Good morning, and welcome to the Lithia & Driveway Second Quarter 2022 Conference Call. [Operator Instructions] I would now like to turn the call over to Amit Marwaha, Director of Investor Relations. Please begin..

Thank you. Presenting today are Bryan DeBoer, President and CEO; Tina Miller, Senior Vice President and CFO; Chuck Lietz, Vice President of Driveway Finance. Chris Holzshu, Executive Vice President and COO, is traveling in Canada with the FAF team.

Today's discussion may include statements about future events, financial projections and expectations about the company's products, markets and growth. Such statements are forward-looking and subject to risks and uncertainties that could cause actual results to materially differ from the statements made.

We disclose 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 place undue reliance on forward-looking statements. We undertake no duty to update any forward-looking statements, which are made as of the date of this release.

Our results discussed today include references to non-GAAP financial measures. Please refer to the text of today's press release for a reconciliation to comparable GAAP measures. We have also posted an updated investor presentation to our website investors.lithiadriveway.com, highlighting our second quarter results.

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

Driveway and GreenCars generating 15% to 20% of our total revenue; up to 20% of all vehicles sold by Lithia & Driveway will be financed through DFC, building out our complementary profit stream without any additional spend to acquire customers.

We also assume penetration rates for our used and new vehicles are at 40% and 10%, respectively; contributions from adjacent business lines requiring relatively small amounts of capital.

This includes fleet and lease management, charging infrastructure for electric vehicles, consumer insurance and business lines that leverage our network of stores, proprietary software and regional footprints. With the scale of our revenue and previous adjacencies, we expect SG&A will be below 50% of gross profits.

The framework we have presented above is designed with the ultimate goal of developing the most diversified vehicle transportation organization with simple, convenient customer experiences, fully leveraging the value of our network and infrastructure.

I would like to shift the discussion to our network development or M&A strategy and provide an update on our progress acquiring and integrating new stores within the Lithia & Driveway family. Before we dive into the details, I want to step back and review the key attributes of our strategy.

First, we look at locations that build out our network to achieve a target of being within 100 miles of a consumer, allowing us to conveniently reach and serve large pools of customers for their full ownership life cycle and efficiently utilize our network for vehicle distribution, restoration and warehousing.

Today, our network is made up of approximately 300 locations within 250 miles of 95% of the population in the United States and 60% of our customer base being within 100 miles of those locations. That's a considerable competitive advantage versus any of our peers.

At the end of the day, we're able to service our customers quicker at lower costs and provide an in-house financing solution in store or online. That's a powerful combination. During Q2, we acquired $1.4 billion in annualized revenues.

In the first half of 2022, we acquired $2.1 billion in annualized revenues, marking 63% of our total revenues targets in our 2025 plan. We are excited to welcome all of our new team members to the Lithia & Driveway family.

In the past month, we have noticed an increase in queries from investors regarding the M&A climate and pipeline for our new opportunities. Investors have been trying to understand our valuation framework, given the macro headwinds and normalization of GPUs.

I want to reiterate, we are disciplined and methodical about our strategy and our pipeline of opportunities remains quite robust. A few final thoughts on M&A. One, we are a seasoned team with a track record of finding assets that fit into our investment profile and integrating new leaders into our culture.

We remain disciplined in our pricing hurdle rates, targeting prices of 15% to 30% of revenues, 3x to 7x EBITDA based on normalized earnings and generating a minimum of 15% after-tax returns. We continue to achieve over 25% historic returns on our acquisitions.

Since launching our 2025 plan just two years ago, our M&A activity has contributed to nearly $1 billion in adjusted EBITDA and $12.6 billion in revenue, a noteworthy achievement. Our approach has been highly accretive to shareholders while consistently earning above our capital cost.

Alongside our strong network across North America, we see significant opportunity to build leverage through expanding verticals, which drives revenue opportunities and horizontals representing adjacencies that increase profitability.

Our e-commerce business vertical, Driveway, builds our online presence by integrating our physical infrastructure and logistics to develop a premier omni-channel business.

We reported another strong quarter of Driveway performance, demonstrating how we are making inroads finding new customers, while many of our competitors are having to reexamine their own growth strategies. Driveway is well positioned to become the premier choice in e-commerce, automotive retailing.

And we remain confident with our plan to profitability in the near future. GreenCars continues to gain traction as we attract consumers with our sustainable vehicle learning center and marketplace powered by Driveway. During the second quarter, online activity on GreenCars grew to over 384,000 MUVs in June.

