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AutoNation (NYSE:AN)

Q1 2012 Earnings Call

April 25, 2012 11:00 am ET

Executives

Cheryl Scully - Former Vice President

Michael J. Jackson - Chairman of the Board and Chief Executive Officer

Mike Short - Chief Financial Officer and Executive Vice President

Michael E. Maroone - President, Chief Operating Officer and Director

Analysts

John Murphy - BofA Merrill Lynch, Research Division

N. Richard Nelson - Stephens Inc., Research Division

Simeon Gutman - Crédit Suisse AG, Research Division

Patrick Archambault - Goldman Sachs Group Inc., Research Division

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

Dan Galves - Deutsche Bank AG, Research Division

Ravi Shanker - Morgan Stanley, Research Division

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Colin Langan - UBS Investment Bank, Research Division

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

Operator

Thank you for standing by, and welcome to AutoNation's First Quarter 2012 Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the call over to Mrs. Cheryl Scully, Treasurer and Vice President of Investor Relations for AutoNation. Ma'am, you may begin.

Cheryl Scully

Good morning, and welcome to AutoNation's First Quarter 2012 Conference Call and Webcast. Leading our call today will be Mike Jackson, our Chairman and Chief Executive Officer; Mike Maroone, our President and Chief Operating Officer; and Mike Short, our Chief Financial Officer. Following their remarks, we will open up the call for questions. Kate Keyser-Pearlman and I will also be available via phone following the call to address any additional questions that you may have.

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 our SEC filings. Certain non-GAAP financial measures, as defined under SEC rules, may be discussed on this call. Reconciliations are available on our Investor Relations website at investors.autonation.com under Financials.

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

Michael J. Jackson

Good morning. Thank you for joining us. Today, we reported an all-time record quarterly earnings per share from continuing operations of $0.56 for the first quarter, a 22% increase as compared to $0.46 for the same period in the prior year. First quarter 2012 revenue totaled $3.7 billion compared to $3.3 billion in the year-ago period, an increase of 10%, driven primarily by stronger retail new vehicle unit sales. In the first quarter, total U.S. industry new vehicle retail sales increased 7% based on CNW Research data. In comparison, during the same period, AutoNation's new vehicle unit sales increased 10%, or 8% on a same-store basis.

In the first quarter, we repurchased 11.7 million shares, or 9% of the shares outstanding as of December 31, 2011, for $405 million at an average price per share of $34.72. Since the year I arrived in 1999, we have bought back over 400 million shares for $7 billion at an average price of under $17 per share.

In the first quarter, we saw an industry selling rate of 14.5 million units, the best quarterly selling rate since the first quarter of 2008. As we look at the rest of 2012, we believe that the improvement in new vehicle sales will continue. And we've increased our planning assumption for 2012 industry new vehicle sales to mid-14 million units. Recovery is driven by replacement demand as the age of the fleet on the road has now increased to almost 11 years old. Also, manufacturers have stepped up the pace of new models. Finally, the credit environment is very strong with low interest rates and ample credit availability aimed for customers with less-than-stellar credit.

Even with the rising fuel prices, we continue see a solid recovery for both trucks and cars. In the past, the consumer had sacrificed size or type of vehicle that they really desired to get better fuel economy. Today, it's a win-win as consumers get exactly the vehicle they want with improved fuel efficiency. AutoNation is well positioned to capitalize on recovery with an optimal brand to market mix and a disciplined cost structure. We continue to demonstrate our ability to drive strong shareholder returns during the multi-year recovery in auto retail.

I now turn the call over to our Chief Financial Officer, Mike Short.

Mike Short

Thank you, Mike, and good morning, ladies and gentlemen. For the first quarter, we reported net income from continuing operations of $74 million or $0.56 per share versus $70 million or $0.46 per share during the first quarter of 2011, a 22% improvement on a per-share basis. There were no adjustments to net income in either period.

In the first quarter, revenue increased $346 million or 10% compared to the prior year, and gross profit improved by $37 million or 6%. In the first quarter of 2011, gross profit was favorably impacted by $4.6 million related to additional incentives under our Premium Luxury program.

SG&A as a percentage of gross profit was 71.8% for the quarter, which represents a 20-basis-point improvement compared to a year ago period. Excluding the benefit from the additional incentives in the first quarter of 2011, SG&A as a percentage of gross profit improved by a more comparable 80 basis points versus the prior period.

On February 1, we issued $350 million in senior unsecured notes at 5.5%, which are scheduled to mature in 2020. We were able to capture attractive long-term financing rates at that time, reflecting the market's view of AutoNation's consistent operating results and strong cash flow generation. Our percentage of fixed rate non-vehicle debt has now increased to 53% from 40% at December 2011, or looking back over a longer time horizon, from 33% at March 31, 2010. Additionally, on April 16, we redeemed $14.7 million of 7% senior notes at par, which were scheduled to mature in 2014.

Returning to first quarter results, net new vehicle floorplan was a benefit of $6.8 million, an improvement of $2.1 million from the first quarter of 2011, primarily due to higher floorplan assistance driven by increased vehicle sales compared to the prior year period. Floorplan debt was approximately $2 billion at quarter end, an increase of approximately $118 million from December 31, 2011, in line with inventory levels.

