Good morning and welcome to Lithia Motors second quarter 2019 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the conference over to your host, Eric Pitt, Vice President of Investor Relations and Treasurer.

Please begin..

Thank you and welcome to the Lithia Motors second quarter 2019 earnings call. Presenting today are Bryan DeBoer, President and CEO; Chris Holzshu, Executive Vice President and Tina Miller, Senior Vice President and CFO.

Today's discussions may include statements about futures 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.

We disclose those 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 to 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 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 on our website, lithiainvestorrelations.com, highlighting our second quarter results.

With that, I would like to turn the call over to Bryan DeBoer, President and CEO..

Good morning and thank you for joining us. Earlier today, we reported the highest adjusted second quarter earnings in company history at $2.95 per share, a 17% increase over last year. Our earnings were driven by record revenues of 3.2 billion for the quarter with same store sales revenue growth in all business lines.

As a growth company, powered by people in innovation, we purchase and build strong businesses that have yet to realize their potential. We achieve operational excellence by focusing our teams on convenient and transparent customer experiences and utilizing proprietary performance management systems to increase market share and profitability.

This combination of operational excellence and value based growth enables our strategy to generate significant cash flows, while also maintaining low leverage. We recently promoted Tina Miller to Senior Vice President and Chief Financial Officer and George Hines to Senior Vice President and Chief Innovation and Technology Officer.

Their dynamic leadership, acute understanding of our model and impact with our operational teams have positioned them to continue to accelerate our performance. We welcome them both to our senior leadership team and look forward to their continued growth and contributions. Our operational results from this point forward will be on a same store basis.

During the quarter, we grew revenue 6% and total gross profit 9%. New vehicle revenues were up slightly and our highest margin business lines were all up double digits with used vehicle revenues growing 12%, F&I revenue up 14% and service, body and parts revenues increasing 10%.

These lines accounted for approximately 42% of our revenues and 80% of our gross profit. From core and value auto used vehicles to lifetime oil contracts and one stop service offerings, our operating model is specifically built to touch the entire lifecycle of vehicle ownership and all consumer types. We generate income from six distinct businesses.

New vehicle sales, used vehicle sales, finance and insurance and service, body and parts. This diversification creates strength in our revenue and profit streams and combined with our growth strategy results in a unique opportunity, unlike most other competitive models.

We generate more than 250 million in free cash flows annually, allowing us to expand our network, invest in innovation and adjacencies and deliver shareholder value. Our physical network enables us to supply convenient touch points throughout the customer’s ownership experience and drive our higher margin used F&I service and parts business line.

This network also provides an infrastructure to deliver our digital solutions to further expand our reach. We target investing two-thirds of our capital into expanding our physical network through acquiring strong assets at a targeted average equity investment of 15% of anticipated revenues. Our current available liquidity is over $500 million.

Combined with $250 million in annual free cash flows, we could add more than $5 billion in revenues or 40% growth. To further illustrate the benefits of our model, if we chose not to add any incremental leverage and just utilize free cash flows for acquisitions, we could add $1.4 billion in revenues and grow approximately 12% annually.

The acquisition market continues to be robust, as we have purchased over $320 million in annual revenues so far this year, expanding our national reach to 82%.

In the second quarter, we purchased Hamilton Honda in Hamilton Township, New Jersey; Freedom Ford in Morgantown, West Virginia, a new state for us, and Jaguar Land Rover in Mission Viejo, California.

We are excited to welcome these new teams to the Lithia family and we look forward to becoming a top performer with our new manufacturer partners, Jaguar and Land Rover. We continue to optimize our nationwide network. During the quarter, we divested two smaller locations, totaling 12 in the past year.

As a reminder, all of these stores originally were acquired as part of a previous group acquisition or as open points.

As one of the top three largest auto groups in the United States, retailing more than 335,000 vehicles annually, offering the second largest owned inventory marketplace online and servicing more than 3.5 million vehicles a year, opportunity to grow still remains.

Our industry is highly fragmented with the top 10 dealership groups controlling less than 8% of the US new vehicle market and no single company controlling more than 2% of the used vehicle market. Combined, the addressable new and used vehicle market is over 1 trillion annually, of which we represent 1.2%.

Over the coming quarters, we look forward to continuing to expand our nationwide footprint through our disciplined acquisition strategy that historically has achieved an 80% success rate of exceeding our aftertax ROE targets. New digital technologies enable us to further activate our physical network and capture additional earnings.

We seek to provide customers with seamless, blended online and physical retail experience with broad selection and access to specialized expertise and knowledge. Our ability to retail a full age range of used vehicles is a hallmark of our growth. Sourcing of the right used vehicle drives this business line.

Our operational leaders have taken us to one to one used to new ratio. Technology now also supports our procurement decisions by guiding us to more of the right vehicle. This combination of aptitude and technology will help us drive towards the national used to new ratio of 2.3 to 1.

