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AutoNation Inc. (NYSE:AN)

Q2 2009Earnings Call

July 31, 2009 10:00 am ET

Executives

Derek A. Fiebig - Vice President, Investor Relations

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

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

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

Analysts

Richard Nelson - Stephens, Inc

Matthew Fassler - Goldman Sachs

John Murphy - Merrill Lynch

Colin Langan - UBS

Operator

Good morning ladies and gentlemen my name is Maryanne and I will be your conference operator today. At this time I would like to welcome everyone to AutoNation’s Second Quarter Earnings Call. (Operator Instructions). I will now turn the call over to AutoNation.

Derek A. Fiebig

Thank you Maryanne and good morning everyone. This is Derek Fiebig Vice President of Investor Relations and I would like to welcome you to AutoNation’s Second Quarter 2009 Conference Call.

Leading our call today will be Mike Jackson, our Chairman and CEO, Mike Maroone, our President and Chief Operating Officer, and Mike Short, our CFO. At the end of the formal remarks, we will open the call to questions and I'll be available by phones to address any follow up questions you may have.

Before we begin I want to remind you that during today's call we may make some forward-looking statements. 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 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.

We also may use certain non-GAAP financial measures as defined under SEC rules and reconciliations for those are provided in our press release, which is available at our website at www.AutoNation.com.

With that I will turn the call over to Mike Jackson.

Mike Jackson

Thank you, good morning, and thank you for joining us. Today we reported second quarter net income from continuing operations of $55 million or $0.31 per share compared to a year ago net income from continuing operations of $56 million or $0.31 per share. After adjusting for certain items disclosed in our second quarter financial tables net income from continuing operations, or the 2009 second quarter, was $51 million or $0.29 compared to $59 million or $0.33 per share in the prior year.

During the second quarter U.S. industry order sales declined 40% over the prior year according to CNW Research. AutoNation new unit sales declined 38%. The industry is in the midst of an historically low new vehicle sales environment driven by the ongoing prolonged recession, rising unemployment, and the continuing credit crisis. This has resulted in the continued postponement by consumers of the purchase and servicing of vehicles. In spite of this AutoNation delivered solid profitability in the second quarter.

The second quarter was a pivotal moment for the automotive industry. We saw three major events: first a bankruptcy and government led restructuring of General Motors and Chrysler, the companies will now be in a stronger position to be profitable with lower cost structures, significant and long over due dealer consolidation, and new labor agreements. We saw this shake out coming over five years ago and developed a strategic plan that would reduce our exposure to the domestic manufacturers, which as a percent of new vehicle sales has been reduced from 60% to 30%.

As the selling rate drastically declined in late 2008 starting with the economic Pearl Harbor caused by the bankruptcy of Lehman Brothers and the precarious viability of domestic automakers became evident, we chose to accelerate our final phase to close our sell domestic dealerships. These final steps, which in the normal course would have taken a couple of years to implement, were also accelerated by the consolidation implemented by General Motors and Chrysler.

We were well prepared for the moment and with the actions completed we have addressed the strategic needs of our portfolio and position our business for increased profitability and operating strength going forward. We are satisfied with our brand mix and store portfolio, and we expect our divestitures going forward to be minimal. I do not anticipate much need for divestitures in the future.

Second we saw stabilization in the selling rate or SAAR which had declined significantly since the third quarter of 2005 and had not seen a sequential quarterly increase since the fourth quarter of 2007. Stabilization is a first important step towards a gradual recovery.

Finally, we have seen a recovery of residual values and demands for trucks and SUVs which suffered declines during the rapid rise of gas prices to over $4.00 in the summer of 2008. With much lower fuel prices than last summer the industry also saw recovery of large vehicles in the quarter with used vehicles and SUVs showing a price recovery year-over-year of 25%. The price recovery has helped to stabilize the domestic business which was disproportionately impacted by the higher gas prices in the prior year.

