AutoNation Inc (AN) 2002 Q3 法說會逐字稿

Thank you for standing by and welcome to the AutoNation's third quarter earnings conference call. At this time all participants are in a listen-only mode later there will be a question and answer session, instructions will be given at that time. Should you need any assistance during the call please press 0 then star and an operator will assist you offline. I would now like to turn the call over the AutoNation.

Good morning ladies and gentlemen and welcome to AutoNation's's third quarter 2002 conference call. My name is John Zimmerman, AutoNation's Vice President, Investor Relations.

This call will be recorded and available for replay at 1-800-475-6701, code 654049 through October 31, 2002. Leading the call will be Mike Jackson, Chief Executive Officer and Chairman Elect of AutoNation. Joining him will be Mike Maroone, President and Chief Operating Officer and Craig Monaghan, our Chief Financial Officer. At the end of their remarks, we will open the call to questions. I will be available by phone to address any follow-up issues.

Before we begin, please let me read our brief statement about forward-looking comments. 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 that may cause actual results or performance to be materially different. Additional discussions of the factors that could cause results to differ materially are contained in the Company's SEC filings. I will turn over to AutoNation's Chief Executive Officer, Mike Jackson.

Thanks, John. Thank you for joining our call.

I'm pleased to report that for the third quarter of 2002, AutoNation achieved record third quarter results for operating income, EBITDA and earnings per share. Records during the quarter on total stores compared to the quarter a year ago, include operating income of $181 million, increase of 29%, higher revenue and gross margins as well as lower inventory carrying costs drove improved performance. EBITDA of $202 million, an increase of 14% and earnings per share of 33 cents, an increase of 38% and our third consecutive quarter of record earnings. Revenue in the quarter increased 4% to $5.2 billion and then income increased 35% to $107 million.

Manufacturing incentives continued to be a driving force with the reintroduction of the aggressive incentives in early July, coupled with fresh products spurred consumer demand once again, leading to a near record sales pace in August.

AutoNation realized a lift in new vehicle sales in the quarter, however pressure continued in used vehicles for both volume and margin. Our business model was able to compensate for this, another illustration of how the retail model with multiple profit screens differs from the more fixed nature of manufacturer model.

This quarter AutoNation demonstrated ability as a specialty retailer to generate profit and cash in an environment where the dynamics range from the positive. Stable interest rates, gas prices and continued record levels of vehicle affordability to concerns about a fragile economic recovery.

We are very pleased with our results in the quarter and with the strength of our balance sheet we continue to generate large amounts of cash, allowing us to reinvest in our business, acquire additional dealerships and repurchase shares. As we look to year-end our focus continues to be on operational excellence. With that I will turn to Craig Monaghan, our Chief Financial Officer.

As Mike said, during the third quarter, we delivered our third consecutive quarter of record EPS. In addition we generated profit of $181 million and earnings before interest, taxes, depreciation and amortization of over $200 million. Strong profits and cash flows have allowed us to reinvest in our business, acquire additional dealerships and continue to repurchase shares. We invested $46 million in capital expenditures, $33 million in acquisitions and repurchased $48 million worth of stock.

Reviewing some details of our performance, revenue for the third quarter was $5.2 billion up 4% versus Q3, 2001. This increase was primarily due to the benefit of current year acquisitions as well as growth in new vehicle same store revenue. Gross margin in the quarter increased by $32 million or 4% to $764 million. Margins increased in new vehicles, parts and service, F&I and others. As a percent of revenue gross margin increased 10 basis points to 14.7% versus 14.6% in Q3, 2001. The primary driver of new vehicle gross margin was a decrease in floor plan interest expense net of assistance. Down $8 million versus Q3, 2001 as a result of lower interest rates.