Non-vehicle interest expense was $20.5 million for the quarter, an increase of $4.2 million compared to the $16.3 million we reported in the first quarter of 2011 due to higher debt levels and a shift towards longer-term fixed-rate debt. We had $400 million of outstanding borrowings under the revolving credit facility at the end of March. On March 31, our total non-vehicle debt balance was $1.9 billion, an increase of $582 million compared to March 31, 2011. The provision for income tax in the quarter was $46 million or 38.5%.

From January 1, 2012, through April 24, 2012, we repurchased 13.8 million shares for $476.3 million at an average price of $34.55 per share. On March 23, we announced that our board authorized the repurchase of up to an additional $250 million of AutoNation common stock. AutoNation has $174 million remaining in that board authorization for share repurchase. As of April 24, there were approximately 122 million shares outstanding. That does not include the dilutive impact of stock options, which was 2 million shares in the first quarter of 2012.

AutoNation will continue to manage within the limits of our financial covenants. Our leverage ratio at March 31 was 2.98x or 2.75x on a net debt basis, including used floorplan availability, compared to our covenant limit of 3.75x.

Capital expenditures were $18 million for the quarter. We continue to expect CapEx to be approximately $145 million for the year. Capital expenditures are on an accrual basis excluding operating lease buyouts and related asset sales.

Our quarter-end cash balance was $76 million, which, combined with our additional borrowing capacity, resulted in a total liquidity of approximately $645 million at the end of March. This provides us with financial flexibility as the SAAR increases. AutoNation will continue leverage our solid cash flow generation and best-in-class operating structure to generate strong company and shareholder returns.

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

Michael E. Maroone

Thanks, Mike, and good morning. 2012 is off to a great start for the industry and for AutoNation. The recovery in auto retail is gaining momentum. Contributing factors include increased consumer confidence, an improved credit environment, restoration of import inventories, high consumer replacement demand with the average age of vehicles on the road at 11 years and exciting new fuel-efficient products rolling out at an incredible pace. In this improving environment, AutoNation delivered all-time record EPS for the second consecutive quarter, as well as strong growth in revenue and gross profit across all sectors of our business: new vehicles, used vehicles, parts service and collision, which we now refer to as customer care, and finance and insurance. We also delivered a very solid 4.1 operating margin.

In the first quarter, Domestic segment income increased $7 million or 16% to $50 million compared to the period a year ago. Import segment income of $62 million increased $7 million, a 13% increase. And the Premium Luxury segment increased by 2% to $59 million. As I continue, my comments will be on a same-store basis.

In the quarter, AutoNation retailed 60,300 new vehicles on a same-store basis with growth across all 3 segments. This represents an increase of 4,600 units or 8% compared to the period a year ago, slightly ahead of industry retail sales, which were up 7% according to CNW Research. Relative to geography, it was a solid quarter in most of the markets where we operate with Texas and Colorado both showing growth in the high teens. And on a very positive note, California and Florida continue to show good year-over-year improvement.

New vehicle revenue increased $173 million or 10% to $2 billion with revenue increases across all 3 segments driven by increased volume. Revenue per vehicle retailed was $32,500, up slightly compared to a year ago.

Gross profit per new vehicle retailed of $2,183 declined 3% or $66 compared to the quarter a year ago. However, excluding the benefit from the additional performance-based manufacturer incentives in the quarter a year ago, gross profit per new vehicle retailed improved $16 or 1% on a same-store basis. Looking forward, we will be lapping a tough comparison in the second quarter this year as our new margins in the second quarter of 2011 benefited from tight supply immediately following the earthquake and tsunami in Japan. New vehicle gross profit as a percent of revenue in the quarter was 6.7%, up 30 basis points compared to a year ago and essentially flat excluding the benefit from the incentives the prior year quarter.

We were very pleased with our new vehicle inventory at the end of the quarter. At March 31, new vehicle days supply was 54 days or 47,500 units compared to 50 days or 41,000 units a year ago.

Next, AutoNation retailed 45,500 used vehicles on a same-store basis in the quarter, an increase of 3,400 units or 8% compared to a year ago with growth across all 3 segments. Same-store retail used vehicle revenue of $789 million increased $62 million or 8% year-over-year. Revenue per used vehicle retailed of $17,350 was relatively flat with the prior year period although still strong due to continued tight industry supply and high demand at retail. At 77 million, same-store retail used vehicle gross profit increased 3 million or 5% year-over-year. Gross profit per used vehicle retailed of $1,697 was down $56 or 3%.

Our used vehicle days supply was tight at 29 days on March 31 compared to 33 days a year ago. In the quarter, we drove a 20% increase in appraisals and a 17% increase in trade-ins acquired compared to the period a year ago with a close ratio of 47% on vehicles appraised. Winning trades is even more important in a tight supply environment, and we're pleased with our performance and have room for improvement.

Turning to parts, service and collision, which we now call Customer Care. Same-store revenue of $593 million increased $23 million or 4% compared to the quarter a year ago. And $199 million customer pay revenue was up $12 million or 7%, representing the largest year-over-year dollar and percentage change increase in recent years. This also marks the seventh consecutive quarter of year-over-year increases in customer pay revenue. We attribute this to our Customer Care sales strategy that emphasizes retailing on the service drive, including tire sales and maintenance, which also drive retention.

