Good morning. Thank you for attending the AutoNation 2Q '24 Earnings Call. My name is Elissa, and I will be your moderator today. [Operator Instructions]. I would now like to pass the call to our host, Derek Fiebig, with AutoNation. Please go ahead.

Thank you, Elissa, and good morning, everyone. Welcome to AutoNation's Second Quarter 2024 Conference Call. Leading our call today will be Mike Manley, our Chief Executive Officer; and Tom Szlosek, our Chief Financial Officer. Following their remarks, we'll open up the call to questions. Before beginning, I'd like to remind you that certain statements and information on this call, including any statements regarding our anticipated financial results and objectives, constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks that may cause our actual results or performance to differ materially from such forward-looking statements. Additional discussions of factors that could cause our actual results to differ materially are contained in our press release issued today and in our filings with the SEC. Certain non-GAAP measures as defined under SEC rules will be discussed on this call. Reconciliations are provided in our materials and on our website located at investors.autonation.com. With that, I'll turn the call over to Mike.

Thank you, Derek, and good morning, everyone. Thanks for joining us today. As I mentioned in today's press release, the CDK outage masked what was developing into a very positive quarter for AutoNation. April and May new unit sales were up about 5%. Used unit sales were flat or accelerating in June. After sales growth was consistent with first quarter trends and margin trends in many of our business lines are moving positively and I was certainly encouraged with where the quarter was sitting when the CDK outage hit us on June 19. Now as usual, Tom is going to take you through more details of our performance during the quarter in his section, but I did want to give you a summary of the scope of the impact on our business. Before I do that, however, I think it's important to state that as of the last week of July, the incident with regard to its operational impact on our business is now behind us. Now to give you a sense of scope, virtually all of our business processes, including CRM deal processing, financial services, inventory management, after sales systems and accounting, I've hired in one form or another to the CDK backbone and therefore, were all immediately impacted. And naturally, we worked with each of our business units to put in place interim solutions, some of which were off the shelf and some of which had to be developed. Now each solution based upon the discipline involved, returned our business to some level of functionality and productivity, but the work around processes were in large part manual. For example, we manually processed close to 60,000 repair orders during the outage. And you can imagine this spoke things down tremendously. Now main functionality of CDK was brought back online…

Okay. Thanks, Mike. I'm turning to Slide 4 to discuss our second quarter P&L. Our total revenue of $6.48 million was nearly identical to the first quarter despite the outage. And as Mike mentioned, we were tracking above expectations across the enterprise when the outage hit during one of the highest volume periods of the quarter. When you combine this with the expected year-over-year normalization in vehicle selling prices, our revenue decreased 6% from 2023. Gross profit of $1.2 billion was 18% of revenue and decreased 3% on a sequential basis. reflecting the productivity drag from the outage. Mike mentioned the encouraging margin rate trends. Gross margin rates improved 60 basis points from the first quarter in both the used and aftersales businesses and the rate of PVR moderation in the new business, as Mike mentioned, was also encouraging. Adjusted SG&A was relatively stable at $782 million compared to $786 million in the first quarter. This resulted in adjusted operating income of $319 million, just under 5% of revenue. Now below the operating line, our second quarter results were impacted by higher interest expense, mainly for floorplan debt and benefited from lower income tax expense. The second quarter floorplan interest expense of $54 million was up $21 million from a year ago as expected, which is a reflection mostly of higher inventory levels and to a lesser degree, higher interest rates. As a reminder, we reflect floorplan assistance received from OEMs and gross margin and assistance was down slightly from the second quarter last year. And so net of OEM incentives, the new vehicle floor plan expense changed from a benefit of $3 million in 2023 with cost of $21 million in 2024. Our second quarter adjusted net income excludes the $43 million of direct costs associated with the CDK…

