AutoNation Inc (AN) 2016 Q3 法說會逐字稿

Welcome to AutoNation's third-quarter 2016 earnings conference call. (Operator Instructions). Today's call is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. Andrew Wamser, Treasurer and VP of Finance for AutoNation. Sir, you may begin.

Thank you, operator. Good morning, everyone, and welcome to AutoNation's third-quarter 2016 conference call and webcast. Leading our call today will be Mike Jackson, or Chairman, CEO and President; Cheryl Miller, our Chief Financial Officer; Bill Berman, our Chief Operating Officer; and Jon Ferrando, our Executive Vice President responsible for M&A. Following their remarks, we will open up the call for questions. Robert Quartaro 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. Certain statements and information on this call constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve risks which may cause actual results or performance to differ materially from 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 will turn the call over to AutoNation's Chairman, CEO and President, Mike Jackson.

Good morning, and thank you for joining us. Today I am pleased to share the next phase of our customer-focused, comprehensive brand extension strategy. In 2013, we launched the AutoNation retail brand, a pivotable moment in the Company's history which set the stage for AutoNation Express; AutoNation customer financial products; and now AutoNation USA, stand-alone, pre-owned vehicle sales and service centers. AutoNation USA is the next step in establishing AutoNation as the most recognized brand in auto retail. We have identified 25 AutoNation USA sites in our existing markets, of which five are planned to be opened in 2017.

Several building blocks for AutoNation USA have already been put in place in our existing franchise stores, with tremendous success. One Price, our negotiation-free, pre-owned vehicle pricing strategy, AutoNation Precision Parts, and AutoNation Auto Gear branded parts and accessory lines were each launched in the third quarter. One Price allows consumers to shop over 20,000 pre-owned vehicles on our website, with transparent, hassle-free and fair pricing. Consumer and associate feedback has been phenomenal. Consumers have said the buying experience was very easy, simple, no hassle; just fair pricing. Employees have said it enhances the overall customer experience.

As part of the continued brand extension strategy, we are expanding our AutoNation Auto Auctions, AutoNation Collision Centers, from coast to coast. Our plan is to open four additional auctions over the next two years. We also plan to acquire an additional 18 collision centers over the same period. We expect that these investments in the next phase of the Company's brand extension rollout will exceed $500 million, in the aggregate, over the next several years. The next phase in the Company's history represents attractive opportunities that we expect will generate significant long-term shareholder value.

Turning to our third-quarter results, today we reported EPS from continuing operations of $1.05, which matched our third-quarter record achieved last year. Revenue for the quarter totaled $5.6 billion compared to $5.4 billion in the same period a year ago, an increase of 4%. AutoNation's total retail new vehicle unit sales for the quarter were down 1%; and, on a same-store sale basis, down 6%.

Today we also announced the acquisition of three premium luxury franchises and the award of three premium luxury franchise add-points, which include our first BMW franchise in South Florida and our first Jaguar Land Rover franchises in Texas. We also acquired our 70th collision center in Westmont, Illinois, a suburb of Chicago. Combined anticipated annual revenue from these acquisitions and add-points is $430 million, once the add-points are fully operational.

I now turn the call over to our Chief Financial Officer, Cheryl Miller.

Thank you, Mike, and good morning, ladies and gentlemen. For the third quarter, we reported net income from continuing operations of $108 million or $1.05 per share versus net income of $119 million or $1.05 per share during the third quarter of 2015.

Effective as of the third quarter of 2016, AutoNation will only report its financial results in accordance with GAAP in its earnings releases and SEC reports, and will not include non-GAAP or adjusted measures.

In the second quarter, revenue increased $214 million or 4% compared to the prior year, and gross profit improved $6 million or 1%. SG&A as a percentage of gross profit was 70.7% for the quarter, which represents a 220 basis point increase compared to the year-ago period. The increase was driven by gross profit pressure from certain manufacturers' disruptive marketing and sales incentives in the new vehicle marketplace. We believe that the continued pressure on gross profit from these incentives, as well as expenses related to the brand extensions announced today, may increase our SG&A as a percentage of gross profit by 100 basis points sequentially in the fourth quarter.

The provision for income tax in the quarter was $67 million or 38.3%. Net new vehicle floor plan was a benefit of $14.9 million, a decrease of $2.2 million from the third quarter of 2015. The decrease was primarily due to increased floor plan balances and higher interest rates, partially offset by higher floor plan assistants per unit. Floor plan debt decreased sequentially approximately $263 million during the third quarter to $3.5 billion at quarter end, primarily due to lower new inventory balances, partially offset by increased borrowings on our used vehicle floor plan facilities.

