AutoNation Inc (AN) 2009 Q4 法說會逐字稿

Thank you for standing by and welcome to AutoNation's fourth quarter earnings conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions) Today's conference call is being recorded. If you have any objections, you may disconnect at this time. Now, I will turn the call over to Mr. Derek Fiebig, Vice President of Investor Relations for AutoNation. Sir, you may begin.

Thanks, Katherine and good morning, everyone. Welcome to AutoNation's fourth quarter 2009 conference call. Leading our call today will be Mike Jackson, our Chairman and CEO, Mike Maroone, our President and Chief Operating Officer, and Mike Short, our CFO. At the end of their remarks, we'll open up the call to questions and I will also be available by phone to address any additional questions you may have.

Before we begin, let me reiterate our brief statement regarding forward-looking statements 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 actual results or performance to differ materially from expectations. Additional discussions of these factors that could cause actual results to differ materially are contained in our SEC filings.

Certain non-GAAP financial measures as defined under SEC rules may be discussed on this call. Reconciliations are provided in our press release which is available at our website at www.autonation.com.

And with that, I will turn the call over to Mike Jackson.

Good morning and thank you for joining us.

Today, we reported fourth quarter EPS from continuing operations of $0.36 compare to a year-ago EPS of $0.42. After adjusting for a favorable tax item in 2009, our adjusted fourth quarter 2009 EPS more than doubled to $0.29 compared to an adjusted EPS of $0.13 for the prior year.

Fourth quarter 2009 revenue totaled $2.8 billion compared to $2.6 billion in the year-ago period, an increase of 8% driven primarily by higher new vehicle sales. In the fourth quarter, total US industry new vehicle retail sales increased 6% based on CNW Research data. In comparison during the same period, AutoNation's new vehicle unit sales increased 7%.

AutoNation delivered solid profitability in the fourth quarter of 2009 and more than doubled adjusted EPS in spite of a SAR rate that increased only 3% to $10.8 million.

AutoNation's full-year adjusted EPS increased 14% to $1.15 from $1.01 for the prior year despite a US industry new vehicle sales decline of 22% in 2009.

Going forward, there are two issues I would like to address. First is the recent recall announced by Toyota. Many have reported that customers are overwhelming dealerships and are outraged about their vehicles. Neither of these are true. Customers are making appointments and in fact, have been very patient with regards to the recent recalls.

The recalls created a disruption in business beginning on January 25, 2010. We have begun to sell Toyotas that were on a no-sales hold and estimate the impact on Q1 2010 EPS will likely be less than $0.01, depending on the availability of replacement parts, cross-shopping to other brands and the rate of recovery to the pre-recall levels.

We expect that Toyota will move aggressively to gain back market share following resolution of these issues and believe that the Toyota brand will not suffer significant long-term damage to its reputation for quality, safety and dependability.

The second topic is to note that we passed the one-year anniversary of the financial meltdown and have prevailed through the multiyear industry downturn. Our aggressive cost-cutting reduction and asset management strategies resulted in a lower cost structure, reduced debt levels and more efficient inventory management. These improvements will allow us to continue to respond to the expected recovery in the retail sales environment. Although sales have been improving from a bottom, the pace of recovery continues to be gradual and the absolute level of sales will remain well below historical levels.

These past few years of low sales volume have resulted in a meaningful reduction in the units in operation which has created a headwind for the Parts and Service business industrywide that we intend to mitigate through targeted initiatives and best in class processes.

I would now like to turn it over to our Chief Financial Officer, Mike Short.

Thank you, Mike and good morning, ladies and gentlemen. Turning to the financial results for the fourth quarter, as Mike mentioned, we reported net income from continuing operations of $62 million or $0.36 per share. These results included a favorable tax adjustment of $13 million or $0.07 per share. So, the adjusted EPS for the quarter was $0.29, which compares to adjusted EPS of $0.13 per share in the fourth quarter of 2008. For the full-year, our adjusted EPS was $1.15 compared to $1.01 last year.

