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AutoNation,Inc. (NYSE:AN)

Q32007 Earnings Call

October 24, 2007 11:00 am ET

Executives

MichaelMaroone – Director, President and COO

Mike Jackson – Chairman and CEO

Michael Short – Executive Vice President and CFO

John Zimmerman – Vice President Investor Relations

Analysts

JohnMurphy – Merrill Lynch

RexHenderson – Raymond James & Associates

RodLache – Deutsche Bank North America

RichardNelson – Stephens, Inc.

RichardKwas – Wachovia Securities

Matt Nemer – Thomas Weisel Partners

Edward Yruma – J.P. Morgan

MichaelGeoghegan – Bear, Stearns & Co.

DarrenKennedy – Goldman Sachs and Company

JonathanSteinmetz – Morgan Stanley

Eric Selle - J.P. Morgan

James Leida – Merrill Lynch

Operator

Ladiesand gentlemen thank you for standing by and welcome to the third quarter 2007earnings release. (Operator Instructions) I will now turn the conference overto AutoNation. Please go ahead.

John Zimmerman

Morningand welcome to AutoNation’s third quarter 2007 conference call. My name is JohnZimmerman, AutoNation’s Vice President of Investor Relations. I’d like toremind you that this call is being recorded and will be available for replay at1-800-475-6701, access code 885245 after 2:30 pm Eastern time today, throughOctober 31, 2007.

Leadingour call today will be Mike Jackson, Chairman and Chief Executive Officer ofAutoNation. Joining him will be Mike Maroone, President and Chief OperatingOfficer and Mike Short, Chief Financial Officer. At the end of their remarks,we’ll open the call to questions. I’ll also be available by phone to addressany follow-up issues.

Beforewe begin let me read our brief statement regarding forward-looking comment andthe use of non-GAAP financial measures. Certain statements and information onthis call will constitute forward-looking statements within the meaning of theFederal Private Securities Litigation Reform Act of 1995. Such forward-lookingstatements involve risk which may cause the actual results or performance todiffer materially from expectations. Additionally discussions of factors thatcould cause actual results to differ materially are contained in the Company’s SECfilings. Certain non-GAAP financial measures as defined under SEC rules may bediscussed on this call. As required by applicable SEC rules, the Companyprovides reconciliations of any such non-GAAP financial measures to the mostdirectly comparable GAAP measures on the Investor Relations section ofAutoNation’s website at www.autonation.com.And now I’ll turn the call over to AutoNation’s Chairman and Chief ExecutiveOfficer, Mike Jackson.

Mike Jackson

Goodmorning. Thank you for joining us. Today we reported third quarter EPS andcontinuing operations of $0.39 compared to a year ago EPS of $0.40. Results forthe third quarter of 2007 reflected the decline in new vehicle retail sales,especially in California and Florida partially offset by taxadjustments and continued share repurchases.

Industrynew vehicle retail sales in the third quarter for California and Florida were off approximately11% compared to last year based on CNW Research data. AutoNation’s decline innew vehicle sales for California and Florida was 11%. Together California and Florida represent approximately50% of the Company’s new vehicle business and 20% of the industry’s retail newvehicles sold in the U.S.

Theslump in the California and Florida housing marketcontinues to impact consumer’s willingness and ability to make large ticketpurchases including autos. Year-to-date California and Florida home sales are downapproximately 25% resulting in speculative homes languishing on the market andthe cancellation of new construction projects. In September, U.S. new home constructiondeclined to its lowest level in 14 years. We continue to have confidence in ourCalifornia and Florida markets and view themas healthy over the long term especially when housing begins to recover.

Iwould like to turn over to Mike Short to provide more details on the financialresults.

Michael Short

Thankyou Mike, good morning ladies and gentlemen. As Mike mentioned we reportedthird quarter earnings from continuing operations of $0.39 per share versus$0.40 per share a year ago. Operating profit for the third quarter was $186million down 8% from $203 million last year.

SG&Ahas a percentage of gross profit increased 50 basis points to 71.3% from 70.8%a year ago. Although our variable cost declined in line with gross profit, wedid experience a [deen] leveraging of our fixed cost structure due to thedecline in vehicle sales.

ForQ3 2007 we had an affective income tax rate of 37.6% versus a prior yearaffective rate of 39.4% reflecting favorable tax adjustments of $0.02 pershare. We expect our ongoing rate to be about 40%.

