AutoNation Inc (AN) 2012 Q1 法說會逐字稿

Thank you for standing by and welcome to AutoNation first quarter 2012 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. Cheryl Scully, Treasurer and Vice President of Investor Relations for AutoNation. Ma'am, you may begin.

Good morning and welcome to AutoNation's first quarter 2012 conference call and webcast. 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 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 available on our investor relations website@investors.automation.com under financials.

And 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 an all-time record quarterly earnings per share from continuing operations of $0.56 for the first quarter, a 22% increase as compared to $0.46 for the same period in the prior year. First quarter 2012 revenue totaled $3.7 billion compared to $3.3 billion in the year-ago period, an increase of 10%, driven primarily by stronger retail new vehicle unit sales.

In the first quarter, total US industry new vehicle retail sales increased 7% based on CNW Research data (technical difficulty) comparison during the same period, AutoNation's vehicle unit sales increased 10% or 8% on a same-store basis. In the first quarter, we repurchased 11.7 million shares or 9% of the shares outstanding as of December 31, 2011 for $405 million at an average price per share of $34.72. Since the year I arrived in 1999, we have bought back over 400 million shares for $7 billion at an average price of under $17 per share.

In the first quarter we saw an industry selling rate of 14.5 million units, the best quarterly selling rate since the first quarter of 2008. As we look at the rest of 2012 we believe that the improvements in new vehicle sales will continue and we have increased our planning assumption from 2012 industry new vehicle sales to mid 14 million units. Recovery is driven by replacement demand as the age of the fleet on the road has now increased to almost 11 years old, whilst the manufacturers have stepped up the pace of new models. Finally, the credit environment is very strong with low interest rates and ample credit availability, even for customers with less than stellar credit.

Even with the rise in fuel prices, we continue to see a solid recovery for both trucks and cars. In the past, the consumer had to sacrifice size or the type of vehicle that they really desired to get better fuel economy. Today it's a win-win as consumers get exactly the vehicle they want with improved fuel efficiency. AutoNation is well positioned to capitalize on the recovery with an optimal brand to market mix and a disciplined cost structure. We continue to demonstrate our ability to drive strong shareholder returns during the multi-year recovery in auto retail.

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

Thank you, Mike, and good morning, ladies and gentlemen. For the first quarter we reported net income from continuing operations of $74 million or $0.56 per share versus $70 million or $0.46 per share during the first quarter of 2011, a 22% improvement on a per-share basis. There were no adjustments to net income in either period.

In the first quarter, revenue increased $346 million or 10% compared to the prior year and gross profit improved by $37 million or 6%. In the first quarter of 2011, gross profit was favorably impacted by $4.6 million related to additional incentives under our Premium Luxury program. SG&A as a percentage of gross profit was 71.8% for the quarter, which represents a 20-basis-point improvement compared to the year-ago period. Excluding the benefit from the additional incentives in the first quarter of 2011, SG&A as a percentage of gross profit improved by a more comparable 80 basis points versus the prior period.

On February 1, we issued $350 million of senior unsecured notes at 5.5%, which are scheduled to mature in 2020. We were able to capture attractive long-term financing rates at that time, reflecting the market view of AutoNation's consistent operating results and strong cash flow generation. Our percentage of fixed-rate non-vehicle debt has now increased to 53% from 40% at December 2011, or looking back over a longer time horizon, from 33% at March 31, 2010.

Additionally, on April 16, we redeemed $14.7 million of 7% senior notes at par, which were scheduled to mature in 2014.

Returning to first quarter results, net new vehicle floor plan was a benefit $6.8 million, an improvement of $2.1 million from the first quarter of 2011, primarily due to higher floor plan assistance driven by increased vehicle sales compared to the prior year period. Floor plan debt was approximately $2 billion at quarter end, an increase of approximately $118 million from December 31, 2011, in line with inventory levels. Non-vehicle interest expense was $20.5 million for the quarter, an increase of $4.2 million compared to $16.3 million we reported in the first quarter of 2011 due to higher debt levels and a shift towards longer-term fixed-rate debt.

We had $400 million of outstanding borrowings under the revolving credit facility at the end of March. On March 31, our total non-vehicle debt balance was $1.9 billion, an increase of $582 million compared to March 31, 2011. The provision for income tax in the quarter was $46 million, or 38.5%.

From January 1, 2012 through April 24, 2012, we repurchased 13.8 million shares for $476.3 million at an average price of $34.55 per share. On March 23, we announced that our Board authorized the repurchase of up to an additional $250 million of AutoNation common stock. AutoNation has $174 million remaining in that Board authorization for share repurchase. As of April 24, there were approximately 122 million shares outstanding. That does not include the dilutive impact of stock options, which was 2 million shares in the first quarter of 2012.

