Matt Pettoni - VP of Finance and Treasurer David Hult - President and CEO John Hartman - SVP, Operations Sean Goodman - SVP and CFO.

Rick Nelson - Stephens Bret Jordan - Jefferies James Albertine - Consumer Edge John Murphy - Bank of America Jake Moser - Wolfe Research Armintas Sinkevicius - Morgan Stanley David Whiston - Morningstar.

Good day and welcome to the Asbury Automotive Group Q1 2018 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Matt Pettoni. Please go ahead, sir..

Thanks, operator and good morning, everyone. Welcome to Asbury Automotive Group’s first quarter 2018 earnings call. Today’s call is being recorded and will be available for replay later today. The press release detailing Asbury’s first quarter results was issued earlier this morning and is posted on our website at asburyauto.com.

Participating with us today are David Hult, our President and Chief Executive Officer; John Hartman, our Senior Vice President of Operations; and Sean Goodman, our Senior Vice President and Chief Financial Officer.

At the conclusion of our remarks, we will open the call up for questions, and I will be available later for any follow-up questions you might have. Before we begin, I must remind you that the discussion during the call today is likely to contain forward-looking statements.

Forward-looking statements are statements other than those, which are historical in nature. All forward-looking statements are subject to significant uncertainties, and actual results may differ materially from those suggested by the statements.

For information regarding certain of the risks that may cause actual results to differ, please see our filings with the SEC from time to time, including our Form 10-K for the year ended December 2017, any subsequently filed quarterly reports on Form 10-Q, and our earnings release issued earlier today.

We expressly disclaim any responsibility to update forward-looking statements. In addition, certain non-GAAP financial measures, as defined under SEC rules, may be discussed on this call. As required by applicable SEC rules, we provide reconciliations of any such non-GAAP financial measures to the most directly comparable GAAP measures on our website.

It is my pleasure to hand the call over to our CEO, David Hult.

David?.

Thanks, Matt. Good morning, everyone. Welcome to our first quarter 2018 earnings call. The first quarter marks a solid start to 2018. During this quarter, we achieved record EPS of a $1.93, 22% increase over last year’s adjusted EPS.

From an operating perspective, our success was driven by enhanced F&I PVR, continued growth in parts and service, and disciplined expense management.

Our plan for the remainder of 2018 is to focus on the aspects of the business that we can control, specifically, parts and service, used cars, F&I, and overall expense management, while continuing to intelligently deploy capital towards the highest return, be that strategic investments in our existing business, notably our omni-channel capabilities, acquisitions or returning capital to shareholders.

This quarter, we repurchased $20 million of our common stock and we acquired a Honda dealership in the Indiana market, which should generate approximately a $120 million in annual revenue.

In addition, in the second quarter, we plan to close two acquisitions in the Atlanta market, which combined should generate approximately $120 million in annual revenue. I would like to share our thoughts on these acquisitions.

The Honda store represents our second location in the Indiana market, after the Chevrolet dealership that we acquired last year. We view Indiana as an attractive market opportunity based on our assessment of dealer concentration, consumer demographics and market growth potential.

The Chevrolet store is performing in line with our expectations, and this gives us confidence to acquire the Honda store which similar to the Chevrolet store, represents a well-run operation that we acquired at a price that should lead to a good return for our shareholders. The two pending acquisitions are in different situations.

These are currently underperforming stores. We are confident that by applying our existing brand recognition, management expertise, and omni-channel capabilities, we can successfully turn these stores around. Given the turnaround situation, we expect to generate a higher return to compensate for the additional execution risk.

I will now hand the call over to Sean to discuss our financial performance.

Sean?.

Thank you, David, and good morning, everyone. We’re pleased with our operating performance in the first quarter. Note that this quarter, we adopted the new revenue recognition accounting standard ASC 606. This new accounting standard impacted revenue recognition for parts and service, and F&I.

The net impact of ASC 606 was to reduce revenue by approximately $1.9 million and reduce gross profit by approximately $1.1 million. It has not impact on our cash flows. We have not adjusted the results to normalize for the impact of ASC 606 this quarter. Overall, compared to the prior year first quarter, gross profit increased by 2%.

