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AutoNation (AN)

Q1 2007 Earnings Call

April 26, 2007 11:00 am ET

Executives

John Zimmerman - VP, IR

Mike Jackson - Chairman & CEO

Mike Short - CFO

Mike Maroone - President & COO

Analysts

John Murphy - Merrill Lynch

Rick Nelson

Edward Yruma - J.P. Morgan

Matt Nemer - Thomas Weisel Partners

Jonathan Steinmetz - Morgan Stanley

Mike Geoghegan - Bear Stearns

Darren Kennedy - Goldman Sachs

Mark Warnsman - Prudential Equity Group

Lee Mahern - Lehman Brothers

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the First-Quarter 2007 Earnings Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at the time (Operator Instructions).

As a reminder, this conference is being recorded. I would now like to turn the conference over to AutoNation.

John Zimmerman

Good morning and welcome to AutoNation's first-quarter 2007 conference call. My name is John Zimmerman, AutoNation's Vice President of Investor Relations. I would like to remind you that this call is being recorded and will be available for replay at 1-800-475-6701, access code 867361 after 2:30 PM Eastern time today through May 3rd, 2007.

Leading our call today will be Mike Jackson, Chairman and Chief Executive Officer of AutoNation. Joining him will be Mike Maroone, President and Chief Operating Officer, and Mike Short, Chief Financial Officer. At the end of their remarks, we will open the call to questions. I will also be available by phone to address any follow-up issues.

Before we begin, let me read our brief statement regarding forward-looking comments and the use of non-GAAP financial measures. Certain statements and information on this call will constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995.

Such forward-looking statements involve risks, which may cause the actual results or performance to differ materially from expectations. Additional discussions of factors that could cause actual results to differ materially are contained in the Company's SEC filings.

Certain non-GAAP financial measures as defined under SEC rules may be discussed on this call. As required by applicable SEC rules, the Company provides reconciliations of any such non-GAAP financial measures to the most directly comparable GAAP measures on the Investor Relations section of the AutoNation website at www.autonation.com.

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

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Mike Jackson

Good morning. Thank you for joining us today. We reported first-quarter EPS with continuing operations of $0.39 compared to a year ago EPS of $0.37, an increase of 5%. The first-quarter EPS was positively affected by share repurchases, which, of course, includes the $1.15 billion April 2006 share buyback and certain tax adjustments, which were substantially offset by a decline in new vehicle sales, especially in California and Florida.

There are several factors affecting our first-quarter operating performance. Industry new vehicle retail sales for California and Florida were off approximately 13% based on CNW Research data, in line with AutoNation's decline for new vehicle sales for California and Florida. Together California and Florida represent approximately 50% of the Company's new vehicle business, while only representing 20% of the retail new vehicle sales sold in the U.S.

Secondly, net income from continuing operations was impacted by an after-tax $9 million increase in other interest expense in 2007, primarily due to the additional debt incurred in connection with our April 2006 $1.15 billion share buyback.

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

Mike Short

Thank you, Mike. As Mike mentioned, we reported first-quarter earnings from continuing operations of $0.39 per share versus $0.37 per share a year ago. Operating profit for the first quarter was $187 million, down 7% from $202 million a year ago.

SG&A as a percentage of gross profit increased 90 basis points to 71.5% from 70.6% a year ago. Although we made headway during the quarter in managing variable costs, especially advertising and compensation, we did experience a deleveraging of our fixed cost structure due to the decline in vehicle sales.

Other interest expense was higher in Q1 versus last year due to the increased debt levels related to our April 2006 recapitalization. However, the EPS impact of higher interest expense was more than offset by the 19% reduction in shares outstanding resulting from our $50 million share equity tender offer for a net benefit of $0.04 per share in the quarter from the recapitalization.

For Q1 2007 we had an effective income tax rate of 35.8% versus a prior year effective rate of 39.7%. The Q1 '07 rate benefited from adjustments from the resolution of various tax matters, resulting in an EPS benefit of $0.02. We expect our ongoing rate to be in the mid 39% range, excluding the impact of any potential tax adjustments in the future.

