AutoNation Q3 2007 Earnings Call Transcript

AutoNation, Inc. (AN)

Q3 2007 Earnings Call

October 24, 2007 11:00 am ET

Executives

Michael Maroone – Director, President and COO

Mike Jackson – Chairman and CEO

Michael Short – Executive Vice President and CFO

John Zimmerman – Vice President Investor Relations

Analysts

John Murphy – Merrill Lynch

Rex Henderson – Raymond James & Associates

Rod Lache – Deutsche Bank North America

Richard Nelson – Stephens, Inc.

Richard Kwas – Wachovia Securities

Matt Nemer – Thomas Weisel Partners

Edward Yruma – J.P. Morgan

Michael Geoghegan – Bear, Stearns & Co.

Darren Kennedy – Goldman Sachs and Company

Jonathan Steinmetz – Morgan Stanley

Eric Selle - J.P. Morgan

James Leida – Merrill Lynch

Presentation

Operator

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

John Zimmerman

Morning and welcome to AutoNation’s third quarter 2007 conference call. My name is John Zimmerman, AutoNation’s Vice President of Investor Relations. I’d like to remind you that this call is being recorded and will be available for replay at 1-800-475-6701, access code 885245 after 2:30 pm Eastern time today, through October 31, 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’ll open the call to questions. I’ll also be available by phone to address any follow-up issues.

Before we begin let me read our brief statement regarding forward-looking comment 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 risk which may cause the actual results or performance to differ materially from expectations. Additionally 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 AutoNation’s website at www.autonation.com. And now I’ll turn the call over to AutoNation’s Chairman and Chief Executive Officer, Mike Jackson.

Mike Jackson

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

Industry new vehicle retail sales in the third quarter for California and Florida were off approximately 11% compared to last year based on CNW Research data. AutoNation’s decline in new vehicle sales for California and Florida was 11%. Together California and Florida represent approximately 50% of the Company’s new vehicle business and 20% of the industry’s retail new vehicles sold in the U.S.

The slump in the California and Florida housing market continues to impact consumer’s willingness and ability to make large ticket purchases including autos. Year-to-date California and Florida home sales are down approximately 25% resulting in speculative homes languishing on the market and the cancellation of new construction projects. In September, U.S. new home construction declined to its lowest level in 14 years. We continue to have confidence in our California and Florida markets and view them as healthy over the long term especially when housing begins to recover.

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

Michael Short

Thank you Mike, good morning ladies and gentlemen. As Mike mentioned we reported third 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 $186 million down 8% from $203 million last year.

SG&A has 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, we did experience a [deen] leveraging of our fixed cost structure due to the decline in vehicle sales.

For Q3 2007 we had an affective income tax rate of 37.6% versus a prior year affective rate of 39.4% reflecting favorable tax adjustments of $0.02 per share. We expect our ongoing rate to be about 40%.

During the third quarter, we repurchased 18.2 million shares of stock at an average price 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 per share for a total of $581 million. We currently anticipate full-year 2007 spending on share repurchases of approximately $600 to $650 million. Our future share repurchases are subject to limitations contained in our debt agreements. As of October 1^st, our basket capacity for share repurchases is approximately $64 million. Each quarter approximately 50% of our earning are added back to the basket along with proceeds from stock option exercises.

We reinvested $50 million in the business through capital expenditures during the quarter, bringing our year-to-date capital expenditures to $129 million. We expect full year CapEx to be approximately 140 million excluding acquisition-related spending, land purchased for future sites or leased by us.

At September 30^th, our non-vehicle debt was 1.7 billion and we had unused revolving credit availability of approximately $250 million. Our non-vehicle debt to capital ratio was 33%.

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

Michael Maroone

Thanks Mike and good morning. Unless noted otherwise, my comments regarding our third quarter operational results will be on a same-store basis. As Mike Jackson mentioned at the top of the call, the new vehicle environment remained challenging for both the industry and AutoNation in the quarter. We attribute this to continued economic pressures affecting consumers in the housing market in particular. The overall weakness in the California, Florida and other high-growth housing markets persist, and once again impacted auto retail in the quarter.

