Welcome to AutoNation Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the call over to Robert Quartaro, Vice President of Investor Relations for AutoNation.

Thank you. Good morning. Welcome to AutoNation's Second Quarter 2018 conference call and webcast. Leading our call today will be Mike Jackson, our Chairman, Chief Executive Officer and President; Cheryl Miller, our Chief Financial Officer; Lance Iserman, our EVP of Sales and Chief Operating Officer; and Scott Arnold, our EVP of Customer Care and Brand Extensions. Following their remarks, we will open up the call for questions. Chris Cade and I will be available by phone following the call to address any additional questions that you may have. Before we begin, let me read our brief statement regarding forward-looking comments. Certain statements and information on this call, including any statements regarding our anticipated financial results and objectives, constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, including economic conditions and changes in applicable regulations that may cause our actual results or performance to differ materially from such forward-looking statements. Additional discussions of factors that could cause our actual results to differ materially are contained in our press release issued earlier today and in our SEC filings including our most recent Annual Report on Form 10-K and subsequent Quarterly Reports on Form 10-Q and current reports on Form 8-K. And now, I'll turn the call over to AutoNation's Chairman, Chief Executive Officer and President, Mike Jackson.

Good morning, and thank you for joining us. Today, we reported second quarter earnings per share from continuing operations of $1.07, a 24% increase in earnings per share compared to the same period in the prior year. Second quarter 2018 earnings per share from continuing operations included a non-cash franchise rights impairment charge of $6 million after tax or $0.07 per share. Net income from continuing operations for the quarter was $97 million, an 11% increase compared to the same period a year ago. Second quarter 2018 revenue totaled $5.4 billion, a 2% increase compared to the same period a year ago. Same-store revenue for the quarter was $5.3 billion compared to $5.1 billion in the year ago period, an increase of 4%. Same-store gross profit was $839 million compared to $806 million in the second quarter of 2017, an increase of 4%. Today, we announced the acquisition of Shelly BMW in Southern California with annual revenues of approximately $140 million. This is our 7th BMW store in California and our 17th nationwide. We have also signed an agreement to acquire our 81st collision center located in the Dallas, Texas market. I'm also happy to share that we've expanded our partnership with Waymo. AutoNation has the exclusive ability to offer its customers in Phoenix, Arizona, the use of a Waymo to move around the city while their personal vehicles are being serviced at AutoNation dealerships. This offers AutoNation's customers a new and unique opportunity to experience Waymo technology first-hand. I now turn the call over to our Executive Vice President and Chief Financial Officer, Cheryl Miller.

Thank you, Mike, and good morning, ladies and gentlemen. For the second quarter, we reported net income from continuing operations of $97 million or $1.07 per share versus net income of $88 million or $0.86 per share during the second quarter of 2017, a 24% increase on a per-share basis. In the second quarter, revenue increased $113 million or 2% compared to the prior year and gross profit grew $26 million or 3%. SG&A as a percentage of gross profit was 73.4% for the quarter, which represents a 60 basis point decrease compared to the year ago period. For the remainder of the year, we expect to see sequential improvement in SG&A to gross profit with the full year ratio in a similar range to last year. However, we believe this will mostly occur in the fourth quarter where we typically see a greater influence of seasonality. The provision for income tax in the quarter was $32.2 million or 24.8%. The second quarter tax rate was positively impacted by the recognition of certain non-recurring favorable adjustments. Going forward, we expect our effective annual tax rate to be in line with our previous guidance. Floorplan interest expense increased to $32 million compared to $24 million in the second quarter of 2017, driven primarily by higher average interest rates. In addition, our net floorplan carrying benefit turned to a modest cost for the first time in almost 10 years. As a reminder, our floorplan facilities are based on one month LIBOR, which has risen approximately 50 basis points year-to-date and almost 100 basis points over the last 12 months. Non-vehicle interest expense increased slightly to $30 million compared to $29 million in the second quarter of 2017, driven primarily by higher average debt balances. At the end of June, we had $2.7…

