AutoNation, Inc. (AN) Q4 2018 Earnings Report, Transcript and Summary

Welcome to AutoNation's Fourth Quarter 2018 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 Robert Quartaro, Vice President of Investor Relations for AutoNation.

Thank you. Good morning. And welcome to AutoNation's fourth quarter and full year 2018 conference call and webcast. Leading our call today will be Mike Jackson, our Chairman, Chief Executive Officer and President; Cheryl Miller, our Chief Financial Officer; and I would like to welcome our Incoming Chief Executive Officer and President, Carl Liebert. Following their remarks, we will open up the call for questions. Chris Cade, Taylor Williams and 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'd turn the call over to AutoNation's Chairman, Chief Executive Officer and President, Mike Jackson.

Good morning, and thank you for joining us today. I'd like to announce the appointment of AutoNation’s new Chief Executive Officer and President effective March 11, Carl Liebert. Carl is an outstanding leader with expertise and customer-centric transformation, omni-channel, digital capabilities and supply chain logistics. Carl’s digital consumer retail and business-to-business experience are expected to lead AutoNation in not just auto retail but a leader in all of retail. I would like to ask Carl to say a few words, Carl welcome to AutoNation.

Thanks, Mike, good morning everyone. I’m excited to join Mike Jackson, AutoNation founder 2.0 and the entire AutoNation family. I refer to Mike as founder 2.0 because over the last 20 years he has built a tremendous company. I love the brand and what it stands for and especially the Drive Pink initiative to cure cancer. AutoNation has a clear strategy that sets it apart in the auto retail sector. Our brand extension strategy gives us an edge in a cyclical business, coupled with AutoNation’s industry-leading store operating model and digital opportunities for retail and business-to-business customers. Across my career I would led the deployment of cutting-edge technology to transform the customer experience. I have implemented successful operational strategies and global sourcing strategies as well as oversaw the future of supply chains. Most recently I served as the Executive Vice President and Chief Operating Officer for USAA's business operations in San Antonio, Texas, and I was responsible for delivering an integrated digital experience for our 13 million members. I believe my 30 years of experience at three Fortune 100 companies as a global leader focused on customer-centric transformation and creating shareholder value will be an asset to the AutoNation team. My vision is to lead AutoNation to define and enable the best carbine and ownership experience in the US. We will continue to build branded businesses that delights customers across the car journey. The opportunities that lie ahead for AutoNation are great and the ability to lead this next chapter is profoundly humbling. I will now turn the call back over to Mike Jackson.

Thanks, Carl. I’m thrilled to hand the talented leadership of AutoNation to Carl. He is uniquely qualified to lead us forward and that unique qualification is recognized by unanimous support from our Board of Directors that he would be the next CEO and the full support of our two largest and longstanding shareholders, Cascade and ESL. So turning to our 2018 fourth quarter results. We reported 2018 fourth quarter EPS from continuing operations of $1.02 which was negatively impacted by approximately $0.08 per share, or $9 million in restructuring related charges. Same-store fourth quarter 2018 revenue totaled $5.3 billion compared to $5.5 billion in the year ago period, a decrease of 4%. Same-store fourth quarter 2018 gross profit of $832 million increased -- decreased by 2% compared to $846 million in the year ago period. Same-store Customer Care gross profit was $383 million an increase of 5% compared to same period a year ago and same-store Customer Financial Services gross profit per vehicle retail was an all-time record industry-leading $1,851. AutoNation retail new vehicle unit sales decreased 8% on a same-store basis for the fourth quarter, primarily driven by industry weakness in our largest markets like California, which was down 9% according to J.D. Power and difficult comparisons due to the hurricane recovery in Texas and Florida that was in last year’s numbers. We expect industry new vehicle unit sales, including fleet to be in the high 16 billion units for the year with an expectation of industry new vehicle retail sales to be down approximately 5%. According to J.D. Power industry new vehicle retail sales for January were down 6%. In January we announced the cost saving plan restructuring that would reduce costs by approximately $15 million annually. This included a reorganization throughout the Company with us consolidating our regional structure and going from three regions to two. The restructuring allows us to create a more agile streamlined and efficient core business that is well-positioned for the potential challenge in year ahead and in longer term success of our company. I would now like to turn the call over to our Executive VP and Chief Financial Officer, Cheryl Miller.

