Edited Transcript of AN.N earnings conference call or presentation 23-Jul-20 2:00pm GMT

Torri Donley

FORT LAUDERDALE Jul 23, 2020 (Thomson StreetEvents) — Edited Transcript of AutoNation Inc earnings conference call or presentation Thursday, July 23, 2020 at 2:00:00pm GMT

* Joseph T. Lower

AutoNation, Inc. – Executive VP & CFO

* Michael J. Jackson

AutoNation, Inc. – Executive Chairman & CEO

AutoNation, Inc. – VP of IR

Welcome to the AutoNation’s Second Quarter 2020 Earnings Conference Call and Audio Webcast. First to speak will be Rob Quartaro, Vice President of Investor Relations. Please go ahead, sir.

Robert Quartaro, AutoNation, Inc. – VP of IR [2]

Good morning, and welcome to AutoNation’s Second Quarter 2020 Conference Call and Webcast. Leading our call today will be Mike Jackson, our Chairman and Chief Executive Officer; and Joe Lower, our Chief Financial Officer. Following their remarks, we will open up the call for questions. I will 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, including any statements regarding our anticipated financial results and objectives constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, including economic conditions and changes in applicable regulations that may cause our actual results or performance to differ materially from such forward-looking statements. Additional discussions of factors that could cause our actual results to differ materially are contained in our press release issued earlier today and in 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.

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

Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [3]

Good morning. Thank you for joining us. AutoNation delivered remarkable results for the second quarter compared to the prior year. Today, we reported an all-time record best-ever quarter adjusted EPS from continuing operations of $1.41, an increase of 18% compared to last year. No question, the second quarter is certainly one for the history books. In early April, same-store retail unit sales dropped 50% compared to the prior year when the entire country shut down due to the COVID-19 pandemic.

For the month of June, thanks to the monumental effort of our associates, we recovered to achieve unit volume in line with last year. In April, same-store new vehicle unit sales were down approximately 50%, and for the month of June, only down 13% compared to last year. Inventory shortages from the manufacturers, plant closures, led to strong new vehicle gross profit per vehicle retailed. At the end of the quarter, new vehicle inventory was down 26,000 units or 41% compared to last year. We expect new vehicle margins to normalize as new vehicle inventories recover. At the beginning of April, same-store used vehicle retail unit volume was down approximately 60%, and for the month of June, increased 14% compared to last year. However, inventory levels are tight, demand is currently outpacing supply. We continue to focus on We’ll Buy Your Car initiative, where we sourced over 6,000 units directly from consumers in the quarter.

For July, we will source 3,500 units to help build our inventory. Customer care is also seeing improvement in April. Our average same-store customer care gross profit per service day was down approximately 40% and for the month of June, it was down roughly 10% compared to last year. The pandemic has accelerated a shift in consumer behavior towards digital engagement. Our AutoNation Express online selling tools enable customers to buy and sell vehicles online and our store-to-door delivery option allow customers to completely take delivery at home. We’re also investing in data and analytics. We have built a proprietary equity mining tool, which leverages millions of sales and service transactions into a central system. The tool automatically appraises the customer’s current vehicle and identifies a newer replacement vehicle for a similar or lower payment. It shows household vehicle service history, propensity to purchase and customer financial service product history. The equity mining tool is linked to our recently launched Customer 360, which has over 8 million active customer sales and service records. Customer 360 allows our associates to see the lifetime value and transaction history of our customers. We will continue to invest in digital capabilities that enable us to provide a truly comprehensive and personal experience for our customers.

Over the last 2 years, AutoNation has taken an aggressive approach to streamline the business, the company’s continued investment in digital created greater efficiencies, which made possible position eliminations and reduction in advertising costs. Additionally, in 2018, AutoNation implemented a restructuring plan that reduced cost annually, consolidated at regional structure from 3 to 2. This year, we made further reductions to headcount, advertising and discretionary spending. These efforts allowed us to deliver adjusted SG&A as a percent of gross profit of 68.2% in the second quarter of 2020, which represents a 520 basis point improvement compared to the second quarter of 2018. We intend to operate below 69% SG&A as a percentage of gross profit on a long-term basis.

Today, we announced plans to build at least 20 additional AutoNation USA stores over the next 3 years. We’ll provide details of the rollout schedule next quarter. We see an opportunity to take a larger share of the used vehicle market, which is substantially larger than the new vehicle market and benefit from the increased interest in vehicle ownership from consumers. AutoNation’s strong brand, first-class digital capabilities, our One Price strategy, combined with lower acquisition costs, stable used vehicle retail pricing, make AutoNation USA stores an attractive investment opportunity.

I’d now like to turn it over to Joe. Please, Joe?

