AutoNation Inc (AN) 2014 Q2 法說會逐字稿

Welcome to AutoNation's second-quarter 2014 earnings conference call. (Operator Instructions). Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the call over to Robert Quartaro, Senior Manager, Investor Relations for AutoNation.

Good morning and welcome to AutoNation's second-quarter 2014 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; Cheryl Scully, our Chief Financial Officer; and Jon Ferrando, our Executive Vice President responsible for M&A. Following their remarks, we will open up the call for questions. 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. 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 such forward-looking statements. Additional discussions of factors that could cause actual results to differ materially are contained in our press release issued earlier today and our SEC filings, including our most recent Annual Report on Form 10-K and subsequent Quarterly Reports on Form 10-Q and current reports on Form 8-K. And now, I'll turn the call over to AutoNation's Chairman and Chief Executive Officer, Mike Jackson.

Good morning. Thank you for joining us today. We reported record second-quarter EPS from continuing operations of $0.83, a 14% increase as compared to EPS of $0.73 for the same period in the prior year. This marks our 15th consecutive quarter of double-digit growth in earnings per share. Second-quarter 2014 revenue totaled $4.8 billion compared to $4.4 billion in the year-ago period, an increase of 8%. In the second quarter, AutoNation's retail new vehicle unit sales increased 8%, or 6% on a same-store basis. In Q2, the industry SAAR was 16.6 million. We believe that the improvement in new vehicle sales will continue and we are reconfirming our full-year estimate of 3% to 5% of plus 16 million sales for the industry in 2014. Now I'd like to turn it over to our Chief Financial Officer, Cheryl Scully.

Thank you, Mike and good morning, ladies and gentlemen. For the second quarter, we reported net income from continuing operations of $101 million, or $0.83 per share, versus net income of $90 million, or $0.73 per share during the second quarter of 2013, a 14% improvement on a per-share basis. There were no adjustments to net income in either period.

In the second quarter, revenue increased $362 million, or 8%, compared to the prior year and gross profit improved $49 million, or 7%. SG&A as a percentage of gross profit was 70.4% for the quarter, which represents a 60 basis point decrease compared to the year-ago period. Net new vehicle floor plan was a benefit of $14.1 million, an increase of $3 million from the second quarter of 2013 primarily due to higher floor plan assistance. Floorplan debt increased approximately $25 million during the second quarter to $2.9 billion at quarter-end due to higher average inventory balances.

Non-vehicle interest expense decreased to $21.3 million compared to $22 million in the second quarter of 2013 primarily due to lower debt balances. At the end of June, we had $365 million of outstanding borrowings under the revolving credit facility and a total non-vehicle debt balance of $1.9 billion. This was an increase of $79 million compared to March 31, 2014.

The provision for income tax in the quarter was $63.5 million, or 38.7%. During the second quarter, we repurchased 1.1 million shares for $64.1 million at an average price of $56.05 per share. AutoNation has approximately $336 million of remaining Board authorization for share repurchase. As of July 16, there were approximately 119 million shares outstanding. This does not include the dilutive impact of stock options.

Our leverage ratio remained at 2.2 times at the end of Q2 as compared to Q1. The leverage ratio was 2.1 times on a net debt basis, including used floorplan availability and our covenant limit is 3.75 times. Capital expenditures were $52.9 million for the quarter. Capital expenditures are on an accrual basis and exclude operating lease buyouts and related asset sales. Our quarter-end cash balance was $69 million, which combined with our additional borrowing capacity resulted in total liquidity of $909 million at the end of June.

As further evidence of our financial strength, Standard & Poor's upgraded our senior unsecured rating to investment grade during the quarter. We now have investment-grade ratings from both Moody's and S&P on our bonds in addition to our corporate family ratings. Our stellar balance sheet, strong cash flow generation and opportunistic approach to capital allocation continues to support our goal of maximizing shareholder value. Now let me turn you over to our President and Chief Operating Officer, Mike Maroone.

Thanks, Cheryl and good morning. In the second quarter, AutoNation delivered a 4.1% operating margin along with solid growth in both sales and customer care. When coupled with the 15th consecutive quarter of double-digit EPS growth and a record second-quarter EPS, we are pleased with the quarter.

As I continue, my comments will be on a same-store basis and compared to the period a year ago unless noted otherwise, starting with sales. In the second quarter, total gross profit for variable operations was $3,279 per vehicle, an increase of $67, or 2%, with expanded gross profit per vehicle for both used vehicles and customer financial services.

Relative to new vehicles, in the quarter, same-store new vehicle revenue increased $200 million, or 8%, to $2.7 billion on the sale of 79,000 new vehicles, which increased by 4,700 vehicles, or 6%. New vehicle gross profit of $159 million grew $10 million or 7% in the quarter and at 2008 dollars, we're able to maintain new vehicle gross profit per vehicle retail in what continues to be a very competitive new vehicle market. At June 30, our new vehicle inventory was 59 days compared to 67 days a year ago.