Gross margin of 16.5% was 30 basis points lower than last year. SG&A as a percent of gross profit improved by 20 basis points to 69.4%. Operating margin of 4.5% was 10 basis points lower than last year. Adjusted net income increased by 20% to $40.1 million. And our earnings per share increased by 22% to record of $1.93.

In Q1 of 2017, adjusted earnings excluded a $900,000 pretax gain on legal settlements. This is equivalent to $0.03 per share. As a result of the recently passed Tax Cuts and Jobs Act, our effective tax rate was 24.9% for the first quarter of 2018, down from 36% in the first quarter of 2017. Turning to expenses.

SG&A as a percentage of gross profit for the quarter was 69.4%, an improvement of 20 basis points over last year. Our SG&A expenses reflect continued investments in our omni-channel capabilities offset by a focus on efficiency and cost control, plus the redirection of certain costs towards digital technology initiatives.

We are beginning to see the benefits of these investments in terms of enhanced productivity and an improved customer experience. This year, we expect to invest in excess of $10 million in omni-channel capabilities.

While the investment will run through our income statement on the SG&A line, it is nevertheless a real investment for which we expect to generate a very favorable return. This investment has an immediate impact on current year earnings.

However, we will offset this by managing overall expenses, so that total SG&A is in line with our previously issued guidance for the year of 69% to 70%. John will talk more about some of the exciting things that we are doing in a few moments. A little more information about the adoption of revenue recognition accounting standard, ASC 606.

In the case of parts and service, the new revenue recognition standard resulted in a decrease in revenue of $1.3 million and a decrease in gross profit of $500,000.

In the case of F&I, the new revenue recognition standard resulted in a decrease in F&I revenue and gross profit of approximately $600,000, which is equivalent to a PVR reduction of approximately $13.

With respect to capital deployed, in Q1, we spent $3 million on non-real estate related capital expenditures, $36 million on acquisitions, $20 million repurchasing our common stock, and $18 million purchasing real estate. At the end of the quarter, our total leverage ratio stood at 2.9 times and our net leverage ratio at 2.4 times.

From a liquidity perspective, we ended the quarter with $5 million in cash, $29 million available in floor plan offset accounts, $107 million available on our used vehicle line, $237 million available on our revolving credit lines and we also have unencumbered real estate with a value of around $200 million.

Looking towards the second quarter of 2018. On April 6th, we experienced a significant hailstorm at our Honda store located in Irving, Texas. While we are still in the process of fully assessing the damage, our initial estimate is a cost of approximately $1 million associated with damaged inventory. This will adversely impact us in the second quarter.

I would now like to hand the call over to John to walk through our operating performance in more detail.

John?.

Thank you, Sean. My remarks will pertain to our same store performance compared to the first quarter of 2017. Looking at new vehicles. Our new unit sales were down 2%, while SAAR was flat from the prior year.

While our margin in the luxury and domestic segments increased compared to the prior year, we experienced declines in the margins for midline imports, resulting in an overall new car margin of 4.5%, 30 basis points lower than last quarter and 40 basis points lower than last year. Our total new vehicle inventory was $724 million.

Despite lower unit sales, we reduced our days supply from prior year quarter by 8 days to 66 days. Turning to used vehicles. Our used vehicle unit sales increased 1% and our gross profit margin of 7.3% was up 60 basis points from last quarter, but 70 basis points lower than the prior year.

We are beginning to see the benefits of the used car enterprise software we implemented in Q4 2017 at all of our stores. This was the first time we saw an increase in used vehicle unit sales since Q2 2017. Our used vehicle inventory of $150 million is at a 29-day supply. Turning to F&I. Our team continues to deliver strong results.

Total F&I gross profit increased by 2% and gross profit per vehicle increased by $44 to $1,559. As Sean mentioned in his remarks, the gross profit per vehicle was adversely affected by the adoption of the new revenue recognition accounting standard. Turning to parts and service.

We grew our parts and service revenue and gross profit by 3%, despite an 8% decline in warranty. This was achieved with a 5% increase in customer pay. The improved used vehicle sales caused our reconditioning work within parts and service to increase by 4%.

Again, parts and service results were adversely impacted by the adoption of the new revenue recognition accounting standard. I want to take a moment to give you some more details on our omni-channel strategy. We are investing in our web and mobile presence to be well-positioned in the future auto retail model. Some developments include the following.