AutoNation will continue to manage within the limits of our financial covenants. Our leverage ratio at March 31 was 2.98 times, or 2.75 times on a net debt basis, including used floor plan availability compared to our covenant limit of 3.75 times. Capital expenditures were $18 million for the quarter. We continue to expect CapEx to be approximately $145 million for the year, capital expenditures on an accrual basis excluding operating lease buyouts and related asset sales. Our quarter end cash balance was $76 million, which, combined with our additional borrowing capacity, resulted in a total liquidity of approximately $645 million at the end of March. This provides us with financial flexibility as the SAAR increases. AutoNation will continue to leverage our solid cash flow generation and best in class operating structure to generate strong company and shareholder returns.

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

Thanks, Mike, and good morning. 2012 is off to a great start for the industry and for AutoNation. The recovery in auto retail is gaining momentum. Contributing factors include increased consumer confidence, an improved credit environment, restoration of import inventories, high consumer replacement demand with the average age of vehicles on the road at 11 years and exciting new fuel-efficient products rolling out an incredible place. In this improving environment, AutoNation delivered all-time record EPS for the second consecutive quarter as well as strong growth in revenue and gross profit across all sectors of our business -- new vehicles, used vehicles, parts, service and collision, which we now refer to as customer care, and finance and insurance. We also delivered a very solid 4.1% operating margin.

In the first quarter, Domestic segment income increased $7 million or 16% to $50 million compared to the period a year ago. Import segment income of $62 million increased $7 million, a 13% increase, and the Premium Luxury segment increased by 2% to $59 million.

As I continue, my comments will be a same-store basis. In the quarter, AutoNation retailed 60,300 new vehicles on a same-store basis with growth across all three segments. This represents an increase of 4600 units or 8% compared to the period a year ago, slightly ahead of industry retail sales, which were up 7% according to CNW Research. Relative to geography, it was a solid quarter in most of the markets where we operate with Texas and Colorado both showing growth in the high teens. And on a very positive note, California and Florida continue to show good year-over-year improvement.

New vehicle revenue increased $173 million or 10% to $2 billion with revenue increases across all three segments, driven by increased volume. Revenue per vehicle retail was $32,500, up slightly compared to a year ago. Gross profit for new vehicle retail, up $2183, declined 3% or $66 compared to the quarter a year ago. However, excluding the benefit from the additional performance-based manufacturer incentives in the quarter a year ago, gross profit per new vehicle retailed improved $16 or 1% on a same-store basis. Looking forward, we will be lapping a tough comparison in the second quarter of this year as our new margins in the second quarter of 2011 benefited from tight supply immediately following the earthquake and tsunami in Japan.

New vehicle gross profit as a percent of revenue in the quarter was 6.7%, off 30 basis points compared to a year ago and essentially flat excluding the benefit from the incentives in the prior year quarter. We were very pleased with our new vehicle inventory at the end of the quarter. At March 31, new vehicle day supply was 54 days or 47,500 units compared to 50 days or 41,000 units a year ago.

Next, AutoNation retailed 45,500 used vehicles on a same-store basis in the quarter, an increase of 3400 units or 8% compared to a year ago with growth across all three segments. Same-store retail used vehicle revenue of $789 million increased $62 million or 8% year-over-year. Revenue per used vehicle retailed of $17,350 was relatively flat with the prior-year period although still strong due to continued tight industry supply and high demand at retail.

At $77 million, same-store retail used vehicle gross profit increased $3 million or 5% year-over-year. Gross profit per used vehicle retailed of $1697 was down $56 or 3%. Our used vehicle day supply was tight at 29 days on March 31 compared to 33 days a year ago. In the quarter, we drove a 20% increase in appraisals and a 17% increase in trade-ins acquired compared to the period a year ago with a close ratio of 47% on vehicles appraised. Winning trades is even more important in a tight supply environment, and we are pleased with our performance and have room for improvement.

Turning to parts, service and collision, which we now call customer care, same-store revenue of $593 million increased $23 million or 4% compared to the quarter a year ago. At $199 million, customer pay revenue was up $12 million or 7%, representing the largest year-over-year dollar and percentage change increase in recent years. This also marks the seventh consecutive quarter of year-over-year increases in customer pay revenue. We attribute this to our customer care sales strategy that emphasizes retailing on the service drive, including tire sales and maintenance, which also drive retention. Increased vehicle sales drove improvement and internal of 17% year-over-year. The growth in customer pay and internal more than offset a decline of 9% in warranty revenue. And I'm glad to report that the warranty decline was narrowed substantially year-over-year and warranty revenue was up sequentially.

Customer care gross profit of $247 million increased $3 million or 1% compared to the quarter a year ago. Customer pay gross profit grew 2%, up for the seventh consecutive quarter year-over-year, and increases in internal gross more than offset a decline in warranty gross.

