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AutoNation (NYSE:AN)

Q4 2012 Earnings Call

January 31, 2013 11:00 am ET

Executives

Cheryl Scully - Former Vice President

Michael J. Jackson - Chairman of the Board and Chief Executive Officer

Michael J. Short - Chief Financial Officer and Executive Vice President

Michael E. Maroone - President, Chief Operating Officer and Director

Analysts

Elizabeth Lane - BofA Merrill Lynch, Research Division

N. Richard Nelson - Stephens Inc., Research Division

Patrick Archambault - Goldman Sachs Group Inc., Research Division

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

Simeon Gutman - Crédit Suisse AG, Research Division

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

Operator

Thank you for standing by, and welcome to AutoNation's Fourth Quarter and Full Year 2012 Earnings Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time.

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

Cheryl Scully

Good morning, and welcome to AutoNation's fourth quarter and full year 2012 conference call and webcast. Leading our call today will be Mike Jackson, our Chairman and Chief Executive Officer; Mike Maroone, our President and Chief Operating Officer; and Mike Short, our Chief Financial Officer. Following their remarks, we will open up the call for questions. Kate Keyser-Pearlman and I will also be available by phone following the call to address any additional questions that you may have.

Before we begin, let me read our brief statement regarding forward-looking comments and the use of non-GAAP financial measures. Certain statements and information on this call will constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve risks, which may cause the actual results or performance to differ materially from expectations. Additional discussions of factors that could cause actual results to differ materially are contained in our SEC filings. Certain non-GAAP financial measures, as defined under SEC rules, will be discussed on this call. Reconciliations are provided in our press release, which is available on our website at investors.autonation.com.

And now I'll turn the call over to AutoNation's Chairman and Chief Executive Officer, Mike Jackson.

Michael J. Jackson

Good morning. Thank you for joining us. I'm joining the call from New York, where today, AutoNation announced the rebranding of 210 franchises under a single AutoNation name. The launch of the AutoNation brand unifies us under 1 flag, AutoNation, rather than as local market brands. The coast-to-coast rollout of AutoNation brand involves 23 manufacturer brands and 210 of their franchises. It will begin tomorrow, February 1, in South Florida and will be completed in June. We have worked to provide a peerless customer experience across the enterprise. AutoNation is a brand that stands for leadership, transparency and peerless customer care.

This is an incredibly important and proud moment for us as a company, and has the full support of our manufacturer partners, who approved the change to the AutoNation brand. Our associates are thrilled and have fully embraced this endeavor. Since my arrival, we have laid the foundation for this transition by investing more than $3.7 billion in new and upgraded facilities, developing best practices in our stores and the Shared Service Center and completing strategic acquisitions across the country, while focusing on the customer as our #1 priority.

Today, we also reported an all-time record adjusted quarterly EPS from continuing operations of $0.67 for the fourth quarter, a 31% increase on a per share basis as compared to $0.51 for the same period in the prior year. Fourth quarter 2012 revenue totaled $4.2 billion, an increase of 13%, driven primarily by stronger retail new vehicle unit sales. We also reported an increase of 18% in operating income to $169 million. In the fourth quarter, total U.S. industry new vehicle retail sales increased 13% based on CNW Research data. In comparison, during the same period, AutoNation's new vehicle unit sales increased 18%, or 17% on a same-store basis.

For the full year, adjusted EPS from continuing operations of $2.54 was a record, also up 31% over prior year. Revenue for the full year was $15.7 billion, up 13% over prior year. 2012 also marked the second consecutive year of over 30% year-over-year growth in EPS from continuing operations. Our planning assumption for 2013 industry new vehicle unit sales is mid-15 million units, which would be a strong improvement over 2012, when new vehicle sales reached 14.5 million units.

We believe that replacement demand, attractive new products and strong consumer credit will continue to support sales, and the improving housing market will also support sales. I would point out that, even though new vehicle buying is recovering from the depression levels of the past few years, our Customer Care and used vehicle businesses, which represent over half of our gross profit, are only beginning to recover in 2013. The auto retail recovery still has many years to run and I remain as optimistic as ever.

I'll now turn the call back to Fort Lauderdale and our Chief Financial Officer, Mike Short.

Michael J. Short

Thank you, Mike, and good morning, ladies and gentlemen. For the fourth quarter, we reported net income from continuing operations of $83 million or $0.67 per share versus adjusted net income of $71 million or $0.51 per share during the fourth quarter of 2011, a 31% improvement on a per share basis. There were no adjustments to net income in the fourth quarter of 2012. Adjustments to net income in prior periods are included in the reconciliations provided in our press release. In the fourth quarter, revenue increased $495 million or 13% compared to the prior year and gross profit improved by $54 million or 9%. SG&A as a percentage of gross profit was 69.9% for the quarter, which represents 140 basis point improvement compared to the year ago period.

Our improved operating leverage continues to reflect our lean cost structure and increased productivity in our stores. As part of our AutoNation branding initiative, we will incur approximately $18 million of incremental, non-recurring SG&A expenses, or about $0.09 per share, primarily in the first half of the year. While we would expect a short term impact to our operating leverage from these investments, it remains our long-term objective to operate below 70%.

