Lithia Motors, Inc. (LAD) Q3 2022 Earnings Report, Transcript and Summary

Good morning, and welcome to the Lithia & Driveway Third Quarter 2022 Conference Call. [Operator Instructions] I would now like to turn the call over to your host, Amit Marwaha, Director of Investor Relations. Thank you. You may begin.

Thank you. With me today are Bryan DeBoer, President and CEO; Chris Holzshu, Executive Vice President and COO; Tina Miller, Senior Vice President and CFO; Chuck Lietz, Vice President of Driveway Finance. Today's discussion may include statements about future events, financial projections and expectations about the company's products, markets and growth. Such statements are forward-looking and subject to risks and uncertainties that could cause actual results to materially differ from the statements made. We disclose these risks and uncertainties we deem to be material in our filings with the Securities and Exchange Commission. We urge you to carefully consider these disclosures and not place undue reliance on forward-looking statements. We undertake no duty to update any forward-looking statements, which are made as of the date of this release. Our results discussed today include references to non-GAAP financial measures. Please refer to the text of today's press release for a reconciliation to comparable GAAP measures. We have also posted an updated investor presentation to our website investors.lithiadriveway.com, highlighting our third quarter results. With that, I would like to turn the call over to Bryan DeBoer, President and CEO.

Thanks, Amit. Good morning, everyone. And we appreciate you joining us today. We look forward to updating you on our business growth and progress towards achieving our 2025 plan and beyond. Earlier today we reported third quarter results growing revenues by 18% to $7.3 billion from $6.2 billion in the third quarter of 2021. Same-store sales numbers were solid, with total revenue increasing 4%, new vehicles were up 1%, used were up 3.5%, while service body and parts were up 10%. This was driven by continued focus on operational excellence at our Lithia stores, expansion of our e-commerce platform Driveway, measured growth the DFC and integration of stores acquired over the past year. We reported adjusted third quarter earnings per share of $11.08, adjusted for foreign currency EPS was $11.62 compared to $10.21 per diluted share in the same period of 2021. Foreign currency was a negative headwind reducing EPS by $0.54. Cyclical inflationary pressures tempering vehicle gross profit and SG&A along with investments at Driveway and DFC impacted results. We're building an agile platform that combines our experienced knowledgeable workforce with our own inventory and efficiency of distributed physical network. Our footprint has doubled over the past couple of years with diversification across products, brands, geographies and channels. This is a competitive advantage that allows us to be a flexible retailer, quickly responding to consumer preferences and market conditions. Digital customer traffic across our platform was up 35% as we continue to make investments in our digital platforms. Both Driveway and GreenCars provide industry leading customer experiences and educate drivers on various transportation options, helping them find the right fit for their needs. Gross profit per unit were mixed in the quarter. New vehicle GPUs including F&I were $8,080 per unit, compared to $8,244 last year and $7,410 a year-ago. Used vehicle GPUs including F&I were $4,496, down $452 from the $4,948 in the second quarter and $5,097 a year-ago. F&I per unit rose to nearly $2,200. Average price of new and used vehicles rose 10% on average from the third quarter of a year-ago. Shifting to day supply. At the end of September, we reported new and used vehicles at 39 and 65 days, up from 24 and 48 days from the third quarter of '21. Driveway closed out Q3 averaging over 2 million unique monthly visitors. In the third quarter, Driveway retailed and wholesaled over 10,300 units contributing over $290 million or almost 4% of our total revenue. Year-to-date, Driveway revenues have totaled more than $650 million. This accounts for both shop transactions and subsequent retail and wholesale transactions of sale transactions. Year-to-date, we retailed over 30,700 vehicles across Lithia and Driveway e-commerce tools. Congratulation to the Driveway and Lithia teams on the progress we've made across our omni-channel strategies. Shifting to our captive finance arm. Driveway finance or DFC, during the third quarter we originated over 17,100 loans totaling $552 million. At the end of September, the total DFC loan portfolio was over 1.6 billion in outstanding receivables. Penetration rate was 11.4% at the end of September. Chuck will be providing some additional color around DFC's growth performance in a moment. Moving on to M&A, we had another busy quarter. Our valuation discipline is paying off and our returns on invested capital continue to perform well. Year-to-date, we have acquired $3.1 billion in revenues, and a total of $13.3 billion in annualized revenue since initiating our 2025 plan in the middle of 2020. I think it's important we highlight our consistent track record of acquiring stores, adding incremental value, which is translated into consistent returns throughout the business cycle. We're well equipped and the market remains robust to continue this trend. As the leader in the auto retailer space, our optionality effectively leverages our existing network and infrastructure. During the quarter, we acquired a portfolio in Wisconsin from the Wilde Group. The stores are projected to generate $625 million in annualized revenues. In October, Lithia also acquired 6 locations in the Pacific Northwest with Airstream Adventures, the leading seller of airstreams in the United States. The outlook for M&A opportunities remains constructive. Stakes have been raised for retailers with shifts towards direct-to-consumer and omni-channel commerce, combined with liquidity constraints of sellers. We are well-positioned to capitalize on the many opportunities presented to us. Stepping back for a moment, I want to provide an update on our 2025 plan. Despite some of the rebalancing taking place in the auto industry and cross currents in the macro economy, we're confident our strategy is durable, and we have the necessary levers to achieve our $50 billion revenue target, translating into $55 to $60 in EPS. Our portfolio mix and focus on profitability will set us up, so $1 billion in revenue will generate $1.20 in EPS, up from our historical level of $1 in EPS. Achievement of our 2025 plan will be driven by a few factors. Let me take a moment to outline our strategy to hit these targets. First, we plan to accelerate the drive towards operational efficiency and leverage across our platform. Margins will improve as we integrate retail stores with our online platform, reducing the friction and costs of purchasing vehicles. Heading into 2023, we're taking proactive measures to right size our cost structure at the stores and e-commerce divisions, while growing our credit portfolio. We are prioritizing our profitability goals rather than volume to breakeven in our e-commerce and captive finance divisions. Combined, this will help drive SG&A as a percentage of gross profits towards 60%, enhance our liquidity and continue strong cash generation. As a reminder, it was only a little more than 2 years ago when we produced $12 billion in annual revenue, resulting in $12 in EPS. Second, we're targeting DFC to grow meaningfully out into 2025. As we increase penetration towards 15% to 20%, we plan to manage our liquidity options and risk. We've been gradually narrowing the credit risk in our portfolio and being tactful with pricing loans given the large swings in interest rates. As DFC becomes a seasoned issuer of asset backed securities, we expect spreads and CECL reserves to normalize resulting in better economics and visibility and interest margins. Third, we will continue to be the consolidator of choice within our sector. Our 2025 plan seeks to reach 95% of our customers within 100 miles and we believe this results in a targeted footprint of approximately 500 locations. This will drive our market share towards 2.5% and solidify our presence as the national auto retailer. Additionally, our physical stores will continue integrating our e-commerce platforms, Driveway and GreenCars, ultimately leveraging our vast physical network creating incremental revenue growth. Fourth, our financial discipline and structure is conservative. And our capital allocation strategy is focused on the best risk reward for our shareholders. We have lowered the leverage on our balance sheet and do not require equity to fund our growth targets. We continue to weigh investments that limit friction and have material upside over time adding to our earnings. We're maintaining our discipline pre-COVID M&A hurdles and continue to balance this with buybacks to be responsive to any economic environment ahead. We appreciate the support and feedback we get from our shareholders and maintain our approach. We will continue to balance our growth objectives with financial discipline with the goal of maintaining a low cost of capital. The Lithia and Driveway strategy is creating a diversified vehicle transportation network that provides amazing experience for our customers, while utilizing the full breadth of our network. We have the right team in place to take advantage of dislocations in the market, and will continue to lead the transformation in our sector. With that, I'd like to turn the call over to Chuck.

