Bryan DeBoer - CEO, President & Director Christopher Holzshu - EVP & Chief HR Officer John North - SVP, CFO & Principal Accounting Officer.

Steven Dyer - Craig-Hallum Capital Group James Albertine - Consumer Edge Research Bret Jordan - Jefferies Christopher Bottiglieri - Wolfe Research Nels Nelson - Stephens Inc. Michael Ward - Williams Trading Armintas Sinkevicius - Morgan Stanley John Murphy - Bank of America Merrill Lynch.

Good morning, and welcome to the Lithia Motors Second Quarter 2018 Conference Call. Management may make statements about future events, including 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 differ materially from the statements made. The company discloses material risks and uncertainties in its filings with the Securities and Exchange Commission.

The company urges you to carefully consider these disclosures and not to place undue reliance on forward-looking statements. Management undertakes no duty to update any forward-looking statements, which are made as of the date of this release. Management may also discuss non-GAAP financial measures.

Please refer to the text of the earnings release for a reconciliation to comparable GAAP measures. Management will provide prepared remarks and then open the call for questions. I will now turn the call over to Bryan DeBoer, President and CEO. Mr. DeBoer, you may begin..

Good morning, and thank you for joining us today. On the call with me are Chris Holzshu, our Executive Vice President; and John North, Senior Vice President and CFO. Earlier today, we reported the highest adjusted second quarter earnings in company history, $2.52 per share, or an 11% increase over our 2017 results.

Quarterly revenue increased 26% over the prior year to $3.1 billion. We generated strong growth both overall and on a same-store basis. We retailed 20% more new units and 20% more used units over the period last year, building new opportunities to earn customers for life.

Total gross profit increased 23% as our used vehicles and service operations outperformed new vehicles. We continue to attack the over $250 million in earnings dry powder available as our recent acquired locations continue to season.

We remain focused on driving substantial top line growth, which will allow us to increase earnings while investing in innovation, diversification and digital initiatives. Leveraging our people, inventories and technology through our network of service and delivery points will position us to be nimble in the evolving automotive retail space.

We believe car buying is local, regional and national. So establishing locations coast-to-coast is important to access new markets and reach consumers. Our nationwide network currently offers same-day delivery to over 80% of the U.S., with the second largest only inventory online in the country.

Our deep expertise in acquiring used cars has been built into our culture and operational leadership over the past decade. Our online traffic increased 35% over the prior year, as we continue to develop digital strategies to allow consumers to shop wherever, whenever and however they choose.

During the second quarter, we acquired Broadway Ford in Idaho Falls, Idaho and Buhler Ford in Eatontown, New Jersey. We also divested a small Mitsubishi franchise in Fresno, California.

In July, we opened a Chrysler Jeep Dodge store in Calallen, Texas, separated a Subaru franchise into a standalone location in Utica, New York and divested an Audi franchise in Monroeville, Pennsylvania.

We are optimizing our network of service and delivery points, primarily through acquisitions, but also through strategic divestitures to balance our footprint and ensure high performance. Our industry remains highly fragmented, and we believe scale is key to future mobility and personal transportation solutions.

We will continue to assemble and expand our top talent pool to foster growth in automotive retail 2.0. As such, we are pleased to announce the two key executives to have recently joined our team. Erik Lewis, our new Chief Human Resource Officer; and George Hines, our Chief Innovation and Technology Officer.

Erik is our first executive fully dedicated to supercharging our mission of growth powered by people. His experience in building high-performing and dynamic cultures to maximize an organization's ability to attract, grow and retain top talent will be a continued catalyst for our success.

George's expertise in technology and innovation will drive our digital initiatives, improve our customer experiences and accelerate our revenue growth. With the addition of Erik and George, Chris will continue his work here at headquarters and further expand his involvement in store operations.

Chris is working diligently with plateauing stores to reenergize them, to take action and quickly expand earnings. While the pace of earnings improvement has slowed this year relative to earlier expectations, we believe the path to substantially improve earnings per share remains unchanged.

We will continue to grow revenue through acquisitions, generate compelling returns on our investments and deploy additional cash flow to leverage our scale and drive innovation rewarding shareholders, both now and in the future. With that, I'd like to turn the call over to Chris..

Thank you, Bryan. Our mission of growth powered by people emphasizes attracting, growing and retaining the best people in the industry to maximize performance at each and every location.

We continue to emphasize that the pinnacle of high performance for our store leaders is to be named to our Lithia Partners Group, and we challenge all our stores to achieve this recognition which exemplifies our core values. As mentioned, we estimate over $250 million as available as earnings dry powder.

Profit opportunity that we can capture as we continue to develop entrepreneurial store leaders and recognize more Lithia Partners Group members that achieve our highest level of performance. I'd like to discuss our same-store quarterly results in more detail. Total sales increased 3%, reflecting strong performance in used and service.