While today’s economic uncertainty may compel potential buyers to put off their purchase decisions until a later date their needs remain. Once consumers begin to sense that their own economic situation has stabilized they will be ready to commit to purchasing big-ticket items like motor vehicles.

We expect to see a gradual recovery in the second half of 2009 and have seen a dramatic consumer response to ‘Cash for Clunkers’ which began officially on July 24. Our traffic has surged sequentially 35% and we expect a sequential lift of over 10% in new vehicle sales for the month of July. Customers responding to the program have better credit scores than our average customers.

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

Mike Short

Thank you, Mike and good morning ladies and gentlemen. Turning to our financial results for the second quarter, as Mike mentioned we reported income from continuing operations of $54.8 million or $0.31 per share. We had a net after tax gain of $3.7 million on asset sales and dispositions which increased our EPS by $0.02 for the quarter. After adjusting for this item net income was $51.1 million for the quarter, or $0.29 per share. The adjustments to net income are included in the reconciliation provided in our press release. Included in our adjusted results was a benefit during the quarter in our finance and insurance reserves related to charge backs to reflect lower exposure in this area. The amount was about $5 million pre tax.

We continue to benefit from the $200 million cost reduction program that we implemented during 2008. SG&A as a percentage of gross profit improved for the second consecutive quarter and remains the lowest of the public dealers. It was down 110 basis points to 76.4% from first quarter’s 77.5% and it decreased 350 basis points to the 79.9% we experienced during the fourth quarter of last year.

On a year-over-year basis SG&A was reduced by nearly 20% to $364 million, however it did increase as a percentage of gross profit reflecting the deleveraging of our cost structure.

Net new vehicle floor plan was a benefit of $2.9 million for the second quarter, an improvement of $3.7 million from last year. This improvement was the result of lower floor plan interest expense as we decreased our inventory levels and benefited from lower LIBOR rates. These were partially offset by a decrease in floor plan assistance.

Other non-vehicle interest expense was $10.5 million for the quarter, less than half of the $21.6 million we reported last year. As a result of $400 million lower average debt balances and a decrease in LIBOR rates.

The provision for income tax in the quarter was $32 million or 37% which was slightly favorable from our estimates. For the full year we expect our ongoing rate to be about 39% excluding the impact of any potential future tax adjustments.

Mike described our portfolio optimization strategy and the acceleration of the sale or closure of a number of our domestic stores. I thought I would spend a moment discussing how that activity has affected discontinued operations in our reported numbers.

Discontinued operations reflects the results from stores that were sold or closed during the quarter, as well as stores that we identified for sale or closure in future periods. During the first half of this year a total of 28 of our stores were added to discontinued operations. As of June 30 we had either sold or closed 21of these locations. Total revenue associated with discontinued operations was $105.5 million for the second quarter and $244.9 million for the first half of 2009. In total our discontinued operations had pretax operating losses of $5.6 million during the second quarter and we reported $18.1 million in largely non-cash pretax losses related to the disposal of these assets. About half of the operational losses and about 85% of the transactional losses during the quarter were related to the stores included in the dealer consolidation announcements by Chrysler and General Motors, which Mike Maroone will discuss.

For the first half of the year the operating losses associated with discontinued were $6.6 million pretax and we reported $42.2 million of non-cash pretax losses related to the disposal of these assets.

During the first half of the year we received more than $40 million of net cash proceeds related to discontinued operations which represents less than half of our expected ultimate proceeds. We expect future orders will have a minimal amount of activity.

Turning to cash flow and balance sheet items, during the second quarter our cash balances doubled to $128.9 million. We reduced our debt by $7.9 million during the quarter including the repurchase of $6 million worth of senior notes. We remain well within the limits of our financial covenants with a leverage ratio of 2.45xs at the end of the second quarter. This is up slightly from a ratio of 2.35xs at the end of the first quarter, however as you likely know our indebtedness number is not on a net debt basis. If we had applied the cash on our balance sheet plus cash available from used inventory flooring at the end of the second quarter to reduce debt, we would have lowered the ration to about 2.1xs.

