AutoNation Inc (AN) 2012 Q2 法說會逐字稿

Thank you for standing by and welcome to AutoNation's second-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.

I will now turn to call over to Ms. Cheryl Scully, Treasurer and Vice President of Investor Relations for AutoNation. Ma'am, you may begin.

Good morning and welcome to AutoNation's second-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 up the call for questions. Kay 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 will 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 an all-time record quarterly adjusted earnings per share for continuing operations of $0.66 for the second quarter, a 35% increase as compared to $0.49 for the same period in the prior year.

Second-quarter 2012 revenue totaled $3.9 billion compared to $3.3 billion in the year ago period, an increase of 17%, driven primarily by stronger retail new vehicle unit sales. In the second quarter, total US industry new vehicle retail sales increased 15% based on CNW Research. In comparison, during the same period, AutoNation's new vehicle unit sales increased 29%.

Our improved operating leverage in the second quarter reflects our disciplined focus on expense management as well as long-term investments in centralized processes. We have effectively leveraged our scale to drive cost savings and deliver improved shareholder returns.

We have continued to focus on investments in technology and best practices which revolve around the customer experience leading to efficiencies in our operations. These investments in the customer experience have continued to improve the productivity of our associates. In the second quarter we saw revenue growth of 17% with an headcount increase of just over 2%.

In the second quarter, we saw import inventories return to normal and import unit sales growth of 44% over the same period last year when both Toyota and Honda were dealing with a limited supply of parts for production due to the earthquake.

As we previously have discussed, the recovery is driven by replacement demand as the age of the fleet on the road has now increased to 11 years old. Also manufacturers have stepped up the launch pace of new models. Finally, the credit environment is very strong with low interest rates and ample credit availability.

AutoNation is well positioned to capitalize on the recovery with an optimal brand and market mix and a disciplined cost structure. We continue to demonstrate our ability to drive strong shareholder returns during the multiyear recovery in auto retail.

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

Thank you, Mike. Good morning, ladies and gentlemen. For the second quarter, we reported adjusted net income from continuing operations of $82 million or $0.66 per share versus $73 million or $0.49 per share during the second quarter of 2011, a 35% improvement on a per share basis. Our second-quarter results for the year excluded $2.6 million or $0.02 per share related to a franchise impairment. There were no other adjustments to net income in the prior-year period.

Adjustments to net income are included in the reconciliations provided in our press release.

In the second quarter, revenue increased $568 million or 17% compared to the prior year and gross profit improved by $45 million or 8%. SG&A as a percentage of gross profit was 69.8% for the quarter, which represents 180 basis point improvement compared to the year ago period. We are pleased with these results and continue to focus on improving operating leverage across our business.

Net new vehicle floorplan was a benefit of $8.2 million, an improvement of $4.8 million from the second quarter of 2011 primarily due to higher floorplan assistance, driven by increased vehicle sales as well as negotiated -- as well as lower negotiated floorplan interest rates compared to the prior-year period.

Floorplan debt was $2.1 billion at quarter end, an increase of approximately $110 million from March 31, 2012, in line with inventory levels.

Non-vehicle interest expense was $22.5 million for the quarter, an increase of $6.6 million compared to the $15.9 million in the second quarter of 2011 due to higher debt levels and a shift towards longer-term fixed-rate debt.

We had $530 million of outstanding borrowings under the revolving credit facility at the end of June. On June 30, our total non-vehicle debt balance was $2 billion, an increase of $584 million compared to June 30, 2011. The provision for income tax in the quarter was $51 million or 39%.

During the second quarter, we repurchased 3.7 million shares for $126.2 million at an average price of $33.99 per share. We announced today that our Board has authorized the repurchase of an additional $250 million of AutoNation common stock. As a result, AutoNation now has $368 million remaining in Board authorization for share repurchase.

As of June 30, there were 120.6 million shares outstanding, which does not include the dilutive impact of stock options, which was 2 million shares in the second quarter of 2012.

Our leverage ratio at June 30 was 3.05 times or 2.83 times on a net debt basis including used floorplan availability compared to the limit of 3.75 times.

Capital expenditures were $32 million for the quarter. We expect CapEx to be approximately $155 million for the year. Capital expenditures are on an accrual basis excluding operating lease buyouts and related asset sales.