Turning to used vehicles, in the quarter, retail used vehicle revenue was $976 million, an increase of $23 million, or 2%, on 52,000 used vehicles retail, which was relatively flat compared to a year ago. Revenue per used vehicle retail increased $527, or 3%, to $18,836. Retail used vehicle gross profit of $87 million was up $4 million, or 5%, and gross profit per used vehicle retail of $1,687 was a solid increase of $91 per vehicle or 6%. We are pleased with the growth in gross profit and clearly recognize that we missed some opportunity on the volume side. We ramped up our used vehicle inventory by 20% in the quarter and are positioned to grow our volume in Q3. At the end of the second quarter, our used vehicle days supply was 36 days compared to 30 days a year ago.

Rounding out the variable side of the business is customer financial services where in the quarter gross profit per vehicle retail was $1,398, an increase of $23 or 2%. Total gross profit for customer financial services of $183 million was up $9 million or 5% compared to the period a year ago. Our CFS team remains focused on the overall customer experience, continuous improvement in store level execution, in long-term customer retention through value-added product offerings.

Next, customer care or service parts and collision for the second quarter marked a record for customer care revenue and gross profit. In the quarter, customer care revenue of $696 million increased $41 million, or 6%, and total customer care gross profit also grew 6%, or $17 million, to $297 million. Expanding on gross, warranty gross increased 15% driven by heightened recall activity, which accounted for nearly two-thirds of our increase in warranty gross profit on a dollar basis. However, recall comprises just 4% of our total customer care gross profit. We also recognized an 11% increase in collision growth and the 16th consecutive quarterly increase in customer pay gross, which was up 1%.

I will note that we have been increasing our technician headcount and are accelerating our efforts in the second half of the year thereby enabling growth in customer care while also serving our recall customers. Our customer care team continues to work diligently on operational improvement in the areas of traffic, appointments and customer satisfaction.

As I wrap up my remarks, last week, we finalized the acquisition of Roundtree Chrysler Jeep Dodge Ram in Mobile, Alabama. This is our third store in the Mobile market and aligns with our strategy of building density within our existing markets. I'd like to thank our 23,000 associates for their contributions in driving our 15th consecutive quarter of double-digit EPS growth and for their commitment to delivering a peerless customer experience each and every day. With that, I will turn it back to Mike Jackson.

Thank you, Mike and we will now take your questions.

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

Good morning, guys. Just a first question on used, which is where there was some variance versus our expectation or the biggest variance versus our expectation. It seems like the same-store sales were a little bit on the light side considering the strength in new. It just seemed like there would be more opportunity for trade-ins and to churn your used vehicle inventory yet you alluded to the inventory for used being at 36 days supply. So it didn't seem like there was a shortage of inventory necessarily. Just really trying to understand what you are seeing in the used vehicle business and if there is a bigger opportunity to maybe re-accelerate those same-store sales growth there.

John, it's Mike Maroone. We were pleased with our gross profits being up $91 a car, but we really did miss some opportunity. We ramped the inventory as the quarter went on and finished the quarter at 36 days. So we have taken the inventory up about 20%. We are up to about 27,000, I believe, in inventory right now and really need to push the volume button this quarter. So we got the gross, we did not get the volume and there is always some shortages, but as the quarter went on, the CPO business was strong, but clearly we didn't retail the trades that we needed to retail and we are going to really focus on it this quarter as we have ramped that inventory.

Okay. So as we think about that, that was really sort of starting the quarter with tight inventory and that was really the reason and it was just sort of a lack of focus with that tight inventory and you think just the reinventorying should really create some opportunities there? It just seems a little -- it just seems a little bit tough in the quarter.

Yes, the supply was tight for the right merchandise. Again, there is plenty of CPO merchandise out there. It's medium-priced reasonable mileage cars that are just in tight supply. We believe with more cars coming off lease in the next couple quarters the supply should be in better shape, but we have ramped our inventory because we can't wait for that to happen.

Okay. And then on parts and service, it was a very good same-store sales comp. I was just curious -- I mean it sounds like the recall is only having a very small impact on the total business. I was just wondering if you expect that to be greater in the coming quarters or is this as good as it gets on the recall activity and really the strength is coming from just an increase in the UIOs in the zero to five to zero to six-year-old population?

Well, first of all, there is growth in the zero to five. It's still probably two-thirds of the business, but there are some headwinds in the six to ten. I think the recall activity is going to continue to be very brisk and we believe there's opportunity. We need to expand our capacity. We came into the year planning on adding about 400 technicians. We are on that plan, but frankly we need more. So certainly the amount of customer activity has tied up some capacity and we're actively out recruiting to expand that capacity and believe there is good opportunity.

What is the base of techs, the 400 off of a base of how many techs roughly?

On a same-store basis, it is 4,300, 4,400; on a total store base, it's about 4,700. So again, this was a plan we'd put in place before all this retail activity or, excuse me, recall activity and we now need to accelerate it.

Okay. And then on the digital expense in the quarter, Mike, you had alluded to that on your interview on CNBC as something that was a little bit of a headwind on cost. Can you give us an idea of what that was in the quarter and what we should expect going forward?