Although interest rates remain low, we are seeing less benefit versus the latter part of 2001, when the rates declined significantly. Other margin improvement was primarily due to approximately $8 million in underwriting profit from favorable loss claims experience in our warranty reinsurance portfolio. Store SG&A was leveraged in the quarter, increasing at a lower rate than revenue, up 3% to $536 million. Importantly, as a percent of gross margin, Store SG&A improved 120 basis points to 70.2% versus 71.4% a year ago. Compensation and advertising both were improved as percentage of gross margin. These improvements were impacted by the fact that during the quarter, we decided to significantly curtail our fleet vehicle sales to rental car companies and we recorded a $5 million write-off of a fleet vehicle receivable.

Other items of note in the quarter were the continued aggressive management of our liquidating consumer loan portfolio which contributed 1 cent per share of profit. We have approximately $104 million of financing receivables and related assets remaining as of the end of the third quarter. In September 2002, we transferred the risk related to our largest warranty reinsurance agreement to an independent third-party, recognizing an $8 million gain on the transfer. As you know, we continue to sharpen our focus on our core auto retail business and we are in the process of eliminating all our warranty underwriting activities.

We also recorded a $10 million property write down related to a decision to relocate a new vehicle franchise from a former megastore property. The net result of all the foregoing was a 35% increase in net income for the quarter versus last year and a net margin as a percent of revenue that increased 50 basis points to 2.1%. Let me give you an update on outstanding income tax matters. As we disclosed, in 1997 and 1999, we engaged in certain transactions that are of a type that the IRS has indicated it intend to challenge.

On October 4, the IRS announced settlement guidelines aimed at resolving these types of transactions with taxpayers. Based on the IRS guideline, an assessment of our tax position with respect to the transactions, we estimate that in connection with a possible settlement, we could owe the IRS net aggregate payments of approximately $500 million to $550 million, a substantial portion of which might be deferred over up to a 15 year period. We believe our deferred tax liabilities are adequate to cover these potential obligations. We estimate that the initial net payment in connection with such a settlement could be in the range of approximately $200 million to $400 million with the remaining amount deferred. Although we have no assurances, we presently believe that if a settlement were reached with the IRS, any such initial payment would not be made until late 2003.

Looking at capital structure, we reduced nonvehicle debt, net of cash, by $53 million versus a year ago to $477 million. At September 30 we had approximately $170 million of cash. In addition, we have credit capacity of $500 million in our revolving facilities, $150 million in our mortgage facilities and an additional $100 million of excess cash that has been used to temporarily reduce our floor plan payable.

This gives over $900 million of available liquidity and as such we are well positioned to settle the tax liability while pursuing other opportunities. Along these lines, we announced today that the board authorized an additional $500 million share repurchase.

The board also authorized management to seek an increase of $400 million in the share repurchase capacity under the terms of our 9% senior notes. We anticipate beginning the consent solicitation process later today. Let me turn you over to our President and Chief Operating Officer, Mike Maroone.

Thanks, Craig and good morning. Today I will walk you through our same store results from an operational perspective and provide details on each area of the business in the process.

In the third quarter on a same store sales basis, AutoNation delivered store performance of $219 million, an improvement $14 million or 7% compared to the same quarter a year ago. Store performance as a percent of revenue also improved 30 basis points to 4.4% and as a percent of gross margin improved 140 basis points to 29.6%, illustrating that our efforts on expense reduction gain traction in the areas of compensation and general store expenses. Turning to new vehicles, volume of 115,000 units in the quarter represented a modest increase compared to the same period a year ago. New vehicle same store revenue increased $91 million or 3% in the quarter to just over $3 billion. And new vehicle same store gross margin increased $3.3 million in the quarter to $211 million. Gross margin per vehicle retail was up $22 to $1837 compared to a year ago. On a trailing 30-day basis, our new vehicle inventory at the end of the third quarter reflected a 59-day supply, in line with our expectations.

