Earnings Call: Q1 2019

Apr 23, 2019

Good day, and welcome to the Asbury Automotive Group Q1 2019 Earnings Call. Today's conference is being recorded. At this time, I would like turn the conference over to Mr. Matt Pattoni. Please go ahead, sir. Thanks, operator, and good morning, everyone. Welcome to Asbury Automotive Group's Q1 2019 Earnings Call. Today's call is being recorded and will be available for replay later today. The press release detailing Asbury's Q1 results was issued earlier this morning and is posted on our website at asburyauto.com. Participating with us today are David Holt, our President and Chief Executive Officer John Hartman, our Senior Vice President of Operations and Sean Goodman, our Senior Vice President and Chief Financial Officer. At the conclusion of our remarks, we will open the call up for questions and I will be available later for any follow-up questions you might have. Before we begin, I must remind you that the discussion during the call today is likely to contain forward looking statements. Forward looking statements are statements other than those which are historical in nature. All forward looking statements are subject to significant uncertainties and actual results may differ materially from those suggested by the statements. For information regarding certain of the risks that may cause actual results to differ, please see our filings with the SEC from time to time, including our Form 10 ks for the year ended December 2018, any filed quarterly reports on Form 10 Q and our earnings release issued earlier today. We expressly disclaim any responsibility to update forward looking statements. In addition, certain non GAAP financial measures as defined under SEC rules may be discussed on this call. As required by the SEC rules, we provide reconciliations of any such non GAAP financial measures to the most directly comparable GAAP measures on our website. It is my pleasure to hand the call over to our CEO, David Holm. David? Thanks, Matt, and good morning, everyone. Welcome to our Q1 2019 earnings call. During this quarter, we achieved record Q1 adjusted EPS of $2.20 a 14% increase over last year. Strategically, we are focused on operating our business as efficiently and effectively as possible, while at the same time investing for the future. We continue to make good progress executing on our vision to be the most guest centric retail automotive company. Our focus is on creating an unparalleled guest experience by transforming the way our stores operate, including staffing, training, processes and the utilization of technology. We are piloting innovative processes that together with new technology save our guests time, enhance their shopping experience and allow for a seamless transition between online and store based interactions. At our pilot store, guests can now purchase a car in a fraction of the time that it would typically take at a traditional car dealership. In addition, we have introduced self-service kiosks in the service lane and we are receiving excellent feedback on the speed, convenience and transparency of the process. Very soon, guests will also have the ability to track online the progress of their car through service or repair process, further enhancing both transparency and the guest experience, while at the same time reducing the number of inbound status calls. This holistic transformation of our business will take some time to perfect and roll out across our stores. We are excited about the potential for our business. I will now hand the call over to Sean to discuss our financial performance. Sean? Thank you, David, and good morning, everyone. The Q1 marked another record performance with adjusted earnings per share of $2.20 Overall, compared to the prior year Q1, revenue increased by 4%, gross profit increased by 5%, gross margin of 16.7% was 20 basis points higher than last year. SG and A as a percentage of gross profit improved by 100 basis points to 68.4%. Adjusted operating margin increased by 30 basis points to 4.8%, adjusted income from operations increased by 10% and adjusted earnings per share increased by 14%. Net income for the Q1 of 2019 was adjusted for a $2,400,000 write off of fixed assets equivalent to $0.09 per share. In Q1 2018, there were no adjustments. Our effective tax rate was 23.8% compared to 24.9 percent in the Q1 of 2018. This quarter, we benefited from certain expect the tax rate for 2019 to be at the lower end of our guidance of between 25% 26%. Looking at expenses, SG and A as a percentage of gross profit for the quarter was 68.4%, an improvement of 100 basis points over last year. This is a very solid performance, especially considering the continued investments in our vision for the future. With the Q1 behind us, we now expect to be at the lower end of our target annual SG and A as a percentage of gross profit of between 69% 70%. With respect to capital deployed, we acquired 4 dealerships, spent $9,000,000 on capital expenditures and $7,000,000 repurchasing our common stock. Our potential acquisition pipeline continues to be robust and our remaining share repurchase authorization stands at $74,000,000 At the end of the quarter, our total leverage ratio stood at 2.9 times and our net leverage ratio at 2.4 times. While a 2.4 times net leverage ratio is a little below our targeted range of 2.5 to 3 times, we believe that our financial flexibility allows us to capitalize on expected attractive future capital deployment opportunities while taking into consideration the economic cycle. As we think about the economic cycle, it is worth noting that almost 50% of our gross profit is generated by the relatively stable parts and services segment of the business. Indeed, during this quarter, we were able to grow total parts and service gross profit by 8% and same store parts and service gross profit by 6% despite a 2% decline in SAAR. Floorplan interest expense increased by $3,600,000 over the same period last year, driven