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Joseph T. Lower, AutoNation, Inc. – Executive VP & CFO [4]

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Thank you, Mike, and good morning, everyone. Today, we reported adjusted net income from continuing operations of $124 million or $1.41 per share versus $108 or $1.20 per share during the second quarter of 2019. This represents an 18% increase on a per share basis. Second quarter 2020 adjusted results exclude an unrealized gain of $161 million after-tax or $1.82 per share associated with our equity investment in Vroom and executive separation charges of $5 million after-tax or $0.05 per share.

Going forward, our investment in Vroom will be marked to market at the end of each quarter with fluctuations in value included in our GAAP results. During the second quarter, same-store revenue decreased $726 million or 14% compared to the prior year as the global pandemic and shelter-in-place orders significantly disrupted our business, particularly in April. We did see a significant recovery sequentially from month-to-month through the quarter, as Mike highlighted earlier, as shelter-in-place orders were lifted and the economy reopened. Despite the economic volatility, our team executed at a high level during the quarter, with same-store gross profit declining only 9% year-over-year, driven by strong PVRs and resiliency of our used vehicle business. Our same-store variable PVRs were up $585 or up 16%, while same-store used units declined only 3%, all compared to the prior year periods. Limited supply and recovering demand benefited vehicle margins in the second quarter. Looking ahead, we expect margins to normalize as inventory recovers through the second half of the year.

Moving to costs. Adjusted SG&A as a percentage of gross profit was 68.2% for the second quarter, which represents a 330 basis point decrease compared to a year ago period. We drove significant SG&A leverage through extensive cost reduction efforts, including leveraging our digital capabilities to reduce expenses across labor, advertising and discretionary spend. As Mike stated, we will continue to maintain a discipline in our cost structure going forward, targeting to continue to operate SG&A as a percentage of gross profit below 69%. Due to the strong execution in our stores, recovering demand and our proactive cost reduction efforts, adjusted operating income was only down 3% compared to the prior year. Further benefiting results, floorplan interest expense decreased to $16 million as compared to $37 million in the second quarter of 2019 due to both lower interest rates and lower average floorplan balances.

Non-vehicle interest expense decreased to $23 million as compared to $28 million in the second quarter of 2019, as we refinanced our 5.5% notes in February with lower-cost debt. Importantly, during the second quarter, we strengthened our balance sheet and improved our liquidity position through rigorous expense management, disciplined capital allocation, strong free cash flow generation and the issuance of new 10-year notes. At the end of June, we had $2.1 billion of non-vehicle debt, a decrease of $432 million compared to the end of the first quarter. Our cash balance at quarter end was $257 million, which combined with our additional borrowing capacity resulted in total liquidity of approximately $1.6 billion at the end of June. This is an increase from $1.2 billion at the end of Q1. Our covenant leverage ratio of debt-to-EBITDA decreased to 2.3x at the end of the second quarter compared to 2.8x at the end of the first quarter. Including cash, our net leverage was down to 2.0 at quarter end. During the quarter, we did not repurchase any shares as a result of the uncertainties presented by the global pandemic, but under the current Board authorization, the company has approximately $139 million available for additional share repurchase.

Capital expenditures were $25 million compared to $67 million in the prior year, reflecting the actions we have implemented since March. Looking forward, we will maintain cost and capital discipline, while we continue to invest in our business, opportunistically allocating capital to maximize shareholder returns. Our AutoNation USA expansion provides an attractive opportunity to increase our used vehicle market share and drive long-term shareholder value.

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

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [5]

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Thank you, Joe. I’m really excited about the great opportunities in front of us as a company. We have an industry-leading brand with scale, proprietary digital capabilities, we’re well positioned for the future. We’re now happy to take any of your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of John Murphy of Bank of America.

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John Joseph Murphy, BofA Merrill Lynch, Research Division – MD and Lead United States Auto Analyst [2]

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Congrats on a great quarter. Okay. Mike, I just had a first question on AutoNation USA. I’m just curious if you can update us on how the 5 stores are progressing that are already launched and what’s kind of triggered the decision to really accelerate the growth over the next 3 years to 20 additional stores?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [3]

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So we built 5 pitot stores, John. And the key was, after building the pilot stores was the pause. And come to conclusions what we had done right and what we have done wrong? And how do we have a clear, understandable path to profitability? And will the stores meet or exceed our return threshold? And that — we did a lot right, but we also did a lot wrong. And I’m glad we took the pause. And we now have a very good understanding of what’s right with the stores and the stores are solidly profitable, and Joe can give you some numbers in a moment. So the amount of investment per store will be 20% to 25% lower than what we originally did. This is primarily because we narrowed the focus of the store to being a transactional delivery center for vehicles and a reconditioning center. The number of service — the amount of service capacity we put in the stores simply didn’t pan out, and we don’t want to repeat that in future stores. So that gets our investment per store down to around $10 million or $11 million a store. Then we perfected the processes that were within the stores and really learned that the AutoNation one price and all the procedures that we use in our existing stores are actually first rate and first-class and no reason to try to reinvent everything. And now we have a very clear path to profitability on the stores. We expect we’ll reach breakeven within 12 months. And within 18 months to 2 years, we’ll be running already at our return threshold we need to greenlight an investment. So if you ignore March and April, which were so severely disrupted by the pandemic and really just look at January, February, we were already on track to greenlight this. So actually, I think the pause period was actually longer than we thought it was going to be. So it’s not all of a sudden, we’ve been building to this, but we wanted to have a high degree of confidence and certainty that we knew exactly what we’re doing and that we would hit the return targets. And so we’re there. And off we go. Joe, you want to talk about any other numbers?