While we have enjoyed the strong new vehicle market year-to-date, as we move into the fourth quarter and 2003, we are carefully monitoring our new vehicle inventory in order to adjust to any changes in manufacturer incentive activities and/or consumer sentiment. Our third quarter same store used vehicle volume was 63,000 units, a reduction of 3.7% compared to a year ago. Driven by an environment that remained challenging as financing for used vehicles became more restrictive and aggressive manufacturer incentives continued to shift customers to new vehicles. Additionally in the quarter the Mannheim Used Vehicle Value Index, a leading indicator of used vehicle values tracking back to 1995 registered 108, its lowest point since March, 1998, reflecting the weakness in the market that resulted from over supply and exceptionally strong manufacturer incentives on new vehicles.

In the quarter we took advantage of the opportunities that existed and kept our inventories tight. At the end of the quarter our used vehicle inventory stood at 37-days supply, two days lower than a year ago, with just 3% over 60 days at the end of the quarter. Turning to parts and service, third quarter comps continued to be impacted by the Firestone tire recall. This coupled with a soft cost collision repair market and a weaker wholesale parts market resulted in our same store parts and service business being off slightly in the quarter. Same store revenue at $605 million was down one half of 1% and gross margin at $263 million was relatively flat, compared to the quarter a year ago.

In the quarter, we continued our focus on fourth core tile stores and our efforts to reduce part and service expenses continued to pay off as evidenced by a 170 basis point reduction in same store expenses. Looking at finance and insurance, we had a great quarter. Recording F&I PBR gross margin on a same store basis of $760, an improvement of $45 or 6% compared to a year ago. F&I same store revenue increased $6.6 million or 5% in the quarter to $135 million. Attributable in part to an increased offering of high quality finance and insurance products.

Work continues with our fourth core tile stores and across the enterprise our focus is on quality menu presentation, on-going training and full compliance. During the quarter AutoNation closed on the acquisition of Claridge's BMW. We also reached an agreement to acquire six new vehicle franchises from the Vista Automotive Group in Corpus Christie, Texas. This acquisition which is expected to close later this year, includes Toyota, Chevrolet, Cadillac, Oldsmobile, Mitsubishi and Isuzu. Also in Texas, we announced last week we've signed a deal to acquire McNatt Honda in the Dallas market. The closing of the Vista and McNatt deals will bring AutoNation's dealership count to 292 stores representing 379 franchises.

In addition to acquisitions, we have made significant investments in our dealerships. Year-to-date we've completed 36 projects, 12 of which represent major upgrades or complete rebuilds. Also of note, AutoNation has been awarded 13 additional franchises this year. Two Mercedes Benz, two Mini Coopers, 5 [Mibach] and one each from Chrysler-Jeep, Hyundai, Pontiac and Nissan. We continue to be very pleased with our branded markets, especially those that have been branded for at least 18 months. During the first six months of 2003, we intend to brand two to three additional markets. With the addition of these markets just over 60% of our franchises will have a local market brand.

In closing, the third quarter was much like the first two with record-breaking results. All in all, it's been a good year for automotive retail in the midst of a very challenging economy. As we look ahead, our associates are very enthusiastic about driving our store performance to the next level. We remain focused on managing our assets and controlling expenses.We're also looking forward to the much anticipated introduction of new common sales and service processes that we believe will provide long-term benefit to AutoNation in terms of customer satisfaction, owner retention and increased market share. With that I will turn the call over to Mike Jackson.

Ladies and gentlemen, AutoNation has delivered another solid quarter. Turning to the remainer of the year we expect our fourth quarter earnings per share to be in the range of 25-27 cents and our 2002 full year earnings per share to be $1.18 to $1.20. Looking ahead to next year, our full year 2003 EPS outlook is $1.25 to $1.30. As we anticipate earnings growth in a market where we expect U.S. sales of new vehicles to decline 3-5% from 2002. Thanks for joining us today. We will be happy to take some questions.