Our quarter end cash balance was $62 million, which combined with our additional borrowing capacity resulted in total liquidity of over $600 million at the end of June. Our strong cash flow generation and lean 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. Good morning. In the second quarter, we saw revenue growth in all business sectors and gross profit increases in new vehicles, customer care, and finance and insurance along with a strong operating margin of 4.2%, an all-time record adjusted earnings per share for the third consecutive quarter. As I continue my comments, will be on a same-store basis and compared to the period a year ago unless noted otherwise.

We recorded strong new vehicle sales in the second quarter with a 29% increase compared to a year ago which was significantly ahead of industry retail sales, which according to CNW Research were up 15% for the same period. AutoNation retailed 66,800 new vehicles in the quarter, an increase of 15,000 units with growth in all three segments, particularly the import segment, where on a total store basis, volume was up 44% as inventory was normalized compared to the quarter a year ago when Japanese production disruption occurred.

Domestic segment, new vehicle sales volume increased 17% followed by premium luxury, which was up 16%. Relative to geography, overall it was a very good quarter in almost every market where we operate with California, Colorado, Texas, and Florida continuing to show strong year-over-year improvement. On a same-store basis, our California new vehicle volume increased nearly 40%. Colorado was up 35%, and Texas and Florida were each up nearly 30%.

New vehicle revenue increased $446 million or 26% to $2.2 billion. Revenue per new vehicle retail was $32,800, down about $900 or 3% due in part to a shift in mix to our Japanese models which have a lower price point.

Gross profit per new vehicle retailed of $2173 declined 18% or $465 compared to the quarter a year ago and new vehicle gross profit as a percent of revenue of 6.6% was off 120 basis points. We attribute this in large part to the tight supply of Japanese inventory in the prior period that drove exceptionally strong margins.

New vehicle gross profit as at a percent of revenue was off just 10 basis points sequentially and flat with the second quarter of 2010.

We were pleased with our new vehicle inventory at the end of the quarter. At June 30, new vehicle days supply was 60 days or 49,200 units compared to 59 days or 38,900 units a year ago.

Next, AutoNation retailed 46,000 used vehicles in the quarter, an increase of 3200 units or 7% compared to a year ago. Same-store retail used vehicle revenue of $827 million increased $41 million or 5% year-over-year.

Revenue per used vehicle retailed of $17,971 declined 2% or $379. At $75 million, same-store retail used vehicle gross profit declined 3% or $2 million; gross profit per used vehicle retailed of $1629 was down $171 or 10% due in part to margin compression on certified preowned vehicles. At June 30, our used vehicle days supply was 31 days compared to 36 days a year ago.

We are working hard to source the vast majority of our used inventory internally through acquiring trades and purchasing off lease vehicles. In addition, we continue to move used vehicles from originating stores to more optimal locations. Under this initiative, we moved 10,000 used vehicles in the quarter with good success at retail.

Turning to service, parts and collision, which we now call customer care, same-store revenue of $601 million increased $29 million or 5% and gross profit of $253 million increased $8 million or 3% compared to the quarter a year ago. We are very pleased with our ability to grow our customer care business despite being at an industry low point for units in operation in the dealership service base that dates back to the mid-1980s. The units in operation base is expected to begin growing again in 2013.

Relative to our customer pay business, gross profit was up 2% more than offsetting a 5% decline in warranty gross on a dollar basis. This was the eighth consecutive quarter of year-over-year gains in customer pay gross as well as revenue.

Internal gross profit increased due to higher vehicle sales and I will also note that in the quarter, we had strong growth in our wholesale parts business and our collision business. Together they represented 25% of our gross improvement.

Next finance and insurance, where in the quarter total gross profit of $145 million increased $28 million or 24% compared to year ago. Same-store gross profit per vehicle retail of $1283 was up $47 for 4% in the quarter. We are very pleased with our continued strong performance in finance and insurance and remain focused on full transparency and providing value-added products that can drive long-term customer retention.

There were no changes to our store portfolio in the quarter. To recap, it stands at 215 stores with 260 franchises representing 32 brands in 15 states.

As always, we continue to actively pursue acquisition opportunities that meets our market brand and return on investment criteria.

In closing, we are very pleased with our performance in the quarter and year-to-date. One of our goals was to exit the downturn as a stronger company and we did just that. Our intense focus on associate development, retention, and productivity is evidenced by the 17% increase in revenue compared to the period a year ago with a headcount increase of just over 2% on a total store basis.