Returning to fourth quarter results, net new vehicle floorplan was a benefit of $6.9 million, an improvement of $0.9 million from the fourth quarter of 2011, due to higher floorplan assistance, driven by higher new vehicle sales volumes, as well as lower floorplan interest rates. Floorplan debt increased approximately $340 million in the fourth quarter to $2.5 billion at year-end, as we increased our inventory levels in line with increasing sales volumes. Non-vehicle interest expense was $21.7 million for the quarter, an increase of $4.3 million compared to $17.4 million in the fourth quarter of 2011 due to higher debt balances.

At the end of December, we had $540 million of outstanding borrowings under the revolving credit facility, and total non-vehicle debt balance of $2.1 billion. This was an increase of approximately $200 million compared to September 30, 2012, primarily used to fund our acquisitions in the fourth quarter. The provision for income tax in the quarter was $52 million or 38.6%. For the full year 2012, we repurchased 16.6 million shares for $581 million at an average price of $34.89 per share. From October 1, 2012, through January 30, 2013, we repurchased 1.3 million shares for $51.2 million at an average price of $39.22 per share. AutoNation has $319 million remaining board authorization for share repurchase. As of January 30, there were approximately 120 million -- excuse me, 121 million shares outstanding. This does not include the dilutive impact of stock options.

Our leverage ratio at year-end was 2.82x or 2.60x on a net debt basis, including used floorplan availability, compared to the covenant limit of 3.75x. Capital expenditures were $57 million for the quarter and $153 million for the full year 2012. Capital expenditures are on an accrual basis, excluding operating lease buyouts and related asset sales.

Our quarter-end cash balance was approximately $70 million, which, combined with our additional borrowing capacity, resulted in total liquidity of approximately $770 million at the end of December. We are well positioned to continue to maximize the value of the company and shareholder returns through our robust cash flow generation, healthy balance sheet and disciplined expense management.

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

Michael E. Maroone

Thanks, Mike, and good morning. I'll begin my comments today by sharing what an honor it is for us to unite our 210 domestic and import franchises under 1 flag as AutoNation from coast-to-coast. Our company has worked diligently since our founding 16 years ago to build an auto retail brand and the timing is perfect for this important change. Our stores will provide a peerless shopping experience across vehicle brands and will place emphasis on putting the customers' needs first. With a unified brand comes great potential. It will raise awareness of AutoNation as a brand and is an important component of enhancing our online presence in the digital age. Our associates are excited about the rebranding, and as a company, we're excited about the opportunities this will afford us. AutoNation is America's largest auto retailer and every associate stands ready to deliver on our mission to be America's best place to buy and service cars and trucks.

Now let's get to the results. I am pleased to share that in the fourth quarter and for the full year 2012, AutoNation delivered growth in revenue and gross profit across all sectors of our business, new and used vehicles, Customer Care, and finance and insurance. We also delivered record adjusted earnings per share for both periods, and a strong operating margin of 4% in the fourth quarter and 4.1% for the full year. We believe this performance illustrates that our business model and sharp focusing on delivering a first-class customer experience positions us well for the continuing auto retail recovery.

Additionally, we completed the acquisition of 6 high-performing stores in Texas in the quarter, which I'll expand on later in my remarks. As I continue, my comments will be on a same-store basis and compared to the period a year ago, unless noted otherwise.

AutoNation retailed 70,600 new vehicles in the fourth quarter, an increase of 10,400 vehicles or 17%, comparing favorably to industry retail sales that improved 13% in the quarter according to CNW Research. Key drivers include: pent up replacement demand, exciting new product introductions that deliver great fuel economy and strong retail financing availability. I'll note that while we saw growth in new unit sales across all 3 segments, normalized inventories continue to be a factor in the Import segment, which recorded the largest gain of 24% on a total store basis. Premium Luxury new vehicle unit sales were up a robust 20% and the Domestic segment increased 9%.

On a same-store basis, our new vehicle volume was up 29% in California, 23% in Colorado, 18% in Texas and 14% in Florida. At $2.5 billion, new vehicle revenue increased $379 million or 18%. Revenue per vehicle retailed increased $238 or 1% to $34,888. New vehicle gross profit of $155 million was up $7 million or 5% in the quarter. Gross profit for new vehicle retailed of $2,188 was off $263 or 11% and at 6.3%, new vehicle gross profit as a percent of revenue declined 80 basis points.

Margin pressure was driven in part by the Import segment, where gross profit was abnormally high a year ago, given the shortage of product at that time, and also by a mix shift within the Premium Luxury segment. At December 31, our new vehicle day supply was 55 days or 58,800 units. This compares to 50 days and 43,900 units a year ago. We continue to aggressively build our inventories to take advantage of the strong new vehicle market and low-cost floorplan financing.

