AutoNation Inc (AN) 2006 Q3 法說會逐字稿

Welcome to the AutoNation third quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to AutoNation. Please go ahead.

Good morning. And welcome to AutoNation's third quarter 2006 conference call. My name is 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 844682 after 2:30 p.m. eastern time today. Through November 2, 2006.

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 Alex McAllister, our interim 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 differ materially from the expectations additional discussions of factors that could cause actual results to differ materially are contained in the company's SEC filings. Certain non-GAAP financial measures as defined on SEC rules maybe 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 www.autonation.com. I will turn it over to AutoNation's chairman and Chief Executive Officer, Mike Jackson.

Good morning, thank you for joining us this morning. Today, we reported third quarter EPS from continuing operations of $0.40, compared to a year ago EPS of $0.45. After adjusting the prior year results for certain items, the comparison is third quarter EPS of $0.40, versus $0.41 in the prior year a decline of 2%. There were three major factors affecting our third quarter operating performance.

First, for the industry, new vehicle retail unit sales declined 11% in the U.S., and were down 16% in California, according to CNW. For AutoNation, new vehicle retail unit sales were down 8% in total, and 12% in California, and California represents 20% of our new vehicle business. California's economy has been suffering due to rising interest rates and a soft housing market and this has had a marked impact on our third quarter. Second, in addition to dampening the general economy, rising interest rates had a direct impact on AutoNation along with all auto retailers. Higher interest rates on our floor plan cost us 14 more, $14 million more than the third quarter last year.

Finally, high domestic inventories remain a major inefficiency and the days supply is is far higher than analysts figures would indicate. The current industry day supply calculation is so outdated it belongs with tailfins. It dramatically understates the Detroit 3 levels of retail inventory. Simply put, the current calculation done by analysts is retail inventory, divided by the combination of fleet sales and retail sales. Of course, fleet sales should be excluded from the calculation. Correct calculation is retail inventory, divided by retail sales. If you use the correct formula, we estimate the following days supply for the industry: Nationally, GM retail inventory is 94 days, not 76. Nationally, Ford retail inventory is 105 days, not 75 days. And finally, national Chrysler retail inventory is 126 days, not 82 days. It's crucial for the industry and analysts to move into the real world so today's inefficiencies in retail inventory can be fully understood and addressed. The entire industry will be better for slaying this beast. Now, Alex will provide details on the financials and Mike Maroone will follow with comments on our operational results.

Thank you, Mike. As Mike mentioned, we reported third quarter earnings from continuing operations of $0.40 per share, versus an adjusts $0.41 per share a year ago. Operating profit for the third quarter was $204 million, down 7% from $219 million a year ago, driven by lower gross profits, and increased SG&A. SG&A as a percent of gross profit increased 170 basis point to 71.3%, from 69.6% a year ago, as we deleveraged against a lower gross profit. Also, the results for the third quarter include a $0.01 per share of stock option compensation expense related to the new accounting standard, and this accounts for 50 basis points of the increase in percent of gross profit.

As Mike mentioned, floor plan interest expense net of OEM assistance, was $14 million higher in Q3 on a pretax basis versus last year. While the year over year negative impacts may diminish as interest rates level out, we expect to continue to have net floor plan costs and unfavorable comparisons to the prior year during the fourth quarter of 2006, and the first half of 2007. Other interest expense was higher in Q3 versus last year, as the increased debt level related to our recapitalization earlier this year. However, the EPS impact of higher interest expense was more than offset by the 19% reduction in shares outstanding, resulting from our $50 million share equity tender offer in April. For a net benefit of $0.04 per share in the quarter from the recapitalization.

For Q3, 2006, we had an effective income tax rate of 39.4% versus a prior year effective rate of 33.3%. The rate last year benefited from adjustment for the resolution of various tax matters. Year to date, our effective income tax rate is 39.3%, and we expect our ongoing rate to be in this mid 39% range.

