AutoNation, Inc.

Good morning. My name is Ellen and I'll be your conference operator for today. At this time, I'd like to welcome everyone to the AutoNation second quarter 2023 earnings conference call. All lines must be placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by one on your telephone keypad. If you would like to withdraw your question, please press star followed by two on your telephone keypad. I'll now like to turn the call over to Derek Fiebig, Vice President of Investor Relations. You may begin your conference.

Thank you, Ellen, and good morning, everyone. Welcome to AutoNation's second quarter 2023 conference call. Leading our call today will be Mike Manley, our CEO, and Joe Lauer, our CFO. Following their remarks, we'll open up the call for questions. Before we begin, I'd like to remind you that 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 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 today and in our filings with SEC. Certain non-GAAP financial measures as defined under SEC rules will be assessed on this call. Reconciliations are provided in our materials and on our website located at investors.autonation.com. With that, I'll turn the call over to Mike.

Yeah, thanks, Derek. And good morning, everyone. Thanks for joining us today. As normal, Joe's going to take you through the results in much more detail than I will, but what I'd like to do is talk about the business, give you a perspective from my side, touch on what we see as industry dynamics, and then give another update on where we're heading and the channels that we're putting in place for growth for the business. So as we know, there obviously continues to be mixed economic signals in the overall economy, but From our point of view, the supply and demand equation, even though it is moderating, we think, does remain favorable for the business. And last quarter, I said that we thought the consumer had in no way tapped out, and we still feel that's the case for sure. Now, notwithstanding the fact that higher interest rates are impacting affordability, lower unit sales over the past few years have contributed to pent-up demand, which, as we see inventory levels improve and some mitigation on that transaction price, continue to convert to sales in the marketplace. And the aging vehicle part, which is now about 12 and a half years, as well as positive household formation, I think are additional favorable dynamics for the business. And these factors, I think, will continue to be a benefit for new and used vehicle sales going forward. Now, as in the first quarter, 2Q light industry vehicle sales increased from a year ago, both driven in this instance by an increase in fleet, but also a notable rise in retail units, which increased by about 10%. And even with these increases, like vehicle sale remains below what most of us who've been in the business a long time would consider trend. You know, where industry incentives and lease penetration, even though they've both been increasing as late, they're still significantly below pre-pandemic levels, which I think just give you an indication that OEMs still have a lot of additional tools to help spur demand if it's needed in the marketplace. And talking about incentives, as you know, Q2 incentives were around $1,700, which was up $700 year over year, but well below the $4,000 pre-pandemic high. And leasing continues to recover, but still only reached about 20% of volume versus 30% pre-pandemic. And I think this channel will further grow, particularly with EVs. And as we close out the year, I think we'll see that come through. Now, for the second quarter, new vehicle sales were in line with the overall growth in retail units for the brands we represent, and gross PBRs, as expected, continued to mitigate, yet remained robust, I think, at around $4,600 for the quarter. Now, clearly, front-end margins have been more resilient than most of us were expecting heading into the year. Now, I expect margins will continue to moderate, partly to maintain current demand in this higher monthly payment environment, and partly as inventory levels continue to increase and fewer vehicles are being sold at MSRP. However, I do not expect margins to return to pre-pandemic levels for the foreseeable future based on higher average selling prices of vehicles and continued lower industry inventory levels. So let me just move to used vehicles. And remaining consistent with the discussions we've had in this area, our focus on enhancing economics through effective self-sourcing efficient reconditioning and agile market pricing, I think has helped us in the quarter in what has been a bit of a choppy market. On our Q1 call, I discussed how the lower new unit sales over the past years led to scarcity of supply of late model used vehicles, and this continues, obviously. But in addition, the velocity of sales is also lower than normal as fewer vehicles were sold to fleet and daily rental over the past few years, and consumers are clearly holding onto their vehicles for longer. Now, our focus on automation has been on internal sourcing, asset turnover, and avoiding purchasing vehicles, which required substantial reconditioning to get them up to the automation quality standards. But as we look back on our first quarter results, we recognize that our lower level of used inventory, whilst bringing a number of benefits, such as lower depreciation and funding benefits, we felt was probably constraining volumes more than it should. So we spent a lot of effort in the second quarter really redoubling our sourcing efforts particularly in those categories that we think deliver quality inventory so that we could progressively through the quarter regrow our injury inventory to get us ready for the third quarter and beyond and we did that i think in a very disciplined deliberate way and that means we exited the second quarter and now go into the third quarter with increased availability which we expect will enable us to drive elevated unit cells and joe will touch on that but obviously that work came with an investment particularly around the development of those channels that we thought were the best places for us to increase our used inventory. But as I said, Joe, I'll touch on that a bit more. Now, the expansion of our Alternation USA footprint obviously remains a core tenet of our growth and densification efforts. I think densification is an important word. And we added our 16th store in Colorado Springs during the quarter. Now, as you know, we've been intensely focused on expanding the range of products and services we offer and sell to our customers. Now, this focus for us is twofold. The first is to increase automation share of our customer spend on transportation and mobility. And the second is to continually develop and grow revenue from what we term as higher recurring revenue sources. Now, one key component of this approach is obviously our financial services performance. And I have been very encouraged with the continued performance the teams have delivered. So I know a lot of our guys and girls are on the call listening to this. Thank you for that. That's your shout out. Let's please... keep that going up because our CFS PVRs structurally higher despite many expecting this valuable source of margin to come under significant pressure, particularly given prevailing interest rates. And I think it's because our team have always taken a balanced approach, driving