AutoNation Inc (AN) 2004 Q3 法說會逐字稿

Welcome to the 3rd quarter earnings call for AutoNation. At this time all participants are on a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. If you should require assistance during the call, please press the star followed by the zero.

As a reminder, this conference is being recorded today, Thursday, October 28th, 2004.

At the conclusion of our conference, replays will be available after 12:30 p.m. eastern time through November 14th. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701. And entering the access code 750554. International participants dial 320-365-3844.

I will now like to turn the conference over to AutoNation, please go ahead.

Good morning, ladies and gentlemen. Welcome to AutoNation's 3rd quarter 2004 conference call. My name is John Zimmerman, AutoNation's Vice President of Investor Relations.

Leading our call today will be Mike Jackson, Chairman and Chief Executive Officer of AutoNation. Joining him will be Mike Maroone, President and Chief Operating Office, and Craig Monaghan, our Chief Financial Officer. At the end of their remarks we'll open the call to questions. I'll 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 be materially different. Additional discussions of the 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. As required by applicable SEC rules, the company provides reconciliations of such non-GAAP financial measures to the most directly comparable GAAP measures on the investor relations section of AutoNation's website at AutoNation.com.

And now, I'll turn the call over to Mike Jackson.

Today we reported 3rd quarter earnings of 35 cents per share for continuing operations, down from 38 cents per share from the 3rd quarter of 2003. During the quarter we experienced four major hurricanes that caused store closings and substantial disruption of business throughout Florida and the southeastern United States that we estimate have a negative impact on approximately 2/10 per share. This was in addition to a retail sales environment that's continued to be challenging.

During the 2nd quarter call, we identified two priorities for the 3rd quarter - - reducing new vehicle inventories and aligning SG&A expenses. At that time, new vehicle inventories were elevated beyond rational levels, not only for AutoNation, but also for the industry as a whole. We're pleased to report that as of the end of September, our new vehicle inventory has been reduced substantially to 53 days supply vs. 75 days at the end of the second quarter. This is a decline of 29%. The industry is also shown reduction in new vehicle inventory levels from 72 days to 63 days or 13%. And both General Motors and Ford, have announced production cut which should result in a more rational level of inventory by the middle of next year.

As for our focus on costs, we recently announced a new regional management structure that we expected to produce an annual SG&A expense reduction of 30 million, which would constitute a portion of the AutoNation's previously announced 200 basis points target reduction in SG&A over the next few years. The implementation of this new structure went smoothly and without any disruption to our business. In spite of the challenges in the 3rd quarter, we continued to generate strong cashflow and expect to generate additional efficiencies going-forward.

With that, I'll turn things over to Craig Monaghan our Chief Financial Officer.

Thank you, Mike.

Mike has covered the high-level financial results for the 3rd quarter. I will now review selected other financial items. As Mike said, we have moved to a new regional management structure. During the 3rd quarter, we incurred costs of approximately $2.5 million related to this reorganization, primarily for severance. We expect to incur up to an additional $2 million of related cost in the 4th quarter. We expect that this reorganization will produce $30 million in annual expense reduction.

In the quarter, our tax rate compared unfavorably to the 3rd quarter a year ago, due to a one-time benefit we recognized last year on our income tax line. The 3rd quarter, 2003, we had approximately $3 million or 1 cent per share of favorable adjustment related to the resolution of various state income tax matters. As a result, our effective tax rate for the 3rd quarter this year was 38.4%, compared to 36.7% a year ago. As we have mentioned in the past, we expect additional tax adjustments, both positive and negative, over the next 6 to 12 months as we continue to work through our tax matters. Once we resolve the bulk of our open tax matters, we expect our base tax rate to be approximately 39%.

Also in Q3 we had losses from discontinued operations of $2.6 million. Net of tax or 1 cent per share. These losses relate primarily to the divestiture of several stores during the quarter. These include stores we have sold or closed or for which we have a definitive agreement to sell. We will continue to evaluate the operating performance of our stores and may have additional divestitures in the future.

As for cashflow, during Q3 we generated approximately 110 million in cash from operations that we use to repurchase $83 million worth of stock and reinvest 27 million in our business through capital expenditures. We did not close any acquisitions this quarter. We remain disciplined in our cash outlays and are targeting 2004 capital expenditures of approximately 130 million. Excluding any acquisition-related to spending for lease buyouts. As you know, we view acquisitions and share repurchase opportunistically. Our full year 2004 target for combined spending on acquisitions and share repurchasing remains the same, estimated to be approximately $400 million. Also our board just authorized an additional share repurchase program for $250 million.

