AutoNation Inc (AN) 2005 Q3 法說會逐字稿

Welcome to AutoNation's third-quarter earnings conference call. At this point all the participant lines are in a listen-only mode. However, there will be an opportunity for your questions and instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, today's call is being recorded. I would now like to turn the call over to AutoNation. Please go ahead.

Good morning, ladies and gentlemen, and welcome to AutoNation's third quarter of 2005 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 1-800-475-6701, access code 799014, after 2:30 PM Eastern Time today through November 3, 2005.

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 Officer, and Craig Monaghan, our Chief Financial Officer. At the end of their remarks we will 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 risks 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 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'll turn the call over to AutoNation's Chairman and Chief Executive Officer, Mike Jackson.

Thank you, John, and good morning. I am pleased to report that AutoNation had a solid performance in the third quarter. Today we reported record operating income of 220 million. Net income from continuing operations of 120 million, or $0.45 per share, which when adjusted to exclude certain tax items, equates to a record third-quarter earnings of $0.41 per share from core operations, up 17% versus a year ago. This increase was driven by across-the-board growth in both revenue and gross profit, with total revenue up 5% and total gross profit up 8%.

In SG&A we had a 90 basis point improvement as a percent of total gross profit, demonstrating continued improvement on the cost side. These efforts continued to produce best-in-class net income margins of 2.1%, which is over 50% higher than the competitive peer group.

The Detroit 3 employee pricing program resonated with consumers and served its purpose as an inventory reduction tool. Without the disruption of four hurricanes that struck Florida and the Southern United States in the third quarter of 2004, we saw an improved retail environment. However, earlier this week, Hurricane Wilma hit South Florida, impacting operations where we have 33 dealerships representing approximately 20% of our national business. We have a short-term disruption to our business at this point. We are in the process of assessing the damage but do not expect a long-term effect on our business. We're happy to report that our 4200 associates in South Florida are safe, and we want to thank them for their efforts both before the storm and during the recovery.

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

Thank you, Mike. As Mike mentioned, we reported record third-quarter operating income of 220 million, up 13% versus a year ago, and adjusted EPS from continuing operations of $0.41 per share, up 17%.

Other financial items of note in the third quarter include the following -- rising floorplan interest rates, net of OEM assistance, cost us 6 million versus Q3 a year ago, in spite of significantly lower average inventory levels. If our inventories had been at last year's levels we would have incurred approximately $6.5 million in additional floorplan interest expense in the quarter. The decrease in net floorplan benefits is similar to the impact in the first two quarters of the year, and we expect this negative trend to continue as we experience increased interest rates versus the prior year, while the effect will be partially mitigated by lower inventories.

During Q3 pre-recorded income tax benefits in continuing operations of 9 million related to the resolution of various income tax matters. The resulting effective tax rate in Q3 was 33.4% versus Q3 2004 effective rate of 38.4%. Excluding the onetime benefits, our tax rate for the third quarter would have been approximately 39%.

During Q3 we reinvested 35 million in our business through capital expenditures, repurchased 1.9 million shares of stock for $39 million, offset by 2.1 million shares of stock option exercises that generated 24 million. We are targeting 2005 capital expenditures of approximately 130 million, while full year combined 2005 spending on share repurchase and acquisitions may approach 300 million depending on market conditions.

As for our capital structure, at September 30, 2005, our non-vehicle debt was 675 million, down 138 million from December 31, 2004 due to debt retirements. In addition, since the end of the quarter, we have used excess cash to prepay an additional 126 million of our mortgage obligation. All of this debt reduction will put us at an 11% non-vehicle debt to capital ratio and has driven our non-vehicle debt interest expense down despite rising interest rates.

Our continued financial discipline, combined with best-in-class operating and net margins, puts us in great shape to capitalize on opportunities in the market today.

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

Thanks, Craig, and good morning. My comments will be on a same-store basis unless noted otherwise.

We are very pleased with our third-quarter performance, where we delivered increased unit volume, revenue, gross profit and margin, while continuing to leverage SG&A expense as a percent of gross profit. Our parts and service business continues to be impressive and we delivered strong results in used vehicles. And I will expand on both in a moment.

