AutoNation Inc. Q3 2009 Earnings Call Transcript

Oct.29.09 | About: AutoNation Inc (AN)

AutoNation Inc. (NYSE:AN)

Q3 2009 Earnings Call

October 29, 2009 11:00 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

John Murphy – Bank of America Merrill Lynch

Colin Langan – UBS

Rod Lache – Deutsche Bank Securities

Jordan Hymowitz – Philadelphia Financial

Mark-Andre Saucier-Nadeau – Goldman Sachs

Ravi Shankar – Morgan Stanley

Operator

Welcome to AutoNation's third quarter earnings conference call. (Operator Instructions). Now, I will turn the call over to Mr. Derek Fiebig, Vice President of Investor Relations for AutoNation. Sir, you may begin.

Derek Fiebig

Good morning everyone and welcome to AutoNation's third 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 their remarks we'll open the call to questions. And I'll also be available by phone to address any additional questions you might have. Before we begin, I will make a 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 actually 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.

Also certain non-GAAP financial measures, as defined under SEC rules may be discussed on this call. Reconciliations are provided in our press release, which is available on our website at www.autonation.com.

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

Mike J. Jackson

Good morning. Thank you for joining us. Today we reported third quarter net income from continuing operations of $65 million or $0.36 per share compared to a year ago net loss from continuing operations of $1.4 billion or $7.90 per share.

After adjusting for the impairment charges and certain items disclosed in our third quarter financial tables, net income from continuing operations for the 2008 third quarter was $44 million or $0.25 per share in the prior year on a comparable adjusted basis. EPS increased 44%.

AutoNation delivered solid profitability in spite of the industry's depression-level new vehicle sales environment. As expected, the Cash for Clunkers program stimulated new vehicle sales and was a psychological signal to consumers that it was safe to begin to buy again.

In the third quarter we saw a recovery in margins for large vehicles, including trucks and sport utility vehicles from last year's level, which were pressured by the spiking gas prices. Our productivity initiative helped us to expand our industry-leading margin.

The third quarter was a pivotal moment for the auto industry. We saw the reduction of inventories, especially domestics to levels not seen in 40 years, allowing the domestics to make the transformation to the pull system from an outdated push model. The tight inventories affected sales in September but all manufacturers have begun to adjust production and product mix in response to expected volume in customer demands.

Having passed the one-year anniversary of the financial meltdown and prevailing through the two-year industry downturn through aggressive cost reduction and asset management strategies, we are now positioned to respond to the expected recovery in the retail sales environment by increasing investments in capital expenditures, new vehicle inventory and acquisition opportunity.

Additionally, we will continue to repurchase shares opportunistically as part of our strategy to maximize shareholder returns. These steps will position us to capitalize on the economic and credit recovery we anticipate in 2010. I would like to turn it over to Mr. Short to provide details on the financial results.

Michael J. Short

Thank you, Mike. Good morning ladies and gentlemen. First, our financial results for the quarter. As Mike mentioned, we reported net income from continuing operations of $65 million or $0.36 per share. And there were no adjustments to our EPS for the quarter. This compared to adjusted EPS of $0.25 in the third quarter of last year.

The quarter benefited from the Cash for Clunkers program which mitigated otherwise soft unit volume and revenue comparisons and contributed about $0.07 to the quarterly EPS. For the first nine months of this year, our adjusted EPS was $0.87 compared to $0.88 last year, impressive performance given an industry volume decline of nearly 30%.

Adjustments to net income for the year-to-date results and for the 2008 periods are included in the reconciliations provided in our press release. A key performance driver was our $200 million cost reduction program that we implemented during 2008.

SG&A to percentage of gross profit improved for the third consecutive quarter. At 73.8%, it was down 270 basis points from the second quarter's 76.5% as we kept costs down and drove higher sequential revenue. On a year-over-year basis SG&A was reduced by 10% to $380 million.

Net new vehicle floor plan was a benefit of $6.7 million for the third quarter, an improvement of $6.9 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 higher spreads and a decrease in floor plan assistance.

Other non-vehicle interest expense was $10.2 million for the quarter, less than half of the $20.9 million we reported last year, as a result of about $350 million lower average debt balances and a decrease in LIBOR rates.

The provision for income tax in the quarter was $39 million or 37.6% which was slightly favorable from our estimates. For the full year, we expect the tax rate to be about 38%, excluding the impact of any potential future tax adjustments.

