Good morning and welcome to the Lithia & Driveway First Quarter 2021 Conference Call. [Operator Instructions].

I would like to turn the call over to Eric Pitt, Vice President of Investor Relations and Treasurer. Please begin. .

Thank you and welcome to the Lithia & Driveway First Quarter 2021 Earnings Call. Presenting today are Bryan DeBoer, President and CEO; Chris Holzshu, Executive Vice President and COO; and Tina Miller, Senior Vice President and CFO. .

Today's discussions may include statements about future events, financial projections and expectations about the company's products, markets and growth. Such statements are forward looking and subject to risks and uncertainties that could cause actual results to 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 discussed today include references to non-GAAP financial measures. Please refer to the text of today's press release for a reconciliation to comparable GAAP measures. .

We have also posted an updated investor presentation on our website, lithiainvestorrelations.com, highlighting our first quarter results. .

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

Thank you, Eric. Good morning and welcome, everyone. Earlier today, we reported the highest adjusted first quarter earnings in company history at $5.89 per share, a 193% increase over last year, and record revenues of $4.3 billion.

These results were driven by strong operational performance across all business lines and channels and acceleration of acquisitions and the strengthening retail environment. .

During the quarter, total revenue grew 55% over last year and 52% over 2019, while total gross profit increased 55% over last year and 58% compared to 2019. As a reminder, the pandemic only impacted our first quarter 2020 results for the last 2 weeks of March. .

New vehicle revenue increased 60%; used vehicle increased 55%; F&I increased 63%; and service, body and parts increased 30% compared to the first quarter of 2020. Total vehicle gross profit per unit for the quarter increased to $4,392 per unit, a $692 increase over last year driven largely by a 24% increase in new vehicle gross profit per unit.

Chris will be giving our same-store sales results and further color on inventory levels and their respective impact on vehicle margins in just a few moments. .

Earlier this month, we announced one of the largest acquisitions in the history of the automotive industry. The Suburban Collection adds $2.4 billion in annual revenues, over 2,000 team members, 34 locations and is a key pillar of the Lithia & Driveway footprint in our most sparse North Central Region 3. .

With nearly $6.5 billion in expected annualized revenues purchased since the launch of our 5-year plan in July 2020, we are considerably ahead of our expectations.

The combination of elevated gross profit levels in the new and used vehicles, rapid integration of high-performing acquisitions, incremental lift from the new Driveway channel, significant improvements in all business lines and strategic cost savings measures instituted last year, led us to earning over $0.25 billion of adjusted EBITDA in the quarter.

.

Entering our 75th year in operations, we reflect on how our history of exponential growth, coupled with our team's ability to execute, has positioned us to pragmatically and profitably disrupt the status quo of the industry.

Our multifaceted strategy for disruption begins by combining our proprietary technology with the scale of our people, inventory and network to modernize the industry.

As we continue to develop and enhance our digital home solutions, our Lithia & Driveway teams are ready to serve not only our traditional customers, but incremental e-commerce customers as well. .

Our focus on the most expansive addressable market of any retailer in the automotive space allows us to leverage our massive competitive advantages to demonstrate that e-commerce can be highly profitable and ultimately yield the highest possible EBITDA returns in the space. .

The used car business lacks barriers to entry.

However, success requires infrastructure, financing solutions for all customers, reconditioning expertise and the procurement of high-demand, scarce vehicles to quickly achieve scale with smooth execution, all of which Lithia & Driveway have established and have proven to be effective at executing on since 1946.

Hopefully, Dick Heimann, our former COO, is listening in today as the 1946 comment was especially made for him. .

Building on the broadest nationwide network and multiyear design and technology development of Driveway, we are excited by our initial success and continue to enhance the most comprehensive e-commerce home solution in the automotive retail space.

Our proprietary consumer applications are maturing and now ready to quickly scale across our existing network that is the broadest in the country. .

Now entering our second quarter with a full spectrum of offerings, Driveway is empowering consumers to simply and transparently shop, sell and service their vehicles from the convenience of their homes. The Driveway brand was designed to attract a different and incrementally new consumer than the Lithia channel.

This is the first time in our history that we've been able to market and deliver our 77,000-vehicle inventory to the entire country under a single brand name and experience. We knew our used inventory was broader and more scarce than our competitors', and we are now realizing these advantages, as evidenced in our same-store and margin results. .

While Driveway's full-spectrum offerings have only been live for a few months, our early learnings and data are showing a clear pathway for Driveway to become the brand of choice for online buying, selling and servicing both domestically and internationally.

We are on target to achieve a run rate of 15,000 Driveway shop and sell transactions by year-end. Important to note that this target does not include Driveway finance and service transactions. .

On our pathway towards this first volume milestone that took other e-commerce use-only competitors 2 to 3 years to reach, we are finding several interesting early trends we'd like to share with you today. .

First, 97.8% of our Driveway customers during our first quarter were incremental and had never done business with a Lithia dealership before. .

Second, we are seeing that it is taking 19 minutes on average for a customer to complete a full vehicle purchase transaction online with financing included. We are also seeing that about 15% of all credit decisions are auto-approved.

An overwhelming majority of our consumers still need help from our Driveway care center to structure their purchase, balance their credit with their desires and get through the financing process. 43% of our sales are out of region and our average shipping distance is 732 miles, with an average shipping fee of $477. .

Lastly, we continue to build our online reputation with an average Google review score of 4.98 stars out of 5. .

During the first quarter, Driveway also became the first e-commerce retailer in the country to offer negotiation-free new vehicles with free in-home delivery and a 7-day money back guarantee at a national level.

Driveway's financing solutions with new vehicle leasing and captive manufacturer financing now totals 29 lenders and are available to consumers with auto approvals in a matter of seconds. This lease and finance auto-approval optionality was released 2 quarters ahead of our previously shared plans. .

Driveway now offers the largest selection of negotiation-free new and used vehicles of any retailer in the country. Our new vehicle inventory represents all major brands, and our selection of used vehicles spans the entire spectrum, from certified used vehicles to 20-year-old value autos. .

Today, consumers can purchase any vehicle accompanied with our full brand guarantees, subscribe to full ownership repair and maintenance options and receive in-home delivery anywhere in the country. In addition, our marketing dollars have recently expanded outside the original Portland and Pittsburgh markets.