Thank you, Mike, and good morning, ladies and gentlemen. For the fourth quarter, we reported net income from continuing operations of $93 million or $1.02 per share versus net income of $152 million or $1.64 per share during the fourth quarter of 2017, a 38% decrease on a per share basis. The fourth quarter 2018 results included restructuring charges of approximately $9 million pre-tax or $0.08 per share and fourth quarter 2017 results included a benefit of approximately $41 million or $0.45 per share due to a favorable impact on our deferred tax liability from the Tax Cuts and Jobs Act of 2017. During the fourth quarter, revenue decreased $272 million or 5% compared to the prior year and gross profit decreased $19 million or 2%. SG&A as a percentage of gross profit was 74.5% for the quarter, which represents a 280 basis point increase compared to the year ago period. Excluding restructuring charges of approximately $9 million, SG&A as a percentage of gross profit would have been in line with our guidance from last quarter. In January we announced the corporate and regional restructuring and savings plan which we expect to reduce cost by approximately $50 million annually. We have already executed most of the planned actions in order to achieve the $50 million of annual run rate savings. We expect to incur additional restructuring charges in the first quarter of 2019. However, the amount is expected to be less than the fourth quarter of 2018. For the full year 2019, we expect SG&A as a percentage of gross profit to improve compared to full year 2018 with the majority of the improvement occurring later in the year. The provision for income tax in the quarter was $36 million or 27.7%. Our fourth quarter tax rate was slightly elevated as compared to the full year rate due to the impact of certain unfavorable tax rate items, including employee benefit plan impacted by market volatility and limits on deductibility of executive compensation. Due to these items we’re estimating our tax rate to be between 26.5% and 28% for the full year 2019 and we expect the rate to be near the high end of this range in the first quarter of 2019. Floorplan interest expense increased to $37 million compared to $26 million in the fourth quarter of 2017 driven primarily by higher average interest rates and higher average floorplan balances. Our floorplan facilities are based on one month LIBOR which has risen approximately 100 basis points over the last 12 months. Non-vehicle interest expense decreased to $29 million compared to $32 million in the fourth quarter of 2017, primarily due to lower average debt balances and lower average interest rates as we refinanced higher cost debt with lower rates senior notes and commercial paper towards the end of last year. At the end of December we had $2.6 billion of non-vehicle debt an increase of $33 million compared to September 30, 2018. Other operating income was $23 million in the fourth quarter of 2018 compared to $25 million in the prior year, a decrease of $2 million. Other operating income was primarily comprised of gains related to store and property divestitures as well as a legal settlement. As part of our asset optimization strategy, we will continue to actively evaluate and manage our store and real estate portfolio likely resulting in further divestitures in 2019. However, we expect business divestitures to decrease in 2019 as compared to recent years. During the fourth quarter, we continued to focus on investing in our brand extension strategy as well as our strategic investment in Vroom and accordingly we did not repurchase any shares during the period. AutoNation has approximately 264 million of remaining Board authorization for share repurchase. As of December 31st, there were approximately 90 million shares outstanding not including the dilutive impact of certain stock awards. Capital expenditures were $97 million for the quarter compared to $108 million in the prior year. Capital expenditures are on an accrual basis excluding operating lease buyouts and related asset sales. Our leverage ratio was 3.1 times at the end of the fourth quarter compared to 2.8 times at the end of the third quarter and our total liquidity was $637 million at the end of December. Our recently announced restructuring and cost savings plan combined with continued growth from brand extension initiatives positions us very well for a challenging retail environment in 2019. And I'll now turn the call back over to Mike.

Thank you, Cheryl. Finally I would like to congratulate to more than 30 AutoNation dealerships who were awarded the J.D. Power 2019 Dealer of Excellence Award. This award recognizes a very select number of vehicle retailers throughout the United States that exceed not only customer expectations, but also provide exceptional customer service and must rank in a very top of the brand Sales Satisfaction Index. Less than 2% of all dealers in the US receive this award. AutoNation had the most recipients in the entire country. These dealerships exemplify AutoNation’s commitment to providing a peerless customer experience from coast-to-coast. I would also like to congratulate AutoNation’s 26,000 associates for selling 12 million vehicles, monumental achievement no other automotive retailer has attained. We will now take your questions.