On last quarter's call, I mentioned that most of the structural changes for our dealer network had been completed and that we did not expect much of an impact from discontinued operations going forward. During the quarter, we did not add any new stores to discontinued operations and total disc ops had a negligible impact on our reported results.

At the end of the quarter, we had zero stores remaining in disc ops. During the first nine months of the year, we've received about $65 million of net proceeds related to discontinued operations, $25 million of which was received during the third quarter.

Turning to cash flow and balance sheet items, during the third quarter our cash balances increased by $75 million to nearly $205 million. We reduced our debt by $18.6 million during the quarter, including the repurchase of $10 million worth of senior notes. We also repurchased 3.7 million shares, with $66 million during the quarter at an average price of $17.81 per share.

During the month of October we have repurchased an addition 1.2 million shares under a 10b5-1 program. After taking these purchases into account, we have an additional $61 million available for repurchase within our restricted payments basket. As Mike has mentioned, the board has authorized additional funds of $250 million for the purchase of shares.

We remain well within the limits of our financial covenants, with a leverage ratio of 2.41 times at the end of the third quarter, down from 2.45 times at the end of the second quarter. Our indebtedness number in this calculation is not on a net debt basis.

If we had applied the cash on our balance sheet plus available cash from used inventory [borrowing] at the end of the third quarter to reduce debt, we would have lowered the ratio to below two times. Although the covenant limit decreases from 3.0 times to 2.75 times in Q4, we are able to manage comfortably within the limit.

Our capitalization ratio which measures floor plan debt plus non-vehicle debt divided by total book capitalization was 49.3% compared with 51.2% at June 30. This ratio benefited from our inventory management, which resulted in lower floor plan as we are well within our covenant requirement of 65%. The calculations of these covenants are included in the tables of the press release.

Our quarter-end cash balance combined with our additional borrowing capacity resulted in total liquidity of more than $400 million at the end of September. For example cash and liquidity, what we deal best in our business and stayed well within our debt covenants.

Floor plan debt was $1.06 billion at September 30, a sequential reduction of about $140 million as we lowered our inventory during the quarter. Floor plan debt is expected to increase during the fourth quarter, as we restock our inventory.

You may recall that we announced last fall that we intended to reduce total debt by an additional $500 million. As of September 30th, we've reduced debt by more than $1 billion over the past 12 months.

We reinvested $6 million in the business through capital expenditures during the third quarter. We expect our full year 2009 unadjusted amount to be about $90 million. As Mike mentioned the board has authorized significant investments in our business over the coming years and we expect to spend about $150 million in CapEx in 2010.

Now let me turn you over to our president and chief operating officer Michael Maroone.

Michael E. Maroone

AutoNation delivered an operating margin of 4.1% in the quarter a 70 basis point improvement after adjusting for last year's impairment charges, illustrating that we are driving strong productivity improvements along with a disciplined low cost structure; something we are committed to throughout the organization.

In addition we expanded new and used margins per vehicle retail on both a year-over-year and sequential basis. In the third quarter the government's Cash for Clunkers stimulus program returned customers to showrooms and brought a renewed optimization to auto retail.

August provided to be bright spot for the industry in what's been a protracted period of uncertainty. AutoNation had approximately 12,500 Cash for Clunker transactions representing roughly 23% of our new unit sales on the quarter. The spike in sales cleared aged inventory and set the stage to rebuild our inventory with the right mix of current model year products.

Turning to detailed results I'll begin with our segment performance. Segment income excluding corporate and other increased $21 million or 18% compared to the quarter a year ago. This despite a drop in revenue of over $400 million.

Segment income as a percent of segment revenue increased for all segments compared to a year ago is a result of higher vehicle grosses, a shift in mix toward higher margin service and parts, reductions in OS G&A and lower floor plan interest expense.

As I continue my comments will be on a same store basis unless noted otherwise. In the quarter our new vehicle volume was off 12% compared to the period a year ago and in line with the industry retail according to CMW research.

Year-over-year revenue per new vehicle retail was $29,600 a reduction of 1% as Cash for Clunkers focused consumers on smaller fuel efficient vehicles, concentrated in the domestic and import segments.

Gross profits per new vehicle grew $187 or 9% to $2,180 driven in part by improved margins on trucks and overall lean inventories. At September 30th our new vehicle inventory was 25,000 units representing a 47 day supply compared to 60 days a year ago.

Our charter and new vehicle inventory at year end is in the mid to high 30,000 unit range as we increased stocking levels of core units. AutoNation retailed 34,400 used vehicles in the quarter, a decline of 18% compared to a year ago.