Yes, John. I talked about it on the last quarter. We launched the brand just a little bit over a year ago. It's been embraced by our customers and our associates. We're really ahead of where we thought we would be at this point both on how well-accepted the brand is and the amount of traffic it is generating for our digital sites. So we've decided to accelerate the next phase, which is increasing our marketing around the brand AutoNation to drive even more customers to our digital sites and of course a big investment in the capabilities of the site itself, which the next big step will be that the site goes transactional at the end of this year. Meaning that you can -- customers can select specific vehicles, get a committed price, give us a deposit and that becomes their vehicle without ever having entered the store. And if somebody walks in 10 minutes later and wants to buy that vehicle, no, it's committed to that digital transaction.

And then through the course of next year, we will expand the digital capabilities to include purchasing customer vehicles and giving them a committed price on trade, giving them committed quotes on financing and of course a dramatic improvement in the entire customer care experience, everything from how you make your appointment to how you pay your bill and how you get an update on the vehicle while it's in for service. So it is a transformational effort on the part of the Company. This is our strategic vision, if you will, that we believe today's customer and future customers want one experience, not an online experience and an in-store experience, but one seamless experience where they can interact and transact both digitally and in the store.

Now we've called out that we are investing an additional $100 million in this effort compared to what we kicked off a year ago. How the spending falls will depend basically on how fast we are able to go and what kind of barriers we come up against. So sometimes we'll move faster, sometimes we'll go slower. So we ask for your understanding that we are not giving a specific breakout as to how it falls on each quarter other than to say it was significant during this quarter and will be significant in further quarters with $100 million being spent over this two-year period of 2014 and 2015 to solidify the brand, drive the traffic to the sites and turn it into a transactional site.

Mike, just one question on that, a follow-up. That must not just have a material impact on improving the customer experience, but it sounds like it would have a material impact on your cost structure. Is that a fair characterization and could we see a dramatic stepdown in your cost structure going forward as a result of this if it's very successful?

John, I would say all of that is in the vision, both whether it is share opportunities or cost opportunities, but I would not bake that into your planning today. I think we have to wait and see how skillful we execute and what the marketplace's reaction is, but this was the reason behind why we rebranded the Company coast to coast. We could not envision doing this with multiple names. We think it is far more powerful with one name, but I think you're thinking about it the right way, but nothing I can bake in the plan today.

It's sort of like the shared service center, which took us seven years to fully implement. That gave us both a cost advantage and a performance advantage and also, in many ways, was a foundational element for this digital undertaking in that we need all the stores on the same technology platform for everything from database management to how we run the Company day to day. So that was a key building block that went in place, then rebranding the stores and now on that digital platform that we have in place, the next big step is to go transactional. So it's certainly not the end of the story over the next two years. There will be more chapters, but we're in a very ambitious and exciting phase -- I call it an investment phase -- that we feel in our ambition to build a great company and a great brand in the long term we need to make and is the right vision for the Company and to win in the marketplace.

Sounds exciting. Just one last one on capital allocation. The stock currently is below where you guys were buying it back in the quarter. I mean obviously it's just below the $56.50 that you guys were buying back in the quarter. Obviously, this looks like a pretty good deal. Obviously, you would be a buyer at these levels, I would assume, as far as your capital allocation given it was below the average price that you bought back in the last quarter?

Yes, John.

I think that's a safe assumption, John. I've never missed a buying opportunity.

Looks like a good one. Thank you, guys.

Rick Nelson, Stephens.

Thanks. I'd like to follow up on the SG&A and the digital marketing spend. SG&A came in about $13 million higher than what we were modeling for the quarter. I think that was about $0.07 in EPS. I know you don't want to break out specifics for the quarter, but what causes you to go faster or slower with that -- with the $100 million spend?

I would say on the marketing spend and the branding spend, when we see traffic to our sites increasing then that means the investment we're making in the brand is getting the right reaction in the marketplace. If traffic was flat to our sites then we would step back and say, hmmm, we've got to rethink this, something is wrong in the message.

So step one is what is the reaction in the marketplace on traffic and Mike, you might have some numbers there we can give you, to our sites. The second step is what is the customer experience on the site and what is our closing rate on the site. Therefore, the type of experience they're having and how effectively the site is working. We've clearly identified from our research, Rick, that the site needs to go transactional. Informational sites are useful. They've taken us to a certain point, but the customers are not interested in doing all that work, disconnecting and then coming to the stores and starting all over again. So the sites need to be able to reach into the store and transact on real inventory, real incoming inventory with real pricing, with market data that validates that pricing and the customer, when they see the car they want at the price they want, are able to send us a deposit and make it their car and for a defined holding period. And again, we'll expand the transactional capability after that. So to the extent that it is working, we go faster. To the extent that we run into opticals where an assumption we've made has proven to be wrong, then we have to slow down and rethink it.