Duringthe third quarter, we repurchased 18.2 million shares of stock at an averageprice of $18.70 per share for a total of $341 million. Our year-to-date basis,we repurchased 29.3 million shares of stock at an average price of $19.86 pershare for a total of $581 million. We currently anticipate full-year 2007spending on share repurchases of approximately $600 to $650 million. Our futureshare repurchases are subject to limitations contained in our debt agreements.As of October 1st, our basket capacity for share repurchases isapproximately $64 million. Each quarter approximately 50% of our earning areadded back to the basket along with proceeds from stock option exercises.

Wereinvested $50 million in the business through capital expenditures during thequarter, bringing our year-to-date capital expenditures to $129 million. Weexpect full year CapEx to be approximately 140 million excludingacquisition-related spending, land purchased for future sites or leased by us.

AtSeptember 30th, our non-vehicle debt was 1.7 billion and we hadunused revolving credit availability of approximately $250 million. Ournon-vehicle debt to capital ratio was 33%.

Nowlet me turn you over to our President and Chief Operating Officer, MikeMaroone.

Michael Maroone

ThanksMike and good morning. Unless noted otherwise, my comments regarding our thirdquarter operational results will be on a same-store basis. As Mike Jacksonmentioned at the top of the call, the new vehicle environment remainedchallenging for both the industry and AutoNation in the quarter. We attributethis to continued economic pressures affecting consumers in the housing marketin particular. The overall weakness in the California, Florida and other high-growthhousing markets persist, and once again impacted auto retail in the quarter.

AtAutoNation, where these two states represent half of our unit sales, weexperienced a drop in total-store new unit volume of 11% compared to the perioda year ago. While disappointing, this performance was in [lock] step with theindustry’s performance in these two states according to CNW. Removing California and Florida from the mix, our newunit volume was down 8%.

Inthis environment, we continue to focus on controlling variable expenses andinventories. In the quarter, total company compensation and advertisingexpenses as a percent of gross margin were favorable to the period a year agoand our new and used inventories are in good shape.

AtSeptember 30th, our new vehicle inventory stood at 59,000 units forstores. This represents a reduction of 5% or 3,000 units, and a day supply of49 days versus 51 days compared to a year ago. On the used side, we closed thequarter with a 43 day supply of 5 days compared to September 30th, 2006. We continue to work to develop and utilizestate-of-the-art technology to improve forecasting and optimize inventory mix.

Ofnote is a decline of $124 in used vehicle gross profit per vehicle retailcompared to a year ago. Our used vehicle business performed in line with newfrom a volume perspective although our margins were compressed slightly more.Our used to new ratio was .61.

At$638 million, same-store revenue for parts and service was relatively flat. Adjustedfor selling days, customer paid parts and service revenue increased 5% comparedto the quarter a year ago. We are pleased with the continued upward trendhowever a 7% decline in overall warranty more than offset the customer paygain. We attribute the reduced warranty revenue to improve quality.

Turingto AP&I, our third quarter same-store AP&I gross profit per vehicleretailed was $1,086 an increase of $38 year-over-year driven once again by ourpreferred lender network, OEM service contract alliances, strong productofferings and improved product penetration.

Optimizingour store portfolio is ongoing process with three focus areas; acquisitions,divestitures, and consolidating domestic franchises into existing showrooms,with the goal of maximizing through-put. Year-to-date, we’ve consolidated eightadditional franchises into four existing stores. We continue to pursueacquisitions that meet our market, brand and return on investment criteria. Tothat end, last week we announced an agreement to purchase Don Mackey BMW in Tucson, Arizona. That transaction isexpected to be completed in January, 2008. The store will be renamed BMW Tucsonand will be our 13th BMW store.

Duringthe quarter, we divested three stores with an annul run rate of 73 million,bringing our year-to-date divestitures to 11 stores representing 14 franchisesand an annual run rate of 303 million. At September 30th, our storecount was 246, representing 325 franchises and 38 brands in 16 states.

Inclosing, I’d like to note that we delivered an operating margin of 4% in thethird quarter as we continued to navigate a very challenging environment bycontrolling the inventories and expenses, while driving significantimprovements in customer satisfaction. Looking ahead, we will continue to workdiligently on improving our capabilities across all areas of our business. Withthat, I’ll turn the call back to Mike Jackson.

Michael Jackson

ThanksMike. As we look at the balance of 2007, we believe that the market will remainvery competitive and challenging. AutoNation will continue to focus on our coststructure by continuing to invest in our business. We are confident in our long-termbusiness strategy and our markets. We believe that in 2007, industry sales ofnew vehicles will be in the low 16 million units.

Thatconcludes our remarks, operator please open the calls to questions.

Question-and-AnswerSession

Operator

Ourfirst question will come from the line of John Murphy of Merrill Lynch. Pleasego ahead.