As such, our Driveway brand marketing is now live in Tampa Bay, Dallas, Houston, Metro New York and New Jersey, Los Angeles, Riverside, Oxnard, Des Moines and the surrounding markets.

With these recent market launches, the Driveway brand message is now reaching over 67 million individuals or 21% of the population, a sixteenfold increase over our 2 initial launch markets. .

As we continue to perfect our execution in these markets, our innovation and product teams are working relentlessly on improving the Driveway experience. Driveway receives continuous enhancements that will be released every 2 weeks throughout the year and is on its way to becoming the e-commerce leader of automotive retail. .

During the quarter, LAD's fintech arm, Driveway Finance Corporation, originated over 1,000 loans per month across the channels. We continue to see Driveway's fintech platform elevating the experience for consumers with the ability to capture up to 20% of all vehicle sales transactions, further differentiating LAD in profitability.

Today, our team of 110 Driveway engineers and data scientists have developed a suite of consumer solutions and functionality that provides the first complete end-to-end digital ownership experience spanning the full vehicle ownership life cycle.

In addition, our exclusive Driveway care center and inventory procurement teams are growing rapidly to mirror the exponential growth in consumer demand. .

The foundation to our omnichannel plan is the growth and expansion of our physical network. Having the ability for consumers to conveniently access all of our business lines and for us to store and recondition vehicles closer to them ensures a highly profitable digital experience across the United States. .

The opportunities for rapid consolidation within our industry remain plentiful, and our acquisition pipeline remains full. For more than a decade, we have successfully purchased and integrated acquisitions that have yielded an after-tax return of over 25% annually. .

During the quarter, we completed the acquisition of the Fields Auto Group in the Greater Orlando market; the Fink Auto Group in Tampa, Florida area; and Avondale Nissan in Phoenix, Arizona. We also opened a previously awarded Infiniti location in downtown Los Angeles.

As mentioned earlier, we completed the acquisition of The Suburban Collection in the Detroit, Michigan area earlier this month, adding a massive platform of 34 locations to our North Central region.

Combined, these acquisitions strengthened our strategic network density in regions 2, 3 and 6 and are anticipated to generate nearly $3.1 billion in annualized steady-state revenues. .

Since launching our 5-year plan 9 months ago, this brings our total network expansion to over $6.5 billion, adding more than $4 in future annualized EPS.

Important to note that the consolidation of the largest retail segment in the country can be accomplished in a highly accretive way, and these cash flow-positive businesses further add to our massive capital engine. .

We are in the most active consolidation environment that we have seen in the last 2 decades. Even with the pace being well ahead of schedule, we continue to replenish the more than $3 billion in revenue still under LOI and the more than $15 billion pipeline of potential acquisitions that we believe are priced to meet our disciplined hurdle rates.

As such, we are expecting our network expansion in 2021 to far exceed our record levels achieved last year as we seek to continue improving our network density especially in the Central and Southeastern regions. .

As our top priority for allocating capital continues to be to accretively expand our network with new vehicle locations, it is important to highlight the competitive advantages and points of differentiation for Lithia & Driveway's network growth strategy. .

First, new vehicle franchises create an accretive growth model with a self-generating profit engine of nearly $1 billion of EBITDA annually. .

Second, network costs are considerably lower investment when compared to any new entrants into the industry. Please refer to Slide 16 of our investor presentation to learn more about our network costs and utilization rates relative to our competition. .

High-ticket new vehicle margins are quite strong at 10%, and the carrying costs are subsidized by our manufacturer partners. .

Upstream procurement from new and certified vehicle trade-ins have more attractive valuations than direct from consumer or auction purchases. .

Fifth, affordable offerings at all levels allows the customers to remain in the Lithia & Driveway ecosystem their entire lives with vehicles and services that match a full spectrum of income and credit levels that change over time. .

A sophisticated reconditioning network with specialized diagnostic equipment located closest to the customer to eliminate any logistics costs. These reconditioning centers are also utilized for the industry's highest or 50% margin service, body and parts businesses.

These businesses bring 10x the consumer life cycle touch points as compared to used vehicle-only retailers and allow for substantially lower marketing cost per vehicle sold. .

Captive leasing through our OEM-affiliated partners provides new vehicles with attractive, competitively priced monthly payments when compared to 1- to 3-year-old used vehicles. .

Additional financing support from our manufacturer partners through rate subvention with their captive financing arm and new vehicle incentives or rebates that allow for the highest level of financeability and absorption of negative equity plus lower down payments for our consumers. .

Tenth, a diverse upstream offering of zero-emission products and supporting repair and maintenance services through manufacturer partners' product lines. .

Also, leading advocacy for lower and zero-emission vehicle ownership with a comprehensive resource center, providing education on vehicles, incentives, charging infrastructure, ownership, affordability guides and a sustainable vehicle marketplace through green cars. .

Lastly, new vehicle franchises create loaner and fleet management opportunities to build a factory-like used vehicle inventory pipeline. .

As our nationwide network continues to grow in each of our 6 regions, we continue to target a 100-mile reach to allow for convenient, affordable and timely consumer servicing experiences during and after the purchase of their vehicle. .

As a reminder, infrastructure costs for delivering the Driveway e-commerce experience are 0 as it resides in the underutilized capacity of our growing network.

Key to our design 3 years ago was allowing the flexibility to adjust our investments between channels and multiple business lines to align with consumer demand, weather any economic cycle, compete with any future competitor and expand our cash engines to expand into further adjacencies.

These, combined with our many competitive advantages, strongly position us to achieve our 5-year plan and pave the way to even greater aspirations. .

In closing, our first quarter results doubled the previous highest first quarter earnings in our history as we live our mission of growth powered by people. We continue to seek new ways to improve and remain tenaciously committed to growing and finding new opportunities.

The advantages of a responsive and adaptable team with a multi-decade track record of executing together is the driving force behind our ability to outperform and compete in any environment. .

With our technology poised for rapid scalability across our existing and future network, we are positioned to, as quickly as possible, lead Lithia & Driveway's progress towards $50 billion in revenue and $50 of EPS, the first leg of our journey. .

