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AutoNation, Inc. (NYSE:AN)

Q1 2008 Earnings Call Transcript

April 24, 2008 11:00 am ET

Executives

John Zimmerman – VP, IR

Mike Jackson – Chairman and CEO

Mike Short – EVP and CFO

Mike Maroone – Director, President and COO

Analysts

John Murphy – Merrill Lynch

Matt Nemer – Thomas Weisel Partners

Colin Langan – UBS

Rick Nelson – Stephens

David Lim – Wachovia

Darren Kennedy – Goldman Sachs

Mark Wamsman – Calyon

Jonathan Steinmetz – Morgan Stanley

Dan Galatin [ph] – Deutsche Bank

Operator

Welcome to AutoNation's first-quarter earnings conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator instructions) Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now, I will turn the call over to AutoNation.

John Zimmerman

Good morning and welcome to AutoNation's First Quarter 2008 Conference Call. My name is John Zimmerman, AutoNation's Vice President of Investor Relations. I would like to remind you that this call is being recorded and will be available for replay at 866-463-4964 after 2.30 p.m. Eastern Time today through May 1, 2008.

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

Before we begin, let me read our brief statement regarding forward-looking comments and the use of non-GAAP financial measures. Certain statements and information on this call will constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve risk which may cause the actual results or performance to differ materially from expectations. Additional discussion 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 and 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 will 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 first quarter EPS from continuing operations of $0.31 compared to a year ago of $0.39. Prior-year results benefit from a favorable tax adjustment of $0.02 per share.

Results for the first quarter of 2008 reflected a decline in vehicle retail sales especially in California, Florida, Nevada, and Arizona where the housing crisis has clearly impacted overall economic activity and consumer demand for vehicle. AutoNation new unit sales for those markets were down 11% and for the industry, California, Florida, Nevada, and Arizona, new unit sales were down approximately 15% according to CNW Research. AutoNation new vehicle sales for the other states were down 4% in the first quarter. We continue to have confidence in our Sunbelt markets and view them as healthy over the long term especially when housing begins to stabilize.

During the first quarter, U.S. retail auto sales had declined 11% according to CNW Research; AutoNation new unit sales declined 8%. While today's economic uncertainty may compel certain potential buyers to put off their purchase decisions until a later date, their needs remain. Once consumers begin to sense that their own economic situation has stabilized, they will begin to be ready to commit to purchase big ticket items like vehicles. Industry analysts like CNW and J.D. Power forecast improved new vehicle sales beginning in 2009 due to fleet age and increase in vehicle scrappage, and a robust line-up of new products. CNW forecast new vehicle sales of 16.3 million in 2009, 16.7 million in 2010, and 16.9 million in 2011. We concur with this assessment for future new vehicle sales.

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

Mike Short

Thank you, Mike. Good morning, ladies and gentlemen. As Mike mentioned, we reported first quarter earnings from continuing operations of $0.31 per share versus $0.39 a year ago. Operating profit for the first quarter was $147 million, down 21% from $186 million a year ago. The prior period included the benefit from favorable tax adjustments of $0.02 per share.

SG&A decreased $13 million versus Q1 2007. Because of the erosion in gross profit SG&A as a percentage of gross profit increased to 74.5% from 71.2% a year ago reflecting deleveraging of our cost structure. Net inventory carrying cost was $3.3 million lower in Q1 versus the prior-year period. The favorable variances primarily a result of lower floorplan interest rates partially offset by a decrease in floorplan assistance resulting from lower new vehicle sales. Other interest expense was $0.4 million higher in Q1 versus last year. The unfavorable variance is a result of increase in debt levels associated with our mortgage facility, our revolving credit facility, and other indebtedness partially offset by lower interest rates on our term loan facility, mortgage facility, and floating rate Senior Notes.

For Q1 2008 we had an effective income tax rate of 40.6% versus the prior year effective rate of 35.8%. The Q1 2007 rate benefitted from adjustments from the resolution of various tax matters, which as I have noted resulted in an EPS benefit of $0.02. We expect our ongoing rate to be about 40%, excluding the impact of any potential tax adjustments in the future.

Also in Q1 2008, we had losses from discontinued operations of $5 million, net of taxes, or $0.03 per share. These losses related to the divestiture of several stores during the quarter.