Increased vehicle sales drove improvement in internal of 17% year-over-year. The growth in customer pay in internal more than offset a decline of 9% in warranty revenue. And I'm glad to report that the warranty decline was narrowed substantially year-over-year, and warranty revenue was up sequentially.

Customer Care gross profit of $247 million increased $3 million or 1% compared to the quarter a year ago. Customer pay gross profit grew 2%, up for the seventh consecutive quarter year-over-year. And increases in internal gross more than offset a decline in warranty gross.

We continue to perform well in finance and insurance. In the quarter, total gross profit was $128 million, an increase of $18 million or 16% compared to a year ago. Same-store gross profit per vehicle retailed was up $81 or 7% in the quarter to $1,213 per vehicle. Our efforts here continue to be focused on providing full transparency to customers while providing value-added products that can help drive long-term customer retention.

As of March 31, our store portfolio numbered 215 stores, 260 franchises, representing 32 brands and 15 states. In the quarter, we were awarded Chrysler and Jeep franchises that were added our Dodge store in Pembroke Pines, Florida. I'll also note that we were awarded an add point for MINI in Valencia, California, which we anticipate opening by year end. Our industry relations and corporate development teams continue to actively pursue opportunities that meet our market, brand and return on investment criteria.

Before I close, I'd like to add that Greg Ravelle has joined AutoNation as Senior Vice President and Chief Marketing Officer. Greg comes to us from Expedia where he served as Vice President and General Manager of Worldwide Online Marketing. A key focus for Greg is to accelerate our efforts to expand our capabilities on the digital front. We welcome Greg and are excited to add an executive of his caliber to our team.

In closing, we are committed to optimizing our performance in this rapidly improving environment and are very grateful to our 20,000 associates who are instrumental in delivering an excellent quarter.

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

Michael J. Jackson

Thanks, Mike. During the first quarter, we saw strong improvement in auto industry sales as consumers enjoyed a great array of choices and a strong credit environment. We believe the accelerated product launches, replacement demand and robust consumer credit will continue to support our strong sales environment even with $4 a gallon. Planning assumptions for 2012 industry new vehicle unit sales is mid-14 million units, which will be approximately a 13% improvement over 2011.

With that, we'd very much like to take your questions. First question, please.

Question-and-Answer Session

Operator

Will be coming from John Murphy, Bank of America Merrill Lynch.

John Murphy - BofA Merrill Lynch, Research Division

Just first question, I mean, there's been a lot of conjecture over whether being a real support and inducing the SAAR in the first quarter upwards. I'm just curious what you guys really think about that or if you think it was really a nonfactor and the key driver here is that we're seeing some release and pent-up demand.

Michael J. Jackson

Well, I think -- this is Mike Jackson. I think the underlying strength of the recovery is clearly there. We went into the year with a forecast of $14 million for the full year, on the high range of many of the forecast out there. And we had a caution or a yellow around the issue of fuel prices where we clearly thought we'd see $4 a gallon, and we viewed that as a risk to sales. And it's just turned out that without increased incentives, $4 a gallon, if anything, is assisting sales, not hurting sales. And we really see dramatic change from 5 years ago in '08. We see overall a 20% improvement in fuel efficiency compared to the end of '07 going into '08. And the consumer, we're not asking them to make a trade-off between size and performance. They can have what they currently have and get a significant increase in fuel efficiency. And that's been done with the traditional drive train with relatively reasonable incremental cost with turbocharging, direct injection and 7, 8, 9 speed automatic transmissions. But looking at the quarter in and of itself, retail was up a solid 7%. There was an emphasis on the replacement of fleet, plus 19, though that will not continue for the full year. But we see it at mid-14.

John Murphy - BofA Merrill Lynch, Research Division

I think we've also heard that Chrysler is reasonably active in the market with dealer incentives. It sounds like they're stair-step programs. I'm just curious if, one, if those programs had any impact in the quarter, and two, if you're seeing any other automakers out there sort of mimicking these programs with new stair-step or buying rebate programs to the dealers directly.

Michael E. Maroone

John, it's Mike Maroone. There continues to be a number of stair-step programs out there, the targets vary greatly. Some are quite reasonable. Some are quite extraordinary. It certainly has an impact on every quarter. I don't know that this quarter was much different. But they are impacted, and it's across a number of different manufacturers.

Mike Short

And John, Mike Short. The reason we called out the premium luxury incentives in the prior period was because they were kind of a catch-up payment which we qualified for in the prior -- in that quarter, and that's why we recognize them. So sort of an aberration as opposed to ongoing incentives.

John Murphy - BofA Merrill Lynch, Research Division

Okay. And just a follow-up on that, Mike Maroone, those programs are not necessarily an acceleration or incremental to what we saw late last year. Are they more of a continuation? Or are they a step-up? I'm just trying to understand.

Michael E. Maroone

John, I think there's more manufacturers involved in them, but they vary greatly from quarter to quarter. We saw strong stair-step programs in Q1 of 2011, saw them again in 2012. We also saw a lot at year end. So each of the quarter, I'd say that our margins going forward, I think, will be similar to our Q1 margins, although I think they'll vary some by quarter.