Also in Q1 2007, we had losses from discontinued operations of $5.3 million net of taxes or $0.03 per share. These losses related to the divestiture of several stores during the quarter. During the first quarter, we repurchased 2.3 million shares of stock for $50 million. Also in Q1, 5.3 million shares of our common stock were issued upon the exercise of stock options, resulting in proceeds of $76 million.

At March 31, 2007, there were 13.9 million stock options outstanding, representing a 6.6% option overhang. We reinvested $42 million in the business through capital expenditures during the quarter. We expect full-year 2007 capital expenditures to be approximately $140 million, excluding acquisition-related spending, land purchased for future sites or lease buyouts.

As you know, we view acquisitions and share repurchases opportunistically and anticipate full-year 2007 combined spending on both for approximately $400 million. At March 31, our non-vehicle debt was $1.4 billion, and we had unused revolving credit availability of $609 million. Our non-vehicle debt to capital ratio stands at 26%.

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

Mike Maroone

Thanks, Mike, and good morning. Once again, the industry faced a challenging new vehicle retail environment in the quarter. In spite of this, we are pleased to report a first-quarter operating margin of 4.3%, along with improvement in variable expenses, growth in customer pay parts and service and yet another increased in F&I PVR.

My comments today will be on a same-store basis unless noted otherwise. According to CNW the industry decline at retail was 5%. AutoNation's new retail volume of 79,000 units in the quarter reflected a decrease of 8% on a revenue basis and 9.5% on a unit basis. We attribute our underperformance to the industry to the weighting of our business in California and Florida.

To reiterate Mike Jackson's earlier point, our business in these two states accounts for 50% of our unit sales as compared to 20% for the industry at large. CNW estimates that California and Florida combined were down approximately 13% for the industry. Our decline for these two states combined was in line with the industry.

We anticipate the softness in California and Florida will continue as their housing markets struggle. With reduced volume having an impact on all segments of our business, work on controlling variable expenses, specifically advertising and compensation, along with aggressive inventory management takes on increased importance.

Of note in the quarter is a 15% reduction in our new vehicle inventory. We are nearly 11,000 units on a total store basis compared to a year ago, driven by a sizable reduction in domestic units. At March 31, our new vehicle inventory stood at 61,300 units, which translates to a new vehicle day supply of 52 days versus 54 days a year ago.

On the used side, our day supply of 38 days represented a 3-day reduction compared to a year ago. We have made great strides relative to our inventory management capabilities and are pleased with our progress in the quarter.

Same-store parts and service revenue increased 1% in the quarter. Of note was a 5% increase in customer pay parts and service compared to the period a year ago. Our ongoing growth in this area is attributed to extensive training of our fixed operation associates, coupled with our service drive process and service marketing initiatives. Customer paid gains in the quarter were offset by a drop in warranty revenue, due in large part to improving quality.

Our finance and insurance team continues to deliver excellent results as evidenced by same-store F&I gross profit per vehicle retail of $1118, an increase of $80 year-over-year. Our preferred lender network, OEM service contract alliances and strong product penetration continue to drive growth in this area.

We continue to optimize our portfolio of stores through both our acquisition and divestiture efforts. During the quarter we divested five stores with an annual run-rate of $167 million. At March 31 our stores numbered 254, representing 327 franchises and 37 brands in 16 states.

On the acquisition front, our corporate development team is actively pursuing opportunities that meet our market brand criteria, as well as our return on investment threshold.

I will close my remarks by saying that, as we enter the spring selling season, we're comfortable with our inventory levels and mix. Work on driving costs out, improving capabilities and optimizing our portfolio will remain a primary focus in order to allow our Company and associates to be more efficient and productive in an environment that continues to be challenging.

