Apr 24, 2008
AutoNation, Inc. (NYSE:AN) Q1 2008 Earnings Call Transcript April 24, 2008 11:00 am ET
Executives
John Zimmerman – VP, IR Mike Jackson – Chairman and CEO Mike Short – EVP and CFO Mike Maroone – Director, President and COO
Analysts
John Murphy – Merrill Lynch Matt Nemer – Thomas Weisel Partners Colin Langan – UBS Rick Nelson – Stephens David Lim – Wachovia Darren Kennedy – Goldman Sachs Mark Wamsman – Calyon Jonathan Steinmetz – Morgan Stanley Dan Galatin [ph] – Deutsche Bank
Operator
Welcome to AutoNation's first-quarter earnings conference call. At this time, all participants are in a listen-only mode.
After the presentation, we will conduct a question-and-answer session. (Operator instructions) Today's conference is being recorded.
If you have any objections, you may disconnect at this time. Now, I will turn the call over to AutoNation.
John Zimmerman
Good morning and welcome to AutoNation's First Quarter 2008 Conference Call. My name is John Zimmerman, AutoNation's Vice President of Investor Relations.
I would like to remind you that this call is being recorded and will be available for replay at 866-463-4964 after 2.30 p.m. Eastern Time today through May 1, 2008.
Leading our call today will be Mike Jackson, Chairman and Chief Executive Officer of AutoNation, and joining him will be Mike Maroone, President and Chief Operating Officer and Mike Short, Chief Financial Officer. At the end of their remarks, we will open the call to questions.
I will also be available by phone to address any follow-up issues. Before we begin, let me read our brief statement regarding forward-looking comments and the use of non-GAAP financial measures.
Certain statements and information on this call will constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve risk which may cause the actual results or performance to differ materially from expectations.
Additional discussion of factors that could cause actual results to differ materially are contained in the Company's SEC filings. Certain non-GAAP financial measures as defined under SEC rules may be discussed on this call and as required by applicable SEC rules the Company provides reconciliations of any such non-GAAP financial measures to the most directly comparable GAAP measures on the Investor Relations section of AutoNation's website at www.autonation.com.
And now, I will turn the call over to AutoNation's Chairman and Chief Executive Officer Mike Jackson.
Mike Jackson
Good morning. Thank you for joining us.
Today we reported first quarter EPS from continuing operations of $0.31 compared to a year ago of $0.39. Prior-year results benefit from a favorable tax adjustment of $0.02 per share.
Results for the first quarter of 2008 reflected a decline in vehicle retail sales especially in California, Florida, Nevada, and Arizona where the housing crisis has clearly impacted overall economic activity and consumer demand for vehicle. AutoNation new unit sales for those markets were down 11% and for the industry, California, Florida, Nevada, and Arizona, new unit sales were down approximately 15% according to CNW Research.
AutoNation new vehicle sales for the other states were down 4% in the first quarter. We continue to have confidence in our Sunbelt markets and view them as healthy over the long term especially when housing begins to stabilize.
During the first quarter, U.S. retail auto sales had declined 11% according to CNW Research; AutoNation new unit sales declined 8%.
While today's economic uncertainty may compel certain potential buyers to put off their purchase decisions until a later date, their needs remain. Once consumers begin to sense that their own economic situation has stabilized, they will begin to be ready to commit to purchase big ticket items like vehicles.
Industry analysts like CNW and J.D. Power forecast improved new vehicle sales beginning in 2009 due to fleet age and increase in vehicle scrappage, and a robust line-up of new products.
CNW forecast new vehicle sales of 16.3 million in 2009, 16.7 million in 2010, and 16.9 million in 2011. We concur with this assessment for future new vehicle sales.
I would like to turn it over to Mike Short to provide more details on the financial results.
Mike Short
Thank you, Mike. Good morning, ladies and gentlemen.
As Mike mentioned, we reported first quarter earnings from continuing operations of $0.31 per share versus $0.39 a year ago. Operating profit for the first quarter was $147 million, down 21% from $186 million a year ago.
The prior period included the benefit from favorable tax adjustments of $0.02 per share. SG&A decreased $13 million versus Q1 2007.
Because of the erosion in gross profit SG&A as a percentage of gross profit increased to 74.5% from 71.2% a year ago reflecting deleveraging of our cost structure. Net inventory carrying cost was $3.3 million lower in Q1 versus the prior-year period.
