ventures.

Saul Rubin - Silverstone Capital

It was done in the quarter, so it would be presented in the balance sheet?

Roger Penske

That’s correct.

Saul Rubin - Silverstone Capital

Did I understand that the $0.02 to $0.04 accretion you expect could come all in the third quarter?

Roger Penske

Yes.

Saul Rubin - Silverstone Capital

Okay, fine. And lastly on PTL, if GE completely came to you with an offer to sell this, how did it work within the various Penske organizations? I would have assumed Penske Corp. would have had a right to first refusal and why Penske Corp didn’t take up the offer?

Roger Penske

I think that number one Penske Corp. owns today 40% of that business. It’s gone from 21% to roughly 40% in the last two years. It’s over $200 million. That’s a significant bite.

But we look at what we could do with our capital, and our leverage capital here, and the synergies that generate this commercial corporate sales capability with our team. We get the accelerated depreciation benefit at this company that we can invest roughly $200 million and we can see 60 to 70% of that come back during a three to four year period.

It was prudent plus it had the brand. It gives us a different mode of selling because today, none of the retailers have a corporate sales staff. Today we get the benefits of probably 600 or 700 of our sales people, who have another menu item and that would be selling vehicles through our network.

We’ll set that up all Internet based. We do some of that in the U.K. now, but we might have a company that’s down in the city that we would have for their employees, have the benefit to go online and be able to buy vehicles that we would represent through our brand mix.

Saul Rubin - Silverstone Capital

Okay. And so just lastly on that, does GE have any rights to sell or put anymore of the business to you? And if so, would Penske take more of it?

Roger Penske

Let me say this: we’d like to own as much as the company as we could. I would be lying to you if I didn’t say that. And it’s just a matter of capital availability from the standpoint of the purchaser.

There is no pressure under GE at all from the standpoint of selling that business. It’s not strategic for them. At this particular point, we’ve negotiated at arms length with them to do these transactions. We would expect as we go forward if we have the capital available and we think it’s prudent, we would continue to own more.

Saul Rubin - Silverstone Capital

Great, thank you very much.

Operator

Mr. Penske, I’ll turn it back to you for any closing comments.

Roger Penske

That’s all we have today. Thanks for the support and we’ll talk to you at the end of next quarter.

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Source: Penske Automotive Group Inc. Q2 2008 Earnings Call Transcript
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