[Operator Instructions]. And our first question comes from John Murphy with Bank of America Merrill Lynch.

Good morning, guys. And Mike congratulations on a very long successful run. We will definitely miss you in many ways, and Carl welcome to the team, we’re happy to see you join the team here. I guess first question, maybe sort of a little bit more of a near-term question is, the GPUs on new, on a dollar basis keep coming down, it’s an industry wide problem. It seems like there’s growing fatigue in the dealer base at least folks we talk to in supporting deals. So I am just curious, as you look at the business in the near-term, are there other ways you may continue to make up that pressure on new GPU through an F&I PVR or other actions on the new vehicle side or are we kind getting to this point where the dealers are going to stop supporting deals, because it’s just not as economic for them and they can’t make it up another ways, and you specifically?

Yes, John, I think everybody is very frustrated and feels the fatigue and feels it. We sort of have to draw a line on GPU and volume that we finally have reached that point. We have successfully managed it in totality and if you look at our brand extension and F&I products, it’s a remarkable success story but it has been frustrating to have to go out the other pocket on the GPU on the new vehicle. So we're intensively working on that almost daily operating discussion of what the right line is between that and we certainly hope and have the ambition to make progress on that issue this year. But it is a challenge, it is an ongoing challenge. But I absolutely see your point.

I mean, and second question as you look at the store footprint, it sounds like it's shifting to some degree, maybe shrinking based on what Cheryl said as far as divestitures in the near-term and even in the long-term, as far as the store footprint. I mean, do you think you are adequately represented across the nation for the future strategy or could there be acquisitions to increase some geographic or -- to increase the geographic exposure in places you're not right now?

Here's the way I look at it, John. I think strategically we're very well-positioned. I'm very satisfied with it. I love being diversified and particularly being on the East Coast with big State of Florida, anchor State of Florida, the central anchor State of Texas, West Coast, anchor State of California. That's absolutely ideal. I love our brand mix, one-third American, one-third Asian, one-third German basically. I love the fact that we have scale, 20 billion of revenue, next year competitor in the US is around 10 billion, something like that. So we're double the size of the next year's competitor within the US. That scale then gives us the ability to do brand extension. If I didn't have scale, that's another story, then I got to go get the scale. But we can -- there's not a supplier or a vendor or a financial institution in this industry that won't take a meeting with AutoNation to discuss what we can do to get there. And then I apply our brand to it and off we go and I would -- I think it's safe to say, an executive of Carl's talent and ambitions wouldn't be here, if AutoNation didn't have this unique scale, this brand and its extensive purpose. So you can already see what it could mean to this company over the next five to 10 years. So -- and then what we're working on is not just brand extension but geographic extension. How do you take our digital platform and move into markets with a lighter capital footprint? Now, I can't promise you anything today but I'm telling you that's in our mind. So I would view when you see us making divestitures, it's more trimming the sales than anything else. We're very happy with the strategic footprint. We have the scale we need. We have the brand that we need that we wanted and that has opened up an opportunity for the future. Now in the near-term are there headwinds in the new vehicle business? Absolutely. But that's the reason why we took all these other steps when this -- day it came. We could look at this difficult period as an opportunity to really make progress for the Company and vis-à-vis the competition.

And if I can so -- perhaps just ask Carl, I'll put Carl on the spot a little bit here. I mean you're entering your company that’s got a very strong core, but it's also transitioning very, very quickly. I'm just curious, as you see that the strategy exists in the core and what's going on for the future, is there anything that you think you would change or looking at specifically the change going forward or you’re more looking at sort of accelerating the process here in the early days as you join?

It’s a great question. And I think look, in today's world, especially brands like AutoNation, we have to be a constant state of innovation and transformation. It has to be a daily part of everything that we do. In this case, I couldn't agree more with Mike, I don't know that I'm here if I'm not staring at stores coast-to-coast, the location strategy, the Customer Care strategy, the brand extension strategy that's already in play and then the opportunity to really create a technology-based digital platform that can serve the car ownership need for our customers. The installed base of 12 million autos sold is just a tip of the iceberg with that we can do for our customers and because we have the brand and the scale that can be delivered. Technology is our friend in this effort. So I would say we’re going to test. We’re going to learn a lot. We’re going to try a lot of things. A lot of things aren’t going to work but that’s way we are going to learn and we are going to leverage this what’s been built here at AutoNation and I couldn't be more excited because I don’t think anybody else has a platform to be able to do that.