Non-vehicle interest expense increased to $28.9 million compared to $21.4 million in the third quarter of 2015. The $7.5 million increase in interest expense was driven by higher average debt balances resulting primarily from share repurchase and acquisitions. At the end of September, we had $2.8 billion of non-vehicle debt, an increase of $50 million compared to June 30, 2016. Non-vehicle debt includes $975 million of outstanding commercial paper borrowings.

At the end of September, we had no amounts drawn under our revolving credit facility. As a consequence, our non-vehicle debt fixed to floating mix was approximately 65% fixed and 35% floating.

During the third quarter we repurchased 1 million shares for $50 million at an average price of $48.62 per share. AutoNation has approximately $316 million of remaining Board authorization for share repurchase. As of October 26, there were approximately 101 million shares outstanding. This does not include the dilutive impact of stock options.

Our leverage ratio increased slightly to 2.8 times at the end of Q3 as compared to 2.7 times at the end of Q2. The leverage ratio was 2.7 times on a net debt basis, including used floor availability; and our covenant limit is 3.75 times.

Capital expenditures were $69 million for the quarter. Capital expenditures, again, 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 $843 million at the end of September.

We are very excited about the brand extension opportunities announced today and their ability to diversify our business, and, once fully ramped, improve our profitability. We will continue to focus on driving shareholder value through strategic investments and opportunistic capital allocation.

Now let me turn you over to our Chief Operating Officer, Bill Berman.

Thanks, Cheryl, and good morning, everyone. Today we are excited to announce and share our comprehensive brand extension strategy. I will start with AutoNation USA, or stand-alone, pre-owned vehicle sales and service centers. Our plan is to open five AutoNation USA stores in 2017. We have also identified 20 additional sites over the next several years within our existing markets. Customers will have the opportunity to purchase an AutoNation certified vehicle and service that vehicle at any AutoNation USA store. AutoNation USA will utilize AutoNation Express, the company's digital platform which allows customers to dramatically reduce their transaction time by offering a seamless, end-to-end experience where they can search online for inventory, select and reserve a vehicle, value their trade, see payment options, and apply for financing.

One Price is a negotiation-free, pre-owned vehicle pricing strategy, which we have already begun to roll out in our current franchise locations, will also at the pricing strategy at our AutoNation USA stores. One Price allows us to leverage our centralized capabilities such as centralized pricing and appraisals. Initial customer and associate feedback has been exceptionally positive. One Price offers customers a transparent and stress-free buying experience, and will be fully implemented in our existing locations by the end of the second quarter of 2017.

AutoNation USA will implement our new sales associate non-commissioned-based pay plan as well. The new pay plan has four simple metrics that give us a strategic advantage in recruiting associates. Our new pay plan offers salaries and paid training; is competitive; and it is a plan that is based on rewarding behaviors that drive productivity while delivering a peerless customer experience.

AutoNation USA stores service [now] centers will utilize AutoNation Precision Parts, an AutoNation branded line of high-quality, competitively priced maintenance and repair parts for the vehicle reconditioning and customer repairs. We launched AutoNation Precision Parts in the third quarter with AutoNation branded batteries, which feature an industry-leading free lifetime replacement guarantee. Service now will also allow us to engage and recapture customers who are post-warranty and are no longer servicing at the franchise stores. We now offer consumers a compelling value and options, as well as drive service retention.

Also in the third quarter, we launched our automotive accessory line, AutoNation Auto Gear, featuring our partnership with WeatherTech, a leader in aftermarket auto accessories. We will continue to expand our Precision Parts and AutoNation Auto Gear product lines in phases, as their product portfolios are developed.

In addition, we are expanding our very successful AutoNation Auto Auction from coast to coast. We have a successful wholesale option in Southern California processing over 25,000 vehicles annually. We plan to leverage our brand and expertise in additional markets by wholesaling our own vehicles and offering third-party buyers and sellers access to high-quality inventory. We plan to open four additional AutoNation-branded auctions over the next two years, starting in Orlando, Florida, and Houston, Texas, in Q1 2017.

Lastly, our brand extension strategy will also include expanding our AutoNation Collision Center footprint. AutoNation currently owns and operates 70 collision and repair centers, including the newly acquired Westmont Body Werks in Westmont, Illinois, a suburb of Chicago. AutoNation has the largest collision center network among automotive retailers, with expertise and certifications with multiple manufacturers, and is a preferred repair provider for many of the major insurance carriers. New locations are planned for key markets were AutoNation has store density but does not have existing collision presence, or has capacity limitations.