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

Thank you, Bryan. We continued the momentum from last year and delivered another record performance in the quarter. The demand from consumers remain strong for both in-home and in-network solutions, and we accelerated the rollout of Driveway through our key strategic markets and our platform. .

Each day, our leaders are rising to the challenge of achieving our 50-50 plan, evolving to meet consumer demand, developing our talent and living our mission of growth powered by people. Our team remains humble and never satisfied as they look to continue record performance levels throughout 2021 and beyond. .

Following the discussion about our quarterly results and is on a same-store basis, and as Bryan mentioned earlier, the pandemic impacted only the last 2 weeks of our first quarter 2020 results. For the 3 months ended March 31, 2021, total same-store sales increased 28% over last year.

These increases were driven by a 29% increase in new vehicle sales, a 32% increase in used vehicle sales, a 30% increase in F&I revenue and a slight increase in service, body and parts revenues. .

Comparing our 2021 results to a 2019 baseline, first quarter same-store sales increased 28%, with new vehicle revenue up 23%, used vehicle revenue up 43%, F&I increasing 32% and service, body and parts increasing 6%. .

For the quarter, our new vehicle business line increased 29% over last year. Our average selling price increased 6% and unit sales increased 22%. Gross profit per unit increased to $2,979 compared to $2,188, a $791 increase or up 36%. .

Total new vehicle gross profit per unit, including F&I, was $4,778, an increase of $897 per unit or 23%. At approximately $4,800 of gross profit per unit, new vehicles remain highly profitable with a 12% margin, similar selling cost per unit as used vehicles and inventory carrying costs that are subsidized by our manufacturer partners. .

As of the end of the quarter, we had a 41-day supply of new vehicle inventory, excluding in-transit orders, indicating we have well over a month's supply of vehicles on the ground and an adequate supply of in-transits that are replenishing our on-ground inventory every day.

However, new vehicle margins may remain elevated in the near term due to continued microchip and other supply chain shortages, coupled with elevated consumer demand levels driven by additional stimulus funds. .

While select OEMs are experiencing a reduced level of inventory, we currently have sufficient inventory to balance the current supply and demand trends expected over the coming months. .

For used vehicles, we saw a 32% increase in revenues for the quarter. Gross profit per unit for the quarter was $2,426, an increase of 14% or $295 over last year. Total used vehicle gross profit per unit, including F&I, was $3,994, an increase of $421 or up 12%.

Total used vehicle gross profit per unit began to normalize early in the quarter but accelerated again in March, finishing at $4,384 per unit. .

Our used vehicle sales mix in the quarter was 20% certified, 59% core or vehicles 3 to 7 years old; and 21% value auto or vehicles older than 8 years. With over 60% of the annual 40 million used vehicles sold in the U.S.

being 9 years or older, our continued strategy of selling deeper into the used vehicle age spectrum and our ability to procure the right scarce vehicles from multiple channels remains the catalyst for the future success and growth of Lithia & Driveway. .

As of March 31, we had a 42-day supply of used vehicles, and our 800 used vehicles procurement specialists are working diligently to ensure we are meeting the current demand environment with their focus on procuring scarce, high-demand used vehicles through the most profitable channels.

As a top-of-funnel new car dealer, 80% of our inventory comes from non-auction sources, which allows us to meet consumer demand in a low-supply environment. .

New and used vehicle sales are supported by our 1,500 experienced finance specialists that help match the complexity of consumers' financial position with lending options at over 150 financial institutions, including Driveway Financial. .

In the quarter, our finance and insurance business..

line continued to show substantial improvement, averaging $1,674 per retail unit compared to $1,557 the prior year, an increase of $117 per unit. New and used vehicle sales create incremental profit opportunities through the resale of trade-in vehicles, greater manufacturer incentives, F&I sales and future parts and service work.

We continue to monitor this through the growth of our total gross profit per unit, which was $4,388 this quarter, an increase of $664 per unit or 18% over last year. .

Our stores remain focused on the highest-margin business line, service, body and parts, which decreased 1% for the quarter. Adjusting for 1 less day of production compared to last year, service, body and parts showed a slight increase for the quarter.

This was driven by a 7% increase in customer pay, a 12% decrease in warranty, a 6% decrease in wholesale parts and a 14% decrease in body shop revenue. Over in March, we saw double-digit increases in service, body and parts driven by a 32% increase in our highest-margin customer pay work.

We expect these trends to continue into the second quarter as the economy reopens further and consumers look to get back on the road and return to their normal routines. .

As a reminder, our service, body and parts business see over 5 million paying consumers and brand impressions annually, which generate over 50% margins and remain a huge competitive advantage for Lithia & Driveway. .

Same-store adjusted SG&A-to-gross profit was 64% in the quarter, an improvement of 990 basis points over the prior year driven largely by the gross profit expansion in our new and used vehicles segment and recovery in service, body and parts.

We expect to see the normalization of SG%A-to-gross profit as supply constraints are alleviated later in the year and gross margins return to normalized levels. .

With our highest-performing stores consistently maintaining an SG%A-to-gross profit metric in the mid-50s, our 5-year plan continues to target an SG%A-to-gross profit level in the low 60% range.

As we continue to properly modernize the consumer experience, the opportunity to leverage our cost structure will continue as we maximize the utilization and integration of our existing location and as our digital home solution, Driveway, adds meaningful additional incremental sales. .

In summary, our teams continued to be responsive to the changing environment and the opportunities available to continuously improve in the evolving personal transportation industry.

We are innovating and meeting consumers' increasing digital and in-home expectations and are focused on meeting the preferences of our consumers wherever, whenever and however they desire.

With the integration of several regional platforms that come with performing teams, including strong operational leaders and customer-focused associates, we remain humble and confident that we continue to deliver industry-leading results while pragmatically modernizing automotive retail. .

While taking a moment to welcome David Fisher, Jr. and the entire team of over 2,000 associates at The Suburban Collection, we also reiterate that we remain focused on our 5-year plan to achieve $50 billion in revenue and $50 of earnings per share. With that, I'd like to turn the call over to Tina. .

Thank you, Chris. .

interest, income taxes, dividends and capital expenditures. .

As a result, we ended the quarter with $1.4 billion in cash and available credit. In addition, our unfinanced real estate could provide additional liquidity of approximately $552 million for a combined nearly $2 billion of liquidity. .