Given the industry-wide new unit sales decline of more than 20%, I'm very proud of this performance. The adjustments to net income are included in the reconciliations provided in our press release.

Compared to last year, revenue increased $218 million and gross profit improved by $21.2 million for the quarter. Despite these increases, SG&A was up only 1% as we benefited on a year-over-year basis from the $200 million structural cost reductions we completed during 2008.

As we've discussed previously, $150 million of this reduction is permanent in nature, while the remaining $50 million is expected to return as volume recovers. As a percentage of gross profit, SG&A was 76.4%, a reduction of 260 basis points. As has been the case in previous quarters, net new floor plan continued to be a benefit.

For the quarter, it was a benefit of $4.3 million compared to a cost of $7.3 million last year, an improvement of $11.6 million. This improvement was a result of lower floor plan financial interest expense due to effective management of inventory levels and significantly lower LIBOR rates, which spiked in the fourth quarter of 2008. These reductions were partially offset by higher spreads and the decrease in floor plan assistance.

Non-vehicle interest expense was $10.2 million for the quarter, down from the $20.1 million we reported last year due to our $236 million lower average debt balance and the decrease in LIBOR rates. The provision for income tax in the quarter was $14.7 million and included the benefit of $12.7 million, as we had favorable resolution of some state tax matters.

During the quarter, we repurchased four million shares of our stock for $69.9 million, at an average price of $17.67 per share. Capital expenditures for the quarter were $35 million, bringing our total annual spend to $75.5 million, a $35 million reduction from 2008. We expect CapEx to be approximately $150 million in 2010.

As of January 1, we had an additional $45 million available for share -- for the repurchase of shares within our restricted payments basket. Thus far, in the quarter, we have utilized approximately $12 million of this amount for the repurchase of 700,000 shares.

We remain within the limits of our financial covenants with a leverage ratio of 2.41 times at the end of the year, unchanged from the third quarter. Our indebtedness number in this calculation is not on a net debt basis. If we had applied the cash on our balance sheet plus cash available from used inventory flooring to reduce debt, we would have lowered the ratio to below two times compared to the limit of 2.75 times.

Our capitalization ratio, which measures floor plan debt plus non-vehicle debt divided by total book capitalization, increased from the third quarter levels as we restocked our vehicle inventory. Floor plan debt was $1.39 billion at year-end, up $328 million from September 30 and down $425 million from December 31, 2008. As of December 31, the capitalization ratio was 52.7%, well within the covenant requirement of 65%. The calculation of these covenants are included in the tables of the press release.

Our quarter-end cash balance was $174 million, which, combined with our additional borrowing capacity, resulted in a total liquidity of $390 million at the end of December, which is ample cash and liquidity to invest in our business and stay within our debt covenants.

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

Thank you, Mike, and good morning.

AutoNation ended the year on a strong note with an operating margin of 3.4% in the fourth quarter, an 80 basis point improvement compared to a year ago. In the quarter, we continued to maintain an extremely disciplined cost structure and it served us well. We managed our inventories prudently, gained new vehicle market share and continued to benefit from our expanding Shared Service Model.

In the period, associate productivity increased and we experienced the lowest associate turnover in the history of the Company. We also attained our best-ever customer satisfaction levels for both Sales and Service in the quarter.

Turning to detailed results for the quarter, I'll begin with our segment performance. In the quarter, segment income excluding corporate and other increased $40 million or 54% compared to a year ago. Segment income as a percent of segment revenue increased for all segments as a result of increased unit volume, higher vehicle grosses, reductions in SG&A and lower floor plan interest expense.

As I continue, my comments will be on a same-store basis unless noted otherwise. AutoNation retailed 46,500 new vehicles in the quarter, an increase of 8% compared to a year ago and favorable to the industry retail number of plus 6%. We were pleased to record new vehicle market share gains in each month of the quarter. Fourth quarter new vehicle revenue increased 15% compared to the period a year ago. Revenue per new vehicle retailed increased $1,900 in the quarter to $33,400, with revenue increases across all segments, this due to reduction in incentives and a shift in mix toward larger vehicles for imports and premium luxury that was partially offset by a mix shift toward cars for domestics.