We continue to perform well in finance and insurance. In the quarter, total gross profit was $128 million, an increase of $18 million or 16% compared to a year ago. Same-store gross profit per vehicle retailed was up $81 or 7% in the quarter to $1213 per vehicle. Our efforts here continue to be focused on providing full transparency to customers while providing value-added products that can help drive long-term customer retention.

As of March 31, our store portfolio numbered 215 stores and 260 franchises representing 32 brands in 15 states. In the quarter, we were awarded Chrysler and Jeep franchises that were added to our Dodge Store in Pembroke Pines, Florida. I will also note that we were awarded and ad point for Mini in Valencia, California, which we anticipate opening by year end. Our industry relations and corporate development teams continue to actively pursue opportunities that meet our market, brand and return on investment criteria.

Before I close, I would like to add that Greg Revelle has joined AutoNation as Senior Vice President and Chief Marketing Officer. Greg comes to us from Expedia where he served as Vice President and General Manager of Worldwide Online Marketing. A key focus for Greg is to accelerate our efforts to expand our capabilities on the digital phone. We welcome Greg and are excited to add an executive of his caliber to our team.

In closing, we are committed to optimizing our performance in this rapidly improving environment and are very grateful to our 20,000 associates, who were instrumental in delivering an excellent quarter. With that, I will turn it over to Mike Jackson.

Thanks, Mike. During the first quarter, we saw a strong improvement in auto industry sales as consumers enjoyed a great array of choices and a strong credit environment. We believe the accelerated product launches, replacement demand and robust consumer credit will continue to support a strong sales environment. even with $4 a gallon.

Our planning assumptions for 2012 industry new vehicle unit sales is mid-14 million units, which would be approximately a 13% improvement over 2011.

With that, we would very much like to take your questions. First question, please?

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

Good morning, guys. Just a first question -- there has been a lot of conjecture over weather being a real support and inducing the SAAR in the first quarter upward. I'm just curious what you guys really think about that or if you think it was really a non-factor, and the key driver here is that we are seeing some release of pent-up demands.

Well, I think the -- this is Mike Jackson. I think the underlying strength of the recovery is clearly there. We went into the year with a forecast of 14 million for the full year, on the high range of many of the forecasts out there. And we had a caution or a yellow around the issue of fuel prices, where we clearly thought we would see $4 a gallon, and we view that as a risk to sales.

And it just turned out that without increased incentives, $4 a gallon, if anything, is assisting sales, not hurting sales. And we really see a dramatic change from five years ago, in 2008. We see, overall, a 20% improvement in fuel efficiency compared to the end of 2007 going into 2008, and the consumer -- we are not asking them to make a trade-off between size and performance. They can have what they currently have and get a significant increase in fuel efficiency. And that has been done with the traditional drivetrain, with relatively reasonable incremental cost, with turbocharging, direct injection and seven, eight and nine speed automatic transmissions.

But looking at the quarter in and of itself. retail was up a solid 7%. There was emphasis on replacement of fleet plus 19, though that will not continue for the full year. But we see it at mid-14 and think the genuine replacement need, exciting new product and great financing will underpin that mid-14.

Second question -- you alluded to some, I think, some rebates from stairstep programs from a previous luxury program. We've also heard that Chrysler is reasonably active in the market with dealer incentives that sound like they're stairstep programs. I'm just curious if, one, if those programs had any impact in the quarter and, two, if you are seeing any other automakers out there sort of mimicking these programs with new stairstep or buying rebate programs to the dealers directly.

It's Mike Maroone. There continues to be a number of stairstep programs out there. The targets vary greatly. Some are quite reasonable, some are quite extraordinary. It certainly has an impact on every quarter. I don't know that this quarter was much different, but they are impacted and it's across a number of different manufacturers.

This is Mike Short. The reason we called out the Premium Luxury incentives in the prior period was because they were kind of a catch-up payment, which we qualified for in that quarter, and that's why we recognize them, so sort of an aberration as opposed to ongoing incentives.

And just to follow up on it, Mike Maroone, those programs are not necessarily an acceleration or incremental to what we saw late last year. Are they more of a continuation or are they a step up? I'm just trying to understand.

John, I think there's more manufacturers involved in them, but they vary greatly from quarter to quarter. We saw strong stairstep programs in Q1 of 2011, saw them again in 2012. We also saw a lot at year end. So each of the quarter -- I would say that our margins going forward, I think, will be similar to our Q1 margins, although I think they will vary some by quarter.

