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Edited Transcript of ACQ.TO earnings conference call or presentation 9-Aug-19 3:00pm GMT

Q2 2019 AutoCanada Inc Earnings Call

Edmonton Aug 14, 2019 (Thomson StreetEvents) -- Edited Transcript of AutoCanada Inc earnings conference call or presentation Friday, August 9, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kevin McPherson

AutoCanada Inc. - Director of Financial Reporting

* Michael Rawluk

AutoCanada Inc. - President & Director

* Paul W. Antony

AutoCanada Inc. - Executive Chairman

* Tamara Darvish

AutoCanada Inc. - President of U.S. Operations

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Conference Call Participants

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* Christopher Allan Murray

AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst

* Derek Dley

Canaccord Genuity Corp., Research Division - MD & Consumer Products Analyst

* Maggie Anne MacDougall

Cormark Securities Inc., Research Division - Director of of Institutional Equity Research

* Matt Bank

CIBC Capital Markets, Research Division - Associate

* Michael Doumet

Scotiabank Global Banking and Markets, Research Division - Analyst

* Roland Keiper

Clearwater Capital Management Inc. - President

* Stephen C.A. Harris

GMP Securities L.P., Research Division - Head of Research

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Presentation

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Operator [1]

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Good morning. My name is Julie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the AutoCanada Second Quarter 2019 Results. (Operator Instructions) Thank you.

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 dated March 14, 2019, which is on the SEDAR website as well as on our website within the Investor Documents and Filings section. I will now turn the call over to Kevin McPherson, Director of Finance. Please go ahead.

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [2]

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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; 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 market closed yesterday. A copy of our results is available for download on our website. For today's call, we will be discussing the current state of the business, discussing the financial results and providing an update on both our Canadian and U.S. Go Forward Plan.

With that, I'd like to turn the call over to Paul.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [3]

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Thanks, Kevin. Good morning, everyone. Thanks for joining us on today's conference call. I'm pleased to report that Q2 represented a significant step forward in our continued efforts to drive operational performance of AutoCanada. This includes our Canadian operations, where I feel we've finally been able to start playing offense in the quarter, as well as the U.S., where we've seen continued progress in stabilizing the business. Specifically in Canada, we saw momentum across almost all geographies and lines of business. This includes same-store gross profit growth of 6.8%, a metric I'm particularly proud of and represented clear out-performance versus the entire Canadian market. The Go Forward Plan also drove performance, as Michael will explain in his remarks. This resulted in the strongest adjusted EBITDA quarter in Canada since the current management team started. I'm also pleased to report that this momentum continued into July. We also continue to look closely at the Canadian dealership portfolio, which led to the divestiture of 2 dealerships during the quarter. We have no plans to divest any additional Canadian dealerships this time. U.S. performance continues to be a different story. Although we've seen meaningful progress in the geography and remain committed to our publicly stated goal of optimizing our U.S. dealership portfolio in the near term, we've taken several steps towards achieving this, led by our U.S. President, Tamara Darvish, who has now been in the role for 5 months and is actively implementing the U.S. Go Forward Plan.

As an example, our Q1 normalized operating loss of $6.9 million was reduced to $1.8 million in Q2. Tammy has also continued to upgrade talent across the dealership network in addition to leading our rebranding initiative to Leader Automotive Group.

We've also made the decision to explore the sale of 4 U.S. dealerships which fall below our performance expectations, with those efforts actively ongoing. I remain highly confident in Tammy, and I'm encouraged by what I've seen in Q2.

I'd also like to comment on our balance sheet and our continued effort to position the company for long-term success through appropriate capitalization. This has been and remains a high-priority focus for the company. And I'm happy to report that over the last 4 quarters, we reduced total debt, excluding floor plan, by $127.1 million, corresponding to a decline in total debt on the business from $417.2 million to $290.2 million over the same period. This not only reduces cash debt service significantly, but better positions us for effective management of our cap structure going forward.

We've also received incredible support from our banking relationships, including the recently announced extension of our increased debt-to-EBITDA covenants. While remain closer to the 4x leverage than we would like and will consider asset sales to improve this metric, the team is primarily focused on continued execution to meaningfully improve this metric over time.

Last but not least, I'm pleased to report that Mike Borys will be joining the AutoCanada team as CFO, effective August 12, 2019. Mike is a chartered accountant with over 20 years' experience as CFO for both public and private enterprises. Mike's proven track record and extensive finance and management experience will be instrumental in driving execution in both Canada and the U.S. On a related note, I continue to view our ability to attract top talent to the AutoCanada team as a huge validation of our franchise and long-term vision.

I'll now turn the call over to Kevin to discuss our financial results.

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [4]

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Thanks, Paul. Before I discuss our Q2 highlights, I want to ensure that everyone is aware of the changes that have occurred with the adoption of IFRS 16 that took effect on January 1, 2019. The adoption of a new accounting standard has resulted in both changes to the balance sheet and the income statement. We have provided enhanced disclosures as part of our MD&A in order to help clearly articulate the impact on our operating metrics for 2019.

Our intent is to provide the highest-quality reporting and transparency of results to all users of our financial information. As such, I'd like to point out that we have updated our definitions and the use of non-GAAP measures as presented for the current period. Adjusted EBITDA, a non-GAAP measure, has been redefined and is now calculated on a basis which represents the recurring operating results. Specifically, we have adjusted out gains and losses that are not part of our core dealership operations. Please note that the comparative periods have been presented under the new definitions within our Q2 2019 MD&A.