Yes. Thank you, Tom. So, as you can imagine, we are pleased to move on, particularly from the end of Q2. And while we do so, I think it's important we do not allow some improvement, performance trends we were seeing to be lost in the midst of the outage. Now I'm encouraged the business delivered reasonably close to what was a strong first quarter despite the difficult circumstances. Margin and cash flow are the highlights as were the pre-outage volume trends. Looking forward, as I mentioned earlier, I view the current levels of vehicle demand we are seeing is positive. With this, coupled with our significantly strengthened supply of new vehicles, I expect to regain any share loss in the coming periods. Now we continue to work -- we have continued work to do in our improving used businesses. As you know, this is a very high-term business and its performance is largely in our control. We have strong self-sourcing capabilities. We remain focused on turning the inventory quickly and are pleased with the quarter-over-quarter margin improvement. With that, I'd like to hand it over for any Q&A you may have. Thank you.

Alissa, if you could please open up the lines for Q&A.

[Operator Instructions]. The first question is from the line of John Murphy with Bank of America. Please go ahead.

Good morning, guys. I just want to ask one very quick one before a second longer one. What was the reaction that your sales folks had to the $43 million that you paid despite the CDK disruption? I'm just curious how much goodwill that may have been gendered with folks.

John, I actually was in the dealerships when we made the announcement. As you can imagine, there was given the nature of their pay and obviously, the dependency on productivity, there was a lot of concern within the businesses about the impact on them and their families. So, the -- I think the center of gratitude and recognition and support from the organization was clearly seen when I was there, and we continue to see it in the business, not just for our sales [indiscernible], but also for our technicians because as you know, and I mentioned briefly in my remarks, we've grown our technician base. It's incredibly competitive late market. Retention and technicians, development of the technicians is so important. And given all of the work that we have done, and I think it was a very necessary and right investment for us to make. And you saw the impact these things are not cheap. But at the end of the day, I genuinely believe if the businesses are created and delivered through the people that they employ and the people that they engage. So, for me, it was a necessary thing to do. Sorry for the long answer to a quick question.

No, I think it will pay dividends for some time to come. Just on cap allocation real quick. I mean, it seems like there might be a slight shift that occurs over time as acquisitions become more realistic on multiples might be more capital that goes towards AutoNation USA stores as a 0-year to 6-year old fleet eventually grows in 1 years to 2 years' time. How do you think about sort of the shift in potential capital allocation over the coming quarters and potentially coming years as things shift and maybe your shares are less attractive relative to -- I'm sure they'll probably -- hopefully be less strict over time as they go up? but to those other incremental opportunities to allocate capital accretively.

Well, I'll start, John, and then Tom, I'll ask you also to comment on this question. There's no change in terms of philosophical approach to capital allocation, and it starts with the best returns we can give our shareholders and will always be centered around our shareholders. And as such, we tend to have a very consistent method of assessing investments we make, whether that's investments in our own stock or investments in dealerships. There is no doubt that we are seeing and we'll continue to see for a period of time a normalization of asset prices in the marketplace. And as such, they become more attractive than they were, for example, 12 months ago. because the combination of returning capital to our shareholders and growth in our organization organically or M&A is important, those two things working in tandem that I think ultimately deliver the best shareholder return over the period and into the future, and that is our focus. So, you're going to see exactly the same view on capital allocation. The resulting allocation of spend may change, but it will only change because assets are very attractive and synergistic to what we already have in place. Tom, I don't know if you want to add.

No, I would have been totally answering the same return-based focus. I don't see a shift. We don't talk about a shift. We are just basing on where we get the best returns. I would say that we still don't think we're at our intrinsic value on the share price. And so that does remain attractive to us.

I would definitely agree. Thank you, very much, guys. I appreciate it.

The next question is from the line of Rajat Gupta with JPMorgan. Your line is open. Please go ahead.