We also completed our annual goodwill impairment testing as of April 30 and determined that no goodwill impairment was needed. One franchise impairment for $1.5 million pretax was recorded.

Our capitalization ratio which measures floor plan debt plus non-vehicle debt divided by total book capitalization was 51.2%; that compared with 54.9% at March 31 and 59.7% at December 31st and it covenant requirement of less than 65%. This ratio benefited from the reduction in our inventory levels which we discussed earlier. The calculations of these covenants are included in the tables of the press release.

Floor plan debt was $1.2 billion at June 30 a sequential reduction of $300 million as we lowered our inventory during the quarter. You may recall that we announced last fall that we intended to reduce total debt by an additional $500 million. As of June 30 we reduced debt by nearly $1 billion.

Our quarter end cash balance combined with our additional borrowing capacity resulted in total liquidity of nearly $450 million at the end of June, which is ample cash and liquidity to invest in our business and stay well within our debt covenants. We reinvested $13.8 million in the business for capital expenditures during the second quarter. Excluding acquisition related spending land purchases for future sites, and lease buyouts, capital expenditures were $6.1 million for the quarter. We expect our full year 2009 unadjusted amount to be about $90 million.

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

Mike Maroone

Thanks Mike and good morning. We are pleased to report an operating margin of 3.9% for the second quarter. This is a 20 basis point improvement compared to the period a year ago and leads the peer group. At 2% our net income margin also leads the peer group and is double that of the closest public competitor. These results were achieved in an environment of very challenging industry conditions and the bankruptcy proceedings of Chrysler and General Motors.

The key drivers of our solid profitability were highly disciplined management of our new vehicle inventory and the entire organization being focused on maintaining and building upon the savings we have achieved relative to our low cost structure. We found the sequential improvement in industry light vehicle sales from the first quarter to the second encouraging.

We also view the ‘Cash for Clunkers’ program as a clear positive even though it likely impacted our second quarter new vehicle volume as consumers were awaiting program details and launch. The program got off to a brisk start. Our observations are that the majority of our ‘Cash for Clunkers’ volume is incremental, a larger percentage of the trade ins are domestic, and on the sales side the majority are imports. In aggregate credit scores for our ‘Cash for Clunker’ customers are better than normal and the program has not negatively impacted our used vehicle business.

Turning to detailed results I will begin with our segment performance. At $93 million our total segment income was off $21 million or 19% compared to the quarter a year ago. Imports were the greatest contributor to the decline followed by premium luxury and then domestic. In the period a year ago domestic segment was first to feel the brunt of increasing gas prices. In the current quarter the domestic segment fared better year-over-year as truck and SUV values rebounded and lower gas prices resulted in higher demand for large vehicles.

Also, in May and June we were successful at liquidating the inventory of our seven stores that were closed as a result of the Chrysler bankruptcy. I will also note that the General Motors approach to winding down affected stores is much more orderly and provides ample lead-time.

Segment income as a percent of segment revenue increased for all segments compared to a year ago due to a shift in mix toward higher margin service to parts business and a reduction in OSGA expenses across all three segments.

As I continue my comments will be on a same store basis unless noted otherwise.

According to CNW Research the industry was down 40% in the quarter at retail. Our performance was moderately favorable with a decline in new vehicle sales of 38% in the quarter. It goes without saying that a volume decline of this magnitude impacted all areas of our business; however on a gross profit per vehicle retail basis we realized improvement in new vehicles, used vehicles, and finance and insurance.

Revenue per new vehicle retailed was $31,000.00 an increase of $1,150.00 or 4% compared to the period a year ago, as consumer preference shifted to larger vehicles due to lower gas prices. Gross profit for new vehicle retailed increased $33.00 or 2% to $1,987.00 per vehicle.