We also continue to invest in technology advancements and best practice processes at every customer touch point. This coupled with disciplined expense control is driving strong results.

On behalf of our executive team, I would like to thank our 20,000 associates for their commitment to delivering memorable customer experiences and for their dedication to AutoNation.

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

Thanks, Mike. Second-quarter industry selling rate was 14.1 million units, a 16% improvement over prior year. As we look at the rest of 2012, we believe that the improvement in new vehicle sales year-over-year will continue and a planning assumption for 2012 industry new vehicle sales in the mid-14 unit range. We believe that the accelerated product launches, replacement demand, and robust consumer credit will continue to support a strong sales environment.

Thank you and we will now be happy to take your questions.

(Operator Instructions). Rick Nelson, Stephens.

Thanks, good morning. Kind of the new car side, the unit growth that we've talked in the quarter, do you think that sort of level can be maintained into the third quarter where comparisons would appear to be potentially even easier given the supply constraint to year ago?

Yes, obviously I just confirmed that we still believe it will be in the mid-14s, so anywhere from 14.250 million to 14.750 million, somewhere in there. I think the third quarter is going to be fine. I think the only questionable period or risky period is how the year closes and nothing to do with the automotive recovery or underlying drivers, just simply the election and the fiscal cliff and all the real drama that will come with that. At the end of the day, I believe there will be a grand bargain but it could even take into the beginning of next year. And how disruptive that will be to the economy and to business, nobody really knows.

But I think we're on the journey back to 16 million units. The only question is the pace with which we get there and so we think it's mid-14 for this year and really the risk is in the fourth quarter, not the third.

If you could comment on inventory, as it appears that the Japanese imports that we have normalized there we are hearing about some issues, some challenges on the luxury side and how you will see that shaking out?

Mike Maroone can talk about it in detail, but I would say in principle, the inventory situation compared to five years ago, we're in an entirely new world. When something is not selling, the manufacturer stops making it rather than putting on additional shifts. The quality of the inventory as far as its configuration is dramatically higher. Manufacturers are really trying to produce exactly what people would like to buy and the absolute levels of inventories are totally acceptable.

But, Mike, you can talk about specific manufacturers.

Rick, you are correct in calling out premium luxury. There's a little bit more pressure on premium luxury but we still have between a 40 and 45 day supply of most product there. We have a 60 day supply in aggregate for our total inventory. But there is pressure in certain product lines for certain manufacturers.

Just for example, BMW certainly has had some production issues with the 3 Series launch. I think those are behind us and I think you will see our inventories build nicely in the fall. And as you know, the end of the year is really the time to shine in premium luxury and I'm confident that we will have the inventory to meet the demand. But that's probably the primary tight spot. There's also some select other gaps but all in all, we are very pleased with our inventory and are continuing to buy aggressively.

If I could just ask one more on the finance, I don't know -- you called that out as a driver of this recovery. In terms of looking at prime and near prime and the subprime, do you think we are back at prerecession levels or do we still have a way to go on the subprime?

No, I would describe it this way. I think as far as automotive finance, we are fully back to 2006 and the availability is just terrific. What is different of course is using home-equity lines as a piggy bank. Those days are over and that has nothing to do with auto finance but it certainly was part of the business that people could use home equity for down payments or even to pay for the entire car. That game is over.

So I think in the period where sales were depressed, you had a certain savings from individuals in order to make some sort of appropriate down payment and now we're through that that the people have a down payment. And so the decision point that the consumer is at is they've postponed replacing the car. It's now very old. They've postponed a lot of maintenance work. They have saved some money so do they spend money fixing this old clunker or do they do something? It's very positive, constructive conversation on the showroom floor whether it's a just going from a very old car to something that's newer or a brand-new car and then you have exciting products and great financing -- is the combination that's driving the business.

That's great. Thanks a lot and good luck.

John Murphy, Bank of America.

Good morning, guys. First question, your sales pace increase on the new vehicle side was really basically double the industry in the quarter. I'm just trying to understand, is that a function of geography and brands or is there something else going on at AutoNation where you are able to really take some market share from your competing dealers?

There's three factors there, John. I would say the first and most important factor is the brand mix, so we were overly impacted by the situation with the Japanese last year in that 50% of our unit volume is with Japanese brands. And so therefore this year of course relative to the industry, we will outperform with the recovery of the Japanese. We were up 44% with Japanese.