Gross profit per new vehicles increased $246 or 12% to $2,289, resulting from improved margins on imports and trucks, as well as overall lean inventories. Total gross profit dollars on new vehicles increased 21% compared to the quarter a year ago.

Relative to new vehicle inventory, as planned, we increased our stocking levels of core inventory and ended the year with just over 35,000 units on the ground with over 90% of our inventory being 2010 model year. Our inventory's in great shape, relative to both quantity and mix. At December 31st, our new vehicle-day supply was 54 days compared to 83 days a year ago.

We retailed 32,500 used vehicles in the quarter, a decline of 2% compared to a year ago, while increasing total used gross by 7%. Used volume growth in import and premium luxury segments was offset by a domestic decline driven primarily by a sizable reduction in domestic certified pre-owned sales. During the quarter, we moved 4,700 used vehicles from originating stores to more optimal locations with good success at retail.

Revenue per used vehicle retail increased 10% or $1,625 to $17,188 in the quarter, as tight supply drove up used vehicle values, especially trucks, post Clunkers.

Total gross profit dollars increased 7% in the period to $48 million due in part to a $3.6 million wholesale improvement. I will note that after experiencing significant wholesale loss in 2008 due to the volatility of the used market, we managed our used inventory much more conservatively throughout 2009. Gross profit per used vehicle retailed was $1,485, an increase of $13 or 1% compared to the quarter a year ago.

At December 31st, our day supply of used vehicles was 41 days, up 11 days compared to a year ago. Days supply calculation was inflated by increased trades at the end of December.

Turning to Parts and Service, fourth quarter revenue of $521 million and gross profit of $227 million were off 2% compared to a year ago with Warranty being the primary driver of the decline. This improved vehicle quality in a declining Service-based continued to impact the Warranty business. Our service base consists primarily of the trailing five years of our new and used unit sales.

Relative to gross profit in the quarter, declines of 13% in Warranty gross and 1% in Customer Pay Service gross were offset somewhat by 14% growth in Internal gross, as we prepped more new and used vehicles for sale.

In the quarter, Internal gross, which is driven by current period volume, improved year-over-year and made up 14% of total Parts and Service gross profit. Customer Pay Service comprised 44% of our Parts and Service gross profit and Warranty accounted for 18%. When you factor in Parts and Collision, more than 80% of our total fixed gross is impacted by changes in unit sales and thus our service base, which has declined in each of the past five years and most dramatically in the past two. This trend will continue for the coming years until sales recover from their current depressed levels.

While the fixed business remains under pressure, to offset the macro issues, we've implemented a plan to grow Customer Pay Service business and improve owner retention, which is a key long-term goal for our Company. We believe our efforts will stabilize our Parts and Service business and that, in total, it will remain relatively flat until the service base stabilizes.

To this end in the quarter, we've expanded our Service Reminder Program, we've added an outbound phone initiative to win back defectors and expanded our Service marketing to reach more prospects.

We've also sold 35,000 Prepaid Maintenance Programs, an important retention tool, with about 40% of them sold on the service drive. We continue to validate our seven-day service pilot in Clearwater, Tampa, and in South Florida.

Next, Finance and Insurance, where gross profit per vehicle retailed was $1130 in the quarter, an increase of $81 or 8%. We attribute this growth to our strong preferred lender network, improved returns from our service contract portfolios with third parties, increased product penetration and ongoing efforts to improve the performance of our third and fourth quartile stores.

In the quarter, there was an improvement in the credit environment compared to a year ago. We noted an increase in approval rates by the majority of captives, as well as our preferred bank lenders for prime and near prime customers. For the higher risk segments of nonprime and used vehicles, credit recovery is slower. On average, advances have increased on both new and used vehicles and the securitization environment continues to improve, with spreads versus LIBOR at the lowest level since the fourth quarter of 2007.