Thank you, Cheryl, and good morning. My comments today will be on a same-store basis as compared to the prior year, unless otherwise noted. Gross profit from variable operations was $456 million, up 6% versus our peers' average of up 2%. Variable gross (sic) [gross profit] was $3,308 on a per-vehicle retail basis, up $88 or 3% versus the peer group average, which was flat compared to last year. Same-store retail unit volumes were up 3% compared to the second quarter last year. We retailed 78,700 new vehicles, an increase of 1%, while the industry and our peers were down 1%. New vehicle gross profit was $123 million, down 9%. New vehicle gross profit was $1,568 on a per-vehicle retail basis, down 10%. The market remains competitive and challenging, and certain OEMs continue to use disruptive marketing and sales incentives. While our same-store new vehicle unit sales outperformed the industry, we continue to experience significant margin pressure, particularly in Nissan, Honda and BMW. We expect to see continued pressure for the balance of the year. Our One Price strategy continued to drive growth in our pre-owned business. Used vehicle gross profit was $88 million, up 22% compared to the year ago period, while our peers' average was up 5%. Used vehicles retailed were 58,500, up 5%. Used vehicle gross profit was $1,455 on a per-vehicle retail basis, which was an increase of $180 or 14%, while our peers' average was down 2% compared to the second quarter of 2017. We continue to set records and outperform our peers in Customer Financial Services business. Customer Financial Services gross profit per vehicle retailed was an all-time record $1,789, an increase of $114 or 7% versus the peers' average which was up 3% compared to the same period a year ago. With our investment in brand extensions, we continue to outperform our peer group and it positions us for continued growth in used cars and Customer Financial Services. I will now turn the call over to Scott Arnold, our Executive Vice President of Customer Care and Brand Extension.

Thank you, Lance, and good morning, everyone. My comments today will be on a same-store basis and compared to the same period a year ago, unless otherwise stated. Customer Care gross profit for the quarter was $382 million, up 4%, compared to $369 million in the second quarter of 2017. Customer pay gross profit was $161 million, up 6% year-over-year; warranty gross profit was $77 million, down 4% year-over-year; and collision gross profit was $32 million, up 2% compared to the same period a year ago. As Mike mentioned earlier, we've signed an agreement to acquire Trade Secret Auto Care, a collision center in our Dallas, Texas market. With this acquisition, we will own and operate 81 collision centers from coast to coast. We remain committed to expanding our collision center footprint to reach more customers and leverage relationships with insurance carriers. Turning to brand extensions, we remain on pace to earn approximately $100 million of incremental gross profit from our parts initiatives in 2018. We are pleased with the ramp-up of our service and maintenance parts and accessory initiatives, and sales are beginning to ramp up in our aftermarket collision parts business. Our brand extension strategy continues to support our customer pay business, which is evident in our solid gross profit growth of 6% for the second quarter. However, we are seeing a significant decline in recall volume as well as overall warranty activity. It'd be more difficult to achieve high-single-digit gross profit comparisons in our Customer Care business for the remainder of 2018. Despite the headwinds, we continue to demonstrate industry-leading results in Customer Care with AutoNation's gross profit growth outperforming our public peers' average, and we remain focused on executing our strategy to drive results. I'll now turn the call back to Mike Jackson, our Chairman, Chief Executive Officer and President.

Thank you, Scott. We still expect industry sales to total 16.8 million units for the year. Year-to-date, AutoNation has outperformed the peer group in both fixed and variable gross profit growth due to our brand extension strategy. We will now take your questions.

Thank you. Our first question comes from Mike Montani with MoffettNathanson. Your line is open.

Hi, thank you. This is Ioana Alecsiu on for Mike. Cheryl, on the SG&A to gross profit guidance, can you please discuss some of the main drivers that you're factoring in on the significant improvement in the back half and especially for 4Q?

