Good morning. My name is Ellen, and I will be your conference operator today. I would like to welcome everyone to the AutoNation Second Quarter 2023 Earnings Conference Call. I would now like to turn the call over to Derek Fiebig, Vice President of Investor Relations. Please proceed with the conference.

Thank you, Ellen, and good morning, everyone. Welcome to AutoNation's Second Quarter 2023 Conference Call. Leading our call today will be Mike Manley, our CEO; and Joe Lower, our CFO. Following their remarks, we'll open up the call for questions. Before we begin, I'd like to remind you that certain statements and information on this call, including any statements regarding our anticipated financial results and objectives, constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks that may cause our actual results or performance to differ materially from such forward-looking statements. Additional discussions of factors that could cause our actual results to differ materially are contained in our press release issued today and in our filings with the SEC. Certain non-GAAP financial 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.

Yes. Thanks, Derek, and good morning, everyone. Thanks for joining us today. As normal, Joe is going to take you through the results in much more detail than I will, but what I'd like to do is talk about the business, give you a perspective from my side, touch on what we see as industry dynamics and then give another update on where we're heading and the channels that we're putting in place for growth for the business. So as we know, there obviously continues to be mixed economic signals in the overall economy. But from our point of view, the supply and demand equation, even though it is moderating, we think, has remained favorable for the business. And last quarter, I said that we thought the consumer in no way tapped out, and we still feel that's the case for sure. Now notwithstanding the fact that higher interest rates are impacting affordability, lower unit sales over the past few years have contributed to pent-up demand, which, as we see inventory levels improve and some mitigation on that transaction price continue to convert to sales in the marketplace. And the aging vehicle part, which is now about 12.5 years as well as positive household formation, I think, are additional favorable dynamics for the business. And these factors, I think, will continue to be a benefit for new and used vehicle sales going forward. Now as in the first quarter, 2Q light industry vehicle sales increased from a year ago, both driven in this instance by an increase in fleet, but also a notable rise in retail units, which increased by about 10%. And even with these increases, light vehicle sale remains below what most of us who've been in the business a long time would consider trend. Where industry incentives and lease penetration, even though they both have been increasing as late, they're still significantly below pre-pandemic levels, which I think just to give you an indication, OEMs still have a lot of additional tools to help spur demand if it's needed in the marketplace. I'm talking about incentives. As you know, Q2 incentives are around $1,700, which was up $700 year-over-year but well below the $4,000 pre-pandemic high and leasing continues to recover, but still only reached about 20% of volume versus 30% pre-pandemic. And I think this channel will further grow, particularly with EVs. And as we close out the year, I think we'll see that come through. Now for the second quarter, our new vehicle sales were in line with the overall growth in retail units for the brands we represent. And gross PVRs, as expected, continue to mitigate, yet remain robust, I think, at around $4,600 for the quarter. Now clearly, front-end margins have been more resilient than most of us were expecting heading into the year. Now I expect margins will continue to moderate partly to maintain current demand in this higher monthly payment environment and partly as inventory levels continue to increase and fewer vehicles are being sold at MSRP. However, I do not expect margins to return to pre-pandemic levels for the foreseeable future based on higher average selling prices of vehicles and continued lower industry inventory levels. So let me just move to used vehicles. And remaining consistent with the discussions we've had in this area, our focus on enhancing economics through effective outsourcing, efficiency conditioning and agile market pricing, I think, has helped us in the quarter in what has been a bit of a choppy market. On our Q1 call, I discussed how the lower new unit sales over the past years led to a scarcity of supply of late model used vehicles, and this continues, obviously. But in addition, the velocity of sales is also lower than normal as fewer vehicles were sold to fleet and daily rental over the past few years, and consumers are clearly holding on to their vehicles for longer. Now our focus on AutoNation has been on internal sourcing asset turnover and avoiding purchasing vehicles, which require substantial reconditioning to get them up to AutoNation's quality standards. But as we look back on our first quarter results, we recognized that our lower level of used inventory whilst bringing a number of benefits such as depreciation, lower depreciation and funding benefits, we felt was probably constraining volumes more than it should. So we spent a lot of effort in the second quarter, really redoubling our sourcing efforts, particularly in those categories that we think deliver quality inventory so that we could progressively through the quarter, regrow our inventory to get us ready for the third quarter and beyond. And we did that, I think, in a very disciplined, deliberate way, and that means we exited the second quarter and now go into the third quarter with increased availability, which we expect will enable us to drive value added unit sales. And Joe will touch on that. But obviously, that work came with an investment, particularly around the development of those channels that we thought were the best places for us to increase our used inventory. But as I said, Joe will touch on that a bit more. Now the expansion of our AutoNation USA footprint obviously remains a core tenet of our growth and densification efforts. I think densification is an important word, and we added our 16th store in Colorado Springs during the quarter. Now as you know, we've been intensely focused on expanding the range of products and services we offer and sell to our customers. Now this focus for us is twofold. The first is to increase AutoNation's share of our customer spend on transportation and mobility. And the second is to continually develop and grow revenue from what we term as higher recurring revenue sources. Now one key component of this approach is obviously our financial services performance, and I have been very encouraged with the continued performance the teams have delivered. So I know a lot of our guys and girls are on the call, listen to this, thank you for that. That's your shoutout but please keep that going up because our CFS PVRs structurally higher despite many expecting this valuable source of margin to come under significant pressure, particularly given prevailing interest rates. And I think it's because our team has always taken a balanced approach, driving both finance penetration