Penske Automotive Group Inc

NYSE:PAG

Earnings Call Transcript 2019-Q1

[Operator]

Good afternoon, ladies and gentlemen. Welcome to the Penske Automotive Group First Quarter 2019 Earnings Conference Call. Today's call is being recorded, and will be available for replay approximately one hour after completion through May 2, 2019 on the company's website under the Investors tab at www.penskeautomotive.com.

I will now introduce Anthony Pordon, the company's Executive Vice President of Investor Relations and Corporate Development. Please go ahead.

[Anthony Pordon]

Thank you, John. Good afternoon, everyone, and thanks for joining us today. A press release detailing Penske Automotive Group's first quarter 2019 financial results was issued this morning and is posted on our website, along with the presentation designed to assist you in understanding our performance and strategy. As always, I'm available by e-mail or phone for any follow-up questions you may have.

Joining me for today's call are Roger Penske, Chairman; J.D. Carlson, Chief Financial Officer; and Shelley Hulgrave, Corporate Controller. On this call, we will be discussing certain non-GAAP financial measures, such as adjusted income from continuing operations, earnings per share from continuing operations and earnings before interest, taxes, depreciation and amortization, or EBITDA. We have prominently presented comparable GAAP measures and have reconciled non-GAAP measures in this morning's press release and investor presentation, which is available on our website to the most directly comparable GAAP numbers.

Also, we may make forward-looking statements about our operations, earnings potential and outlook on the call today. Our actual results may vary because of risks and uncertainties outlined in today's press release, which may cause the actual results to differ materially from expectations. I direct you to our SEC filings, including our Form 10-K for additional discussion and factors that could cause results to differ materially.

I'll now turn the call over to Roger.

[Roger Penske, Chairman]

Thank you, Tony. Good afternoon, everyone, and thank you for joining us this afternoon. In the first quarter of 2019, PAG retailed more than 127,000 new and used automotive units, including a 1.3:1 used to new ratio. We generated a 7.7% increase in same store new and used retail commercial truck units, which drove a 12.4% increase in same store commercial truck dealership revenues.

We increased our dividend to shareholders to $0.38, representing the 31st consecutive quarter of dividend increases yielding 3.2%. During the quarter, we repurchased approximately 1,250,000 shares of our stock representing 1.5% of the outstanding shares. Income from continuing operations was $100.1 million or $1.19 per share.

During the three months, ended March 31, income from continuing operations and related earnings per share were negatively impacted by 7.6% after taxes, or $0.09 per share of net restructuring charges and product availability shortages related to Worldwide Light Vehicle Testing Protocol or WLTP.

These costs were partially offset by $2.4 million after taxes or $0.03 per share relative to a favorable litigation settlement at Penske Truck Leasing. Foreign exchange negatively impacted our earnings per share by $0.04. Our results continue to highlight the diversification strategy of our company into used vehicles, commercial truck, retail, distribution and our Penske Truck Leasing investment.

In Q1, we generated earnings before taxes of approximately $134 million, 63% through our retail automotive dealerships, 12% through our commercial truck dealerships, and 25% through our non-automotive investments such as Penske Truck Leasings, and our operations in Australia and New Zealand.

Turning to retail automotive. Same store retail units were down 3.8%. Same store new was down 8.5%, representing approximately 4950 units. New unit sales were impacted by product availability from change around certain models, WLTP, and continued pressure on oil diesel powered vehicles in the UK and Germany. U.S. were down 5.9%. Our volume foreign was down 800 units, Audi was 500, and Mini was down 300 units.

Internationally, we’re down 11.7%. We reduced our lower margin commercial business sales with the Audi brand in the UK affecting sales by over 1,000 units. BMW in Germany was down 800 units due to diesel, and Porsche from LTP was down 400 units internationally. Same store used was flat. U.S. down 3.3%, and international was up 2.9%.

Same store retail automotive revenue declined 4.5%. However, when excluding the impact of foreign exchange, the same store decline was 1.4%. New was down 6.9%. Used was up 3.4%. F&I up 2.8%, and service and parts up 5.6%. Same store service and parts revenue, excluding exchange, customer pay was up 3.8%, warranty was up 12.4%, and collision repair was up 1.4%.

To exclude foreign exchange on a same store gross profit per unit retail, new was up $149, used was down $163, and F&I was up $83. However, on a sequential basis new was up $218, used was up $25, and F&I was up $37. Same store service and parts gross margin increased 70 basis points to 59.2%.

Let me move onto our used vehicle supercenter business. We operate, as we know, 14 dealerships, five in the U.S. and nine in the UK, plus one reconditioning center in the UK These operations use a one-price-no-haggle approach. In the first quarter, we retailed 18,000 vehicles generated nearly $314 million in revenue, and a return on sales of approximately 2.7%.

The average transaction price was $14,567 and variable gross profit per unit was $1,990 for a gross margin of 13.7%. On a same store basis, used unit sales were down 3.4%. In the U.S. 70 units. In the UK 560. U.S. is down 2.2% and the UK was down 3.7%. In the U.S., sales were certainly impacted by weather winter cold capped in the East to snow emerged in two days in our Pennsylvania market affected sales.

While in the UK, unit sales were impacted by difficulties with sourcing due to a higher car auction prices during the quarter. Although unit sales were down in the first quarter, unit sales increased 21% from the fourth quarter of 2018. Excluding foreign exchange gross profit per unit was minus $267, while F&I increased $124 per unit. So overall, variable gross per unit, excluding foreign exchange was down $143.