Ladies and gentlemen, if you have a question at this time, please press the "1" on your touchtone phone. You will hear a tone indicating you are placed in queue. You may remove yourself from queue at any time by pressing the pound key. Once again if you do have a question, please press the "1" at this time. Our first question is from Vinay Shah with Morgan Stanley. Please go ahead.

Hi, could you just talk about guidance for next year? Can you talk about expectations for the used vehicle side of service and parts if you are expecting growth or if those - the businesses will be flat for example? Thanks.

It's Mike Maroone, on the used vehicle side, assuming that we continue to have ultra aggressive manufacturer incentives, we would project used vehicle volume to be flat. On the parts and service side, I think we can still see 3-5% growth in today's environment.

This is Mike Jackson. On the used vehicle side, it's also a credit challenge segment at the moment. Lenders are very reluctant to put the full value into vehicle that is lead to a decline in vehicle values and they've also raised the credit standards. So there's a credit crunch in used vehicles combined wit the issues that Mike talked about.

One quick follow-up. Can you talk about what you have seen so far in October in terms of overall business?

Well, naturally the comparison to next year will be a meaningful decline. I expect that retail sales for the fourth quarter will probably about 8-10% behind last year on a year-over-year basis.

Okay, great. Thanks.

Our next question is from Domenic Martilotti with Bear Stearns.

Good morning, I have several questions. I don't know if I should go one at a time, but we'll start somewhere. Looking at new car gross margins, they were down sequentially and down quite a bit year-over-year. Kind of surprising. I would expect to have seen a more margin erosion on the used car business given the fall in prices. Can you explain what's going on between the two a little bit?

It's Mike Maroone. Good morning. The way we looked at used cars is with very robust incentives on 2002s and I think seeing a big price gap between the '2's and '3's, it was a very, very competitive market.

I think people as we got into the end of the quarter were really running out of the hotter models and I think people were looking to move the maybe "not so hot" models. We got some margin compression. All in all, I don't think our margins were bad shape.

As far as the used cars in terms of the wholesale market, what kind of sell rate or the level of sales are you seeing first time through those auctions, compared to where they have been?

The auctions are certainly much softer and if we can sell 60-70% of our offerings the first time through, we are pretty pleased. At one time we were probably north of 80, but the market has been moving down on a pretty regular basis and doesn't feel like it hit bottom yet.

As far as new car margins, should we expect those since we are not really dealing with the '02 versus '03 anymore to be pretty consistent from the third to the fourth quarter if we see stable incentives from the manufacturers?

I would expect to see normal new car margins, I don't think we feel the exact same pressure. We are being restocked with the right balance of '03 product and I think you'll see the margins normalize.

Okay, I want to touch on acquisitions a bit, you guys are at about $500 million annual revenue to date. I think the guidance you had given going into this year was that you are looking to do about a billion in revenue. Should we expect an acceleration on acquisitions in the fourth quarter or are you guys taking a little step back at this stage?

The original guidance was between $500 million to a billion, five. I expect we'll finish the year somewhere between $500 million and $1 billion.

Are you seeing the opportunities any less frequent out there or is it just a matter of finding the right franchises.

You know our philosophy when we go into the year is only to do acquisitions that meet our return thresholds which is at 15%, after tax, return on capital deployed. Counter balance with the opportunities we see on the share repurchase side.

Clearly the current values in the equity markets present a significant opportunity the share repurchase side. We are always balancing one against the other.

Okay, and I want to touch on the ANC liability. Where does that stand and what is the likelihood of there actually being some sort of pay out at some point?

The ANC liability we have been calling out as an exposure of $25 to $60 million. We feel now that exposure is actually beginning to mitigate somewhat and it's probably now in the range of $25-50 million.

As that company continues to make progress and move forward, we would expect the exposure to continue to reduce. I don't think I can make a firm statement about that. Anything beyond what I said.

Lastly, touching on the floor plan assistance versus expense delta, you guys are still benefiting from a nice assistance difference there. Where do you expect it to go and when do you expect to see that trend to reverse?

