Q2 2020 Lithia Motors Inc Earnings Call
Well once in place Tom Mutryn background noise.
After the speaker's remarks, there'll be a question answer session.
I would now let's turn the call over to Eric Pit, Vice President Investor Relations and Treasurer. Please begin.
Thank you and welcome to the Lithia Motors, the second quarter 2020 earnings call.
As any today or Brian de Boer, President and CEO, Chris Holzshu Executive Vice President and COO, and Peter Millar Senior Vice President CFO.
Today's discussion May include statements about future events financial projections expectations about the company's products markets and grip.
But they are forward looking and subject to risks and uncertainties that could cause actual results could 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, where do you look carefully consider these displays or if not the place undue reliance on forward looking statement.
We undertake no duty to update any forward looking statements, which are made at the date of the three leases.
Result, that's got today include references to non-GAAP financial measures. Please refer to detect the today's press release for a reconciliation to comparable GAAP measures.
We have also posted an updated investor presentation on our website that the investor relations dotcom, highlighting our second quarter. So.
With that I would like to turn the call over to Brian or President and CEO.
Thank you Eric good morning, and welcome everyone.
Dip again and as our local communities around the country continue to reopen in a Josh.
Our priority remains to ensure the health and wellbeing of our team members to customers and community.
We would like to thank our team members for their strength adaptability encourage they have demonstrated navigating the impact of this pandemic.
Earlier today, we reported the highest adjusted second quarter earnings in company history at $3.72 per share at 26% increase over last year.
These results were driven by strong sequential improvement.
Throughout the quarter and all business lines, culminating with used vehicle sales increasing 23%.
And returning to the year over year growth levels experienced Greek hub in 19.
Our rapid growth continues to be powered by people in innovation and our teams remain committed to safely meeting customers needs through the entire ownership life cycle, while elevating the experience through affordability transparency and convenient.
Our omni channel strategy, let us to another quarter of record earnings and that step closer to our recently shared five year plan to eclipse $50 billion of revenue and $50 of earnings per share.
During the quarter, we experienced one of the lowest monthly new vehicles Carson history, and not only maintain profitability.
To achieve the strongest net income levels in our history for both man June with net income, increasing 44% and 97% respectively over the prior year.
As noted in our interim quarterly updates.
Sequential improvements we recognized throughout the quarter concluded in Japan with total revenues do decreasing 2% and total gross profit increasing 15% for the month.
Our declines in revenue were offset by significant improvement in margins that Chris will speak to ingest a few minutes.
While we focus on executing each day, we are guided by our long term vision and will now discuss the details of our five year plan and the introduction of our new National Digital home channel in brand.
We are in an exciting time as we embark on our five year plan to expand our presence in the over two trillion dollar market.
Automotive products and services.
Our strategy focuses on the most expansive addressable market of any retailer in the automotive space.
This plan was designed to address both the full vehicle ownership lifecycle and all levels of affordability.
It includes new and certified vehicle sales from 30 manufactures a full spectrum of non certified used cars and the high margin aftermarket businesses, including service body in part.
Our history of exponential growth within the industry.
Coupled with our team's ability to execute has positioned us with itself generating cash engine producing over a half a billion dollars annually to pragmatically and profitably disrupt this industry.
Our 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 bring to market our digital home solutions in the second half of the year. Our teams are ready to serve not only our traditional customers, but also incremental E commerce customers through our new National brand.
The past few years of research and development on our new revenue channel and the recent acceleration of consumer demand for in home solutions has culminated with its brand launch.
Our new National brand name expresses the qualities in services that will be delivered through each of our digital home solutions.
With much anticipation we are excited to announce our new national brand name drive away at the glass guiding light for our own new experiences and relationships.
As the foundation of our E Commerce digital home solutions driveway is designed to reach consumers thirsting for transparent empowered flexible and simple buying in servicing experiences.
Driveway pricing is completely negotiation free providing shopping experiences across our new vehicle certified vehicle used vehicle and service body in parts revenue stream.
Dr. way its home enable what the ability to deliver anywhere in the country through our coast to coast National Logistics network with a free home pickup and delivery for customers.