Thank you, Bryan. We posted another strong quarter at DFC as we continue to be the number one lender for Lithia and Driveway. Our portfolio continue to grow at a healthy pace despite the shift in lending markets. In the third quarters, DFC realized a net interest margin of $17.3 million, which resulted in a pre-tax loss of $4.2 million. At quarter end, the portfolio had a weighted average contract yield of 7.8%, which continues to trend upward. Recent changes in the macro capital market rate environment has driven our year-to-date average cost of funds to 3.3%, up approximately 150 basis points from last year. DFC's penetration rates for the quarter increased to 11.2%, up from 9.7% in the prior quarter, which translates to $552 million in contracts originated. In the second quarter, we raised our 2022 full year penetration rate target to 10% and we remain on track to achieve that rate, which will result in portfolio assets of approximately $2 billion by the end of 2022. Over the past year, we have continued to execute our strategy of mitigating credit risk volatility, primarily by increasing the FICO scores of our originations, which in the third quarter resulted in a weighted average FICO of 721. Additionally, we have continued to reduce our loan to values on originations, which for the quarter we're at 99%, down from 105% during the same period in 2021. Today, nearly half the loan portfolio is composed of FICO scores greater than 720. DFC is reacting to increases in our cost of funds and continues to monitor and raise yields rates to mitigate spread compression. Current and future rate increases could temper originations growth, as we strive to maintain spread rates in a rising interest rate environment. As expected, loan provisions remain a headwind and continue to have a disproportionate impact on DFC earnings in the near-term, totaling approximately $25 million year-to-date. In the third quarter, provisions as a percentage of managed receivables, remain stable, averaging 2.7%. Delinquency rates across the industry and for DFC increased in the quarter overall, but DFC did see a decline in September month-over-month rates. DFC continues to track below our internal benchmark rates during the quarter. We continue to expand DFC's capital structure to ensure forward looking liquidity to support our continued growth. We have increased the size of our short-term conduit facilities, and will look to increase the cadence and size of our ABS term issuances in 2023. In addition, DFC is nearing a point where bifurcating its ABS term issuances into separate prime and nonprime offerings may be feasible, which could result in a capital structure that better aligns with our forward looking portfolio design increasing both the [technical difficulty] balance sheet and earnings growth. Going into 2023, DFC will focus our efforts away from accelerating originations growth to achieving a profitable return on the portfolio and improving free cash flow. As Bryan indicated earlier, we are reaffirming our guidance of the future state expectation, the DFC can add $650 million in earnings to Lithia and Driveway, again predicated on DFC's portfolio fully seasoning after maintaining a 20% penetration rate on Lithia revenues at our 2025 plan levels of $50 billion. In closing, DFC continues to monitor market rates and manage our credit risk, while growing and diversifying our capital structure. We're using a disciplined data driven approach to mitigate spread compression without moving down the credit risk curve consistent with our credit risk appetite, which should result in DFC achieving its financial return goals. With that, I'll now turn the call over to our CFO, Tina Miller.

