AN

Business Context and Reporting Period

Company: AutoNation, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2010
Business Overview: AutoNation is the largest automotive retailer in the United States, operating 249 new vehicle franchises across 204 stores, primarily in the Sunbelt region. The company is organized into three reportable segments: Domestic, Import, and Premium Luxury.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 19.7% for the quarter and 19.2% for the six-month period compared to the same periods in 2009, driven by higher unit sales and increased revenue per vehicle.
• Profitability: Operating income rose 24.8% for the quarter and 22.9% for the six-month period. Gross profit margins improved across new and used vehicle segments.
• Debt Restructuring: The company completed a significant debt refinancing in April 2010. It issued $400 million in 6.75% Senior Notes due 2018 and used proceeds to retire approximately $263 million of older notes and reduce its term loan facility. This resulted in a $19.6 million pre-tax loss on debt extinguishment recorded in the second quarter.
• Share Repurchases: The company aggressively repurchased common stock, spending $414.4 million in the second quarter and $451.6 million for the six-month period. No repurchases were made in the comparable 2009 periods.
• Discontinued Operations: Loss from discontinued operations decreased significantly to $2.7 million for the quarter (from $17.3 million in 2009) and $6.0 million for the six months (from $35.3 million in 2009).

Guidance, Outlook, and Risks

• Outlook: Management anticipates continued improvement in the automotive retail market over the next several years, citing improved credit availability and consumer confidence. The company expects to deploy capital opportunistically for share repurchases and acquisitions.
• Capital Allocation: Following the debt refinancing, the company has increased flexibility. On July 20, 2010, the Board authorized an additional $250 million for share repurchases. The company also entered into agreements to acquire three stores (Toyota and Hyundai in Atlanta, Hyundai in Seattle) with an aggregate purchase price of approximately $60 million.
• Financial Covenants: As of June 30, 2010, the company was in compliance with its amended credit agreement, with a leverage ratio of 2.66x (limit 3.25x) and a capitalization ratio of 45.1% (limit 60%).
• Risks:
  • Market Sensitivity: Results are highly dependent on new vehicle sales levels and economic conditions.
  • Inventory: A decline in new vehicle sales over recent years may adversely impact the parts and service business in the future due to a shrinking service base.
  • Regulatory: Potential impacts from the Dodd-Frank Act and the Patient Protection and Affordable Care Act on financing and employee healthcare costs.
  • Concentration: Significant ownership by ESL Investments (approx. 55%) and Cascade Investment (approx. 15%) may influence corporate actions.

Investor Verification Checklist

• Debt Refinancing Impact: Verify the long-term interest rate exposure following the issuance of the 6.75% Senior Notes due 2018 and the reduction of variable rate debt.
• Share Repurchase Sustainability: Assess the impact of the $451.6 million in share buybacks on liquidity and the remaining $55.3 million authorization under the program.
• Inventory Levels: Monitor new vehicle inventory days supply (55 days at June 30, 2010) and used vehicle days supply (45 days) against industry trends to gauge potential write-down risks.
• Acquisition Integration: Track the closing and integration of the pending $60 million store acquisitions in Atlanta and Seattle.
• Discontinued Operations: Confirm the final resolution of the remaining store classified as discontinued operations to ensure no further unexpected losses.