Higher fuel prices have boosted consumer interest in all types of electric vehicles, and GreenCars provides a wealth of information on sustainable options from BEVs to hydrogen propulsion solutions centered around affordability for all customers. To date, we have installed 600 chargers supporting the adoption of sustainable vehicles.

We're also training our technicians and increase our breadth of services to provide the same level of service for sustainable vehicles provided to our traditional fleet of vehicles. Driveway Finance Corp., or DFC, our most developed horizontal posted another strong quarter, making inroads as the primary lending option for Lithia & Driveway customers.

At its future state, we believe DFC can contribute approximately $650 million in incremental profits a year and is a key contributor to driving SG&A as a percentage of gross profit down to 50%. I'm pleased with the pace of growth and our ability to not sacrifice near-term growth at the expense of adding risk to our portfolio.

While remaining nimble, our conviction in the Lithia & Driveway strategy remains strong, and I'm confident we're well positioned to deliver on our 2025 plan and beyond. Our portfolio mix, acquisition strategy and all sales verticals are performing ahead of expectations.

We're rapidly growing market share and generating some of the best returns on capital in all of retail. Our capital allocation strategy is balanced, and we're ready to take advantage of dislocations in the marketplace. We have the right team in place to respond and find opportunities in changing market conditions.

We will continue to lead the growth, transformation and consolidation of our industry, the largest retail sector in the world. With that, I'd like to turn the call over to Chuck..

Thank you, Bryan. DFC continues to be Lithia & Driveway's largest lender as we accelerated our growth in originations. For the second quarter, DFC's penetration rate increased to 9.7%, up from 6.2% in the prior quarter with an active rate of 12.9% in June.

For 2022, we are revising our full year penetration rate to between 9% and 10%, up from 7% we communicated last quarter. This would not have been possible without our stores' continued focus on retail readiness.

Retail readiness is critical for DFC to realize our value proposition to maximize the revenue potential of our existing customers rather than incurring the frictional cost of new customer acquisition.

We continue to maintain an appropriate fully risk-adjusted return on the finance contracts we originate which, on average, is 3x as profitable as loans originated by third-party lending partners.

As Bryan indicated earlier, we are reaffirming our guidance of the future state expectation that DFC will contribute $650 million in earnings to Lithia & Driveway.

This will be predicated on DFC maintaining a seasoned and mature portfolio after consistently achieving penetration rates of 20% of all Lithia & Driveway sales with a minimum base of $50 billion in revenues.

From a credit quality perspective, DFC was able to increase our weighted average FICO score by 28 basis points from 690 in our first quarter this year origination to a weighted average FICO of 718 as we continue to leverage the top-of-funnel potential of being a true captive.

The increase in credit quality is particularly noteworthy as we look to mitigate any potential negative impact of economic and industry fluctuations.

Last, in the second quarter, we experienced a modest compression on both interest margin and spread rates primarily attributable to the higher credit quality of our originations and the impacts of a rising interest rate environment, respectively.

We continue to monitor market rates on a real-time basis and will increase DFC's yield rates by maintaining our internal risk-adjusted total rate targets balanced against market conditions.

Increases in yield rates will mitigate spread compression in the short term without sacrificing our ability to achieve our portfolio and risk-adjusted financial targets. I'll now turn the call over to our CFO, Tina Miller..

interest, income taxes, dividends and capital expenditures. As a reminder, this number does not include a pro forma of the full EBITDA contribution of acquisitions purchased within the last 12 months. Year-to-date, we have generated nearly $653 million in free cash flow.

We were opportunistic in the quarter, repurchasing 1.9 million shares or 6.5% of our outstanding shares at an average price of $284 per share. We have just under $100 million available on our authorization. Our capital allocation strategy continues to balance acquisitions, internal investments such as DFC and Driveway and shareholder return.

Our approach is a durable strategy that positions us well to be a leader in the personal transportation space for years to come. Shifting to the balance sheet. We continue to maintain our investment-grade discipline. At the end of the quarter, our net debt to adjusted EBITDA was 1.7x.

Our team's ability to allocate capital and manage risk effectively puts us in an attractive position, particularly around liquidity and generating returns for our shareholders. In conclusion, we are poised to take advantage of possible volatility of the macroeconomic environment and hypothetical changes underway in the auto sector.

Our balanced approach towards growth and returning capital sets us up to achieve our 2025 plan of $50 billion in revenue and $55 to $60 in EPS with significant runway into the future. This concludes our prepared remarks. We would now like to open the call to questions from the audience.

Operator?.

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

Good morning, guys. Thanks for taking the questions. Bryan, I want to start on the new unit side. I think a little bit of a surprise there, just the same-store down around 27%, a bit weaker than the industry.