We were also disproportionately impacted with our geographic mix. We were ground zero for the housing meltdown in our big states of Florida, California, Arizona and Nevada. What we now see is that housing has stabilized in those markets and there are the first indications of a housing recovery and we had excellent performance in those markets this past quarter.

Finally, we are indeed taking share and Mr. Maroone can talk about that and the drivers of that.

John, we have been very aggressive this year. We have been aggressive buying inventory. We have been aggressive marketing and we are really pleased with our performance. We felt we had an opportunity and I think it goes back to what Mike Jackson's objectives were when we entered the downturn and that's to come out as a stronger company. So he and our Board allowed us to continue to invest in acquiring talent. We invested in facilities. We invested in IT and of course, continue to invest in the process and I think it paid off for us very nicely.

So if I was to weight those for you, John, just back of the envelope, I would say it's 50% the Japanese situation, then the geography is probably another 30%, and taking market share is probably 20%.

That's incredibly helpful. Then a second question just on the parts and service business because it appears to be sort of reaccelerating here. I think last quarter you were up about 4% same store. This quarter you are up about 5%. There's been this fear that UIOs have declined yet you seem to be trumping that quite handily.

We've also heard a lot of noise about some weakness in the aftermarket in general from some of the retailers and even the tire companies. So I'm just curious what you are seeing in your parts and service bays, what's going on there, what the consumers are coming in for and what kind of efforts that you were putting forth to really outpace what appears to be a weak aftermarket in general?

I will start. This is Mike Jackson again starting with the big picture. No question that the dramatic decline in units in operation has been a headwind for our customer care business for the last several years and we can really feel that we are at the trough at the moment and the rate of decline has slowed significantly. You can feel a bottoming out and we are certain that a headwind will become a tailwind going into next year.

Like anything in life, when we faced this difficult headwind, we redoubled our efforts and focused on customer care and we are determined to come out of this tumultuous period stronger than we went into it. That included structural changes here with our organization, creating a separate division for customer care with a singular focus within an executive to lead that effort with Alan McLaren joining us from Mercedes-Benz.

Mike, you can talk about some of the specific initiatives we have underway.

There's a lot that's going on, John. I will call out a few. One is we made some real investments in collision and are really seeing a nice growth in the collision business. We have consolidated some parts wholesale opportunities and finding ways to use our size and scale. And lastly, our tire business, which is up about 25%, we've got very effective and efficient tire operations in every single store which we were just developing a year ago. And I think it's a nice payoff.

But there's a real retail focus here. As Mike said, we have added some real talent in the organization and we are really pleased that we are growing 5% at a time where we are hitting the bottom of the UIO cycle which we expect to begin to increase at the end of this year and into 2013. So we're very optimistic about our efforts and we will continue to look for ways to invest in our capabilities.

Okay and then just lastly on SG&A, you guys continue to surprise on the positive side there and we sort of used to as a rough rule of thumb historically think about SG&A is about half fixed and half variable. Are we at the point where you have cut real deep here, you're going to get much better leverage and we should think about maybe three-quarter fixed and one-quarter variable? I'm just trying to ballpark this because you do continue to surprise to the upside there.

John, again Mike Jackson to make a basic statement. We really view it as a productivity drive. We are not trying to cut or squeeze. We really want to put in place a system of productivity that we can attract talent and the talent that is with us can really be successful both with a career and with their earnings capacity. That leads to great morale in the company, and we have achieved that. So that's a great place to be.

And we have our associates today who are -- the whole culture is how do we do it smarter, better, faster next year than we did it the year before? And how do we find -- I call it win-win or win-win-win, win for the customer, win for the associate, and win for the company. That's a very different approach than a pure cost-cutting approach. And it's difficult to predict exactly when all of that falls through but the trend line is absolutely in the right direction. And Mr. Short, why don't you add something.

Sure. Thanks, Mike. John, you know we've been focusing on this productivity theme for many, many years with the investments in the shared service center. We're almost complete with the extended model. We will be complete before the end of the year with the Florida region, which is the last region to go in and that has allowed us to take some of our costs and make them more fixed, adding lower cost structure. And to Mike's point, it's as much a focus on how do we get our business to generate gross as it is to how we get our business to operate at a lower cost level?

I think just in terms of main themes on SG&A, we know that we have operated below 70% of gross profit in the past and it has been our target to get there, so we're very gratified to see the organization at that level or essentially meeting that 70% threshold right now and we think there's room to go beyond that.