First, we are building a centralized brand certified team to manage all our digital traffic. The team currently supports 25% of our stores, and we are planning for them to support the entire Company within next 18 months. Stores participating in the program are experiencing a 20% increase in conversion rates coupled with enhanced sales efficiency.

Second, PUSHSTART, our online sales tool enables customers to purchase vehicles online, get instant financing approvals and receive driveway delivery. This quarter, we saw a further growth and now upto 7% of our vehicles sold started through PUSHSTART. Third, we continued to grow the traffic in our digital and parts service scheduling tool.

And for the quarter, online appointments were up 65% from the prior year. Fourth, we’ve applied our omni-channel capabilities to online parts sales. And in our initial test markets, we have significantly increased sales.

We are extremely excited about these initiatives and proud that we’ve been able to maintain our industry-leading SG&A management while investing in the future. In conclusion, we’d like to express our appreciation to all of our teammates in the field and in our support center who continued to produce best in class performance.

I’ll now turn the call over to the operator and take your questions.

Operator?.

Thank you. [Operator Instructions] Now, we’ll take an opening question from Rick Nelson of Stephens. Please go ahead..

I’d like to ask you about the TPU pressures on both new and used cars. It looks like, it’s concentrated in the import segment.

Is that across the brands within import or is it specific brands that are driving that erosion?.

The manufacturers change their -- extended programs quarterly. And we’ve got about in the -- specifically in the midline imports, we got about 72% of that available money, which certainly affected our margins in that segment. Specifically, the Nissan stores, we saw a significant decline in both volume and margin.

And when 58% of our volume comes from midline imports, that certainly affected our margins..

Are pressures in the other brands like Honda and Toyota within the import segment….

No, it was just on Nissan..

And then, used cars, we saw margin erosion there.

Curious about the systems challenge that you had last quarter, the volumes yet were much better this quarter, if you think that systems issue is now behind you?.

I think, as a company, we’ve gotten better with the tool. This quarter, certainly the results reflected that. A lot of transparency in the used car market as far as pricing. So, we’re really focusing on our cost of acquisition and making sure we’re competitive there..

The acquisition environment, things really seem to be heating up with this acquisition in Indiana, now Atlanta. If you could speak to the pipeline and the multiples that you’re seeing out there, that would be helpful..

Absolutely, Rick. I am going to go back and touch on the margins and then I’ll finish it up with the acquisition piece. As John touched on with Nissan, all the brands are cyclical and they have highs and lows. As a company, we’re doing a great job managing through it, and we have great people in the field.

While our volume was backwards year-over-year in Nissan, we actually outperformed our competitors within the markets that we do business in. It’s just one of those cycles with the brands that makes it difficult. And we certainly have a lot in Nissan stores.

From a used car perspective, we’re actually pretty happy with the quarter, above our guidance that we gave from the last call, but certainly down year-over-year and are excited to see our teammates in the field really adapting to the new software.

And we by no means have maximized the opportunity yet, but we’re directionally correct and happy with where we’re at. On the acquisition standpoint, this year, we’ve been lucky to see a lot of deals, but we’re really very disciplined and strict and thoughtful about how we look at each acquisition.

We don’t believe getting bigger is always necessarily better. So, we really want to be wise in how we deploy the capital and really make sure when we look at an acquisition, that it’s going to create a great return for our shareholders. So, very disciplined, seeing a lot more activity, significantly more than last year. We anticipate that to continue.

But, I think you’ll see us be our traditional, very slow and making sure it’s a good acquisition for Asbury as a whole..

The balance sheet, how do you sum that up, in terms of acquisition opportunities?.

Sorry. Rick, Hi. It’s Sean. I am not sure I am following your question..

Your net debt to EBITDA versus targets and how much capacity do you think you have to make further acquisitions?.

Well, Rick, as I stated in prepared remarks, our leverage ratio is currently 2.5 times, which is a little bit less than our target range of 2.5 to 3 times. And obviously with acquisitions, we get the EBITDA associated with that acquisition as well. So, we think we have significant capacity to do value-enhancing acquisitions..

We will take our next question from Bret Jordan of Jefferies. Please go ahead..

When you think about the trajectory about of the quarter, I guess from a margin standpoint or maybe some of the OE incentive programs, did it moderate? I guess, what -- were the pressures higher in the beginning of the quarter or later part of the quarter?.