In the quarter, we retailed 42,700 used vehicles, an increase of 765 vehicles or 2%. Same-store retail used vehicle revenue of $783 million increased $30 million or 4% year-over-year. Revenue per used vehicle retailed increased $374 or 2% to $18,342. Same-store retail used vehicle gross profit of $67 million was up $5 million or 8%, and gross profit per vehicle -- per used vehicle retailed increased $86 or 6%, to $1,571. Gross profit as a percent of revenue for used vehicles increased 30 basis points to 8.6%. At December 31, our used vehicle day supply was 35 days compared to 31 days a year ago.

Next, Customer Care, or service parts and collision, where same store revenue increased $26 million or 4% to $599 million with growth in internal warranty, wholesale parts and collision. Customer Care gross profit of $252 million increased $14 million or 6% compared to the quarter a year ago. Strong contributors were internal, driven by increased vehicle sales and warranty gross, which grew 13% in the quarter. Customer pay gross increased for the 10th consecutive quarter.

Overall, Customer Care gross profit as a percent of revenue improved 50 basis points to 42.1%. We're very pleased with the momentum of our Customer Care business and believe we are well positioned to capitalize as the units and operation base begins to grow again this year.

Turning to finance and insurance. Our preferred lender network, OEM service contract alliances, strong product penetration and store level execution continue to drive outstanding performance. In the quarter, our finance and insurance team once again delivered a record same-store gross profit per vehicle retailed of $1,307, an increase of $84 or 7%. Total F&I gross profit of $148 million increased $23 million or 19% compared to a year ago. For the full year, same-store gross profit per vehicle retailed was an impressive $1,275 per vehicle, an increase of $74 or 6% compared to the full year 2011.

As I mentioned earlier, in the fourth quarter, we completed the acquisition of 6 great stores in our high-performing markets of Dallas and Houston. 5 stores from the Dallas area are Boardwalk Porsche, Boardwalk Audi, Boardwalk VW, Park Cities VW, and McKinney VW. And the sixth store, Spring Chrysler Dodge Jeep Ram, is in the Houston area. These acquisitions are a great example of our continued focus on building density within our existing markets. I'll also note that nationally for their brands, Spring Chrysler Dodge Jeep Ram ranks in the top 5, Boardwalk Porsche in the top 10 and Boardwalk Audi is in the top 20 of their respective brands.

The acquisitions and other activity in the quarter brought our store portfolio at the end of the year to 221 stores and 265 franchises, representing 32 brands in 15 states. As always, we continue to actively pursue acquisition opportunities that meet our market, brand and return on investment criteria.

As I wrap up, I'll share that we're looking forward to the customer experience and associate productivity enhancements, driven by technology and training investments, that will be brought to life at AutoNation this year. We are also extremely excited about uniting our domestic and import franchises under 1 flag as AutoNation. I'd like to thank every AutoNation associate for their commitment and dedication to our company, as well as thanking them in advance for serving as AutoNation brand ambassadors, by delivering first-class experiences to our customers, 1 customer at a time, every time.

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

Michael J. Jackson

Thank you, Michael. On a personal note, announcing today that we have unified under 1 flag, AutoNation, is a major milestone for our customers, associates, manufacturer partners and shareholders. It's something Mike and I envisioned, when we partnered 13 years ago, to lead AutoNation. Today is a historic moment for auto retail, and under our new AutoNation flag, we will continue to provide a peerless customer experience, both in our stores and online.

Thank you, and we will now take questions.

First up is Mr. Murphy.

Question-and-Answer Session

Elizabeth Lane - BofA Merrill Lynch, Research Division

This is actually Elizabeth Lane on for John. It seems like the new branding strategy could potentially mean more consistent marketing across the various markets, and are there current plans to consolidate advertising with some kind of national campaign? And then, what degree of cost savings could potentially come from the move towards one company brand?

Michael J. Jackson

Yes. This is Mike Jackson. We, anticipating this, had already pretty much moved to common themes in our communications, like the "who are you going to call" theme, runs in all 15 markets today. And we felt by having those as themes, established in all 15 markets, then we launched the AutoNation brand, we'll just keep the same theme and put in AutoNation. So we've already achieved that, and will continue it. Obviously, though, there is tremendous efficiency to move it to one unified brand, both on the cost side and on the impact side. I'll also tell you though, the biggest opportunity that we see and probably the tipping point to finally take this step, is the opportunities that are in digital. As we've discussed, we've made -- we're making a -- we view our foundation for digital as established, we're at an inflection point, we're investing heavily in that. And all our calculations show, that as we make this bet on digital, that the payoff can be much bigger with 1 brand from coast-to-coast, namely AutoNation. So the benefits just go on and on and there's no question, year after year, it'll just get stronger and stronger.

Elizabeth Lane - BofA Merrill Lynch, Research Division

Okay, great. And you mentioned that the automakers are onboard with the new branding strategy. Are the OEMs generally growing more comfortable with large partners like AutoNation, and could that open up more acquisition opportunities?

