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AutoNation, Inc. (NYSE:AN)

Q4 2008 Earnings Call

January 29, 2009 11:00 a.m. ET

Executives

Derek A. Fiebig - Vice President, Investor Relations

Mike J. Jackson - Chairman of the Board, Chief Executive Officer

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

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

Analysts

Matt Nemer - Thomas Weisel Partners

N. Richard Nelson, Jr. - Stephens, Inc.

Rod Lache - Deutsche Bank North America

Matthew J. Fassler – Goldman Sachs & Company

John Murphy - Merrill Lynch

Rick Kwas – Wachovia

Colin Langan - UBS

Himanshu Patel - J. P. Morgan

Rex Henderson - Raymond James and Associates

Operator

Welcome to AutoNation's Fourth Quarter Earnings Conference Call. (Operator Instructions) Now, I will turn the call over to AutoNation.

Derek A. Fiebig

Thanks, operator, and good morning everyone. I'd like to welcome you to AutoNation's fourth quarter 2008 earnings call. My name is Derek Fiebig, AutoNation's Vice President of Investor Relations. I'd like to remind you that this call today is being recorded, and will be available for replay later today.

Leading our call today will be Mike Jackson, our Chairman and CEO. Joining him will be Mike Maroone, our President and Chief Operating Officer, and Mike Short, our CFO. At the end of their remarks, we'll open up the call to questions, and I'll be around for the rest of the day to answer any follow-up questions you might have.

Before we begin, let me read out a brief statement regarding forward-looking comments in 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 our expectations. Additional discussions of factors that could cause actual results to differ materially are contained in our filings with the SEC.

Certain non-GAAP financial measures, as defined under SEC rules, may be discussed on this call. As required by applicable SEC rules, the company provides reconciliations of any such non-GAAP financial measures to the most directly comparable GAAP measures, and you can see these on our website.

And now, I'll turn the call over to Mike Jackson.

Mike J. Jackson

Good morning. Thank you for joining us. Today we reported fourth quarter EPS from continuing operations of $0.40, compared to a year-ago EPS of $0.28. In the quarter, the company had net benefit from tax and other items. After adjusting for these items, net income from continuing operation for the 2008 fourth quarter was $0.12 per share.

Fourth quarter 2008 revenue totaled $2.7 billion, compared to $4.1 billion in the year-ago period, driven primarily by lower vehicle sales. In the fourth quarter, total U.S. industry new vehicle retail sales declined 49%, based on C&W research data.

In comparison, in the fourth quarter, AutoNation's new vehicle units sales declined 40%. In the fourth quarter, AutoNation continued to remain profitable, even with the U.S. selling rate near ten million new vehicle units, a 27-year low.

I would like to address two items today. First is in regard to the U.S. economy and credit and how AutoNation responded. The fourth quarter was negatively impacted by the credit panic triggered on September 15th by the bankruptcy of Lehman Brothers. Automotive retail sales collapsed from one day to the next by an additional 25%, which credit for our customers was withdrawn from the market. Credit from captive finance companies and prime lending institutions declined over 40% from Q3 2008 to Q4 2008.

At AutoNation we saw a 99% decline in December '08 versus December '07 from GMAC and Chrysler Financial Services. This panic continued to erode consumer confidence and accelerate the decline of the U.S. economy in the auto retail market.

Second, I'd like to address the action we have taken in response to the events of September 15, when Lehman Brothers went bankrupt. In July we announced our plan to reduce costs by $100 million on a annual run-rate basis, and have successfully achieved this goal, a significant accomplishment in its own right.

As market conditions collapsed in the second half of September, additional actions became necessary to further reduce costs. We have successfully implemented an additional cost reduction program of another $100 million. Taken together, AutoNation's total annual cost saving is $200 million, an unequivocal demonstration of our company's adaptable business model.

For the full year ended December 31, 2008, the company reported net loss from continuing operations of $6.89 per share, compared to net income from continuing operations of $1.44 per share in the prior year. After adjusting for the impairment charges and certain other items as disclosed in the attached financial tables, net income from continued operations for the full year ended December 31, 2008 at $1.02 per share, or $1.38 per share in the prior year.

The company's revenue for the year ended December 31, 2008 totaled $14.1 billion, down 19%, compared to $17.3 billion in the prior year.

I would like to turn it over to Mike Short to provide more details on the financial result.

Michael J. Short

Thank you, Mike, and good morning, ladies and gentlemen.

First, our financial results for the fourth quarter, as Mike mentioned, we reported net income from continuing operations of $70 million, or $0.40 per share. We recognized a gain of $24 million after tax, or $0.14 per share in the quarter, related to the repurchase of a $145 million notional value of our senior notes. We also had net favorable tax items of $32 million, or $0.18 per share, and $8 million of after-tax impairment charges worth $0.04.

After these items, adjusted net income for the quarter was $22 million, or $0.12 per share, compared to $0.28 for the fourth quarter of 2007.