The favorable variances primarily a result of lower floorplan interest rates partially offset by a decrease in floorplan assistance resulting from lower new vehicle sales. Other interest expense was $0.4 million higher in Q1 versus last year.
The unfavorable variance is a result of increase in debt levels associated with our mortgage facility, our revolving credit facility, and other indebtedness partially offset by lower interest rates on our term loan facility, mortgage facility, and floating rate Senior Notes. For Q1 2008 we had an effective income tax rate of 40.6% versus the prior year effective rate of 35.8%.
The Q1 2007 rate benefitted from adjustments from the resolution of various tax matters, which as I have noted resulted in an EPS benefit of $0.02. We expect our ongoing rate to be about 40%, excluding the impact of any potential tax adjustments in the future.
Also in Q1 2008, we had losses from discontinued operations of $5 million, net of taxes, or $0.03 per share. These losses related to the divestiture of several stores during the quarter.
During the first quarter, we repurchased 1.9 million shares of stock at an average price of $14.84 per share for a total of $28 million. Our future share repurchases are subject to limitations contained in our debt agreements.
As of April 1, 2008, our basket capacity for share repurchases was approximately $32 million. Each quarter we are permitted to add back 50% of our net income after tax and any stock option exercise proceeds.
We reinvested $23.5 million in the business through capital expenditures during the quarter. We expect full-year 2008 capital expenditures to be approximately $110 million net of asset sales.
That excludes acquisition-related spending, land purchase for future sites or lease buyouts. At March 31, our non-vehicle debt was $1.8 billion and we had unused revolving credit availability of $436 million.
Our non-vehicle debt-to-capital ratio was 33%. Now, let me turn you over to our President and Chief Operating Officer Mike Maroone.
Mike Maroone
Thanks, Mike, and good morning. Thus far in 2008 economic headwinds have been a significant factor for the auto retail industry sustaining an environment that is both challenging and increasingly competitive.
In the first quarter, AutoNation retailed 71,400 new vehicles on a same-store basis, was down 9% compared to the period a year ago. It compares favorably to the industry that was off 11% in the quarter according to CNW Research.
Of note is a $231 reduction in profit per new vehicle retailed. The highly competitive and distressed market along with the tightening of credit are factors that impacted both volume and margin.
The same factors impacted our used vehicle results where in the quarter our same-store used vehicle retail volume was off by approximately 2300 units, or 4% compared to the period a year ago. And profit per used vehicle retailed was down to $233.
Given the linkage between new and used we were encouraged that our used vehicle volume was off less than new and attribute this to the additional dedicated used resources that were put in place early in the quarter. Relative to strength or weakness in the markets where we operate, we have already called out ongoing pressures on markets in Arizona, California, Florida, and Nevada.
In the quarter, Texas continued to perform well, especially South Texas. And the markets of Chicago, Knoxville, and Memphis held their ground compared to the rest of the country.
At March 31 our new day supply was 57 days, an increase of 5 days compared to a year ago driven by softer-than-expected March sales. We closed the quart with a used day supply of 40 days, an increase of 2 days compared to a year ago.
In the quarter, parts and service same-store revenue grew $5 million to $650 million, an increase of 1%, and gross profit held steady at $281 million compared to the quarter a year ago. We remain focused on growing our customer pay, parts and service business and as we transition from a service culture to a service retailing culture utilizing our customer friendly service sales process.
Turning to finance and insurance, same-store F&I gross profit per vehicle retailed was $1183, an increase of $66 year-over-year this despite a revenue decline driven by lower volume. We attribute continued growth in PVR to increased product penetration, improved returns from our service contract portfolios with third parties, our strong preferred lender network, and ongoing efforts to improve the performance of our third and fourth quartile stores.
In closing, I will note that we are committed to continued investment in our associates through robust training and in technology along with consistent implementation of our best practice processes across all stores. In addition, managing expense throughout the organization continues to be a priority.
In this environment, we remain focused on building our capabilities to emerge stronger when the economy rebounds. With that, I will turn the call back to Mike Jackson.
Mike Jackson
Thanks, Mike. As we look at the rest of 2008 we believe the market will remain very competitive and challenging.