I think that trend will neutralize in the fourth quarter. And by neutralize I mean the net floor plan assistance we realize in the fourth quarter will be very much in line with what we realize in the fourth quarter of last year. No incremental impact, and that's because, by the time we get into the fourth quarter, interest rates on a year-on-year basis will be pretty much flat.

Okay. Thank you.

We have a question from Rick Nelson with Stephens. Go ahead. Rick Nelson, your line is open.

Thank you, guys. Great quarter.

I wanted to follow-up on the manufacturer assistance it was flat in the quarter and down in the year to date and more than offset floor plan interest expense. What exactly are the factors that drive floor plan assistance and where do you see that going beyond the fourth quarter? Interest rates are obviously one factor.

Floor plan assistance in its most simple form and I will over simplify somewhat. We get assistance from the manufacturers and from the domestic manufacturers that is a function of interest rates. To over simplify you can think of assistance as being them funding the vehicle for 60 days at book plus the spread. We pay a floor plan rate to carry that inventory at book plus the spread. If we can move that vehicle in less than 60 days, we earn a net credit, if you would.

With inventory levels relatively stable and interest rates getting to the point, where, on a year-over-year basis they're relatively flat, the entire floor plan assistance game becomes how quickly can we turn the vehicle relative to the period on which it is funded for us. Some of the import manufacturers provide flat floor plan assistance. If you can move your vehicles quickly and manage your inventory levels well, you can create credit. In the fourth quarter of last year, we had a credit in the vicinity of $10-15 million. We would expect to see something that in the fourth quarter this year and on a longer term basis, again with well-managed inventories, I think you could expect to see something in the same type of range.

Thank you. On the F&I front, we saw nice improvement in F&I per unit. Is there anything inherent to that business that would create a feeling on how high it can go?

It's Mike Maroone. I thing you can continue to see growth in F&I, but you won't see the spectacular growth in the last two to three years, but our focus is really on improving our fourth core tile stores. 'Cause our band width is still larger than we would like to see it.

We are also focusing on products that don't have charge backs. Things like security systems that provide customers with value and don't provide us with exposures. I think you'll see us continue to improve, but I don't think you will see huge leap and bounds.

Thanks.

Our next question is from Jerry Marks with Raymond James.

Good morning. With the tax liability, I think in you guy's 10K you've indicated in the past like $600 million. Are you lowering that assumption?

We've indicated in the past that the tax liability associated with these transactions is $680 million. You are correct in assuming that if we can reach a settlement, there is upside potential there for us relative to that reserve. But until the deal is done, we are not ready to make any firm commitments.

Did I read you right that any payments or settlement would happen near the end of '03 and it would somewhere be in the range $200-400 million with the balance then maybe amortized over 15 years or however you can do it?

That's correct. This is all subject to negotiation. I'd point out that that's the federal piece of this liability, as well. I think I would call it a most likely scenario, but at this point until a transaction is finalized, we are only able to give you these broad ranges.

Mike, could you comment about the collision and repair markets? What the trends are happening there, it seems to be kind of soft.

Jerry, it has been soft and I would say it was softer in the first half of the year and is starting to pick up again. It's really related to a couple of things. One is very mild weather across the country compared to prior years.

Also we are seeing a tendency for insurance companies to total more or a higher percentage of the wrecks than in the past. Those two factors with some level of increased competition from new consolidators have caused that market to be a little soft, but again, third quarter is a little bit better and we are seeing October probably picking up a little bit more.

Forgive me, but what do you mean by total? Like do you mean just scrap 'em?

Right. They say this vehicle is a total loss and we scrap it and replace it as opposed to a high-dollar repair.

Okay, so it's partially due to kind of a weather issue and a structural thing that's happening as well?

That's correct.

Okay and then, I apologize. I got distracted when Vinay was on - when he was asking about the '03 guidance. If you've said this already, I apologize but have you given with that '03 guidance what you are assuming for your capital outlays? I know it's a mixture of acquisitions and share repurchases, but have you given a total in terms of what that is? What that plan number is?