Got you. And then just lastly, you showed a willingness to lever up a little bit, certainly not much, but a little bit, to buy back shares in the quarter and then what you have done so far in April. And I'm just curious if you were willing to go further on that. And it looks like you have plenty of room on your covenants. Would you get to something that's closer to that 3.7 times net debt to EBITDA? Do you feel like that would be something that you would be willing to do? Or, as we just look at the cash flow generation, we should expect a lot of the cash flow generation should be allocated to share buybacks going forward? Just trying to figure out how aggressive you might get on a share buyback program given where the stock is right now.

John, it's Mike Short. We've demonstrated over the last number of years that we are good stewards of the balance sheet and we make be prudent, opportunistic investments in share repurchase using the balance sheet where appropriate, but certainly not running up near that 3.75 times leverage level.

But when you can borrow at 5.5% it seems like it makes sense all along.

Yes, certainly we don't want to get too close to covenant levels. But given the financing that is available now and our view on the value of the stock, it has been a good investment for us here over the last quarter or two.

Great, thank you very much, good quarter, guys.

Rick Nelson, Stevens.

I have a question about unit growth that was reported for the quarter, 8% same-store. With the March sales release, I think you reported 13% unit growth for the quarter, and I'm curious what the difference is. You mentioned some add points this morning; maybe that's it. And I know there's some differences in accounting, but I'd like some clarity.

Rick, this is Mike Jackson. Our monthly report is what we reported to the manufacturers, so we are aligned with the manufacturers' reporting calendar for that. And this report, of course, is GAAP. And I think there was a three-day difference this quarter, three additional days in the manufacturer calendar compared to the GAAP calendar.

Got you. Also, I'd like to follow up on John's question about potential pull-forward into the first quarter. Any commentary on April sales would be helpful.

Well, what's nice about us compared to everybody else is we do report every month, and next Wednesday we will report in detail the results for April.

Got you. Sub-prime finance availability I know has been a big driver to this recovery. To sub-prime, I guess, specifically I'm interested in how that is growing maybe as a proportion of your customer base, your sales, like where you see the potential for that category. Where are we now versus a few years ago when sub-prime was a big driver?

Rick, it's Mike Maroone. The sub-prime financing environment has been good for several quarters right now, so we're not seeing huge growth there. If you compare it back to 2008 and 2009, certainly it's a very different market. But sub-prime was a strong part of the business in 2011. It has continued on to the first quarter of 2012. And I think it will continue to be strong. I don't think it's a huge driver of the business in comparison to most recent quarters.

Got you. And finally, any comments on the shared service center would be helpful. I think there was one more region you were working on and maybe some of the savings that you are achieving with that -- your SG&A to growth is the lowest in the sector.

This is Mike Short. You're right; we are finishing probably about halfway through the rollout of the Florida region, which is the last region to go into the extended mode of the shared service center. That will complete that platform execution and we think that there will be additional initiatives that we lay on top of that going forward. Those are yet to be identified and announced, but certainly we view this as having completed the foundation of the SSC and now will be adding additional functionality and capabilities to it. And that is a key part of how we have achieved the level of efficiencies that we have, and it's a key part of that strategy going forward.

Thank you, good luck.

Simeon Gutman, Credit Suisse.

Mike, I'm curious if you can talk I guess on the brand side. We're starting to see some subtle shifts, most of which are probably expected with the domestics taking a little step act and the J3 picking back up. I'm curious if you can give us some thoughts on that.

Well, I think everybody should expect the Japanese to post very good numbers for the next six months and to take a lot of the share that they give back. I think that's fully to be expected. We've had an extraordinary circumstance in the marketplace last year starting in April, but by mid-May there was dramatic shortages on Japanese products that really Nissan got resolved first, I would say, in the fourth quarter. First quarter, Toyota got it resolved, and it looks like Honda will have it resolved in the second quarter.

So it's really for an extended period, and they have a lot of new product offerings and launches coming with that. So there will be some rebalancing with the Japanese brands on share over the next six months, and they have really on the volume side very easy comps that they will beat. But I have to tell you, the Renaissance with the domestics is across the board. It's strong, it's real. And those who simply say the domestics have lost their stride during this period where the Japanese now have full availability again, I think, are missing the story. This is a recovery that is for all brands -- European, domestic, Japanese -- across the board. Everybody has exciting product from small cars through trucks. And, yes, the Japanese will do very well in the next six months, no doubt. But I would not say it's totally at the expense of the domestics.

Right, and to your point that there will be some rebalancing, there wasn't just an early sort of catch-up from some pent-up demand. Maybe there were some people waiting for the inventory to come back. And exactly to your point, it feels like the domestics are stronger. So do the J3 continue to take back an accelerating rate, or does that kind of cool off here after this initial period?