We attribute the decline to a combination of lower new volume that drove less trade-ins, abnormally high auction prices which limited purchase opportunities and maintaining conservative inventories over the past 15 months.

Late in the quarter we began ramping up our core used vehicle inventory as prices moderated somewhat. Revenue per used vehicle retailed was $16,300 an increase of $1,016 or 7% in the quarter. Our used luxury sales increased and pricing and mix improved on larger vehicle including trucks and SUVs compared to a year ago when values on these vehicles plummeted as the price of gas reached record levels.

Gross profits for a used vehicle retailed was $1,672 an increase of $109 or 7% compared to the period a year ago. Due to the shift in mix toward luxury vehicles and lean used inventories. Also of note certified pre-owned sales represented 28% of our used volume in the quarter compared to 24% a year ago.

Appraisals and trade-ins were down year-over-year 9% and 7% respectively. However, sequentially from Q2, we noted a 9% increase in appraisals and an 11% increase in trade-ins. In the quarter we moved just under 4,100 used vehicles from originating stores to a more optimal location with good success at retail.

At September 30th our day supply used vehicles was 48 days, up seven days compared to a year ago. In the quarter we recognized a wholesale gain of $2.1 million compared to a loss of $2.2 million in the quarter a year ago as a result of disciplined inventory management coupled with lean used vehicle inventory and rising valuations.

Turning to service and parts, third quarter revenue of $536 million and gross profit of $233 million are both flat sequentially and off just 4% and 5% respectively compared to a year ago.

Our customer pay business showed resiliency with revenue flat year-over-year and down just 1% sequentially. In the quarter internal and sublet were down 8% and warranty declined 11% due to lower vehicle sales and improved vehicle quality.

As part of our efforts to grow customer pay revenue we've heightened the focus on increasing service traffic and customer retention with marketing and best practice process training. Success here will mitigate the impact of lower vehicle sales volume and declining units in operation in our service and parts customer base.

Beginning November 1st we're expanding our Tampa and Clearwater, Florida pilot of service seven days a week to our 29 stores in south Florida. Customer response to seven day service in Tampa and Clearwater has been positive. It's generating new customers and providing greater convenience for our existing customers.

We also use our prepay maintenance program called Value Care as a mechanism to grow service traffic and improve customer retention. In the quarter 39,000 Value Care programs were sold half on the service side, the other half in the F&I department.

Next, finance and insurance, where gross profit per vehicle was a $1,071 in the quarter a decline of just 1% 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 were encouraged by sequential improvement in the lending environment. We noted improved advances in approval rates nearly across the board for the captives and our preferred bank lenders for both prime and near prime. The securitization environment is also improving. Sequentially spreads were down securitization reached its highest levels since 2007 and lease and floor plan securitization returned.

A great deal of effort has gone into optimizing our store portfolio and we are very pleased with our current mix. At September 30th our store portfolio stood at 203 stores and 245 franchisees and 15 states.

Our corporate development team continues to pursue acquisition opportunities that meet our market brand and return on investment criteria. To that end earlier this week we announced that we have entered into agreements to acquire Valley Honda and Valley Acura in Spokane, Washington. Both stores will be renamed to our market brand of Appleway and are a great complement to our brand mix in Spokane. The transaction is expected to be finalized by year end.

Our associates worked hard to deliver a strong quarter we thank them and are appreciative of the extraordinary job they continue to do. We are very proud of our industry leading operating and net margins in what remains of very challenging auto retail environment.

In this difficult environment we've accomplished a great deal. We've retained our best associates, achieved all-time record low associate turn over, invested into technology and facilities, maintained best ever customer satisfaction ratings and continue intense training on our best practice processes at every customer touch point.

With the industry selling rate forecasted to begin growing again in 2010 we are keenly focused on driving additional sales and service volume on our low cost structure and delighting customers in the process.

With that I'll turn the call back to Mike Jackson.

Michael Jackson

We expect the automotive retail market will remain challenging throughout the remainder of 2009 with a gradual recovery beginning in 2010. We do anticipate a continuation of Depression-level of new vehicle sales of just over 11 million in 2010. While much improved by 2009 sales levels, it's still Depression level, but we expect to welcome recession level sales in 2011.

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, our geographic footprint and our brand portfolio.

That concludes our remarks operator please open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is coming from Mr. Rick Nelson of Stephens, Inc.