both finance penetration levels, but really importantly, increasing per unit product sales. And as such, we've increased our per unit performance. And as a result, the team delivered a record PVR of more than $2,800 for the quarter. Well done. Now, talking of higher recurring revenue streams, let me touch on after sales. As you know, we've constantly talked about this, and we've been very deliberate in consistently growing this high-margin, higher-frequency business. And we recorded a gross profit record of more than $540 million, which is up 13% from a year ago. Now, notwithstanding the degrees in late-model vehicle park, which, as you know, is where all franchise dealerships have the high penetration and obviously lower new unit sales over the past year, I think that we have successfully been able to combat that headwind. Still work in progress, but a good result in a quarter, no doubt. And a big part of that is our focus on expanding our technician workforce and serving more customers. So I'm expecting to be able to talk about further growth in the future on these calls. Now, business continues to generate significant cash flow, which, when you combine it with the strength of our balance sheet, allows us to continue to invest to change our business for the long term. obviously make investments in our core operations, but also return capital to our shareholders, and we do that through share repurchases. And during the second quarter, we invested more than $200 million to repurchase over 1.5 million shares at a price of about $132 per share. And years to date, we've reduced our shares outstanding by more than 8%. Now, as we previously said, the structural changes we have made to WaterNation during a time when the supply and demand economics have been a tailwind for our operations will have a lasting and meaningful impact on a go-forward basis and help to continue to drive shareholder value and returns. So before I hand the call over to Joe, let me provide some updates on where we're heading and talk a little bit more about those channels for growth. Now, as I've previously discussed, we've been very intentional, I think, at looking at areas where we can expand and grow to meet the transportation needs of our 11 million-plus customers and their households. And there is a very significant opportunity set of customers who really only transact with AutoNation once or twice or have become active over the years. And we are commencing a much more targeted effort to engage with this customer base. I think it's an asset that we don't talk enough about, certainly externally, but very focused on internally. When you've had a business that over many years has not only built up some phenomenal franchise assets in great locations with what I think is great density in our operations, those 11 million plus households and customers that we've interacted with represent increasingly with technology a very, very valuable source for the company. And Rich Lennox, our CMO who joined us from Macy's, as you know, brings substantial non-automotive retail experience. So he is already looking at both lifetime value and customer loyalty with his team. And I'm really excited about what I expect to come from that area. Because if we can extend our core business and increase the depth and breadth of our product and services offer, that will deepen and lengthen our relationship with our customers, as well as continuing to provide a convenient, trusted, and transparent customer experience, which I think is vital to be successful in the marketplace. And we've put a lot of time and effort, obviously, as an organization, as a group of people, on those customer-centric actions, and I'm very pleased to see that it hasn't been lost on some industry observers. And this May, 143 of our stores were certified as 2023 Dealers of Excellence by J.D. Power. So shout out to those stores. Well done, guys. And that recognizes dealers for exceptional customer service. Now, 143 stores this year. That's up from 129 last year and 78 in 2021. So great progress. I'm also very pleased with the performance of AM Finance as the group continues to expand. As Joe's often said, we're taking a metered approach and pace to make sure that we can progressively increase the penetration of this business with the vehicles sold at ARA and USA stores, and they are doing that, and they're also navigating, as you can imagine, quite an interesting and sometimes challenging environment with all the rate rises. RepairSmith, I think, has extended the reach and the brand of our after-sales business, and we've begun to integrate this mobile service and repair business into automation ecosystem. And one of the things that I think will become increasingly obvious is as we continue to grow ANUSA, it's the only standalone used car dedicated business that has one of the most convenient service and warranty provision in the entire marketplace. Imagine that. And I mean, you have phenomenal selection of used vehicles, great transparent pricing, Great preparation, good quality vehicles, but then you also get the best convenience out of your vehicle serviced and repaired by a mobile, well-qualified technician. So really pleased about how that business is coming together. A lot of work to do, obviously, but I think it's going to be a complement to the other things that we're doing. And talking about used car business, it's obviously grown substantially from our pre-pandemic levels, both at our franchise stores and through ANUSA, now 16 locations with the addition of Colorado Springs, increases our footprint density in that area, which is another important strategy that we're focused on to drive market efficiency and economics. Now over time we expect our actions and initiatives will garner a larger share of wallet from consumers, which will reduce our relative exposure to the more cyclical parts of the business, and that approach is really centered onto that customer base I mentioned and talked a little bit about earlier, and the 11 million households that we serve. Now, during the second quarter, we built on more customers. Thank you, one has now added more than 400,000 new customers for the year. And we're focused on enhancing our relationship with active customers. But as I mentioned, really going back in, reactivating lapsed customers, adding products and services to our base so that we can really be that comprehensive provider to all of those customers that either are part of our active customer base or hopefully will be reactivated through the work and the products and services that were added. And we think that these actions will add to the structural changes that we've brought to the business over the past few years. Now, that said, I have to say we are very focused on the franchise business and supporting our vehicle manufacturers partners. And we are in a privileged position to have a lot of great relationships with some of the best automotive brands in the world. And I'm pleased to say in June we added to our franchise density in Southern California with the purchase of Bob Baker Auto Group in Carlsbad. Welcome, everybody. Really pleased to have you on board. Now, you guys are going to bring at least $300 million, hopefully more, of annual revenue and five great stores that obviously help us with building our customer base, as I said. And with that, Joe, I'm going to hand it over to you to take us through the details. Thank you.