During the third quarter, we repurchased 6 million shares of stock for $119 million, reinvested $88 million in the business through capital expenditures, including $30 million on land for future store sites, and spent $21 million on acquisitions. We expect full year 2006 capital expenditures to be approximately $130 million, excluding acquisition related spending, land purchase for future sites, and lease buy-outs. As you know, we view acquisitions and share repurchases opportunistically, and anticipate full year 2006 combined spending on both of approximately $400 million excluding our Q2 equity tender offer.

At the end of September, our non-vehicle debt was $1.5 billion, and we had unused revolving credit availability of approximately $450 million. Our non-vehicle debt to capital ratio stands at 29%. Now let me turn you over to our President and Chief Operating Officer, Mike Maroone.

Thanks, Alex, and good morning. My comments will be on a same store basis unless noted otherwise. As Mike mentioned at the top of the call, the new vehicle environment remained challenging for the industry, and for AutoNation in the quarter. In addition to the overall weakness in California, factors affecting our performance include declining consumer demand for trucks and reduced warranty revenue. In spite of this, we delivered gross profit growth in parts and service as well as finance and insurance, which points to the great strength of these segments in our business model. We also grew gross profit per vehicle retail for both new vehicles and finance and insurance.

Now, I'll touch briefly on each segment of our business, starting with new vehicles AutoNation generated third quarter same store new vehicle revenue of $2.9 billion, on 99,000 new vehicles retailed, a decline of 6 and 8% respectively compared to the period a year ago. As mentioned earlier, industry new vehicle sales were down 11% in the quarter. Year over year, new vehicle gross profit per vehicle retail was $2,154, an increase of $82, and gross profit as a percent of revenue improved 10 basis points to 7.3%.

In the quarter, we noted a significant decline in non-luxury truck sales, offset in part by a stronger car market. This was in step with the industry as consumer preference trended away from trucks, due in large part to economic issues that include softness in construction, and higher gas prices. The truck segment should show signs of improvement as gas prices have eased, and new models are being introduced by GM, Toyota, and Ford. In September 30, our new vehicle inventory stood at 51 days, 8 days higher than the period a year ago, when the employee pricing incentive programs spiked consumer demand and drove inventories to abnormally low levels.

Turning to used vehicles, on a same store basis, third quarter retail revenue was up 3%, to $943 million, on the sale of nearly 60,000 used units. A decline of 1%, in used retail volume, compared to the period a year ago. In the quarter, retail used vehicle gross profit declined 3% to $105 million and we experienced modest margin compression with gross profit for vehicle retailed at $1,757, down $24 or 1% on a year over year basis. Retail used vehicle gross profit as a percent of revenue, at 11.1%, was off 70 basis points compared to the period a year ago. In September 30, our used vehicle day supply was 38 days, a level that is 3 days lower than a year ago. At $650 million, same store revenue for parts, service and collision declined 4 million, or about .5% compared to the period a year ago. Our customer pay business increased 3%, however, an 8% decline in warranty which we believe was driven by improved quality, more than offset the customer pay gain.

In the area of finance and insurance, our same store revenue in the quarter increased by 1% to $165 million, compared to the period a year ago. F and I gross profit per vehicle retailed reached $1,042 for the quarter, an increase of $66 or 7%. We remain focused on improvement in our third and fourth quartile stores and are committed to intensive associate training as well as maximizing our preferred lending relationships. Our fully transparent F and I process supported by our F and I pledge continues to be a win-win for our customers and our company.

Turning to acquisitions, our corporate development team continues to actively pursue acquisitions that meet our market brand criteria as well as our return on investment threshold. I'm pleased to share news of four transactions that collectively represent an estimated annual revenue of approximately $200 million. First, we've signed an agreement with Harloff BMW in northern San Diego County, California. The transaction is expected to be finalized by year end. AutoNation owns and operates the largest network of BMW dealerships in the country, and we look forward to expanding our BMW offerings in California when Harloff becomes our sixth BMW store in California, and our tenth nationwide. As previously announced AutoNation completed the acquisition of Land Rover of Fort Lauderdale in the third quarter. This brings our Land Rover store count to four, which includes Land Rover Encino, the largest Land Rover store in America. And finally, during the quarter, we acquired Fairbanks Dodge in South Florida, and Fremont Jeep in Northern California. Both were added to existing facilities in support of the domestic franchise consolidation strategy.