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Joseph T. Lower, AutoNation, Inc. – Executive VP & CFO [4]

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Yes. The one thing I guess I would add, Mike, is if you look at the stores today, and again, great performance, but we’re generating about a little over $2 million a quarter on a run rate. And I think that’s kind of a good estimate of what our existing footprint has done, recognizing there are, obviously, very good performance in that. But a model, kind of going forward, as Mike said, to give you some confidence that it is a profitable model that we have now demonstrated success with.

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John Joseph Murphy, BofA Merrill Lynch, Research Division – MD and Lead United States Auto Analyst [5]

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Okay. That’s helpful. And then just a second question on M&A and the online efforts. I mean, obviously, been doing this for a long time and have a lot of perspective. It seems that there’s a loosening of framework agreements and constraints by the automakers allowing sort of networks to potentially grow above and beyond where they used to be limited, whether it be in the physical or virtual world. I’m just curious, in your interactions with the automakers, are they at a point where they’re accepting more and more that these larger wealth yields partners and distribution like yourself can get larger without trading issues, that they kind of anticipated in the past.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [6]

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Yes. Well, I would say, as the largest, there’s still issues there that are, by no means, completely behind us. And the gating to get the greenlight has implications for every store you already own with that particular franchise. So the bar gets higher and higher. So when we look at future capital allocation, of course, we love our existing business, and you see how it’s performing. We made a surge investment in digital that we have a much more capable, robust platform with proprietary tools that fully prepared us for when there was this surge in the consumer moving in this direction. And on the cost side, it had a double benefit in that the surge investment is behind this. We’re on the other side of the mountain now. And now that investment is allowing us to operate at a lower SG&A as a percent of growth, and you’ve heard the new target. And John, you and I have talked about, one will be under 70 again while we’re there. So that was a solid investment. So we love the returns on the U.S.A. stores, and then I don’t have — we don’t have to pay goodwill. We don’t have to deal with all the manufacturer restrictions. And we also look at the pricing that we see on the deals for new vehicle franchises and hitting our return threshold, it’s not always clear, that that’s the best place to put our capital. So I’m not saying we won’t do deals, but they’ll probably be more in the line of tuck-ins rather than something big. That would be my expectation. So we’ll invest our capital in making sure our existing business is first class. We’ll always look at share repurchase opportunistically. Quite frankly, during the second quarter, even though the price was attractive, there was just too much uncertainty as what was going to happen next. Then we had to be disciplined and refrain from share repurchase, but we’ll certainly be very keen to watch for opportunities in the future. And then we’ll do tuck-ins on new vehicle franchises.

The basic footprint we have — basic footprint we have, we like — as you know, we took a look at everything in our footprint from top to bottom. And I would say, basically, the divestitures of new vehicle franchise that is for AutoNation is complete.

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John Joseph Murphy, BofA Merrill Lynch, Research Division – MD and Lead United States Auto Analyst [7]

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Okay. That’s very helpful. And then just lastly, real quick on SG&A. I mean I know you guys are saying an opportunity to remain below 69%. I’m just curious if there’s a greater opportunity to go lower as more sales and more of the process goes online? And then also as AutoNation USA stores ramp up, do they have a lower SG&A to growth, so maybe we could blend down over time? So what does online mean? And then what does Autonation USA mean to that number?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [8]

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Yes, John. I would — directionally, I would agree with your statement that our efforts have certainly not — will not cease, but I can’t commit today that it’s going to be — I have to stand on what we said today. We want to be below 69%, but our work has not stopped. Certainly, there was a big step taken in the second quarter. Certainly, you can see this is 2 years of effort that’s been underway with this focus on digital, improving both effectiveness and efficiency. There is no reason to stop.

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John Joseph Murphy, BofA Merrill Lynch, Research Division – MD and Lead United States Auto Analyst [9]

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Okay. Great.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [10]

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As far as the — with U.S.A. stores, I don’t know the answer to that. I’ll have to get back to you.

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Operator [11]

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Your next question comes from the line of Rick Nelson of Stephens.