John Murphy - BofA Merrill Lynch, Research Division

Got you. And then just lastly, I mean, you showed a sort of a willingness to lever up a little bit, certainly not much, but a little bit to buy back shares in the quarter and then what you've done so far in April. And I'm just curious, if you were willing to go further on that, and it looks like you have plenty of room on your covenants, I mean, would you get to something that's closer to that 3.7x net debt to EBITDA? I mean, do you feel like that would be something that you'd be willing to do? Or as we just look at the cash flow generation, we should expect a lot of the cash flow generation should be allocated to share buybacks going forward. Just trying to figure out how aggressive that you might get on the share buyback program given where the stock is right now.

Mike Short

Yes. John, it's Mike Short. We've, I think, demonstrated over the last number of years that we are good stewards of the balance sheet. And we will take prudent opportunistic investments in share repurchase using the balance sheet where appropriate, but certainly not running up near the 3.75x leverage level.

John Murphy - BofA Merrill Lynch, Research Division

But when you can borrow at 5.5%, it seems like it makes sense all day long.

Mike Short

Yes. I certainly don't want to get too close to covenant levels. But given the financing that's available now and our view on the value of the stock, it has been a good investment for us here over the last quarter or 2.

Operator

The next question is coming from Rick Nelson of Stephens.

N. Richard Nelson - Stephens Inc., Research Division

I have a question about unit growth that was reported for the quarter, 8% same-store. With the March sales released, I think you reported 13% unit growth for the quarter. And I'm curious what the difference is. You mentioned some add points this morning, maybe that's it. And I know there's some differences in accounting, but I'd like some clarity.

Michael J. Jackson

Rick, this is Mike Jackson. Our monthly report is what we've reported to the manufacturers. So we are aligned with the manufacturers' reporting calendar for that. And this report, of course, is GAAP, and I think there was the 3-day difference this quarter, 3 additional days in the manufacturer calendar compared to the GAAP calendar.

N. Richard Nelson - Stephens Inc., Research Division

Got you. Also, I'd like to follow up on John's question about potential pull forward into the first quarter. Any commentary on April sales would be helpful.

Mike Short

Well, what's nice about us compared to everybody else is we do report every month. And next Wednesday, we will report in detail the results for April.

N. Richard Nelson - Stephens Inc., Research Division

Got you. Subprime finance availability, I know it's been a big driver to this recovery. But subprime, I guess specifically I'm interested in how that is growing maybe as a proportion of your customer base or sales and where you see the potential for that category? Where are we now versus a few years ago when subprime was a big driver?

Michael E. Maroone

Rick, it's Mike Maroone. The subprime financing environment has been good for several quarters right now. So we're not seeing huge growth there. If you compare it back to '08 and '09, certainly, it's a very different market. But subprime was a strong part of the business in 2011 to continue down to the first quarter of 2012. And I think it'll continue to be strong. I don't think it's a huge driver of the business in comparison to most recent quarters.

N. Richard Nelson - Stephens Inc., Research Division

Got you. And any -- finally, any updates on the Shared Service Center would be helpful. I think there was one more region you were working on, and maybe some of the savings that you're achieving with your SG&A to gross was the lowest in the sector.

Mike Short

Rick, this is Mike Short. You're right, we are finishing, probably about halfway through the rollout of the Florida region, which is the last region to go into the extended mode of the Shared Service Center. That will complete that platform execution. And we think that there will be additional initiatives that we lay on top of that going forward. Those are yet to be identified and announced. But certainly, we view this as having completed the foundation of the SSC, and now we'll be adding additional functionality and capabilities to it. And that is a key part of how we have achieved the level of efficiencies that we have, and it's a key part of that strategy going forward.

Operator

The next question is coming from Simeon Gutman of Credit Suisse.

Simeon Gutman - Crédit Suisse AG, Research Division

Mike, I'm curious if you can talk, I guess, on the brand side. We're starting to see some subtle shifts, most of which are probably expected with the Domestics taking a little step back and the J3 picking back up. I'm curious if you can give some thoughts on that.

Michael J. Jackson

Well, I think everybody should expect the Japanese to post very good numbers for the next 6 months and to take a lot of the share that they give back. I think that's fully to be expected. We had an extraordinary circumstance in the marketplace last year starting in April. But by mid-May, there were dramatic shortages on Japanese products that, really, Nissan got a resolve first, I would say in the fourth quarter. First quarter, Toyota got a resolve, and it looks like Honda will have a resolve in the second quarter. So it was really for an extended period. And they have a lot of new product offerings and launches coming with that. So there will be some rebalancing with the Japanese brands on share over the next 6 months. And they have, really, on the volume side, very easy comps that they will beat. But I have to tell you, the renaissance with the Domestics is across the board. It strong. It's real. And those who simply say that Domestics have lost their stride during this period when the Japanese now have full availability again, I think, are missing the story. This is a recovery that is for all brands, European, Domestic, Japanese, across the board, everybody has exciting product from small cars through trucks. And yes, Japanese will do very well in the next 6 months, no doubt. So I would not say it's totally at the expense of the Domestics.

Simeon Gutman - Crédit Suisse AG, Research Division

Right. And to your point that there will be some rebalancing, there wasn't just an early sort of catch-up from some pent-up demand. Maybe there were some people waiting for the inventory to come back. And exactly to your point, it feels like the Domestics are stronger. So does the J3 continue to take back at an accelerating rate? Or does that kind of cool off here after this initial period?