Yes. And John can jump in, this is David. I would say, we’re up in luxury, both in volume and in margin. And we like where we ended there. So, it was kind of pace well the whole quarter. Domestic, we don’t have a lot of domestic stores, you can see by our unit account. But, we’re happy with our performance there as well.

This is a situation where with the brand that we already mentioned, it’s a quarterly target. The numbers were so -- it’s no secret that the brand went into ‘18 with a lot of ‘17 product on the ground. So, it had a material impact.

And when your quarterly objective is tied to that number and you miss that target, it’s going to have a material impact on your PVRs and margin..

And then, on customer pay, the plus five, how do you feel that compares to the underlying market? Is that a share gain? And I guess, within that, this discussion of online part sales, how big is that relative to what you’re doing on the P&F side of the business? And is that selling to DIY customers and is that something that I guess is a buy online, pickup in store, or you actually shipping the stuff out?.

On the customer pay, we’re really focusing on increasing our technician headcount. And we do that we see a material difference in the growth. So, that’s really the focus of operation to make sure we have the headcount to serve as the business.

As far as the parts sales go, we’re doing in a test market, it is online, it can be -- we’re shipping parts and people are still picking up in stores..

And that 5%, the customer pay growth, how does that feel relative to the underlying market and do you think that’s a share gain or is that just -- are we sort of in line with that general demand?.

I’ll tell you, we’re feeling the pressure on technicians; and we’re confident if we had more technicians, that number would be higher. And that there’s more out there. We just have to acquire more technicians..

We’ll take our next question from James Albertine of Consumer Edge. Please go ahead..

A clarification to your question, was just asked, the pressure on the headcount side.

Is that a function of increased or accelerating turnover, or it’s -- that you’ve identified that there’s a lot more need for technicians, given some of -- perhaps the off lease supply coming online or what have you -- or the share gains you alluded to and customer pay.

So, is it one of that is turnover or is it just the opportunity that you’re assessing?.

Sure. We all experienced turnover. But year-over-year, there’s no material difference in turnover. We have and have had empty days for years without technicians in them. Technicians are the hardest people to acquire right now.

And as we cannot hire them and fill some of these empty days, the day they start, we incrementally add gross profit to our books..

If I may, my question, more of an assessment of demand than anything else.

When you are kind of digging into sort of segment by segment trends, and I know you alluded to some of this in your prepared remarks, but it does seem that when you kind of high level looking in the newer vehicles, the Volkswagen Atlas or the Tiguan are massively outselling some of the legacy vehicles in the portfolios.

And there’s very few new vehicles and a lot of legacy vehicles out there.

So, I am just wondering if there’s anything you could sort of asses out in terms of the nature of demand, as you see it? Do you feel as though sort of at retail, we’re in a part of the market where there is some sustainability there or alternatively, do you see this as a function of either newness or very attractive incentives on some of the legacy vehicles? And in another words, this could be kind of last or even more indication of later innings on the SAAR side.

So just trying to kind of get your view on sustainability versus later innings?.

I’ll do the best I can in answering them. Please let me know if I missed it. In all the decades of doing this, there’s a lot of great vehicles out there, everyone is making better vehicle now and clearly like anything else, the hot product sell well at high margins and you don’t have enough problem.

And then with other models within segments, the long in the tooth is as far as not being refreshed and they’re more of a push situation. You can see in the quarter from our perspective and what you read, incentives are still very high.

Manufacturers have done a good job at cutting back some production, but it’s not tight by any means, which is still keeping the incentives pretty high. I don’t know what the future holds with that, but this market I feel like it’s almost like going back to the early 2000s where it bumps around a little bit.

January and February were a little bit bumpy on the SAAR, March came back and put a lot of tailwind and everyone sale. So, I think you’re going to have some of that as you go forward. I think, some months are going to be like while that was pretty strong and other months are going to be like well, it’s just a beginning where we’re at.

I don’t see a significant downturn coming. But, I see it being choppy or bumpy throughout the year..

We’ll take our next question from John Murphy of Bank of America. Please go ahead..

Just a first question on the omni-channel efforts really on parts and service, and your digital presence there. I am just curious, you gave us sort of a 7% of your new vehicle sales being sold through sort of these online driveway delivery channel.

