Penske Automotive Group, Inc.

Good afternoon, ladies and gentlemen. Welcome to the Penske Automotive Group second quarter 2021 earnings conference call. Today's call is being recorded and will be available for replay approximately one hour after completion through August 4th, 2021 on the company's website under the investor tab at www.penskeautomotive.com. I will now introduce Anthony Pordon, the company's executive vice president and of Investor Relations and Corporate Development. Sir, please go ahead.

Thank you, Sarah. Good afternoon, everyone, and thank you for joining us today. A press release detailing Penske Automotive Group's second quarter 2021 financial results was issued this morning and is posted on our website along with a presentation designed to assist you in understanding the company's results. As always, I'm available by email or phone for any follow-up questions you may have. Joining me for today's call are Roger Penske, our Chair and CEO, Shelley Hulgrave, our Chief Financial Officer, and Tony Ficcioni, Vice President and Corporate Controller. Our discussion today may include forward-looking statements about our operations, earnings potential, outlook, future events, growth plans, liquidity, and assessment of business conditions. We may also discuss certain non-GAAP financial measures, such as adjusted income from continuing operations and related adjusted earnings per share, earnings before interest, taxes, depreciation, and amortization, or EBITDA, and adjusted EBITDA. We have prominently presented the comparable gap measures and have reconciled the non-gap measures in this morning's press release and the investor presentation, which are available on our website to the most directly comparable gap measures. Our actual results may vary because of risks and uncertainties outlined in today's press release, which may cause the actual results to differ materially from expectations. I direct you to our SEC filings, including our Form 10-K, for additional discussion and factors that could cause results to differ materially. I'd now like to turn the call over to Roger.

Thank you, Tony. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report all-time record second quarter results for PAG. These results were driven by outstanding performance across all parts of our business. Our revenue increased 91% to $7 billion. An income from continuity operations before taxes increased 658% to $464 million. An income from continuity operations increased 653% to $339 million. And related earnings per share increased 650% to $4.20. Our earnings growth was driven by strong business conditions across all areas of our operations, including stronger unit sales, higher gross profit per unit retailed, increasing service and parts gross profit, and the continuing expense leverage and lower interest costs. I'm particularly pleased today with the continued expense discipline driving an 1,860 basis point improvement in SG&A as a percentage of gross profit to 63.4%. Additionally, earnings before taxes from our commercial truck dealerships improved 172%, and the earnings from Penske Transportation Solutions increased 243%, demonstrating the strength of the company's diversified business model. Looking at our retail automotive operations, on the same store basis for Q1-21 versus Q2-20. Unit sales increased 82% to 131,000. Our new was up 92% on the same store basis. Used was up 75%. Retail revenue increased 98%. New vehicles up 105%. Used vehicles up 99%. Our finance and insurance increased 119%. and service and parts was up 60%. Our gross profit increased 124%, including a 69% increase in service and parts. Variable gross profit increased 45% to $5,169 per unit, compared to $3,562 a unit. Comparing Q221 to Q219, same-store retail revenue Units increased 6%, revenue increased 23%, new unit vehicle was up 26%, used vehicles up 26%. Finance and insurance was up 29%, and service and parts was up 2%. Our gross profit increased 35%, including 5.5% in service and parts. I might note that during the second quarter of 21, we experienced showroom closures in the UK and Europe, which obviously impacted our comparisons. We opened two locations for car shop during the second quarter, and we now operate 19 locations. During the second quarter, car shop unit sales increased 184% to 18,742 units, and revenue improved 208% to over 400 million, and gross profit per unit retail increased 17% to $2,700. We improved vehicle sourcing by increasing the volume of trade-ins purchased and also from the consumers and our franchise dealerships using our proprietary internal online transfer portal. Based on current sales rates since reopening in the UK, Supercenter showrooms on April 12th were forecasting a current run rate of approximately 80,000 units annually. Turning to our retail commercial truck dealership business, Primer Truck Group represented 9% of our revenue, and the return on sales in the quarter was 6.3%. During the quarter, we completed the acquisition of Kansas City Freightliner, which is expected to add $450 million in annualized revenue. We sold over 4,100 new and used trucks, and vehicle margins increased versus the same time Last year, due to stronger market conditions, same-store service and parts gross profit increased 18%. Total service and parts operations represented 65% of the total gross profit and fixed cost absorption was 133%. As a result of these items, our earnings before taxes for Premier Truck increased 172%, to $39.7 million for the quarter. The Class 8 commercial truck market remains very strong, as expected to continue for the near future. During the second quarter, North American Class 8 net orders increased 205 percent, retail sales increased 63 percent, and the backlog increased to 253,000, which represents approximately a 10-month supply. ACT Resources forecasting A 29% in retail sales increase to approximately 300,000 units compared to 233,000 in 2020. We expect the strong market will provide tailwinds to our commercial truck and our truck leasing businesses for the remainder of 21 and 22. Moving on to Penske Transportation Solutions. As you know, we own 28.9% of PTS, which provides us with equity income. Cash Distributions and Cash Savings. PTS currently operates a fleet of over 330,000 vehicles and Q2 PTS generated $2.8 billion in revenue, an income of $354 million or a return of 15.4% on sales. As a result, our equity earnings increased 243% to $102.5 million Our full-surface leasing and contract sales were up 11%. Our commercial rental revenue was up 62%. We had a utilization all-time high of 87%. Consumer one-way rental was up 71%, and the demand remains very strong. Our logistics increased 45%, including the recent Black Horse Carriers acquisitions, which we expect to add at least $600 million in revenue for PTS. The gain on sale of used trucks is up 245% to $45 million, a strong freight environment and shortage of buy of used trucks and new trucks is driving the demand for used vehicles. I'd now like to turn the call over to Shelly Hulgrave, who assumed the Chief Financial Officer role on June 1st to discuss the balance sheet and cash flows. We're very fortunate to have Salman with her experience and tenure with our company Thank you, Roger.