Thank you, Mike. And good morning, everyone. As Mike described, this quarter's results were really driven by healthy margins, record after-sales performance, record CFS PBRs, disciplined expense management, and our balanced capital deployment strategy, which largely offset used unit sales, lower growth PBRs, and higher financing costs. The result was second quarter adjusted EPS of $6.29 per share, just below last year's record EPS of $6.48 per share. and above the $6.07 we reported in the first quarter of this year. Second quarter total revenue of $6.9 billion was essentially flat from a year ago, as increases in new vehicle volume and the continued growth of our after-sales business offset lower used vehicle sales. AutoNation's new unit sales increased by 8% in the quarter, which, as Mike mentioned, was largely in line with the overall industry when adjusted for brand mix. This increase in volume partially offset lower new vehicle PBR margins, which, although moderating, still remain healthy at $4,600. Inventory for new vehicles increased by one day from the first quarter to 26 days. As is the case with the overall industry, we have a wide dispersion of inventory levels by brand and model. In-court brands are generally below the company average, domestic brands generally above, and premium luxury generally in line with the average. The overall new vehicle market remained healthy during the quarter, as almost 40% of our vehicles were sold at MSRP, which continues to be far higher than pre-pandemic levels. This is down from about 45% in Q1. Our total used vehicle gross profit decreased by 14% from a year ago, reflecting lower unit sales and used PBR margins, which declined slightly from a year ago. We continued to support our used VFL economics through effective self-sourcing, which was above 90% during the quarter. After-sales gross profit grew 13% year-over-year as we continued to drive strong performance in this key area of our business. Customer pay, warranty, internal, and collision all experienced double-digit growth year-over-year. The recurring revenue stream for master sales continues to grow, with our trailing 12-month gross profit up nearly $400 million, or more than 24% since 2019. CFS performance also remains very strong, and we continue to lead the sector with PBRs exceeding $2,800 for the quarter. We are pleased that our product penetration of more than two contracts per vehicle pushed the percentage of CFS profit from products above 70%, and outpaced lower profits associated with the finance portion of our service offerings. Customers continue to invest in products which will protect both the performance and appearance of their vehicles. As Mike mentioned, we're very pleased with the performance of AutoNation Finance and the progress we have made integrating the business into our operations. We will continue to grow this business in a measured manner supporting our AutoNation stores. AutoNation Finance represented over 20% of new loans originated in our AutoNation USA stores in the month of June, which is facilitating our shift to a higher tier credit customer. Moving to costs, SG&A has a percentage of growth with 61.9% for the quarter, remaining significantly below pre-pandemic levels and reflecting permanent structural changes to our cost basis. SCNA, as a percentage of growth, profit was slightly higher than recent periods, reflecting investments in technology and new business initiatives as we expand our offerings to customers, as well as additional advertising support for our Will Buy Your Car program, as Mike referenced earlier. As noted in today's press release, we excluded $12.4 million of after-tax expense from our second quarter results. These expenses are related to weather events, including major hailstorms in the quarter that damaged more than 2,800 vehicles. In comparison, there were no such weather-related losses last quarter or in the year-ago quarterly period. Second quarter floor plan interest expense was $33 million, impacted by both higher rates and increased inventory levels. This all culminated in adjusted net income for the second quarter of $285 million, or $6.29 per share. As Mike referenced, our cash generation remains robust and, combined with the strength of our balance sheet, provides a significant capacity to deploy capital into our businesses and return capital for our shareholders. Our cash flow from operations incorporating proceeds from additional floor plans was almost $240 million in the quarter, and that included cash tax payments of $190 million. During the quarter, we invested more than $180 million in our business operations, including the acquisitions of five new dealerships, as Mike mentioned, and over $100 million of a capital expenditure. We also continue to expand our AutoNation USA footprint with our food new location this year, which increases our offerings in a key strategic market. The AutoNation USA stores play an integral part in both our long-term growth plans and the achievement of scale, scope, and density in our markets to better serve our customers. We also continue to return capital to other nation shareholders through share repurchase. Year to date, we have now repurchased 4 million shares, or 8% of the shares outstanding at the beginning of the year. The pace of share repurchase has down slightly from previous two years, but still very significant by any comparable measure. We currently have approximately 670 million of remaining authority for share repurchase. We ended the second quarter with total liquidity of approximately $1.4 billion. Our covenant leverage of debt to EBITDA was slightly below two times or at the bottom of our historical two times to three times range. And earlier this month, we successfully amended and extended our credit facility. The new five-year facility has similar pricing to the prior facility while increasing our revolving borrowing capacity by $100 million, so $1.9 billion, and increasing the flexibility of our financial covenants. Looking ahead, we will continue to focus on operational excellence and disciplined capital allocation, supporting growth to drive long-term shareholder value. With that, I will turn it back over to Mike.