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Nels Richard Nelson, Stephens Inc., Research Division – MD [12]

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So other car dealers are pointing to a big step change in profitability in June. Curious if you could comment there and whether that’s continuing here into 2Q. Maybe you could talk about the SG&A that you saw in June to give us some perspective.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [13]

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Well, June was a remarkable month. I think our SG&A in June was at a level — you have the number there, Joe. I would assume it’s in the 60s, Joe, I think.

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Joseph T. Lower, AutoNation, Inc. – Executive VP & CFO [14]

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It was the low mark of the — it was clearly the low mark of the quarter. I would put it that way. So it was below 68%.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [15]

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Yes. It was a very good number, but not the run rate we’re declaring. We’re declaring 69%, will be below with opportunity and work to go, and we’ll see what the future brings there.

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Nels Richard Nelson, Stephens Inc., Research Division – MD [16]

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Okay. Got you. So we did see improvement in the service and parts operation. You mentioned minus 40 in April, minus 10 in June. Mike, what you’re thinking there as we push forward?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [17]

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Rick, let me tell you exactly where we are. Usually, we don’t give updates on the current month, but this is extraordinary circumstances. So new unit sales so far in July are running minus 15%. It’s definitely a supply issue. The manufacturers are ramping up and they have challenges. And I think our shipments of new vehicles to us will be 25% lower than a year ago. So I think it’s really into the fall before new vehicle inventories normalize. Our used, preowned sales are running plus 7, plus 8, something like that. Good demand. And if we had more, we could sell more. So we’re — we had a really strong close end of June. So inventories were tight going into July. We’re working to get more, but the demand is definitely there. And on customer care, the pace continues to improve, and we are running on a daily basis at minus 7% compared to a year ago? And if the trend continues at some point during this quarter, I expect customer care will be running equal to prior year. And there’s going to be a lot of pent-up demand ultimately for maintenance. No maintenance was done during this pandemic period. We only did repairs that had to be done. So it’s gradually — it’s only down 7% in July and still getting a little better each day.

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Nels Richard Nelson, Stephens Inc., Research Division – MD [18]

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Great. Also I’d like to ask about the markets where we’ve seen some COVID outbreaks here at like Texas, Florida, California, any commentary about what you’re seeing there would be helpful.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [19]

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Yes. So we’re — first, for AutoNation, I think we’re the first, if not today the only auto retailer that — of any size and scale that mandated masks for all employees. We had them — we started buying them, acquiring them in late March. By early April, we had a good supply and the policy went in place on April 17 as well as social distancing within the stores. And that put our employees in a safe environment, and we could really see that customers appreciated it. I will tell you the overriding theme we’re hearing from customers is their demand for personal mobility rather than shared mobility in every aspect. And this is trumping any concern they may have about leaving the house or not leaving the house. They want to come out and get their personal mobility situation to a new place. And so with these markets where have become so-called hotspots, we have seen no change in customer behavior. Business is fine. No real change with additional outbreaks. Now that’s not to say there won’t be government action in some of these places between now and the year-end, there could still be some twists and turns. But if I put it all together and try to step back from that, I mean, ultimately, there will be a vaccine. So let’s look at ’21. I think this demand for personal mobility will very much remain. So for retail, automotive, new and preowned, I think the outlook is quite positive, quite confident. You combine that with the fact that I believe we’re going to have low interest rates for both ourselves and our customers for years gives me a very positive outlook about auto retail sales. The keyword there is retail. Fleet is another whole story. Not our expertise, not our issue, I’m talking automotive retail.

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Operator [20]

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Your next question comes from the line of Armintas Sinkevicius of Morgan Stanley.

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Armintas Sinkevicius, Morgan Stanley, Research Division – Associate [21]

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I did not have my mute button on, but glad you’re — glad we’re connected now. There seems to be a greater focus on digital, particularly in the press release, your prepared remarks. Maybe you could talk about your plan here for digital going forward. Some milestones you hope to hit or some initiatives that you’re targeting on rolling out?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [22]

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Well, we had a surge investment in digital over the last few years. That was quite remarkable. And we felt the customer was on a migration to digital. And certainly, this pandemic is an inflection point for which we’re fully prepared. So we have a very robust platform today that performs across the enterprise flawlessly. That is really quite remarkable, and we have proprietary tools that we will systematically add to. But we’re now, as I said earlier, on the other side of the mountain. So we were rolling the stone uphill, where we had to make these significant investments with the hope and the belief that it would give us capabilities and get us to a different cost basis. So one of the reasons we’re so confident on the cost basis is that the surge investment period is passed and the tools are working, and we can see the effectiveness and efficiency that they bring. And we’ll just continue to build on the platform that we have. And we have very smart, talented people, but climbing the mountain and cresting the mountain was the hard part, and I’m happy to say we’re on the other side.