Great. Thanks for taking my question. I had a question on parts and services. You gave us the April and May commentary, 9% same-store growth. I mean really, that's well above what we've seen at your peers. You mentioned the 3% growth in technician headcount. I'm curious if you could unpack that 9% a bit more in terms of how much is coming from price from mix and just traffic? And how should we think about how July is tracking right now and expectations for the remainder of the year? And I have a quick follow-up.

So, when I reflect back and think about the delivery of that a large amount came from the incremental capacity that we had and Christian and all of the aftersales teams in the dealerships really focused on service effectiveness, which is the penetration into the vehicle park. It's an area where traditionally franchise retailers are only getting 50% of what's out there within a 7-year park and for us. That is the key focus. So when I think about our 9% growth, some of it did come from mix because we saw a reduction, for example, in some of our wholesale and retail counterparts and a little bit of reduction in our internal work, but the majority of what we're seeing is incremental revenue and income on a per repair order basis because some of the technology that we've put in place and the interface that we have with our customers means that we're much more effective communicating with our customers opportunities for them to preemptively in many instances, look after the service needs of their vehicles. So, it's a combination of mix change on one hand and also incremental revenue per repair order. Tom, any other color to add to that.

No, just he'd asked about July, Rajat.

Yes. Well, I think July is -- I mean, has returned very strongly on the aftersales, on the service and parts business. I mean, and maybe that's some of the unlocking that John mentioned from our people. Now I don't think that we will recover per se all of the hours that were lost because there is still a capacity limitation that we have. But I think if I look across the various elements of our business, the aftersales teams, I think, have recovered the quickest. And I would say we exited July on a good pace.

Got it. That's very clear. And just a follow-up, a bit of a long-term question. with the experience you had with the CDK outage. I'm curious like what does this mean for your thinking around long-term like systems that you have in place? Are you thinking about like maybe adding more redundancy, factoring with other lenders or any more like cybersecurity, cyber insurance expenses that might start to flow through? Curious like what's -- have you started to think in that direction? And what that would mean just from like an IT expenses or cost structure perspective? Thanks.

So, let me try and give you a good answer on this. So Obviously, what we're able to do looking back now is we're able to see which elements and systems have the biggest impact on us across our -- across the integrations that we've had. AutoNation has spent a lot of time integrating with the DMS system to drive some productivity levels, enabling us, for example, to provide large volume back-office services from central locations. And that integration, frankly, would have been developed, whether it was rent orders or Reynolds, CDK or any other DMS provider. So, from my point of view, I think one of the important things as we review that period of time is to see which had the biggest impact in our performance. And what should we do in terms of providing either a backup system or a degree, if you like, redundancy that means that impact could be limited. So, we've done that work. And as I mentioned, some of the things that we did in response to the initial outage were systems that were on the shelf that needed further development and integration so that we could use them much more productively. So, we now understand things that we may want to invest in and have invested in that would protect us in some of those key, let me call, contribution areas that were impacted the highest. For example, CRM, the speed, the accuracy and the professionalism that we respond to inbound opportunities, particularly digital inbound opportunities has a significant impact on the conversion rate and the output of those. When you lose your CRM systems, you obviously -- your productivity drops dramatically. So that's an area where we can because of our IT guys and go develop a light system that doesn't involve a huge amount of investment that will not have the full functionality of all the work that we have done with our CKD [ph] partners in this area. But we'll provide a degree of functionality that means the productivity loss that we saw will be mitigated to a certain extent. And obviously, it's incumbent upon us to look at that. and strike the right balance between investments that we want to make, recognizing that this event was -- I don't want to use the term onetime, but this event was not something that you would completely structure your business around. I would rather structure our business around making sure that we are adequately invested, for example, in cybersecurity. Clearly, there are learnings for everybody involved in this, and we're just trying to expect the most beneficial ones for the company.