The decline in gross profit per unit really relates to two items: weaker retail market prices in the UK when compared to last year; increases in wholesale used car auction prices in the U.S. and the UK. Traditionally we've sourced 35% of our cars in the UK and 80% in U.S. from auctions.

In the UK, we're making changes on how to source vehicles relying less on traditional auctions while focusing on the opportunity to source up to 15,000 vehicles annually from our Sytner UK franchise businesses.

In the U.S., we saw a big improvement in March and April is performing well. We also expect to grow the standalone used business organically as we remain on track to open four new sites in the second half of 2019.

Let me now turn to the retail commercial truck dealership business. The medium and heavy-duty Class 8 market continues to experience strong conditions. Class 8 retail sales on North America increased 17.4% to 76,922 units. The backlog, at the end of the first quarter, was 255,000 units.

In the first quarter, our Premier Truck Group increased same store commercial truck retail units by 7.7% and generated $332 million in revenue and had a return on sales of 4.7%.

Same store revenue increased 12.4% and service and parts gross margin increased 190 basis points, representing 66% of our total gross profit. And we covered 117% of our fixed cost in the quarter.

Turning to our ownership of Penske Truck Leasing, our 28.9% ownership provides PAG with equity earnings, quarterly cash distributions and tax benefit generally associated with accelerated depreciation. Good news, this quarter our fleet is now over 300,000 vehicles.

During the first quarter, total revenue was up 12% to $2.1 billion. Our full service leasing portfolio grew 7%. Contract maintenance was up 9%. Rental was up 16% and our logistics was up 28%. Accordingly we recognized $25.8 million of equity earnings.

Turning to our power systems, distribution business in Australia and New Zealand, we certainly had good news during the quarter. The Australian Commonwealth recently announced it had awarded contracts for the new Attack-class submarines.

The engines for these submarines will be provided through Penske power systems. The first test engines are expected to be delivered in 2021, although, first production engines are expected to be delivered in 2024.

While Penske power systems will generate revenue and profit through the sale of these engines, we also expect to see opportunities in parts and service which could last several decades.

Looking at our balance sheet, at the end of March, we had $43.5 million in cash. Our total inventory only increased $64 million to $4.1 billion. We have 210 vehicles representing $8.6 million on stop sale, 147 new and 63 used vehicles.

Our supply of new vehicles was 62 days at the end of March compared to 54 days at the same time last year. Our supply of used was 41 days at the end of March compared to 42 days at the same time last year.

Floor plan was $3.9 billion and non-vehicle debt was $2.2 billion of which 36% is at fixed rates. During the quarter we spent $86 million on dividends and share repurchases. We kept our non-vehicle debt flat at the end of last year.

Debt-to-total capitalization was 45.4% and our leverage ratio was 2.7 times consistent with December of 2018. At the end of March, we had $780 million in liquidity for acquisitions, dividend share repurchases and other corporate opportunities.

We have remaining share repurchase authorization from our Board of approximately $150 million at the end of March. Let's talk a little bit about digital initiatives. We continue to improve and enhance our digital capabilities. Across the enterprises, we have approximately 62,000 vehicles online and ready for purchase.

In the first quarter, 34% of our new and used unit sales in the U.S. were from digital sources. And we continue to reduce our reliance of third-party leads. The enhanced tools we introduced from our service department customers are performing well.

When compared to the first quarter of last year, online service appointment scheduling increased almost 30%. And online payments are up nearly 40%. Also, we're over halfway, the installation of a docuPAD concept in our U.S. finance and insurance offices.

DocuPAD is an interactive tool that allows us to engage customers digitally through a menu presentation and document processing. Customer and our employees are responding favorably to a transparent digital experience. We are now seeing also improved efficiency in our F&I offices.

For the next few months, our U.S. used supercenters will launch a new digital experience allowing customers to select a vehicle for purchase, appraise rates, obtain financing and securely upload lender requirements, electronically sign documents, and schedule express pickup or home delivery.

Also later this year, our U.K. franchise dealerships are expected to launch a digital dealership platform for used vehicles that will provide 100% of online functionality. In closing, I'm pleased of the performance of our business in the first quarter.

We saw an improvement in market conditions in March and we expect that strength to continue through the traditional selling season. We also believe product availability challenge we have experienced since last September related to WLTP in Western Europe will certainly be hopefully behind us.

We're excited about the expansion of our used car supercenter business and the new digital initiatives. And our commercial truck business remains very strong. As such, we remain confident and optimistic about the future of our business.

Thanks for joining us on the call today and your continued confidence in PAG. At this time we'll turn it over to the operator.

[Operator]

Thank you. [Operator Instructions] Your first question comes from the line of John Murphy with Bank of America Merrill Lynch. Please go ahead.

[John Murphy, Bank of America Merrill Lynch]

Good afternoon, Roger and Tony. How are you?

[Roger Penske, Chairman]

Hi John.

[Anthony Pordon]

Hey! John.

[John Murphy, Bank of America Merrill Lynch]

Just a first question around WLTP, it sounds like there's a little bit of a rebound occurring. I'm just curious if you could talk about that maybe more generally. And if you can without getting into too much detail, and getting in trouble, maybe talk by brand and sort of what kind of recovery you're seeing maybe by brand if you can, but at least, generally give us an idea of what kind of snap back you're starting to see there or if you are?