Revenue per used vehicle retailed was $16,000.00 an increase of $350.00 or 2%. Gross profit per used vehicle retailed was $1,656.00 an increase of $5.00 compared to the period a year ago.

Finance and insurance gross profit per vehicle retailed at $1,148.00 increased $37.00 versus a year ago and as Mike Short mentioned our performance here benefited from favorable charge back reserve adjustments due to reduced exposure. Without the adjustment our F&I gross profit per vehicle retailed was $1,080.00 off $31.00 compared to the quarter a year ago driven primarily by lower commissions on vehicle financing that was partially offset by solid F&I product sales.

In the quarter we noted some improvement in the lending environment with many captives and bank lenders increasing prime and near prime volume and approval rates slightly. That being said, volume and approval rates remain substantially below the levels of a year ago. I will note that subprime financing remains especially difficult and according to JD Power leasing as a percent of total industry sales hit a ten-year low in the quarter.

Turning to inventory, at June 30, with approximately 31,000 new units in inventory our new vehicle day supply was 53 days compared to 60 days a year ago. This represents a year-over-year reduction of nearly 22,000 units or 41% on our total store population. Sequentially compared to March 31, we are down about 8,000 new units or approximately 20%. We have clearly managed our new vehicle inventory very conservatively and have benefited from a net floor plan credit as a result. We are now starting to increase our orders and are doing so with a two-pronged approach, first based on core model needs and second in anticipation of sales volume increasing in the back half of the year. I will note that we increased our mix of fuel-efficient vehicles in preparation for ‘Cash for Clunkers’.

Relative to used vehicle inventory at June 30 our day supply was 35 days, a reduction of six days compared to a year ago. While appraisals and trade-ins were both down roughly 30% compared to a year ago sequentially from Q1 we noticed a 10% increase in appraisals and a 20% increase in trade-ins. In the quarter we moved 3,900 used vehicles form originating stores to more optimal locations with good success at retail. I will also note that certified pre-owned sales represented 30% of our used volume in the quarter compared to 23% a year ago.

A $533 million same store revenue for service and parts was off 8% compared to a year ago, as was gross profit at $234 million. Lower vehicle sales, declining units in operation and improvements in quality are all factors. Once again, we are pleased with the resiliency of our customer pay business where it performed at 98% of the prior year and grew at 3% sequentially compared to the first quarter which equated to 1.4% growth when adjusted for selling days. We continue to work on strengthening our customer pay business through our defined and measured service sales process and enhanced service marketing.

In the quarter lower retail sales volume impacted internal, sublet and warranty revenue. Internal and sublet was off roughly 25% compared to a year ago and warranty, which was also impacted to a lesser extent by improved vehicle quality, declined 7%.

Efforts to grow service customer retention include the sale of our Value Care program. We have been offering it on a service drive in addition to the F&I department since May of 2008 with growing success. In the quarter we sold a total of 43,000 of these prepaid maintenance programs with 24,000 of them being sold on the service drive. This is a key link to service growth and customer retention.

Turning to our store count, at June 30 our portfolio consisted of 210 stores, 264 franchises in 15 states. Related to the Chrysler bankruptcy seven stores were closed in early June. We retained many of our best associates from these stores and as I mentioned earlier we were successful at liquidating the inventories if these stores in the very compressed time frame provided by Chrysler.

Relative to the General Motors bankruptcy three of our stores will not transition to the new company. These stores are currently included in our portfolio count. When these stores are closed AutoNation will operate 36 General Motors stores and 10 Chrysler stores.

In closing, we are operating successfully in what remains an unprecedented environment. Our net margins are strong, associate turnover is the lowest in the Company’s history and customer satisfaction is extremely high. We are committed to the ongoing training of our associates as our work continues to emerge from this downturn as an even stronger company.

Finally, I would like to thank each of our associates for their efforts and dedication to delighting our customers.

With that I will turn the call back to Mike Jackson.