In the quarter, new vehicle revenue was flat, our average selling price increased 3% and unit sales decreased 3% below national sales, which increased 2% in the quarter. Gross profit for new vehicle retailed as $1,998 compared to $1,964 in the second quarter of 2017, an increase of $34.

Same-store retail used vehicle revenues increased 7%, of which 4% was due to greater unit sales and 3% to an increase in selling prices. Our used-to-new ratio was 0.84:1. Gross profit per unit was $2,294 compared to $2,321 last year, a decrease of $27. Core units increased 7%, certified units decreased 1% and value auto units increased 4%.

We continue to target selling 85 vehicles per location each month, and in the quarter, on a consolidated basis, we sold 57 used vehicles per store, unchanged from the prior year. F&I per vehicle was $1,305 compared to $1,298 last year.

Of the vehicles we sold in the quarter, we arranged financing on 73%, sold the service contract on 45%, and sold a lifetime oil product on 24%. Our service, body and parts revenue increased 3% over the prior year, customer pay work increased 5%, warranty increased 1%, wholesale parts increased 2%, and our body shops decreased 2%.

Gross margin was 15.1% in the quarter, a decrease of 10 basis points from the same period last year. Our SG&A to gross profit was 17.8%, an increase of 4% or $20 million. Personnel and marketing expense in our vehicle sales department drove the majority of that increase.

Additionally, we experienced a $5 million headwind related to decreased profitability and higher reserves on our in-house financed portfolio. The other significant variance in our anticipated cost structure was flooring interest, which, on a continuing operations basis, increased 68% over last year.

Approximately half of the increase is due to acquisitions and the other half is a function of higher interest rate. As a result, our store leaders have developed action plans for approximately 50 stores to strategically reduce inventory levels and rationalize expenses, while improving gross profit.

It's important to remember that the majority of our stores are making market adjustments on their own, although our group leaders are providing more specific support and guidance where appropriate.

As we stated last quarter, our SG&A remains mostly variable, and we anticipate building momentum on these adjustments over the next 2 quarters, as we target $25 million in annualized savings. A 188 locations understand the opportunity to increase growth and to control cost, and are focused on achieving results in the next 2 quarters.

And now, a few comments from John..

Thanks, Chris. At June 30, 2018, we had approximately $234 million in cash and available credit as well as unfinanced real estate that can provide another $223 million in 60 to 90 days for an estimated total liquidity of $457 million. At the end of the second quarter, we were in compliance with all of our debt covenants.

Our leveraged EBITDA, defined as adjusted EBITDA less used floor plan interest and capital expenditures, was $88 million for the second quarter.

Our net debt to EBITDA is 2.9x, unchanged from last quarter, although, we still anticipate the ratio to decrease to a targeted range of 2 to 2.5x in the future, as our recent acquisitions annualize into the trailing 12 months EBITDA. Regardless, we still maintain with the lowest leverage ratios in the sector.

We have taken advantage of the volatility in our stock to utilize our authorized share repurchase. Year to date, we have retired over 670,000 shares or nearly 3% of our outstanding float at a weighted average price of $99.57 per share. Under our existing $250 million authorization, approximately $99 million remains available.

We announced the dividend of $0.29 per share for the second quarter, continuing our philosophy of a balanced approach to capital allocation. Our adjusted tax rate was just under 27% in the quarter, consistent with our expectation for the full year.

We have updated our outlook for the year, anticipating revenue of $11.75 billion to $12.25 billion, and $9.50 in earnings per share. We are also announcing that beginning in 2019, we will no longer provide our earnings outlook. In summary, we continue to generate significant free cash flow, and our leverage remains at comfortable levels.

We will deploy capital towards accretive investments and opportunistically return it to shareholders as efficiently as possible. We are continuing to evaluate ways to innovate and capture more of the automotive value stream as we balance earnings today while investing for the future. This concludes our prepared remarks.

We'd now like to open the call to questions..

[Operator Instructions]. Our first question is from Steve Dyer with Craig-Hallum..

SG&A to gross is obviously, again, a little bit higher than we're accustomed to seeing. I'm just wondering, it sounds like there was some very specific targeted investment. And I think still a decent amount of inefficiency just around bringing a lot of the acquired stores up to speed.

Are you able to sort of bucket the different pieces of that? And how much of that may persist just because you're continuing to choose to do so versus how much should improve going forward?.

one was our personnel cost, which I think is something that we are tangibly addressing, and I'll talk to that in just a second; and the second one is related to the finance company. We have identified almost $25 million in the 50 stores that have the biggest opportunity, primarily driven in the sales department.

And we think that's something that we can accomplish relatively quickly. The other things to keep in mind is that nothing has changed in our operating model.

And the other 140 stores that aren't on the top 50 list right now for us are remaining diligently focused on bringing down our leverage and targeting that mid-65% that a lot of our mature and seasoned stores actually continue to accomplish today..

