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«AMERICA’S LARGEST AUTO RETAILER The Future of Auto Retailing Letter to “In the same way that AutoNation is not your typical auto retailer, this ...»

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The Future of Auto Retailing

Letter to

“In the same way that AutoNation is

not your typical auto retailer, this report

is not your typical end-of-year recap.

We’re going to talk about what makes

AutoNation run - how we successfully

laid the groundwork for an industry-leading

company, how we’ve executed a strategy that’s changing what it means to buy and own vehicles. We continue to set standards that all other retailers measure themselves by.

But even more than that, it’s about how a talented team with vision and tenacity can achieve unprecedented results on an unprecedented scale.” After 41 years in the automobile business, I’ve seen it all from every level – back shop, showroom floor, Mercedes-Benz dealership, corner office – and I can say I have never been more optimistic about where it is headed than I am today. The U.S. economy is improving, consumers are becoming more confident, and sales are going up. The vehicles we sell are more reliable, enjoy better fuel economy, and are made with higher quality than ever before; faster design changes, as well as new safety and convenience electronics, are energizing customers. These are good times.

Shareholders Luck is what happens when preparation meets opportunity, and thanks to strategic decisions we have been implementing for over a decade, AutoNation – the nation’s largest auto retailer with 258 franchises in 215 stores at the end of 2011 – is uniquely positioned to benefit from the lifting of the economic clouds by building on our extraordinary performance in 2011. We reported record EPS (earnings per share) and made progress toward building the digital dealership of the future.

Barring unforeseen calamities, such as the earthquake and tsunami that struck Japan with such tragic impacts a year ago, I am optimistic that when I write this letter a year from now, I will be able to report an increasingly bright sales picture and the continued rollout of our industryleading efforts to make every phase of car and truck ownership a customer-pleasing experience.

Historically, the auto business has followed the ups and downs of the economy, but at AutoNation we are not waiting around for the next wave of buyers to wash in; we are erecting a corporate culture andtechnology infrastructure that is built to last. Our goal is to hire the best people, train them in our own facilities, use best practices across all our dealerships, and make our interactions with customers simpler and more transparent. It hasn’t always been easy, I can assure you. Auto retailing is more than a century old and ingrained practices are hard to change. There is still hard work ahead. But I am convinced that your company is developing a sustainable advantage that will be difficult for any competitor to duplicate within the foreseeable future.

–  –  –

Despite partisan divisions, budget worries and threats from abroad, America is still a great place to do business. To paraphrase Winston Churchill, the U.S. economy looks weak until you look at all the others. Europe appears to be heading into a second recession and China is cooling off at the same time that the U.S. is adding jobs and growing GDP. The Detroit Three are healthy again and profitable despite historically low industry sales levels, and have wisely given up their selfdestructive practice of production push. Building more cars than they could sell without enormous incentives, as I have stated many times, was like a vampire sucking blood out of the industry.

Regrettably, it took the bankruptcy of General Motors and Chrysler to bring them to their senses.

Based on the numbers, you can’t help but be excited about the prospects for the auto business.

We expect U.S. industry new vehicle sales to reach 14 million units in 2012, up from 12.7 million last year, and even higher sales look likely in the following years. The average age of the auto fleet is now 10.8 years old and even though cars and trucks last longer these days, they can’t go on forever.

Some 12 million to 13 million vehicles are scrapped every year and need to be replaced. Another one to two million sales over the next few years will be driven by the expected formation of a million new households each year. I expect changing fashions will also play a role in accelerating activity.

New models stimulate sales and automakers are making over their fleets more frequently – now at the rate of 25% a year. A few years ago, the redesign rate was often at an average of 15%.

In addition, auto financing is more available than it has been in recent years. Capital is abundant, money is available, and car buyers are a good credit risk. A little known fact is that people are more likely to default on a mortgage than they are on a vehicle loan. The reason is they can usually find another place to sleep but they always need transportation. Leasing has returned to more responsible levels, and represents 20% or so of sales.

The results we reported for 2011 show that we are well-positioned to benefit from the rebounding market. We retailed approximately 400,000 new and used vehicles through our stores in 2011 vs.

approximately 367,000 in 2010, and those sales were quite profitable. A new vehicle that we sold in 2011 delivered an average of $33,472 in revenue and produced $2,445 in gross profit, up 12% from the prior year. New car sales have a domino effect; they generate trade-ins we can resell as The Future of Auto Retailing used cars, purchases of financing plans and extended warranties, and service business. All helped contribute to our record performance in 2011, as our EPS from continuing operations rose 30%.

AutoNation reported net income from continuing operations of $284 million, or $1.93 per share. We also reported buying back 17.1 million shares of our own stock during the year.

–  –  –

Honda of Dulles, Sterling, VA AutoNation is now reaping a return on investments we began making 12 years ago. When I joined the company as CEO in 1999, I had a vision for the kind of enterprise I wanted to build – one that would use technology to create a new ownership experience for customers and enable new efficiencies for our operations. It has been a long haul that requires work from the ground up. You don’t build a new corporate culture with wall posters and pep rallies. With Mike Maroone, my longtime partner and president and chief operating officer who grew up around the auto business from the age of five, we redefined the car-buying business.

We spent my first three years on the road evaluating 350 of the company’s key executives.