AutoNation will continue to focus on our cost structure while continuing to invest in our business. We are confident in our long-term business strategy and our markets.
That concludes our remarks. Operator, please open the calls for questions.
Operator
(Operator instructions) Our first question comes from Mr. John Murphy with Merrill Lynch.
Your line is open.
John Murphy – Merrill Lynch
Good morning, guys. I was wondering on the new margin pressure that seems to be ramping up here, it sounds like you are getting more competition from some of your weaker local competitors.
I am just wondering if that is something you see reversing as the market gets better or is this sort of more structural here as we go forward?
Mike Short
I think it’s more cyclical, John. I think we are at the point now where you have such tough economic conditions between the uncertainty around housing and what is the value of your housing.
Gas prices. We always said the sensitivity begins at $3, now we are at $3.50 with the prospect of $4 on the horizon.
So it is a very value-conscious price buyer that we see out there right now. And they are willing to give up size and other capabilities to get to a price point.
And so to keep volume moving at all, that puts tremendous pressures on margins. So I think it’s primarily cyclical in nature.
John Murphy – Merrill Lynch
Mike Maroone
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John Murphy – Merrill Lynch
Okay. And then on the cost side, I mean are you through all the cost cutting you really can do at this point on the structural side and at this point it’s really just getting the grosses back up as volumes ultimately recover over time?
Is there anything else you can do in the near term on the cost side to help out the SG&A line?
Mike Short
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John Murphy – Merrill Lynch
Okay. And then just lastly on parts and service, customer pay versus warranty work where are we at on that right now and where is that sort of trended over the last couple of years and where you see that going forward?
Mike Maroone
John, it’s Mike Maroone. Our customer pay was up 2.4% offset by about a 2% reduction in warranty.
So, warranty is starting to moderate a little bit. On a customer pay point of view our traffic was down slightly about 1% but our dollars per repair order were up.
So, we are still optimistic about our service business. As I mentioned that we are moving to a service selling culture and have got a lot of programs in place.
We are working really hard on the ‘e’ side, and I am pretty optimistic about our ability to grow that business.
John Murphy – Merrill Lynch
Any idea what the average ticket was there was on those, one the--?
Mike Maroone
Our customer pay ticket averages about $300.
John Murphy – Merrill Lynch
Great. Thank you very much.
Mike Maroone
Welcome.
Operator
Thank you. Matt Nemer with Thomas Weisel Partners, your line is open.
Matt Nemer – Thomas Weisel Partners
Good morning everyone. My first question was on the finance availability topic.
Is the decline in used vehicle margins, is that just a mix shift away from subprime where the subprime deals generate a lot more margins than plain vanilla deals? Is that the way to think about that?
Mike Jackson
I don’t’ think it is that simple. I think there is pressure all through both prime and subprime.
There are less subprime lenders. There are certainly some conservatism there.
There is some big fees from the subprime lender, but it’s really a cautious advances both on new and used from all lenders.
Matt Nemer – Thomas Weisel Partners
Okay. And then on that same topic of financial availability have you seen any issues either in your own business or in the industry where lenders are becoming more cautious with floorplan lines and any risk that there is a chance of some of the terms on those lines change?
Mike Jackson
Matt Nemer – Thomas Weisel Partners
Okay. And then just two housekeeping questions.
Your new and used ASP, average revenue per unit ticked down sequentially and I was just wondering if – what’s driving that, if you can give us some color on the mix of sales in the quarter.
Mike Jackson
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Matt Nemer – Thomas Weisel Partners
And is that within brands or people actually crossing over to value-oriented brands?
Mike Maroone
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Matt Nemer – Thomas Weisel Partners
Okay, great. And then my last question is on your cash flow statement it looks like you spent $29 million on acquisitions in the quarter.
Can you give us some detail on that?
Mike Jackson
Yes, we acquired one dealership in the quarter, a BMW dealership.
Mike Short
Which was previously announced.
Matt Nemer – Thomas Weisel Partners
Got it. Great.
Thanks so much
Operator
Thank you. Colin Langan with UBS.
Your line is open.
Colin Langan – UBS
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Mike Jackson
This is Mike Jackson. If anything the multiples have gone higher because earnings by and large are down and prices haven't changed.