Was that driven by any one, maybe OEM in particular? Can you just talk about what you think maybe drove that underperformance for the industry here in the second quarter?.

Sure, Daniel. Actually, our franchise mix in relationship to the industry, and we actually measure something called market share. And our manufacturers actually help us do that, which is called MSR sales efficiency.

We were actually up year-over-year 5% in market share as compared to our brands, which doesn't show in the read-through of the down 20-plus percent in new vehicles..

Got it. That's helpful. So just a mix shift. Tina, maybe moving to SG&A. I think you called out 160 basis points of impact from Driveway advertising. But I'm curious, can you quantify what the impact of Driveway Finance is? I think last quarter, you said as you build CECL reserves, that's a net loss flowing through the SG&A line.

Just any help quantifying that, yes, the impact in the quarter?.

Yes. So combined, when we look at Driveway and Driveway Finance, it's about 185 basis point impact to SG&A combined. So Driveway Finance, most of that's driven by those CECL reserves that we need to take upfront. As we originate those loans, there's obviously some offset from the interest income that we're receiving..

I think the net amount in the quarter impact to P&L was $3.5 million in burn rate..

Yes, for DFC..

For DFC..

Great. And then just a follow-up to wrap up on Driveway Finance. Can you remind us just what your expectations are at this point in the credit cycle for kind of the credit profile? Chuck, I think, mentioned average FICO was up. But just kind of curious how you guys are modeling that internally.

And then, as it's related, you're up to almost 13% penetration. I mean when -- do you guys have a plan to start disclosing some of those credit metrics such as charge-offs or delinquencies? Just trying to think about modeling that out going forward as it becomes a bigger piece of the earnings..

Yes. Thank you, Daniel. In terms of our credit profile, our target is really to be on the upper sort of scale of the near prime portion of the credit spectrum. But as I indicated in my comments, just based on sort of the economic environment, we are clearly looking to move up into the lower tier market.

So I would say our weighted average FICO over time should be migrating to the upper 600s, maybe even low 700s. And we just think that, that's prudent in order to achieve our risk-adjusted fully burdened return metrics..

And then in terms of timing for reporting, Tina, do you want to....

Yes. I think as DFC's portfolio grows, we plan on adding some disclosures probably toward the end of the -- with the Q4 reporting cycle, around that time. Obviously, we have the balance sheet disclosures already in our 10-Q, but we do see that getting to be a larger part of our disclosures as we hit year-end and the year-end reporting cycle..

Great. I appreciate all the color. I'll hop back in the queue, but best of luck..

Thanks, Daniel..

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

Thanks for taking the question, and good morning.

Maybe the first question -- Bryan, maybe the first question on just how are you planning for the operation if the economy does go into a mild or moderate or severe recession? Can you give us some boundaries around what the earnings power might look like in different scenarios? If you do end up in a new vehicle SAAR environment, which is probably close to like 12 million, 13 million in a recession and GPUs normalize back to pre-pandemic levels faster than expected, how does the earnings power of the business look like? Any color on SG&A to gross in that scenario or F&I? How should we think about that, given the starting point today is so different than prior downturns? And I have a follow-up..

Understood, Rajat. This is Bryan. I think most importantly, remember that Lithia Motors and Driveway has added $12.5 billion in revenue over the last -- a little less than two years now, which helps backfill the loss that we'll see from GPU recessions. I think most importantly, we look at a couple of different levers in our organization.

And as Tina mentioned, we burned almost 185 basis points or $25 million last quarter on the new initiatives. And I think our first steps are to tone back some of the initiatives and maybe we're growing DFC a little bit slower.

And we are now getting pretty good organic out of Driveway.com that we can probably taper back ad budgets and reduce that burn rate from $25 million to something lower, around $15 million or so, which is important.

I think also in terms of operations, we found a lot of efficiencies within our businesses in terms of personnel costs, and that's -- the big push is to share best practices and simplify those processes to increase productivity. That's always a big lever into what we do.

And then I think with, I would say, the relaxation in pricing on transactions allows us the ability to deploy our war chest of capital that's quite robust right now.

And even in a lower earnings type of environment, we're going to be generating $1.2 billion to $1.5 billion in cash flows, which allows us to buy somewhere between $3 billion and $7 billion in revenue depending on pricing. So there's a lot of things that we can do to be able to do that. I would also point you, Rajat, to Slide 7 of the investor deck.

We did originally model out what lower GPUs and what a slower environment would look like, okay? It's highlighted in a dotted white section for anyone that would like to see it to give you some thoughts on how maybe to model that, and we can sure try to help you with that a little closer..

