Group 1 Automotive, Inc. (GPI) Q3 2010 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to Group 1 Automotive 2010 Third Quarter Financial Results Conference Call. Please be advised that this call is being recorded. ':

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Thank you, Lance, and good morning, everyone. I am pleased to report that our results for the third quarter of 2010 were extremely positive in almost every area. Most noteworthy was the continuation of very powerful sales performance in almost every area of our business. This sales performance generated an overall revenue increase of more than 17% for the quarter, which continues to leverage the aggressive cost reduction actions our company took last year. I am also pleased at our major balance sheet improvements throughout the first nine months of this year. Our current cash position is extremely strong for a company of our size. And our long-term debt to equity position is one of the best in our recent corporate history. John will provide more details during his presentation. As I just mentioned, our sales performance remained strong in the third quarter. Retail used vehicle and parts and service performances were exceptional and well beyond our projections. In the current challenging economic conditions, many customers see more value in used vehicles. We have been capitalizing on this trend as evidenced by our third quarter retail used vehicle revenue increase of 33.7%; 29% on a same-store basis. This substantial increase was driven by a 24% lift in retail used vehicle unit sales on a consolidated basis and 21% more unit sales on a same-store basis. ': With that comparison in mind, industry retail sales actually decreased slightly during the third quarter whereas our new vehicle unit sales increased 2% on a same-store basis and 5.3% on a consolidated basis. After nine months in the calendar year, our new vehicle revenues are up 17.5% on a same-store basis. ': Biggest factors currently affecting these margin levels are the overall competitiveness of the market and extremely low vehicle margins for several volume brands. Our used vehicle retail margin of 9.1% was also a bit soft due to the continuing need to supplement our inventory with outside purchases as well as our focus on volume increases. We would anticipate retail vehicle margins to return to more normal levels as new vehicle sales rebound. The strong new and used vehicle retail sales performance was complemented by a nice increase in our finance and insurance penetration to $1,037 per retail vehicle profit. This is an $83 per unit improvement from the same period last year and reflects significantly improved penetration rates for both financing and service contracts. And perhaps the most impressive facet of our sales performance in the third quarter was our same-store parts and service growth of more than 7%. In a market where any year-over-year growth is a decent accomplishment given declining units in operation, we are very pleased with the performance of our operating teams in this key area of our business. Additionally, our parts and service margins increased on both a year-over-year and sequential basis, coming in at 54.3%. This increase in parts and service sales was driven across all categories, including higher sales in customer pay, warranty, collision, and wholesale parts sales. Driven by the overall strong selling performances I just mentioned, our same-store selling, general and administrative expenses as a percent of gross profit reflected further improvement on both a year-over-year and sequential basis, with 75.9%. Our third quarter same-store operating margin remained flat with the second quarter at 3.2%. These operating results drove an overall 15% growth in adjusted net income and John will have more color on that item in just a moment. Turning back to our third quarter new vehicle business, some additional details on our consolidated brand mix, 37% of our unit sales were from our Toyota/Scion/Lexus stores. Nissan/Infiniti remained our second best seller with 14%. BMW moved up into third place with 12% of unit sales. And Honda/Acura came in right behind with 11.8%. Rounding out brand sales for Ford was 7%; Mercedes-Benz 6%; and GM and Chrysler representing 4 and 3% of our unit sales respectively. ': ': With that, I will now turn the call over to our CFO, John Rickel, to go over our financial results in more detail. John?