AutoNation retailed 110,000 new vehicles in the third quarter and generated same-store new vehicle revenue of $3 billion, both increases of 2%. Year-over-year, our new vehicle gross profit per vehicle retailed increased $55 to $2054. And gross profit as a percent of revenue increased 20 basis point to 7.2%.

At September 30, our new vehicle inventory stood at 43 days, 10 days less than a quarter a year ago and a reduction of 17,000 units, or 22%, aided somewhat by the employee pricing programs. Looking ahead, we are building our 2006 inventories focused on core products.

Turning to used vehicles, we delivered an outstanding quarter. The drivers were an increase in high-quality inventory, driven by trade-ins from employee purchase promotions. In addition, the limited supply in new vehicles drove some customers to used vehicles. On a same-store basis, compared to the period a year ago, retail revenue was up 9% to 931 million on the sale of 62,000 used units. In the quarter, retail used vehicle gross profit of 110 million reflected an improvement of 15%. Gross profit per vehicle retailed of $1767 improved by $139 per car, and retail used vehicle gross profit as a percent of revenue improved 60 basis points to 11.8% compared to the period a year ago. Overall in the quarter, Las Vegas, Phoenix, Seattle, Mobile, Southern California and Florida were strong for the brands we represent, while Texas, Cleveland and Baltimore were off.

Our parts, service and collision business remained strong in the quarter, as our full disclosure customer-friendly service drive process, service marketing programs and pricing initiatives continued to deliver results. Same-store revenue of 669 million increased 8% and gross profit of 291 million reflected an increase of 9%, both compared to the period a year ago. Parts, service and collision gross profit as a percent of revenue held steady with the period a year ago at 43.4%.

Turning to finance and insurance, same-store revenue in the quarter increased 5% to 167 million compared to the period a year ago. Gross profit per vehicle retailed of $974 was a same-store increase of $19 per vehicle. Our ongoing solid results in F&I are a result of our fully-transparent process supported by intense training and our preferred lender relationships that continue to strengthen.

In closing, we grew revenue and gross profit across the board in the quarter. This coupled with continued leverage of our cost structure drove an operating income margin of 4.2%, an improvement of 30 basis points compared to the period a year ago. We are very pleased with our performance in the quarter and grateful for our 27,000 associates who continue to work hard at delighting both customers and shareholders.

With that, I'll turn the call back to Mike Jackson.

Thanks, Mike. AutoNation had a solid performance in the third quarter with across-the-board growth in both revenue and gross profit. We still expect new vehicle industry sales will be approximately 17 million units for the year, equal to the average of the last six years. That concludes our remarks. And operator, please open it to questions.

(OPERATOR INSTRUCTIONS). John Murphy, Merrill Lynch.

Just looking at your inventory situation, it is incredibly lean. I'm just wondering if you were work inventory-constrained in any markets or any specific models or brands in the quarter, and maybe going forward.

I think we were constrained in the quarter with certain models -- how would I describe them -- that were not profit opportunities. We really run our inventory on a core basis where we feel we have the best margin opportunity. And if you look at the fact that during the quarter we were actually able to expand our new vehicle margins despite the fact that it was a summer clearance environment, clearly showed that the benefit of that strategy. So, we are very much focused on a profitable volume relationship. And we were probably disadvantaged on some distressed selling. I'm not sure we missed any profit, by we probably missed some volume opportunity. Mike, do you want to talk about the forward looking?

John, we are building our inventories. And again, as Mike said, we're focused on core products, core models, core equipment packages, core colors. And we are pleased as our inventories have started to grow a little bit, but we are clearly moderating them coming into the fourth quarter.

Just a question on SG&A. I mean, you are approaching 70%. That is incredibly low. You guys are doing a great job there, obviously. Is there the opportunity -- I mean, that's a tough question to upper to answer. But is there an opportunity to get lower than 70% going forward?

It's Craig Monaghan. We are targeting another 100 basis points over the course of the next three years. We think there's a lot more we can do to take out costs. We are, obviously, well aware of the work we're trying to do in our shared service centers. It's a work in process. It takes time. But we think over that period of time we have got plenty of opportunities to work on.