Over the next two years, we plan to open or acquire at least 18 new AutoNation-branded Collision Centers across the country. The steps we have taken with the launch of our customer-focused comprehensive brand extension strategy and diversified business model will position us to capitalize on our industry's leading retail brand.

Now turning to our third-quarter results, my comments today will be on a same-store basis as compared to the prior year, unless noted otherwise. Gross profit for variable operations was $435 million, down 8%. Variable gross was $3,320 on a per-vehicle retail basis, which was relatively flat compared to the same period last year. New and used same-store unit volume was down 6% compared to the third quarter last year.

Certain manufacturers continued their disruptive marketing and sales incentives, which resulted in multi-tier pricing despite new vehicle sales being down again in the third quarter. Manufacturers must find a rational and disciplined approach that does not erode their future brand value.

New vehicle revenue for the quarter was $3 billion, a decrease of $87 million or 3%. We retailed 81,600 units, a decrease of 6%. New vehicle gross profit was $1,805 on a per-vehicle retail basis, down 7%. As of September 30, approximately 14% or 5,400 units of our total used vehicle inventory was on hold, due to the Takata airbag recall. The Takata airbag recall negatively impacted our net income from continuing operations by $6 million after tax, or $0.06 per share. We started to receive limited Takata airbag replacement parts for Honda and BMW only.

Used vehicle retail revenue was $1 billion, a decrease of $25 million or 2%. Used vehicles retailed for $51,500, down 7%. Used vehicle gross profit was $1,543 on a per-vehicle retail basis, an increase of 2%.

Customer Financial Service's total gross profit was $215 million. Customer Financial Service's gross profit, on a per-vehicle retail basis, was $1,617, an increase of $60 or 4%.

We set an all-time record in customer care gross profit of $338 million, an increase of $6 million or 2%. Also in the quarter, customer care revenue was $782 million, an increase of $22 million or 3%. [Customer] paid gross was $138 million, up 4% year-over-year. Warranty gross was $71 million, up 9%. Collision gross was $29 million, up 1% year-over-year.

Finally, I would like to welcome our new San Diego, California, and Westmont, Illinois, associates to AutoNation; and would like to thank AutoNation's 25,000-plus associates for their hard work and dedication. This is truly an exciting time to be part of the AutoNation team as we launch AutoNation USA and implement our customer-focused, comprehensive brand extension strategy which will create new revenue and profit streams for the Company.

I will now turn the call over to Jon Ferrando, Executive Vice President responsible for M&A.

Thank you, Bill, and good morning, everyone. We are pleased to announce the addition of six premium luxury franchises and a collision center, with combined anticipated annual revenues of $430 million. Three of the premium luxury franchises are add-points awarded to us by the manufacturers; and the other three premium luxury franchises and the collision center our acquisitions.

Starting with acquisitions, in October we completed the acquisition of BMW of Vista, our second BMW store in the Northern San Diego market, and our 15th BMW store nationwide. As part of our AutoNation brand extension strategy, we also completed the acquisition of Westmont Body Werks in our Chicago market, our 70th collision center. In the fourth quarter, we expect to close on the acquisition of Jaguar Land Rover Bethesda, our 10th store in the Baltimore/DC market, and our eight Jaguar Land Rover store nationwide. The store has the largest Jaguar Land Rover showroom in the United States, and fits well with the strong premium luxury demographics in that part of the Baltimore/Washington DC corridor.

We also announced the award of BMW of Delray Beach and Jaguar Land Rover West Houston add-points. BMW of Delray Beach is our first BMW franchise in South Florida, and our 25th premium luxury franchise in Florida. Jaguar Land Rover West Houston is our 10th premium luxury store in Texas. The add-points will be large premium luxury stores located in excellent auto retail locations with very attractive luxury and growth demographics. Both of these add-points are expected to open in 2018.

In 2016, we have completed or announced the acquisition or award of 49 franchises which are expected to generate approximately $1.5 billion in annual revenue, once fully operational. As of today, we represent 35 manufacturer brands. And our store portfolio numbers 372 franchises and 262 auto retail stores, along with 70 collision centers in 16 states.

Looking forward, we will continue to actively pursue acquisitions and new store opportunities with a focus on enhancing brand representation within our existing markets, and markets that can be supported by our existing management infrastructure. We will continue to be selective and prudent with our capital, with a focus on investing to produce strong returns and long-term shareholder value.

I will now turn it back to Mike Jackson.

Thanks, Jon. This year, and through the third quarter, certain manufacturers continued disruptive marketing and sales incentives which resulted in multi-tier pricing that were unfair for consumers as well as retailers. In the third quarter, these marketing programs had a significant negative impact on new vehicle volume and gross profit for vehicle retail. These disruptive incentive programs are damaging to the OEM brand, and, in my view, unsustainable.