As of March 31, we had $4 billion outstanding of debt, of which $1.8 billion was floor plan, used vehicle and service loaner financing. The remaining portion of our debt is primarily related to senior notes and the financing of real estate as we own over 85% of our physical network. .

A unique aspect of debt in our industry is the financing of vehicle inventory with floor plan debt. The financing is integral to our operations and collateralized by these assets. The industry treats the associated interest expense as an operating expense and EBITDA and excludes this debt from balance sheet leverage calculations. .

Unadjusted, our total debt-to-EBITDA is overstated at 4.3x. Adjusted to treat these items as an operating expense, our net debt-to-adjusted EBITDA is 1.7x.

This means we can add over $1.2 billion in additional debt, which equals acquiring $4.8 billion in annualized revenues at our 25% purchase price-to-revenue metric while remaining within our targeted range. .

If our network growth and associated planned capital deployment would increase our leverage beyond 3x for a sustained period, we would look to deleverage quickly through the equity capital markets.

As a reminder, our disciplined approach is to maintain leverage between 2 and 3x as we continue to progress toward another sizable competitive cost advantage of achieving an investment-grade credit rating. .

Our capital allocation priorities for deployment of our annual free cash flows generated remain unchanged. We target 65% investment in acquisitions; 25% internal investments, including capital expenditures, modernization and diversification; and 10% in shareholder return in the form of dividends and share repurchases.

Earlier this morning, we announced a 13% increase in our dividend to $0.35 per share. .

Even with the acquisition of The Suburban Collection announced earlier this month, we continue to have the capacity to grow and are well positioned for accelerated, disciplined growth.

We continue to make strong progress in modernizing the consumer experience through Driveway and building a robust balance sheet, positioning us to be the leader in consolidating this massive industry, all while progressing toward our 5-year plan of achieving $50 billion in revenue and $50 of earnings per share. .

This concludes our prepared remarks. We would now like the call to open for questions.

Operator?.

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

And congrats to a kind of great start to 2021. .

Thanks, Rick. .

Thanks. .

It sounds like the acquisition pipeline remains robust. Curious with the approval process with OEMs, what you're hearing.

Do you see any challenges to that $15 billion that is in active discussions and, I guess, from a bigger standpoint, the $50 billion in revenue target that you have out there?.

Great question, Rick. This is Bryan. Good to have you on the call this morning. I think when we think about our OEM partnerships, they're really built off of a foundation of value-based acquisitions over the last couple of decades where we're able to take underperforming stores and improve their performance.

So most of our manufacturer partners, if not all, are very stable. They're involved with in-depth discussions in regards to what our growth aspirations are and are supportive of those aspirations. .

The $15 billion that we believe is priced appropriately, we still purge any data if we're -- have like what I would call contiguous markets or there's limitations by region within a manufacturer framework agreement to give you kind of a pure sense of what does our network look like for growth, net of any of those issues that may occur.

I mean one example would be like on the Keyes acquisitions. We actually reached our Western limitations, okay? And in that case, we ended up divesting some -- 2 businesses even though we got bigger businesses in Keyes. And that's part of our M&A strategies, and we've solved for that typically in the asset purchase agreements. .

On the $50 million (sic) [ $50 billion ] base case 5-year plan, we still see no impediments to reaching that level as well. And remember, almost $10 billion of it is coming from Driveway.

And those things may shift over time, but we see a lot of headroom even beyond that in regards to what our framework agreements say or what our manufacturers would feel comfortable with. .

Got you. Also, a follow-up on inventory. It remains very tight across the industry here at 41 days supply for new. Curious your thoughts on when you see inventory normalizing and the implications for GPU and expense ratios. I know one of your peers was suggesting that this tight supply condition continues through 2021. .

Yes. Hey, Rick, it's Chris. At a 41-day supply right now, I think we feel really comfortable that without even counting in-transits, which is probably another similar days' supply that we feel like is still coming into the pipeline, most of our OEMs have plenty of inventory on the ground right now to meet customer demand. .

And with that and the supply issues that we have, you're also seeing the impact of that on 2 things. First of all, new vehicle margins, obviously up $800 per unit, is definitely a byproduct of supply and demand.

And then used car valuations as well are definitely ramping up, which actually gives new car customers the advantage of the positive equity or more equity, I guess, on a used vehicle trade. .

But our days supply is calculated at 41 days' supply coming off of a 17.7 million SAAR run rate from March. And so based on what we're getting right now and the feedback that we're getting, we may have some tight inventory issues running through the summer months.

But at the same time, because of supply and demand, I think the margin offset on that and our ability to procure used cars to offset any issues that we see on the used car -- or on the new car side, we feel pretty comfortable that we're in a good spot right now today. .

Okay. Great. And finally, if I could ask you, with Suburban Collection, I understand that came with some used only at stores and curious if you have any plans to expand that strategy. .

Rick, this is Bryan again. It was actually 34 new car stores. There is no stand-alone used car P&Ls. There may be a few used car lots that are attached to new car stores. And I think most importantly, there's a number of body shops as well.

But we're really looking at that Detroit being the core for Region 3, which is our Upper Central region, where we don't have a big presence. .

And I know David and his teams are pretty excited about jumping in and supporting the last-mile delivery and activating their inventories on Driveway as well, and that will come over the next few quarters, I would imagine. But there is no specific used car independent stores in the $2.4 billion in revenue. .

Our next question comes from the line of John Murphy with Bank of America. .

Just a first question on Driveway. Can you talk about what the average vehicle and average customer was there that you -- the people that you sold and the customers you sold to? And then also, if you could give us some information on the 43% of vehicles and customers that were sold out of region.

Just trying to understand if there are high-end customers or average customers or maybe lower-end customers. Just trying to understand the Driveway and then the out-of-region portion of those. .

Sure. Sure, John. This is Bryan. I think most importantly, I mentioned that we're having about a 15% credit decisioning auto approval on consumers.

But let's also remember that, that 15% doesn't automatically complete the purchase, okay? So our what we would call happy path is about 1/3 of that, okay, meaning it's a heck of a lot lower of those consumers that go all the way through get auto approved and end up buying. .