During the first quarter, we repurchased 1.9 million shares of stock at an average price of $14.84 per share for a total of $28 million. Our future share repurchases are subject to limitations contained in our debt agreements. As of April 1, 2008, our basket capacity for share repurchases was approximately $32 million. Each quarter we are permitted to add back 50% of our net income after tax and any stock option exercise proceeds.

We reinvested $23.5 million in the business through capital expenditures during the quarter. We expect full-year 2008 capital expenditures to be approximately $110 million net of asset sales. That excludes acquisition-related spending, land purchase for future sites or lease buyouts. At March 31, our non-vehicle debt was $1.8 billion and we had unused revolving credit availability of $436 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.

Mike Maroone

Thanks, Mike, and good morning. Thus far in 2008 economic headwinds have been a significant factor for the auto retail industry sustaining an environment that is both challenging and increasingly competitive. In the first quarter, AutoNation retailed 71,400 new vehicles on a same-store basis, was down 9% compared to the period a year ago. It compares favorably to the industry that was off 11% in the quarter according to CNW Research. Of note is a $231 reduction in profit per new vehicle retailed. The highly competitive and distressed market along with the tightening of credit are factors that impacted both volume and margin.

The same factors impacted our used vehicle results where in the quarter our same-store used vehicle retail volume was off by approximately 2300 units, or 4% compared to the period a year ago. And profit per used vehicle retailed was down to $233. Given the linkage between new and used we were encouraged that our used vehicle volume was off less than new and attribute this to the additional dedicated used resources that were put in place early in the quarter.

Relative to strength or weakness in the markets where we operate, we have already called out ongoing pressures on markets in Arizona, California, Florida, and Nevada. In the quarter, Texas continued to perform well, especially South Texas. And the markets of Chicago, Knoxville, and Memphis held their ground compared to the rest of the country.

At March 31 our new day supply was 57 days, an increase of 5 days compared to a year ago driven by softer-than-expected March sales. We closed the quart with a used day supply of 40 days, an increase of 2 days compared to a year ago. In the quarter, parts and service same-store revenue grew $5 million to $650 million, an increase of 1%, and gross profit held steady at $281 million compared to the quarter a year ago. We remain focused on growing our customer pay, parts and service business and as we transition from a service culture to a service retailing culture utilizing our customer friendly service sales process.

Turning to finance and insurance, same-store F&I gross profit per vehicle retailed was $1183, an increase of $66 year-over-year this despite a revenue decline driven by lower volume. We attribute continued growth in PVR to increased product penetration, improved returns from our service contract portfolios with third parties, our strong preferred lender network, and ongoing efforts to improve the performance of our third and fourth quartile stores.

In closing, I will note that we are committed to continued investment in our associates through robust training and in technology along with consistent implementation of our best practice processes across all stores. In addition, managing expense throughout the organization continues to be a priority. In this environment, we remain focused on building our capabilities to emerge stronger when the economy rebounds.

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

Mike Jackson

Thanks, Mike. As we look at the rest of 2008 we believe the market will remain very competitive and challenging. AutoNation will continue to focus on our cost structure while continuing to invest in our business. We are confident in our long-term business strategy and our markets. That concludes our remarks. Operator, please open the calls for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Mr. John Murphy with Merrill Lynch. Your line is open.

John Murphy – Merrill Lynch

Good morning, guys. I was wondering on the new margin pressure that seems to be ramping up here, it sounds like you are getting more competition from some of your weaker local competitors. I am just wondering if that is something you see reversing as the market gets better or is this sort of more structural here as we go forward?

Mike Short

I think it’s more cyclical, John. I think we are at the point now where you have such tough economic conditions between the uncertainty around housing and what is the value of your housing. Gas prices. We always said the sensitivity begins at $3, now we are at $3.50 with the prospect of $4 on the horizon. So it is a very value-conscious price buyer that we see out there right now. And they are willing to give up size and other capabilities to get to a price point. And so to keep volume moving at all, that puts tremendous pressures on margins. So I think it’s primarily cyclical in nature.

John Murphy – Merrill Lynch

Okay. And then on the used margins which saw some pretty good strength or relative strength anyway, is there anything you are seeing in that market because I mean pricing has been pretty tough and volume sounds like it is tough in that market but you did pretty well on margins. What is going on there?