Mike Jackson

Thanks Mike. The industry in the second quarter stabilized which is the first step to recovery. As we look at the rest of 2009 we believe the new vehicle market will improve. 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 markets.

That concludes our remarks. Operator, please open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Rick Nelson of Stephens, Inc.

Rick Nelson - Stephens, Inc

Can you talk about the sequential improvement that we saw in the new car margin and whether or not you think that is sustainable given your own inventory reduction efforts as well as that of the industry?

Mike Jackson

I think what is truly remarkable and a first is despite these precipitous declines in sales the industry has cut production faster than the rate of decline of sales, and the industry has gone from an inventory of over four million units down to just over two million units, about 2.1 and you have to go back to 1975, 1976 to find a comparable number. So the industry is really in a good position going forward. We have increased our forward orders by 45%. That is a combination of the fact that we like where we are in the production cycle, meaning it is the beginning of a model year, inventories are low. There is going to be an improvement in sales, we don’t know exactly when and how much, but it is definitely going to be an improvement, and it is safe to put in an aggressive forward order.

I think the industry is going to keep the inventories in line. I think one of the big historic facts of the second quarter is the depth of production push and it is all going to be about sustainability, viability, and profitability for manufacturers, suppliers, and retailers, and I think there will be more opportunity on the front angle side.

From an operational point of view, Mr. Maroone, why don’t you talk about that?

Mike Maroone

Well Rick, I believe that the liquidation of Chrysler and to a lesser extent GM product did impact the margins, so I think there is some upside opportunity and I very much support what Mike Jackson said. With the inventory showing the discipline and not having over supply, I think there are opportunities to expand our margin. We are pleased with what we did in the quarter and I think there is more opportunity there.

Rick Nelson - Stephens, Inc

Do you think with the impact you may have missed some sales opportunities with that 53A supply?

Mike Maroone

I think the benefits outweighed what could have been missed. We looked at our market share and we think we performed well from a market share point of view, so I don’t feel like we missed a lot. I am sure we missed a few deals, but the benefit in floor plan year-over-year was about $4 million, so that impact was very positive for us.

Rick Nelson - Stephens, Inc

Thank you for that. Turning to the used car side, I see the growth per unit fell sequentially from the first quarter to the second quarter. Are you seeing any resistance there to the rise in prices?

Mike Maroone

I think the used car grosses are more normal to some of our prior periods. Certainly we had a spike in Q1 and in Q2 we found rising used car prices, very limited availability, not enough trade-ins, so I think there was a lot of competition to buy vehicles externally and I think it had some impact on our margins; although we are certainly not unhappy with the margins where they are.

Mike Jackson

I would add I think the critical path on used car margins, to a great extent, is the financing and the banks, not necessarily the customer. The customer would be willing to sign a contract for more, but we can’t get a bank to advance more. That seems to be what we hit up against.

Rick Nelson - Stephens, Inc

Finally, I would like some more commentary on ‘Cash for Clunkers’. This talk of suspension of the program, what do you think the future is for ‘Cash for Clunkers’ and what is really going on?

Mike Jackson

My sense is that the billion was always viewed as a first traunch. To put it out there, see what the reaction is, and what happens. With the possibilities ranging all the way from you get a surge of sub hot, subprime traffic that you would look at and say is that really healthy for the industry or not? The reality has turned out to be that this is a genuine stimulus package that is brilliantly conceived, that is absolutely, positively spot on.

So, I think there will be a considerable effort on the part of the administration to marshal significantly more resources for ‘Cash for Clunkers’. This is exactly what stimulus programs are supposed to do, and really you can’t talk about the recovery of the U.S. economy without the recovery of the American automobile industry and this is certainly factor. It has driven traffic beyond just ‘Cash for Clunkers’. Traffic has really been almost permission sign that it is safe for people to come back in, and it has lifted volume beyond just clunkers.

