AutoCanada Inc
TSX:ACQ
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AutoCanada Inc
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Good morning. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the AutoCanada Second Quarter 2020 Earnings Call. [Operator Instructions] I would like to remind everyone that certain statements in this presentation and on our call are forward-looking in nature, including, among other things, future performance and the implementation of the go-forward plan. These include statements involving known and unknown risks, uncertainties and other factors outside of management's control that could cause actual results to differ materially from those expressed in the forward-looking statements. AutoCanada does not assume any responsibility for the accuracy and completeness of the forward-looking statements and does not undertake any obligation to publicly revise these forward-looking statements to reflect subsequent events or circumstances. For additional information about possible risks, please refer to our AIF, which is available on SEDAR and our website within the Investor Documentation and filings section. I would now like to turn the call over to Kevin McPherson, Director of Finance. Please go ahead.
Thank you. Good morning, everyone, and thank you for joining us on today's second quarter results conference call. For today's call, I'm joined by Paul Antony, our Executive Chair; Mike Borys, Chief Financial Officer; Michael Rawluk, President of our Canadian Operations; Tamara Darvish, President of our U.S. Operations; and Peter Hong, our Chief Strategy Officer. We released our Q2 results after the market closed. A copy of our results is available for download on our website. For today's call, we'll be discussing the current state of the business, the financial results, providing an update on both our Canadian and U.S. segments. With that, I'd like to turn it over to Paul.
Thanks, Kevin, and good morning, everyone. Thanks for joining us on today's conference call. Before we get started, I'll provide an update on our progress on recent initiatives. I'll start out by saying I'm very pleased with the performance overall in Q2 against a backdrop of unexpectedly complex market. Despite those challenges, we achieved a number of significant milestones advanced our strategic priorities and continue to execute on our go-forward plan. We're able to do this while substantially strengthening our balance sheet, reducing net debt by $45.8 million in the quarter to $124.2 million, levels not seen since the current team arrived 2 years ago, when net debt was $374 million. Very early on in the pandemic, we took decisive actions, implementing a range of measures that have enhanced our resiliency and position the company for industry-leading performance that will drive growth and competitive differentiation going forward. In fact, our cost reduction measures have resulted in annualized cost savings of approximately $10 million. These actions, combined with the substantial work done over the last 18 months on the business overall, give me great comfort that the foundation of AutoCanada is exceptionally strong. Importantly, Q2 volatility also served as a catalyst for reevaluating our business practices, operations and other key initiatives. This includes both operating performance in existing segments as well as initiatives expected to drive growth and competitive differentiation going forward, one of which I'll touch on later in this call. Q2 started with substantial COVID-related impacts across all of our markets. However, we experienced steady improvements in the unit sales through the quarter with ongoing easing of restrictions and our business model adapting to the new normal. Accordingly, Canadian new and used vehicle, our retail vehicle unit sales for AutoCanada progressively improved from a year-over-year decrease of 50% for the month of April to a decrease of 25% for the month of May, to an increase of 33% for the month of June. Preliminary results for July reflect continued momentum with an increase of 19% year-over-year. The challenging environment, combined with the management's response to the pandemic drove a decrease of $27.3 million in Q2 adjusted EBITDA from the prior year to $4.8 million. That said, adjusted EBITDA included $43.2 million in inventory write-downs, provisions and typically nonrecurring charges. The great majority of which are approximately $40 million were noncash in the quarter. Absent these and other one-time events normalized, adjusted EBITDA for the quarter would have been $21.8 million as compared to $32.1 million in the prior year. Michael will review some of those provisions in a moment. But I'll note here that we took the opportunity provided by the pandemic crisis to complete a comprehensive review of all aspects of our business, in essence, reengineering the business model where applicable. As part of this review, we actioned $10 million in structural cost savings, along with a comprehensive review of inventory, receivables and other accounts. As a result of this review and all of our recent actions taken to strengthen the business, we feel we're now better positioned than we've ever been in the history of the company to deliver industry-leading performance. I'll touch on some operational highlights. In Canada, Michael and his team have done an excellent job in continuing to prove our complete business model. For the sixth consecutive quarter, we outperformed the Canadian market with same-store new retail units down 23.9% compared to the market decline of 44.3%. That said, our same-store overall unit sales were down only 13.4% in Canada, bolstered by a year over year same-store increase of 0.7% for used retail units. Our used to new retail units ratio on a year-to-date basis also increased 1.04 from 0.8, with an at or better than 1:1 ratio for the second consecutive quarter, providing critical diversification in our business, as seen in overall performance. Our same-store finance and insurance gross profit per retail unit increased 18% compared to last year, the eighth consecutive quarter of year-over-year growth. Suffice it to say, our go-forward plan efforts over the last 2 years delivered real strength and diversification at a time when it was needed. In the U.S., ongoing government restrictions are greater in Chicago than the rest of Illinois and most other parts of the U.S., which impacted Q2 results. Prior to the impact of COVID-19, we saw marked improvement in performance, and Tammy's initiative continue to focus on profitability and improvement to expense structure. Adjusted EBITDA in Q2 for the U.S. operations reflected a decrease of $3.3 million compared to prior year. This included a noncash provision of $4.4 million, primarily associated with inventory write-downs. Adjusting for these provisions, normalized, adjusted EBITDA was $0.9 million, an increase of $1.1 million from 2019. With Tammy's initiatives continuing to gain traction, we believe we're well positioned for better-than-breakeven adjusted EBITDA in the U.S. going forward. Speaking to the Q2 balance sheet, as mentioned, we continue to successfully manage cash with a focus on preserving liquidity and our financial flexibility. Net debt is down by $148 million as compared to Q2 last year from $272 million to $124 million. We generated strong free cash flow in the quarter of $52.6 million compared to negative $21.8 million in the prior year. Our ongoing actions to manage working capital, combined with our refinancing of the debenture and our credit facility renewal have allowed us to achieve the strongest balance sheet, the current team, myself included -- since the current team and myself included joined the company. Again, I want to thank all of our fearless employees in Canada and the U.S., who have worked tirelessly and delivered excellent performance under challenging conditions. We entered 2020 on a very solid footing, and we remain well prepared to face the current environment. I'll come back to speaking more about our business model and strategy, including some exciting news on our strategy going forward in my concluding remarks. But for now, I'm going to turn it over to Mike. Mike?