Jerry, we've have not. We are not in a position just yet to give detailed '03 guidance. I think you can assume we will continue to do what we have done in the past. And that is look at what the opportunities are on how we redeploy that capital. We will move back and forth between acquisitions and share repurchase where we get the best return on invest.

Okay, I guess from our standpoint though, would it be safe to assume whatever we are assuming for cash flows for next year? Is that what you tend to try to do is match it in that regard?

Yeah, I think that's fine.

That's all I had. Thanks.

The next question is from Janet Clay with State Street Research.

I had a question on the consent solicitation that you will be doing with the bonds. Just to clarify, you have the board to approve $500 authorized share buybacks would be another additional $400 million on top of that? A $900 million total in share buybacks?

No, that's $400 million would be a piece of the $500 million.

What are the terms going to be on the consent?

The terms have to be negotiated. We are intending to kickoff that process later today, but until they are finalized, we can't give you details on that.

The only other question is looking at the possibility of that tax payment at the end of '03, wouldn't it make more sense to conserve that liquidity and make sure that you are in good liquid terms in case you had to pay out $400 million at the end of '03? I'm wondering on the timing of additional share buybacks with that possible cash payment looming.

This is Mike Jackson. We always had a very strong conservative balance sheet with our nonvehicle debt aiming at the mid-teens, 15-16%. We've kept it that way with the deferred tax liability in mind that when it was finally settled with the IRS, we would be in a very strong position to deal with it.

As that bandwidth of settlement gets more defined, it gives us confidence to look at the opportunities that we have. With that low leverage, we are well-positioned to deal with the IRS and take advantage of the opportunities we have in the market place.

If I can follow-up and give you a little sense of comfort there, again at the end of the quarter, we had cash of $170 million.

We actually during the quarter had more cash than that but we used some of that to pay down a floor plan note payable because we have attractive Arbitrage opportunities when we do so. That was about another $100. The revolving credit totals are untapped, they total $500 million and we have $150 million of mortgage facilities we have not used yet. If you add all that up, that will take you to in excess of $900 million of available liquidity today. So, relative to a tax payment in the $200-400 million vicinity, we feel like we are in extremely good position, not only to pay that but to exploit other opportunities that might come our way.

Thank you, very much.

The next question is from Nate Hudson with Banc of America Securities.

Good morning. A question on your same store sales of new vehicles, specifically. They're weaker than I would have thought, given I think the market was up 9% and I was wondering if you can talk about some of the factors there, if it was a brand issue, a regional issue or why you think you under performed the market.

Nate, it's Mike Maroone, I don't think that the 9% number is accurate. We think that we performed in line with the market. We on do an extensive market share analysis for every single market we're in. We're showing that our market share is relatively flat. So I don't think we gave up share in our particular markets. We are heavy in Florida, Texas, and California. Certainly the Texas market has been impacted by a number of economic things. But, all in all, we're pretty happy with our new vehicle performance.

If you could expand on that just a little bit. Regionally, what were the best performers and were there any regions that were down significantly?

Our California markets, both Southern California and Northern California performed extremely well. The Florida markets also performed well. And Las Vegas was, again, a very strong market for us.

On the weaker side, I would point to Houston and Denver as being markets that are most challenged by the economic factors in those markets. But, all in all, we were pleased.

A question on the gross margins on the new side. Is the trend similar across your brands there or is the weakness concentrated with the domestics or with Ford specifically?

Well, certainly the gross margins vary by brand and I would say there is probably more pressure on Ford and Chrysler from a gross margin point of view. GM was very strong and certainly the imports have been strong and the luxury continues to hold up very, very well.

The next question is from David Zino with Cabelli and Company.