Our next question is from Chris Bottiglieri with BNP. Please proceed with your question..

Thanks for taking the questions. The first question I want to ask is, it looks like you have about $1 billion of unsecuritized auto loan receivables on balance sheet today.

I just want to understand kind of what your path to current liquidity for that business is in the current environment? Like when do you expect to return to ABS market? What are your conversations with like ABS bankers telling you in terms of your ability to tap those markets?.

Yes. Chris, Chuck answering the question here. In terms of our capital deployment strategy and capacity planning for primarily the Driveway Finance Corporation, it's really a four-pronged strategy. First, obviously, that will require some amount of liquidity.

But we really see the primary conduit of our financing as a combination of an ABS warehouse conduit facility for transitory lending and then moving into the ABS term market.

And speaking with a lot of our investors as well as other interested parties in the ABS market, I mean, obviously, that market has experienced a fair amount of volatility in terms of rates.

However, we do see that starting to taper off as more stability in terms of longer-term yield curves and Fed interest rates start to become more clear and apparent. We still feel like the ABS term market is active. There's plenty of liquidity and investors do have sufficient capital to maintain those markets, both in the short term and midterm.

So we do see that as the longest or the highest form of our capital requirement. And then last, we will look for other forms of liquidity, perhaps the forward flow arrangements or both portfolio sales to make sure that we have a robust capital structure to fund DFC..

Got you, that's really helpful.

And then unrelated -- or semi-related question, I guess, still on credit, but could somebody help walk me through kind of how we should be thinking about floor plan interest expense moving forward? Are those still LIBOR-based or have you moved to SOFR? And then it looks like that expense actually went lower quarter-on-quarter even as rates went higher.

Are there any offsets right now? And I think you get four points of systems, so that shows in COGS, I think, as a contra COGS. So just trying to understand how to model floor plan interest expense moving forward as benchmark rates go a little bit higher..

Chris, this is Tina. Thanks for the question. So yes, most recently with our amendment to our credit facility, we didn't move to SOFR, so off of LIBOR, and that's the benchmark rate that we'll be using for a majority of our floor plan debt. We have a few captive floor plan silos as well that I think have different rates. I think some are prime.

But really SOFR is probably a majority of our floor plan financing to really model off of. And then you're correct. We do get floor plan assistance from some of our manufacturers. A lot of that money actually goes to cost of sale, though, from a presentation perspective.

So, I know we've disclosed in our Qs and Ks in the past sort of what that looks like. But just a reminder that the floor plan interest expense is really a pure interest expense number there. The credits actually are within cost of sales.

So it's managing through the inventory and the velocity and speed at which our stores are selling through and just managing inventory levels..

Thanks, Chris..

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

Good morning, everybody. Just a first question on used vehicle inventory at 62 days. It seems like it's a little bit on the high side. I mean, that might be total and not finished goods, stuff that might be in process so it might be a little bit I'm just curious what you think about that and how you might manage that down over time..

John, thanks for joining us today. This is Bryan. I think on used vehicle inventory at 62, we're pretty comfortable. That's a real normalized level of where we were pre COVID. And I think today knowing that we have two additional national brands in GreenCars and Driveway, it's what our efforts are trying to push is the ability to find cars.

I think it's also important to note that our ability to grow inventory is quite important because it expands the selection to our customers through all three of our channels. Most importantly, when we're starting to see now some of our e-commerce peers are used-only peers that are really struggling just getting inventory.

So we're pretty comfortable at that 61-, 62-day supply and know that there is probably some softness that will come in the market towards late summer. But again, we're talking about a 2-month supply, and we'll adjust things according to what the market conditions are heading into fall and winter..

Okay. And then just a second question around SG&A. I mean, I know the longer-term target is 50% and potentially lower relative to gross. It seems like the majority of that is coming from business mix as DFC ramps up and other efforts ramp up that have lower SG&A burdens.

But what could you think is sort of on a store basis, on an actual retail basis, where that could get to and where that could comp down to base on efficiencies through online selling, et cetera? Is that the kind of thing that you could get below 60% materially just on a like-for-like basis?.

I would say that it's a 60% to 62% SG&A in operations and what we call the verticals now, okay? That's probably the realistic number.

And the disconnect, as you mentioned, really comes from DFC, the fleet and leasing companies and in the other adjacencies, that DFC alone, I believe, is 800 to 1,000 basis points drop in SG&A just from that one horizontal, which is a big part of it.

Now obviously, the other horizontals that we're working on, we're still modeling, we're still learning about and they're in beta stages but can obviously be the other large disconnects.