In the quarter, we noted strength in the Atlanta and Denver markets and we're encouraged by a solid performance in Florida. Distressed areas of California and Phoenix and Vegas were all up slightly compared to the period a year ago.

At year-end, our store portfolio numbered 203 stores and 246 franchises in 15 states. In January, we completed and successfully integrated our most recent acquisitions of AppleWay Honda and AppleWay Acura in Spokane, Washington. Looking ahead, our corporate development team is actively pursuing acquisition opportunities that meet our market and brand criteria as well as our return on investment threshold.

We are proud of our performance in what was a very challenging year. I would like to thank our 18,000 associates for their dedication and determination. As the economy recovers, we're focused on gaining profitable new and used market share, growing our service customer base and strategically acquiring franchises. We'll continue to invest in training and technology to support the consistent execution of our best practice processes in order to deliver superior customer satisfaction.

Before I turn it back to Mike Jackson, I would like to comment on our Toyota business. Our first priority continues to be servicing our affected customers to alleviate their concerns and ensure their trust in Toyota and our stores. The vast majority of customers are very understanding and are awaiting notification from Toyota before coming to the dealership. Parts are arriving daily and we're completing customers' cars first, then turning to stock units.

The recall initially affected 56% of our new inventory and 22% of our used inventory. Based on what we've been told, relative to the availability of parts, along with the relative simplicity of the repair, we expect to have all inventory saleable in the next week to 10 days. Our incoming phone calls and service visits are up significantly and are manageable with our increased staffing and expanded hours. Showroom traffic is down about 20%, but should increase as available inventory and advertising increases .

Our associates view this as an opportunity to reinforce our commitment to customers and clearly understand the need to extend ourselves at each interaction. We appreciate and value their efforts. With that, I will turn the call over to Mike

Thanks Mike. As we look at 2010, we believe that the gradual improvement in new vehicle sales will continue to take place and will ramp up in the second half of the year. Our planning assumption for 2010 industry new vehicle unit sales is 11.5 million units. With that, we would be happy to take questions.

(Operator Instructions) Our first question is coming from John Murphy, Banc of America Merrill Lynch. Your line is open.

Good morning, guys.

Good morning, John.

On the Toyota issue, when we look at the benefit that you're getting from Parts and Service versus the lost sales and profits from new vehicles, is there any way to quantify what that offset is? Do you think that might be a greater offset than the pressure you're seeing here in the short-run on sales?

This is Mike Jackson. Obviously, the sales impact is right now, with the no sale impacting the business immediately. The fixed recoupment of that will take more time and come over the course of the next several quarters. I would say all in, they probably offset each other. So, for the total year, it is a nonevent, with perhaps an impact of $0.01 in the first quarter with the disruption of sales.

Okay. Second question, obviously inventory is being managed very tightly right now, but are there any parts or any brands where you think that you are inventory constrained and that may have pressured sales, or do you think you see that generally in the industry?

Mike Maroone will give some specifics. I would make a general statement that all manufacturers are much more conservative in their production run and are much more responsive to signals from the marketplace if something is not selling, to curtail production. And we have many vehicles from all manufacturers where there's clearly more demand than supply. If you really think about the business, there is only two ways -- there's only two things you ever hear from the marketplace. You have too many or you have too few. You never hear it is just right. So, the only way to go through life in this business is to have more demand than supply, but you're trying to keep that as close as possible. But, that you have tight inventories with the demand-pull system.

It looks like the industry has done a phenomenal job of transitioning to that coming out of all of the difficulties of last year. So far, all manufacturers we deal with are much more responsive to push back when there is difficulties in the marketplace and trying to respond much quicker to what people actually want to buy. So, it is really a new world. Mike, you want to fill in any details?

John, I think Mike covered it well. I would tell you every manufacturer has models that we want more of and we're constantly trying to get more of. There's just select products in almost every line that's that way, But I think Mike properly characterized it. It is a nice situation to be in. Our inventories are really clean. We've got almost -- I think it's 91% of our inventory is 2010s and we're in good shape. But yes, there are a few models. But I don't think they are unique to any one manufacturer.