[Roger Penske, Chairman]

Great John, let me, first position. We got to go back to September 1st, when WLTP was enforced in the European markets for all the OEMs. To date 22% of our revenue comes from the Volkswagen Group. And that's Lamborghini, that's Bentley, that's Audi, that's Porsche, Volkswagen et cetera.

So because of the emission, cheating scandal obviously the Volkswagen Group has been under probably supreme scrutiny from the standpoint of their particular cars. So we've seen an impact across all of those brands really starting early -- late in the third quarter and also certainly in the fourth quarter which is carried on to Q1.

And just to give you one highlight and I'll take this brand, because it's probably the biggest impact. In our portfolio, we have 19 Porsche dealerships throughout the portfolio.

During Q1, we sold 350 units. And when you look at the business overall and when you look at U.K. specifically the 350 units were sold in the U.K. And the Q2 forecast is 680 units for Q2, Q3 and Q4 which will give us a good smoothing.

And when you think about the margin around those businesses, I'm not counting everything there's probably $5 million to $6 million that we didn't get. And compounding rate which I think is very important there's probably a 0.7:1 used-to-new ratio. So we didn't get trades that also typically are quite beneficial to us from a margin perspective.

So, this particular issue certainly will give us the ability once we get this back again and get these vehicles. It will smooth this out. So I see that kind of going forward basis as positive. Certainly, we've seen Bentley -- we haven't seen the new Bentley here yet. We're selling them now in the U.K.

So, overall I think that Volkswagen is moving through the issue. We've had some issues with BMW and Mercedes-Benz, but they seem to have handled the issue a little bit better. So, I think that gives you the highlights and really the significant impact.

And I think the example, I used at Porsche would really give everyone an idea of how it hurt us in the quarter.

[John Murphy, Bank of America Merrill Lynch]

And just to -- so you'll be introducing -- 680 is the forecast for Porsche in the second quarter versus 350 for you in the first quarter. Is that almost doubling? Is that correct? I just want to make sure I heard that right.

[Roger Penske, Chairman]

Yeah. In the U.K. or in the international market, the international market this will go from 350 to 680 correct almost double.

[John Murphy, Bank of America Merrill Lynch]

Got you, just a second question on the superstores and used in general, you mentioned shifting sort of the channels of acquisition. I'm just curious how you think you're going to go about doing that to get maybe more or better priced inventory.

And then also as we think about the superstores, as there is some tightness in the market is there the potential to maybe go to slightly older vehicles that are still high quality? You've kind of opened up the market maybe a little bit for the superstores. I'm just trying to understand, what potentially they are might be there as well?

[Roger Penske, Chairman]

Well, let me say this that, obviously everyone is awake now. There's a real opportunity to sell used cars, whether at superstores, whether it's individual dealer groups or individual dealers. So, you're going to see some I think some upward pressure, on certainly at the sale when you're trying to buy these vehicles.

And if you look at us, from the standpoint of the U.S. about 80% of the vehicles that we use through CarSense would come from auction. It's only about 35% in the U.K. When you look at our selling price John, across the whole network it's about $14,000.

Its GBP 11,000 cars in the U.K and that's one of the things that through their algorithms that they use, their technology to the look at the right car, at the right place, at the right price, they were underwhelmed from the standpoint of being able to have cars in that group line during the first quarter. So they actually didn't buy the cars that they could.

Now they were down 550 units' year-over-year. And ironically, in the U.S. we were down about 70. So what we're doing just to mitigate some of that obviously we're focusing on buying cars on the curb. You've heard that I think from everyone. Certainly, CarMax has done a really good job of that in the past. I think we're all going to accelerate that because those cars seem to bring a little more margin.

But probably the most dramatic thing that we'll do in the U.K. is we have what we call SEA. That's the Sytner Electronic Auction. This is an auction that we've put together at Sytner which has been quite effective for us. In fact, we sold 25,000 vehicles through that. These are wholesale vehicles that went through that last year.

What we've done, we've taken those vehicles that would typically go on SEA and we've moved 6,700 of those over to CarShop in 2018. We expect that to go anywhere from 10,000 to 15,000 in 2019. So that's going to be a source of fishing pond really for CarShop and CarSense as we think will be beneficial. Because number one, we're not going to wholesale those on our auction and maybe make ₤200. We'll be able to move those directly over to CarShop and they can take those vehicles and we'll end up probably with an all-in profit of about $2,000.

And to me what that does, it gives us that advantage of being able to have those cars, the visibility of those cars even before they're traded, because this is -- there'll be an open line to CarShop to see those. So we get visibility. We get cars, the right cars coming through to Sytner that don't go to Sytner auctions. So we see that.

And then what we're going to continue to do is try to mind more of the closed auctions where we have the ability to enter those and be able to buy directly through the OEM closed auctions, if possible.

[John Murphy, Bank of America Merrill Lynch]

Got it. And then just lastly, given where rates are and your access to capital in the credit markets, just curious, I mean, as you look at sort of the M&A environment and sort of the adjacent market on the used car superstores, I mean is there an opportunity to maybe get a little bit more aggressive with leverage or capital and go out and really kind of accelerate growth?

Because I mean, you've done some great work in adjacencies. I'm just wondering if there might be greater opportunities particularly given the cost of capital is low and potentially going even lower.

[Roger Penske, Chairman]

Well, I think we've got to be prudent in our use of capital. And we've talked about it before. Obviously, we've got certain requirements from the OEMs from a CI perspective. We're pushing back on a lot of that today that we don't think functionally makes any difference to the customer.