Michael J. Jackson

I think the Domestics will still show positive sales, and -- but the Asians will be even stronger and take back share. It's one of the reasons why I've moved my forecast to mid-14. If the first quarter average 14.5, then you look at the fact that we were supply restricted for a major manufacturing base for 8 or 9 months last year, and I want to comp against that. If you keep your number in the high 13, if not 14, then you're really forecasting a significant downturn for the rest of the year to get the year to average 14. I don't really see a circumstance of that happening. So we're very comfortable in the mid-14. You're absolutely right. We expect the Japanese to put up very good numbers over the next -- the balance of this year, but the Domestics are for real. And imagine, the numbers, the 14.5 that was averaged in the first quarter was in the face of $4 a gallon gasoline and no net increase in incentives to speak of. Yet how incentives are used and whether they're stair-step or not, you've got a lot of moving pieces there, but if you net it all out, there was no major incentive move in the first quarter of this year.

Simeon Gutman - Crédit Suisse AG, Research Division

Okay. And then a question on -- for Mike Short on the operating leverage and the flow-through, which was solid in the quarter. I guess compared to some other ones, it may not have been as strong. Curious if there was anything maybe acquisition related that was in there that held it back. And then with regard to the SSC, from a timing standpoint, is there anything to think about as far as a step function of improvement when some of those extensions start to fall in place?

Mike Short

So just one thing, Simeon, when you're looking at that SG&A leverage, do make sure that you pull out the Premium Luxury incentives in the prior period. If you just look at our reported numbers, we had a 20-basis-point improvement. But when you normalize for that, it was about 80 basis points. We're looking for generally about a 50% flow-through on incremental gross. Didn't quite get that this quarter because most of the gross profit growth that came in, in the quarter came on the new vehicle side, and that doesn't flow through quite the same rate as some of the other gross profit streams that we have. In terms of the Shared Service Center, we'll be completed with the Florida rollout by the end of this year and then roll into some of the applications, purchasing and some of other capabilities that we can add to that going forward. And we haven't called out a specific target in terms of step-level changes associated with those. But as I've mentioned in previous calls, we've been sub-70 on our SG&A as a percentage of gross in the past, and we're targeting to get back there.

Operator

The next question is coming from Patrick Archambault, Goldman Sachs.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

On the topic of inventories, I understand -- I guess 2 questions. On a headline basis, you definitely see levels at Nissan, Toyota and even Honda getting up to more normalized levels. But is there pockets of constraints that are still an issue there? Or do you think that at this point, they're in a position to largely meet all the pent-up demand that is presumably there? And then maybe just extending that broadly, I think there was an article or 2 talking about passenger car inventory constraints in the system, and I was just wondering if that was something you're seeing as well.

Michael J. Jackson

This is Mike Jackson. First, I think the inventory, as far as its overall level, is in great shape. And the quality of the inventory and the quality of what's being built compared to what consumers want is one of the closest matches that I've ever seen. The industry is behaving in a very disciplined way. When something's not selling well, they stop producing it rather quickly. That's not the behavior of the past. Certainly, there will always be something that's a little overproduced and needs a tactical incentive to deal with, and there will always be something that's hot and in short supply. Mike, why don't you talk about some of those imbalances?

Mike Short

Patrick, again, we're pleased with our inventory, pleased with the supply-demand balance. But underneath it, we would love to have more Premium Luxury inventory. We would love to have more small car inventory, and there are always select models that we'd like more of. But we've been buying aggressively. We've been buying what's available and really paying attention to our turn rates so that we can earn more of the more desirable product.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Okay. Very helpful. And maybe one, I don't know, I feel like it might be -- it might have been a little while since we sort of revisited the M&A theme. You guys do have some dry powder. Clearly, the choice has been buybacks. I think you've said that explicitly. But how are you thinking about inorganic growth as an opportunity here?

Michael E. Maroone

Patrick, it's Mike Maroone. We continue to look for opportunities. Where we're looking for opportunities is in the markets that we're currently in, and our goal is to get representation of every major brand in those markets. So there, it's a matter of what's available and can we buy at the right price. So we're out looking. We're out making offers and are very interested in growing by acquisition, but only in a very disciplined way.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Okay. And is the environment sort of more or less conducive today than it was last year or kind of unchanged, I guess?

Michael E. Maroone

I haven't seen a major breakthrough in the environment. I think there are still deals out there. And again, it gets down to price and getting the right store and the right location. But I don't -- I haven't seen any fundamental changes in valuation.

Operator

The next question is coming from Jamie Albertine, Stifel, Nicolaus.

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

Just very quickly, just to touch on a point you mentioned a moment ago. Could you dig into, in a little bit more detail, maybe by brand, some of the constraints you were up against on the Premium and Luxury side during the quarter? Just noticing in your breakout, obviously, a 2% increase in sales and a 14% increase in units, if I have it right. Wanted to understand in a little bit more detail what's going on there.

Michael E. Maroone

Jamie, it's Mike Maroone. Again, going back to Mike Short's comment from the aberration from a year ago, if you adjust for the onetime incentives a year ago, that segment, actually, was at a plus 11%, not a plus 2%. So I think the segment's still very healthy. But clearly, there was a very strong market in Premium Luxury. At year end, the market was very heavily incented. The inventories were way down in January. They're starting to rebuild, but we clearly would love to have more inventory in the Mercedes, BMW, Audi, Lexus business and continue to work hard to get that inventory.