Thank you, Chuck. In the third quarter, we reported adjusted EBITDA of $510 million, down approximately 4% from the same period last year. This was primarily a result of our investments in Driveway and DFC and inflationary pressures flowing through our vehicle gross profits and SG&A line. During Q3, Driveway advertising and personnel expense was $32 million, up $22 million from last year. As a percentage of gross profit, SG&A was up 380 basis points to 59.6%. Year-to-date, we've generated nearly $930 million in free cash flows, up 25% year-over-year. Shifting to capital allocation. Thus far in 2022, Lithia has repurchased 2.25 million shares at a weighted average price of $282 per share. During the quarter, we purchased an additional 115,315 shares at an average cost of $243 per share. We currently have 77 million remaining for sharing repurchases, having repurchased 7.6% of our outstanding shares this year. I want to take a moment to clarify the direction of our capital allocation program. Overall, we remain comfortable with current strategy and allocations across M&A, internal investments and balance toward shareholder return. Given the shifting macro environment, we have adjusted some of our focus towards improving our operational efficiency to offset some of the near-term headwinds facing our sector, namely higher interest rates and normalizing vehicle gross profit levels. We are proactively working to refine our cost structure in response to these trends with curbing discretionary spending and realigning compensation plans. Given the likely GPU and volume decline in the months ahead, we think it's prudent to strengthen our liquidity and maintain the quality of our balance sheet. We expect opportunities for M&A to remain strong. We regularly assess the risk adjusted returns over time and compare this against opportunities across our portfolio. The long-term goal is to expand our market share to 2.5%. Based on downside model scenarios, we are comfortable our business will generate free cash flows that support achievement of our 2025 plan. Our omni-channel presence is a foundation to our international strategy coupled with our captive finance arm. Combined, we think these levers give us plenty of optionality to reach $50 billion in revenue by the mid decade. As we work through the normalization in our market, we will apply a conservative approach toward managing our buyback program. The dynamics of higher interest rates and rising market risk premium could potentially weigh on the returns we are used to generating on equity. We have the experience and ability to expand our earnings and free cash flows over time. In Q3, we continued with a conservative level of leverage. Leverage and current ratios rose marginally to 1.8x and 1.5x, respectively. This was a result of normalization trends in GPUs. In conclusion, we're confident we have the right instruments and liquidity to work through the macroeconomic environment and shifting consumer dynamics underway. Balancing growth and returning capital to shareholders are key pillars towards achieving our 2025 plan of $50 to $60 in earnings per share. This concludes our prepared remarks. With that, I'll turn the call over to the audience for questions. Operator?

[Operator Instructions] Our first question comes from Daniel Imbro with Stephens. Please proceed with your question.

Hi, guys. This is Joe Enderlin on for Daniel.

Hi, Joe.

So you noted Driveway finance penetration was 11.4% at the end of September, while the end of June penetration was 12.9%. Just wondering if these last 3 months change how you're thinking about desired penetration next year, or at least the cadence as delinquencies are increasing?

Thank you, Joe for your question. This is Chuck. Our current sort of viewpoint on penetration is in light of the current economic environment. We want to sort of stay in that 10% to 15% range and feel pretty comfortable as that as we continue to derisk the portfolio. However, looking forward to next year, we still believe that 15% to 20% range is still our target that we could achieve in 2023.

Got it. Thank you. That is super helpful. As a follow-up, just wondering, sourcing vehicles gotten more challenging as wholesale prices are depreciating. I was wondering if you're still sourcing the same amount from consumers or if your activity in the auction lanes has picked up at all?

Hi, Joe. This is Bryan. We were up a little bit in the auction lanes. I think we moved from 13% to about 16% of our inventory mix was procured from auctions. Our main source of inventory procurement as we all know is from our consumers. And that dropped from, I believe, 75% at a peak to around 74% of our total inventory procurement.

Great. That is all for us. Thank you guys.

Thanks, Joe.

Our next question comes from John Murphy with Bank of America. Please proceed with your question.

Good morning, guys. There have been sort of anecdotal stories of demand weakness in new and used, but because supply is so tight, it's really kind of tough to gauge how true those are. And what -- what's exactly going on Bryan? As you look at your stores, both on the new and used side, from ops or showroom traffic and what you're seeing on in Driveway traffic, I mean, what is your take on the general state of the consumer and demand for new and used vehicles at the moment?

Good question, John. I think most importantly, the demand lookers is big. We are up 35% in our digital traffic as a whole. Year over a year, which is a big number. Unfortunately, the inventory doesn't match that and we're really sitting at a point on new vehicles that we're really at. We don't have the bigger backlogs that we used to have. It's really more of a just in time inventory today. But we are starting to see some manufacturers, mainly the domestics that are starting to have better inventories were our domestics were up almost 10% in unit sales for the quarter year-over-year, which is a pretty, pretty good number. And the Koreans that we mentioned had pretty good supply as well. We are up a couple of percentage points. So, all in all, in new vehicles, we're starting to see the inventory starting to loosen a little bit. We also, as I noted, our GPUs were down about $164 on used, which is the first in a few quarters. So we should see that start to subside as well. On used vehicles, I think it's important to note, we're basically back to pre-COVID level, front end margins or vehicle margins, okay? But the real win on both items is that F&I is still remaining strong, we're not seeing weakness. In fact, in the quarter, we were up almost $100 per unit, which is a nice number that helps offset some of the clients in GPUs. And obviously, the big thing is, as that inventory begins to loosen up, we think that they're starting to -- we're starting to see some correlation between those drop in GPUs with inventory loosening, and hopefully, volume increases as well.

Okay, that's helpful. And then just a second question, Bryan. As you think about stress testing your model go-forward. I’m not using a specific year, but I mean just thinking about sort of the downside risks in the model, there's not a lot of room on new vehicle. Unit volume as you just kind of alluded, the inventories is tight and we're already at recession level vibes. But how do you think about stress testing your model, and if you would venture a guess on what sort of downside EPS could be, or if there is that much downside? I’m sorry, it's an open-ended question, but if you could maybe frame up how you're thinking about it, and maybe even better?

