AutoNation Inc (AN) 2011 Q3 法說會逐字稿

Thank you for standing by and welcome to AutoNation's third-quarter 2011 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.

I will now turn the call over to Ms. Cheryl Scully, Treasurer and Vice President of Investor Relations for AutoNation. You may begin.

Good morning and welcome to AutoNation's third-quarter 2011 conference call. Leading our call today will be Mike Jackson, our Chairman and Chief Executive Officer; Mike Maroone, our President and Chief Operating Officer; and Mike Short, our Chief Financial Officer. Following their remarks, we will open up the call for questions. Kate Keyser [Pearlman] and I will also be available by phone following the call to address any additional questions that you may have.

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 expectations. Additional discussions of 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 on our website, at investors.AutoNation.com.

Now I will turn the call over to AutoNation's Chairman and Chief Executive Officer, Mike Jackson.

Good morning. Thank you for joining us. Today we reported earnings per share for continuing operations of $0.48, a record for third-quarter results, up 23% compared to the $0.39 in the third quarter of 2010. Operating income increased 19% to $144 million, compared to the period a year ago.

Third-quarter 2011 revenue totaled $3.5 billion compared to $3.3 billion in the year ago period, an increase of 7%, driven primarily by higher new and used vehicle average selling prices.

Based on CNW Research data, in the third quarter, total US industry new retail vehicle unit sales increased 1%. In the third quarter, AutoNation's total new vehicle unit sales were flat and on a same-store basis declined 2% as the Japanese earthquake affected availability of vehicles produced by the Japanese manufacturers.

This quarter we once again demonstrated that our diversified business model is the right strategy as well as our ability to rapidly adapt to change and execute effectively in a changing marketplace. In light of the Japanese supply constraints, we adjusted our operating plan to optimize our inventory to maximize gross profit. While shipments from the Japanese manufacturers improved in the third quarter, inventory levels for these vehicles remained constrained. We would expect that the improving supply environment will result in sequentially lower margins on these vehicles in the fourth quarter.

I will now turn the call over to the Chief Financial Officer, Mike Short.

Thank you, Mike, and good morning, ladies and gentlemen. For the third quarter, we reported net income from continuing operations of $71 million or $0.48 per share versus $59 million or $0.39 per share during the third quarter of 2010, a 23% improvement on a per share basis. There were no adjustments to net income in either period.

Last quarter we indicated that we expected to receive the remaining incentives under the premium luxury program during the second half of 2011. We did not receive any of these incentives during the third quarter but expect to receive approximately $2 million in the fourth quarter of 2011. This compares to gross profit from incentives of $13 million received in the fourth quarter of 2010.

Third-quarter revenue increased $233 million or 7% compared to prior year and gross profit improved by $30 million or 5% for the quarter. SG&A as a percentage of gross profit was 71.5% for the quarter, which represents a 240 basis point improvement compared to the year ago period.

Net new vehicle floorplan was a benefit of $6.6 million for the quarter, an increase of $1.9 million compared to $4.7 million benefit in the third quarter of 2010. This improvement was due to lower floorplan interest expense driven by lower credit spreads compared to the prior year period. Floorplan assistance rates also increased compared to the third quarter of 2010. Floorplan debt was approximately $1.51 billion at quarter end, a decrease of approximately $162 million from June 30, 2011, in line with inventory levels.

Non-vehicle interest expense was $16.4 million for the quarter, an increase compared to the $16.1 million we reported in the third quarter of 2010 due to higher debt levels. During the quarter, we borrowed $25 million under our revolving credit facility, resulting in $300 million of outstanding borrowings under the revolving credit facility at the end of September.

Our third-quarter non-vehicle debt balance was $1.49 billion, an increase of $107 million compared to the third quarter of 2010.

The provision for income tax for the quarter was $45 million or 38.8%. By comparison, the tax rate in the third quarter of 2010 was 37.5%, which reflected the benefit of certain favorable tax adjustments.

From July 1, 2011 through October 19, 2011, we repurchased 7.2 million shares for $247 million at an average price of $34.45 per share. Today we announced that our Board authorized the repurchase of up to an additional $250 million of AutoNation common stock. AutoNation has $316 million now remaining in Board authorization for share repurchase. As of October 19, there were 139.9 million shares outstanding.