Got it. And then I guess, secondly, just -- actually lost my train of thought there. I'll hop back in the queue..

Our next question is from James Albertine with Consumer Edge..

Just want to follow on, on the same line of thought there. If you could maybe help us isolate from a duration perspective. I mean, this has been several quarters now where you've highlighted plateauing legacy acquisitions.

How long should we expect some of these initiatives to take to play out, when you can kind of grind back into the 60% range for SG&A to gross? And if applicable, can you help us distinguish sort of the problem areas on a urban versus rural market bases? I guess, the supposition here is that you might be having more difficulty in urban markets.

Just wanted you to address that, if possible..

Thanks, Jamie, this is Bryan. Good questions. So when we look at our ability to gain that SG&A leverage back, we look at in a couple different ways and you touched on those specifics. I'd -- first, let's talk about the network, okay? If we think about our network, we've bought, what, 3 to 4x the amount of stores or revenues that we had 4, 5 years ago.

In many of the groups that we purchased, there was assets that we believed had a chance to become successful and we tried those. So now we're looking at network optimization and we have a half a dozen to a dozen stores that are really dragging on earnings.

And they're typically stores that are smaller, typically sell less than 600 new vehicles a year, but they're taking resources. And obviously, they take our SG&A numbers up considerably. So over the coming months, you'll see that we're going to be cleaning up the network a little bit and getting rid of some of that.

We also experimented with some different franchises and stores, in different locations. And we mentioned a few of those that we divested within our existing model. And I think we've learned and grown from that.

We also know that 86% of the time, our investment strategy, our buying strong assets that just aren't quite performing right is the solution to good growth. And I think whether or not we happen to buy too many at once that maybe a little dilutive, then that can occur.

Now, if we look at world versus metropolitan areas, we're not seeing any delineation between that, and maybe I could just give you some quick numbers. So Alaska is pretty strong. Revenues were down 1%, earnings were up 6%. California was up 3% in revenue, but earnings were down 15%. So a little bit worse.

But we see the same things in like Montana, where revenues were down 4% but earnings were down mid-20s, which is tough. But then we go to New Jersey that's full metro, and we're flat on revenue and we're up a couple percentage points on earnings.

We also could look at Pennsylvania, which is solely in the Pittsburgh market or the #30 or so market in the country. And let's see, revenues are up 14% and earnings are up 27%. So we're not seeing the anomalies that it's either metro or rural.

But we are seeing that it can take a little longer sometimes to be able to achieve that ultimate state and capture that dry powder. So if I was going to frame up when could we get there? What we know is this, we -- our company is built up of people that we empower to make the decisions in the field.

And ultimately, we know that the stores in our existing base even with the optimization as we divest a half a dozen or a dozen stores, we know that our earnings power is somewhere between $9 and somewhere upwards of $15 a share once we get there.

And I think it's purely a formula of putting the right people in the right place at the right time and getting those results. And I think our track record has shown that. And this is a -- I get that it's 3 quarters. But also if we look back, we are over 3x the earnings base of where we're at and we have the revenue, which is most important.

We believe capturing those customers to take us into auto retail 2.0 is the key to be able to start the relationships that start to blend into shared vehicles or leasing or the next vehicles that they purchase, which is an important part of our overall outlook for the future..

Jamie, just one clarification. All those state numbers Bryan gave are same-store. Just want to make sure everyone picked up those all same-store numbers..

Appreciate that, John, and thank you, Bryan for the thoughtful response. If I may just follow on to that and then my final question related. It seems as though the second quarter was incrementally worse than what you had thought at the end of the first quarter.

And while we don't disagree with the trend toward providing no guidance over time, it just seems as though pretty choppy time to sort of embark on that venture.

And so wanted to understand the thought process with respect to why sort of deciding to be more opaque at a time when it does seem as though there are some key structural initiatives underway? And then as well to Bryan's comments, are the right people in the right place right now? Or is this an ongoing search to make sure you can get sort of the right management at the store level situated in order to sort of undertake these initiatives?.

No problem, Jamie. We'll try to get through all of that. I think there are 2 parts. I'll talk to the guidance first, this is John, and then Bryan maybe can talk to the people part of your question. I think our intention with the guidance is to give everyone plenty of notice. We typically provide our outlook for the following year in October.

We did provide an outlook for the remainder of this year. And I think the idea is to try to not give anyone a heart attack in terms of a big change in our structure. To Chris's point, SG&A was off by about $15 million in the quarter relative to expectation. And our SG&A is running over $250 million a year.

And I think we're still going to continue to run the company the same way we have. We still have been focused on opportunity. And frankly, even at 71% SG&A to gross this quarter, I mean, that's not an objectably terrible number.