Thanks, Paul, and good morning to everyone on the call. Going back to Q3 of last year, our focus has been on improving our financial flexibility, our level of debt and debt leverage. We continue that disciplined focus on cash through this challenging quarter, what we'll call the eye of the storm of the pandemic crisis. At the end of the first quarter, our net debt was $170 million. At the end of our second quarter, net debt improved to $124.2 million, a net debt reduction of $45.8 million. Free cash flow was $52.6 million in the quarter or $1.92 per share, which compares to free cash flow of negative $21.8 million in the prior year. This was our fourth consecutive quarter of positive free cash flow. A real note. On a 12-month trailing basis, free cash flow was $178.1 million as compared to 12-month trailing free cash flow in Q2 2019 of negative $19.5 million. This is a swing of close to $200 million. We have demonstrated over these past 4 quarters good consistency in our performance, both from an operations and balance sheet perspective. Our net debt leverage, based on the last 12 months to Q2, increased to 5.2x, but the increase is anticipated to be temporary. Our net debt bank covenant leverage was 3.2x, remaining level with the prior quarter. As we move into the balance of the year and work towards what we'll call a normalized run rate coming out of the worst month of this COVID-19 impact environment, we expect to see our net debt leverage move readily back within our target 2.5x to 3x debt leverage and likely better. Speaking to our impressive positive cash flow generation in the quarter, I'd highlight that we absorbed typically nonrecurring provisions of $43.2 million. Of this amount, approximately $40 million were noncash in nature. I'll call out that of the $26.2 million in waste subsidies that we recorded as income only half of this amount was received in cash in Q2. We will see the balance in Q3. The point here that our positive free cash flow did not benefit from the entire waste substitute. We'll pick up another $13.2 million or so in cash in Q3 from wage subsidies. I'll also call out the severance costs we absorbed in Q2 of just over $8.2 million to cover both temporary and permanent layoffs. We expect to see an annualized benefit of approximately $10 million in structural headcount reductions going forward, reflecting a better than 1-year payback. Michael will speak to the inventory provisions we took, but, as noted in our Q1 webcast, our intention for Q2 was to take a realistic stance on all items potentially impacted by the effects of the pandemic crisis in this quarter, so that we can move forward positively beyond this first half. I'll end my piece here as I have with the last quarter. We don't know what the future holds with COVID-19, but we feel we're very well positioned with the actions taken to weather any outcome. With that, I'll turn it over to Kevin to discuss our results. Kevin?
Thanks, Mike. For the first 2 months of Q2 2020, COVID-19 had a dramatic effect on our financial performance, with June seeing a marked improvement. At the consolidated level, revenue was $727.4 million, a decrease of $218 million or 23%. Gross profit came in at $97.9 million, a decrease to $55.5 million or 36%. Adjusted EBITDA came in at $4.8 million, which was a decrease of $27.3 million from the prior year. In our Canadian segment, total retail vehicles sold came in at 13,053, a decrease of 14%. The Canadian segment generated revenue of $656.4 million, a decrease of 20.9% versus the prior year. Gross profit was $89.9 million, a decrease of 34.9%. Adjusted EBIT decreased to $8.3 million, a decrease of $24 million. It's important to note that the Canadian adjusted EBITDA includes nonrecurring provisions of $38.8 million. This includes a write-down to Canadian new vehicle inventory of $9.2 million, used vehicle inventory of $4.8 million and parts inventory of $3.9 million. The provisions also include severance charges of $8.2 million. We also recognized $26.2 million related to the Canadian wage subsidy in the quarter. In our U.S. segment, revenue was $71.1 million, which decreased from Q2 2019 by 38.8%. Gross profit was $8 million, a decrease of 47.6% over Q2 of 2019. Adjusted EBITDA was negative $3.5 million, a decrease of $3.3 million from 2019. U.S. adjusted EBITDA includes typically nonrecurring noncash provisions of $4.4 million, which were primarily associated with the inventory write-downs. For the quarter, we also wrote off $3.9 million of capital assets, which was made up of $0.6 million related to land and buildings held for sale and $3.3 million of operational assets that management identified have no future value. I will now turn the call over to Michael Rawluk to discuss our Canadian operations.