We incurred $50 million in capital expenditures for the quarter reflecting our commitment to continue to reinvest in the business. For the full year, we expect to incur $145 million in CapEx net of proceeds from related asset sales.

We remain within the limits of our financial covenants. Our leverage ratio at September 30 was 2.38 times or 2.11 times on a net debt basis including used floorplan availability compared to our limit of 3.25 times.

Our quarter end cash balance was $67 million, which combined with our additional borrowing capacity resulted in a healthy total liquidity of $446 million at the end of September. Our robust balance sheet, strong cash flow generation, and disciplined cost structure position us to continue to invest in our business. We remain focused on actively allocating capital to maximize shareholder returns.

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

Thanks, Mike, and good morning. In the quarter, we continued to navigate the Japanese product disruption and economic uncertainty while growing both total revenue and total gross profit. We delivered strong new vehicle in finance and insurance gross margins and a solid operating margin of 4.1% on a 40 basis point improvement year over year.

Third-quarter total segment income of $134 million grew 22% or $24 million compared to the period a year ago with increases across all three segments. The $65 million import segment income increased $14 million or 27% similar to the second quarter. This improvement is attributable in large part to increased new vehicle gross profit as inventory supply remained constrained.

The domestic segment at $47 million increased $4 million or 10% and the most stable segment, premium luxury, increased $2 million or 4% to $50 million.

As I continue, my comments will be on a same-store basis unless noted otherwise.

In the quarter, AutoNation retailed 55,000 new vehicles [up]2% year-over-year for same stores compared to the industry that was up 1% at retail according to CNW. Even with extremely tight supply of higher demand models in all segments, we realized increased unit sales of 12% in the domestic segment and 11% in the premium luxury segment on a total store basis. However, these increases were largely offset by a drop of 10% in import volume due to the ongoing effect of the Japanese inventory disruption.

From a geography standpoint, Texas continued as our strongest market in the quarter. Florida and our Western markets, while in recovery, were more heavily impacted by the Japanese inventory disruption due to the higher mix of large import stores in these states.

At $1.8 billion, new vehicle same-store revenue increased $62 million or 4%, driven by increased revenue per vehicle retailed, which at $33,000 was up $1,900 or 6% with increases in each segment.

Gross profit per new vehicle retailed of $2,456 reflects an increase of $462 or 23% with improvement across all three segments. New vehicle gross profit as a percent of revenue was 7.3%, an increase of 100 basis points compared to the period a year ago. We attribute these improvements to the tactical plan we implemented in the second quarter in response to Japanese inventory disruption.

We also continue to utilize our proprietary web-based pricing tool described during our second-quarter call. The tool captures various market pricing metrics and establishes target and floor prices by model.

While we are very pleased with strong new vehicle margin growth, we expected some moderation as inventory levels continue to normalize. I will also note that in the fourth quarter of 2010, our new vehicle margins benefited by about $250 on a per vehicle basis from additional performance-based manufacturer incentives.

At September 30, new vehicle day supply was 45 days or 34,000 units compared to 57 days or 42,000 units a year ago. Looking ahead, our new vehicle inventory will continue to build throughout the fourth quarter and we expect to reach normal levels in the first quarter of 2012.

Turning to used vehicles, AutoNation retailed 43,000 used vehicles on a same-store basis in the quarter, up 1% versus the period a year ago. Our used to new ratio in the quarter was 0.79, up from 0.76 a year ago. Same-store retail used vehicle revenue of $776 million increased $33 million or 5% year-over-year. Revenue per used vehicle retailed of $17,600 was up $560 or 3% as industry used vehicle prices remained strong in the quarter due to consumer demand and tight inventory availability.

Same-store retail used vehicle gross profit of $66 million declined 2% and gross profit per vehicle retailed at $1,529 was [off] 3% compared to the period a year ago.

In the quarter, we noted a 6% increase in appraisals and a 7% increase in trade-ins acquired compared to the period a year ago with a close ratio of 47%. I will also note that we continue to move used vehicles to locations that will drive a faster turn and higher gross. In the period we moved nearly 11,000 vehicles with good success at retail.