Our finance and insurance profits continue to grow, but opportunities to increase vehicle volume and F&I per unit remain plentiful. To illustrate further, almost half of our consumers have a credit rating of 700 or below and 71% of our consumers with trade-ins [ph] have negative equity.

The majority of our customers need specialists who can help obtain a financing structure that balances their credit rating, desired vehicle purchase, potential negative equity and an affordable monthly payment.

Alongside this expertise, digital solutions are creating a convenient, transparent environment for those customers that have the financial strength to transact and complete financing online.

These specialists along with digital flexibility allows us to maximize the full economic benefit of this channel, while also selling a greater number of vehicles throughout the entire credit and vehicle age spectrum. This combination will continue to grow profits and expand the reach of our network. Our partnership with Shift continues to mature.

We learn from their digital solutions that are simplifying the car purchasing and selling experiences. Our team provides industry knowledge to Shift, as we continue to create synergies. Thus far, we are sharing data, technologies or physical network and vendor lender relationships.

This strategic partnership supports one aspect of our evolution, as Shift inspires us to think differently as a retailer. In closing, we like to reflect on the diversification and value each of our six business lines creates relative to other companies that only have one or two of these components.

Then, add the industry consolidation opportunity, our proven growth, existing network potential, combine this with our ability to generate significant cash flows and the differences in value creation and profitability become apparent. We have included further details on page 16 of our online investor presentation.

We look forward to continuing to drive operational excellence, further the reach of our network and expand our customer offerings with innovative solutions. Combined, this unique strategy springboards us towards a much more meaningful share of the $1 trillion new and used vehicle market and achievement of our $15 EPS milestone and beyond.

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

Thank you, Bryan. Lithia’s mission of growth powered by people is the foundation of our high performance culture. Our team members embrace our customer focused environment and promote our value to continuously improve. Our results are driven by our operating model, which combines acquiring, integrating and growing our stores.

This model utilizes our store performance scorecard or SPS to align our core values with the key metrics that drive our short and long term success.

With our recent acquisition, our seasoned store that has been with us since inception, our 15,000 team members leverage this information to find ways to improve the customer experience and improve operations at each location.

Additionally, we standardized our non-customer facing processes, removing the need for store personnel to manage administrative aspects of the business, so they can stay focused on creating customers for life.

Turning to same store results, in the quarter, total sales increased 6% and total gross profit grew by 9%, reflecting strong performance in used vehicles, F&I and service, body and parts.

As Bryan mentioned earlier, our operating model is built upon six independent business lines, that driver our overall performance and the following is additional detail on each of these lines. The new business line, which is the top of funnel in automotive retail grew slightly.

Our average selling price increased 5% and unit sales decreased 5% in line with retail SAAR. Gross profit per unit was $2,087 compared to $2,068 last year, an increase of $19. Our stores remain nimble in their volume and growth strategies and adapt to local and regional market conditions.

Retail used vehicle revenues increased 12%, unit sales increased 12%, while average selling prices remained flat. Used retail gross profit per unit was $2,179 compared to $2,247 last year, a decrease of 3%.

Our used vehicle sales mix in the quarter was 24% certified, 54% core or vehicles 3 to 7 years old and 22% value auto or vehicles with over 80,000 miles. Both core and value auto continue to see unit growth in the mid-teens. We remain focused on procurement of these units and the opportunity to sell more of these vehicles at most of our rooftops.

Our investment in different innovation channels help store leaders leverage technology to procure and sell more used vehicles overall.

Most recently, we have incorporated additional online functionality for used vehicles in certain markets that add customer directed monthly financing and payment options, instant price quotes on trade ins and negotiation free financing insurance product offering.

These changes mark our store’s continued progress in creating a blended online and physical retail experience. With the additional information customers provide, our financing specialists gain insights faster that help guide customers through a personalized solution that meets their specific needs and personal budget.

As a result, we continue to target selling at least 85 units per location per month. In the second quarter of 2019, we reached 72 used units per store per month, an increase of 7% over the prior year. F&I per vehicle remained strong for the quarter at $1,451 compared to $1,304, an increase of $147 per unit.

Overall growth in F&I was due to higher penetration rates, improving our profitability in nearly all of our product offerings. Of the vehicles we sold in the quarter, we arranged financing on 74%, sold a service contract on 48% and sold a lifetime oil product on 22%.

As Bryan mentioned, we continue to capture the additional earnings potential in F&I by leveraging our F&I specialists to provide the right products to consumers, while leveraging relationships with current F&I partners.

As 71% of our consumers with trade-ins have negative equity averaging $5100, our experienced associates have tremendous opportunities to help customers meet their buying needs and accelerate our sales growth.

New and used vehicle sales create incremental profit opportunities to the resale of additional trade in vehicles, greater manufacturer incentive, F&I sales and future parts and service works. One measure of this is through the growth of our total gross profit per unit, which was $3,602 this quarter, or an increase of $129 per unit over 2018.