Thank you for that. I'd also like to ask about your industry assumptions for the year. You were up 6% same-store new vehicle sales in the second quarter. You are up 5% year to date with a lot of strength in May and June combined. Your full-year forecast up 3% to 5%. Do you view that as a conservative forecast at this point?

No, I'm glad you're asking the question, Rick. So my forecast of plus 3% to 5% is for industry sales, not AutoNation sales. That is my opinion of industry sales. So that's two different things. Now here's my thinking on industry sales year to date. They were basically flat in the first quarter because of the disruption with weather and they were very strong in the second quarter taking the year-to-date improvement to 4.5%, which is on the high end of our range.

Within that, I look at the fact that car sales are flat and truck sales are up 8%. That is a very strong signal from the consumer because it's saying the following. We all know transaction prices on trucks are higher and we also know that we've dealt with volatile and higher gas prices during the quarter, yet the consumer has continued to buy trucks. So that is a bullish consumer and the industry has a comprehensive answer for the consumer around fuel economy where it's not that this time the consumer doesn't care about fuel economy, they actually care very deeply about fuel economy, but with the internal combustion engine and everything that comes with it today, they are able to have a larger vehicle that goes faster and gets improved fuel economy.

So all that says we're at the higher end of our range, certainly plus 5%, if not more. So we could end up at 16.4 million, 16.5 million units this year for the full year. We could end up there. So it's an optimistic outlook for new vehicle sales for the industry. Within that, we don't give our specific forward guidance on our sales, but every month we tell you what we sold according to what we reported to manufacturers.

That's very helpful data. Good luck as we move forward.

Thank you.

Gary Balter, Credit Suisse.

Hi, Gary.

Hi, how are you?

Excellent.

Two questions. First, just doing quick math when you mentioned you're adding about 10% technicians, I'm assuming we're going to start to see P&S start growing at 10%. Is that fair?

Yes, I don't think that -- I think we're staying with a mid-single digit growth, Gary. You've still got some headwinds in the 6 to 10.

Right. On the customer pay side.

That target was over a period of a year and we think there is opportunity in customer care, but I would not call a growth rate (multiple speakers).

No, we're not saying next quarter, but we're thinking over the next few years that you'd start to see even better growth.

We think there is great opportunity in the customer care business and that is why we're investing for it.

And then on the digital side, we hear the investment and is there a way to talk about like some of the opportunities that this creates from a numerical point of view. For example, savings by not going on other people's websites because they're going to be more identified with the AutoNation site or just the ability to drive sales and like close sales from the Web. How should we thinking about what the positive impacts of this investment we're seeing now are going to be in the future?

Well, the way we think about it, Gary, what we're looking at is we see the third parties with whom we do business over the last few years were taking an ever-increasing percentage of our marketing pie, and to put that in some context, they were -- 13% of our business -- 13% of our vehicle sales were generated by third-party sites, but the marketing spend with them was higher than that. So we were like at a fork in the road where we have to decide to take that money, invest it in our own brands or invest it in their brands. So that was certainly a point and we think that we can generate that traffic at a significantly lower cost than we are with the third parties with our own sites or just generate a heck of a lot more traffic. But we know there is a major cost differential between third-party traffic and AutoNation site-generated traffic, a significant cost delta.

Additionally whether there'll be cost savings in the store as we make a more efficient, faster experience with the customer where so much of the work is done digitally and what that means within the store and our ability to price much more centrally rather than store by store, there are a whole list of thoughts and ideas, but they're really somewhat over the horizon in that our concentration at the moment is on this period of building the brand, driving the traffic and moving towards a transactional experience. Those are the building blocks, the next building blocks that have to go in place. Beyond that, I think there's a lot of opportunity and we could realize that opportunity in different ways either from a share opportunity or a cost opportunity. But it's difficult to put numbers on it today and I think as we get deeper into the journey, obviously a big milestone, we will be going transactional later this year. 2015 we will know far more exactly how this is working.

Thank you. I think it's great that you're leading this charge. I look forward to watching it over the next few quarters.

Yes, we're very excited about it.

Patrick Archambault, Goldman Sachs.

Yes, thank you very much for taking my question. I just wanted to follow up on the used side. So it sounds like there was a lack of inventory that was the main constraint in the quarter to getting the volume you wanted. You've since kind of trued up those inventories by 20% to drive volume. Should we be thinking about -- or how should we be thinking about the implication on margins? You had a good margin performance this quarter, but if you're going out and sourcing a lot of stuff in the auction market, is that something that could potentially be a little bit of a headwind in the shorter term until some of the lease returns come back?

Patrick, it's Mike Maroone. First is by pushing the inventory up, we've already seen a benefit. So far in July, we're up about 7% on a year-over-year basis. We have not seen pressure on the margin at this point. It's still early in the quarter, but we're really working hard to win more trades, doing a lot of training in the field, a lot of metrics, a lot of benchmarking to make sure that we're winning all the trades we can. We agree if we've got to go out into an auction environment and acquire larger numbers of vehicles, there's going to be some pressure. But the off lease -- the number of vehicles off lease really is starting to accelerate. We think there'll be enough supply. We're just probably being bolder on the supply side and don't want to give up a lot of margin. We may have to give up some from time to time.

