AutoNation, Inc. (AN) Q3 2019 Earnings Report, Transcript and Summary

Good morning. My name is Amy, and I will be your conference operator today. At this time, I would like to welcome everyone to the AutoNation's Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Robert Quartaro, Vice President of Investor Relations you may begin your conference.

Thank you. Good morning, and welcome to AutoNation's third quarter 2019 conference call and webcast. Leading our call today will be Cheryl Miller, our Chief Executive Officer and President; and Chris Cade, our Interim Chief Financial Officer. 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 Chief Executive Officer and President

Good morning and thank you for joining us. AutoNation and Waymo will continue a multiyear service agreement, and will launch an autonomous parts delivery program in Phoenix, Arizona. Waymo an independent Alphabet subsidiary is the leader in self-driving technology with a mission to make it safe and easy for people and things to move around. We're excited to broaden our partnership with Waymo and support their fleet and operations. So what sets AutoNation apart is our industry-leading position in retail automotive, investments in our brand and our people, and the strategic partnerships that align with the mobility needs of our customers. Today, we reported third quarter earnings per share from continuing operations of $1.11 per share, which included previously announced severance and related expenses of $10 million after-tax or $0.11 per share. Same-store third quarter 2019 revenue totaled $5.4 billion, an increase of 3% compared to the year-ago period. Same-store gross profit of $877 million, increased by 5% compared to the year-ago period For the quarter same-store total variable gross profit per vehicle retail was up $114 or 3% compared to the same period a year ago. Same-store new vehicle gross profit per vehicle retail increased $9 on a year-over-year basis. However, our prior year same-store new vehicle gross profit per vehicle retailed was positively impacted by a non-recurring OEM payment. Excluding this impact, our same-store new vehicle gross profit per vehicle retail would have increased approximately $54 compared to the prior year. Moving forward, we remain committed to seeking the optimal balance between new vehicle pricing and volume. We continue to manage our inventory levels to meet consumer demand. Year-over-year, we have reduced our new vehicle inventory by approximately 7,000 units. Same-store Customer Financial Services delivered another record-breaking quarter with gross profit per vehicle retailed of $1,939 which was up $150 or 8%. The AutoNation USA group broke even for the second consecutive quarter and we are pleased with the improving performance trend at these stores. Same-store customer care gross profit was $403 million, an increase of 6% compared to the same period a year ago driven by growth in customer pay, which was up 7% and warranty which was up 6% year-over-year. I'll now turn the call over to our Interim Chief Financial Officer, Chris Cade.

Thank you, Cheryl, and good morning, ladies and gentlemen. For the third quarter, we reported net income from continuing operations of $100 million or $1.11 per share versus $112 million, or $1.24 per share during the third quarter of 2018, a 10% decrease on a per-share basis. EPS from continuing operations for the third quarter of 2019 included previously announced severance and related expenses of $10 million after-tax, or $0.11 per share. In addition, net gains from store and property divestitures in the third quarter of 2019 were lower by $9 million after-tax or $0.11 per share compared to the prior year. During the third quarter, same-store revenues increased $179 million, or 3%, compared to the prior year. On a total store basis, revenue increased $112 million, or 2% and gross profit increased $32 million, or 4%. SG&A as a percentage of gross profit was 73.7% for the quarter, which represents a 50 basis point increase compared to the year-ago period. SG&A included previously announced severance and related expenses of $11 million pre-tax. Excluding these charges SG&A to gross profit would have been 72.4%, a decline of 80 basis points compared to the prior year, reflecting disciplined expense management. We continue to expect full year 2019 SG&A to gross profit to improve year-over-year compared to 2018. The provision for income tax in the quarter was $37 million, or 27.1%. As a reminder, our prior year tax rate of 22.6% was favorably impacted by 340 basis points due to adjustments made in connection with the 2017 Tax Cuts and Jobs Act. Floorplan interest expense of $33 million was relatively flat compared to the third quarter of 2018. We managed inventory lower, resulting in lower average floorplan balances, which were offset by higher average interest rates. Non-vehicle interest expense decreased to $26 million as compared to $28 million in the third quarter of 2018, primarily due to lower average debt balances, as we paid down debt from free cash flow. Non-vehicle debt was lower sequentially at the end of the third quarter by $170 million, ending at $2.3 billion. Other operating income was $5.1 million in the third quarter of 2019 compared to $17.4 million in the prior year, a decrease of $12.3 million. Other operating income was primarily comprised of gains related to store and property divestitures in both periods. The company has approximately $219 million of remaining board authorization available for share repurchase. As of September 30, there were approximately 89 million shares outstanding, not including the dilutive impact of certain stock awards. Net capital expenditures were $60 million for the quarter, compared to $81 million in the prior year. Capital expenditures are on an accrual basis and exclude operating lease buyouts and related asset sales. Our leverage ratio decreased to 2.6 times at the end of the third quarter, compared to 2.8 times at the end of the second quarter and our total liquidity was approximately $1 billion at the end of September. Our strong cash flow generation and investment-grade balance sheet continue to enable us to invest in the business and effectively allocate capital to maximize shareholder returns. And with that, I'll now turn the call back over to Cheryl.