We continue to accelerate growth in our highest margin line of business, service, body and parts. As onboard technology in vehicles becomes increasingly complex, the need for our skilled certified technicians will continue to drive demands and service.

In addition, as the car park continues to grow with an average age of almost 12 years, more vehicles are staying on the road longer, creating more recurring repair and maintenance opportunities. Our service, body and parts revenue increase 10% over the prior year.

Customer pay work, which represents over a half of our fixed operations revenue stream increased 8%. Warranty increased 19% and wholesale parts grew 4% and our body shops increased 7%. Same store adjusted SG&A to gross profit was 69.9%, an improvement of 110 basis points compared to the second quarter of last year.

As we work to integrate the 7 billion in acquisitions completed over the last five years, we target an SG&A to gross profit metric in the mid to high 60% range. Our teams have made progress on cost savings efforts and continue to focus on personnel, advertising and facility cost, which makeup over 85% of SG&A.

Lithia’s unique operating model leverages our employees to make decisions closest to our customers, allowing us to react quickly to market dynamics and still leverage our scale.

Our employees are taking the steps necessary to exceed their annual plans, capture store potential and carry the trends of the first half of the year into the rest of 2019 and beyond. Now, before I turn it over to Tina, I wanted to say congratulations on your promotion.

Working with you over the past 14 years, it's been great to see you embrace our operational mission and watch you live our value of growth powered by people. We look forward to your continued leadership and many more years of success together..

Thank you, Chris. We have a great company and are fortunate to have a strong talented team in accounting, tech, finance and FP&A. It is an honor to work with each of them and to support and partner with our operational team. As of June 30, we had approximately 263 million in cash and available credit.

Unfinanced real estate could quickly provide us with an additional 247 million for an estimated total liquidity of approximately 510 million. We generated free cash flows of 80 million for the quarter and 141 million for the first half of the year.

We define free cash flow as adjusted EBITDA plus stock based compensation, less interest, income taxes, dividends and capital expenditures paid in cash. Our capital deployment strategy is a catalyst to support our growth.

We target 65% investment in acquisitions, 25% investment in capital expenditures, innovation and diversification and 10% in shareholder return in the form of dividends and share repurchases. Earlier this morning, we announced the dividend of $0.30 per share related to our second quarter results.

Additionally, we have approximately 234 million in remaining availability under our existing share repurchase authorization. A unique aspect of debt in our industry is the financing of vehicle inventory with floor plan debt. Vehicle financing is integral to our operations and collateralized by these assets.

Because of this nature, the industry treats the associated interest expense as an operating expense in EBITDA and excludes this debt from the balance sheet leveraged calculation. As of June 30, we had 2.4 billion outstanding as floor plans and used vehicle financing. Unadjusted, our total debt to EBITDA is overstated at 6.2 times.

Adjusted to treat these items as operating expense, our net debt to adjusted EBITDA is 2.1 times at the low end of our targeted range of 2 to 3 times. Our adjusted tax rate was 27.6%, up 130 basis points compared to 2018, primarily driven by changes enacted in certain states late last year. This concludes our prepared remarks.

We would now like to open the call to questions.

Operator?.

[Operator Instructions] Our first question comes from Rick Nelson with Stephens..

Good morning and congrats on a great quarter..

Thanks, Rick..

Bryan, can you discuss the acquisition environment, kind of, how the pipeline looks today and are you paying more opportunities in Lithia type markets or the metro area?.

Thanks, Rick. This is Bryan. We're seeing good activity in all parts of the market. We've done 320 million thus far and we have a fair amount of other things in the pipeline. I would say, it's typical to where it was three or four years ago. There are a fair amount of larger deals as well.

It's just a matter that the pricing on them sometimes is a little bit outside of our pretty tight ROE expectations. So we sit a little bit and watch those.

We also, as we start to think about our footprint, as a nation, the southeast is starting to come into focus a little bit better and we have a number of things in that area that hopefully will come to be in the next number of quarters or year..

Okay, thanks for that color. Also like to ask about SG&A, we saw a nice narrowing this quarter, 70.1%.

If you could talk about the drivers there and the outlook as we push forward for SG&A?.

Yeah. Good morning, Rick. This is Chris. As Bryan mentioned, we purchased 320 million in rev in the last year, but over the last five years, we've purchased over 7 billion in revenues. And, typically those stores that we're bringing on our team are strong assets, but are underperforming and running at SG&A levels as high as 90% or more.

And so, what we continue to do is, optimize top line growth for those stores, generate as much growth as we can and then leverage expenses. And so, through the three core areas, really personnel, advertising and other incremental costs there, we continue to drive our SG&A down to that mid-60% range that we're focused on..