This brand will include our own inventory of over 55000 vehicles, providing consumers selection. In addition to leveraging 2000 of our existing employees as a customer facing vallese and behind the scenes specialists to fulfill the driveway experience.
Our hundredninety existing locations will retain their local brands, while you future locations may carry the driveway name or utilize driveway and their branding message is.
Overtime, we expect marketing efforts from our local brand to also support the driveway national brand through the my driveway portal a customer experience has.
The my driveway portal will allow our 5 million paying customers from our local brands as well add new Dragonwave brand customers to shop sell in service and manage their vehicles.
Simply put in a single location a customer can manage their view vehicle ownership lifecycle from the vehicle information and maintenance history. The after knives product subscriptions.
Now I would like to walk through each of the consumer interaction points in revenue generation opportunities within that ecommerce strategy.
Let's begin with our in home driveway service experience that will launch later this quarter here in the northwest.
It's experience will allow consumers to schedule service work with free home pickup and delivery, including loan or vehicles within a pre defined geo fenced area.
This service is a key differentiator in our model as it allows for over 10 times the brand impressions compared to digital experiences that only sell a customer vehicle. Once every five to six years.
This revenue stream will include premium level pricing and allow the consumer to subscribe to services for the lifetime that they own their vehicle.
The next consumer interaction point is our used vehicle revenue stream, which has two components inventory procurement and vehicle sales.
The inventory procurement component expands our five channels the procurement and it's key to generating incremental vehicle sales through our E Commerce platform.
Our procurement technology, which was deployed in the third quarter of 2019 included the key components of Geo fencing workflow management and scheduling that every engines for the other home digital solutions.
This selling experience infrastructure of the impending other components can be seen life today on driveway dotcom.
They used vehicle sales experience, there's also coming to market in the fourth quarter and will be a one price digitally enabled experience that will include immediate financing and a massive selections of vehicles that can be delivered anywhere in the country.
Our selection will include the entire spectrum of used vehicles.
From certified vehicles to 20 year old value autos.
All vehicles will include a seven day return policy and other brand guarantees to reassure consumers have their purchase and include home delivery fulfilled by our existing logistics network.
Lastly, our new vehicle revenue stream will launch early next year as we continue to perfect. The digital integration of manufacturer rebates.
Leasing options and other variables unique to new vehicles.
All of our business lines offered through driveway will leverage our virtual centers of excellence or VC east to provide a helping hand behind the scenes for buyers that need support along the way.
Our VP ease include financing sales managers to assist in financing them more complex transactions.
Used vehicle specialist who value. The few one off vehicles that are AI is unable to value.
And service advisers to Oscar can customer support on pricing for the more complex repairs generated from upsale opportunities for their service work.
Though not assumed in our model, which can be found on page 11, our of our updated investor presentation.
We believe that there is opportunity for margin expansion and considerable SGN a reduction as we further leverage are extremely profitable network.
With that we look forward to sharing further details on driveway.
Over the coming months as each component becomes a reality.
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 businesses.
It's a competitive advantage to ensuring a highly profitable digital experience across the United States.
Our customers proximity to our physical network is a key element to our design.
This enables us to supply convenient and affordable touch points throughout throughout the ownership lifecycle, especially related to our highest margin service and associated parts solutions.
Increasing our physical network to approximately 400 locations in six regions gives us the ability to reach over 90% of U.S. consumers and two hours or less.
As such our top priority for allocating capital will continue to be accretive Lee expanding our network by acquiring strong new locations.
With less than 1% of the two trillion dollar market, our physical network will be leveraged through driveway and continuing to grow our core business, allowing consumers to create the experience that they desire.
The opportunities for consolidation within our industry remained plentiful and our pipeline for acquisitions remains fall.
Our plan models acquiring approximately $4 billion than revenues annually over the next five years.
It's highly fragmented market has allowed us to consistently invest in increasing the reach and density of our physical network by acquiring strong assets for more than a decade. We have successfully purchased an integrated acquisitions that have yielded an after tax return of over 25% annually.
After a strong sequential recovery throughout the second quarter, we renegotiated and restarted acquisitions in the latter half of the year.