Yes. I'd say in the quarter, that was reported on the gross profit side by really good results in the used side of the business as well as in F&I. Towards the back of the year, Q4 is always seasonally stronger, so based on the strength of premium luxury in the quarter as well as the ramp-up in our collision parts initiatives that we talked earlier in the year about investing in the collision parts initiative. We're starting to ramp that up, so early in the year, we had the expense phase before we started to generate the growth and we expect that cadence to improve as we go through the balance of the year.

Okay. Thank you. And Mike, can you please share some of the learnings from AutoNation USA? Is there anything in particular encouraging or challenging versus your expectations on the profit front? And should we still expect an update on the rollout plan in 3Q?

Everything is about as expected. The trend line towards profitability is positive, but we're going to give it another quarter before we go into a more detailed update and we do not expect to break around on any additional USA stores this year. So it'll be – later in the year, we'll say more, but the trend line on profitability – towards profitability is positive.

Great. Thank you.

Our next question comes from Armintas Sinkevicius with Morgan Stanley. Your line is open. Armintas Sinkevicius - Morgan Stanley & Co. LLC: Good morning. Thank you for taking the question. As you pursue the AutoNation USA strategy, it's replicating a lot of what CarMax has been doing. But the traditional auto dealers have actually had pretty strong used same-store sales growth in the last several quarters while AutoNation has had some macro headwinds. Just curious what you're seeing on the used side of the business and thoughts in that regard.

It was down far more in the pre-owned business than just five USA stores. And if you look at our franchise stores, we have a 5% improvement in unit volume on a same-store sales basis. And you combine that with also an improvement in gross profit per vehicle retailed due to the customer having embraced our One Price approach. It led to a 22% improvement in gross profit in pre-owned for the quarter on a same-store sales basis. So the USA stores are part of our brand extension story, but brand extension included One Price for our franchise business, which now has unquestionably been successfully implemented across the entire country. Brand extension included AutoNation products and financial services, which has led us to an industry-leading position. Brand extension includes accessories and precision parts and customer care. Brand extension includes expansion into collision and auction to support our pre-owned. So the USA stores are part of a grand overarching brand extension strategy. And if you look at our ability to improve and grow gross profit for the company, we are doing that at a far greater pace than the peer groups. Now there are costs that are coming with it. But if you look at the customer acceptance of brand extension and of the brand and at the gross profit opportunities it creates, it's definitely a compelling strategy. And at some point, leverage will kick in and it will be falling through to the bottom line. Armintas Sinkevicius - Morgan Stanley & Co. LLC: Okay. Sorry, maybe I asked it incorrectly. Just curious why the traditional dealers are having, yourselves included, strong same-store sales growth on the used car side versus the macro headwind that CarMax is citing. How do we bridge that gap just from your perspective in what you've seen?

We called this out as an opportunity a few years ago that you really now have three distinct segments in the vehicle marketplace for the customer to choose from. You have brand new, nearly new and pre-owned. The nearly new is of a size and a dimension that never existed before, due to the manufacturers putting incentives into leasing years ago which pushed leasing as a percentage of the business out there over 30% for the first time at a sustained period. So you have 4 million nearly new vehicles coming off lease, a big percentage of which are eligible for extended warranty from the manufacturers through a certified pre-owned program. So the consumer is coming in and they have brand new to choose from, nearly new to choose from and pre-owned. And this nearly new category is dominated by the franchise dealers. Therefore, we get the first look at this opportunity and we're ready for it and have seized it as forecasted several years ago. Armintas Sinkevicius - Morgan Stanley & Co. LLC: Got it. Okay. Great. Much appreciate it.

Absolutely.

Our next question comes from James Albertine with Consumer Edge Research. Your line is open.