Finally, if I can ask you on the technology front, if you could update us on Shift, how you're planning or using or planning to use their technology in your dealerships and Baierl, if there's an update there, what you're learning from a digital standpoint..

This is Bryan again. The Shift partnership is going really well. We should learn a lot from, I would say, a clear perspective of our consumers and how to go to market with them. We've expanded the partnership in a pretty big way. If you remember, we announced the data sharing back in May.

We now have three locations that we’re collaborating either with purchasing vehicles and selling the vehicles that they purchased for us in California, and then one in Oregon. And then in many of those cases, we're getting reconditioning as well as storing their facilities and we see that continuing to grow, as their growth plans continue to grow.

I think it's important to note that their strategy is an independent channel for us. It's their strategy doing that, whereas our strategy is developing on its own. And as we look at the Pittsburgh market and Baierl.com as you asked about, we're showing pretty good signs of success in the digital space there.

And we can elaborate a little bit more on that as we get into the used vehicles and the new vehicle sales..

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

When I look at the strength in same store used car sales running in the low teens, and you've talked about the opportunity around procurement of vehicles, but then I see GPUs coming in a little bit lower versus at least consensus expectations.

Maybe you could help me bridge the delta on the strong same store sales growth with an emphasis on procurement versus a touch softer the GPU side?.

Sure, this is Bryan. I think to begin with, it's important to always recognize that we base our expense and cost structure based off total deal average, which was a little over $3600 this quarter. So looking at individual percentages on margins isn't as relevant as looking at that, because that will drive the bottom line profitability.

I think when you think about our ability to procure, we spend a lot of dollars in personnel costs to procure and that's got us to that 1 to 1 used to new ratio. I think what you're seeing now is some separation from just pure, heavy lifting on personnel and we're activating that with digital solutions.

It's helping us target the right inventory, and then I think much differently than most of the other new or used car retailers, either pure plays or the new car retailers that are selling used. What we do is specifically look for scarcity.

Okay? So when you look at our numbers and you're looking at where do we build growth, we build gross profit and margin through value auto and core primarily, which is about 70% of our sales. Okay? And those are lower cost cars that are very difficult to procure.

So being top of funnel in terms of our trade in cycle is very important because those new and certified cars are the first shot at those core vehicles. And if you remember those core vehicles, I mean, we're producing, let's see here, gross margins of a little over 10% in that bucket.

Okay? And that is primarily the only way that we're able to procure the value auto vehicle, which is producing 17% gross margins, which is massive and that's on a 13,000 car base. So as we think about the digital solutions that we're finding, it's more about pointing people to scarcity and older products in that five year and older vehicle.

And how do we find those quicker? By using digital solutions, which means querying the web and finding things on Craigslist or eBay or different types of sources.

We're running those through Manheim, or other things and hopefully pointing stores back to where can they find the right cars for our customers to be able to sell in a wider spectrum of used vehicle..

And, I was looking at Baierl.com, it's quite a nice website.

How do you think about the timeline of, the inventory appears to be a bit limited on the website as you're in pilot mode, but how do you think about expanding that to the broader lithia.com?.

This is Chris. I think it's a little too early to kind of gauge how we're going to expand that out. Nationwide, we have a lot of positive things happening right now in the Pittsburgh market on baierl.com specifically. I mean, like, for example, we're seeing 6000 unique visits right now to the baierl.com site.

And when we start to do things like focusing on home delivery, looking at a streamlined online purchase for those consumers that can actually take a vehicle purchase end to end or having fixed pricing and buying F&I products directly online without a salesperson or even taking the site unseen offers for purchasing a customer's vehicle, I mean, all of these things are generating a lot of data for us to leverage to figure out kind of what the next steps are in the evolution that we have.

And so I think Bryan's got some more feedback on that as well. But that's early signs we're seeing there..

As we think about how do we leverage what we're learning in the Pennsylvania market, I think it's important to think about how we look at innovation. We have 185 centers around the country that are always working on best practices because we have a more decentralized model that we want decisions made closest to our consumers.

And because of that, we get incremental innovation, which I think is a more important way to think about our development. So it's not like there's some massive silver bullet that's going to change the world. We really believe that what's happening in Pennsylvania is the catalyst for other stores to begin to work on those same solutions.

At some point, we will pull the trigger and have a national footprint with either lithia.com or a third party type of branding to really be able to leverage the inventory and the personnel that we have within our network.

Right now, Pennsylvania, for the, so far for the quarter was up 6% in sales, but they’re up 43% in profitability, which is a nice move, they're starting to produce, I think they were at 4% operating margin, which is a pretty good move in a short, almost 18 months that we've been together with them when they were about half of that previously and their leadership teams are very in tune with the consumers in that next wave of digital retail..

Our next question comes from Steve Dyer with Craig-Hallum..