levels, but really importantly, increasing per-unit product sales. And as such, we've increased our per unit performance. And as a result, the team delivered a record PVR of more than $2,000 for the quarter. Now talking to higher recurring revenue streams, let me touch on After-Sales. As you know, we've constantly talked about this, and we've been very deliberate and consistently growing this high-margin, higher-frequency business, and we recorded a gross profit record of more than $540 million, which is up 13% from a year ago. Now notwithstanding the decrease in late-model vehicle parts, which, as you know, is where all franchise dealerships have the higher penetration and obviously, lower new unit sales over the past year, I think that we have successfully been able to combat our headwinds; still a work in progress, but a good result in the quarter, no doubt. And a big part of that is our focus on expanding our technician workforce and serving more customers. So I'm expecting to be able to talk about further growth in the future on these calls. Now business continues to generate significant cash flow, which when you combine it with the strength of our balance sheet allows us to continue to invest to change our business for the long term, obviously make investments in our core operations but also return capital to our shareholders, and we do that through share repurchases. And during the second quarter, we invested more than $200 million to repurchase over 1.5 million shares at a price of about $132 per share. And year to date, we've reduced our shares outstanding by more than 8%. Now as we previously said, the structural changes we have made to AutoNation during the time when the supply and demand economics have been a tailwind for our operations will have a lasting and meaningful impact on a forward-looking basis and help to continue to drive shareholder value and returns. So before I hand the call over to Joe, let me provide some updates on where we're heading and talk a little bit more about this channel for growth. As I've previously discussed, we've been very intentional, I think, on looking at areas where we can expand and grow to meet the transportation needs of our 11 million-plus customers in their households. And there is a very significant opportunity set of customers who really only transact with AutoNation once or twice or have become active over the years. And we are commencing a much more targeted effort to engage with this customer base. So I think it's an asset that we don't talk enough about, certainly externally, but very focused on internally. When you have a business that over many years has not only built up some phenomenal franchise assets in great locations with what I think is great density in our operations, those 11 million-plus households and customers that we've interacted with represent increasingly with technology a very, very valuable source for the company. And Rich Lennox, our CMO, who joined us from Macy's, as you know, brings substantial non-automotive retail experience, so he is already looking at both lifetime value and customer loyalty with his team, and I'm really excited about what I expect to come from that area. Because if we can extend our core business and increase the depth and breadth of our product and services offer, that will deepen and lengthen our relationship with our customers as well as continue to provide a convenient, trusted and transparent customer experience, which I think is vital to be successful in the marketplace. And it would put a lot of time and effort, obviously, as an organization, as a group of people and those customer-centric actions, and I'm very pleased to see that it hasn't been lost on some industry observers. And in this May, 143 of our stores were certified as 2023 Dealers of Excellence by J.D. Power. So shout-out to those stores, well done guys. And that recognizes dealers for exceptional customer service. Now 143 stores this year, that's up from 129 last year and 78 in 2021. So great progress. I'm also very pleased with the performance of AN Finance as the group continues to expand. As Joe has often said, we're taking a metered approach and pace to make sure that we can progressively increase the penetration of this business with the vehicles sold to AN USA stores, and they are doing that, and they're also navigating, as you can imagine, quite an interesting and sometimes challenging environment with all of the rate rises. RepairSmith, I think, has extended the reach of the brand of our aftersales business, and we've begun to integrate this mobile service and repair business into the AutoNation ecosystem. And one of the things that I think will become increasingly obvious is as we continue to grow AN USA, it's the only stand-alone used car dedicated business that had one of the most convenient service and warranty provision in the entire marketplace. Imagine that phenomenal selection of used vehicles, great transparent pricing, great preparation, good quality vehicles, but then you also get the best convenience to have your vehicle serviced and repaired by mobile well-qualified technicians. So really pleased about how that business is coming together. A lot of work to do, obviously, but I think it's going to be a complement to the other things that we're doing. I'm talking about the used car business. It's obviously grown substantially from our pre-pandemic levels, both our franchise stores and through AN USA, now 16 locations with the addition of Colorado Springs, increases our footprint density in that area, which is another important strategy that we're focused on to drive market efficiency and economics. Now over time, we expect our actions and initiatives will garner a larger share of wallet from consumers which will reduce our relative exposure to the more cyclical parts of the business. And that approach is really centered on that customer base I mentioned and talked a little bit about earlier and the 11 million households that we serve. Now during the second quarter, we built on more customers than Q1 have now added more than 400,000 new customers for the year. And we're focused on enhancing our relationship with active customers. But as I mentioned, really going back in, reactivating lapsed customers, adding products and services to our base so that we can really be that comprehensive provider to all of those customers that either are part of our active customer base or hopefully will be reactivated through the work and the products and services that were added. And we think that these actions will add to the structural changes that we've brought to the business over the past few years. Now that said, I have to say, we are very focused on the franchise business and supporting our vehicle manufacturer partners, and we are in a privileged position to have a lot of great relationships with some of the best automotive brands in the world. And I'm pleased to say in June, we added to our franchise density in Southern California with the purchase of Bob Baker Auto Group in Carlsbad. Welcome, everybody. Really pleased to have you on board. Now you guys are going to bring at least $300 million, hopefully more of annual revenue and five great stores and then obviously help us with building our customer base, as I said. And with that, Joe, I'm going to hand it over to you to take us through the details. Thank you.

