AutoNation, Inc. (AN) Q4 2014 Earnings Report, Transcript and Summary

Welcome to AutoNation's fourth quarter 2014 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 Andrew Wamser, Treasurer and Vice President of Investor Relations for AutoNation.

Good morning and welcome to AutoNation's fourth quarter 2014 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, Cheryl Scully, our Chief Financial Officer and Jon Ferrando, our Executive Vice President responsible for M&A. Following their remarks, we will open up the call for questions. Rob Quartaro and I will also be available by 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. 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 such forward-looking statements. Additional discussions of factors that could cause actual results to differ materially are contained in our press release issued earlier today and our SEC filings, including our most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q and current reports on Form 8-K. Certain non-GAAP financial measures as defined under SEC rules will be discussed on this call. Reconciliations are provided in our press release, which is available on our website at investors.autonation.com. And now, I will turn the call over to AutoNation's Chairman and Chief Executive Officer, Mike Jackson.

Good morning. Thank you for joining us. Today, we have reported an all-time record quarterly earnings per share from continuing operations of $1.02 for the fourth quarter, a 23% increase on a per-share basis as compared to $0.83 for the same period in the prior year. This is our 17th consecutive quarter of double-digit year-over-year growth in quarterly EPS from continuing operations. For the full year, adjusted EPS from continuing operations of $3.49 was also an all-time record, up 17% over prior year. Fourth quarter 2014 revenue totaled $5 billion, an increase of 12%, driven by stronger performance in all our major business sectors. We also reported an increase of 12% in operating income to $227 million. Revenue for the full year was $19.1 billion, up 9% over prior year. Operating income for the full year was $821 million, an increase of 11% over prior. During 2014, AutoNation repurchased 9.4 million shares for an aggregate purchase price of $485 million. As of February 2, 2015, AutoNation has approximately 113 million shares outstanding. Our planning assumption for 2015 industry new vehicle unit sales is above 17 million for the year. We believe that replacement demand, attractive products and great consumer credit will continue to support sales. In 2015, we will continue to invest in our digital storefront of AutoNation Express. We have successfully began our launch of December 2014 and we will continue to roll out AutoNation Express from coast-to-coast. I will now turn the call over to our Chief Financial Officer, Cheryl Scully.

Thank you, Mike and good morning, ladies and gentlemen. For the fourth quarter, we reported net income from continuing operations of $117 million or $1.02 per share versus adjusted net income of $102 million or $0.83 per share during the fourth quarter of 2013, a 23% improvement on a per-share basis. There were no adjustments to net income in the fourth quarter of 2014. Adjustments to net income in prior period are included in the reconciliations provided in our press release. In the fourth quarter, revenue increased $524 million or 12% compared to the prior year and gross profit improved $80 million or 11%. SG&A as a percentage of gross profit was 67.9% for the quarter, which represents a 70 basis point decrease compared to the year ago period. In addition to solid cost control, SG&A as a percentage of gross profit benefited from seasonally strong premium luxury vehicle sales, which support new vehicle gross profit dollars as well as our expense leverage. Net new vehicle floorplan was a benefit of $15.2 million, an increase of $3.4 million from the fourth quarter of 2013, primarily due to higher floorplan assistance. Floorplan assistance increased primarily due to higher new vehicle sales. Floorplan debt increased sequentially approximately $323 million during the fourth to $3.1 billion at quarter-end, due to increased inventory balances. In December, we amended our unsecured credit agreement by extending our maturity three years, lowering our borrowing costs by 25 basis points, increasing our revolving credit facility to $1.8 billion and eliminating the term loan. In the amended facility, the maximum leverage ratio remains at 3.75 times and the maximum capitalization ratio increased from 65% to 70%. We continue to secure financing at favorable terms due to our strong operational results in addition to our investment-grade debt profile, disciplined financial management and robust cash flow generation. Non-vehicle interest expense increased to $22.1 million compared to $21.7 million in the fourth quarter of 2013, primarily due to higher debt balances. At the end of December, we had $1.1 billion of outstanding borrowings under the revolving credit facility and a total non-vehicle debt balance of $2.1 billion. This was an increase of $195 million compared to September 30, 2014. The provision for income tax in the quarter was $71.6 million or 38%. From October 1, 2014 through February 2, 2015, we repurchased 1.4 million shares for $69 million at an average price of $49.35 per share. AutoNation has approximately $281 million of remaining board authorization for share repurchase. As of February 2, there are approximately 113 million shares outstanding and again, this does not include the dilutive impact of stock options. Our leverage ratio increased to 2.3 times at the end of Q4 compared to 2.2 times at the end of Q3. The leverage ratio was 2.2 times on a net debt basis including used floorplan availability and our covenant limit is 3.75 times. Capital expenditures were $52 million for the quarter and $192 million for the full year 2014. Capital expenditures are on an accrual basis and exclude operating lease buyouts and related asset sales. Our quarter end cash balance was $75 million which combined with our additional borrowing capacity, resulted in total liquidity of $770 million at the end of December. In 2014, we continue to demonstrate the strength and flexibility of our business. During the year, we repurchased 9.4 million shares for $485 million and announced acquisition and add points with $550 million in expected future annual revenues. Looking forward, we remain committed to driving shareholder returns through strong operating execution, as well as investments in strategic initiatives, acquisitions and share repurchase. Now let me turn you over to our President and Chief Operating Officer, Mike Maroone.