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

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

At September 30^th, our new vehicle inventory stood at 59,000 units for stores. This represents a reduction of 5% or 3,000 units, and a day supply of 49 days versus 51 days compared to a year ago. On the used side, we closed the quarter with a 43 day supply of 5 days compared to September 30^th, 2006. We continue to work to develop and utilize state-of-the-art technology to improve forecasting and optimize inventory mix.

Of note is a decline of $124 in used vehicle gross profit per vehicle retail compared to a year ago. Our used vehicle business performed in line with new from 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. Adjusted for selling days, customer paid parts and service revenue increased 5% compared to the quarter a year ago. We are pleased with the continued upward trend however a 7% decline in overall warranty more than offset the customer pay gain. We attribute the reduced warranty revenue to improve quality.

Turing to AP&I, our third quarter same-store AP&I gross profit per vehicle retailed was $1,086 an increase of $38 year-over-year driven once again by our preferred lender network, OEM service contract alliances, strong product offerings and improved product penetration.

Optimizing our 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 eight additional franchises into four existing stores. We continue to pursue acquisitions that meet our market, brand and return on investment criteria. To that end, last week we announced an agreement to purchase Don Mackey BMW in Tucson, Arizona. That transaction is expected to be completed in January, 2008. The store will be renamed BMW Tucson and will be our 13^th BMW store.

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

In closing, I’d like to note that we delivered an operating margin of 4% in the third quarter as we continued to navigate a very challenging environment by controlling the inventories and expenses, while driving significant improvements in customer satisfaction. Looking ahead, we will continue to work diligently on improving our capabilities across all areas of our business. With that, I’ll turn the call back to Mike Jackson.

Michael Jackson

Thanks Mike. As we look at the balance of 2007, we believe that the market will remain very competitive and challenging. AutoNation will continue to focus on our cost structure by continuing to invest in our business. We are confident in our long-term business strategy and our markets. We believe that in 2007, industry sales of new vehicles will be in the low 16 million units.

That concludes our remarks, operator please open the calls to questions.

Question-and-Answer Session

Operator

Our first question will come from the line of John Murphy of Merrill Lynch. Please go ahead.

John Murphy – Merrill Lynch

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

Michael Short

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

John Murphy – Merrill Lynch

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 1^st…

John Murphy – Merrill Lynch

And it’s cumulative right?

Michael Short

That’s right.

John Murphy – Merrill Lynch

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

Michael Maroone

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

John Murphy – Merrill Lynch

Thanks. Then Mike, some of the comments that were rolling across the tape today, and I think they were attributed to you, but I’m not sure they’re correct quotes, you had mentioned something about tighter credit standards really hurting, or sort of depressing – putting pressure on demand, and then you also mentioned luxury is strong even in California and Florida. I mean if you could just sort of expand 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

Well it 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 we see the same thing in the automotive market? And I made the observation that automotive lending practices have been very disciplined over the last few years. We did not see a dramatic decline in standards that happened in the home mortgage business, particularly in sub primes. Therefore, other than the normal economic stress that comes with tougher times, I don’t anticipate any serious problems in automotive credit because the practices remain very disciplined.

Michael Maroone

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

John Murphy – Merrill Lynch

And then just lastly, if you look at this quarter, in the earnings that you generated, it looks like that if you sort of seasonalize this or annualize it based on what typically happens in the third quarter, your sort of run rate is about $1.43 to $1.45 in earnings in your current structure. I mean, are there other large cost opportunities or streamlining that you can really take advantage of to – in this kind of a market, to really generate higher earnings?

Mike Jackson

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

Michael Short

And John, maybe when you think about that to build our point that Mike Maroone made a little while ago, our variable costs actually came down in line with gross profit, in fact a little bit more than gross profit. So that those were managed affectively. Also our fixed costs were actually down in absolute dollar terms and you might imagine that given year-to-year inflation, you would see those have some normal level of rise to those but they were actually down in absolute dollar terms. So those are some evidence of some of the productivity initiatives that we’ve been putting in place and are starting to pay some dividends.

John Murphy – Merrill Lynch

Great, thank you very much.