Thank you, Mike, and good morning, everyone. As Mike described, this quarter's results were largely driven by healthy margins, record aftersales performance, record CFS PVRs, disciplined expense management, and our balanced capital deployment strategy, which effectively countered the decline in used unit sales, lower growth PVRs, and higher financing costs. This resulted in a second quarter adjusted EPS of $6.29 per share, just shy of last year's record EPS of $6.48 and above the $6.07 we reported in the first quarter of this year. Total revenue for the second quarter stood at $6.9 billion, remaining stable compared to a year ago, as increases in new vehicle volumes and the continued growth of our aftersales business balanced out lower used vehicle sales. AutoNation's new unit sales rose by 8% in the quarter, aligning closely with the overall industry when adjusted for brand mix. This volume increase partially mitigated the impact from lower new vehicle PVR margins, which, although moderating, still remained healthy at $4,600. Inventory for new vehicles increased by one day from the first quarter to 26 days. Similar to the overall industry, we observe a wide variance in inventory levels by brand and model. Core brands are generally below the average, domestic brands above, and premium luxury brands are in line with the average. The overall new vehicle market remained robust during the quarter, with nearly 40% of our vehicles sold at MSRP, substantially higher than pre-pandemic levels, but down from about 45% in the first quarter. Our total used vehicle gross profit fell by 14% from a year ago, driven by lower unit sales and slightly decreased used PVR margins. We continue to enhance our used vehicle economics through effective self-sourcing, maintaining rates above 90% throughout the quarter. After-Sales gross profit saw a 13% year-over-year increase as we achieved significant growth in customer pay, warranty, internal services, and collision areas. The recurring revenue from After-Sales continues to increase, with a trailing 12-month gross profit nearing $400 million, representing more than 24% growth since 2019. The performance remains strong, and we are leading the sector with PVRs exceeding $2,800 for the quarter. We are pleased to note that our product penetration now exceeds two contracts per vehicle, raising the proportion of CFS profit from products to above 70%, counterbalancing lower profits linked to the finance side of our service offerings. Customers are increasingly investing in products that enhance the performance and appearance of their vehicles. As Mike highlighted, we are very satisfied with AutoNation Finance's performance and the integration progress into our operations. We plan to continue growing this business steadily while supporting our AutoNation stores. AutoNation Finance accounted for more than 20% of new loans originated at our AutoNation USA stores in June, facilitating our shift to a higher-tier credit customer base. Regarding costs, SG&A as a percentage of gross was 61.9% for the quarter, significantly below pre-pandemic levels due to permanent structural changes in our cost basis. SG&A as a percentage of gross profit was slightly higher than in recent periods, reflecting investments in technology and new initiatives as we broaden our customer offerings, as well as additional advertising support for our program, as Mike mentioned earlier. As indicated in today's press release, we excluded $12.4 million of after-tax expenses from our second quarter results, which stemmed from weather incidents, including significant hailstorms that damaged over 2,800 vehicles. In contrast, there were no such weather-related losses in the previous quarter or the same quarter last year. Second quarter floorplan interest expense was $33 million, impacted by higher rates and increased inventory. This all led to an adjusted net income for the second quarter of $285 million or $6.29 per share. As Mike noted, our cash generation remains strong, and combined with our solid balance sheet, provides us with significant capacity to invest in our businesses and return capital to our shareholders. Our cash flow from operations, including proceeds from additional floorplan, was almost $240 million in the quarter, which covered cash tax payments of $190 million. During the quarter, we invested over $180 million in our operations, including acquiring five new dealerships, as Mike mentioned, and more than $100 million in capital expenditures. We also continued to expand our AutoNation USA presence with our third new location this year, enhancing our offerings in a strategically vital market. The AutoNation USA stores are essential to our long-term growth strategy and achieving scale, scope, and density in our markets to better serve our customers. Additionally, we consistently return capital to AutoNation shareholders through share repurchase programs. Year to date, we have repurchased four million shares, or 8% of the shares outstanding at the start of the year. Although the pace of share repurchase has slightly decreased compared to the previous two years, it remains significant by any standard. We currently have approximately $670 million remaining in our share repurchase authority. We ended the second quarter with total liquidity of about $1.4 billion, and our covenant leverage of debt-to-EBITDA was slightly below two times, consistent with the lower end of our historical range. Earlier this month, we successfully amended and extended our credit facility, establishing a new five-year agreement with similar pricing to the prior one, while expanding our revolving borrowing capacity by $100 million to $1.9 billion and enhancing the flexibility of our financial covenants. Looking ahead, we will maintain our focus on operational excellence and disciplined capital allocation to foster growth and enhance long-term shareholder value. With that, I will turn it back over to Mike.