Michael J. Jackson

Obviously, we have an outstanding relationship with the manufacturers based on partnership, trust and mutual respect, or they never would have approved this step. And on naming the manufacturers, have tremendous power because we need their affirmative consent to the states in order to get our license. So it's not like you can do this, and then fight about it. We need their affirmative consent. And they, as we discussed this with them, they set very high standards that would have to be met, and that's understandable, and I'm very proud to say that AutoNation, from coast-to-coast, has met and exceeded all those standards. So our relationships with the manufacturers are stronger than ever.

Elizabeth Lane - BofA Merrill Lynch, Research Division

Great. And just one quick question on January. Did you see any impact on sales from the expiration of the payroll tax cut and consumers seeing a bit less in their paychecks this month? Or did it seem like it was still a pretty healthy month of sales?

Michael J. Jackson

The month, obviously not over. Today's the last day, but we did have concerns, considering December was such a strong close, would there be a lull or a hangover, and I'm very happy to report that January was like a sprinter out of the starting blocks. And we will report our new vehicle sales results on Monday, but I expect them to be up 15% to 20%.

Operator

The next question is coming from Mr. Rick Nelson of Stephens.

N. Richard Nelson - Stephens Inc., Research Division

Just a follow-up on the rebranding. I'm curious if you're planning to pull the regional name off the stores and replace them with AutoNation? Or if you would add the AutoNation?

Michael J. Jackson

That's a very good question, and there is some confusion about that, Rick, so let me be clear. Let's take South Florida, which will be the first market to change, tomorrow. Now, mind you, Maroone is a fantastic local market name. It's a -- for 58 years, vehicles have been sold under the Maroone name. Our associates, when they go home today, the name Maroone will be on the dealership. When they go back to work tomorrow, the Maroone name is gone and AutoNation has replaced it. This is a full scale replacement. The Maroone name disappears, never to be seen again, unless one of Mike's grandchildren opens a dealership, let's say in Buffalo, something like that. But the AutoNation, the Maroone name comes down, and AutoNation goes up. So if it was Maroone of Pembroke Pines, it now becomes AutoNation of Pembroke Pines. And that will continue across the country, being fully completed by June. We will have -- and this is the reason for an incremental surge in marketing communication spend of $18 million. That is non-recurring, that is simply dedicated to educating the marketplace that the Maroone name is now AutoNation. And that the go name is now AutoNation, and that the power name is now AutoNation. We think that is important to do, to bridge the transition as these names go away. We did not want to straddle the fence and mix apples and oranges. We're ready for this step, we are all in. And you might say, well, why didn't you do it before, we had -- Mike and I discussed 2 different approaches. We could put the name up first, and then add the capabilities and the customer experience and the attributes. So in other words, overpromise and under-deliver, or we could be patient and make the investment of $3.7 billion in facilities, in additional car lines and most importantly, in the customer experience. And then, when we're really able to deliver a peerless experience, then name the baby. So we're at that point, and to be unequivocal, this is all-in. We're not going back. These 15 local market brand names, under which we have retailed almost 9 million vehicles, start going away tomorrow, and will be replaced by the name AutoNation.

N. Richard Nelson - Stephens Inc., Research Division

Got you. And just to be clear, this includes the luxury stores as well?

Michael J. Jackson

No. Again, another good question, spot on, Rick. For our Premium Luxury business, and by Premium Luxury, that's primarily the Germans, the Mercedes-Benz, BMW, Audi portion of the world, there we've always had a different strategy. So we've never sold Mercedes-Benz under the name Maroone, for instance in South Florida. So the Maroone name was never associated with our Premium Luxury business. It was always Mercedes-Benz of Fort Lauderdale, per se. So that will stay exactly the same. So the Mercedes-Benz of Fort Lauderdale, there is no change whatsoever, those names continue. So we always had a bifurcated strategy between high-volume marketing and Premium Luxury marketing. So for the high-volume business, where that -- there, the local market brand names were used. They're going away, being replaced by AutoNation. That's about 82% of our unit volume is now going under the AutoNation flag. And on a unit volume basis, the Premium Luxury business will retain the strategy that we put in place long ago. It's working very well for us.

N. Richard Nelson - Stephens Inc., Research Division

Got you. And if I could ask just one final question. The incremental spend that you talked about, the $18 million, is that going to be fairly consistent through the first half, or is that front-end loaded or back-end loaded?

Michael J. Jackson

It's front-end loaded in each market, so it'll hit very heavy, starting in South Florida tomorrow. And we do Texas next week. And then there is a whole schedule for the other markets, completing in June. It is $18 million incremental spend, purely focused on the name change. Now for instance, in South Florida, when we change the name tomorrow to AutoNation, all the other communication that normally, that selling vehicles, that normally would say Maroone, now say AutoNation. So then, the amount of marketing dollars going behind AutoNation is -- will migrate through the entire communication effort, but they're -- on top of that, there is a non-recurring, $18 million surge in spending that, I would say, maybe Mr.Short, you know, is about equally split between the first and second quarter.

Michael J. Short

That's correct.