How much of your parts and service is funneling through appointments that are scheduled online and you’re offering pickup and delivery, just curious, what kind of takers you’ve there, because that sounds like that’s a pretty attractive program for customers/.

Currently about a third of our total appointments are scheduled online. We find the dollars for payer order are as the same and the customer satisfaction is as good as when the consumer comes into the store..

And I think you mentioned were up 60% -- 65% though in the quarter.

I mean, how much of that is incremental or how much of it is just convenience in replacing sort of in-store visits or do you have a read on that?.

I think it’s a little bit of both. I think, like anything, when you book an airline ticket online, it’s much more convenient for the customer. It also alleviates the phone traffic coming into the stores where same thing as we call in airline, the experience tends to be not as good.

So, I think it’s really just the customer satisfaction and convenience..

John, I’ll give you a little bit more color on that. The other pieces that we’ve guided to that is sending texts and videos and pictures of the cars and what’s going on with the car and what’s needed in your car, having the consumer pay for their bill online before they come to the dealership.

The more we can transact online and make it more efficient for our customers whether it’s via text or email, that’s the direction we’re going. And so, when you hear that 65% increase year-over-year, some of that is incremental lifted business but a lot of that is phone traffic coming off the traditional way of doing business and pushing it online..

An then, just a follow-up to that. As we think about maybe creating some incremental flow into the service days, I know you’re talking about technicians being an issue. But, where do you think you’re on cap unit [ph] flat stalls or even stalls that are equipped? I am just trying to understand what kind of incremental flow you could take.

I mean, I know it’s a tough call, but I mean could you be up 20%, 30%, 40%, 50% in parts and service before you run out of your install capacity, not tax?.

So, if we filled every bay we had and didn’t invest $1 in brick-and-mortar, we would be up in excess of 30%. And quite honestly, this is a little -- this is very frustrating on our end but we actually govern the amount of business that we bring in because obviously level of services is our key barometer and differentiator in the industry.

So, we can’t afford to flood the business and have upset customers..

So, if you had to tax, we could be looking at some really solid growth on a organic same store basis in parts and service?.

No question about it..

And then just on the Atlanta stores, the two underperformers. Obviously, you’re huge there, so you understand the market very well. It’s pretty crowded with dealerships. So, some folks kind of shy away from that market.

I’m just curious what really kind of attracted you to those two stores, and what’s the opportunity and what are the brands if you can disclose that?.

It’s a Chevrolet store and Toyota store, two very solid brands. We happen to have a Honda store that operates across the street from the Chevrolet store and next to the Toyota store that does really well. Atlanta is a very tough competitive market and one of the most competitive markets in the United States. We’re lucky.

We have a good brand name and we have solid leadership and great people in the stores that really generate great returns. We’re confident based on these strong brand and locations of the stores and the team that we have in place. These would be very nice turnarounds for us..

And then, just lastly, as we think about the calendar for the April sales reporting, there was some real funky stuff going on there with the month closing, the March month closing on April -- April 2nd.

Just curious, as you were closing your sales for the month, did you guys close at the end of the March or do you actually close on April -- sort of April 2nd based on sort of the technical reporting, just trying to understand what was going on there and how big a benefit you think that extra weekend and those extra days was to April -- or I am sorry March actually?.

From our books perspective, we shut it down on the 31st. Some of the OEMs, the way they report vehicles, those sales do carry in to April and cover the weekend you’re talking about. So, from an OEM standpoint, reporting sales wise, those sales went into March. From our books standpoint, the month ended on the 31st..

So, your quarter saw no extra benefit from those extra days, but the aggregate SAAR may have?.

Correct..

We’ll take our next question from Chris Bottiglieri of Wolfe Research. Please go ahead..

Hey, guys. This is Jake Moser on for Chris. So, your SG&A control has obviously been very impressive.

How do we think about wage inflation in your industry? Does the variable pay model leave you inflated from wages a bit or have you taken other measures to offset this pressure?.

Jake, dealerships, both parts service and sales, most of your people in the dealership are productive people. So, their compensation flows up and down with the gross profit generated. So, you don’t see that incremental lift. The support staffs within stores are very light and in immaterial amount I would say. So, it’s really not an impact..