Then if we're just to think about showroom traffic and ups and your ability to close those, close the ups, where is -- how is that trending and how is the closing rate trending in general?

I would say traffic is relatively flat. We measure both our showroom visits, our E-traffic and our phone traffic. What we are seeing is higher closing rates and I really credit that to improved credit year-over-year. So, people are coming in, are serious buyers, we're being able to get them financed for the most part, other than the subprime segment, which is more difficult --It is not impossible, but it is more difficult -- and our closing rates are up.

And then just lastly, on real estate values, it is a big part of the equation for not just you, but also as you think about acquisitions or explore acquisitions. What are you seeing in sort of the assumption in the potential sellers in their thought process on the value of their real estate versus sort of the blue sky or the operating part of the equation, and is that helping or hurting what might be some potential acquisitions that could come in the future?

John, this is Mike Jackson. Sellers are in denial to a great extent and so there's a definite gap between buyers and sellers, and it is on three issues. One, I would say the extreme volatility of the industry over the past couple years. If you look at what happened around gas prices, if you look around what happened around credit. It means the bandwidth of what can happen is much broader than what anyone thought -- Imagine, we got down to a selling rate below 10 million units -- meaning you need to be much more conservative in the multiple you pay because the volatility is higher. I think that's pretty well accepted by sellers.

The next step is, though, absolute earnings of the dealerships are down because we're at the bottom of the trough and they want to apply this lower multiple to what they used to make, not what they're making today, because they think what they used to make is what they will make. And the buyer's attitude, certainly our attitude is, well, that could be. We've got a pretty optimistic view about the future, but nobody knows for sure what's going to happen and why should I pay you for what I think is going to happen. I'm going to pay you for what is happening. And if you want to hold the store for two or three years and we see how well this develops, that's your privilege.

The final issue, indeed, you've already touched on, is real estate. And with the fact that the rationalization of retail did not take place year-by-year as there were changes and shifts in the industry, it happened all at once with the bankruptcy of Chrysler and General Motors and the collapse of the market. There is a lot of automotive real estate on the market, which is going to affect values for some period of time as the economy recovers and the use of those properties change. And again, sellers want to be paid for what it used to be worth and what they think it will be worth in the future and buyers are saying if you want to sell now, this is all we're willing to pay you now because this is the market today. So, there is a gap there and somebody's going to have to capitulate. And we'll just have to see who that is.

Great. Thank you very much.

Okay.

Our next question is coming from Rick Nelson of Stephens. Your line is open.

Thank you and good morning.

Hi, Rick, good morning.

I would like to follow up on Toyota recall. Can you ballpark the revenue per vehicle, the parts and the labor and also what sort of attachment rate you're seeing when these customers come in to other services in the store?

Yes, I'll take a stab at it and if I don't get it exactly right, we have experts here who will get it exactly right. The sticky pedal couldn't be simpler. It is a very small shim about the size of a postage stamp. They're probably giving them to us for free, I would guess. I don't know. $0.50, there you go, I've just been corrected. And it is a half hour repair. $15.00 for a shim? $0.15, okay -- now we have that pinned down. That's a half hour repair. The floor mats is a bit more complicated. It is about a two and a half hour repair. One five -- an hour and a half repair. Any parts involved in that, Greg? Go ahead.

It's about $250 for the entrapment. About $70 for the shim. That's the revenue. If that was the question, Rick.

Yes. And the labor flow through is what? About 70%? And the parts flow through around 30%?

I think it is higher on one and about right on the other. But, your other question is we're not attempting to up sell these folks at all. What we want to do is alleviate their concerns, get their car repaired and certainly keep their trust.

And I think that's the right decision. On many recalls, we up sell and take a full examination of the vehicle and see what else the customer wants to do. I think in this case, considering the level of concern that's out there, that it's all got to be about the customer first. As little inconvenience as possible. Get them in, get them fixed and get them back on the road, happy with their Toyota. So, that is our focus in this circumstance.