Good afternoon, everyone. I'm pleased to accept this role. Having been the corporate controller over the past six years and spent 15 years in total with PAG, I look forward to continue working with our team and each of you on the exciting opportunities in front of us. Looking at the PAG balance sheet and cash flows, the balance sheet remains in great shape. At June 30th, we have $165 million in cash and we ended the second quarter with approximately $1.1 billion in liquidity under our credit agreement. When looking at our capital allocation, we maintain a disciplined approach that focuses on opportunistic investments, capital expenditures to support growth, delivering a strong dividend to our shareholders, reducing debt whenever possible, and share repurchases. Year-to-date, we repurchased nearly 500,000 shares, and as we announced today, our Board of Directors increased the repurchase authority to $250 million. Year-to-date, we generated $917 million in cash flow from operations, and we invested $91 million in capital expenditures. including $6 million to acquire land for future car shop expansion. At the end of June, our long-term debt was $1.52 billion. We have repaid $842 million of long-term debt since the end of 2019. In addition, we've either repaid or refinanced our senior subordinated debt to lower rates while lengthening the terms to take advantage of current market conditions. These initiatives have lowered our debt to total capitalization to 28.7% compared to 33.7% at December 31st and 45.6% at the end of 2019. Our leverage ratio sits at 1.0 times, an improvement from 2.9 times at the end of 2019. At the end of June, total inventory is $2.9 billion, which is down approximately $500 million from December 31st and June 30th last year. Retail automotive inventory is $2.3 billion. We have a 26-day supply of new vehicles, and we expect the current supply-demand imbalance to continue into 2022. Our day supply of premium is 30, while volume foreign is 14. Use vehicle inventory is in good shape with a 38-day supply. At this time, I will turn the call back over to Roger.

Thank you, Shelley. Moving on to our digital initiatives, we continue to grow, expand, and enhance our digital footprint, including the introduction of new tools and technologies to offer our customer a hybrid customer-driven shopping model. Depending on their preferences, customers can purchase either fully online, in-store, or any combination of the two. Last week, we announced a fully automated technology platform to facilitate online retail sales of our used vehicles. This platform is driven by Cox Automotive's patent-pending artificial intelligence. It's currently being used exclusively at CarShop to provide consumers with the ability to complete an automated 100% online vehicle purchase. With this new technology, customers can now perform The following 100% online. Receive approval for financing and aftermarket protection products. Receive personalized payments for all eligible vehicles based on each consumer's credit profile, including tax title and other fees. Complete an electronically signed deal paperwork. Make any required down payment. And even we provide an online notary. We intend to expand and use this technology to our franchise dealerships as well. Looking at our other digital tools, we retailed almost 3,000 vehicles or approximately 4% of our U.S. unit sales directly through preferred purchase and 14% of our customers used preferred purchase in some way during their buying journey. Using the Sitner Buy Online tool in the U.K., a customer can reserve a car for 99 pounds, apply for financing, receive instant credit approval, obtain a guaranteed trade-in price, and PayOnline all through our proprietary platform. During the quarter, we sold 4,500 vehicles or 9% of the UK unit sales using this platform. So when you combine our online buying tools in the US and the UK, along with our online service scheduling and online pay and the new technology available at CarShop, we have the tools to allow a customer to perform any part of the transaction online to shorten their visit to the dealership. Let's look at corporate development. So far this year, we've completed acquisitions totaling $600 million in annualized revenue. We opened a new Porsche dealership earlier this year in Washington, D.C. and have two open points under construction. Combined, the new points represent approximately $150 million in annualized revenue. We have another $700 to $800 million in annualized revenue of deals in our pipeline representing retail automotive or commercial truck dealerships. We also opened two car shop used vehicle super centers this year to date and plan to open four additional locations by the end of the year. We plan to execute our growth plan to increase car shop footprint from its current 19 locations to 40 by the end of 2023. At this time, we expect car shop will generate at least 150,000 unit sales and 2.5 to 3 billion in total revenue, doubling the size of the current business. And we are targeting a 3.5 to 4% return on sales and 100 million of EBT. As we look across our diversified portfolio of businesses, we can continue to target organic and acquisition growth as well as further operating efficiencies to continue to grow and expand our business. I'd like to thank our team for the outstanding results in Q2 Producing all-time record results for PAG. Thanks for joining us this afternoon on the call and your continued confidence. This time we'll open the call up to the operator for your questions.