Sure, John. I think we, at Lithia and Driveway, tend to play the long game and look -- take a longer view at things and look at that what we're seeing over the next few quarters as there's a more normalization of GPUs, that it's just a short-term part of the game and we do know that our original design was basically built on the fact that we are a lower margin business with a little bit higher SG&A costs and a lot of businesses. And our 2025 plan is there to redesign things. And now we're going into a little bit more volatile environment where we have a few more balls to juggle, but ultimately, the outcome of what we've designed with Driveway financial, with Driveway.com, that can obviously have lower SG&A costs in a traditional business and the other businesses that we're thinking about are there to really help relieve some of the stresses of a low margin business. Now, that doesn't really answer your question of what happens over the next few quarters. I think that's where our operational expertise is quite good, okay? And that -- and that's where our ability to navigate through different type of environments is where we seem to shine. And I think our ability to do that is going to help drive us towards the $55 to $60 in EPS by 2025. And I think, though, we've -- we breached the -- probably the $40 in EPS target that was caused by market conditions that I believe weren't expected in our original 2025 plan that was announced 2.5 years ago, okay? That wasn't contemplated. I mean, what we have built for is a 5-year plan that can achieve that $55 to $60 in EPS or about $1.20 of EPS production for every $1 billion of revenue with a steady state future goal to get to $2 of EPS for every $1 billion of revenue. And I think, that's maybe a little different way to look at it. But on a quarter-over-quarter basis, that's not really the game that we're playing, even though we're experts at managing through the dynamics of current market conditions.

Okay. And then just lastly, I mean, you're generating a lot of capital reallocating to growing the network. Historically, OEMs have been sort of roadblocks, but now it seems like they're receptive to you building out this network and even almost encouraging you to in some ways. I'm just curious if you can characterize sort of that relationship with the automakers and how receptive or encouraging they are to you to build out this network and how that's changed over time?

Sure, John. I think it's important to remember that we really haven't ever took our foot off the accelerator in terms of growth. And it's primarily because our relationships with our manufacturers are the key foundation of how we build things. Basically grow market share and earn loyalty of the customers for the long-term and that creates an environment where the manufacturers are supportive. And I think most retailers have times where they're approvable and not, but most of the time we're approvable with almost every manufacturer, meaning that we're usually there when there's a group that has a mix of franchises that we're able to buy and others typically aren't. And, as we noted in the prepared remarks, I mean, we've done $3.1 billion thus far this year. And that's coming off the back of a $6.7 billion year in M&A. And the year before that was $3.7 billion and then we had a little bit of a pause a year before that as we were in our design theory, and really building out our digital strategies and encoding all those great products for Driveway Finance, Driveway.com and GreenCars.

Okay, great. Thank you very much.

Thanks, John.

Our next question comes from Ryan Sigdahl with Craig-Hallum Capital. Please proceed with your question.

Good morning. Thanks for taking our questions.

Hi, Ryan.

I want to start on used inventory. So current composition of kind of the core value versus CPO that you have and where you're seeing the biggest pricing or margin risk kind of as you look out currently and then over the next several months.

Let me just get this. Chris, why don't you jump in. You've got that.

Yes. I don't think we've seen any major changes right now. This is Chris, on what our composition looks like. I would say that one of the big benefits that we have, having kind of this omni-channel environment, especially with Driveway is about 10% of the used vehicles that we have in stock right now, came from a channel that we didn't have previously. And so I think we continue to work the multiple channels that we have, whether obviously, trade-ins are huge being top of funnel as a new car dealer and having the opportunity to be first in line for any trades that are coming in, in a more difficult environment. And then after that using the traditional secondary sources, but the third source now Driveway being 10% of our inventory stock [ph] to the sale, it's huge. So we'll continue to work that up going forward.

Yes, more or less, I guess, what are you seeing to get the structural advantages kind of you guys have been procuring. Curious in the inventory you have where you skew more to value and core versus others that skew more to CPO and kind of those newer light model or mileage vehicles. Where are you seeing more of the pricing pressure and more of the margin pressure given the current dynamics with the consumer today?

Yes, not a major shift in overall what value auto is. It's about 10% -- 20% of our used inventory today. I think that, generally speaking, just because of ASPs and where pricing has been, all of those sets are up at a higher ASP and inventory carrying costs than they've been historically. But again, us carrying a 60-day supply of inventory means that we've already turned through 25% of the inventory we were carrying at quarter end. And so I think the dynamics in the sources hasn't changed and then the dynamics in what we have in carrying costs and the inventory pricing is going to continue to fall as the market adjusts.

Chris, thanks for giving me a little breather. One other thing just to add to what Chris said, on a positive note, our value inventory, which is probably the least exposure to market swings because they're lower priced and they're typically the highest scarcity, okay? It's up about 16% in day supply or in our total mix of what we are, which is a real positive sign. And I think that's that. On the opposite side, you have your CPO, which is probably the most volatile ads, new car inventories return to some level of normality. And as manufacturers begin to think about how to incentivize oversupply and those type of things in the coming quarters.

Thanks. Yes, that was what I was getting at. One more for me. Just as you think about capital allocation, M&A opportunity, how do you think about dealership expansion, which I know is a priority, but is there also an opportunity to acquire technology in health more in that regard?

Great question, Ryan. I mean, we obviously are focused on the network growth, both domestically and internationally. But I think as we begin to think about the different verticals and horizontals that are built into our design thesis. The idea of sharing data across the different adjacencies is quite important to us. So when we begin to think about our growth and our ability -- whether we buy or whether we build, I think there's a good argument to be made that we could look at CRM systems or possibly DMS systems or those type of things to glue things together a lot cleaner to be able to share data on both customer platforms and other stuff to really maximize the experiences throughout the life cycle of the consumer. And I think we're really at the forefront of that, knowing that we do know how to build things already, okay? We got 140 engineers or so on staff and know that their abilities are quite high, and it's really taking the steps of one of most important and critical things to be able to do that and referring back to M&A. There may be a chance that we could find parts of that at some point or maybe a holistic approach that could help accelerate our growth and really maximize the design value that we are creating.