Retail sales volume for manufacturers who use these toxic marketing programs are significantly below market with, let's say, the market basically at retail flat for the year, and the irrational players being down 6%. And I also observed that they are eroding the three-year residual value of their brand. Whereas the rational marketers have a three-year resale value of 50%, the irrational marketers are at 43%. This is undermining the resale value of their existing customers and, therefore, their brand. These certain manufacturers must find a rational and disciplined approach that does not erode their future brand value.

Having said that, this is an exciting time for AutoNation with the launch of AutoNation USA and our comprehensive brand extension strategy. We have built an outstanding, industry-leading brand. And we remain committed to achieving and sustaining operational excellence by continuing to create a peerless customer experience.

With that, we are delighted to take your questions.

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

Just a first and probably obvious and simple question, Mike -- as you are going through this process and launching all these new initiatives, really just a very simple question is, why now? And what's driving this decision? Is it something that is hampered or pressure you're seeing in your core business? Is it something that you are seeing your competitors do that is pretty good? And how does this differ from the old cradle-to-grave strategy of the late 1990s that wasn't that successful?

Thanks, John. Well, I view -- if I look at the automotive retail marketplace, for retail, new, it's less than $15 million. For retail, pre-owned, it's approaching $40 million. So you also have to take into consideration that the new vehicle market is definitely cyclical with 1 to 3 phases: growth, plateau and decline. Now, you can be in plateau quite some time, but plateau brings a whole other set of issues. So if I go back five years ago, anticipating the plateau would eventually arrive, I said I need a strategy that we can take much more of our destiny in our own hands and continue to grow the business.

Now, to be able to do that successfully, I felt we needed two foundational elements. One was a brand that was well-known in the marketplace already, and a digital capability that we knew could deliver sales. So we've done both of those steps successfully with the AutoNation brand. And with our AutoNation Express launch, it now delivers almost 30% of our sales from those sites.

So, having taken that step as preconditions, in order to give us the confidence that these stores would turn profitable quickly, we knew we needed a value equation for the consumer and an outstanding experience. We know the customer craves fairness and transparency in price. And that means they need to be one priced. So then we said, well, the brand has to be in alignment between our existing franchise business and this extensive business; therefore, we have to One Price our existing pre-owned business. So that started already this year as a conditional element, and has gone extremely well. And we will have all AutoNation franchise pre-owned at one price sometime at the beginning of next year, but certainly by the time the first AutoNation USA stores open.

Next, these AutoNation USA stores have a customer care component. We wanted a value story there. Again, to your point, we do very well taking care of cars that are new to five, six, seven years old, and then there's a big drop-off. So we want to attract that market, but we need a value equation. So we went -- we are significant purchaser of parts already today; so we went to major suppliers and negotiated exactly what the consumer would want, and are launching AutoNation branded parts and accessories.

We are highly confident of the degree of trust from the consumer because of the AutoNation financial products that we have already launched. Again, we went to the major suppliers; say we have a profound understanding what the consumer wants; here's the value equation have to meet. But now the customer has to trust the product. And so it has to be branded AutoNation. And we see already that the adoption rate in all the AutoNation branded stores is approaching 95% of the AutoNation customer care products.

All of that means that the significant cost of launching a brand has been done. The significant investment in launching AutoNation Express is done, opening the door to make brand extensions and realizing opportunities that you have created by what has come before.

Now, referring back to the old megastores, I was here for that. And there was many customer-friendly elements that I liked. There was cradle-to-grave elements that didn't make sense, like the whole linkage between the rental car business and the megastores. The megastores, having said that they had many customer elements that were to be admired, were conceptionally completely the wrong size and scale, with no ability to fix it. And most importantly, a brand didn't exist, and there was no alignment between the franchise business and what would be this free-standing business. So conflict was inherent.

So all those issues are resolved today. And we now move into this brand extension step with many more elements; alignment with the existing business; and in a very strong position, with the goal of having much more control over our destiny. And what I perceive we ultimately having then is the largest premium luxury business at retail in America, approaching with what Jon Ferrando just announced -- 100 franchises in the premium luxury business, coast to coast; a volume franchise business branded under the name AutoNation; and, now, a free-standing AutoNation USA business that we can -- what we see as a significant opportunity to grow in the much larger pre-owned business, but doing it from a position of strength.

Okay, that's very helpful. Mike, given that you have the brand established and you are looking to go longer in the lifecycle of the asset, or to a second or third consumer -- I'm just curious how far you go down, or how far out you go in the extension of the life of the vehicle. I know you're just talking about 5 to 6 years. But is there an opportunity to go deeper to sell the asset and then service the asset, and leverage what you have built right now?