At September 30, used vehicle day supply was 43 days compared to 46 days a year ago and 47 days at June 30. During the quarter, we reduced our used vehicle day supply to better prepare for seasonal pricing changes and we experienced moderate wholesale loss.

Same-store parts, service, and collision revenue of $569 million increased $5 million for 1% compared to the quarter a year ago. We are pleased with our results in customer pay, where revenue increase of 3% to $193 million marks the fifth consecutive quarter of year-over-year increases. This gain was more than offset by a significant decline in warranty revenue where our repair order count dropped about 10% year-over-year.

We attribute this to the ongoing trend of fewer units in operation and improved vehicle quality.

Gross profit of $238 million declined $8 million or 3% compared to the quarter a year ago. Customer pay gross profit grew by 2%; however gains here were offset by a 15% decline in warranty gross profit.

Customer pay gross profit was up for the fifth consecutive quarter year-over-year driven in part by aggressive efforts to grow tire sales and other lower margin service offerings both aimed at increasing customer retention. I will also note that there was one less working day in the quarter compared to a year ago.

Turning to F&I, we continue to be pleased with our industry-leading performance. Total gross profit in the quarter was $119 million, an increase of $7 million or 7% compared to a year ago. Same-store gross profit per vehicle retailed was $1,214 per vehicle, up $84 or 7% compared to a year ago. Results continue to be driven by solid process execution, which drove improved rate and product commissions.

We continue to benefit from our strong preferred lender network for prime, nonprime, and subprime, as well strong product penetration. The credit environment was solid and stable in the quarter.

At September 30, our store portfolio numbered 214 stores and 257 franchises representing 32 brands in 15 states. In the quarter we opened Go Fiat in Denver and added two smart franchises to existing Mercedes-Benz stores. Our corporate real estate team is also wrapping up several other significant projects that are slated for completion by year-end.

Looking ahead, we are actively seeking acquisition opportunities that meet our market, brand, and return on investment criteria.

In closing, in the quarter we delivered a 19% increase in operating income along with record third-quarter EPS. We did it with best ever customer satisfaction levels, low associate turnover, a disciplined cost structure, and a one team-one goal approach.

I would like to thank all of our 20,000 associates for their commitment and dedication to AutoNation and with that, I will turn the call back to Mike Jackson.

Thanks, Mike. Our record third-quarter results once again demonstrate our leadership position in the industry and the strength of our diversified and adaptable business model. We are optimistic about the long-term recovery for the US auto market and our ability to capitalize on it.

We continue to use the planning assumption for 2011 full year US industry sales of mid 12 million new vehicle units.

We would now like to open up the call for questions.

(Operator Instructions) John Murphy, Bank of America Merrill Lynch.

Sorry about that. I just got -- just hopped on from another call. I have sort of a longer-term question for you guys. As we look at the first three quarters of this year, the SAAR has run at about 12.5 million units and if look back to a period of time where you had similar earnings to what you did in the first three quarters of this year, it would be really the first three quarters of 2007 when the SAAR was 16.1 million units.

And looking at that, you guys have really kind of shot the lights out here on execution and growing the earnings or stabilizing the earnings in a tough time. Just curious as we step forward and the SAAR really recovers, do you think there's any cost creep or any risk that or this great execution kind of slips a little bit?

Or are we just looking at this real paradigm shift in your earnings potential here and that as we see the SAAR increase, hopefully dramatically over the next couple of years, that you really can earn significantly more money than you have in the past?

I'd answer it this way. First, we give an outlook of where we think the industry and the market is going and there we are convinced that this market is on a journey back to something around 16 million units plus or minus 0.5 million either way. I think there's three fundamental drivers to that.

There's definite pent-up demand, genuine replacement needs. The cars that we are appraising every day and looking at are old and tired and the customers want to trade them in with the average age pushing 11 years.

At the same time for the brands we represent, every manufacturer there with a fantastic product cadence and with the full spectrum of small cars through pickup trucks. And finally, the financing for our customers is very much available and very much at attractive rates.

The banks and the finance companies during this disruptive period from '08 until today really took minimal if any losses in automotive retail and consequently since there is still stress in commercial real estate, in the home mortgage market, in small business loans, they are really interested in the automotive space. So those three factors of genuine replacement need exciting new product and very good financing available convinces me that we are on the road back to 16 million and the only debate is the rate of the recovery.