by increases in the LIBOR rate and inventory levels. We believe that we have an opportunity to reduce our inventory levels and improve our inventory days outstanding during the remainder of the year. From a liquidity perspective, we ended the quarter with $11,000,000 in cash, dollars 45,000,000 available in floor plan offset accounts, $107,000,000 available on our used vehicle line and $152,000,000 available on our revolving credit lines. Note that effective January 1, 2019, we adopted the new lease accounting standard ASC 842. In summary, the impact of the new standard is to establish a right of use asset and an associated lease liability on the balance sheet for all leases with terms longer than 12 months. There was no material impact on our income statement from the adoption of this standard. I would now like to hand the call over to John to walk us through the operating performance in some more detail. John? Thank you, Sean. My remarks will pertain to our same store performance compared to the Q1 of 2019. Looking at new vehicles, while SAAR for the quarter was at 16,900,000 units or 2% below last year, we focus on retail SAAR, which was down 4% for the quarter. In this lower retail SAAR environment, new unit sales decreased 1.5%, outperforming the market. Overall, our new car margin was 4.3%, down 20 basis points from the prior year period, but flat for the last three quarters. While import margins were flat from the prior year period, domestic margins were down significantly. Our total new vehicle inventory was $973,000,000 and our day supply was 87, up 21 days from the prior year. While our new vehicle inventory is higher than we would like, we are working diligently to bring our inventory levels back to our target range of 70 to 75 days. Turning to used vehicles. We are pleased with our gross profit margin of 7.2%, which while down 20 basis points from the prior year is up 30 basis points from Q4 2018 and represents a gross profit per vehicle of $15.76 up $13 from last year. We are however disappointed that our used vehicle unit sales decreased 1.4% from the prior year. Our used vehicle inventory of $153,000,000 is at a 21 day supply. This is the same as last year and slightly below our target range of 30 to 35 days. Turning to F and I. Our team continues to deliver strong results. Total F and I gross profit increased by 1% and gross profit per vehicle increased by $39 to $15.85 from the prior year quarter. When we think about gross profit per vehicle, we look at the total front end yield, which combines new, used and F and I gross profit. This provides the best view of our true profit per vehicle sold. In the Q1, our front end yield per vehicle increased to $3,159 from $3,147 last year. Note that our front end yield has remained stable over the past decade. Turning to parts and service. Our parts and service revenue increased 7% and gross profit increased 6%. This was achieved with a 7% increase in customer pay and a 12% increase in warranty. Reconditioning work within parts and service was flat versus last year. Finally, we continue to build our digital capabilities to enhance the guest experience in both sales and service. The rollout of our centralized brand certified digital sales team continues and stores participating in the program see significant increases in digital sales. Our PUSHSTART online sales tool handled over 3,600 vehicle sales in the quarter, which is up 19% from the prior year and represents approximately 8% of our total retail units. We continue to grow the traffic utilizing our digital parts and service scheduling tool and we reached a record of 120,000 online service appointments, which is up 28% from the prior year. We are excited about the development of our omni channel driven growth, which is part of our vision to be the most guest centric automotive retailer in the industry. In conclusion, I would like to take this opportunity to welcome our new team members from the Bill Estes Group that joined Asbury this quarter and expressed appreciation to all our teammates in the field and our support center who continue to produce best in class performance. We will now turn the call over to the operator and take your questions. Operator? Thank you so much. And we'll take our first question from Rick Nelson of Stephens. Thanks. Good morning. Great quarter guys. SG and A, if you could discuss the driver there to that 100 basis point improvement and the guidance of 69% to 70% suggests the ratio goes the other direction up 50 to 150 basis points and the drivers also of that guidance, if you would? Hi, Rick, it's Sean. So a couple of things on SG and A. Firstly, SG and A management, as you know, is part of our DNA, the efficient and effective management of SG and A. And fortunately, the majority of our SG and A expenses are variable. This quarter, we benefited by the business mix. As you saw in our results for the quarter, parts and services was the strongest growth area, growing our overall parts and services gross profit by 8%. So this resulted in a higher mix of parts and service in our gross profit. And as we show in our investor presentation, the flow through from gross profit to operating profit is higher for parts and services than for the rest of our business. So we definitely benefited from that this quarter. We're continuing to invest in the future in our omnichannel initiatives. And what we saw this quarter is that some of these investments that started not this year, but in previous years are starting to generate a nice return both from a gross profit point of view and from a cost savings in other areas of the business point of view. But we control the timing of our investments in the future and our omnichannel initiatives. And that's why when you look at our guidance for the full year 2019, we're saying that the SG and A will be at the lower end of the 70%. That's really related to the timing of when we spend the money on our omnichannel and future investments. The