So, it is full green on all lights. Obviously there is concern that they have gone through the first billion too fast. Whether there will be a pause while they get more money, or they are able to keep it going without a pause is open to question, but my view is they are going to move heaven and earth to get more resources for ‘Cash for Clunkers’ because this is a stimulus program that is spot on and it is working perfectly.

Rick Nelson - Stephens, Inc

If it is upsized do you see it as a pull forward program and how do you see it affecting the used car business?

Mike Jackson

I do not view it as a pull forward. It is certainly incremental. It is not sustainable incremental, but it certainly is incremental in the traffic we are looking at. Rick these are people who were in these cars and were going to stay in these cars forever. The only reason they are coming in is because this program exists, so in that sense it is truly incremental. The overall business activity that it is generating, this second factor of telling people hey it is safe to go out and buy a car again, that is what will be sustainable, so it is really working, as stimulus should.

The other fascinating thing is it has had no impact on the used car business. That may seem counter-intuitive except if you look at this customer, this frugal, conservative customer that has stayed in his car so long. It is not really actively out there trading in the business day-to-day, it is really something new to the market. You can only trade the clunker to get the incentive on a new vehicle. So, it is a unique transaction that at this point is not affecting the rest of the business and we saw no impact on our used vehicle business in July whatsoever.

Rick Nelson - Stephens, Inc

Good to hear it. Thank you and good luck.

Operator

Your next question comes from Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs

First of all while we are on ‘Cash for Clunkers’, I know the traffic is up 36%, does a high proportion of the customers you find walking in incrementally actually have a clunker to sell you, or is it just simply in addition to that stirring up general interest in the category?

Mike Jackson

It is definitely both, Matt. It is people who have a clunker, people who think they have a clunker, and people who wish they had a clunker. To get a sequential 36% boost in traffic, and by the way we are going to be very interested in seeing what happens this weekend, but the trend line is still upward, so we will see where that goes, but it is really across the board in the volume mass market. There has been no lift in the luxury business from ‘Cash for Clunkers’, but for the volume markets it is people who have them, people who think they have them, and people who wish they had them.

The fascinating thing though, is that even if they think they have one and we inform them that they don’t, they are not walking away. The conversation continues and we have an excellent closing rate on what is quality crafted.

Matthew Fassler - Goldman Sachs

Following up, I guess some brands are getting less traffic from that, presumably, maybe the domestics and some of the lower end import brands, if you will, might be up more than 36% on a dealership-by-dealership basis. Would that be a fair read?

Mike Jackson

As far as traffic it is pretty much across the board. The majority of the trades are domestic trades, but as you think about it that is logical because if you go back 10, 15 years the domestic had 60%, 70%, 75% share and these are vehicles with poor fuel economy. So that is a domestic by definition. The majority of the purchases so far are indeed imports, but there is also excellent traffic at the domestic stores and incremental sales at the domestic stores.

The report I have the numbers, there is really no dramatic bandwidth there.

Matthew Fassler - Goldman Sachs

Okay. My second question relates to the financial model as you see the volumes stabilize and that ultimately recover, not ‘Cash for Clunkers’ with a spurt, but on a more sustainable basis. What do you think the proportion of gross profit that you can pass through would look like? What do you think the marginal expense rate is on the incremental new car sale given what you have done to your cost structure? If we think about the SAAR going from 9 or 10 today up to something in the low to mid teens over time?

Mike Short

I think one of the things you need to consider is as new vehicles grow in the overall mix of the business you have a margin mix difference, right, in the proper [inaudible] in that stream relative to get in fixed costs are obviously the more profitable side of the business. But, in terms of the actual flow through on the new vehicles it is 40% to 50% plus what you get in F&I which is very high.

Matthew Fassler - Goldman Sachs

So in other words, we would look at the new car gross and take 40% or 50% allocated to margin, less G&A, and the rest flows down?

Mike Short

Yes, that is fair.

Matthew Fassler - Goldman Sachs

That’s great. Thank you so very much.