Thank you, Cheryl and good morning. We are extremely pleased with our fourth quarter performance where we delivered revenue and gross profit growth across the business, an exceptional 4.5% operating margin, an all-time record quarterly and annual EPS and the 17th consecutive quarter of double-digit EPS growth. As I continue my comments, it will be on a same-store basis compared to the period a year ago. Starting with sales. Total gross profit for variable operations was up 10%. On a per vehicle basis, total variable gross was $3,450 per vehicle, an increase of $71 or 2%, driven by solid contributions from used vehicles and customer financial services. Combined new and used same-store unit volume was up 8%. In the quarter, we retailed 80,800 new vehicles, an increase of 6,700 units or 9%, generating new vehicle revenue of $2.9 billion, up $277 million or 11%. New vehicle gross profit of $179 million grew by $10 million or 6%. Gross profit per new vehicle retailed at $2,220 was off $67 or 3% compared to a year ago, attributable in part to continued pressure in the import segment as well the introduction of several new premium luxury models in the quarter a year ago that commanded higher margins at launch. Sequentially, compared to Q3 2014, gross profit per new vehicle retail increased $344 due to the seasonal lift in premium luxury and achievement of several manufacturer year-end volume-based incentives which were higher in the quarter than anticipated. Looking ahead, we expect gross profit per new vehicle retail to return to normalized levels in sync with technical seasonality and subject to market conditions. At year-end our new vehicle inventory was 54 days compared to 62 days a year ago. Turning to used vehicles. We had another solid performance in the quarter at $984 million. Retail used vehicle revenue increased $75 million or 8% on the sale of 52,500 used vehicles, an increase of 3,500 units or 7%. Retail used vehicle gross profit of $88 million was up $11 million or 14% and gross profit per used vehicle retail was $1,679, an increase of $97 or 6%. We are focused on optimizing the acquisition of used inventory, as well as pricing our used vehicles to market. We continue to see opportunity in used due to the increasing supply of used vehicles, both from new vehicle trades and off-lease and feel we are well-positioned looking forward. At December 31, our used day supply was 38 days compared to 35 a year ago aligning with our intent to build inventory for Q1. Rounding out the variable side of the business is customer financial services, where in the quarter, we achieved a record gross profit per vehicle retailed at $1,444 an increase of $71 or 5%. Total gross profit for CFS of $193 million was up $24 million or 14% compared to the period a year ago. We continue to be extremely pleased with our performance here and remain focused on the overall customer experience, continuous improvement in store level execution and growing long-term customer retention through value-added product offerings. Next, customer care, which encompasses or service, parts and collision business. In the quarter, customer care revenue of $713 million increased by an impressive 10% or $65 million and customer care gross profit of $298 million grew 8% or $23 million. Expanding on gross. Warranty gross increased 24% supported by continued strong retail activity which represented just over 5% of our total customer care gross. Customer pay gross grew 3% in the quarter and accounted for nearly 40% of the total customer care gross. This also marked our 18th consecutive quarterly increase in customer pay gross, as we continue to focus on growing our customer pay business while ensuring we address recall for our customers. And finally, collision gross was up 11% in the quarter. I will note that looking ahead, we maintain our outlook that customer care gross comps will be in the mid-single-digit range as we previously discussed, absent elevated recall activity. In closing, I would like to thank our 24,000 associates for their contributions to an outstanding quarter and year, as well as their commitment to delivering a peerless customer experience. As was announced on January 15, I will be retiring from AutoNation on April 1. As that transition begins, I will share that it's been a privilege to serve the company for the past 18 years. I am proud of our accomplishments and confident about the company's succession plan including Bill Berman taking on the Chief Operating Officer position. I am very optimistic about the future of AutoNation where my family remains significant shareholders. With that, I will turn the call over to Jon Ferrando.

Thanks, Mike and thank you for your leadership and partnership over the last 18 years. We completed two acquisitions since year-end Mercedes-Benz of Reno and Nevada and a Volkswagen store in the Atlanta market that will operate as AutoNation Volkswagen Mall of Georgia. In 2014, these stores collectively generated approximately $120 million in revenue and sold approximately 3,400 new and used retailed units. Both franchises are located in attractive auto retail locations and facilities. We are excited about adding our 21st Mercedes-Benz franchise to the AutoNation family. It's a great way to enter Reno, Lake Tahoe, an attractive auto retail market with good demographics. As of today, our store portfolio numbers 284 franchises and 234 stores in 15 states, representing 34 manufacture brands. Looking forward, we will continue our strategy of pursuing acquisitions and add points that enhance brand representation within our auto retail markets, as well as markets that can be supported by our existing management infrastructure. We will continue to be selective and prudent with our capital with a focus on investing to produce strong returns and long-term shareholder value. I will now turn it back to Mike Jackson.