For the full year of 2008, we reported a net loss of $1.2 billion. After adjusting for the $1.5 billion good will and franchise impairment and other items including tax settlements and gains on senior not repurchases, net income was $181 million, or $1.02 per share compared to $277 million, or a $1.38 per share last year.

The adjustment to net income for the fourth quarter and full year are included in a reconciliation in our press release. Mike pointed out that we early to recognize the headwinds facing the industry in 2008. In response we began significant cost and debt reduction incentives.

We've exceeded our cost savings target of $100 million and achieved a run rate of $200 million in annualize savings. During the fourth quarter of 2008, we reduced SG&A by #102 million, a 21% reduction fro Q4 2007.

SG&A percentage of gross profit increased to 79.9% from 73.6% a year ago reflecting the deleveraging of our cost structure, partially offset by our cost savings. Also we finalized our estimate for our goodwill write off in Q3, and determine that no additional adjustments were required.

New vehicle inventory carrying costs of $8 million for the fourth quarter was down $2 million from last year. The decrease primarily resulted from lower LIBOR rates, partially offset by a decrease in fore plan assistance.

Other non-vehicle interest expense was $20 million for the quarter, decreasing $12 million from last year as a result of our debt reduction incentives and lower interest rates.

Income tax for the quarter was a benefit of $9 million resulting from the $32 million item I mentioned earlier. Going forward we expect our ongoing rate to be about 40%, excluding the impact of any potential future tax adjustments.

Turning to our cash flow and balance sheet items, we are very proud of the work done by our team to maximize profitability and generate cash during the quarter through discipline, management of CapEx and working capital.

This success enabled the company to reduce non-vehicle debt by $155 million during the fourth quarter primarily through the repurchase of $145 million of senior notes at an average discount of 30% at face value.

Of this amount, $50 million related to the floating rate notes, $95 million to the fixed rate notes. Also before the end of the quarter, we entered into trades to repurchase an additional 11 million notional amount of fixed notes that settled in January.

For the full year, our non-vehicle debt was reduced by over a half billion dollars.

Turning to our financial coventance, our debt reduction and cost savings incentives enabled us to reduce our leverage ratios to 2.4 five times at the end of 2008. A couple of points on the calculation, the trailing 12 month adjusted EBITDA fo $544 million include the gain on our note repurchases, funded indebtedness was 1.33 billion.

The indebtedness number is not on a net/net basis so we don't get benefit of our $111 million year-end cash balance, which was up from $33 million last year. I think its worth noting that the leverage ratio improved significantly from the end of 2007, when it was 2.78 times.

Our capitalization ratio, which measure floor plan debt plus non-vehicle debt, divided book capitalization was 59.7% at December 31st, compared with 61.5% as of September 30th and a covenant requirement of 65%.

The calculation of these convenants is included in the tables of the press release. Our strong year-end cash balance combined with $300 million in covenant limited revolter bill (inaudible) brought our total liquidity to more than $400 million at year-end.

Our total debt reduction and cash balance increase in Q4 was more than $200 million. You may recall that last quarter we announced our intention to reduce debt, reduce total debt by this additional $500 million and as you can see, we are well on our way.

We reinvested $20 million in the business through capital expenditures during the quarter and $117 million for the full year. We estimate spending of approximately 90 million in 2009.

Excluding acquisition-related spending, land purchases for future sites and lease buy outs, CapEx was 14 million for the fourth quarter and 65 million for the full year.

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

Michael E. Maroone

Thanks, Mike. And good morning. I'll begin by saying that given all the external challenges we recorded a solid 2.3% operating margin in the quarter and also delivered solid profitability.

This was encouraging in light of the steep decline in volume for the industry. We believe this further validates our business model.

In 2008, we made tremendous progress on the cost side and, as Mike Jackson and Mike Short both said, we will realize annualized cost savings of $200 million. We reduced inventories, improve cash flows, and gain market share.

We also recorded the lowest associate turnover in our history. During we achieve our best ever customer satfisfaction levels for both sales and service. The ability of our team to continue to fight through all the issues and deliver outstanding service, this result was definitely impressive.

Our associates remain dedicated to sharpening the delivery of our customer focused best practices, controlling expenses, improving cash flow with the goal of emerging even stronger from this downturn than when we entered it.

I've been in the car business all my life and cannot recall the environment ever being more difficult than it was in the second half of 2008. The skyrocketing fuel prices of the summer months made trucks and SUVs undesirable. The demand shifted quickly to fuel efficient cars.

In the middle of September, the crisis that was brewing in the financial community spread to Main Street. Mike Jackson mentioned credit evaporated. Consumer confidence all but disappeared driving showroom traffic down.

This lead to a weak selling environment in both new and used vehicle sales. Trucks drove most of the decline in sales for the first part of the year while car sales remained more robust.