Operator

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

Rex Henderson – Raymond James & Associates

Good morning, first of all and congratulations on a pretty good result in a tough environment. I wanted to follow-up on, I think it was Mike Maroone’s comments about productivity, particularly on the fixed side, can you give me some more color on exactly where you were getting the productivity, any progress on the shared service center initiative and what’s going on there to generate that fixed cost productivity?

Michael Maroone

I’ll talk about the associate productivity and then I’ll turn it over to Mike Short on the shared service center. From an associate point of view, we installed common element paid plans early in the year that really focused on driving higher CSI, rewarding longevity and also rewarding productivity. And those common element paid plans are delivering the result that we had expected so we are getting more efficiency and productivity out of our associates while improving our customer satisfaction. So we view that as being a strong success. Mike?

Michael Short

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

Rex Henderson – Raymond James & Associates

Okay, another question on the used car side, can you give some color about why gross profit per vehicle in the used car side was down? Is it a mix issue; is it a pricing 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 an intensely competitive market and I think both ourselves and our competitors are fighting for every unit on the new and used side. In a soft market, you really can’t afford to miss a deal. I think secondly, we’re seeing less trade-ins with less volume so that we’re forced to go to other sources to obtain our inventory and I think it puts some gross margin pressure. We don’t see it as a serious problem, but certainly we’re competing for every sale and fighting for every deal.

Rex Henderson – Raymond James & Associates

Okay, in the second quarter, your new car results in California and Florida were somewhat worse than the industry. In this quarter you were in line with the industry. Were you more 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’s just an all out war for every deal as I said on the used end. It’s really the same answer. So we feel we’re competitive. We were down in line with the market. We weren’t down more than the market and we still like those two markets even though they’re pretty tough right now.

Rex Henderson – Raymond James & Associates

Okay, well all right, thanks a lot.

Operator

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

Rod Lache – Deutshe Bank North America

Good morning everyone. A couple of things, on this – the SCC and the DMS initiatives, is there a prospective dollar or margin savings target that you would look at from this point going forward?

Michael Short

You know Rod there’s a – I know in the past we’ve had targets out there in terms of basis points. I don’t really think about it in terms of basis point reduction because I think in any of those cases, like right now, we’re in a situation given 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 the numerator and the denominator of the ratio in operation. So, we think of it more as building foundational components that will allow us to generate significant competitive advantages going forward and we’ve highlighted some of those, but we haven’t set out specific numerical targets for them.

Rod Lache – Deutshe Bank North America

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

Michael Short

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

Rod Lache – Deutshe Bank North America

Okay, also maybe you can clarify this. I’m just looking at the data that you provided on 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 terms of your same store sales performance nationally, but does this imply that you’re overall network declined in line with what Florida and California did? Or am I reading this number wrong?

Michael Maroone

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

Rod Lache – Deutshe Bank North America

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

Mike Jackson

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

Rod Lache – Deutshe Bank North America

Okay, thank you.

Operator

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

Richard Nelson – Stephens, Inc.

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

Michael Maroone

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

Richard Nelson – Stephens, Inc.

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

Mike Jackson

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

Richard Nelson – Stephens, Inc.

Thanks for that.

Operator

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

Richard Kwas – Wachovia Securities

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

Michael Maroone

I think it’s always, it’s a judgment call. I wouldn’t say there’s a lot of fat left but what we’ve really tried to do is incent our top performers and our high producers to get to the next level. So we skewed the paid plans to make sure that our real volume performers, volume and gross performers are very well rewarded and put the longevity components and the CSI incentives. So our people that 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 to reward productivity. We’re not looking to cut commissions per se.

Mike Jackson

The fat cutting ended a long time ago. We’ve been a very lean organization for many years and it’s really a productivity drive and we don’t think there has to be a cut or a loser in order to be more productive. As Mike Maroone articulated earlier, we established a goal to improve customer satisfaction, improve productivity of our associates and improve our underlying economic performance as three common goals. We’re well on our way to having achieved that with the common paid plans that we put in at the beginning of this year. Was it disruptive and difficult to put it in? Yeah, you betcha. Any time you change pay plans that happens. But we don’t view it as cutting fat; we really view it as a productivity drive and a win-win. When you do it that way, and everyone can see the mutually beneficial results, you don’t hit the wall and run into what I call cost cutting fatigue, where you’ve taken so much out that you no longer recognize what you have or as you say, you hit the bone. That’s how you avoid hitting the bone.