John Murphy – MerrillLynch

Goodmorning guys. On the share repurchased, it looks like you guys used, orincreased your debt levels to fund some of these share repurchases about $200 millionin the quarter, is that correct and are there any restrictive [basket]payments, sort of covenants in your current debt that would restrict sharebuy-backs going forward or the pace of them?

Michael Short

HiJohn. You’re correct in your comment, we used some of our revolver capabilityto buy back some of the shares and on a going-forward basis, as of October 1st,we had $64 million in our basket that’s available for share repurchases andother types of restricted payments. That basket increases quarterly goingforward based on half of the net income that’s generated in that period.

John Murphy – MerrillLynch

Okay,so you can spend half your net income, based on that covenant.

Michael Short

Right,starting with a basket of $64 million on October 1st

John Murphy – MerrillLynch

Andit’s cumulative right?

Michael Short

That’sright.

John Murphy – MerrillLynch

Okay,then secondly on the stores that you’re divesting, any – are there a lot ofother opportunities to sell some of the, maybe the dogs in the portfolio torichen the portfolio?

Michael Maroone

John,we’ve divested about 50 stores over the last several years. We’re nearing theend of this wave of divestitures. Most of those divestures were either out ofmarket stores or stores that required CapEx that we did not believe wasprudent. So, you know, I’m not saying we won’t do a lot more but it appearsthat we’re nearing the end of that phase.

John Murphy – MerrillLynch

Thanks.Then Mike, some of the comments that were rolling across the tape today, and Ithink they were attributed to you, but I’m not sure they’re correct quotes, youhad mentioned something about tighter credit standards really hurting, or sortof depressing – putting pressure on demand, and then you also mentioned luxuryis strong even in California and Florida. I mean if you could just sort ofexpand on both of those statements, if they are truly attributed to you. I apologize;I got those from the headlines that are rolling across the tape.

Mike Jackson

Wellit was certainly said by Mike, we just don’t know which of the three it was.There was a discussion about what’s going on in sub prime and housing and do wesee the same thing in the automotive market? And I made the observation thatautomotive lending practices have been very disciplined over the last fewyears. We did not see a dramatic decline in standards that happened in the homemortgage business, particularly in sub primes. Therefore, other than the normaleconomic stress that comes with tougher times, I don’t anticipate any seriousproblems in automotive credit because the practices remain very disciplined.

Michael Maroone

Ithink the other piece John was on the luxury business. What we said was is thatthe premium luxury business was relatively flat, while other segments had a lotmore pressure. I think we were down just about a percent and a half from arevenue point of view on the new side in premium luxury.

John Murphy – MerrillLynch

Andthen just lastly, if you look at this quarter, in the earnings that yougenerated, it looks like that if you sort of seasonalize this or annualize itbased on what typically happens in the third quarter, your sort of run rate isabout $1.43 to $1.45 in earnings in your current structure. I mean, are thereother large cost opportunities or streamlining that you can really takeadvantage of to – in this kind of a market, to really generate higher earnings?

Mike Jackson

AsI look at the quarter, obviously it was a very difficult environment and wedelivered an EPS figure that was only a penny behind prior year and obviouslythat took a lot of effort on controlling the controllables in a very toughenvironment. That’s the hallmark of AutoNation and we tend to take thatdiscipline going forward.

Michael Short

AndJohn, maybe when you think about that to build our point that Mike Maroone madea little while ago, our variable costs actually came down in line with grossprofit, in fact a little bit more than gross profit. So that those were managedaffectively. Also our fixed costs were actually down in absolute dollar termsand you might imagine that given year-to-year inflation, you would see thosehave some normal level of rise to those but they were actually down in absolutedollar terms. So those are some evidence of some of the productivityinitiatives that we’ve been putting in place and are starting to pay somedividends.

John Murphy – MerrillLynch

Great,thank you very much.

Operator

Ournext question comes from the line of Rex Henderson of Raymond James &Associates.

Rex Henderson – RaymondJames & Associates

Goodmorning, first of all and congratulations on a pretty good result in a toughenvironment. I wanted to follow-up on, I think it was Mike Maroone’s commentsabout productivity, particularly on the fixed side, can you give me some morecolor on exactly where you were getting the productivity, any progress on theshared service center initiative and what’s going on there to generate thatfixed cost productivity?

Michael Maroone

I’lltalk about the associate productivity and then I’ll turn it over to Mike Shorton the shared service center. From an associate point of view, we installedcommon element paid plans early in the year that really focused on drivinghigher CSI, rewarding longevity and also rewarding productivity. And thosecommon element paid plans are delivering the result that we had expected so weare getting more efficiency and productivity out of our associates whileimproving our customer satisfaction. So we view that as being a strong success.Mike?