And John just to make one last comment because I think it’s on to the point to the issues that you raised. When we started the process led by the Board to find a successor for me and we have this criteria in mind of what we wanted in this next executive, there was quite some discussion whether we would openly find it all in one individual and I’m thrilled and excited that in fact we did. So when I look at Carl, I see a proven outstanding leader that has demonstrated the ability to move into new industries and mass-driven, that's quite something. One who's done retail, selling things one at a time, fixing things one at a time at scale, you really can't teach that, he is an operator and we are in operating business, that’s a strength we need. And he has a tremendous respect for operations. Then I look at our brand extension in parts, we need a world-class skill in supply chain logistics. That is something that we’re currently building. I would say it’s not something I grew up doing, I’ve never done it in my life, in my career. And so we very much wanted to add as a core skill set of the next CEO. So not only does Carl have that skill but he looked at the opportunity and sees what it can mean to this company and finally is the digital platform. And if you look at USAA I got to tip my hat to them, they are approaching 13 million members that are serviced by digital platform that's primarily mobile, that’s really quite something. So we found it all in one individual and then love and behold, the icing on the cake is that he is a car guy, owned a drag-strip and he was the announcer at the drag-strip as a kid growing up, it doesn’t gets better than. He has got the love and the passions for the cars -- and cars and we will teach in the ins and outs of the automobile business but there is no question in my mind that he will master it and be a great leader for this company over the next decade.

Great. Thank you very much guys and hope you stay vocal on the industry, it might be appreciated.

Oh! Yes, yes. You call me up, I have an opinion what to do.

Thank you. And our next question comes from Rick Nelson with Stephens.

Thanks, good morning. And good luck to you Mike in your new role.

Thank you.

Welcome to Carl. I want to follow-up on the servicing parts, the gross profit for the year 2018 was up $65 million. I believe your branding initiatives were supposed to drive incremental gross profit of about $100 million in 2018. If you could reconcile that difference?

Yes, Rick. So we talked about when we launched the brand extension, we’d be achieving $100 million. Keep in mind that some of that incremental growth was originally earned in 2017. So we have earned $100 million of incremental from the parts initiatives throughout '18. And you do see that in the 5%. As we talked about earlier in the year, we did have warranty headwinds during the year that offset some of that within the Customer Care business. So we're extremely pleased and you see that flowing through in the margin percent of 45%.

And fair enough.

And you also see we outperformed the peers.

And keeping in mind that when you have pressure in unit volumes, you lose some of that reconditioning as well.

Got you. So other income also $65 million $0.53 a per share that added in 2018, how should we think about modeling that going forward of the assets’ divestiture potential?

Yes, so we talked about some potential additional divestitures. It'll flow from the prior year rates. Keep in mind also that we did have some legal settlements within other income for the year as well. So I would expect reduction in that certainly comparatively year-over-year.

And finally, I'm calculating pro forma SG&A to gross profit with that $50 million and expense savings at 72%. How do you think about that going forward and I know in the past you've operated below 70%. Do you think that is still possible and with these digital initiatives and supply chain, those had actually reduced SG&A or those had caused potentially a rise?

Yes I think if you think about long-term, Rick, definitely I think below 70% will be attainable over the long-term. In the mid-term what we're doing with respect to SG&A certainly is the $50 million of cuts, keeping in mind that a portion of that will be all set this year with some of the expenses and when you think about where the pressure is going into business, it's been in new vehicle sales. So as I look at 2018 and then the potential for retail new unit sales to be down in 2019 that's in the lowest flow through part of our business. So do you think we have to be mindful of that as the index is more towards Customer Care? I expect that to helping the ratio but we're going to continue to invest during the course of the year. So we certainly believe it will be lower in aggregate SG&A in '19 verses '18. I haven't committed to how low we'll get at this point, but I do think as we consider a digital platform plays a lot of those things over time, should reduce expenses, but as you know, omni-channel investments end up crossing some of the interim as we're building it out. But it's an important part of our positioning. Particularly, auto remains cyclical business and we want to continue to be well-positioned building off of this multi-year investment that we've had in brand extension.