And again, it's not a cost-cutting mode, it is really change the process to drive higher productivity. So, it keeps the morale strong in the Company when they see the added value that comes from the performance side of the changes, and the cost savings are a byproduct. And doing it that way, we're able to keep moving forward.

Just one last question on your brand portfolio. It seems like you are moving a little bit more towards luxury and imports over time. How much -- I mean, are you going to continue to move in that direction and how much of that will help you lower this SG&A line?

John, as you know, strategically we view the market in three segments -- traditional big three volume, import volume and premium luxury -- with different dynamics in each one of those segments. We would sort of like to be ultimately at a third, a third and a third. Whether we'll actually get there I can't tell you for sure. That is dependent on what kind of acquisitions we are able to make and how the market itself develops. But strategically, if I was sitting here five years from now, or when I'm sitting here five years from now that's where we would like to be. I can't guarantee you, though, that we would get there.

Rick Nelson, Stephens.

Can you talk about October store traffic, maybe excluding Florida, given some of the issues there, how it compares between the domestic and the imports? And maybe some feel for new and used.

Rick, as I said at the beginning of the year, I felt it was going to be a 17 million unit market with many peaks and valleys. That has been an absolutely true statement. And I'm confident when we get to the end of the year it will be right around 17 million units. Certainly, the peak has passed, and that was the June, July, August period. September you saw the pull forward effect, which has continued into October. Exactly what it will be, we'll get the figures next week. But I think even with that pull forward effect, by the end of the year it will be right around 17 million units. Mike, do you want to comment on any --?

Rick, if I could just add -- the used car business has been strong all summer and continued into the fall. We have not seen a traditional slowdown coming into the fourth quarter. Both our traffic, our volume and our gross margins continue to be impressive.

Thank you for that. How about inventories looking at SUVs and trucks relative to cars? Do you have a days supply?

We don't break them out externally in those terms, but I would tell you that certainly there's softness in the large SUVs. The pickup truck market has held pretty firm, and we still think that is a core business for us.

And is it the cars? Is that where you are chasing the business and may be too lean on inventories?

Again, I think Mike spoke to that earlier. Our inventory -- our strategy is a core inventory strategy for both cars and trucks. We certainly saw a shift in the market through the quarter compared to '04, where the car business got stronger as people looked for more fuel-efficient products and the truck business overall got a little softer. Underneath that, there still was some strength in small SUVs and crossovers, etcetera.

How about acquisition opportunities and valuations? Have you seen any changes out there?

I haven't seen big changes in the valuations. They're relatively constant. We continue to look for opportunities. I think there's opportunities out there.

Matthew Nemer, Thomas Weisel Partners.

First question is on your SG&A goals. I believe you were at -- you had a goal for 120 basis points in '05 and '06 that you were looking to take out. If I leave the fourth quarter flat, it implies that you have 45 basis points to go in '06. And you just mentioned 100 over the next three years. If it fair that that would be sort of front-end loaded, or how should we think about how that plays out?

Matt, I think the way you want to look at it is we have made very good progress this year on SG&A. Maybe we are a little bit ahead of the curve there. But what we are saying today is that the year is not over yet. We want to see how it continues to play out. But for '06, '07 and '08, we think we can put another 100 basis points of SG&A reduction on the table.

And that goal is net of the investments that we have to make in technology and productivity process to do that, and I could see quite a number of investments in '06. So, that is a net number, of course, net of the investment we estimate.

I guess on that topic of technology, can you give us an update on what's happening with your used vehicle inventory management technology? I guess specifically, have you been able to move a number of cars in the quarter from dealership to dealership?

It's Mike Maroone. We continue to move inventory. We call it non-core inventory where it's non-core to one store, but might be core to another. We move that after a period of about three weeks. We keep it in the originating store and then we move it. We're moving several thousand cars a month.

Is that just in one market or is that nationally?

That's across the country.

Any cultural barriers to kind of expanding that? Has that been difficult to sell the used car manager on -- hey, you may lose this vehicle even though it was a good buy for you?