We have completed three acquisitions, that's far smallest Chrysler Dodge Jeep Ram and Nissan and Bend, Oregon, and Latin Subaru and thousand Oaks, California. These location increase our revenues by $160 million annually, while further improving density within our northwest.
And southwest region.
Including the addition of two Lexus stores acquired earlier. This year. This brings our total network expansion to $320 million, thus far in 2020.
With more than a billion dollars in cash and available credit.
Finance real estate that can add an additional $250 million gonna liquidity.
Over $500 million and EBITDA production annually and an adjusted leverage ratio below two times, we're poised for accelerated growth.
Assuming an average equity investment of approximately 20% of revenues.
Our available liquidity, an annual free cash flows could add another $7 billion in revenue or more than 50% growth.
And just a few minutes Tina will discuss additional avenues of liquidity to expand our robust and disciplined capital strategy to support our strategic goal.
Despite reporting our highest adjusted earnings in company history, We're just getting started.
Our company and all of our team members live our mission of growth hired by people and the corresponding value to improve constantly.
As such we remain humble and never quite satisfied as we are tenaciously committed to improve grow and find new opportunities.
To summarize.
Our diversified high growth business strategy is highly complex and has been built despite the considerable barriers to entry in new vehicle, making it difficult if not impossible to replicate.
Our industry remains right for considerable consolidation and his thirsting for modernization.
Our growing network composed of our people inventory in physical network combined with our dry driveway digital home solutions completes our unique omni channel strategy.
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 that I'd like to turn the call over to Chris.
Thank you, Brian I want to start by recognizing our operational leaders, who have loved our mission of growth powered by people and focusing on what they can control and identifying the levers that allowed them to persevere through these unprecedented times, our team's ability to be agile and nimble, let us to solutions that continue to meet our customer needs safely and conveniently.
Resulting in one of the most profitable quarters and the company's history.
With that I'd like to discuss our same store quarterly result.
For the three months ended June Thirtyth 2020, total same store sales were down 18% led by a 24% decrease in new vehicle sales, a 1% increase in used vehicle sales.
7% decrease in half and I revenue and 21% decrease in service body in parts revenues as previously reported results improved throughout the quarter with total same store sales improving for June to a decrease of only 6% compared to the prior year.
The new vehicle business line was down 24% for the entire quarter, but improved to a decrease of 13% for the month of June for the quarter, our average selling price increased 5% and unit sales decreased 27% gross profit per unit increased to $2625 compared to $2095 last.
If you're a $530 increase or 25% total new vehicle gross profit per unit, including Ethanizer was $4291, an increase of $685 per unit or 19% at approximately $4300 of gross profit per unit new vehicles remain highly.
Comparable with a tenant a half percent margin similar selling costs per unit has used vehicle inventory carrying costs that are subsidized by our manufacturer partners.
Our Oems to reopen their factories and adjusted plans to avoid any significant disruption in the availability of new vehicle inventory.
As of right now our stores our position with the inventory necessary to meet the increase demand that we were seeing throughout the network.
For used vehicles, we saw 22% increase in revenues for June and a 1% increase for the quarter gross profit per unit for the quarter was $2243, an increase of 2% or $48 over last year total used vehicle gross profit per unit, including up and I was $3774.
An increase of $185 or 5%.
Our strategy of selling deep into the used vehicle age backstrom through our high margin core values and value auto vehicles provided us with inventory that have valuations resistant to short term market fluctuations. In addition, our ability to procure the right scarce vehicles to the five different channels, it's a catalyst for the future success and growth of driveway.
Additionally, in weaker economic times. These already scarce vehicles are in high demand as consumers move to less expensive monthly payments and more affordable product option.
New and used vehicle sales are supported by our experienced finance specialist that helped mass the complexity of consumers financial position, what the lending options and over 150 financial institutions in the quarter, our finance and insurance business line showed massive improvement averaging 1500, not $90 per retail unit compared to one thing.
I was in $454, an increase of $136 per unit over the prior year as consumers continue to take advantage of the product offerings available that protect their mobility investment as well as a record incentives from our OEM partners and historical low interest rates offer.