Mike Maroone

John, it’s Mike Maroone. I thinkwe did have some margin pressure in used as well. We are off about $233 a vehicle. We reallysay that it’s the tightening of credit, especially subprime. We are seeing shorter advances. We are seeing more restrictions, tighter verification. It’s just the credit market is tightening up. We were relatively pleased with our used vehicle performance, but the credit environment is making it tough on margins.

John Murphy – Merrill Lynch

Okay. And then on the cost side, I mean are you through all the cost cutting you really can do at this point on the structural side and at this point it’s really just getting the grosses back up as volumes ultimately recover over time? Is there anything else you can do in the near term on the cost side to help out the SG&A line?

Mike Short

John, this is Mike Short. I don't think we are ever done with a diligent look at our cost structure. It’s an ongoing process for us here at AutoNation. We are workingeach of the store is now putting in place tactical plans that make sense for the business both in the short and long term to make ourselves as efficient as we can. So, it’s an ongoing continuous improvement idea here.

John Murphy – Merrill Lynch

Okay. And then just lastly on parts and service, customer pay versus warranty work where are we at on that right now and where is that sort of trended over the last couple of years and where you see that going forward?

Mike Maroone

John, it’s Mike Maroone. Our customer pay was up 2.4% offset by about a 2% reduction in warranty. So, warranty is starting to moderate a little bit. On a customer pay point of view our traffic was down slightly about 1% but our dollars per repair order were up. So, we are still optimistic about our service business. As I mentioned that we are moving to a service selling culture and have got a lot of programs in place. We are working really hard on the ‘e’ side, and I am pretty optimistic about our ability to grow that business.

John Murphy – Merrill Lynch

Any idea what the average ticket was there was on those, one the--?

Mike Maroone

Our customer pay ticket averages about $300.

John Murphy – Merrill Lynch

Great. Thank you very much.

Mike Maroone

Welcome.

Operator

Thank you. Matt Nemer with Thomas Weisel Partners, your line is open.

Matt Nemer – Thomas Weisel Partners

Good morning everyone. My first question was on the finance availability topic. Is the decline in used vehicle margins, is that just a mix shift away from subprime where the subprime deals generate a lot more margins than plain vanilla deals? Is that the way to think about that?

Mike Jackson

I don’t’ think it is that simple. I think there is pressure all through both prime and subprime. There are less subprime lenders. There are certainly some conservatism there. There is some big fees from the subprime lender, but it’s really a cautious advances both on new and used from all lenders.

Matt Nemer – Thomas Weisel Partners

Okay. And then on that same topic of financial availability have you seen any issues either in your own business or in the industry where lenders are becoming more cautious with floorplan lines and any risk that there is a chance of some of the terms on those lines change?

Mike Jackson

No, we really haven't seen much change on the floorplan side of the business at all.

Matt Nemer – Thomas Weisel Partners

Okay. And then just two housekeeping questions. Your new and used ASP, average revenue per unit ticked down sequentially and I was just wondering if – what’s driving that, if you can give us some color on the mix of sales in the quarter.

Mike Jackson

This is Mike Jackson. It is what I was referring to that thethis combination of the situation in housing, the credit crisis, gasoline prices. The customers that are in the market at the moment are very value conscious and they are willing to move to lower price points in order to get willingthey are asking to move to a lower price point to get in a vehicle. I think that will change with the cycle. I don't think that’s a permanent change in consumer preference, it is just a sign of economic stress.

Matt Nemer – Thomas Weisel Partners

And is that within brands or people actually crossing over to value-oriented brands?

Mike Maroone

I think there is – it’s Mike Maroone. I think it’s across all brands. There are a couple of exceptions where thefor example in Toyota the revenue is up slightly, but most brands were down slightly. The growth in segments in the quarter was clearly in small cars and crossovers which have a larger price point which really ties back to Mike Jackson's comments about the value-conscious price buyer.

Matt Nemer – Thomas Weisel Partners

Okay, great. And then my last question is on your cash flow statement it looks like you spent $29 million on acquisitions in the quarter. Can you give us some detail on that?