Yes. Thanks, Joe. So before just taking your questions, obviously, what I want to do is to thank the people that every single day deliver results for us, and that's our 24,000 associates. Thank you for what you've done in the quarter. Also, as you know, in May, we announced that Joe will be moving to a newly created role, which is basically going to oversee all of the business transformation initiatives for the company. Joe will continue to report directly to me and he's going to coordinate the execution and integration of our business transformation products really with a focus on process improvement, operational efficiency. And I think as a result of that will help accelerate our growth. Now I can tell you that since I joined the organization in late '21, Joe, in a very short space of time has been a trusted adviser and has been doing an incredible job in the management of our balance sheet and guiding our capital deployment. But you also need to look below that and really look at what the business and how it was performing in terms of some of the efficiencies and cost structure. You can see the lasting effect that he and his team, in conjunction with the operational people, have added to our business, and I think it's absolutely tremendous. Now in August, Tom Szlosek will join us and replace Joe. Many of you know Tom; he's helped drive change and innovation across medical technology and manufacturing industries and frankly, like Joe, he is a best-in-class Fortune 500 CFO. Tom is going to be responsible for continuing our focus on operational excellence, obviously the development of our company as well as making sure we continue with a really balanced but focused capital allocation approach. So just a quick update on those things. And with that, should we open up to questions?

Yes. Yes. Ellen, if you could please remind people how to get in queue.

The first question comes from John Murphy from Bank of America. John, your line is now open. Please go ahead.

Good morning, everyone. Joe, congratulations on your new position, and I'll begin with that. Mike and Joe, as you consider this, there are additional funds being allocated here. I'm interested to hear what those amounts were for the quarter regarding these initiatives, but also, more generally, you have 11 million customers in your portfolio that you can leverage and potentially engage with for an extended period. As you navigate this transformation, what implications does that have? Could it mean retaining these customers in that vehicle for ten years instead of five, with the profit potential being twice as much or more? How are you approaching this comprehensively in terms of the addressable market you could pursue? Is it mainly traditional routes like another used vehicle sale, extended parts and services, financing, or are there other opportunities you're considering?

