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

Rick Nelson - Stephens Bret Jordan - Jefferies James Albertine - Consumer Edge John Murphy - Bank of America Merrill Lynch Armintas Sinkevicius - Morgan Stanley Christopher Bottiglieri - Wolfe Research.

Good day and welcome to the Asbury Automotive Group Q2 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 second quarter 2018 earnings call. Today's call is being recorded and will be available for replay later today. The press release detailing Asbury's second 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?.

Thank you, Matt. Good morning everyone and welcome to our second quarter 2018 earnings call. We are very pleased with our second quarter performance. During this quarter, we achieved record adjusted EPS of $2.08, a 32% increase over last year's adjusted EPS. Our plan for 2018 remains unchanged.

We will continue 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 returns.

This quarter, we acquired two stores in the Atlanta market, which combined should generate approximately $120 million of annual revenue. We also returned $20 million to our shareholders through share repurchases and we continued our investments in building our omnichannel capabilities.

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

Sean?.

Thank you, David and good morning to everyone. The second quarter marked another record performance by Asbury with adjusted earnings per share of $2.08. Accounting standard ASC 606 once again impacted revenue recognition for the parts and services and F&I businesses.

The net impact of ASC 606 in Q2 was to reduce revenue by approximately $1.6 million, reduce gross profit by approximately $800,000, and earnings per share by $0.03. There was no impact on our cash flows. Note that we do not adjust the results to normalize for the impact of ASC 606.

Overall, compared to the prior year second quarter, our revenue increased by 6%; gross profit increased by 4%; gross margin of 16.1% was 30 basis points lower than last year; SG&A as a percentage of gross profit improved by 90 basis points to 68.6%; adjusted operating margin of 4.6% was 10 basis points higher than last year; adjusted net income increased by 29% to $42.7 million; and adjusted earnings per share increased by 32% to a record of $2.08.

Net income for the second quarter of 2018 was adjusted for a $700,000 pretax gain on legal settlements or $0.03 per share. In Q2 2017 adjusted earnings excluded an $800,000 pretax gain on investments or $0.02 per share and $2.9 million of pretax real estate-related charges or $0.08 per share.

Our effective tax rate was 25.8% for the second quarter of 2018, down from 38.1% in the second quarter of 2017. Turning to expenses. SG&A as a percentage of gross profit for the quarter was 68.6%, an improvement of 90 basis points over last year. This is a very pleasing performance considering our continued omnichannel investment.

As previously noted, during 2018, we are investing in access of $10 million in omnichannel capabilities. SG&A as a percentage of gross profit for the first half of 2018 was 69%, which is 60 basis points better than the prior year. We continue to target 69% to 70% for the full year 2018.

During the second quarter, we experienced to hailstorms at our Honda store located in Irving, Texas. We recognized a cost of approximately $800,000 this quarter associated with damaged inventory. Note that in the second quarter of 2017, we recognized a cost of approximately $1 million due to a hailstorm that hit two of our stores in Plano, Texas.

With respect to capital deployed this quarter, we spent $9 million on capital expenditures, $20 million repurchasing our common stock, and we acquired two dealerships that we expect to generate around $120 million in annual revenue. At the end of the quarter, our total leverage ratio stood at 2.8 times and our net leverage ratio at 2.4 times.

Despite a reduction in our inventory days, floor plan interest expense increased by $1.9 million over the prior year quarter. This is driven by increases in the LIBOR rate. A reminder that our floor plan debt has a floating interest rate while all other debt is fixed rate.

From a liquidity perspective, we ended the quarter with $3 billion in cash, $28 million available in floor plan offset accounts, $85 million available on our used vehicle line, $234 million available on our revolving credit lines, and we also have an incumbent real estate in excess of $200 million.

I would now like to hand the call over to John to walk us through the operating performance.

John?.

Thank you, Sean. My remarks will pertain to our same-store performance compared to the second quarter of 2017. Looking at new vehicles, while SAAR for the quarter was strong at $17.2 million or 2.4% above last year, we focus on retail SAAR which was flat for the quarter. In this flat retail SAAR environment, we were able to grow our new unit sales 1%.

Overall our new car margin was 4.4%, 10 basis points lower than last quarter and 20 basis points lower than last year. The decrease in our import margins was due to aggressive incentive targets coupled with a reduction in available incentive dollars.