Thanks a lot, good luck and look forward to working with you both going forward.

Thank you Rick.

Thank you. The next question comes from Derek Glynn with Consumer Edge Research.

Yes, good morning. Thanks for taking my question, Mike wish you the best in your transition and welcome to Carl. Just want to get your read on the health and state of the average US consumer today? And along those lines if there are higher tariffs on imported vehicles, to what extent would you be able to offset a shortfall in demand or pass through higher prices to consumers and how should we think about that demand elasticity to changing price?

So auto tariffs will make the steel and aluminum tariffs look like a picnic. They will be very disruptive to the auto industry and probably not the global economy often stride significantly. And almost the way to think about them is that they're in -- there are so disruptive, it’s almost unthinkable. I think it's all about leverage and brinkmanship and the trade negotiation and at the end of the day, it's mutual disruption to implement tariffs at these levels on orders. Let alone the fact this is no underlying authority that's justifiable to do it. That it’s a national security issue when the US auto industry is healthier than it's been in decade is a stretch. But okay, that's not let any facts or clear thinking get in the way. So I think at the end of the day, it's all about negotiation. But we also know in negotiations, things can spiral out of control. And there can be unintended consequences, but I think that's a very low percentage. At the end of day that will happen, but it will be very entertaining between now and the end of the negotiation. And then we will have to read about and talk about it every day. Now, as far as the state of the consumer, it's a very interesting picture. The consumer for big ticket items, housing, auto, durable goods is nervous, because of the level of uncertainty that exists in America today around anything and everything that you want to think of. They also are at the higher price point, whether it's a home or vehicle because of what they want. It's a choice. They wanted to opt in for us at a higher price points than a car, they’re getting more vehicle for their money but that's what they want. And you combine that with higher interest rates, which are still very low and from historical point of view, but consumers aren't historians, they don't remember who fall go for low, all they know is it’s higher than the last time they were in the market. So they're hesitant around big ticket items, but that then leaves free to spend a lot of money on other stuff, that's short-term commitment that gives -- we'll definitely send the signal that the consumer is healthy in economies okay. So that's why you get such a bifurcated picture. You put it all together and I think the markets for the US is high60s with a fleet still strong. So that probably increases with a backdrop of 5% in new vehicles on -- at retail. There will be a shift towards pre-owned and certified vehicles. We view that as an opportunity that we wish to capture that shift. The total market is pretty stable all-in, Customer Care business should be absolutely fine.

We'll go to next question comes from Chris Bottiglieri with Wolfe Research.

Want to follow up with the comments earlier on, as you look into a potentially into a more asset light geographic expansion, I was curious on where you stand with the Vroom, would you be willing to harvest your own powerful brand initiative or seek greater collaboration?

Yes. I don't have an answer for that today. We have some very interesting partnerships that we try to pick someone that we believe we can partner with for the long-term on a win-win basis such as Waymo, such as Vroom. We're doing things with Vroom that's already win-win. We're very good at reconditioning, reconditioning costs and we're in discussion, can we do more to get it there? They are very good at moving into markets. Now, exactly, how that will all work out and what it all means, I don't have an answer for you today. I can’t put a number to it either to Waymo or to Vroom, what it altered the mean to the Company, but both Waymo or to Vroom are very interesting companies. We’re very happy to be partners with them. We’re looking for win-win relationship and we will keep you posted, how it develops. It just one of those where it's an iterative process and you try to find the optimal line. But the point is, we are thinking long and hard about how we move into markets without having to do it through acquisition and how do we extend geographically. I don't have an answer for you today, but we’re working on it.

And then just want to follow up earlier. You've mentioned the retails are being down. Just curious in terms of like to what extent you participant in the fleet market? I know the economics are much weaker. Some of those units periodically bypass the dealers. But wondering if you could maybe give us some context or some framework to understand to what extent at all, that all you participate in the fleet market?