James J. Albertine - Stifel, Nicolaus & Co., Inc., Research Division

That's very helpful. And just one follow-up. Congratulations on -- you've been one of the most efficient, if not the most efficient, dealer in the sector now for some time and to show leverage on an SG&A per gross profit basis was really impressive, I thought, in this quarter. We've seen now pre-recession levels of EPS on what really amounts to trough or trough-like SAAR. I was hoping to get some of your sort of, I mean, not guidance, but sort of views on where you think long-term EBIT margins could trend over time just given what we've seen in terms of efficiencies?

Mike Short

Jamie, this is Mike Short. Generally, what we said about this is that as gross continues to grow, we expect about 50% of that incremental gross to flow through to the bottom -- to the op income line. And so I think you see us delivering in that ballpark here now. We expect to continue to do that as we get through the recovery. So that'll help drive those margins up. And we've been, in terms of SG&A as a percentage of gross, below 70% before and targeting to get back there again.

Operator

The next question is coming from Rod Lache of Deutsche Bank.

Dan Galves - Deutsche Bank AG, Research Division

It's Dan Galves in for Rod. Just wanted to ask about gross profit per vehicle retailed. On the new side, saw a pretty significant reduction in that versus the last couple of quarters. And on the other hand, for used retailed units, the gross profit per unit went up quite a bit sequentially. Just wondering if you could give us any more color on what's driving those changes and how we should be forecasting for going forward?

Michael J. Jackson

Sure, Dan. Again, if you take out the onetime performance-based incentives from a year ago, our gross margins were actually up 1% from a year ago. So I don't -- there wasn't a fall-off in the new car gross. As we look at -- as we look forward, we're saying that we believe that on a full year basis, that you'll see comparable grosses as what we delivered in Q1. Again, each quarter will vary some with how some of the incentives and stair-step volume-based incentives fall. But I think you can look for stable margins. We're always looking to grow margins, but I think you could call out stable margins. On the used vehicle side, the inventories are very tight. And we've worked really hard at putting the proper discipline in our inventories and our pricing. And we're able to have some -- did a good job in gross with almost $1,700 in gross margin per unit. And I think looking forward, I think you can expect, again, comparable grosses looking forward.

Dan Galves - Deutsche Bank AG, Research Division

Okay. Just to clarify, the fourth quarter gross profit per new vehicle retailed was like $24.50. I think if you adjust for some incentive programs, it was maybe $24.20, something like that. And it was 20 -- around $21.80 per unit in the first quarter. So just looking sequentially, like what do you think was the driving force behind what was, I think, was a reduction versus the fourth quarter levels?

Michael J. Jackson

The fourth quarter level -- the fourth quarter is always heavily influenced by Premium Luxury. Premium Luxury is very robust. And I think you can assume that fourth quarters will be that way. So we -- that's why I said, as when we look over a full year, we're comparable -- or we're comfortable in the 2,150 to 2,200. I think you will see spikes in certain quarters due to mix and incentive activity.

Dan Galves - Deutsche Bank AG, Research Division

Okay. That's really helpful. And just wanted to ask for a second, just wanted to get your take on how big the mix shift has been in the first quarter in terms of customer demand for smaller vehicles versus larger vehicles. And then we've noticed that fuel prices were down slightly last week and more meaningfully this week. Usually, that signals kind of a normalization of mix. I just wanted to get your thoughts on that going forward.

Michael J. Jackson

We actually saw no shift in mix during the quarter. And that's one of the things I referred to earlier, that you can get the size vehicle you want, the performance your vehicle want and dramatically improve fuel efficiency without downsizing. Now the offering is better in every segment. Everybody has much more attractive small cars today than they did 5 years ago. But really, the transformation that's occurred is that the consumer comes in and says, "Tell me what the technology does for me at what price." And they -- where the downsizing is occurring is in the size of the engine displacement. They're willing to take fewer cylinders and a smaller displacement engine, that's higher tech, that gives them the same performance with dramatically improved fuel efficiency. And they wouldn't have done that in the past. In the past, they would have insisted on their V8 pickup truck, but that is the big change that's out there. And I think it's permanent. I think this more sophisticated approach to technology is not going to unwind as gas prices go back down. So we're not seeing the traditional stampede to smaller vehicles as consumer reaction to higher gas prices. It's more tell me the technology and the technology that's addressing the consumer need has a relatively modest incremental cost and why hybrid sales are up. It's not the issue or the answer. It's direct injection, turbocharging, 6, 7, 8, 9 speed, automatic transmissions. That's what's selling.

Dan Galves - Deutsche Bank AG, Research Division

One more quick one. Are you hearing anything about the resin shortage from the OEMs? And also just housekeeping, when comparing to your leverage covenants, should we be using the 2.98 that you mentioned earlier or the 2.75 net number?

Michael J. Jackson

On the resin, all manufacturers have confirmed the production plan for the next 6 weeks. No disruption. And they say while there are challenges, they expect to have them all resolved before it becomes an issue. And so the situation is nothing comparable to the earthquake or to the floods in Thailand.