Thank you. To ask a question, you would need to press star then 1 on your telephone. To withdraw your question, please press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of John Murphy with Bank of America. Your line is now open.

Good afternoon, Roger. Just a first question on sustainability of current market dynamics, which is a tough one to answer. As far as the GPUs or grosses per vehicle and the very low SG&A or

I lost you. You there? Operator, are you there?

Can you hear me?

Go ahead. We lost you. I want you to go back. You talked about sustainability, and then you went blank. Sorry. Go ahead.

Sorry. So if we think about the grosses, which appear to be a little bit high at the moment, and they might normalize over time, as well as the SG&A growth, to gross being very good performance right now, but there's some concerns that that will inflate a little bit over time. I'm just curious if you could talk about the sustainability of those two parts of the equation, so first on grosses and then second on structural savings on the SG&A side.

Well, I think basic economics says low inventory obviously grows the demand and we get strong gross profits, which I think will continue. The big question there is can we keep the discipline at the OEM level from the standpoint of day supply into 30 to 40 days, which I think many of them are talking to us about. They see what it does for them from a profitability standpoint, and obviously it's been key for us at the dealer level. You know, obviously if the growth comes down, it impacts SG&A. I think the most important thing is what we've done. We've taken 11.5% of our workforce out. We've reduced other costs significantly, which has taken... The SG&A down to 63.4%. And at the end of the day, we will continue to commit to those types of reductions on our people. We're finding out we've got better productivity. Our mechanics are over 120%. We see sales now per unit for a sales associate going from 9 to maybe 12 or 13. And I think when we look in the service side, we see our vehicle maintenance is down, John. Less loaner cars, less comebacks. and many more. I think we're going to see some deterioration with that. We did a little bit of back of the envelope here this morning. We did 131,000 units and let's say at $5,200, it's about $66 million. And if you take $500 worth of gross out and then take 30% of commissions, you'd end up probably with about $45 million of lost gross profit. And then you look at growing your parts and service business, up 5% would be about $25 million. So we're really looking in the $18, $19 million of lost gross, even if we dropped our margin, $500 I'd say would be 10%. and I think with the increased opportunity in parts and service, you know, acquisitions we're making that we can earn that back. But it's easy to say, but I think that just gives you a little bit of sense on some of the elasticity on the growth side.

Yeah, that's incredibly helpful. And then just a second question on the used car opportunity. I mean, obviously, car shop, you know, you're looking at a little bit more than double the store count. but you also have this relationship or system that you're running with Cox in car shop. The way you're talking about the car shop business, it's almost like a linear increase with the store base as opposed to getting any real power with online tool from Cox or what that Cox tool might mean for your dealerships directly on used cars. I'm just curious, as you think about that business and not to Say, you're undershooting. I appreciate the conservatism and realism, but is there a much bigger opportunity for you on the used side as you grow the network, maybe you get a little bit more productivity out of the existing stores, and then you turbocharge it with the online efforts?