Yeah, thanks, Joe. So before just taking a question, obviously what I want to do is to thank the people that every single day deliver results for us, and that's our 24,000 associate thank you for what you've done in the quarter also as you know in May we announced that Joe will be moving to a newly created role which is basically going to oversee all of the business transformation initiatives for the company Joe will continue to report directly to me and he's going to coordinate the execution and integration of our business transformation products really with a focus on process improvement operational efficiency and I think as a result of that will help accelerate our growth. Now, I can tell you that since I joined the organization in late 21, Joe, in a very short space of time, has been a trusted advisor with me and business partner. So I'm incredibly pleased and excited as he moves into this new role to be continuing to work with him. And I think he's done a tremendous job in the management of our balance sheet and guiding our capital deployment. But you also need to look below that and really look at what the business and how the business was performing in terms of some of the efficiencies, some of the cost base, and everything else. And you can see the lasting effect that him and his team, in conjunction with the operational people, have added to our business. And I think it's absolutely tremendous. Now, in August, Tom Slozek will join us and replace Joe. And many of you know Tom. He's helped drive change and innovation across medical, technology, and manufacturing industries. And frankly, like Joe, the best-in-class Fortune 500 CFO. And Tom's going to be responsible for continuing our focus on operational excellence, obviously the development of our company, as well as making sure we continue with a really balanced but focused capital allocation approach. So just a quick update on those things. And with that, should we open up to questions? Yes. Ellen, if you could please remind people how to get in queue.

Thank you. At this time, I would like to remind everyone, in order to ask a question, please press star. followed by the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster, but the first question comes from John Mercy from Bank of America. John, your line is now open. Please go ahead.

Good morning, everybody. Joe, congrats on the new role. I'll start with that. Mike and Joe, as you look at this, there's incremental dollars being spent here. I'm just curious if you could talk about what those were in the quarter for these initiatives, but also maybe more broadly. I mean, you've got 11 million customers in your Rolodex there, as we would say in the olden days, that you can really leverage and potentially engage with for a longer period of time. As you're going through this exercise of transformation, what does that mean? I mean, and could it mean that you're you know holding on to these customers in that vehicle for 10 years as opposed to you know five years and the you know the profit opportunity is 2x or maybe maybe more i mean how are you kind of thinking about this holistically as the sort of the addressable market of what you could get after and it is more traditional things like another used vehicle sale and extended parts and service um and then cig and doing some you know more financing or there are other things that are potentially entering the equation as you look at the opportunity set.

John, I'm going to start with that and then Joe can talk about the investments that we've made. When you look at our customer base that we have built up, there are a number of things that I think are really relevant. Firstly, the percentage of active customers within there, and we can define an active customer by somebody that has a transaction within a period of time. So if you took active customers, including service, the actual percentage of active customers in the 11 million is well below 50%. So then you have to ask yourself, why do you get that level of attrition with the rest of the customers? Because if you look at our reputation scores and our customer satisfaction scores, it's purely not because of that. because circumstances and needs change within that customer base. And that may well be that their geographic position to our dealerships has changed, they're further away, or as the vehicles age, they've decided to take a non-franchise solution to service and repairs, or a whole host of different reasons. And as we've looked at that and spent time working with that customer base, identifying what is driving that, we're adding and building our business so that we can offer products and services that meet their changing needs from when they maybe originally bought the vehicle, more convenience in terms of service and repair, so that, for example, if they are 20, 25 miles away from a dealership and just looking for a quick oil change, we can provide that at a great level of convenience for them as well, as well as then build out different products. We've added the finance company. That was really... twofold one because it's a deep relationship with customers obviously and secondly it was a perfect match for the growth that we were trying to achieve and are achieving with ANUSA so without taking too much of the call I think you in the question itself you answered a lot of it and that is big percentage of those customers are one and done and there's an opportunity for us there and A big percentage of those customers have needs outside of themselves in their household, whether it is family members or whether it is relatives. And what we are striving to do through the expansion of our products and services is increase the average length of the relationship that we have. And of all of the spend they make on transportation or mobility, however you want to define it, and I'm not too interested in what word you used, that we want more of that. and earn more of that because of the quality of service, the price of our service, and the transparency of working with automation. So a long answer to your question, but hopefully that will add some color.