I think we are beyond that at this point. I think what they realize is if it's non-core, it's not going to turn necessarily at acceptable margin. And for every car they're giving up, in most cases they're getting a car or two back. So, it's working both ways and we think it's a good strategy and one that is unique to AutoNation because of the critical mass we have in the markets that we participate in.

I think the cultural battles were in my early years here, and the Company is at a point where everybody sees the added value of advances in technology and process. We really set it up in a win-win way that it creates its own momentum. And no longer do we have a cultural debate. Execution is still an issue, bearing out exactly how to do it to make it work. There's a lot of intensity around that, but it's all about how do we make it happen, how do we do it better, not will we go in new ways. That's an old story.

On the topic of used vehicles, I noticed that you have signed some kind of an agreement with Adessa, and I was wondering if there has been any change to your auction policies, or sort of what you are thinking about in terms of auctions going forward.

We do not require that people use one auction company nationwide. We have done some strategic things with Adessa, but we also work with other auctions in select markets. We try and pick the strongest player in the market and then try and leverage our scale at that point.

Last question is on CapEx. Can you give us a sense of any major changes that might be coming in terms of brand identity? Are there any large CapEx projects, or should we sort of model CapEx constant as a percent of revenue going forward?

I think we have been clear with our targets. I think our spend this year is 130 million. Probably the biggest CapEx deal out there right now is Toyota. With Toyota continuing to push strong volume through their dealerships, they have looked to their retailers to expand capacity in fixed operations and just overall storage, along with showroom upgrades and image upgrades, rather. So, that is a big project. But we continue to make investments with all the major manufacturers and continue to reinvest in our business.

Any thoughts on 2006 levels?

This is Mike Jackson. I think, again, it's going to be a high 16 million if not 17. I know there's some others out there who have had a very different view. To me, the volume -- if you look at the overall economy and if you look at the economies of scale for the manufacturers, the sweet spot is clearly somewhere between 16.5 and 17 million. The variable is what is it going to take to get there from an incentive/program-type approach. And that is why I always say it's going to be a roller coaster during the year with peaks and valleys as everyone struggles to figure out how to get there and what it's going to take from an incentive program point of view. But at the end of the year, it's going to be high 16 million if not 17 million. That view will now have been right from me for seven years in a row, and I predict it will be right again next year, despite the fact that I know both some analysts and some industry leaders have a different outlook.

Mike Heifler, Deutsche Bank.

Mike Jackson, it sounds like maybe you're not really a subscriber to this view. But if you look at the comments that GM and Ford have been making about taking out capacity, do you think -- one, they're going to be successfully at doing this? And two, what do you think -- what is your perspective on the implications for distribution for the retailers?

First, they have a lot of capacity that they need to take out. I don't know the exact figures; somebody else can figure that out that is smarter than me. But let's say it is for the industry to produce for the U.S., it's something over 20 million units. Well, there's a lot of capacity that needs to come out before you really change the calculation that gets you between 16.5 and 17 million units. So, I fully applaud their move to take inventory to a more rational level and to take out capacity. That's absolutely the right thing to do. What was the second part of your question?

What would the implication be for the retail industry and in particular for AutoNation given your position in the industry?

If what happened?

If the manufacturers took out a significant amount of capacity.

That's what I said. We can take out a significant amount of capacity and I think we're still going to be right where we are. You would have to take out 3, 4 million units of capacity before it became a material issue as to what the size of the market is going to be.

It's Mike Maroone. I think the implications for the retailer here at our level are there was a tremendous oversupply of product a good part of the year. I think it rationalizes inventories. And in an increasing rate environment, that is a good thing for us.

So, Mike, if there was some sort of volume effect, it might be offset by margin improvement?

I think as we brought our inventories down, we brought our margins up slightly. I think that's a logical deduction. The other thing is in our markets, we have got good critical mass where we have got multiple stores of the same franchise that allows us to share inventory, and we think it gives us an advantage.

Now, if you go back to my remarks a year or a year and a half ago about the levels of inventory, I was clearly saying until inventories were brought in line, we had no chance to improve or to recover the decline of front-end gross margins. And with interest rates going up, you really need to offset that cost with an improvement on the front-end gross margin. So, we really applaud the balancing of inventories and applaud a better ratio between capacity and demand in the marketplace.