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Armintas Sinkevicius, Morgan Stanley, Research Division – Associate [23]

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Okay. And how many of your sales during the quarter and since then have been involving delivery and/or curbside pickup? Have you seen that continue to increase since — just over the last several months?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [24]

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So we have that capability, and we do it for our customers, both on the sales and service side. But our experience remains that the customer wants to do a substantial amount of the transaction digitally, and you better have that capability to interact with the customer or else you’re going to lose them to someone else? But ultimately, the customer wants to come in to take final delivery. And that’s what they want. We’re good at it. It’s efficient. It’s effective. It’s a safe environment. But the point is we have the capability to move wherever the customer wants to go. And I think we certainly demonstrated that during this corona period. If they want to surge to digital, we’re ready for it. If they want to surge to home delivery, we’re ready for it. We have the capability to do both. But on home delivery and pickup, I would say it’s less than 10% of the business.

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Armintas Sinkevicius, Morgan Stanley, Research Division – Associate [25]

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Okay. And just last one here. Any lessons learned from Vroom? I know it was a financial investment, but anything that you were able to take away from that experience in working with them?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [26]

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I think Vroom has been a terrific investment, and it’s a company that we admire. And I think the — having been at the table as a Board member and all the bilateral discussions was constructive for both companies, but it did not lead to any operating partnerships. And I would say we are now an investor in Vroom.

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Operator [27]

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Your next question comes from the line of David Whiston of Morningstar.

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David Whiston, Morningstar Inc., Research Division – Strategist [28]

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Can you — in the press release, you were really differentiating between Customer 360 and the equity mining tool in terms of 360 being a more personalized experience. And I’m just curious, could you go in a little more detail on what makes it more personalized and the insights you’re already getting from the mining tool?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [29]

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So what’s amazing about 360 and what we mean by 360 degrees? First, it’s a customer-centric approach rather than a vehicle-centric approach. So if you’re Mr. Smith, and you go in L.A. and buy your daughter who’s going away to college a preowned car, and you fly to Miami, your home and walk into our Mercedes-Benz store, we know instantly when you enter in the Miami store what you just did in L.A. So it’s not in silos. It’s a pan enterprise, customer-centric platform, that’s quite remarkable. So we know your whole history, both sales and service with every AutoNation store in our system in real time. Then equity mining tools and analytical tool. It’s applied to that, which then identifies when customers on certain vehicles they own are in the maximum opportunity window to do something. So if we know your XYZ number of months into a Toyota and we see that it’s what the equity is you have in the vehicle, where — and then there’s a special deal on what we think with a predictive model, but you will want next that you can move into this other vehicle at the same price or less price. And you’re coming in for service tomorrow at our store, then we walk up to you and say, “Hey, by the way, this opportunity is there. We just wanted to make you aware of it.” You think about it, but here it is. So we proactively turned a service visit into a sales opportunity with a very specific, compelling offer that is in the customer’s interest. It’s not where we just make a cold approach. It’s like we know all this. You should think about this, this is in your interest. And the closing rate is remarkable, and the customers are delighted that we are thinking for them. We could not, cannot do that without a customer-centric database that goes across the entire concern and without the analytics that go with it.

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David Whiston, Morningstar Inc., Research Division – Strategist [30]

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That’s very helpful. I appreciate the detail. Moving on to new vehicles. Unit volume was down 23%, but the profitability, at least on a unit basis, was up over $400. And then your total new vehicle gross profit dollars, I think we’re only down about just under 5%. So is there no price war really going on amongst the few new vehicle customers that are there because it’s all just supply constrained?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [31]

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Yes, it’s very reminiscent of 2011 when the Japanese factories closed due to that horrific dichotomy. We just took — the factories were closed for how long, we just looked at our inventory and said there’s no reason to rush it out the door unless there’s something — some reason to. And we just adjusted our prices and felt that we would get a higher yield on it. And that’s exactly how it played out. Exactly how it developed. Now — but we’re not saying it’s sustainable, open-ended. I mean when inventories normalize and the plants are all humming again, then I think the prices will also normalize. But it is again a demonstration of how resilient the auto retail model is that in very challenging circumstances, there’s a lot of ways to manage the business and I’m happy to tell you in my 20 years here, we’ve never had an operating loss at store level in the company’s history, including the month of April. Month of April, this April was the toughest. Shelter-in-place was really tough, but we still made money. A lot of different ways to go.