But the movement toward the 10 units are in the fourth quarter was driven by credit panic underneath fuel efficient car sales literally collapsed while truck sales, which had been lagging, picked up some ground on a relative basis.

As falling fuel prices coupled with aggressive incentives, made them a more attractive product for consumers, falling over all demand levels and shifting mix within that demand, made for a difficult environment to say the least.

At $43 million, our total segment income was down 73 million or 63% compared to the quarter a year ago. The contribution to the decline was approximately 30% domestic, 40% import, and 30% premium luxury.

A clear illustration that no segment was immune to the collapse of retail sales in the quarter. Mike mentioned that industry new vehicles were down 49% in the quarter, which is the most severe decline we've ever seen.

The use vehicle market, which is usually less volatile than new, was also significantly impacted in the quarter. For new vehicles our same store performance was favorable to the overall market as we retailed 45,000 vehicles, 40% decline from the fourth quarter of last year, but better than the 49% industry decline.

Revenue per new vehicle sold decreased by $562 to 31,300. This decrease was less than we had experienced in the first nine months of the year. Our gross margin for new vehicle retail was off $216 to $2,027. We attribute this continuing over supply, a competitive environment, and issues around credit that include reduced lender advances.

At December 31, our new vehicle base supply was 84 days, an increase of 32 days, compared to a year ago, and significant lower than the industry at 119 days. Despite the collapse of industry sales, which drove day supply up on a unit basis, we ended the year with 54,000 units, compared with 61,000 a year ago, a reduction of 11%.

Day supply ended higher than we would like it but as previously mentioned the shift to and from fuel efficient cars was a factor as was the weaker than expected sales environment.

Our first quarter orders to date will be down 55 to 60% from a year ago and are also down significantly from the fourth quarter. This will reduce our inventory by approximately another 9,000 units.

Turning to used vehicles, the industry saw the weakest annual retail volume in well over a decade. AutoNation retailed nearly 36,000 same store units which represented a decline of 22%, compared to a year ago.

Factors were the overall macro economic conditions, along with significantly reduced trade ins, compare to the prior period. In the quarter, our used to new ratio was .8 a best ever metric at AutoNation.

Revenue per used vehicle was off $1200, or 7%, driven by a decline year-over-year in used vehicle values as well as ongoing consumer demand for lower price vehicles, a $1436 gross margin per used vehicle retail was off $180 or 11% , resulting in part from our willingness to accept lower margins to avoid the extremely volatile wholesale market.

We grew our certified pre-owned business by 30% compared to the same period last year, and during the quarter we also moved 4,600 used vehicles, from originating stores to a more optimal location, with good success at retail.

At December 31st, our used vehicle inventory stood at 30 days. This was a conscious prudent effort to keep our inventory lean, in the volatile market we've described.

Next, service and parts we're at $568 million, same store revenue for the quarter held up much better than the variable business with the decline of just 9%. Even in a down economy, vehicle maintenance is a necessity. We remain focused on growing our customer paid business, which was off about 3% in the quarter.

Efforts include ongoing training and certification of our associates on a retail base service sales process, our online appointment program, and aggressive service marketing. Our value care, or prepaid maintenance program, which also serves as a customer retention tool is a good example of how we are expanding our offerings on the service drive.

In the fourth quarter, we sold nearly 12,000 plans. We experience some pressure throughout our service and parts business, and in particular, in internal and warranty. The internal drop was driven by a decline in vehicles sales volume, and we attribute the warranty decline to the continued trend of improved quality.

Gross profit of $246 million was down in line with the service revenue decline. In the area of finance and insurance, same store revenue declined 41% on lower volume, same store F&I gross profit per vehicle retailed was $1,024. A decline of $127 or 11% compared to the quarter a year ago.

Credit availability, increasing lender conditions on approvals, reduced advances, higher charge backs, all impacted our F&I performance in the quarter. In this challenging environment, we remain focused on the performance of our third and fourth quartile stores, the sale of F&I products, and improving cash opportunities from contracts in transit.

Our work to optimize our portfolio stores overall, as well as within each segment, is ongoing. In the quarter we sold or terminated a total of six stores, representing an annual revenue run rate of $142 million. We also acquired two domestic franchises that we tucked into existing stores. At December 31st, our portfolio consisted of 232 stores, and 302 franchises, in 15 states.

As we navigate what continues to be a very challenging environment, we're committed to providing a supportive work place for our associates, and a great place for customers to purchase and service their vehicles. We will continue to work diligently on the cost side of the business and in the consistent delivery of our best practice processes in all areas of our business.

We believe that we are operationally stronger today, than ever before, and we’ll be well positioned as the industry recovers. With that, I’ll turn the call back to Mike Jackson.

Mike J. Jackson

Thanks Mike. As we look at the rest of 2009, we believe that the market will remain very competitive and challenging. AutoNation will continue to focus on our cost structure, while continuing to invest in our business. We are confident in our long term business strategies, and our market.