In closing, our performance in the quarter was impacted by increased interest rates, and a softer economy as well as comparisons against the quarter a year ago which benefited from the employee pricing promotions. We continue to make investments in our technology platform, and implement best practice processes in every store, driving improved levels of customer satisfaction. We are confident that our business model performs even in a challenging environment as evidenced by our industry leading 4.1% operating margin in the quarter. And with that, I will turn the call back to Mike Jackson

Thanks, Mike. As we head into the final months of 2006, we believe the auto retail market will remain extremely competitive and challenging especially in California, and for the Detroit 3, as they carry their high inventory positions. We expect 2006 sales for the industry will end up somewhere between $16.7 to $16.8 million vehicles. That conclude our remarks. And with that, operator, we would like to open to questions.

[OPERATOR INSTRUCTIONS] First question is from Jonathan Steinmetz with Morgan Stanley.

Thanks, good morning, everyone.

Good morning.

Few questions. First of all, it seems like you anticipate some continued pressure on the gross profit line. The floor plan expense shows no signs of relenting, so when you look at the SG&A line and some of the things that you can control going forward, where can you turn the dial back a little bit, are there opportunities to save more going forward here?

First, on your two points, we'll have very difficult floor plan comparables for the next three quarters. If I look at the outlook it will be the second half of next year where we will have stability on floor plan costs. As far as gross margins with these high retail inventories, of course, even if we have our inventories in line, the competitive environment remains very tough, so I think both those points are very valid. Mike, why don't you talk about our steps on variable costs.

Jonathan, I think there's three things that I would like to speak to today. One is we are really expanding our purchasing platform. We're using the SSC as a platform to drive increased usage of our preferred purchasing vendors, we think there is some opportunity there. I think there is also some opportunity in the marketing costs, and I think you'll see us be a little bit more aggressive there in the fourth quarter, and I think overall, we are just going to continue to try and drive our inventories down and be even more efficient as we go forward.

Do you think you could save on absolute dollar basis, or do you need to get some leverage on gross profit to take that SG&A to gross ratio down?

I think we need to do both.

Okay. You talked a little bit about the reduced warranty business down 8%, is that more a D-3 type of thing, or was that pervasive across the foreign guys? Was there any tough comparison in there on recall or something that made that particularly negative?

It was across the board, it was, and we've actually analyzed it quite deeply. This quarter seems to be an aberration, but we did see a reduction across the domestic, and across the majority of the import and luxury franchises. I think it's too early to call it a trend but it certainly was a more dramatic move than we have seen in prior quarters. We were down 8% overall in warranty parts and labor.

In that vein, can you talk about things like the GM warranty extension? Does that provide you a lot of opportunity going forward, or does it also impact your ability to sell extended warranty product?

Long term, it's going to be very beneficial for the customer and for us, but obviously that's years down the road, and in the short term, it could impact our ability to sell extended contracts, but I absolutely applaud GM's decision to do this. Again, it's a demonstration of their long-term thinking. They have a perception gap on quality, they have made tremendous strides in quality, we're approaching parity today, but that's not what consumers think, and you need to give the consumer a bridge back, you need to put in place a mechanism that changes the perception, and the extended warranty does that, and we certainly applaud it.

Okay, and last question, you referenced the domestic consolidation strategies of putting franchises under existing rooftops, is there a lot more opportunity for you to do that and can you talk at all about the economics of when you tend to do that? How good is that from a return on capital perspective?

I would say all of the-- Detroit 3 have definitely taken up the issue, and are addressing it, but it's a very difficult issue to do anything meaningful in the short term, it really takes a long time, but at least they are coming forward with strategies to deal with it, and we're going to cooperate with them every chance we get.