Thank you, Earl, and good morning, everyone. For the third quarter of 2010, our adjusted net income increased to 19.3 million or $0.84 per diluted share. This result excludes $1 million after-tax non-cash asset impairment charges and a 761,000 after-tax gain on the sale of a non-operating real estate holding. On a comparable basis, adjusted net income increased 2.5 million or 14.6% from 16.8 million in the third quarter of 2009, which excludes the following: a 461,000 non-cash after-tax impairment charge primarily related to our real estate holdings that are held for sale; a 393,000 after-tax gain on the reduction of a portion of our 2.25 convertible notes; and a 1.6 million after-tax gain for an income tax benefit related to tax elections that reduced the tax liability for the prior period items. As a reminder, comparisons to the third quarter of 2009 for most of our operating metrics were made tougher by the significant impact that U.S. Government sponsored Cash for Clunkers program had on our results last year. For example, the Cash for Clunkers program drove heavy new and used retail vehicle volumes and significantly skewed the mix of vehicles sold towards small cars. The additional incentive money and the short-term spike in demand also significantly inflated new and used margins during the program period. During the third quarter, on a consolidated basis, revenues increased 215 million or 17.2% to 1.5 billion compared to the same period a year ago, reflecting increases in each of our business segments. Specifically, our new vehicle revenues improved 12.9% to 822.1 million on 5.3% more units, and used vehicle retail revenues increased 33.7% to 340.6 million on 24.2% more units. New and used vehicle retail gross margins declined 100 and 130 basis points respectively. Given the difficult comparisons from the Cash for Clunkers program that I just described, we are particularly pleased with these results. ': Overall, our gross margin declined 130 basis points to 15.7%, primarily reflecting the change in mix as new and used vehicle revenue increases outpaced the rest of the business. Our gross profit increased 16.8 million from the third quarter a year ago to 228.8 million. Adjusted SG&A expense as a percent of gross profit was unchanged from the comparable results in the third quarter of 2009 at 76.6%, but improved 140 basis points sequentially as we continue to leverage our cost base. Floorplan interest expense increased 1.5 million or 19.9% in the third quarter of 2010 to $9 million as compared with the same period a year ago. This increase primarily reflects a $264.6 million increase in weighted average floorplan borrowings during the quarter. At September 30, 2010, our new vehicle inventory stood at 17,402 units with a value of 537.6 million compared to 9,206 units with a value of 298.7 million a year ago. The inventory levels at the end of 2009 third quarter were abnormally low primarily because of reduced manufacturer production earlier that year coupled with the sales surge from the Cash for Clunkers program that depleted our inventory and inventories throughout the dealer network. Other interest expense decreased 400,000 or 5.8% to 6.9 million in the third quarter of 2009, primarily reflecting interest earned on cash investments which continue to build. Our consolidated interest expense includes non-cash discount amortization of 2.1 million related to our convertible notes. ': Now turning to the third quarter same-store results, in the third quarter, we reported revenues of 1.39 billion, which was a 14% increase from the 2009 period. Our new vehicle retail sales improved 9.4% to 783.8 million on 2% more units, which as Earl stated, outpaced the overall retail industry results. On a per unit basis, our average new vehicle selling prices increased more than $2,000 or 7.2% to 31,158 reflecting the shift in car-truck mix back towards trucks as well as a higher mix of luxury brand sales. Our used business was very strong this quarter with retail used vehicles revenues increasing 29.2% to 321.3 million on 20.8% more units. On a per unit basis, retail used vehicle revenues were up $1,200 or 6.9% from 2009 levels to 19,305. We also experienced an increase in our wholesale used vehicle revenues of 11.9 million on 667 more units. While wholesaling more vehicles seems inconsistent with our need for more used vehicle, most of vehicles that we are sending to auction are relatively low value, higher mileage and older age. Besides the outstanding results in our used vehicle business this quarter, the other significant highlight was the strength in our parts and service business. Parts and service revenues grew 7.3% reflecting a 4.9% increase in our customer pay parts and service revenues, 9.2% growth in our wholesale parts business, a 10% increase in our collision business, and a 9.9% improvement in our warranty business. While the Toyota recalls announced earlier this year continue to bolster our parts and service revenues for the quarter, the positive impact only accounted for 1 percentage point of the overall improvement. It is also important to note that our parts and service revenues are not bolstered by increases in internal business. This varies across the sector as some of our competitors account for internal work differently. We realized improvements in customer pay revenues in each of major brands that we represent as new initiatives focused on customers, products, and processes continue to build momentum and generate results. We are also seeing strong growth in our domestic brand stores that are benefiting from the recent domestic dealership closures in their respective markets. ': Our F&I revenues were up 6.7 million or 18.2% compared to the same period a year ago on the higher retail sales. In addition to the positive impact from the increase in new and used retail unit sales, our F&I revenues were bolstered by increases in our finance, vehicle service contracts, and lease penetration rates to 70.4%, 35.4%, and 19.3% respectively as well as, an 11.8% increase in finance income per contract. Overall, our F&I income for retail unit increased $83 to 1,037 from the same period a year ago. Compared to the Cash for Clunkers fueled results a year ago, our same-store new vehicle gross profit declined 9% on a per unit basis to $1,770 resulting in a 100 basis point decline in gross margin to 5.7%. Retail used vehicle margin declined 120 basis points to 9.1% as compared to the third quarter of 2009. Even though we have begun to get a better flow of trade-ins from the increase in new vehicle sales, the demand for quality used vehicles has outpaced our new vehicle growth, requiring us to continue to source a higher proportion of our used vehicle inventory via auction at a higher cost for the inventory. New vehicle trade-ins are our best source of quality used vehicles. Our same-store parts and service margin grew 40 basis points to 54.3%, primarily reflecting the impact of increased internal work, which was driven by the higher new and used retail vehicle sales volumes. We also experienced margin improvement in our warranty and collision businesses. ': In absolute dollars, SG&A increased 9.9 million from the third quarter a year ago to 167.6 million. Personnel expenses increased 7.6 million. And advertising expenses grew 2 million as we continue to focus on capturing market share and stimulating parts and service activity. Now, turning to liquidity and capital structure, during the third quarter of 2010, we generated cash flow from operations on an adjusted basis of 54.6 million. As of September 30, 2010, we had 96.2 million of cash on hand and another 57.9 that was invested in our floorplan offset account, bringing immediately available funds to a total of 154.1 million. In addition, we had 137.5 million available on our acquisition line that can also be used for general corporate purposes. As such, our total liquidity at September 30, 2010 was 291.7 million. During the quarter, we used 7.5 million to acquire 294,000 shares of our outstanding stock at an average price of $25.56 per share, which brought weighted average diluted shares outstanding to 22.9 million for the three months ended September 30. We continue to remain focused on strengthening our balance sheet by reducing debt levels and lengthening maturities. ': We have updated financial covenant calculations within each of our debt agreements and as of September 30, we were in compliance with all such covenants. Based upon our industry outlook and projected earnings for 2010 and 2011, we expect to remain compliant for the foreseeable future. With regards to our real estate investment portfolio, we own 319.2 million of land and buildings at quarter end, which represents approximately one-third of our total real estate. To finance these holdings, we have utilized our mortgage facility and executed borrowings under other real estate specific debt agreements. During the third quarter, we executed three notes with Toyota Financial Services for an aggregate principal of 12.8 million to finance the purchase of two real estate parcels to be utilized in the relocation of existing Toyota dealerships and refinanced borrowings under our mortgage facility for an existing Toyota dealership facility. As of September 30, we had 157.4 million outstanding under our mortgage facility and 78.3 million of other real estate debt including capital leases. The execution of these three note agreements with Toyota Financial Services is the first step in our strategy to replace the existing syndicated mortgage facility which matures in March 2012 with separate mortgage loans with tenures of 5 to 7 years through several of our manufacturer partners and a smaller group of our banking partners. We expect to complete the execution of this strategy by the end of this year. We used 5.6 million for capital expenditures during the quarter to construct new facilities, purchase equipment, and improve existing facilities. We will continue to critically evaluate all planned capital spending and work with our manufacturer partners to maximize the return on our investments. We anticipate that our full year capital spending now will be less than 30 million in 2010. For additional detail regarding our financial condition, please refer to the schedules of additional information attached to the news release as well as the investor presentation posted on our website. With that, I will now turn back over to Earl.