I think the domestics will still show positive sales, and -- but the Asians will be even stronger and take back share. It's one of the reasons why I have moved my forecast to mid 14. If the first quarter averaged 14.5, then you look at the fact that we were supply restricted for a major manufacturing base for eight or nine months last year, and we are going to comp against that. If you keep your number in the high 13, if not 14, then you are really forecasting a significant downturn for the rest of the year to get the year to average 14. I don't really see a circumstance of that happening.

So we are very comfortable in the mid-14s. You're absolutely right; we expect the Japanese to put up very good numbers over the next -- the balance of this year. But the domestics are for real, and imagine the numbers, the 14.5 was averaged in the first quarter was in the face of $4 a gallon gasoline and no net increase in incentives to speak of. Yes, how incentives are used and whether they are stairstep or not -- a lot of moving pieces there. But if you net it all out there, was no major incentive move in the first quarter of this year.

Okay, and then a question for Mike Short on operating leverage and the flow-through, which was solid in the quarter. I guess, compared to some other ones, it may not have been as strong. I'm curious if there was anything maybe acquisition related that was in there that held it back. And then with regard to the SSC, from a timing standpoint is there anything to think about as far as the step function of improvement when some of those extensions start to fall in place?

So just one thing, Simeon -- when you are looking at that SG&A leverage, do make sure that you pull out the Premium Luxury incentives in the prior period. If you just look at our reported numbers, we had a 20 basis point improvement, but when you normalize for that it was about 80 basis points. We're looking for generally about a 50% flow-through on incremental gross. We didn't quite get that this quarter because most of the gross profit growth that came in in the quarter came on the new vehicle side, and that doesn't flow through at quite the same rate as some of the other gross profit streams that we have.

In terms of the shared service center will be completed with the Florida rollout by the end of this year and then roll into some of the applications, purchasing and some of the other capabilities that we can add to that going forward. And we haven't called out a specific target in terms of step level changes associated with those, but as I've mentioned in previous calls, we have been sub-70 on our SG&A as a percentage of gross in the past and we are targeting to get back there.

Okay, thanks.

Patrick Archambault, Goldman Sachs.

On the topic of inventories, I understand -- I guess, two questions. On a headline basis, you definitely see levels at Nissan, Toyota and even Honda getting up to more normalized levels. But is there pockets of constraints that are still an issue there, or do you think that at this point they are in a position to largely meet all of the pent-up demand that is presumably there? And then maybe just extending that broadly, I think there was an article or two talking about passenger car inventory constraints in the system. And I was just wondering if that was something you are seeing as well.

This is Mike Jackson. First, I think the inventory, as far as its overall level, is in great shape. And the quality of inventory and the quality of what is being built compared to what consumers want is one of the closest matches that I've ever seen. The industry is behaving in a very disciplined way. When something is not selling well, they stop producing it rather quickly. That's not the behavior of the past. Certainly, there will always be something that's a little overproduced and needs a tactical incentive to deal with, and there will always be something that's hot and in short supply. Mike, why don't you talk about some of those imbalances.

Patrick, again, we are pleased with their inventory, pleased with the supply/demand balance. But underneath it, we would love to have more Premium Luxury inventory. We would love to have more small car inventory. And there are always select models that we would like more of. But we have been buying aggressively, we have been buying what's available and really paying attention to our term rates so that we can earn more of the more desirable product.

Okay, very helpful. And maybe one -- I don't know; I feel like it might have been a little while since we have sort of revisited the M&A scene. You guys do have some dry powder, clearly. The choice has been buybacks; I think you said that explicitly. But how are you taking about inorganic growth as an opportunity here?

Patrick, it's Mike Maroone. We continue to look for opportunities. Where we're looking for opportunities is in the markets that we are currently in, and our goal is to get representation of every major brand in those markets. So there it's a matter of what's available and can we buy at the right price. So we are out looking, we are out making offers and are very interested in growing by acquisition, but only in a very disciplined way.

And is the environment sort of more or less conducive today than it was last year or kind of unchanged, I guess?

I haven't seen a major breakthrough in the environment. I think there are still deals out there, and again, it gets down to price and getting the right store in the right location. But I haven't seen any fundamental changes in valuation.

Okay, great, well, thanks very much.

Jamie Albertine, Stifel Nicolaus.

Just very quickly, just to touch on a point that you mentioned a moment ago, could you dig into in a little bit more detail, maybe by brand, some of the constraints you were up against on the Premium Luxury side during the quarter? Just noticing in your breakout, obviously a 2% increase in sales on a 14% increase in units, if I have it right. I want to understand in a little bit more detail what's going on there.

It's Mike Maroone. Again, going back to Mike Short's comment from the aberration from a year ago, if you adjust for the one-time incentives a year ago, that segment was actually at a plus 11%, not the plus 2%. So I think the segment is still very healthy, but clearly there was a very strong market in Premium Luxury at year end. The market was very heavily incented. The inventories were way down in January; they are starting to rebuild. But we clearly would love to have more inventory in the Mercedes, BMW, Audi, Lexus business, and continue to work hard to get that inventory.