Michael Short

Overon the SSE side, there are a couple of key foundational elements that we needto get completed that we are well on the way of getting [beyond] us. I’ve beenreporting out on a quarterly basis our progress in our DMS conversions. We nowhave almost 95% of the stores on a common DMS system. That will be completed bythe end of this year. Almost 70% of our stores are now in the baseconfiguration of the SSE. We expect to be largely complete with that at the endof next year. And that really provides a foundation for us to be able to put inplace some of the productivity initiatives that Mike was talking to, TheNational Payroll Center, purchasing initiatives. Once we have all the stores inthat, we have great visibility to identify best practices and leverage thatacross the entire AutoNation portfolio.

Rex Henderson – RaymondJames & Associates

Okay,another question on the used car side, can you give some color about why grossprofit per vehicle in the used car side was down? Is it a mix issue; is it apricing issue compared to this year? What’s going on there?

Michael Maroone

Rex,I think it’s really a result of a couple of things. One is it’s just anintensely competitive market and I think both ourselves and our competitors arefighting for every unit on the new and used side. In a soft market, you reallycan’t afford to miss a deal. I think secondly, we’re seeing less trade-ins withless volume so that we’re forced to go to other sources to obtain our inventoryand I think it puts some gross margin pressure. We don’t see it as a seriousproblem, but certainly we’re competing for every sale and fighting for everydeal.

Rex Henderson – RaymondJames & Associates

Okay,in the second quarter, your new car results in California and Florida were somewhat worsethan the industry. In this quarter you were in line with the industry. Were youmore competitive on pricing in those markets this year, in this quarter?

Michael Maroone

Again,there was certainly some margin pressure in both of those markets. I think it’sjust an all out war for every deal as I said on the used end. It’s really thesame answer. So we feel we’re competitive. We were down in line with themarket. We weren’t down more than the market and we still like those twomarkets even though they’re pretty tough right now.

Rex Henderson – RaymondJames & Associates

Okay,well all right, thanks a lot.

Operator

Andnext we’ll go to the line of Rod Lache with Deutshe Bank, please go ahead.

Rod Lache – Deutshe BankNorth America

Goodmorning everyone. A couple of things, on this – the SCC and the DMSinitiatives, is there a prospective dollar or margin savings target that youwould look at from this point going forward?

Michael Short

Youknow Rod there’s a – I know in the past we’ve had targets out there in terms ofbasis points. I don’t really think about it in terms of basis point reductionbecause I think in any of those cases, like right now, we’re in a situationgiven the pressures we’re seeing on the top line, we’re in a deleveraging mode.So, it’s hard to set those types of metrics when you can have both thenumerator and the denominator of the ratio in operation. So, we think of itmore as building foundational components that will allow us to generatesignificant competitive advantages going forward and we’ve highlighted some ofthose, but we haven’t set out specific numerical targets for them.

Rod Lache – Deutshe BankNorth America

Okay,and if we look at the SG&A going forward, could you just remind us whatpercentage of that is variable and what percentage at this point is fixed?

Michael Short

Someof it is step variable, roughly 50-50 is the number that we’ve thought of inthe past but it does change a little bit. It’s not a linear 50-50.

Rod Lache – Deutshe BankNorth America

Okay,also maybe you can clarify this. I’m just looking at the data that you providedon the same store sales and it looks like the number 87,209 is down about 10.5%year-over-year. Does that – I know that you quoted a different number in termsof your same store sales performance nationally, but does this imply thatyou’re overall network declined in line with what Florida and California did? Or am I readingthis number wrong?

Michael Maroone

Whatwe said was, if you exclude California and Florida, we are down eight. Weare using CNW data on a nationwide basis and CNW has called out that retail wasoff 10% in the quarter. So you know, we do think California and Florida and some of the otherhigh growth housing markets are certainly softer than the rest of the country,but there is definitely some [melees] throughout the country.

Rod Lache – Deutshe BankNorth America

Okay,and just one last one, maybe if Mike Jackson or Maroone would just chime in onany thoughts about the markets going forward, are you thinking that,particularly California and Florida, are they stabilizingat this level or do you have any thoughts going out to 2008?

Mike Jackson

Ithink the Federal Reserve rate cut of a half point was a psychological tippingpoint which begins the process of stabilization. Without that rate cut, the downwardspiral just continues. So now people can roll up their sleeves and astabilization process has begun. I think further rate cuts are needed and Iexpect further rate cuts. It still though will take time for the stabilizationprocess to work through. I don’t think we need housing to be completely sortedout before vehicle sales will stabilize. I think people just need to sense thatthe worst is over and that they see how it’s going to play out and then they’llbe willing to make a long term commitment again. It’s too soon to call exactlywhen that will happen, but I would say, I’m confident the stabilization processhas begun.