And then, when we think about this extension that you are -- extension you are manufacturing right now, when will the payback period come into play, because we are talking about big dollars here? I'm just curious, as you build out these collision centers, or acquire collision centers and build out these stores, we're just trying to understand what the payback period will be. And if it's really successful, you keep going deeper and deeper in the asset life, or the life of the asset.

Absolutely, John. You are spot-on. So we intend to be involved with customers on vehicles that are up to, if not beyond, a decade old. And we know these vehicles very well: who owns them, where they are, why they drop off. And we absolutely intend to attract them.

So, as far as the payoff, here's the way I think about it. If you look at our performance in financial products, it's already exceptional. And a big part of that growth, and why it's sustainable is because of the AutoNation financial products. So it's if the payoff was immediate for having built the brand.

So what are the extensions that have immediate benefit to the Company? Parts. Because these parts, these AutoNation parts are going to be available in our franchise stores as well as the AutoNation USA stores. The benefit is immediate. We have significant batteries, wiper blades, filters, already in there. And we are in negotiation with a supplier for hundreds of more parts that will be available both in our franchise business and in the AutoNation USA store. The benefit of that is immediate, both for the customer and for AutoNation.

Of course, we will continue to offer OEM parts. And of course we will use them for all warranty work, or all customer care work that the manufacturer pays for. But beyond that, we will offer our customers choices. And we think there will be a high adoption rate, just like we saw in the service contracts. And oh, by the way, we will then be able to have this supply of parts on a much better cost basis for our reconditioning in our USA stores, and in the customer care aspect of our USA stores. So there is an immediate benefit for that; the same thing with accessories. And by the way, the returns or moves to profitability from our auction site and on collision centers is very quick.

Now, the USA stores -- there's a ramp in it. I think we'll be, in the second year, to see profitability from these stores, or break into profitability. But I have a high degree of confidence that we will have significant market awareness and ability to generate sales because of our AutoNation Express capability. So that gives me a great deal of confidence to say the second year, these stores are going to break into profitability.

Now, for the last few quarters and early into next year, is there a surge of spending and investment in all the training, building up the facility teams, and everything else that has to go on to launch something? Yes. We will take that in stride. It's nothing like launching a brand or launching AutoNation Express, but it's in there. And then that will move behind us. And then as the stores, the AutoNation USA stores, start moving into profitability, we will continue to build out, as we have identified another 20 sites in development.

So we are not starting from a standstill here, is my point. And the return that we are receiving for certain initiatives is already a payback for some costs or past costs that we have already put into the brand in AutoNation Express, is the way I think about it. Now we are really going to be reaping the opportunity of what we paid for in 2013, 2014 and 2015. Now everyone sees why we took the risk and spent the money to create a brand and create additional capabilities.

Now, in the very near term -- by that, I mean right this minute and into 2017 -- will I have some more costs to get these things up and going? Yes, I will. But that will be mitigated by the other initiatives. And once you get past that first tranche of stores, off we go.

Paresh Jain, Morgan Stanley.

Good morning, everyone. I just have one question, on -- again, a follow-up on AutoNation USA. When look at the public dealer space, it's kind of split here on having stand-alone use stores, which obviously involves a lot more brick-and-mortar spending; and then there are new entrants focused completely on online transaction, and taking massive SG&A costs out of the selling process. And they're getting some traction too, but it obviously requires a lot of marketing push.

The question is, given AutoNation's unique positioning here, why not leverage your brand and digital capabilities through a bigger marketing push in the near term for online-only businesses and gaining share through an asset-light model, with much lower SG&A costs, rather than a brick-and-mortar strategy?

So we have all that. I have the brand AutoNation, and you can't attract millions of leads to your websites without a brand. That's one of the reasons why we took down local market brands that were 100 years old and went to AutoNation. And if you look at AutoNation as an automotive retail site generating business, it is extraordinary what we've achieved in two short years.

Now, to your point on the cost side, we will absolutely take AutoNation Express, extend it into the store as an operating system, as the enterprise operating system. However, we are still convinced that brick-and-mortar plays a role. That it is an expensive item that people are purchasing and they want the flexibility to change their mind. But you've got to get them there in a cost-effective way, and have a cost-effective experience that moves at a speedy pace. So we think we have all that thought through. And there's no question in our minds that we will be able to compete.

And by the way, the one price across the entire enterprise, as we are now doing, means that you're centralized pricing and you're centralized purchasing, and you have an auction system to support it all. All of that is either done or underway. So all those risks and costs have been borne, have been taken. And now we have the bulldozers moving on the sites. And that gives us a high degree of confidence that it will present the consumer with a compelling value equation with a brand that they trust, that we've been able to attract to the store and deliver to them in a very cost-effective way.