Tina, welcome aboard, first of all. Secondly, just wondering if you could kind of go in a little bit more to what drove the F&I strength. Obviously, with new units down, same store basis, up 14%, so really, really strong number.

Maybe just going to sort of, if you could bucket how much of that is attachment as well as some of the ancillary products that make up that growth?.

Yeah. Good morning, Steve. This is Chris. We continue to focus on F&I as a core component of integrating the more recent acquisitions.

I mean, the disparity that we have between kind of our legacy stores and the newer acquisitions, that 7 billion in revenue that we picked up over the last five years, is probably 400 or 500 bucks, and in some cases between our top performing stores, which are closer to 2000 and the bottom stores that are still at that 700 or 800, we have a lot of work to continue to do there and we see a lot of upside.

We did see attachment rates up in virtually every one of our business lines. So, all of our business product, sorry. And, we continue to leverage the strength of our finance specialists to figure out ways to meet the customers’ needs, protect their vehicles, and put product offerings out there that customers want to buy.

So, it's really around people, products and making sure that we have a good process in the store to continue to improve that F&I..

And then I guess same thing really around parts and service, is that primarily just bringing up a lot of the newer stores that are newly acquired stores sort of up to what you’d consider to be a standard and was there anything in particular warranty work or anything like that, that jumped out in the quarter?.

Hey, Steve, this is Bryan. We're seeing good strength across all the business lines, which is nice. But most importantly, our CP or customer pay was up 8% in the quarter. That's a big number.

And I think it speaks to our commodity type offerings in the service strides and that more customer transparent type of environment where it's more affordable and convenient than most other types of businesses where we're digging much deeper into the value base. If you remember, we've been doing non-OEM parts now for over a decade.

So, as the warranty expires, that becomes more prevalent. We're at about 20% premium over what the average is in terms of retaining our customers.

And a lot of that starts with that F&I attachments that Chris was speaking to as well, but you're starting to really see some of that separation, which is what we really want to see is in our higher margin businesses that we’re able to extract those experiences and then profit from it..

Our next question comes from Rajat Gupta with JP Morgan..

Thanks for taking my question and also wanted to congratulate Tina on the appointment. Just wanted to follow up on the parts and services question, tracking up double digits so far in the first half. I mean, warranty obviously has a lot there.

Could you break out within the parts and services gross profit or revenue and how much of that is volumes or transactions versus price or how much is parts versus service and could we get a little bit of color on that and then how should we expect that to trend in the second half? And are you seeing any market share shifts versus the independent assets out there..

Hey, Rajat, this is Bryan. So in terms of revenue mix in those areas, in the service department, customer pay us 55% of the mix. Warranty is exactly a quarter or 25%, wholesale parts is 14% and body shop parts is 6%. So that gets you to the 100%.

When you look at the gross profit mix, 60% of the gross profit is coming from customer pay, followed by 30% from warranty and as you can imagine, parts and body shop are really low margin at only 6% and 5%. If we extrapolate that forward, we actually had one less service day this year than we did last year. So we're pretty pleased with those results.

We believe that looking forward, we see strength in the warranty as complexity of vehicles still continues to be something that provides us opportunities to upsell consumers and provide other services and win them back to our service drives with more convenient and affordable experiences.

And I think in terms of those commodity sales, it is something that is a little different than most new car dealers, because I think we really think about the full life cycle of a customer and it is the way to keep them as part of our family throughout their entire experience. So, hopefully, they're able to buy another used or new car from us..

So, just to follow up on that, I mean, of the high single digit growth on same store sales, how much of that is just volume versus price? I mean, is there a way to distinguish that, if you can get some color on how that trended in the quarter?.

Why don't we circle back with you on that? Eric, can we get him that information. And I think it's important to remember that when we buy stores, they perform at about 15% less than average when it comes to units in operation, their ability to service units and operations, which is typically a 10 year model range.

So -- and once they get to season, they're doing almost a 20% better than average. So keep that in mind as you think about building out your models. That is one of the drivers that we're always having some pent up demand in those service departments because of lack of experiences and lack of offerings in those service lanes when we buy those stores..

And then just a follow up on F&I GPUs, could you break out [indiscernible] new there internal GPUs and how much of the strength in the recent quarter is being driven by getting the prior acquisitions up to speed versus growth in the already well-established dealership?.

Yeah, so the GPUs are a little bit higher on new vehicles than used vehicles, but we're seeing opportunity and growth in both segments and about the similar overall GPU dollar amount. And your second question, sorry, was –.

Let me take the second question, Rajat, this is Bryan. When we buy stores again, the average is $700 a car. And if you reflect back on the 1450 that we did, that's about doubling of that F&I average, we usually get about half of it or about $400 in the first 6 to 12 months, and that typically comes through a more transparent selling process in F&I.

If you recall, we have 100% fixed pricing in our F&I products across our network. So that's pretty easy to be able to talk about benefits and really meet our customers’ needs. And that's where we get most of that.