We believe that in 2009 industry sales of new vehicles will be in the range of 11 million units. With industry used vehicle sales in the 1st half of 2009, continue to trend, we saw in the fourth quarter of 2008.

For the U.S. auto industry to recover, we need the restoration of credit for our customers, which means the success of the launch of the term asset loan facility program, which will begin in February of 2009. This coupled with the comprehensive stimulus package which should include tax and purchasing incentives for autos.

Finally, it is vital the Detroit three continue to have access to bridge loans to support their recovery. With that, we look forward to your questions. Operator, if you could please open the lines.

Question-and-Answer Session

Operator

Yes. Thank you. At this time we will begin the question and answer session. (Operator instructions) Mr. Rex Henderson, with Raymond James and Associates, your line is open.

Rex Henderson - Raymond James and Associates

Thank you. First of all, I wanted to return some comments by Mike Maroone about inventory levels. I missed a bit of it, but in addition to that I wanted to kind of focus on based on some of your recent comments, it appears that you think that inventory levels were too high. And I’m wondering where you think an appropriate inventory levels is, and how long it takes you to get there?

Mike Maroone

Rex, its Mike Maroone, our inventory level right now is about 84 days. We definitely believe that's too high. And as a result, we have reduced our ordering by between 55% and 60%. We believe that our day supply, on a weighted average basis could be in the 50 to 55 days supply. We are at 84, so we definitely want to move it down and see an opportunity to do so.

Rex Henderson - Raymond James and Associates

The second part of my question was, how long does it take you to do that, and what kind of push back you have gotten from the OEMs’ in cutting orders that much.?

Mike J. Jackson

Obviously any time you have such a precipitance decline in sales from one day to the next, where the selling rate declines, your day supply is going to go up dramatically. So in absolute terms, we've continued to take our inventory down.

We are forward-looking, assuming a selling rate of 10 million open ended, we do believe that there is a possibility of an improvement in March if the credit really begins to thaw. But we're taking a wait and see attitude. We want to see it before we'll stock to that level.

There is definitely push back from the manufacturers. Several manufacturers on inventory I would say the most extreme case would be General Motors and Chrysler. Both of whom have implemented wholesale incentive programs.

Where they basically say to get the incentives to the inventory you want, you have to buy more inventory. I think this is the wrong thing to do. I think it’s appropriate that retail inventories be adjusted to this selling rate. And that has definitely created some friction, but we are not playing that game.

Rex Henderson - Raymond James and Associates

Okay. Well thank you for your frank comments. That is very interesting. And the second part of my question, really relates kind of an evergreen question I asked about your SG&A cuts. And that is can you cut $200 million in SG&A reductions, annualized? How much of that is kind of structural and how much of that is variable in response to the lower sales volumes?

Michael J. Short

Hi Rex, this is Mike Short. As we’ve laid out these initiative plans, we have tried to focus the reductions on elements that we are going to permanently take cost out of the system. That said there are some of those areas are going to be variable and we’ll come back a little bit as conditions improve. Ballpark, I would say I think 70% to 80% of the cost that we have taken out, is of the structural variety.

Rex Henderson - Raymond James and Associates

Okay. Very good. All right, thank you very much. I’ll pass the questions on to someone else.

Operator

Thank you Mr. Reiglass (ph) with Deutche Bank. Your line is open.

Rod Lache - Deutsche Bank North America

Good morning everyone.

Derek A. Fiebig

Good Morning.

Rod Lache - Deutsche Bank North America

On a sequential basis your floor plan assistance looks like it sell, but the expense was up sequentially, even though LIBOR fell, and I was just wondering if you can give us some more color on that, the inventory is down. Are the OEMs’ adjusting floor plan assistance, and what is that related to?

Mike J. Jackson

Yes. Sequentially the assistance piece of it is not down all that much. But we are seeing that in certain cases there is an attempt to adjust some of those programs. The bigger issue for us is the balance in the account.

Unidentified Company Representative

Of course this evolves with the lower volume. So the assistance goes down because of the collapse of sales, and also with the collapse of sales, your selling rate is lower than what you have expected, and what you stocked for.

So during the course of the quarter, we had to correct for that. And by the end of the quarter, we actually had inventory down, in absolute terms, but on a basis by basis trial.

Rod Lache - Deutsche Bank North America

Okay, but why would the floor plan in truth expense be up sequentially with lower inventory and lower LIBOR rates?

Michael J. Short

I don’t believe our inventory was lower in the quarter.

Rod Lache - Deutsche Bank North America

Okay. It was at the end of the quarter, but not necessarily over the course of the quarter.

Mike J. Jackson

On a dollar basis.

Rod Lache - Deutsche Bank North America

Okay. When do your floor plan lines renew? Is there any pressure - upward pressure on spreads there?

Mike J. Jackson

Over the course of this whole process the spreads have increased from LIBOR plus one to about LIBOR plus two now. But I think they have been fairly stable lately.