Thanks, Kevin. Good morning, and thanks for joining us today. I have to start with a sincere thank you to all of our team members, our dealers and our head office support team. This has been a very trying time, and each one of you has endured unimaginable adversity, uncertainty and health risks in order to keep AutoCanada moving forward. We are grateful beyond words. We'd also like to thank our OEM partners and our strategic partners for the significant support you've provided us during these unprecedented times. Your guidance and assistance at all levels was invaluable and greatly appreciated. In beginning my review over Q2 performance, there are some key highlights that helps tell the story of what we see as a strong and successful quarter, especially in light of the pandemic crisis. For the sixth consecutive quarter, we outperformed the Canadian market for those brands represented by AutoCanada. Same-store new retail units decreased by only 24% as compared to the market decline of 44%. And same-store used retail units increased during the quarter by 0.7%. Our used to new retail ratio increased to 1 from 0.73, our second consecutive quarter at or better than 1:1. Same-store F&I gross profit per unit increased by $409 per unit, up 18% to $2,678. This was our eighth consecutive quarter of year-over-year growth per unit. Same-store F&I gross profit percentage increased to 91.1% as compared to 90.2% in the prior year. Same-store parts and service and collision repair gross profit percentage are showing a decrease of 49.9% from 51.2% but after normalizing for the provision we took on tightening up our parts policy, our gross profit increased to 54.8% as compared to 51.2% in the prior year. Adjusted EBITDA for our Canadian operations was $8.3 million for the quarter, down $24 million year-over-year. Included in our results was $38.8 million in typically nonrecurring provisions. In addition, we recorded $26.2 million as an offset to our employee expenses associated with the Canadian emergency wage subsidy. Adjusting for these 2 factors drives a normalized view of our adjusted EBITDA to $20.9 million as compared to adjusted EBITDA of $32.3 million in the prior year. I would highlight here that $8.2 million of the charges taken in the quarter will drive permanent headcount savings closer to $10 million moving forward. Our same-store new and used vehicle gross profit percentage was down year-over-year for new vehicles gross profit fell from $7.5 million to $3.3 million, used retail fell from 8.5 to 1.5. The main driver for the reduction in same-store new vehicle gross profit was a $9.2 million charge we took in the quarter to adjust inventory cost base to market values. We proactively managed inventory levels by writing down new vehicle inventory in order to address initial challenges brought on by the onset of COVID-19 and the associated disruptive impact on the market's key selling months from the last weeks of March through May. The timing of the market disruption essentially took away what are typically key selling months and resulted in a buildup of inventories with 2019 and 2020 models in advance of expected receipts in 2021 models. To some extent, OEM and product mix also had a bearing on that charge. With the charge taken in the quarter, we've localized the value in these value impacts to Q2. After normalizing for the write-down, same-store new vehicle gross profit decreased to 6.2% as compared to 7.5% in the prior year. The balance of the gap in margins was driven by write-downs taken on vehicles sold during the quarter. In addition to simply realizing and taking those impacts on inventory values in the quarter, we are also ensuring that we are positioning ourselves well to move forward. We are making room for 2021 model year inventory. We are setting ourselves up to earn F&I, parts, service and repair revenue on the back end. We'll earn volume-based OEM incentives. We'll earn greater OEM allocations for 2020 and 2021 model years. We'll ensure that our top-performing, commission-based sales team members are protected on their compensation incentives, and we are proactively reducing what would otherwise be curtailment payments on aged inventory. Much of the same logic will apply to our used vehicle write-down of $4.8 million. After normalizing for the write-down, same-store used vehicle gross profit decreased to 4.6% as compared to $8.5 million in the prior year. And similarly, with new vehicles, the balance of the GAAP in margins was driven by write-downs taken on used vehicles sold during the quarter. We have aggressively pursued strategies focused on enhancing our resiliency to ensure we emerge from the current environment much stronger and more agile, an attack plan was developed at the outset of this pandemic, consisting of 233 project plans, 1,281 individual tasks that were executed over a 90-day period. The attack plan span across all elements of the business. We worked through cost efficiencies, process reviews, enhanced business intelligence including management dashboard technologies, advanced inventory strategies, online sales processes and continued focus on working with our OEM partners to improve business processes and the customer experience. In closing, we are very happy with the progress we've made this past quarter in fine-tuning our business model. We believe we forward plan 70% to 100% effective. As demonstrated by the many personal bests achieved and the individual team and all-time record set by our dealerships in June. Some of the highlights include multiple net profit records, all-time net profit record and brand first place in almost every region we have a dealership. Further, as we move into Q3, we started the quarter positively with July total retail units up 19% year-over-year. And we're continuing to see excellent momentum across our operations with strong revenue and bottom line performance. Tammy, over to you.
Thank you, Michael. Good morning. I'm pleased to report that we continue to make significant progress in the second quarter in the U.S. despite the impacts from COVID-19. I'll begin by speaking directly to the results in the quarter. Adjusted EBITDA for our U.S. operations decreased by $3.3 million to negative $3.5 million as compared to negative $0.2 million in the prior year. Included in this is typically nonrecurring noncash provisions, primarily associated with inventory write-downs of $4.4 million. Normalizing for these provisions, normalized adjusted EBITDA for our U.S. operations was $0.9 million, an increase of $1.1 million compared to prior year. These results are a reflection of our core focus on profitability by ensuring vehicle profits are not sacrificed in the pursuit of vehicle unit sales, focus on improved fixed operation structure and continued improvements to the expense structure. Signaling the good progress made on driving improved segment profitability, gross profit percentages for used cars, parts, service and collision repair and finance and insurance improved compared to the prior year. Other notable improvements in the quarter included used vehicle gross profit percentage increasing by 1.4 percentage points. We've been focused on increasing used retail vehicle sales volume with improved inventory management. Used to new ratio increased from -- increased to 0.69 as compared to 0.54, representing an increase of 28.5%. F&I gross profit percentages increased to 95.7% as compared to 94.7% in the prior year. This improvement is attributable to favorable rebate and compensation terms we negotiated with our F&I partner in late 2019, which allowed for higher profit retention in Q2 2020. We've also implemented formal financing and insurance structure and process certification. The training has resulted in a shift to ensure our core F&I products offered provide value to our customers while simultaneously also drive retention. Parts, service and collision repair gross profit increased by 5.7 percentage points. This improvement is largely attributable to an in-depth review and assessment of our fixed operation structure. We have refined our effective service labor rates, limited discount programs and have maximized our technician productivity, all resulting in sustainable improvement to our gross profit percentage. The noted prioritization of F&I products has also contributed to an increase in maintenance and service work in our fixed operations performance. We continue to prioritize and implement changes to improve customer experience and drive customer loyalty. We're taking disciplined actions to manage through the challenging environment, including building on our recent successes and improving customer retention to create sustainable growth, implementation of better training and related processes, a continued shift in culture towards a focus on the customer versus a focus on the unit sale, continued strict discipline over operational expenses and, finally, a focus on the optimization of fixed operations as we've implemented new systems as well and further cost rationalizations where appropriate. We're also improving working capital management and leveraging successful Canadian operation initiatives. As of August 11, our U.S. operations are open for service and sales at our locations, so long as we continue to adhere to capacity and social distancing restrictions set by our state. Prior to June 3, 2020, our sales operations were by appointment only. We'll continue to monitor the development and ensure that our operations safely comply with all federal, state and local requirements as restrictions in our businesses hopefully continue to ease. Lastly, we are pleased to announce a newly formed strategic partnership with Ally Financial. While at its core, Ally will be our new floor plan finance provider, their dealer-focused business model will also allow us to leverage their strength in retail financing as well as wholesale vehicle purchase and sales capabilities. With their 100-year history and a proven record over many credit cycles, we expect that this partnership will provide us with a competitive edge in our markets. I, too, would like to express my personal deep appreciation, especially to our dedicated team members, who relentlessly committed to serving each other, our customers and our communities with a simple mission of whatever it takes through this challenging time. We also appreciate our valued business partners and our OEMs, who continue to be the key for us to deliver on our U.S. go forward plan, and I'm really honored to be able to continue to lead our team forward. Thank you. And now back to you, Paul.