I think then also speaking of '08, '09, and '10 if you looked at AutoNation's performance and you ever want validation of the work that we were doing with our eye on the long-term, that was the ultimate test. And if you look at our performance relative to competition, I think we really distinguished ourselves.

Now having said all of that, we don't give forward guidance per se. We say hey, look at our past performance. Look at where we think the market is going and the rest is really up to you.

John, this is Mike Short. Let me just add a thought on the operating leverage because I think that's tangentially related to the question that you asked. I think what we have tried to communicate in the past is we think right now our operating cost structure is about 50% fixed and 50% variable, with the variable elements largely being compensation and things that are commission structure based.

So as time passes, we would expect to see that leverage continue to drop to the bottom line and we are operating at a pretty -- at a dramatically improved SG&A as a percentage of gross from where we were a year or two ago but we are still not back to where we have been at the past. We've been down below 70% in SG&A as a percentage of gross in the past and our goal was to get back there and continue to drive that number lower.

We have been investing, as Mike mentioned, throughout the downturn in some of the very important initiatives that we have including our shared service center and that's coming along very well. We are almost done with the rollout of that. We have one region left to go that we should do next year as well as building new capabilities.

For example, we are only starting -- we are in the very early innings of developing our ability to leverage our purchasing capability. And so there's additional opportunity out there in front of us but we are working hard on it and I think you are seeing it in the results.

Okay, thank you. Second question, obviously pricing was strong in the quarter. That was a really good factor for yourselves and the industry. There's some real concern that as Toyota and Honda restock that we're going to see this new round of pricing wars as they try to claw back some of their lost market share, which I am not sure I would really agree with.

I just wanted to hear your thoughts on that specifically because it does not make a whole lot of sense to me given that inventory is tight across the board and probably will still be tight there. It just seems not to be too logical but there is a real prevailing thought that pricing might erode significantly and may impact your business as well as the industry at large.

John, it's Mike Jackson first and then I'll have Mike Maroone discuss it in more detail. In principle, I see a much more rational sustainable industry than what we have had in the past and I think the manufacturers have really fundamentally changed their outlook, not to say it won't be competitive but I really don't see a price war being unleashed as the Japanese availability improves in the marketplace. I think incentives will step up somewhat but my sense from the domestics is that they know they've stabilized their share. They know they may even have improved their share somewhat but that they have a spike in share due to the lack of availability by the Japanese. And I don't see any steps on their part to do mega-programs like that we had in the summer of '05 of employee pricing in order to try to keep their share at 47.5.

So I don't expect that. I expect that it will be normal marketing between here and now in. By that I mean aggressive and competitive, but no attempt to say the domestics have to stay in the high 40s.

Having said all that, I think we have had an extraordinary detour away from normal marketing for six months with this unique situation with the Japanese. We learned a lot from it with our pricing tool. Some of that I think is a permanent value to us but there will probably be some impact on front-end gross profit going into the fourth quarter but I don't see anything dramatic.

Mike Maroone, what would you like to add?

John, just to support Mike's view, we are at -- we are about to rollout version 3 of our pricing tool and we believe that we have really developed a new capability in this disruption. No, I don't believe we can maintain our Q2 and Q3 margins but we definitely believe that there's opportunity over where we have been in the past. We have improved margins both on the domestic side, the premium luxury side, and the import side.

So we are optimistic. We are updating our pricing weekly now. Our whole organization is focused on it. We just got done doing our quarterly operating reviews and everybody is confident that we have developed a new capability and we can put it to good use going forward.

I do want to point out as I did in my script though that in Q4 we have got a comp that includes about $250 a car that was a one-time performance-based incentive last year.

Then just lastly on the share repurchase program or the new one that has been in place and what has been going on for years, from 2003 to where we are right now, you have cut your share count in half. If you were to keep that rate up, you guys would have bought back all your shares in the next eight years if you kept up that absolute rate.

I'm just curious as to all of us in the investment community thinking about where your share count ultimately will go and really what the end goal is here. It almost seems like it is a slow motion or maybe not even such a slow-motion privatization of the Company. I'm just curious, how far do the share buybacks go? Obviously they make a lot of sense from a capital structure standpoint but just curious how far you go with this?