Well, I think we all have to look at what we look at as a retail sale used cars. We're operating at about $2,700 per unit if we look across our network today. and I think the growth that we've had has been excellent. We've been shut down, obviously, with showrooms shut down. In the UK, we had the shutdowns in Pennsylvania here last year, so we've had some noise in the system. You know, from the standpoint of the Cox tool, I think I mentioned it before, we looked at the landscape and quite honestly, when we look at used cars online, we look at technology, it's pretty much going to be plain vanilla as we go forward. And to me, We wanted to partner with someone that had the toolbox that could help us to be able to construct something that would give us 100% digital transaction. And we've had our preferred purchase tool for years, which they've been working with us on. And what we did, we brought our human capital, our domain expertise. They brought their toolbox and their capability together. And we said we want to build the best tool in the industry. And I think when you look at that, it's unique technology. It features, obviously, the ability to compare multiple vehicles, personalized payments. I didn't need to go through all of this, but you can see when you actually operate and use the tool what it has. And to me, it was a way for us to get in the market without spending millions of dollars, on the other hand, utilizing our capability with Cox. Now, on the other hand, you really got to look at the three pillars we have. One would be, obviously, today would be car shop. We will also... start to bring in our used car and the OEM network into this car shop population so we have more vehicles for sale online, which will happen as we go through the next few months. And then after that, you look at the preferred purchase product that we have at Penske Cars, and also in the UK, the Sittner Online. And I think our growth strategy is the right one. We'll have bricks and mortar, and we'll also have online. And I think at the end of the day, I can't give you that we're going to grow at a multiple that's higher than is realistic. And I think that our growth target today of 150,000 by 2023, I think, is really realistic. And we're going to be doubling the size of our business during that period going from 19 to 40 locations.

Gotcha. That's helpful. And then just lastly on the M&A front, which, I mean, you constantly do, but you don't get a lot of airtime on In the core, you did $600 million between KFCL and a couple of dealerships. You talked about what's in the pipeline, but if we think about a full year, and I know this is kind of a tough thing to do because valuations and deals are a little bit squirrely to get over the hurdle and finish, but as you think about the full year, what would you roughly think A run rate on acquisitions would be – because we're hearing a lot of targets from other companies, but you don't really talk about the targets. You just do it. So I'm just curious what you think about for this year and how we should think about acquisitions going forward.

It's hard for me to tell you what we're going to do in 2022, 2023, and 2024, but I can say this, that we think that we'll have annualized revenues, not including the open points we have of $1 billion in 2021. and we have a pipeline that's more than that from the standpoint of the initial 400 we already have going into 22. So we feel good about it. But on the other hand, we want to be very selective from the standpoint of what we're going to do from the standpoint of our purchasing of dealerships because at the multiples today, I think we've got to look at just exactly where we are. What's the benefit? Is there a consolidation in the market? The back office, because we've driven because of scale. We want to focus on premium luxury and probably volume foreign. We want to grow our commercial truck footprint, as we've talked about before, because the returns on those is better than the retail auto at the moment, and certainly the multiples in some cases are half, with little or more cap ex, which obviously is something we need to take a look at. Then we've got to look at the value proposition between stock buyback and retail. and acquisition both in truck and in car.

Got it. So if we were to roll in those two open points, you know, in addition to what you think you're going to get done on the M&A front, I mean, you're talking about, you know, north of a billion dollars, probably the $1.1 to $1.2 billion in acquisitions and open points this year roughly. Is that correct characterization?

I think I'm timing. That's correct, yeah. That's correct.

Okay, great. All right. Thank you very much, guys. I appreciate it. Thank you, Roger.

Thanks, John.

Thank you. Our next question comes from the line of Michael Ward with Benchmark. Your line is now open.

Thank you. Maybe just to follow on with what John was addressing. Roger, can you talk a little bit about how you evaluate some of these growth investments, how you prioritize them? Because you have a unique position. You can go U.S. retail, you can go U.K., heavy-duty truck, car shop, cash returns. How do you evaluate them? Is it just straight return on capital?

Well, I think it's their synergy because we have that same brand in the market. We bought the two Lexus stores in Austin, which would be a perfect example of moving into a market where we already had capability and a premium luxury. We would always look for those types of acquisitions. At the moment, I don't think we have big acquisitions in mind because many times there's two or three that maybe don't fit your model. We would certainly look at what is the requirements for CapEx. at this particular time when we are going in paying the kind of multiples you have to. And then at the end of the day, we've got to be sure that this is an acquisition that fits our scale from the standpoint of if it's a truck dealership and does it fit our network because today as we look across the country for the Freightliner business, to have a network is really key for us as we go forward. And the acquisition has always got to be lifetime. It's just not one we buy today and sell tomorrow, which I think is key. And then, of course, you look at the returns. and we're seeing the cash returns or just the book returns, and to me that's going to be key. But again, as I look at it, and what is also the people? Today it's easy to buy something, it's hard to run them, and what kind of people, human capital, do you get with these acquisitions? And I would say that now is becoming more and more important. Does the seller want to stay with you? What's the management team? These are all key. And then you also have to deal with the framework agreements. All of us have framework agreements which limit us, by the way, Thank you, Roger. Shelley, I wonder if you could talk a little bit about the balance sheet restructuring that's taken place over the last 12 months.