Thank you, Jon, Like I like to personally say, thank you for being my partner for the last 18 years. Thank you for your dedication for the last 18 years to AutoNation. We had our strongest year ever. We set said all time record in 2014. It is a great final chapter. Thank you for having succession plan that well positions bill Berman and the entire operations team to continue their march of providing a peerless customer experience. Mike, after 60 quarter together, I want to thank you on behalf of myself, AutoNation's 24,000 associates for your 18 years of contribution and dedication to our fine company and we wish you nothing but success in your future endeavors. With that, though, you need to remain and answer some questions here. We throw the floor open. Are there any questions for us today?

[Operator Instructions]. Our first question comes from James Albertine with Stifel. You may ask your question.

Great, thanks and congratulations on a great quarter and let me add, sorry to see you go, Mike, but you have done a great job and we wish you the best and look forward to working with Bill in the future. Mike Jackson, if I may, on a higher level just in terms of, how important do you think consolidation is to the trajectory of AutoNation going forward? And quite frankly, if you can opine on some of the bigger acquisitions that have been announced recently among sort of the outsiders, if you will? So with Berkshire entering the fray, there's some conversation now around Soros Fund Management, looking at an acquisition in the dealer space as well. So what does that say about the bigger picture dealer outlook long term? What does it do for purchase multiples? And why do you think that Buffett at least targeted a private group versus a public group? Thanks.

Well, I certainly welcome sophisticated astute investors such as Warren Buffett and George Soros to auto retail. It's not a new experience for the auto industry. It's particularly not for AutoNation. I would observe that Eddie Lampert invested in us 15 years ago and owns 20% of the company today and Bill Gates through his fund Cascade and Michael Larson have been with us for over a decade and owns 15% of the company. So having astute sophisticated long-term investors is not new to us and I welcome more to auto retail. I think it's absolutely a validation of the attractiveness and the sustainability of auto retail. Now as far as the pace of consolidation, I see no change. There will be a gradual evolutionary consolidation into larger entity's hand, whether they are public or private. If I look at it, right now the publics are at 7% to 8% and if I take the top 100 retailers in America, it's around 20%. And I go back a decade ago, that was made 15%. And why is the consolidation gradual and evolutionary? It is because you need willing sellers to come to in a reasonable price, a fair price, as to what to acquire the business for. There's a lot of emotion invested in independent entrepreneurial family businesses that in many cases have existed for over a generation. And if you try to preemptively buy that strictly on price, the only way you can get that deal done is to dramatically overpay. And certainly industry, for over a decade, has shown an understanding of this fact and a discipline around price and certainly they knew, entity that you called out, have all built their enterprise based on paying a fair value price, not overpay. So I don't think there's any change there. I think it will be a gradual evolution. I think tat having larger players in the future is inevitable that as private entrepreneurs build up bigger entities, you will need more financial muscle and a bigger balance sheet to go to the next level of consolidation. But again, it will be a gradual evolution. Now whether those entities are public or private, I think that is a separate story. The big story is the top 100 is approaching 20%. And where that line gets drawn between public and private, we will move over time. As far as why Warren Buffett buys what he buys, that's a question you should address to Mr. Buffett. I met him years ago at Bill Gates' home. He asked me questions about auto retail and the auto industry. So I am not surprised that he is in the space but as to why Warren finally does what he does is far beyond my pay grade. And I can't give any insight there.

Understood. Still waiting for a call back there actually.

Okay. Good luck. I didn't even place the call. So there you go.

If I may ask a quick follow-up though, just given your size and how well you have done recently and particularly in January results, there is some consternation out there, at least I am sensing, as it relates to the credit market whether it's the risk of rising rates or what have you? I just want to know from your experiences, what would be the first indicator or concern the metric that you would be focused on the most? Is it residual values on the used side? Is there something out there that you are looking for that would make you incrementally negative? Because it doesn't sound like the credit market has tightened up? It sounds like it's just as available and supportive of a strong SAAR in 2015, at least early 2015.

Here is how I look at the credit market and what I watch for. The American consumer has approximately $12 trillion of all forms of debt outstanding, of which auto loans are less than $1 trillion, let's say $900 billion with the lowest default rate of any form of credit. Lower than mortgages, credit card, student loans, whatever form of credit you want to point to. People pay their car loans. And by the way, that $900 billion is secured. It's not unsecured like credit cards or student loans. It's secured. And the industry has never bought into the folly that a car is an appreciating asset like the financial service industry said about houses, that they would always go up. No, the mindset of lending in automotive is, it is a depreciating asset. It always goes down. And structure the loan accordingly. So I watch the lending. Now, there is some risk on residuals in leasing, particularly around the price of gasoline, because as the price of gasoline moves with a lot of volatility, it really affects the resale value of whatever is coming back into that market. So if you have very high gasoline prices and your Prius' are coming off-lease, you are going to do very well. If you have very low gasoline prices and you have trucks coming off-lease, you are going to do very well. So that's the only wild card that lenders need to watch for. As far as subprime, for us as a company, when we retail 100 vehicles, eight of them are financed by subprime loans. So it's a small part of the business for us at our level. That's not to say you can't find further out on the price spectrum a subprime business that is different. But for AutoNation, that's not an issue. As far as the overall interest rates, we expect gradual increases to start in 2015. We are thinking like 50 basis points in the course of the year and a bit more in 2016. But all that looks very manageable. So as far as 2015 is concerned, I think the safest prediction I have ever made about industry unit volume breaking through $17 million or being above $17 million is one of the lowest risk predictions I have ever made. $17 million will happen in 2015. We are very confident about that and if I look at the pent-up demand, economy moving at a better rate, there will be good years after that. Too soon to say what the actual number will be.