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

Mike Jackson

Thanks Mike. Today we also announced that the Company's Board of Directors have approved an additional $500 million for a repurchase of AutoNation's common stock, which is part of our ongoing strategy to redeploy capital to enhance shareholder value.

As we look at 2007, we believe that the market will remain very competitive and challenging. We believe that in 2007 industry sales of new vehicles will be in the low 16 million units for new vehicles.

That concludes our remarks, and we would be happy to answer any questions.

Questions-and-Answer Session

Operator

(Operator instructions) We have a question from line of John Murphy of Merrill Lynch. Please go ahead.

John Murphy - Merrill Lynch

Good morning guys.

Mike Maroone

Good morning.

John Murphy - Merrill Lynch

I was just wondering if you could comment on the cadence of sales through the quarter in general and maybe specifically in Florida and California and if you have seen any changes here so far in April?

Mike Maroone

John, it’s Mike Maroone. I would say that the year started very slowly. January and February were especially slow. We did see a pickup in the market in March, especially at the end of March.

There was a fair number of manufacture of what we call stair step incentives that really gave us some volume targets to go after, and the market seemed to respond well to those at the end of the quarter.

John Murphy - Merrill Lynch

And that is continuing into April generally?

Mike Maroone

I didn’t say that, and I would say that April was thus far probably a little more of a pace as the quarter as a whole as opposed to that spurt at the end of March.

John Murphy - Merrill Lynch

Got it.

Mike Jackson

It feels like overall like the first quarter.

John Murphy - Merrill Lynch

Okay. And then if we think more generally about your diversification strategy maybe away from the Detroit three, how is that going? And does that maybe expand into a little bit more of a geographic diversification also given the weakness in Florida and California?

I mean some other dealers have dealerships up in the Northeast. You guys kind of shied away from those traditionally. But I am just wondering if there might be a further diversification into different geographies at this point?

Mike Jackson

We’re very happy with our geographic footprint, primarily Sunbelt have no enthusiasm to move into the Northeast. We are big believers in Florida and California, their economies in the long-term. These economies got overheated with interest rates too long too low a speculative real estate bubble developed and has now popped.

We are going through an adjustment period. But both of those economies, California and Florida, long-term we are very optimistic about. As far as our brand mix, as we have often discussed, we have shifted to where we are today with this quarter being about 35% domestic and the balance import.

And I think with continued select divestitures and acquisitions, plus the overall share shift that is going on in the business anyway, I would expect over the next year or two for that number to continue to shift away from domestic.

John Murphy - Merrill Lynch

And when we think of the acquisition environment and making acquisitions outside of the Detroit three, is there anything that changed there or sort of more status quo? I mean there is no big change in multiples?

Mike Jackson

There is no big change in multiples even with the economic distress that we're talking about. Primarily because the other retailers see it the same as we do. What is going on in Florida and California is temporary, and it is not going to affect their valuations.

Overall, though, things are pricey quite frankly. Everybody wants to sell the same thing. Everybody wants to buy the same thing. So you have to really work hard to get a deal that makes sense.

John Murphy - Merrill Lynch

And then just lastly, on the authorization on the share repurchase, the last one was 250. What was the authorization size before, and do you think the upsizing or the doubling of this authorization is just an endorsement by the Board of the stock?

Mike Jackson

Yeah, I think that is what it is. We wanted to have the flexibility that is a significant buying opportunity developed to take full advantage of it. Our view is that the circumstances in Florida and California are temporary. Don't know how to define temporary, but we're absolutely convinced that they will change. And in our judgment, that means that we could have a buying opportunity between now and then, and we want to take full advantage of it.

John Murphy - Merrill Lynch

Thank you very much.

Operator

We have a question from line of Rick Nelson. Please go ahead.

Rick Nelson

Thank you and good morning.

Mike Maroone

Good morning, Rick.

Rick Nelson

Mike, or one of the Mike's, can you talk about regional performance outside of California and Florida where you are seeing strength and weakness and maybe brand strength and weakness, as well outside of those two markets?