Well, I think share buyback has been very beneficial for our shareholders over the years and I think it's actually on my watch more than half I think. When I arrived it was something like 530 million shares outstanding and today we are at 140 million shares outstanding. And if you look at how we bought in this last quarter again, we did it opportunistically. There's a lot of volatility in the equity markets. That applies to us also. So large price swings within the quarter and we saw moments where we could step in and take advantage of it. Whether we will have those types of opportunities in the future, no one knows. We don't know.

So again, we have the same capital allocation approach that we have had since I have been here and there is no end game specific in mind. We decided on a quarter-by-quarter basis looking at the opportunities on acquisitions and we have share repurchase opportunities and we discuss the full range of capital allocation possibilities that are there and we make those decisions on a quarterly basis.

Okay, great. Thank you very much.

Himanshu Patel, JPMorgan Chase.

Hi. This is [Amy Carroll] in for Himanshu Patel. I just had a few questions. I wanted to touch base a little bit on the retail used vehicle margin. I think like last quarter you guys had suggested that it would be -- pricing would be more of an issue but that the margin would still be relatively okay. I heard what you just said to John, but do you mind just kind of drilling down a little bit deeper on what was the change and what was expected versus what actually occurred?

It's Mike Maroone, Amy. A couple of things. One is we have continued to grow what we call the VVO or value vehicle outlet business, which are lower-priced cars that have lower margins. We retailed 4,300 of those in the quarter at lower margin but we believe we are expanding our customer base in doing so. So that was one.

Secondly is as the inventory disruption occurred, we got very aggressive buying Hondas, Toyotas, and other import products and frankly, the market shifted slightly as they began to resume production. The production resumption was a little bit ahead of schedule and so what we did is we liquidated some of that inventory and took both -- took small wholesale losses but also took lower retail grosses. So I think it was a little bit of an unusual situation but we felt we wanted to get right sized so that we could compete in both the new and used vehicle business.

I think the third factor is that the premium luxury segment had far less off lease returns and those were generally high-margin business that we were not able to take advantage of in that quarter.

So all in all, our used car business was up slightly. We did give up a little bit of gross but we feel very good about our position today and our inventories are clean and in good shape and we're looking forward to performing in the quarter.

Could you just clarify how many of the Japanese -- I think you said you had 44 days total of used or 43. Do you have a breakout of the different like J3 versus domestic and premium?

It generally -- I don't have it at the tip of my fingers but it generally doesn't change much. We try and run normally in a 35 to 38 day supply and I think you'll see our inventories in that range in the fourth quarter but it doesn't vary greatly. Where we did have exposure in our import, we did bring that down at the end of the quarter and again as I said, we are in good shape today. So that doesn't vary much by segment.

Okay, then the last question I had was on your comments about interest and acquisitions, are you guys looking to fill in like brands or footprint or if you could give a little bit of color on what you are looking for -- and what the size -- what do you see in terms of size potential that you could possibly have appetite for?

This is Mike Jackson. We have had basically the same diversified strategy since I have been here but when it comes to acquisitions, the principal is density and all the major brands in a market. So we are very much focused on our existing footprint, not going to additional markets and then we are targeted and ultimately ideally someday we'd like to have all the major brands within the markets that we are in.

We think there's a lot of power in that idea, in that concept. Whether we will be able to get there or not is another story entirely, but that's where the focus of our acquisition team is and that's where we would ultimately like to be.

Okay, great. Thank you.

Rick Nelson, Stephens.

Thanks and good morning. We're hearing that [Crown] stock to dealer lots is building very slowly and your 45-day supply would suggest that. When do you think we are going to normalize inventory levels?

I couldn't hear the question, Rick. Was it on the Japanese three?

Yes, for the J3 getting back to normalized inventory levels, what do you think --?

We have an excellent shipment scheduled from the Japanese for the fourth quarter of something over 30,000 units for us. To put that in some sort of perspective, I would say normally we would like to have gotten 27,000. We got under 20,000 in the third quarter and even less than that in the second quarter. So clearly they are approaching 100% if not 110%, 115% on production side. You have to make an assumption on what the selling rate of that is going to be. We think it's going to be fairly high meaning to get back to an inventory level that of 45 to 60 days that would make sense, you are probably in the first quarter of next year if not even into the second quarter depending how the selling rate goes.

