Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

AutoNation Inc. (NYSE:AN)

Q4 2009 Earnings Call

February 11, 2010 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

John Murphy – Bank of America Merrill Lynch

Richard Nelson – Stephens, Inc

Matthew Nemer – Wells Fargo Securities

Matthew Fassler – Goldman Sachs

Dan [Galebson] – Deutsche Bank Securities

Colin Langan – UBS

Derrick Winger – Jefferies & Co.

Operator

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

Derek Fiebig

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

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

Mike J. Jackson

Today we reported fourth quarter EPS from continuing operations of $0.36 compared to a year ago EPS of $0.42. After adjusting for a favorable tax item in 2009, our adjusted fourth quarter 2009 EPS more than doubled to $0.29 compared to an adjusted EPS of $0.13 for the prior year.

Fourth quarter 2009 revenue totaled $2.8 billion compared to $2.6 billion in the year ago period, an increase of 8%, driven primarily by higher new vehicle sales. In the fourth quarter, total US industry new vehicle retail sales increased 6% based on CNW research data. In comparison during the same period, AutoNation’s new vehicle unit sales increased 7%.

AutoNation delivered solid profitability in the fourth quarter of 2009 and more than doubled adjusted EPS in spite of a SAAR rate that increased only 3% to 10.8 million. AutoNation’s full year adjusted EPS increased 14% to $1.15 from $1.01 for the prior year despite a US industry new vehicle sales decline of 22% in 2009.

Going forward, there are two issues that I would like to address. First is the recent recall announced by Toyota. Many have reported that customers are overwhelming dealerships and are outraged about their vehicles. Neither of these is true. Customers are making appointments and in fact have been very patient with regard to recent calls.

The recalls have created disruption in business beginning on January 25, 2010. We have began to sell Toyotas that were on a no-sales hold and estimate the impact on Q1 2010 EPS will likely be less than a penny, depending on the availability of replacement parts, car shopping down the brand, and the rate of recovery to the pre-recall levels.

We expect that Toyota will move aggressively to gain back market share following resolution of these issues and believe that the Toyota brand will not suffer significant long-term damage to its reputation for quality, safety, and dependability.

The second topic is to note that we passed the one year anniversary of the financial meltdown and have prevailed through the multi-year industry downturn. Our aggressive cost cutting, reduction, and asset management strategies resulted in a lower cost structure, reduced debt levels, and more efficient inventory management.

These improvements will allow us to continue to respond to the expected recovery in the retail sales environment. Although sales have been improving from a bottom, the pae of recovery continues to be gradual, and the absolute level of sales remains well below the historical levels.

These past few years of low sales volume have resulted in a meaningful reduction in the units in operation which has created a headwind for the parts and service business industry wide that we intend to mitigate through targeted of initiatives best-in-class processes.

I would now like to turn it over to our Chief Financial Officer, Mike Short.

Mike J. Short

Turning to our financial results for the fourth quarter, as Mike mentioned, we reported net income from continuing operations of $62 million or $0.36 per share. The results included a favorable tax adjustment of $32 million or $0.07 per share, so the adjusted EPS was for the quarter was $0.29 which compares to adjusted EPS of $0.13 per share in the fourth quarter of 2008. For the full year, our adjusted EPS was $1.15, compared to $1.01 last year. Given the industry-wide new unit sales decline of more than 20%, we’re very proud of this performance.

The adjustments to net income are included in the reconciliations provided in our press release. Compared to last year, revenue increased $218 million, and gross profit improved $21.2 million for the quarter. Despite these increases, SG&A was up only 1% as we benefited on a year over year basis from the $200 million structural cost reductions we completed during 2008.

As we’ve discussed previously, $150 million of this reduction is permanent in nature, while the remaining $50 million is expected to return as volume recovers. As a percentage of gross profit SG&A was 76.4%, a reduction of 260 basis points.

As has been the case in previous quarters, net new floor plan continued to be a benefit. For the quarter, it was a benefit of $4.3 million, compared to a cost of $7.3 million last year—an improvement of $11.6 million. This improvement was the result of lower floor plan interest expense due to effective management of inventory levels and significantly lower LIBOR rates which spiked in the fourth quarter of 2008. These reductions were partially offset by higher spreads and a decrease in floor plan assistance.

Non-vehicle interest expense was $10.2 million for the quarter, down from the $20.1 million we reported last year due to our $236 million lower average debt balance and the decrease in LIBOR rates.