I believe the rest of it we get over the next couple of years and that comes through better personnel as well as more transparent, what I would call, vehicle purchasing process. So the consumer is more comfortable because they're in control of their buying experience.

And because of that, they're less combative or they're more open to the idea of F&I attachments because they're actually looking at their budget and going this extra $30 on a finance, on a service contract or something is smart to do.

Whereas, if you're pushing on the vehicle sales, and then you push on the F&I product, it's not as easy to sell product as it is, once that vehicle experience becomes better..

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

Wanted to circle back on the parts and services, that's pretty prolific. Just wondering if there's a way to help us think through the incremental margins of that business. I would imagine much higher than the auto business, probably underappreciated piece of your business. Any way to contextualize that for us..

I mean, I think we, Bryan hit on a lot of the items in the margins and the way they impact our bottom line. We had 170 million in gross profit in parts and service. We continue to see growth. Our UIO continues to grow.

The technology advancements that we continue to see in vehicles make our certified technicians to kind of the go to place for any significant repairs and we continue to focus on commodity sales. So I think the parts and service business that we have is a core part of what we're going to continue to do.

And we expect to see continued growth in that area..

From an SG&A perspective, I was more curious, like when you push through incremental sale, is there any rule of thumb to help us think through how much incremental is today when you drive more parts, is that simple?.

Yeah, this is Chris again. I mean, our overall goal that we have in all of our stores is continue to try and leverage 50% what we call throughput. So for each incremental dollar of growth that we generate, we want to see at least 50% of that come to the bottom line.

And that's the way that we continue to focus on it, it does seem that in parts and service, the opportunity to exceed that throughput is a little bit higher, but 50% is a target and if you look in the quarter, overall as a company, we saw about $42 million in incremental gross profit and we've – we hit our 50% throughput target on our line..

And then just wanted to talk about warranty specifically, like that’s scripted, right, plus 90%, that's pretty acceptable. Can you help us think through like how much more legs there is to this? I know it's not easy to forecast and it's lumpy.

But is that all being driven just by more campaigns, given the kind of stores are flat for a period of time now, are there other factors driving it, CPL or prior insurance contracts sold, any way to just help us kind of think through the growth of warranty over the next call it like 6 to 18 months would be helpful..

Yeah, again, this is Chris. Overall, and on pretty much all of our mainline manufacturers, we saw a pretty good growth in warranty work and you got to remember warranty work just isn't a function of a major problem. It's just general wear and tear that happens to vehicles that are covered by the mainline manufacturers.

So, increase in UIO, increase in sales, increased focus on retention, which is another big component of when we do an acquisition, trying to grow the retention in our service departments are all driving to a really nice lift that we're seeing in overall warranty work.

And if we do a good job in the warranty work and we continue to push on good customer satisfaction, the goal is they’d come back in for the CPE work down the road as they retain their vehicle past the warranty lifecycle of the manufacturer..

Our next question comes from Bret Jordan with Jefferies..

A question, I guess sort of regional dispersion, did you see any particular strength or weakness from an underlying demand standpoint, and then sort of follow up with the regional dispersion on performance within your store? You talked about Pennsylvania being a 4% EBIT, and maybe what you are saying in that trajectory with DCH, or upstate New York stores as well..

This is Bryan, Bret. We're seeing pretty balanced same store sales growth across the country, which is great. Alaska was up 12%, Iowa was up 9%. Montana was up 10. New Jersey was up 11. Washington was up 18.

So you're seeing some of the better numbers, the double digit numbers kind of broadly spread across the country and I think pre-tax profits follow that similarly. We did also see some strength in brands, such as Subaru and BMW as well as a few other luxury, which was nice. And that translated into the bottom line as well.

In terms of, Chris, do you have the numbers on each of those, the other acquisitions, DCH, their operating margins, I saw that somewhere. I believe DCH is pushing 4%. Baierl was at four.

Our one weakness is still up in upstate New York, in Carbone, which is a little bit, it's really close to break even, which isn't where we would have liked to see that. But we got some good opportunities there to be able to grow..

Yeah, the one other one that Bryan already mentioned was Pennsylvania and the incremental lift that we're seeing right there in that market with the Baierl Day acquisition. So, and again, it comes down to people.

So, we can talk about regions, but then you look within the region as specific stores and we have pockets of stores that are doing extremely well, and then a couple of opportunities that we continue to focus on..

Our next question comes from Derek Glynn with Consumer Edge Research..

Could you just think about your target leverage, two to three times in the context of a new star, which may be turning, you still have a pretty robust pipeline of M&A opportunity? Do you have a preference or expectation to be at the low end of that range at this point in the cycle?.

Derek, this is Bryan.

I think the way that we look at 2 to 3 times as our target is that we want to have headroom that if there is -- if we are late cycle, which I think most indicators are pointing towards that we still have a number of years and it's 17 million stars pretty stable for the next couple of years, we still want to have that headroom and I think our covenants go all the way up to five times.