Great. Thanks, Bryan and Chris.

Thanks, Ryan.

Our next question is from Rajat Gupta with JPMorgan. Please proceed with your question.

Hi. Good morning. Thanks for taking the question.

Rajat.

Maybe just wanted to follow-up on John's question earlier. If the economy does slide into a recession and used card demand has already slowed down considerably, maybe new car demand does not improve from current levels, and in a scenario where new vehicle SAAR is closer to, say, $13 million, $13.5 million and GPUs are normalized, would there be any boundaries you would draw on this power? Is there a trough level of EPS investors should keep in mind? Or any boundaries or any other metrics that you could help us think about maybe SG&A to grow or for parts and services or F&I that you can help us think about in order to maybe just reset expectations for next year? And I have a follow-up. Thanks.

Sure, Raj. I think the way that we look at 2023, we really believe that because of the pent-up inventory that we are really looking at the environment's most likely scenario is about a 3% to 5% increase in both new and used SAAR levels, okay, which is going to put you into a little over $14 million and a little over $42 million unused and really basing our expectations on that. Now when you begin to stress test like you're indicating, if GPUs drop and we sit at a 13% to 13.5%, I think that's where the expertise of Lithia Motors is there. And it doesn't change how we think about the world, okay? Because ultimately, we know where we are going very clearly and a blip for a quarter or two. We know that the demand and the other macro drivers in mobility are there. I mean people's average cars are more aged than they were pre-COVID by about 18 months, okay? We know that the affordability of cars went up dramatically. And most likely, the decontenting of cars are going to come into play. And there's a lot of other moving parts that I think we try to focus on the things that we can control. And I'd love to be able to tell you that it's ex-EPS level and ex-revenue. I just know that I believe that we're leaning more towards a positive SAAR increase rather than a negative. And I think beyond that, I think GPUs will subside probably by midyear. I think it may be a little bumpy getting there, okay? And that's important, okay? F&I, we're going to hope it stays strong. I mean it is the anomaly that's out there, and it has recarved what the profit profile looks like. And obviously, we're going to do the best that we can in terms of managing SG&A, and that's something that Chris and our operational teams are quite savvy and Tina and our support teams here in Medford and throughout the country are quite savvy on, and we are going to deploy our resources in the best way possible no matter what the market delivers us.

Maybe just as a follow-up on SG&A. You have a new Chief People Officer. How are you thinking about the composition and compensation at a store level going forward? How do you expect that to change? I think Tina mentioned that you're already starting to proactively make some changes just in light of the macro. Just if you could elaborate a little bit more on that on what's going on. How should a store level look like going forward, which is where it was pre-pandemic? And maybe if you could tie that into any boundaries around SG&A to growth as well, that would be helpful. Thanks.

Sure, Raj. I'd love to do that. Maybe that will help put you -- put the parts together a little better for you, too. Hey, we are so glad to have Gary Glandon also join our team a couple of years ago and be able to grow into that Chief People Officer and really guide our future because as everyone knows, our mission is growth powered by people. And Gary understands our culture and the ability that we lead people to things that no one could imagine, could be accomplished, and it's a fun time for him. When we think back about the SG&A of the stores, I think it's important to remember going into the recession, we were in the high 60 percentile range. We did have some constructive cuts in personnel. Our personnel makes up about two-thirds of our SG&A costs, okay? And that's primarily variable departments, the sales departments, personnel cost because remember in service that that's a cost of labor. So there's another part of our personnel costs that are in the cost of labor, okay? Ultimately, the 300 basis points was cut out of that okay? But we also know that there's many other synergies that we worked on today. So I think once level -- GPU levels normalize to some extent and we can all guess as to what that may be and what the impacts are on F&I, I think we're looking at somewhere between a 61% and 64% SG&A as a percentage of gross at a normalized level. And Chris did some really cool work a few days ago on our spreads on stores. We have stores in our top -- our top wide [ph]. It's a top 10% of size of stores, have a fair amount -- lower SG&A costs than what our smallest stores have. And it's something that we've come to realize over the last 3 years of growth, buying bigger stores, but those top 10% have around 43% SG&A as a percentage of gross. And in normalized times, it looks like it's a sub-50%. And this is before we even begin to think about overlaying the horizontals and the efforts that DFC and Chuck are participating, which is an additional 20% profit, which is about an 800 basis point reduction in SG&A, okay? To compare and contrast on the other side of the spectrum, so the smallest 10% of stores have about 75% SG&A as a percentage of growth, okay? Overlay the DFC efforts, overlay some of the other horizontals hopefully, the e-commerce leverage that we get from our inventory, our people and our network. And you get to some really nice numbers long-term and that hopefully gives you a little bit better perspective on where we are going in the future. Long-term, Rajat, I think we've said we're really looking, we believe that in the design that we've developed and the execution of the strategy and normalized state, you're talking about the entire company being sub 50% levels, okay? Sub 50% SG&A as a percentage of growth. Now that future state has to be steady state, and we don't have the drags of CECL reserves and DFC or burn rates in Driveway or the other things in the economy that are occurring.

Got it. That’s helpful color. Thanks and good luck.

Sure. Thanks, Rajat.

Our next question comes from Ali Faghri with Guggenheim Partners. Please proceed with your question.