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David Whiston, Morningstar Inc., Research Division – Strategist [32]

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I agree on your and [your open eye] has been awesome too. Staying on that shutdown topic, though, are you worried about California, Texas and Florida possibly shutting down again?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [33]

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Well, look, anybody who says they know the end to the COVID-19 story, I don’t believe. I think it still has some twists and turns left. I can tell you just what we hear from customers, it’s like they do not want to shelter in place again. That, by and large, people are being responsible and how we’ve all seen photographs of those who are not. But the idea of shelter-in-place, again, is not what we’re hearing from customers. Now what the authorities, government finally decide? I can’t predict. But I think American people are, like, okay, let’s be responsible, 1 step in front of another. Thank goodness, better treatments are here every day. And can’t wait for a vaccine. So still ways to go, and hard to predict.

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David Whiston, Morningstar Inc., Research Division – Strategist [34]

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I agree. I agree. I just want to clarify finally, one thing you said on the U.S.A. stores at the beginning. Did you say going forward, they would have basically no service or just very limited service?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [35]

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They’re primarily — firstly, they are reconditioning centers. So we have 2 choices. Do a centralized reconditioning center, which means we acquire a vehicle, ship it to a central reconditioning center, recondition it, ship it back to the point of sale, deliver to a customer. So we’ve analyzed that whole model and have concluded that we have the ability to do very cost-effective reconditioning and a technical expertise at the point of sale that we’re not shipping the car multiple times to get it in frontline conditions. So speed to market, speed to frontline sale with point of sale, reconditioning is a very strong advantage. Because our intention is very serious in the sense that we want to grow our preowned business profitably. So we want the shortest time from opening a store to breakeven. We now feel it’s about 1 year, and then the quickest time until we hit our return targets. And that’s now 18 months to 2 years. So that’s a very — and in our return, those losses have to all be factored in. So when your focus is really on profitability, grow the preowned business profitably, these are the conclusions we came to. And so it is a reconditioning center near the point of sale, speed to front end — frontline presentation to the customer. There will be some service capability in those stores, but not nearly as much as was in the original plan.

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Operator [36]

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Your next question comes from the line of Rajat Gupta of JPMorgan.

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Rajat Gupta, JPMorgan Chase & Co, Research Division – Research Analyst [37]

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Congrats on the quarter. Very well executed. I just had a follow-up on the SG&A question. Could you give us a sense of where your staffing levels are right now? Are you back to a level of staffing that you think you’re good at right now? Or do you think you need to continue to ramp that up? Just trying to get a sense of like how much personnel headcount reduction is likely to be permanent in nature. And related to that, also, how should we think about how the advertising expense might move forward here? Keeping in mind, you’re also expanding automation you are seeing. And how do those all blend in to the spending profile? And I have a follow-up.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [38]

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Yes. So on staffing, I’ll just pick up where we entered 2020. We had already taken actions in 2019, but let’s just do 2020. We had 25,000 associates when we entered 2020. We have 21,000 associates. Today, there is no plan on a ramp. Now within that, I would say we’re very certain that 3,000 are permanent reductions. There is discussion around another 1,000. And maybe the truth is somewhere in between ’21 and ’22. But there’s no plan to ramp to ’22. That is what somebody asked me earlier, are you still working on SG&A? Do you still see possibilities in SG&A? It’s within that 1,000 there that we’re working on right now. So I can’t commit today one way or the other, other than to say, for the same level of business that we were tracking at in the first quarter, we can now do that with 22,000 employees rather than 25,000 and maybe even less than 22,000, but we’ll have to see on that.

And Joe, you want to take the other cost questions, please?

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Joseph T. Lower, AutoNation, Inc. – Executive VP & CFO [39]

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Sure. Maybe just to kind of break down the SG&A pool discussion. So if you think about SG&A, we’ve talked a lot about the digital enablement. So I think of SG&A in 3 big buckets. I think of it as in compensation. I think of it as in advertising, I think of it as overhead. So you take those 3 buckets, comp, not surprisingly being the largest.

Our compensation quarter-over-quarter was down about 14%. It’s pretty consistent with the headcount reduction. And clearly, we are seeing the majority of that is in the store. And clearly, the more efficient sales process, in particular, is enabling those reductions. It’s 100 basis points as a percentage of SG&A year-over-year improvement. So clearly, we see opportunity there. And as Mike said, an area we think has further leverage going forward.

The next bucket, I think of, is advertising. It’s the smallest in dollars, but clearly, the one that had the biggest impact from a year-over-year perspective. We were down about 40% in advertising year-over-year. Really driven by the environment and our digital capabilities and being far more efficient in using our advertising dollars, and that was 180 basis points year-over-year improvement.

And then the third bucket, I think of, is overhead in the store and in corporate, and that was down again, primarily headcount and discretionary spend 13% or 50 basis points. So each of those buckets have been impacted by the headcount reductions and been enabled by our digital capabilities that cumulative was about 15% down year-over-year or 330 basis points. And as you look at the model going forward, we do see continued leverage, particularly as some of the higher-margin customer care type business recovers.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [40]

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I hope that helps.