And just sort of like a related follow-up. Could you give us an estimate on how the mix of SG&A breaks out between parts and service, and vehicle sales, and then how much of each of those….

We don’t provide that level of detail on our SG&A. We rather look at overall SG&A numbers. We’ll tell you that we’re very data orientated in the way we measure our SG&A expenses. We really look at the productivity and efficiency of the various parts of our business very closely.

And we view that productivity and efficiency and things like [indiscernible] vehicles, sales personnel, service advisors, et cetera, and that’s how we effectively manage our SG&A expenses..

We’ll take our next question from Armintas Sinkevicius of Morgan Stanley. Please go ahead..

A bit of macro question, one of your peers [indiscernible] this quarter on gross profits for used car prices. And I just wanted to see if that’s something you’re experiencing or if is it dealer specific, and what some of the contributing factors could be..

We did feel some pressure in our margins with used, kind of I alluded to before, it’s a very transparent market. We priced our vehicles for market based price. So, when you’re online and you’re looking, the market kind of determines the price.

And we really focus on our cost to acquisition and trying to maintain the margin by acquiring the inventory at the right price..

And I guess, what -- how do you feel about your capabilities on being able to price acquisitions? Is there any improvement in the process that you think could happen? We look at CarMax for instance where they have a lot of history with pricing vehicles. Just curious if there’s sort of any lesson that you think you could pick up there..

We really try to focus on the consumers that are already coming to us to purchase a new vehicle. For every 100 customers that come in the door, we’re trying to trade a good percentage of those vehicles..

And then, on just what is your view on used car prices on a go forward basis? It looked like it was a bit soft this quarter. And from a macro standpoint, there was a benefit there after the storms and it seems to be normalizing here, but just curious what your thoughts are for the rest of the year..

When you say storms, I’m assuming you’re referring to the hurricanes. And that really only affected Texas and specifically Houston which is really one store for us. So, it wasn’t material. We gave guidance of around 7% margin for the year. So, we’re actually happy with where we came in the quarter.

To get at a higher macro level, last year, I mean ‘17 versus ‘16 was the big incremental lift of off lease cars coming to market. This year, it’s up again but not quite the impact it had last year. So, we’ll -- I think we’ll continue to see pressure throughout the year on used car pricing, but it’s all about acquisition.

And the one benefit the dealership model has over CarMax or anyone else, we have the ability to have relationships with our customers and our service departments and in our showrooms to acquire the car there. We’re not at an auction, either online or in person.

And when you buy cars either way like that, the only way you acquire them is because you pay more for them than anybody else did, which puts pressure on the margin on the other side. And as we have talked about in the past, we really look at that internal gross profit and we’re very happy that we’re up 4% in the quarter with internal gross.

So, again that holistic approach of a fair profit on the frontend, a fair profit in parts and service and then F&I, and that’s a pretty good model for us if we can get the volume going..

We’ll take our next question from David Whiston of Morningstar. Please go ahead..

You guys talked earlier on the call about you do have the capacity to lever up to do a deal.

Would that include doing a really large deal, let’s say over 10 stores at once?.

Having that capacity and being at the lower end of our leverage ratio allows us to be flexible and opportunistic. And such as to the extent there’s opportunities to deploy our capital in ways that can enhance the return for our shareholders, we can take advantage of those opportunities.

And should there be, as you gave an example of a large potential acquisition at the right return, that’s certainly something that we’d have the capacity to do. Should there be opportunities to invest our capital in other areas, to generate a high return, we’ll take advantage of that as well..

And on import brand, in particular, I am just trying to understand that story a little better. It’s been a consistent problem across the dealer space and pressure there.

Is that really a function of one OEM in Nissan, is it a function of [indiscernible] programs, or you’re just having a discount pretty heavily every quarter?.

I think for quarter one which we’re talking about I mean specifically we had an issue with that manufacturer. We did miss out on a lot of their incentive money and we did feel some significant margin pressure with retail sales..

But, I could stress enough, we missed the incentive money because we missed the volume target, but we actually outpaced our market competition. So, while we didn’t do well, we went back with volume and missed the money, we actually fared better than the competitors within our marketplace..

Got it. Thank you..

Thank you. This concludes today’s discussion. We appreciate your participation. Have a great day..

Ladies and gentlemen, that will conclude today’s conference call. Thank you for your participation. You may now disconnect..