We were looking for managers who combined the skill and energy of an entrepreneur with the ability to operate within the structure of a publicly-owned corporation. Traditionally, auto retailing has been populated by dealers who were good at cutting deals, but sometimes took shortcuts and operated on the other side of the tracks. I wanted people with the highest integrity and ethics who were more interested in processes than transactions, and wanted to be part of something big. And oh, by the way, they had to be passionate about the auto business. It’s demanding, competitive, and the hours are long – you have to love it to be the best at it.

Back in 2000, as I dug into my personnel review, I discovered that only 50% of our managers fit our profile or had the potential to change. 50% did not, including a few top producers. Most of them had to be separated from the company, which produced a collective outcry from the survivors. It was a moment of truth, but there is no room in our organization for solo acts. The entire process took six years and has been the foundation of the culture we have today. One thing in our favor was that AutoNation presented a unique opportunity for industry professionals with the right skill set.

Our next big task was to change the relationship between manufacturers and retailers. Nobody dictates to Wal-Mart how they are going to take orders, ship product, and collect payment, but that’s how the automakers operated. Factories ran just-in-time production, but distribution was order-and-wait. They wouldn’t allow us to integrate our inventory management and ordering system with their production systems, so paperwork clogged the works and market intelligence turned stale. We waited over three months to get some deliveries. That purple sedan with whitewall tires parked in back of the lot? That came from a manufacturer who reacted too late to changed customer preferences. The only way to bridge the gap between unsuitable product and a resistant customer when that kind of mismatch occurs is by lowering the price. Today we have a proprietary sales forecasting and inventory management system.

With our suppliers on board and our management team in place, we began a long-term effort to put information technology to work enhancing customer relationships and improving productivity. High on our list of goals is to enable a customer to buy a vehicle, make a trade, and complete the process before taking delivery at a retailer. It has so far taken seven years and it has been expensive – we have some 180 people working in IT – but we couldn’t have afforded it without our scale. When we are done, we will have a capability that is enjoyed by no one else, and because of our size, it will be very difficult to duplicate.

We have begun to develop AutoNation Direct, our vision for the future. Using a computer or a smartphone, customers will be able to shop for a vehicle by make and model, lifestyle, and functionality. With our Smart Choice program, they already get an easy-to-understand sales menu that lists the purchase price, suggests financing options and calculates monthly payments. Standardizing a process like this hasn’t been easy. Last year, we had to incorporate tens of thousands of vehicle incentive programs into our pricing model.

The Future of Auto Retailing

–  –  –

AutoNation’s strategy has been consistent and it is one that we have followed for a decade: We believe in market density. Our goal is to represent every major brand in the markets where we operate.

The Future of Auto Retailing House of Imports, Buena Park, CA As they begin to narrow their choices, customers will be able to start to take advantage of AutoNation’s unique scale. Customers today have begun to shop by vehicle type. They may want to look at prices and features for half-a-dozen small crossovers from different manufacturers. In most cases, that would require visiting multiple websites or multiple retailers. But AutoNation is able to offer one-stop shopping. Remember what I said about market density? We concentrate our stores in 15 selected markets where we represent as many as 32 brands. That means customers can, say, compare a Toyota Camry with a Ford Fusion.

There’s more. With AutoNation Direct, buyers will be able to identify an actual vehicle on a retailer lot, schedule a test drive, value a trade-in, and then negotiate a price. By utilizing market price data from third party sources like Edmunds.com and Kelley Blue Book, we have greatly narrowed the potential bandwidth for bargaining and simplified the process. After the sale is completed, our digital connection with the customer will remain in place. Owners will receive electronic reminders about scheduled service and get assistance in making appointments. While their car or truck is in the shop, we can communicate with them on work to be completed.

Traditional bazaar-style haggling has a limited future in the showroom of tomorrow. Deals will no longer be taken into the back room for some sharp-pencil calculations. We would like to see our sales associates follow the example of Apple stores and become our resident “geniuses.” Digitizing the sales process will pay big dividends in the back office as well. We have already centralized store level accounting at our Shared Services Center in Irving, Texas and lifted a heavy burden of paperwork and data entry. Government regulations make buying a car complicated and the average deal generates 65 different pages. Instead of the retailer inputting the data multiple times, we can scan all of the forms and store the data in a central location. We started rolling out Shared Services in the Texas region in 2004 and will have it in place for our entire network by 2013.

It has already provided us with a valuable cache of data and cut our accounting costs significantly.

Our new digital capabilities will also help us monitor activities at the retailer level. Individual general managers will be able to watch all the critical functions of their stores – new and used vehicle sales, finance and insurance, service and parts – on a real-time basis and compare their performance to prior periods day-by-day. They can also measure individual employees on their productivity. We call it the Daily Tracker, and it will be in place at all our stores by the end of 2013.

Our store-based system for cars and trucks has served us well over the years. But like everything else, the system can be improved. We believe we have put in place an industryleading infrastructure for engaging and satisfying customers that will not only serve our company well but also will be very difficult for our competitors to duplicate. We thank you for your support over the past year and we hope to continue to deliver outstanding performance as the largest and most profitable auto retailer in the United States.

Mike Jackson Chairman and Chief Executive Officer

–  –  –

Land Rover of Encino, Encino, CA Operations Success in the auto retail business means focusing on the big picture while not losing sight of the details. We want to delight our customers and improve our operating efficiency by using best practices across our industry-leading scale. That means everything from replacing new model brochures on glossy paper with digital ones to adopting a web-based customer relationship tool to facilitate a better understanding of our showroom traffic activity.

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