Operator

The next question is coming from Patrick Archambault, Goldman Sachs.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

A couple of items here. I guess to -- somebody asked earlier about January, you saw a rate. Can you just give us a sense like, how do you assess the impact of Sandy on new sales in the fourth quarter? I think you have different OEs saying different things. And is that something that we should sort of think about as we're trying to project forward into Q1, a bunch of replacement demand that happened, that may not recur as we get into January, February, March although January seems good?

Michael J. Jackson

So we're not the expert on Sandy, since we are primarily a Sunbelt company, and we had no impact on our business by Sandy whatsoever. So then, but then you say, "Okay, let's look at AutoNation's performance in the Sandy period," and we announce our new vehicle sales every month. There you have a proxy for the rest of the country, not counting Sandy. And if you look at our numbers, the numbers are excellent. So there's no surge -- there's no Sandy decline or surge in our numbers. Our numbers are unaffected by Sandy. So if you want to carve out Sandy and say, "Well what happened in America other than Sandy," go look at our sales numbers, it's right there.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Okay. Yes, no, that's an interesting way to put it. The follow-up question I have is just on used then. It looks like the used to new ratio has been coming down a little bit here. Is that a function of just kind of a share shift from used to new, as the economy recovers, or is there something more sort of micro in nature that's driving that?

Michael J. Jackson

Mr. Maroone, can you talk about our used business, please?

Michael E. Maroone

Sure can. Patrick, thank you. Your question's a good question in I think there is certainly a shift from used to new. I think it varies by quarter and by what's being offered to the consumer. On the used side, the primary issue was supply. The mileage of our trade-ins continues to elevate. It's gone up each of the last 2 years, as people have held off. So we're seeing a lot of high mileage trades, some that can be retailed, some that can not. We also have a limited number of vehicles coming off lease that really goes back to the disruption in '08 and '09. I think the used car business, over time, will be back. But if I look at both new and used together, we're up like 12% on a total store, 11% on a same-store, so we're pleased with the business. Certainly, I think on a go-forward basis, as there's more supply available, I think the used vehicle business will get better for the industry and for AutoNation.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Okay, great. And one last one, if I may. The pace of parts and service sales continues to stay very high, in the mid-single digits. Can you just tell us, as we go forward, how sustainable is that? I mean, I know that there's a number of new initiatives that you put in place to help drive that. Is that something that might get pared back a little bit, as those mature? Or how should we think about that growth opportunity going forward?

Michael J. Jackson

I'll speak strategically first, and Mr. Maroone then can address the business directly. I think it's important -- the most important thing I can tell you, is that service and parts is the foundation of our business, it gives us our tremendous fixed coverage and it's a tremendous driver of repeat referral business and it's excellent margins. 2012 was the trough. It was the most difficult environment that we faced, because if you think about it, our service base is vehicles from brand-new through 5, 6 years old, and with the sales collapse in '08, '09 and '10, the units in operation available to service reached their nadir, the absolute lowest point, in 2012. And now with the sales recovery, beginning in '10, '11, '12, the units in operation now begin a recovery that will last for years, it'll run. So if you look at our performance, our performance is with the wind on our face on units in operation. But now you have to say, "Well, now they have a improved environment with higher units in operation, plus their initiatives and plus their capabilities." So the hard part is done on Customer Care, and the opportunity only gets greater as we go forward. Mike, you want to talk about it further?

Michael E. Maroone

Yes, I do. And certainly, Mike Jackson hit the macro perfectly. And '13 is just the beginning, and '14 and '15 really accelerate. But in addition to that, as we anticipated that recovery in units in operation, we've made some really important investments. We made an important investment in talent, bringing in Alan McLaren to head up our Customer Care business. He had a tremendous background and has made real improvements in the team. We're also making technology investments, facility investments in collision centers, and so I think the payoff is really nice, but it is just beginning. For the quarter, we are up 4.5% in revenues, 6% gross. That's our best performance in many years. And on the full year, we are up 5% revenue, 4% gross. So we're actively managing the margins, we're driving the business and I think the branding will allow us, again, to unleash some digital capabilities that we have not had. So great talent, great investment in technology and facilities and we are extremely optimistic about our Customer Care business going forward.

Operator

The next question is coming from Jamie Albertine of Stifel, Nicolaus.

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

Really an unprecedented announcement here with rebranding nationally. The question I wanted to focus on though was on the F&I side. Obviously, we're looking at record performance here, north of $1,300 a unit for the fourth quarter. I just wanted to take -- kind of dig in a little bit deeper, get some more granularity around what's driving that, whether it's new products on the F&I side, better selling of those products or better penetration rates. And then overall, I know this question's been asked every quarter, but where do you think this can trend to over time, given what you have seen now, most recently?

Michael J. Jackson

Mr. Maroone.