Understood; that's good color. Just a quick follow-up on the size of the store. Can you comment on that? Because, again, when you look at some of your public peers, they are gravitating more towards smaller-format stores. Is that something AutoNation would be doing, or what kind of store size we could expect from AutoNation?

So we will just describe the size of the store, and you can judge whether that's big or small.

Bill, could you please describe a typical store?

Sure, Mike and Paresh. There are between 4 to 6 acres. The building footprint will be between 30,000 to 35,000 square feet. Total capital required, inclusive of property, is in the $12 million to $14 million range, obviously depending on what market we're going to be operating in.

Got it. Thank you so much.

Bret Jordan.

On the labor model on the AutoNation USA, given the fact you are going to go to aftermarket parts, are you also going to be charging similar labor rates for the franchise? It seems like most used-car buyers are looking to save money on the service side; yet, you are pushing service. And from a same-job level, will pricing be different with the franchise?

I resent the aftermarket term, or whatever it is. These are going to be AutoNation parts from outstanding suppliers with a brand that the consumer can trust.

Bill, why don't you discuss a little bit how you see the customer care business?

Absolutely. Thank you, Mike. And, Bret, the way we are looking at it, it's going to be a value proposition to our consumer. They will be able to have the experience of a new car franchise dealer but at a price point that more closely resembles independent and outside repair facilities. So it will be a value proposition. To Mike's point, we will be able to secure and leverage our AutoNation branded parts, our AutoNation Auto Gear; and then have a price point, once again, that is more competitive towards the independents and provide the customer with a value proposition.

On those parts, how do you manage the supply chain? Obviously a lot of parts in the automotive space -- not the aftermarket, of course -- turn fairly infrequently. How deep are you going to go in direct sourcing the parts? And are you warehousing? Are you direct importing these products? And could you describe the supply chain around that?

This is Mike Jackson. We're going to start with the most straightforward parts we can; namely batteries, wiper blades, filters. And that's already done. And then, step-by-step, we are in discussion with all the various suppliers where we lay the market opportunity, the value creating, and what the consumer wants. And you can see that expanding into hundreds of parts, or it could be thousands of parts. But that's going to be something that develops over the next several years. And it's a little bit difficult to say how we are going to structure all that from an operating and distribution point today. But we will find the optimal line and pursue it.

Okay. One housekeeping: what did you say your collision growth was in the quarter?

It was 1%.

Okay. Great. Thank you very much.

David Tamberrino.

The first one is just on your One Price initiative. Just trying to understand what type of impact you may be expecting from that on your average selling price and your gross profit per unit, going forward.

We expect no change on volume or pricing is our working premise. But having happier customers and happier associates, and taking cost and complexity out of the transaction, and to be able to put in place a different play plan and an associate with a different skill set. We have done several markets so far. Bill will call out which ones. And that is basically -- the result we have, you could maybe describe it even more optimistic than that. But I would say it basically is affirming that as a working premise.

Bill, why don't you talk about -- you go to every market and roll it out. Why don't you talk about the reaction you get from the store associates and from customers, and how it's performing?

Thanks, Mike. So currently we are in Corpus Christi; Houston, Texas; Las Vegas, Nevada; Phoenix, Arizona. We are in the process of rolling out the balance of Texas, as well as Denver. And to Mike's earlier point, we will have the entire country rolled out by the end of the second quarter of next year. The response from the field has been overwhelmingly positive both from our associates, management, and even, most importantly, from our customers. To Mike's point, we have seen no degradation in our volume or in our PVRs. In a lot of cases, we are actually seeing a little bit more productivity out of our salespeople because they are not having to do the back-and-forth on the used vehicles, and the transaction times have come down significantly.

Understood. That's very helpful. Maybe my second one -- Mike, you have been very outspoken on the state of the industry and OEM discipline and the state of incentives; in stair-step programs again today, some more comments. I'm curious to get your thoughts on what impact you believe that has been having on the pace of sales, and what your early thoughts are heading into 2017, from a US SAR perspective, as it looks like, at least from our perspective, that sales are being somewhat pulled forward from incremental incentive and stair-step and leasing penetration levels?

So I go back to my Automotive News World Congress speech at the beginning of the year. And I said those manufacturers who pursue stair-steps that result in multi-tier type pricing, it will be a disaster, and very disruptive in the marketplace. So most manufacturers did not go down that road. Most manufacturers -- I give them credit -- are running the business in a very disciplined way, successfully, with an eye on the future. And I see nothing to alarm me.