But I think when we think about 2019 and beyond, and building the company and the success of the company for the longer term, it's important to us to not constantly be on a quarterly earnings treadmill. We are talking plus or minus 5% of the SG&A cost that can move our stock obviously, I think, what, 12% today.

And I think that we're trying to get a little more separation between that and the longer-term vision of the company. We want to build to prosper in the future. I think if we do a large acquisition or there's some transformative change, we'll obviously give some good color around that and what it means for the outlook of the company.

And I hope that's helpful. I'll turn over to Bryan now..

Jamie, you asked a question about do we have the right people in the right locations? I really believe that we do.

I think what we find when we manage people through our, what we would call, a detective type of measurement reports that manage trends is, when you buy underperformance, what we noticed is that we get pretty good gains and we can probably use DCH as an example or probably most of the other groups that we've purchased.

When they gain those benefits quickly, okay, which comes from higher revenues, through used cars and obviously maintaining their cost structures a little bit better than they have in the past, it's easy to get relaxed, okay? And I think our measurement reports will point that out.

But the revenue base that we're hitting, it's -- you get into a comfort state, okay? And the market was driven to some extent off a growth in registrations and not growth through good business behaviors. And I think the combination of both of those gets you into this plateau state.

The ability to get through a plateau state is different, and it's one of the values that we live in our organization, which is continuous improvement and taking personal ownership. It's difficult for people to see when they've come so far, how to get to the next level.

So starting last week, we began, myself, Chris and a number of our group leader team started General Manager meetings again, and we haven't done them in a couple years.

And we believe it's the right answer to be able to motivate our teams to hopefully challenge them and help them see the opportunities that are in front of them, and then hopefully get there in a quick manner. So I really believe that we have the right people.

I believe that there is an urgency that gets lost in the clouds of feeling like you really have taken a store a longways or a department a longways. And we know that our team is built around our value base, and we'll find the opportunities and it may take us a little longer to get there. But ultimately, we're not changing our strategy.

We still believe in the dry powder that we've purchased outside of that little bit of optimization in our store network..

Our next question is from Bret Jordan with Jefferies..

On the units, I guess, down 3% versus national retail which I think was fractionally up ex the fleet.

Could you talk maybe, I guess, in particular, either sort of product lines or markets? Do you feel like you -- I guess, it would imply a loss on market share but you think your regions performed in line with the national average? And maybe you could give us the highlights, the lowlights of the quarter on units..

Yes. Let me start by saying, the stores that we're looking at divesting were the majority of our deficiencies within most manufacturers. So that's where the key focus is recently is to be able to move on those stores quickly and we'll be able to share some of that probably by the end of the third quarter as well.

Chris can give you some specifics by manufacturer as to what we're seeing on the -- on our major brands..

Yes, Bret, this is Chris. So I guess, on the domestic side, I think things looked pretty good. GM was down about 1.5%, all the other domestic OEMs being somewhat neutral.

On the import side, Toyota was down about 5%, Nissan and Hyundai, which both are working hard to, I think, reinspire stores on their incentive programs that they have right now that are all stairstep-based and having a little bit of trouble hitting the objectives, are moving more towards the gross model, were down in the mid-20s.

And then on the luxury side, Mercedes was probably our biggest opportunity, that was down 8%, MINI following that, about 15%. But I think in the quarter, the other thing that we really saw was a big driver in the fleet sales, which drove the national numbers up.

So all in all, I think with -- given where [indiscernible], we feel like our stores are responding well and definitely maintaining the profit side, which we said on the gross profit per unit basis was effectively up 2%..

Okay.

And then on the guide this year, obviously, a pretty big takedown from 10.60%, is that just expecting a higher SG&A as you start to unwind some of these underperforming stores? Or is there a more credit true-up in the second half of the year?.

Bret, this is Bryan again. So actually the stores that we unwind, we're actually going to be making money in aggregate on those stores, which is obviously a balance sheet item. It does help our SG&A a little bit, and you'll see that come through over the coming quarters.

I think also though when we think about SG&A, the SG&A is mostly determined by a lot of acquisitions. And I mean, remember, we buy stores that could have upwards of 90% SG&A. I mean, to be fair, some are even greater than that if they're losing money. What we also know though is, and I think keep this in mind, we're confident.

You're going to like our overall strategy in the long term because ultimately we are 86% successful on the stores that we bought, okay? And we need to be a little bit more diligent on divesting the 14% and knowing what those are and if there's ones that come in the group, you'll see that, that will occur.

But ultimately, the strategies that we have in place that we've always had in place in regards to buying strong assets that just underperformed will be rewarded in the long term. It's just sometimes you have to make decisions like a Prestige.

That's an extremely strong asset in New Jersey that was losing a couple millions dollars a year when we bought it and we're turning it in. Now it's making a little bit of money but it took a lot of capital to invest, and those things play out a little bit differently..