Michael E. Maroone

First of all, I'm thrilled with our F&I team. We've led the industry, of all the people reporting publicly, for quite some time, and it's gotten a lot better, up $84 year-over-year in the quarter, just a huge increase. There is no new products. What there is, is better and better execution. We really look at the bandwidth of performance in our stores. We've got an intense training and certification program in, and a real focus on selling extended service contracts, which creates a much greater linkage to our stores and will help drive that Customer Care volume up. So the other piece that we've done so well, and it's something that Mike Jackson introduced many years ago, is what we call the AutoNation pledge, which really starts by letting consumers know that they're not forced to buy products. It's not a high-pressure process. It's a very methodical process that really puts the customer first and puts the value on these service contract and prepaid maintenance products. And we don't want to drive our F&I by pushing rates up. We really want to do it with value-added products. So it's a -- it's just a continual improvement process and a tightening of the bandwidth. And I don't want to put a stake in the ground for where it can go. I will say that we're forecasting continued growth in F&I PVR. It's a very important part of our strategy.

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

That's very helpful, and if I may, just ask a quick follow-up on the branding, or the rebranding. It's been asked a couple of different ways now, but aside from the operating expense leverage, it sounds like you can pull away from either an advertising standpoint or from a digital standpoint. Where do you see, from a competitive standpoint, the national branding effort really start to take shape? Is it going to be more manifested in maybe more trade-ins, so helping your used business, or maybe some parts and service, customer pay work that you didn't have otherwise? Is there better buying power, presumably on the new side? I mean, how should we think about this over the longer term, with an eye toward maybe market consolidation?

Michael J. Jackson

So this is Mike Jackson. You'll notice we're not using the term national branding, I mean, it's from coast-to-coast. We basically, as we discussed before, are very comfortable with our footprint. Basically a Sunbelt footprint, where we started in Washington D.C. down through Florida, across the Sunbelt, through Texas, up through California, ending in Washington state. And are -- and everything is self-reinforcing, so our acquisition strategy is to improve the density within the existing footprint. That footprint reaches about 50%, like with our big states, about 50% of where all the vehicles are sold in the United States, and we're trying to achieve a very simple concept. If you work or live in one of our markets, you cannot think about buying a car or truck without shopping AutoNation. We want to be the dominant brand in every market that we're in, and whatever you want, we have it. So we are the go-to place to shop. And that when you do shop with us, we embrace this consumer of the future. So now, so this is the next step. We have a profound understanding, we believe, of today's consumer, where they are and where they're going. And we see a consumer that's empowered by digital, has all these extraordinary new experiences in all these other industries, and do not want to go back 1, 2, 3 decades when it comes time to buy a car or truck. And this new consumer wants to enjoy the experience and they want high added value for their time and they're very impatient. And so we've embraced that consumer by making all our processes very customer friendly and high added value. So we think this combination of dominant positions for the markets where we're in, in alignment with where the consumer is and will be, will just be a self-reinforcing momentum. And it doesn't matter what you talk about, whether -- any aspect of the business, where you have it cared for, how it's cared for, where your finance it, where you trade your used cars. We want all of that, all of it. And we think this brand strategy does support all of it, especially in the digital world. Now admittedly, this is very different than what others are doing in our business. And I'm not talking about publics or private caps per se, I just look at competitors. We have competitors who use old-school techniques, which are very effective and work. But we would never do that, and we think it's a dead end, and so we're going, really, our own way. And so we are -- I've always said, our first priority on capital is this core organic business. And if you look at the $3.7 billion that we've invested in facilities and strategic acquisitions, I have no interest in going to China, Brazil, Italy, England. If others want to go there, that's great for their company, but it's not for us. We will be sitting there, waiting to fill in the missing pieces in our brands, in our markets, and when we are complete, there'll be us and everybody else, and I sum it up with that statement. You can just think about it this way, if you live or work in one of our markets, you cannot make an intelligent decision about buying a car or truck, or having it cared for, without considering AutoNation. I like that positioning, that's where we're going, that's what we're building, and to do it under a 1 unified flag, from coast-to-coast. I don't see anybody else that's in a position to challenge us on this strategy. So we have a unique strategy that is compelling, it's powerful, that we're well on the way to executing. The hardest thing to do in business is to open up a sustainable competitive advantage. I'm declaring today, we've done that. And this branding is a declaration of that, and we will not stand still and we will keep moving forward with our strategy, I believe in it and I think we will prevail.

Operator

The next question is coming from Simeon Gutman of Crédit Suisse.

Simeon Gutman - Crédit Suisse AG, Research Division

One more on the brand strategy, not to belabor it...

Michael J. Jackson

No, you can ask all you want on the brand strategy, this is a big day.

Simeon Gutman - Crédit Suisse AG, Research Division

Well, so this is more a little related to timing. Because I think this was, I guess, maybe just correct me if I'm wrong, this was laying [ph] vision with this company 1 day. And if there's a pioneer to do this, I think AutoNation would be the pick. The question is, you mentioned digitalization. Is there some capabilities that you have developed today that cannot go in further until you have this unified brand in place? Meaning why now, and is there any rhyme or reason, special rhyme or reason, for the month of February to begin this?