When we start to think about the e-commerce platforms, if you remember, originally, we were talking about sub-60% levels in Driveway, okay? We think that, that's still possible but that's going to require us to get to 12 units per associate per month, okay? And today, we sit at a little under 9, okay? But again, we're just under two years into the program, and we have a new CRM system going into place that we've developed and should increase the efficiencies in the care centers as well as be able to expand our penetration rates and our closing ratios..

Okay, that's helpful. And then, Bryan, just lastly, I mean, there's a lot of concern around the consumer and risk of a recession, but you guys have day-to-day contact with your consumers. I'm just curious if you could maybe comment on the state of your new vehicle buyer and your used vehicle buyer.

Because I mean, it just seems like with this pricing and grosses, that your consumer is still pretty damn strong and wanting more vehicles than you can even get for them. So I mean, there's a lot of crosscurrents here, but it seems like the new and used vehicle buyer is still relatively healthy.

I just wanted to get your take and your view of where this is going..

Well said, John. I mean, there's still a backlog in most manufacturers in new vehicles. Our used vehicles are still turning at quite a high rate.

I'm going to guess on this but we probably added five to seven days supply just from buying vehicles in other parts of the country and then getting them to reconditioning centers that are a little further away because we've had to expand the fine vehicles.

So I think when we think about the consumer impact on days supply, the demand is strong, okay? I mean, we were down, what, about $200 in GPUs and years, but that's still considerably higher than normalized states, and we still see that as quite healthy. Obviously, on new, we're still at peak levels and the backlog of vehicles are quite high.

Just a couple of highlights. Our domestic days supply on new is around 60 days. So we have pretty good flow even though there's some in-transit on that.

Really our softness in days supply, which is where we really are selling every car that we get about as quick as we can get them is in our imports, which we're sitting at a 16-day supply and our luxuries are sitting at about a 29-day supply..

Okay.

And just are there any anecdotal or maybe systematic data points you could kind of highlight just on people waiting for vehicles and right sort of almost a build-to-order operation where somebody is buying well ahead of the vehicle, actually showing up for these commitments?.

Sure. I would say on new vehicles, about one-third of our product is presold that's coming in. So that's good. And I think it's a lot of high-demand vehicles. The rest of the stuff maybe wait-listed but it's not presold where we have money on the car, okay? So that's probably a pretty good relative number.

The consumers, and if you look at our unique visitors to our website, it's still up massively. So there is still good demand for vehicles.

And I think it's important to remember in affordability that when people are buying new vehicles, their used cars are so highly valued that the delta between the trade-in and the vehicle they're buying when the new vehicle is capped at MSRP and the used vehicle is uncapped is quite lucrative for the consumers.

I mean, we have examples of some consumers that bought cars -- new cars from us within the last year, 1.5 years, and they've now turned around and sold those same cars either on trade-in or direct sales for something north of $5,000 to $10,000 more than what they paid because they're really playing a commodity almost on their transportation needs.

So it's neat to see that the consumers can win, especially if they are buying new cars where that price for the new car has really been capped somewhere south of MSRP..

Yes, and it seems that towards the impact of rates, so that's good. That's a really good guide. Appreciate the insight..

Thanks, John..

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

Thanks for taking my questions. Just a follow-up on your comment. I think you said one-third of vehicles now are presold. Has that changed? I actually kind of thought almost everything was -- you had to wait several months to get any car right now.

Has that changed over the last three to six months? Is that 50%?.

Colin, yes, and again, we don't have the exact data. We got it by franchises somewhere. But I would say it was close to 50% 90 days ago, okay? So since interest rates have come up, it definitely has affected things, but it's pretty -- it's still a robust environment where those cars hit the ground.

And if someone that wants to drive the car and there's two other people waiting to drive the same car, and it's still a bit of a frenzy. And we imagine that it will continue through the rest of the year, especially knowing that supply lines for most manufacturers are going to remain quite tight until Q1 or Q2 of next year..

Got it. That's helpful color. I also noticed, I mean, new GPUs still very close to record levels on a nitpick, but they are down slightly from Q1. And I've heard automakers are talking about how they're going to take pricing from the dealers through different mechanisms.

Is that starting to happen? Is that driving the slight weakness or is that really sort of a rounding error from your perspective?.

I would probably say it's closer to the latter, the rounding error. I believe that manufacturers' transparency on pricing and stabilization on pricing will help stabilize front-end margins at something higher than normal levels. I don't believe that, that's what's occurring quite yet.

It's just not how transactions are done, unless a manufacturer chooses to move to a 1-price type model for their network, which we'd probably welcome because it does take away complexity in the relationship with the consumer. When today, we do deal with two different moving parts of a transaction.