Michael E. Maroone

And on the leverage question, the 2.98 is really the mechanical test versus the 3.75x covenant. So that's actually where we stand relative to the covenant. We provide the additional data point to give you a sense for if we applied cash that we have on hand, how low could we get it. So they're both relevant, but for different reasons.

Operator

The next question is coming from Ravi Shanker, Morgan Stanley.

Ravi Shanker - Morgan Stanley, Research Division

When you look at the SAAR back up to the 14 million to 15 million level, would you say that the California and Florida markets are also getting back up to a more normalized level of sales? Or is there a long way to go there?

Michael E. Maroone

Ravi, it's Mike Maroone. We're pleased with the progress. California, for us, was up about 5% in the quarter. Florida was up about 7%. So they're making good steady progress. They made good progress in 2011. Certainly, all of the formerly hot real estate markets have had some pressure. We also saw 7% growth in Arizona, which was another key market for us. So I think they're coming back. They're certainly not coming back at quite the pace for the rest of the country, but we're very pleased with the progress.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And also just going back, just following up on the M&A strategy you highlighted earlier, it does look like you're focusing a little bit more on adding new points rather than acquisitions. Would you say it's a fair characterization of your strategy? And what benefits of that might be?

Michael J. Jackson

Certainly, we work real hard at the relationships with key manufacturers. There's been a lot of give and take. There's been a lot of investments and a lot more dialogue with manufacturers than there was. And add points are very desirable for us. They're typically in the markets we represent with the brand that we don't represent. So we're taking advantage of some real estate that we've got and some opportunities and are very pleased to be selected. But at the same time, we are looking actively for acquisitions and have teams out there talking to different retailers, trying to find the right opportunities. So we'd like to grow with both strategies.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And finally, you said you made a new hire to expand your digital capabilities. Can you talk a little more about what that might entail and what the opportunities are?

Michael J. Jackson

I don't know that we're ready to lay out a whole digital strategy on this call. But certainly, the world shifted very rapidly, and e-commerce is a very important part of our business. The traffic that comes online continues to grow. We want to be sure that we're positioning the company looking forward and making sure that we've got those capabilities. Greg Ravelle has got a very unique background coming out of Expedia. He brings some new capabilities to the company, and we're really excited to have him here. And I think you'll find that our marketing going forward will be aggressive. And it'll really take advantage of some of the size and scale we have and some of the expertise that Greg and other members of our team bring.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And to the extent that you can comment on that, are you talking more about just getting better websites and listing your inventory more efficiently? Or is it directly selling cars on the Internet potentially like GM tried to do a couple of years ago?

Michael J. Jackson

Well, we're already in some pilot programs. We're selling cars online. We think there's opportunity everywhere. Customers have had experiences online. They're getting much more comfortable online. And they certainly are looking to search for product, get pricing. We're now providing values on trade-ins, finance quotes online. We're really expanding our product offerings. We're at the early stages and are piloting a bunch of new ideas, but we believe there is opportunity. Certainly, every website's got opportunity to improve. You've got to improve your search capabilities. And we're working really hard on those issues.

Operator

The next question is coming from Matt Nemer, Wells Fargo Securities.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

I just had a quick question on parts and service, customer care. Your margin, gross margin percentage, was below 42% for the last 3 quarters, and it's been running 30 -- 43% to 44% pretty consistently over the last 10 years. So I was just wondering what's changed in the last few quarters? Is it primarily mix? Or is there something within one of the segments?

Michael E. Maroone

Matt, it's Mike Maroone. Certainly, we have become much more aggressive in the tire business and the quick service business. We also are a big player in parts wholesale and collision. All of those have impact on margins. We believe that the margins have bottomed at this point. But what we're really looking to do is capture more of the customers' spend and be able to be a full-service retailer. And I think we're making good steps in that way. Just as an example, our tire revenue was up 38% year-over-year in the quarter. And it really shows an aggressive attempt to serve customers in that segment.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Okay. And then secondly, in the used car business, you mentioned a pretty significant increase in appraisal traffic, and we've heard that from some other players including CarMax. Just wondering why appraisal traffic is running so much higher than new vehicle sales or even used vehicle sales.

Michael J. Jackson

I think people have held on to their cars longer. You've got cars with much higher mileage, and it's -- we're getting to the point where it might not be an option as to whether they trade as much as there might be a need to trade. That's only speculation on my part. What we're more focused on is when we do get an opportunity to appraise a vehicle, to win that appraisal at the right price and ultimately retail that vehicle.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

And on that topic, you mentioned a 47% close ratio. How does that compare to historical close ratios on appraisals? And have there been any changes in the customer experience around appraisals?

Michael J. Jackson

Matt, we were -- we used to be in the high 30s, low 40s. So we have made progress. We've got a lot of training and a lot of discussion as to what best practices are in appraisals, have a very defined process. And I'm really pleased with the team's execution. There's a lot of data out there in the market available, and we're trying to take advantage of that data to put the right money on the car and win that trade. So it's -- I would it's process improvement, training and focus.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

And then just one quick follow-up on used business. Can you give us the number of used vehicle transfers in the quarter? And then do you have any information you can share around the volume in your value vehicle outlets?