Good morning. A follow-up on Mike Maroone. You mentioned weakness in the wholesale parts market. Your response to the question before as far as picking up in October, was that just regarding the collision market or does that encompass the wholesale parts market as well.

The wholesale parts market is driven in large part by the collision market. so I'd anticipate a modest pick up there. But I think the other factor is the way manufacturers distribute parts certainly had an impact on the dealer to dealer business, which is the other big segment. Our wholesale business certainly was impacted by the collision over all though.

That's generally the biggest factor in that business, it's not related to warranty work or anything like that?

Warranty is a factor. I don't think it's a big factor on the wholesale side, but certainly there is pressure from "The Big 3" as they continue to work on the cost side of the business to keep pushing their warranty costs down.

No sense that consumers are deferring maintenance or anything along those lines?

No, our customer pay business is holding up well.

Thank you.

Our next question is from J.P. Morgan.

It's actually Carla CASSELA at J.P. Morgan. I wonder if your 2003 guidance assumes any changes in interest rates on the floor plan financing or your debt?

This is Craig, we do have a slight interest rate increase towards the later part of the year. But, it's not material.

Okay. I'm also wondering how inventory positions look on a new vehicle and used vehicle, the break up. The break up. Can give us the break out of inventory or generally just your sense of how you feel you are positioned.

On inventories, new vehicle at the end of September, 59 days and used, 37 days.

Okay. Great.

I might add on the inventories, that our new vehicle inventory, our units over are - over 90 days are down to 19%, which is the lowest it's been in sometime. On the used vehicle inventories over 60 days, only 3%. We think our inventories are in great shape.

Great. Thank you.

The next question is from Glen Chin with Lehman Brothers.

I'm sure this question has been asked before and I will ask it at the risk of sounding redundant.

Given that "The Big 3" are struggling to maintain profitability and most of the constituents in the business circle to varying degrees are struggling as well, with the exception of the dealer network, how much of a risk is there that they may come to you guys looking to narrow margins or do you think they'll be hands off given how frayed relationships have been recently.

This is Mike Jackson. First, we are very encouraged to see GM and Chrysler take market share this year.

While Ford remains under pressure on market share and has lost market share this year. We think with the product pipeline they have in the next couple of year they'll be able to stabilize if not regain some of that share. As far as the transfer of cost, the manufacturers have done that vis-a-vis the dealers decades ago. That has already been built in.

What we have today is a very efficient distribution system for the manufacturers. If you look at our gross margins, on new vehicles it's only 7%. There is not a lot of fat there for them to come and take out. I think the balance of power between the retailers and manufacturers is at an equilibrium. And I don't see where they have opportunities to do more than what they have done. That's the reason you don't see it happening.

Okay, thanks, Mike.

The next question is from John Stacy from BMP Paribas.

Good morning. I think you just answered my question.

And that is how do you mitigate the concern that "The Big Three" or other manufacturers will start increasing production of cars and, so-called, stuff them down the dealers and try to get you guys to hold them on your lots and sell them. Obviously if they do that and you have to move them and the margins get much thinner on those sales. So, how do you mitigate the concern that that's not going to happen?

This is Mike Jackson. That's already happened. We have been dealing with that ever since I have been in the business. There is a push system from the manufacturers out of Detroit. We have reached an equilibrium that's appropriate. We care an appropriate amount of inventory to meet the needs of customer and meet the manufacturers.

The lifeblood of that system is the floor plan system where it's basically a payable for the manufacturer and extend that we turn that in in less than 60 days, we have no carrying cost on that inventory. So that's the last thing they're ever going to touch. That's their system to move from the factories to retailers and have revenue recognition on their side. I see no structural change in the balance between the manufacturers and retailers.

Thank you.

Our next question is from Art Weiss from Symphony Asset Management.

What were the transactions that lead to the IRS problem?

I wouldn't call it a problem, number one - this is Mike Jackson - we call it an issue.

Issue then.