Rod Lache - Deutsche Bank North America

Okay. But there aren’t any lumpy maturities on these lines over the course of this year, or is it pretty

steady over the course of the year?

Michael J. Short

It’s pretty steady over the course of the year.

Rod Lache - Deutsche Bank North America

OK. And, can you maybe just talk a little bit about expectations for the parts and service business into 2009? Obviously, it’s come off a bit here. But, what generally are you expecting? Would it be more similar to the levels that you're experiencing in the fourth quarter or would you expect that to improve a bit?

Michael E. Maroone

Rod, it’s Mike Maroone. The last two quarters, we’ve clearly seen consumers sitting on their wallet, and certainly there’s a reluctance to spend. On a customer pay basis, our traffic is down about 2.5%; our revenue is down 3.3%. Where the real pressure in fixed comes from is warranty is down, internal is down dramatically from our sales volume. So, I think you're seeing a reluctant consumer and I think at least for the next quarter or two, we’ll see a similar type trend. But, the business is certainly more resilient than the variable business.

Rod Lache - Deutsche Bank North America

OK. And, then lastly just looking forward, would you expect the used business to begin recovering in advance of the new business? Any thoughts on how the cadence of the year is likely to look?

Michael E. Maroone

Well, we’re obviously more optimistic on the used business and feel that it’s a little bit more in our control. We’re seeing strength really at two ends of the business. One is the CPO business, the certified pre-owned was extremely strong in the fourth quarter. We were up about 30% year-over-year. And, we see more progress on that part of the business.

The other end of the business is the $6,000 to $10,000 vehicles, where there’s a very short supply and a very high demand. The challenge to the business frankly is what Mike Jackson has been referring to and that’s the credit side of the business. So, I think we do feel there’s more opportunity there and we’ll continue to work really hard at it. We are especially prudent with our inventories, trying to get very lean, so we can escape that volatile used car market and also position ourselves to be buyers at the right time.

Rod Lache - Deutsche Bank North America

OK. Thank you.

Operator

Thank you. Mr. Rick Nelson with Stephens, your line is open.

N. Richard Nelson, Jr. - Stephens, Inc.

Thank you. Good morning.

Mike J. Jackson

Good morning, Rick.

N. Richard Nelson, Jr. - Stephens, Inc.

Congratulations for navigating a very challenging environment. Question on service and parts, can you provide the warranty and customer pay numbers?

Michael J. Short

Yes, customer pay was down 3%. The warranty was down 6.6%.

N. Richard Nelson, Jr. - Stephens, Inc.

OK. And, how about the premium luxury segment? Are the comps holding up better there than they are in the other two segments in service and parts?

Michael J. Short

They are. And, actually the import and the premium luxury is stronger than the domestic segment on customer pay. The majority of the customer pay decline came out of the domestic business.

N. Richard Nelson, Jr. - Stephens, Inc.

Thank you for that. Question also about the content of inventory. I know you talked about the 84 days’ supply. Where do you stand now with trucks and SUVs versus the fuel efficient versus where you need to be?

Michael E. Maroone

Rick, it’s Mike Maroone again. We actually are perfectly balanced, which we were not a quarter ago. We’ve got 56% of our inventory in cars, 44% in trucks. Our sales almost matches that identically. So, we think we’re well balanced. As Mike Jackson said earlier, we are looking forward in our ordering, but I think we’re in pretty good shape. We’re also in good shape on the ’08 versus ’09 mix. We’re I think 81/82% 2009. So, we’re in very good shape and we just need a little help on the credit side.

N. Richard Nelson, Jr. - Stephens, Inc.

Gotcha. And, the TARP fund that GMAC received, are you seeing any thawing there or have they indeed not received those funds at this point?

Michael E. Maroone

If they’ve received the funds, we have not been the beneficiary. We still see a lot of challenges in credit. We have not seen any loosening of credit. We’re hopeful as we move into February that there will be more, but we have not experienced any noticeable change.

N. Richard Nelson, Jr. - Stephens, Inc.

Gotcha. And one final questions as it relates to the covenants, could you provide the fixed charge coverage ratio where you stand now?

Derek A. Fiebig

Yeah, we’re in compliance with that. We don't provide the detail on it, because it’s out – the other ratios are tighter than that ratio. But we could provide that to you.

N. Richard Nelson, Jr. - Stephens, Inc.

Gotcha. Thank you.

Operator

Thank you. Mr. John Murphy with Merrill Lynch, your line is open.

John Murphy - Merrill Lynch

Good morning, guys. Just wondering if you could talk about your exposure to GM and Chrysler and your opinion of how that situation is going to shape up for your dealerships specifically and also if you're seeing any opportunity here in the short run in some of those weaker dealers in those brands are dying off and if you see any conquest business on the new, used, maybe even in the parts and service business?