You know, specifically, it seems like your maturity profile is greatly improved. What impact does it have on the income state going forward?

Sure. Thanks, Mike. You know, we consider our refinance in May to be very successful. We reduced our interest rate by 175 basis points. We extended our term out eight years. So all of that, you know, secures lower rates well into the future. That refinance resulted in annual savings of $8.8 million annually. And when you look at that combined with our refinance and repayments from 2020, we're looking at annualized savings of about $36 million or 33 cents per share. We also had, you know, $12 million in floor plan interest savings year to date. That's down about 40%.

So if I look out on the next 18 months, I mean, the cash flow in the first half was through the roof. and even if we don't assume that's going to continue, when you kind of look at your capacity, your current liquidity, your debt capacity, the cash flow, it seems to me that there's $2 to $3 billion of kind of firepower. Is that the right way to think about it?

Yeah. You know, like you said, we generated $900 million in cash flow from operations, so we were able to self-fund $280 million in acquisitions. We've returned $110 million to our shareholders, invested $90 million in CapEx, particularly for the car shop expansion and those open points, and still repaid $170 million in debt. So we'll continue to focus on that. We like our strategy. As Roger said, dividends remain a priority, and we have those acquisitions in the pipeline. We'll complete those open points. and we're incredibly focused on the car shop expansion. So, yeah, I think your estimate is correct.

Okay. And just lastly, I think a while back, I think, Tony, you guys put out like a target of pre-tax income of about a billion dollars and I think you're blowing through that a lot sooner than expected. Is there a new target to think about or is that too early for that?

I think when we talk about the target, that we had talked about at the billion at 2023. Mike, we certainly had a great year so far this year, and we will surpass our billion EBT target maybe sooner than we anticipated, to be honest with you. Year-to-date EBT is $728 million, $449 million from $133 last year. The business is strong. We think, you know, based on maybe supply chain issues, it's still going to remain strong through the balance of the year. and based on the current environment, the inventory supply of light vehicles and commercial trucks still could be challenging, but we think our business to continue will grow well beyond 1 billion EBT target, but however, we're not gonna give you a number today.

Not just yet, okay.

I think that wouldn't be the right thing to do based on all the things that are circling at the moment, but our focus is gonna be remain expanding our car shop businesses and making strategic, and opportunistic acquisition and driving further cost reduction. So again, I think all the levers we've been pulling, the market inventories, the products we represent, our PTS investment, our heavy truck investment, all of this has certainly paid off to get us where we are for six months.

Well, thank you. Thank you, everyone.

Thank you. Our next question comes from the line of Stephanie Moore with Truist. Your line is now open.

Hi, good afternoon and congrats on a good quarter.

Thank you, Stephanie. Thanks, Stephanie.

I was hoping you could talk a little bit about what you're seeing, particularly with your UK business, both from a supply standpoint as well as demand. It's obviously come back pretty tremendously and up year over year, but Any impact from spikes in COVID cases, or how would you characterize the overall environment, especially compared to the U.S.? Thanks.

Well, I think when you look at this year, you know, we just opened, the dealer reopened on April 12th. Since then, I think you'd say business has been brisk due to registrations for 154,000 versus 56,000. in the second quarter of 2020. And our business at Sittner was up 153% versus last year. And to me, that bodes well for the future still. We're seeing the parts and service business recover slowly. People are just told not to move around the country. You've seen that. It's been locked down to people coming from Europe, et cetera. They just opened it here in the last, I think, 24 hours. From a used car perspective, when our showrooms were closed, we really had an impact on used, even in car shop. We were selling about 5,000 units and went back to about 2,500. That's kicked back into gear here in June, and going into July, we feel good about that. We still see a shortage of product. Obviously, when you think about right-hand drive vehicles have to be made special, so we're going to continue to see some shortage of vehicles. based on supply chain disruption. But simmer on supply to the U.S. I think the consumer has pent up demand. There's no question about it. And certainly on the premium luxury side, we have leadership in all the key brands there and continue to hold that.