Our participation in fleet is de minimis, if you’re talking about the rental car companies, they are basically purchasing directly from the manufacturers, negotiating directly with the manufacturers, and there's a pro forma system to run the title to a dealer someplace in America. And that’s a couple million units a year fleet that’s in the rental car company. Then there is some fleet businesses it's interesting where you have companies that buy 10, 15 to 20 units a year that can be interesting, but I think Cheryl overall to us, I would say as far as making money or profits, it pretty de minimis to us.

Yes, if you look at that, that’s in the other revenue line. So year-over-year for instance step down $10 million, that line is largely driven by fleet. And as you can see in total, it's very material to total results. That being said, if we have opportunities where we can provide customers care services to flee or people like drive in fleet, that something we continue to like and perceive a potentially opportunity for the right customers, in the right market structure.

And the next question comes from Rajat Gupta with JP Morgan.

Just had a question on AutoNation USA, you mentioned the fact that you know you would think about we have to wait and watch kind of strategy there. Has that changed at all or any updated thoughts there? And also what’s kind of profitability level right now for those stores?

I think we had $0.02 impact loss from the USA stores in the fourth quarter with good earnings, all very acceptable and we're making steady progress. We have no plans to build the store, an additional storage in 2019. We have five stores. We will learn all the lessons we need to find the road to profitability, consistently for these stores; and since we've already said, we're heading into our more difficult market. Overall, we're going to be very strict on both capital side and on the cost side of operation. So, while we’re doing these learnings, we don’t need more stores. We just need five and we will stick with that for 2019 and then see we’re at going into 2020.

On parts and services, pretty strong margin uptake here in 2018, and GPUs and F&I also look pretty solid. What's kind of your outlook for 2019 based on what you see in our customer base? And even if you're able to drive a little bit single-digit kind of revenue growth, could you -- do you think and can you expand margin in parts and services? And then on the F&I side, we would do with higher rate environment and the mix shift used versus new, do you think you can still see GPU growth there in 2019?

Go ahead, Cheryl.

Yes, so I think from a margin perspective, we expect to see continued strengths in parts and service margins. So, as we look at the brand extensions and the mix of business in that area, we feel very good and you've seen very consistency of us getting up towards that 45% level. With respect to F&I, I think you're seeing it accurately, the brand extension. This was our first area of brand extension in F&I products and you certainly see in the industry leading results at $1850. That being said, in an environment where new vehicle sales outpaced used -- sorry, when new is down more than used is, the blended dollar could be under pressure but we still expect very good gross profit, and there, we have very good penetration levels on service and other contracts which are branded under AutoNation. So, we feel good about the trajectory, but we do just note that the dollar blend of used is lower than the dollar blend of a new vehicle unit sale.

This is just one more on floorplan interest. You've announced the restructuring actions that you're taking, are there -- and this is action -- is there any opportunity that you see some inventory perspective to control those costs given where we are with the rates? Just wanted your thoughts there?

Yes, if you look at floorplan and what impact that, certainly, we had a 100 basis points of rate hike last year. So that puts over a $35 million headwind year-over-year. We always knew that was coming, and so that's something we always plan for and accepted within our business. We do focus on managing inventory levels. They are a little bit year-over-year, however, there still below industry average and we want to make sure we're properly positioned into the March selling season and important May selling season as well. That being said, we selectively move floorplan lenders where it makes sense. We constantly pushed on race and we're very focused on contracts and transit in partnership with the operations and finance teams to maximize that. So, I think there's some opportunity will consider inventory levels, but we do want to make sure we're positioned for selling. This has always been a known cause. If you go back five, six years ago, we always predicted and expected to absorb it within the business. But it is a headwind, I think the good news is I don't expect for rate hike this year in 2019. We may not get any. We may get two. We will have a full year impact this year before rate hikes last year. So, there will be some increase so our focus is really managing contracts and transit and keeping appropriate inventory levels.

Again next question comes from Bret Jordan with Jefferies.

On the brand expansion strategy around parts, could you maybe give us an idea what inning we're in? Maybe how many SKUs we have? And I guess from Carl's perspective, given his supply chain background, I mean, how broadly do you expect to stake such strategy? I mean how many SKUs, Mike, you have in the future?