At the consolidated level, we saw improvement on many significant metrics. From both a revenue and gross profit standpoint, we had a good quarter of positive performance over prior year. In Q2 2019, revenue was $945.8 million, an increase of $116 million (sic) [$65.2 million] or 7.4%, and gross profit grew to $153.4 million, an increase of $12.8 million or 9.1%. Adjusted EBITDA increased 91% to $32.1 million, an increase of $15 million. Please note that the adoption of IFRS 16 contributed $10.4 million to this increase, with operational improvement contributing the balance.

In order to fully understand the numbers as a result of a different operating economic environment, we've broken down the results between the Canadian and U.S. operations. For the second quarter, the Canadian group generated higher revenue and gross profit against Q2 2018. Revenue was $829.7 million, up 6.4%. Gross profit grew to $138.1 million, an increase of $11.5 million or 9%. In addition, adjusted EBITDA increased 101% to $32.3 million, an increase of $16.3 million. IFRS 16 contributed $8.4 million to this increase, with operational improvements contributing the balance.

Total vehicles sold also increased to 16,983, which is 5.3% higher than the previous year. For our U.S. operations, revenue was $116 million, 15.6% higher than Q2 2018, and gross profit increased to $15.3 million, an improvement of $1.3 million or 9.6% over 2018. We are continuing to work on our operational efficiencies in both groups. Specifically, the Canadian operating segment did see an improvement in operating expenses, cutting it to 81% of gross profit, which compares to 89.6% in Q2 2018. The adoption to IFRS 16 resulted in a reduction to operating expenses of $2.5 million or 2.3%.

AutoCanada continues to dispose of unproductive real estate assets, which resulted in the sale of $4.4 million of vacant land in the 2019 second quarter. We also are actively marketing $23 million of unproductive real estate.

In June, we completed the sale leaseback of 3 dealership properties for a purchase price of $30.4 million. Funds from the sales were used to pay down our revolving credit facility. On July 29, we announced our credit facility amendment that extended the total funded debt to bank EBITDA ratio to 4.5:1. And that's for the period of July 1, 2019, to March 31, 2020. We've also declared a quarterly eligible dividend of $0.10 per common share on our outstanding common shares, payable on September 15, 2019, to shareholders on record at the close of business on August 31, 2019.

And with that, I will turn the call over to Michael.

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Michael Rawluk, AutoCanada Inc. - President & Director [5]

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Good morning, everyone. We'd like to start with a big thank you to all of our team members, our dealers and head office support team. We're very proud of everyone for the performance they produced this quarter. I would also like to thank our OEM partners, strategic partners and everybody that's helping this full team effort to improve operations. This is truly a group effort, and we thank everyone.

We started the Canadian recovery process a year ago, beginning with the full operational review, followed by the creation of the Go Forward Plan. Implementation started in the fall, and we then spent the winter building up new profit centers and getting comfortable with an adjusted operating methodology. While the early part of this year was soft for the overall market, momentum really built into the spring, and we saw that momentum on full display in Q2. As a result, we are seeing positive performance from our Canadian operations on the Go Forward Plan. Vehicle sales are growing in a down market on a same-store basis. In fact, total vehicles sold increased to 13,651, 8.3% higher than the period a year ago. This includes a 1.4% decline in new vehicle units for AutoCanada on a same-store basis versus a market decline of 7.8%, but also includes a 24.5% same-store increase in used vehicle sales, a great example of our Go Forward Plan efforts. This performance translated to same-store revenue growth of 4.7% and same-store gross profit growth of 6.8%.

All the same-store metrics aside, our Canadian operations also grew total vehicle sales by 9.4%, revenue by 6.4% and gross profit by 9.1%, and adjusted EBITDA grew by 101.4%. This increased profitability reflects decreased costs on an absolute basis and decreased costs on a percentage of gross basis. In addition to vehicle sales, service -- or in addition to vehicle sales, service, parts and collision are also growing and were meaningful contributors to this performance.

Our business development initiatives with strategic partners like Kijiji and DealerMine are producing double-digit growth in their respective areas, and the new profit centers are just starting to make strong contributions. New initiatives include a special finance division, which has recently started marketing online to credit-challenged customers through RightRide.ca (sic) [RightRide.com]; a new wholesale division that is capitalizing on arbitrage opportunities for used cars; long-term initiatives to sell more used cars; and a new strategy for collision centers and increasing our occupancy in our service bays. While we have lots of work to do, I'm very pleased with the progress we've made in the first 6 months of 2019, and we're all very enthused about the second half of the year. Tamara, over to you.

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Tamara Darvish, AutoCanada Inc. - President of U.S. Operations [6]

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Good morning. Since joining the company in March, the last 5 months have been focused on evaluating our U.S. operations and starting to implement our U.S. Go Forward Plan. These efforts are focused on expense management, dealership-level initiatives and department-focused gross profit initiatives. While preliminary, we started to see a turn in a relatively short period of time. This includes a meaningful reduction in our operating loss for Q2 as compared to Q1 when normalized for impairment charges. Specifically, operating profit loss for the second quarter of 2019 improved to $1.8 million versus $6.9 million for the first quarter of 2019. Importantly, operating expenses also decreased to 113.6% in the second quarter of 2019 from 152.7% in the first quarter of 2019.