Yes, this is Chris. Specifically it rates -- relates to coming into Q3, I mean, you also remember that we have a lot of acquisitions that are unseasoned that are coming into the same-store comp numbers. And as a good example of that, we acquired Downtown LA last year, which will be coming partially into our comps in Q3.

And they're running at SG&A somewhere near 85%. So we have those anomalies that we're going to have to call out as we move forward, if the focus is going to be on SG&A on a same-store basis, which seems to be a lot of the discussion on the call today..

Okay. And then the last question. I mean, Bryan, I think you commented, you think you're 9% to 15% in earnings power per share. What's assumed in that? Because obviously we're at the low end of that this year.

Is the 15% assuming incremental store growth as well?.

So it's five components, and you can refer to our slide deck to be able to get the specifics. But it's ideally -- it's gross to 120% of sales efficiency, which means you're 20% better than what the average store is, which is where we've typically run. It's used vehicle gross up to approximately 80 to 85 units per site.

And typically when we buy the stores, and if we look at our currently purchased stores, they typically sell around 40 units in each of those. It's F&I growth from the $700 range up to the company average of $1,300, $1,400.

And then it's controlling SG&A as well as growing our service retention up to a plus 10%, which means that the 10-year units in operations that we're going to do 10% better than what a typical dealer does within our geographic competitive area, okay? So those are the five components that drive that $250 million in dry powder.

And as we've discussed in the past, it can take some time to get there. But what we know underlying is that these are strong franchises, typically three domestics, the three import keys and the 3 or 4 luxury keys. And that makes up the 10 of what we consider strong franchises.

And in metropolitan areas, they need to be in retail quarters that are dominant..

Okay.

But is it more realistic to think maybe half of that dry powder -- I mean, do you also think that everything performs in line with the top quarter of the stores as ignores the law of averages? So is there -- I mean, if 9% to 15% is the range, is the probability it's 11% to 13%, I guess, is the question?.

There is validity to that. But remember, the goal on dry powder is not to get into the top 25% of our stores. That's to get -- I mean, our best stores, for example, like for sales efficiency, they sell 300%. So 3x what the average dealer stores. Our best stores in service retention do 160% not 110%.

Our best stores in SG&A do mid- to low 50 percentile not 65%, as Chris mentioned. Are you following me? So this is a realistic number for a, what we would call, a be-job performance. We believe that the people that we're growing within the organization have the ability to get there within a reasonable period of time..

Our next question is from Chris Bottiglieri with Wolfe Research..

First one, I guess, just -- I'm not sure if you've given any context to this but is there a way to quantify how much of the most recent 15 acquired stores from last quarter contributed to the SG&A gross metric? Like how different would that metric have looked without those stores in it?.

I don't think we have that prepared. This is John. We can probably try to help you out offline on that. But I think trying to swag something on the call would be a mistake. So not sure I can give that to you..

No, that's fine. I just want to understand that, like quarter-to-quarter move there. All right. Then there's a couple high-level strategic questions. So wanted to get your perspective -- I'm kind of sticking with the decentralized management model, I know this has worked pretty well prehistorically.

Just given that there is like just so much bigger greater geographic brand diversity, there's such a proliferation of technology, do you think it still makes sense to be so decentralized? And is -- are there any benefits or best processes that you kind of move up to the corporate level as you think to your strategy?.

Good question, Chris, and I know a lot of people think about that and the benefits of that. We know for sure that the customer-facing functions at a decentralized empowered state in the store, where our people can be entrepreneurs, has proven successful, okay? So we have no intent to change that.

We also go to market within local markets and regional markets, so we do have brand names that do things more similarly, and maybe go to market with the same promises and guarantees to the consumers and processes.

But ultimately, what we found is that the real benefits, long-term or more around, they're behind the scenes in noncustomer-facing functions, which we've always centralized to a pretty high state. We all have the same reporting, we all use the same IT solutions. However, some of the go-to-market solutions are a little different in every store.

Our general managers and department managers have autonomy to do that. And I think whether or not our SG&A has grown a little bit, we know that people are the drivers of automotive retail. We know that technology is becoming a larger portion of driving customer relationships in automotive retail.

But we also believe that having 189 locations that are innovating, and then 1 location here in Medford that's also innovating and looking for diversification or innovative relationships, those type of things can all be utilized to share best practices with the store to create greater market share, which we believe it is about scale and volume and the idea of building out our footprint.

And as we think about our growth, it's about capturing that next customer. And I think for the foreseeable future, the decentralized model on customer-facing items is the single best way to go to market and allows us to grow people.

It allows us to attract people and allows people to understand the competitive pressures within their area and the consumers and how to capture the greatest market share doing so..

Got you. Okay. Then just 1 related follow-up or maybe unrelated.