Extremely helpful as always. Thanks again and good luck in the next quarter.

Thank you.

Thank you. Your next question comes from John Murphy with Bank of America Merrill Lynch.

Hi, John. How are you today?

Good morning, guys. I am doing well and congratulations, Mike Maroone. It's really been a pleasure and you have obviously done a great job. I do have one question for you though specifically. As you depart, will you be carrying a bat phone that you can be consulted on very quickly if need be? I know you have got great succession planning, but will you still be available?

I consider myself a friend of the company. I will always be supportive of the company and also be available to them. Thank you, John.

Okay, great. Second question, as we look at the consolidation of the dealership base, it can happen in many ways and what we have seen is, like you said, the top 100 groups becoming a greater percentage of the total, but we also saw a massive reduction in dealerships from 2008 to where we are right now. As we think forward about this consolidation, Mike, is it possible that this happens without big acquisitions? Meaning, with your digital strategy and your focus on trying to expand your footprint and your reach, is there the potential to really consolidate sales without making big acquisitions as long as you have a presence in a market?

Well, that principle has actually, John, guided our acquisition strategy for the last decade that digital is a game changer, brick-and-mortar still is valid and relevant, therefore for fulfillment and customer care base you need all the brands in a given market to really make it work. It simply costs too much to ship product from market to market. And to really control the entire experience and bridge the great gap that exists, you need to control it from end-to-end. You need to own the store. Literally, own the store. Not have a relationship with the store, own the store so you can dictate the processes and the technology in the store and you need to control and own the website. That's what we are pursuing as a totality. Now whether that leads to more rapid consolidation benefit, that's bigger than I would predict. As far as it being a significant competitive advantage, absolutely.

Okay and then a second question. If we think about AutoNation Express just being launched in December, a lot of digital spending going on, a lot of spending on national branding exercise, has there been any benefit from that to-date in your results? Or is that largely still in the investment process and we will see benefits further down the line?

It's definitely in the investment process, John. Its benefits are down the road. Although I think you know branding AutoNation, that was part of this. That's been a tremendous benefit to our associates after two years to attract talent, retain talent. As far as awareness in the marketplace of the name AutoNation within our markets, Mike, you might have exact numbers. It has already surpassed our legacy names, think about that. Some legacy names we have been pounding on for 100 years and in two years the name AutoNation has surpassed it in awareness in consideration. The next piece of the puzzle is transactional websites and traffic to our websites. Traffic to our website is growing at double-digit, significant double-digit rates. Our own websites now generate more business than all the third parties combined. So there is significant progress. But if I look at the level of investment relative to those factors, I would say we are still very much in investment period. And I would say that will certainly be for all of 2015. As far as my conviction, are we on the right course or not? I am 100% convinced. 100% convinced that the strategy we are pursuing, over time, will be a sustainable competitive advantage for AutoNation, which is one of the hardest things to do in business. Mike, you have any marketing awareness numbers for us?

No, but I think you are correct. I don't have a number in my head, but you are correct in saying that every one of our former local market names has been surpassed by the AutoNation. There is not one that stands taller. And that's in a very short period of time.

So think about that, John. In two years, on the AutoNation brand, we have surpassed the legacy names, some of which were 100 years old.

Yes. It's very impressive. But if we just think about this in totality though, it sounds like there's still a little bit of heavy sledding through 2015, but you will reach a tipping point as we go from 2015 to 2016 where the investment fades and the benefits come in or the benefits at least usurp and outweigh the ongoing investment.

Yes. We are not doing so badly. In the meantime, if you look at the fourth quarter.

My first guess, yes.

So we can afford to be an investment phase and the internal thinking is that it will be gradual. It's not an inflection point where you flip the switch and you go a-ha, we are checkmate on everybody. I am really thinking in a five-year block from today. So imagine, this has been underway for seven years. We are now implementing in the marketplace. The initial reaction is fantastic. If I look out five years from now, I am convinced we will be looking back on this investment phase and say, wow, that was great money that we invested. I am convinced of it. But we have to go through an investment phase. And I should be clear, it's not cheap. I have been very straightforward. It's over $100 million. Well over $100 million. If you combine what we are investing in the brand and you combine what we are investing in technology to make our website attractive and transactional, plus the processes that have to change in the store. But this total integrated technology solution where a customer can seamlessly move back and forth between a online experience and in-store experience. We are convinced is the Holy Grail for automotive retail. When you combine that with the brand where you control and own your own website and you have a fulfillment footprint with a customer care to cover your fixed costs. This is a winning combination.

Seems like you are going to grab a lot of market share over time.

Let me just say on that, John. So the position I want to be in is to decide whether I am going for share or margin. I want to control the margins in the future. If you become over dependent on third party lead providers, you will lose control of your margin. So this is as much about having control of our future margins, which I am absolutely convinced we will have much more say over or I can do the calculation and say we go for share or its a combinations of both. But that's the position you want to be in.