And then let me try to put some quantification behind that, John. So if you think about really what Michael was saying, to deliver that, it's investments in technology, it's investments in people, capabilities, incubation of businesses, and marketing. I mean, those are kind of the buckets that we look at as we are developing solutions, developing capabilities, developing businesses. The cost of that, as I indicated last quarter, is tracking basically between 100 to 200 basis points as a percentage of growth. In this quarter, it was about 150 basis points. When you look at our 61.9 as a percent, about 150 basis points of that are those types of costs that I've tracked that we kind of deemed the support of these critical initiatives, which I think will, as Mike referenced, position us fundamentally different going forward.

Yeah, thanks very much. John, just one thing I want to add. Sorry, John, go on. I didn't mean to interrupt you. What were you saying?

No, no, go. No, finish up. I'm sorry. I just had one quick other one.

Yeah, what I think is important is that, you know, what we're talking about is a progressive expansion of our business. This isn't a light switch because those customers that have become inactive are obviously transacting with someone else or a different, obviously with someone else or a different way. Maybe they're getting a service or part now from a non-franchised family-owned store. But the reality is they are continuing to transact So this is not a light switch, all of a sudden, okay, you know what, come back to us and everything changes. So you will see a progressive development of this part of the business. But I think what's really important is it hasn't just begun. If you look at the investments automation, PreMe have been making, for example, in their after sales business and the development of their technicians, all of that type of business, I think, and Stability in times when new vehicle sales are up or down and margins are really in the hands of someone else and continues to lay down a base of profitability that enables us to develop great cash flow so that we can invest in these businesses. So it is not a short, quick burn flash. It's a longer burn part of the business, John. So I think that's important for me to say that as well.

That's very helpful. Just real quickly on inventory levels. and the potential for a UAW strike, which seems like it's fairly likely. Mike, I mean, obviously, your former life, you're close to this stuff. I wouldn't say it's probably near your heart, but not dear to it. This situation is going to be pretty difficult, and it sounds like we're going to have some level of an extended strike at one, if not all, of the D3. How are you setting up to handle that, and what kind of implications might that have as we go through the end of the year for the business.

Obviously John, we're watching you very closely as I'm sure a lot of people are. I think your overview of the situation is probably right. Having been on one side of that table, I think ultimately what needs to prevail is the fact that the interests need to be balanced and ultimately get aligned. Now, whether that is a stride or prolonged strike or they get to an agreement beforehand, I don't know. But what I can tell you is if you look at the inventory development, the biggest growth in inventory that we've had is in our domestics. That, to me, gives me a level of comfort. We know we can survive on inventory levels way below the ones that we have today. And it looks as if it will continue to build as we get through the summer before the summer shutdown in the plant. So I think you need to look at that. So the distribution of our base supply is much lower in other divisions. The second thing, and I've touched on this before, the good news about a balanced business, the really good news about a balanced business is we have different sources. And as I mentioned, we came out the first quarter, I was pleased with the efficiency of our stock turn on our used vehicles, but I did think, and the team felt, that we probably constrained ourselves. So we spent a lot of time rebuilding that And you'll see quite a change in our used vehicle inventory from the end of Q1 through to the end of Q2. That process isn't finished because I still think that we can put more inventory in there because I think the market's robust. And obviously, if we do see a shortfall in terms of our domestic businesses on new vehicle sales because we get to a level of inventory that really is constraining sales to a large extent, we will have the ability to switch on and refocus on our used cells as well as that increase in after cells that we're seeing. But I would tell you, I think it's going to be an interesting summer. And, yeah, nothing else apart from that.

Great. Thank you very much. Yeah, thank you very much, guys. I appreciate it.

Thank you. Our next question is from Daniel Imbrow from Stevens. Daniel, your line is now open. Please go ahead.

Good morning, everybody. Thanks for taking our questions. Mike, I want to follow up on that last question around the used business. Obviously, end market demand is choppy, and you guys are moving your inventory around to address it. I guess two questions on that side. I guess, one, just what is your outlook on when that affordability issue starts to get fixed? Are we seeing lenders extending terms any further? I'm just curious kind of how you position the inventory, if you could expand on that, if there's any assumption there. And then strategically, last quarter, you guys felt like focused more instead of per unit profitability, maybe less focused on unit growth. GPU stepped down a bit more than we thought they would this quarter. Just kind of any change in your strategic thinking there around market share versus profitability per unit, and then how do you weigh those two factors in this current backdrop?

Well, firstly, on the affordability, what we're seeing is that mix is changing. So you saw the average price of used retail coming down. That's pure mixed change. We're seeing prices, wholesale prices mitigating. They peaked in March. The last few months, they're trending down. Much more normal depreciation pattern, which is bringing down net prices on used as well. Our terms, our periods are remaining solid. But we do know that we are competing against lenders that have increased the term that they're prepared to offer in the marketplace to keep and balance that monthly payment. So at the end of the day, the equation, whether it's price, whether it's term, whether it's accessories, the reality of what's not changing very much is the monthly payment available. And as always, we're finding ways to still be able to maintain sales, and I think that will continue. Secondly, no, I still think we've got a very robust margin. It's not a change in our focus at all. But even with that, I still think it's important that we balance the volume that we want to achieve as well as taking, I think, a very deliberate approach to maintaining used margin. So I was pleased with the margin. I think that there was more volume without a significant impact on margin. But we are in a period now where we're seeing, as I said, a return to what we would consider more traditional depreciation in the used market. And we just have to stay very agile with pricing. So you're going to see, as you always do, fluctuations in margin. But we want quality business, but we want our fair share of business. And I don't want to constrain being the fact that we don't have enough used vehicles to meet the demand. So it's always a balance, but it's not a changing strategy.