We are seeing that the credit tier is a little more impaired and a little more challenging than what we expected. Whereas originally, we were thinking that the ideas of a 30 unit per associate in the care center could be achievable.

It still may be, but our early blend of technology with consumer decisioning is really yielding about a 12 unit to every 1 care associate. .

And I think to highlight one of our competitors that's 7 to 8 years old, with their technology being live for now that long, they're really looking at about a 7 unit per care associate.

So technology in the e-commerce space, it's a lot of people that are mid- to low-tier credit, okay, and I'd say a 550 to 700 Beacon score or FICO Score that are looking for an easier solution than going into a traditional dealership where they're having to negotiate and then also solve for their credit issues where now they're able to solve for it themselves.

.

Secondarily, you asked about the logistics fees at about 732 miles or about 43% out of region.

We have about 32% of our vehicles that have no shipping fee, meaning that they're within 100 miles of the location of the vehicle, okay? An important thing to remember, okay?.

So also, our customers are seeing the value of our extremely convenient experience and being able to find scarce, high-demand vehicles, which is a different credit spectrum at each level of our inventory, which we'll be able to give you some specific data offline as well, but hopefully that gives you enough color to keep us moving along.

Thanks, John. .

That's helpful. Just a second question on Driveway FinCo.

Is there any potential over time to start underwriting directly and maybe float an ABS deal to fund that? I mean having a captive finco that would grow over time kind of like CAF at CarMax?.

Yes. So we're now doing -- I think we almost hit 1,400 contracts in the month of March. Again, 17.7 million SAAR. So much more robust than I think we will see averaging for the year when we get done.

But we've -- on that pace, we should have an appropriate amount of receivables to be able to go to the ABS market late this year, okay? And then once we get on that cadence, we'll have those out there every, I would say, 1 to 2 quarters to be able to accomplish that and take it off-balance sheet and redeploy that capital that's now warehoused and that leverage is actually sitting out there into the network again.

.

And just to follow up, the bulk of those contracts or those loans would be on the used vehicle side, is that correct? Or almost all of them, right?.

You're correct, John.

So we believe that our aggregated population of all vehicle sales should be around 20%, but it's massively tainted towards used, okay? We would say that we should be able to achieve a 40% to 50% penetration rate on our used finance contracts, with a 5% to 10% on new, being that new vehicles are subsidized with subvented rates from the manufacturers and have the advantages of leasing, okay?.

So we think our penetration rates will be quite low. As well as, certified vehicles a lot of times have subvented rates. So obviously, the deeper you go into the age of vehicles, the higher penetration we'll have on Driveway Finance Corp. .

Okay. And then just lastly on the stock. I mean you're trading at a multiple that's far higher than some of your peers'. Obviously, the growth is what people are looking at there.

So I'm certainly not saying it's not justified, but why not use that multiple to do a stock-for-stock deal and accelerate or add to your plan here? I mean it just seems like that would be very accretive even if you pay a 20% premium for one of the other public groups. .

And then also on the stock, it was, I think, September 30 of last year when you did a stock issuance or secondary issuance, and I think it was -- stock was around $220. We're looking at almost $380 right now.

I mean why not issue more stock to have capital to go after these acquisitions maybe even at a faster pace? So why not a stock-for-stock deal? And why not raise more capital?.

John, I think maybe the easy answer is you're probably right. I mean it does make sense. That's in our repertoire of solutions, and we always try to balance the long-term opportunities and stabilize the likelihood of getting it through capital.

And we do sit there nicely today, and we're fortunate that we do trade at a little bit of a premium to the sector, but we still also trade at a discount to some of the new entrants by a pretty considerable amount. .

And obviously, our early learnings in Driveway have taught us it is a more formulaic business, okay? And I think it's going to be exciting over our second, third and fourth quarters of being in business and e-commerce to be able to actually extrapolate that when we open markets and we have top-of-funnel that's at X number of unique visitors, that translates into X number of sales.

.

It's quite different than what we've experienced in auto traditional retail on the vehicle side that there's some art in it, okay? And this is not as much art.

It's a lot of science, okay? And it's exciting to be able to see that there's a trajectory that is different with unique customers than our traditional channel, where we've had to really roll up our sleeves and fight those battles and find solutions for customers, whereas here, you're throwing a much broader net with a lot lower closing ratio, but it is somewhat formulaic based off your investments in marketing and care associates and the technology.

And we think that we progressed quite nicely over the first quarter of being live and now about -- almost 2 years of having the technology under development. .

So if I understand you, Bryan, I mean, do you think that you could use the stock for an acquisition or potentially use it to raise capital to accelerate the plan? Is that a fair characterization?.

That's an accurate statement, John. .

Our next question comes from the line of Rajat Gupta with JPMorgan. .

I just had a question on the parts and services recovery. Pretty strong numbers here in March. Can you help like just dissect that a little bit? How much of that is just pent-up demand versus like a more normalized level of demand? I'm just curious as to how you see the trajectory of the recovery or -- in the second quarter and in the second half.

I mean when do you see the business just getting back to pre-pandemic levels just on a normalized basis given like you might be in a potentially lower miles-driven environment versus pre-pandemic? And I have a follow-up. .

Hey, Rajat, this is Chris. Obviously, pent-up demand is a big driver, and we are starting to see that coming out of March, where we actually started to finally see some real big volume increases year-over-year were great.

But what we're really trying to do is figure out when will we start to get to a normalized recovery over what was really the 2019 kind of year if we use that as a base case. And in the quarter, we saw ourselves about 5% up over that 2019 level.

And prior to the pandemic last year, we were projecting a double-digit -- low double-digit increase in our parts and service business. .

So we definitely see that trend continuing into April, and we expect that to continue through the summer months as we kind of rally the customers coming -- normalizing their lives again and getting back on the road and driving their vehicles and then needing parts and service work, so. .

Rajat, one other fact.

As Chris was talking, I was looking at March year-over-year-over-year or 2021 as compared to 2019, okay? And our service, body and parts were up 9%, okay? So we're starting to get back into those comparatives that we've been running at for the last half a decade of that, like Chris said, in certain quarters, we're low double digits; in most quarters, we're high single digits.

.

Got it. Got it.

And that's continued into April so far on a 2-year comp basis, right?.

Yes. .