Mike Jackson

Yes, we acquired one dealership in the quarter, a BMW dealership.

Mike Short

Which was previously announced.

Matt Nemer – Thomas Weisel Partners

Got it. Great. Thanks so much

Operator

Thank you. Colin Langan with UBS. Your line is open.

Colin Langan – UBS

Great. Thanks for taking my question. Actually on the M&A front, has the price, I mean ishave you seen any changes in the multiples for dealers out there? Has that market gotten any better for acquisition?

Mike Jackson

This is Mike Jackson. If anything the multiples have gone higher because earnings by and large are down and prices haven't changed. And so you are not seeing too many deals get done and I don't think there has been a reflection on the part of the sellers where we are in the cycle, the fact that the cycle is a reality that has to be factored into the pricing when you acquire something. So right now there is a gap between sellers and buyers. And as of this moment the sellers really haven't reduced prices.

Colin Langan – UBS

Okay. And then what do you think about strategically given the market conditions? Would you consider divesting more dealerships or are you currently pleased with your portfolio mix?

Mike Jackson

We are always optimizing the portfolio, and we are well into concentrating on high throughput stores and divesting marginal stores. There is still some of that to do. But we are probably in the best shape ever as far as our portfolio.

Colin Langan – UBS

Okay. And then on to theyour performance in terms of sales. It looks like youin terms of retail basis outperformed the market in general which is something in a down market I always got the impression you guys tended not to do because you are not willing to give in on the price which from where your margins is it sounds like you are willing to take a little bit on the margin in order to get some volume. Is that a new strategy for you or is this just – is this going to be a change in the way going forward on how we should look at that margins going forward?

Mike Jackson

I would first say overall that the environment is so tough out there it’s really hard to separate the impact betweenof the stress on what part is on volume and what part is on margin. But having said that, Mike, as far as our share performance this quarter--?

Mike Short

I think, Colin, I think the way to look at it is that we started this process about two years ago. California really started to slip about two years ago, so we are probably a little bit ahead of the curve and we have really focused on an intense training program with our sales associates focused on our three channels of business that’s really e-com, phone, and walk-in, and developed very specific processes of how to handle those customers. So I believe that we are executing better than we had in the past. But in terms of a change in strategy, no, we still want to go after profitable market share.

Colin Langan – UBS

So, the margin in this quarter is that a one-time thing or should we consider that a rate for the rest of the year?

Mike Short

I think it is difficult to say. But I think margins and volume will be under pressure till we get into a more stable period. You know, we – way to think, we are deep into the cycle now of decline. This isand as Mike said we were the tip of the sphere with Florida, California, followed by Nevada and Arizona. So, if you take the declines of '06, '07, and what it looks like in '08, you are into a 22%-23% decline in retail. So we are deep into the cycle. And when you get this far into it, it is the most difficult. Now, medicine is on the way. We have interest cuts. Actions are being taken to stabilize the credit markets, and all that will work their way into the system, but it’s probably the fall before we feel the benefit of that and in the meantime I think both volume and margins will be under significant pressure.

Colin Langan – UBS

Okay. And just one last one. In terms of your parts and services sales growth is a little bit lower than I had expected. Was that driven mostly by the decline in warranty and was there a particular brand that was weak in the warranty side?

Mike Maroone

It’s Mike Maroone. I think we just stated earlier, but our customer pay was up 2.4%, our warranty was down 2%. I don't think there was any brand that really stuck out from a warranty decline. I think all of the manufacturers have worked really hard on their quality and we are seeing it reflected over the last two to three years in warranty declines although the warranty declines are less than they have been in the past, so it kind of indicates that that revenue stream is stabilizing.

Colin Langan – UBS

So, how should we think about it goingI guess I am trying to getgoing into the rest of the year is the warranty issues still going to be an issue or if it’s kind of one particular brand?

Mike Jackson

I think the trend is for more stability and warranty revenue. I don't really want to try and predict the next few quarters because as you know its; reliant on product rollouts and other factors. I do think there is opportunity for us to continue to improve our customer pay business both in terms of traffic and in terms of dollars per repair order and we are working hard at doing that.

Colin Langan – UBS

Okay, great. Thanks for your help.

Operator

Thank you. Mr. Rick Nelson with Stephens, your line is open.