That's very helpful, and just one follow-up. Congratulations on -- you have been one of the most efficient if not the most efficient dealer in the sector now for some time. And to show leverage on an SG&A per gross profit basis was really impressive, I thought, in this quarter. We have seen now pre-recession levels of EPS on what really amounts to trough or trough-like SAAR. I was hoping to get some of your -- not guidance, but sort of views on where you think long-term EBIT margins could trend over time, just given what we've seen in terms of efficiencies.

Jamie, it's Mike Short. Generally, what we said about this is that as gross continues to grow, we expect about 50% of that incremental gross to flow through to the op income line. And so I think where you see is delivering in that ballpark here now, we expect to continue to do that as we get through the recovery. So that will help drive those margins up. And we have been, in terms of SG&A as a percentage of growth, below 70% before and targeting to get back there again.

Very good, think you so much for the detail and congratulations again.

Rod Lache, Deutsche Bank.

Good morning, guys, it's Dan Galves in for Rod. Just wanted to ask about gross profit per vehicle retailed. On the new side, saw a pretty significant reduction in that versus the last couple of quarters, and on the other hand, for used retail units, the gross profit per unit went up quite a bit sequentially. Just wondering if you could give us any more color on what's driving those changes and how we should be forecasting going forward.

Sure, Dan. Again, if you take out the one-time performance-based incentives from a year ago, our gross margins were actually up 1% from a year ago. So I don't -- there wasn't a falloff in the new car gross. As we look forward, we are saying that we believe that on a full-year basis that you will see comparable grosses to what we delivered in Q1. And again, each quarter will vary some with how some of the incentives and stairstep volume-based incentives fall. But I think you can look for stable margins. We're always looking to grow margins, but I think you could call out stable margins.

On the used vehicle side, the inventories are very tight and we have worked really hard at putting the proper discipline in our inventories and our pricing, and we are able to have some -- did a good job in gross with almost $1700 in gross margin per unit. But I think (multiple speakers) as you look forward, I think you can expect, again, comparable grosses looking forward.

Okay, thanks for that. Just to clarify, the fourth quarter gross profit per new vehicle retail was like $2450, I think. If you adjust for some incentive programs, it was maybe $2420, something like that. And it was around $2180 per unit in the first quarter. So just looking sequentially, like what do you think was the driving force behind what I think was a reduction versus the fourth quarter levels?

The fourth quarter is always heavily influenced by Premium Luxury. Premium Luxury is very robust, and I think you can assume that fourth quarters will be that way. So that's what I said, is when we look over a full year, we are comfortable in the $2150 to $2200. I think you will see spikes in certain quarters due to mix and incentive activity.

Okay, that's really helpful, thanks. Just wanted to ask about mix, segment mix for a second. Just wanted to get your take on how big the mix shift had been in the first quarter in terms of customer demand for smaller vehicles versus larger vehicles. And then we've noticed that fuel prices were down slightly last week and more meaningfully this week. Usually that signals a normalization of mix. I just wanted to get your thoughts on that going forward.

We actually saw no shift in mix during the quarter, and that's one of the things I referred to earlier, that you can get the size vehicle you want and the performance of the vehicle you want and dramatically improve fuel efficiency without downsizing.

Now, the offering is better in every segment. Everybody has much more attractive small cars today than they did five years ago. But really, the transformation that has occurred is that the consumer comes in and says tell me what the technology does for me at what price. And where the downsizing is occurring is in the size of the engine displacement. They're willing to take fewer cylinders and a smaller displacement engine that's higher tech, that gives them the same performance with dramatically improved fuel efficiency. They wouldn't have done that in the past. In the past, they would have insisted on their V-8 pickup truck. But that is the big change that's out there, and I think it's permanent. I think this more sophisticated approach to technology is not going to unwind as gas prices go back down. So we are not seeing the traditional stampede to smaller vehicles as a consumer reaction to higher gas prices. It's more tell me the technology and the technology that's addressing the consumer need as a relatively modest incremental cost and why hybrid sales are up. It's not the issue with answer. It's direct injection, turbo-charging, six, seven, eight, nine-speed automatic transmissions. That's what selling.

Thanks a lot, Mike. One more quick one. Are you hearing anything about the resin shortage from the OEMs? And also just housekeeping -- when comparing to your leverage covenant, should we be using the 2.98 that you mentioned earlier or the 2.75 net number?

On the resin, all manufacturers have confirmed their production plan for the next six weeks, no disruption. And they say, while there are challenges, they expect to have them all resolved before it becomes an issue. And so the situation is nothing comparable to the earthquake or to the floods in Thailand.