But you've recently put out some press releases announcing new Chief Technology Officer, HR Officer, how do we think with the timing of these announcements? And what is the signal about the level of innovation or investment you tend to make moving forward? And then just lastly, like where some of the capabilities you feel that you're currently lacking? And what do you see the biggest opportunity is as you think about your business moving forward?.

Sure. Chris, this is Bryan again. I think when we look at both of those people, Erik obviously -- Chris has been in the role of our first Chief Human Resource Officers with a lot of other duties as well.

Erik brought the formality and the understanding to proactively be able to grow our team and to expand that culture to be able to attract the best talent, ultimately, with 1 goal in mind, to raise the bar of performance. That's how we're built. And we thought it was the appropriate time. We've been looking for approximately a year to do that.

And he seemed to fit our culture and we're excited to have him on here, and he's already showing the benefit that we hope to gain on that end to capture that additional dry powder, best what it's going to take is to develop a culture that's entrepreneurial, that challenges people at the right level and if it doesn't work out, then to have people on the benches to be able to replace them with.

I think when we think about the technology angle, one thing that we know as the technology can make our lives easier, it can also make our inventory more scalable and the people that we have focusing on sales and service a little bit more productive, okay? So we really believe that as an organization, we've bought some great companies that had some great technology, we grew technology ourselves.

But also we know for the long term that auto retail 2.0, that our abilities, and we've been working now a couple years behind the scenes on expanding and being able to leverage our assets, which is our inventory and our people, that we believe that this is the right time to elevate that position into more of an offensive role.

And George comes to us with a lot of experience in terms of how to do that and how to aggregate those assets into something that we can all be proud of in the future. Because our goal today is still focused on hitting earnings and achieving a hypothetical $15 a share, once we capture all the dry powder.

But also it's to build the company that is a bigger part of auto retail 2.0., whenever that occurs, okay? And I think if we're solely focused on earnings, it can take your eyes off of building a company for the future. And I think those 2 hires were built around understanding our weaknesses and strengths and understanding where opportunity lies.

And we know that that's how our organization is built. And if we're going to be and when we're part of that next gen, that's how we're going to get there in a more efficient and stronger way..

Our next question comes from Rick Nelson with Stephens..

Can you lay out your plan for automotive 2.0? I know you've referenced the service and delivery model. And you've got those new digital executive. I'd be interested in hearing more about this..

Rick, let me answer it quickly and then we'll take it offline and we'll be able to embellish on that little further. Primarily, we believe one thing. We believe that the ability to procure inventory, primarily in the used car arena is key to success. We also know that we're pretty darn good at that.

Right now with 75,000 units online, we are the second largest owned inventory in the country, and we don't think that we're leveraging it to the same ability that we have. And I'm sure you've been on lithia.com. It's okay, but it's no different than most dealers' websites.

We also know that our ability to leverage that whether regionally or on a national basis can be done fairly efficiently and fairly easily with the use of technology.

So as we begin to talk over the coming quarters, you'll see that our strategies will unfold how to leverage that alongside the great talent that we have in our organization to be able to expand and take a larger portion of whatever automotive retail 2.0 is.

And we can get on the phone later today, where I can give you a little bit more detail on that..

That sounds good, Bryan. Also curious on the stores that you're planning to unwind.

If those are unprofitable as a group, and if so then can you quantify the magnitude of the loss?.

Sure. Sure. So we have a -- what, a half dozen stores or so already under contract to be sold. Like I said, we're fortunate that even buying those assets, we still make money on them when we sell them. So it wasn't all the worst investment. We also know that it will have an impact positively on earnings.

It's not massive amounts, because we don't have that wider range of performance. So I would say in -- John, you got a guess there? Somewhere in the $0.20 range probably by the time we get through all dozen or so. And that may take us till the end of the year to complete all the divestitures and the optimization..

Right. Finally, if I could ask about capital allocation.

How you look at the trade-off between acquisitions and stock buybacks with your stock now at current levels?.

Yes, Rick, this is John. I think we're fortunate in that. We still believe that there's plenty of capacity available to do both. We've obviously retired a significant number of the shares this year, nearly 3% of float. And clearly at these levels, I'm sure we're going to continue to be in the market.

But at the same time, I think we've got plenty of capacity available to be able to buy proofs and opportunities that come along, and I think we can maintain the same strategy that we've had for the last 8 years in terms of how we think about deploying capital..

Our next question is from Michael Ward with Williams Trading..

In your slide deck, it seems that you're targeting the Southeast United States for potential expansion. Is there anything that limits the potential size of a transaction? I know there are several large groups in the Florida region in particular.

Is there anything that restricts that size? Or could we be looking at another transformative acquisition the size of DCH?.

Great question, Michael. There are a number of, what we would call, great fits, that are larger groups in the Southeast. I think the biggest limitation -- the South East appears to be pretty competitive for stores and ultimately, we're not willing to flex what our hurdle rates are on returns. So that's what's really kept us from moving into there.