Michael E. Maroone

It’s Mike Maroone. Let me just talk about the changes in the market. Certainly, with the closing of some stores and the industry consolidation, I think there’s some long-term benefit to it. Short-term benefit has really been outweighed by the macroeconomic factors that have really depressed the industry. So I don't think we’ve seen a short-run lift on the variable side. Certainly, we’ve seen some on the fixed side of the business.

John Murphy - Merrill Lynch

OK. And, then also in the fixed business, in parts and service, have you been hearing that Chrysler is lowering labor rates on some of their warranty work. Is that something that’s providing an incremental pressure to the parts and service business? Is that something you're seeing from other auto makers? Or is that just very specific to Chrysler at this point?

Michael E. Maroone

It’s Mike Maroone. There’s an ongoing effort in the industry to tighten some of those labor rate times. I don't think it’s a material event at this point in time, but it is something we monitor. It definitely puts pressure on our techs and their income as well as our labor rate, but it’s not material today.

John Murphy - Merrill Lynch

And, then just lately on acquisitions. I mean, it’s a tough environment. I’ve got to imagine there’s a lot of dealers that may be looking to exit the business. Do you see any big opportunities as we chug through 2009 for richening the mix in our portfolio or just the opportunities in general?

Mike J. Jackson

I think there’s tuck in opportunities with the domestics, but I don't see any big deal you would want to do with the domestics and pricing for the sellers of import and premium luxury is they consider the current market an aberration and a major dislocation and will not adjust prices considering the environment whatsoever. Which in principle I have some understand for, but I think the idea that we’re not in a cyclical business and you don't have to factor in some bad years with good years in your pricing is unrealistic. So I would say there’s a gap in valuations between sellers and buyers that I’m not sure is going to be closed anytime soon.

John Murphy - Merrill Lynch

OK, great. Thank you very much.

Operator

Thank you. Mr. Matthew Fassler with Goldman Sachs, your line is open.

Matthew J. Fassler – Goldman Sachs & Company

Thanks a lot. Good morning. Just a couple follow ups on parts and service. Can you discuss the mix between customer pay, warranty, and internal and also the relative profitability of each of those revenue streams?

Michael E. Maroone

It’s Mike Maroone. The customer pay business is generally 50% or more of the total. I don't have an exact mix of warranty and internal. We can get back to you. But, obviously that’s the other 50%. But customer pay is the area that we really focus on, both with our service merchandising and our service drive processes.

Matthew J. Fassler – Goldman Sachs & Company

And, in terms of the profitability of the different revenue streams?

Michael E. Maroone

Well, they’re I would say customer pay and warranty are equally profitable and we price our internal that way too. So I would say the profitability is close.

Matthew J. Fassler – Goldman Sachs & Company

Gotcha. So, to the extent that you were down high single digits, in the aggregate customer pay was down only 3%. I guess, internal then would have been the bulk of the drag on your business?

Michael E. Maroone

Yeah, internal was down 26%.

Matthew J. Fassler – Goldman Sachs & Company

Gotcha. And, that I would imagine more or less parallel your new car sales trends.

Michael E. Maroone

Yeah, it aligns very closely with vehicle sales. Primarily, it’s prep income that we pick up from manufacturers or internal labor from reconditioning our used vehicles.

Matthew J. Fassler – Goldman Sachs & Company

And like to what degree is the customer pay revenue stream tied in a lagging way if at all to the SAR, in other words – or to your new car trends? Does the stream of customers that you sign on or that you renew have any relationship over the years to the amount of follow up business that you do or do you find that that’s independent of that factor?

Michael E. Maroone

No, I don't think it’s independent. I think – we call them UIOs, units in operation, and declining UIOs ultimately impact you on the warranty and the customer pay side. So, that’s – we see trends by different brands and they really follow the industry trend, in many cases lag two to three years.

Matthew J. Fassler – Goldman Sachs & Company

Gotcha. And one other question on the used car market, what have you seen of late kind of real time in terms of the used car market’s adjustment from a pricing perspective? We obviously had some very, very steep price declines that we saw in the auction market in the fourth quarter. You all kept your inventories very tight. At this point in time, has that market started to stabilize or is the pricing still uncertain?

Michael E. Maroone

No, it’s clearly strengthened. It’s more difficult to buy vehicles at the price levels we would like. We’re specifically seeing some strength in the SUV side. Some of GM and Ford’s big SUVs are very desirable due to the drop in fuel prices that Mike Jackson’s talked about so often. So, overall the market is a different market than we saw in November and early December and that’s why we’re glad that we’re lean and we’re able to respond to those changes.

Matthew J. Fassler – Goldman Sachs & Company

Gotcha. Thank you so much.

Operator

Thank you. Mr. Matt Nemer with Thomas Weisel Partners, your line is open.