Strategically, we have also rebranded our U.S. dealerships to Leader Automotive Group, and the reaction has been very positive. I have also been very pleased with our ability to recruit talented dealership professionals as we continue to further reinforce best-practice processes within the businesses that should drive further benefits in the third quarter. I, too, would like to thank all of our hard-working team members and partners, who are the key to helping us deliver on our U.S. Go Forward Plan, and I look forward to working with everyone in the coming months. Now back to Paul.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [7]

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Thanks, Tammy. Before we finish, I'd like to thank our team of more than 4,000 hard-working AutoCanada team members, who are the key to helping us deliver on our Go Forward Plan in both Canada and the U.S. I'd also like to thank all the support from our strategic partners, financial institutions and OEM partners, as Michael and Tammy have as well.

Without everyone's support and devotion to the Go Forward Plan, this opportunity to turn this company around would not exist, and we would not be on the trajectory we're on today. As we continue down this bold path, we believe that we have the right team and the right culture in place to deliver continued improvement in results as we continue to move forward into Q3.

We appreciate everyone's patience and continued confidence, including all of our long-term investors who share our vision for the success of this company. Thank you. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Chris Murray with AltaCorp Capital.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [2]

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Maybe we can return to talking about the U.S. operations for a second. Tammy, I appreciate you've only been there a few months, but one of the things I know we talked about maybe more extensively was some of the more granular moving parts around the Canadian Go Forward Strategy. But do you mind giving us some additional color on exactly -- maybe some of the more key levers that you see in the U.S. operation? And the other piece of that is your thoughts around the path to profitability for the stores you're going to keep and thoughts around why you're divesting 4 stores, and the timing of that as well would be appreciated.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [3]

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So, this is Paul. As far as the divestiture of the 4 stores, we'll just say that we're in process, and we're not at liberty to discuss anything more than that. But we are currently managing a process. I'll let Tammy take over the questions, I mean with regard to the expense reductions and increased revenues.

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Tamara Darvish, AutoCanada Inc. - President of U.S. Operations [4]

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Good morning, and thank you for your questions. I think the key -- some of the key initiatives that have made the most meaningful difference for us in our expense structure begins first with a lot of vendor contracts, that 100% of them were renegotiated; some consolidation throughout our operations, specifically on the accounting and finance side of our business; a lot of restructuring of compensation to be more performance based rather than fixed compensation; and most importantly, ensuring and making great efforts in ensuring that we have the right people in the right place.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [5]

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Okay. So back to the path, I mean, I guess what we're trying to understand, I mean, there is certainly a different profile of dealerships in the U.S. versus Canada. But at what point -- or maybe a different way to frame it is those extra 4 stores that you're thinking of divesting, what's your thinking around kind of when you think you get back to a normalized level of profitability comparable to what you'd see in typical U.S. dealerships?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [6]

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So what we're aiming for right now is -- in previous months, we've only discussed the previous [quarter meaningful]. We're just trying to figure out what we have. We now know what we have there. Implementing on the Go Forward Plan in the U.S., which involves selling more used cars, more finance and insurance, more service, more fixed ops. Our goal is over the next 6 months to make those stores at minimum breakeven and then start turning the corner to actual profitability and that's [our goal].

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [7]

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Okay. All right. That's helpful. And then just for clarity, I don't know who wants to take us this, the impairment charge that you're taking for the 4 stores that you are going to sell, is that a goodwill impairment or does that actually have something more to do with the leasing profile?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [8]

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It's Kevin here. You have that correct. It is associated with goodwill, so it would be more or less the valuation [of the dealer stock].

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [9]

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Okay. And that's just your expectation of what you're going to go -- and then you did mention, I think, in the notes that there could be some further impairment depending on the final purchase price.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [10]

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Yes. So as I said, those stores are in process right now. And as a result of our learning from the process, we've come to realize the actual market value of those stores.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [11]

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Okay. And then just a quick question for you. Just maybe looking at some of the parts in Canada. I mean, certainly, the sales numbers are pretty impressive. There's just -- one of the things that we kind of noticed that you guys didn't report on was your absorption rate. And I know that's been a bit of a discussion around your utilization of your bays. And you talked about bringing in some CRM product and some call center product to try to help improve that. I'm just kind of curious on how that's been trending in terms of service and any reason why you've stopped reporting your absorption rate.

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Michael Rawluk, AutoCanada Inc. - President & Director [12]

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Yes. It's a good question. We could report the absorption rate in future quarters. And we'll take that as a takeaway. For right now, we're obsessing about service bay occupancy. We want to maximize all the existing real estate that we have right now. We think that absorption is a byproduct of that. And so we're just focusing on the measurements that we feel that really control -- that we can control, and we'll take care of (inaudible). That's the takeaway.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [13]

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But the other thing, and Michael, you might want to talk about this, and I don't know that we've really talked about this, but what we have is, when Michael started, the service bay occupancy was, Michael, I think it's...

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Michael Rawluk, AutoCanada Inc. - President & Director [14]

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43%.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [15]

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43%. And now, because of our relationship with DealerMine and actually selling service bay occupancy, I think we're...

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Michael Rawluk, AutoCanada Inc. - President & Director [16]

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North of 60%.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [17]

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So north of 60%. And in fact, we're actually actively retaining talent that's actually going to manage the inflow of service work that we're getting in the bays. So we're actually having to hire more mechanics to actually take care of the volume that we have.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [18]

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Okay. So yes -- all right. We're just trying to -- I mean, again, back to -- I'll just make the comment, we're trying to understand the path towards it. I know that getting that number up has been something you've talked about as a key component. So I'm just curious about the changes.