Rod Lache – Deutshe BankNorth America

Okay,thank you.

Operator

Nextwe’ll go to the line of Richard Nelson of Stephens, Inc. Please go ahead.

Richard Nelson –Stephens, Inc.

Thankyou and good morning. Can you talk about market share outside of California and Florida on the new car side andwhat areas are you showing strength and weakness?

Michael Maroone

Rick,our market share outside of those two states is relatively flat. We actuallyhave taken some share in Texas and Colorado and we’re fighting forshare everywhere. So, the two states that you called out, we have the mostshare pressure, but elsewhere we’re in pretty good shape.

Richard Nelson –Stephens, Inc.

Thegross margin on new cars, 7% this quarter, looks like it has stabilized albeitat low levels, how do you view that trade-off between market share and grossmargin?

Mike Jackson

Iwould say we have basically three operating gears. When we see a market that isstrong and growing basically our processes, technology and operating systemswill lead – and customer satisfaction, will let us take share without havingany impact on growth. So it’s a big plus. In a stable environment, we think wecan still take share. In a declining environment, there is so much irrationalbehavior by competitors, as far as inventory levels, pricing, advertising, wewill not chase that irrational business and we will be willing to give up someshare. That’s our basic operating lines and we make a call for each market.

Richard Nelson –Stephens, Inc.

Thanksfor that.

Operator

Nextwe’ll go to the line of Richard Kwas of Wachovia Securities.

Richard Kwas – WachoviaSecurities

Goodmorning guys. Mike Maroone, could you just go a little bit further about theSG&A. You’ve done a pretty good job in a tough environment here, managingvariable costs. How much more fat is there to cut and you know, do you worryabout cutting into some bone here?

Michael Maroone

Ithink it’s always, it’s a judgment call. I wouldn’t say there’s a lot of fatleft but what we’ve really tried to do is incent our top performers and ourhigh producers to get to the next level. So we skewed the paid plans to makesure that our real volume performers, volume and gross performers are very wellrewarded and put the longevity components and the CSI incentives. So our peoplethat are in the upper cortiles can really make a lot of money and we like that.It does put some pressure on some of the other cortiles, but again, we want toreward productivity. We’re not looking to cut commissions per se.

Mike Jackson

Thefat cutting ended a long time ago. We’ve been a very lean organization for manyyears and it’s really a productivity drive and we don’t think there has to be acut or a loser in order to be more productive. As Mike Maroone articulatedearlier, we established a goal to improve customer satisfaction, improveproductivity of our associates and improve our underlying economic performanceas three common goals. We’re well on our way to having achieved that with thecommon paid plans that we put in at the beginning of this year. Was itdisruptive and difficult to put it in? Yeah, you betcha. Any time you changepay plans that happens. But we don’t view it as cutting fat; we really view itas a productivity drive and a win-win. When you do it that way, and everyonecan see the mutually beneficial results, you don’t hit the wall and run intowhat I call cost cutting fatigue, where you’ve taken so much out that you nolonger recognize what you have or as you say, you hit the bone. That’s how youavoid hitting the bone.

Richard Kwas – WachoviaSecurities

That’shelpful. And Mike Jackson, you made this comment about – just now aboutcompetitors being irrational. Are you seeing any particular trend across themajor brands and what I’m getting at is imports versus domestics? Theindustries come down here. It’s been tougher for the imports to post salesgains. In your markets, are you seeing some of the imports competitors beingmore irrational?

Mike Jackson

Firstlet’s be clear, it hasn’t been more difficult for the imports to post gains.The imports are going backwards at retail. This is not a domestic phenomenon inthese high growth markets. At retail, the Japanese are down. Not as down asmuch as domestics, but they are down so it’s a very difficult environment outthere. But for the Japanese, we’ve seen higher inventories, we’ve seen higherincentives and we’ve seen declining sales. So it’s a very tough environment outthere and as far as import dealers, yeah, when you put those factors togetherwe see irrational behaviors across the board, import and domestic.

Richard Kwas – WachoviaSecurities

Okay,that’s helpful and then finally, Mike Maroone, any thoughts here in terms ofthe wild fires in southern California? Any impact, potentialimpact on facilities and then what have you seen in the last week? I can’timagine traffic has been too strong. What are you seeing so far?