But -- so the point is we will have good shipments. We will have good, fresh inventory that is aligned with what customers want but to really restock is going to take some time of shipments above 100% of market demand.

In that type of environment, Mike, would you think the incentives out of the J3 would probably be relatively restrained and you would be able to hang on to some of those gross profit and (multiple speakers)?

I agree with that, Rick. I think there will be some increase in the incentives. The Japanese clearly have to stabilize if not recover some share. But I don't see a price war being unleashed that is going to be ruinous for manufacturers and retailers as far as their margins. I think the whole industry is much more rational, much more long-term view and that's how I expect it to unfold.

So it won't be the extreme shortages that we have had for the past six months but it's still -- there's still going to be an imbalance between demand and supply and I think there will be some moderation of front-end grosses but it will not be dramatic.

Mike, you've been very accurate with your SAAR forecast as long as I have followed the Company. Any initial thoughts on 2012? (multiple speakers) flat SAAR for 2012?

Yes, you won't hear the word flat coming out of my mouth, so I think I disagree with that point of view. Again going back to the three fundamental drivers, genuine replacement need, exciting new product, really wonderful financing available, so everything that we look at says sales will be higher next year than they were this year. And I really want to see the inflection rate and the closing selling rate of December to put a number out and say this is where we think 2012 is going to come out. But it well -- I fully expect it will be a number higher than the final number of 2011. It will not be flat, it will be up. The only question is how much up.

Great. Thanks a lot and good luck.

Simeon Gutman, Credit Suisse.

Thanks, good morning. Mike, following up on the SAAR issue, is the 13.1 million that we did in September, does that tell you that the demand is ready to burst a little bit at the seams when the inventory comes back here in the next few months or it is just a big mix shift that's going to happen?

I think that's what I'm waiting for the fourth quarter to unfold. You never want to forecast next year off of September. September is always a squirrely month with a significant SAAR adjustment factor in it. So I would really like to see how the fourth quarter unfolds to really make a sound judgment on what next year will be.

So I think it's really just too soon to say with too many variables other than I fundamentally believe that 2012 will be higher than 2011.

Okay, that's fair. And if I heard right, there was one less day of I guess work in the service, in the parts and service business. If that's right, can you just quantify if it was significant, any impact on the comp?

Then just as far as the gross margin goes and even a little bit of the topline slowing from warranty, unless we get to a new car SAAR of something 14 million-ish, high 13 million anytime soon, it doesn't seem like the whole supply is going to change rapidly. So are we in a new normal here for parts and service for the time being?

It's Mike Maroone. The one less day adds about 1%, so on a customer pay gross, we go from 2% to 3%, just as an example. So it does impact the calculation.

In terms of where that business is going, we think there will be pressures on the units and operation for another year. We kind of see a tipping point at the end of '12 beginning of '13 where it begins to climb again. So we are very optimistic about that business. Certainly we have had significant warranty compression but I think when you really think about that, that's a good thing. It really speaks to the products, the quality of the products that's coming out and the customer experience with those products.

So we really focus on the customer pay side where we are being very aggressive in our customer offerings and are really glad to be growing that business five consecutive quarters on a year-over-year basis with our initiatives.

Okay, and then one more maybe for Mike Short. The incentives that you are cycling, they have been mentioned several times now. It's a pretty fair amount and there's a little bit of offset it sounds like. Are there any other offsets to that whereby the total EBIT dollar amount for the business or at least the way it's shaping up -- it looks that it's going to be pressured or challenged to show growth given the SAAR environment we are in now unless it gets a lot better. So how do you think about that as far as showing that growth year over year?

Simeon, I think that's why we pointed those numbers out to you because they do disrupt the trendlines a bit and there's not a normal -- there's not an offsetting amount for it. So that's why we have called it to your attention.

I think the other thing to consider is that to the extent that they improve PVRs, that has a beneficial effect on compensation rates as well. But there's not an offsetting amount anywhere else in the P&L for it.

Okay, and was there any -- in SG&A, was there any items, spend items that were cut back more so in this quarter than the previous even though the sales rate picked up a little with something short-term such as marketing?