And then finally, Paul, you talked about Canada seems to be somewhat stabilizing, [rest] of the last couple of stores as you've seen. As we move into the back half of the year, just thinking about as the leverage metrics improve, part of that, you would assume, would be rolling into a better EBITDA pattern as you roll off some weaker quarters. How should we be thinking about longer term your thoughts around acquisition strategy? I know you really haven't been adding anything there of late. But any additional thoughts on that, both from a geographic and brand perspective, if you wouldn't mind?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [19]

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Yes. Listen, this is probably the most exciting thing that I have to talk about because if you look at what Michael and our team in Canada have done, we're actually outperforming the market by a big margin. And so I think we're outperforming the entire market by 6%. But if you look at just the brands that we have, I think we're almost 9.1% outperforming the market.

And if you think about that, that overlay on acquisitions is actually really exciting. It means that when we take over a store, which we've demonstrated with both Rose City and Heritage Valley since we've purchased them, we're able to get operational efficiency out of them. And so that actually -- that whole notion of being an acquisition engine in Canada puts us in a great spot. And so building out this kind of machinery that we have, and that Michael has done in Canada and Tammy's endeavoring to do out of the U.S., is going to be exciting as we kind of trend into the future. We're getting calls all the time on stores, but building out that capability and the muscle to deliver on operational excellence has been job #1. We talked about selling off real estate, paying down debt, but the real test is going to be operating, right? And so as we continue to operate over and above the market, every acquisition that we make becomes accretive to our company, and we're very excited about that.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [20]

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All right. And any thoughts about what we should be looking for in terms of leverage levels before you start getting comfortable to get back into the acquisition space?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [21]

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Again, we still have a lot of wood to chop when it comes to operating the business. And so our key focus right now, as Mike is going to take the chair as CFO, what our -- what we're very concerned about and what we focus on every day is getting our balance sheet clear. Once we do that and continue to operate our way into a good financial position, we're looking forward to making acquisitions.

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Operator [22]

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And your next question comes from Michael Doumet with Scotiabank.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [23]

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That was a great quarter. So I'll start with Canada. Obviously, a strong improvement sequentially, more than can be explained by normal seasonality. So nice to see your initiatives kick into gear. Two questions, can you discuss maybe on a month-to-month basis how the Canadian business performed? I'm just trying to get a sense for the trajectory of the improvements through the quarter and into Q3? And second, can you discuss in some depth the initiatives and how they ramped through the quarter, just to get a sense for how the initiatives are tracking starting Q3 versus where they started Q2?

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Michael Rawluk, AutoCanada Inc. - President & Director [24]

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It's Michael here. So just to give you a flavor, I would say that in the winter, we were just retooling, reorganizing, like we're going through a material -- a material change in the business and also building brand-new profit centers. We started going in January and February. We had a little bit of a false start. And in March, we felt the first impact of new operating methodology and some of the impact of the new profit centers. That continued into April and May into June.

The performance and improvement is felt across all business lines, which is something that we're all very proud of is that you can see it everywhere. And in addition to that, you can see it in all the brands and in all of our geographies, like from coast-to-coast, there's improvement absolutely everywhere. And so I will say that the end of Q2, we felt very, very good about the talent that we had, the new profit center performance, the contribution across all of our business lines. And we felt a great sense of momentum going forward. To put it I guess anecdotally, we are just getting started, and Q2 was just a little bit of a glimpse into the impact of some of the changes that have been made over the last number of months. So we have a lot of -- we can't really talk about July, but let's just say that there was quite a bit of celebrating going on as well. And we feel confident.

I have to say, too, that when you back up and you look like 10,000 feet, you back up from all these temporary problems that there's a lot of smart people fixing right now, and everybody's aware of the problems and everybody is fixing them. But if back up and look at the organization as an auto group, we have a world-class operating platform. We have the best people in the business. We've got BMW stores, Mercedes stores, Audi stores, VW, Nissan, and we have had a lot of FCA stores in the right spots. Like, we're not selling Ram trucks in Downtown Montreal or Toronto. We're selling Ram trucks in Alberta and Edmonton. And these are very strong and profitable stores. So it's hard to reconcile what's going on. But I'll tell you, from an operating standpoint, is this is a world-class organization. And once we get through this little bit of rough patch, we will be the consolidator in the country.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [25]

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There's actually one more thing to add to that. And just quickly, [it shows up] to all of our stores, but we had the #1 and #3 BMW stores for 1 month, and we're very excited about that. We're very, very excited about seeing these stores kind of turning the corner and really, really operating at maximum efficiency. So I mean, that's just one of many anecdotes.

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Michael Rawluk, AutoCanada Inc. - President & Director [26]

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Yes. I can go through -- I can spend 20 minutes going through all the #1s and new record sets and everything else I've got. It's a strong operation.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [27]

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Yes. No. Maybe we could take that off the call. But look, in the same vein, in terms of what's been realized and what has yet to be realized, I think at some point, it was discussed that the company could generate, I think it was $30 million of EBITDA beyond 2019. I think service was quoted as a driver; used car sales, a driver. So without necessarily pinning you down to a number here, can you give us a sense for the magnitude or maybe the opportunity of growth beyond, call it, 2019 or even next quarter?