Michael Maroone

WellI just spoke to our California team again. Weobviously speak daily and at this point in time, we’ve only had one store closeand it’s been about two days. That store was not touched by the fire as it wasa couple miles away from the fire. That’s a store we had in San Diego. Our other stores areall open for business. Certainly there is smoke and a threat of fire on some ofthe roadways so; they’ve tried to restrict the use on some of the roadways. Ourtraffic has been impacted over the last couple of days but latest report I hadwere the winds had calmed down some. They were beginning to contain some of thefire. But I believe there are 17 different fires out there. The good news is,to the best of our knowledge, they haven’t touched our facilities and theyhaven’t impacted our associates which are, you know, our prime concern. Butcertainly there is a bit of a slow down, but it’s only a couple of days and ifthe winds continue to die down, we should be in decent shape.

Richard Kwas – WachoviaSecurities

Super,thanks so much.

Operator

Nextwe’ll go to the line of Matt Nemer with Thomas Weisel Partners.

Matt Nemer – ThomasWeisel Partners

Goodmorning everyone. My first question is on SG&A. I’m just wondering ifthere’s still an opportunity on the advertising side, I realize that themovement was favorable relative to gross profit, but as you look at ad spendingper unit and maybe [mix] shift that away from traditional media into new media,how big of an opportunity is there there over the next few years?

Michael Maroone

Mattour gross spend is down about $10 million year-over-year and it’s reallyattributed to the things you mentioned. It’s a shift in media, certainly not atotal shift away from print, but a reweighing. We’ve made strong ecommerceinvestments that we believe are paying off. We’re doing a good job with Direct,so we are definitely shifting. The thing that’s important to us, is we want tomeasure every dollar we can and when we measure it, we can then reweigh orreapply our spending elsewhere. So, there may be some more opportunity, butwe’re really trying to be prudent and trying to react to what’s working.

Matt Nemer – ThomasWeisel Partners

Okaygreat and then my next question was on AutoNation Direct. I read somewhere thatthat was – the plan was to roll that out in November and I’m just wondering ifyou can maybe give us an update on that and if we should expect any disruptionor potentially upside from that?

Michael Maroone

Ithink at this point in times it’s relatively small numbers. We’re sellingDirect online in a couple of markets and we’re – we like what we’ve seen butit’s too early to say that it’s going to go across the whole country and whatkind of impact it would have. I can tell you that the customers that are buyingonline really like the experience.

Matt Nemer – ThomasWeisel Partners

Okayand then the last question, just a housekeeping item, it looks like there’s aline in here for acquisitions in the quarter of 3.4 million. I don’t rememberthere being a specific deal so I was just wondering is that expansion or afranchise addition or something like that?

Michael Maroone

Ibelieve that that information revolves around the King acquisition we madewhere we bought their Pontiac, Buick, GMC and Saturnstores. We also bought a Chrysler Jeep store up in Bellevue, Washington. We got a LincolnMercury ad point in Alpharetta, Georgia. So they’re relativelysmall deals. It fits in with our strategy of trying to consolidate franchisesonto existing locations to gain higher through-put.

Mike Jackson

Yeah,those first ones Mike mentioned were franchise outfits we bought, not thestores.

Matt Nemer – ThomasWeisel Partners

Gotit okay, that’s helpful, thank you.

Operator

Andnext we’ll go to the line of Edward Yruma of J.P. Morgan.

Edward Yruma – J.P.Morgan

Hi,this is Neham Ambudia for Edward Yruma, I had one quick question relating yourrecent acquisition. Can you comment on the acquisition environment and have youseen any change in the multiples, in the import and luxury brands?

Michael Maroone

Iwould say the environment is similar to what it’s been in the past. It, youknow, we look at an awful lot of deals and we’re really being quick picky aboutthe thresholds so I would say the environment is similar. I don’t think theenvironment has changed a lot.

Edward Yruma – J.P.Morgan

Andhow about – have you seen customers trading down vehicles, you know, in theclass of vehicles because of the environment, do you see them purchasing lowerpriced vehicles or used vehicles instead of new?

Michael Maroone

Idon’t see a major shift in consumer spending patterns. Certainly probably theonly one that’s notable over the last year, is there has been a good number ofbig SUVs traded for more fuel efficient cars, but that’s probably the singletrend that I’d call out.

Edward Yruma – J.P.Morgan

Thankyou so much.

Operator

Nextwe’ll go to the line of Michael Geoghegan of Bear, Stearns & Co.

Michael Geoghegan –Bear, Stearns & Co.

Thankyou, can you hear me? Back to the used vehicle gross profit numbers, I cancertainly appreciate having to fight for every deal on both the new and usedside, but can you tell me, are you having to fight harder for the used buyer?In other words, is the used buyer being hit disproportionately by these macroeconomic headwinds? I think this is probably similar to the last question butcan you put some color around that?