Got it. Got it. I just had a follow-up on the SG&A-to-gross comment earlier.

Just based on the deals done this year and just how strong the first quarter had started, assuming no further deals -- of course, there are going to be more deals, but like -- so assuming further deals, like any sense of what we should expect the SG&A-to-gross be for 2021 overall? I'm not sure if you gave that. I might have missed it. .

Rajat, this is Bryan.

I think when we think about SG&A-to-gross in this environment, it's important to remember that margins are impacting the gross more than cost reductions are because remember, we have considerable ramp-up costs in terms of Driveway engineers as well as marketing budgets and other things, and we're still able to to gain that level of leverage.

So as you see margins either stabilize, which I think they're pretty solid into probably Q3 and maybe even into Q4, as Chris indicated, you should see good, stable SG&A at this what I would call exceptional level or anomaly level, okay?.

Now once we move outside of COVID-impacted or inventory-impacted sales, it is more of the heavy lifting that we did last year, where we did do staff reductions that were a permanent 200 to 300 basis point drop in SG&A. .

And I think you can reference back to pre-acceleration of network development from '14 and '15. On a steady state, we were running at 64%, 65%.

That's not looking at any sharing of best practices, technology that's helping consumers do more of the work themselves, which would give us productivity gains in personnel, which makes up almost 2/3 of our SG&A costs. .

So some different things to be thinking about, but really -- we're really targeting that low 60 percentile on the 5-year plan. And we really didn't build in a lot of what we would call synergies or advantages for the Driveway channel that could be scaled over time. That's more the aspirational plan that we internally aspire to achieve.

And that over time, we'll be able to share more in terms of what that looks like beyond the 50-50 plan. .

Got it. So say if that 12 units per care member goes to 30, that's all incremental upside, right? Is that what you guys... .

You got it. You got it. And we're assuming in the 57% SG&A in the Driveway channel of the 5-year plan that we get to 57% SG&A as a percentage of gross. And that would imply about $1,000 in personnel costs per unit sold, okay, which is not much lower than what we currently sit at in the Lithia channel.

So most of that drop from a mid-60% SG&A to the 57% is no network cost, okay? So that's the biggest part of what that drop is. There's not a lot of synergies. .

We're also assuming almost $1,000 in marketing budget. And as we know, we only spend about $250 to $300 in the traditional channel. And I think we can clearly see a pathway to Driveway's marketing budgets at scale and national presence getting to that level over some longer period of time. .

Our next question comes from the line of Ryan Sigdahl with Craig-Hallum. .

Bryan, I just want to follow up quickly on the last kind of the customer care center, and you mentioned kind of 1 -- or I guess 12 sales per employee, longer term 30.

Do you think that's purely kind of a scale thing as you scale Driveway and the care center? Or has there been kind of a structural change as you're getting into the care center and kind of how much work and time and effort it takes per sale?.

This is Bryan again. I think there's -- it's surprising that our original design -- we thought the 30:1 was a no-brainer, and a lot of that came from our experiences with Shift Technologies, which was our partner and still is our partner in a sense. So we saw a 30:1 care center to -- vehicle-to-care center associate level. .

But when we start to look at the spread of credit spectrum and the age of vehicles that we're looking at, it may be that midterm, over the next 2 to 3 years, that 12:1 is our real number. Fortunately, they are a little bit lower cost than what traditional associates cost in a traditional channel.

So we still think that the $1,000 a unit for the next 5 years is still doable. .

I think it's going to -- we're not positive that our technology today -- and we have 29 APIs with lenders, which is almost 4x what our competitors in the e-commerce space have.

And we're still seeing massive amounts of this auto finance fall through the cracks, meaning that most people aren't able to structure their transaction, even with us guiding them digitally, to be able to match this -- what credit companies are able to accept.

So there's that looping idea that consumers today in Driveway are having to go back and change information, whereas what our ultimate state is, is really where the consumer just puts in what it is. We query all 70,000 vehicles that are in inventory against all 29 APAs (sic) [ APIs ] with our lenders, and we spit back that -- these 900 cars.

You can buy exactly the way you want for the payment you want. .

Okay. That is what our design 3 years ago was ultimate state, okay? And no one today in the industry even gets close to doing that. And we believe that we will be the first later this year, early next year to be able to do that.

And we'll have multiple iterations of that type of logic over the next couple of quarters that improve that to at least the level or competitive level to what some of the others that are doing today. .

Great. And then just on the Driveway, 97.8% of customers are incremental.

Is that a function of marketing specifically to a new customer? Or I guess why do you think that's such a high percent of out-of-network customers today?.

Yes. So Ryan, it's 2 things. One is we are specifically focusing our dollars to tech-savvy or credit-based decisioning, where consumers are looking for a simpler, more transparent, empowered experience, okay? A little bit different. It's why it's a separate channel.

It's not an adjunct to the Lithia channel, okay?.

Also, the 40,000, 50,000 vehicles online today in Driveway are now reaching customers that aren't in our basic AORs, or areas of responsibility, where we have business.

Remember, it's 732 miles, I believe, was the distance, average, of our customers, while our average reach in our traditional network is around 45 miles, okay? So those 2 things together are really leveraging the inventory that we've never leveraged before, and then targeting consumers with that inventory to match the 2 to keep that -- what we would call that incremental level up to a very high level.

.

Our next question comes from the line of Eram Zaghi with Morgan Stanley. .

And this is on behalf of Adam Jonas. .

Oh, great. [indiscernible]. .

It's more in regards to the --yes. Yes, yes. I won't be as entertaining as him but certainly [indiscernible] questions. .

So in regards to the acquisitions, it seems that priority #1 for Lithia is building an omnichannel strategy. Now your M&A strategy is an outgrowth of that omni objective.

So question is, why would you make your biggest acquisition thus far a dealer with 34 sites on 1 metro area? Can you help us understand how this fits with the broader omnichannel strategy that one might imagine would lend itself towards a more balanced/broader market coverage rather than concentration so much -- is concentrating so much capital in a single city?.

Great question, Adam and Eram. No, that makes a lot of sense. I think when we think about our strategy of e-commerce and the ideas of transparency and empowerment and then overlay those with the network, we don't look at them independently.