Richard Nelson – Stephens, Inc

Mike, can you comment on what you're seeing in October both new and used cars from a sales standpoint and then inventories were at pretty low levels at the end of the quarter, maybe where those stand now and how long you think it's going to take to get the stores fully stocked?

Michael E. Maroone

All the published reports speak to a higher selling rate in October. We're seeing the same thing. I think the forecasts that are out are at about 10.3 million rate. We are seeing re-stocking. We are moving our new and used inventories up and today find our inventories sufficient. Our mix is in much better shape. We've cleared out a lot of the old merchandise and prior year models and really have a lot of good, fresh inventory as we work through the fourth quarter.

Richard Nelson – Stephens, Inc.

Could you also comment on geographic areas of strength and weakness and California and Florida would be of particular interest?

Michael E. Maroone

I would say that California continues to struggle, although it's stable. It doesn't fall more but it hasn't recovered a lot. We see a lot of pressure in Arizona and Nevada, which were a little bit later to the party. Florida recovered some for us in the third quarter and actually had a pretty decent third quarter.

I think it's too early to really point to a full recovery but we clearly have hit bottom and it looks like we're recovering in Florida. Some of our other markets, Texas continues to be a good, stable market for us, and we have other markets such as Denver and Atlanta and Memphis and Chicago that have performed at a very nice level.

Richard Nelson – Stephens, Inc.

Also want to ask you about used cars. We have seen price erosion at auction. I think you made reference to that in your comments. Do you think that says anything to demand for used cars?

Michael E. Maroone

I'm not sure about the demand. I think as the economy recovers, I think the used car market will get stronger. I think the improvements in the credit markets and the ability to get financing has given that business a lift.

We felt that the prices were very high in the third quarter and took a pretty conservative posture on our auction purchases. We're happy to see the prices moderate and I think you'll see us build our inventories through the fourth quarter.

Richard Nelson – Stephens, Inc.

Do you think those price changes at auction are more seasonal issues or is it more than that?

Michael E. Maroone

I think it's both. I think it's seasonal and I also believe the prices were too high and are beginning to be more rational. But certainly this time of year, you do see a drop in prices and I think there's a very opportunistic buying time in both November and December.

Operator

The next question is from John Murphy – Bank of America Merrill Lynch.

John Murphy – Bank of America Merrill Lynch

If we think about the third quarter and the SAR of 11.5 million that the industry ran at in the third quarter and the $0.36 that you printed, I mean if we annualize that, I mean would we be looking at something that's basically four times that?

Or was there anything going on in the quarter where you got significant operating leverage or there might be potential for most cost savings? I'm just trying to understand if we can use this to think about sort of an annual earnings number at 11.5 million units SAR.

Michael J. Short

As you know, we don't give guidance in terms of forward-looking numbers and I would just – the only thing I'd say about picking a SAR number and dropping that and assuming that's a predictor of future EPS is that there are other dynamics within the model, right.

There's what's going on in used F&I and fixed ops that will also drive that. So I don't necessarily think that you'd take that as a strict indicator. Although I do think it's very telling that in this particular environment where you add volume back into this model, how much flow through there is as you leverage the fixed cost base that we have right now.

John Murphy – Bank of America Merrill Lynch

Okay, then second question, are you guys seeing any return in leasing in any brands or broadly in the market? I appreciate the comments on credit availability but what's going on with leasing that you're seeing in the market?

Michael E. Maroone

Clearly, the import captive lenders have stayed the course in leasing. Toyota's particularly aggressive as they've increased their residuals that are well above ALG and really speak to the confidence they have in the resale value of their product and of course where the used vehicle inventories are going to be two and three years out.

So Toyota's been aggressive. We're beginning to see the domestics re-enter the leasing business. It's coming back. We're happy to see it come back. Same thing with subprime, it's coming back but it's certainly not back to the levels that were there prior.

John Murphy – Bank of America Merrill Lynch

So you'd view that as still a little bit of pressure on demand right now?

Michael E. Maroone

I think that there's more opportunity there but I can see why people have been cautious. But I think the most positive thing is that it is coming back and there are more vehicles being leased. And consumers clearly are interested in leasing. And as you know the premium luxury have stayed very consistent in the lease front and continue to have good, strong leasing programs.