Good morning and thanks for taking my questions. My first question is on the SG&A to gross profit. It's great to hear you can keep it in the low 60% range even in a normal GPU environment. That's a big improvement from where you were pre-COVID. I guess what gives you confidence that these cost cuts are actually structural and won't be competed away. It seems like a lot of its driven by headcount reductions over the last few years, but we are also in a very constrained supply environment with strong demand. I guess what gives you confidence those headcounts and those costs don't need to come back and what would be a more normal supply demand backdrop?

I think that's fair insights, Ali. I mean, we are facing some inflationary pressures that obviously affect salaries as well. But we are pretty confident that the way that we've designed both our back end e-commerce solutions and the way that we are thinking about store operations in the future, where we got general managers hopefully running a couple of different stores, okay, and then spreading those costs and doing the same thing with a simplified consumer model. The ability for us to have to negotiate hopefully take some of the complexities out of the model that we think over time, that it's going to be a simpler model and our ability to have higher productivity in each person, so they can maintain and grow their inventories while the organization still realizes benefits in SG&A is an important part of the entire design that we've developed. So we are pretty confident that those are realistic numbers even with the adjacencies having some drag for the next few years. And I think it's important to remember, I mean, we did clean up our network, okay? And even though it may look like our revenues were a little bit off, we did sell almost $450 million in revenue. And the stores that we sold even in a COVID-based environment, we are pushing 80% SG&A as a percentage of growth. So we had some fat in the model even way back 7, 8 years ago that were more efficient now. We are more -- we optimize our network a lot better, and we find partners that are able to help drive those numbers closer to those bigger store numbers rather than the smaller store numbers.

Thanks, Bryan. That's very helpful color. I guess my next question is on used GPU. It's almost back to 2019 levels, which makes sense since we are no longer in an appreciating used car pricing environment. So I think it was fair to assume your spreads should go back to normal there on the used car side. But what's the risk as used car pricing starts to decline more meaningfully in coming quarters that used GPU could overshoot to the downside and perhaps go below 2019 levels for a period of time.

Again, I mean, that’s obviously a likelihood. I don't think anyone's ever seen a graph that has a spike. And when it comes back, it stops at the average level. So I think we are contemplating that on both the new and used car side. I think the advantage in our design over many of the used car retailers that really don't have the ability to absorb this equity because I think what we are all saying is at some point, there's going to be a greater amount of disequity and a portion of the consumers now sitting at around a quarter of the consumers have transacted over the last 3 years that disequity is going to push people into new car dealerships, which is a massive advantage. And you may ask why. But if you remember, that disequity has to be absorbed in the financing or offset by cash down. And today and for the last year or so, we've really been in an environment where the disequity has been offset by the true cash down and then normalized times. That's not what's happened pre-COVID and normalized times, the average consumer, about 71% of them had this equity and average disequity of $5,100 and only $1,800 of pure cash down, meaning $30 some hundred has to be transposed into the new loan, okay? We are sitting 4, 5 months ago where the average consumer had $2,500 down, $2,500 this equity, they can sell the car to whoever they want and walk into any dealership and buy whatever they want. Today and in the future, in the coming quarters, that additional disequity means they got to find cars that have more margin to absorb their disequity and that moves you really to new cars that are more of a staple diet, not high demand car that eventually will have incentives again on them to absorb that disequity. So we like that environment. And remember that with the really sell 0 to 20-year-old cars, and that zeros there for a lot of disequity and the 20-year-old cars are those scarce cars that people that typically have a greater chance of paying full cash or have quite good credit because those cars are sold for substantially over ACVs or valuations or Kelly Blue Book.

That's helpful, Bryan. And I guess my last question here, if you don't mind, is on the 2025 target of $55 to $60 of EPS. It's great to see that you're reiterating that target, but have the building blocks changed? I'm asking because I think roughly about $10 of that EPS was supposed to come from Driveway. Do you still have confidence that that's the appropriate target? Or is the expectation that the building blocks have changed from your prior view?

Yes. I think that when we gave those goals, we were obviously looking out 5 years, and that can be a cloudy crystal ball. I think we are reiterating the overall numbers. I think you're right. There could be some adjustment in terms of where the EPS comes from and definitely where the revenue comes from. I think it's important to us, especially knowing where the capital positions of some of the e-commerce retailers are sitting that we may be one of the only people standing at the end, and now it's more about improving profitability in a quick manner, okay? So we probably will turn our attentions to reaching profitability. And I think it's still possible to reach profitability by the end of 2024 and then hopefully have a profitable year in 2025. And I think most of our metrics are there, even though there's a lot of heavy lifting that will come from Carol Deacon, our Senior Vice President that leads our Driveway efforts and all the other efforts that we're working to. And obviously, we are probably still a touch conservative on the DFC side in terms of what its contributions could be ultimately. But again, there's capital constraints from the ABS market and those other things that we have to message and work our way through. And I think that's what my management team and I are experts at, and though it may seem complex to us. It's just another day at the office.

Thanks, Bryan. I appreciate all that color.

Thanks, Ali. Good insight.

Our next question is from Colin Langan with Wells Fargo. Please proceed with your question.

Great. Thanks for taking my questions. Just wanted to follow-up, you mentioned that you thought SAAR would rise in a recessionary environment. But I guess I think investors are struggling with inventory did tick up. I think you reported about 15 days and your volumes look fairly flat quarter-over-quarter. So why haven't we seen with the inventory uptick a sort of, in the near-term a volume increase measurement with that? And then also, I think last quarter, you gave some helpful numbers on presold. Have you seen a decline in the percent of inventory that's presold as well?

Colin, hi. This is Bryan again. I think we’ve seen that because last quarter, if you remember, the whole sector was down in same-store unit sales of between 25% and 27%, okay? This quarter, we are looking at new vehicles down, what have I got? Is it down 6%, 7%?

New units.