As for our capital structure, as of September 30th, our non-vehicle debt was 817 million. Essentially unchanged from where we ended the 2nd quarter. Our cash at September 30 was 91 million, up $30 million from June 30. We have available cash and incremental borrowing capacity of 600 million at 17% non-vehicle debt-to-capital ratio.

In conclusion, we believe that our strong balance sheet combined with our best-in-class operating and net margin puts us in great shape to capitalize on opportunities in the market today.

Now, let me turn it over to our President and Chief Operating Officer, Mike Maroone.

Thanks, Craig. And good morning.

As I begin, please note that my comments this morning will be on a same-store sales basis. As Mike mentioned, our performance in the 3rd quarter was impacted by a retail environment that remains challenging and an unprecedented four hurricanes that made landfall between August 13th and September 25th in Florida. A state that represents approximately 30% of our operating profits. Our business was disrupted as residents focused on monitoring the projected path for the storms in either preparing for, waiting out, or cleaning up from them. Widespread power outages resulted in store closings throughout Florida as well as coastal Alabama and the Atlanta area.

Let's take a brief look at the business starting with new and used vehicle sales. In the quarter, we retailed 168,000 new and used vehicles on a same store sales basis, down 6% compared to the period a year ago. Our estimate is that approximately half of our volume shortfall resulted from the adverse weather conditions. In what remains an intensely competitive marketplace, our new unit volume was 108,000 in the quarter down 6% compared to a year ago. While industry sales were flat in the quarter. pleat surged more than 14%. With pleat removed retail sales declined approximately 4%. Our gross profit per vehicle retailed was relatively stable compared to the period a year ago.

We made strides in the quarter on new inventory levels and were particularly pleased with our progress relative to domestic units. At September 30th, our domestic inventory was down 25% compared to June 30th and down 5% when compared to the same period last year. Our overall day supply of 53 days, positioned us well entering the 4th quarter.

Turning to used vehicles, same store volume of 60 thousand units was off 7% compared to the period a year ago. And gross profit per vehicle retailed of $1619 was off just less than 1%. Stepped up incentives on new vehicles by domestic manufacturers in September contributed to softness in the demand for used vehicles. Our used vehicle day supply of 41 days at September 30th was in line with levels a year ago, although slightly higher than anticipated. Due in part to reduced volume, the weather in Florida, and the unusually high number of trade-ins in the closing days of the quarter as GM and Ford introduced short term lucrative consumer incentives.

Over all in the quarter, the Las Vegas and Phoenix markets were strong for the brands we represent. Though our Baltimore, Florida and Texas markets were all off. In the area of service, parts and collision, the weather impact in Florida is evident again, in same store revenue of 624 million that was relatively flat compared to the period a year ago. In gross profit of 270 million that was off 1.5%. Customer pay service and parts revenue increased 2% in the quarter, attributable to the continued implementation of best practices that include - - our service drive process, our customer-friendly maintenance menu, and our service marketing program. In addition, work continues on optimizing our in-store pricing models and training our service associates on our customer-focused initiatives.

Turning to finance and insurance, gross profit per vehicle retailed was a record $951 per vehicle, an increase of $22 per vehicle, or 2% compared to the period a year ago. Continued improvement is due to narrowing the bandwidth of our performance by focusing on fourth quartile stores in an effective compliance program that ensures full menu presentations with complete transparency to our customers. The cornerstone of this program is the AutoNation pledge that we introduced last quarter. This industry-leading F&I disclosure pledge has been very well received by our customers, our associates, and our lender and product partners.

On the acquisition front, during the quarter we announced definitive agreements to acquire a Schooley Cadillac and in Palm Beach, Florida, and Borton Volkswagen and Borton Volvo of Del Rey Beach, Florida. We expect the acquisitions of the three stores to be completed in the 4th quarter, bringing the annual revenue run rate of our 2004 acquisitions to approximately 465 million. Our corporate development team continues to actively pursue acquisitions that meet our market brand criteria as well as our return on investment thresholds.