John Murphy – Bank of America Merrill Lynch

And Mike Jackson, you've been on the warpath on the industry's excess inventory for years. And now that we're at a level where inventory is a little bit too low and we're rebuilding that inventory, I mean, do you see any risk that this inventory gets rebuilt to those excess levels that we were at before or do you think the inventory has really gained – I mean, the industry has gained religion and that you have enough power to push back to keep this inventory at healthy levels going forward.

Mike J. Jackson

No, I think this has been a transformational experience for every manufacturer. And it's all about profitability, sustainability, viability. And the push system is basically dead. And we see a completely different conversation with the manufacturers today about purchasing vehicles that's all about what do they need to build that people want to buy and how do they need to configure them?

And they're trying to get as close as possible. And there is absolutely for the first time in my career, no pressure to buy more than we need. And it's a wonderful place to be and I think it's the real deal. I don't think this is a temporary situation and that we're going to screw it up because what was going on was unsustainable.

And now we've had this very disruptive event, they've been restructured. And their new shareholders very much want it to be about profitability. So I think the inventory policy is completely different, I think the incentive policy is going to be different.

I think incentives are going to migrate back to being tactical moments and not be part of the strategy that you got massive incentives day in and day out, so the levels of incentives will mitigate, the timing of incentives will change and production push is definitely dead.

Mike, maybe you want to talk about it since you're in this war and it's been a war, with me every step of way. The difference in conversation you see at the store level today.

Michael E. Maroone

I think it's an incredible difference, Mike, and you said transformational and I think it is. The discussions are very positive. Manufacturer's representatives that call on our store are coming and really talking about our sales forecast and talking about our needs.

And frankly we can't get enough of certain products and that's a good feeling. The gross margins have certainly benefited. And I think as you look at Cash for Clunkers clearing out the '09 and positioning us for 2010, there's a very positive discussion going on with every one of the manufacturers. And the spirit is totally different than it's been in the past.

John Murphy – Bank of America Merrill Lynch

Thanks. And then just lastly on the share repurchase, it sounds like you've got a lot of room to run on the authorization. But with the stock trading right now if it's [minus] 1793, just two questions, is there anything that we should be thinking about as far as restrictive payment baskets on your ability to buy back shares? And if you could just remind us what price you bought back shares in the third quarter.

Mike J. Jackson

John, we've been buying back in the 1780 range in the third quarter. And we do have a restricted payments basket in our notes. And within that basket we were at about $69 million or so remaining in the basket at the end of the quarter.

John Murphy – Bank of America Merrill Lynch

That's about 50% of net income for quarter, is that –

Mike J. Jackson

That's what happens going forward is as you generate net income in the quarter, 50% of that gets added back into the basket –

John Murphy – Bank of America Merrill Lynch

Okay, so that will get rebuilt on the coming – well I mean, theoretically, we think it will, I mean yes, okay.

Operator

The next question is from Colin Langan – UBS.

Colin Langan – UBS

On that topic, you have $200 million in cash, I mean how would you rank your priorities in use of that cash in terms of dealer acquisitions or share repurchase because it seems like you're – which one is the bigger priority for you?

Michael E. Maroone

That depends on price. And that's an evaluation we make literally every day, every week, looking at the pricing on acquisitions and looking at the price of the stock. And there will be times where we'll do neither, there will be times where we'll swing aggressively one way or the other and there will be times where we do both. It really is a function of price.

Colin Langan – UBS

And in terms of acquisition, I think you've said that you're more willing to buy GM, Chevy or Ford dealers. What about – is that still the same to you? You're willing to buy more of those three brands? And what about geography, I mean are you willing to now that maybe some of the regions that were less competitive? Has that changed now with some of the consolidation in the dealer base?

Michael E. Maroone

I would say our primary focus would still be on our existing geographic footprint. We really would like to represent all the major brands in all the markets that we're in and we clearly are not there yet today, and we definitely would buy Chevy brand or Ford brand where we would not have done that a year ago.

So we think there are solid companies going forward and they're great brands going forward. But again it's a matter of price and the seller still has this idea that everything's going to go back to the way it was and want that same time type of pricing that they were asking for back on '04, '05, '06 and we see it different and so we're going to stay disciplined on the price side. If the price is right though we're ready to move.

Colin Langan – UBS

Do you have any targets for how much you would be willing to spend next year on M&A?

Michael J. Short

No, we don't have a target. We have what's a very strong balance sheet so we really have all the flexibility in the world for just about any scenario you could come up with. So if there is a precipitous drop in the price of the stock that would be a big buying opportunity, we would make a move to go after it.

