AutoNation Earnings Call Nuggets: Capital Allocation and New Car Side

AutoNation Inc (NYSE:AN) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Capital Allocation

James Albertine – Stifel Nicolaus: The first thing I wanted to delve into, it seems like you or your engineering had somewhat of a transition as it were from a capital allocation standpoint. Hearing a lot more about M&A, new franchises, awarded points. Can you help us understand sort of how you’re thinking about SG&A? We noticed a little bit more deleverage this quarter than we anticipated and just kind of want to think through the process over the short and quite frankly longer-term?

Mike Jackson – Chairman and CEO: This is Mike Jackson. You know our capital allocation strategy has not changed at all in 14 years. It’s pretty straightforward. We first look at the opportunities within the existing business both the needs to maintain the standards and the investment opportunities are there, and you can see we have a 14-year track record of investing in the existing business. Then quite frankly, we look at on an opportunistic basis between buying stock, what’s available in the marketplace as far as acquisition and at times we have even found debt to be the most attractive thing to buy. And I think if you look at the performance over that coming up on 14 years in September for me. It’s – you can see the discipline that’s been applied and the shareholder value that’s been created. So, depending on what period of time you’re in and what is the balance in the opportunities, there you see the behavior. Clearly in ’08, ’09 and ’10, very few acquisitions got done because the gap between what sellers were willing to take and what buyers were willing to pay was too big. So, you now have a backlog of the natural arrival in the marketplace each year of deals, so there’s a lot of people to talk to and the gap on price is much closer, so you are able to get to a finished line on more transaction. So, we’re in discussions with a lot of sellers out there whether they will result in deals or not, you never know. You have to keep your discipline on the price side, so that remains to be seen. But, at the moment – looking backwards we’ve been in a phase where the opportunity on the acquisition side has been there and we have acted on that. Going forward I can tell you the philosophy will be exactly the same and what actually happens there will depend on how negotiations go and where the stock goes in price and other variables. On the costs side, I think it’s important to keep in mind that we’ve included in our results here, the one-time cost of re-branding the Company. We didn’t hesitate to make this investment. We think it’s a great investment. It’s 0.09 so far year-to-date, $0.06 in the second quarter. You could almost double our growth in earnings per share if we hadn’t rebranded the Company but we did and I think it’s the right decision for the long-term. If you look at our leverage ratio without that cost it’s below 70%, but I would ask Mr. Short to give more insight on the cost side.

Michael J. Short – EVP and CFO: Just to echo what Mike said in the quarter, our headline number was 71%. If you back out the rebranding costs that takes you down to 69.3%, which as I have indicated on previous calls, our intent is to operate below 70%, so absent those rebranding costs that’s where we were. I do think that there were some headwinds we faced in the quarter. Mike called out some of the PBR pressure that we had on our new vehicles that creates challenges with some of the flow-through on the SG&A side. Of course with acquisitions there always are integration costs that you incur in the first few months of an acquisition that over the long term pay off in very strong returns. But you do have those startup costs. So those were the dynamics that we faced during the quarter and I think at 69.3% adjusted number is in line with where we want to be given the acquisitions that we completed during the quarter.

New Car Side

Richard Nelson – Stephens: I wanted to ask you about market share on the new car side. The 7% unit growth, how do you think that compared to the overall industry and how you fared maybe by (indiscernible), whether strength was by brand or weakness and geographically as well?

Michael E. Maroone – Director, President and COO: Rick, it’s Mike Maroone. I think from a share perspective, I think we competed strongly. The numbers reported for retail vary tremendously, but I think we’re very satisfied with 7% especially in the midst of rebranding 200 franchises. I think that in terms of who is strong, who is weak; I think we were very strong with Ford on a unit basis. We had great growth with Chrysler on a unit basis, with Nissan, with BMW. We are very satisfied with our performance across all three segments.

Richard Nelson – Stephens: I’d like to ask on the F&I side too, have you seen any changes in pricing there as a result of the CFPB, some other comments?

Mike Jackson – Chairman and CEO: My position remains the same that, indirect lending as it’s called has tremendous added value for all the constituencies; the customer most importantly, the lender, and we get an appropriate origination fee. We are able to provide a very competitive rate to the customer often much better than what they could get in the marketplace and we’re able to originate loans for the finance intuition at a cost lower than what they could do directly. So, when you have a situation like that, it’s very sustainable. I would say that even the regulators acknowledge that there’s tremendous added value from dealers in indirect lending and that they do an appropriate compensation for that. I would say the focus is on of course despaired impact and a broad range. I think with the big public companies which have had caps in place and procedures in place for a decade, it’s not much of an issue, and if lenders were to transition to some sort of flat fee, I don’t think for the big public companies there would be much of an issue. However, if you are a retailer where your model is dependent upon a wide range of markups then you’re going to struggle with the transition. I don’t think it’s an issue for us from everything I’ve heard.

Richard Nelson – Stephens: Can you tell that did we see any effects of it yet, that (indiscernible) a unit, quite strong.

Mike Jackson – Chairman and CEO: Yeah, but you have to look at how we do it. We do it with excellent penetration to begin with. Mr. Maroone, I think it’s 70% to 75% of the units we sell?

Michael E. Maroone – Director, President and COO: That’s correct.

Mike Jackson – Chairman and CEO: 70% to 75% of the units we sell, we arrange the financing for that almost $9 billion worth of loans. We originated for instance in 2012. Our average margin on that is about 120 basis points, which seems to be quite reasonably for all the value that just we just limited and by the way there is no discussion with the banks and the regulators said that that is unreasonable compensation for what we generate. The number you referred to is only for one-third of that is for the financing, the other two-thirds is for products that we generate and Mike you can call out a list of the type of products that consumers buy from us. What’s interesting to note of course is that we only show you the commissions on that the revenue does not go through on our books. So it shows as 100% margin but that’s because we don’t recognize the revenue because we are acting as an agent to originate those products. But they are high added value for the consumer. We have very narrow reasonable margins on it. So when you have high added value for the consumer and reasonable margins it’s sustainable. So Mike, why don’t you talk about some of the products that we sell?

Michael E. Maroone – Director, President and COO: Well, Rick as you know, the primary product that we focus on is vehicle service contracts and we think it provides excellent value to the customer. It also drives more business into our service departments and allows us to focus on retaining customers in both sales and service. The other product we feature is prepaid maintenance and just to give you an idea of how the industry looks at that, more and more manufacturers are now including that with the vehicle and we are very happy to see that. Toyota being the leader along with premium luxury BMW, VW and most recently General Motors is introducing it. So those are the products that we focus on. There is other products like gap insurance and others that have a lesser impact. But as Mike said 65% of our F&I revenue comes from those value added products, our compensation plans are heavily skewed to promote those products and we are very confident that we can sustain this level of performance or even get better.

Mike Jackson – Chairman and CEO: So Rick, there can be, in principle, a debate about the disparate impact, whether it’s applied to housing, autos or other things and whether that’s an appropriate regulatory step or not. I think someone other than us will discuss that. Certainly, for large companies and large financial institutions that have had caps in place for decades, the differences are so narrow and so tight that I really don’t see an issue there, and if there is a transition to a different compensation system, I think it’ll be manageable for us.

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