Good day, 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 Pettoni. Please go ahead, sir.
Thanks, operator, good morning, everyone. Welcome to Asbury Automotive Group's second quarter 2018 earnings call. Today's call is being recorded and will be available for replay later today. The press release detailing Asbury's second quarter results was issued earlier this morning and is posted on our website at asburyauto.com. Participating with us today are David Hult, our President and Chief Executive Officer, John, our Senior Vice President of Operations, Sean, our Senior Vice President and Chief Financial Officer. At the conclusion of our remarks, we will open the call up for questions. 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. 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-K 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 Hult. David?
Thank you, Matt. Good morning, everyone, welcome to our second quarter 2018 earnings call. We are very pleased with our second quarter 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&I, and overall expense management, while continuing to intelligently deploy capital towards the highest returns. This quarter, we acquired two stores in the Atlanta market, which combined should generate approximately $120 million of annual revenue. We also returned $20 million to our shareholders through share repurchases. We continued our investments in building our omni-channel 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 second 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&I businesses. The net impact of ASC 606 in Q2 was to reduce revenue by approximately $1.6 million, 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 second quarter, our revenue increased by 6%, gross profit increased by 4%, gross margin of 16.1% was 30 basis points lower than last year. SG&A, as a percentage of gross profit, improved by 90 basis points to 68.6%.
Adjusted operating margin of 4.6% was 10 basis points higher than last year. Adjusted net income increased by 29% to $42.7 million, and adjusted earnings per share increased by 32% to a record of $2.08. Net income for the second quarter of 2018 was adjusted for a $700,000 pre-tax gain on legal settlements, or $0.03 per share. In Q2 2017, adjusted earnings excluded an $800,000 pre-tax gain on investments, or $0.02 per share, and $2.9 million of pre-tax real estate-related charges, or $0.08 per share. Our effective tax rate was 25.8% for the second quarter of 2018, down from 38.1% in the second quarter of 2017. Turning to expenses. SG&A, as a percentage of gross profit for the quarter, was 68.6%, an improvement of 90 basis points over last year. This is a very pleasing performance considering our continued omni-channel investments.
As previously noted, during 2018, we are investing in excess of $10 million in omni-channel capabilities. SG&A, as a percentage of gross profit for the first half of 2018, was 69%, which is 60 basis points better than the prior year.
We continue to target 69%-70% for the full year 2018. During the second quarter, we experienced two 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 second quarter of 2017, we recognized a cost of approximately $1 million due to a hailstorm that hit two of our stores in Plano, Texas. With respect to capital deployed this quarter, we spent $9 million on capital expenditures, $20 million repurchasing our common stock, and we acquired two dealerships that we expect to generate around $120 million in annual revenue. At the end of the quarter, our total leverage ratio stood at 2.8 times and our net leverage ratio at 2.4 times. Despite a reduction in our inventory days, floorplan interest expense increased by $1.9 million over the prior year quarter.
This was driven by increases in the LIBOR rate. A reminder that our floorplan debt has a floating interest rate, while all other debt is fixed rate. From a liquidity perspective, we ended the quarter with $3 million in cash, $28 million available in floorplan offset accounts, $85 million available on our used vehicle line, $234 million available on our revolving credit lines, and we also have unencumbered real estate in excess of $200 million. 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 second quarter of 2017. Looking at new vehicles, while SAR for the quarter was strong at 17.2 million or 2.4% above last year, we focused on retail SAR, which was flat for the quarter. In this flat retail SAR 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 million. We reduced our day supply from the prior year quarter by two 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% was down 10 basis points from last quarter and 40 basis points lower than prior year. Our used vehicle inventory of $151 million is at a 31-day supply. Turning to F&I. Our team continues to deliver strong results. Total F&I gross profit increased by 5%, and gross profit per vehicle increased by $33 to $1,551 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&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. 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 omni-channel growth. We are pleased that we've been able to maintain our SG&A discipline. In conclusion, we would like to welcome all our new employees at our Nalley Chevrolet and Nalley Toyota dealerships. We 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. At this time, we will open the floor for questions. If you would like to ask a question, please press the star key followed by the one key on your touchtone phone now. Again
Press number one.
Our first question comes from Rick Delson.
Thanks. Good morning. Nice quarter. I'd like to follow up on the SG&A. That really was a standout in the quarter, narrow 90 basis points. You're confronted with this GPU margin pressure. If you could speak to the drivers to that leverage and if you think these SG&A levels are now sustainable.
Hi, Rick, it's Sean. Regarding SG&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 million during 2018. With this in mind, we've been very focused and cost conscious in our SG&A spend. We are a very data orientated, attention to detail, lean operating organization. We've been very cost conscious and disciplined in our SG&A spend. We estimate that around 80% of our SG&A is variable in nature, and the vast majority of that relates to personnel costs, which we're able to manage. We've been very thoughtful in the way we've scheduled and done our staffing to manage those SG&A costs during the quarter. We can't point to one specific item, but it is the overall management of the operations.
Got you. These omni-channel investments, the $10 million, is there a timeline to when you think you'll start to leverage those investments?
We are already starting to get the benefits from those investments. We started the spend, not this year, but in the previous year, and we're already starting to see some of the benefits of that coming through. That's one of the reasons that we're able to leverage our SG&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. Within 18 to 24 months, we should start to see even more leverage coming from these investments.
Just to jump on top of that, Rick, I would say, the goal coming into this was a higher conversion rate with the traffic that we have and lowering our overall expenses per transaction, not just in sales, but in all departments. 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 acquired two stores this quarter. If you could comment on the valuations that you're seeing out there and your appetite for acquisitions versus stock buybacks.
Hey, 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. 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. 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. 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 that 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, I think some of that is a little bit geographic and market driven and brand driven. We're very excited about all the M&A activity out there and what we've looked at. We're still very disciplined and thoughtful in how we look at it. 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.