Domestic margins were also down because we underperformed in certain domestic brands, thereby missing some incentive money. While both import and domestic margins were down, we were able to grow both our luxury line by 2% and our margins by 20 basis points. Our total new vehicle inventory was $776 million.

We reduced our days supply from the prior year quarter by two days to 72 days. Turning to used vehicles, our used vehicle unit sales increased 5% over a strong 6% comparable in 2017. Our gross profit margin of 7.2% was down 10 basis points from last quarter and 40 basis points lower than prior year.

Our used vehicle inventory of $151 million is at a 31-day supply. Turning to F&I, our team continues to deliver strong results. Total F&I gross profit increased by 5% and gross profit per vehicle increased by $33 to $1,551 from prior year quarter.

As Sean mentioned in his remarks, the gross profit per vehicle was adversely impacted by the adoption of the new revenue recognition accounting standard. This decreased our F&I PVR by $12 per vehicle. Turning to parts and service.

Our parts and service revenue remained flat and gross profit increased 2% despite a 13% decline in warranty compared to the prior year quarter. 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 6%.

I want to take a moment to give you an update on the progress of some of our omnichannel initiatives. Our centralized brand certified digital sales team currently supports 30% of our stores and we are on track to onboard the entire company within the next 15 months.

Stores participating in the program during this quarter increased digital sales by 15% year-over-year. Our PUSHSTART online sales tool converted over 3,100 vehicle sales in the quarter.

We continue to grow the traffic in our digital parts and service scheduling tool and for the quarter, online appointments were up 39% from the prior year, now approaching 10,000 online appointments per week. We are excited about our omnichannel growth and we are pleased that we've been able to maintain our SG&A discipline.

In conclusion, we would like to welcome all our new employees at our Nalley Chevrolet and Nalley Toyota dealerships and express our sincere appreciation to all of our teammates in the field and in our support center who continue to produce best-in-class performance. We will now turn the call over to the operator and take your questions.

Operator?.

Thank you. At this time, we will open the floor for questions. [Operator Instructions] Our first question comes from Rick Nelson..

Thanks. Good morning. Nice quarter. I'd like to follow-up on the SG&A. That really was a standout in the quarter of 90 basis points. You were confronted with this GPU margin pressure.

If you could speak to the drivers to that leverage, if you think these SG&A levels are now sustainable?.

Hey Rick, its Sean. Regarding SG&A, we are very conscious this year of the investments that we are making in omnichannel. As I said in the remarks, it's about $10 million during 2018. And with this in mind, we've been very focused and cost conscious in our SG&A spend. We are a very data-orientated attention-to-detail lean operating organization.

We've been very cost-conscious and disciplined in our SG&A spend. We estimate that around 80% of our SG&A is variable in nature and the vast majority of that relates to personnel costs, which we're able to manage and we've been very thoughtful in the way we've scheduled and done our staffing to manage those SG&A costs during the quarter.

So, can't point to one specific item, but it is the overall management of the operations..

Okay.

These omnichannel investments of $10 million, is there a timeline to when you think you'll start to leverage those investments?.

So, we are already starting to get the benefits from those investments. We started the spend not this year but in the previous year. And we are already starting to see some of the benefits of that coming through. And that's one of the reasons that we're able to leverage our SG&A.

The rollout -- as John said in his remarks, the rollout of our digital sales team will take another 15 months. And then there's a period of time before that becomes up and running. But within 18 to 24 months, we should start to see even more leverage coming from these investments..

And just to jump on top of that, Rick, I would say the goal coming into this was the higher conversion rate with the traffic that we have. And lowering our overall expenses per transaction, not just in sales, but in all departments.

And while it's early on, we're certainly seeing the results of that and we're very pleased and look forward to the future..

Thanks for that color. Finally if I could ask, you acquired two stores this quarter. If you could comment on the valuations that you are seeing out there and your appetite for acquisitions versus stock buybacks..

Hey Rick, its Sean. I'll start and I'll let David finish up. Just generally a couple of thoughts on how we look at acquisitions. We look at each project on its own and it needs to stand on its own both from qualitative factors and quantitative factors.

We look at the risk of the project and the return thresholds for each project depend on the risk of that project. So, for example, a turnaround situation, which is what these two stores in Atlanta represent, will require a higher return than share buybacks or an investment in one of our existing stable stores.