Provision for income tax in the quarter was $14.7 million and included the benefit of $12.7 million as we had favorable resolution of some state tax measures. During the quarter, we repurchased 4 million shares of our stock for $69.9 million at an average price of $17.67 per share. Capital expenditures for the quarter were $35 million, bringing our total annual spend to $75.5 million—a $35 million reduction from 2008. We expect Capex to be approximately $150 million in 2010.

As of January 1st, we had an additional $45 million available for the repurchase of shares within our restricted payments basket. Thus far in the quarter, we have utilized approximately $12 million of this amount for the repurchase of 700,000 shares. We remain within the limits of our financial covenants with a leverage ratio of 2.41 times at the end of the year, unchanged from the third 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 flooring to reduce debt, we would have lowered the ratio to below two times, compared to the limit of 2.75 times.

Our capitalization ratio which measures floor plan debt plus non-vehicle debt divided by total book capitalization increased from the third quarter levels as we restocked our vehicle inventory. Floor plan debt was $1.39 billion at year end, up $328 million from September 30th and down $425 million from December 31, 2008. As of December 31st, the capitalization ratio was 52.7%, well within the covenant requirement of 65%. The calculation of these covenants is included in the tables of the press release.

Our quarter end cash balance was $174 million, which combined with our additional borrowing capacity resulted in a total liquidity of $390 million at the end of December, which is ample cash and liquidity to invest in our business and stay within our debt covenants.

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

Michael E. Maroone

AutoNation ended the year on a strong note with an operating margin of 3.4% in the fourth quarter, an 80 basis point improvement compared to a year ago. In the quarter, we continued to maintain an extremely disciplined cost structure and it served us well. We managed our inventory prudently, gained new vehicle market share, and continued to benefit from our expanding shared service model.

In the period, associate productivity increased, and we experienced the lowest associate turnover in the history of the company. We also attained our best ever customer satisfaction levels for both sales and service in the quarter.

Turning to detailed results for the quarter, I’ll begin with our segment performance. In the quarter, segment income excluding corporate and other increased $40 million or 54% compared to a year ago. Segment income as a percent of segment revenue increased for all segments as a result of increased unit volume, higher vehicle grosses, reductions in SG&A, and lower floor plan interest expense.

As I continue, my comments will be on a same store basis unless noted otherwise. AutoNation retailed 46,500 new vehicles in the quarter, an increase of 8% compared to a year ago, and favorable to the industry retail number of plus 6%. We were pleased to record new vehicle market share gains in each month of the quarter.

Fourth quarter new vehicle revenue increased 15% compared to the period a year ago. Revenue per new vehicle retailed increased $1900 in the quarter to $33,400 with revenue increases across all segments, this due to reduction in incentives and a shift in mix toward larger vehicles for imports and premium luxury that was partially offset by a mix shift toward cars for domestics. Gross profit per new vehicle increased $246 or 12% to $2289 resulting from improved margins on imports and trucks, as well as overall lean inventories.

Total gross profit dollars on new vehicles increased to 21% compared to the quarter a year ago. Relative to new vehicle inventory, as planned, we increased our stocking levels of core inventory and ended the year with just over 35,000 units on the ground, with over 90% of our inventory being 2010 model year. Our inventory is in great shape relative to both quantity and mix. At December 31st, our new vehicle days supply was 54 days compared to 83 days a year ago.

We retailed 32,500 used vehicles in the quarter, a decline of 2% compared to a year ago while increasing total used gross by 7%. Used volume growth in the import and premium luxury segments was offset by a domestic decline driven primarily by a sizeable reduction in domestic certified pre-owned sales. During the quarter, we moved 4700 used vehicles to originating store to more optimal location with good success at retail.

Revenue per used vehicle retailed increased 10% or $1625 to $17,188 in the quarter, as tight supply drove up used vehicle values especially trucks post clunkers. Total gross profit dollars increased 7% in the quarter to $48 million due in part to a $3.6 million wholesale improvement. I’ll note that after experiencing significant wholesale loss in 2008 due to the volatility of the used market, we managed our used inventory much more conservatively throughout 2009.

Gross profit per used vehicle retailed was $1485, an increase of $13 or 1% compared to the quarter a year ago. At December 31st, our days supply of used vehicles was 41 days, up 11 days compared to a year ago. Days supply calculation was inflated by increased trades at the end of December.