Those who embraced stair-steps, whatever you want to call them -- in the short term, yes, you get a pull forward in sales. But over an extended period, and certainly by the third quarter it is an extended period, you clearly -- it's indisputable that these multi-tier pricing systems are so unpopular with the vast majority of customers and retailers that your business begins to decline.

So if I bifurcate the world into disciplined and undisciplined, or rational and irrational, and look at the numbers, basically retail for the disciplined, rational group is flat. And it's down 6% for the stair-steppers. And if I look at retail values for the stair-steppers, it's eroding significantly, meaning it's unsustainable. Now, I salute a company like Ford Motor Company that endeavored with stair-steps. They have stepped away and have taken a much longer, disciplined few. They are to be congratulated.

The one practitioner who is still absolutely convinced that stair-steps is the way to go is Nissan. And it's obviously a very contentious situation at the moment. And the end of that story I don't know, but I do know it's very disruptive to the Nissan business. And we will have to see what happens there.

But I think, in principle -- I think this is the big message: in principle, the whole industry has watched this story unfold in 2016. And once you see the resale values gap remain as large as it is, it's not growth. 700 basis points of difference, you cannot make the case that stair-steps work. And then what you see is they start dumping more into fleets to try to cover up the fact that it's not working at retail. In my view, it's unsustainable. And there's movement away from them by certain manufacturers. I don't expect others to get in, in a significant way; but how plays out with Nissan, I don't know.

Very helpful. And then just any early thoughts on where we are tracking to, and what you think the industry looks like from a new perspective in 2017?

I think it looks a lot like 2016, with more movement towards trucks. I've said this before. I said it at the beginning of the year. I think the demand for trucks is over 60% of the market, and the only restriction has been -- it's call productive capacity. So I think all the manufacturers agree with that, and have been adapting their production as much as possible to be more in alignment with the marketplace. And that is certainly good for the industry overall to have -- first, it's more profitable for the manufacturers on the truck side than on the car side. And they have a better alignment between what people want to buy and what you are producing. It is always better.

But I think it's basically a plateaued environment. And when I say plateaued, that's a couple points up, a few points down or flat, something in a narrow corridor is most likely what we are looking at. Hopefully, -- I wouldn't even say -- I am confident there will be fewer practitioners of extreme stair-steps in 2017. And, most importantly, I hope there's a much better availability of Takata air bags.

Understood. Thanks for your thoughts.

Michael Montani.

I just wanted to ask, if I could, on the $0.5 billion of investment, can you split out what is overhead versus CapEx in that? And also, how should we think about the SG&A ratio for the next year or two, as well as CapEx needs for the next year or two, Mike?

The $500 million is all capital. So that includes the five stores that we will open next year and the other 20 in development. It includes expanding our collision footprint by 40% -- don't go by rooftops -- we are expanding our collision production potential over the next several years by 40%. And we are building an auction system. So the $500 million covers those 25 stores, the additional collision capacity, and the additional auctions.

On the SG&A side, the cost of building the brand, AutoNation Express, et cetera, is already in our numbers. There is certainly some cost, at the moment, into next year with all the training, development, systems to extend into the stores, both the franchised -- changing the franchise business and the existing stores, as Cheryl already said. There will be some impact on SG&A, whether she wants to add something there.

But there is a tipping point that we'll go through where the brand extensions and operating profits they create for us, versus the cost of opening stores, do cross over. And after that, it's all very beneficial with outstanding returns. Our calculation on the $500 million is it is significantly above what it costs us to acquire a franchise business.

Cheryl, you want to talk about SG&A?

Yes. [I think] I would add is just that the base cost of the business, we are keeping very tight, but we are continuing to be bullish on the brand extension strategies. So we're going to put some cost there in the ramp-up phase. As Mike pointed out, we expect collision, other businesses we have been in a long time, we understand the ramp of that. That's very quick. The parts expansion margin opportunities will be very quick over the next several quarters. You're going to see some pressure in SG&A.

But as we continue to run the other cost type, we talked about a sequential 100 basis points left in SG&A as a percentage of gross profit. You may see some of that push in the beginning of next year. And then you'll start to see some of the brand extensions kick in. So in the next call, we will give further guidance on that.

Thanks. Can you flesh out a little bit, Cheryl, maybe the CapEx? I think $250 million or so was the run rate. But is that still relatively steady, or is there going to be an incremental step-up we should know about?