Excellent. And then just switching gears, your Penske Transportation Solutions joint venture obviously had a record quarter and pretty tremendous results. I think you called out not only some nice top-line trends, but some gain on sales for used trucks as well. I mean, can you call out anything in the quarter that you thought was kind of one-time specific or unique to just this environment or Really, just given the strong freight environment we're seeing now, should a lot of this continue as we kind of go through the balance of the year? Any color there would be helpful.

Well, I think what I would call out is we're now up over 330,000 vehicles, which is a big growth from the standpoint of units and generating profit. And remember that when you look at our logistics business and you look at our leasing and contract maintenance business, all of those have multiple-year contracts. with Economic Escalator. So this is not just the rental business. So we see that growth is really strong. The Black Horse acquisition of $600 million in revenue at the end of 2020 certainly has kicked a lot into gear. There's no question about that, and that has helped us. But when you look at what might be different, I think the 87% utilization across our rental fleet, with all the action in the marketplace today, we don't have enough trucks and we've added more trucks into the fleet. So that's given us obviously margin and also sales. So I'd say that would be one thing that would be key. From a consumer rental, this is the one way, rent it here, leave it there. With all of the people moving out of the core cities, Portland, Seattle, San Francisco, L.A., New York, Chicago, we're seeing that product line really on fire. People want to move out of these big cities and the rental distance is longer. Obviously the RPT, which is rental per transaction, has gone up significantly. So those two rental products probably have driven some bottom line benefit that we might not have seen to the extent we saw during the second quarter. Our gain on sale, quite honestly, was 45 million, which was nothing really out of sight from the standpoint of the future. And I think that at the end of the day, We've seen that being steady, but again, because of utilization, we don't see as many used trucks right now that we have available for sale. So we'll see that even grow as we take some of these new units in, as we add new customers. We have over 20,000 units today, believe it, on order with the OEMs. Our big challenge is to get those on time to meet our customer demands.

Got it. Well, really appreciate everything. Thanks so much.

Thanks, Stephanie.

Thank you. Our next question comes from the line of Rick Nelson with Stevens. Your line is now open.

Thanks. Good afternoon, Roger, Tony, Shelley. So, Roger, you know the OEMs as well as anybody in the business company. Curious your thoughts when supplies do normalize. Do you think they're going to run tighter on inventory than they have in the past? It seems everybody's more profitable in that type of environment, but curious your thoughts.

Look, we've had a year to re-engineer our businesses, take a deeper look at costs. It's one thing to look at costs, but it's also to look at margin and bottom line. and I think with this inventory issue and for many different reasons, not all microchips, I understand on heavy trucks today it's tires even, but at the present time, the OEMs that I'm talking to at higher levels understand it. They understand that their costs are down on supporting inventories, being able to not have to support extra bonuses for the dealer people, the incentives for customers, buying down rates. This all has been very attractive to them, and I hope that they see this, and we certainly are preaching that to them today because what happens is this wave is raising all boats, and hopefully at that point they'll understand that we don't need to push. The problem is if they start building units to fill these plants that aren't the ones that customers want, we're then going to start to see an inventory pickup of vehicles that are not ones that people want to buy. And that's going to start turning us back into the same direction we were before. So I think that the main focus should be what is selling, what has sold, and really reducing many of the product lines that they have. Now, that's me talking, not the OEMs around the table. But Rick, I do think that there's a conscious effort not to have to be the leader in the clubhouse. Let's be the leader for the customer. at the dealership level with a consumer, our guest, and also with a shareholder. And I think that's got to be the focus. And I think the street will expect that. They'll expect the profitability. On top of that, they've got billions of dollars that they're committing now to electrification and hydrogenation. So to me, this is one way to be able to generate that cash flow.

Great. Thanks for that, Keller. Also, you mentioned EVs. I'm curious how you see that impacting the service and parts segment. Any early learnings along those lines?

Well, let's think about 300 million vehicles in the marketplace. And I think the average age is approximately 12 years old. And over the last five years, what the market, you know it better than I do, has sold about 83 million vehicles. and 98% of that's been ICE. So the Bev Park is 2%. And I think that we're supporting certainly our OEMs with EV. EV is gonna be driven by political, it's by governmental. We see it much, much more pressure in Europe than we do obviously in this country. And I think the national infrastructure is gonna be something that's gonna make a big impact on that. Now from a dealership standpoint, Until we get a significant market of EVs, I don't see a big issue from the standpoint of my parts and service growth. It's going to take a different technician. It's also going to be, from a safety perspective, have to be done at an OEM-compliant dealership. And I think that initially we might see more work because of the technology. Remember, if you go to Hudson Toyota... over in Jersey City. We were supplying most of the Priuses in New York for cabs for a number of years, and we learned how to take care of that. But there was warranty along with that, and I think that we'll see some interface with EVs now. I don't know what the actual impact will be, when will be the shift, when will be the pivot, but the warranty will have to be done by us. and we'll also obviously have to deal with the complexity. So I think it's a jump ball right now. Certainly it's not going to take anything away from us over the next 12 to 24 months for sure. And, again, I say the national infrastructure is going to drive that.