Thanks, Tammy. I'd like to thank our fearless, hard-working AutoCanada team members in Canada and the U.S., who are truly the drivers of our vision. And I'd like to say thank you for all the continued support from our strategic partners, financial institutions, OEM partners, customers and investors, as Michael and Tammy have as well. I remain very pleased with the progress we've continued to make against the priorities we've set for ourselves at the start of 2019, which have really set us up for resiliency in the current environment. Despite the impact of COVID-19, we continue to see strong operational improvement and related traction in Canada. We're building a better business case in the U.S. We reset our balance sheet, debt leverage and credit profile, and we're generating strong free cash flow even in a challenging environment. These accomplishments speak to the strength of our operations and the success of our complete business model and our disciplined focus on cash management. Q2 2020 marked the 2-year anniversary of our current management team taking the reins at AutoCanada back in 2018, and I'm extremely proud of the significant milestones we've achieved over this period. Until recently, we've been focused primarily on our turnaround strategy of operational excellence and resetting the balance sheet, what we've been calling the go-forward plan. Now after achieving many of the key priorities outlined in the go-forward plan, we started increasingly thinking about the future. With these accomplishments under our belt, combined with all the actions and learnings we've taken so far to bolster our business, we're better positioned than at any other time in the history of the company to achieve our potential. This potential includes a new initiative we've been contemplating for quite some time, and I'm excited to announce today, a fully realized Canadian digital retail strategy. While we'll provide additional specifics in the coming months, I'm thrilled to share that we've set in motion a number of steps designed to address the substantial opportunity in the Canadian market with the sale of used vehicles through omnichannel and completely online. As you know, we've been focused on the sale of used vehicles for some time as part of the go-forward plan and our progress there, which has been echoed by the experience of our U.S. peers has provided incredible validation of both this end market and our ability to execute. Our experience in Q2 reinforce this across every metric, where, even in the midst of a pandemic, our used business accelerated. Importantly, this starting point provides us with not only a Canadian first-mover advantage in the category and a wealth of domain experience, but the ability to build a digital retail strategy with unit economics that should allow us to scale rapidly without substantial cash burn. Now that's a notable difference from some of the digital retail players in the U.S. As I've mentioned on prior calls, we view ourselves as a platform for acquisitions in the space, and we expect that would apply to this strategy down the road as well. Again, more to come on this in the coming months, but I believe the digital retail strategy will be a foundational driver of performance for years to come and another example of AutoCanada leadership in the markets we serve. Speaking of M&A, with all the pieces of the puzzle coming into place, we're currently unleashing the strength of our business development team to begin looking at much more seriously at acquisitions. It's also worth noting that we're starting to see more activity in our pipeline of opportunities. Strategic objectives aside, we are still unclear as to how deep and prolonged a recession we may be in for as a result of COVID-19. As I've mentioned many times before, our new and used sales progressively improved through the quarter to a year-over-year increase of 33% for the month of June, with July showing follow-through at an increase of 19% compared to last year. So while the impact to our business remains more modest than originally expected, and we continue to see improvements on just about every metric we track, we remain vigilant. While we don't know what the future holds at this point with COVID 19, we've taken our learnings from this situation to reevaluate and adapt our business to drive industry-leading performance. We're confident that our nimble and proactive focus will be a top decile performer in any environment, and that our complete business model, our balance sheet and our team will position us to emerge from this pandemic even stronger. In the meantime, we'll continue to prioritize what's within our control, the safety of our people and support for our customers. Now I'll turn it over to the operator for any questions. Thanks.
[Operator Instructions] Our first question is from Chris Murray with ATB Capital Markets.
I just -- my first question is around the inventory in the Canadian business and the write-downs that you guys did take. I guess a couple of questions for you on this. So first of all, part of the commentary in your presentation was around the absolute inventory levels that Canadian dealers need to keep relative to some of the U.S. dealers. So my first question is kind of lessons learned about size of inventory. Then I was -- just a question because you did have to essentially discount that inventory in advance of the 2021 model year. Is there any possibility that your OEM partners come back and give you some sort of relief on that? Or is it, basically, that's just the way it's going to be?
Great question. For a couple of reference points. You mentioned U.S., so I'll just reference that relatively speaking. Now all the information out there shows that in April, the U.S. dealers has a composite across all brands and all franchise dealers at 125-days supply. In Canada, relatively speaking, because of seasonality and also challenges with geography and distribution hubs and all things that go along with less population density and more space, Canadian dealers had 204-days supply on average. So again, 125 in the U.S., 204 in Canada. And so to be a Canadian automotive dealer means that you ramp up in the winter and you have lots of inventory to meet the spring market. Now this cuts both ways. If you run into a global pandemic, which was not on our strategic plan, then you have too much inventory and you have to adjust for it for the market. The other way it cuts, though, is because there's more slack in the system in Canada, overall, we have inventory, and we still have inventory. Where, in June, U.S. dealers left that month with 79-days supply, Canadian dealers had 146-days supply. And the numbers we're seeing in July is that U.S. dealers breached into the 50-days supply, and that's going to be a theme in Q3 in the U.S. of struggling for inventory, where that won't be a theme in Canada. So that does cut both ways. But when you have an automotive business that you ramp up your inventory for a spring market for 90 days, and your business comes to a stop, there's damage to your balance sheet. And any Canadian dealer that tells me that the COVID impact didn't impact their balance sheet, losing all of your top-selling months, frankly, I don't believe it. And so we went through a robust process of reevaluating and mark to marketing our inventory because we want to contain all financial impacts of COVID into Q2. Because I don't want to be talking about COVID. Our dealers don't want to be talking about COVID. Nobody wants to hear it anymore. And we don't want to bleed that problem into future quarters and use it as an excuse for low margins and on and on and on. So our objective was to contain everything in Q2, which is exactly what we did.