Yeah, hi. Thanks for taking my questions. This is Derek on for Jamie. As it relates to the parts and service and warranty business, looking ahead, do you see anything structurally different with respect to the number or pace of recalls, or are we just still lapping periods of heavy Takata-related recalls, so we have difficult compares currently that could be weighing on warranty?

This is Scott Arnold. So, yes, warranty is starting to decelerate. The recall volume is starting to drop off in some of the franchises, and the overall mix of warranty in even the non-Takata recall stores is dropping somewhat. So, yes, we do feel that is a headwind.

Okay. Understood. And then, also just want to get your pulse on the M&A environment currently, whether you're seeing any changes in multiples or private seller expectations from recent quarters, and then just more broadly in terms of capital allocation, how you're weighing those potential M&A decisions against further share repurchases? Thank you.

We haven't seen any real change in the ask from sellers in the marketplace. Would you agree with that, Lance?

Correct. It's basically the same as it's been for the last couple of years. We're being prudent and disciplined at everything we look at. We've already called out we have a particular focus on collision. We're trying to build our collision business and add another acquisition there to announce. So, no material change there. We continue to look at share repurchase on an opportunistic basis.

Thank you.

Our next question comes from John Murphy with Bank of America. Your line is open.

Good morning, guys. This is (20:08) on for John. Thanks for taking my question. So, first one on F&I, you guys posted very strong numbers this quarter and another record level here in terms of F&I PVR. So can you talk about what is driving the strength there? And what do you think that F&I PVR can continue to improve going forward? Are we just kind of reaching an upper limit now?

No question that AutoNation branded products have been a tremendous benefit and opportunity. Customers have embraced them. And, Lance, what would you say is the percent in the volume stores where we offer AutoNation branded products that they choose ours something over 90%?

Yes.

Over 90% of the customers choose our product over the manufacturers' product. And the improvement is that primarily driven by more customers choosing to get a product from us rather than us getting more from each customer that we already have. So, Lance, why don't you talk about our strategy as far as how we develop the product and train the stores in new offering of the products?

Yeah. So we've had a robust training around this area for many, many years – seven, eight, nine years going back and this has been one of our strengths going way back. But when we rolled out our brand extension, this is our first brand extension strategy of the CFS products and we've expanded those, and we're just seeing a higher take rate. Obviously, customers, as Mike spoke to, are choosing our products and we are able to have high penetration levels and we're improving our margins on those individual products. So as we go forward, I think we're at an area this first half of the year where we're probably about where we're going to be, I think, with continued headwinds on new vehicle volumes compared to used. So we'll see as our used vehicle volumes increase closer to 1:1 used-to-new, that will give us headwind, but we still see opportunity to grow it, so we have some strengths and some headwinds, but I think what you're seeing now in the first half of the year is probably indicative of where we're going to be going forward.

Great. It's very helpful. Thank you. And then just on the new side, can you guys maybe talk about the drivers behind the margin erosion on the new vehicles segment this quarter? And I know a number of your peers have highlighted GPU pressures at BMW and Honda as a near-term issue. So are you facing the same pressure or is there anything else that was driving the weakness there this quarter?

No. It's clear we have the same pressures. I think with BMW, it's more a product cycle issue that we should be in a better position next year than we are at the moment with some of the launches they have coming up. And for the volume business, it's just very tough on the gross margin side. Lance, you want to add anything, please?

Yeah. Nissan and Honda really drove our import margin compression for the quarter. Domestic is basically flat for us, slightly up. But it's Nissan, Honda and BMW in the premium luxury, which really drove it. Probably 70% of our decline were in those three brands for the total compression.

Okay. That makes sense. Thank you. That's all for me.

Our next question comes from Rick Nelson with Stephens. Your line is open.

Thanks. Good morning.

Good morning, Rick.

Good morning, Rick.

Last year, you had talked about kind of AutoNation branded parts being a $100 million gross profit opportunity this year in 2018. Interested how you are tracking to that goal and what the opportunity is beyond 2018.