Okay, that's helpful perspective. I appreciate that. And I guess another question was just on the M&A environment. You have gone to M&A maybe a little bit more recently than some of your public competitors. Can you just give us maybe an update as to how good the environment is, what kind of targets you are seeing in terms of the overlap in terms of valuation. And then I'd be specifically interested actually in that perspective if there's more opportunities on the domestic side than on the import side, just that perspective on dealer points would be helpful. Thanks.

Yes, Pat, it's Jon Ferrando. In terms of acquisition, yes, over the last 24 months through acquisition and ad points, we have successfully added $1.2 billion in annual revenue. We've been very focused on adding brand representations in our existing markets and if you look back at all of those deals, including the most recent one, that fits very well with our strategy and we've been successful.

In terms of going forward, we don't give growth forecasts, but I can say there's certainly a solid pipeline of potential deals out there and I would say that will run over the next few years, so we will have plenty of opportunities with sellers to continue to execute our strategy of acquisitions meeting our brand, market and return criteria. We will do deals. Again, depending upon the market, we'll do domestic acquisitions. That was our last acquisitions, but you also saw a very healthy mix of luxury and import over the last couple years. So I think you'll also see that going forward.

Okay, terrific. Those were my questions, guys. Thanks a lot.

Ravi Shanker, Morgan Stanley.

Thanks, good morning, everyone. Just a couple of follow-ups. On the F&I side, your F&I per unit declined sequentially and growth slowed year on year to the lowest level in about three or four years. Was that just a one-off in this quarter or are you seeing some signs of pressure on the F&I side maybe from higher rates or just more competition?

I don't think that we feel like we've flattened out. I think the quarter might have been a one-off, but we are very confident of our ability to grow that and again, we really worked hard to shrink the bandwidth of performance and are pretty optimistic going forward. We have put a huge concentration on selling service contracts. Have really moved that number up in terms of our penetration there and that is the focus is value-added products and I'm very confident of our ability to grow that going forward. We've had a steady growth path for almost 10 years and I don't think this quarter would be anything to indicate that there won't be future growth.

Got it. And in your comments earlier in the call, you said that the industry was very competitive. Any further color on just pricing trends in the industry? And also as you roll out the digital initiative, what do you think that does to your overall pricing? There are some other dealers who are trying to take steps to go to fixed pricing and such. Do you think the public dealers as a whole can come together and maybe make some moves to kind of reduce that competitive pressure a little bit?

First, this is Mike Jackson. I don't see the public retailers coming together to agree on price. That is not going to happen. But if you look at our performance, our variable gross profit per vehicle retail is increasing steadily. So I think the situation is entirely manageable. Mike, what would you like to add to that?

Again, we're up $67 a car when you take the total variable gross per car. We were pleased to be able to hold margin on a dollar basis in a super competitive industry and there's a lot of volume-based incentives that put pressure on volume and gross and I thought our team did a very good job. We continue to develop our capabilities internally to provide our stores with real-time market information and continue to put more science into how we price, but I don't see us going to fixed price, but certainly the bandwidth of margin on transactions has tightened a good bit as we've got a very well-informed consumer. But we are really pleased with our ability to manage the gross and have done it over several quarters. So we're pleased with our margins.

Got it. Just finally on the used business, you said that CPO supply is good, but I think late-model used non-CPO was tight. Where do you think the vintage sweet spot is in the industry right now? Is it that three to six-year-old non-CPO vehicle or maybe even something older than that?

Yes, so the inventory itself, you've got some cheap, very high mileage vehicles. Those turn very quickly and you've got the nearly new product. I think you've identified the sweet spot. It is anywhere between two and four years depending on miles and as you look at -- your average lease term right now is about 35 months. So I think the vehicles that have gone into service are going to be coming out at a very good point, but really the way to run the used-car business is to win more trades. That is our most effective, most efficient way of doing it and we're going to continue to hone our abilities. We'll supplement it with outside purchases, but the off lease and the trades are really where we need to shine and I think, again, our short-term results, based on pushing our inventory up, gives us great optimism about the used-car business.

Great. Thanks.

Brett Hoselton, KeyBanc.

Good morning. I was hoping to ask you to begin with, on the M&A front, what do you think the possibility of doing a more material or a larger acquisition is, i.e., something with maybe $1 billion or more in revenue? Do you think that is a low probability for AutoNation or do you think it's a possibility?

Hey, Brett, it's Jon Ferrando. I think our focus will continue to be on deals that meet our brand, market and return criteria. I would say we certainly have the capital and resources to successfully acquire a larger group if at some point in the future that came together from a brand, market and financial return standpoint, but our primary focus is on adding brand representation in the markets that we're in.

Thank you. And then the $100 million that you're looking to spend on your digital initiative, can you give us a rough estimate of how much of that you spent in the second quarter?