Thanks for all the great commentary and good luck.

Thanks, Rick.

Thanks, Rick.

Thank you.

As a reminder to ask a question, you would need to press star then one on your telephone. Our next question comes from the line of Rajat Gupta with JP Morgan. Your line is now open.

Oh, hey, great. Thanks, Roger and Tony, for taking the questions. You know, just had a question, you know, on the parks and services, just following up on Rick's question. You know, any commentary on, you know, how the linearity was in the quarter, you know, April, May, June, you know, how those months progressed? to the quarter in the business, and how are you seeing early 3Q tracking in that business? Any color across the different segments, customer pay, warranty, body shop, would be helpful. Thanks.

Sure. Well, let's look at the quarter, and when we look at the company globally, we understand that the U.K. was shut down in certain cases because of showrooms. That would have impacted our internal business. There's no question that we're seeing over the last three months growth in customer labor. We see warranty is really down, and we came from a low base after Q1 in the body shop, and we see that all coming back. In fact, we had some locations in the U.S. that I know for sure actually were better than they were last year from the standpoint of of Parts and Service Gross Profits. So I would say trajectory-wise, it's coming back. People are now starting to drive vehicles. In fact, we're out calling our customers, telling them it's not just the miles driven time you need to bring your vehicle in for service. So we're being very proactive on that. And I think from a quality standpoint, even though we see these recalls every day in the paper, I think we're seeing many of the OEMs have given us some a better quality product, which in some cases is driving warranty down.

Got it, got it. That's helpful. And I have a question on just the UK market in general. A lot of the OEMs have been recently talking more about the agency model there. Just curious as to what kind of conversations you're having with the OEMs right now, anything going on behind the scenes? that might be changing and how the structure might look like there. I'm just curious on your thoughts there and what kind of impact can that have on the business?

To put it in perspective, we won't see an agency model here in the U.S. and I don't think we'll see an agency model in China. I think continental Europe, Mercedes has been invoicing cars for their dealers in Germany for a number of years. I'm not sure how that ties into a complete agency model. They've had agency models for for Big Fleets. In fact, when you look at even our truck business here in the U.S. from a leasing perspective, you could say it's not an agency model. Right now, as I said, I think they're applicable to continental Europe. We're having ongoing discussions to understand what impact that would have on the customer and the customer experience. But I think we're a long way off. I see in the U.K. today I saw something that came across yesterday or they're even going to look at the competition level within the government to see if agency models have any impact on what you would call a retail franchise. So I'd stay tuned. I think there's many laps to go before this race is over as far as agency agreement.

Got it. Got it. That's helpful. And just lastly on electric vehicles, obviously a very small sample size today for the business, but anything that you see that's different in terms of You know, the F&I attach rates or, you know, just the F&I per unit or, you know, anything like from leasing versus buy mix for those vehicles. Thanks.

I don't – can I be honest with you? I'll let Tony call you on that one. I can't give you anything on the phone here today that would be probably an important answer to that particular question. You know, we're looking at EVs, obviously. Quite honestly, when we look at EVs from the standpoint – I think residual value is going to be the most important thing, the big R. What's it going to be? You buy one today that has a 300-mile range and the same vehicle two years from now has got 500. What's yours going to be worth? And I can tell you the OEM is not going to give you a different battery. So that's going to obviously have an impact from the standpoint of pricing. And a lot of these are second vehicles, at least the premium ones are, and people want to turn those on a lease basis and not buy them. So I think there's going to have to be a certain amount of support from the OEM themselves to support a lease program on EVs. I can tell you that the ones I've driven have been real sporty. I think that the infrastructure adaptation is going to be critical in order to be able to support that long term. And that, to me, is not going to be what we do at the dealership level. We're committed to brands like Porsche and Audi and some of these BMW to have capability, short and long term capability for fast charging. We're investing in those today, so we're not certainly walking away from the product. We're supporting it.

Got it. Great. Thanks for all the color and good luck. Thanks, Roger. Thanks.

Thank you. Our last question comes from the line of David Whiston with Morningstar. Your line is now open.