We have our dividends and we have our share buybacks. Then obviously the balance would be for acquisition. And I think that we have a bond that's coming up next year. It's about $300 million. And what we would like to do is have the cash available unless we make some big acquisition that we could pay that off.

Now the market's pretty good. Yesterday, we had a bond offering at PTL $500 million that we upsized to $700 million because there was $2 billion of interest and that was at 3.5%. Now, they're -- they have an investment grade rating. We're just slightly below that. But there's no question that the market is highly available to us, both in PTL and PAG. And I think the acquisition aspect if you look at Q4, we sold two Lexus stores in Edison and Bridgewater, New Jersey and bought the two Lexus stores in Austin. So that was a major acquisition.

I think also as we look through the portfolio over the next three to six months, we're going to look very deep into these to see are these really viable for us over the long term? And then we can look at other acquisitions. And I would say opportunistically certainly on the retail side. And right now we seek a lot of activity on the truck side -- on the retail truck side which we would expect to look at that as we go forward in the short term.

So, somewhat of a wait and see for opportunistic. On the other hand let's get our cash in a position that we can reduce our debt. And when you look at our overall debt it was flat, if you don't count our floor plan. And really when you look at floor plan, we're really in good shape. If you just take the 3% increase and probably MSRP actually our debt was down if we didn't have that 3%.

So, again, I think the -- we're in really, really good shape from a capital standpoint. And acquisition-wise, we're looking at it and we've got people coming to us. I would say we're getting more calls today for people wanting to maybe get out of their retail business because maybe they think it's peak because the SAAR has been roughly 17 million with a 16.8 million. And then they did -- it has given us is probably the number. But overall that's our position.

[John Murphy, Bank of America Merrill Lynch]

Great. Thank you very much.

[Operator]

Our next question is from Rick Nelson with Stephens. Please go ahead.

[Rick Nelson, Stephens]

Thanks. Good afternoon, Roger, Tony.

[Roger Penske, Chairman]

Hi, Rick.

[Anthony Pordon]

Hi, Rick.

[Rick Nelson, Stephens]

So, PAG has posted some big service and parts growth up 5.6% in local currency. What do you see as the drivers? We're hearing that from others as well. Is it more traffic? Is it more dollar per repair order? Or what -- is it something structural that's occurring, that's boosting that segment?

[Roger Penske, Chairman]

Well, as you mentioned we're up 5.6%. If you exclude foreign exchange, the U.S. was up 3.5% and international was up 9.7%. And I think I've said it to a lot of people. I don't think -- we've got to be careful taking a lot of credit of this increase because remember over the last three to four years and we're looking at zero to five years as the sweet spot for us. There has been so much technology that's gone into these vehicles. Software availability to outside sources is almost minimal. So the customers are really being driven back into the shop for its service and in its maintenance items that you would have normally. So that's a positive.

On top of that we're using our technology. Everyone is not just PAG. We're using our technology now to fish into that pond where we have sold, but not serviced. And I think that we've had a much, much bigger focus on that from the standpoint of our ability to bring more service in. Beyond that, we're doing more reconditioning -- internal reconditioning, Rick, where instead of having used cars going out we're doing vents, we're doing windshields, we're doing the things that we hadn't done in the past. We're doing it internally. So that's driving our internal business. And there's no question that with the use of our technology from a service rider perspective that we're getting more dollars per RO.

We've reduced our discounts on the drive lane. In fact, I think if you look at Q1, we've probably increased our effective labor rate $3 per RO which obviously would increase overall parts and service growth. So now these are things that are taking place. It's really a function. It's amazing also that we never -- we haven't -- we didn't not ever think about it, but we're now focusing more and more on having salespeople on the service drive. And I would say in many stores it could be 10 to 15 to 20 units that we sell actually on the service drive to customers who are coming in with their vehicles.

So I think all of those levers are what we're doing today and I think it gives us a tremendous opportunity. But the parts and service business will continue. We talked about EV penetration and all these things. The internal combustion engine vehicles, remember we have 280 million vehicles in the marketplace. And if we sold all the premium luxury vehicles over the next five or seven years that's -- say it's 18 million vehicles we'll still have 260 million of ICE. So we need service departments.

And one other point. We have really worked hard on acquisition of mechanics. And I think our people have done a very good job on the initiatives. So our requirements are down from what they are. We've changed shift requirements four days 4/10s. We've got night shifts where we're doing our PDI so opening up more base for service. And I think we're just not the only ones doing it. And I think we're just much better at what we're doing as we go forward into 2019.

[Rick Nelson, Stephens]

So do you think that mid single digit same-store growth is that a sustainable type of number?

[Roger Penske, Chairman]

Well, I certainly would have a single digit goal certainly within PAG. One other thing that we've done that's really helped us. When you see the increase in service and parts in the 9.7% in internationally. In the U.K they have a program called Mission 100. And Mission 100 is where we want every store to cover 100% of their fixed cost through parts and service.

So, there has been a lot of things going there. And we saw probably I think in the U.K almost a ₤10 million increase in our parts and service growth during -- on the Mainland business during the first quarter.

[Rick Nelson, Stephens]

Thanks for that. So commercial trucks parts and service has been a big driver there. If we do see a downturn in Class eight truck sales like many are calling next year, do you think that impacts parts and service in that business?