Yes. It's very impressive. Then just two last very specific questions. Parts and service obviously came in pretty strong. You guys are still talking about mid-single digits. It seems from like the recall activity that, particularly GM is calling for this year versus last year on cash, at least half is coming in, in 2015. So it means that the recall that was at the earliest curve of this wave is only half done. It seems like you will get as much recall activity in 2015 as in 2014, if not more and the zero to five year old car fleet continues to grow. So I am just curious why you think there might be that slowdown in parts and service? Or that's just a reasonably conservative planning assumption

That's reasonably conservative. That's our base plan plus exceptional. That's a way to think about it. And it's very hard to predict exactly what the level of recall work that will be done, particular on recall on vehicles this old whether people will really bring them in or not. So mid-single digits is without the recalls. That's just what we are going to do with the business. And then you put the recall on top of it, if you can figure out how much is actually going to be done. Good for you. On the Takata recall, we estimate the industry has completed about 10% of that. And on the ignition switch, it's about 50% complete. Now the question is, on vehicles that old, will that continue in 2015? We just don't know the answer.

Yes. It's tough to call. And then just lastly, specifically on used vehicle pricing. I mean there is this constant consternation that pricing is going to come down. The Manheim Index is holding up reasonably well. You and the other public groups as well as CarMax continue to post positive average transaction prices in your used vehicle business. I know there's some mix that's going on here, but it seems like the reality of what's happening in the market is still very strong and as we get miles driven growing and the supply of vehicles is still relatively constrained, we could be in an environment where used vehicle pricing holds up better than people are generally perceiving. I am just trying to understand what the disconnect is between this consensus view that used vehicle pricing is coming under pressure, but it's actually really not? And I am just trying to understand what you think is going on there.

Well, if we look at the chart of the vehicle return rate, it definitely increases in 2015. It hasn't happened yet, but it will in 2015 and what that does to valuations, we will adjust for it. But here is my point, John. Let's say, used values come down because there is more availability. Let me see if I have that straight. My acquisition cost has gone down and I have more of them to buy. If I look at our used car capabilities that we have developed, that makes me even more optimistic about the used car business. I think we are really at a point where we can succeed either way. Now could there be an adjustment period if it moves with a lot of volatility quickly. Well, of course. There could be a quarter where that happens. But then you are on new level. And I have more margin space between used cars and new cars. So we are optimistic about the used car business and we think whatever's coming, there won't be extreme volatility to it. I think that's the most important point and we will be able to adjust to whatever the new circumstances are. But you well could be proven right that the demand for used cars is such that even with improved supply and there will be improved supply in 2015, prices don't move much. We will have to wait and see. We will manage it either way.

Okay. Great. Thank you very much and really fantastic execution, guys.

Thank you. The next question comes from Patrick Archambault with Goldman Sachs. You may ask your question.

Hi. Thanks. Good morning. Congrats on a great result. I wanted to just follow-up actually first on the SG&A leverage piece. It does indeed look like, based on the fourth quarter as you pointed out, not doing too badly in terms of the fixed cost absorption, despite the fact that you have got some investments that are ongoing here. So as we look through 2015 where there's still some investment to go, is there still an ability to see improved leverage in spite of this like you saw in 2014?

Yes. Pat, this is Cheryl. We are really focused on cost discipline. So you look at the fourth quarter with a seasonally strong premium luxury and customer care, you get some benefits from that on the gross side. If you look at the full year, we were just under 70%. And that's where we continue to target. So we think as we look into 2015 and forward, the goal is still to continue being under 70% despite that continued investment in digital. There's some different levers to pull there and growth will dictate some of that but that still remains a goal. We know that there is leverage there to be had. I think fourth quarter, seasonally tends to be very strong. You do get some seasonality in SG&A but certainly remain focused on staying below 70%.

And just on that, in terms of the performance, is it just kind of pure operating leverage that is on your ongoing business that's offsetting the incremental costs? Or are there other savings that are still forthcoming? You mentioned, for instance, less reliance on lead generation companies, which I know are expensive, as maybe just an example.

If I look at our cost for third-quarter lead providers, my goal is to invest that money in the AutoNation brand rather than third party lead providers. So we pay third party lead providers X amount of money and it generates 14% of our business today. I would like to take X amount of money and spend it on the AutoNation brand and whether that customer comes to us on the telephone, driving in or through our websites, it really doesn't matter to me. But my view is, every time I spend a dollar on the AutoNation brand, it's a double win. I sell a car today and I build awareness for the future. Whereas when I spend money with third party lead providers, yes, I get to sell a car today, but they take that money and build their brand and get the future sale. And maybe I get a shot at that, maybe I don't and most likely I have to compete on price to get the next one. So this is over time. When we successfully execute this shift of resources from third party lead providers to AutoNation, I think over time, it makes the company stronger and stronger. But my idea is not that I can simply take that money and spend it with lead providers and not spend it any more. I don't see that. I think it's reallocated to AutoNation marketing.