We deal with finance ability and then we deal with price negotiations. And then throw in a trade and it gets quite complex. And if we can take away that uncertainty about price by having it tighter to actual transaction prices, we're all for moving towards that as manufacturers.

I will say this, most manufacturers, though, are tending against that because they fear that they want a fluid market where consumers have been trained for so long that there's a good price and a bad price and I can do better if I negotiate on my own.

There's a lot of consumers still think that way, and I think most manufacturers believe that the freedom of pricing is something that can be adjusted that based off markets and regions and states. So important to know that there's not big pushes in that arena outside one or two of the European manufacturers..

Got it. And just lastly, F&I was down a bit. Is that attributed to -- and maybe I missed this in the commentary because I know that when you do the DFC, it takes away some of those profits.

Is that the main driver there or there's other factors going on?.

It is. I mean, I think you saw F&I increase as GPUs increase. And I think as GPUs start to subside, you'll see F&I, to some extent, subside that they're both driven off this supply and demand type of environment. I think the difference that you're seeing in the last few quarters is about $130.

So as Chuck mentioned, we were pushing 10% penetration rate, which means that now 10% of our business is being taken out of F&I and diluting the F&I number. So it's about $130 per unit.

Is that right, Tina and Chuck?.

Yes, year-to-date..

Year-to-date. Year-to-date, it's about $130. So if you see our penetration levels go up, okay, which Chuck mentioned, we were almost 13% in the month of June. So you're going to continue to see a little drag in F&I from that effect..

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

Good morning, guys. On the GPU, I guess, SG&A to gross and your outlook for GPUs returning to pre-pandemic levels, I guess as we look at '25, you're looking at a 60% SG&A to gross. Would you expect sort of materially higher levels in the interim? Obviously, a lot of the development spend continues and you're looking at a return to $2,100 GPUs.

As we model it, should we think sort of mid-upper 60s in the shorter term? Or do you manage down some of those investment costs around DFC in the interim?.

Yes. I think internally, the way that we think about it is how fast does demand and supply change and how quickly do those GPU levels rescind.

I think we're in the camp that if there's a normal rescission where it's quarter-over-quarter declines and not month-over-month declines, I really believe that we will get back to some level that's higher than the normal state of GPUs. Now we were about $2,600, $2,700 pre-pandemic so we're going to shoot in the $3,000 to $3,200 range.

It's probably a normalized level if it subsides that in a slow, methodical way. If there's some large economic event or further excessive increases in interest rates that affects demand in a big way, it may be a little harder to manage for a few months.

But ultimately, we're pretty confident that we can get our operational part of the business to that 62% SG&A as a percentage of growth with knowing that if Chuck can tone back our growth rates a little bit on DFC, that we can get those to profitability in three to four months typically.

And now you start to see the real impacts that can drive SG&A, and we can adjust SG&A in operations to some extent with the horizontal in the finance company..

Okay, great. And then a question. I guess, on Slide 14, you have the mix of value, which has clearly been growing in this environment. But you commented about a $5,100 average negative equity.

Do you see an environment where given the spike in values in the last 18, 24 months, that we're going to have to, I guess, swim upstream against negative equity as normal depreciation returns? Or is that reason....

Good insight, Bret. Yes. I mean, I think today, we've calculated that about one-fourth of the consumers haven't transacted in a higher GPU type of environment. But remember also that it was offset by higher trade values, like I mentioned to John.

So though we know that, and today, we sit at about 35% of consumers have this equity and it's around $2,000 of this equity, they also have now over $2,000 of cash down, okay, which is a vast difference from what we are normally at pre pandemic, okay, where we saw 71% of our consumers with this equity averaging $5,100, average cash down of only $1,800.So, you're talking about a $3,500 delta so there's probably 25% of consumers that could have something a little north of that.

But remember, that plays well to new car dealers or Driveway and Lithia, most importantly, because of why, the easiest vehicles to absorb this equity on are ultimately new cars and late-model used cars.

The best is what we would call mainstream or lower-demand new cars that eventually will have incentives again or will have price variance in them, that allows us to absorb that $5,000 in this equity or that net difference of $3,500 with their cash down to make sure that we can get that.

And I think that's very important to note in the model that our ability to find used cars come from trade-in, okay? And those trade-ins are about two-third of our inventory in normalized times.

And I think that's the advantage of being a new car dealer, that when there is this equity, it means you typically have to trade in your car because you can't clear your debt because you have to carry over some of the debt to the car that you're buying..

Right.

So you would expect that the next couple of years, negative equity situation would be better than pre COVID?.