Turning to parts and service, fourth quarter revenue of $521 million and gross profit of $227 million were off 2% compared to a year ago, with warranty being the primary driver of the decline as improved vehicle quality and a declining service base continued to impact the warranty business. Our service base consists primarily of the trailing 5 years of our new and used unit sales.

Relative to gross profit in the quarter, declines of 13% in warranty gross and 1% in customer pay service gross were offset somewhat by 14% growth in internal gross, as we prepped more new and used vehicles for sale. In the quarter, internal gross which is driven by current period volume improved year over year and made up 14% of total parts and service gross profit.

Customer pay service comprised 44% of our parts and service gross profit, and warranty accounted for 18%. When you factor in parts and collision, more than 80% of our total fixed gross was impacted by changes in unit sales and thus our service base, which has declined in each of the past 5 years and most dramatically in the past two. This trend will continue for the coming years until sales recover from their current depressed levels.

While the fixed business remains under pressure, to offset the macro issues, we have implemented a plan to grow customer pay service business and improve owner retention which is a key long-term goal for our company. We believe our efforts will stabilize our parts and service business and that in total it will remain relatively flat until the service base stabilizes. To this end, in the quarter, we have expanded our service reminder program, we’ve added an outbound phone initiative to win back defectors, and expanded our service marketing to reach more prospects. We have also sold 35,000 prepaid maintenance programs, an important retention tool with about 40% of them sold on the service drive, and we continue to validate our 7-day service pilot in Clearwater, Tampa, and in South Florida.

Next, finance and insurance, where gross profit per vehicle retailed was $1,130 in the quarter, an increase of $81 or 8%. We attribute this growth to our strong preferred lender network, improved returns from our service contract portfolios with third parties, increased product penetration, and ongoing efforts to improve the performance of our third and fourth quartile stores.

In the quarter, there was improvement in the credit environment compared to a year ago. We noted an increase in approval rates by the majority of captives as well as our preferred bank lenders for prime and near prime customers. For the higher risk segments and non-prime and used vehicles, credit recovery is slower. On average, advances have increased on both new and used vehicle, and the securitization environment continued to improve with spreads versus LIBOR at the lowest levels since the fourth quarter of 2007.

In the quarter, we noted strength in the Atlanta and Denver markets, and we were encouraged by a solid performance in Florida. Distressed areas of California and Phoenix and Vegas were all up slightly compared to the period a year ago. At year end, our store portfolio numbered 203 stores and 246 franchisees in 15 states. In January, we completed and successfully integrated our most acquisitions of Appleway Honda and Appleway Acura in Spokane, Washington. Looking ahead, our corporate development team is actively pursuing acquisition opportunities that meet our market and brand criteria as well as our return on investment threshold.

We’re proud of our performance in what was a very challenging year. I’d like to thank our 18,000 associates for their dedication and determination. As the economy recovers, we’re focused on gaining profitable new and used market share, growing our service customer base, and strategically acquiring franchises. We will continue to invest in training and technology to support the consistent execution of our best practice processes in order to deliver superior customer satisfaction.

Before I turn it back to Mike Jackson, I would like to comment on our Toyota business. Our first priority continues to be servicing our affected customers to alleviate their concerns and ensure their trust in Toyota and our stores. The vast majority of customers are very understanding and are awaiting notification from Toyota before coming to the dealership. Parts are arriving daily, and we’re completing customers’ cars first and then turning to stock units.

The recall initially affected 56% of our new inventory and 22% of our used inventory. Based on what we’ve been told relative to the availability of parts, along with the relative simplicity of the repair, we expect to have all inventory salable in the next week to 10 days. Our incoming phone calls in service business are up significantly and are manageable with our increased staffing and expanded hours. Showroom traffic is down about 20%, which should increase as available inventory and advertising increase.

Our associates view this as an opportunity to reinforce our commitment to customers and clearly understand the need to extend ourselves at each interaction. We appreciate the value of their efforts.

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

Michael Jackson

As we look at 2010, we believe that the gradual improvement in new vehicle sales will continue to take place and will ramp up in the second half of the year. Our planning assumption for 2010 industry new vehicle unit sales is 11.5 million units.

With that, we’ll be happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is coming from John Murphy – Bank of America Merrill Lynch.