So John, I'll begin with that, and then Joe can discuss the investments we've made. Looking at our customer base, there are several important factors to consider. Firstly, the percentage of active customers is defined as those who have had a transaction within a certain time frame. Currently, when including service, the percentage of active customers among the 11 million is significantly below 50%. This raises the question of why we see such a level of attrition among the remainder of the customers. Our reputation and customer satisfaction scores do not indicate dissatisfaction. Instead, changes in circumstances and needs within our customer base may be influencing this. For example, the distance of our dealerships may have increased for some customers, or as their vehicles have aged, they may have opted for non-franchise solutions for service and repairs, among other reasons. We have been examining this issue and working closely with our customer base to understand these drivers. We are expanding our business to offer products and services that align with their evolving needs since their initial vehicle purchase, such as enhanced convenience for service and repairs. For instance, if a customer is 20 to 25 miles away from a dealership and requires a quick oil change, we aim to provide a convenient solution for them. Additionally, we've integrated a finance company into our offerings. This relationship is beneficial as it strengthens our ties to our customers and aligns perfectly with our growth objectives at AutoNation USA. In essence, you highlighted in your question that a significant portion of our customers only engage with us once. This presents an opportunity for growth. Many of these customers likely have additional needs, either personally or within their households, involving family members or relatives. Our goal through expanding our product and service offerings is to enhance the duration of our customer relationships. We want to capture more of their transportation and mobility spending, whatever terminology you prefer, because of the quality, pricing, and transparency we provide at AutoNation. So, while it's a lengthy response to your inquiry, I hope this gives you a clearer picture.

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

Sorry, Jon, I didn't mean to interrupt you. What were you saying?

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

Yes. It’s important to understand that we are experiencing a gradual expansion of our business. This isn’t an immediate shift because the customers who have become inactive are still engaging in transactions with other providers, possibly even local family-owned stores instead of franchises. The fact is, they are still purchasing. Therefore, this won't change overnight with their return to us. You can expect to see a steady growth in this area of our business. Moreover, it's crucial to note that this process is not something new. If you observe the investments AutoNation has made previously, particularly in their aftersales business and technician development, this all contributes to creating stability, especially when new vehicle sales fluctuate and profit margins are influenced by external factors. This approach continues to build a profitable foundation that allows for strong cash flow, enabling further investments in these areas. Thus, this is not a fleeting or quick initiative; it’s a long-term aspect of our business, which I think is important to highlight.

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

Yes, John, we are monitoring the situation very closely, as many others are. I believe your assessment is likely accurate. Having experience on one side of the negotiating table, I think it's crucial to find a balance in interests. Whether this will result in a strike, a prolonged strike, or an agreement beforehand remains uncertain. However, I can share that our inventory growth is primarily in the domestic market, which provides me with some reassurance. We are equipped to manage with inventory levels significantly lower than our current ones, and it appears that our inventory will continue to increase as we approach the summer and before any plant shutdowns. It’s important to consider that our day supply is much lower in other divisions. Additionally, one positive aspect of our balanced business is our diverse sources. As I previously mentioned, I was satisfied with the efficiency of our stock count for used vehicles in the first quarter, but I believe we limited ourselves. We have dedicated considerable effort to rebuilding that, and you will notice a significant change in our used vehicle inventory from the end of Q1 to the end of Q2. This process isn't complete as I still think we can add more inventory, particularly with such a strong market. If there is a decline in new vehicle sales due to constrained inventory levels, we will be able to shift our focus back to used sales and the increase in aftersales we are experiencing. I expect it will be an intriguing summer.

Thank you very much guys. I appreciate it.

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

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

Daniel, first regarding affordability, we are observing a shift in the mix. The average price of used retail is declining due to this mix change. Wholesale prices, which peaked in March, have been trending down recently, showing a more typical depreciation pattern that is also reducing net prices on used vehicles. Our terms and periods remain solid; however, we are facing competition from lenders offering longer terms to keep monthly payments manageable. Ultimately, whether it's price, term, or accessories, the monthly payment available is relatively stable. We are continuously finding ways to maintain sales, and I believe that will persist. As for our margins, I still believe we have strong margins, and this hasn’t shifted our focus. That said, it’s essential that we balance our desired volume with a careful approach to maintaining used vehicle margins. I was pleased with the margins, as we managed to increase volume without significantly affecting them. We are currently experiencing a return to more traditional depreciation in the used market, so we need to remain flexible with our pricing. You can expect to see fluctuations in margins, but we aim for quality business while capturing our fair share. I don’t want to limit ourselves due to insufficient used vehicle inventory to meet demand. It’s all about balance, yet it doesn't signify a change in strategy.