Got it. New units, okay. So I think it's high single digits. So it's a pretty [indiscernible]. Down 10%?

Yes, down 10%.

Down 10%. That's a 17% quarter-over-quarter sequentially improvement. So I think we are beginning to see that. And I think by year-end, we are going to see some recovery. I think remember that a 13.5 SAAR level is depressed by almost 20%. So that is in itself a recessionary level. And if there's a relaxation in pricing, I believe that consumers -- there's enough pent-up demand of people that are sitting on the fence because they weren't -- they can't rationalize the idea of paying MSRP for a car that I think that will be a tailwind for us in the future.

Okay. You also did bring up the 10.5% sort of same-store unit decline. That is worse than the market. I think market is only down 1%. Why the large delta of underperformance this quarter? Is it brand mix, is it geographic mix, any drivers there?

Colin, it's partially mix, but the market is down more than 10.5%, look at the retail numbers as well. So we are down -- we are up 10% in domestic. We are off 18% in import. And remember, we were up 2%, 3% in the Korean imports, okay, which means that the Japanese imports are the ones that are off the most, okay, we were off 10% in luxury.

Okay. You are saying retail was -- the retail market was worse than the overall market with the industry?

You can probably pull those numbers and take a peek at it.

Okay. Okay. And just lastly, you mentioned in a recession, F&I -- you said F&I is holding up. I mean, how should we think about that in a recession? Because I mean, I imagine with interest rates rising, customers may start scrutinizing the payment, and that sort of slides in there. You haven't seen any evidence or should we kind of anticipate maybe that softens a bit?

Yes. I would say, Colin, I mean, it's important to us to be fair to our consumers. But I also know that when there's volatility and uncertainty, it usually creates gap and expectations and we are usually able to capitalize on that. And I think that's what's really happening. There's such change that people are looking at the opportunity, and we are still holding our -- about 2,200. I do believe if it's a more prolonged recession, I think our normalized level is probably around $1,800, okay. And whether we get back there next year or the following year, we ultimately know that DFC once the CECL reserves start to under pace the spreads on our interest at DFC. It's a massive impact because we know that we make 3x the $500 that we currently get from our third-party lenders. We make about 3x that over the life of the loan, okay, when we control the contract ourselves for DFC. So we'll have pretty good tailwinds at some point once the growth rates on DFC don't outrun the spreads like they are today still.

Okay. All right. Thanks for taking my questions.

You bet, Colin. Thanks.

Our next question is from Bret Jordan with Jefferies. Please proceed with your question.

Hey, good morning, guys.

Hi, Bret.

You bought a half a dozen RV dealerships recently. Is that a change in strategy at all? And how are the valuations on RV dealerships versus automotive?

Yes, yes, it's good. I think it's really a beta test. And we've obviously talked about the idea of all different mobility channels. okay? It's here, it takes little effort because it's based out of Portland. It's with the best RV manufacturer with the greatest level of exclusivity. It's a really low cost investment and Ted is a wonderful asset. He's a dynamic leader that can help us paint pictures of what 3 to 5 years from now could really look like. Some of it is just to help our teams understand how to digest this. But ultimately, these RV and many of the other mobility industries are run by car people or are the same basic model. It was a very small investment. And like I said, it's an organ based company that sells almost 1/5 of all airstreams in the country, which is quite a special business, and it has an upfitting business where he modifies those airstreams, which are already pretty darn cool with these great captain shares and different types of things. And we all know that the world is moved a little bit more domestic in terms of travel and the RV space, though it has been cyclical over the decades, I believe, and I think our team believes that the volatility may be a little less impactful than normal because people are spending more time out in the woods and on the roads of America to create a difference. But again, very small focus for the company relative to what we are doing and no real initiative to grow that business other than to really get a feel for what some of these other mobility verticals could look like.

Okay. And then a quick follow-up on F&I. I guess given what the DFC's [ph] proposing as far as restricting some of the product sales, do you see that as something we should worry about? Or are those products that you weren't typically including in F&I transactions in the first place?

Yes. Bret, I think that one thing that we've learned is that transparency in our F&I products is an important part. And if certain products are eliminated, there's usually other products that will be out there in the future for hybrids or for electric vehicles where we are reconditioning cars or most importantly, we really believe that F&I becomes the conduit for subscription services that help create a bond with a consumer that's in home or there's a more convenient experience than what they're looking for of coming into dealership and whatever happens with the CFPB. For us, we are pretty nimble at being able to adjust, and we will again adjust accordingly depending on what their final determinations are. I think the big keys are always treat everyone fairly and make sure that we provide them value in what they're looking for in a transparent environment.

Okay, great. Thank you.

Thanks, Bret.

Our next question comes from Adam Jonas with Morgan Stanley. Please proceed with your question.

Hey, everybody.

Hey, Adam.

So thanks. Hi. Hi, Bryan. So my question on the CFPB was taken. So I will just have a couple of quick ones for you. Have you had the chance or have you made any changes to your loss reserves either on new deals or have you made any true-ups to existing deals My first question. I just got a brief follow-up.

I will let Chuck take that real quick.

Yes, Adam. Thanks for your question. I mean, we are definitely looking at our provisions, but they stayed constant at 2.7% this quarter relative to the percentage of the total assets under management. We are obviously monitoring that very closely. Right now, I would say we feel pretty comfortable that, that's the correct amount. But obviously, if market conditions continue to deteriorate, we will certainly increase provisions accordingly.

Chuck has done a nice job. if you remember, Adam, we are up almost 30 basis points in FICO scores or 30 FICO score points. And our average LTV is down a pretty good amount. So he stayed in front of it as best as possible.

Agreed, agreed. And just last one, the -- you were asked earlier about the preorder ratio. I think last quarter, you said for new, it was -- it used to be 50%, but I believe your last quarter was about 30%.