Michael J. Jackson

In terms of moving vehicles, I think we moved somewhere in the neighborhood of 12,000, 13,000 vehicles in the quarter and are pleased with our ability to do that. That's why we've got concentrations in markets, so that we can achieve that. In terms of the vehicle -- value vehicle outlets, there's 27 of them open at this point in time. It continues to grow. That segment continues to grow and provide opportunity for us. We're really pleased with that segment. And certainly, there's more work to do.

Operator

The next question is coming from Colin Langan, UBS.

Colin Langan - UBS Investment Bank, Research Division

Can I just quickly confirm, when you're addressing the resin issue before, did you say that the automakers have confirmed that the next 6 weeks of production will not be impacted?

Michael J. Jackson

That's correct. We have no reports of any production being canceled or delayed. Now I would point out, we had the same situation there with the earthquake and with the floods, that there usually is 4 to 6 weeks of parts in the system. So when something like this happens, you have 4 to 6 weeks before it's an issue. And we're being told that during that period of time, they will find solutions.

Colin Langan - UBS Investment Bank, Research Division

Okay. And they said this is a recent number, this sort of 6 weeks of -- not as of the beginning of the disaster?

Michael J. Jackson

That's as of today.

Colin Langan - UBS Investment Bank, Research Division

Okay. And on the stair-step program, do you expect those incentives to be flat year-over-year? Or is that going be a headwind since there were some pretty big stair-steps last year?

Michael E. Maroone

It's Mike Maroone, Colin, I think that overall incentives will be flat. The tactic seemed to shift quarter to quarter based on need and based on what manufacturers are trying to accomplish. I don't know that we have a crystal ball on which elements of incentives will grow and which ones will shrink. But we do anticipate that the overall incentive environment will be flat.

Colin Langan - UBS Investment Bank, Research Division

Okay. And then you disclosed that there was a $4.6 million luxury incentive this quarter. What was that compared to last year? Were there no incentives last year in Q1?

Michael J. Jackson

That was last year's number. There's none this year. So what we're demonstrating is that the new vehicle margin was up slightly year-over-year, not down as we exclude those numbers.

Colin Langan - UBS Investment Bank, Research Division

Okay. That makes more sense to me. And then lastly, there's -- obviously, with gas prices, until recently, rising, what is the impact to the dealer? I believe a lot of the compact cars are pretty low profit? Or are there -- is that a concern for you, that people continue to shift towards the smaller cars? Or is there any other actions that you can take?

Michael J. Jackson

We see no shift to small cars.

Colin Langan - UBS Investment Bank, Research Division

But is there -- from the profit side, those are lower profits, right? Or is it the profits are like the same?

Michael J. Jackson

Well if there's been no shift, there's no impact. The margins on a percentage basis are the same, if not higher, than trucks. But of course, the transaction price is lower. So Mike, do you have the exact earning grosses?

Mike Short

I don't have them at my fingertips for the segments. But I do want to echo what Mike said, is the small car mix is identical to a year ago. Certainly, within quarters, there's some movement. But year-over-year, they're the same.

Colin Langan - UBS Investment Bank, Research Division

And the margins are the same as what you have just said, too?

Mike Short

The margins as a percent, not in raw dollars. As a percent -- just for example, as a percent, the small car margins in Q1 were 6.7%. Midsize cars were 6.6%, AUVs were 6.7%. And large pickups were 5.4%, which really illustrates Mike Jackson's point of higher price point, less percent margin. The dollar margin was actually higher than small cars. So it's a little bit of a mixed bag.

Michael J. Jackson

So my point is there has not been a shift to small cars. It's 20% of the business a year ago, 20% of the business today.

Operator

The last question will come from Brett Hoselton of KeyBanc.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

I think you already answered a couple of my questions, but let me just verify. First of all, it sounds like you're not anticipating any increase in incentive activity by possibly Toyota or Honda driving overall incentive activity in the marketplace. I mean, in order to regain the market share that they've lost, it sounds like your thoughts are we're probably going to see them just maintain incentive activity where it's currently at and just allow the inventory rebuild to regain market share or something along those lines?

Michael J. Jackson

Yes. I don't see -- I think that they're really focused on production and rolling out new products. There's a slew of new products coming out of Toyota, brand new CRV from Honda, refreshes coming up on the Accord and Civic. But I think it's about new product launches and production. And I don't think that either one of them is going to go out and try and buy the market with incentives. I think they're going to try and earn the business through product.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

Okay. And then switching to credit availability. As you pointed out, we've seen a nice steady improvement in terms of credit availability even at the lower end. My question is, have you been approached or seen any potential subprime startups or something along those lines, which might result in some sort of a stair-step increase in the availability of credit and particularly at the low end of the market? Or do you anticipate just possibly a slow, continued, steady, gradual improvement in credit availability?

Michael E. Maroone

Brett, it's Mike Maroone. There are some new players in subprime. I don't think they're big new players. I think they're niche players. And I think the restoration of credit over the years, subprime was the last to come to the party. And it's now back, and we can get people without stellar credit financed. And it's a good healthy environment. But I don't see a slew of new players that takes subprime up to another level. I think the industry has been very disciplined and has had really developed the ability to collect. And the delinquencies never got way out of control even in the downturn, and they seem to be in good shape today.

Michael J. Jackson

Thank you, everyone, for your time today.

Operator

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

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