Yes. I mean the thing that I would add is that it's a great question, John. I mean, we're early days in trying to get to what this means for us. And obviously, we've been trying to restore continuity over the last six weeks, which, as Mike said, we're pretty much there. When you look at the overall profitability of the business, I mean, obviously, 75% of it is in service and CFS. And you would want those two platforms to be trouble-free and any kind of disruption, particularly on a short-term basis. So, some of our thinking will revolve around that as well, the ability to handle, repair orders and maintenance to be able to have continuing our spare parts supply to be able to process customer tickets, all of that really, really important. And our workarounds were pretty effective. But I think we see some opportunity there as we move forward. Same thing with CFS in terms of being able to have continuity around presentation of alternatives and helping customers understand the product and finance offerings that we have.

The next question is from the line of Douglas Dutton with Evercore. Your line is now open.

Thanks for taking my question here. Just wanted to ask first on SG&A normalization in Q3. Are there still some latent effects from the lost productivity and lack of continuity early in July. And do we expect that percentage to stay elevated? Or do we head back towards the more normal mid-66% range as a percent of gross profit?

Yes. Great question, Doug. I mean I'd encourage you to look at the overall spend on SG&A. We do think that the impacts that we mentioned, roughly $0.76 of loss -- the profit, mostly at the gross margin level do distort the ratio of SG&A to gross profit. When you look at just the SG&A itself, it's almost identical from Q1 to Q2, which kind of says that we are able to understand the mix. Probably 70% of it is variable and 30% is fixed. The fixed piece, we've done a very good job of keep holding a line on and we do see further opportunities for productivity as we get into the more densification and more centralization of some of our back-office activities. So as the volume returns, and we're able to keep those costs flat and continue to drive the productivity in them from our initiatives I think you'll see ongoing improvement in the ratio.

Let me just jump in there a bit. Tom and I'll also add some color for Doug. You're going to see elevated as percentages of SG&A for the period of, I would say, 80% of July as we were returning to levels of productivity that were still being impacted from the ancillary systems and services that were being integrated. I view that now behind us as we get into August. But it will have a residual effect on that percentage. Tom is exactly right on the dollar amount, but your question was around the percentage. So just my color on that point.

Okay. That's super helpful. I appreciate that, guys. And then just on PVRs, they continue to look better on sort of a deceleration basis. Have you had any internal change and thesis on where these could land once we get to some fully normalized level and USR grows back above, say, $16.5 million. Has there been any sort of internal discussion on that?

Yes, we always have internal discussion on our PVRs. And I think you guys will recall on the call when I was asked this question coming into the year. I think many of you thought I was relatively pessimistic when I said our expectations are they'll be fully normalized back to '19 at the end of the year. I have to say I'm moderating that view on our experience over recent months. I still think that there will be some continued moderation for the year, but probably not at the pace that saw before. If you even look at the difference in mix, for example, of bevs now compared to what it was expected to be, and I think, as you all know, the margin on full battery electric vehicles for the OEMs and for us is significantly lower than their combustion and their hybrid counterparts. So, you're going to see a moderation on our outlook for Bevs, I think, in the year, which will also moderate our outlook on PBR. So, in summary, we're still going to see some moderation in my view on those, but not to the level I'd anticipated early in the year.

The next question is from the line of Bret Jordan with Jefferies. Please go ahead.

Good morning, guys. On that PDR question, I guess, the moderation. How much is mix driven? If you think about the outperformance of import versus domestic, are you seeing maybe a silanes till deteriorator have that prior rate, but those products like Toyota that are in shorter supply are outperforming and supporting PBR? Or is everything generally stabilizing?

Well, I think there is a mix impact for sure because if I look just year-over-year in the quarter, I think mix and Tom, you've got to -- you moderate what I say, but my estimate mix is somewhere between $70 and $80 year-over-year quarter in Q2. But I expect that to largely wash back out the system as we recover market share, particularly in our premium luxury. There's been a lot of discussion and debate about different OEMs and their volumes in the marketplace and inventory build. The reality is the reality is inventory, there are many OEMs that recognize they are where they want to be and maybe a bit higher on their inventory, and they're going to have to step into the marketplace to address that because dealers in and of themselves are not going to be able to get to the net transaction price that will create the volume momentum that they need and they're looking for as well. So, my answer to the question is I do think that there's potentially mix improvements as we get into Q3 and beyond that impacted us year-over-year in Q2. But I think generally, you've got a number of things going on in the marketplace, including higher levels of lease, for example, that just lead us to believe that you're going to see a moderation in the reduction we're seeing on our margins. Tom, do you want to add anything.