Thanks, Chris. Earlier this month, AutoNation sponsored its third annual Drive Pink Across America Day, where thousands of AutoNation associates delivered thousands of care packages to children and adults across the country. This day is a reminder that we are not just servicing and selling vehicles, but that we have a purpose and the purpose is to drive out cancer each and every day. It's not just a statement but it is a part of AutoNation's core. AutoNation's Drive Pink campaign has raised more than $20 million for cancer research. We remain focused on executing our strategy for our core business and our commitment to our brand extension strategy and our Drive Pink efforts. And with that, we'll now open up the line for your questions.

[Operator Instructions] Your first question comes from the line of Bret Jordan of Jefferies. Your line is open.

Hi. Good morning, guys.

Good morning, Bret.

Good morning, Bret.

Could you give us, I guess, a further update on the AutoNation USA? I think you said it was breakeven second consecutive quarter, but maybe as far as trends and what your sites are as expansion and where inventory sourcing is coming from, how you're doing as far as the direct purchase program?

Absolutely. So if you look at the trend there, second quarter where the group broke even. And certainly there are some stores doing even stronger than that within the mix. We have not at this point announced any further expansion. From a sourcing standpoint, we do have the successful We'll Buy Your Car initiative. But keep in mind also that, AutoNation as a whole self-sources between trade-ins, We'll Buy Your Car and lease returns over 70% of our inventory. And so, that's a great competitive advantage for us. So really volume is the name of the game. So as we think about those stores, we are focused on increasing that sourcing and driving additional volume through those stores.

Okay. So you are taking trades at AutoNation franchise stores and allocating that used inventory to AutoNation USA stores for retail?

Absolutely. We've always done that. And so when you think about our system, we take trades at different locations across AutoNation and USA and we move and share that inventory where it best suits our customers.

Okay, great. And then I guess a question on incentives. Obviously some of your peers that have already reported -- talked about one particular import program incentive, but what do you see out there as far as OE incentives across the board from a cadence standpoint either increasing promotional levels or decreasing promotional levels?

So, I'd say incentive as a whole are reasonable. They're up 4% to 5% year-over-year. I would say with respect to a particular import manufacturer, we're actually encouraged by their overall approach to retail. Their incentive dollars are now accompanied by more realistic targets. And so we like that approach. We were supportive of them eliminating the wholesale program. So, we feel like we are in a good position relative to our performance versus incentives.

Great. Thank you.

Your next question comes from the line of Rick -- sorry -- Derek Glynn of Consumer Edge. Your line is open.

Yes, hi. Good morning. Thanks for taking our questions. Just given the improvement in new GPUs ex that nonrecurring payment, can you elaborate more on how you're thinking about the trade-off between price and volume particularly as we think about 4Q and heading into 2020?