This is Mike Jackson. The way I think about it -- first, our ability to generate cash and capital is very compelling. And our first investment of capital will be in the existing franchise business to keep it absolutely as it needs to be. And in our brand extension, that is -- the AutoNation brand extension -- that is our clear focus. We keep an eye on our investment-grade balance sheet. I like that very much. If there is a significant share repurchase opportunity, we wouldn't hesitate to take it. Or if there is a significant acquisition opportunity that fits into our footprint and our strategy, we would be open to it. But that's how I think about it.

Cheryl, anything you want to add?

Yes, I would just add that on base CapEx, we continue to be prudent. We look at the brands and markets where we think it makes sense to continue to invest in, so there's really no changes to the space. Capital strategy -- so I would add that with AutoNation Express and the different programs with respect to the brand extensions in Auto USA, we are being prudent. We are doing most of that in existing markets. So in certain cases, you can repurpose or look at existing land and different things there to control the total capital investment. Again, the potential for $500 million is based over a number of years. And we'll continue to pace that out as we identify sites and as we look at our base CapEx plan.

So I think big message is we have $850 million of liquidity today, great access to the capital markets for future. And we feel extremely well-positioned, really supported by the fact that the base model kicks off a lot of cash. Keep in mind that with Auto USA, we have service component in there, as well, which is very cash-generating.

Thank you.

Bill Armstrong, C.L. King Associates.

On the AutoNation USA, where would you be sourcing the inventory? Will this come mainly from auctions and consumers? Or would some of the existing stores supply some of the inventory, either initially or on an ongoing basis?

It will be all of the above. Obviously, we are going to need a lot more inventory. And we have worked very hard to build a central acquisition team to do that, that we can supply incremental product both to our existing AutoNation franchise business and the AutoNation USA stores. It is the reason we are building an auction system to -- for what we do acquire and trade, that we have a very good way to balance inventories. And I'm not worried about supply. I think we have that pretty well thought through.

Bill, anything you want to add?

Yes. What I would add is, once again, because of our centralized capabilities, we have access to inventories that not everybody else has. We will be buying from auctions. To a limited extent, there will definitely [be the will] buy your car component, which is to sit here and attract inventory from consumers that are not looking necessarily to purchase a vehicle. Plus we have our current source of inventory which comes from trade-ins from our existing stores. Plus with the influx of cars coming off of lease over the next 12 to 18 months, there will be additional inventory that's going to come in that the existing new car franchise stores will not be able to handle all of it. And we will be able to use that inventory to help supply our USA stores.

Got it. And then on the expansion of your in-house auctions, I think you've got one right now in Southern California. What's the rationale for that? Is that to try to maybe get better GPUs on your wholesale cars? Or is it more to supply the AutoNation USA, or all of the above?

We have found the auction system that we have in California gives us outstanding market information, and gives us the highest value for the vehicle that is not appropriate for us to retail. So that auction is very profitable for us. So I think building an auction system across the enterprise to run this integrated AutoNation pre-owned One Price system is a key component. And we think, yes, it will be profitable, in and of itself.

Okay, because most of the public dealers don't make money on wholesale, or they lose a little bit of money. And in the obvious exception is CarMax, who makes about $1,000 per vehicle. So it seems like there could be an opportunity there.

We think centralized valuation with an auction system is the Holy Grail to achieve that goal.

Got it, thank you.

David Whiston.

A couple questions on a few different areas. First, for Cheryl, on the balance sheet: regarding the April 2018 note maturities, and then mortgage bullet next November, do you intend to pay those from cash on hand or a refi?

Yes, Dave, from the mortgage perspective, that's not a material maturity for us, given the $850 million of liquidity. We certainly have opportunities to refinance that in an existing way, if needed. So beyond that I think with respect to note maturities, certainly that is something that we look out well in advance. We have continuous capital market discussions. And we will elect a great time in the market that results in a good outcome for investors and ourselves.

So we continue to keep an eye on those maturities but we don't view any of those as causing any liquidity issues or considerations, given the relative size of those. We continue to obviously be very well-received in the investment-grade market. I would highlight that we are the largest A3/P3 commercial paper issuers. And certainly investor appetite for the AutoNation brand and name remains extremely strong.

Thank you. On AutoNation USA, I'm not clear on the age spectrum of the inventory to be retailed. Are we talking mostly late model, or the full spectrum?

No, they will definitely be late models. We start with our CPO, manufacturer CPO program in our franchise business. That will remain there, and a big part of our business. Then you have vehicles that are somewhat older that do not qualify from an age or mileage point of view for the CPO programs within the franchise business. And we will have an AutoNation certified program within the AutoNation USA stores. But they will be of an older age and higher mileage than what's in the franchise business. So it's a different market segment.

I'd like to thank everyone for joining us today. We are at the time limit that we have been allotted for. Thank you for all your questions; very much appreciated. Thank you for joining us.

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