No, you got it right.

Okay. And then I guess the question is you're seeing stability in used profits. Does that make you think about reaccelerating AutoNation USA? We didn't really talk about it much in the prepared remarks, but how does that look in the next couple of years from a growth strategy?

Well, one of the things that I think we're comfortable with is the revised pace of openings because particularly through the back through last year, I think we were opening too many. And our capacity to operationalize those get the right level of inventory into those businesses. really does mean we have to be, I think, more paced in terms of how many we bring on stream. We -- I would anticipate another maybe 4 or 5 this year, max. So, 10, 11 coming on stream. I think that's something that we can easily absorb into our system, connect in to our processes and make sure that we have the sourcing in place to give them what they need in terms of used vehicle inventory. There are still interesting dynamics in the used market. As I mentioned in my remarks, you're seeing mix changes in terms of price buckets, which are important for us, and you still see certain availability issues for different price categories and that's going to continue through the year. We -- our used vehicle inventory, Tom mentioned, dropped, particularly due to that last period of June. We're in the process of recovering inventory levels. So, our used vehicle sales volume will fully recover once we get our inventory levels up to what I would consider a normal amount, and they're probably 15% below where they need to be at this moment in time. But closing that gap. So, I don't know if that fully answered your question, Bret, but let me know if it did or not.

No, that was good. Thank you.

Our final question will be from the line of Adam Jonas with Morgan Stanley. Please go ahead.

This is Danielle Hogan on for Adam Jonas. So, my question is on vehicle affordability, which continues to be a problem for many Americans, higher for longer ASPs and also rates. What is your view on the state of the consumer? And is there anything you're seeing on the auto credit side that gives you concern.

There's no doubt that affordability is top of mind for many of the consumers that come into this marketplace, whether it's on new or used vehicles. I mentioned the fact that if you look at our CFS performance, it's moderated very slightly. That was about product attachment rates. And that is all about -- not desire for the product per se, but it's all about managing to a monthly budget. So, I think that there are impacts in the marketplace. We're also beginning to see increases, I think, in delinquency rates that I think are manageable and not where they were a year ago. But I do think there are signs in the marketplace that consumers continue to feel the pressure from the current environment. In response to that, you have already talked about the mix shift that we are facilitating and seeing in our used vehicle business. We're also seeing, I think, from the OEM side, increase in leasing, which helps affordability. And I think you'll continue to see OEMs responding in an appropriate way, we're managing that transaction price to help that situation and keep momentum in new vehicle sales because, in my view, there's still quite a large pent-up demand on new vehicle sales that will get released over the coming periods with the right pricing in the marketplace.

Got it. Thank you.

That concludes our question and A portion. Mike, if you want to make closing comments here?

Yes. Thank you. And again, thank you for all your questions and for being on the call today. When we came into this year, I said I was certain that we -- the year would continue to bring our normal mix of headwinds and tailwinds. And while the CDK outage was far from a normal headwind. As I said in my earlier comments, I can see that the operational impact of the CKD incident is now behind us as we exit July. And obviously, our daily focus is on fully rebuilding the momentum that we lost and regaining any share that we lost, particularly in that last period of June. I'd like to thank all of our associates and employees in the business, not just for their response to the outage, but also for the work that they've done creating the momentum that we saw through May, it's a pleasure to be in the same organization as you. Thank you for what you do every day. Thank you, everyone.

This concludes today's AutoNation second quarter call. Thank you all for your participation. You may now disconnect your lines.