And so you are not seeing too many deals get done and I don't think there has been a reflection on the part of the sellers where we are in the cycle, the fact that the cycle is a reality that has to be factored into the pricing when you acquire something. So right now there is a gap between sellers and buyers.
And as of this moment the sellers really haven't reduced prices.
Colin Langan – UBS
Okay. And then what do you think about strategically given the market conditions?
Would you consider divesting more dealerships or are you currently pleased with your portfolio mix?
Mike Jackson
We are always optimizing the portfolio, and we are well into concentrating on high throughput stores and divesting marginal stores. There is still some of that to do.
But we are probably in the best shape ever as far as our portfolio.
Colin Langan – UBS
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Mike Jackson
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Mike Short
I think, Colin, I think the way to look at it is that we started this process about two years ago. California really started to slip about two years ago, so we are probably a little bit ahead of the curve and we have really focused on an intense training program with our sales associates focused on our three channels of business that’s really e-com, phone, and walk-in, and developed very specific processes of how to handle those customers.
So I believe that we are executing better than we had in the past. But in terms of a change in strategy, no, we still want to go after profitable market share.
Colin Langan – UBS
So, the margin in this quarter is that a one-time thing or should we consider that a rate for the rest of the year?
Mike Short
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Colin Langan – UBS
Okay. And just one last one.
In terms of your parts and services sales growth is a little bit lower than I had expected. Was that driven mostly by the decline in warranty and was there a particular brand that was weak in the warranty side?
Mike Maroone
It’s Mike Maroone. I think we just stated earlier, but our customer pay was up 2.4%, our warranty was down 2%.
I don't think there was any brand that really stuck out from a warranty decline. I think all of the manufacturers have worked really hard on their quality and we are seeing it reflected over the last two to three years in warranty declines although the warranty declines are less than they have been in the past, so it kind of indicates that that revenue stream is stabilizing.
Colin Langan – UBS
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Mike Jackson
Colin Langan – UBS
Okay, great. Thanks for your help.
Operator
Thank you. Mr.
Rick Nelson with Stephens, your line is open.
Rick Nelson – Stephens
Mike Short
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Rick Nelson – Stephens
Got it. The OEMs have these CapEx requirements.
Mercedes-Benz with Autohaus and wondering how you approach that and can you achieve your return on capital objectives with these CapEx?
Mike Jackson
Well, everybody knows that we are very tough on CapEx and we have to hit our return threshold or we don't go forward and if that creates some stress with the manufacturer so be it. We are not going to do irrational things.
So with each and every one of those initiatives it is a very intense discussion and negotiation, but we are extremely disciplined and we’ll do things that make sense.
Rick Nelson – Stephens
Okay. The manufacturers also are talking about consolidating the dealer base.
Are you actually seeing any evidence that that's taking place?
Mike Jackson
Yeah, well, of course, Rick, as you know we have been arguing for it since the day I arrived here knowing that it was essential that it would happen. It finally is moving at a faster pace than just the dribble that we have had the last several years.
They have really embraced it as a strategy, they really understand the implications if they can't get it done to their business. And we are able to do a lot more today than we haven't been able to do in the past.
Having said that though, it’s a huge gap or a huge overcapacity issue that they are just beginning to address that’s even with their best efforts it’s still going to take quite some time.
Rick Nelson – Stephens
And just one final question on the brand mix. It looks like in the luxury segment you increased your brand proportion of sales with BMW and Lexus, but Mercedes slipped a bit.
Is that geography that contributed to that or--?
Mike Jackson
Rick Nelson – Stephens
Got it. Thank you.
Operator
Thank you. Mr.
David Lim with Wachovia, your line is open.
David Lim – Wachovia
Thank you. Good morning, gentlemen, just several questions.
Can you talk a little bit about your CPO performance in the quarter I mean granted there was some pressure but I just want to get an idea of how well your certified pre-owns did?
Mike Maroone
David Lim – Wachovia
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Mike Maroone
David Lim – Wachovia
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Mike Maroone
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David Lim – Wachovia
Okay. Understood.
When we come to the luxury mix side of it I mean are you seeing more of an in-elastic demand behavior? I know that all things have been hit hard but I mean relative to let’s say mainline imports, et cetera, I mean how is luxury side of your business holding up?
Mike Jackson
This is Mike Jackson. The way the cycle usually plays out at the beginning of the downturn is very much the volume segment that gets hit first.