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Rajat Gupta, JPMorgan Chase & Co, Research Division – Research Analyst [41]

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Yes. That’s how — so the advertising dollars per unit, if you just divide it by like the new unit sales, I mean, does that move lower here going forward on a normalized basis? Is that fair to assume?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [42]

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Yes.

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Rajat Gupta, JPMorgan Chase & Co, Research Division – Research Analyst [43]

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Okay. That’s super helpful. And on the F&I GPU, really very solid numbers in the quarter. Was any of that temporary nature you would think? I don’t know if there was higher penetration on any of the buckets that helped that? Or is that a pretty good sustainable number that we can expect to see in the near term?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [44]

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So this is Mike. I’ll go first. Our remarkable success in F&I is due to the AutoNation products that we’ve developed that customers are choosing. The amount of finance income over the last few years is relatively stable. I don’t know, $500, $600 a car, like that. That’s not the growth. And it’s not that we’re selling customers more expensive products. That’s not the growth. Greater percentage of customers are choosing AutoNation service contracts, maintenance contracts, which, by the way, is building a customer care business for the future. And that adoption by customers just continues, and we refine the products and we refine our processes every quarter. It’s a continuous improvement loop. And so that goes on. It’s not some quirk, that is a windfall. It’s — at the core level, it’s really a branded product that customers just want and are adopting at a higher level. So anything you want to add to that, Joe?

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Joseph T. Lower, AutoNation, Inc. – Executive VP & CFO [45]

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One thing I would add, Mike, I reiterate the point that it’s less than 1/3 is the financing piece. And now with (inaudible) completely digitally enabled, it makes it even a more efficient process. So I agree with Mike. I do not — I would not expect any sort of material reduction and think that is a number that we will continue to see improve.

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Rajat Gupta, JPMorgan Chase & Co, Research Division – Research Analyst [46]

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Got it. That’s helpful. Just 1 last 1 for me, if I may ask. On the management change, I know you’ve said that you would be appointing a successor sometime in early 2022. Could you give us a sense of just the kind of candidate you would be looking for as a successor? I mean do you think that process could be accelerated at any point? Just curious as your thoughts there.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [47]

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Certainly. So the second quarter of 2020 will live in my memory forever that in the midst of this pandemic we achieved the best earnings per share in the history of the company. That was a tremendous performance on behalf of all our employees and a lot of decisions we, as an executive team, had to make. And we also had to have the shock of unexpectedly losing Cheryl as a part of the leadership team here, and she was doing a terrific job. And I have to tell you, I miss her. I worked side-by-side with her for 10 years and I miss her. Now having said that, I love — as you all know, I’m passionate about auto and auto retail, I’m passionate about AutoNation. I love the business. I love the people in the company. I love the Board. I love every day. Here, and the Board said, “You know, Mike, you’re not exactly chopped liver, and we’re in the middle of a pandemic. We think there should be a singular focus by the Board, by the executive team and by management, that not only we get through this pandemic, but we on the other side of this pandemic, we’re stronger than ever.” That was the singular mandate from the Board. And we all felt nobody knows exactly how this pandemic is going to play out, but we all sort of felt, well, certainly, by beginning of 2022, we can do succession in an orderly fashion and this pandemic will be behind us. So that’s the singular focus. And there’s been not a single meeting or a single discussion about succession process, this, that, that, that, nothing. Singular focus, lead the business, run the business and achieve something remarkable through this difficult challenging period with the pandemic. And I think our results show that decision to go for a singular focus was the right one. That’s the road we’re on. And I don’t expect much change in the time line one way or the other.

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Rajat Gupta, JPMorgan Chase & Co, Research Division – Research Analyst [48]

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Got it. Got it. That’s helpful. So there is no discussion as now if like the successor would be internal or external or…

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [49]

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0.

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Rajat Gupta, JPMorgan Chase & Co, Research Division – Research Analyst [50]

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The kind of profile — okay, got it.

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [51]

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0, singular focus, run the business.

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Operator [52]

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Your next question comes from the line of Stephanie Benjamin of SunTrust.

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Stephanie Benjamin, SunTrust Robinson Humphrey, Inc., Research Division – Associate [53]

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I wanted to touch on — I kind of go back to the digital initiatives and the commentary you said before, and I apologize if I missed this, but did you quantify the percentage of units or sales in the quarter that did come from a digital platform or anything like that?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [54]

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Well, we were — for the way we measure it for our metrics, we were somewhere entering the year in the low 30s and if I went back 5 years ago, we were in the low 20s, something like that. And each year, there would be a 100, 200 basis point increase. And so that’s the road we were on. With the arrival of corona, in a matter of 10 days, that number moved into the low 40s. And it hasn’t moved back. And I don’t think it will. I think there was an inflection point that lifted the whole digital issue accelerated, if you will. Now I think we go back to increasing 100, 200 basis points a year, but you’re going to have this inflection point where all of a sudden it went from the low 30s to low 40s and doesn’t go back. So the only thing I can say is that I’m happy we made the investments that we were fully prepared for that moment. We didn’t expect that moment, but there was, and we were able then to perform for the expectations of our customers and take that moment to move to a different cost basis.