[Roger Penske, Chairman]

Well, I would think if we don't sell more new trucks, we're going to get more trucks in for service because they'll have run miles. And I think that's going to be -- probably it will help us maintain or even grow that. I think we saw that sometimes when new is down used goes up. So that to me that business continues to grow a little bit like on the new car side because the complexity of those trucks and the ability to have service centers that take them. We see this across all of our Premier Truck locations that -- when it got up to 117%. And I think even in the fourth quarter there were some stores that covered 100 -- all 100% of their costs.

So I think that's one of the key benefits. We don't have the CapEx requirement in these businesses so we're not building these large showrooms. On the other hand, what we're doing now is getting more efficient with dynos and things for quick service that we can do for the truck or even when we bring a truck in now we don't take it out. We fix it as we're in the diagnostic lane. So these are things that we're doing which again will help us penetrate that more. And again the same effective labor rate hour I think is key. When you look at our business today, 26% of our revenue in Premier Truck is parts and service and 66% of our growth -- all 60% of our total gross profit comes from parts and service and body shops. So I think that's really the foundation of that business.

[Rick Nelson, Stephens]

Great. Thanks for all the color and good luck

[Roger Penske, Chairman]

Yeah, no problem. Thanks, Rick.

[Operator]

Next we go to Derek Glynn with Consumer Edge Research. Please go ahead.

[Roger Penske, Chairman]

Hey, Derek

[Derek Glynn, Consumer Edge Research]

Hi. Good afternoon. Thanks for taking my questions. Apologies if I missed this, but I believe last quarter you discussed in addition to WLTP there's new emission tests expected to hit later this year in Europe related to the Real Driving Emissions. Could you just provide updated thoughts on how you think OEMs are positioned to handle that? Do you think there'll be less of an impact relative to WLTP?

[A –Roger Penske]

Well, I sure hope there'll be less of an impact. Look they've had plenty of time to understand what they've provided the government and the dyno test procedures they've done over the last let's say, six months or seven months. And our expectation is that they'll be ahead of that. I don't have a particular number that I can give you. But based on my conversations -- with the OEMs, they think that they're in a much better position on the RDE versus the -- dyno test that they've had to do for the government expectations on rules that we've talked about before. We'll continue to work with the OEMs. And we could -- Tony or I can give you an update on that if we have anything that's more positive.

[Derek Glynn, Consumer Edge Research]

Okay. Great. That's helpful. And just secondly, relating to capital allocation specifically around your real estate strategy. Has there been any change in philosophy around owning versus leasing real estate? This seems to differ widely across public dealers. I'm just wondering if you've seen anything in terms of cap rates or anything else that will cause you to pivot one way or the other this year or in the coming years? Thanks.

[A –Roger Penske]

Well, you know, as we grew our business quite honestly, we were very, very active in the sale-leaseback area. In fact, I've got some sale-leasebacks at 10% and 11% that I wish I could get out of. I can't. We're going to have to take them through the end. And with the capital that we have and the ability for us now to get mortgage financing from the OEMs and other sources, we've really pivoted certainly to real estate ownership. In fact we bought probably $4 million or $5 million of land on expectations during the first quarter. Today we own about 15% of all of our real estate -- on a worldwide basis. And that increased over the last, let's say, I can say two quarters, but at least over, let's say, the last two quarters probably by 5%. So definitely we're pivoting that way. Now when we get to 50% the problem actually is no. But when we look today a 10-year mortgage rates with the sources we have yes we're looking anywhere from 4% to 5% depending on the property and the size.

[Derek Glynn, Consumer Edge Research]

Great. Thank you. That’s very helpful. Thanks guys.

[A –Roger Penske]

Thank you.

[Operator]

Next we go to Armintas Sinkevicius with Morgan Stanley. Please go ahead.

[Armintas Sinkevicius, Morgan Stanley]

Great. Thank you taking the question. I just wanted to get more color on the truck business. You know, the ACT estimates have -- is going from 320,000 units sold in 2019 to 260,000 units sold in 2020. You mentioned the backlog but how do we square the estimates there with your outlook on the commercial truck business?

[A –Roger Penske]

Well, I think, we -- someone asked that question earlier with the potential downturn ACT talking about next year. I think that we'll wait and see. We were not able to – we are not, remember our markets today we're headquartered in Dallas, Dallas-Fort Worth. We're out in the Permian Basin where we've got Amarillo, Midland, Odessa. We're up in Oklahoma. We have the whole market in Toronto which is a booming market. We also are over in Tennessee and in Georgia. So we think where our markets are we're going to continue because they're growth markets when you look at what's going on with basic investment. So I think based on our business and we're getting better at running the business based on -- we haven't been in this business that long. So to me, I think that more units in operation that will -- have been put in over the last two or three years, we'll continue to grow more service and parts business. Remember that business has a margin of probably somewhere between 50% and 60% when you meld it together versus the 5% or 6% or 7% on new vehicles. So looking at -- Tony just mentioned to me that looking at that margin it's probably between when you take parts and service together it's probably about 30% to 40%.

[Armintas Sinkevicius, Morgan Stanley]

Got it. Okay. That’s helpful. I appreciate that.

[A –Roger Penske]

Thanks.

[Operator]

Next we go to Stephanie Benjamin with SunTrust. Please go ahead.

[Roger Penske, Chairman]

Hi, Steph.