We're always cognizant of the alternative investments that we have as well when we consider our investments. So, for these two stores, given the turnaround situation for them, we would expect a higher return. I don't know, David, if you want to--..

No, I would say you summed it up well. Every deal stands on its own. We look at it differently and certainly the higher the risk the higher return, as Sean stated, is what we look for. And we certainly see that in these two acquisitions and are very excited about the future for them..

And are the valuations that you are looking at out there, are they coming down or is there more of a meeting of the minds, I guess, in terms of pricing?.

I think there's a lot of conversation, there's a lot of activity out there, Rick. I certainly don't see prices going up. In some cases they are coming down, but I think some of that is a little bit geographic and market driven and brand driven. We're very excited about all the M&A activity out there and what we've looked at.

We're still very disciplined and thoughtful in how we look at it. So, we like our pace and what we're doing and we are not out there just for the sake of buying something. If we don't think it's a good asset for our shareholders and is going to create a great return, we just keep moving on..

Got you. Thanks a lot and good luck..

Thanks Rick..

Thank you..

Our next question comes from Bret Jordan of Jefferies..

Hey good morning guys..

Good morning..

Could you talk a little bit about -- I guess incentive cadence as the quarter progressed was either particular players involved more aggressively or did it change as time went along in the quarter?.

Yes, I would say it was fairly stable. One of the import brands kind of kicked it up a little bit in June compared to where they started off in April. But luxury and domestic were -- and most of the midline imports were stable through the quarter..

Okay, great.

And then on omnichannel as we think further down the road, what are the top set of maybe two or three metrics you want to measure that by, I mean lead generation that might be online? You talked about the service scheduling that's being done online, but as we look forward how do we want to grade the success of that initiative?.

Yes, I would say it depends -- not so much from a lead traffic volume standpoint; we all have the ability to generate that. It's converting at higher rates and the easiest way to do that is being consistent in the level of service that you offer. And we feel like we've found a mix to do that.

From the service online perspective, no differently than booking an airline ticket online. We think it is fast, easy, and convenient for our customers to do that and in three years we've gone from 400 appointments a week to almost 10,000.

As we see those increasing the customers are actually spending more dollars per repair order, our CSI is better and we are doing a lot more transactions that way. We're also seeing that with online part sales with the do-it-yourselfers now.

So, it's really looking at all our avenue streams -- or revenue streams, excuse me, and seeing how we can optimize the conversion rates and lower our costs while doing it to be competitive for the future..

Okay.

And I guess on that service question, as you look at 5% growth in customer pay, do you have a feeling sort of anecdotally how that compared to growth in your markets? Is that -- that's a share gain number you think?.

We think we're currently pacing probably at or above average within the markets that we compete in. Our biggest opportunity for growth lies within our ability to acquire technicians. I've stated this before, the good news is we don't have any CapEx investments; we don't have brick-and-mortar issues.

We have capacity issues in the sense that we need to bring on more technicians..

Okay. All right. Thank you..

Thank you..

Our next question comes from James Albertine of Consumer Edge..

Great. Thank you and good morning. I wanted to ask a question first.

As you are thinking about the business holistically here and you are laying on more omnichannel initiatives, can you just help us bullet point a handful of items where you think it makes sense to build in-house versus going outside to third-parties? I'm thinking of cars.com, car gurus in the sense of advertising.

But perhaps as well maybe on the dealer management side.

I mean where do you think it makes more sense to build and invest in building resources internally versus leaving it to outside experts?.

This is John. I think you need to do a combination of both. We do a lot in-house with our digital marketing team. And I think you still need to use those third-party providers to bring leads in. But I think the more we can do in house, it lowers your overall expense and you can get a better result a lot of times..

Can you articulate where you are going in-house more, is it in certain discipline areas? Or just can you help us triangulate that a little bit further?.

Well, the digital teams work with the markets as far as SEO and SEM and we do a lot of the maintenance in-house..

Understood. And a follow-up to an earlier question on M&A. It sounds like the Chevrolet and the Toyota stores -- I think you said turnaround if I heard you correctly.

But just really want to try and bookend how much further behind are those stores from a profit before tax perspective? Are they negative? And in what kind of timeframe do you expect those -- or I should say that $120 million in revenue to start to approximate your consolidated PBT or EBIT margins as you think about it?.