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Michael Rawluk, AutoCanada Inc. - President & Director [28]

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Well, what I -- what I will say, hopefully just to provide some value, is that we're keenly aware of the EBITDA margins for our peer group. And we don't see any reason why we can't hit those. The only variable is time.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [29]

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Okay. And for that EBITDA margin, would you say that it's a matter of getting more gross profit with sort of the same base here? Or is it a cost issue?

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Michael Rawluk, AutoCanada Inc. - President & Director [30]

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Well, like I would say, some of -- if you talk about the largest quantum drivers, it's used cars and it's service and parts. And that's the growth generation.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [31]

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And that's just starting, correct?

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Michael Rawluk, AutoCanada Inc. - President & Director [32]

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Just starting.

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Operator [33]

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Next question comes from Derek Dley with Canaccord.

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Derek Dley, Canaccord Genuity Corp., Research Division - MD & Consumer Products Analyst [34]

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I just wanted to follow up sort of on that last comment. Are you guys -- I mean, I'm assuming a big part of the plan would be used vehicles, to convert some of those used vehicle buyers into your parts and service business. So have you started to see any of that customer conversion happening in the early stages of what's been some strong used vehicle growth?

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Michael Rawluk, AutoCanada Inc. - President & Director [35]

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Well, we're tracking -- well, the impact of the strong used vehicle growth is initially felt in the reconditioning of those cars. And -- but we are tracking used car customer retention, and we have a bunch of programs within our finance and insurance operations, like products like extended warranty and prepaid maintenance, which we have a huge focus on, to make sure that we bring these customers back.

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Derek Dley, Canaccord Genuity Corp., Research Division - MD & Consumer Products Analyst [36]

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And then what would be sort of the margin -- is there a margin differential between a used car using a -- a used car buyer using your parts and service, collision versus a new car buyer?

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Michael Rawluk, AutoCanada Inc. - President & Director [37]

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Yes. Service retention is much higher for a new car customer. But if you focus on it from a used, again, really pushing products like extended warranty and prepaid maintenance, you can close the gap, you can get close. But typically, your new car retention is a lot higher.

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Derek Dley, Canaccord Genuity Corp., Research Division - MD & Consumer Products Analyst [38]

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Okay. So I meant just on a percentage basis, is there -- do you see a delta in the margin percentage for parts, service and collision between those 2 buckets?

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Michael Rawluk, AutoCanada Inc. - President & Director [39]

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Yes. The margin is much higher for used cars from a reconditioning standpoint and also customer because it's an older car. Yes, there's more repair work rather than maintenance and oil change.

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Derek Dley, Canaccord Genuity Corp., Research Division - MD & Consumer Products Analyst [40]

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Okay. That's helpful. Just in terms of some of the brands, I appreciate you guys still have a sizable exposure to FCA, which I suspect will increase a little bit now with the divestiture of the Honda dealerships. Have you -- can you just talk a little bit about some of the trends you're seeing in terms of OEM incentives? And maybe if you could specify for the FCA brand that'd be helpful, but just overall as well.

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Michael Rawluk, AutoCanada Inc. - President & Director [41]

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Well, are you talking dealer incentives or customer incentives?

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Derek Dley, Canaccord Genuity Corp., Research Division - MD & Consumer Products Analyst [42]

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On the dealer side?

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Michael Rawluk, AutoCanada Inc. - President & Director [43]

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Yes. On the dealer side, I would say there hasn't been much change in that regard. We're a lot more focused on aligning our efforts with the OEMs so that we can maximize the dealer incentive money. It's not as simple as just selling cars, but it's how you sell cars and your customer service index scores and market share and everything. So we're a lot more aligned with the OEM, which we have seen an improvement. A lot of the gross profit improvement on the new car side has come from better alignment with the OEMs and maximizing that incentive money as opposed to getting those additional dollars from the customer.

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Derek Dley, Canaccord Genuity Corp., Research Division - MD & Consumer Products Analyst [44]

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Okay. And then just more generally speaking, we saw the July sales numbers in Canada come out, and Chrysler was exceptionally strong. Is there any reason for that or can you point to any color there?

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Michael Rawluk, AutoCanada Inc. - President & Director [45]

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The Jeep brand is strong. The Ram truck is starting to catch on. It's -- we like FCA. And I know that we've heard we have too much FCA. I'll tell you from my standpoint, we're very happy with the FCA we have because we have the right stores in the right locations. They're very profitable dealerships, and the Ram brand, and especially the Jeep brand have a huge, loyal following. So I like our portfolio.

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Operator [46]

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You next question comes from Matt Bank with CIBC.

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Matt Bank, CIBC Capital Markets, Research Division - Associate [47]

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My first question is, could you share how you expect your debt levels to evolve through the back half of this year, both from a free cash flow perspective, which I presume will be stronger in the second half, and then any timing you can give in terms of the more lumpy stuff like the divestitures?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [48]

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Yes. Thanks, it's Kevin here. So we've taken a lot of strides over the last year in terms of paying down our debt, so we're definitely focused on that. We've been pulling levers that are available to us through sales of our kind of redundant land pieces, some of the sale leaseback transactions. So we're going to work with our lending partners in regards to getting the covenant relief extension into March. So kind of with all of that going forward and the improvement in the operations, we're seeing a really good trend into where we think we're going into -- way into the latter half of the year.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [49]

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And just to add to that. Listen, we've been very disciplined about paying down that debt by the sales of real estate and just doing whatever we can to make sure that we're within our covenants, but getting that extra boost from our lenders, who also have a high degree of confidence in us, along with operating, is going to be the true solution to long-term righting of the balance sheet.