Michael J. Jackson

So we, Mike Maroone and I, when we met 13 years ago, before I joined AutoNation, sat there and discussed this vision and this ambition. And we decided to under-promise and over-deliver. So therefore, it's taken this length of time to come to this point. In that journey we've made big investments in digital and we're now at an inflection point, and we are overinvesting in digital. Let me give you an example of what I mean. Let's take our Shared Service Center, just as an example of the type of things that AutoNation does. Seven, 8 years ago, we had the idea that we would unify all our accounting, finance and analytics in 1 center, and that was built out of Dallas. It took us 7 years to complete, 7 years to complete. Now though, we have an operating discipline within the company that I have no fear or risk, of systemic risk, in the company, AutoNation. I'm not saying something can't go wrong, but it will be small and it will be localized. So we have tremendous understanding of the business, transparency into the business and control into the business, and oh, by the way, it costs a lot less to operate the business that way. But it was tedious and difficult and disruptive to build. So now let's go to digital. I see it exactly the same way. We've taken the first steps. We have a good understanding. We know where we want to go. And by overinvest, I mean we are investing in digital, where money is going out the door, that the return on it is years away. So in the Shared Service Center, I invested for 3, 4 years before I got the first dollar back. We're doing the same thing with digital. But when we finally make this bet, when we finally make this risk, we think we've really figured it out, and then we have an extremely high chance of success. So as we start this journey, we were at a intersection between having a customer experience that was peerless, the operating discipline that we had control of the business and we're making this big bet on digital. And no question, a unified brand name is more compelling in digital. So we said, "okay, we're ready to go." Mike and I did that, made that conclusion, sometime in the first part of last year into the spring. Of course, we needed to get the manufacturers' approval. Now, Mike and I spent the summer on our regular visits with the manufacturers, adding to the agenda that we are ready to take this step. And I would say the verbal reaction was always very positive, but there's a gazillion things that have to be checked. So -- and then, if you want a little humor, when we finally -- coming down the home stretch, if you want to know what the critical path was, was why now? It's the permitting process from the various states and the various agencies. We had to get -- there is so many licenses involved to get names changed, and to get signs up, it's unbelievable. And the reason we can't do the whole company in 1 day is the permitting process. It's just a bureaucratic nightmare out there, but anyway, we have our first big market ready to go on -- tomorrow. And we knew earnings would be today, so we said, "Well, we've got everybody on the phone. Why don't we not have another teleconference in 2 weeks. We'll do it all today." So off -- here we are, off we go. We'll have the whole country done and the whole company done by June.

Simeon Gutman - Crédit Suisse AG, Research Division

Okay, well, so one follow-up to that, and this is, I guess, a general question which I'm sure you've answered before. Is digitalization good or bad for gross profit per vehicle over time? Because in a sense, this is expediting, almost empowering that digitalization a little quicker. So how do you think about the rate at which, either that transparency accelerates as you become 1 unified brand, or how do we think about gross profit dollars?

Michael J. Jackson

Yes, so first in our view, is this empowering consumer by digital is here to stay. Digital's not going away. You can be in denial. You can be an ostrich and fight it, and we see competitors who are. I think that a -- in my opinion, that's a losing battle. And the consumer's not going to be willing to go backwards when it comes time to buy a car or truck or get it fixed, so you might as well embrace this future. In many ways, the transparency makes for a much more efficient, effective, enjoyable experience for acquiring a car. I would not want to go back to the old days and the old-school ways of selling cars and trucks. Let's face it, it was like going through the -- it was just tedious and so complicated and I hate 3-card monte. Just be straightforward and transparent and fair with your customers and you can win in the marketplace. Now admittedly, we're going to go through a difficult period, where you still have old-school and new thinking, and I'm not saying old-school doesn't work, it does work. It can -- we have competitors who are very good at it in the marketplace, but it's just not us. We think, in the end, we'll carry the day. And I feel, in principle, that transparency is very good for the industry. You will -- when you hear me, though, speak out against certain practices that I see in the industry, some of them from the manufacturer, that are not in alignment with this new empowered consumer, that's the reason I'm speaking out, because I think they're out of step with where the consumer would like to be, such as stair-step incentives, where you create huge gaps between what -- a customer comes in at 10:00 and the customer comes in another store at 4:00 in the afternoon, you can have a huge price difference. When the manufacturers create those distortions, we argue against it.

Simeon Gutman - Crédit Suisse AG, Research Division

Okay. And my last, promise, a quick question is, AutoNation has clearly done either banner conversion or banner transformation before. Is there any sales disruptions that could happen? It's just natural and then, that you get over the hump, and the timing, and any magnitude?

Michael J. Jackson

I think it's a very fair point. When you take down a name like Maroone that's been in the marketplace for 58 years, I think you're naive to think that you don't have to manage that situation. That's the reason we have this surge in marketing communication spend. And whether I can predict to you, whether there will be some disruption of sales, it's hard to say. We think we've got it all planned through. We think we'll manage all the risk. I will point out we have changed names in markets before. We did it in Denver, when we went from John Elway to Go and we were able to manage that. So we have all the learnings from that. I think we'll manage this, but you -- it's a fair thing to say. These are strong local market brand names that are well established that we are leaving behind and going forward. But in the long term, in the strategic term, it's not a close call.