Rick Nelson – Stephens

Thank you and good morning. Hi, Jim, Mike, what are you seeing in April and how might that compare to the March results?

Mike Short

Since March is over, we can talk about March. Usually the last two weeks of March signify the arrival of the spring market and you see a strong surge in business. That did not happen this year. And whether it was, of course, the economy, but also everybody freaked out over the Bear Stearns situation or whether Easter moved into March and nobodythat's not a big shopping day, it is hard to say. But I can tell you, business did not come to life at the end of March as it usually does. It's very uncertain to predict how April will end up and whether that pick-up is now occurring in the beginning of April, I am hesitant to say. The months are simply too unpredictable and unstable for me to put a stake in the ground.

Rick Nelson – Stephens

Got it. The OEMs have these CapEx requirements. Mercedes-Benz with Autohaus and wondering how you approach that and can you achieve your return on capital objectives with these CapEx?

Mike Jackson

Well, everybody knows that we are very tough on CapEx and we have to hit our return threshold or we don't go forward and if that creates some stress with the manufacturer so be it. We are not going to do irrational things. So with each and every one of those initiatives it is a very intense discussion and negotiation, but we are extremely disciplined and we’ll do things that make sense.

Rick Nelson – Stephens

Okay. The manufacturers also are talking about consolidating the dealer base. Are you actually seeing any evidence that that's taking place?

Mike Jackson

Yeah, well, of course, Rick, as you know we have been arguing for it since the day I arrived here knowing that it was essential that it would happen. It finally is moving at a faster pace than just the dribble that we have had the last several years. They have really embraced it as a strategy, they really understand the implications if they can't get it done to their business. And we are able to do a lot more today than we haven't been able to do in the past. Having said that though, it’s a huge gap or a huge overcapacity issue that they are just beginning to address that’s even with their best efforts it’s still going to take quite some time.

Rick Nelson – Stephens

And just one final question on the brand mix. It looks like in the luxury segment you increased your brand proportion of sales with BMW and Lexus, but Mercedes slipped a bit. Is that geography that contributed to that or--?

Mike Jackson

It’s absolutely geography. Our Mercedes presence is primarily in California and Florida.

Rick Nelson – Stephens

Got it. Thank you.

Operator

Thank you. Mr. David Lim with Wachovia, your line is open.

David Lim – Wachovia

Thank you. Good morning, gentlemen, just several questions. Can you talk a little bit about your CPO performance in the quarter I mean granted there was some pressure but I just want to get an idea of how well your certified pre-owns did?

Mike Maroone

David, it’s Mike Maroone. We don't call it out as a separate line item, but I will tell you it’s a focus of our business. We believe there is opportunity on the CPO along with the C car side which is the much less expensive product. So, we are working hard at those. There is a lot of vehicles coming off lease especially on the luxury side. So, we see it as a big opportunity and it’s a big focus in our used car initiative.

David Lim – Wachovia

Got you, got you.. Now relative to yourthe same-store sales gross profit on the used vehicles I mean did you see a lift or was it a similar kind of performance for CPOs I mean just directionally?

Mike Maroone

I think that the CPO business probably goes in line with the balance of the rest of the business, it’s – you have got the same factors with the CPO business, but I do think it’s a bigger – it’s a bigger share of used, but from a margin perspective I don't think it’s that different.

David Lim – Wachovia

Got you. Now on thefrom a cost savings perspective on the SG&A line how much more can you guys let’s say cut on the advertising spend or I should better rephrase – let me rephrase that to refined advertising spending. What additional opportunity is there?

Mike Maroone

It’s Mike Maroone. I think there is always opportunity and our basicour basic strategy is to measure everything we can and allocate our dollars based on where we are getting the highest amount of traffic and the ability to close that traffic. So, it’s a continual tweaking. Certainly the e-commerce business continues to grow exponentially and we have made significant investments in our website and our e-capability. So, it think that – that’s the biggest trend you are seeing. Certainly there is some mix shift away from print. But I do think there is opportunities there, but we are really looking at returns and measurability for everything we do.

David Lim – Wachovia

Okay. Understood. When we come to the luxury mix side of it I mean are you seeing more of an in-elastic demand behavior? I know that all things have been hit hard but I mean relative to let’s say mainline imports, et cetera, I mean how is luxury side of your business holding up?