Okay. That's helpful. And one last one from me, just on the parts and service, I think getting back to maybe John's question. I understand how you guys are thinking about it, but more specific to the cadence of it. It does seem, right, based on actually what you provided there, 40% completion on ignition, 10% on the Takata and now obviously we have TRW's issue. It does seem that at least in the first part of the year, right, there's something to sustain pretty high comps, especially seeing the comps in the beginning of last year weren't as tough. So is there one of these things where we can expect similar performance maybe in the first half and barring anything unique kind of slows down in the second?

Well, I would say, that's for you. You figure it out. Directionally we have given you a very clear picture of how we think about it. I don't see anything I would take exception with in your assumptions. But we just don't know on these old vehicles, how people are going to react. That's all I am pointing out. So we have given you the number that we feel good about. We are going to grow customer care mid-single digits plus whatever exceptional recall activity comes out. And the where and when, do your best.

All right. We will figure it out from our end. All right, thank you very much for the responses.

Thank you. Your next question comes from Rick Nelson with Stephens. You may ask your question.

Thanks and my congrats to Mike Maroone as well. It's been a great run, Mike. Thanks for all the help over the years.

Thank you.

I would like to ask you about what appears to be market share gains in the fourth quarter on the new car side, if you could comment there? And whether you think this branding in digital spend is really starting to kick in?

Well, I think our share is stable to plus, Mike. Is that how I would describe it there? It's a hard thing to pin down exactly, though I would say it's probably on the plus side.

I thin it is plus and we have got benefit from our mix as well and our geography. So it's been good.

And that strength in January unit sales appeared to have accelerated. Is that just easier compares with the weather? Or is it the underlying business?

Yes. If you go back to a year ago, Rick, I was very clear that I thought January and February last year were nominally not a true indication of the market and thought we would end up at 16.5% and we ended up at 16.5%. So something definitely, whether it was severe winter weather or some other economic block, it was going in the first quarter last year, that was temporary. What that means from a comp point of view is January and February are easy comps. I think our sales last January were flat 2014 versus 2013. So think about that. No increase whatsoever. So that's a very easy comp. So you can't take January now and extrapolate it for the full year. But to be off to such a good start for the year, with everything else as I have described as a backdrop, means our forecast of the industry of the $17 million looks pretty clear.

Yes. Thank you for that. And finally, if I could ask you about Texas. If you are seeing any change there versus the rest of the chain?

We have seen no change in Texas yet. No change in fourth quarter. No change in January. But the anecdotal stories of what's going on in Houston and other parts of Texas would lead one to believe that most likely Texas will have to make some sort of adjustment to this new price of petroleum and we are watching for it, but it hasn't happened yet. It's a reasonable expectation.

Yes. That does sound reasonable. Thanks a lot and good luck.

Thank you. The next question comes from Ravi Shanker with Morgan Stanley. You may ask your question.

Good morning, everyone. This is Paresh Jain, in for Ravi. Mike, let me first congratulate you on a successful career on behalf of the entire Morgan Stanley team here and thank you for your help over the years. A couple of questions, just following up on Rick's question on Texas and if I could, making it more generic for all oil states. It was obviously very strong volume quarter for you, but have there been any early signs of lenders in these oil states becoming less aggressive at lending terms which may have impacted sales?

This is Mike Maroone. We haven't seen any pull back from the lenders and I think Mike's already said, the business is tracking quite well. Our South Texas business, which is right in the energy corridor performed very well in the fourth quarter and we have not seen of disruption yet, either on the lender's side or on the volume side.

Thanks and just one quick follow-up on the SmartChoice program. Any early indications of impact on either share, gross profit or even transaction times in those 30 stores?

It's very early. We are just in South Florida and it's less than a month old. So too soon to say. The anecdotal reaction of the stores and the consumers is extremely positive. Those that have used it, absolutely love it. Their recommendation on repeat referral business is off the chart. But that's just an initial indicator and it's really too soon to draw any conclusions from that.

No, that's good to know and lastly one housekeeping. Parts and services, obviously the other customer care business rather posted strong double-digit growth, margins kind of declined year-on-year. Any color on what's driving that year-on-year decline?

It's Mike Maroone. First let me point out that our total margin for the whole company was stable at 15.5%. We did see some small pressure on the customer care margin, but it's really about a change we made on how calculated our reconditioning rates and some of that moved to used vehicle margin. When we look at the core service business of customer pay and warranty, our margins were actually up slightly. So the margins that are subject to the marketplace were up and the ones we control internally we made some tweaks to and created that margin compression. But overall, the total margin for the company is stable.

Thanks guys.

Thank you. Our next question comes from Colin Langan with UBS. You may ask your question.

Great. Thanks for taking my question and congrats on a good quarter. Any color on, can you give an update on your website strategy? Where are you? And how should we think about the IT spending directionally year over year? Is it going to accelerate? Or is it going to be about the same as this year?

This is Mike Jackson. Our investment in AutoNation Express will increase significantly in 2015 as compared to 2014. That includes investment in the brand. It includes investment in IT capabilities and it includes investment in the store as far as features that have to be in the store. The IT part of that, Cheryl, do you have any color on that?

I think when you look for total year, I would say the main metrics to look at are going to be the fact that we will target below the 70%. I think the cadence of the actual investment is going to vary quarter-by-quarter. From a capital perspective, I would say, the cost are up within the aggregate but nothing, I think, that's not sustainable within the context of the total business.