Matt Nemer - Thomas Weisel Partners

Hi. Good morning everyone. My first question is just a follow up to the last one on used vehicle pricing. Given the strength or I guess the strengthening that we’re seeing at wholesale auctions with conversion ratios much higher, are you seeing - do you feel like used vehicles have turned a corner and we’re actually starting to see some strength in that market? And, do you have any data on potentially people trading down from new to used? They went into buy a new and they got talked into buying a used car instead?

Mike J. Jackson

I think what’s happened over the past nine months and certainly accelerated towards the end of ’08, is that used prices adjusted very quickly in the marketplace to the velocity of the business and to market conditions. Whereas, new have lagged, even though incentives have been changed somewhat. Meaning the price differential from a consumer point of view between used and new has widened. And, since the consumer is very value-oriented at the moment, they’re saying, “I can get more vehicle for my money on the used side, why pay the premiums on the new side? And, you have this transfer of new customers over used customers.

Michael E. Maroone

It’s Mike Maroone. It really shows up in the growth and the CPO business to have your certified pre-owned business being up 30% where the new vehicle market for us was down 40%. I think it just speaks to exactly what Mike Jackson just described.

Matt Nemer - Thomas Weisel Partners

And, given that, do you feel like your inventories are aligned with where the market is right now? Your used day supply is low, obviously the sales rate was much better than new. But, does it make sense to shift farther in that direction and maybe stock up on used?

Michael E. Maroone

Well, I certainly think coming into the spring market, we’re aggressively pursuing trade-ins and we definitely want to build those inventories, but we’re being very prudent. We want to be able to take advantage of the things that Mike Jackson just describe and that’s the real short-term adjustments in the market. So, I’m comfortable where we are, but we certainly will be looking to build those inventories prudently.

Matt Nemer - Thomas Weisel Partners

OK. And, then my next question is for Mike Jackson. Just wondering on TALF and I guess TARP and maybe the stimulus package, is there something in there that you think really gets the asset-backed securities market going or do you think that more is needed to restart or recharge that market?

Mike J. Jackson

I think really the whole ballgame is TALF, whether something is going to make a difference. Clearly, the banks need to continue to be stabilized and they’ll do that. But, I don't see the banks opening up without someplace to securitize the loans that they make. And, the idea that the private (inaudible) market is going to come back to life, that’s not going to happen in the foreseeable future. So, TALF is really it and if the Federal Reserve executes it well, you could really see a difference in the business.

You know, if we have a 40% decline in our new vehicle sales with a 20% decline in traffic. The other doubling of that decline is the lack of normal credit. I don't call it loose credit. I mean the lack of normal credit for very good customers. So, I don't care what you do with stimulus, new products, pricing, incentives, marketing, to simply drive more traffic when there’s not credit available for the traffic makes no sense. You've got to fix the credit first and then go from there. So, we could have a lift in the selling rate of 10, 15, 20% in a very short period of time if we could get some level of normal credit.

So the key moment is in February and how well the Federal Reserve executes that and whether they do it in a meaningful way. If that doesn’t happen and we still don't have credit in March, then of course people become more discouraged, there’s more layoffs, unemployment goes higher and it becomes a self-fulfilling downward spiral at a certain point triggered by the lack of credit. So I really see a tipping point here in the first quarter in February with TALF. And, we’re going to be watching it very closely.

Matt Nemer - Thomas Weisel Partners

OK. That’s helpful. And, my last question for Mike Short. On capital expenditures, the 90 million is a bit higher than some of your peers. Obviously, you're not – you're all different sizes. But, is there a downside potential to that number and how much – what’s in there other than maintenance? Are there specific projects in that number?

Michael J. Short

There are some expenditures associated with some land purchases and M&A capital associated with those for specific dealerships that we bought. So, if you pull those out, we had done a reconciliation of for example the full year number of 117 to get you down to excluding all those items. If you were to do that on our 2009 callout, we’d be more like in the 75-ish range on that basis.

Matt Nemer - Thomas Weisel Partners

Great. Very helpful. Thank you.

Operator

Thank you. Mr. Rich Kwas with Wachovia, your line is open.

Rich Kwas - Wachovia

Hi, good morning. Just following up on that question, Matt’s question with the CapEx, the 75 number, how much more leeway do you have to cut that?

Michael J. Short

We think that’s pretty skinny. We worked really hard to get to that level. It would depend on the conditions and what was demanding it. But, we think that that’s a fairly skinny number as it is right now.

Rick Kwas - Wachovia

OK, OK. Mike Jackson or Mike Maroone, F&I per unit declined year over year. Do you think the current run rate on a PVR basis is the way to – what you're budgeting for the business? Or, do you think there’s more potential for it to come down.

Michael E. Maroone

It’s Mike Maroone. I don't think there’s – I don't think we’re concerned that it’s going to go down a lot further. I think we think there’s opportunity on the upside. It’s really about credit tightening and lender advances. And, I think with the anticipation that the TALF money will help loosen the credit markets, I think there could be some upside. What we really work hard on is our product penetration, because that’s in our control. The lender advances at this point are not in our control. We’ve also got slightly higher chargebacks year over year. But, the big issue really is credit availability, lender advances, lender conditions on the loans that are being approved.