Yeah. We're thinking about maintaining balance there. So you've seen that we've been slightly ahead of peer with respect to PVR performance. We're slightly up on a unit basis, you saw us catch up a little bit compared to industry on units in the most recent quarter versus where we were earlier in the year. And we want to strike that right balance. When we strike the right balance, you see good flow-through. And so if you exclude the one-timer from SG&A, you saw a good flow-through and good cost discipline and we like that balance. We'll continue to keep an eye on that but we want balance. We don't want to over-index on volume or price in new. And importantly, you see exceptionally strong F&I on the back end so Customer Financial Services, an important part of the business and we strike that right balance. There's good flow through in that as well.

Okay, got it. And then also I notice CapEx just running down significantly year-over-year year-to-date. How should we think about the normalized run rate of that spend on an annual basis? And what are the expected major buckets of spend we should keep in mind over the next year?

So we haven't given a specific target on it. But I will say year-over-year, if you look at our CapEx over the last two years, we had some of the build-outs of the auction and the initial AutoNation USA stores, the brand extension strategy. We also had some OEM awarded ad points during that time period. You can see this year that CapEx is down somewhat and that was also intentional as a broader part of our cost discipline plan we put in place earlier this year, but we are making sure that we are providing great facilities for customers, and we feel like at this level of CapEx we can. We'll continue to evaluate that as we go into 2020, depending on the pace of brand extension strategies. No announced plans at this stage on AutoNation USA. But as we continue to update you in the upcoming quarters that will determine the cadence of CapEx into 2020. But we feel really good about the returns and being prudent about our capital expenditure.

Okay, thank you.

Thank you.

Your next question comes from the line of Rick Nelson of Stephens. Your line is open.

Thanks. Good morning.

Good morning, Rick.

Hi, Rick.

Talk about trade-off of a lot of OEM for GPU on the new car side, look like we saw declines in volume this quarter, but less than what we've been saying it increases in GPU but less than we saw in the first half.

Yeah. I think that's a great observation Rick. So we did try to rebalance that a little bit. We still like having some strength in the GPU, so we don't want to go all the way on that but we like that midpoint of balance with respect to new GPU. At the same time, you saw a lot of strength in used units. So we have to keep in mind that we're looking at the totality of customer preference, which is also towards nearly new. So we're always trying to optimize that line for customers between new and nearly new and where they're playing depending on the segment that they're buying in.

Yes. And in terms of capital allocation, we're seeing debt reduction. We haven't seen much buyback activity or acquisitions? Is that something we should come to expect as we push forward?

Yes, I think it was important that we took a look at the debt we were getting up towards three times and we have now de-levered a bit and with the non-ash flow generation of our business, we are in a good position. As you know we are always opportunistic. So, we're not programmatic at the wrong prices in acquisitions and other things in the market. And so we like our strong balance sheet. It's there for a reason and we will be opportunistic as we go forward with deploying capital to the best uses be that M&A and that could be M&A in the brand extension area, that could be additional development of our brand extensions, as well as we always have the potential at the right time periods for share repurchase.

Thanks and good luck.

All right. Thanks Rick.

Your next question comes from the line of Chris Bottiglieri of Wolfe Research. Your line is open.

Hi, thanks for taking the question. I wanted to maybe hit back on Brett's question a little bit. Not sure if you answered it. How are you -- I guess one for Cheryl. How are you thinking about that business? Is there any change in your personal view relative to your predecessor? And then two, I guess, what are the milestones or I don't know any way to frame like what are you looking for before deciding the future fate of AutoNation USA whether to accelerate that growth again? Like what should we be looking for in our seats?

Yes, Chris, I think the thing you're looking for is volume. So, it's throughput. So, that's the biggest thing we're focused on right now is the throughput through those stores. No change in approach. And you can see from recent numbers that used is very strong and we continue to be bullish on used not only in our AutoNation USA stores, but throughout our total portfolio. And you see customers as affordability in certain time periods gets a little bit stretched. You see customers go back and forth between new and used. Fortunately, now we have a bit of a tailwind as well. So, instead of having three rate hikes for the year, we've had two rate cuts. We'll see if we get a third tomorrow. So, the indicator I'm looking for is volume. I'm looking for flow-through of those and we want to make sure that we have that model tuned. We'll look to see the increases in self-sourcing, so we're ready -- have strong self-sourcing across our portfolio at 70% and we'd like to see that edge even further up to be able to show that volume. So, if we look comparatively, we think we can support a higher number of units on the existing store sizes.