I don't know what Carl can tell you, how many SKUs we're going to have. I think it's a little premature, but more on year early innings. It's a tremendous opportunity and issue is in demand. Our issue is execution. That's how I'd describe it. And that's going to be a tremendous concentration of Carl over the next year and let's give him a few months to give you a compressive answer there. I think the fact that that was we -- in our criteria for the next CEO that it's crucial that the individual had supply chain logistical expertise of the world class level. We wouldn't have done that if we didn't think there was a remarkable opportunity. So there's your answer.

And this next one sort of a bigger picture on used. I think you're talking about a bigger shift at used and pre-owned as well. I think one of your competitors a couple days ago, when they're discussing their dedicated used strategies. So their frontend margin was effectively zero. And I guess with so many folks out there whether it'd be online strategies or brick-and-mortar guys focusing in used. Do you see anybody acting less rationally around margins in used to get volume with all the new entrants? Or is the market fairly stable?

Oh, no, I mean we have Carvana out there that is all in has a -- it's probably the most aggressive or whatever word, irrational, irrational front margin policy, all in combined. So, we have to deal with all of that. But I -- listen the pre-owned business is far more rational all in the new vehicle business and we have more control the entire universe and that it's an arbitrage between your ability to acquire, recondition present something that's not a commodity to a consumer and then sell it. So I'm much more comfortable in the pre-owned and competitors with very aggressive pricing. They have a question of how long they can do that, how long they can raise capital to fund losses and then you have to have a road to profitability. So, everybody has to face it. Now, you enter the new vehicle business, that's really a different world where it's controlled by -- the marketing strategy is controlled by the manufacturer. And there's not much we can do about it, we just do the best -- the just best we can with a go-to-market approach that's fundamentally misaligned with what the customer wants and what you should do to build a brand and that remains frustrating, but I despaired that in my lifetime, it'll get resolved.

Taking our next question comes from Armintas Sinkevicius with Morgan Stanley.

Mike, you haven't interacted a whole a lot of, but I know the -- my predecessors in the firm have a tremendous amount of respect for you. So that's what we look going forward, and Carl, look forward to getting to know you're here. Maybe my first one for Carl, I know its early days, but when you look at the digital initiatives and in the strategy there. What are some similarities that you see between your experience at USAA and AutoNation? And what are the some differences so some things you could bring along and some things you may have to do differently, just at a high level glace that you had so far?

You bet and I think this is, first of all, I have a lot to learn and recognize that I want to harness the knowledge only Mike, but also the 26,000 associates that are here at AutoNation. And so probably from an operator's perspective, I believe the answers is here in the stores. And the only way to find those answers is to get out and ask your teammates, like what gets in the way, the way customers want to shop and how do we enable that to go make that happen? So to your earlier point is a little premature for me because I need to shop more stores, they need to walk with my leaders that actually been doing this a long time and need to have those conversations that how do we enable that customer shopping experience, both present and in future. Your translation I think what you're asking is, how do you translate a brick-and-mortar to digital, and I had privilege to be on both sides of that equation. You’re saying we don't have agents, we don’t have branches, we have to do things through technology and mobile and phone and increasing through voice, so Alexa and Google Home and thinking about those kind of things. So, the beautiful thing about it is, I don't have a constraint there and I have to innovate around that whether taking a picture of your check and so you can deposit because I don't have branches for you to deposit your checks. We have to innovate and own that pattern to be able to deliver that. On our side though, I think the trick and it’s not really trick, but it’s understanding what the data is telling us and getting that data in the hands of our store managers, our general managers, our customer care associate, and allowing them to tailor the shopping experience or the service experience of the customer based on what they want to do, and I think that's the secret to great brands like Home Depot or USAA. We’re going to serve you the way you want to be served, not the way that we want to serve you. And I think the nuance conversation, but in this case AutoNation because of our J.D. Power awards, our coast-to-coast, I will call it breadth and depth, we have the ability, the question really is how do we leverage the data to know when a customer wants to come and spend three or four hours and getting every vehicle and spend a lot of time and be on the lot and enjoy that experience. Or how do we deliver that to the example that we talked about already is, I want to complete end to end digital experience, and I want the automobile delivered to my front driveway. Those are the great things that I think omni-channel brings but you are going to start with the data, you have to start with the data what your customers are asking for and then you have to use a little design thinking and go a little deeper and understanding of what and why and then from there you count on great people and processes to bring that together. And so I actually love the idea of owning the last 5 yards finally, we have the store so we own the last 5 yards, which is the most important in the customer care effort and we have the locations, so like our changes.