I have to again make the statement. We are standing unequivocally with Toyota. They've been a great partner for ten years. We're going to get this through this together. We're making no attempt at AutoNation to divert traffic to other brands during this. We're standing unequivocally with Toyota. My belief is that looking at the faces of the customers coming into the Toyota stores and their depth of goodwill, confidence and trust in Toyota, that once we can go back to full sales, Toyota, during the months of March and April will, by and large, have recaptured almost all of the share that they have lost during this disruptive period.

Thank you. That's helpful. The strategies that you outlined to drive the Customer Pay business, how long have those been in place or is that relatively new?

Rick, it is Mike Maroone. We continue to add to those so we've been on a constant Service Reminder Program. Our outbound sales calls are relatively new. Our seven-day service is in pilot. We really understand that the declining Service base is a headwind for us and a big challenge and we're determined over time to grow that Customer Pay business. We know that that Service base will grow as sales recover, but we're impatient and we're aggressively trying to go after it.

Thanks a lot and good luck.

Thank you.

Our next question is coming from Matthew Nemer from Wells Fargo Securities. Your line is open.

Good morning, everyone.

Good morning, Matt.

My first question is on the used business. Your used units lagged the group last quarter and it seems like, based on your comments, that you're just playing a little more conservative in that business during 2009. But, I'm just wondering if you're planning going forward to get more aggressive in used either on an inventory or a pricing basis.

This is Mike Jackson first. AutoNation has been in a conservative, defensive posture for several years on all fronts, considering the shakeout we saw coming and thinking about how severe it might be. We're past that now. We really like the restructuring that's taken place in the industry. We see it as much more rational, viable, profitable, that plays to our strength. Therefore, our risk profile is going to change in every business segment including used cars. And Mike, why don't you talk about the specifics.

Sure. Matt, in the quarter, it is interesting. Our used business was up 3% in imports, up 12% in premium luxury and down 12% in domestics. What we really saw was the softening of the CPO business in domestics in the quarter; and our situation was coming out of Clunkers, our inventories in new were low. Our inventories in used were low and we were hesitant to go out and aggressively buy in what was an increasing price environment. So, typically, in the fourth quarter, prices dropped. This time, prices kept increasing and we played it a little bit conservatively.

But, I think Mike Jackson has already called out, our risk profile has changed. We've got some unique pilots that we're working on in the used side including some centralized buying and trying to get more aggressive on the buying side, and it is clearly our intention to grow our used vehicle business this year. I do want to point out, though, that our units were down, too, but our total used car gross was up 7%. So, I think that the conservative nature of not wanting to buy in what normally is a declining market played well for us from a financial point of view. We clearly know we need to ramp up the volume going forward, and will.

Okay. That's helpful. And then turning to expenses, could you just talk about how you see reinvesting in the business as revenue and gross profit recover with the market, particularly the semi variable expenses, how should we expect those to come back over the next 12 to 24 months?

Hi, Matt. This is Mike Short. I think you should look for the structural cost reductions that we put in place to stay in place. You may recall that we had said from the end of 2007 until we hit the bottom of the trough, we had taken out a total of $400 million in costs. Of that, $200 million was totally variable, $150 million was structural and going to stay out and then $50 million was call it step variable, that would include things like advertising and certain other programs that we had taken out that we expect to come back.

So, the variable will come back as volume and gross increase. The $150 million will stay out, and that $50 million will begin to come back as part of this initiative to get more aggressive in some of our advertising campaigns, for example.

Okay. And then on CapEx, the year-over-year change which you had talked about previously, so that's not new news, but is the change related to deferred maintenance on existing stores and does it provide any cushion related to potential acquisitions?

The CapEx we're talking about is reinvesting in our existing stores. So, the -- and some of it does have to do with deferred maintenance on stores as well as working with our manufacturers to compile some of the things that they would like to see the stores do.

And then just one last question on the Service business. In terms of -- the disclosure actually is really helpful in terms of the decline in units and operation and kind of what you plan to do to offset that. Is one piece of your strategy, is it possible that you would consider testing lower prices? I think you've talked about that a few years ago.