We look at those as hand-to-hand functionalities that they need to work together, okay?.

And then on the network development side, we still have to remember that when you were able to buy acquisitions at a 15% to 25% of revenue, okay, and on day 1 they're somewhere between $0.50 -- or $0.25 and $0.50 for every $1 billion of revenue accretive, it's very easy to be able to still have the advantage of that while still not assuming that new car dealers are just going to not exist.

.

They've been -- the new car business is quite a stable business that has 4 business lines and is quite accretive and profitable. And I think when we think about it that way and we know that our returns are in the 15% to 25% investment range, we know we get our money back in 3 to 7 years.

And for the 3- to 7-year outlook, even though we believe Driveway will become a much larger portion of our business, we also know that the heavy lifting in the car business has to occur. And if we have our money back on that investment within 3 to 7 years, then it's all a win-win in terms of how we look at things. .

So it's -- the way that consumers buy cars today, even knowing what others are able to do with technology and now what we're able to do with Driveway, most consumers require a lot of help to be able to do that. And help means that there's trust that's built, and we can build that with technology.

Or if a consumer chooses, we can build it with face-to-face interaction. .

And we understand the concept of 34 stores in the Midwest, but what we got was a wonderful cross-section of luxury vehicles, okay, as well as domestic vehicles and Honda, Toyota and import vehicles to be able to service and recon and store those vehicles closer to our customers in Region 3. .

Our next question comes from the line of Nick Jones with Citi. .

I have 2.

The first one, as you roll out advertising for Driveway into new markets, how should we be thinking and how are you thinking about the transition to more kind of national advertising where you can get more leverage on that spend?.

Nick, that's a great question, and it's something that our Digital Steering Committee is dealing with every single week, is how do we balance that. I think if you remember, we increased our budgets from a couple of hundred thousand dollars a month to over $1 million a month starting in April.

So this is our first month of a quadrupling or quintupling of our budget, okay?.

And what we're balancing is really what is our funnel efficacy, okay? So what are we getting in brand impressions? How many unique visitors does that produce? And how effective are we at what we call our golden ratio, okay, which is ultimately what's our sales or actually revenue generated off of top-of-funnel, okay? And until we see that really start to take hold, it gives us indications that we still need work in improving our care center, that our technology may not be solving as much for the consumers as we like.

We look at happy path to be able to determine what personnel cost do we need outside of happy path to support that, and we look at that 12:1 or 30:1 eventual ratio of vehicle sales-to-associate to be able to determine that. .

Nick, I will say this. We're definitely leaning, and some of it is even coming from your challenges and aspirations that why would you not spend more money on marketing if you can sell more cars. And I think that's accurate.

We're leaning towards that level of accelerating to get to national scale when the numbers really drop back to a reasonable level. And we'll be able to talk more about that in the coming months and quarters.

But right now, we're at a 4 to 5x of where we started 90 days ago, and that may end up doubling or tripling again depending on how we think about allocating our capital in different types of buckets. .

Great. That's helpful. And then a follow-up just kind of on the competitive landscape. I know there are some slides in the deck and investors talk about it, we talk about it.

But given the fragmentation from here, how are you and how should we be thinking about competition? I guess given the size of the TAM, the number of units that kind of the top players are doing, it seems like there's probably many years before these competitive moats really start to show.

Is that the right way to think about it? Or is it more important to focus on kind of the competitive dynamics today? Or is this really more of kind of 5, 6, 7, 10 years out when the consolidation is a little bit more penetrated?.

Nick, great question. And I think it's great insights to the largest retail sector in the country and probably the world. If you take it in the United States, it sits at $2 trillion. I don't believe this is a winner-take-all, even though I believe that we're nicely positioned to get as much as we possibly can and really strive to that 5% of U.S.

market share and beyond that we've talked about now for a couple of years. .

But ultimately, this is not a winner-take-all game, okay, because you have to solve, especially on the used vehicle side, for inventory. It's not a factory that you just are able to turn your inventory quicker and get a larger portion of that.

You actually have to go buy the vehicles or take them in on trade, then you have to recondition those and have expertise to be able to do that. And that's something that's highly competitive and ultimately the most efficient channel. We'll be able to pay the most for the vehicles to be able to do that. .

And by having all 4 business lines, I really believe that we've designed a structure that will put us into the best competitive positioning with anyone that comes into that used car space. And obviously, we know the barriers to entry in the new car space as well as that high-margin, 60-plus-percent repair business.

That is really how we've thought about our design, is those higher-margin businesses because we know that, that's what allows us the ability to boost marketing and boost care associates and expand our innovation solutions to be able to go to market with the next best thing for our consumers as the world changes. .

Our next question is a question from the line of Bret Jordan with Jefferies. .

With another quarter under your belt, I guess, with zero emissions experience, could you talk about how you see zero emissions products impacting that maintenance service business going forward?.

Absolutely.

So I think when we talk about our serviceability of future product lines, I believe it's always important to think about affordability okay? And it's important to remember that 42% of vehicles today, new and used, sold in America or about 58,000 vehicles with the 17,000 new and 40,000 used are 9 years and older, okay, meaning that it's a very low payment, okay, and is what people can afford.

.

There's another large percentage of the remaining 58% that is really what we're talking about as the possibility of moving into, the impact of serviceability, right, and the lower cost that could come from BEVs or zero-emission vehicles. So think about affordability as the driver.

And I think today, we sit at 10% to 15% of the consumers that can afford a $30,000-or-greater vehicle in the total buying public in any given year. .

So it is going to be slow moving. We do believe and we hope that our Congress, our current Congress passes a zero-emission bill.

It's important to remember, though, that this isn't a BEV bill, it's a zero-emissions bill and that there's different solutions that can impact the service effectiveness of the vehicles, okay?.

Of -- more affordable vehicles are typically hybrids because it's lower cost to produce. And ultimately, at end of life when you have to replace a battery, that's a very high cost amount and it affects ultimately the LEV or the lease end value or the termination value of that vehicle. So think of those. .

Now we are seeing that today, a hybrid is costing a little less in the first 7 -- 5 to 7 years of life but is a little more expensive in the later years of life because you start to get into battery replacements, okay? We're also trying to adjust for content on those cars when we did those evaluations, because we know that the hybrids that we sell today are decontented over our typical vehicles.