Operator

The next question is coming from Matt Nemer.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

I've got another follow-up on the branding change, which is, if we look at the digital impact of this, can you get more specific around what this could do for you online? Does it help your Google rankings? Does drive web traffic, et cetera?

Michael J. Jackson

There you go. You're -- now you're talking. Mr. Maroone, take over.

Michael E. Maroone

Matt, good morning. Clearly, our capabilities from search will get better. I don't think it happens overnight, it takes Google a little bit of time. But going to market under 1 name versus 15 names, I think, is quite an opportunity. And certainly, search is a big driver of traffic. So yes, we do believe our capability's increased. It's hard to guesstimate how much, time will tell. But it is much more effective under 1 name, especially a name like AutoNation.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Okay, that's helpful. And then secondly, can you get more specific on your plans to capitalize on the growing units in operation this year? Are there any kind of specific efforts in marketing or menus that are changing this year to drive more service business?

Michael J. Jackson

Mr. Maroone, please.

Michael E. Maroone

Again, Matt, I think that the digital age will help us a lot, but we are very aggressive and continue to be aggressive in investing in that business, both with people and talent and training and now, technology. We're piloting some new technology in stores right now that we're very confident about, that, if successful, will roll out over the next 1 year to 1.5 years, that will make that customer experience just what Mike Jackson has talked about, and that's transparent, faster, giving customers real choice, both online and in the store. So there's technology investments, there's marketing investments, and as I spoke to earlier, we've added some real talent in that business and we're really excited. We think the timing is perfect.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Any price investments? Do you think that you're kind of optimized at the current prices that you're charging, or would you look to potentially lower prices in some markets?

Michael E. Maroone

Well, I don't think that we need to. I think what we need to do is have consistency in pricing, which we've now accomplished. We continually survey the market and make sure that we're priced in line with that market. But if you're asking, do we need to discount our business to really drive more traffic, I don't think it's that kind of price sensitivity. I think customers are looking for the right experience. They're looking for trusted professionals. They want to do business in new, clean, first-class facilities, and it really speaks to the $3.7 billion investment that Mike Jackson spoke to. So I think that we'll be able to deliver an even better product going forward, as this UIO increases, with the facility, technology, training and talent investments we've made.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Okay. And then just 1 housekeeping item. The $18 million, does that include the sort of surge in marketing?

Michael J. Jackson

It is the surge in marketing.

Operator

The last question is coming from Brett Hoselton, KeyBanc.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

I was hoping you could drill down into used cars a little bit. As I look at your performance this year versus, let's say, CNW or some of the other public available numbers out there, it looks like you were outperforming the industry in the first half of the year, and then kind of underperforming the industry in the back half of the year, just on a year-over-year percentage change basis. And I understand there is some supply challenges, and I presume they're not necessarily, completely unique to yourself. But I'm wondering, is there -- would you agree with my assessment? And if so, is there some rationale for why you may have slowed down? And then, what are you doing about the future?

Michael J. Jackson

I would say we agree with your assessment. Mr. Maroone, you want to give any insights on that?

Michael E. Maroone

Yes. I think that we are working really hard on the supply side. I think there's -- I think you can expect better results with us going forward. We are actually working harder to retain more of our trades and have made some structural changes in the first of the year, that our team's very bought into. But I think, first half, strong performance, second half, certainly we've -- there's more opportunity there than we got, and I think you can look forward to a better performance from us. We are -- if I could just expand one more time, we are working really hard on developing some out-of-store capabilities. For example, we're now buying cars online through a very interesting process, using some big sources like Edmunds and eBay, taking trades. We're taking trades for Tesla. So we're trying to develop the capabilities to go beyond store sourcing and source in other ways. And I think that, again, under a common brand name, it will become even easier and we are making incremental investments in that part of the business.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

And then, as we think about your free cash flow generation, obviously you're a solid free cash flow generator. How would you rate your -- or prioritize your uses of capital beyond CapEx? I mean, are we at a point where acquisitions are equally as appealing to share repurchases? Or what are your thoughts there?

Michael J. Jackson

This is Mike Jackson. Clearly, you'd see that we have an outstanding record on capital allocation, and I've said it over the years. We give as much thought and effort to capital allocation as we do to making the money. In the first place, I've always said our first call is on the core organic business, and you now see that totals $3.7 billion over these past years. And that will continue to be our #1 focus, is the core organic business. And then as far as future acquisitions, they -- again, we will be patiently looking for opportunities within our existing footprint. And as they are presented, we are prepared to act, as you saw on the Texas deal. We're in a lot of discussions, but it's always hard to say what deal gets to the finish line and what does not. And we always look at share repurchase on the opportunistic side. We've been very good at that. We've repurchased -- we spent $7 billion on repurchase and -- at an average share price of $17 for a stock that's now trading at $47. So obviously, we've created a lot of shareholder value there. But those -- that balance between acquisition and share repurchase opportunity is made on an opportunistic business, depending on what is presented to us. And we like to stay unpredictable on a forward basis, but you got to admire the track record.

I think that was last question. Ladies and gentlemen, thank you very much for joining us today.

Operator

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

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