': ': Our team has worked hard during the last two years to make these improvements and is looking forward to demonstrating the full leverage of these efforts as sales increase in the coming years. ':

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No, I think the assumption you implied is true, over time some of this used demand will morph back into the new vehicle market and price relativities will push some of that as well as increasing consumer confidence, but right now consumers are just very cautious and very practical, and there are a lot of very good high quality customers that are opting for used instead of new right now because of economic uncertainty or housing issues or unemployment issues or whatever the major macroeconomic factors are. But over time, I think clearly some of that demand will get back over on the new vehicle side.

And then just one last question on parts and service. You guys had a good performance in the quarter. And it was I think a lot better than some of your peers to-date. I was just curious what you are seeing in your local markets versus competition and if competition has really been taken out as dealerships have been closed? Because it appears there has been a drastic reduction in the number of service bays even though there might be an aggregate reduction in parts and service business, the cars per service bay may have gone up in some of the markets that you operate in. Have you seen anything like that, are there any other sort of exogenous factors that are explaining the strength in your parts and service business?

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And I would add to that, not only the 7% growth but also we grew margins in what is the competitive environment that Earl described at 54.3%. To be able to grow the margins 60 basis points on a sequential basis, we feel pretty good about that.

Our next question comes from the Rick Nelson with Stephens.