Perfect. That's helpful, Culler. And then maybe this is a follow-up on the new side. Inventory obviously is still tight at 26 days, but GPUs were under a bit more pressure than expected. Is that just a certain brand mix issue that kind of pulled down the sequential step down in GPUs relative to the one day in inventory? Just trying to help better understand the sensitivity of maybe how quickly GPUs will compress as inventory builds from here, given that move this quarter sequentially.

Thanks. No, I don't think that. Well, a number of things are happening, aren't they? So you talked about affordability on used vehicles. You have the same impact on new vehicles. And as availability picks up, obviously maintaining momentum in the new vehicle market is important. Net transaction prices are clearly coming down. Some of that was expected from a margin compression. And frankly, I think where we're sat is probably better margins than I expected coming into the year, which is why I made the statement that I think margin compression will continue, but won't reach the levels, certainly this year, in my opinion, that we saw pre-pandemic. So what I would say is that... And by the way, that's also... On the OEM side, the increase we saw in incentives, the move to leasing, are all about affordability issues, all about maintaining momentum in the new vehicle market. I think that there are plenty of tools available to maintain that going forward, but it's driven by not just improved supply of inventory, but it's also driven by making sure that some of the issues and pressure on affordability are mitigated in certain ways. As I said, we expect to see ongoing mitigation of margin, but not at the levels yet that we saw pre-pandemic.

Perfect. I appreciate all the color and best of luck.

Thank you. Our next question comes from Rajat Gupta from JP Morgan. Rajat, your line is now open. Please go ahead.

Great. Good morning. Thanks for taking the question. And congrats, Joe, on the new role. I had a first question on parts and services. Thank you. I had a first question on parts and services. You know, the growth there accelerated, you know, from 1Q to 2Q, you know, both revenue and gross profit. Are there any specific areas you would attribute that to? Is it just broader industry strength? You know, was there anything automation specific? You know, perhaps repair smithies, begin to contribute, you know, if you could just get a little more granularity there would be helpful and help follow up. Thanks.

Yes, Mike. I think there are really three things in play. The first thing goes back to some of the things that we're talking about before, and that's being really looking at the penetration of our franchise businesses in the areas that they're responsible for. and recognizing that if the branded vehicle part, which is the primary target for a franchise dealership, offers a lot of opportunity in exactly the same way you consider market share. So it's really the teams focus very much on where is our service and parts market share and where do we want to take it. That leads you to the second part, and that is do you have the capacity We certainly have the physical capacity because OEMs for many, many, many, many years oversized their dealerships, which means that we have physical capacity already paid for and installed. And we've been very focused on increasing our human capacity to be able to take advantage of improvements in penetration. But the real effect that we're seeing, I think, is a return to obviously you've got more miles driven, you've got longer ownership of vehicles, and therefore there's more work being done on a per vehicle basis. So it's a combination of those things that has delivered the result. You're not seeing the effect of RepairSmith yet. That will take some time to be integrated into the business, as we've said on many occasions. But our focus on those three areas that I touched on is what's driving it, and hopefully we'll continue to drive it for a little while yet.

Got it. Got it. That's helpful. Maybe a follow-up on, you know, in finance, you know, the loss rate there, it seemed like it improved quite a bit from 1Q to 2Q, you know, just the total contribution from that, unless I'm missing anything else in the other line item there. But curious if you could clarify that. And then any color you could share on, you know, how delinquencies or charge-offs uh tracked sequentially uh in that portfolio um and any neotrim trends uh have changed your view around the ramp up of that business uh and how do you view penetration there you know uh progressing through the course of the year thanks just one or two questions i'm happy to talk about uh and finance so um it is it is progressing um as you know we kind of stepped into some headwinds

But it's progressing with a lot of attention in a very positive direction. We are very deliberately increasing the penetration within the AutoNation USA stores, as I mentioned. And, you know, 20% of the loans now are coming of the AutoNation stores are through AN Finance. That's allowed us to drive down costs. It's allowed us to improve credit quality. In a marketplace that generally, you know, delinquencies have been a challenge for the industry, continue to be a challenge, but we've mitigated that by expense discipline. We've mitigated that by portfolio pruning and being very deliberate in, you know, how we continue to build the book. That book is very rapidly becoming an AN finance dominator, AN automation-dominated book, which will continue. as that really is obviously aligned with our strategy of penetration of the customers. So from a contribution standpoint, you're correct in that it's had sequential improvement each of the quarters. I expect that to continue, but as we've indicated, it will be at a very governed pace given the environment and given kind of our strategic initiative. So is there anything else on automation finance I can address for you?