Thank you.

Thank you. Our next question is from Rick Nelson from Stephen's. Go ahead, please.

Thank you and good morning.

Good morning.

My question, to calculation for industry days supply, can you provide AutoNation days supply for those three brands?

Yes, I can for General Motors, doing it retail to retail, it would be 72 days, for Ford, 64 days, and for the Chrysler group, 105.

Thank you for that. Also, I want to follow up on the west coast issue. I know one of your peers said that they had record results in California. Is there a disparity between the northern and southern regions? And maybe could it be brand mix issues?

Rick, it's Mike Maroone, I think there is some differences, we have a presence in both southern and northern, but our presence in southern California is much larger. I think that southern California has probably suffered more and Mike talked about the variable rate mortgages and talked about the pressure on the consumers. The other piece really is a pretty significant drop in the truck business in southern California, driven by the lack of construction or the slow-down of the construction industry. So I do think there's some differences and as we looked at CNW and Art Spinella's comments, they really echoed the business environment that we faced.

Rick, just going back to the days supply discussion for a second, and show you the distortion that including fleet sales creates, if you go to brands like Toyota and Honda which have relatively low levels of fleet business, the difference for Toyota is 29 versus 34, and for Honda, it's 41 versus 42. So since their figures are closer to pure retail, you get an accurate indication. But if you include in the selling rate these huge fleet numbers, which of course fleet sales did not pull from retail inventory, that's where you dramatically understate the days supply available at retail.

Where do you think the industry needs to be?

Industry, I think for the domestics, full line manufacturer with major rural networks, I think a worthy target is absolutely 60 days, and they would meet all the needs of marketplace.

and do you think these margin pressures will linger until we get the days supplies to those levels?

I think it's an absolute issue, because everything beyond 60 days is inventory pressure, there's no natural demand from the marketplace beyond that, and you end up with circumstances like we have now. Plus it's a huge inefficiency for everyone when it comes to carrying costs.

Thank you, Mike.

Thank you. Our next question is from from Matt Nemer from Thomas Weisel Partners.

Hi everyone. First question is regarding the inventory situation, can you give us an update on what manufacturers are doing in terms of offering cash incentives to take additional inventory from so-called banked vehicles? Is that limited to Chrysler? Has that, is that program continuing? And has it spread to any of the other manufacturers?

Matt, it's Mike Maroone, I think Chrysler has done it for a longer period of time. They really started in early spring, and have continued with different levels of incentive. GM has recently come up with some unique incentives, although it's been in a shorter time frame.

Okay. We heard a rumor that GM was entering the fray. Second question --

Matt, you are absolutely on the point that when inventories are at these levels, the wrong decision is to come with wholesale incentive rather than addressing the fundamental issue.

Seems like it's hurt Chrysler dealers this year. Second, is on acquisitions. Does the $21 million spent cover all the four stores or is there, did one close in a different quarter? And then also, is that, is that all blue sky or are there land and other assets included in that acquisition?

Matt, the $21 million included the Land Rover and the 2 domestic consolidation stores. The BMW store is signed and not closed, and we mentioned in our call that we hoped to close that by the fourth quarter. In the two domestic consolidations, there was not real estate acquired, nor was there in the Land Rover store.

Okay. And did you give a revenue number for just those three stores?

We haven't broken it out. The number in aggregate is about $200 million.

Okay. And then lastly, I'm just wondering if you could give us an update on the search for a new CFO.

Going very well, first and foremost our acting CFO, Alex McAllister, is doing a fantastic job, and second, we have tremendous interest in the position, we have excellent candidates and we are going through a very careful and thoughtful process to make a good decision for the company and our shareholders.

Great. Thanks for providing the real inventory numbers.

You're welcome.

Thanks. Our next question is from Edward Yruma from JPMorgan. Go ahead, please.

Hi. Thank you very much. I was wondering if you could give us an update on your Smart Choice and your shared accounting services initiative, and whether we could potentially see more SG&A saves in the not too distant future from those initiatives.