So that gives us the ability to be able to grow at a quicker rate when we believe that pricing on deals maybe come down, which is one way to look at it. I think as we think about our geographic positioning, the southeast is an important part of our ability to activate digital solutions on a national basis.

So I think we're willing to push that into the middle of that range, if we can find the right opportunity in the southeast, and hopefully get a footprint so we can then go apply our typical value based model to be able to do that..

Our next question comes from Michael Ward with Seaport Global..

Tina, do you -- can you provide the -- what you spend an acquisitions in the second quarter?.

Sure. Give me a minute. So, we invested about 80 million in acquisitions as well as any capital expenditures associated with acquisitions from the prior year in terms of capital deployed associated with that..

Okay.

And there was no share repurchase?.

The only share repurchases in the first half of the year that we've had have been associated with stock compensation that’s vested. So, no opportunistic share repurchases..

Okay. So it sounds like if I can tie this together with the acquisition strategy, I think last quarter, one of the comments you made, the company made was that you were letting some of the other acquisitions that have been completed in the year, two years before to kind of season and get back up to more close to the corporate average.

And so now it looks like the shift is now towards growth through acquisition.

Is that a fair statement?.

Michael, this is Bryan. I think we always are balanced in terms of our approach. So I think you're seeing that we're -- we are doing more acquisitions. And I think we have -- there's a belief that we stopped buying stores in 2018, because of a, maybe a lapse in performance of the existing stores that we were trying to capture the potential of.

We don't believe that was why, we believe that there was a disconnect in stock price that made it more attractive for us to buy our own stock than it did to buy other acquisitions. And now that our stock price has recovered to a somewhat respectable level, we again turn to acquisitions rather than buy our own stock back.

So it's kind of how we've always looked at things, is just to balance those two things as we look forward.

I do believe that the market is pretty robust, and there's a lot of good deals out there and I think the more that we find ways to activate our network with digital solutions or to find adjacencies to generate more profit out of our stores, it does make us more competitive, because ultimately our ROI is up 15% to 20%, after tax returns will still be achieved.

But we'll be able to forecast that profitability at even a higher number than what we currently forecasted at. .

If you look at the acquired stores, and specifically at the SG&A, it sounds like they're getting -- the acquired stores over the last couple of years, they're getting closer to the corporate average.

Can the corporate average get back to the 2017 levels with SG&A as a percentage of growth?.

Yes. This is Bryan again. I mean, we believe that the corporate SG&A can get back to the 2014 level before we were buying a fair amount of stores, we bought that $7 billion in revenue where it was in the mid-65% range, so that really – and remember this Mike, I mean, our best stores operate in the mid to high 50 percentile range.

So when we buy stores, they're typically at 90%. So it's really that equation of being able to grow your new car business, grow your used car business, that brings along the F&I, and then over three to five years, their units and operations grows to be able to drive your service and parts business.

And those things combined together create two to four times more profitability, which is ultimately the entire basis of our value based model and why our leverage ratios remain so much lower than even our peer group, while still growing at two to four times faster than the rest of the peer group..

One last question. I think, I may have missed this, is Shift currently working with three stores.

Is that correct or is it more now?.

It's four, it’s three in California and one in Oregon..

Our next question comes from John Murphy with Bank of America Merrill Lynch..

This is [indiscernible] on for John. So I think you touched upon this shortly in your opening remarks, but can you maybe give us an update on your portfolio optimization efforts? I think it was about a year ago, when you mentioned you're starting to focus a bit more on divesting underperforming stores.

So what innings are we with respect to this process?.

Sure. This is Bryan. This is -- we believe that calling out our network is really important, because it keeps the bar performance really high. So, we sold 12 stores in the last 12 months. All of those stores were purchased with a group or were open points to those, okay. They were all underperforming to some level.

We sold two very small ones of that 12 in this quarter. One was in what Great Falls, and the other was in the Pittsburgh market. So -- and I think that's something that we will always do. But I would say this, it's a minor part of what we do. And if you're talking about innings, we're probably in the seventh to eighth inning.

I mean, we probably have a half a dozen to eight, nine stores that we believe are not as strong assets as we typically buy. And if you recall, we have a pretty darn good success rate over 80% of hitting that 15 plus percent ROE achievement within that five year period.

So and these are typically those outliers that we believe just don't quite fit the network, but occasionally we test and try to make sure that we're always capturing every part of growth that we can..

And then on the M&A front more broadly, I think you've expressed in the past an interest in potentially expanding internationally to Canada or the UK, is this an option you guys are still considering or do you still prioritize domestic acquisitions?.

This is Bryan again. We definitely prioritize domestic acquisitions and when the market is so lucrative, and it's so plentiful, it's really hard to look at other countries and go, this makes more sense than deploying dollars domestically, especially when we only touch 82% of the country today.