Yes. So, that's helpful. And then kind of digitally related but how are you thinking about the Vroom investment? Is that still passive at this point? Or is there any kind of collaboration going on? And then do you see that changing? That will be -- I guess that's it.

As we think about investments and partnerships so from Vroom to Waymo, we think about learnings. And so as we've said before with Vroom, some of that is understanding and learning. There are some things that we do together with respect to reconditioning and other things that we generally learn from having that investment in there. On the Waymo side, as we think about formability. We're excited in the coming months to be launching autonomous parts delivery. We're excited about the extension of that multiyear servicing agreement where we are servicing vehicles on the ground in Phoenix that are very technically complex. And that really plays to our skill set of being able to work on electric, being able to work on autonomous, and being able to meet future customer mobility needs. So, we think about our strategic investments in those arenas.

Got you. So, just what's autonomous parts delivery like, what does that actually mean?

Yes. So, if you're a parts customer from AutoNation, Toyota, Tempe. So, you're in the GFN and you're an independent car repair shop and you buy Toyota parts from us and from that store, we will now instead of putting a person in a vehicle, we will now put a part in the coming months in a vehicle in a Waymo and then we will deliver it autonomously to our customer.

Got you. interesting. Okay cool. Thank you.

Great. Thank you.

Your next question comes from the line of Rajat Gupta of JPMorgan. Your line is open.

Hey, good morning. Thanks for taking my question. I just had a question on parts and services going into the fourth quarter here obviously pretty solid results in 3Q. Looks like warranty comps probably get a little tougher. I don't know if you have any impact from the GM's drag. But should we expect a similar kind of growth rate continuing into the fourth quarter here on parts and services? Or I just want to make sure, if there's any one-timers or any tough comps to keep in mind there? And I have a follow-up.

Yes, warranty comps are tough to predict. So we've seen some improvements in warranty rate which helps with that, but it's always hard to predict the pace of recalls and other items. The GM strike from an vehicle inventory perspective were in really good shape. Parts got a little bit tighter. There was no material impact of the GM strike in the third quarter. We're continuing to keep an eye on that as regular parts movement resumed into Q4. And so we feel really good about parts and service and its relative flow-through. And so, I think that that business remains strong. And certainly that's supportive. So despite the fact that new unit sales have plateaued and certainly you lose pre-delivery inspection income on those used units are strong you pick up the reconditioning on those. So when you add those in combined with customer pay and warranty which were up 6% and 7% in the quarter we feel good about Q4.

Got it. And then on SG&A execution was solid once again. I appreciate the color on the FY guidance there. But just to put a final point on the fourth quarter. Typically those expenses have been up 3Q to 4Q and adjusting for the severance payment this quarter, should we still expect that kind of seasonality to continue here in the fourth quarter? Just trying to get a little bit more closure on the SG&A to gross profit number here for the fourth quarter? Thanks.

Hi Rajat, it's Chris. So typically we actually see leverage on SG&A during the fourth quarter. So we don't see any reason why that historical trend would be any different this time around. We've -- we did a great job on SG&A this year. I think really even amidst some onetime payments related to severance and the like we feel that we've done a really good job from a cost discipline perspective. And especially when you think about it in the context of our brand extension investments which have an SG&A investment component to it as well. Even with that we're still running below the annual levels that we ran out last year. So -- and that's on investments that are not necessarily fully mature at this point and may not be mature for several more quarters. So we don't even have the growth pull-through yet on that. And we're still seeing improved SG&A and we're happy with where we're at.

Got it. Just last question on F&I, GPU's number -- GPUs again pretty solid there roughly $150 higher year-over-year. Is there a way to just break that apart into the components that's driving that? Because I mean new Waymo sales were down for the year, sales mix is slightly a headwind. But is there any way to break apart what's driving that year-over-year improvement including things from that extension and things like that? Thanks.

