Earnings Call: Q2 2018

Jul 24, 2018

Good day, and welcome to the Asbury Automotive Group Q2 2018 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Matt Petone. Please go ahead, sir. Thanks, operator, and good morning, everyone. Welcome to Asbury Automotive Group's Q2 2018 earnings call. Today's call is being recorded and will be available for replay later today. The press release detailing Asbury's Q2 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 2017, any subsequently 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 applicable 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 Holt. David? Thank you, Matt. Good morning, everyone, and welcome to our Q2 2018 earnings call. We are very pleased with our Q2 performance. During this quarter, we achieved record adjusted EPS of $2.08 a 32% increase over last year's adjusted EPS. Our plan for 2018 remains unchanged. We will continue to focus on the aspects of the business that we can control, specifically parts and service, used cars, F and I and overall expense management, while continuing to intelligently deploy capital towards the highest returns. This quarter, we acquired 2 stores in the Atlanta market, which combined should generate approximately $120,000,000 of annual revenue. We also returned $20,000,000 to our shareholders through share repurchases, and we continued our investments in building our omnichannel capabilities. I will now hand the call over to Sean to discuss our financial performance. Sean? Thank you, David, and good morning to everyone. The 2nd quarter marked another record performance for Asbury with adjusted earnings per share of $2.08 Accounting standard ASC 606 once again impacted revenue recognition for the parts and service and F and I businesses. The net impact of ASC 606 in Q2 was to reduce revenue by approximately $1,600,000 reduce gross profit by approximately $800,000 and earnings per share by $0.03 There was no impact on our cash flows. Note that we do not adjust the results to normalize for the impact of ASC 606. Overall, compared to the prior year's Q2, our revenue increased by 6%, gross profit increased by 4%, gross margin of 16.1% was 30 basis points lower than last year, SG and A as a percentage of gross profit improved by 90 basis points to 68.6 percent, adjusted operating margin of 4.6% was 10 basis points higher than last year, Adjusted net income increased by 29 percent to $42,700,000 and adjusted earnings per share increased by 32 percent to a record of $2.08 Net income for the Q2 of 2018 was adjusted for a $700,000 pretax gain on legal settlements or $0.03 per share. In Q2 2017, adjusted earnings excluded an $800,000 pretax gain on investments or $0.02 per share and $2,900,000 of pre tax real estate related charges or $0.08 per share. Our effective tax rate was 25.8 percent for the Q2 of 2018, down from 38.1% in the Q2 of 2017. Turning to expenses. SG and A as a percentage of gross profit for the quarter was 68.6 percent, an improvement of 90 basis points over last year. This is a very pleasing performance considering our continued omnichannel investments. As previously noted, during 2018, we are investing in excess of $10,000,000 in omnichannel capabilities. SG and A as a percentage of gross profit for the first half of twenty eighteen was 69%, which is 60 basis points better than the prior year. We continue to target 69% to 70% for the full year 2018. During the Q2, we experienced 2 hailstorms at our Honda store located in Irving, Texas. We recognized a cost of approximately $800,000 this quarter associated with damaged inventory. Note that in the Q2 of 2017, we recognized a cost of approximately $1,000,000 due to a hailstorm that hit 2 of our stores in Plano, Texas. With respect to capital deployed this quarter, we spent $9,000,000 on capital expenditures, dollars 20,000,000 repurchasing our common stock and we acquired 2 dealerships that we expect to generate around $120,000,000 in annual revenue. At the end of the quarter, our total leverage ratio stood at 2.8 times and our net leverage ratio at 2.4x. Despite a reduction in our inventory days, floor plan interest expense increased by $1,900,000 over the prior year quarter. This was driven by increases in the LIBOR rate. A reminder that our floor plan debt has a floating interest rate, while all other debt is fixed rate. From a liquidity perspective, we ended the quarter with $3,000,000 in cash, dollars 28,000,000 available in floor plan offset accounts, $85,000,000 available on our used vehicle line, dollars 234,000,000 available on our revolving credit lines, and we also have unencumbered real estate in excess of $200,000,000 I would now like to hand the call over to John to walk us through the operating performance. John? Thank you, Sean. My remarks will pertain to our same store performance compared to the Q2 of 2017. Looking at new vehicles, while SAAR for the quarter was strong at 17,200,000 dollars or 2.4 percent above last year, we focused on retail SAAR, which was flat for the quarter. In this flat retail SAAR environment, we were able to grow our new unit sales 1%. Overall, our new car margin was 4.4%, 10 basis points lower than last quarter and 20 basis points lower than last year. The decrease in our import margins was due to aggressive incentive targets coupled with a reduction in available incentive dollars. Domestic margins were also down because we underperformed in certain domestic brands, thereby missing some incentive money. While both import and domestic margins were