Yes, Brett, we're not providing a specific number into the quarter. I would say generally our SG&A as a percentage of gross came in at 70.4% for the quarter. We typically like to target that below 70%, so somewhere between where we came up and where we've traditionally been is -- directionally a big portion of that would be digital.

And then over the next few years, parts and service growth, we've seen some increasing -- an increase in the growth rate in warranty. It looks like your customer pay has slowed down a little bit possibly offsetting that. What do you think would be a reasonable parts and service, same-store parts and service revenue growth rate over the next few years? Is it low single digits, mid-single digits? Do you think you can get into the high single digits? Do you think you can get into the low double digits?

Our target continues to be -- this is Mike Maroone -- to be in the mid-single digits. We believe we've got opportunity on the customer pay side. The recall activity really did take up a fair amount of our capacity and I think you'll see, as that levels out, you'll see more growth on the CP side. But all in, we think mid-single digits is an appropriate way to look at the business on a forward-looking basis.

And then just one final question for Mr. Jackson. CFPB, can you just give us an update as to what you are seeing there in F&I?

We've implemented in nine stores what we call the [Pacifico] technique. It has been successfully implemented without much disruption and no impact on results. We will now take it to additional stores on a gradual basis. The discussion continues in Washington. My view is ultimately there will be some sort of common ground found around the issue that is acceptable to banks, dealers and CFPB. And that will unfold over the course of the year but my expectation is there will be some sort of agreement and some sort of common ground.

Excellent. Thank you very much.

Colin Langan, UBS.

Great, thanks for taking my question. Any color -- can you just remind us, the recall is 4% of gross profit. What percent of -- 4% of your parts and service is gross profit. What percent of your sales was the recall benefit in the quarter?

I'm not sure that we've got that metric. It is 4% of gross, which is up from prior quarters. The actual sales number I do not have at my fingertips.

And how should we think about the recall? I mean there was obviously some at the very end of the quarter announced. So will this continue through the rest of the year or should we see a dramatic decline going forward? How does it normally play out for these type of recall volumes?

I would say these are not normal times and the recall cadence continues to be quite brisk. Obviously, the OEMs have taken a different view and certainly a more conservative view and are recalling a lot more vehicles. It is difficult to get a forward look. By the way, on your first question, it is about 3% of the revenue. One of my teammates just provided that information.

Okay, thank you. But we should expect -- usually it's -- because people don't usually bring it back and many of them don't come back immediately. So we should still see a lot of them come back over the next couple months.

I think it is going to provide a lot of traffic and that is why we're moving even more aggressively to add technician count, which gives us more capacity, brick-and-mortar capacity.

You can think about it this way. If you just take General Motors, which is approaching 30 million announced recalls of which 500,000 are completed.

Okay, that's helpful.

We'll be talking about this next year.

Okay. Any color -- you mentioned a couple times when you're focused on M&A that you're focused on your core markets. So any thoughts though about going into other geographies that you haven't been in? Is that something that you think might make sense longer term with your new brand strategy and leveraging that in other markets?

Yes, Colin, this is Jon Ferrando. I wouldn't -- we are focused on our core markets, but we also look at secondary markets that fit into our management infrastructure. So that is certainly a possibility if we find the right assets that are very attractive and that fit nicely into a secondary market that we can manage from our existing regional management structure.

Okay. And one last question. There's been some articles about the CFPB starting to look at add-on F&I products. Is there a risk there or any concern about potential regulation on those non-financing products?

We have seen zero real activity in that area. All the focus is on the reserve amount. And when you think about the reserve amount in all the discussion of dealer reserve being put under the microscope, if we look at our finance income, the markup to the customer is about 90 basis points. Our income is higher than that because the bank is paying us a higher origination fee than what's in the contract for having originated the loan. So our finance income is a combination of a markup on a loan to a consumer of 90 basis points on average, and an additional contribution from the bank.

So CFPB is focused on the customer portion, and our 90 basis points is so in line with their thinking, that is why I think we'll find common ground and a solution. My sense is that CFPB will be very satisfied if they can come to an industry agreement on how dealer reserve works. It's always hard to predict the future with the government, but I do not see a lot of scrutiny around the product issue.

All right. Thank you very much.

Rod Lache, Deutsche Bank.

Good morning, everyone. A couple things on used. It seems like a growing number of retailers are focusing on used now, and some are experimenting with the category to drive growth. A couple things on that. Are there signs that the category might become somewhat more competitive going forward? Has AutoNation reassessed the used model, the used business model, in any significant way? And is there a digital opportunity here as well which would help you leverage the inventory beyond individual stores?

It's Mike Maroone. First of all, it's certainly a very competitive environment, and a lot of the discussions about what is happening going forward haven't yet occurred. So people that are announcing they're going to open stores haven't even opened a store. Certainly CarMax has had a pretty aggressive opening, so it has been a very competitive environment. Will it be more competitive going forward? Yes. The market is huge. The market is over $40 million a year versus a new car market in the $16 million. Have we reassessed our desire to go outside of our current store footprint? The answer is no. We think we've got plenty of ability to drive that business in our current footprint. We've been in the standalone business again and I don't see us going back.