As you know, in early September, we announced a structural change that consolidated our business operations from 10 districts to five regions. The new structure has been implemented, and in addition to substantially reducing overhead, it's expected to deliver increased efficiency and effectiveness to our operations. Reduced span of control of our field leadership will drive our common processes deeper into the stores. These efforts will be supported by common element pay plans and a robust training component to ensure that processes are in place and remain in place. Store management has enthusiastically embraced the new structure and our team is looking forward to the opportunities that lie ahead.

With that, I'll hand it back to Mike Jackson.

Our associates performed admirably and in the face of very adverse circumstances created by the four hurricanes. The results they produced, especially in light of lost time, reduced traffic is a testament to the character of our associates. That being said, we expect that 4th quarter EPS from continued operations be in the range of 30 cents to 33 cents per share. As we have noted before, our full year 2004 guidance for EPS for continuing operations will be in the range of $1.32 to $1.35.

Also, in the future, we will no longer provide quarterly or annual earnings per share guidance. AutoNation's focus has always been long term. Well continue to provide insight into strategic initiatives, value drivers, trends, and industry data, critical to understanding our businesses and operating environment. The key assumptions in the drivers include annual U.S. light vehicle unit sales we expect in the high 16 million range. A reduction in SG&A as percent of gross profits of approximately 200 basis points over the next three years, continued redeployment of our cashflow, among share repurchase, debt reduction, capital expenditures and acquisitions for the targeted return on incremental and invested capital of approximately 15% after tax. We believe with our diversified business model, we can achieve EPS growth at a long-term average annual rate of 10 to 12%.

Thank you. I will now open the floor to questions.

Ladies and gentlemen, at this time, if you would like to ask a question, please press the star followed by the one on your touch-tone phone. You will hear a tone indicating that you have been placed in cue. At any time if you wish to decline from the question and answer period, please press the star followed by the two. As a reminder, if you are using speaker equipment, please pick up your handset before dialing the numbers, once again at this time, if you would like to ask a question, please press the star followed by the one at this time. One moment, please, for the first question. Our first question comes from the line of Charles Grom. One moment, please. Our first questions from the line of Rick Nelson, please go ahead with your question.

Thank you. And good morning.

Good morning, Rick.

At a 6.9% gross margin in the new vehicle segment. Is that a profit generated for you, or are you actually selling cars at a loss? If you loaded in all the SG&A associated with it.

Rick, this is Mike Jackson. I don't think we've got an exact calculation, but my instinct would say it's largely in the black. And if you fully load in the S & I benefit from the sale, and the trade-in and everything else, it's still a generator overall for the business. However, I think you're very much on the point that 6.9% is not a very exciting or interesting figure. And that's been one of the reasons why we have been so vocal and so determined on the inventory bubble that's existed for some time now. That excess inventory sitting at retail is what is putting so much stress and pressure on front end growth, and they simply aren't conducive to rational business. So we've brought our inventories in line. We're happy to see the industry take a major step in the right direction. We're encouraged by the production cuts that we see going in place for next year, and feel that sometime next year, an environment will exist where well be able to address the front end growth situation. That's what we're trying to create.

You mentioned the middle of next year, you thought this inventory bubble could get corrected. Why the -- can't it happen quicker than that?

Well, we may be there, but it's going to take, I think, the industry somewhat longer. If I look at the production schedule that's in place, why it is indeed less than last year, and you put in some sort of prudent sales rate, I'm a little reluctant to say victory is going to arrive before the end of next year. If I'm proven wrong, all the better.

How does your mix of '04, '05 models look?

Rick, it's Mike Maroone, we closed the quarter with about 60% of our vehicles as '04s and 40% as '05s, which was opposite of where we were a year ago. So we're pleased, it's right where we wanted to be, and we worked really hard on the inventory.

Any comment on October sales and especially Florida, if that's rebounding?

I would say our October sales are up over a year ago, really due in part to two things, one is recovery in Florida, and second is in California, if you remember, we are comping against a very weak October where it was impacted by a tax increase. So those two factors have given us a favorable year-over-year comparison from October to date.

and for the balance of the quarter, Rick, our concern again remains how the presidential election goes, I think as well as we have a victory. A victor on November 3rd, the market will be relatively fine. If it's a protracted, contested election, it could have an impact on business.

Thank you.

Our next question comes from the line of John Casea. Please state your company name followed by your question.