Okay. And the second part of the question was around support from the OEMs, just with the nature of the business. I'm sure they appreciate the fact that it's an unusual cycle, but are the expenses that you guys incurred in order to vend the inventory, is that something that's just your issue to have to deal with? Or will they come back with some relief?
It's a partnership. So they have aggressive programs on right now and 0% inventory -- 0% financing on inventory to help dealers move it. But ultimately, if you were to walk into one of our FCA dealerships today with all the OEM programs and you want -- you looked at a 2019 Dodge Ram and a 2020 Dodge Ram, those vehicles are the same price. So as a consumer, if we said, "Hey, Chris, you can buy this truck for 55, it's a 2020, and this one for 2019, it's -- I mean, 55 into 2019, you're going to want a discount. And so that's as far as the OEMs have taken it, but the responsibility is on us to move all scale inventory. And so we've recognized that market evaluation in order to preserve our margins going forward. So that we don't believe the economic impact of this global pandemic into our future business.
Okay. And then along those lines, just so I understand this correctly, I mean, you took inventory write-downs in new, used, and it looks like the service group as well. So you're talking about coming back into Q3 sales starting in July, up, I think the number was 16%. Does that also mean, though, with the inventory that you're vending in Q3 that, that should be returning to, call it, normalized gross profit margins?
Yes. So all things COVID -- and this is like a common theme with everything, all things COVID have been contained in Q2. So in Q3, it's all normalized margins. We don't have inventory issues, be it the valuation of inventory. And although our supply's tighter than we're used to, it's very manageable. So Q3 is more normalized. In June, we saw a strong resurgence in margins year-over-year in part service collision, new used all areas of our business, and July continued with that trend.
I'd just like to remind you, Chris. Just to add to that, Michael said, all things COVID have been contained to Q2. Just as a reminder to everybody, obviously, we don't have a crystal ball. And as long as there's no resurgence in the virus and things don't shut down again, that is absolutely true.
Okay. Fair enough. Next question, and I don't know who wants to take this one. But the other offset in the quarter was a huge payment. And is it fair to think -- I mean, the intent of the program really was to allow you to bridge staff back to, call it, a more normalized operational focus. But I guess the way I would think about it is if you hadn't taken the cues payment, you probably would have just laid the staff off and either restructured or save the cost. Is that a fair way to think about it?
Yes. Chris, it's Mike. I'll take it. I think as we're moving into this quarter, like, I think it's hard to isolate actions we may or may not have taken. I think when we went into the quarter, we embarked on what Michael has talked about in terms of the comprehensive review, and Tammy would have done the same thing in the U.S. And we did have the benefit of beginning to understand what impact we are going to be getting from cues. And so I think all of that kind of plays into it. So yes, it has an impact on what we do with people, but I'd probably try not to draw isolated decisions based on one piece of the equation. I think you're looking at everything in totality as you're taking actions and managing through the quarter.
Okay. Fair enough. And then, I guess, just last question for me really quick. The new digital retail strategy. Is that intended to be an AutoCanada -- like AutoCanada-owned-type platform? Just maybe some more details around what that looks like, any capital investments that might be required? And is this a platform? And Paul, I think you've got some experience in building cross-functional platforms across the industry. Is that something that you guys are looking to actually build out as a platform that can be used by other dealers?
So I would start by saying this is going to be a separate division of AutoCanada, but it will reside within AutoCanada. And look, we've been studying this market for a long time, and we've been taking our learnings from Michael and Tammy, both doing an exceptional job of selling used vehicles. And also notice the hedge against cyclicality and seasonality of the used car business. And it's a business that we want to be in more, and we will be in more. And so kind of taking those learnings and also understanding the way consumers buy and being able to watch our U.S. counterparts actually go after it, meaning from the new car stores like Sonic and Lithia and AutoNation, or Carvana and Vroom and Shift and Carmax, what we wanted to do was be very disciplined in the way we launched this, understanding that we couldn't go out and afford to lose $100 million or $1 billion in a year. And so we've spent a lot of time building out a strategy in order to enable us to be able to sell many thousands of additional incremental used cars. And so we intend to execute on that strategy in a very cost-effective way.
Okay. So I mean, the other question was capital requirements or any other investments that we may have to see in SG&A over the next -- over the period of time it takes to get this launched.
As I've said, we're going to be doing this in a very cost-effective way. And so at this point in time, we'll build out our strategy with a mindful eye on our balance sheet.
Our next question is from Michael Doumet with Scotiabank.
I wanted to go back to the inventory discussion. I understand you pointed out that there are some fundamental differences between Canada and the U.S. But from what appears to be playing out, given the OE shut down faster than expected to recovery, it does feel like demand for new and used could be outstripping supply. And even if I look at your inventory levels, they're down 15% year-over-year. Meanwhile, your July unit sales are up 19%. So I mean, just to push that a little bit further, I mean, should we expect gross margin per unit improvement in the second half?
So the answer -- great question. And the answer to that is, yes. And again, the issue with inventory in Canada versus U.S., I just want to reemphasize this, cuts both ways. And we have -- so in the U.S., just to remind everybody on the data points is the Canadian market dropped 75% in April, and the U.S. only dropped 50%. And the U.S. market came out 20 to 30 days faster than the Canadian market. So you have -- in Canada, we carry -- in April, the data was we carried 63% -- average Canadian dealer carried 63% more new cars than the average U.S. dealer. And we -- but we dropped harder and came out slower. They didn't go down as much, and they came out a lot quicker. And so, right now, they've breached into the 50s with days supply, and the average Canadian dealer has still over 100, 105, 110 days supply. So although it's tighter than we would normally want it, we've got enough inventory to meet the surge in demand to take us through to the new model years. We're running with 55 days supply in used. So we're good on used. But as we start to take some of the inventory out of the system, we're finding that we can hold our margins better. We can get closer to retail asking price. And as the OEMs are stepping up with excellent programs, right now, that's enough of a discount for the consumer. And so in June and July, we're seeing a strong resurgence of margins. And in parts and service and collision as well, we're seeing in the area of 50 to 75 basis point improvement year-over-year in July with growth in parts and service as well. So that business is coming back. So a long way to answer, yes, we expect strong margins in Q3.
Got it. And I wanted to maybe get your thoughts on your ability to continue to grow sales of your F&I products. I mean, central math I'm running, if you had managed the same F&I per vehicle in last year that you did this quarter, your EBITDA would have been, call it, close to $10 million higher. Can you maybe remind us of what some of the drivers are there, just how sustainable they are, and whether even if you expect more growth going forward?
Okay. So sustainable, 100%. Growth going forward, again, and I said this the last call as well, is that this team is a world-class F&I team. Our F&I managers and our dealerships are world-class. You benchmark our F&I performance to any public information available. On the planet, we're #1 worldwide. And so this team continues to advance. I don't know how far they're going to go. They continue to impress, but sustainable, 100%.
And just I'm curious, actually, Michael, if you can share your thoughts there. I mean, just as it relates to COVID and the customer engagement process, I mean, any impact to F&I in the quarter at all from customers maybe somewhat being reluctant to stay in stores for longer or anything of that sort of maybe into Q3 could wash away somewhat?
Yes. So with Q2, that forced us into more of a remote delivery online sales process. And we had a strong foundation. We had great trainers. We had processes already developed and technology that we were working on. And so that just accelerated everything. And our F&I continues to grow as a result, even though we weren't base to face with consumers. And so that just goes to show us that we can continue to grow. And again, keyword on sustain our F&I improvement in an omnichannel environment.
Our next question is from Luke Hannan with Canaccord Genuity.
I wanted to focus a bit on the parts and service segments, I guess, both in Canada and the U.S., saw a margin uptick there in both segments. And I think there's commentary in the MD&A talking about how because of there's closure of -- or the lack of the nonessential -- the closure of nonessential business, there is less warranty work, less tire changes, and that may have improved the margins there going forward. Mike, I appreciate the commentary on the 50 to 75 basis points improvement year-over-year that you're seeing in margins in the segment as of July in parts and service. I'm just curious to know, though. Is that -- does that include the warranty and the tire changes work or maybe that other lower margin work coming back? Like is that a structural shift? Or just any color there would be helpful.
Okay. So great question, and that's something that we're monitoring very closely. So in Q2, the internal business, so we've got 3 components to our service, internal warranty and then retail or customer pay, as it's called in the industry. And the internal really, really dropped because all the auctions were closed down. OEMs weren't delivering new cars. We couldn't buy used cars, everything just went through this hard shutdown. Again, different -- that's a different experience than in the state, where all the auctions actually physically shut down and they all went home. And so you lose -- we lost that internal revenue. At the same time, the OEMs weren't sending out recall notices and soliciting customers back to their dealerships during this crisis because a lot of the dealerships and a lot of the network were shut down, and we weren't able to handle that business. So that dialed back naturally internally in warranty, where our retail and our customer pay dropped in line with the slowing down of, like, retail and foot traffic. And the interesting part was that -- and if you were driving around in April and May on the street, you realized that you were probably the only person driving around. And that really goes to speak to, in parts and service, we're not seeing this pent-up demand. It was actually a shutdown in kilometers for that time period. And so that took out retail, and again, with internal and warranty and everything just came to a hole. So the most comforting data point we have is that in June we showed gross margin improvement in growth year-over-year, same month to same month. The warranty business started coming back. New cars started flowing. The auctions opened up. We started buying used cars again, and everything started to normalize. And so our margins, we have put in effect last year a lot of initiatives on focusing on retail margins and parts, matrix things and all sort of surgical maneuvers around pricing. And we really started to see the margin growth on that in January and February, again, shut down in March through the pandemic. And then now that the business is coming back in June and July, we're seeing reasonable growth. And we've recaptured that margin improvement that we were starting to see the fruits of our labor in January and February.
Got it. That's helpful. The second question I had was just on, obviously, the sales performance in June and July is fairly encouraging. I'm just curious, though, what that customer mix looks like. Is this a lot of people who had maybe deferred some of their purchases from the earlier months of the year where they would have already had an existing vehicle? Or are you seeing a lot of first-time vehicle buyers just moving into June and July?
That's an excellent question, and that's another topic of conversation and what we're trying to figure out right now. The brands we represent do not have a lot -- like do not have very high lease penetration rates. And so it's not like there's this -- we're not benefiting from a massive deferral business in Q2. We're -- but we are benefiting from kind of a surge in retail activity and demand on new. But on the used, we see lots of first-time buyers. And these are the buyers that you read about in all the articles of people that have decided not to take public transit anymore. They don't rideshare. They don't know Uber. They don't taxi. These are people that have said it's time for a car. And so there's a significant amount of first-time buyers, and our hope is that also creates a delayed effect of growth in parts and service as we believe the car market or the car park is a -- they say is actually growing on an absolute basis.
Last one for me before I turn it over, just a quick one. There's commentary, I believe in the MD&A or maybe the press release, about how the company is positioned to turn into a top decile performer. I'm just curious what the basis is for that. Is that just sales or operating efficiency? Any insight there would be helpful.
Yes. I would say, look, we've debated this internally as we constantly get questions as to what the next quarter's going to look like and what the guidance is going to look like. And then a market like this, where we're going through unprecedented times with a pandemic, and the history that this team has had, where we're basically in a -- we took over a business that was running into the rocks, and we took it from going into the rocks to maneuvering out. And now we're kind of in comp season even in the midst of a pandemic. And so the way we think about it is the only thing that we can control is how our performance according to our peers. And so we've made a conscious effort internally to make sure that when we are in a market, we are a top decile performer in that market. And that's the best way for us to understand how well we're doing is the one thing we can't control is the economy.
The next question is from Maggie MacDougall with Stifel.
We've talked a lot about the rebound that you've seen in demand for new and used vehicles. I was wondering if we could touch on the patterns in the service market. Have they also played some catch-up? Or are you still seeing some deferrals occurring around people just kind of staying at home?
So excellent question. And we -- on the service side, we service miles and -- or kilometers in Canada. And if you read some of the material that Dennis DesRosiers has put out as of late, he speaks to people working at home and being shut down during the COVID crisis, and we actually lost miles. So the miles weren't there or the kilometers weren't there for us to now recapture into Q3. In our minds, those are actually lost kilometers. And so I think that's been probably the biggest surprise out of the pattern of heading into this crisis and coming out of it, which is different because of the government response of just shutting everything down. So we haven't ever seen that before, where all the cars in the country or vast majority were also unparked in everybody's driveway not moving. But the cars are moving now. So we don't think it's much of a catch-up, but we think that, that market is poised for growth as people move away from public transportation and shared ride and Uber and everything else like that. And everybody is expecting a lot of road trips and a catch-up in mileage as they can't travel. So we expect a nice resurgence into the fall, but we don't actually think that's catch-up from Q2. Is that helpful?
Yes, very helpful. And then following on that question, obviously, you've had a big increase in the used-to-new ratio that you've been selling. Also, your commentary around first-time buyers and in the used car market, I find pretty interesting. I'm wondering what your sort of thoughts are on follow-through into part service over the next year or 2 as you see some of those cars start to get on the road and need some work.
Yes. Excellent question. We're actually just talking about that earlier this morning. And we absolutely believe that our carpark, which is the number of cars in our market areas that we serve, we believe that there's absolute growth in the carpark as a result of changed consumer behavior. And we expect that to come back into our dealerships. Now with our better database management and our BDC strategy, service reminders and all the automated marketing we're doing, we think that we're well positioned to make sure that those customers return to our dealerships. So we expect some good growth in that area.
Okay. Final question for me. You commented on the fact that your business development team is now starting to look more seriously at acquisitions for the first time in a while. And I'm wondering if you could elaborate on the particulars of your M&A strategy, either in terms of geography or brand, and whether or not there's a link there to pursuing a more robust digital strategy as well in terms of the networks that you currently have of infrastructure in Canada to support that initiative.
So this is Paul. So we've kind of been forced to sit on the sidelines until we got our ship in order, right? And so we've spent the last 2 years rebuilding the company, the balance sheet, the operations, the process and have kind of been forced into a hold position on M&A. And frankly, we've been offered a lot, but I don't think it would have been reasonable for us to be buying in that environment. And so we met as a team in February, just prior to everything shutting down with pandemic, and really kind of hammered out what our acquisition strategy would be go forward and thought about when the right time to deploy and act on it and how we'd like to think about it, both geographically and by brand. And frankly, we do think we would like to expand our footprint more in Ontario and diversify into brands that we're not currently in today. And so there's really no magic to how we thought about it, though we want to be in top-performing brands and high-volume geographies. And that's kind of what we've been thinking about. As far as the digital overlay, look, as I said, we want to be very, very responsible with our balance sheet. It took us a long time to get it back in order. We're now there. And again, getting lessons from our U.S. peers as to how much money you can spend on building out a digital strategy, we sat back and kind of made a tally of all of our assets and looked. And we're one of the only players in Canada -- we're certainly the only publicly traded dealer group in Canada with kind of a coast-to-coast geographical difference and that we can actually use that as the scaffolding for service, for reconditioning for vehicle acquisitions. As you know, with used vehicles, the key is the acquisition of the vehicle. And so we intend to -- because we have this vast network currently in place, we intend to use that as kind of the prewiring for our digital strategy.
Our next question comes from Jonathan Norwood with Viking Capital.
I just had a quick question on the dividend. And so, Paul and Mike, you're probably going to be used to me asking a question about the dividend. But essentially, I mean, this is a company that's always paid a dividend right from its inception as an income trust, which is probably a mistake. But you guys generated, I understand it was cut in sort of in advance of -- nobody knew in terms of how this was all going to play out. But you generated, I think, $52 million in free cash flow in Q2, primarily from working capital, if not all from working capital, improvements. But that's $2 a share, and you eliminated a dividend in the quarter that was $0.10 a share. And on a trailing 12-month basis, you've pointed out you've made $178 million of free cash flow or something like $6.50 a share. And so it's crazy. And when you think about eliminating a dividend the size that you did, so can you talk a little bit about how you think about the dividend? Will there be a dividend reimplemented? And can you also clarify whether not paying a dividend is related to the -- receiving COVID-related funds?
So I'll start from the last question first. The -- not paying the dividend is not the result of not receiving or receiving COVID funds. It's the result of being disciplined about not knowing what the future is and wanting to make sure that we have ample liquidity in case things get really bad. And frankly, I don't know, and I don't think any of us know what the future holds. And so we -- I don't mean to be a broken record on this, but we don't know if the fall and winter is going to be bad. We do know that we're grappling, as everybody is in the world, with a very contagious virus that has the capability of shutting down our organization completely. And frankly, I think it would be, I think -- and I think this goes for our entire Board, we feel it would be irresponsible of us to put a dividend back in place. We've suspended it, we haven't canceled it, but we've suspended it given that we don't know what the next 2, 3, 6 months hold. And so as we kind of walk our way out of this, and, hopefully, it's sooner rather than later, we can revisit it at that point in time. But again, I'd like to emphasize, Jonathan, we haven't canceled the dividend. We've suspended the dividend. And I think as stewards of the business right now, it's upon us to actually make sure that we survive to the other side. And I know given the results that we gave this quarter were through the roof, and you think we should put the dividend out, but, frankly, everything that I believe and know is that we just need to be very, very cautious while I'm very optimistic about our business, I want to also be very cautious.
Okay. No. I mean, I understand that. And I understand that is a prudent thing to do in kind of the valves of this saying like 3 or 4 months ago. But clearly, I mean, you're feeling better about the business, you're talking about getting back on the acquisition trail, so to speak. And so, to me, that implies that if you can go out and spend $10 million on a dealership or more, a $10 million dividend, which is essentially what it was per annum, something in that order would be palatable, too. So maybe just talk about how you feel about making an acquisition versus reinstating the dividend.
Well, the reason that we're actually even getting on the acquisition bandwagon right now is because what we're noticing is multiples compress. And so if multiples are compressing as a result of people being unsure unclear what the future is, and we have the opportunity to take advantage of that in either an accretive fashion or being able to bring on a new brand that we've never brought on before, I think we have to look at the dividend and kind of risk-adjust which is more valuable. And frankly, at this point in time, every deal has to stand on its own. And so we look at -- we're looking at all those things. Does it make sense? Is it accretive? Is it a new brand? Is it the right geography? Versus in the face of a pandemic, buying a new dealership, does that make sense? I mean, we're trying to risk adjust all those things. What I would tell you is that our pipeline right now is probably as strong as it's been in several years, and that we're also seeing, as I said, multiple compression.
Our next question is from Michael Doumet with Scotiabank.
Just a question for Mike. Obviously, another nice quarter for working capital management. I believe last quarter, you commented that you still had some room for further optimization. But I don't think anybody was expecting a $65 million cash outflow. So just wondering whether that was a pull forward given some of the backdrop or if you got sustainable? And if you could just expand that into what your expectations are for cash flows in the second half, including the $13 million of the weight subsidies.
Yes, Michael. No, we're -- I mean, we're very happy with how we've managed working capital. I think part of the strength comes from as well how we ended the quarter. I do come in as strong as it came in. So there's a working capital component to it. And I think our focus as we move into the second half of the year is really going to be on trying to maintain. And there's going to be -- again, we're always going to -- we're going to continue to try to refine and drive more cash onto the balance sheet. But I think I would say, and I've probably said this before and that we overachieved. But I think our balance of the year focus is going to be on protecting and maintaining what we've been able to do this date. We are feeling pretty confident with our balance sheet right now and where we are and where the business is going. And I think you were able to hear Michael's optimism and some of Tammy's optimism in the opening comments. So we are feeling pretty good about where we're going. Again, with the qualifier, we don't know what COVID's going to bring with -- through the balance of the year depending on whatever happens. But I think the theme would be protect and maintain what we have done with respect to cash and working capital.
Our next question is from David Ocampo with Cormark Securities.
My first one is just circling back on the gross margin guidance, I mean, kind of you're probably providing improving in the back half of the year.
David, I'm having difficulty hearing you. I don't know if everybody else is?
Is this better?
Yes, yes.
Yes, I think so. Yes.
Yes. Okay. So I just wanted to circle back on the gross margin profile that you guys provided. Sort of with the inventory write-downs that you guys have been taking, when I think about your U.S. gross margin profile, particularly on the new retail side, can we expect this to sort of get more in line with the industry average? Or is there still other areas that you guys need to improve in order for that to get there?
I'll take it. And then if Tammy has any more color, she can weigh in. But again, I would say for Q2, and we kind of -- we saw this for Q1, we saw with Q2, you have a lot of noise in the quarter with respect to the write-downs we've taken both in Canada and in the U.S., the expectation would be that as we've taken those charges, we've tried to contain most of the impact of COVID-19 to Q should begin moving towards that normalized margin. And I would -- I'd say the same thing for or the U.S. but again, Tammy may have more color.
Yes, I agree with what you said, Mike, and we are continuing to move towards that normalized margin. We, as Michael indicated earlier, may have a shortage of new vehicles for the next 6 to 8 weeks. But because our strategy has been so focused on the used car operations, it was done strategically to be able to keep the gross margins where we need them to be.
No, that's good. And my last one here is just circling back on the relative outperformance. I understand part of it is part of the go-forward plan to continue to outperform the overall market. But is there anything specific that allowed you guys to outperform by roughly 20%?
I'll take that, if you don't mind. I would say, yes, I would say that and Tammy were adamant that they needed to show up and everybody within the organization showed up. I think that while you've heard about other dealerships and what they did, like, I mean, we've heard about looting and riots in Chicago. And every day I'd talk to Tammy and her team showed up. And Michael mentioned many times how eerie was driving on the street, and nobody else was on the road, but everybody at the dealership showed up. And I think there's -- in the face of everything that was going on, the fact that everybody banded together as a team to really show up. I think the results are -- that's what earned the results. And Michael, I don't know if you'd add, or, Tammy, if you'd add anything, but I mean, our team was present in there even in the face of everything that was going on. But Michael, I'll let you maybe elaborate.
Yes. So I agree that's a big part of it. And this event strengthened our business, strengthened our culture, strengthened our team. We -- where we are right now, is where, as a team, we've been all dreaming, we would be 2 years ago. And so we feel like we're here. Unfortunately, we can't call out specific brands, but we have dealerships, well, one in particular that broken all-time Canadian sales record, an all-time Canadian sales record since the manufacturer started selling cars in Canada. We have multiple dealerships that were #1 in the province, #1 in their territory. We had a podium finish for certain brand out West, where we were #1, #2 and #3. We are just absolutely dominating our markets. We've got confidence. We've got strength. We've got a good balance sheet. And this COVID quarter has allowed us to take a look ultimately at our EBITDA margin and finish off the final pieces and the most difficult pieces of the go-forward plan to permanently reengineer our EBITDA margin and basically propel this company or drive this company into a zone where we originally had dreamed that we wanted to get to.
And I think on the U.S. side, I would say that in my comments, I talked about that whatever it takes spirit. And when Paul says that the team showed up every day, the team showed up every day. Regardless of what was going on in the environment around us. They were very focused on doing whatever we had to do to get the job done. And with a clear focus on what can we do to protect our business as much as possible rather than all the reasons why we can't sell cars or service vehicles, it really boils down to the team.
Ladies and gentlemen, this concludes the Q&A period. I'll now turn it back over to Paul Antony for any closing remarks.
Listen, we really appreciate everybody's time today. And we look forward to talking to everybody next quarter. And hope that if this quarter was any insight into next quarter, and hopefully the pandemic is maintained at bay that we will have an equally great quarter, if not better, the next one. So thank you very much, and look forward to talking next time.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation, and you may now disconnect.