[Stephanie Benjamin, SunTrust]

Hi. Thank you. I just wondered if you could touch on a little bit more on the strengths of the Penske Truck Leasing business, you know, what you're generally obviously strong growth across each of the segments. What's really what's going on behind the scenes to cause some of the strong contractual lease growth? I think rental is pretty apparent. So just any more color there would be appreciated. Thanks.

[Roger Penske, Chairman]

Well point number one we crossed over 300,000 vehicles, which I think I mentioned earlier. And PTL was up 12% to $2.1 billion. Full-service lease was up 7%. Contract maintenance is up 9%. And then we had commercial and consumer up 16% and logistics. Now I think that what we've done from a business perspective, we have a very good management team.

We've got probably over 900 locations that we can take a truck in and do work on it. And with truck prices increasing complexity and also increasing within the units, the ability for some of the smaller fleets just haven't been able to keep up plus being able to train and keep their technicians because there's a huge access for those people to come out and work in maybe some of the other dealership environments which might be better. So we see that continuing to grow from the standpoint of out of ownership.

We're not in a competitive situation with rider or these other people. They've got plenty of customers. What we're trying to do is conquest people who are in ownership and we have the ability today that we can take these vehicles that they have. We could take over their shops. They might be captives in some cases. And that seems to be the route that we're following. We did make one acquisition in the quarter last year in 2018. It was Epes. It was a small regional carrier in -- down in Greensboro. It had some good logistics business, but also gave us some support in our mainland carrier side. And that give -- that will give us an opportunity to go forward.

Also we have a very sophisticated SOS service center in Redding and we have the ability to connect with our trucks on a technical basis. We have cloud computing with all of our trucks downloading -- a good portion of the trucks on the road can download at night. We're looking at predictive maintenance. So from a cost perspective, we have the ability to offer these conquest customers a number of opportunities. The ability and logistics through GPS and other technology we have being able to track loads and being able to tell the customer at the moment where is their truck.

And to me we give them complete access through dashboards on a weekly and monthly basis that they can see what is the operating metrics of their trucks their drivers fuel economy, speeds. And if there's an accident, obviously, we have the ability to handle that. On top of that our rental business is basically, 50% of that business comes from our contract customers. And when you look at our customer base even if the new truck business goes away we have customers with 3 to 5 year contracts that have economic escalators. So we have a very, very solid base with 75% under contract and 25% which would be in the rental side and half of that going with our customers. So our utilization in rental over the last six months is at almost 85%. So I think we've got a great management team. I think we've got a very strong balance sheet. I think I mentioned earlier, we did a bond offering yesterday. We went out for $500 million. We had $2 billion of interest and we took down $700 million of five term -- a five year term and 3.5% rate. So that's going to be a driver for us. And with the kind of investment we have there and the ability to compete in these markets and the cash flow that comes out of there it's a benefit to PAG. We also get the tax benefits for the accelerated depreciation. So I think, it's a great asset that we have here at PAG.

[Stephanie Benjamin, SunTrust]

Thank you so much for the color.

[Roger Penske, Chairman]

Thank you.

[Operator]

Next we go to John Healy with Northcoast Research. Please go ahead.

[John Healy, Northcoast Research]

Thank you. Roger, I wanted to ask a little bit about the e-commerce strategy. I thought the commentary you provided and the slide you had in the deck was incrementally more than we've heard from you guys on that topic. And I was curious to just get your big picture view of where you expect the company to go over the next year to e-commerce. Is it more about conducting the transaction online or parts of the transaction online? Or do you see yourself potentially looking at partnerships with some of the asset-light or asset-less-light businesses that have been established? Or do you even see yourself getting bigger into this business with potentially another brand? And just kind of what your big picture view of how this market evolves for Penske?

[Roger Penske, Chairman]

You did say a little bit about like the logistics business. We're in the logistics business basically with hard assets. And then we've taken on good software and built a lot of it ourselves, so we can provide a lot of the information to our customers. So what we're trying to do here at PAG is look at the businesses we have. And we can see the complexity today because of state and government regulations on new cars and the complexity with the different incentives, different maybe in New York than they are in Cleveland as they are on the West Coast.

So we started to focus primarily on the used car side where we want to have a complete digital experience where we can complete the transaction online. And maybe people are saying they're doing that but our approach is as we go forward as I talked earlier, we're going to have a complete opportunity to do that first with our CarSense operation here in the U.S. and we think we can do at 100%. We can deliver the car or the customer can come in.

And then adding docuPAD which we've talked about earlier and this is a multi-million dollar investment for us. We want the customer to be able to sit down at their desk -- it's highly technical and he can look at the transaction. We complete the transaction through all the steps. We give him a thumb drive. He goes home and that information then goes into our accounting systems and there's no paper. So that's good for us from the standpoint of reducing manpower at the admin level. We can reduce manpower from an SG&A perspective.

And I think the customers are more engaged when they're doing this. So I think that's a big focus to get that benefit across our business. Because what that's going to do, we've already seen it will drive our F&I per unit up. So you'll see used car come in from the standpoint of fully digital and also online to get to the final end of buying the car.

I think it'll take sometime with the states and everything else from the standpoint on a new car perspective. And many of the OEMs still want to have signed copies from the customers. And you can go to each one of them it's a little bit different. We're trying to get them to be able to go online where they'll fund us. In some cases already we can actually get the money for the car we sold before the customer leaves the lot. So there's a lot being done there in partnership with the OEMs.