It would probably be a little worse. We're going to probably guess in the $5,500 per unit, okay? We hope people will save a little more. Maybe there'll be some tax savings, so you're talking about a $4,000 delta between cash down and disequity rather than a $3,500, which should push more people into mainstream new vehicles..

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

Good morning, guys. Curious, just want to dig into DFC a little bit more. So the loss expectation on the year increased from $9 million last quarter for 2022 to $20 million now. Penetration higher, though, so 7% to 9% to 10%.

How much of that loss change is from that higher penetration in those CECL reserves versus other assumptions?.

Ryan, this is Chuck. I would say the vast majority of it. There was a small amount of spread compression that was pretty much offset by the increase in volume. So the vast majority of it was just that planning for future losses..

That came from volume of business, not from loss expectations..

Correct..

I think, Chuck, you had mentioned to me that the loss ratios are actually running below what we had reserved for..

Correct. And so again, as we move up -- thanks, Bryan. As we move up the credit quality spectrum, obviously, our loss reserves as a percentage are going down.

And so even though we're growing our provision rates pretty dramatically as the overall portfolio book continues to increase, but on a percentage basis, we're either static or slightly going down as we again improve that credit quality..

Great. Then just one on used. So pricing is starting to potentially come down a little bit here.

But how do you think your overweight mix of core and value, particularly at the legacy Lithia dealerships, how do those segments position you relative to your peer group?.

Good question, Ryan. I know that someday, everyone will sell value auto cars because it makes up about 17% of our business today. I think we all just get enamored with the CPO sales that make up 20% of our business. But our real thrust is in our core business.

That's 63% of our volumes today, and that's really the heartbeat that comes from those trade-ins of high-demand vehicles that create better margins and the ability to sell lesser demand cars at a more attractive price than used only dealers.

So I think if we think about what cycles we went through with value auto or the higher aged vehicles, they're always hard to get, okay? And maybe even more importantly than that, they're really hard to recondition. So, when we look at our mix of value auto versus our peers, we're usually sitting at double to triple our mix rates.

They're sitting at 5% to 6% typically. The used car retailers, obviously, they don't have the ability to recondition those cars because it typically requires diagnostic tools that are 10 years and older that we still have in our tool rooms to be able to fix those cars and a little bit more experienced technician to be able to do that.

Now we don't mind that other people get into that business because most value auto cars are taken in on trade, okay? So what we don't typically buy those on the street, okay? So we're actually getting those, which means that anyone else that decides to keep the value auto cars typically send them to us if there's a drivability issue or there's a higher cost repair on the vehicle for them to get it to the front line.

A simple example would be a check engine light. The only person that can turn off a check engine light is us, okay? And sometimes that can be $400 to $600 to really just check an O2 sensor and modifies how the flow mass sensors are working or something.

So lots of simple things that we are far enough upstream that we get the profits as others begin to move into value autos as well because it is a pretty easy area of the highest demand cars that creates an affordability level that starts that consumer into the Lithia & Driveway life cycle that has really been our mantra for decades..

Our next question is from Michael Ward with Benchmark. Please proceed with your question..

Thanks. Good morning, everyone. I just want to clarify something, Bryan. When you were talking about gross profit per unit on new and used going down to $2,100, that was solely for the purpose of when you were saying you can get $1.20 in earnings per share from $1 billion in revenue.

Is that correct?.

Correct..

Okay. So as you go forward, everyone out there is saying that inventory levels on a more normalized basis are going to be, whatever, 30% below historical.

In that environment, is there any reason why new vehicle grosses wouldn't be materially higher than they have been in the past?.

We do think that grosses will remain higher, mainly because of greater price transparency and a better ability to build the market, okay? I don't know though that in a normalized supply and demand environment, that days supply is a direct reflection of GPUs, okay? And I think that's something that we'll have to see out.

We haven't seen the correlation in the past because if you remember, we've run with our -- like Subaru as a manufacturer, we ran a teens days supplies for a decade before the pandemic and we run at similar levels with them today. So, I don't know that there's a direct correlation.

I do believe that the ideas of price transparency and taking away the ideas of negotiation, to some extent, so we can deal with finance ability, trade values and working with the consumers in a transparent and simple way is beneficial for the consumers from factory to driveway. And obviously, our efforts with our manufacturers are to focus on that.

I think that will play a bigger role in stabilization of GPUs, above normalized levels than probably days supply will..

Is it converting though from more of like a shop and pick where it would be a discount type model? And so where consumers come in, if they're going to order a vehicle and they're going to wait three months for it, which may become more of the norm, isn't that a more profitable environment than it would be just shop and pick?.