Mike Jackson

This is Mike Jackson. The way the cycle usually plays out at the beginning of the downturn is very much the volume segment that gets hit first. And it is only when you are deep into the cycle that you have an impact on luxury. And that is where we are at now. And I would describe it more as the uncertainty factor as to where all this is going that customers are hesitating. The purchasing power is still there. So I think once there is a clear line on where the economy is going that the worse is behind us, I see the luxury business resuming the quickest. So it’s the last to hesitate and it’s the first to resume.

David Lim – Wachovia

Interesting. And finally, I was wondering when it comes to your ordering right now, are you still backing off on orders especially with the domestic makes or how should we take a look into that? Granted there is that strike with American Axle in Detroit. I just want to get an idea of also your large GM SUV inventory.

Mike Maroone

I think there is plenty of availability out there across all brands.

David Lim – Wachovia

Okay.

Mike Maroone

We are working hard to manage our inventory. We finished the quarter at 57 days. I would say that’s slightly higher than where we have been over the last few quarters. A lot of that’s because the March sales pace didn’t deliver as Mike Jackson has already called out. In terms of our GM inventory, we have got an adequate supply of GM inventory. The strike has not impacted our ability to sell GM products. I think all manufacturers are probably a little bit on the heavy side with the big SUVs and pickups and I don't think GM is any different there.

David Lim – Wachovia

Got it. Now are youhow is your ordering policy? Are you still hesitating on orders or are you still accepting what the OEMs are distributing or how should we take a look into that?

Mike Jackson

We view the marketplace as remaining more risk than opportunity and we are managing the business on the conservative side.

David Lim – Wachovia

Got you. Great, thank you very much. Appreciate it.

Operator

Thank you. Mr. Darren Kennedy with Goldman Sachs, your line is open.

Darren Kennedy – Goldman Sachs

Hi there, I am here with Matt Fassler and I guess my first question is you have aare you running out of room for expense cuts in this environment? I mean should we continue to see pressure there or are there opportunities outside advertising?

Mike Short

Hi, Darren, it’s Mike Short. We have been seeing the de-leveraging in the cost structure reflecting the – in this environment. As gross declines it’s more and more difficult to extract SG&A savings, but I wouldn’t – again, there going back to the comment that I made earlier it’s a continuous process for us. We do think that there are more opportunities for efficiency and we are pursuing them.

Darren Kennedy – Goldman Sachs

Okay. And on the inventory side it’s one of the higher numbers, I think it’s the highest I have seen in seven quarters and clearly environment is responsible. Is this mostly focused in specific geographies you mentioned and can we expect that this is also primarily in some of your luxury brands now or is this kind of spread across brands.

Mike Jackson

This is Mike Jackson. I would say for the domestic, with this combination of the economic uncertainty and high gas prices over this period of time you are going to have a real shift towards the value price points, which coincidentally is also the high fuel economy point because we don't charge the fuel economy in this business; quite the opposite. So, restructuring our inventory towards that buyer that is really appearing for the first time to this degree in the first quarter is an issue for us. With the imports you have the issue that for our geography is there a sweet spot. So you have Toyota, Honda, and Nissan all under pressure and with much more inventory than they traditionally care to carry and so we are managing that. With luxury, I don't think there is any real issue at this point. To you, Mike.

Mike Maroone

Luxury inventories have been very stable and has been disciplined though there is not much pressure there. The pressure, as Mike said, is really in the domestic and...

Mike Jackson

So, it’s a restructuring of the domestic inventory and for the first time there is plenty of availability on the Japanese volume products.

Darren Kennedy – Goldman Sachs

Great. On the tax rate, which is at 40.6, I think it’s now over 40. I don't know if it has ever been in any other point. Why is it tracking higher these days and why do you expect it to continue?

Mike Short

Hi, Darren, it is Mike Short. I think we have called out, we expect the ongoing rate to be about 40% and prior quarters have as a matter ofof course seem to have benefited from resolution of state tax matters that have resulted in a lower effective rate in that quarter.