No. When you look at the components of SG&A, I think the real strength in the quarter was in the compensation rate in terms of the overall components of the SG&A as a percentage of gross. And again I would point to the fact that while there's good control around the overall compensation structure to begin with, the fact that you put those numbers on higher gross profit per unit sold really is an amplifying effect.

Okay, thanks.

If I could add, it's Mike Maroone, we have really focused on productivity and while our gross is up, our headcount is relatively flat and Mike Jackson has really talked all through the downturn about us making the appropriate investments in developing our people and providing better and better technology. So we are really seeing a lot more productive work force. So that combined with the cost control is really working for us.

Okay, thanks.

Patrick Archambault, Goldman Sachs.

Good morning. Just on the -- wanted to circle back on some of the future efficiency gains that were referred to in one of the questions, I think you had mentioned that in terms of the shared service center you had one region that was left to go and then interestingly you had mentioned purchasing. I would like to hear a little bit more about that. Are there actual purchasing benefits that you can get? I suppose you can get them on the used side but on the new side by having efficiencies with your different manufacturers or is it in other places?

It's Mike Jackson first. The entire company is on the shared service center for certain accounting functions, to be clear, and we have one region to go where we take them to the full level. Mike, maybe you can talk a little bit about the different levels there and then you can talk about purchasing.

Okay. So, Patrick, within the shared service center there's the base level and that's accounts payable, receivables, bank reconciliations, and as Mike mentioned, we have rolled that out now and for over a year, we have had everybody in that configuration.

The real -- the next level which we call extended has a much more beneficial effect in terms of the cost structure and that's where we actually ship the actual car transactions electronically to our shared service center and they are all processed directly from the shared service center.

Just to give you an anecdotal example of that, in all of our stores today that are not in the extended shared service center model, you have one, maybe two people responsible for billing the car deals. For the three regions, 75% of the company that we have in the shared service center in extended right now able to do all of that billing with eight people. So it gives you a sense of the magnitude of the efficiencies that we can generate and why we are so bullish on the shared service center model here at AutoNation.

And it's running very well in the three regions where we have it operating right now. So the Florida region is the only region that has not yet gone into extended shared service center. We're just completing the Central region right now and Florida will go next year. So I think that's the key behind it.

On the purchasing side, we do have a sourcing group here within the Company. They're doing a great job. We're thinking about now that we have demonstrated the capability expanding their scope to other spend areas. I want to be clear though we are not talking about purchasing new vehicles from manufacturers at different prices. This is primarily in SG&A items, potentially aftermarket parts, purchases and things like that. It's less about the buying of vehicles.

With respect to our used vehicle business, we do have people who have specific expertise in buying used vehicles on behalf of our stores but that's different than the kind of core purchasing areas in SG&A and parts and service that I'm talking about.

This is Mike Jackson again. Coming back to shared service center, of course there's a cost benefit and an efficiency benefit, but the transparency and the control that we have in the enterprise through the capabilities of the shared service center are really remarkable and again I think it epitomizes -- it's a project that epitomizes AutoNation. It's a five-, six-year project, Mike?

At least.

Five-, six-year project that was quite daunting at the beginning, took a lot of investment in the early years, a lot of disruption, a lot of pain but we knew at a certain point it would turn and pay a tremendous benefit to the Company and we are willing to do that in a lot of different areas of the enterprise and over time, that builds the momentum for the Company.

Thank you, that's very helpful. In terms of -- in that case, if you look at the past years where you have hit sales numbers in that 16 million, 15 million, 16 million range that you cited over the long term we could get to, you have been at SG&A to gross profit of as low as 71 on an annualized basis.

Just given where you are and just how far along you are in some of these initiatives, can you get materially below that ratio in a similar kind of volume environment?

That's the goal, Patrick, and we have been below 70% in individual quarters. We had had a quarter that was at 68 and change and so we are targeting that. And we -- the entire organization is focused on it. It's not just a finance organization. I would point out that these ratios have both a numerator and a nominator to it and the partnership that exists between the finance organization and the operations team at AutoNation is one of the hallmarks of the Company. And because we are able to work together to identify benchmarking opportunities, we can drive both the numerator and the denominator.