Okay and can you frame for this year, I don't know if I missed this, of your full-year 7% same-store increase? What do you think recall contributed to the growth this year? Do we kind of have a base of the growth?

I think it's around 30% of the growth came from recalls.

That's in the quarter.

In the quarter. For the fourth quarter, 30% of the increase in customer care growth was related to recalls.

Okay and any --

You know, it's a total of 5.5% of the total customer care gross. So it's still a relatively small fee, but clearly drove the growth. Drove some of the growth.

Okay. Well, all right. Thank you very much for taking my questions.

Thank you. Your next question comes from David Lim with Wells Fargo Securities. You may ask your question.

Hi. Good morning. I just wanted to talk a little bit more about your e-commerce strategy. It looks like you guys are putting in a lot of money. Is this something that you may consider monetizing in the future to other dealer groups that may not be competing in your geographical areas?

I really don't foresee that. That's not in our plan. We have created a common technology platform across the company centered out of our shared resource center in Dallas, Texas. Within that, critically, is our lead management system and our customer relationship management system, which is proprietary called Compass and now we are building transactional capabilities on our site that have literally been several years in development to perfect how they work. So it's quite an effort and the key to make the whole thing really compelling and different is that we control it from end-to-end. We own the website. We on the stores and we describe exactly how everything works from the store back to the website, back and forth, in real-time. So when you talk about giving this out to someone else, well, if they don't have the store process to align with how we are designing everything, it immediately falls apart. It's no longer an integrated technology solution that works from end-to-end. So we have had people approach us and ask us, but I don't know hoe much benefit it would really be worth and it's not in our plan.

Got you. The other question I have is, with the advancement of all these vehicles, the technology, whether it be engine, power-train, infotainment systems, et cetera, do you guys eventually foresee the DIFM guys being squeezed out and more of the car park out there, even outside of warranty, start to flow back more into the authorized dealer base?

Well, if we look at the strategically what's happening here, on the one hand, in principle, the quality of the car is significantly improved year after year. However the complexity and sophistication of the car goes up exponentially year after year and those who have the infrastructure and the expertise to care for them, as you rightly point out, becomes less and less. So if we can address the issue of why customers would leave the authorized dealer network, both convenience and cost, then the percentage we can retain for our customer care business is a significant opportunity. So we think we can grow our customer care business open ended. The only question is the rate of growth.

Got you. So I mean in theory, Mike, if these become, like if we look at electric vehicles, OEM electric vehicles or hybrid vehicles or, as you said, the exponential improvement in technological complexity, in theory, the requirement of capital is going to be really be limited to you guys as well as some of the bigger groups. The local mom-and-pop shops may not have the capital to actually compete on that level. Would that be a fair commentary for where it is going forward? And given that, I mean wouldn't that give you a little bit more optimism of maybe even touching double-digit same store sales growth on a more consistent basis, way out in the future? Thank you.

Yes. Way out in the future. So I think I am not to go beyond the statement that we can grow our customer care business open ended. The only question is the rate of growth. I will give you an update on the rate of growth year-by-year, but I am not putting in a stake in the ground today, for let's say 2022.

Got you. Thank you so much.

In principle, you have a very valid point. I have long thought that, believed that and I think that's how it's playing out in the marketplace.

Thank you.

Thank you. Our next question comes from Brett Hoselton with KeyBanc. You may ask your question.

Good morning.

Good morning.

Maroone, Mike, congratulations. Great career thus far and you have done the Maroone family name proud in the industry. So congratulations.

Thank you very much. I appreciate that.

Berman, you have big shoes to fill, my friend. So good luck. I wanted to ask you on the digital expense, just very simply, how do we think about the spending going forward? Do you see a step-up in your spending plans into 2015 and into 2016? Or are you already at a level where you are just going to continue at the same pace?

Things are going so well, we are stepping up the investment in 2015. If I go back and look at it, remember when we launched the AutoNation brand, we stepped up investment in that and said okay, then we will see how it goes and we will see what the next step was. Well, quite frankly, it went so well that we stepped up investment in 2014. We accelerated the plan in 2014, both investing in the brand and investing in digital technology. Our results in 2014 are so good, we are stepping up the investment in 2015, both in branding and in digital. And we still have gateways where we can slow down, if we get reactions that would say we didn't get it all right, but so far everything is green lights. And I am not shooting for a point and a half moment where you can then say, look at this number, look at this number, it all worked out, but we are convinced we are on the right track. And so we are stepping up investment in 2015.

And Brett, I would just add that it really becomes part of AutoNation's ongoing operating costs over time. So unlike rebranding, which was a discrete launch event, digital will get incorporated and become part of AutoNation's ongoing operating costs over time as we switch from a traditional brick-and-mortar only strategy into more of an omnichannel and digital web strategy.

Okay. Thank you and then switching gears. Just looking at your used vehicle same-store sales, the cadence, the beginning of this year or 2014, kind of flat. In the back half of the year, you pushed up into that 6% to 7% range. What is it that's driving the improvement? I don't see easier comps driving the improvement. It seems as though either maybe increased supply or maybe some internal changes at AutoNation. What is it that is driving that improvement towards the back half of 2014?