Michael Maroone

Idon’t think there’s a lot more pressure on that buyer. Certainly there’spressure on all consumers with consumer debt going up and fuel prices going up,so I think there’s all pressure but I don’t think it that’s the driver. I dothink that we’re fighting hard for our deals. I think there’s times that peopleare being very aggressive with trade-in values and I think it reflects in somemargin pressure. But most importantly, we are seeing less trade-ins from lessnew vehicle volume so we’ve got a source those vehicle somewhere and when yougo outside, it is a little bit more expensive. Our new to used ratio is .61,it’s about in line so from a macro point of view, the used business is movingsimilarly to the new.

Michael Geoghegan –Bear, Stearns & Co.

Okay,thank you.

Operator

Nextwe’ll go to the line of Darren Kennedy of Goldman Sachs and Company.

Darren Kennedy – GoldmanSachs and Company

Hi,it’s Darren Kennedy with Matt Fassler here. I have a couple of questions, mostof them have been answered. One of them is about Texas, which is about 20% ofyour dealerships a little under as well, and we speak a lot about Florida and California. But I was wondering ifthere’s any color you can give me on them or as well as any nuances you havebetween trucks and cars there?

Michael Maroone

TheTexas market for us continuesto perform at a very high level. I would say, south Texas is stronger than north Texas. I would assume that’sinfluenced by the price of oil. In terms of the car to truck mix, I thinkthere’s pressure everywhere on the pick-up truck business mainly because it’sintensely competitive, but all in all, the market is healthy and we’reperforming at a very high level, increasing our market share, increasing ourcustomer satisfaction and increasing our profitability.

Darren Kennedy – GoldmanSachs and Company

Okay,and on the credit side, you had said you know, that there are – there’sobviously been more conservative policies in place for vehicles versus other –versus let’s just say housing in particular. But we have started to seepressure and delinquencies in used, not in used in vehicles overall inSeptember, in terms of delinquencies for most banks that, and not just isolatedsub prime, have you been seeing any of that come through yet? It’s usually thefirst month where we’ve started to see it creep in.

Michael Short

WellI think you used the right word. I think it’s a – there may be some creepbecause of just the higher level of economic distress out there. I think thatought to be expected but I think it is indeed a creep and not a tidal wave.

Darren Kennedy – GoldmanSachs and Company

Okayso you’re not really expecting that to be [arbinture] of things to come, thingsare going to get much worse?

Michael Short

Idon’t see a tidal wave. I don’t see anything at this point comparable to whathappened in home mortgages.

Darren Kennedy – GoldmanSachs and Company

Understood.Finally, inventories look like they’re in good shape and they’ve been acrossthe industry and they’ve been throughout the year. Is there any particularmarkets or brands where it’s exceptional or exceptionally bad?

Michael Short

Ithink it’s been quite understandable with the domestics going into the labornegotiations to have not to wind down their inventories too aggressively. Ithink now that hopefully, let’s say a month from now, that we’re past all thislabor negotiation. Clearly you’ve seen steps by [inaudible] and domestics toproactively try to keep their inventories more in line with demand. That’s ahigher level of discipline than we’ve seen in the past. I think we need to giveit some time after labor negotiations to really see what we have.

Darren Kennedy – GoldmanSachs and Company

AndI also think that initiatives, incentives rather, haven’t really built upyear-to-year or sequentially throughout this year, are you seeing any –resorting to incentives coming online right now?

Michael Short

Ithink the incentive market remains relatively high but I see no sign of a supermega program on the horizon, similar to what happened in the summer of ’05. Ithink that taking out the capacity, they’ll see where the market goes and ifadjustments need to be made, I think they’ll be made on the inventory side ratherthan a super mega program. That’s not to say that incentives won’t remain atthe levels that they are and they’ll be constantly thinking of ways torepackage those and refocus those and try to get them more effective. But Idon’t see a mega program on the horizon.

Darren Kennedy – GoldmanSachs and Company

Understood,that’s all I have, thank you.

Operator

Nextwe’ll go to the line of Jonathan Steinmetz of Morgan Stanley.

Jonathan Steinmetz –Morgan Stanley

Thanks,good morning everyone. A few questions here. First on the new and I guess alsothe used grosses on a revenue per vehicle or gross per vehicle retail basis,you talked about some irrational competitors and that sort of thing, are youseeing big differences year-over-year by geography? In other words, is this alot more acute in places like California and south Florida where sales aretougher? Or has this been more pervasive nationally?

Michael Maroone

Jonathan,it’s clearly in the markets that are most affected by housing; California, Florida, Phoenix, Vegas, those marketsclearly have more margin pressure than others.