And on the leverage question, the 2.98 is really the mechanical test versus the 3.75 times covenant, so that's actually where we stand relative to the covenant. We provide the additional data point to give you a sense for if we applied cash that we have on hand how low could we get it. So they're both relevant but for different reasons.

Okay, thanks very much, gentlemen.

Ravi Shanker, Morgan Stanley.

When you look at the SAAR back up to the 14-15 million level, would you say that the California and Florida markets are also getting back up to a more normalized level of sales, or is there a long way to go there?

Ravi, it's Mike Maroone. We are pleased with the progress. California for us was up about 5% in the quarter, Florida was up about 7%. So they are making good, steady progress. They made good progress in 2011. Certainly, all of the formerly hot real estate markets have had some pressure. We also saw 7% growth in Arizona, which was another key market for us. So I think they are coming back. They're certainly not coming back at quite the pace of the rest of the country, but we are very pleased with the progress.

Got it, and also just going back to follow up on the M&A strategy you highlighted earlier, it does look like you are focusing a little bit more on adding new points rather than acquisitions. Would you say it's a fair guide characterization for strategy and what benefits of that might be?

Certainly, we work really hard at the relationships with key manufacturers. There's been a lot of give-and-take, there's been a lot of investments and a lot more dialogue with manufacturers than there was. And add points are very desirable for us. They are typically in the markets we represent with a brand that we don't represent. So we are taking advantage of some real estate that we've got and some opportunities and are very pleased to be selected. But, at the same time we are looking actively for acquisitions and have teams out there talking to different retailers trying to find the right opportunities. So we would like to grow with both strategies.

Got it, and finally, you said you had made a new hire to expand your digital capabilities. Can you talk a little bit more about what that might entail what the opportunities are there?

I don't know that we are ready to lay out a whole digital strategy on this call, but certainly the world shifted very rapidly, and e-commerce is a very important part of our business. The traffic that comes online continues to grow. We want to be sure that we are positioning the Company looking forward and making sure that we've got those capabilities. Greg Revelle has got a very unique background coming out of Expedia. He brings some new capabilities to the Company and we are really excited to have him there. I think you will find that our marketing going forward will be aggressive and it will really take advantage of some of the size and scale we have in some of the expertise that Greg and other members of our team bring.

And to the extent that you could comment on that, are you talking more about just getting better websites and listing your inventory more efficiently, or is it directly selling cars on the Internet potentially, like GM tried to do a couple years ago?

Well, we are already in some pilot programs. We are selling cars online. We think there's opportunity everywhere. Customers have had experiences online, they are getting much more comfortable online and they certainly are looking to search for product, get pricing. We are now providing values on trade-ins, finance quotes online. We are really expanding our product offerings. We are at the early stages and are piloting a bunch of new ideas. But we believe there is opportunity. Certainly every website has got opportunity to improve. You've got to improve your search capabilities and we're working really hard on those issues.

Great, thank you.

Matt Nemer, Wells Fargo Securities.

I just had a quick question on parts and service, customer care. Your margin, gross margin percentage, was below 42% for the last three quarters. And it has been running 43% to 44% pretty consistently over last 10 years, so I was just wondering what has changed in the last few quarters. Is it primarily mix or is there something within one of the segments?

It's Mike Maroone. Certainly, we have become much more aggressive in the tire business, in the quick service business. We also are a big player in parts, wholesale and collision. All of those have impact on margins. We believe that the margins have bottomed at this point, but what we are really looking to do is capture more of the customer spend and be able to be a full-service retailer. And I think we are making good steps in that way. Just as an example, our tire revenue was up 38% year-over-year in the quarter and it really shows an aggressive attempt to serve customers in that segment.

Okay, and then secondly in the used car business you mentioned a pretty significant increase in appraisal traffic. And we've heard that from some other players including Carmax. Just wondering why appraisal traffic is running so much higher than new vehicle sales or even used vehicle sales.

I think people have held on to their cars longer. You've got cars with much higher mileage and we are getting to the point where it might not be an option as to whether they trade, as much as it might be a need to trade. That's only speculation on my part. What we're more focused on is when we do get an opportunity to appraise a vehicle, to win that appraisal at the right price and ultimately retail that vehicle.

And on that topic, you mentioned a 47% close ratio. How does that compare to historical close ratios on appraisals, and have there been any changes in the customer experience around appraisals?

Matt, we used to be in the high 30s, low 40s, so we have made progress. We've got a lot of training and a lot of discussion as to what best practices are in appraisals, have a very defined process. And I'm really pleased with the team's execution. There's a lot of data out there in the market available and we are trying to take advantage of the data to put the right money on car and win that trade. So I would say it's process improvement, training and focus.