This is Scott. As I stated earlier in the opening, we are tracking – on track to the $100 million incremental. And as we continue to expand our offerings, we think that we'll continue to stay on track with that $100 million incremental. So as was noted earlier, aftermarket collision parts will start to ramp up, and continued adoption of our precision parts within our franchise operations will continue to adopt and help to drive to that total number.

No. Rick, if I look at the peer group for the last three quarters, the gross profit for fixed same-store sales improved by 2.7%, and at the same period of time we improved by 4.8%. The difference there is precision parts.

Okay. Thanks for that color. Those precision parts, are they in the premium luxury stores or is that just domestic and midline (25:29) import where you branded AutoNation?

Primarily in the volume stores. We have some in the premium luxury stores, but it's primarily in the volume stores.

And your acquisition appetite today, Mike, if you could clarify that. You acquired a BMW store. Is that what you're shopping in the premium luxury segment today?

Yes. I think premium luxury still looks solid in that we have excellent Customer Care business with high fixed coverage, and depending where you are in the life cycle, like we just discussed with BMW, but pretty stable front end gross profits on new vehicle sales. I think when you get to the volume business, the margin compression on new vehicle sales is a headwind that continues unabated. And I'm not sure pricing reflects that reality.

And do you have an opportunity to push these branding initiatives more steeply into the premium luxury business? Are you doing it in the F&I side, for example?

So in pre-owned, it's already done. So for all of AutoNation coast to coast, every pre-owned operation we have including in the premium luxury store is One Price. Our Financial Services products are in the premium luxury stores by and large. And on parts and accessories, it depends on the store and it depends on the part. And that's a good question for early next year.

Right. Thanks. And good luck.

Thank you.

Our next question comes from Bret Jordan with Jefferies. Your line is open.

Hey. Good morning, guys.

Good morning.

Hey. On the parts initiative, I guess how does that $100 million of incremental profit split between mechanical, I guess the precision parts and the collision parts business?

Well, year-to-date, it's all in the precision parts. The collision parts are just starting in the second half of the year. So the majority of it this year will be in precision parts. As far as the second half of the year, you're going to have better color and a better understanding of the split.

I guess as you look at importing parts directly, are there any issues around the tariffs in China that you're seeing?

No. Not really?

Not really.

Not really.

Okay. And then a final question on collision. I guess of your 81 stores, how many of those are on separate pads? I mean obviously collision businesses get better valuations than dealerships these days. Is that something that you could potentially spin out at some point or are they within your dealership base?

We would not spin them out. That's not under consideration. We are going to build that within AutoNation. Scott, how many are freestanding? I think the majority of them are freestanding.

They're all freestanding today.

They're all freestanding. Yeah.

Okay. Great. Thank you.

And, Cheryl, they're all on their own chart of accounts.

Yeah. We've separated...

Completely separate business.

We separated that out. I would also note that there tends to be a lot of dealership referral business within our existing collision centers.

Okay. Great. Thank you.

Our next question comes from Chris Bottiglieri with Wolfe Research. Your line is open.

Hi. Thanks for taking the question. Want to go a little deeper on the gross profit per unit improvement that really popped sequentially, year-over-year, however you want to look at it. I would think the hurricane, kind of getting past that probably helped. But how should we think of this level going forward now? Do you think there's still room to improve via One Price or should we kind of look at this as like the new run rate moving forward?

You're talking pre-owned?

Pre-owned. Yeah.

Yeah. So we haven't hit the hurricane comp yet.

The hurricane last year, I'd say the flooding first in Houston occurred in late August. And then the hurricanes that affected Florida and into Georgia, which resulted in store closures, were in September. So we're not really lapping those comps at this point in time. And I think it's been a while. We had talked at the end of last year that we had largely managed through the hurricane backlog at the time. So it hasn't really been an impact for the last two quarters.