It's Mike Maroone, Edward. First, on Smart Choice, smart choice continues to perform very well in south Florida, which was our pilot market, we are now expanding into north Florida and into our Denver market, the training is in process, and we continue to be very pleased both with our customer feedback, our CSI scores with manufacturers, as well as the performance of our business. So I think that is moving well.

On the shared resource center, shared service center, I would say the one time implementation costs are still eliminating any operating costs and we're probably a couple years away from the cost over line there. Great. Thank you very much.

Thank you, our next question is from Mike Geoghegan with Bear, Stearns. Go ahead please.

Good morning. I just wanted to go back to the service and parts numbers because to me, that was, I guess, the biggest surprise here. I know that you said that the warranty work being done was an aberration this quarter, but would you care to speculate at all on, you know, why that occurred?

To be honest, I don't think we know. We went back over many, many quarters looking for trends, and couldn't find them. It's very difficult to see beyond that, but we clearly know that our customer pay business is growing, and that the warranty declines were almost across the board with a couple of exceptions, but they are fairly dramatic.

Okay.

There's no question that on warranty there is genuine improvement in quality which we applaud. It's a win for everyone, and specifically, Mercedes has made great strides in quality, and we are seeing that in the figures. So I think we will have to see how it develops this quarter to know if this is a step down. And this is the new level or whether there was something in the third quarter that accelerated what is an overall trend line in warranty costs.

Is the positive 3% customer pay, is that sort of ongoing, I guess? Is that standard?

We've actually been a little bit higher in prior quarters. But the good news is we've got a common service drive process in place that we measure on a daily basis, with consumer feedback, and we're pretty confident that initiatives we've taken in service are working, and continue to deliver for us quarter after quarter.

Okay. And what's the -- I believe margins are roughly similar, customer pay might be a little bit better, but what is the split, the ratio of customer pay to warranty work?

Don't have that in the top of my head, we can get back to you.

Okay.

Certainly, there's more customer pay than warranty.

If I back into it, these sort of imply it's maybe 75% customer pay? Does that sort of sound right?

Warrant is usually around 20, 22% of overall service and parts, but we'll check it and we'll have it before the end of the call.

We actually have it and it's -- customer pay is twice what warranty is.

OK, 66/33. All right, thank you, guys.

Our next question is from Joe Amaturo with Calyon.

Good afternoon. Or good morning. I was wondering if you could comment on what your view is for 2007, light vehicle sales given the expectation for weaker housing throughout '07.

I would say, Joe, for once it's too soon to call. I would say the factors are, of course, the transition in the economy, and it's unclear at the moment whether this is going to be a soft landing or hard landing, and that will definitely be a factor. On the other hand, we have record new product launches from the manufacturer next year that will keep the consumer in the marketplace, so you are really at cross currents, and not really knowing exactly how the economy is going to play out. So I think it's too difficult to call at the moment.

What's your view on the full size pickup segment? Because the work we've done would suggest that there's a pretty hard correlation to full size pickup sales to new housing starts.

There's absolutely no question. The personal use or cool factor portion of pickup trucks is relatively small. The pickup truck is the backbone of the work force of America. It's the canary in the mine for when the economy turns, and with these housing starts plummeting and housing permits plummeting, all these owners of pickup trucks are pausing to see exactly how it's going to play out. So despite the fact we do have two fantastic new pickup trucks coming and better gasoline prices, I don't think you'll see a full recovery in pickup trucks until this economy gets its legs under it again in housing.

And if would you have to guess, how would you expect the whole market share shift to unfold with respect as you said, the Tundra coming out, the Silverado coming out, up against the F-series?

It's very difficult to say with all these variables exactly how that is going to play out, quite frankly.

Okay. Thank you.

Thank you. Our next question is from Rich Kwas with Wachovia. Go ahead please.