And then just one quick follow-up on the used business -- can you give us the number of used vehicle transfers in the quarter? And then do you have any information you can share around the volume in your value vehicle outlets?

In terms of moving vehicles, I think we've moved somewhere in the neighborhood of 12,000-13,000 vehicles in the quarter and are pleased with our ability to do that. That's why we've got concentrations in markets, so that we can achieve that. In terms of the value vehicle outlets, there's 27 of them open at this point in time. It continues to grow. That segment continues to grow and provide opportunity for us. We are really pleased with that segment, and certainly there's more work to do.

Okay, great, nice quarter.

Colin Langan, UBS.

Just a quick confirm -- when you were addressing the [residential] report, did you say that automakers have confirmed that the next six weeks of production will not be impacted?

That's correct. We have no reports of any production being canceled or delayed. Now, I would point out, we had the same situation there with the earthquake and with the floods, that there usually is four to six weeks of parts in the system. So when something like this happens, you have four to six weeks before it's an issue, and we are being told that during that period of time, they will find solutions.

Okay. And they said that this is a recent number, so the six weeks is not as of the beginning of the disaster?

It's as of today.

Okay. And on the stairstep program, do you expect those incentives to be flat year-over-year, or is that going to be a headwind since there were some pretty big stairsteps last year?

It's Mike Maroone. I think that overall incentives will be flat. The tactics seem to shift quarter to quarter based on need and based on what manufacturers are trying to accomplish. I don't know that we have a crystal ball on which elements of incentives will grow and which ones will shrink, but we do anticipate that the overall incentive environment will be flat.

And then you disclosed that there's a 4.6 million luxury incentive this quarter. What was that compared to last year? Were there no incentives last year in Q1?

That was last year's number. There's none this year. So what we are demonstrating is that the new vehicle margin was up slightly year-over-year, not down as we exclude those numbers?

Okay, that makes more sense to me. And then lastly, obviously with gas prices until recently rising, what is the impact to the dealer? I believe a lot of the compact cars are pretty low profit, so is that a concern for you as people continue to shift toward the smaller cars? Is there any other actions that you can take?

We see no shift to small cars.

But from the profit side, those are lower profits, right? Or is it the profit (multiple speakers) --

Since there has been no shift, there's no impact. The margins on a percentage basis are the same, if not higher than trucks. But of course, the transaction price is lower. Mike, do you have that exact grosses?

I don't have them at my fingertips for the segment, but I do want to echo what Mike said, is the small car mix is identical to a year ago. Certainly with importers, there's some movement, but year-over-year they're the same.

And the margins are the same as what you just said, too?

The margins as a percent, not in raw dollars. As a percent -- just for example, as a percent, the small car margins in Q1 were 6.7%. Midsize cars were 6.6%, CUVs were 6.7% and large pickups were 5.4%, which really illustrates Mike Jackson's point of higher price point, less percent margin. The dollar margin was actually higher than small car. So it's a little bit of a mixed bag.

Okay, that's very helpful.

And my point is, there has not been shift to small cars. It's 20% of the business a year ago, it's 20% of the business today.

Okay, great, thank you.

Thank you, we have time for one last call.

Brett Hoselton, KeyBanc.

I think you already answered a couple of my questions, but let me just verify. First of all, it sounds like you are not anticipating any increase in incentive activity by possibly Toyota or Honda driving overall incentive activity in the marketplace. In order to regain the market share that they've lost, it sounds like your thoughts are we're probably going to see them just maintain incentive activity where it's currently at and just allow the inventory rebuild to gain market share or something along those lines?

I don't see -- I think that they are really focused on production and rolling out new products. There's a slew of new products coming out of Toyota, a brand-new CRV from Honda, refreshes coming up on the Accord and Civic. But I think it's about new product launches and production. And I don't think that either one of them is going to go out and try to buy the market with incentives. I think they're going to try to earn the business through product.

And then switching to credit availability, as you pointed out, we've seen a nice steady improvement in terms of credit availability, even at the lower end. My question is, have you been approached or seen any potential sub-prime startups or something along those lines which might result in some sort of a stairstep increase in the availability of credit, particularly at the low end of the market? Or do you anticipate just possibly a slow continued steady gradual improvement in credit availability?

Brett, it's Mike Maroone. There are some new players in subprime. I don't think they are big new players, I think there are niche players. And I think the restoration of credit over the years -- subprime was the last to come to the party, and it's now back. And we can get people without stellar credit financed. And it's a good, healthy environment. But I don't see a slew of new players that take subprime up to another level. I think the industry has been very disciplined and has really developed the ability to collect, and the delinquencies never got way out of control even in the downturn, and they seem to be in good shape today.

Excellent, thank you very much, Mike, thank you gentlemen.

Thank you, everyone, for your time today.

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