John Murphy – Bank of America Merrill Lynch

On the Toyota issue, when we look at the benefit that you’re getting from parts and service versus the lost sales and profits from new vehicles, is there any quantify what that offset is? Do you think that might be a greater offset than the pressure that you’re seeing here in the short run on sales?

Michael Jackson

Obviously the sales impact is right now with the no-sale impacting the business immediately. Recoupment of that will take more time and come over the course of the next several quarters. I would say all in, they probably offset each other, so for the total year, it’s a non-event, with perhaps an impact of $0.01 in the first quarter with the disruption of sales.

John Murphy – Bank of America Merrill Lynch

Obviously inventory is being managed very tightly right now, but are there any parts or any brands where you think that you’re inventory constrained and that may have pressured sales, or do you think you see that generally in the industry?

Michael Jackson

Mike Maroone will give some specifics. I would make a general statement that all manufacturers are much more conservative in their production run and are much more responsive to signals from the market place as something not selling to curtail to production, and we have many vehicles from all manufacturers where there is clearly more demand and supply. If you really think about the business, there are only two things you ever hear from the market place. You have too many or you have too few. You never hear it’s just right. So the only way to go through life in this business is to have more demand than supply, but you’re trying to keep that as close as possible, but that you have tight inventories with the demand pull system. It looks like the industry has done a phenomenal job of transitioning through that coming out of all the difficulties of last year, and so far all manufacturers we deal with are much more responsive to push back when there are difficulties in the market place and trying to respond much quicker to what people actually want to buy. So it’s really a new world. Mike, you want to fill in any details?

Michael E. Maroone

John, I think Mike covered it well. I would tell you every manufacturer has models that we want more of and we’re constantly trying to get more of. There are just select products in almost every line that is that way, but I think Mike properly characterized it. It’s a nice situation to be in. Our inventories are really clean. We’ve got 91% of our inventory in 2010, and we’re in good shape, but there are few models, but I don’t think they are unique to any one manufacturer.

John Murphy – Bank of America Merrill Lynch

If we were just to think about showroom traffic and ups and your ability to close those, how is that trending and how is the closing rate trending in general?

Michael E. Maroone

I would say traffic is relatively flat. We measure both our showroom business, our e-traffic, and our phone traffic. What we are seeing is higher closing rates, and I really credit that to improved credit year over year. So people that are coming are serious buyers. We’re being able to get them financed for the most part, other than the subprime segment, which is more difficult; it’s not impossible but it’s more difficult, but our closing rates are up.

John Murphy – Bank of America Merrill Lynch

Lastly on real estate values, it comes as a big part of the equation, for not just you but also as you think about acquisitions or explore acquisitions. What are you seeing in the assumption in the potential sellers in their through process on the value of their real estate versus the blue sky of the operating part of the equation, and is that helping or hurting what might be some potential acquisitions that could come in the future?

Mike J. Jackson

Sellers are in denial to a great extent, and so there is a definite gap between buyers and sellers, and it’s on three issues. One I would say the extreme volatility of the industry over the past couple of years. If you look at what happened around gas prices, if you look at what happened around credit, it means the bandwidth of what can happen is much broader than what anyone thought. Imagine we got down to a selling rate below 10 million units, meaning you need to be much more conservative in the multiple you pay because the volatility is higher. I think that’s pretty well accepted by sellers. The next step is though absolute earnings of the dealerships are down because we’re at the bottom of the trough and they want to apply this lower multiple to what they used to make, not what they’re making today, because they think what they used to make is what they will make, and the buyer’s attitude and certainly our attitude is, well, that could be, we’ve got a pretty optimistic view about the future, but nobody knows for sure what’s going to happen, and why should I pay you for what I think is going to happen. I am going to pay you for what is happening, and if you want to hold the store for 2 or 3 years and we see how all this develops, that’s your privilege. And then the final issue and indeed you’ve already touched on is real estate, and with the fact that the rationalization of retail did not take place year by year as there were changes and shifts in the industry, it happened all at once with the bankruptcy of Chrysler and GM and the collapse of the market. There is a lot of automotive real estate on the market which is going to affect values for some period of time as the economy recovers and the use of those properties change, and again, sellers want to be paid for what they used to be worth and they think it will be worth in the future, and buyers are saying if you want to sell now, this is all we’re willing to pay you now because this is the market today. So there is a gap there, and somebody is going to have to capitulate, and we’ll just have to see who that is.