Operator

Your next question comes from John Murphy from Merrill Lynch.

John Murphy - Merrill Lynch

Just looking at the inventory situation here, obviously we have gotten a lot of fat out of the system, and I think it is something you have been talking about for a long time, that the industry just needs to take one-step backwards and actually just cut production to get inventory in line. Obviously it took the fear of God to get the automakers to do that. As things recover and we go forward do you think that you, combined with everybody else in the industry, are going to be able to enforce that discipline as things get better, or do they start over producing once again as demand starts to recover and the fear of God is lost in their memories?

Mike Jackson

I think Dracula is in the coffin with a stake through the heart and I will tell you why. As far as GM and Chrysler the only way they can pay back the Federal Government is through profitability and creating entities that the equity is worth something that can be sold. That is going to have to be a very rational business model sell. The underpinnings to get to that were a very painful restructuring. Cars that had been sitting there for decades finally had to be dealt with, and these companies have really taken the break-even points from a $16 million SAAR down to a $10 million SAAR with really agonizing pain. So it is all about viability, profitability, and sustainability going forward. So, this is really a pivotal, historic, moment for the industry.

Where as in the past the fixed costs were simply so high relative to marginal costs that they would always over produce, though I think everybody is committed to this and I travel in the industry, everybody sees it as a pivotal point. I look at the irrational players that were squeezed out in the shake out, even at retail, so this dramatic period of time has really crushed all irrational players; they really got killed. So I really see it as a different time.

So what is going to happen going forward? I think you are going to see step backs from extreme incentives and that is going to be something we have to manage. How the customers are going to like that is going to be interesting. Whether we are able improve our margins at the same time that incentives are being scaled back is a challenge to us, so it is not a cake walk, but I think it is a new world.

John Murphy - Merrill Lynch

Following up on your comments there Mike, I mean you guys are operating it looks like 10 Chrysler stores after you have gone through the closures and 36 on the GM side. Obviously you have more exposure to Ford which seems like it is a good thing. It seems like you are though looking at sort of a bifurcation in what is going on in Detroit. It seems like you are giving more of an endorsement just based on your business mix to Ford than you are to GM and Chrysler. Do you think that is going to continue and that you may actually even further work down those Chrysler and GM stores going forward? Are you comfortable with what they have done so far and their product offerings going forward, that those are stores that you want to keep in the portfolio?

Mike Jackson

I think your statement is very insightful and it’s not a coincidence. That is where we are at and I have to emphasize with Ford, we’re with Ford brand and we’re with Chevy brand. If I look at the spectrum you really have a different quality of traffic in a Ford showroom today than Chrysler all the way on the other end of the spectrum. If you look at the product cadence I think Ford has the best with the least disruption and Chrysler with the biggest technical challenge to execute on their product development.

So, I think that is a fair statement and we will see how it develops, but we are basically satisfied with our footprint and don’t foresee much dramatic change there. I would say at the right price I would definitely be interested in a Chevy or a Ford store. I think it is a new world. This moment has been decades in the coming. It is here. It think the auto taskforce did a brilliant job in restructuring these companies and changing the industry and creating this new world, which we are happy to be in by the way.

John Murphy - Merrill Lynch

Then just lastly, you guys have been pretty good stewards of shareholder capital and generating it for a long time with a good record of actually returning it to shareholders through share buybacks. Obviously there has been a pause in that here as the world has been turned upside down. How do you think about that going forward? I mean are there going to be more opportunities to start making acquisitions again that might drive higher shareholder value, or are you are looking at debt pay down as a better way to return value, or do you get back into the share buyback game here in the near term?

Mike Jackson

Clearly we were in a debt defensive position for the past period of time. I think that was highly appropriate and I think we moved defensively early enough that we could manage through the challenges extremely well. I think you see the cash position that we have today, which signals let’s rethink, we are entering a new world and we certainly are going to opportunistically consider acquisitions, debt repurchase, and share repurchase and see where the opportunities develop that will bring the most shareholder value.