It is Mike Maroone. We do a price match guarantee today. But certainly, we know that that service base of up to five years that we spoke of, we know there's vehicles that are in excess of that and we're looking at opportunities right now to expand the market because we do want to be a share taker on the service side as well. But, I think it is too early to call out benefit from it or what we anticipate, but there is certainly an opportunity.

Great. Thank you very much.

Our next question is coming from Matthew Fassler with Goldman Sachs. Your line is open.

Thanks a lot and good morning. I've got two quick questions. First of all, you alluded to some of the dynamics impacting used inventory and used margin. What do you think the trajectory is for the loosening up of the used market, if you will? Is it totally dependent on the new car market coming back and trade-ins increasing, or are there other dynamics that you think will need to adjust?

It is Mike Maroone. I think that you have called it out right. If the new vehicle business improves and as you know, we've forecast an 11.5% market, which, if you take out Clunkers, is about a 15% improvement. If that improves, I think the used vehicle margins start to improve and will get better. It is clear that when you're an auction buyer and you're paying more for the vehicle, it does put pressure on margins. When we earn more trades at the door and generate more business, we do have better margins, so as the new vehicle business picks up, I think our margins can improve.

Our full-year margins last year were about $200 higher than they were in the quarter and I think, as you get into the spring selling season, you can see some recovery in those margins, yes.

That's very helpful. And then the second question that we wanted to ask related to your customer pay business. Early in the presentation, you spoke about essentially the pool of logical customers you have for that business based on prior year sales. As you look forward over the next year or two, thinking just directionally and obviously excluding the distortion from Toyota, which will help in the short-run, do you think customer pay will remain under some pressure going forward? Just given that installed base of five years or younger cars is going to be shrinking or do you still think that's a line item that can grow for you?

I think we're going -- Matt, this is Mike Jackson. We want to see how it develops. This is a multiyear phenomenon. It is not something that's going to go away in a few quarters or something. If you think about it as a rolling target market for us of vehicles sold in the prior five to six years, we now have, on top of a cyclical climb, a decline to depression levels which have substantially -- will substantially shrink that rolling fleet over the next several years. So, that's a headwind that's built in that will require quite some effort and skill to mitigate. But -- so, on the other hand, as sales recover, gradually that phenomenon will unwind the other way. But it is a multiyear phenomenon.

Thank you very much.

Our next question is coming from Rod Lache from Deutsche. Your line is open.

Thanks and good morning. This is actually Dan Galves in for Rod this morning.

Welcome, Dan.

Thank you. Just on the used industry, again, we noted a pretty substantial decline in the used percentage margin to 8.6% and a dollar margin that was low historically. Can you talk about what occurred sequentially because I mean it didn't -- I would think that the source of vehicles would have still been fairly auction-based in the third quarter as well. And with wholesale pricing remaining stronger, are you getting squeezed on the retail side with how much you can realize in those increased prices?

This is Mike Jackson. First, every year, the fourth quarter is almost the lowest gross margin as a percentage in the used car business. It is the readjustment annual period and every year, almost every year the first quarter is a recovery of these. So, you have that phenomenon and then you have some unique circumstances that Mr. Maroone will talk about.

Yes, Dan, we already spoke about the shortage of product and the shortage of trade-ins. Remember that Clunkers also took away what we call C-cars, which are our higher mileage, less expensive cars and so we didn't have those to retail. Our inventories were extremely light. So, we did go out and buy and I think Mike Jackson called it properly. Typically, our fourth quarter is our lower margin. We're actually up over the fourth quarter a year ago. And I really am confident going forward that we can normalize our margins. So, I don't think it is a structural issue. I think it is something that we're going to have to work and find different sources of cars because it appears that the used car market is going to stay fairly tight.

Ok, thanks. Then on the F&I side, there was a nice sequential increase here. One of the reasons people have pointed to about weakness in F&I is how much loan-to-value a bank would forward and your ability to kind of roll in services into the monthly payment. Has that changed at all, and should we be looking for F&I's per units in the same range going forward?