Operator

Your next question comes from the line of Rick Nelson – Stephens, Inc

Rick Nelson – Stephens, Inc

I’d like to follow up on the Toyota recall. Can you ballpark the revenue per vehicle, the parts and the labor, and also what sort of attachment rates you’re seeing when these customers come in to other services in the store?

Mike J. Jackson

I’ll take a stab at it, and if I don’t get it exactly right, we have experts here who’ll get is exactly right. The sticky pedal couldn’t be simpler. It’s a very small shin about the size of a postage stamp that they’re probably giving them to use for free. It’s 15 cents; there you go, I’ve just been corrected, and it’s a half hour repair. The floor mat is a bit more complicated. It’s about a 1-1/2 hour repair. Any parts involved in that?

Michael E. Maroone

It’s about $250 for the entrapment, about $70 for the shim.

Rick Nelson – Stephens, Inc

The labor flow through is what about 70% and the parts flow through around 30%?

Michael E. Maroone

It’s higher on one and about right on the other, but to your other question, we’re not attempting to up-sell these folks at all. What we want to do is alleviate their concerns, get their car repaired, and certainly keep their trust.

Mike J. Jackson

And I think that’s the right decision. On many recalls, we up-sell and take a full examination of the vehicle and see what else the customer wants to do. I think in this case considering the level of concern that’s out there, it’s all have to be about the customer first, as little inconvenience as possible, get them in, get them fixed, and get them back on the road, happy with their Toyota. So that is our focus in this circumstance. And I have to again make this statement—we are standing unequivocally with Toyota. They’ve been a great partner for 10 years. We’re going to get through this together. We’re making no attempt at AutoNation to divert traffic to other brands during this time. My belief is that looking at the faces of the customers coming into the Toyota stores and their depth of goodwill, confidence, and trust in Toyota, once we can go back to full sales, Toyota during the month of March and April will by and large have recaptured almost all the share that they’ve lost during this disrupted period.

Rick Nelson – Stephens, Inc

The strategies that you outlined to drive the customer pay business, how long have those been in place, or is that relatively new?

Michael E. Maroone

We continue to add to those. So we’ve been on a constant service reminder program. Our outbound sales calls are relatively new. Our 7-day service is in pilot. We really understand the declining service base as a headwind for us and a big challenge, and we’re determined over time to grow that customer pay business. We know that that service base will grow as sales recover, but we’re impatient and we’re aggressively trying to go after it.

Operator

Your next question comes from the line of Matthew Nemer – Wells Fargo Securities.

Matthew Nemer – Wells Fargo Securities

On your used business, your used unit lagged the group last quarter, and it seems like based on your comments that you’re just playing a little more conservatively in that business during 2009, but I’m just wondering if you’re planning going forward to get more aggressive in used either on an inventory or pricing basis?

Mike J. Jackson

AutoNation has been in a conservative defensive posture for several years on all fronts considering the shakeout we saw coming and thinking about how severe it might be. We’re past that now. We really like the restructuring that’s taken place in the industry. We see it as much more rational, viable, and profitable. That plays to our strength; therefore, our risk profile is going to change in every business segment including used cars. Mike, why don’t you talk about those specifics?

Michael E. Maroone

In the quarter, our used business was up 3 in imports, up 12 in premium luxury, and down 12 in domestics, and what we really saw was a softening of the CPO business in domestics in the quarter, and our situation was coming out of clunkers, our inventories in new were low, our inventories in used were low, and we were hesitant to go out and aggressively buy in what was an increasing price environment. Typically in the fourth quarter prices drop. This time, prices kept increasing, and we played a little bit conservatively, but I think as Mike Jackson has called out, our risk profile has changed. We’ve got some unique pilots that we’re working on on the used side including some centralized buying and trying to get more aggressive on the buying side, and it’s clearly our intention to grow our used vehicle business this year. I do want to point out though that our units were down too, but our total used car gross was up 7, so I think that the conservative nature of not wanting to buy in what normally is a declining market played well for us from a financial point of view. We clearly know we need to ramp up the volume going forward and we will.

Matthew Nemer – Wells Fargo Securities

Turning to expenses, could you just talk about how you see reinvesting in the business as revenue and gross profit recover with the market, particularly the semi-variable expenses? How should we expect those to come back over the next 12 to 24 months?