If we're presented with a number of acquisitions that are really attractive and we don't have the cash on hand, we'll do what it takes to get it. So to summarize it, my mindset, always weighing risk and opportunity; I've always seen more risk over the last six years than opportunity knowing that there was going to be a big shake out with the domestics and who knew how it was all going to end.

Well, we're now past that and we're at the absolute bottom of the trough, a firm bottom has formed. Production portion's dead. We're into a new world about viability, sustainability, much more rational with a great deal of consolidations on both the manufacturer and at the dealer level and even though it's going to be a slow, gradual recovery, my risk outlook has changed completely and I think we're perfectly positioned to go on the offense rather than be on the defense.

And those are not just words. If you look at the third quarter, where we increased our capital investment for next year in our own stores by 60%, repurchased shares, closed an acquisition, increased inventory. Six months ago I would not have done that. Today, I will. And that will be our mode of operation going forward on all fronts.

Colin Langan – UBS

Okay, actually switching topics. You talked about new vehicle margins being helped by year-over-year because of truck – better margins on the truck business. Does that mean you think those margins are sustainable going forward or is that really boosted for this quarter buying the Cash for Clunkers Program?

Michael J. Short

All those positive things I just said about the industry, the wildcard is still for our industry gasoline prices. And within the context of where gasoline prices are at the moment, even within the context of a gradual increase in gasoline prices, if it's gradual you could even go to $4 a gallon over several years, it wouldn't matter.

We would be able to manage the margin. The only event that we have to worry about is volatility in gas prices like we had in the summer of '08. If gas prices move dramatically in a short period of time it's extremely disruptive and makes us stupid from one day to the next as far as what we have in stock. And then we have to use price to reconfigure the inventories and then by the time we get that done the gasoline price would come back down. So it can really drive you crazy.

The one thing that I do very much like looking at going forward is that every manufacturer is committed to offering a full range of vehicle from fuel efficient through trucks or performance. Knowing that there is going to be a migration towards fuel efficiency over time, everybody assumes gasoline prices will be higher, but if there is a disruptive event that introduces extreme volatility around the price of gas, manufacturers will be able to react with product in a shorter period of time than what we had to go through in '08.

Colin Langan – UBS

Okay, so I mean in terms of this quarter though, there actually was no boost from Cash for Clunkers, it just has to do with the strengthening of the truck margins?

Michael J. Short

I would say there was a benefit in that Cash for Clunkers definitely took inventory to a historic low and they cleared a lot of de-stressed inventory that was lumpy from the whole gas nightmare from the bankruptcies, the disruption of production, vehicles partially built and then finished.

All that got cleared by Cash for Clunkers and helped front end gross during the quarter to that extent. But then going forward, I've never seen inventories in better shape and I've never seen the pipeline closer to what people actually want to buy. So that's a positive.

Colin Langan – UBS

Okay and just one last one to ask. Can you just – what percent of your parts and services customer pay warranty in internal and just generally how you're thinking of warranty now that sales have been down over the last year, is that going to be a headwind going into the next 18 months?

Michael E. Maroone

The customer pay gross is about 46% customer – or excuse me, the fixed gross is 46% customer pay, about 18% warranty. Obviously the internal fluctuates with our sales rate. I would say going forward there'll be continued pressure on the warranty business with improved quality in declining [UIO].

Our intention is to continue to aggressively merchandise and market on the customer pay side and we've got some really innovative ideas on how to do that, some of which are in pilot stage right now.

Colin Langan – UBS

So are those percentages the 46 customer, 18 warranty –

Michael E. Maroone

Right, and then there's wholesale collision and internal underneath that. But the two big players are customer pay and warranty.

Operator

Our next question is from Rod Lache – Deutsche Bank Securities.

Rod Lache – Deutsche Bank Securities

Did you have an estimate for the impact of Cash for Clunkers on your grosses this quarter? You did comment that it was a positive. I was just wondering what you feel the underlying numbers look like.

Mike J. Jackson

I don't believe we've quantified them. I will tell you, post clunker, in September our grosses continued to hold up well, albeit the supply was tight.

Rod Lache – Deutsche Bank Securities

But just to clarify what you said earlier, it sounds like you believe that the transformation implies structurally higher margins in that business, just the new business and do you have a sense of any way to quantify what that really means about long term sustainable margins in the new car business.

Mike J. Jackson

That's further than we're willing to go. I mean we don't give guidance. We don't give exact [inaudible], but directionally I'm saying we're in a different world, and we faced pressure on front end margin for years now.