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

No, I don't think that a number of things are happening on these. You talked about affordability on used vehicles, and the same impact applies to new vehicles. As availability increases, maintaining momentum in the new vehicle market is key. Net transaction prices are clearly decreasing, some of which was anticipated due to margin compression. However, I believe that our current margins are better than I expected at the start of the year, which leads me to think that while margin compression will continue, it won't reach the pre-pandemic levels this year. Additionally, the increase in incentives from OEMs and the shift towards leasing are focused on affordability and sustaining momentum in the new vehicle market. There are various tools available to maintain this progress going forward, driven not only by improved inventory supply but also by addressing some affordability challenges. Therefore, while we anticipate ongoing margin mitigation, it won't reach the pre-pandemic levels yet.

Operator: Our next question comes from Rajat Gupta from JPMorgan. Rajat, your line is now open. Please go ahead.

Great. Congrats Joe on the new role. I had a first question on parts and services. The growth there accelerated from 1Q to 2Q, both revenue and gross profit. Are there any specific areas you would attribute that to? Is it just a broader industry strength? Was there anything AutoNation specific, perhaps RepairSmith is beginning to contribute. If you could just get a little more granularity there would be helpful. And I have a follow-up.

Yes, it's Mike. There are really three factors at play. First, we need to examine the penetration of our franchise businesses within their designated areas. The branded vehicle market, which is our main target for franchise dealerships, presents significant opportunities similar to those seen in market share considerations. The team is primarily focused on assessing our service and parts market share and determining our goals for it. This relates to the second point: we have the capacity. We possess ample physical capacity because OEMs have historically oversized their dealerships, which means the necessary infrastructure is already in place. We are also actively working to enhance our human capacity to leverage improvements in penetration. The notable impact we are witnessing is tied to the increase in miles driven and longer vehicle ownership, leading to more service being performed per vehicle. These factors combined have driven our results. The influence of RepairSmith has yet to be realized as it requires time for integration into our operations. Nonetheless, our attention on these three areas is what's fueling our progress, and we hope to sustain this momentum for the foreseeable future.

Got it. Got it. That's helpful. Maybe a follow-up on AN Finance. The loss rate there it seemed like it improved quite a bit from 1Q to 2Q, just the total contribution from that, unless I'm missing anything else in the other line item there, but curious if you could clarify that. And then any color you could share on how delinquencies or charge-offs tracked sequentially in that portfolio? And any near-term trends have changed your view around the ramp-up of that business? And how do you view penetration there progressing through the course of the year?

I'm happy to discuss AN Finance. It is making progress. While we encountered some challenges, we are moving in a positive direction. We are intentionally increasing our presence within the AutoNation USA stores, and currently, 20% of loans from these stores are through AN Finance. This has enabled us to reduce costs and enhance credit quality. In an industry where delinquencies have been problematic, we have managed to address this through careful expense management and portfolio pruning. We are being very strategic in how we build our portfolio, which is increasingly focused on AN Finance. This aligns with our strategy to deepen customer penetration. You are correct that there has been sequential improvement in contributions each quarter, and I expect this trend to continue. However, as we’ve noted, this will happen at a measured pace in light of the current environment and our strategic goals. Is there anything else about AutoNation Finance I can clarify for you?

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

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

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

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

Yes, you mentioned you talked about operating cash flow being $240 million. I think from what I can tell, most of the inventory increase was on the used side and that's probably largely financed by non-trade floor plan, which is below the operating line. Are you including any of that increase in floor plan in your operating cash flow number of $240 million. No. You are correct, and you understand the nuances of the accounting related to trade and non-trade. When we mention the $230 million that includes used floor plan, that reflects the benefits from the increase in used floor plan. It's really about tracking both what appears in operations on the cash flow statement and what is effectively paid through the cash flow, which is related to financing activity. So you are correct.

Okay. So that and then you also had the seasonal $190 million in the care side?