We really want to get that closer to the 90, 95 percentile. So as we begin to co-develop these digital solutions, that we’ll have the footprint there to be able to activate the entire country to be able to gain many of those leverage benefits you can in marketing or other personnel type of benefit..

And then finally, can you maybe share with us how big were value auto sales in 2Q 18. I think you said it was 22% of total used vehicle sales this quarter. Just trying to have a better idea of how is that business evolving..

So that is what we call the third tier of the waterfall. It's evolving very nicely. I would still say this, over half of our stores don't play in the value auto game. And right now, it's about a fifth of our total sales in used cars. It's also somewhere that most other retailers don't plan, including the pure play used car retailers.

Part of the reason is, it's a very difficult business to play in, because of reconditioning standards. And for us, it's really important to sell super safe vehicle.

And I think what we found is jumping into that space that our guarantees and our offerings are much better than what those used car retail store down the street or a wholesale place for people typically buy this, but consumers still aren't used to looking at new car dealerships to find those type of stores.

And our sales people aren't used to selling the car in that type of condition, which is typically over 80,000 miles. And our technicians don't typically want to fix those kind of cars. So, you're working on three different dichotomies that have to work in adjacency to be able to maximize that stream in that benefit.

I'll throw in one more thing to think about, okay. As you think about the financing part and the ability to sell that type of car, or for that matter a three to five year old core product, the ability to finance those cars is something that Lithia Motors is specialist at.

So we have nearly 100 lenders that are out there to meet each individual's specific needs. Okay, and I think it's, it's easy to get distracted that all consumers are going to be able to buy digitally online when we really believe that only 20% of the consumers can do that.

And that's really because of their equity situation in their trade in, okay, which means it translates into the loan to value on the car that they're purchasing. Combine that with their credit score, and you get about 80% of the consumers that really need expertise to help them find financing for whatever type of vehicle they're looking at.

And I think one of the things that Chris mentioned that I thought was really important, 71% of Lithia consumers that have trade ins have this equity on the car that they're trading in. That's a big -- that's a large number of our customers. More importantly than that, the average equity on those consumers in our company is $5100.

Okay, so if you think now about value auto core products certified or for that matter, even new vehicles, the ability to get into an equity position requires a lot of capital down. Okay, and that's where specialists are able to really fit credit scores and loan to value with what the consumer is trying to buy. .

Our next question comes from David Whiston with Morningstar..

Tina, Congratulations. Wanted to go back to F&I. I guess I'm just trying to understand something at the market level in terms of what you see at source you acquire, because it sounded like and it was Chris earlier, you were basically saying that some stores they just focus on selling the vehicle and they don't do enough with all the add-ons.

And what’s surprising to me about that is that even if you're a smaller dealer, I would think you would really like 100% gross profit business, but it sounds like -- yeah, he was saying and that's what's confusing me.

I just want to confirm there is nothing structural that prevents a smaller one or two store, 8 store, 5 store group from pursuing F&I more, it’s just purely a choice that those managers are making, right..

This is Chris. I think it partly is the choice. That's correct. But the other thing that we're able to do is leverage our scale and size to work with a national vendor to create products that really, from a cost perspective, bring incremental gross profit to the bottom line.

So, comparing an individual dealer to our network of 12 billion in revenue is very difficult to do.

And so I think it is partly a focus on the price of the product, the people that we have, and then obviously the offerings, we really make sure we tailor our offerings to the individual markets, the individual brands in the individual regions, which may be more difficult for an individual dealer to do, but the opportunity is there specifically, and I mentioned this earlier, LAD, our traditional Lithia stores, almost 2000 and copy in certain stores versus newer acquisitions, trying to pass that $1000 per unit mark, and it's an area that is definitely on the radar, it's a constant source of discussion, it’s front and center on our store performance scorecard, which is our key catalyst for many..

It all drops to the bottom line..

Is there any -- moving on to light trucks and just your customer preferences? Is there any – two part question there? Is there any change in perhaps a waning enthusiasm or even slightly at the margin for light trucks and two, have you gotten any feedback yet from your customers, especially your pickup truck customers in terms of how much interested are they in a pure electric pickup truck, whether it's from the [indiscernible]?.

David, this is Bryan. The answer to your first question is, there's been no weakness in trucks and the answer to your second is, there's virtually no interest in electric trucks, at least from the domestic side. And we really believe that it's not just about the power plant in the truck.

It's about the build of the truck and the features in the truck and the utilization of the truck that makes it a different game than a sedan that you get in and you move people around. But, over time, that can change and it will adapt, and I think we'll see some demand for that over time as that becomes more available to consumers..

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 over to Bryan DeBoer for closing comments..

Thanks, Rob and thank you everyone for joining us today and we look forward to updating you on third quarter results in October..

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