Richard Kwas – Wachovia Securities

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

Mike Jackson

First let’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 in these high growth markets. At retail, the Japanese are down. Not as down as much as domestics, but they are down so it’s a very difficult environment out there. But for the Japanese, we’ve seen higher inventories, we’ve seen higher incentives and we’ve seen declining sales. So it’s a very tough environment out there and as far as import dealers, yeah, when you put those factors together we see irrational behaviors across the board, import and domestic.

Richard Kwas – Wachovia Securities

Okay, that’s helpful and then finally, Mike Maroone, any thoughts here in terms of the wild fires in southern California? Any impact, potential impact on facilities and then what have you seen in the last week? I can’t imagine traffic has been too strong. What are you seeing so far?

Michael Maroone

Well I just spoke to our California team again. We obviously speak daily and at this point in time, we’ve only had one store close and it’s been about two days. That store was not touched by the fire as it was a couple miles away from the fire. That’s a store we had in San Diego. Our other stores are all open for business. Certainly there is smoke and a threat of fire on some of the roadways so; they’ve tried to restrict the use on some of the roadways. Our traffic has been impacted over the last couple of days but latest report I had were the winds had calmed down some. They were beginning to contain some of the fire. 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 they haven’t impacted our associates which are, you know, our prime concern. But certainly there is a bit of a slow down, but it’s only a couple of days and if the winds continue to die down, we should be in decent shape.

Richard Kwas – Wachovia Securities

Super, thanks so much.

Operator

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

Matt Nemer – Thomas Weisel Partners

Good morning everyone. My first question is on SG&A. I’m just wondering if there’s still an opportunity on the advertising side, I realize that the movement was favorable relative to gross profit, but as you look at ad spending per 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

Matt our gross spend is down about $10 million year-over-year and it’s really attributed to the things you mentioned. It’s a shift in media, certainly not a total shift away from print, but a reweighing. We’ve made strong ecommerce investments 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 to measure every dollar we can and when we measure it, we can then reweigh or reapply our spending elsewhere. So, there may be some more opportunity, but we’re really trying to be prudent and trying to react to what’s working.

Matt Nemer – Thomas Weisel Partners

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

Michael Maroone

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

Matt Nemer – Thomas Weisel Partners

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

Michael Maroone

I believe that that information revolves around the King acquisition we made where we bought their Pontiac, Buick, GMC and Saturn stores. We also bought a Chrysler Jeep store up in Bellevue, Washington. We got a Lincoln Mercury ad point in Alpharetta, Georgia. So they’re relatively small deals. It fits in with our strategy of trying to consolidate franchises onto existing locations to gain higher through-put.

Mike Jackson

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

Matt Nemer – Thomas Weisel Partners

Got it okay, that’s helpful, thank you.

Operator

And next 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 your recent acquisition. Can you comment on the acquisition environment and have you seen any change in the multiples, in the import and luxury brands?

Michael Maroone

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

Edward Yruma – J.P. Morgan

And how about – have you seen customers trading down vehicles, you know, in the class of vehicles because of the environment, do you see them purchasing lower priced vehicles or used vehicles instead of new?

Michael Maroone

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

Edward Yruma – J.P. Morgan

Thank you so much.

Operator

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

Michael Geoghegan – Bear, Stearns & Co.

Thank you, can you hear me? Back to the used vehicle gross profit numbers, I can certainly appreciate having to fight for every deal on both the new and used side, 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 macro economic headwinds? I think this is probably similar to the last question but can you put some color around that?

Michael Maroone

I don’t think there’s a lot more pressure on that buyer. Certainly there’s pressure 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 do think that we’re fighting hard for our deals. I think there’s times that people are being very aggressive with trade-in values and I think it reflects in some margin pressure. But most importantly, we are seeing less trade-ins from less new vehicle volume so we’ve got a source those vehicle somewhere and when you go 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 moving similarly to the new.