Hi, David.

Thanks. Hi, everyone. I guess Roger, you made a comment on framework agreements earlier and hitting a ceiling. Obviously, everyone knows in this industry that the largest groups are going to keep consolidating and getting open points. Factories, I think, want those largest groups to have the open points. Are we at a point right now in 2021 where the largest groups maybe need to be a bit more aggressive in demanding change to these framework agreements to facilitate growth?

Well, I think a framework agreement is individual. It's not the same for everyone. It's based on your size, your capital, maybe the brand experience that the OEM might have. But I think it's right now, these are pretty much ones that you sign. Now, if they decide over a period of time to change that, obviously, that could be key, but it might be on how you're performing. This is just not having six people. Toyota dealerships in one city. It's how many are meeting the sales targets, how many are meeting the service, how many are meeting the customer satisfaction. So there's more than just what I would call performance data from the standpoint of units and maybe parts and service sales. I think there's other metrics that come into the play. But I think that they're going to look at this now. It's been said before because the – let's say I'm going to take the peer group that were in the public companies. The investments that we're making in technology, all of us, and I think everyone's done a great job, the real commitment on facilities, we're talking about hundreds of millions of dollars in CapEx, drives probably a real discussion about to open those up based on experience, based on performance. So I don't think you're wrong. I'm not sure we get aggressive, wouldn't be the word I would use. I think that you could have a pretty good, reasonable conversation about what you might want to do on your framework. Now, today, you know, they've got a framework agreement, I'm sure, for Hummer. And there's an agreement to have a Bronco separate site. These are all things that will be looked at. Now, on the truck side, you know, quite differently, I know that Freightliner has decided they would rather have more partners than less or less partners than more because then they can take into consideration this network of capability and utilizing obviously the technical capability to take care of their customers because it's not just a local customer with a truck customer it's one that travels the country so I think it's a little bit different on the truck side but certainly based on performance I think As you said, you could have a conversation, but we do have framework agreements, and I don't think they're going to bend them just overnight because you want to buy six more stores in a market.

Okay, thanks. That's helpful. And then on the Cox Essentials platform, can you just talk a little bit about the rationale for getting a partner as opposed to trying to do something yourself? A time and money trade-off that you thought about, or were there some other variables? Could this eventually be also used for new vehicles, and could it eventually replace preferred purchase?

Well, number one, we all go back 12, 14 months, maybe 18 months ago, and we're all talking about buying online. You can buy all the way from A to Z. You know, we looked at it. There were a number of products out there, but at the time, we decided that... Based on getting to market with the proper product, let's look around and see who really is the real leader in capability around the auto business. We talked to a number of people, and finally we landed with Cox because they'd been the ones that had helped us develop our preferred purchase product. So we went to them, and we determined that with our human capital and really our domain expertise, along with what they were able to do that we put a team together. And they worked for 12 solid months. I mean, I was in a number of the meetings and it was roll up your sleeves and go. And I think what we agreed to do is come out with the best product. That gave us the ability to have that working as we continue to run our business from a cost perspective. It was our people supporting the process and the outcome. Obviously, we think we have a world-class product. From the standpoint of going forward, we now have only our car shop use car businesses using that product. We will expand that into our OEM network use car business where we go from a new perspective. At this point, we've not made that decision.

I'm sorry. So you're saying you are eventually going to go into new or you haven't made up your mind on that?

We've not made it. I think we've got a step one was car shop. Step two, obviously, is integrate all our use cars that we have online into within our OEM use business. And at this point, we've not made a decision on where we're going to go from a standpoint of new. That'll be something we'll look at in the future.

Okay, and just one last question, probably for Shelly or Tony. I know it's maybe early to ask, but if the Biden administration does increase the U.S. federal corporate tax rate, I know you've got some large internet exposure. Can you say at all what your sensitivity on your tax rate would be, say, for every 100 BIP increase in the U.S. rate?

Sure. So there's a lot of subjectivity and a lot of discussion going on. But if the rate were to increase to 25%, our blended tax rate would increase by a minimum of 3.74%. So we'd also need to take a look at revaluing our deferred tax liabilities, and that impact would be about $130 million at 25%. So just like we took them down a few years ago, we'd have to take those liabilities back up. If it went to 28%, we're looking at 6.5% to 7% percentage points when you combine that with the increase at the UK.

Okay, thank you. Very helpful.

Thank you. There are no further questions. I will now turn the call over to Mr. Penske for closing remarks.

Thank you everybody for joining us. We look forward to talking to you after Q3. Have a great day. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.