We also wouldn't buy typically 1 or 2 small stores, because it's not worth the effort, okay? So we do need that, let's call it, small or midsize group just to get a footprint there. But you're absolutely right, outside of hitting ROE target, that's probably the only a limiter.

We have noticed in the Southeast, it doesn't appear that there's as much nonperformance, which typically part of our ROE ability is to find stores that perform at half or quarter of what the earnings potential is. And obviously, when you look -- like on Page 11 of our deck, it talks about dry powder, you can see what the formulations are.

Well, the Southeast is a pretty robust economy that doesn't have that. So that can limit and restrict us a little bit. But we're confident we'll be able to build it out over the coming quarters or years..

Our next question comes from Armintas Sinkevicius with Morgan Stanley..

I was hoping maybe you could walk me through the puts and takes to your guidance. How you see 2018 from a SAAR perspective? How you see that impacting you? How you see the SG&A flowing? What numbers are you -- do you have in mind to get to that $9.50? Just trying to make sure that I understand the puts and takes there..

Sure, Armintas, this is John. I'll try to give you a quick summary. I mean, I think we're anticipating significant changes in kind of our top line revenue run rate. I mean, we've obviously seen nice growth due to the acquisitions on a same-store basis.

We've been up kind of single digits, mid-single digits depending on the business line, and I don't think we're anticipating big changes there now. Obviously, we're not economist and so to the extent that there is geopolitical macroeconomic tariffs, those kind of things, I guess, that is going to be something we respond along with everyone else.

In terms of below the line, I think our expectation is obviously to address the opportunity around some of these cost areas, and Chris spoke to that. It's going to be happening over the next coming quarters. And clearly, we're putting a different flag in the ground at $9.50 than where we were.

And so we've restacked things based on kind of how things are running today. I think our flooring interest expense is a bit higher than we anticipated. And obviously SG&A, delevering a bit is reflected in the outlook. So we're trying to get everyone a realistic version of where we think things can go.

And obviously, we're going to try to do better than that if we can accelerate performance like we always do. So I don't think that's really changed. Hope that helps..

Okay.

And then the change from the $10.60 to $9.50, is that largely SG&A in floor interest expense? Or are there some other moving parts there to be mindful of?.

No. I mean, it's the combination of all of that. I think we're obviously looking at the first two quarters of the produce an indication of the back half. And the first quarter is seasonally weaker than the other 3. But I think you can kind of do the math that way. You're obviously going to have a pretty detailed model I'm sure..

Okay. And then the other question is, you talk about the dry powder opportunity, the hypothetical $15 of EPS.

Your guidance right now assumes sort of the current run rate of the stores, it doesn't include any of the dry powder, is that right?.

That's correct..

Our next question is from John Murphy with Bank of America..

Just want to follow up just on one point you guys made on the SG&A. I mean, you're saying 71% is not too bad relative to some of the comps. And I would agree but you guys typically operated around the 68% range and usually are close to best-in-class, if not.

Is 68% the target sort of long run without talking about the next quarter or the next year? I mean, as you think about managing this business, what is the SG&A level that is optimal to get to?.

Yes, John, this is Chris. As we stated, our matured, seasoned stores are running in that mid- to lower 60% range and that remains the target that we have mid- to long term..

So a follow-on. When you think -- I mean, for your operating without putting us in the model yet.

But I mean, you think it stick around 65% plus or minus is plausible once you get everything worked out?.

Yes, that hasn't changed. And as we said, we got a lot of acquisitions that are unseasoned, that are coming online, that are continuing to drive that number up. But we want to keep buying stores, extending our footprint and reinvesting in the business. So we can't manage the SG&A line. But over time, we definitely plan to get back down in that range..

John, keep in mind, I mean, 2/3 of our stores joined our organization in the last 3 to 4 years. And if you look at that they started at 85%, 90%, it takes some time to be able to get that.

And when you -- if you're comping it against the rest of the sector and those type of things, most of our competitors haven't grown, okay? And they're buying stores typically that have similar SG&A than what they do.

And I think that's the strength of the Lithia model and always will be is the ability to buy that underperformance and then understand that it can take some time to get there. And unfortunately, we're not seeing the best of it right now. But the dry powder is there.

I'd rather have the asset and have the ability to get there than not have the asset and the strength to be able to get and leverage that our cost and our revenues to that capacity. I mean, we did -- we grew revenues 26%. Our same-store revenue was up 3%. It's just not falling to the bottom line right now.

But ultimately, if you think about auto retail 2.0, if you get to the end with the most customers, and I think that's what we're trying to accomplish and that's why we're scaling and that's why we're trying to build out our footprint is to be able to leverage our nationwide footprint on a way that we can go to consumers the way that they choose..