down, we were able to grow both our luxury volume by 2% and our margins by 20 basis points. Our total new vehicle inventory was $776,000,000 We reduced our day supply from the prior year quarter by 2 days to 72 days. Turning to used vehicles. Our used vehicle unit sales increased 5% over a strong 6% comparable in 2017. Our gross profit margin of 7.2 percent was down 10 basis points from last quarter and 40 basis points lower than prior year. Our used vehicle inventory of $151,000,000 is at a 31 day supply. Turning to F and I. Our team continues to deliver strong results. Total F and I gross profit increased by 5% and gross profit per vehicle increased by $33 to $15.51 from prior year quarter. As Sean mentioned in his remarks, the gross profit per vehicle was adversely impacted by the adoption of the new revenue recognition accounting standard. This decreased our F and I PVR by $12 per vehicle. Turning to parts and service. Our parts and service revenue remained flat and gross profit increased 2% despite a 13% decline in warranty compared to the prior year quarter. This was achieved with a 5% increase in customer pay, improved used vehicle sales caused our reconditioning work within parts and service to increase by 6%. I want to take a moment to give you an update on the progress of some of our omni channel initiatives. Our centralized brand certified digital sales team currently supports 30% of our stores, and we are on track to onboard the entire company within the next 15 months. Stores participating in the program during this quarter increased digital sales by 15% year over year. Our PUSHSTART online sales tool converted over 3,100 vehicle sales in the quarter. We continue to grow the traffic in our digital parts and service scheduling tool. And for the quarter, online appointments were up 39% from the prior year, now approaching 10,000 online appointments per week. We are excited about our omnichannel growth and we are pleased that we've been able to maintain our SG and A discipline. In conclusion, we would like to welcome all our new employees at our Natalie Chevrolet and Natalie Toyota dealerships and express our sincere appreciation to all of our teammates in the field and in 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. Our first question comes from Rick Delson. Thanks. Good morning. Nice quarter. I'd like to follow-up to SG and A. That really was a standout in the quarter, narrow net new basis points. You're confronted with this GPU margin pressure. You could speak to the drivers to that leverage and if you think these SG and A levels are now sustainable? Hey, Rick, it's Sean. So regarding SG and A, we're very conscious this year of the investments that we're making in omni channel. As I said in remarks, it's about $10,000,000 during 2018. And with this in mind, we've been very focused and cost conscious in our SG and A spend. We are very data orientated attention to detail lean operating organization. We've been very cost conscious and disciplined in our SG and A spend. We estimate that around 80% of our SG and A is variable in nature And the vast majority of that relates to personnel costs, which we're able to manage. And we've been very thoughtful in the way we've scheduled and done our staffing to manage those SG and A costs during the quarter. So we can't point to one specific item, but it is the overall management of the operations. Got you. These omni channel investments of $10,000,000 is there a time line to when you think you'll start to leverage those investments? So we are already starting to get the benefits from those investments. We started to spend not this year, but in the previous year. And we're already starting to see some of the benefits of that coming through. And that's one of the reasons that we're able to leverage our SG and A. The rollout, as John said in his remarks, the rollout of our digital sales team will take another 15 months And then there's a period of time before that becomes up and running. But within 18 to 24 months, we should start to see even more leverage coming from these investments. Yes. And just to jump on top of that, Rick, I would say the goal coming into this was a higher conversion rate with traffic that we have and lowering our overall expenses per transaction, not just in sales, but in all departments. And while it's early on, we're certainly seeing the results of that, and we're very pleased and look forward to the future. Got you. Thanks for that color. Finally, if I could ask you on the you acquired 2 stores this quarter. If you could comment on the valuations that you're seeing out there and your appetite for acquisitions versus stock buybacks? Hi, Rick. It's Sean. I'll start and I'll let David finish up. Just generally, a couple of thoughts on how we look at acquisitions. We look at each project on its own, and it needs to stand on its own, but from a qualitative factors and quantitative factors. We look at the risk of the project and the return thresholds for each project depend on the risk of that project. So for example, the turnaround situation, which is what these two stores in Atlanta represent, will require a higher return than share buybacks or an investment in one of our existing stable stores. We're always cognizant of the alternative investments that we have as well when we consider our investments. So for these two stores, given the turnaround situation for them, we would expect a higher return. I don't know, David, if you want to No, I would say you summed it up well. I