And the breadth of the portfolio that we have allows us to do benchmarking analysis and a number of things that we build capabilities around that are unique to AutoNation and separate us from our peer group.

Got you, and one last one. I would be remiss if I didn't ask about how auto sales were trending this month. It sounds like some of the initial 10-day surveys were pretty good, but any color on that?

Well, we never -- again, one of the things we never give color on during the midst of a month. However, we are the one Company that will report our new vehicle retail sales at the end of every month to try to give you the most accurate information in a timely manner.

There's one thing I learned in this business is in the middle of a month in the car business is not a good time to stick your neck out as to what's going to happen. You wait till the end of the month when it's clear and the dust settles and you go out and make a clear statement. So that's how we do it and I think next week, we will be out with our number.

All right. Thank you.

Colin Langan, UBS.

Great, thanks for taking my question. It seems like mathematically you had to generate quite a bit of cash during the quarter. You repurchased 195 million shares or a dollar's worth of shares and your cash was down only $15 million and debt was only up about $50 million. So which part of the -- I guess a lot of that was from working capital. Which part of the working capital actually drove a lot of the cash flow generation this quarter?

It's driven by a number of things, Colin. Working capital is a primary component of it. The actual details of what's within working capital we haven't broken out in the past. The inventory size -- we've worked down the used inventory and some of the declines in new inventory don't affect at all that much because those are financed through our floorplan facility, so it's really managing payables and receivables.

So when you rebuild some of the used inventory in the future, will that mean you are going to dip into the revolver to --?

Right now much of that used inventory is Ford. So it doesn't require us tapping into the revolver to the extent that we have the floorplan capacity to continue to do that.

Okay, you were talking before about parts and services and I don't know if I got this right that you said that the tipping point I guess would be 2012. What does that mean? Is that when that is -- when it will the worst? Does that mean it should be relatively flat until that point? Why 2012 does things suddenly start to get better?

It's Mike Maroone. It's really 2012 to 2013 and that's a units in operation and that really reflects the downturn in the '08-'09 period and the improvement in sales in '10, '11, and '12. So that units in operation you will see vehicles beginning to be scrapped and you will see more -- the increase in sales basically will drive the UIO and there's not a precise moment but we do believe that we have been in a downward trend in UIO. We know we have been and we believe that will turn back upward in the '12, '13 timeframe.

From your sales perspective, that downturn has been a current headwind, so it's not that we're going to see negative declines in parts and services over the next year, or --?

No. I think there's been strong headwinds on the warranty side that really reflects the UIO and quality of we've really worked hard to offset that on the customer pay side. So the customer pay is about a third of our revenue and about 45% of our gross margin. So that's why we focus so much on the customer pay side and our goal is to keep it positive and keep that business growing through our customer pay initiatives.

Okay. In that business, you mentioned the margins were hit by increasing tire sales. Does that mean that the current margin is a normal run rate or is this maybe a bit lower than normal because it is down sequentially?

Our focus has really been on serving all of our customers' needs and really broadening out our service offerings in what we call good, better, best as well as tires. Some of those activities are lower margin and our tire business is one that is a low margin business but it keeps customers in our service department. It gives us an opportunity to make additional offerings.

So I don't -- we don't project our margins going further down but at the same time we are willing to compete for all kinds of business. It's a high-margin part of the business and there are opportunities to compete.

Okay, just one last question. I know last year earnings were up from Q3 to Q4. And (inaudible) that is sort of not normal seasonality and I guess you did point out that luxury is a part of that. We do seem to be heading into a period where it sounds like Q4 actually might from a sales perspective be strong. Does that -- could that pattern -- would it be surprising again to see abnormal seasonality where earnings actually rise into the fourth quarter?

I don't really understand the question.

Yes, I missed a piece of that, please, if you could say that again, Colin.

I believe historically from Q3 to Q4, you usually see earnings decline because usually auto sales fall. I think it was the opposite last year. Is that possible to see that again this year or should we go back to normal seasonality again?

If you're asking for earnings guidance, we don't give earnings guidance. So we call where the market is. We talk about our past performance but we don't give earnings guidance.

Okay.

Everyone, thank you for your time today. I appreciate it very much.

This will conclude today's conference. All parties may disconnect at this time.