We have a pivot point here where we've reversed it and absent a disruptive event like around gasoline prices we think the margin pressure is somewhat relieved.

Rod Lache – Deutsche Bank Securities

Okay and I was wondering how you were thinking about the service and parts business going forward. It looks like the comps should get quite a bit easier over the next few quarters.

But obviously there are a number of varying drivers the population of under warranty vehicles declining, but maybe some more willingness from consumers to spend some money on maintenance. Do you have a sense of when this starts to flatten out?

Michael E. Maroone

Well our customer pay business is flat year over year which I think is amazing considering the pressure on consumers. We've certainly seen some sequential improvement in consumers loosening their spending some. I think there's some pent up demand there. I wouldn't forecast large growth but I think you'll see some level of growth in 2010.

Operator

Our next question is coming from Jordan Hymowitz – Philadelphia Financial.

Jordan Hymowitz – Philadelphia Financial

Guys thanks for taking my call. A couple of questions following John Murphy's question about some one-time items in the quarter if you could explain them. The other expense turned from a negative 25 for a positive 31, what caused that and what does that represent?

Michael J. Short

Hey Jordan, last year there were some impairment charges in the quarter and this year we actually had a gain on – we've relocated our headquarters and so as a result of that we had a gain on a lease.

Jordan Hymowitz – Philadelphia Financial

Okay, so that's a onetime item then?

Michael J. Short

Yes.

Jordan Hymowitz – Philadelphia Financial

Okay. Also under other gains and losses, you went from a negative 2.2 to a positive 2.2. What does that represent?

Michael J. Short

That's our DCP program – Deferred Compensation Program. It actually has zero net impact on the total P&L, but it ends up with a – so for example, there's a $2.2 million favorable item in 2009 in that particular line. There's an offsetting number in SG&A. So the net impact is zero on the overall P&L, but it is called out separately in that line.

Jordan Hymowitz – Philadelphia Financial

Okay, but it's in no benefit in that regard?

Michael J. Short

Yes, and I would just – if you're thinking about the overall business, you've got to begin to just pull it out of the there. You take an equal number of SG&A.

Jordan Hymowitz – Philadelphia Financial

Okay, and then on the floor plan interest expense, you actually had a $6.7 million benefit. I assume that's because you sold cars so quickly that you get the credit for 60 days and the expense only as long as they're out there. I mean is it – what would be a quote "normal" [amortization] of this ratio, because you usually have some floor plan expense costs rather than a benefit?

Michael J. Short

Right, and we've had benefits in the past as well, so it's not unheard of that we have these. But you just have to look at what the overall day supply is at inventory levels to make that assessment. But you're correct in your assumption as to what the driver is.

Jordan Hymowitz – Philadelphia Financial

So it's usually something with, depending how long inventory carries, but it's usually between 20 and 50 percent more on the expense side, and under a quite "normal," if such an animal exists anymore, environment, correct?

Michael J. Short

No, I don't think I'd go there on that, Jordan. I think it's a function of where LIBOR is, as well as how long we have the units in inventory.

Michael E. Maroone

I think if you go back and look historically, before the push system got out of control, it was very common to have credits in floor plan. And I think as we look forward, if we manage our inventories correctly and manufacturers operate in an improved manner, I think there's opportunity there.

So I don't think that's a one-timer. If you look at the full year, we've got a nice credit on the full year as well, certainly at accelerated with Cash for Clunkers and a quick inventory turn and reduced inventories.

Jordan Hymowitz – Philadelphia Financial

And what is your sensitivity now then to interest rates? I mean obviously if it's tough to know because if you're getting a credit it's almost negligible.

Michael J. Short

Yes, and LIBOR is one of the drivers there, Jordan, right? So the fact that LIBOR is down is helping that – the [full] bank credit as well. Other than that, on our varied – on our non-vehicle debt side, our notes are 50% fixed, 50% floating, and our term loan is entirely floating at LIBOR plus 87.5.

Jordan Hymowitz – Philadelphia Financial

And then a final question is, can comment about the new car margins stayed similar in September as it was for the quarter. Can you comment, and if you won't that's fine, too. In October, did it also stay at similar levels?

Michael E. Maroone

We typically don't comment on current quarter, and I think we'll stay with that. We did have good strong margins in September and are pleased with the current state of where our inventories are and where our margins are.

Operator

Our next question is coming from Mark Saucier – Goldman Sachs.