Mike Jackson

This is Mike Jackson. I will give that to Mike Maroone. I would say overall, I'm satisfied with our operating discipline in the first quarter. If you consider the headwinds, the fact that during the quarter we were able to adjust inventories, keeping them in line at 52 days and move our variable costs, that we're still able to put up a very respectable operating result considering the environment is a good performance.

With that, though, to talk about regional differences, I give you Mike Maroone.

Mike Maroone

We've already called out California and Florida as being tougher markets. We did see a very good market, Texas, and our performance in Texas we were real pleased with. We also felt our performance in Colorado, and Denver specifically, where we moved to a new brand, we are very satisfied with that. We performed very well.

We also saw some strength in the Midwest, in Cleveland and Chicago, where the brands that we sell there got a little bit stronger. I would also put Memphis in that same category. So we did have some markets that performed well. Certainly our waiting in Florida and California drove the results that you have seen.

Rick Nelson

Thanks for that. And how about on the expense side, particularly in some of these more challenging markets? I know you have made a lot of headway with variable expenses there, but how much more opportunity is there I guess to call expenses adjust?

Mike Jackson

Rick, this is Mike Jackson. I would answer it this way. One, you have the things that are controllable in the short-term that you react to the velocity of the business. And that would be inventory commissions and advertising. And I think this was really a tough test in the first quarter, and I think we passed it.

On our longer-term efforts on cost and expenses, that goes on, but that is not something that we can accelerate just because business is difficult at the moment. So in principal restructuring has been done. We’re lean. We’re efficient.

We’re adaptable to the velocity of the marketplace. We're making long-term investments that will improve our productivity, but there is no major short-term action that we can take beyond adjusting the variable cost structure.

Rick Nelson

Thank you.

Operator

We have a question from the line of Edward Yruma of J.P. Morgan. Please go ahead.

Edward Yruma - J.P. Morgan

Thank you for taking my question. Can you give us a quick update on both Smart Choice and your shared services center?

Mike Jackson

Mike Maroone will take Smart Choice, and Mike Short will take shared services.

Mike Maroone

Edward, Smart Choice continues to be a success for us, and we have rolled it into a number of other markets. We started, as you know or you may know, in South Florida. We've now expanded it into North Florida. We expanded it into the Denver market and are beginning to do work in the Phoenix market as well.

Our next will be up into what we call our East Central, which will be Memphis. So we are moving rapidly, and we are really pleased with both our associate acceptance of it and our customer’s acceptance of it.

Mike Short?

Mike Short

And on the shared services center, we continue to have momentum there as well, we’re continuing the ADP conversions, and we have about 87% of our stores complete with that now, largely complete with that program by the end of the year and the core conversions into the SSC. The rest of the stores are right now at about 61%, and we have good momentum there as well.

Edward Yruma - J.P. Morgan

Got you. And in terms of the year's performance, how much of the weakness there is really due to lower foot traffic due to the weakness on the new side of the business?

Mike Maroone

I think there is two things. One is lower traffic, especially in our two markets, and second is less trading from less volume. So our used business was better than our new business. Our used to new ratios continue to improve. But certainly the economic distress we found in our two key markets cascaded into the used business as well.

Edward Yruma - J.P. Morgan

Great. Thank you very much.

Operator

We have a question from the line of Matt Nemer of Thomas Weisel Partners. Please go ahead.

Matt Nemer - Thomas Weisel Partners

Hi, good morning guys. Just one quick question. As you look at your D3 stores, clearly I think from a market-wide standpoint these stores are becoming less profitable either on a per store basis or a per square foot basis.

Is there something else that you can do with that space either by maybe branding a separate used car side of the store or a quick lube lane or someway to improve the productivity of those stores beyond what you are already doing?

Michael Jackson

Yes, I would describe that the domestic stores that we are enthusiastic about long-term basically fit the profile of being a great location with high throughput, and there the economies of scale still work, and those stores are very competitive with import stores as far as the profitability.