Hey, Rajat, it's Chris again. So for sure as you move more of a mix towards used away from new there is a difference in total F&I PVR. We've said in the past that that's usually a few hundred dollars difference between the two. And then you combine that though with higher penetration rates and some pricing power that we have now in our brand extension that's been overall supportive. So it's helped to counterbalance some of the mix shift we've seen towards used. But that mix shift if the new-to-used ratio or the used-to-new ratio continues to strengthen as it will there'll still be upward pressure on that mix impact.

Got it. Okay. Thanks, I will pass on.

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

Good morning everybody. Just a few follow-ups first. I mean on AutoNation U.S.A., I mean has there been any change in your thought process about opening new stores? I mean I know you're talking about throughput needing to increase in your existing stores, but you're at breakeven and they've been in operation for a while. Is there anything sort of change in the thought process there that you might get more aggressive and start opening stores again?

I think when you see the group for the second quarter gets to breakeven that certainly increases the confidence level, but we would like to see some of that flow-through. Certainly, we have the balance sheet to do the rollout. We certainly know how to build and stand them up in what markets we would do that, but we're continuing to follow through for that increased throughput.

Okay. So we're still waiting for that before you decide to do it. I mean, just seems like you've been in operation -- it seems like it might be still question of timing at this point. Is that correct Cheryl or...

Yes, I would think of it probably in terms of timing. We want to make sure -- and look we've piloted things over the years. And when we move too quickly on things before we perfect them, we get mixed results. And so we want to make sure that we're focused on tuning things to the point we want to before we proceed with a broader rollout.

Okay. That's helpful. And then if we think about floorplan, I mean, there could be a real opportunity there as rates decline to save a bit of money on floorplan expense. Is -- how do you see that opportunity going forward? And also are you seeing any sort of offset on floorplan assistance? Or should we think about a rate reduction as really dropping to the bottom line for you guys?

It definitely drops to the bottom line. So the thing I like about inventory levels right now is we're down 7000 units year-over-year. So if you look at the DSO, it's down to 55, which is still a healthy level. It's a good level to meet customer demand but it's right-sized. So you have lower inventory balance and then we'll be hitting an inflection point soon where rates will be dropping year-over-year. So if you think about last year, you had a three rate hike. Now you've had two rate cuts. You might have a third one tomorrow and that actually provides a benefit in floorplan cost. It provides better customer affordability and it also provides lower non-vehicle debt. And a lot of our non-vehicle debt is fixed but it does -- we do have some floating, where it provides a benefit. So certainly for us, it's a nice tailwind to the business and it's a nice tailwind for the consumer.

Okay. And then on gain on disposition obviously, they're lumpy and tough to call, but is there any way that we can think about sort of the backlog of assets or real estate that you have sort of in your portfolio that might be for sale, so we could think about how that might flow out over time? Is that something you've dimensioned? Or is that a moving target?

Yes. If you think about any quarterly timing it's a little hard to predict the exact timing of where something closes. I would say, we have -- we did state a couple of years back some select dispositions. We're substantially through a lot of that. So there's always periodic portfolio trimming that we will do. But I'd say, the bigger portion of dispositions we've successfully done over the last couple of years.

That's helpful. And then just lastly volumes on your auctions which are a stepped-up focus for you. Is that all flowing through the wholesale line? And of the auction profits you are running through the gross line for wholesale? I'm just trying to understand where that's showing up in the segments and in the income statement?

Yes, that's exactly correct. That's where it shows up. And so we're pleased with the options that we have today.

Great. Thank you very much.

Just to be clear John, that's not affecting PVRs either since it's gone through the wholesale line.

Yes, it's not on the retail, yes, it's not hitting the retail numbers. Yes got it. Thank you so much.

Thanks, John.

Your next question comes from the line of Armintas Sinkevicius from Morgan Stanley. Your line is open.