Yes, the tax payments in the second quarter present an opportunity for us to contribute to the government. This quarter will always be when our substantial tax payments occur.

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

It's definitely normal course. And you can see that in the $236 million it does include the tax payments, right, that's buried in the operating cash flows. So I think pretty clearly, when you look at what's reported from cash from ops and you look at new and used floor plan, I think you'll pretty quickly get to the $236 million number.

Okay. And then just one last thing about the off lease. I believe we are at the end of a three-year period related to COVID, during which time very few vehicles have returned off lease. Did this contribute to the underperformance of retail on the used side compared to the overall market?

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

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

Just wanted to follow up on the commentary you mentioned. SG&A was impacted by investments in technology and new business initiatives. Any sizing of the impact? And is that sort of in the go-forward rate? Or is that more of a one-time cost?

Yes. As I mentioned, it involves people, technology, capabilities, and business. As we have indicated before, it accounts for about 100 to 200 basis points of gross, and this quarter, it was around 150 basis points in terms of growth. We track it this way and will continue to do so going forward.

Got it. All right. I appreciate it. Sorry I missed that. And then in the past, you've talked about AutoNation...

To be fair, I want to clarify that we expect our spending to continue. We are committed to investing in the business. I mentioned earlier that one aspect of SG&A that exceeded our expectations going forward was advertising, which was about 75 basis points higher than typical for us. This increase was related to some unique initiatives we undertook in the quarter, and I do not anticipate it remaining at that level in the future.

Got it. Okay. And then in the past, I think you put out by 2026 for AutoNation USA, 130 stores. I mean, I think you're at 60 now. I mean any color on how we should be thinking about it and when maybe the ramp will start to reaccelerate?

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

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

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

We do have a penetration that depends on the density we have with other businesses in the marketplace. If we have suitable franchise businesses, we can effectively maintain or hand off the service work. However, a significant percentage of customers have historically sought alternatives for their servicing and warranty needs. Moving forward, they will increasingly need to do so because they will have access to RepairSmith, and replacements will progressively become the service and parts division for AutoNation USA.

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

I can't speculate on their thoughts, but I tend to believe it’s a cautious approach to building. When I examine the mix of vehicles being produced and consider the turnover rate we’re still achieving, I feel reassured that this is the right direction. Currently, we only have 43 days of domestic inventory. I must admit, in my earlier experience, we operated at 130 days. So while we are discussing building, it’s important to remember that especially for domestic vehicles, high inventory levels and spot deliveries are what many customers expect and are accustomed to. We are indeed talking about increasing build, but right now we are only at 43 days.

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

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

That's a great question. I must say that the relationships built over the years at AutoNation are valuable assets. The team has done an excellent job, and sometimes you come across incredible opportunities, as we've seen in Miami. Ultimately, this is going to be great for the sport and the region. With our name prominently displayed, we expect significant benefits, and we're already noticing a positive change in our media engagement. It's important to distinguish between good luck and good strategy, and this truly falls into the category of good luck.

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

Trading values are currently declining, a trend that has been ongoing since February and March, and I expect this pattern to continue. At the same time, we are observing increases in incentive rates, which will lead to a reduction in new vehicle margins. This creates an offset impact. As I mentioned, there are three key factors that contribute to achieving a monthly payment that customers are seeking. When considering pre-pandemic levels, particularly in terms of new vehicle pricing and incentives, we are still far from where we were. There are several strategies that can be implemented. Therefore, while trading values will likely continue to decline normally, there are numerous tools, especially from the OEMs, that can be utilized to stimulate and sustain demand.

And just one more question about EON's significant discounting of the Model Y. Does that negatively impact any specific brand for you, whether on the premium side or in your crossover volume brands?

No. There’s no doubt that it has had a significant impact on the marketplace. One of the key points is that the situation is very fluid right now. You saw Ford's recent announcement, and there are other pricing adjustments occurring that may not receive as much attention. Currently, we are focused on determining the appropriate net price for vehicles in the market, considering the sales volumes the original equipment manufacturers (OEMs) aim for. As a result, we can expect ongoing adjustments, whether through noticeable changes to the manufacturer's suggested retail price or less visible changes through incentives. We are particularly cautious about the used market because any adjustments made to MSRP or incentives on the front end will immediately affect the back end. For instance, with our inventory, we are concentrating on the prices and term rates of electric vehicles since there is a market for them.

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

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