And it is only when you are deep into the cycle that you have an impact on luxury. And that is where we are at now.
And I would describe it more as the uncertainty factor as to where all this is going that customers are hesitating. The purchasing power is still there.
So I think once there is a clear line on where the economy is going that the worse is behind us, I see the luxury business resuming the quickest. So it’s the last to hesitate and it’s the first to resume.
David Lim – Wachovia
Interesting. And finally, I was wondering when it comes to your ordering right now, are you still backing off on orders especially with the domestic makes or how should we take a look into that?
Granted there is that strike with American Axle in Detroit. I just want to get an idea of also your large GM SUV inventory.
Mike Maroone
I think there is plenty of availability out there across all brands.
David Lim – Wachovia
Okay.
Mike Maroone
We are working hard to manage our inventory. We finished the quarter at 57 days.
I would say that’s slightly higher than where we have been over the last few quarters. A lot of that’s because the March sales pace didn’t deliver as Mike Jackson has already called out.
In terms of our GM inventory, we have got an adequate supply of GM inventory. The strike has not impacted our ability to sell GM products.
I think all manufacturers are probably a little bit on the heavy side with the big SUVs and pickups and I don't think GM is any different there.
David Lim – Wachovia
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Mike Jackson
We view the marketplace as remaining more risk than opportunity and we are managing the business on the conservative side.
David Lim – Wachovia
Got you. Great, thank you very much.
Appreciate it.
Operator
Thank you. Mr.
Darren Kennedy with Goldman Sachs, your line is open.
Darren Kennedy – Goldman Sachs
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Mike Short
Hi, Darren, it’s Mike Short. We have been seeing the de-leveraging in the cost structure reflecting the – in this environment.
As gross declines it’s more and more difficult to extract SG&A savings, but I wouldn’t – again, there going back to the comment that I made earlier it’s a continuous process for us. We do think that there are more opportunities for efficiency and we are pursuing them.
Darren Kennedy – Goldman Sachs
Okay. And on the inventory side it’s one of the higher numbers, I think it’s the highest I have seen in seven quarters and clearly environment is responsible.
Is this mostly focused in specific geographies you mentioned and can we expect that this is also primarily in some of your luxury brands now or is this kind of spread across brands.
Mike Jackson
This is Mike Jackson. I would say for the domestic, with this combination of the economic uncertainty and high gas prices over this period of time you are going to have a real shift towards the value price points, which coincidentally is also the high fuel economy point because we don't charge the fuel economy in this business; quite the opposite.
So, restructuring our inventory towards that buyer that is really appearing for the first time to this degree in the first quarter is an issue for us. With the imports you have the issue that for our geography is there a sweet spot.
So you have Toyota, Honda, and Nissan all under pressure and with much more inventory than they traditionally care to carry and so we are managing that. With luxury, I don't think there is any real issue at this point.
To you, Mike.
Mike Maroone
Luxury inventories have been very stable and has been disciplined though there is not much pressure there. The pressure, as Mike said, is really in the domestic and...
Mike Jackson
Darren Kennedy – Goldman Sachs
Great. On the tax rate, which is at 40.6, I think it’s now over 40.
I don't know if it has ever been in any other point. Why is it tracking higher these days and why do you expect it to continue?
Mike Short
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Darren Kennedy – Goldman Sachs
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Mike Short
Well, that’s largely our deferred comp plan. It’s an asset valuation on that.
Darren Kennedy – Goldman Sachs
Okay, thanks. Matt?
Matt Fassler – Goldman Sachs
Hi, good morning. On the credit front, I listened with great interest to your comments on tightening of credit.
You spoke about subprime, you spoke about shorter advances, et cetera. If you can think about prior cycles and the way credit typically plays out because I think we are hearing a little bit more about that today than we have in the past it seems like a bit of a lagging indicator, but I wonder do the banks tighten up late in the game and sort of stay tight and exacerbate the issue?
Mike Jackson
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Matt Fassler – Goldman Sachs
How long does it tend to last? I mean do they sort of stand in the way when natural demands will be coming back because of lower rates or other factors?
Mike Jackson
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Matt Fassler – Goldman Sachs
So you think it’s only a couple of quarters before they feel like they have done what they need to do?
Mike Jackson
Matt Fassler – Goldman Sachs
Great. Thanks guys.