Great. Good morning. Thank you for taking the question. The new day supply came down nicely here to 55 days, as you just mentioned. How are you thinking about the right levels here, because it's a bit lower than last year? So thinking about the fourth quarter, are you looking to take up inventory? Or should we see some seasonality off of that where fourth quarter comes down a bit? Just any color there would be helpful.

55 to 65 is usually a good broad target range. You can run a little lighter, you can run a little heavier. We certainly always position well in front of holiday selling season. So we always -- we do essentially manage the inventory and we will make sure we have the appropriate amount of inventory for the hotter model lines. As you know it's a blended balance, so you want to make sure that even if the average is 55. It's important that you understand what the barbell looks like around demand. And so we feel well-positioned that we'll have the right amount of inventory to hit a strong holiday selling season at the end of the year, which is typically, the seasonally strongest month of the year.

Okay. And then you mentioned that you tried to rebalance a little bit as far as units versus GPU on the new side. I think last quarter the conversation was that, there was no change of strategy going to the dealership. So I'm just curious, was there something that changed in the quarter that that made you push more units versus GPU or...

We really think of that as a broad strategy. The way I think of our strategy is executing a strong core focusing on brand extensions and strategic partnerships. And so within each of the individual lines. And keeping in mind now that you're seeing customers sit on that line of new versus nearly new. So they might come in thinking they want a new. And then we look at broad pricing and affordability. They may say, hey, look there's a three-year old lease return in Premium Luxury, looks pretty good to me. Maybe I'll opt for that. And so as we think about the execution between new and used and the balance between pricing and volume, I think of that as tactical execution versus a particularly strong statement of strategy that we were going to over index one direction or the other. But we did feel like when we looked at retail volumes that we may have left some units on the table. And so we did want to grab a little bit more of unit demand without really giving up too much in the way of PVR, and I think we struck a decent middle balance.

Okay. And then last one here from me. Mike was always forward-thinking here when it comes to the industry. Carl was excited about the potential of digital. In your current role, how do you view the impact or the influence the opportunity so to say from digital?

I think it's hugely important. And I think you have to think of digital is not just an initiative. It's really embedded in retail businesses these days. So you have to think about our early days of AutoNation Express, where we had people reserving the vehicles online transparent pricing. Now you've got online one price in use. And importantly, as we extend the brand further into customer care, the ability to do more digital on the back end in the parts and service part of the business. So I think it's not just one initiative in one place. I think it's throughout the business and we continue to focus on that in multiple areas.

Great. Thank you.

Thank you.

[Operator Instructions] Your next question comes from the line of David Whiston of Morningstar. Your line is open.

Thanks. Good morning. I have three questions for you guys. First is on leasing particularly around Premium Luxury. Are you seeing that getting more expensive for the Lexus domestic customer now either due to supply issues or due to the rise of the Model three from Tesla?

We actually -- we see strong performance in Premium Luxury and we've always seen great support from the Premium Luxury captives with respect to leasing. So leasings at a reasonable state is 29% to 30% of the industry volume. And certainly Premium Luxury always has a heavier leasing component than does domestic or import. So we feel good about customer relationships in Premium Luxury and leases.

And staying on Premium Luxury that segment compared to the other two, its earnings were up about 16% much better than the other two. Can you just talk about what was driving that?

Yeah. Some really great product coming out, so you had great refreshes. Mercedes had the new A-Class the GLE CLS. BMW 3 Series and they also had a new 8 Series and Audi was out with the Q3. So if you just look across the board, you had some really strong products that helped drive great results in Premium Luxury.

Okay. And I know it's still October, but did you have any thoughts on the 2020 SAAR yet?

We have not yet made the oracle prediction. But I will say for this year we do expect $17 million. So when you take a little bit more fleet sales, and you add in two rate cuts and possibly a third we think that supports the $17 million for the year. And if you asked us earlier in the year, we probably would have thought it wouldn't have quite made it, but now it looks like it's going to.

Okay. Thanks Cheryl.

And there are no further questions at this time.

Thanks so much everyone. Appreciate everyone's time today.

And this concludes today's conference call. Thank you for participating. You may now disconnect.