What is on the bubble are the domestic stores that do not have economies of scale, and there is despite whatever you do, it is difficult for those stores to make sense in our business model. That is not to say they don't make sense for somebody else, but they don't make sense for us. We are able to sell those and get our money out of the real estate, working capital and some degree of blue sky.

Now, as far as what we're doing in all of our volume stores to enhance the performance, Mike?

Michael Maroone

Well, we continue to look at all of our real estate and look to optimize it. I don't think there is one solution such as a branded used car outlet. I think there’s a number of a solution and it is really a store-by-store analysis.

We continue to look at those to invest prudently in those facilities, and all-in-all there's a real shortage of properly zoned commercial real estate in the major metro markets, and we continue to look at our locations as being a strong asset. But it's a store-by-store analysis, not a blanket one.

Matt Nemer - Thomas Weisel Partners

Okay. That is helpful. Just a follow-up to the geographic data that you provided, can you make any comment regarding your performance at metro stores versus suburban stores or those that are maybe a bit more rural to the extent that you have any of those?

Michael Jackson

I don't think we have any rural stores. It is just not our thing. And, Mike, I don't really have any --

Michael Maroone

I don't think we split the business that way, and to Mike's point we do not have any rural stores. So I think they are all major metro markets, and I don't see any way to split that performance out.

Matt Nemer - Thomas Weisel Partners

Okay. Thank you

Operator

We have a question from the line of Jonathan Steinmetz of Morgan Stanley. Please go ahead.

Jonathan Steinmetz - Morgan Stanley

Great thanks. Your gross profit per vehicle retail I think on a comp basis was about flat. How did that look if you were to break it out D3 mainline, import and luxury?

Michael Maroone

I did not see any major margin deterioration in any of the three buckets. They were relatively in line with the group. I think if you add in the F&I performance, we looked at our aggregate gross profit per vehicle retailed as being up slightly. I think it is up like $47. But we did not see any abrupt changes in any of the three buckets.

Certainly, on the luxury side, the S-Class launch of the Mercedes a year ago pushed that number up a little bit. But besides that, I would say it was fairly constant.

Jonathan Steinmetz - Morgan Stanley

Okay. On the F&I, I came in a little late. So if you covered this, I will look at a transcript. But did you give a walk at all on the year-over-year increase, and did you get a lot from the preferred lender and the service contract unwind, so to speak, or the benefits on the service contract as you did in the fourth quarter, or was this more warranty penetration and finance fee?

Michael Maroone

I think it was both preferred lender network. It was certainly the retro performance on our warranty portfolios with the OEM. In addition, we have put a greater emphasis on warranty and prepaid maintenance sales. Where we are not putting emphasis is on the rate side of it.

So we increased on a total store basis $72. On a same-store basis, $80. We are real pleased with the team and the process, the compliance. All the pieces to that are really in good shape.

Jonathan Steinmetz - Morgan Stanley

Okay. And lastly, with the added authorization on the buyback and the remaining I guess $42 million on the current program, will you guys take on added financial leverage near-term to enact a buyback, or is this just used free cash flow as it sort of comes in to buy back stock?

Michael Short

Our expectation is to fund it out of free cash flow and coming out of the business. We're not anticipating levering up to do this.

Jonathan Steinmetz - Morgan Stanley

Would you rethink that if the stock price declined or you saw it as more attractive?

Michael Short

Of course. Or if we had an attractive acquisition. Would not hesitate.

Jonathan Steinmetz - Morgan Stanley

Okay. Thank you.

Operator

We have a question from the line of Mike Geoghegan of Bear Stearns. Please go ahead.

Mike Geoghegan - Bear Stearns

Good morning. Thank you. If you had to carve it up, could you tell us how much of the sales decline is due to an issue of credit availability versus sort of affordability and consumer confidence? Is it 20/80? Is it 70/30? What do you say?