mean, every deal stands on its own. We look at it differently. And certainly the higher the risk, the higher return, as Sean stated, is what we look for. And we certainly see that in these two acquisitions. They are very excited about the future for them. The valuations that you're looking at out there, are they coming down or is there more of a meeting of the minds, I guess, in terms of pricing? I think there's a lot of conversation. There's a lot of activity out there, Rick. I certainly don't see prices going up. In some cases, they're coming down, but I think some of that is a little bit geographic and market driven and brand driven. We're very excited about all the M and A activity out there and what we've looked at. We're still very disciplined and thoughtful in how we look at it. So we like our pace and what we're doing and we're not out there just for the sake of buying something. If we don't think it's a good asset for our shareholders and it's going to create a great return, we just keep moving on. Got you. Hey, thanks a lot and good luck. Thank you, Rick. Thank you. Our next question comes from Bret Jordan of Jefferies. Hey, good morning guys. Good morning. Could you talk a little bit about, I guess, incentive cadence as the quarter progressed? Was either particular players involved more aggressively or did it change as time went along in the quarter? Yes. I would say it was fairly stable. 1 of the import brands kind of kicked it up a little bit in June compared to where they started off in April. But luxury and domestic were and most of the midline imports were stable through the quarter. Okay, great. And then on omni channels, we think further down the road, like what are the top sort of maybe 2 or 3 metrics you want to measure that by? I mean, lead generation that might be online. You talked about the service scheduling that's being done online. But as we look forward, I mean, how do we want to grade the success of that initiative? Yes. I would say it depends. Not so much from a lead track volume standpoint. We all have the ability to generate that. It's converting at higher rates, and the easiest way to do that is being consistent with the level of service that you offer. And we feel like we've found a mix to do that. From the service online perspective, no differently than booking an airline ticket online. We think it's fast, easy and convenient for our customers to do that. And in 3 years, we've gone from 400 appointments a week to almost 10,000. As we see those increasing, customers are actually spending more dollars per repair order. Our CSI is better, and we're doing a lot more transactions that way. We're also seeing that with online part sales with the do it yourselfers now. So it's really looking at all our revenue streams and seeing how we can optimize the conversion rates and lower our while doing it to be competitive for the future. Okay. And I guess on that service question, as you look at 5% growth in customer pay, do you have a feeling sort of anecdotally how that compared to growth in your markets? Is that that's a share gain number, you think? So we think we're currently pacing probably at or above average within the markets that we compete in. Our biggest opportunity for growth lies within in our ability to acquire technicians. I've stated this before, the good news is we don't have any CapEx investments. We don't have brick and mortar issues. We have capacity issues in the sense that we need to bring on more technicians. Our next question comes from James Abertin of Consumer Edge. Great. Thank you and good morning. I wanted to ask a question first. As you're thinking about the business holistically here and you're laying on more omni channel initiatives, can you just help us sort of bullet point a handful of items where you think makes sense to build in house versus going outside to 3rd parties? I'm thinking of cars.com, CarGurus in the sense of advertising, but perhaps as well maybe on the dealer management side, I mean where do you think it makes more sense to build and invest in sort of building resources internally versus leaving it to outside experts? This is John. I think you need to do a combination of both. We do a lot in house with our digital marketing team. And I think you still need to use those 3rd party providers to bring leads in. But I think the more we can do in house, it lowers your overall expense and you can get a better result a lot of times. Can you articulate where you're going in house more in discipline areas? Or just can you help us sort of triangulate that a little bit further? Well, the digital teams work with the markets as far as SEO and SEM, and we do a lot of the maintenance, in house. And a follow-up to an earlier question on M and A. It sounds like the Chevrolet and the Toyota stores, I think you said the word turnaround, if I heard you correctly. But just really want to try and bookend, how much further behind are those stores from a profit before tax perspective, are they negative? And then what kind of timeframe do you expect those, right, I should say that $120,000,000 in revenue to start to approximate your consolidated sort of PBT or EBIT margins as you think about it? Sure. Neither store was both stores were profitable, not by much. We looked at those stores coming into them. The 1st year would be about getting the right people on the bus, so to speak, and stabilizing the operation and truly seeing the gains in the 2nd year. We're actually ahead of schedule in one of the two stores