In terms of how do you think about the cost structure going forward, 50% fixed, 50% variable is fairly close and our goal is to continue to deliver about 50% of the increase in gross profit as a flow through to the bottom line. So we continue to focus on that and I think if you go back over time, you will see that we have consistently executed at that level. So we are very pleased with the contribution from all the associates against that productivity initiative.

That's very helpful. Thanks a lot. Keep it up, guys.

Simeon Gutman, Credit Suisse.

Thanks, good morning. If you look at the new vehicle comp in the quarter, is there any way you can provide some color on how the growth was driven among the different credit groups, whether it was prime, subprime, or the nonprime?

Simeon, it's Mike Maroone. We are seeing real competition in all three of those segments, so subprime, which was the last to be restored, is now very robust. I think it's still rational but I don't think we are seeing any particular growth in any of these segments. Subprime was restored last year and we just see great competition. We see big lenders that really believe they can get good returns on automotive credit and the competition is good. So I think all three are fueling the recovery.

Okay that's helpful. Just on the topic of replacement demand, does that mean that when you are selling a new car, are you seeing a lot more trade in in at least the self sourcing of used? Is that improving and should that continue?

I think it will. We are seeing cars with higher mileage. We are seeing older cars which I think reflects the pent-up demand in the replacement need that Mike Jackson speaks to. And for our part, we are just finding more ways to retail those cars rather than wholesale them. We've now got 27 of our valued vehicle outlets open.

We now testing another concept with a premium value outlet that we are opening and so we are seeing the trades and our idea is to monetize the trades and not to go outside the network to buy a lot of inventory. And so I think it has been very successful for us.

Then when we get that inventory we really look at it and say how do we optimize the inventory? Which franchises and locations can we get the best value from? As I mentioned in my comments, we moved 10,000 vehicles last quarter and I think that speaks to the size and scale that we have as a company.

Staying on the used car theme, do you have an outlook or sense for the gross profits? I think year-over-year we saw this normalization, which was expected just given how good things were a year ago. But it looks like the depreciation may have started a little earlier than normal and it's starting and it has happened for a couple months now. Do you think the depreciation will be above average given that and given the shift that we are seeing with new car sales so strong?

We have seen in the last couple of months, we are seeing a little bit of softening in prices but it's very consistent with the seasonality we have experienced over our careers. I think the used vehicle business is still a great opportunity. The margins do seem to fluctuate a little bit quarter-to-quarter, but I think we can be confident we will be in the low 9%s to 10% margin as a percent of revenue and we are running our inventories very lean. We are running -- this quarter we ended with a 31-day supply. David Koehler is overseeing our sales operation, doing a good job of keeping us lean and when we do that, we are not as susceptible to fluctuations in price.

Okay. Lastly for Mike Short, the leverage ratio, that 3.05, how do you feel about that versus sort of where the buyback is and what sort of limitations or what the comfort range of where you can flex that to in the context of the buyback?

Yes, I mean we think having a strong balance sheet allows you to be opportunistic. Over the last year, we bought back almost $1 billion in stock at just below $35 a share, so we have been aggressive and tried to be -- create value, create opportunities for our shareholders. And we continue to believe that our balance sheet is strong and we have room relative to our covenants and we will continue trying to be opportunistic.

In terms of actually communicating specific targets about how high we would be willing to take the ratio, we have avoided that because obviously we don't want to tie our hands in any way.

All right. I appreciate the answers and nice quarter.

Adi Oberoi, Goldman Sachs.

Thanks a lot. First of all on the margins in the new business, obviously there was a little bit of a sequential decline. Are you guys feeling a pressure of the competition in the market just because of the stairstep incentives that some OEMs have redeployed and that is creating some extra competition in the market at the dealer level?

This is Mike Jackson. Of course the biggest reason for the change in margin is the comparison with the prior year, an extraordinary situation and the sequential decline I think is very minor.

10 basis points.

10 basis points -- but in principle, you are right. There's still a lot of competition out there in the marketplace. Stairsteps are still used by certain manufacturers. They are definitely an old-school practice that wreaks havoc with customers and with the margins and seeds a lot of distrust in the marketplace and really have no reason to be in today's marketplace, so we have to struggle and deal with those. But yes, it remains competitive out there even though you have growing demand.