No, I think that's very clear. I appreciate it. And I'll get back in queue. Thank you.

Thanks, Raja.

Our next question comes from Michael Ward from Benchmark. Michael, please go ahead. Your line is now open.

Thanks. Good morning, everyone. First off, Mike, you mentioned that you thought maybe the vehicle manufacturers might turn a little bit more to interest rate or lease incentives. Certainly, you're down at lows, and we'll see that increase. Does that have any impact, positive and negative, on your F&I or variable gross margins on the new?

OEMs are very, very adept and well-practiced at making sure that the pressure is equally born, unfortunately.

Okay. You know, Joe, you mentioned you talked about operating cash flow being $240 million. I think from what I can tell, most of the inventory increase was on the used side, and that's probably largely financed by non-trade floor plan, which is below the operating line. Are you including any of that increase in floor plan in your operating cash flow number of 240?

No, when we talk about, so you are correct, and you understand the nuances of the accounting associated with trade and non-trade. So when we talk about it, we're going to try to make sure we clarify this Further, when we talk about the 230 that does have use floor plan in it, and that is the benefit of the increase of the use floor plan. And so it's really a matter of tracking both what shows up in operations on the cash flow statement and effectively page two of the cash flow, which is the financing activity. So you are correct.

Okay. And then you also had the seasonal 190 million in the cash side?

Yeah, unfortunately, the way that the tax payments go, Q2 is an opportunity to contribute to our government. So that is always going to be the quarter where we have substantial tax payments.

Okay. So the operating cash flow number we see is, from a seasonal standpoint and then from the floor plan standpoint, is going to be lower than we thought when the Q comes out later today. But all things being equal, it's normal course of operations.

It's definitely normal course. And you can see in the 236, it does include the tax payments, right? That's buried in the operating cash flows.

Okay.

So I think pretty clearly when you look at what's reported from cash from ops and you look at new and used floor plan, I think you'll pretty quickly get to the 236 number.

Okay. And then just one last thing on the off-lease. I think we're anniversary-ed up the three-year type period with COVID-19. where you probably have no vehicles coming back off lease or very little. Was that one of the things that contributed to the, when you look at the retail on the used side, underperforming the overall market?

Yeah, I mean, there were a couple of things that happened. Firstly, to your point, there weren't many vehicles that were put on lease. And then secondly, because of the appreciation of used vehicles, many customers, for one of two reasons, were buying their own vehicle off the end of the lease either because they didn't want to step into the market and wanted the market to mitigate from a price point of view or secondly they did want to step into the market and then see if they could maximize their margin on their own vehicle i think some of those things are now dissipating and we will see but the reality is there is that shortfall that um that in the marketplace of those vehicles now age one to three four years old and you've seen all of the retailers step up their activity to self-source those vehicles to fill the hole, and I think we've done a great job in Q2, and that will continue to be a focus. It does come with some incremental costs from a marketing and development perspective, but I think that is an investment well worth making, and as I said, as you get through in the summer months, who knows what's going to happen. We touched on a potential headwind in terms of negotiations. We want to make sure that So we have things that we can turn to and sell effectively. So it's always a balance.

Thank you very much.

Thank you. Our next question comes from Colin Lange from Wells Fargo. Colin, your line is now open. Please go ahead.

Thanks for taking my questions. I just wanted to follow up on the commentary you mentioned. SG&A was impacted by investments in technology and new business initiatives. Any sizing of the impact, and is that sort of in the go-forward rate, or is that more of a one-time sort of cost?

As I mentioned, and we just had this kind of earlier question on the nature of it, it is people, it's technology, it's capability, it's business. As we've indicated previously, it's 100 to 200 basis points as a percentage of gross And this quarter, it was about 150 basis points as a percentage of gross. And we track it that way, and we'll track it that way going forward.

Got it. All right. I appreciate it. Sorry, I missed that.

And then in the past, you've talked about – And just to be fair – I was just going to say, just to be clear, we anticipate that spend will continue. We're going to continue to invest in the business. What I did reference or referenced earlier and referenced in my comments was the one element of SG&A that was higher than I anticipated going forward was advertising. That was, you know, 75 basis points or so higher than you would expect from us on a going forward basis really associated with some of the unique things we did in the quarter. And that I would not expect to continue at that level going forward.

Got it. Okay. Thank you. And then in the past, I think you put out by 2026 for AutoNation USA, 130 stores. I mean, I think you're at 16 now. I mean, any color on how we should be thinking about it and when maybe the ramp will start to reaccelerate?

Yeah, I touched on this somewhat last year and earlier. And what I said was, and maybe I wasn't clear enough, and I apologize for that. we will get to 130. I'm not going to be governed by a timeline that as things develop in the marketplace, make that 130 the wrong thing to do for the business. We're very clear on the locations we want to be on. We have a fantastic strategy and team working on it. We're very clear now having opened 16 of these that we've learned a lot, frankly, from opening 16, both on the size, the footprint, the capital involved. but also the cadence of opening. And one of the things I said was that you'll see a mitigation in terms of the speed we're opening ANUSA so that what we don't do is disrupt the existing growth and development of the USA stores, number one. And two, we don't force a bad decision, a bad location because of some aspirational timeline to achieve 130. So we will achieve 130. You'll probably see seven more through the balance of this year. Will you see an acceleration? Only if I believe and the team believe operationally we can cope with it and that it is the right location at the right capital cost.