quarter started off relatively slow, if you just look at the SAAR numbers in our business as well. And so we govern the timing of our investments in those areas during the quarter, but we do expect to see higher expenses per quarter for the remainder of the year than we saw in the Q1. Thanks for that color. Can you discuss what these omni channel investments are exactly? Obviously, the brand centralized teams are that's part of it, but anything beyond would be helpful. Sure, Rick. I'll take a shot at it. This is David. We're kind of looking at the whole ecosystem of the automobile retail business. So from the online, I mentioned briefly the script, from the online piece to the interactions within the dealership, we're trying to look at areas of opportunity to reduce our staff levels, to be more productive using technology, being flatter and more transparent in how we choose to do business in both sales and service. So initiating the kiosk that we that I mentioned in the service lane is a start for us. I made mention about tracking your car while it's being repaired every step through the process. We don't think it's in our shareholders' best interest to go out and invest in software companies. We think our core competencies are selling and servicing cars and trying to be the best at that. So our differentiator is our guest experience. But we like to partner with software companies and share our ideas and get them to see that this is accretive for them and a good investment for them because they'll be able to sell it to other dealers as well. We think the whole space eventually ends up in the same place. We just think that we might be a little bit ahead of others how we look at it. So, we started this a few years ago with consistency of online sales, handling the leads and calls. But naturally, it's more of a transformation than that between the service appointments, communicating with the customer online, how quickly can we do a transaction, where is the best software application to use, how can we use the marketing and digital team that we have to integrate with that. And then naturally, our best resource, which is our teammates in the field, who we think operate at a high level. Thanks, David. Also, I'd like to ask you about used cars. The units dropped, fell a bit short of where we were thinking, if you could discuss what happened there and the opportunities going forward. Hey, Rick. Good morning. This is John. As I stated in my remarks, we were disappointed being down 1% in volume for the quarter. As a company, we actually had markets that were up and used volume and some significantly. We did have a couple of markets with some personnel issues. Those personnel issues led to some process issues that affected our results. We're correcting those now and don't see this as an issue moving forward. Got you. Thanks and good luck. Thank you. We'll next hear from John Murphy with Bank of America Merrill Lynch. Good morning, guys. Just a first question on the front end gross or front end yield, I should say. I just wanted to approach this from 2 different perspectives. I mean, as we look at the new vehicle margins, they're coming under a little bit of pressure, but it seems like that's abated to some extent and you're handling it well. But you did highlight some pressure on new vehicle margins for domestic. So I'm just curious what's going on there? What you're seeing? I mean is this Dodge getting or I should say Ram getting more aggressive with the pickup? Or is there something else going on there on the domestic side that we should be thinking about on new vehicle grosses? So John, this is John Hartman. A couple of issues affecting the domestic margins for us. First, most of the domestic brands have decreased the incentive money available over the past couple of years. They've made changes to their programs. One brand specifically made a significant change to their program this year, where if our performance was the same, the incentive money would have been much less to earn. 2nd was more on us as a company. We had 1 brand where our new vehicle volume where it shouldn't be, should have been much better and we need to perform much better with that brand. So to answer the question, it's really a mix of the incentive money available and the one brand where we could have performed better in the quarter. But there's not a wholesale change where these guys are getting more aggressive in the market with incentives that is putting a pressure on new vehicle grosses. Is that part of it? Or it really is just this performance side of the equation? Yes. It's the overall programs and the performance on that one brand. Okay. And then the other angle on the front end grosses is F and I PVR has been incredibly strong for the past 3 years. You guys are doing a good job of managing it. There's been a lot of concern that as rates rise that F and I PVR may come under pressure. But with sort of the more recent outlook on rates maybe going back down, we'll see where this goes. Have you seen any change in F and I, PVR, any activity there in the last quarter or 2 that may have been a little bit of a headwind? And then if rates actually go back down, there could be a little bit of headroom in F and I PVR as we go forward? As a company, John, we really focus on product, which represents about 70% of that number that you see. So we try to focus more on the product sales than on the rate. Okay. So I mean based on what we're looking at right now, it doesn't seem like there's significant risk to the F and I PDR? No, I wouldn't say so, John. In doing this for a lot of years, as the rate floats up or down, the consumer amazingly absorbs it well and the industry kind of keeps their piece of it, so to speak. I think to your point, if the rates decrease, there's going to be a tailwind, but I think that's going to be more I don't know so much in the PVR, but in the actual unit sales themselves. As John pointed out, only 30 percent of