I would think that there's value adds for building something specific to what you want. I think most manufacturers, though, have to then deal with their production capacities and their production flexibility.

I think most manufacturers are still going to be building a lot of inventory in the United States because we do have facilities to do that and consumers in America like selection.

And it's a little different than Western Europe, where there's space constraints and 70% of your cars are typically built to order, where a consumer in America today wants to look at the blue one and wants to look at the one with the cool new electric drive systems and so on. So a little bit different environment here in the United States.

I think that they'll still be on-ground inventories for years to come..

Our next question is from Evan Silverberg with Morgan Stanley. Please proceed with your question..

It's Adam Jonas actually on for Evan Silverberg. So look, having the really high portion of your new volume being preordered vehicles, gives you some great insight, I think, on forward demand. We never thought to ask car dealers about preorder backlog or the length of that or cancellations.

But it's not an irrelevant question, given how much of your businesses is preordered, and you have a good visibility into 3Q and into the back half of the year.

So what can you tell us about that? Is there any rate of change on the length of the order to delivery time, rising, falling, stable? Or any kind of comment on cancellations to give us a little color on one data that I'm sure you're tracking daily?.

Sure. I think in a normalized environment, Adam, we were probably around 5% to 10% of our new vehicle sales were preorders, typically on things like Wranglers and 911s and BMW M3s, that higher demand type of product, okay? And we are sitting at about one-third of our sales now are order bank.

When we did peak a few months ago at probably around 50%, so it's a little bit softer but maybe we end up stabilizing in the 15% to 20% level and more things are built to order. We sure hope they are. I know when consumers have the optionality to do things, the way that their own personality and their own driving habits fit.

It's typically a better experience for them as well..

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

Thanks. Good morning. Just going back earlier, you were talking about how demand is still very strong. Consumers still want to spend money on vehicles. Also on the positive side, we've got rising wages, tight labor market.

But on the negative macro side, we've got inflation high but falling oil prices and falling copper prices so there's some mixed signals there.

I mean, do you think we're heading into a recession? Or do you think maybe the overall economy might be in bad shape but the auto market will remain strong?.

David, we try to keep our eye on what we can control, and we obviously have a very proactive field team that runs each individual location, and each part of the country responds differently just as we learned from the Great Recession, where we knew that those that responded at the local levels closest to our customers were the ones that really won the day, and we built an organization and a mission that's Growth Powered by People and rely on them to be able to make those decisions.

Now I know that may not have answered your question. I do believe that demand will soften as interest rates and inflation either take hold further or hope to subside.

I do believe that this is a supply and demand inflation imbalance that's creating inflation, which is a little different than actual price inflation, okay, that I think we'll see a return to some level of normality.

And if we do see a recession, I think Lithia & Driveway are nicely positioned with its adjacency to continue to execute through our strategy that we've developed, to maximize shareholder returns and maximize our ability to grow to become the largest automotive retailer in the country and probably the world..

Our next question is from Josh Taykowski with Credit Suisse. Please proceed with your question..

Hi, thanks for sneaking me in here. Just had one for me. Just trying to understand the year-over-year dynamics in used a bit better.

Maybe I'm missing something, and I appreciate that GPUs are obviously still elevated from a historical standpoint, but just wanted to see if you could talk through same-store being same-store used 18% higher average selling prices still year-over-year, but GPU down 14% on what looks like kind of flattish used volumes.

Is that a function of just added procurement expenses based on some of your previous commentary or how should we think about that?.

Sure, Josh, it's Bryan again. I think most importantly, the used car market is down a pretty good portion. So being flat, we thought, was a pretty good level. and we're pushing those out of multiple different channels of Driveway and GreenCars.

I think most importantly, though, it is taking us a little longer as we buy cars further away from our reconditioning centers, that even though we're sitting with most -- with a broad network to be able to recondition cars when we're buying cars in the Mid-Atlantic and I get a BMW and the Lamborghini stores, basically all we own there, we got to move those cars 300 miles.

And unfortunately, that takes us six, seven days to do at times, and then you're reconditioning in 72 hours, which is another three, then it does build stuff. So I think we'd rather be on the side that knowing that exposures to price devaluations in our inventories is really a 60-day window.

We like the ideas of building inventory, knowing that Driveway is building momentum and GreenCars is building momentum, that we can push those out in any environment, knowing that GPUs are still quite strong in used..

Thank you. There are no further questions at this time. I would like to turn the floor back over to Bryan DeBoer for any closing comments..

Thank you, everyone, for joining us today. We're going to get back with you in October and look forward to catching up again then. All the best..

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..