From Merrill lynch. I have two questions, first, on acquisition valuations, are these challenging retail conditions, working their way into more attractive valuation opportunities or have you seen anything change in the market?

No, John, it's Mike Jackson. I have not seen it reflected in valuations, that's why we have not seen us do too many deals this year. The feeling out there is that the environment is temporarily difficult, and, therefore, they're not adjusting valuations for this environment, and our view is, well, let's wait and see. That's a true statement, we'll do some acquisitions, but we're going to be very conservative considering the circumstances.

Okay and then just in terms of the inventory situation in '05, what's your thinking on why it might get better by the middle of the year? Do you think there will be some demand stimulus, do you just think that the industry will take more actions scheduled? It is possible, Mike, that the industry starts to run at a higher level of inventory longer term. It seems improbable, but if you look at the last two years, that's what's happened.

I think that's what has happened in the last two years, that's putting pressure on our front end margin. I think the combination of the pressure on the front end margin and a rising rate environment, the retailers is are going to push back on the inventory levels. Don't forget, John, one of the big reasons why these inventories were accepted by retailers was the extraordinary low rate environment. That is over. And I think there's going to be push back on these inventory levels, because everyone knows that we're not selling, we're not retailing one more car because of these inventory levels. It is a log jam in the system, and an inefficiency in the system that should be squeezed out. We do see signs, though, of production cuts year-over-year in the schedule that lead us to believe that by the middle of next year we could be in a better environment. But, you know, it could come sooner, it could come later, but I think it's a key issue, and I do not believe retailers are going to accept at the inventory levels of the last two years are now the norm.

That's a very good point. And Mike, just to follow-up, I mean, do you feel that generally your larger competitors in your markets are taking the same view on inventory? I mean, is it possible that you could run leaner inventories but can't benefit from it for a while because everyone is out there with excess stuff and they're cutting price?

Exactly. That's why I'm trying to make very clear, that even while we're satisfied where we have our inventory, that does not change the overall environment. The overall environment is lagging where AutoNation is. Until more of the environment, more of the market, moves to where we are, it's going to remain intensive competitive. I feel a rising rate environment, with no one arguing as far as any benefits to these higher inventories, it will not be accepted as the norm, it will take some time, but I feel sometime next year we're going to be at a more rational basis.

That's great, thanks. Very helpful.

Our next question comes from the line of Charles Grom. Please state your company name followed by your question.

J.P. Morgan. In Florida specifically, could you speak to insurance replacement activity versus the normal recovery in the market at this point.

Charles, it's Mike Maroone. I think there's some insurance replacement, I don't think compared to some hurricanes of several years ago there was as many cars damaged. In most of our major markets, we were more impacted by disruption from lack of power and people preparing for the storm and cleaning up after the storm. So I don't see a -- in our markets a huge influx of insurance money, although there was certainly some deferred purchases and we do have a good start to October.

Thanks. And the second question, just with regards to your long-term 10 to 12% EPS goal. Could you break that down into organic growth versus acquisitions versus share buybacks?

Charles, this is Craig Monaghan. I would say just broadly speaking, that we should expect to see about half of that from core organic growth, and the other half from reinvestment capital.

Thanks. Good job.

Our next question comes from the line of Matt Nemer. Please state your company name followed by your question.

Good morning, Thomas Weisel partners, my question is to just dig a little deeper on inventory, do you have any sense of what percent of dealers in the U.S. are using variable rate floor plan financing versus fixed? I'm assuming it's pretty high?

We say all.

All?

All.

And at what point -- what is the natural rate of inventory where you have enough selection of color and options that gives you kind of the optimal sales rate? I mean, is it 60 days or is it really 40 days or 30 days?

The optimal efficient inventory where you have enough selection to offer your consumer to meet their expectations. And they don't leave any volume on the table, there is a little bit -- somewhat by brand, so if you have a rather narrow brand offering, it can be lower, and if you have an extremely broad diverse offering, it would be somewhat higher. I would say the range is somewhere between 40 and 60 days. With some manufacturers, some brands even being able to run lower than that, and not leave any volume on the table. If you put it all together. I think it's somewhere down around 50 days. I do not accept the conventional wisdom that it's 60 days that everybody talks about, because that includes fleet sales in that calculation, which, of course, had nothing to do with retail inventory. My view is, the inventory -- the industry could run very efficiently at 50 days.