Is there an opportunity in digital? There is a huge opportunity in digital and that is why we've rebranded the Company coast to coast and believe that we'll be able over time to provide more traffic driven to our website that we think can give us really nice returns.

Okay, great. And can you also just quickly comment on what drove the $80 million of other revenue in the quarter? It seemed like that was a pretty meaningful uptick.

Other revenue is on the fleet side, so what you see there is an increase in fleet, which is not a material portion of our business.

Okay, great. Thank you.

Brian Sponheimer, Gabelli.

Hi, good morning. Mike, with all the recall activity and all the publicity that GM has gotten, it really hasn't shown up in their retail sales. Just anecdotally what are your GM level dealers telling you about what customers are saying when they're coming back? And do you think -- if you're thinking two or three years down the road, does this open any opportunities for you from an acquisition basis to potentially buy more GM dealers at say a discount than you would some other brands?

This is Mike Jackson. There is a clear, rather sophisticated bifurcation in the consumer's mind about the situation with GM. On the one hand, everybody sees this catastrophic tragedy that occurred around this ignition switch, but they definitely blame that on the old GM and the old GM culture. And at the same time, they see that the new GM has taken all the appropriate steps you would expect a responsible company to take. Mary Barra has given exceptional leadership from meeting with the victims' families to the Valukas report, which is riveting reading and he spared nothing, to her retaining Ken Feingold (sic) to deal with the compensation issue.

And also clearly GM is looking at anything and everything that should even think about being recalled and recalling it to sort of hit the reset button with the vehicles they have on the road and what they have in the pipeline. So that's resulted in the business today within the GM stores is actually quite good. The consumers like the new products, they're buying the new products and as long as GM continues and Mary continues to give this level of leadership through the remainder of the crisis, I think GM will be fine. We have not seen or been presented with any GM store in a distressed sale circumstance. And I don't expect that circumstance to develop.

Okay, thank you. Just one other question, just kind of big picture for the market. We're starting to get some deceleration -- well, certainly some declines actually in housing starts, particularly in the southern United States. Is that affecting how you're thinking about potential increases specifically in pickup truck sales, but also whether we may be running out of a little bit of steam for large durable purchases?

As far as the economic outlook, housing is in a cyclical recovery after a horrendous readjustment period of six years and will now be a long recovery. Will it be perfect every month, every quarter? No, of course not, but I think for the next several years, we are optimistic about the US economy and that includes housing, auto, energy. You really put it together and on a run rate throwing out the first quarter as an anomaly, I mean high 2% if not 3% GDP growth is entirely possible. So we're not concerned about it.

All right, thank you very much.

David Lim, Wells Fargo.

Hi, good morning, everyone. I just wanted to sort of ask about the used vehicles. Going into Q2, I think you mentioned that inventories were light, but I'm sort of curious, back in Q1, I would have imagined that you may have anticipated the flow in Q2 or was there an issue where there wasn't enough new vehicle sales to drive the trade-in? If you could give additional color on that, I would appreciate it.

This is Mike Maroone. We had good enough new vehicle sales. We didn't take the kind of trades we wanted to take and late in the quarter, we went out and started supplementing that inventory and built that inventory as the quarter went along. Again, there was plenty of CPO product and there was a lot of high mileage product, both of which we like, but that mid-tier affordable used car, we didn't acquire enough of them and so we just need to redouble our efforts there.

Was that just a function of availability as you were exiting Q1 or was there some sort of other circumstance behind that?

The market was very tight through Q1 and coming into Q2 and again, we didn't -- you always have pressure on values in Q2 as you move toward the summer, but we just didn't acquire enough of the right product. Again, we've now done that and have experienced a nice short-term growth in the business.

Got you. And then the other question I have is just to clarify, did you hire additional technicians in Q2 and if so, if it weren't for the hiring of those technicians, how would P&S gross margin -- how would that have come in in the quarter?

Well, we've been -- this is not just a Q2 initiative. We've been ramping our technician population up and have -- again, we have a goal of 400. We are over halfway through that goal, but we also have expanded our quick service capability tremendously and those techs aren't quite as efficient as you are shop tech. So we continue to push the envelope and think there is even more opportunity there. So it is a key initiative in the Company.

But another way to answer the question, David, is if we were not adding technicians, we would not be able to grow the business. Our utilization rate's in the high 90%s.

Okay, so your utilization rate -- when you say utilization rate in the 90%s, is that related to your bays or technicians or how should I think about that?

That's related to the technicians.

The capacity issue's on the technician side, not on the bay side, so that's taking your technicians and available hours and to Mike's point, we're in the high 90%s and that is why we're accelerating our efforts.

So to sort of -- to talk about that a little more, so you don't have an issue with bay capacity, it is mainly technician capacity. Are you finding it difficult to hire more qualified technicians?