Michael Jackson

I think it is more on the lines of the psychological impact of housing being so uncertain. It is probably the primary factor here. So you have to sort of break it into segments. Pickup truck sales have definitely been impacted by the cancellation of so much construction. And pickup truck sales are not really going to recover until new construction resumes. So that means existing housing inventory has to be rebalanced before that happens.

As far as nonprime credit for autos, it is still very available, and we don't see a lot of distress there so far for the following reasons. One, we did not have adjustable-rate mortgages -- adjustable rate loans in automotive. The principal amount is lower, and we had pretty good discipline from the lenders for the last few years.

So it is all sort of goes together with different drivers for different facets. But I would say the overall malaise, if you will, is people coming to terms with higher payments for their homes and not sure what their home is worth.

Mike Geoghegan - Bear Stearns

Okay. That is helpful. So my follow-up question there is -- and I recognize you are not in the business of forecasting real estate values -- but if the dealers you are talking to, if valuation multiples have not come in because potential targets are looking at things the same way you are, what is the overall sentiment as far as how long this correction might last?

Michael Jackson

I have traveled both these markets extensively and asked people in all of the -- experts who have lived in them for decades, and I get all kinds of answers.

The best insight I could give you at the moment is, it's not getting worse but it is not getting better. So it sort of feels like we are bumping along the bottom, but how long we are going to be bumping along down here is hard to say. And Mr. Maroone has spent decades here in Florida. Mike, do you want to weigh in here?

Michael Maroone

I'm not sure my crystal ball is any clearer. Long-term we have got tremendous confidence in both the markets, but to Mike's point, we just have not seen the recovery yet. It is a stable but not satisfactory situation. I think we're just going to take some time to work through it.

I agree with Mike, especially on the pickup truck answer, that until new housing starts get moving, I don't see the pickup truck business growing at the same rate that it was or being the same chunk of our business that it was.

Mike Geoghegan - Bear Stearns

Okay. And finally, I heard you say that there's no short-term fix for cost restructuring. But does that include -- I mean is there any staff reductions going on at the store level?

Michael Jackson

There is no significant new initiative for staff reduction. So, first I need to be clear. The operating discipline in the first quarter to adjust inventories, advertising rates, compensation, variable -- make sure the compensation is variable, with this degree of slowdown in these big markets is already quite some operating discipline. To say that there is a structural cost that we can rapidly take out would be misleading. I don't see it.

Mike Geoghegan - Bear Stearns

Okay. Thank you very much.

Operator

There is question from the line Darren Kennedy of Goldman Sachs. Please go ahead.

Darren Kennedy - Goldman Sachs

Hi there. It is Darren Kennedy here with Matt Fassler. Your last comment is pretty interesting to me, talking about you are clearly undergoing some clear significant operating challenges today. There was a time when you talked about removing structural costs and extracting ex number of base points of SG&A out of your cost structure over a period of years.

And then Mike Short, with you coming in as CFO, understandably you wanted to get acclimated and understand the numbers and make your own targets. Is there time in the future when we might be having these conversations again?

Michael Jackson

All that is still underway. I don't want to mislead you. But there's nothing that can be accelerated because of the temporary situation in Florida and California. So all of that is still underway.

Mike, do you want to add to it?

Mike Short

Yes, just let me echo Mike's earlier comments. We're quite happy with the operating and cost performance that we extracted out of Q1. Variable costs came down with volume.

Despite normal inflationary cost increases that you would have in salaries and things like that, they did come down with the reduction in gross. And fixed costs were actually down in dollar terms on a year-to-year basis.

So they absorbed inflation in a difficult environment. The reason that you are -- I think there is a lot of focus on this particular discussion, is that you are not seeing the reduction in the basis points that we have talked about over the last couple of quarters.

And I think that is just a fact with the gross coming down, the costs are not going to come down as rapidly.

Darren Kennedy - Goldman Sachs

Understandable. And that sort of -- yes, I understand that we won't be seeing as much leverage until you get through this environment.

Mike Short

Right.