Thanks so much from both of us.
Operator
Thank you, Mr. Mark Wamsman with Calyon, your line is open.
Mark Wamsman – Calyon
Good morning. Regarding personnel, are you facing any challenges in retaining your top sales personnel at the point?
And if you are, what steps are you taking to do so?
Mike Jackson
I am very happy to say that all our retention initiatives that we implemented years ago are performing very well. And every year we have high retention and lower turnover and that is still the case even starting in '08.
Mark Wamsman – Calyon
Great.
Mike Jackson
I mean our training, development, retention program, they are all working extremely well. And a final irony is we did lose talent in '04, '05, '06 to the housing industry where it was easy to make a lot of money and now they are all coming back to the real world.
Mark Wamsman – Calyon
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Mike Maroone
Mark Wamsman – Calyon
Okay. And then on a different subject, is it fair to say that there are really two independent but interrelated trends here with the economic stress and gasoline prices?
In other words that while the economy might improve gasoline prices would continue to be a problem?
Mike Jackson
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Mark Wamsman – Calyon
The reason I ask is I am trying to figure out the extent to which we will see the segment shift from larger vehicles to smaller vehicles continue into the future as a result of elevated gasoline prices and then really my question for you is whether you see any evidence at this point of people downsizing for fuel economy reasons but at the same time specing smaller vehicles more highly because, perhaps they while concerned about the operating cost they still have the disposable income to want to drive around in a more highly speced although smaller vehicle.
Mike Jackson
Mark Wamsman – Calyon
Operator
Mr. Jonathan Steinmetz with Morgan Stanley, your line is open.
Jonathan Steinmetz – Morgan Stanley
Mike Maroone
Jonathan Steinmetz – Morgan Stanley
Okay. And I jumped on a little late and I heard some of your comments related to tightening of credit and that sort of thing, so I apologize if I missed this, but did you give – do you have any statistics related to that in terms of approval rates on loans or even cost of credit for sort of various tiers of credit because rates have come down a little bit maybe spreads have gone out.
So, anything related to data that sort of supports what seem to be a strong anecdote.
Mike Maroone
Jonathan, again it’s Mike Maroone. I think probably the piece that we focus most on is advances of how lenders advance versus invoice or advance against the wholesale value of the vehicle and we are seeing the advances across our lender base off between 2% and 4% and we do think that’s a significant factor in our used vehicle margin compression.
Jonathan Steinmetz – Morgan Stanley
Okay.
Mike Maroone
On approval policies, I don't have statistics across our lender network, but the advances are certainly under pressure.
Jonathan Steinmetz – Morgan Stanley
Okay. And you are saying that this is a much bigger problem than on the used side than the new side.
Mike Maroone
At this point, yes.
Jonathan Steinmetz – Morgan Stanley
Okay. Thank you.
John Zimmerman
We have time for one more question.
Operator
Thank you. Mr.
Rod Lache with Deutsche Bank, your line is open.
Dan Galatin – Deutsche Bank
Good morning, this is Dan Galatin [ph] for Rod. Can you hear me?
John Zimmerman
Yes.
Dan Galatin – Deutsche Bank
Mike Maroone
It’s Mike Maroone. I think we still have some upside.
I don't know that’s dramatic upside. We continue to focus on our third and fourth quartile stores.
There is still a pretty decent bandwidth from our best to our worst stores. So, that’s really where our focus is going forward.
The other piece is that these numbers reflect higher charge-backs than we have seen over the last several years, so they probably if anything kept the margin down. So, I do think there is upside based on our working in the quartiles and over time a lessening of charge-backs, not necessarily in the near term.
Dan Galatin – Deutsche Bank
Okay, thanks, and one other one. Do you see much activity with people coming into the dealership looking for a new vehicle and ending up with a used?
Mike Maroone
I think that’s always an opportunity and I believe that is happening. Certainly there is a lot of payment buyers.
Mike Jackson referenced the value conscious price buyer. That’s the person that’s coming into our dealerships and I do think they are looking at all opportunities both new and used and in different vehicles.
Dan Galatin – Deutsche Bank
Okay. Thanks.
John Zimmerman
Thank you for your time today. Appreciate all your questions.
Operator
Thank you. That concludes today's conference call.
You may disconnect at this time.