Darren Kennedy – Goldman Sachs

Okay. Yeah, I just never seen it that high over 40 in any quarter until now and unless I am missing one. But also – and then Matt has a questionsome questions around credit. There is a $1.8 million pre-tax loss from Other. Could you describe that?. In case I missed it, I apologize.

Mike Short

Well, that’s largely our deferred comp plan. It’s an asset valuation on that.

Darren Kennedy – Goldman Sachs

Okay, thanks. Matt?

Matt Fassler – Goldman Sachs

Hi, good morning. On the credit front, I listened with great interest to your comments on tightening of credit. You spoke about subprime, you spoke about shorter advances, et cetera. If you can think about prior cycles and the way credit typically plays out because I think we are hearing a little bit more about that today than we have in the past it seems like a bit of a lagging indicator, but I wonder do the banks tighten up late in the game and sort of stay tight and exacerbate the issue?

Mike Jackson

Matt, you are right on the point. Let me describe the behavior that we have seen and we see right now just to give you a feel for it. So, I describe it as the banks are in cleanup mode. They are, for instance, accelerating repossessions or any vehicle that they see out there that has a question mark over it they are proactively trying to deal with it now rather than later. So that is quite a differentto give you an insight on the mindsetthey are trying to take the losses now. They are trying to deal with the situation now. And at the same time, they are tightening credit standards to get a running start of a very clean portfolio. So, you have both those factors happening at the same time, and yes it happens deep in the cycle and then you get past this and you will get back to the normal operating state.

Matt Fassler – Goldman Sachs

How long does it tend to last? I mean do they sort of stand in the way when natural demands will be coming back because of lower rates or other factors?

Mike Jackson

I don't think it’s going to take too long in auto because we did not make the catastrophic behavioral decisions that happened in housing where there was a total collapse of any sort of credit standard. So, the credit standards were pretty disciplined. The stress that’s out there is really related to the economy now. During cleanup mode of let's get allanything that’s bad out of the way now, let's get a running start on a clean portfolio, and I think later this year you are going be into a more normal operating environment.

Matt Fassler – Goldman Sachs

So you think it’s only a couple of quarters before they feel like they have done what they need to do?

Mike Jackson Yes.

Matt Fassler – Goldman Sachs

Great. Thanks guys. Thanks so much from both of us.

Operator

Thank you, Mr. Mark Wamsman with Calyon, your line is open.

Mark Wamsman – Calyon

Good morning. Regarding personnel, are you facing any challenges in retaining your top sales personnel at the point? And if you are, what steps are you taking to do so?

Mike Jackson

I am very happy to say that all our retention initiatives that we implemented years ago are performing very well. And every year we have high retention and lower turnover and that is still the case even starting in '08.

Mark Wamsman – Calyon

Great.

Mike Jackson

I mean our training, development, retention program, they are all working extremely well. And a final irony is we did lose talent in '04, '05, '06 to the housing industry where it was easy to make a lot of money and now they are all coming back to the real world.

Mark Wamsman – Calyon

So you don't anticipateas the economy improves, you don't anticipate any lag as you have to staff up or fill any holes.

Mike Maroone

[inaudible] it’s Mike Maroone, Mark. I’d say our turnover is the lowest it's been. We are always looking for additional talent, but we have taken a lot of steps to grow our own and really pleased with the development efforts of the team here.

Mark Wamsman – Calyon

Okay. And then on a different subject, is it fair to say that there are really two independent but interrelated trends here with the economic stress and gasoline prices? In other words that while the economy might improve gasoline prices would continue to be a problem?

Mike Jackson

Well, let's use the word 'issue.' We don’tyou won't really know what the mix impact has been until the economic storm has passed and let's say gas prices remain high but the overall economy is stabilized, credits available and you are in a more normal operating environment except for gasoline prices. My personal view, if I look at the stress at the moment I say 80% the overall economy and 20% gasoline prices. So, we won't really know. I can guarantee that when the economy improves and housing resumes pickup truck sales will come back. So that’s real economic stresses that’s what’s affecting those vehicles.

Mark Wamsman – Calyon

The reason I ask is I am trying to figure out the extent to which we will see the segment shift from larger vehicles to smaller vehicles continue into the future as a result of elevated gasoline prices and then really my question for you is whether you see any evidence at this point of people downsizing for fuel economy reasons but at the same time specing smaller vehicles more highly because, perhaps they while concerned about the operating cost they still have the disposable income to want to drive around in a more highly speced although smaller vehicle.