But I think the ability for us is just to upgrade our websites. And I think that our Preferred Purchase which we've been doing now for probably two years has been consistently beneficial probably 22% closing ratio with that. So I think that the -- certainly the new opportunities from the websites will be able to -- we'll do that as we enhance them on Preferred Purchase also. So that will bring payment calculations taxes and fees to the penny obviously. Full F&I integration and the real-time communication with the customer I think digitally will be good. So we're not forgetting this.

And then of course the same thing is taking place over in the U.K. It's interesting to think about that we've had for almost two years now SEA, Sytner Electronic Auction. We're auctioning over 30000 vehicles on an annual basis. And that's pretty -- we really haven't talked too much about that. So we have a tremendous both in the U.S. and in the U.K. our own internal capability to write this off or be able to take pieces that we can get from certain vendors.

But I don't see us at the moment aligning ourselves with an outside source unless they can bring vehicles to us that we can retail at a profit. But we'll look at that if that's required. But also from an e-commerce perspective, we're looking like everyone else is at Carvana and some of the people that have -- at least are effectively selling units online. Is that something that we can do? We have the ability to do a test market in the U.S. or the U.K. And that's something that we might look at maybe here in the future the short-term future.

[John Healy, Northcoast Research]

Great. Thank you, guys.

[Roger Penske, Chairman]

Okay.

[Operator]

Our next question is from Michael Ward with Seaport Global Securities. Please go ahead.

[Roger Penske, Chairman]

Hey Mike.

[Michael Ward, Seaport Global Securities]

Two things. On the stand-alone used car business in the USA and the U.K. it sounds like there was more of a supply issue. Is that correct?

[Roger Penske, Chairman]

No question. I mean we just did not get the vehicles. Remember, I talked about that price range over £11000. We just -- we didn't have the access to those vehicles so -- because there is competition at that level. And I think -- and I didn't want to bring this up, but maybe I will. Brexit might have had a little bit of impact on that customer in the U.K. in the £11000 area. Maybe he's not sure what's going to happen to him personally if Brexit goes in or if Brexit goes out.

So to me, we might have some impact there because -- but we're only down with 500 units when you think about it. But obviously sourcing is a focus both in the U.S. and the U.K. especially when we're coming out of these auctions. And cars cost us more when we buy at auctions because there's more people bidding on that vehicle rather than buying one over the curb. So I think you'll see all of us not just PAG, but I think all of our peers are focusing on that now whether it’d be internationally or domestically.

[Michael Ward, Seaport Global Securities]

And in the U.S, I'm not -- there's never really good data on actual used vehicle sales. But the NADA data seems to be the best data. And that showed a big drop in February, down 12.5% which is highly unusual to used vehicle data. Did you see any seasonality in your months in the U.S. business on the used vehicle on the stand-alone side?

[Roger Penske, Chairman]

Well yes. When I would look at the supercenters, I think we really had weather didn't we? Remember we had weather across the country which had -- it certainly had an impact. When you have the frigid weather we had on the East Coast and snow in Atlanta places like that people are not going to come out and buy a used car. But I think if you look sequentially, there's no question that our used business climbed when you look to January, February and March. And probably it was up say 20% over January if you just looked at units only in the U.S. I don't really have the -- I don't have the U.K. data with me but I'm assuming...

[Michael Ward, Seaport Global Securities]

No that's all right. So what you saw -- so that data that we saw from NADA where you have a soft January, really soft February, improvement in March and who knows April, but I'm assuming April maybe you get back on track a little bit. Is that fair to say the way the U.S. business is going on a stand-alone?

[Roger Penske, Chairman]

Yes. And the other thing that we've got to think about and this has really caught us at CarSense, we typically run our inventory down let's say late October and November as we run the inventory down in 2018. So we can look at this lowest point which is typically when all the wholesalers -- everybody wants to get rid of their cars to show their balance sheet in good shape at the end of the quarter, the fourth quarter. And typically, we get to the bottom of the market value of vehicles sometime at the end of -- sometime in December. We thought we were at the bottom. We probably bought 1000 vehicles at CarSense. Obviously that didn't happen. We went over the year into January. And probably in the first couple of weeks of January those markets even went lower. So we had some cars that were overpriced, so we had to work those through the system. So there was some time there where we couldn't get the cars that we wanted. And maybe that had some impact also for some other people I don't know.

[Michael Ward, Seaport Global Securities]

Okay. And then your store count on the stand-alone is it still five U.S., nine U.K?

[Roger Penske, Chairman]

That's correct.

[Michael Ward, Seaport Global Securities]

And you're adding four on the second half? Where are those going to be added?

[Roger Penske, Chairman]

Well so let me give you right now. We're under construction outside of Wilmington or south of Philadelphia with one store. We're under contract in a shopping center which is in New Jersey that would -- it will be probably take four to five months to refurb that. And then in the U.K., we have Homebase which is probably like a Target store that we bought. And that business will be refurbed and we'd be in business sometime later in the second quarter. Then we have a brand-new startup in Bristol which will be opened at the end. So I'm looking at late third quarter early fourth quarter where you'll see these.

[Michael Ward, Seaport Global Securities]

Okay, so both -- two in the U.K two in the U.S.?

[Roger Penske, Chairman]

Correct, yes.

[Michael Ward, Seaport Global Securities]

Awesome. Thank you very much.

[Roger Penske, Chairman]

Good. Thanks.

[Operator]

Next we'll go to Rajat Gupta with JPMorgan. Please go ahead.