Sure, neither store was -- both stores were profitable, not by much. We looked at those stores coming into them. The first year would be about getting the right people on the bus, so to speak, and stabilizing the operation and truly seeing the gains in the second year.

We're actually ahead of schedule in one of the two stores and seeing better results than anticipated this early on. But we have high hopes for both stores. When you talk about turnaround, your ability to grow them is fairly dramatic from a percent standpoint..

Understood. Thanks again and best of luck next quarter..

Thank you..

Our next question comes from John Murphy of Bank of America..

Good morning guys.

Just a first question and maybe if you can sort of outline or illustrate as we think about a person coming through the PUSHSTART program to actual culmination of a sale versus an up at a dealership and sort of the cost savings and process there, maybe just so we can understand what the ongoing SG&A savings might be over time as we see more of this PUSHSTART volume growth..

Hey, John; this is John. I think in the environment we are in, consumers are very conscious of their time. And PUSHSTART basically lets the consumer interact with our stores on their time, how they want to interact. And then at the end of the day it's really just the process has changed.

So, it's a much more digital environment we're living in and we're trying to make it easy for the consumer to interact with us and deliver product to them in their preferred medium..

Let me add on to that if you don't mind. The consumers are doing their own F&I. We have a direct API with Route 1 and lenders. So, they are doing their F&I on their own, they're doing their loan application; they are uploading their trade information. Very soon we'll be signing off documents except for some DMV stuff online as well.

And really the cost savings down the road, the way we look at it is our only differentiator between us and any of our competitors out there is the level of service that we offer. And one thing that we all struggle with in our stores is turnover.

By creating this team and this approach and what we're doing, we're able to staff our stores with less people and we're creating more transactions per employee, which is lowering the turnover and increasing the productivity per employee. So, it's a win-win for the employee and it's a win for the company because we're bringing our costs down..

So, is it fair to say there's a decent amount of upfront investment that you're making in this $10 million number you're talking about right now, but over time the personnel and ongoing operating cost of pushing a transaction through the system versus up in a store versus digitally is pretty dramatic? I mean you lose a sales commission everything else along the way including F&I process becomes that more efficient and it has less hands.

So, the profitability on each transaction should go up dramatically -- or materially I should say over time..

Correct..

Okay, that's helpful. Thank you. And then a second question, lease returns are ramping up. There's a lot of debate whether they get captured at the grounding dealer and resold as CPOs or direct to the consumer.

Just curious what your experience has been so far as we see lease returns ramping up and how you're processing them, if you are capturing a higher level at your dealers and grounding them and putting them into your inventory or if you're actually punting them a little bit more into auction.

Just trying to understand how that's benefiting you and how you are dealing with it?.

Well, the off-lease cars have continued to increase, creates a great sourcing opportunity for high quality, low mileage preowned vehicles. So, we basically try to grab as many as we can and re-retail them to the consumers. We are not taking these vehicles and taking them back to auction; we're trying to retail as many as possible..

And given what's going on with used vehicle pricing, you're putting up pretty good grosses on those?.

Overall, our margins are decent on used. We're focusing on bringing our cost of sale down. Obviously those off-lease vehicles drive that up because they are later model vehicles. But I think we're in a pretty good place as far as margin goes..

Okay. And then just lastly on the pricing environment, I mean we are seeing mix improve pretty dramatically in the industry, yet your average selling price on a same-store basis on a holistic basis is up 1% or 2%, reasonably consistent with the industry.

Is there something underlying the benefit of mix where pricing appears to be deteriorating, or you're having to give up more to get deals done? I'm just curious there's kind of a belief that pricing is strong, yet it seems like there's some early signs of a bit of weakness..

Well, if you're talking about used specifically, the market dictates the price of the vehicle. So, we really focus on our acquisition costs and our reconditioning costs to try to keep our margins high..

But on the new vehicle side, it looks like there's waning strength in the ATP or the average selling price yet mix is improving.

So, is there an aggressiveness on the automaker side or are you having to give up more to get deals done?.

John, this is David. I'll jump in. The question is it varies so much by brand. I mean generally speaking, industry levels are down a little bit; they are not quite producing as many. Some brands have backed off their incentives a little bit and as you know, some brands have stepped up their incentives. We still see it very competitive out there.

We still need, unfortunately, the need for high incentives to keep the ball rolling, so to speak. But I don't see anything materially going on where there's any cause and effect right now..