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?
I would say it was fairly stable. One of the import brands kind of kicked it up a little bit in June compared to where they started off in April. Luxury and domestic were, and most of the midline imports were stable through the quarter.
Okay. Great. Then on omni channels, we think further down the road, what are the top sort of maybe two or three 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. As we look forward, how do we want to grade the success of that initiative?
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 in the level of service that you offer. 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. In three 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 parts sales with the do-it-yourselfers now.
It's really looking at all our revenue streams and seeing how we can optimize the conversion rates and lower our costs while doing it to be competitive for the future.
Okay. 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 a share gain number, you think?
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 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.
Okay. All right. Thank you.
Thank you.
Our next question comes from Jamie Albertine of Consumer Edge.
Great. Thank you. Good morning. 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 third parties? I'm thinking of Cars.com, CarGurus in the sense of advertising, but perhaps as well, maybe on the dealer management side. 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. I think you still need to use those third-party providers to bring leads in. 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 certain 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. We do a lot of the maintenance in-house.
Understood. A follow-up to an earlier question on M&A. It sounds like the Chevrolet and the Toyota stores, I think you said the word turnaround, if I heard you correctly. Just really want to try and bookend. How much further behind are those stores from a profit before tax perspective? Are they negative? In what kind of timeframe do you expect those, or I should say that $120 million in revenue, to start to approximate your consolidated sort of PBT or EBIT margins as you think about it?
Sure. Both stores were profitable. Not by much. We looked at those stores coming into them. The first year would be about getting the right people on the bus, so to speak, and stabilizing the operation, then truly seeing the gains in the second year. We're actually ahead of schedule in one of the two stores and seeing better results than anticipated this early on. We have high hopes for both stores. When you talk about turnaround, your ability to grow them is fairly dramatic from a % standpoint.
Understood. Thanks again. 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&A savings might be over time as we see more of this PushStart volume growth.
Hey, John, this is John. I think in the environment we are in, consumers are very conscious of their time, and PushStart basically lets the consumer interact with our stores on their time, how they want to interact. At the end of the day, it's really just the process has changed. 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.
I would jump on that, John. Let me add onto that, if you don't mind. The consumers are doing their own F&I. We have a direct API with RouteOne and lenders. They're doing their F&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. 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.
One thing that we all struggle with in our stores is turnover. By creating this team and this approach in 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. It's a win-win for the employee, and it's a win for the company because we're bringing our costs down.
Is it fair to say there's a decent amount of upfront investment that you're making in this $10 million 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? You lose a sales commission and everything else along the way, including the F&I process becomes that more efficient, and it has less hands. The profitability on each transaction should go up dramatically or materially, I should say, over time.
Correct.
Okay. That's helpful. Thank you. 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 to 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. It creates a great sourcing opportunity for high-quality, low-mileage pre-owned vehicles. 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.
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're later-model vehicles. I think we're in a pretty good place as far as margin goes.
Okay. Just lastly, on the pricing environment. We're seeing mix improve pretty dramatically in the industry, yet your average selling price on a same-store basis and a holistic basis is up 1%-2%, reasonably consistent with the industry. Is there something underlying sort of the benefit of mix where pricing appears to be deteriorating or you're having to give up more to get deals done? I'm just curious. There's kind of a belief that pricing is strong, yet it seems like there's some early signs of a bit of weakness.
If you're talking about used specifically, the market dictates the price of the vehicle. We really focus on our acquisition cost and our reconditioning cost to try to keep our margins high.
On the new vehicle side, it looks like there's waning strength in the ATP or the average selling price, yet mix is improving. Is there a sort of aggressiveness on the automaker side, or are you having to give up more to get deals done?
John, it's David. I'll jump in. That question varies so much by brand. 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. I don't see anything materially going on where there's any cause and effect right now.
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 Sinkevicius of Morgan Stanley.
Great. 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? 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. If you remember, a couple of quarters ago, we did have a change in our enterprise software. I think over time, the team's adapted, gotten better with that software. 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. It's really just been a focus and a decent job by the team in the field.
Got it. 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, I think I just said it a couple of minutes ago, we price our cars to market. People will travel quite some way to come get a used vehicle if it's the right car at the right price. We can ship the car anywhere. We've shipped cars all over the U.S. if somebody wants it shipped.
Got it. 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.
Thank you so much.
Thank you.
Our next question comes from Chris Bottiglieri of Wolfe Research.
Hi, thank you for taking the questions. 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 second half versus first half. Is there any reason to think the 2-year hold, 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 3 and 4, I don't see it changing.
Got you. Okay. I want to talk more broadly, though, what you're seeing in wholesale. I know it's a small segment, but anecdotally, looking for some signs. You'd previously been generating losses in that segment. Now, I would say incrementally small profits. I guess, one, what are you doing differently that's driving the increased profitability? Maybe just start there. Then two, 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, et cetera? Thank you.
Well, our enterprise technology has an appraisal tool, obviously, in it, and the wholesale's 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. It's really just knowing 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. One high-level question on imports, then that's it for me. Obviously some weak there in the market right now, and you're looking at the gross profits on the import segment particularly on the new side, and those continue to kind of creep lower. Is there a way to think about what a lower bound could be? Is there one, I guess, to start with? And then two, 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&I and used the way you have the rest of your business? Or maybe just how should we think about that?
Yeah, I would say it talks to the 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 ride 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&I, and used. We also have some pretty strong mid-line import brands where we do some volume with them as well, and certainly appreciate the relationship. Those customers tend to be pretty good parts and service customers as well, which again, mid-line import customers also have a lot of trade-ins. 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 of the yield?
What are we doing in parts and service and F&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 your day.