Good morning, Mike, I want to ask you about the recent production cuts coming out of the Detroit 3, do you think there's a sea change in their approach to working with dealers, and do you think we are near the end of stuffing incentives down consumers throats just to push volume and they are going to be more rational on the production side?

I would say one of the reasons why I'm so vocal today about the calculation is because in my mind, this remains an issue that really hasn't been tackled. And that there's still a lot of work to be done. So I know there are production cuts, but if I look at the inventory levels and the challenges in the economy, I think the days supply situation, or inventory level with the Detroit 3 is going to be an ongoing conversation into next year. That's my judgment.

So it sounds like you think there are more production cuts coming. Or you'd like to see them.

You know, I'm not the one to say whether it's going to be a spurt in sales or production cuts. I am saying that in my mind, these inventory levels are an issue that need to be addressed.

Okay. And in terms of California, during the quarter, how did your domestic stores fare against your import and luxury stores? Was there a difference?

Rich, it's Mike Maroone. I think there is a difference, the domestic stores certainly suffered more because obviously in California, they rely much heavier on their truck sales. We still saw pretty vibrant Toyota sales, I think some of the others, imports were impacted a little bit more. Luxury performed at a fairly good level, but certainly not at the level of prior quarters.

Great. And then, do you have an update on your new vehicle inventory software, where you are in the Beta testing on that?

Yes. We've mentioned in prior quarters we are working with Trilogy, a company out of Austin, Texas, to try and use demand sensing to more accurately portray what we should have in stock, we've worked with three different manufacturers, we are now spreading it across more models, very impressed with the early results, and I would say we will over the course of 2007 continue to expand it, and we do believe this can be a competitive advantage for AutoNation.

Thanks, Mike and Mike.

Thank you. We have a follow up question from Matt Nemer.

One quick follow up regarding the internet, it looks like you've changed your website and it's more functional. You can order parts online and schedule appointments. I'm wondering what your strategy is on the internet if you can give us an update on the usage, and potentially what you are doing with search engine marketing. It sounds like if three quarters of buyers are using the web to do research, that it's an area you could expand in.

As you mentioned, we have rolled out new websites, I think it's a little too early to start sharing metrics on them, although we are pleased with the first few that were rolled out. What they are really intended to do is give consumers more choice, allow them to do easier comparisons, and allow for more efficient navigation of the site, so we are excited about them. But again, too early to claim victory here. In terms of the search engines, we've been working on this issue for quite some time. It's clear that consumers are using the web in different ways, and we are just trying to get in front of it, and continue to have a sustainable advantage from the e-side. We have put a lot of resources and a lot of time and effort there, and certainly, search engines are the hot way to get to customers.

Time for one more.

Are you using a third party for the website or is that built in-house?

We do use third parties.

Okay. Thank you.

We have time for one more question.

Thank you, our final question is from Lawrence Heller from Helios. Go ahead please.

First of all, thanks very much for your candor on inventories industrywide. And my question is with respect to that particular subject. The 16.7, 16.8 unit sales numbers you referred to at the very end of your segment of the call, does that include the inventory or should we be subtracting that, should we be saying that these companies together really collectively are selling more like 14 million, 13.5 million units?

Oh, absolutely, that number that I quoted at the end includes --that's total industry, including fleet.

So that's just production.

No, no, no, that would be, that would be total sales including retail and fleet.

Okay.

And fleet is about 32% of that number.

So if you take the Big 3, you figure they're maybe 50% of the marketplace, you assume everyone else's inventory is more or less within industry norms, these guys have something like 25% of a year's worth of sales, so that's 50% of 16 million is 8 million, they have 2 million units on top of the 16.7 sitting around?

I really don't think we are on the same page, I'd recommend you call John Zimmerman after the call, and he'll take you through it in detail.

Great, thank you.

Should we do this?

No.

Ladies and gentlemen, thank you for joining us today, we very much appreciate it!

Ladies and gentlemen, that does conclude or conference for today. Thank you for your participation, and for using AT&T Executive Teleconference.[OPERATOR INSTRUCTIONS]