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Matt Bank, CIBC Capital Markets, Research Division - Associate [50]

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Okay. And then I wanted to ask on operating expenses. So just wondering, that $129 million number in the quarter. Was there any noise or onetime costs in that number? And then as you think about -- the gross profit was quite strong in the quarter, but OpEx seemed a little bit higher as well. So just wondering in terms of the improvement in the OpEx, is that really based around the U.S.? Or is there also a scope in Canada?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [51]

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There will be scope in both places. And so within the MD&A, we do split it out so you can see it on a per segment basis. So some significant improvement in the U.S. when we're looking at a Q1 versus Q2 perspective, and some big strides there Tammy has made in order to -- rightsizing those expenses. And on the Canadian side, there is also some appropriate expenses that are associated with the Go Forward Plan, but those are driving growth, so any added expenses at this point are driving profit.

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Operator [52]

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Your next question comes from Maggie MacDougall with Cormark.

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Maggie Anne MacDougall, Cormark Securities Inc., Research Division - Director of of Institutional Equity Research [53]

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I wanted to just revisit the restatement of EBITDA that was done in the quarter just for clarification. Are there still costs in the prior year quarters related to management transition, the strategic review, legal fees, consulting, et cetera, that are not going to repeat this year and so are onetime and, perhaps, inflate the OpEx in 2018?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [54]

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Hi, Maggie. Yes. So the adjustment was really made to pull out both the gains and losses that we consider not to be recurring or part of our core operations.

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Maggie Anne MacDougall, Cormark Securities Inc., Research Division - Director of of Institutional Equity Research [55]

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Okay. What are those -- are those real estate sale-related gains and losses? Or they pertain to other costs [that are related to legacy cars]?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [56]

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So the dealership sales, the land sales we're pulling out whether it's the gains -- gain or loss to help normalize that adjusted EBITDA figure. In regards to kind of onetime costs, there's nothing new that's added in there in terms of a [pull-over] add-back. We've kept that at the same. I would just refer you kind of to our MD&A. We've added the very detailed table in the back to give you line by line what we're adding back. And if you need any more color, definitely willing to reach out to you after this, yes.

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Maggie Anne MacDougall, Cormark Securities Inc., Research Division - Director of of Institutional Equity Research [57]

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Sure. I'm just trying to figure out if the management transition costs from last year and all that stuff is still in the OpEx for 2018.

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [58]

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The management transition cost is for 2018, yes.

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Maggie Anne MacDougall, Cormark Securities Inc., Research Division - Director of of Institutional Equity Research [59]

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Okay. Okay. And then so when I look at the used car operations, I understand it's really early in your Go Forward Plan to improve the sales there, but also noticed that the gross margin is down and the price per used vehicle sold is down. And so is that because previously the cars were being sold too expensively, which was limiting volume? Or is it the nature of the inventory you have? Can you just maybe extrapolate a little bit on the reasons for that and then what strategy is to sort of get that initiative going?

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Michael Rawluk, AutoCanada Inc. - President & Director [60]

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Maggie, Michael here. So the quick answer to that is that you'll notice in the numbers that our wholesale unit sales have decreased and our retail sales have increased, and that explains a lot of the story, is the older cars that were previously being sent to the auction are being held now by our dealerships and so we're retailing them. So instead of looking for $100 or $200 profit at the auction, we're keeping them and turning it into -- if you look at front and back margins from F&I, we're turning that into a transaction that's worth north of $4,000 a car from $100 a car.

And so you'll see a steady decline of gross profit on a per unit basis, but the margin should hold because the sale price of the car will come down. And ultimately what we're looking for is the total gross profit pool as we get into what we call deeper segments of used cars to grow the business. So rather than just sticking to the traditional newer premium trade-ins, we're keeping the 5-year-old car, the 6-year-old car, 7-year-old car and attracting a whole different customer that has typically gone to independents and we're bringing them to our operation. We're also benefiting from the additional mechanical reconditioning that comes with that transaction.

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Maggie Anne MacDougall, Cormark Securities Inc., Research Division - Director of of Institutional Equity Research [61]

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Okay. Does that tie into your near prime strategy in order to provide a way to get people into a car where maybe you wouldn't have been able to in the past?

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Michael Rawluk, AutoCanada Inc. - President & Director [62]

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Yes, that's part of it. And a big part of it is just trying to transition from being just new car dealers and premium trades to being new car dealers and true full-service used car dealers.

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Maggie Anne MacDougall, Cormark Securities Inc., Research Division - Director of of Institutional Equity Research [63]

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Okay. Switching gears on F&I. I recall that this is one area from your original buckets for EBITDA growth that was expected to contribute to improved EBITDA this year, and there hasn't been a whole lot of change in the F&I sales or gross profit contribution. Wondering what the back story there is. And what sort of reasonable time frame should I think of to expect some contribution from that effort to materialize?