And Mike one for you, just as you think about the AutoNation USA, lessons learned here and continue the evaluation of the initiatives here. We’re seeing a number of dealers try to pivot to standalone used car business. Maybe you could talk about some of the puts and takes there, some of the 230 challenges so to say as we think about what you're evaluating what we think others should be evaluating as well?

Well, so it can be successfully done, I mean, we’re not trying to put a man on Mars here. So, I remind everybody from that from time-to-time when there's some frustration. And then when your benchmark some -- we benchmark the competition and see, what they're doing that we're not that needs to road the profitability. And we've made a number of our assumptions that we had going in and proven to be invalid, unless what would we call that, mistakes. So we've made our mistakes and we faced up to them adjust, and now we probably on our fourth iteration of mistakes. But on every time it gets better, and I don't think there's any maybe the next call we can take you through every one step-by-step. But we're on the way, we're optimistic we're confident. We're going to give it another year. There's no reason to invest more though until we have we figured out. You don't need more than five stores to figure out what works and what doesn't work. And once we have that we'll tell you what the ingredients were on the road to profitability and why we're confident that then we would announce building additional stores.

Okay, great. Thank you.

And I would make one more comment on that. So, if I step back and look at the entire portfolio of brand extension that was launched, the other side of this coin is, within our company now it's a competition for capital as to which brand initiatives produce the highest returns the fastest. So far in that competition, clearly, the USA stores are the caboose. So there's good news and bad news in that, if you follow me. So, not only do we have to find the road to profitability, but they're going to have to get over investment hurdle that matches or beat other brand extension. So, there's good news and bad news and what I'm telling you.

Our last question comes from Colin Langan of UBS.

Just more basic question. Why the underperformance in Q4 is mostly on unit side, on the new side, new units? Why is it geographic or brand mix over the major drivers there?

One of our largest states was on fire for just about the entire fourth quarter and if you look up the J.D. Power, retail industry numbers in the entire state of California was down 9% in retail sales in the fourth quarter. And so there it is, so California. Then we had difficult comparisons, particularly in the state of Texas with this snap back in 2018 from the hurricane that occurred in third quarter of 2017. Then overall, there are headwinds in new vehicle sales and managing headwinds is always difficult, but that would be the third issue. There is when you have that kind of disruption in your new vehicle business, you're trading flow into your pre-owned is not exactly what you had planned, and it's hard to adjust your stocking through the precipitous slowing trades coming in. So, you have to manage it. So, it all started with the disruption in California in the fourth quarter for the entire industry, which also impacted us. And then we have the comparison with the state of Texas after the hurricane. That's principally the story. We managed it as best as we could, but it was challenging.

I would want to say, we still think overall it's going to be a difficult market and retail in 2019. I'll say that right up front and if you look at J.D. Powers numbers, we've got printed for United States in the month of January was down 6. So that was exactly what we've had predicted 5 for the year and first number out in the box is minus 6. So again you have to be very careful on that headline number for January where the industry was down one. But you know you got to adjust, you got to wait, take a deep breath, count to 10 and then the fleet number comes out, and then you adjusted, you see what's happening in the real economy in the world that we live in and that was minus 6, as we took the costs measures already well underway in the fourth quarter, very going into this year. And that was my gift to Carl. I said, let's get it's done. Why, it's on my watch, I know exactly where to get the 50 million and what to do and let's clear the decks for the new CEO and that's what we do. So, everyone, thank you for joining us today, it's been a great discussion. Thank you for your very interesting questions. We're happy to answer them for you. And off we go and for me to you Carl, I'm thrilled to hand you with the baton.

Thank you.

I'm thrilled to hand you the baton. There is no question in my mind that we have a great leader for our company for the next decade for us. Thank you everyone for joining us today.

Thank you. This concludes today's conference. Thank you all for joining.