Rick Kwas - Wachovia

Do you think the market’s fully adjusted to lower LTV ratios, meaning have the consumers adjusted? Is this all the way through? Or, do you think there’s more to go on the bank side and the consumers are going to have to adjust further.

Michael E. Maroone

I think the banks are more informed than ever before and they’re very careful about what they do and got a lot of data at their hands in order to figure out how much to advance.

Rick Kwas - Wachovia

OK. And, then on the next incremental 100 million on the SG&A, two quarters ago you broke out the buckets where you were taking it out of. Can you provide some detail on the buckets you're going to take this incremental 100 million?

Michael J. Short

Sure, Rich. I think if you look at the 200 all in, I’m not splitting it between which and which bucket, but if you look at the 200 all in. We think about 45% of it is coming from compensation. About 25% from advertising. And, 30% from other SG&A. And, again all of those, you know, we’re targeting the structural elements behind each of those and so when you hear about an advertising reduction, those are less about reducing working media and more about being effective with it as demonstrated by our ability to take share despite that reduction.

Rick Kwas - Wachovia

OK. And, then finally Mike Jackson on the dealer consolidation with the Detroit Three, GM has provided a fair amount of disclosure regarding what their plans are by 2012. What’s your sense? Do you think there’s more – it seems like there’s more to go if they’re trying to get to a through-put level of some of the imports. What’s your sense of it? You know, do you think there’s going to be some incremental on that as well?

Mike J. Jackson

Well, I think it’s an historic opportunity for consolidation that should not be missed. You have this unique combination of the dramatic decline in volume with a credit restraint for small business. And, usually the finance companies, automotive finance companies bridge their dealers through periods like this, whether wisely or unwisely, and they’re not in a position to do it.

Whether they’ll take full advantage of the opportunity, I don't know. You know, one of the things that they have to deal with is they have to repurchase parts and inventory every time a dealer closes. And, so that’s still a burden for them, even though there’s no other costs involved in closing the store. I think it’s an historic opportunity. I’ve urged them to take full advantage of it. Whether they will or won’t, we’ll have to see.

Rick Kwas – Wachovia

OK, great. Thank you.

Operator

Thank you. Mr. Colin Langan with UBS, your line is open.

Colin Langan - UBS

Oh, thank you. Can you just comment a little bit about your cash flow generation in the quarter? Like how much gain – I would assume a lot came from working capital? I mean, was that mostly from liquidation of accounts receivable? Or, was there any impact from – I know there was a charge related to tax adjustment?

Michael J. Short

Quite a bit of it came – we don't break out the elements of it specifically, but quite a bit of it came from a number of efforts around accounts receivable, around our contracts in transit, management getting those days down significant – that was a big component of it, managing our used inventory and (inaudible) vehicles. Mike Maroone and I have teamed on an effort with our field associates and they really answered the call on all fronts through as you said, those elements to generate that cash flow.

Colin Langan - UBS

So, going into Q1 as next year, is there any seasonality? Or is that rate sustainable? I mean, should we continue to expect more working capital or have we kind of reached –

Michael J. Short

In terms of the days and the reduction of those efforts, I think that those are sustainable rates. Obviously, as the business begins to recover, you obviously expect us to begin to use working capital in those areas.

Colin Langan - UBS

OK.

Derek A. Fiebig

Thank you. We have time for one more question.

Operator

Yes, thank you. Mr. Himanshu Patel with JP Morgan, your line is open.

Himanshu Patel – J. P. Morgan

Hi. I just have a couple of follow-up questions. On the parts and service business, the – I think you mentioned the domestic portion of customer pay was down more than the other portions. What is the split within customer pay between domestics, foreign and imports – foreign and premium?

Michael E. Maroone

It’s Mike Maroone. I don't have those exact number to you. We can come back to you. But, my comment as I believe there was a $7 million reduction in customer pay overall and I think $6 million came out of the domestics, which goes back to that units in operation issue, in addition to the consumer confidence issue. But, we can come back to you with that split.

Himanshu Patel – J. P. Morgan

OK. And, then last questions just housekeeping. Can you give us the CPO business growth rates for the first three quarters of the year? I think you said it was up 30% in Q4.

Michael E. Maroone

I can't give it to you off the top of my head. Again, we can come back to you. On a full-year basis, I believe we were up 18%. I don't have the quarterly split.

Himanshu Patel – J. P. Morgan

OK. Thank you.

Mike J. Jackson

Thank you everyone for your time today. I very much appreciate it.

Derek A. Fiebig

I’ll be around the rest of today to answer your questions. Thanks for joining us.

Operator

Thank you for participating in today’s conference call. You may disconnect at this time.

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