.

Now when we move into BEVs or 100% battery powered, that's a totally different number, okay? We're still too early into the game to know what the ultimate costs are of BEVs, knowing that the battery at some point may or may not need to be replaced, okay? And those numbers could get blown up, when as today our BEVs are about 30% to 40% less to maintain.

However, I will remind you that the diagnostic tools and the repair tools to fix them are way more expensive and new car dealers are the ones that have that proprietary technology to do it. So any offset in efficiencies for owning a BEV, that may lower our service ability. We believe that we will conquest some independents.

And then throw in our Driveway in-home service, and we believe that can conquest new vehicle dealers' businesses as well in the long run is how we really thought about the design. .

Okay. Great. And then one question. I guess you saw almost 98% of the Driveway customers were new to Lithia.

I guess to put that in perspective, on a traditional brick-and-mortar footprint, how many of your customers or what percent would be first-time users at Lithia as well?.

So in our traditional channel, it's around 50%, okay? So it's a massive difference in terms of what we've seen. But remember, we're getting 98% because we're reaching consumers that never saw our inventory before and we didn't have a national brand.

Now we have the ability to leverage the scale of our inventory into areas, and I think that's creating a lot of that 98% plus the marketing things that we talked about where we're specifically targeting a different type of consumer so we're not really getting into that cannibalization of our existing pipeline. .

Our next question comes from the line of David Whiston with Morgan Stanley -- I mean, with Morningstar. .

I guess first on The Suburban Collection deal. Obviously, it's a top group nationally. But other than that, I'm just curious why you guys wanted to focus for that region on Detroit metro versus another major Midwestern city like Chicago or Cleveland, St. Louis, et cetera. .

Great question, David. I would start by saying that the Suburban organization is an absolutely wonderful organization with cultural values and history very similar to Lithia Motors'. They started 2 years after Lithia in 1948, which was a great sound bite. They've been close acquaintances, and they've built an organization that is community based. .

In terms of a business decision, remember, Detroit is the strongest domestic metropolitan area in the country, okay. And the profitability of those assets are extremely good. .

There's one other secondary decisioning that went around this. Remember what a plan A and plan B customer is, which are the employees that work directly for manufacturers.

So almost 80% of their new car business are employee -- factory employee customers or friends and family of factory employee customers, meaning that they're one price or negotiation free on all of those vehicles. And remember, the Driveway model is one price.

So that, obviously, sharing of best practices and those initial earnings of a more negotiation-free environment were something that had a lot of attraction to us when our existing Lithia traditional network today has only a small fraction relative to that, that's being sold. .

To compare and contrast, only about 25% of our new vehicle sales in the Lithia network are sold at a negotiation-free or one-price solution, whereas our used cars in Lithia are about 51% non-negotiated. And remember, Suburban is over 80% negotiation free on the new car side.

So a couple of other things that we thought about aside from the fact that it did give us massive presence in Region 3. .

That's helpful. And I guess staying on the acquisition, I mean, as well as Suburban and Baierl, you've done a lot of deals, obviously, in the past roughly 9 months. But, I mean, why are you very often, if not always, successful, especially for a prime asset like Suburban? I mean you've got 5 publics. There's Berkshire and there's Terry Taylor's firm.

Why does the seller pick you?.

So most importantly, we do what we say we're going to do, and our track record of success is now oh, about 286 out of 288 successful closings as a company. We've only lost, sorry, 3 deals, I did my math a little bit wrong there, over the last 25 years of M&A. We know what our manufacturers expect of us.

We know how they look at approvability to ensure that we meet those qualifications in all cases, okay?.

And today, we do sit in a capacity with the synergies that we bring with Driveway that allow for an overlay and another incremental lift with Driveway Financial as well as the Driveway leveraging of those new customers to be able to expand their profitability in even a greater sense, which again allows us to be more competitive over time. .

I will say this, David. We don't see massive competition of our -- on our deals. I mean we've now been doing this for 25 years. It's something that is cultural. We don't have a VP of M&A, okay? I mean I think I was the last one that was in that role. It's something that everyone does.

In fact, Chris Holzshu is doing deals, and we got general managers that are doing deals. .

It's a bonded relationship with sellers and those 2,600 leads for the last 25 years that we now can pay the amount that they're looking for, okay, while still making sure that it's highly accretive. And there's not a real reason to put it out to market to put risk in their employees' minds or have things go to market.

And our industry closes 4 out of 10 deals even at a definitive level, and we're closing 98% of all deals that we sign. And I think that's a risk that many sellers don't want to put their people in the firing line of having a deal fall apart, which we all know that, that occurs fairly often. .

Okay. That's helpful. And just -- I know it's early to talk about 2022.

But just directionally speaking, do you see a scenario where 2022 -- given the low inventory we've had for a long time now plus the very high consumer demand, 2022's start could possibly just explode upward? And really, do you want to get a lot more inventory? Or would you -- do you like this high pricing power environment you have now?.

I think, David, if we think about 2022, that's a long ways into the future. But I think a 17 million SAAR is a pretty good assumption, varying a little bit here and there each of the next 4, 5 years, okay? And that is still growing the average age in the car park to now almost 12 years old. .

I think in terms of how we think of things, I'm really -- and I think Chris would reiterate this, we're benign to what happens in the greater marketplace if it's a 15 million SAAR or 19 million SAAR or inventories are high or low. .

We're -- we have 4 businesses -- business lines. We have 3 distinct channels, including the green car channel, that we really designed our strategies 3 to 5 years ago to not have to worry about that.

We have enough levers to be able to pull that we can be highly profitable and really drive towards that 50-50 plan and whatever is really there, knowing that, I would say, 12 months into Driveway's development, now all of a sudden it's really within our control, is how do we procure more used car inventory than anyone else and recondition that inventory.

And we're finally at a state that we really believe that we're in control of our destiny and not at the mercy of the market or, for that matter, what our manufacturers decide to build on the new car side. .

I'd like to hand the call back over to Bryan DeBoer for closing remarks. .

Thank you. Thank you, Doug, and thank you, everyone, for joining us today. We look forward to updating you on our Lithia & Driveway second quarter results in July and wish everyone a wonderful spring and stay safe. .

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day..