our PVR is rate. The rest of it's product, and we're actually trying to increase that above 70%. So, we our rate margin is very small. Got it. Okay. And then just lastly on parts and service, customer pay had a good bump up 7% same store this quarter. I'm just curious how much of that you attribute to sort of the market dynamics of more 0 to 5 year old vehicles that are out there for you to service or UIOs really? And how much of it is sort of the online booking efforts? It might be hard to decompose, but I mean if you could talk about those two factors and how sustainable sort of this mid to high single digit same store sales growth number might be going forward? This is David, John. I think it's sustainable for a long time. This is an area that dealers have really been haven't been focused on as they should have been for years years years. And the average dealer retains 50% of their business. So the potential out there to grow is dramatic. Yes, I'd really like to credit our folks in the field. We've implemented new technology over the last few years. Our simplistic look at things is if you can account for it, you can improve upon it. We're really starting to work well with our new software and really starting to get better at what we do. We're more efficient. We're more productive. And they're generating more dollars while continuing to grow the traffic count. So again, we still have a long runway and a lot of room to improve, And certainly, none of us are performing at 100% retention from a customer standpoint. So I see it sustainable for a long period of time and I see continued growth. Great. Thank you very much. Thank you. Next from Jefferies, we'll hear from Bret Jordan. Hi, good morning guys. Good morning. Good morning. A quick question, I guess on new units in the quarter, could you talk maybe about the cadence? Obviously retail was down 4% industry wide, but did you see either an improving trend as rates were sort of in the news as holding steady or weather or tax refunds or any timing that allowed the quarter to end or to start or end stronger? Hey, this is John. January February kind of started off as expected. The retail saw in January February was extremely low, lowest it's been in a couple of years. We saw March bounce back pretty well. So, we were excited about that and we were happy that even though the market was down overall, we still outperformed it, which has been 3 or 4 quarters in a row now. Okay. And then on parts and service, the 12% growth in warranty, is that the front end of another airbag repair cycle? Or is there anything that's driving that that should factor in going forward? I think our comps were probably pretty, easy last year as you saw the decreases. So I think it's more just that we were up against easier comps last quarter. Okay. So no particular driver of warranty going forward? Between luxury and port and domestic, all segments are actually up in warranty year over year. Some brands are backwards. But I would say, to John's point, last year, this quarter was a little bit soft for us on the warranty side, so a little bit more. But it's fairly consistent and generally smaller warranty issues than the large airbag stuff. Okay, great. Thank you. And from Morgan Stanley, we'll hear from Artemas Sinkevicius. Please go ahead. Good morning. Thank you for taking the question. Just wanted to polish up a few things. I think the guidance for parts and services was for mid single digits growth year over year. It seems like you've gotten off to a good start. Just any sort of updates there? Could we expect that to be better? Any reasons why it can't be? I think we bounced around a little bit, and last year was a little choppy for us. So we're very pleased with the way we started off the year and the initiatives that we have and where we're going, but we still feel comfortable giving that for guidance. Okay. And then the front end yield you were managing for about 3,100 and new GPU would be down year over year. Again, new GPU started off well. Any reasons why that can't be better on a year over year basis? On the news side, this is John, 60% of our volume comes from the import segment, which as you can see has the tightest margins. So I think that we've been pretty flat the last few quarters with the margin. I don't see that going down at all. We should be able to maintain it or maybe a slight improvement. Okay. And then anything to call out from a geographic perspective, certain parts of the nation performing better or worse than others? Yes. This is David. I would say we're mainly in the Southeast from Virginia over to Texas and Indiana. I would say it's for us, it's very stable in all the markets. And any hiccups that we had, specifically in news that John talked about, were isolated to personnel issues in certain markets. So pretty consistent, pretty stable for us. Texas did well. Florida did well. Georgia, the Carolinas, very consistent for us. Great. Thank you for taking the questions. Thank you. We'll next hear from Chris Battaglia with Wolfe Research. Hi, thanks for taking the question. This is Chris Bottiglieri. Wanted to ask maybe a theoretical or somewhat a quantitative question, but I want to try to understand how reliant industry is on manufacturing incentive to dealers. Is there a way to contextualize how much lower your gross profit per unit would be if you didn't earn any manufacturing incentives? And how has that contribution from the OEMs changed in recent years? Yes. I talked about it with the domestics. We track the available incentive money by manufacturer every month, every quarter. We garnered just under 90% of it last quarter. It's a material impact to the stores. So that money is very important to the profitability. But we can't control what the OEMs putting out there for incentives and they do change the programs periodically. Got you. And when you say it's periodically, do you think it's getting worse? Is it being less supportive directionally than