and seeing better results than anticipated this early on. But we have high hopes for both stores. When you talk about turnaround, your ability to grow them is fairly dramatic from a percent standpoint. Understood. Thanks again, and best of luck in the next quarter. Thank you. Our next question comes from John Murphy of Bank of America. Good morning, guys. Just a first question and maybe if you could sort of outline or illustrate as we think about a person coming through the PUSHSTART program to actual sort of culmination of a sale versus an up in a dealership and sort of the cost savings and process there, maybe just so we can understand what the ongoing SG and A savings might be over time as we see more of this push start volume growth? Hey, John, this is John. I think in the environment we are in, consumers are very conscious of their time and push start basically lets the consumer interact with our stores on their time, how they want to interact. And then at the end of the day, it's really just the process has changed. So it's a much more digital environment we're living in and we're trying to make it easy for the consumer to interact with us and deliver product to them in their preferred medium. And I would jump on that, John. Let me add on to that, if you don't mind. The consumers are doing their own F and I. We have a direct API with Route 1 and lenders. So they're doing their F and I on their own. They're doing their loan application. They're uploading their trade information. Very soon, we'll be signing all documents except for some DMV stuff online as well. And really, the cost savings down the road, the way we look at it is, our only differentiator between us and any of our competitors out there is the level of service that we offer. And one thing that we all struggle with in our stores is turnover. By creating this team and this approach and what we're doing, we're able to staff our stores with less people, and we're creating more transactions per employee, which is lowering the turnover and increasing the productivity per employee. So it's a win win for the employee and it's a win for the company because we're bringing our costs down. So is it fair to say there's a decent amount of upfront investment that you're making in this $10,000,000 number you're talking about right now, But over time, the personnel and ongoing operating cost of pushing a transaction through the system versus up in the store versus digitally is pretty dramatic. I mean, you lose the sales commission and everything else along the way, including the F and I process becomes that more efficient and it has less hands. So the profitability on each transaction should go up dramatically or materially, I mean, I should say, over time? Correct. Okay. That's helpful. Thank you. And then the second question, lease returns are ramping up. There's a lot of debate whether they get captured at the grounding dealer and resold at CPOs or direct to the consumer. Just curious what your experience has been so far as we see lease returns ramping up and how you're processing them, if you're capturing a higher level at your dealers and grounding them and putting them into your inventory or if you're actually punting them a little bit more into auction? Just trying to understand how that's benefiting you and how you're dealing with it? Well, the off lease cars have continued to increase, creates a great sourcing opportunity for high quality, low mileage pre owned vehicles. So we basically try to grab as many as we can and re retail them to the consumers. We are not taking these vehicles and taking them back to auction. We are trying to retail as many as possible. And given what's going on with used vehicle pricing, you're putting up pretty good grosses on those? Overall, our margins are decent on used. We're focusing on bringing our cost of sale down. Obviously, those off lease vehicles drive that up because they are later model vehicles. But I think we're in a pretty good place as far as margin goes. Okay. And then just lastly on the pricing environment, I mean we're seeing mix improve pretty dramatically in the industry, yet your average selling price on a same store basis on a holistic basis is up 1% to 2%, reasonably consistent with the industry. Is there something underlying sort of the benefit of mix where pricing appears to be deteriorating? Are you having to give up more to get deals done? I'm just curious, I mean, it's kind of a belief that pricing is strong, yet it seems like there's some early signs of a bit of weakness. Well, if you're talking about used specifically, I mean, the market dictates the price of the vehicle. So we really focus on our acquisition cost and our reconditioning cost to try to keep our margins high. But on the new vehicle side, it looks like there's waning strength in the ATP or the average selling price yet mix is improving. So is there is a sort of aggressiveness on the automaker side or are you having to give up more to get deals done? John, this is David. I'll jump in. That question is it varies so much by brand. I mean, generally speaking, inventory levels are down a little bit. They're not quite producing as many. Some brands have backed off their incentives a little bit. And as you know, some brands have stepped up their incentives. We still see it very competitive out there. We still need, unfortunately, the need for high incentives to keep the ball rolling, so to speak. But I don't see anything materially going on where there's any cause and effect