[Rajat Gupta, JPMorgan]

Thanks for taking my question. Hey, thanks. Good afternoon. I just had a question on the SG&A to gross profit profile for the rest of the year. 1Q looked a little bit elevated but perhaps the U.K. and the timing of some initiatives. But how should we think -- see that progressing through the remainder of the year? And I have a follow-up.

[Roger Penske, Chairman]

Well, I think that – I think we have to position SG&A as kind of like a spring, isn't it? When we had the write-offs the restructuring they go against SG&A and then with a compression on our gross that we took WLTP it certainly had an impact on SG&A. But we expect SG&A to come down from where it is at this level in the next quarter. I'd like to see this thing level out, before I give you some answer of a projection. But it's a big focus for us. But I don't think we had the ability – leverage we had in our hands to do anything other than the way it came out. Obviously, it needs to come down. But if you take those impacts out and add back, I really haven't done the math on it. Maybe, Tony can do that and let you know, but it certainly would have been better.

[Rajat Gupta, JPMorgan]

Got it. That makes sense. And then on the F&I GPU, it looks like you're seeing sustained strength there. How should we think about that also for the rest of the year particularly with the mix changes you're seeing on used versus new? And what you're seeing with the rates environment out there? I mean, could we see this type of growth continuing? Or is there more of a flattening out expected here? Thanks.

[Roger Penske, Chairman]

Well, on our F&I 60% is product. 40% is certainly F&I products. And remember, because of our premium/luxury in the U.S. 55% of our business is leased. So we get flats on those particularly and those are typically a three-year contract. And the ability to sell, a lot of extra product on a three-year lease probably isn't as great as if you were selling a 60-month or 72-month contract from a finance perspective. And I think that, when we look at our total variable gross ex-foreign exchange, we were up $18.

And I think the F&I will continue to be increased, because of the docuPAD that we are adding across a given functionality to our salespeople and business managers, which will make certainly a big difference. So we'll continue to grow that. We have always trailed our peers I think because 66% of our business overall is premium/luxury. And I think that there's less opportunity with the premium/luxury, because of our lease penetration to drive a higher F&I margin.

[Rajat Gupta, JPMorgan]

That makes sense. Thank you.

[Roger Penske, Chairman]

Okay. Very much thanks.

[Operator]

And we'll go to David Whiston with Morningstar. Please go ahead.

[David Whiston, Morningstar]

Thanks, guys.

[Roger Penske, Chairman]

Hey, David.

[David Whiston, Morningstar]

Going back to the stand-alone used vehicle stores and the fall on profitability you said you couldn't get the vehicle. Is that more you just couldn't find them or you just didn't want to pay a higher price for them?

[Roger Penske, Chairman]

Well, using the algorithms that we used to look at vehicles, color type, price location in the U.K. we have a certain band we want to buy in. And we've been in that band for the last – before we bought CarShop. And in the first quarter, they didn't have the opportunity or maybe to offer through the auctions or have vehicles at the price range where they felt they can make a front-end margin. Now obviously, our front-end margin went down because we reached for some of those. But on the other hand, we want to augment that with the Sytner used cars which we'll get at better pricing. So, I think that was a big impact. And there's more action in the market. Obviously, with us taking over CarSense and our CarShop and consolidating Car People, people are waking up on the used car side. So, there's more people at the auctions to buy these vehicles. And I think that when you look at the U.K., 35% of the vehicles come typically from just the Manheim- Adesa-type auctions. And then they have the other sources to off-lease vehicles from finance companies and leasing companies. And then of course now we've got the Sytner access so along with buying at the curb from the customer.

So, I think there's going to be a reengineering across everybody's platform what's the best way and we'll all be competing. We're going to have to find from an economic perspective and also the standpoint of technology how to reach out to those customers that want to sell their vehicles and make it an easy trip from the standpoint of sale and being able to get capital for that even if we don't do a new or used car transaction with them.

[David Whiston, Morningstar]

Okay. And just in -- within your U.S. customer base on the franchise source side, are you seeing any big difference in demand or customer sentiment with consumers coming in shopping for a premium/luxury brand versus a volume brand? Is one group more confident than the other for example?

[Roger Penske, Chairman]

Well, I think the credit availability is there. The unemployment is in great shape. All the manufacturers want to sell vehicles. So, even though incentives were about 9% of the MSRP in the quarter down a little bit from Q4, I don't -- we don't see anything that's making a difference. I think there's -- one thing a dynamic which I guess I might say upfront here.

Remember the last -- over the last 12 to 18 months, there has been a disparity between what OEMs have SUV and trucks versus ones that have more sedans. I think that field has leveled now. So, everybody has this prized product which is an SUV-type truck. And those things obviously now are what people want.

So, there is more competition there and I think in there obviously the OEMs make more money on those vehicles. And when you think about a Ford truck at $120,000 or something a Special Texas version, these things become very profitable for both the dealer and the OEM.

So, I see pretty much the mix changing as it has. Incentives are up. So, there's no question if you're selling cars, incentives will be up from the OEMs. But at the moment, I don't see anyone coming in and not wanting to buy a premium car. And that's where our -- as you know that's where our mix is and that's where our mission is.

[David Whiston, Morningstar]

Okay. Thanks.

[Operator]

And Mr. Penske we have no further questions in queue.

[Roger Penske, Chairman]

All right. Thank you David. We'll see you next quarter. Thank you.

[Operator]

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.