Got it. All right. Thanks for taking my questions.

Thank you. Our next question comes from Brett Jordan from Jefferies. Brett, your line is now open. Please go ahead.

Hey, good morning, guys. On the AutoNation USA service penetration, I guess, how does that compare to the used cars sold out of the franchise stores? I mean, the mobile vans are still ramping, but are you seeing those customers coming back after the purchase at the rate you see them at the legacy business?

No, no. We do have a penetration. It depends on the densification that we have or the density we have with other businesses in the marketplace. Because if we have appropriate franchise businesses, then we maintain or hand off the service work effectively. But there's an important percentage of customers that have historically found an alternative to look after their servicing and warranty needs. Progressively going forward, they won't need to do that because they'll have access to repair smiths and repair smiths will effectively become, increasingly become the service and part arm for automation, you would say.

Okay. And then a question, I guess the domestic inventory build, you know, given your background, do you think it's strategic that the big three are building given UAW risk or are they building for the sake of building?

I think that obviously I can't get into their minds, but I would certainly be building in this way. I think it's prudent build, frankly. And when I look at the mix of vehicles that are being produced and I think about the turn rate that we're still able to achieve with those vehicles, I'm comfortable and I think it's the right thing that's happening. We're still only sat at 43 days of the domestics. I have to say, embarrassingly, in my time, we were up at 130. So when we talk about build, I think we still have to remind ourselves and ground ourselves that, particularly for the domestics, high levels of inventory, spot deliveries is what most of the customers are used to and expect in those businesses. So, yes, we are talking about a build, but we're only at 43 days. Great. Thank you.

Thank you. Our next question comes from Daniel Whiston from Morningstar. Daniel, your line is now open. Please go ahead.

Thanks. Good morning. I wanted to ask about your advertising spend. You've got a lot of mileage out of it recently with the Panthers making a Stanley Cup final, your F1 partnership, and now Messi at the Dry Pink Stadium. And particularly with the F1 deal, that's a global sport, as you know. So I'm just curious if you're laying the ground for international expansion.

That's a good question. I've got to tell you that, and again, if you look at the relationships that build up over many years within automation and consider those as assets, I think the team have done a great job. You occasionally trip over an amazing opportunity as you've seen with Into Miami. You know, I think at the end of the day, it's going to be fantastic for the sport, it's going to be fantastic for the region, and obviously with our name all over it, it's going to have big benefits for us, and we're already seeing quite a diverse change in some of the hits that we're achieving on our media channels. As we've said, so you've got to put it into the category of what is good luck and what is good strategy. Messi genuinely falls into the category of good luck. With that, I think that's the best answer I can give you.

Okay. And with trade-in values and everything else going on in the economy, I'm just curious, are you at all concerned that at some point trade-in values for consumers are going to come down while new vehicle pricing stays elevated to the point that it does hurt new vehicle affordability?

Well, trading values are heading down now. They've been heading down since February, March, and I think they'll continue on that normal pattern. But what's also happening is you're seeing increases in incentive rates. You're seeing mitigation in new vehicle margins. So you're seeing an offset. And as I said, that's kind of the three-legged stool balance to get to a monthly payment that customers are looking for. I still think if you look at pre-pandemic levels, purely on the On the new vehicle pricing and incentive side, we're still a long, long way from that, and there are a number of levers that can be pulled. So, yeah, I think you will continue to see trading values decline in a normal fashion, but I think there's plenty of tools, particularly with the OEMs, that they can deploy if they want to stimulate and maintain demand.

And just one more question on the... on Elon's massive discounting of the Model Y, does that at all hurt any particular brand for you guys, either on the premium side or volume brand in your crossovers?

No, I think there's no doubt it ripples through the marketplace and had a big ripple effect. I think one of the things, it's so fluid at this moment in time. You saw the announcement from Ford, obviously, and There are other pricing adjustments that are going on that don't necessarily get the headlines that those do. So I think where we're sat right now is a drive to really try and understand what is the right net price for those vehicles in the market at the volumes the OEMs want to sell. And I think as a result of that, you're going to see constant adjustments, whether it is headline adjustments with MSRP or less visible adjustments with incentives. I think what's important and where we're being incredibly cautious is in the used market because whatever is adjusted on MSRP or incentives on the front end immediately impacts the back end. So if you look at our inventory, for example, one of the things that we are really focused on is if we have EVs in stock, which we do because there is a marketplace for those that we're very, very focused on what price and what term rate.

All right, thank you.

All right, thank you. Thanks, everyone, for joining us on the call today. I look forward to speaking with you after next quarter.

This concludes today's conference call. You may now disconnect your lines. Thank you all for joining.