Darren Kennedy - Goldman Sachs

Okay. And just switching gears to your mix, which, Mike, when we spoke recently and everybody we spoke about how you really wanted to continue to move away from the big three and change your mix.

I thought it was to shift the size of your ship that it would be hard to really turn it. And then I looked at your mix, and from 1/2/04, 50% big three now to 36%, and luxury 17% goes to 25%, and imports over that same period 33% to 40%.

Is there somewhere where we could see these settling, if you just kind of focused big picture on big three, luxury and import, if you have a target mix?

Mike Jackson

You know, I think when we are talking about this two years from now for the big three, we will be somewhere in the 20's.

Darren Kennedy - Goldman Sachs

Somewhere in the 20's. Okay. Thank you.

Operator

(Operator Instructions) Mark Warnsman of Prudential. Please go ahead.

Mark Warnsman - Prudential Equity Group

Yes, good morning. Reference was made to the decline in warranty related to service revenue. I'm curious particularly as Ford today in their report sighted warranty experience as a key causal factor for them reducing their warranty reserves.

Do you see an acceleration in the decline of warranty-related service revenue, one? And the second part of the question is, what are the key steps you're taking within your business model to offset those declines?

Mike Jackson

This is Mike Jackson. We're seeing two factors. One, certain manufacturers that lag the industry in quality have clearly taken steps to close the gap between themselves and everyone else. And to the extent that you had that acceleration, that is reflected in our numbers.

And what I expect to happen, though, is then when everybody -- when those gaps close, then you will have a more modest trendline of overall quality improvement that matches the industry trendline. So right now we're dealing with two factors.

One, the overall trendline, which is very manageable, and a closing of the gap from certain manufacturers who had, shall we say, an opportunity on the quality side.

Mark Warnsman - Prudential Equity Group

And how are you -- would you say your service capacity is structured consistent with the post-gap closure, or are you taking specific steps as some of those manufacturers close those gaps?

Mike Maroone

It is Mike Maroone. I believe that our capacity is fine. We have made significant investments in our import and luxury stores where we might have had some capacity constraints. We will make some additional investments, but I think we're in pretty good shape.

We're really focusing on our customer pay business, both on driving more traffic, working hard on our pricing and really focused on our process. We actually have put a new process in all of our stores. We measure it. We train to it. We certify to it.

We're really pleased with our efforts there on the customer pay. And I think, as you see the leveling out of the trendline as Mike Jackson spoke about, I think you will see some more top-line growth out of our fixed operations.

Mark Warnsman - Prudential Equity Group

Thank you.

Mike Jackson

We have time for one more question.

Operator

Thank you. We have the question from the line of Susan Jansen of Lehman Brothers. Please go ahead.

Lee Mahern - Lehman Brothers

Hi. This is Lee Mahern (ph) on behalf of Susan. I had two brief questions. The first one is around inventory controls. Given the falloff in new vehicle sales, you would have expected I think new day supply to be down and I mean up instead of down.

How did you guys actually manage to get that number down? What were the specifics? Did you see this coming and cut back orders? Going forward, where do you see supplies if this weakness in California and Florida persists?

Mike Maroone

This is Mike Maroone. Your statement is correct that when you see a falloff in sales, typically day supply goes up. We were very proud that our day supply was down two days.

We have made some significant investments in technology and process and been working really hard on not just bringing the inventories down, but bringing them down and getting into even better mix of product. And we're really pleased with those efforts.

I think that our current inventory levels are appropriate. We will always work harder and harder on the mix to be sure that our mix is reflective of customer demand. All in all we have dropped our inventories about 15% or 11,000 units.

There was a dramatic decline in our domestic inventories, but all in all we're really pleased with where we are. The work did not happen just in this quarter; it has really been going on in the last six months.

Lee Mahern - Lehman Brothers

Thanks a lot.

Mike Jackson

Thank you, everyone, for joining us today. We very much appreciate it.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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Source: AutoNation Q1 2007 Earnings Call Transcript
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