Congratulations on a really nice quarter. Can you, Earl, comment on the acquisitions and how you evaluate that versus alternatives of debt pay down, et cetera?

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Thank you. Where do you stand with Toyota today on the acquisition front? Do you have the green light there?

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Right. What do you think is driving that? Are the incentives any more aggressive?

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': It does appear that rental companies and fleets are buying a lot more cars all of a sudden, and that could put a little softness into some parts of the used vehicle pricing market. But, overall, I would hope we could hold at a minimum somewhere closer to current margins we have and work it up from there.

Our next question comes from Adi Oberoi with Goldman Sachs.

I just had a quick question on used margins, just following up on some of the previous comments that you have made. So is it fair to say that acquisition, high acquisition cost is the only thing that is holding you guys from the double-digit margins that you guys used to post a few quarters back, on the used side?

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Got it. And on the collision business, your collision business was up 10% year-on-year. Are you guys seeing some deferred maintenance in that segment coming back?

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Yes. That would be our goal and our priority.

Our next question comes from Matt Nemer with Wells Fargo.

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And just remind us are there any components in service that are variable related to the current quarter new and used vehicle business, i.e., PDI or anything like that?

Matt, this is John again. On a revenue basis, no. The only benefit within parts and service is it does help improve the margin results. But there is no revenue impact for us.

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And actually if I could just sneak one more in, as we look to 2011, Earl, could you just maybe give us a quick preview of what your strategic priorities are in terms of maybe operating changes or enhancements that you plan on making to the business?

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Our next question comes from Scott Stember with Sidoti & Company. Scott Stember - Sidoti & Company: Can you just talk about some of your bigger brands, how they performed in the quarter, such as Toyota, Nissan and BMW?

Yeah, Scott, Toyota sales for the quarter were down 2.9% and were up 10.2% for the year. Our best sales increases were Mercedes at 24.5%; General Motors at 20%; Ford at 13.4%; Nissan up 5%; Honda up 1.8%; BMW up 1.9%. Our Chrysler business was down 10.7%. That covers most of the major brands. Scott Stember - Sidoti & Company: Great. And can you talk about some of your geographies, namely Texas?

': ': Scott Stember - Sidoti & Company: And, John, I missed what the parts and service of the customer pay same-store sales increase was?

Yeah, on a customer pay basis, we were up 4.9%. Scott Stember - Sidoti & Company: ': ': ':

In parts and service? Scott Stember - Sidoti & Company: Yes.

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Our next question comes from Himanshu Patel with JPMorgan.

I am wondering if you could go back a little bit to the discussion on used vehicle sales outlook going forward. If you sort of assume new vehicle sales do grow at a nice clip of 10% a year or so. Is there a general rule of thumb that you are thinking about as to the pace of used car sales growth in that sort of context?

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Okay. And then separate question, any shift in the last quarter or even in the last couple of months in how deep the various captives are starting to buy now?

Not that I have been aware of, though the credit performance in the third quarter and so far this month has been fairly stable with our brands. So, clearly much better than it was a year ago, but no step function changes that I have witnessed.

And, I guess, Earl, maybe, if you could just elaborate on the subprime opportunity. I mean do you feel like as it particularly pertains to the new car market, is that a segment where the customer is just underserved right now and should someone get into that market more aggressively? Could that help some of the volumes that you see on the new car side?

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Our next question comes from Ravi Shanker with Morgan Stanley.

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The overwhelming factor was the gross profit we put on the books. And, again, some of it was not done at a high margin percentage rate. But have 30% revenue increases on used and 13% on new and so forth. That was the real key, while not adding the expense back in quite as quickly. ':

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Right. And then something else you said early in this call was you own about a third of your real estate right now. Do you have a long-term target there and how do you see that evolving in the next few years?

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We do have a follow-up question from Adi Oberoi with Goldman Sachs.

Sorry, can you hear me? This is Pat Archambault here from Goldman. Just wanted to follow up actually on the geography question, could you just give us a little bit of an overview how California, sort of Florida, you did mention Texas already, but how I guess the Eastern region, Florida and California also trended?

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Pat, just I guess to add a little flavor to that, this is John, we saw pretty good strength along the Atlantic Coast, New York, and then the Gulf Coast. We saw good strength in Tulsa in particular. Central Texas, Dallas and California, which Earl mentioned, would be basically the markets I would highlight as areas of strength.

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Thanks, everyone for joining us today. We look forward to updating you on our 2010 fourth quarter earnings results in February. Have a good day.

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