Just one other question on the used cars. It sounds like pretty strong used inventory, and people kind of switching out of the new vehicle market into used drove the strength that we saw in the third quarter. And now you're saying that that's also going into the fourth quarter. What is driving it at this point and is it sustainable in your view?

I think affordability is one of the issues. Difficult to say how sustainable it is. It's been four or five months of real strong used car volume for us. And again, I think it was driven by a number of things. It was driven by some really high-quality trades in the June, July, August timeframe. Secondly, there was some shortage of new vehicle products. And third, I think, overall the employee purchase program just stimulated the market. Now, how far that will go, I'm not sure. We're working -- we continue to watch our inventories very closely. But we're real pleased with our used car performance at present.

Jonathan Steinmetz, Morgan Stanley.

A few questions. First, I jumped on a bit late, so I apologize if I missed this. On the parts and service comp, can you give a little bit of color on how this broke out between some of the import luxury stores versus the Detroit 3, or warranty versus customer pay? That sort of thing.

I can give it to you on the warranty versus customer pay. I don't have the breakout in front of me on the growth in each of the import, domestic, luxury. But customer pay was up about 8%. Warranty was up 5. Wholesale parts were very strong, up 10. Overall, it drove an improvement on the revenue side of about 8%, 9% on the margin side.

Is it fair to think that the import luxury would have been a bit stronger than -- just directionally than the Detroit 3?

Yes.

When you guys think about we have had sort of a rough October for the industry and maybe a rough November, how are you thinking about the quarter from a staffing-type level, from advertising? And even, are you looking to bring inventory up ahead of December with the idea that the manufacturers are going to come with big incentives? Or do you sort of want to play it close to the vest here?

Well, you know us; we play it pretty much close to the vest. We only buy core inventory. But there well could be something that happens before the end of the year, and we just want to do -- whatever happens we want to be able to do it profitably.

Finally, what do you think is a right level of leverage in this business? You talked about down at 11% net debt to capital. You haven't done a lot of acquisitions. Presumably the cash flow and the cash keeps building here. I'm just trying to figure out where you want to go on a leverage basis.

We certainly feel that having achieved investment grade considering the outlook on rates going forward was the right strategy for the Company. We have already identified 10 million in spread savings next year, just for getting -- so far just for having achieved investment grade. Clearly, we could take on more leverage and still keep our investment grade. And if the right opportunity is there, we would do that.

Is it just harder to find? I mean, the acquisitions have been pretty light this year. Is it just harder to find things this year?

You know, we had a period of extraordinary low interest rates, which everybody's performance -- it was their performance, not Mr. Greenspan's performance. And they added that into the value of the business. It made valuations very expensive. What we are seeing as interest rates go up I would call a more rational discussion. And we just sort of felt that let that reality sink in and then move into the market and we'd find the right opportunities. You know us; we are very patient, and we think those opportunities will be there next year. We have time for one more question.

David Siino, Gabelli & Company.

Two quick questions for Craig. So, the 277 million of cash at quarter-end, that's pretty much open for in regards to refinancing the -- I think you had mentioned refinancing one of your debt facilities.

We spent 126 million to pay down a mortgage, so that came out of that 227. But, obviously, there's a whole lot left over after that. And we continue to generate cash.

Your comments on the tax refund -- does that indicate that there has been some closures as far as the IRS situation is concerned?

I think the way maybe to give you some color on that is we closed the audit. What it forces us to do then is to go back and modify all the state returns. So, what we are in the process of doing now is just that -- modifying every one of the state returns and then closing out the state audits. That will continue for sometime, but that's what has caused that tax event we saw here in the third quarter.

So, the payable to the IRS that has come down over time, where does that stand at 9/30, or will that be in the Q?

We have a tax liability on the balance sheet of about 60 million. The vast majority of that is associated with potential state tax liabilities that could take 12 to, I would say, 36 months to resolve.

Thank you, everyone, for joining us today. We very much appreciate it.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.