Michael Geoghegan – Bear, Stearns & Co.

Okay, thank you.

Operator

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

Darren Kennedy – Goldman Sachs and Company

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

Michael Maroone

The Texas market for us continues to perform at a very high level. I would say, south Texas is stronger than north Texas. I would assume that’s influenced by the price of oil. In terms of the car to truck mix, I think there’s pressure everywhere on the pick-up truck business mainly because it’s intensely competitive, but all in all, the market is healthy and we’re performing at a very high level, increasing our market share, increasing our customer satisfaction and increasing our profitability.

Darren Kennedy – Goldman Sachs and Company

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

Michael Short

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

Darren Kennedy – Goldman Sachs and Company

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

Michael Short

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

Darren Kennedy – Goldman Sachs and Company

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

Michael Short

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

Darren Kennedy – Goldman Sachs and Company

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

Michael Short

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

Darren Kennedy – Goldman Sachs and Company

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

Operator

Next we’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 also the 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 you seeing big differences year-over-year by geography? In other words, is this a lot more acute in places like California and south Florida where sales are tougher? 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 markets clearly have more margin pressure than others.

Jonathan Steinmetz – Morgan Stanley

Okay.

Mike Jackson

You know, it goes back to what I discussed earlier about the three environments and how we operate in the three environments. What we observe is when a market is in distress and the total market is declining, by and large, we react much sooner to the new environment and begin adjusting than our competitors do. Our competitors continue to buy, end up dramatically overstocked relative to us, in a downward environment and then they have to take extreme measures to deal with the 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 beginning of the call, but do you think in Florida and California, you’re sort of comping up against relatively weak comps in ’06 and maybe you were arguably above trend in ‘04 ‘05, do you think you’re now substantially below trend and do you have any data that would support that idea if you do think that?

Mike Jackson

Substantially below trend?

Jonathan Steinmetz – Morgan Stanley

In those 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 rate with normal growth would be in those markets?

Mike Jackson

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

Michael Maroone

I’m not sure.

Mike Jackson

Not sure.

Jonathan Steinmetz – Morgan Stanley

Okay, all right, thank you very much guys.

Operator

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

Eric Selle – J.P. Morgan

Hey guys, focusing on the balance sheet real quick, you guys said you had availability of $250 million, what was outstanding on your revolver and mortgage facilities at the quarter end?

Michael Maroone

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

Eric Selle – J.P. Morgan

And the 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 seems pretty tight right now. We’ve seen in other years in albeit in better markets a pretty substantial growth in inventory. What type of working capital trends should we see going into the fourth quarter?

Michael Maroone

We expect working capital – we did improve, we had a spike in working capital at the end of last year. We’re anticipating that while that’s a normal annual kind of event just because of as you mentioned, the end of year affect, we don’t expect to see it as dramatically this year, so we expect working capital to kind of remain about where it is.

Eric Selle – J.P. Morgan

Okay, and then you guys, Michael Jackson, you guys spoke about incentives. You know we 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 interest rate incentives?

Mike Maroone

I don’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 normalized I’d say.

Eric Selle – J.P. Morgan

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

Mike Jackson

We never 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’ve called you guys a free cash flow machine in the past and continue to be that and very favorable from the debt side, you know, looking out having share repurchases somewhat capped next year, what is going to be the use for the free cash flow? Is it acquisitions, is there any CapEx that needs to be spent?

Michael Short

We try and have a balanced portfolio and I think that we will continue to look at each of those opportunistically, certainly on the acquisition front depending on what comes along. You’re correct in saying that we have a limit now on our share repurchase basket, but we’ll make that call in 2008 as the market evolves. I think we have a good discipline both on the acquisition front as well as the capital expenditure front. I think you’ll continue to see up tapping into all three of those areas of capital allocation.

Mike Jackson

We have time for one more question.

Operator

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

James Leida – Merrill Lynch

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

Michael Maroone

That would be probably a fairly expensive transaction to do, so I don’t anticipate us moving forward in that direction right now. We’ll evaluate it obviously as time goes on.

James Leida – Merrill Lynch

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

Mike Jackson

Thank you for your time today, we very much appreciate it.

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