Great. A second question on the used to new ratio, this is the first time you guys went below 0.7 for quite a while now. So as the new continues to pick up, do you think -- how should we think about the used to new going forward given that -- do you think used will grow at a slower pace or you will put some more measures so that the used to new ticks back up to above the 0.7 mark?

It's Mike Maroone. We are very focused on the used car business. I think the decline, the changes really are more recovery in the new vehicle business specifically in the Japanese brands but we are very committed to the used car business. As I mentioned earlier, we are trying to retail more of our trades than ever before. We've put more resources in used and I think we'll continue to enjoy good growth. We grew the volume at about 7.5% and I think this prior quarter we are probably a maybe about 10%, 11%, so we're still seeing good, strong growth. I think the new vehicle is maybe a little bit of a distorted number but we are really committed to the used car business and have a lot of talent and focus on that area.

That's very helpful. Finally, if you can comment on July auto sales. Any early read on that please?

We never comment on the current month while it's underway but we do as you are well aware, at the end of the month we will report our new vehicle retail sales as to the manufacturers to give you as much information as we can on a timely basis.

Okay, great. That's a lot, guys, and congratulations on a great quarter.

Jamie Albertine, Stifel.

Great. Thank you for taking my question and good morning. Congratulations on a great quarter, particularly on the operating expense levers that you were able to show and it looks like all the initiatives that you are investing really are paying off. But I wanted to focus on two separate questions, one topic on the used side. I just wanted to understand your strategy.

Given the lack of late-model supply and the lack of the CP of a vehicle and your ability to retail an older vintage, perhaps higher mileage vehicle, are you able to enhance your acquisition offer or trade-in offer given your scale and breadth relative to competition? So in effect, are you paying more for trade-ins and is that helping consumers make the decision to convert their existing car to a new vehicle?

It's Mike Maroone. Yes, we clearly are very aggressive trying to win trades and we do that full knowing that we can move that trade to another location that is going to allow us to generate a higher revenue and more gross margin, so we are competing vigorously. We have made a conscious attempt to not be a big auction buyer, so that's the source of our product and we know when we create that transaction even if we have to step up to that nice trade, we create that transaction and give ourselves an opportunity to have several other transactions both in the F&I side, the used side of the business, and ultimately in our customer care owner base.

So yes, we do step up but we also are very careful about how many we keep in trade, what our are balances and our inventory and as I mentioned earlier, staying lean really make sure that we don't have a surprise coming around the next corner. So we are very aware of the valuations and I think our critical mass really helps us.

And as a follow-up to that question, what are you seeing in sort of a geographic basis in terms of demand on the used side helping you to retail -- the 10,000 vehicles and parts that you are moving between facilities?

From a geographical perspective, I think you are seeing the same kind of things we saw in new and that's strong recovery in California and Florida, both of which had previously been impacted by the real estate crunch. Texas is a very strong used car market, as is Colorado. So the used car market is really follows the new car market because that's where the trade-ins are in many cases.

Thank you and then my final question, I wanted to get an idea or an updated view on the M&A environment, so are potential sellers in a sense becoming more rational in terms of the takeout prices that they are expecting or are you seeing in general more or less sort of deals come to the table? Thanks so much.

It's Mike Maroone. There's not been a lot of deals done in auto retail this year and I think there's still a price gap between buyers and sellers. In this recovery, auto retailers are certainly making more money and are more optimistic about the future. They still have capital demands with manufacturers requesting new facility.

So there's pressure on both sides but the stalemate doesn't appear to be broken. But we're talking to people across the country. There are opportunities there. It's just about finding the right price value combination for both ourselves and the sellers.

Great, thanks so much.

Ravi Shankar, Morgan Stanley.

Good morning, guys. This is CJ in for Ravi. First question, I know we are only a month into the program, but could you talk a little bit about AutoNation Direct, how the response has been and how you see that relationship with the (inaudible) evolving over time?

AutoNation Direct has been very successful for us and what we really use it for is to test different concepts in retail and to try a number of different ideas in pricing and serving customers. What it's really showing us though is that our size and scale does work and as we build these affinity relationships, which is the basis of AutoNation Direct's customer flow, it allows us to serve customers in a very alternative way. It's quite a unique opportunity and we are really pleased with it and we're learning a lot from the AutoNation Direct business.