So disregarding sort of the hour-long sort of hard time it's been giving you on your SG&A cost being inflated, do you think to have this going forward? I mean, will you be willing to sort of stomach this temporary period of having inflated cost and still be pretty aggressive on acquisitions just because you think the endgame here being much larger and the sort of the valuations in the market make sense? And that you worry about the SG&A a year or 2 down the line if it -- if that's the case? I mean, the trade-off is it rather get a lot bigger -- okay, is that -- that's a fair assessment?.

You just nailed it, John. I mean, we're not going to sacrifice pushing too hard in areas that we don't believe help us long term. We know we can achieve that in SG&A over time. But we also need to put our resources into areas that will change our future. And I think the difference of achieving 71% or 65% is going to come.

But ultimately, the only difference is a little bit of cash flow in the short term. But ultimately long term, the model and the way that we've built our company is to create innovation that changes our outlook for the future.

So we don't build things short term, which means at times, we're going to hit plateauing environment, like this, where we go through these things but it's -- we know that we've built a company that is strong for the future because it's figuring out solutions and spending some of its earnings base on the future.

And it's a little bit different than what we've discussed. And to be fair, we thought we could absorb most of the cost of that and the stores have plateaued and now it looks like the SG&A is a little bit out of lacking to be fair.

We agree, okay? And we're going to be able to capture that back but you're right on -- John, in terms of how you are thinking about that..

Okay. That's helpful.

And then just a second question, when you think about the ramp-up in lease returns, I'm just curious what you're seeing in your dealerships as far as these lease returns? How they are processed, given some of the swings in used vehicle prices so they haven't been that bad yet? And how many of them you're sort of capturing in CPOs? Meaning are you capturing a higher level or retaining a higher level of the vehicles that you're grounding off of lease? And what kind of opportunities that present for your used vehicle business?.

Yes. John, this is Chris. I mean, we continue to manage the used car business in the three primary buckets being -- certified being one, and our certified sales in the quarter were actually down 1%. So even with a moderating start, I think that's kind of consistently moderated over the last several years.

We're starting to see kind of a deceleration in the number of lease returns, which typically result in certified cars. Our focus is our core product, which was up 7% in the quarter, has a highest gross profit per unit, which is at $2,600 per unit.

And then of course, the residual effect of that is focused on our value auto vehicles, which was up 4% and still has a $2,100 gross profit per unit. So I think that we did see a deceleration a little bit in the certified unit.

But giving us a lot of opportunity based on prior model years to grow our core and value auto, which is kind of the secret to our long-term success in used cars..

And just if you could just remind me the core is in what price point? I think values $10,000 and lower.

What are the bands roughly?.

You bet. So value auto is at $12,000, core product is at $22,000 and our CPO cars are right around $25,000..

That's super helpful. And then just lastly, the pricing activity/incentive activity, I should say, from Nissan and I think you were kind of highlighting Hyundai, and even the whole industry on stairsteps is -- has been a little bit more aggressive or complicated than usual.

I mean, how do you see this developing going forward? I mean, the sales are kind of plateauing here. It seems like there's more gain/complexity in these dealer cash and dealer incentive in stairstep programs.

What is your sort of opinion on how this is developing and how you're managing it, because one large [indiscernible] you got caught on the quarter on this.

And I'm just curious what your opinion is?.

Yes. This is Bryan, John. I think when we think about incentives, we don't attack incentives from a global basis other than when we look at M&A. So when we think about M&A, we think about what type of stability is there in the way that our manufacturer partners go to market.

And obviously, we all know that the three manufacturers that play this stairstep game and we put people in those stores to make the decisions that understand that game, okay, and do pretty good at it. And we know that it's always going to be changing. So they're nimble thinkers. And I think that's how we think about it from a global basis.

We're not really sure that it's a big influence on who we are or how we operate other than it helps to balance out supply and demand and pricing..

So no significant change more recently.

I mean, it's sort of the normal complexity what you always deal with?.

Yes, maybe Chris could speak a little bit to the [indiscernible]..

Yes, John, I spoke to the specific unit volumes by manufacturer a little bit ago, but -- and I alluded to the fact that our gross profit per unit was actually up. So we saw a 2% decline in units and we saw a 2% increase in our gross profit per unit.

So our store leaders are taking action based on what's happening with their individual manufacturer and their market and they are adjusting a play. Obviously, they drive as much money to the bottom line as they can. Specifically, related to domestics, our domestic gross profit per unit was up almost 3.5%.

Our import was down about 2% and our luxury line was up almost 6% in GPU. So while we may give up a little bit on volume, luxury being down 2%, we feel like we're maintaining and holding a line on our GPU..

Ladies and gentlemen, we've reached the end of the question-and-answer session. At this time, I'd like to turn the call back to Bryan DeBoer for closing comments..

Thank you, again, for joining us today, and we look forward to updating you again on our results in October. Bye-bye..

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