We're very pleased with where we are in F&I. It is hard to forecast large growth, but I think we can have stability. What we had in this particular quarter is we actually had less chargebacks that benefited us. We also had some retro experience payments on our extended warranties. So, with the declining service base, that will be under some pressure, but as volume increases, your chargebacks as a percent of the gross you generate are less. So, I do think that we can hold at this level and it probably gets even a little better as we continue to work on our third and fourth quartile stores.

Okay. Great, and then one more. The Luxury business seem to have picked up somewhat. Could you characterize that as an improvement in credit availability or traffic? Or a combination of both?

I would say overall for the Luxury business, the recovery of the equity markets was a significant factor. If equity markets hadn't recovered, the Luxury business wouldn't be what it is today. So, that was an important step; and the second step is once the employment situation turns, sometime this year, then the Luxury buyer is going to feel it's a bit more socially acceptable to buy a new vehicle. They're holding back to a certain extent at the moment.

So, the point is both of those things can happen fairly rapidly and did so. The equity thing did happen fairly rapidly. You saw the change in behavior. I think, once the employment situation is not as extreme as it is at the moment, you'll get the next leg up in the Luxury business.

Ok, thanks very much.

Our next question is coming from Colin Langan from UBS. Your line is open.

Hi, Colin.

Hi, Colin. Colin, we can't hear you.

Hello. Can you hear me now?

We can hear you now.

Okay, sorry. Can you comment on the pace of those $50 million in costs that are going to come back? Is that like a $16 million SAR when all of those $50 million come back or will that be realized actually coming back into results next year?

I don't think it will all come back next year, Colin. It is a multiyear increasing cost as we get back to a more normal selling level of $15 million to $16 million.

Okay, so it is based on a $15 million to $16 million. You talked a bit in your comments about Parts and Services you expected to be -- I believe this is right, flat for next year. Can you break it out between Customer Pay and Warranty? Is it going to be a big decline again in Warranty and offset by some stability in Customer Pay, or will it really be on both sides?

This past quarter, our Warranty was down 13%, which is the steepest decline we've seen, but I think you could look forward to continued declines in Warranty. It is about 18% of our business. Our Customer Pay is about 44% of our business. So, as we -- those will be offset by increases in Internal that is tied to sales volume. So, those are the components and that's why, when you put -- when you mix them altogether, we believe that we will be stable on a year-over-year basis.

To be clear, that's Customer Pay Service is 45%. We also have Customer Pay in Collision, Retail Parts, Counter, et cetera.

Okay. And then I guess just lastly, can you comment on cash flow? You seemed to generate a lot of cash this year because you improved your balance sheet. Is there going to be some cash outflow next year, potentially, as sales ramp up?

Colin, this is Mike Short. As you think about operating cash flow, you're right. There has been quite a bit of work done to improve working capital during the downturn. It is a combination of reduced units and the overall size of the balance sheet. But, more importantly, I believe, are the improvement in the ratios on CIP days outstanding, receivable days outstanding, et cetera. So, as the business volume recovers, it would be natural for there to be a little bit of a use of cash in working capital. But, I think it will be much less of an increase than it was a decrease on the downside.

Okay, do you expect to be cash flow positive next year with the earnings boost?

Yes, when you think about our cash from operations, before you put in CapEx, that will obviously be positive. When you get down into investing activities, it just depends on -- in addition to the $150 million CapEx, are there investment opportunities that we identify.

We have time for one more question.

Our last question is from Derek Wenger from Jefferies & Co.

Yes, just on the bank lines, what is the availability there and what is letter credits drawn?

So, we have a total revolver size of $700 million, and included in that is use of some of that funding for lines of credit of $70 million or so. When you think about how much we can actually draw on the existing revolver after you apply the leverage ratio, it's about $165 million.

And what was the CapEx outlook for 2010?

$150 million.

Great. Thank you.

Thank you, everyone for your time today. We very much appreciate it.

Thanks a lot.