John Murphy - Merrill Lynch

Okay, thank you very much.

Operator

Your final question comes from Colin Langan from UBS.

Colin Langan - UBS

Can you give us an update on your restructuring? How much of the $200 million is left? I think in the past you have commented, could you just update us on how much of that will be variable and how much of it is actually going to be picks going forward?

Mike Short

Sure. We have accomplished the $200 million. In fact, we have actually grown that a little bit and some of that was transferred into stores that were put into discontinued operations so we continue to build on it, but $200 million is the number that we’re at right now. Of that about 45% or so of that is coming out of compensation areas. About 30% of it is coming from we bought other SG&As generally store related expenses like travel and meetings and things like that, and the balance is coming from advertising.

In terms of the amount that is structural versus what we expect to come back as the market improves, what we called out in the past is about ¾ of it is structural and I think that is what we would see with that number.

Colin Langan - UBS

Okay. Even though ads and comp are a pretty big portion? When you say comp is that just from a lot of that is just actual headcounts out of the system?

Mike Short

When you actually look at how much total SG&A is down, it is down by $400 million, I think that was the number we called out in the past. So all we are really targeting in the $200 million that we have identified are initiatives that we have put in place. So, in terms of the comp number that we are calling out that is largely through headcount reductions, not just because the volume is down so you are paying lower sales rates out. So, the comp number that we are calling out is largely headcount driven; that is why we consider it structural.

Colin Langan - UBS

Okay, that makes sense. In terms of parts and services what was the break down between customers pay and warranty?

Mike Maroone

In terms of the performance the customer pay was down two on a revenue basis, warranties are down seven, internal is down 24. If you look at the weight of those businesses customer pay is about 62% of the labor gross, warranty 22%, and internal 16%. So, the bulk is customer pay. The customer pay business is quite stable compared to the variable business and we have got a lot of iniatives in place to drive that as we move forward.

Colin Langan - UBS

So what is your outlook for parts and services? Do you think you could continue to see some sequential lower declines here?

Mike Maroone

I think as volume comes back you see the internal gross go up, you see the warranty gross go up, and I think you’ll see some growth on the customer pay side. So, I do think we have got an opportunity as the economy recovers and the industry recovers to grow that business.

Colin Langan - UBS

Okay and in terms of parts and services it seems like a lot of your competitors were down year-over-year. I think you called out a $5 million reserve adjustment there. Was it more flat when you take that adjustment out or?

Mike Maroone

On a PBR basis I think the number that Mike had called out was about $5 million in the adjustment: when you pull that out that lowers the PBR. But, that is in F&I not parts and services, that is the finance and insurance number and that is a result of year-to-year changes versus prior period changes in our reserve largely related to charge back experience.

Colin Langan - UBS

Okay, I’m sorry I must have misspoke, I meant F&I. Because a lot of your competitors that were down, when you take that out it still kind of looked about flattish still; so, is there a reason why you guys are doing so much better there or?

Mike Maroone

We have always performed at a high level on F&I. Our emphasis has been on product sales and we have continued to have good product penetration, offset a little bit by some rate pressure from lender conditions.

Colin Langan - UBS

Okay and then one last question. Why aren’t there any, I expect the charge is related to the GM and Chrysler store closings, are they all within discontinued operations, is that why they are not special items for that?

Mike Maroone

That is correct Colin, all of that has been put into discontinued operations. There are one or two exceptions that are [inaudible] but your comment is correct.

Colin Langan - UBS

Okay, all right thank you.

Operator

I will now turn the conference back to AutoNation.

Mike Jackson

Thank you for your questions. Thank you for joining us today. That concludes the call. I will be around for the rest of the day to answer your questions. Thanks a lot.

Operator

This does conclude today’s conference call. (Operator Instructions)

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Source: AutoNation Inc.Q2 2009 Earnings Call Transcript
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