Mark-Andre Saucier-Nadeau – Goldman Sachs

Hi, just had a quick question first on the used car auction pricing losing momentum. Like could you talk about what the impact is on grosses, maybe what it's going to be going forward? And secondly on F&I, could you talk about [service] centers, and I know you've talked about things improving, but if you could just comment on geographic differences and how the recovery in F&I plays out? Thank you.

Michael E. Maroone

First on the used car prices, we try and keep our inventories generally in a 35 to 37-day range. At the end of this quarter we're a little bit higher as we've ramped up the inventory. But when you run your inventories in a disciplined manner, the auction prices don't have a huge impact.

Certainly the wholesale market in the third quarter was a benefit to us, and you see that we showed a $2.2 million profit. But I think we can continue to maintain good margins by going forward, and again, it is part seasonal and part taking some of the irrational pricing out of the third quarter. So I think it's a more normal situation.

In terms of F&I, most of our lenders are national lenders, and our preferred lender base is nationally focused. So we're seeing pretty good consistency. Certainly there is a little bit of reluctance in the markets that have been hit so hard with housing.

And Phoenix and Vegas are suffering pretty high repossession rates, but from a national perspective, the approval rates up. The advances are improving, and as Mike Jackson said, both leasing and subprime are beginning to reenter the market. So overall I think it's a positive.

Mark-Andre Saucier-Nadeau – Goldman Sachs

And finally if I may – just one follow-up on the M&A side, what are you seeing in the markets in terms of what dealerships are selling for on EBITDA multiples at the moment?

Michael J. Short

I don't have a specific EBITDA number to give you, but we're definitely seeing moderation in pricing from what existed before the downturn. There's a backlog of sellers that are waiting. And but we think if need – we think there needs to be more movement on price before we're ready.

Operator

Our last question is coming from Mr. Ravi Shankar – Morgan Stanley.

Ravi Shankar – Morgan Stanley

Thank you. A couple questions on the used side. How do you think the consumer has reacted to the high used prices so far this year? Has there been incline to buy new or stay out of the market then? And as it looks like the prices are coming down, how do you think they're going to start reacting to that?

Michael E. Maroone

I think that a consumer saw a great opportunity in Cash for Clunkers and with the Government making a significant contribution. So it's clearly the businesses shifted to a greater focus in new. Our used-to-new ratios outside of Clunkers was very strong at 0.8, used to new, 0.8 to 1.

Going forward I think, again, pricing is normalized, and I think the used car market will be good. We continue to see strength on the certified pre-owned side, and now that Clunkers is over, we're seeing some lower priced vehicles, which are always quick sellers. So I think consumers will – I think demand will be normal and I think there's good opportunity there.

Ravi Shankar – Morgan Stanley

All right, and can you also talk about the inventory spike in the used that you saw towards the end of the quarter? Were you trying to like build up on something that you're short on, or were you just trying to take advantage of prices? Or do you see like a recovery in used volumes coming?

Michael E. Maroone

Right, I think that the spike in inventory was a conscientious attempt to say we're seeing some moderation at the auction. We are now buyers. In the third quarter for a period of time, we were relying on trade-ins and there wasn't as many trade-ins as normal. So we have clearly – we clearly did not want to overpay for our used cars. And I think we managed very conservatively and appropriately, given the environment.

Ravi Shankar – Morgan Stanley

Right, but do you see yourselves coming down towards the target range that you said of 35 to 37 days pretty soon?

Michael E. Maroone

Yes, and again, yes. Mike Jackson called out our risk profile has change, and we are ramping our inventories, but we're doing it intelligently, watching traffic and demand, and making sure we're making good business decisions as we do ramp up.

Ravi Shankar – Morgan Stanley

And finally, can I just talk about the potential uses for the additional CapEx in 2010? It seems like a fairly large ramp, especially given that your view on [saw] recovery is probably not nearly as strong.

Mike J. Jackson

Yes, well we have to look at these projects will – that we've basically green-lighted in the third quarter – will take 2, 2.5 years to build. So it's renovation, expansion of existing facilities and building entirely new facilities, along with existing owned franchises at our locations.

Ravi Shankar – Morgan Stanley

Great, and is this more discretionary or is this like a bunch a maintenance stuff.

Mike J. Jackson

No, I would say it's expansion and to new facilities.

Derek A. Fiebig

Well, that concludes our remarks today and the call. I'll be around to answer any questions you have. Thanks for joining us.

Operator

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

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