they have in recent years? Or as you said, have you seen any material changes such as one OEM? Just maybe like at an interesting level, I'm trying to understand. Yes. There's been some of the domestics, have made some significant changes to the programs. But for lack of a better term, sometimes they just move the cheese around and you just got to accomplish the goal in a different way. Got you. Okay. And then maybe similar line of questioning. So you've already like I mean, it's been pretty amazing how well the profitability has stood in there as your import gross profits have really bottomed out. Is there a reason is there something structural about import, whether it's like volume per store or something like that, that if like if domestic came to that same level of GPU as import, would you still be able to achieve that same profitability? Yes. I would say every brand is a little bit different. But when you think about imports, most of our costs are variable. I understand your point about the low margin. But again, when you think about the total yield, how strong our F and I numbers are, Our parts and service numbers are generally very strong with our midline imports. And when you're doing a lot of new car volume, you take in a lot of trades, which allows you to do really well at the used car. And again, we look at the used car, the reconditioning profit that service gets, obviously, the front and the back end grow. So, while that margin looks very low, some of our most profitable stores in our company are those midline import stores. And again, credit to them, they're very efficient at running their business, and they're very strong in areas that they can control, meaning parts, service, F and I and used cars. Gotcha. Okay. Thank you. Thank you. Our next question comes from Rajat Gupta with JPMorgan. Hey, good morning. Thanks for taking my question and appreciate the color on the call so far. Just had a quick question on capital allocation. I mean, you've shown disciplined capital allocation in the past. Can you talk about what you're seeing in the market there in terms of M and A, just in terms of the multiples you're seeing in the space? And is there any chance you could see you get a little more aggressive down the road given where your leverage ratio is? Thanks. This is David. I'll start and then Sean can certainly jump in. We don't see any need to be the biggest in the space. And it's not it's easy to acquire something. It's harder to run it. So we really try to be very thoughtful when we look at an acquisition. And is this value add for our shareholders? Can we be a good steward of the business and continue to grow the business? So M and A is very strong. It's robust. There's a lot of activity out there. There's a lot of transactions we look at, but we're looking for the right transactions for our company that are going to be accretive. We also think in the last cycle from 2012 to 2016 were probably well elevated years in performance. And those are when you get highest multiples, and it's maybe not always the best time to be in M and A. We think now and as the future comes, the next couple of years, we could be really opportunistic with our acquisitions and thoughtfully grow the company. And that's the plan as a team. Got it. Great. Thanks. Thank you. Next up from SunTrust is Stephanie Benjamin. Please go ahead. Hi, good morning. Thank you for the question. I just had a quick question. I wanted to make sure I'm thinking about it. I know that when you called out SG and A expense on your Q4 call, you talked about this higher overall incentives and just kind of employment costs in store. Is there anything that we should be looking at from the Q1 that would be expected to pick up throughout the year? Or is that fully reflected in the Q1 print? Thanks. Yes. This is Sean. Hi, Stephanie. So we have been investing in the benefits that we disclosed at the beginning of this year. We will be continuing to invest in those benefits for our associates during the remainder of this year. And at this point, we're very pleased with the results of these investments and what they're doing for our associates. And yes, we will just be continuing at that rate for the remainder of the year. And now we'll hear from David Winston with Morningstar. Thanks. Good morning. Going back to M and A, are you seeing any more sellers wanting to get in now just because we are late in the new vehicle cycle and thinking if I don't sell 2019, it could be a few more years before I would be able to or is that not a factor? I would say that the activity was very strong last year and it's very strong this year. But I also think part of it is a life where in some cases there's no succession planning. I think that's a piece of it. Or their children just don't have interest in the business or the space. To your point, there's naturally some dealers that think the timing is right. And in the next year or 2, if they wait, maybe the multiples will come down even more. And naturally, there's pressure on the business as well. So that could obviously frustrate people and push people out as well. I'm sorry, was there another question or? I have a new topic, so go ahead if you were going to say something on M and A. No, that was pretty much it, unless you have a follow-up question for that. No, I was just going to ask real quick on gas prices. I mean year over year, they're not that much higher, but more recently short term, they have gone up a lot. Are you seeing any change in customers coming in wanting sedans more than light trucks? Yes, which is typically what happens over the last few years when that's happened. We haven't experienced that yet. They're just starting to creep up. But if they continue to creep up, we expect to see a lot more activity with hybrids and certainly sedans as well. Okay. Thanks. One thing I'd like cars currently. This concludes today's discussion. We appreciate your participation in the call today. Have a great day.