Got you. Sorry, I thought you had elevated inventories from the hurricane. I misunderstood that. All right. And then, I guess a follow-up question. This fleet and (30:21) other bucket for gross profit seems to be down pretty materially in the front half. Can you just remind us kind of what drives that and how we should kind of think of that moving forward? Is there accounting change there or is there something that's temporarily putting that line under pressure?

I know that was primarily due to decreased fleet in two brands. So there's some timing related to it if there are certain fleet buys that we have in the market. Fleet is not a large composition as a percentage of our business, but that was really two brands that had lower fleet year-over-year.

Got you. Okay. All right. Thank you for the help.

Our next question comes from David Tamberrino with Goldman Sachs. Your line is open. David Tamberrino - Goldman Sachs & Co. LLC: Hey, great. Good afternoon. Mike, I want to get some of your thoughts around where we are with the industry, where the consumer is and OEM's ability to price some of the headwinds that they're seeing coming through their P&L, given that ASPs have marched higher probably by 30% since the downturn, interest rates are going up and it looks like monthly loan duration isn't really getting pushed out. Just wanted to get an understanding how you think the customer is looking at potential price increases from this rising input cost and potentially higher input costs if we go through with a couple of incremental tariffs.

I think the consumer overall is healthy. Credit is available. Credit is still very affordable, but we're at a plateaued elevated level. And I would say year-to-date, retail is down slightly. And the only reason the industry is up year-to-date pending what sales results come out today, is in the fleet category and there're some very high comps in the rest of the year. So I'm sticking with 16.8% (32:19). Now clearly, the manufacturers have absorbed the steel and aluminum tariffs thus far without really moving prices. And I think they're in a wait-and-see attitude whether these tariffs are becoming permanent and, therefore, really affect the import cost open-ended, in which case they will have to adjust prices for it. And, of course, tariffs on automobiles, well, hopefully we've pulled back from the brink of that last week with the construction negotiation and discussion with the European Union, and hopefully NAFTA gets to the finish line. But if tariffs come on the actual vehicle themselves and the percentages that are being discussed, there will be no choice, but to raise prices. Consumers will not pay those higher prices. Volume will fall and they'll have a material impact on the industry and on the economy, but hopefully it doesn't come to that. David Tamberrino - Goldman Sachs & Co. LLC: Great. Understood. And then on the Waymo relationship, it looks like it's continuing to progress that you guys noted in the press release and you just kind of talked about a little bit further. What more could this evolve into as you're working with them with a smaller fleet of cars as the vehicles – with the couple of – tens of thousands of orders I think they have coming for 2018 and 2019 with a couple of manufacturers. What incremental opportunities are there for AutoNation to partner with Waymo? And where do you see it going in the next, call it, two or three years?

Well, we have a strategic relationship with Waymo and we want to grow with Waymo wherever it makes sense. We want to understand the business. We want to be part of the business. I think what we've seen so far is that the relationship works and that Waymo really values are added value that we bring capabilities to the relationship that's extremely worthwhile. That gives me a lot of optimism that this relationship will continue to grow. But to be clear, as far as profits, well, that's something down the road. This is at the beginning of a journey and it's important for learning and to partner and to go from there. But with the most recent announcement, it says the relationship is working. It's working well and I expect it to continue to grow. David Tamberrino - Goldman Sachs & Co. LLC: Okay. And then maybe since you touched on net profits further out, how much of a drag has that business been on the second quarter or first half results?

As far as Waymo is concerned? David Tamberrino - Goldman Sachs & Co. LLC: Yes.

Not materially at all. David Tamberrino - Goldman Sachs & Co. LLC: Okay.

We've pretty much priced it on a breakeven basis. David Tamberrino - Goldman Sachs & Co. LLC: Understood. Appreciate the time.

All right. Great. Thank you, everyone, for joining us today. Very much appreciate it.

Thank you for joining today's conference. That does conclude the call at this time. All participants may disconnect.