Great, and as a follow-up on that, the rental guys seem to be pretty focused on moving into the direct to retail model and your partnership with Avis notwithstanding, do you see this becoming a threat to you guys over time?

I don't see it as a threat. I see there is very few of the rental companies that have an appetite to open a large number of retail locations. I think the Avis test and it's early in the test shows that maybe there's an opportunity there for retailers to partner with rental companies to find ways to innovate and we are excited to go down those roads.

All right, that's all I have. Thanks a lot, guys.

Rod Lache, Deutsche Bank.

Good morning. It's Dan Galves in for Rod today. I apologize but I missed the split of the business and customer care. Did you say customer pay was up 2% year-over-year and was that gross profit or revenue?

Customer pay is up 2% in gross, 5% in revenue and it's about 43% of our total gross margin. So we are seeing nice topline growth as we are competing for that customer's business. I mentioned tires being up 25% but we are seeing nice growth on the revenue side and I think it is the eighth consecutive quarter that we've seen growth in customer pay.

Okay, great, and the other parts of the business, warranty?

The warranty business is down some but at one time -- or for several quarters it was down double digits. It think it's down about 5%. Where we are seeing very strong growth is in our wholesale parts business and our collision business and we are really pleased with that. It is making a big contribution to gross margin.

Okay, great. Then how do you track -- I know you said units in operation you feel like is troughing right now. What definition is best to use for AutoNation's units in operation? Is it like one to five years or something different?

That's generally the number that's used. We certainly would love to penetrate that market in the 6 to 10 but traditionally it has been up to five years is the pool that's measured and it's measured by a third party, not by us. We watch that trend very carefully and it's giving us tremendous optimism about the future of customer care with both the restoration of that owner base and with the capabilities we are developing here.

Okay, got you. Thanks. Then just one last question on the F&I business, 1280 per unit, very high historically. Is there any way to split out kind of where the major strength was there and kind of how do you feel about sustainability of that type of a per unit level?

First of all, the F&I numbers vary some by quarter depending on retro commissions and reserves, so we do see some fluctuation. We still think there is opportunity there. Our opportunity is always focused on value-added products, specifically service contracts and prepaid maintenance sales. We think that's best for the customer. It's best for customer retention and that's where the focus of this company is. We have very strict controls on rate. We have very strict controls on customer disclosures, so it's got to be in value-added products and that's where we are seeing the primary growth.

Okay, got you. Maybe one more if I can. Over the course of the quarter, it seemed like there was a bit of a dip in consumer confidence. How did the quarter flow for you guys in the different businesses in terms of month by month?

This is Mike Jackson. We announce our sales every month, so you can see the pacing. There is no question that there is a lot of economic uncertainty there, out there in the overall economy. Employment is a problem. Customers talk about it when they come in, but the trump card is they need to do something. They simply cannot go on. They need a better vehicle to run their lives and to get to work and so they are doing something. So those drivers are taking auto sales and disdaining them despite the economic headwinds that we face.

What do you think it takes to kind of drive the next leg of growth towards the 16 million that you were talking about? Does it have to be an improvement in employment or are there other any other drivers you see that could move the sales up from the 14.5 million range?

You know, I've said this before and I'll say it again. The next leg that we need is housing both for the employment that it brings and for the support of truck sales, light vehicle truck sales that come with it. As I said, we are seeing signs of stabilization in housing where you still have demographic growth. The pressure is there for household formation and the inventories of homes are dropping dramatically and the differentiator between buying new and rent has balanced.

So all the signs are there that housing is going to improve and that will be very beneficial going into next year. Ultimately to get the final leg to 16 million, at some point you need an economy that is growing more than 2%. I think that's going to take resolution around the fiscal cliff issue. Remove that big cloud of uncertainty that sitting over the US economy. Most likely that will happen with some sort of extension in the lame-duck session into the first part of next year and there will be some sort of grand bargain in the first part of the year because let's face it, you can only do something big right after a presidential election and then there's an excuse for the next three years.

So everybody knows this really has to be done and the window is there with a genuine crisis and a genuine need. So it may be disruptive in the short term then but most likely some sort of grand bargain is struck. That would be very healthy for the US economy. Then housing is hitting its stride and the growth rate improves with the fiscal cloud removed and we are on our way back to 16 million.

But exactly the pace of all that we really need to see how those two issues play out.

Thanks a lot. I appreciate your comments.

Thank you, everyone, for your time today. I appreciate you having on the call.

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