And then have you seen any change in terms from the OEMs on floor plan assistance, I know at one point you mentioned the GM was at 130 days and Ford is at 60. Can you give us an update on where people are?

It's Craig. GM's did get to the point where the floor plan was extended well out beyond 100 days, but more recently we've seen them begin to pull back. I think broadly speaking, all the other manufacturer's floor plan programs are unchanged.

Going back to what I said earlier, I think in a rising rate environment, whatever they do with floor plan credits will not be fully able to cover the rate increases. And if you're a prudent businessman you'll do the calculation, you have to reduce inventory to manage that escalating cost, and realizing that the excess inventory you have is not bringing you any additional volume, you would reduce inventory to counterbalance that cost pressure.

If I could just follow-up from Mike's point. If you look at us this quarter, you look at our net floor plan, so the floor plan expense versus interest, you can see that year-on-year it's deteriorated by about $3 million. Broadly speaking, if you look under the covers at some of the specific brands, where we have higher inventory levels in the face of rising rates, which we've already seen happen, in some floor plan programs. We've got some brands where we are approaching the point where we're heading towards a net interest expense by brand rather than net assistance.

Got it, great, thanks, so much.

Our next question comes from the line of Mike Heifler. Please state your company name followed by your question.

Good morning, it's Mike Heifler from Deutsche Bank. I just want to dive a little bit deeper into the used car business. Mike, you had mentioned the sales were a little weaker in the quarter related to the new car incentives. It looks like the margins were down as well. And I'm just wondering, you know, what turns that around? Is that entirely tied to the new car market and inventories and incentives or -- is there a possibility that the used car market could pick up before the new car market?

It's Mike Maroone. I believe that the used car market will continue to be under pressure with the excessive incentives, I think it goes back to having more rational new vehicle inventories that allows the manufacturers to not have to incent the new vehicle as much. With that said, I also believe there's opportunity for us on the used vehicle side. And we know there's tremendous demand for vehicles under $10,000, and we also see consumers highly valuing the certified used. So we think there's opportunity in those two sides, but we do believe overall that the industry will be under pressure until the incentives are moderated some.

Okay. Thanks.

Our next question comes from the line of Jonathan Steadman. Please state your company name followed by your question.

Morgan Stanley. Good morning, everybody.

Good morning, Jonathan

A couple of questions, on the pressure on the gross margins and on the comp store gross per vehicle retail, if you peeled it back, is this more a domestic issue, or would the pressure be kind of pervasive across the brands?

This is Mike Jackson. I would say it's weighted toward the domestics, it is an industry -- it is an issue for any brand at the moment, almost. And I would say it's dominantly --

Okay. And you guys talked about a 2% increase in customer pay. Did you give a number on what the warranty was? I don't know if you have it this way, but what the customer pay would have looked like outside of Florida? Because it seems like it would have been pretty strong.

Jonathan, it's Mike Maroone. Our warranty overall was up about 1.4%. We have not totally segregated out Florida, but my guess is that without Florida we'd be in probably the 3% or little over 3% range in customer pay increase.

Thank you very much.

Our next question comes from the line of Bill Armstrong, please state your company name followed by your question.

CL King & Associates. I was wondering if you could comment on wholesale pricing trends in the used car market? Whether trade-in pricing or wholesale pricing? Whether you're seeing that starting to move downwards, so the spread between a late model used car and a comparable new car makes more attractive for people to buy used cars?

That's an excellent point because at the moment, wholesale values are somewhat defying gravity. If you look at the indexes. When you see weak sales, that means you have to change pricing downward to get the volume back. But so far we're not able to buy vehicles at lower prices. This is caused somewhat by the fact that the peak years of lease vehicles coming back has already passed. And the new vehicle market hasn't fully adjusted to it. But I think you're right on the point. Something has to give. We haven't seen it yet.

Okay. So, the Manheim index indicated through September anyway, prices still high, so now we're at the end of October. You're still not seeing any relief on that front?

No, not yet.

Okay. Thank you very much.

Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by the 1 on your touch-tone phone. As a reminder, if you are using speaker equipment, please pick up your handset before dialing the numbers. One moment please. There are no further questions at this time. Please go ahead.

Thank you very much. We very much appreciate everyone joining us today. We appreciate your time.

That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.