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Michael Rawluk, AutoCanada Inc. - President & Director [64]

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Two parts to that one is, one, if you look at the new vehicle gross profit per unit contribution, is -- we are up over $200 a car. And a the big part of that is due to the F&I contribution. On the used side, it's when you sell older cars, there's less opportunity to sell F&I products. And so some of that is a bit of a drag on -- when you look at it as the gross per unit. But we're really focused on total gross pool. So if you look at the F&I growth -- the growth of the total F&I gross profit contribution is -- we're off, I think it's around 9% on a same-store basis. And so a lot of that is from the F&I plan. That being said, like a couple of initiatives -- well, a good handful of initiatives, they're going a bit slower than we would like. We still fully expect to get to where we originally thought we would land. The variable is time.

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Maggie Anne MacDougall, Cormark Securities Inc., Research Division - Director of of Institutional Equity Research [65]

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Okay. And then one final question for me, and it's on the U.S. business. Do you think that your goal of breakeven, let's say, by the end of the year or maybe a little -- a few months into the new year, is possible without selling the 4 dealerships that are earmarked for disposal?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [66]

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I think it definitely becomes more difficult.

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Operator [67]

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Your next question comes from Stephen Harris with GMP Securities.

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [68]

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Just wanted to follow up on that last point. Is it fair to say that the 4 dealerships that you're selling in the U.S. are the weakest 4 dealerships from a financial performance perspective?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [69]

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I would say yes.

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [70]

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Okay. And then I just wanted to switch back to the balance sheet question. I think you had 4.01x until -- to [hit the bell] with the covenant calculation. And then we can't really duplicate those covenant calculations, but I'm just wondering if you think that Q2 was the peak in that number. And is it likely to improve as the year goes on? Or is the peak still ahead of us?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [71]

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It's Kevin here. So what we're seeing is with the operational improvement, it's going to help bring -- level out that ratio. It peaks to that 4 level, which is why we sat with our lenders and our banks and seek that extension of that relief period. But we continue to look at it all daily, weekly, monthly to ensure we're both managing it and aware of where it's going. We're comfortable moving forward.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [72]

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We also recognize we still have more levers if we need to pull. But as I said before, the most important thing is for us to operate and make sure we can get on the right side of those covenants in a meaningful way, in the quickest amount of time.

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [73]

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Okay. And in terms of your thought process about where you'd like to have the business, has there anything changed there?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [74]

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Sorry?

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [75]

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What's your target, basically?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [76]

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High 2, 3, like, that's where we'd like to be for our covenant.

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [77]

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Okay, perfect. And most of my questions are answered. But just one other follow-up one on the dealerships that were sold. Is this anything -- were the decisions to sell those dealerships mostly around location or some other factor? Or was it more brand driven?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [78]

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So I would say that -- and I'll let Michael opine as well, but I would say those dealerships were suited in better hands that could maximize the profits there than for us. Our -- we have a better use of funds than in those stores, in those jurisdictions. And we weren't able to operate them in a meaning -- in the right way to optimize the profit. And I think that they're better suited with the owners today.

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [79]

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Is it a scale question?

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Michael Rawluk, AutoCanada Inc. - President & Director [80]

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Yes. It was really just a time issue. We know that we're -- there's a high sense of urgency to get going, and so we've just evaluated on what stores we could maximize based on timing.

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [81]

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Okay. Okay. Are these smaller dealerships sale-wise?

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Michael Rawluk, AutoCanada Inc. - President & Director [82]

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Yes, absolutely. And the impact to [net] is negligible.

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Operator [83]

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(Operator Instructions) Your next question comes from Roland Keiper with Clearwater Capital.

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Roland Keiper, Clearwater Capital Management Inc. - President [84]

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Just wanted to -- I got a number of questions, but maybe if we circle back to the U.S. I noticed again in this particular quarter your segmented results. If I compare the gross profit margins in the U.S. compared to Canada for used parts and service and F&I, all of those business units have higher gross profit margins in United States than in Canada. For example, if I consolidate those 3 business units, in the U.S., it's roughly 33% gross profit margin and it's 29.5% in Canada. The key difference is the new gross profit margin, Canada was 7.3% in this quarter. It was 2.0% in the U.S. It was slightly negative last quarter in the U.S. So this gross profit margin compares unfavorably with your Canadian experience. It also compares unfavorably with -- Lithia was 5.6% in Q2. Others were higher in Q2 on new.

And if I pro forma your CAD 74 million of new sales in the U.S. for that margin difference, go from 2% to 7.3%, it's $4 million in the quarter. It appears to be all of the difference in profitability between Canada and the U.S., and I'm wondering if there's a cost allocation issue that leads to higher gross profit margins on used, parts, F&I in the U.S. and some costs are allocated to new that, otherwise, there's a cost allocation that differs from your accounting practices internally between Canada and the U.S. And if not, if you can shed some light, what gives, why is this margin so low?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [85]

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Roland, I'm going to -- I'll answer the question as best I can right now. If you want to answer more offline, I'm happy to. But let's just put it this way, and I think Tammy alluded to this when she was talking about it. The biggest issue that we have in the U.S. is our cost structure. There were many contracts that we took over that were off-market and, therefore, affecting our gross profit in the United States. And so as part of Tammy's go-forward strategy, she's reinterviewed all vendors, realigned all contracts going forward, starting with the bigger ones and we'll finish with the smaller ones.

And so while you might see something today, I don't think it's fair to actually say that's going to be the future. I don't think you can pro forma that because she's in the midst of realigning everything, so you're just seeing like early, early, early days.