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Stephanie Benjamin, SunTrust Robinson Humphrey, Inc., Research Division – Associate [55]

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Got it. And in the same vein, I wanted to hear your thoughts on just your ability to continue to penetrate your F&I products, particularly the warranty and extended service with a fully digital platform. So maybe kind of discuss how you’re able to sell those digitally and kind of engage the consumer without it being in person. Any — and then just the adoption rate you’ve seen with those — with those digital sales?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [56]

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So as discussed earlier, the — over 90% of our customers, I don’t know what the exact number is, Joe may have it — of our customers prefer to take delivery of their vehicle at the store. And I think our selection rate from customers for AutoNation branded products is somewhere around 42%, 43%, something like that. So we have excellent penetration and it’s steadily growing. Quite frankly, though, as far as achieving that level of penetration digitally, we have not been able to do that successfully yet. We’ve made various attempts. But we do not — I don’t know the exact number, but we do not have the same adoption rate of those products digitally online that we do with an in-store process. Now with the in-store process, the customers are delighted. They’re happy that they have the product. Of course, they have the right to walk away. So it’s not for sale. It’s something they really choose and are happy to have, but we have it, I would say, perfected in the stores. There’s still work to do in the digital world on those products.

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Operator [57]

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Your last question comes from the line of Bret Jordan of Jefferies.

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Bret David Jordan, Jefferies LLC, Research Division – MD & Equity Analyst [58]

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As you guys deemphasize the customer pay service of AutoNation USA a bit, does that change your strategy around the AutoNation branded parts at all?

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [59]

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Now the AutoNation branded parts have been a big success. As far as all the maintenance parts and mechanical parts, it certainly has put us on a very good basis for recondition, and it will be AutoNation branded parts that we use in the U.S.A. stores for reconditioning, that’s a complete success and has made a meaningful contribution to the profitability of the company. Now AutoNation Collision Parts is another story. The whole collision business was very challenged during the second quarter with the dramatic reductions in the amount of miles driven. And that business wasn’t profitable even before the marketplace got much more difficult. That’s a relatively small part of the AutoNation parts world, but I would say that’s the only area of concern. Everything else is moving in a very good direction.

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Bret David Jordan, Jefferies LLC, Research Division – MD & Equity Analyst [60]

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Okay. And then 1 big picture question. I guess as it seems most everyone, including all the online start-ups are really focusing on building out used volumes and growing units quickly. Do you see the structural change in the inventory sourcing? I guess, is the world just going to be more competitive to buy the incremental used car? Or is the share just going to shift from independent used car dealers to the larger players like yourself? And the total number of buyers out there won’t escalate into…

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Michael J. Jackson, AutoNation, Inc. – Executive Chairman & CEO [61]

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It’s absolutely the second one. First, it’s a huge market, $35 million a year. You have private transactions, independent transactions and you have franchise dealers and then you have the big players. I think there is a yearning in the preowned market for a brand that can be trusted. And scale also brings in the consumers’ mind an idea of trust. And if you really have a good experience and you stand behind the product, I think that’s where the business is going to consolidate around and whether that’s Carvana, CarMax, AutoNation, Vroom, I think the big players that are branded are clearly going to take share. It’s a share consolidation in a very big ocean. That’s how I see it developing. Now when it comes to making money then in that consolidation, I like our position. We’ve built the brand. We have the brand, the brand is respected. Our reputational score is through the roof. We figured out how to do reconditioning competitively. And I like our acquisition plans because I have a new vehicle business, which is huge on which I’m taking trades very cost effectively. Then I have a big preowned business that I’m taking trades very cost effectively. We’re building our world by our car business. We’re going to buy directly from consumers another 3,500 in July. And then you have the auction component as the icing on the cake.

So I think we’re very competitive in how we acquire. We have a brand that’s trusted and we one price on the retail side. We had a very good idea that retail pricing was not moving in the second quarter downward precipitously. That gave us the confidence to go out and buy a lot of inventory, even though there was a lot of those who said the sky was falling and we really performed well through there. So a core skill set of AutoNation is acquiring preowned vehicles at very good prices, and we know how to one price them centrally across the company. We know how to recondition them cost effectively. We have a brand. We have a process. We have digital capability. I’m optimistic about our future in preowned. And I view the big players as the winners. I think that’s what the yearning is out there for.

Great. Thank you everyone for joining us today. Thank you for all your questions.

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Operator [62]

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There are no more questions at this time. Therefore, this concludes today’s conference call. You may now disconnect.

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