Michael J. Short

I think you should look for the structural cost reductions that we put in place to stay in place. You may recall that we had said from the end of 2007 until we hit the bottom of the trough, we had taken out a total of $400 million in costs. Of that, $200 million was totally variable, $150 million was structural and going to stay out, and then $50 million was step variable. That would include things like advertising and certain other programs that we had taken out that we expect to come back. So the variable will come back as volume and gross increase. The 150 will stay out, and that 50 will begin to come back as part of this initiative to get more aggressive in some of our advertising campaigns for example.

Matthew Nemer – Wells Fargo Securities

On Capex, the year over year change that you had talked about previously, that’s not new news, but is the change related to deferred maintenance on existing stores, and does it provide any cushion related to potential acquisitions?

Michael J. Short

The Capex that we’re talking about is reinvesting in our existing stores, and some of it does have to do with deferred maintenance on stores as well as working with our manufacturers to comply with some of the things that they like to see the stores do.

Matthew Nemer – Wells Fargo Securities

On the service business, the disclosure is actually really helpful in terms of the decline in units and operation and what you plan to do to offset that. As one piece of your strategy, is it possible that you would consider testing lower prices? I think you had talked about that a few years ago?

Michael E. Maroone

We do a price match guarantee today, but certainly we know that’s service based, so up to 5 years that we spoke of. We know there are vehicles that are in excess of that, and we’re looking at opportunities right now to expand the market, because we do want to be a share taker on the service side as well, but I think it’s too early to call out benefit from it or what we anticipate, but there is certainly an opportunity.

Operator

Your next question comes from the line of Matthew Fassler – Goldman Sachs.

Matthew Fassler – Goldman Sachs

First of all, you alluded to some of the dynamics impacting used inventory and used margin. What do you think the trajectory is for loosening up of the used market if you will? Is it totally dependent on the new car market coming back and trade-ins increasing or are there other dynamics that you think will lead in to adjust?

Michael E. Maroone

I think that you have called it outright. If the new vehicle business improves, and as you know we forecast an 11.5 market which if you take out clunkers is about a 15% improvement; if that improves, I think the used vehicle margins start to improve and will get better. It’s clear that when you’re an auction buyer and you’re paying more for the vehicle, it does put pressure on margins. When we earn more trades at the door and generate more business, we do have better margins. So if the new vehicle business picks up, I think our margins can improve. Our full year margins last year were about $200 higher than they were in the quarter, and I think as you get into the spring selling season, you can see some recovery in those margins, yes.

Matthew Fassler – Goldman Sachs

The second question that we wanted to ask relates to your customer pay business. Early in the presentation you spoke about essentially the pool of logical customers that you have for that business based on prior year sales. As you look forward over the next year or two, thinking just directionally and obviously excluding the distortion from Toyota which will help in the short run, do you think customer pay will remain under some pressure going forward just given that installed base of 5 years or younger cars is going to be shrinking, or do you still think that’s a line item that can grow for you?

Mike J. Jackson

We’re going to have to see how it develops. This is a multi-year phenomenon. It’s not something that’s going to go away in a few quarters or something. If you think about it as a rolling target market for us as vehicles sold in the prior 5 to 6 years, we now have on top of a cyclical decline, a decline to depression levels which will substantially shrink that rolling fleet over the next several years, so that’s a headwind that’s built in that will require quite some effort and skill to mitigate. On the other hand, as sales recover, actually that phenomenon will unwind the other way, but it’s a multi-year phenomenon.

Operator

Your next question comes from the line of Dan Galebson – Deutsche Bank Securities

Dan Galebson – Deutsche Bank Securities

On the used industry again, we noted a pretty substantial decline in the used percentage margin to 8.6% and a dollar margin that was low historically. Can you talk about what occurred sequentially? I would think that the source of vehicles would have still been fairly auction based in the third quarter as well, and with wholesale pricing remaining stronger, are you getting squeezed on the retail side with how much you can realize on those?

Mike Jackson

First, every year the fourth quarter is almost the lowest gross margin as percentage in the used car business. It is the readjustment annual period, and almost every year, the first quarter is recovery of these, so you have that phenomenon and then you had some unique circumstances that Mr. Maroone will talk about.

Michael Maroone

Yes, we already spoke about the shortage of product and the shortage of trade-ins. Remember that clunkers also took away what we call C cars which are higher mileage, less expensive cars, and so we didn’t have those to retail. Our inventories were extremely light, so we did go out and buy it. I think Mike Jackson called it properly. Typically, our fourth quarter is our lower margin. We’re actually up over the fourth quarter a year ago, and I really am confident going forward that we can normalize our margins, so I don’t think it’s a structural issue. I think it’s something that we are going to have to work and find different sources of cars because it appears that the used car market is going to stay fairly tight.