Okay. And then just one last housekeeping. On reconditioning, are you guys booking that at 100% gross profit through parts and service? It looks like it's a roundabout there..

It is, yes..

Great. Thank you very much guys..

Thank you..

Our next question comes from Armintas Sinkevicius of Morgan Stanley..

Thank you for taking my question. Used car volumes, transaction prices, gross margins were particularly strong this quarter -- at least versus our estimates. Can you talk about the strength that you are seeing with used? Because when we look at, for instance, CarMax there's been some headwinds there on a same-store sales basis.

So, I'm curious what you are seeing in that market..

We've really focused on used vehicles. And if you remember, a couple quarters ago, we did have a change in our enterprise software. So, I think over time the team has adapted, gotten better with that software. And we've really -- we've had a focus on used vehicle sales in general.

As far as the CarMax model goes, one of the advantages we have being a new car franchise is that we get an opportunity to trade a lot of vehicles. We've got vehicles coming through our service drive, so we've got a lot of the stores that have service drive initiatives to trade people out of vehicles.

So, it's really just been a focus and a decent job by the team in the field..

And then I noticed in the slide deck there was one slide that said you can ship anywhere.

Can you talk about some of your logistics and transportation abilities?.

The funny thing on a pre-owned vehicle and I think I just said it a couple minutes ago, we priced our cars to market. So, people will travel and quite some way to come get a used vehicle if it's the right car at the right price. But we can ship the car anywhere. We've shipped cars all over the U.S. if somebody wants it shipped..

And then last one for me.

Your trends through July versus a year ago and your targets, how is July turning out so far?.

July started off pretty well. It is as expected..

All right. Thank you so much..

Thank you..

Our next question comes from Christopher Bottiglieri of Wolfe Research..

Thank you for taking the questions. So, I wanted to follow up on the last question on used to start with. You have pretty easy compares in the back half from last year.

How are you thinking about the trajectory given what you did in Q2? Or maybe looking more broadly at two half versus first half? Is there any reason to think [Indiscernible] I'm asking?.

I think as far as the used vehicle sales, we'll stay focused on it. I think we've got some decent comparables we're up against in quarter three and quarter four. So, I don't see it changing..

Got you. Okay. I want to talk more broadly about what you're seeing in wholesale? I know it's a small segment, but anecdotally like if there are some signs. You had previously been iterating losses in that segment, now I would say incrementally small profits.

I guess, one, what are you doing differently that's driving the increased profitability? Maybe just start there. And then two, there has been some changes to the industry in terms of mobile-to-mobile platforms and stuff like that. Are you using any different technology as you think about trade-ins, et cetera? Thank you..

Well, our enterprise technology has an appraisal tool obviously in it and it's really -- the wholesale is really just about appraising the cars properly. If you know it's going to be a wholesale vehicle, we appraise it as such. If it's going to be a retail vehicle, we appraise it as such.

So, it's really just being -- knowing the market and being sharp in the appraisal process and then disposing the cars quickly. The wholesale vehicles, just like the retail, we try to turn them quickly and not hold onto them..

Got you. Okay. Then one high level question on imports, then that's it for me. So, obviously some weak there in the market right now. You're looking at the gross profit on the import segment particularly, on the new side, those continue to creep lower.

Is there a way to think about what a lower bound could be? Is there one, I guess to start with? And then two, just given your consolidated, fundamentals look pretty strong.

What could we read across for the import segment? Have you been able to offset this weakness in terms of F&I and used the way you have for the rest of your business? Or maybe just how should we think about that?.

I would say it talks to the diversity of our model. We are predominantly an import brand company, so you would think it would affect us more, but yet we tend to ride the top of our peer group as far as operating margin. And I think it's because of our performance in parts and service, F&I, and used.

We also have some pretty strong midline import brands where we do some volume with them as well and certainly appreciate the relationship. And those customers tend to be pretty good parts and service customers as well. Which again, midline import customers also have a lot of trade in. So, there's a good ecosystem there that works.

We don't sweat out the new car margin probably as much as others might because we kind of look at the holistic approach, where is our total yields, what are we doing in parts and service and F&I and pre-owned..

Got you. Okay, helpful. Thank you for the time..

Thank you. Thank you all very much. This concludes today's discussion. We appreciate your participation in today's call. Have a great day..

Thank you, ladies and gentlemen. This concludes today's conference. Have a great rest of your day..