Jonathan Steinmetz –Morgan Stanley

Okay.

Mike Jackson

Youknow, it goes back to what I discussed earlier about the three environments andhow we operate in the three environments. What we observe is when a market isin distress and the total market is declining, by and large, we react muchsooner to the new environment and begin adjusting than our competitors do. Ourcompetitors continue to buy, end up dramatically overstocked relative to us, ina downward environment and then they have to take extreme measures to deal withthe situation that they find themselves in.

Jonathan Steinmetz –Morgan Stanley

Okay.I don’t know if you commented on this, I missed a little bit of the beginningof the call, but do you think in Florida and California, you’re sort of compingup against relatively weak comps in ’06 and maybe you were arguably above trendin ‘04 ‘05, do you think you’re now substantially below trend and do you haveany data that would support that idea if you do think that?

Mike Jackson

Substantiallybelow trend?

Jonathan Steinmetz –Morgan Stanley

Inthose two markets, in other words, ’04 and ’05 may have been way above trend.Do you think you’ve gone substantially below what a sort of replacement ratewith normal growth would be in those markets?

Mike Jackson

Idon’t know. I don’t have an answer there. Mike, your thoughts?

Michael Maroone

I’mnot sure.

Mike Jackson

Notsure.

Jonathan Steinmetz –Morgan Stanley

Okay,all right, thank you very much guys.

Operator

Nextwe’ll go to the line of Eric Selle of J.P. Morgan.

Eric Selle – J.P. Morgan

Heyguys, focusing on the balance sheet real quick, you guys said you hadavailability of $250 million, what was outstanding on your revolver andmortgage facilities at the quarter end?

Michael Maroone

Atthe end of the quarter we had on the revolver, we had $361 million outstandingon the revolver compared to 195 same quarter prior year.

Eric Selle – J.P. Morgan

Andthe mortgage facility, is that still in kind of the 120 range?

Michael Maroone

Yes,right around there.

Eric Selle – J.P. Morgan

Okay,looking at working capital towards year end, you know your inventory seemspretty tight right now. We’ve seen in other years in albeit in better markets apretty substantial growth in inventory. What type of working capital trendsshould we see going into the fourth quarter?

Michael Maroone

Weexpect working capital – we did improve, we had a spike in working capital atthe end of last year. We’re anticipating that while that’s a normal annual kindof event just because of as you mentioned, the end of year affect, we don’texpect to see it as dramatically this year, so we expect working capital tokind of remain about where it is.

Eric Selle – J.P. Morgan

Okay,and then you guys, Michael Jackson, you guys spoke about incentives. You knowwe really haven’t seen – we’ve seen some discipline on the cash incentives,have you guys seen any difference over the last couple months on the interestrate incentives?

Mike Maroone

Idon’t see it being much different than what it’s been. Certainly as rates drop,there may be more coming ahead, but right now it’s been relatively normalizedI’d say.

Eric Selle – J.P. Morgan

Andthen, could you guys give us any color on October sales, how it’s tracking?

Mike Jackson

Wenever comment on the current month.

Eric Selle – J.P. Morgan

Okay,and then finally, you know, you guys are you know, at your RP basket and I’vecalled you guys a free cash flow machine in the past and continue to be thatand very favorable from the debt side, you know, looking out having sharerepurchases somewhat capped next year, what is going to be the use for the freecash flow? Is it acquisitions, is there any CapEx that needs to be spent?

Michael Short

Wetry and have a balanced portfolio and I think that we will continue to look ateach of those opportunistically, certainly on the acquisition front dependingon what comes along. You’re correct in saying that we have a limit now on ourshare repurchase basket, but we’ll make that call in 2008 as the marketevolves. I think we have a good discipline both on the acquisition front aswell as the capital expenditure front. I think you’ll continue to see uptapping into all three of those areas of capital allocation.

Mike Jackson

Wehave time for one more question.

Operator

Thankyou and that will come from the line of James Leida of Merrill Lynch.

James Leida – MerrillLynch

Goodmorning. So it’s pretty clear that the size of RP basket is restricted at thispoint, but the question might be given prior statements, I think someone saidthat you guys can’t repurchase enough shares. Is it possible that you guyswould approach bond holders and request consent to grow the size of the basket?

Michael Maroone

Thatwould be probably a fairly expensive transaction to do, so I don’t anticipateus moving forward in that direction right now. We’ll evaluate it obviously astime goes on.

James Leida – MerrillLynch

Okay,all right. All my other questions were answered, thank you.

Mike Jackson

Thankyou for your time today, we very much appreciate it.

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Source: AutoNation Q3 2007 Earnings Call Transcript

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