right now. Okay. And then just one last housekeeping. On reconditioning, are you guys booking that at 100% gross profit through parts and service? It looks like it's around about there. It is, yes. Great. Thank you very much, guys. Thank you. Our next question comes from Armintas Sekevicius of Morgan Stanley. Hi. Thank you for taking my question. Used car volumes, transaction prices, gross margins were particularly strong this quarter, at least versus our estimates. Can you talk about the strength that you're seeing with used? Because when we look at, for instance, CarMax, there's been some headwinds there on a same store sales basis. I'm curious what you're seeing in that market? We've really focused on used vehicles. And if you remember, a couple of quarters ago, we did have a change in our enterprise software. So I think over time, the teams adapted and gotten better with that And we've really we've had a focus on used vehicle sales in general. As far as the CarMax model goes, one of the advantages we have being in new car franchises is that we get an opportunity to trade a lot of vehicles. We've got vehicles coming through our service drive. We've got a lot of the stores that have service drive initiatives to take trade people out of vehicles. So it's really just been a focus and a decent job by the team in the field. Okay. And then I noticed in the slide deck, there was one slide that said you can ship anywhere. Can you talk about some of your logistics and transportation ability? The funny thing on a pre owned vehicle, and I think I just said it a couple of minutes ago, we price our cars to market. So people will travel, in quite some way to come get a used vehicle if it's the right car at the right price. But we can ship the car anywhere. We've got we've shipped cars all over the U. S. If somebody wants it shipped. Okay. And then last one for me. Just your trends through July versus a year ago and your targets, how is July turning out so far? July is starting off pretty well. It is as expected. All right. Thank you so much. Thank you. And our next question comes from Chris Bottiglieri of Wolfe Research. Hi. Thank you for taking the questions. So I wanted to follow-up on the last question on used to start with. It's pretty easy compares in the back half from last year. How are you thinking about the trajectory given what you did in Q2 or maybe looking more broadly at 2 half versus first half? Is there any reason to think like the 2 year went out, I guess, is what I'm asking? I think as far as the used vehicle sales, we'll stay focused on it. I think we've got some decent comparables we're up against in quarter 34. So I don't see it changing. Got you. Okay. I want to talk more broadly about what you're seeing in wholesale. I know it's a small segment, but anecdotally looking for some signs. You'd previously generated losses in that segment. Now, I would say incrementally small profits. I mean, I guess, 1, what are you doing differently that's driving the increased profitability? Maybe to start there. And then 2, there's been some changes to the industry in terms of mobile to mobile platforms and stuff like that? Are you using any different technology as you think about trade ins, etcetera? Thank you. Well, our enterprise technology has an appraisal tool obviously in it. And it's really the wholesale is really just about appraising the cars properly. If you know it's going to be a wholesale vehicle, we appraise it as such. If it's going to be a retail vehicle, we appraise it as such. So it's really just being known in the market and being sharp in the appraisal process, and then disposing the cars quickly. The wholesale vehicles, just like the retail, we try to turn them quickly and not hold on to them. Got you. Okay. The one high level question on imports, and that's it for me. So obviously some weak there in the market right now. And you're looking at the gross profits on the import segment particularly mean, on the new side, those continue to kind of creep lower. Is there a way to think about like what a lower bound could be? Is there 1, I guess, to start with? And then 2, just given your consolidated fundamentals look pretty strong, what can we read across for the import segment? Have you been able to offset this weakness in terms of F and I used the way you have the rest of your business? And maybe just how should we think about that? Yes. I would say it talks to diversity of our model. We're predominantly an import brand company. So you would think it would affect us more, but yet we tend to be right at the top of our peer group as far as operating margin. And I think it's because of our performance in parts and service, F and I and used. We also have some pretty strong midline import brands where we do some volume with them as well and certainly appreciate the relationship. And those customers tend to be pretty good parts and service customers as well, which again, midline import customers also have a lot of trade in. So there's a good ecosystem there that works. We don't sweat out the new car margin probably as much as others might, because we kind of look at the holistic approach, where's our total yield, what are we doing in parts service and F and I and pre owned. Got you. Okay, helpful. Thank you for the time. Thank you. Thank you all very much. This concludes today's discussion. We appreciate your participation in today's call. Have a great day. Thank you, ladies and gentlemen. This concludes today's conference. Have a great rest of