I answered that question on the call of the second quarter of 2014, where I clearly said that we were understocked for various operating reasons in the first half of the year and we felt that we had taken measures in the second quarter to address it. And I was very optimistic about used car sales for the second half of the year. And Mike, how did we do?

That's exactly as we have had a couple of very strong quarters back-to-back where we had volume increases and margin expansion. I think it's our third straight quarter of really nice market expansion. The team has worked really hard. We have got an excellent used car team. They are working really hard on pricing, working really hard on getting the right product. The wind is there, from an off-lease perspective. You get 23% improvement in 2014, 19% improvement in 2015 and vehicles coming off-lease. So supply is a big deal, but I think the execution by our operating team from coast-to-coast really was a big driver as well.

And then if I could, just one final conceptual question for you, Mike Jackson. Let's see, Tesla. Mr. Elon, he would kind of suggest that at some point in time, we would be able to seemingly disaggregate the franchised auto dealer, let's say between the OEM and the customer, let's say, possibly by servicing the cars over the Internet, so on and so forth. That's just kind of conceptually it seems like what he's driving towards or suggesting might happen to some degree. I guess my thought is, how do you feel about that relative to your business model?

I think I don't see that as it as an issue for us at all. We are investing $150 million, $200 million per year in just bricks-and-mortar, not counting then the investment in digital and a huge percentage of that is for customer care to expand our capacities there. And as I just said, I think that business grows open-ended. With Tesla, well, you know, I observed where his service centers are and I think he's going to have to address it at some point. The idea that these cars don't need to go anywhere to do anything, I don't buy into. You can only do so much over the Internet with these vehicles and then you have got to have experts hands-on and people want to be able to do that in a convenient friendly way. So as it's owner base gets larger and as he wants bigger volume, I think he is going to need a different strategy. But that's just my opinion and for him to figure out. But as far as what he's doing is a complete revolution, revolution auto retail that's going to change everything, I don't buy into that at all.

Well, thank you very much and a great quarter. Congratulations.

Thank you.

Thank you. Our final question comes from David Whiston with MorningStar. You may ask your question.

Good morning. Just two questions. First, looking at the press release at your operating profit contribution by segment, it looks like there was a really nice uptick in the domestic contribution at the expense of the other two segments. Yet on the same page, I am seeing the Ford new retail unit volume was down. So can you just flesh out a bit what happened on the domestic side that was positive to drive growth there?

The drop in gasoline prices are a huge plus for the domestic business. The American consumers have trucks on their mind. I assure you when the industry figures are finalized later today, I expect trucks to be over 55% of the mix. And they were trending towards 45% of the mix, year-and-a-half, two years ago. And let's face it, trucks are strength of the domestic manufacturers. So that's a huge plus for them. Ford at this moment is caught in this huge changeover of the number one selling vehicle in America for the last 36 years, the Ford F-150. One plant is down still completely and the other plant is doing nicely. But they are literally in the midst of this changeover and if I look at that production schedules, I don't think we will take full availability on the F-150 till May. So May. Their figures are going and our Ford figures are going to be impacted by that. The good news is, of the F-150s that we receive, we have customers waiting in line for them. They come in and go right out. There's no issues about the aluminum. They love the way it drives. They love the towing capacity. They love the vehicle dynamics. So, it's all good, but this is probably one of the biggest production changeovers ever attempted in industrial history. Ford's well in the way to executing it, but it's going to be May until we have full availability of this vehicle.

Okay and last question is on the AutoNation Express initiative. Once down the road, all the investment is done and you are at full operation across all your stores nationwide, do you plan to do an extremely extensive advertising campaign at really a national level to get the word out that shopping at AutoNation is not like going to other dealers?

We have already started a campaign in South Florida on the first capability of AutoNation Express. It's up and running. And as we move to other markets, we will begin marketing AutoNation Express. And as the capabilities expand, we will begin to advertise the new features that are available to consumers. And again, here's how the way to think about it. I am going to take all that money we are spending with third party lead providers and shift it over to advertising AutoNation and AutoNation Express. And this over time, gives us a much stronger position in the marketplace. That's the power of what's behind this idea, this concept, this strategy. And I am very much optimistic that it will succeed. But to your point, it's already up and running. We are already advertising in our market South Florida. We can put the commercials up on our website so that you could go there and see them. Now, we run the campaign for the markets that we are in with the capabilities as they go online. There is not a national ad idea. We would need a national footprint. So it's very much focused for the markets that we are in. And as we move into new markets, then of course, we would roll it into new markets.

Okay. So something really extreme like a Super Bowl ad down the road is probably not on the table?

Super Bowl ad is not on the table.

Okay.

Again, I have to make the point. We think bricks and mortar is extremely relevant. What happens within the bricks and mortars is changing dramatically. And so we only own brick and mortar in our footprint. And so it's an integrated solution between owning the entire experience from the website right through the process in the store. That's our concept. And it's far in the future that AutoNation will be doing a AutoNation ad. I am not even going to speculate on a date.

Okay. Thanks very much.

Thank you, everyone, for joining us today.