Mike Jackson

No, I think as I said earlier, at $3 a gallon you begin to get a change in behavior around the price of gasoline. At $3.50, looking at the prospect of $4 that really accelerates to full long-term implication of that. You won't really to be able to judge until you are in a normal economic operating environment.

Mark Wamsman – Calyon

Fair enough. Thank you.

Operator

Mr. Jonathan Steinmetz with Morgan Stanley, your line is open.

Jonathan Steinmetz – Morgan Stanley

Thanks, Good morning, everyone. Just a few market related questions. The Company specific stuff seems to have been covered. Are you guys seeing with the decline in the used values [ph] the full-size pickup and large SUV side, are you seeing it more difficult for consumers to trade in a significant way? Is negative equity a bigger problem and this becomes a vicious cycle. I don't know if you have any statistics on that how many people come back with negative equity now versus before. Maybe just some color on that.

Mike Maroone

Jonathan, it’s Mike Maroone. I don't have any specific statistics, but I will tell you it is a challenge in valuing that product and we have really watched our inventories in that product and it’s not easy to trade customers out of that if they don't have equity and there is a lot of negative equity out there. I don't know if there is a lot more than there has been in the past. But valuation is a challenge on those two segments.

Jonathan Steinmetz – Morgan Stanley

Okay. And I jumped on a little late and I heard some of your comments related to tightening of credit and that sort of thing, so I apologize if I missed this, but did you give – do you have any statistics related to that in terms of approval rates on loans or even cost of credit for sort of various tiers of credit because rates have come down a little bit maybe spreads have gone out. So, anything related to data that sort of supports what seem to be a strong anecdote.

Mike Maroone

Jonathan, again it’s Mike Maroone. I think probably the piece that we focus most on is advances of how lenders advance versus invoice or advance against the wholesale value of the vehicle and we are seeing the advances across our lender base off between 2% and 4% and we do think that’s a significant factor in our used vehicle margin compression.

Jonathan Steinmetz – Morgan Stanley

Okay.

Mike Maroone

On approval policies, I don't have statistics across our lender network, but the advances are certainly under pressure.

Jonathan Steinmetz – Morgan Stanley

Okay. And you are saying that this is a much bigger problem than on the used side than the new side.

Mike Maroone

At this point, yes.

Jonathan Steinmetz – Morgan Stanley

Okay. Thank you.

John Zimmerman

We have time for one more question.

Operator

Thank you. Mr. Rod Lache with Deutsche Bank, your line is open.

Dan Galatin – Deutsche Bank

Good morning, this is Dan Galatin [ph] for Rod. Can you hear me?

John Zimmerman

Yes.

Dan Galatin – Deutsche Bank

Okay, thank you. Can you talk I mean the F&I per units have been very impressive. Is there a ceiling to those? And also as volume start to come back is there any reason we’d see F&I per unit start to go back down slightly?

Mike Maroone

It’s Mike Maroone. I think we still have some upside. I don't know that’s dramatic upside. We continue to focus on our third and fourth quartile stores. There is still a pretty decent bandwidth from our best to our worst stores. So, that’s really where our focus is going forward. The other piece is that these numbers reflect higher charge-backs than we have seen over the last several years, so they probably if anything kept the margin down. So, I do think there is upside based on our working in the quartiles and over time a lessening of charge-backs, not necessarily in the near term.

Dan Galatin – Deutsche Bank

Okay, thanks, and one other one. Do you see much activity with people coming into the dealership looking for a new vehicle and ending up with a used?

Mike Maroone

I think that’s always an opportunity and I believe that is happening. Certainly there is a lot of payment buyers. Mike Jackson referenced the value conscious price buyer. That’s the person that’s coming into our dealerships and I do think they are looking at all opportunities both new and used and in different vehicles.

Dan Galatin – Deutsche Bank

Okay. Thanks.

John Zimmerman

Thank you for your time today. Appreciate all your questions.

Operator

Thank you. That concludes today's conference call. You may disconnect at this time.

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Source: AutoNation, Inc. Q1 2008 Earnings Call Transcript
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