20%, 30%. Yes, exactly.

Yes. What's that doing that? What is that now? What's it trending to?

So I made the comment earlier that we are really at a just-in-time inventory, but we still have those high demand vehicles like Broncos and Wranglers and Tacoma and those vehicles that still have big backlogs, okay? But we are also now in an environment where there are free flow, and we have a pretty good day supply in many of the domestic products that aren't as high a demand.

Okay. We will follow-up after. Thank you so much.

Thanks, Adam.

Our next question comes from David Whiston with Morningstar. Please proceed with your question.

Thanks. Good morning. Just curious on the M&A environment, if you were to go into Europe, in particular, the U.K., we've got very strong dollar, but a lot of macro turmoil over there. And I know you're probably more thinking on the long-term, so perhaps it's a good time to be maybe a value investor in the U.K., but at the same time, you would said more wanting to wait for more stability there?

Yes, David, I think when we think about Western Europe, I think that there's some pretty good read-throughs that we are not getting at the front level that two of our competitors are able to get, and that's Group One and PAG that there is some things happening there, and those are positive consumer experiences and there may be read-throughs a decade or so from now as to what that looks like in the United States. And those Western European business typically have traded at a lot lower multiples than what they trade and what dealerships trade at in the United States. And if we can find the right team because of the strong value of the dollar, it seems like it's a good time to be able to do that and I know there were some alleged rumors of us working on a project over there. And I think we were pretty clear on if that was us that was talking about it, it wasn't just about the raw dealership assets. It was about the raw dealerships assets as well as some fleet and leasing type of exposure that helps open up a new horizontal and probably most importantly, that the ability that they may have a DMS system that's pretty savvy and may help us with our $110 million annual cost of our DMS stack today, okay? That's a big amount. We can save half of that is $50 million or a couple of dollars a share. So at $50 billion in revenue, you can double that. So there's some pretty constructive things that we're looking at, but we do believe that Western Europe can give us some pretty good insights into maybe what a more efficient model can look like and maybe what a more streamlined consumer experience could look like.

Thanks for that. And just shifting gears over to omni-channel and pure digital transactions. Over the past 18 months or so, have you seen consumers are perhaps more willing to skip the test drive than in the past?

That's a good question. I do believe that the world -- and I don't have the data right here with me, but I do believe that there is becoming a greater portion of the consumers that are getting more comfortable with the idea of a vehicle being delivered to home and i.e., not having to test drive a car. So I mean, we are doing pretty good at that. We sold 30,700 vehicles through Driveway and our other digital experiences, which a lot of those are without test drives, okay? But we also know that there's pockets where there's strength and comfort with transacting in home. And then there's pockets that people aren't comfortable with it. And I think a lot of the e-commerce retailers, the early adopters did help change that environment, which is really, really cool, and it makes it easier for us and Driveway and GreenCars to be able to penetrate the market a little bit easier. I think the other thing that helps is we all have a 7-day type of return, where if the consumer isn't happy with it, and they do take their first test drive when they own it, they want to bring the car back and we take the car back. No questions ask and keep it quite simple that way.

You mentioned there are some areas where people don't necessarily want to go online. Is there a particular area or are you talking about a particular customer demographic or?

We noticed early on, we had this basic thesis that Arizona and Georgia and some of the Southeast where one of the big e-commerce retailers began their presence and had been in, in a longer period of time. had a greater portion of customers. And it was really in that Southeast and a little bit of the Southwest where we saw a little bit softer underbelly for consumers' propensity to want to be able to transact that way. And it just takes less marketing dollars to push the market. You don't have to explain the story. You don't have to sell the guarantees quite as hard as what you do in the snow belt where really the e-commerce in-home experience hasn't quite been as prevalent.

Okay. Thank you very much.

Thanks, David.

Our final question comes from the line of Lee Cooperman with Omega Family Office. Please proceed with your question.

[Indiscernible] opportunity. In any cyclical business, which you are obviously in a cyclical business, is the concept of peak earnings, trough earnings and normalized earnings, what do you view as your trough earnings?

Offline, okay. I think we get to talk tomorrow morning, right?

Yes. All right. I figure I asked your question on open line.

You bet.

So you have a view of your trough earnings?

We will take it offline.

Offline, okay. And secondly, you obviously got to be very disappointed in what's going on. You bought back a ton of stock 30% plus higher than it is now and you're buying less now. So I assume the environment is turning out to be a little bit different than you anticipated? Can we take that offline as well?

No, no, no, not at all. I mean, I think the environment is what we've been talking about for the last year. I mean, I don't think anyone expected GPUs to stay at these elevated levels, and it was a matter of when they began to normalize. And we are starting to see that normalization and we are quite happy with our results and the execution on our overall strategy and really are thinking about what does '25 look like, knowing that what happens in the economy isn't something that we can control, okay? And I think that is the mantra of Lithia and Driveway that we are going to do everything in our power to manage our day-to-day business, while still focusing on the long-term business that we're focused on. It was me, I was talking with my son yesterday on the phone. His name is Trent anyway, quite insightful. He's taking the international finance course. And he was talking about how America over the last two decades has turned into this quarterly approach of earnings, whereas most of Western Europe takes the long approach and is winning in different areas because they're not quite as reactive in terms of what's happening. I'm like, oh, that's really great info. I think that's how Lithia and Driveway really thinks about its business. So we look forward to talking tomorrow more, and we can get into more specifics.

We have reached the end of the question-and-answer session. I'd now like to turn the call back over to Amit Marwaha for closing comments.

Thanks for joining us today. We look forward to meeting with many of you in the next weeks. With that, I wish everyone a good day. Thanks.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.