Back in that time frame of 1997 and 1999, under what was then current tax law, it was possible to set up entities and in our case I will tell you, the bulk of this is in an entity that was established to manage our benefit cost.

What that entity did, or what they were able to do with that tax planning transaction was to basically accelerate medical cost deductions and therefore take a tax deduction. What it was was a deferment of a tax liability over a 10 to 15 year period.

So this structure deferred the tax liability and didn't necessarily eliminate it?

Exactly. It deferred a tax liability, the law was subsequently changed. And then the transactions were later challenged.

We went to the IRS on a proactive basis when the new management team arrived and said we would like to sit down and talk about this. We were more than happy to share information with them so they had a complete picture. Both parties had the same set of facts and tried to drive to a resolution.

If the settlement comes in in the range you projected, net of the benefits that you took during this period, would you have lost money, so to speak, on this tax issue or would you have come out even in the end?

At the end of the day, the -- I'm trying to give a simple answer. At the end of the day the government is looking to collect the amount of money that was originally owed. What is up in question is over what period of time will that be paid back?

So they are not looking for a sizable penalty, or a penalty of any sort it sounds like?

There's no penalty involved.

Ladies and gentlemen, if you have a question, press 1. We have a question from John Cassesa with Merrill Lynch.

Mike, actually either Mike, what do you think is happening in the market right now. September was a little bit soft in terms of SAR. October seems to be about the same. What do you attribute this softness down, really sequentially, there, I know year-over-year why we're down.

This is Mike Jackson. First, we are as a retailer ,very impressed with how the market stayed well above $16 million for four years in a row. We expect next year will be another good year above $16 million. We think it will pull back from this year 3 to 5% exactly for the reasons you touched on and we see and feel.

Namely it's a fragile economic recovery that's dragging out and the American consumer has factored that into their behavior. But the powerful combination of great new products and incentives will still keep it at a good market of plus 16 million.

What do you think about the consumer confidence numbers. Do you get a sense of that factoring into the decision making now or what's at the heart of your answer?

That's at the heart of the answer. The economy is fragile, it's wobbly and this is not a booming recovery. That will be factored into people's behavior.

However, I will have to point out that it will still be plus 16 million market for the fifth year in a row. Which has never happened in the history of owner retail. It's overall a pretty good environment and, again, it's a combination of terrific products from the manufacturer keeping the consumer in tight and interested in the market, if you combine that with incentives and the value equation and you have a relatively good market. Without a stronger economic recovery, I don't feel like we will equal last year's numbers.

Thanks very much.

Our final question is from the line of Michael Millman with Salomon Smith Barney.

I have a couple of questions. Give us the split in P&S between the warranty work and the collision work and maybe an idea of the margins on each and which direction they are going.

Also, secondly, on the 3 to 5% following the last question, that suggests that you are looking for your new sales, same store to be sort of flattish. Then finally the last time I asked you this, you indicated that you saw it break even on a SAR basis was around 10 million units. Is that still a valid number?

This is Mike Jackson. The 10 million is still valid - more so than ever. In that as AutoNation matures as a company with a focus on operating policies and internal control, we are much stronger to deal with anything that the market place throws at us. That is absolutely solid. What was the question on the 3 to 5?

On the 3 or 5, does that suggest that your new sales are flattish?

I would expect our new vehicle sales to probably decline in the 3 to 5% range along with the market. I don't think we have the strength to overcome a macromarket trend like that.

In other words, you don't think you can take market share?

We may take a little bit of market share, but not enough to overcome a 3 to 5% decline. To me the fact to focus is despite that decline, we will still increase EPS next year.

The other question related to the P&S split?

We don't have that information in our hands, but I'm sure John Zimmerman can get it to you. The labor margins are in the neighborhood of 65% and parts margins are anywhere from 38 to 42.

Thank you.

Thank you very much for joining our call today. Appreciate having you here.

Ladies and gentlemen, that concludes your conference for today. We thank you for your participation and you may now disconnect.