Yes, it's an issue. These are great-paying jobs. If you take the top 20%, average pay is above $75,000; top 10% is in six figures. These are very well-paying jobs for skilled individuals, but we are competing with other industries for this technical skill. If you look at the energy industry, like fracking, I mean that is completely different than drilling an oil well and checking on it in five years. That is like running a factory. There is technical people on those fracking sites all the time.

So there's a real demand in industry, multiple industry for individuals with technical skills that are willing to pay very well for, but it's not like when we say we need to hire more technicians, we've got a line standing at the door with applications and we just bring them in. We really have to go out and find them. So that is a critical path -- that is a critical path for us on growing the customer care business.

So the question there is I know that a lot of people have been discussing this wave of zero to five, zero to six-year-old vehicles coming through, but it seems like the real bottleneck to really take advantage of that particular wave is having enough technicians on hand. How would you -- would you categorize that as a true statement or is there some sort of thing that I'm missing there?

I think the unexpected level of recalls this year made your statement true. In that, if we had more technical capability, we would be growing faster right now. We have not folded into the plan a record year of who knows what the final number will be, 40 million, 45 million recalls, whatever it is. So in that sense, it gives you an indicator that how on the margin we are here and with just that surge in demand, we are at this point substituting retail recall work for normal customer care work because we don't have enough technicians. So that is why we raised it as an issue, but I also say it's not something we can fix from one day to the next, but we have increased our plan to add technical capacity.

And one final question for you, Mike Jackson. Where do you think US sales will eventually plateau?

Well, I've said that the sustainable rate is between 16 million and 17 million. We give a forecast at the beginning of the year for the specific year. I think we can sustain something between 16 million and 17 million even when rates begin to normalize next year, but I am not one of those who sits here and says you can make a case for 18 million or 19 million. From today's vantage point, I don't see that. If it happens, I'd welcome it, but it's not in our plan. We see a sustainable rate between 16 million and 17 million.

Great, thank you very much.

James Albertine, Stifel.

Great, thanks and good morning, everyone. I'll keep this relatively brief and sorry to beat a dead horse here with a question on used, but I want to understand -- arguably nobody's doing as much incremental work considering that you're ahead of the curve here on this coast-to-coast branding and digital initiative arguably. So I wanted to understand conceptually which is more important considering where we are in the new cycle. Is an incremental new vehicle customer or sale more or less important than a used vehicle customer or sale? So how do you think about how each of those impacts the broader ecosystem?

Well, I think it depends quite frankly on the brand. If you take our Premium Luxury business, it's booming. We have tremendous demand for both new and used, so there is no tension there. I think in the Domestic business, as I called out earlier, trucks are having a great year and that is a traditional strong point of the Domestics, so there's no real tension there.

I think on the Asian business, and we've talked about it before, with the stairstep and very aggressive volume-based incentive programs that, at the store level, at certain points in the month, there is a dilemma and a tension between new and used because you're staring at a very specific new target that has to be met and you have a finite amount of traffic. So I think it's an issue there and we're working very hard to balance that. Mike, do you want to add something?

Yes, I agree with what Mike said and where we really saw it is we saw a fall-off in the CPO business in the Import segment for just the reason he described. There becomes that inflection point where, if you're going to hit the target, you really need to push in one direction. So that's where it really showed up.

Last question please.

Sure. Well, quickly -- go ahead, thank you.

David Whiston, Morningstar.

Thanks. Looking at your new vehicle brand mix within Premium Luxury, Lexus had a lot of the growth in that segment from a mix point of view. Can you talk about what Lexus models are selling well and what type of consumer demographic is driving that increase?

Well, first of all, Lexus has had a number of new products on the car side. They've always dominated on the crossover side, at least in the Premium Luxury. They've got capacity that others don't have. So we're seeing real strength in the Lexus line. It's really performed very well for us. We do not have a lot of stores, but the stores we have high throughput, but it's both in the sedans and in the crossovers.

Okay. And briefly since we're running out of time here, could you just, on the age-old question with Tesla doing the factory-run stores versus the franchise model, can you just comment on why franchise model works, why you think it's superior?

So first, I think Elon Musk has the right to pick whatever distribution system he wants since there's no existing Tesla dealers to harm. When I look at the franchise model, I see that the consumer -- what a consumer pays for a vehicle, around 6% is for retail distribution. 6% of the price they're paying goes to the retailer. I don't think you can find another industry that has a comparable number and we have to pay all our costs out of that. So it is highly cost-effective for the consumer and it is also highly cost-effective for the manufacturer. Again, where else can you distribute a product and only have 6% of its price dedicated to retail distribution costs? So if we were sitting on big fat margins, that would be one thing, but it's very hard to create another model that's going to make that 6% even more efficient than what it already is. There can be some movement here or there, but that's not the case.

So that's how I think about it and then you say, well, how are you guys still in business with that small front-end margin. Well, it's because of used cars, finance, insurance, service and parts and collision, all the other things we do where we have high added value and higher margins. So it's a system that works for all constituents and I'm very optimistic, very confident that 10 to 15 years, 20 years from now, this auto franchise system will still be in place.

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

Thank you. This concludes today's conference. Thank you all for joining.