Dan Galebson – Deutsche Bank Securities

On the F&I side, there was a nice sequential increase here. One of the reasons that people have pointed to about weakness in F&Is, how much loan to value a bank would forward and your ability to roll in services into the monthly payment. Has that changed at all, and should we be looking for F&Is per units in the same range going forward?

Michael Maroone

We are very pleased with where we are in F&I. It’s hard to forecast large growth, but I think we can have stability. What we had in this particular quarter is that we actually had less chargebacks that benefited us and we also had some retro experience payments on our extended warranties, so with the declining service base, that will be under some pressure but as volume increases, your chargebacks as a percent of the gross you generate are less, so I do think that we can hold at this level and probably get even a little better as we continue to work on our third and fourth quartile stores.

Dan Galebson – Deutsche Bank Securities

The luxury business seems to have picked up somewhat. Could you characterize that as an improvement in credit availability or traffic or combination of both?

Mike J. Jackson

I would say overall for the luxury business, the recovery of the equity markets was a significant factor. If equity markets hadn’t recovered, then luxury business wouldn’t be what it is today, so that was an important step, and the second step is once the employment situation turns some time this year, then the luxury buyer is going to feel it’s a bit more socially acceptable to buy a new vehicle. They are holding back to a certain extent at the moment. The point is both of those things can happen fairly rapidly. The equity thing did happen fairly rapidly. We saw the change in behavior, and I think once the employment situation is not as extreme as it is at the moment, you’ll get the next leg up in the luxury business.

Operator

The next question comes from the line of Colin Langan with UBS.

Colin Langan – UBS

Can you comment on the pace of the $50 million in cost that are going to come back? Is that at 15 million selling level when all of those $50 million come back or will that be realized actually coming into results next year?

Mike Short

I don’t think it will all come back next year. It’s a multi-year increase in cost that as we get back to a more normal selling level of 15 to 16 million

Colin Langan – UBS

You talked a bit in your comments about parts and services. You expect it to be flat for next year. Can you break it out between customer pay and warranty? Is it going to be a big decline again in warranty and then offset by some stability in customer pay or will it really be on both sides?

Michael E. Maroone

This past quarter, our warranty was down 13% which is the steepest decline we have seen, but I think you could look forward to continued declines in warranty. It’s about 18% of our business. Our customer pay is about 44% of our business, so those will be offset by increases in internal that is tied to sales volume, so those are the components and that’s why when you mix them altogether, we believe that we will be stable on a year over year basis.

Mike J. Jackson

To be clear, that’s customer pay service that is 45%. We also have customer pay in collision, retail parts, counter, etc.

Colin Langan – UBS

Can you comment on cash flow? You seemed to generate a lot of cash this year because you improved your balance sheet. Is there going to be some cash outflow next year, potentially as sales ramp up?

Mike Short

As you think about operating cash flow, you’re right, there’s been quite a bit of work done to improve working capital during the downturn. It’s a combination of reduced units and the overall size of the balance sheet, but more importantly, I believe are the improvements in the ratios on CIP days outstanding, receivable days outstanding, etc., so as the business volume recovers, it will e natural for there to be a little bit of use of cash and working capital, but I think it will be much less of an increase than it was a decrease on the downside.

Colin Langan – UBS

Do you expect to be cash flow positive next year with the earnings boost?

Mike Short

When you think about our cash from operations, before you put in capex, that’ll obviously be positive. When you get down into investing activities, that just depends on, in addition to the $150 million in capex, are there investment opportunities that we identify.

Operator

The next question comes from the line of Derrick Winger with Jefferies & Co.

Derrick Winger – Jefferies & Co.

On the bank lines, what is the availability there and what is the letter of credits drawn?

Mike Short

We have the total revolver size of $700 million. Included in that is use of some of that funding for lines of credit of $70 million or so. When you think about how much we can actually draw on the existing revolver after you apply the leverage ratios, it’s about $165 million.

Derrick Winger – Jefferies & Co.

What was the capex outlook for 2010?

Mike Short

$150 million.

Derek A. Fiebig

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

Operator

This will conclude today’s conference.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: AutoNation Inc. Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts