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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon, ladies and gentlemen. Welcome to the Penske Automotive Group Second Quarter 2019 Earnings Conference Call. Today's call is being recorded and will be available for replay approximately one hour after completion through Tuesday, August 6th 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. Sir, please go ahead.
Thank you, Justin. Good afternoon, everyone, and thank you for joining us today. A press release detailing Penske Automotive Group's second quarter 2019 financial results was issued this morning and is posted on our website, along with a 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, our Chairman; J.D. Carlson, our Chief Financial Officer; and Shelley Hulgrave, Corporate Controller.
On this call, we may be discussing certain non-GAAP financial measures such as earnings before interest, taxes, depreciation and amortization, or EBITDA. We prominently presented the comparable GAAP measures and have reconciled the non-GAAP measures in this morning's press release and investor presentation, which is available on our website, to the most directly comparable GAAP measures.
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.
At this time, I'll now turn the call over to Roger.
Thank you, Tony. Good afternoon, everyone. Thanks for joining us for our call. Today PAG reported income from continuing operations of $118 million and related earnings per share of $1.42 for the second quarter. We also announced a commercial truck dealership acquisition, which is expected to add $1.1 billion in annualized revenue and nearly double the size of our retail commercial truck dealership operations, which I will talk more about later.
During the second quarter, our U.S. Retail Automotive business, our North American Commercial Truck Dealership business and our investment in Penske Truck Leasing performed well during the quarter, in fact driving a 6% improvement in earnings before taxes. However, weak market conditions in the UK from Brexit and the timing of customer deliveries in Australia impacted our second quarter results.
In the UK market, new vehicle registrations declined approximately 5%, including 7% decline in private retail registration, which significantly impacted our new vehicle sales volume. Additionally, the oversupply used vehicles in the UK market negatively impacted used vehicle market values and our margins. In fact, industry statistics show a 2% drop per month and used car values during Q2.
Including exchange, gross profit in the UK and decline on $19 million in the second quarter and the Company second quarter earnings were negatively impacted by approximately $0.16. Despite the impact of these items strong performance we had in our U.S. operations, the reoccurring revenue stream provided by service and parts which continued to generate between 45% and 50% of our overall gross profit and our investment in Penske Truck Leasing helped produce a strong cash flow for the quarter.
During the first six months of this year, we generated $300 million in cash flow from operations. This allowed us to increase our dividend 2x, personally we yield 3.4%. We repurchased 3 million shares for $130.6 million and we invested $123 million into our business to net CapEx including $15 million of land. While keeping our vehicle debt relatively flat, our non-vehicle debt relatively flat with December last year.
Turning to the details of our Retail Automotive, same-store retail units were down 4.4%, new was down 9% or 5,400 units. Looking at the U.S. by itself, we were down 6.9% on units or 2,400 driven by Honda down a 1,000 units and Audi down 500 units, International was down 12% or 3000 units, the UK was down 1800 units driven by declines with Audi and BMW. Italy and Germany were driven continued lower unit, bought volume because WLTP pressure on Porsche and Audi vehicles.
Looking at used vehicles. Same unit sales were flat with last year. The traditional dealership business increased 1.3%, while used supercenters declined 1,057 units mainly due to market conditions in the UK.
Although same-store total unit sales were down in the U.S. I'm pleased that our U.S. same-store variable gross profit per unit increased nearly 4% to $125 per unit during the quarter. Same-store retail automotive revenue declined 4.6%. However, when excluding the impact of foreign exchange, same-store revenue was down 2.1%. New was down 6.2%, used was up 1.2% and F&I was up 5%.
Turning to service and parts revenue that increased 3.1% during the quarter, customer pay was down 0.6% versus a high comp last year of almost 9% while warranty was up 14.8%. As many of you know, our highest margin businesses service and parts that represent 42% of our retail gross profit and 64% of our truck dealership gross profit comes from a service and parts business.
Let's move on to our used vehicle supercenters. We operate 14 dealerships including five in the U.S. and nine in the UK, plus one reconditioning center in the UK. These operations use at one price, no haggle approach. In the second quarter, we retail nearly 18,000 vehicles and generated revenue of $312 million.
Our unit volume was down 5.6% or 1,057 mainly due to market conditions in the UK. Variable gross profit was down $142 in the UK, but was flat in the U.S. at $3,036. The decline of gross profit per unit in the UK relates to the oversupply of used vehicle and the UK market, which is driving down used vehicle market values and grosses.
Turning to the retail commercial truck dealership business. The medium- and Class 8 heavy-duty market continues to experience strong conditions. In the second quarter, Class 8 retail sales in North America were up 13% to 86,000. The backlog at the end of June was 195,000.
In the second quarter, same-store commercial truck retail unit sales increased at Premier Truck Group by 23.2%, generating 427 million of same-store revenue, up 26% when a strong return on sales at 4.4%. Service and parts gross margin increased 50 basis points represented 64% of the total gross profit of the company and covered 119% of our fixed cost in the quarter.
As I mentioned earlier, we completed a Commercial Truck Dealership acquisition in July, which enhances our non-auto diversification and provides future growth and increased profitability.
Warner Truck consists of six locations, mainly operating in the Northern and Central transportation corridor of Utah and Idaho, a major crossroad for east, west transportation, coupled with our existing location across the South Central U.S. and Toronto. Our President stretches across several key transportation corridors in North America.
This acquisition is expected to generate over $1.1 billion in revenue, bringing our revenues from $1.4 billion to $2.5 billion on an annualized basis. With this acquisition, we operate 25 dealerships and are the now the largest Freightliner and Western Star dealership group in North America.
When compared to traditional car dealerships, the truck dealership business as a return on sales that are typically two times higher than a traditional car dealerships. Due to higher fixed cost absorption of 119% in Q2 and lower fixed assets to revenue, which are about 50% less than the auto business and lower SG&A, the gross profit of 64%. In fact, our business generally has averaged a pre-tax annual return in our truck dealership business between 23% and 25% on our acquisition costs.
Turning to our Leasing business. Our 28.9% ownership in PAG with equity earnings and cash distribution at tax benefits. PTL now managing a fleet of over 310,000 vehicles in the second quarter, revenue was up 10% to $2.3 billion. Net earnings for PTL increased 9% to $132 million.
Accordingly, we recognize $38 million of equity earnings and increase of $3 million or 8.6% over the second quarter of last year. Over the last 12 months, our investment in PTL is provided cash benefits of $75 million through distributions in cash tax savings.
Let me turn now to Australia and New Zealand. We operate a commercial truck and power system distribution business where we show Western Star, MAN, and Dennis Eagle commercial trucks. And on the power system side, we distribute to marine, defense, power generation and the construction industrial segments of the market. The key to driving the commercial vehicle in power system distribution business is units in operation. The units in operational will drive future service and parts opportunities.
In fact, we expect parts and service gross profits to represent approximately 80% of the total gross profit in this portion of our business. As such, we continue to collaborate with OEMs to drive sales across the on-highway, marine, military, and construction markets. Although our profitability was down approximately $3 million during the second quarter, and this was due to a large sale of defense service and defense contract equipment. Last year, we expect the second half to be stronger and we will make up the difference to meet our budget.
Digital initiatives. We continue to improve and enhance our digital capabilities. Across the enterprise, we have over almost 60,000 vehicles online ready to purchase. In the second quarter, 33% of our new and used unit sales in the U.S. were from digital sources and we continued to reduce our reliance on third-party leads.
The enhanced tools were introduced from our service department customers for online service appointment scheduling and online payments continue to perform well. During the quarter, our business development centers and online inquiries produced 400,000 service appointments for our dealerships. Every service customer in the U.S. has sent an invitation to pay by online. As a result, our online payments increased in the quarter by 68%.
We continued to pilot new digital retailing tools that focus on improving the customer experience, such as online estimating for our collision centers, video and digital pictures for our customers for service updates and upsell and an enhanced preferred purchase or online buying tool. Also we are on track to complete the docuPAD integrated document management software rollout by the end of the year with 70% now.
docuPAD is an interactive tool that allows us to engage customers digitally to menu presentation and document processing. We have approximately a $5 million investment for this at the moment. So far our customers, employees are favorably responding to a digital experience, transparency and we are driving higher F&I profits were implemented.
We continued to enhance our proprietary online post bid auction site in the UK. We have over 3,500 active online bidders and we wholesale over 11,000 vehicles in the first half of the year. Further, our UK franchise dealership begin the initial launch of its new digital dealership platform in the third quarter. This launch will occur in phases ultimately resulting in the capability to complete a total vehicle purchase 100% online.
Looking at our balance sheet. At the end of June, we had $44 million in cash and our total inventory declined $62 million to just under $4 billion. We have 1,215 vehicles on stop sale, representing 705 new and 510 used vehicles for a total of $44 million. Our supply of new vehicles was 78 days at the end of June compared to 72 at the same time last year. Our supply of used vehicles was 47 days at the end of June compared to 45 days at the same time last year. Floor plan was $3.8 billion, and non-vehicle debt was $2.2 billion, of which 35% is at fixed rates.
At the end of the quarter, we had no money outstanding on our U.S. revolver and only $92 million outstanding in the UK and we have the ability to bring forward $900 million from the UK without any tax consequences in the U.S. Our total debt-to-total capitalization was 45.6% and the leverage ratio was 2.7% flat for December last year. At the end of June, we had over $800 million in liquidity for acquisitions, dividends, and share repurchases and other corporate opportunities under our credit agreement.
Before I close, I'd like to congratulate the 33 U.S. dealerships that were recently named by Automotive News to the 100 best dealership to work for, for listing. We are honored for this accomplishment. This is a team effort. I'd like to thank all of your employees for their contributions.
Just before I close and open up for a call, I just want to point out that for the quarter we had $300 million of cash flow. Again, we paid $65 million at dividends with a return of 3.4%. We bought $130 million worth of stocks back and we had CapEx of $123 million and our debt was flat, so this shows the strength of our cash flow of this business.
PTL had a 10% increase in earnings to $132 million. We had $38 million of that that we took on our income statement and we were 30% higher than our biggest peer during the quarter. We also made the acquisition in the Warner Truck business, which obviously shows a much stronger return on sales than we do in our traditional business, giving us the ability to grow that business, and typically we think we can grow that business to nearly where we are in Premier over the next 12 to 18 months.
One other thing I think to point out with the truck business, we don't have the pure and interbrand competition on trucks. There is 134 partners across the United States, so we think we bode well with this strategy of diversification. And again, we think our used car superstores are in good shape as we had two more stores before we end the year, one in the UK and one in the U.S.
In closing, I'd like to thank you for joining us and I’ll open the call for questions.
[Operator Instructions] And first, it looks like we have the line of John Murphy of Bank of America. Your line is open.
Good afternoon, Roger and thanks for the time. I appreciate it.
Hi, John.
The first question I have is when we look at the $0.16 headwind that you guys highlighted from Europe as well as the Australia/Power business, just curious if you can break that out for us between new, used and maybe the power business, so that we can understand sort of how that will develop over time from market dynamics and your efforts to cut costs?
Well, let me take the 3% or the $0.03 basic that was Australia. This was basically a profitability on big service jobs that were built in the second quarter last year in Australia. This was defense. And then we had some big equipment sales that went through in the second quarter last year. As I said in my text, I think earlier we expect that to flatten out and we'll hit budget at the end of the year. From the standpoint of used, we've looked at that carefully and it's about 50-50 new car impact versus used car.
So I mean the opportunity on the used side, I mean, is there something in the business in our market other than the pricing dynamic or is this a question of working through some inventory that got hit from sort of the dynamics and pricing in the market? I’m just curious about how fast do you think that'll work through to then how fast the cost actions on the new vehicle side may help out?
John, good question. I think that obviously with pricing dropping as fast as it did 2% per month for the three months, we were caught with a lot of vehicles that were overpriced and obviously it slowed down our sales. In order to move those out, we have to reduce that and we're on a inventory reduction and overage vehicles today. I would say it's going to take probably 60 days, maybe 90 by the end of the quarter to get to where we want to be for overage vehicles and again then we can go out and buy vehicles so that we can make our normal margin back.
Something else you have to remember that with diesel sales being almost 50% of the market over the last three to four years, a lot of those cars are coming back and there really not vehicles that we want to buy and try to resell because people don't know whether they can drive them into London or other places in the UK. So that also has an impact. So I feel strong that we can right size ourselves. Obviously, we're going to have the addition of Bristol, which will help us from the used car perspective and our traditional business.
On the newer side, I think it's a little more complex because we have the OEM manufacturers pushing for registrations and we end up pre-registering in some cases, some brands in order to meet our bonus targets. And with that, we have young used cars really with no miles on them and those cars are sold really at lower costs.
Just to give you an actual point, at the end of the quarter, there was approximately 23,000 used BMW's online at the end of the quarter, 17,000 of those were less than a year old. So that pressure at the higher end of the used pushes all the way down and that's some of the impact we're seeing on the used car values. And I think we're going to work our way out of those hopefully over the next three months.
Okay. That's helpful. And then on the parts and service, it seems like customer paid was close to flat, the warranty was up 14%. That's a bit different than we seen from other dealers. Is there something going along with the mix of the business there and it seems like customer payout prices for other gears was a bit stronger.
Yes, I've seen those comps, and that made us look pretty hard at ours too, to be honest with you. And with that, we had a big comp on customer, labor last quarter, the second quarter of last year. Also, when you think about today we're about 55% premium luxury.
And with the premium luxury, we sell these maintenance packages and also it try to gives you a maintenance care, auto care, I think it's called, and with those that margin and that profit goes into warranty. It doesn't go into customer labor. So I think the full circle programs that they have some impact on that. But again, it's something that we'll continue to look at. But overall, our parts and service business is good.
We've reduced the number of technicians we need by 200 through the first six months and we continue to train. We're just – we just announced that we'll have a partnership with some of the Army basis where we can access military that are coming out of service and are looking to get into our type of technology. So we think that's a good partnership that we've developed with UTI.
Got it. That's pretty helpful. And then just lastly, this is kind of you combined with the Warner acquisition. I mean, if we think about you had a slight in near-term hiccup with that break it the best you know that’s exit, there's only so much you can do about that. But you still have very strong free cash flow and you have this high class, issue of how to allocate that free cash flow and that capital?
And kind of look at the three major buckets being sort of investing back in the core auto business or the core truck dealership business or the stock and sort of the three big buckets? You didn't Warner acquisition. So it seems like you're kind of leaning a little bit more to the truck side. But if you think about cap allocation, in your diverse portfolio, what direction are you kind of more leaning at this point and it should we expect more aggressive buybacks that we've seen or should we see more truck dealers just trying to understand which direction the business is going to get ahead maybe in the near-term?
Well, I think our management team, along with the Directors, of course look at the value of our stock in the marketplace and opportunistically we would continue to buy stock back. Obviously we're committed to do a dividend policy, which we've continued to grow each quarter. And then from an auto perspective, we'll look at the strategic acquisitions such as the Lexus businesses in Austin and markets like that that we would continue to add.
But when you start to look at the metrics and this Warner Trucks and came together quite quickly, when you start to look at the SG&A to gross profit, the return on sales, the capital that's required, the CapEx required to revenue it's a much better picture. And with less interbrand competition, I think that will continue to grow that business, we're exclusive with Freightliner to great brand they've got 40% to 41% of the market. So I would see us continuing to look at that.
We've got a strong balance sheet also when you think about our leverage is 2.7 and by taking on the Warner acquisition is we're going to go to 2.8 projected to 2.8. And I think that we're committed to growth in all three of these particular capital allocations. And I think we'll look at it on a quarter-by-quarter basis. There's lots of activity people calling us on acquisitions, which I'm sure is part of the Peer Group activity today.
And I think that we're going to continue to diversify. We think having the PTL, as I mentioned earlier, the Truck businesses, certainly that the standalone used car centers. We took a little bit of a hit in the UK as we talked about earlier, but we feel very good about it.
We're opening a new store between Philadelphia and Wilmington, a large store we'll do the same in Bristol and the UK and we'll have two open in the first quarter of next year. So we're on the ability to grow that we're going to grow it in the right markets, where they might be contiguous, where we can take advantage of our marketing and advertising.
So it seems like it’s more opportunistically the deal flow and the opportunity to come – differently than stay disciplined on share buybacks and dividends. And then the other channels are as returns are highest rate. That's a safe way to say kind of it's opportunistic over time.
I think it's opportunistic, but we're going to look at the core values that we have built already. Premium luxury, today, when you look at us overall were 66%, volume foreign is roughly 25%. So we're going to stay in that – we're going to stay in that probably mix. And then of course the Truck Dealership business, which has continued to grow, is a great opportunity for us. Because remember we run the largest truck fleet in the world with 316,000.
So our expertise, internally is very strong. A lot of the things that we're learning from the standpoint of predictive maintenance, the technology and what we're able to do with our mechanics, a lot of this will be, we'll be able to be carried over to certainly in our auto side. And I think that's to me going to be very good for us in the 20% plus return on our investments at least that's the history. I hope we can return that and we'll continue to return that. What we've had on Premier Truck since 2014 when we bought that business.
Great. Thank you very much Roger.
Yes, John.
Next in queue, we have the line of Rick Nelson with Stephens. Your line is open.
Thanks. Good afternoon, Roger and Tony.
Hi, Rick.
I have two follow-up on the Warner acquisition of – you could tell us where their margin structure? How that compared to premier truck today, the 4.4% and any opportunities to improve there and to learn about the acquisition multiple as well and how you plan to finance them?
Well, we'll use our working capital. We did use our working capital line to finance and obviously we had nothing out on our line at the end of the quarter. From an overall standpoint, this was a fourth generation business, and obviously things that they had inside their businesses, expenses. We obviously would pull out.
But as I said earlier, hopefully it won't be until we're mature. And when I say mature, when we get the consolidated completed, which might take 12 to 18 months to have it completely mature. We would hope to approach that 4% number. But I think it would be lower than that from the standpoint of we start out of the gate.
We've got some interest costs. You probably have some, some other costs that we'd have to deal with from the standpoint to build that, but from a gross profit, we think that there's a real opportunity from an SG&A perspective to drive that.
Plus we've got technology. Plus we got the ability to market one brand across our whole network. When you think about 25 locations, and the good news is from a real estate perspective, we bought no real estate and are on our rent is a percent of sales will be half of what it is on our traditional U.S. auto businesses. So overall I think we're in good shape. And the multiple was reasonable from the standpoint a multiple like this was probably around 5x.
But below what you would pay for an auto dealership without the CapEx requirements?
Well, the CapEx requirements, we had $2.5 million of CapEx – fixed assets and remember, no interbrand competition. We don't have any of the requirements on the CI, which you have obviously on the retail auto side. So that's a big factor.
And again, I talked about assets employed other than inventory is half of what is an auto. So you put it on paper side by side, there's no comparison. Now you don't get a deal like this every day. It's the same thing. You're not able to buy a Lexus in Austin every day.
So continue as I said earlier to John, we're going to continue to look at those as a board and as a management team to see what we do. But this is a strong acquisition for us driving revenue of $1 billion, for us who will be strong as we go out to the next 12 to 18 months.
Almost doubled your size down at premier truck with the steel, are there any framework agreement challenges now to grow from here?
Well, obviously we have certain framework agreements that you have with the OEMs and we're in discussion, we're not at the top of our limit right now, which was made a member a – number of years ago when we got into business. So we think there's obviously ability to grow and we're going to continue to talk to the customer or to the OEM.
And finally, if I could ask you about PTL, really strong performance here, I know it's a public peer report. It today and took their guidance down, just curious, your perspective on the outlook kind of for PTL.
Well as you, as I say, we had a 30% increase over our peer, pre-tax for the quarter, revenue being up, 10% and certainly from the standpoint of our pre-tax, but looking at a slowdown in the truck industry, light and medium duty market remain strong due to e-commerce and final mile delivery.
So medium duty, we don't see anything impacting that over the next 12 months because of – obviously it's final mile. And when you look at our business in our leasing and contract maintenance, typically these are three to four to five year contracts with economic escalators. So we're not in any risk there from the standpoint of losing that business.
Certainly, we have the benefit of defleeting and rental. And remember our logistics has two to three-year contracts also. But we can defleet and we looked at this marketplace over the last, really since the beginning of the year because we had such a strong year and rental last year and we could see the fleets now accessing the additional trucks they needed. So we could see some downward pressure on our rental utilization.
However, we got the numbers over 90%, which is not good. We need to be around 80% to 85%. That's our model. So we started defleeting our rental fleet probably back 90 days ago and we'll be down over 3,500 trucks. We're up over 18,500. So this will bring us down to probably around 15,000 in our rental fleet and we're still getting good utilization.
And I think that we feel good about the full service lease business because what's happening is many of the people that we access that are in ownership don't have the technology advantages that we have in our business and also the guided repair, that's voice-activated PMs and vehicle diagnostics. So we take that and that gives us cost reduction from the standpoint of heading the fleet plus we have the ability to find technicians.
We talked about people coming out of the service, things like that, that we can drive our business. They have a difficult time disposing of their trucks or we can tie that together with the packages that we sell. So overall, I see the market coming down, but still when you think about the – today the backlog is almost 200,000. I think it's 195,000. So we'll see some downturn in the heavy side, tractor side when I see the mid-range is pretty much static through the next 12 months.
All right. Thanks and good luck.
Thanks Rick.
Next up, we have Stephanie Benjamin with SunTrust. Your line is open.
Hi, Stephanie.
Hi, good afternoon. Hi, Roger. Hi, Tony. I just wanted to follow-up on your used super centers in the U.S., or I think the ability to see kind of flat GPU despite a negative volume environment is really positive. So can you talk a little bit about what you're seeing from just a demand perspective and the levers that you're able to pull the kind of protect profitability even in this environment? Thanks so much.
Okay. Number one, CarSense has had a DNA, a history of providing the best used vehicle that around 20,000 MSRP and they're very selective of what they're able to buy. So there's been some pressure on trying to find the right vehicles. There's no question about that. But during that time, we still maintain our margin. But with the front-end gross and also F&I, as I said earlier, we're at 3,000. So I think it's a discipline. I think we have low turnover of our salespeople. It's a salary plus a unit bonus. There's no margin being pressed.
We price the cars to market and again, we've been able to stabilize that, plus we have a good parts and service business there. So overall it's about execution, which I think they've been able to do consistently since we bought the business. And the good news is we're going to now open up a new location, which will give us an overall growth in the company. And really when you look at units, we're down 2% year-to-date through today and we're up 6% in July.
So when you think about this, I think we're on the right rotation now from the standpoint what we can buy and what we can sell. And with that, I think that we'll be able to lead our business through the third quarter with an up both year-to-date and for the quarter. So at least that what's reflected today. And the return on sale on this business is again, over 4%.
Great. Thanks so much for the color as always.
Thanks.
Next up, we have Armintas Sinkevicius of Morgan Stanley. Your line is open.
Great. Thank you for taking the question. My question is, as we start to think about RDE in September, what are you hearing from your partners with regards to the supply of vehicles that you'll have access to?
Well, this is the new standard. We had WLTP and RDE is real driving emissions where they – the WLTP did all of those tests on dynamometers. So now we'll get into looking at fuel consumption in certainly CO2 and NOx will be part of that. To me, we're still not getting through from an Audi or Volkswagen group, Audi, Porsche the vehicles that we would expect it to get through the first six months. So that's still an overhang. So I can't give you a clear path. I don't have a clear path on what's going to happen between now and the end of the year, especially with RDE. I would put a caution light on because they certainly haven't lived up to what we had expected to have through the first six months.
And then the other question in a bit of a different direction with digital you mentioned 33% of new and used from digital sources? Does that mean that 33% of the Retail Automotive units sold come from PenskeCars.com and third-party lead generators and just trying to get a sense of how many vehicles have you sold through PenskeCars.com this quarter?
Probably from our owned, obviously we're using websites, OEM sites, and probably somewhere around 8% to 10% of our – would be through PenskeCars.com and preferred purchase.
Okay. That's 8% to 10% of your Retail Automotive units.
Right.
Okay. Much appreciated.
Next up, we have Derek Glynn, Consumer Edge Research. Your line is open.
Thanks and good afternoon.
Hi, Derek.
As we think about SG&A in the back half of the year. We're in this backdrop of various potential headwinds in the UK, but also the Warner acquisition and some cost savings initiatives you just announced. What's the trajectory of expenses look like in the second half and do you think you can drive leverage on SG&A in the next couple of quarters?
I just to make a point, on if you compare Q1 of 2019 to Q2 we were down 120 basis points on a sequential basis, obviously we had some costs that we don't call out. During in our information that we provide you during the second quarter. But we think certainly with Warner being in somewhere in the 60s that should help us. And there's no question that Darren Edwards in the team in the UK have got a prescriptive plan on cost reduction that would – we expect to take out a significant costs over the last six months.
And you know, also it's not just about SG&As we also got to drive gross and obviously when you look at our new car grosses, really we're flat at 7.5%. Our used was down and that was primarily driven by the UK super centers because of the oversights used car inventory plus the pricing that we had. That was a high due to the lowering of the used car prices, 2% a month during the quarter. So that drove us to inability to sell some of those vehicles. But we expect to have that out during the rest of the year. So overall we expect to get leverage for sure.
Got it. Thanks for all the commentary.
Thank you.
Next up, we have the line of Rajat Gupta of JP Morgan.
Hi, thanks for taking my questions. Just wanted to start with the UK new vehicle business. One of your peers recently, [Dr. Bob], Electing to Forgo certain volume bonuses, by not says industry new equals? Is that something that you plan on doing or is that in your thought process?
Well, this is - I think what was mentioned, it was pre-registration, because what happens in the UK, you've got quarterly targets and if you hit these targets, it unlocks a significant amount of bonus. The problem is if you pre-reg these cars, and I think – and I heard that same comment. What it has, you then have a young used car really that has no mileage on it.
And I said earlier, that is BMW as an example had 17,000 out of 23,000 on the Internet at the end of the quarter that we're less than or less than a year old. So obviously it's a case by case basis depending on what the OEM is. It particularly, I know BMW was much tougher this past quarter. We've been able to manage that because of the size, we're the number one retailer in the UK and Northern Ireland about $8 billion in revenue.
So obviously we have more locations to spread some of those vehicles over, but we're going to be very disciplined. I would say this, we've talked to the OEMs about changing some of their programs to reducing these targets because if the targets are too high, it impacts them too because obviously it hurts their margins or hurts or residual values on a going forward basis. So we'll continue to manage that. But I think it's going to be on a case by case basis.
And again, the OEMs are going to have to manage inventory based on sales. Because when you look at the OEMs in the UK, the actual retail in some cases is only 40% of what's being sold. You've got mobility plans, you've got rental car, you've got corporate deals, and these sometimes in brokers and the brokers end up selling cars. If they buy cheaper at the end of the quarter, they sell those retail and we got to get through the volumes and stop that. That to me is a key option for them in the future.
Got it. And then you talked about some of the cost saving initiatives. Could you give us a sense of the actions that you're planning to take, is it would there be any costs associated with that initially? And then what kind of savings are you expecting from those?
Well, it's going to be several million when you think about it. Obviously, when you look at cost savings, I think there's opportunities for us with our loaner car programs, in our demonstrators. Certainly there's a lot more of that in the UK. We don't have – we have loaners obviously for service over here, but we don't have demos. We use cars that we would have in stock for a quick demo ride. Certainly a headcount will also – we'll look at, do we stop hiring? Do we replace people that trade out of the business? This will be an opportunity.
We can look at other activities buses outside services. Today, when we move a car from one location to another, we have a third-party to do that from the standpoint. We'll probably do that with our salespeople on a going forward basis, training and certainly other things that we'll be able to look at from a standpoint of cost.
But I think Darren's got a good plan. It's several million dollars of savings when we look at it. As I said earlier, over the next six to 12 months, and also we had costs in the UK for the building of our two new supercenters here. We have to carry people, redundant people when we're doing that to be sure they're trained to move into the next location. So there is some costs associated. We don't call out those costs obviously because they're not material in our numbers.
Got it. Got it. Just last one from me, just from the balance sheet capacity. You probably ended 2Q around 2.7 probably goes up slightly with a Warner acquisition. How much – I mean you generally a good free cash flow every year? How much could you stretch that leverage to for the right deal in the future, either like a rough range you could go to or do you think, you want to be at?
Well, right now we were 2.7 at the end of the quarter. But we'll be at 2.8 as we talk based on the acquisition. But the cash flow out of that business will be strong and we're expecting profitable business between now and the end of the year.
We don't have a number. I guess we'd have to sit down with our Board. At any time, there was a significant acquisition that would put us in a position. But I guess you could stretch it to 3.3. The way we're calculating today and again when we did PTL, we were at 3.3.
Got it, okay. Thanks a lot.
Next in queue, we have the line of Michael Ward of Seaport Global. Your line is open.
Thanks very much. Good afternoon, Roger. Good afternoon, Tony.
Hi, Michael.
If I'm looking on a churn on Page 5, so when you're operating cash flow. In $300 million in the first half, but on an annualized basis, you basically have doubled over the last five years with operating cash flow. And if I got this right about a third of that has come from retail auto, a third of it from PTL and a third of it from retail truck. Is that about right?
I'd have to look at the numbers exactly. But I'm assuming you've done the calculation.
But directionally that's about right, okay.
Right.
So, if I look at that, then the actual sustainable portion of that operating cash flow that is less subject to cyclical risk has grown closer to 3x, because of the parts and service in PTL?
Well, when you think about the PTL cash flow, I think I said earlier at $76 million of cash benefits to PAG for the last 12 months. That's cash and also a tax cash savings that will continue as PTL, but they continue to buy equipment and we get the benefit of the accelerated depreciation that that lands on our portion of that partnership.
And then of course with a truck business, it's 64% to 65% parts and service gross profit. That will continue even if we have some softening in the topline in on the new and used truck sales. So overall then you look at Australia with 80% coming out of parts and service and that's certainly sustainable.
So I think we've got a good model. And that cash flow I think will continue to be strong even with some slight movement in the new car SAR and maybe even the UK Brexit issue that we'll have to face here for the next probably three to six months until we see about Brexit [indiscernible] Boris Johnson [indiscernible] will they go to a hard Brexit and have to have another election?
So is that what you look at just the ultimate goal to have a higher level of more sustainable cash flow? The ultimate goal of your global transportation services business?
Well, I think we have to look at your cash flow from the standpoint of any business and remember we started this business back, when in 1999.
Not everybody looks at it that way?
Well, I think that cash flow is very important. Now obviously, we've been aggressive in investing in facilities from the very beginning. I think some of our peers find out now as you get into premium luxury, some of these numbers are pretty big. I think we're being probably a little – will scrutinize some of these deals a little further. We pushed back on the OEMs in some cases.
But from a cash flow, today obviously we're not running 1-to-1 and we need to be sure that we have cash flow to cover our dividends. Corporate CI obviously is something that we do. The stock buybacks, which we talked about earlier in the conversation today, is certainly something that the directors look like. And I think that most important is that we're giving a payout of 30%, so we need to manage the cash flow, and I think with the 45 to 60 and 80 when you start looking at parts and service as part of our total gross profit, that's going to continue to allow us to get good cash flow.
Perfect. Thank you. Thank you very much for your time, Roger.
Thanks, Mike.
And next in queue, we have the line of David Whiston of Morningstar. Your line is open.
Hey, David.
Thanks. Hi guys. I wanted to go back to the issue of pre-registering in the UK. Group One in their cost specifically said they didn't want to pursue these targets. You guys, at least this quarter did. And I know there's probably a different brand mix between the two of you guys. You're being – you guys are in the premium and more, but just how important it is getting that quarterly bonus for you guys every quarter. And just can you talk a little bit about the thought process that you and the leadership team have as to, do you want to take that route each time?
Well, look we've been taking advantage, I don't know if we take an advantage. We've earned that big bonus for the last what, since 2001 or 2002 when we bought the business. That's been a component of the profitability in some of the larger German luxuries. Obviously with the market changing today and the pressure to move vehicles and our targets are higher than in many cases than the market growth is.
Obviously, we have a decreasing market and when we get to higher growth targets, it pushes you, and I think that the guys at Group One, maybe had a smaller number and we've looked at ourself, I will say we did hit the bonus number, but what we do have is a reciprocal of that is, we have more what I call young used cars, zero kilometer cars, and we have to sell out and we got 17 BMW stores.
So we can do that probably pretty efficiently. But again, we would rather have – we had purchased at market and not they'd be in this young used car business. So I think it's really OEM by OEM, other OEMs we're fine. We don't have any of that. So I've met lately with a BMW people specifically to talk about targets and I think it's an ongoing negotiation.
We had some of this in Spain, we were able to no negotiate that Italy is fine and now we're talking about the UK. And I think there understand that the management at the senior levels in Munich understands they can't push these targets. On the other hand, when you're looking at the U.S. I think it's very well balanced.
Okay, thanks. Moving on to Trucks. The new vehicle volume was obviously very, very good, but F&I suffered. And can you just talk about why, F&I was down so much?
That's obviously because of the more units we sold. You see you've got to look at we sold a considerably more units in the quarter. You look at, I think that today we've probably got a little more fleet business. And in the customer finance area, this is basically they do their own many of them company was with their own financing. Now, the one good thing is that we have a strong F&I department at Premier and we expect to take that same capability into Warner. And I think that this varies quarter-to-quarter.
Okay. And on the M&A environment, is it fair to say you might have a preference towards the truck site now versus light vehicles or just depend on, but the deals that come up?
I said look, this Warner deal came up probably – came up and closed in the last 90 days. We're not going to – we're not getting out of the auto business for sure. But again, you remember we made the acquisition at the end of December to get the two Lexus stores and in Austin, which we think was strategic and we sold two stores in New Jersey.
We're going to continue to prune the under performing dealerships out on an ongoing basis similar to our peers. And we're going to look for opportunity or we can Google them on where we have market scale already. And I think that we're not going to sit here just saying its trucks are going to be cars.
And I think that's the importance of our diversification. Is there more opportunity out in Asian and Pacific area where we are? There could be real opportunities out there that we would be able to add to our business in that part of the world.
Again, as we look at the truck business, I know that a Freightliner is continuing to consolidate and 134 partners. I know they want to bring that down. So and some of their people are willing to sell. We could add to that. So it will be a balancing discussion. But really our Board really comes into that discussion from the standpoint of where we want to put our capital.
I said earlier, I think the Mike Ward, look, it's dividends, it's corporate identity, the stock buyback and I think it's acquisitions and I think all of those take priority of each, other depending on what the requirement might be in the opportunity.
Thanks. And since you mentioned opportunities in Asia, do you have interest in going into China?
This time, no, we looked at that a number of years ago. We do not have interest going to try. I'm thinking more of areas where can we add Indonesia, where we have business, today with [indiscernible] are there big mining there. We're doing a lot of business there too. We establish that dealer group there. These are things we can do out of Australia without – with very little costs and would give us good coverage. I think there's opportunities there.
Okay. Thanks guys.
Thank you.
And with no further questions here in queue, I'll be happy to turn it back to the Company for any closing remarks.
Okay, Justin. Thanks for the time and we'll see you folks on the call next quarter. Thanks.
Ladies and gentlemen, that does conclude the presentation for this afternoon. We thank you very much for all of your participation and using our executive teleconference service. You may now disconnect.