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Roland Keiper, Clearwater Capital Management Inc. - President [86]

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Okay. So to the extent that you got there in March and the reduction is taken to Q1 or Q2 to reduce costs that affect gross profit margin in addition to costs below the gross profit margin line, what would be the difference between the actual you experienced in Q2 and the run rate -- the exit run rate of these management actions and initiatives?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [87]

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So Roland, Q1, Tammy wasn't there. So Q2, she got there. And as I've said before, it was -- it's basically a learning experience, and so a lot of those contracts have been readjusted, probably, in the last 2 months, maybe even months. And so again, anything talking about pro forma run rate, et cetera, et cetera, I don't think is probably helpful in this call for most people, and I'm happy to take that offline with you.

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Roland Keiper, Clearwater Capital Management Inc. - President [88]

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Okay. I'll move on from that. The impact -- I assume that all assets held for sale are run through the income statement and reflected in your adjusted numbers. Is my assumption correct, Kevin?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [89]

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That's correct, Roland. Yes.

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Roland Keiper, Clearwater Capital Management Inc. - President [90]

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Okay. So the 4 dealers that are planned to be sold, I see there's no -- you typically -- if you get conditional agreements in place, you announce the date of that and when you expect it to close, that's been your past disclosure practice. I assume you don't have any conditional agreements in place for one or...

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [91]

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Nothing's been signed as yet.

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Roland Keiper, Clearwater Capital Management Inc. - President [92]

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Right. Got it. So what's the EBITDA -- negative contribution of those 4 dealers in totality?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [93]

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Yes. So at this point in time, while we're in process, we don't think it'd be appropriate to actually discuss that.

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Roland Keiper, Clearwater Capital Management Inc. - President [94]

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Okay, good. Fine. A question of fact, Kevin. I've asked you before about these covenants, and you know that's a challenge because of pro forma adjustments for sales. It's customary to have pro forma adjustments for sales and divestitures of dealers in the bank EBITDA covenant. We can't calculate it. Can you just give us the last 12 months bank EBITDA amount and the total funded debt amount as defined under the bank agreement at the end of the quarter?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [95]

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Now Roland, that's one of those ones where it's getting into pretty discreet information, so I think it'd be best if we take that off-line. I understand the challenges of -- with the bank EBITDA metric, which is difficult to put together from the statement and it's stuff that you wouldn't be able to pull apart.

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Roland Keiper, Clearwater Capital Management Inc. - President [96]

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All right. And just circling back to what Maggie had asked about, there was some -- last year, there was $11.3 million higher -- of higher variable expenses, and it was and I either -- I can't remember if it was in the Q&A in the quarter or off-line with Raj afterwards, but my understanding was substantially all of those costs were onetime.

In the MD&A, it said that there was a special -- it referred to special committee and legal expenses. You have not gone back in your restatement in Q2 for your change in EBITDA methodology to back out special committee and legal expense. Can you confirm those numbers?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [97]

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That's correct, Roland. So we have not added additional reductions of any adjusted EBITDA. Those are just part of the core operating expenses, so I did not add any new...

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Roland Keiper, Clearwater Capital Management Inc. - President [98]

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But I would think special committee and these legal expenses for that -- we're not changing the Board again, are we? Like, these are nonrecurring things.

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [99]

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Yes. It's correct to state that, that would be considered nonrecurring.

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Roland Keiper, Clearwater Capital Management Inc. - President [100]

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Can you identify those amounts?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [101]

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The specific dollars, I don't want to get into, no.

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Roland Keiper, Clearwater Capital Management Inc. - President [102]

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I see. Okay. It's just because people are comparing this quarter versus last and before -- what's happening economically and without that, it's -- we're guessing a little bit, as you can understand. Last question, Paul, this is for you. This is not to be difficult, but you know the sensitivity of related-party issues. You're taking an action against former management about lost opportunities, amongst other related-party activity. And we noticed some new disclosure about related-party disclosures with respect to your own activities.

Was there some cost that was experienced last year in the second half and in the first quarter? And so we're trying to -- I think it's more important if we understand, are these temporary things? Is this going to be an ongoing related-party costs and what the nature of those things are?

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [103]

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I don't really think that there's -- so I gave full disclosure to the Board and said anything that my family office might or might not be doing, but I don't think it's actually even material.

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [104]

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It's not material, but he's putting it out there because we're following the letter of the rules and ensuring that we're being absolutely transparent, so it's there.

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Roland Keiper, Clearwater Capital Management Inc. - President [105]

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So of that $900,000 in Q -- the first half, was any part of that from -- in Q1?

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [106]

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There was certain components of it from within Q1, and it's not all Paul's. If you read through the note there...

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [107]

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Very little of it.

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Kevin McPherson, AutoCanada Inc. - Director of Financial Reporting [108]

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It speaks to the 3 components.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [109]

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Yes. I don't think that there were very much of it that had to do with me, to be frank.

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Operator [110]

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There are no more questions at this time.

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Paul W. Antony, AutoCanada Inc. - Executive Chairman [111]

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Okay. Thanks, everyone. And again, we appreciate everybody's patience. This is definitely a journey, and we talk about it every time. Our goal is to continue to under-promise and over-deliver, so hopefully, we can do it again next quarter. Thanks, everyone. And we'll chat with you next quarter.

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Operator [112]

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Thank you again for your participation. This concludes today's conference call. You may now disconnect.