Overall, new and used vehicle sales create incremental profit opportunities through the resale of additional training vehicles greater manufacturer incentive f., a nice sales and future service and parts work. We continue to monitor this the growth of our gross profit per unit, which was $4030. This quarter, an increase of $412 per unit or.
11% over last year.
As a result of the accelerated demand seem in the second half of the quarter total gross profit per unit improved to $4418 for June.
In addition, our stores remain focused on the highest margin business lines, our service body in parts, which decreased 21% over the prior year, but down only 4% in June.
Our service body and parts business captured over 5 million paying cousin consumers and brand impressions annually generating over 50% margin and this remains a huge competitive advantage at lithia.
The increasing demand from consumers asking are sourced to offer home solution has shifted the mind set up our team and has accelerated the ability to leverage our digital home solutions combined with online vehicle sales used vehicle inventory purchases.
And at home service solutions, the driveway launch positions our company to leverage our growing network, which has the largest reach in the industry our facilities inventory and people are ready to deliver our online in dealership and in home solution. The non traditional auto consumers that we previously may have not have appealed team.
Store leaders continue to take prudent and decisive cost saving measures and personnel and advertising expenses, which comprised approximately 75% ever asked DNA.
These actions led to significant sequential improvements throughout the quarter same store adjusted EPS you need a gross profit was down to 64.8% in the quarter and improvement of 480 basis points over the prior year.
To reinforce the S. DNA opportunities. We have ahead for the month of June our company SG Nana gross profit improved the sit 57.4%, while our high performing stores consistently maintained S. You need to gross profit metrics at these levels significant leverage in the cost structure is attainable as we maintain discipline and look to our ecommerce and digital homes.
Allusions to provide incremental sales with lower delivery costs in summary, our teams continue to adapt and operate in ways. The best match each of their local market and meet the needs of our evolving consumers wherever whenever and however, they desire with the information provided by our data science, our teams are nimble and responsible to the chip.
Changing environment.
We are innovating and improving the consumer experience through incremental and pragmatic modernization and are poised for growth in the back half of the year. Our teams our team's ability to achieve high performance in any environment continues to be the foundation as we remain focused on our longer term goals with that I'd like to turn the call over to Dino.
Thank you Chris.
For the quarter, we generated free cash flows of $96 million as a result, we ended the quarter with over $750 million on cash and available credit.
Earlier this month, we completed an over a $250 million syndicated real estate credit facility, bringing our total current cash and available credit to over $1 billion.
As of June Thirtyth, we had 2.9 billion outstanding into a much 1.5 billion wet floor plan you see a call service on a financing a unique aspects of that in our industry is the financing of vehicle inventory with heartland that this financing is integral to our operation and collateralized by these assets.
Industry treats the associated interest expense as an operating expense and EBITDA and actually this that from balance sheet leverage calculation.
On adjusted our total debt to EBITDA is overstated at 5.3 times.
Adjusted to treat these items operating funds, our net debt to adjusted EBITDA was 1.8 times. Additionally, this week, we filed an equity shelf registration statement, allowing us to issue equity periodically opportunistic point through various avenues, such as an aftermarket equity program or follow on equity offering.
This will allow us to expand liquidity options within our capital structure and ensure we have the necessary firepower took salary and execute our growth in any environment.
In line with our overall capital discipline, our intent is to issue equity if and when our share price needs. Our internal part hurdle rate antiquated proceeds quickly to expand our network in an accretive plane.
Offer we make under the registration statement well be pursuant to the prospectus supplement filed with the FCC containing more details at the time offering.
Our capital allocation priorities, which support I can first high high growth strategy, I mean unchanged, we target, 65% investment acquisition, 25% internal investment, including capital expenditures modernization and diversification and 10% and shareholder return and the five dividends and share repurchases.
Earlier this morning, we announced a 3% increasing our dividend to 31 cents per share.
Brian and Chris mentioned earlier, we are well positioned for continued growth throughout the second half Tony Tony We have over 1 billion in available liquidity to deploy in acquisitions that meet our strategic objective internal her only.
Additionally, in the upcoming yeah, we plan to pragmatically inbox and modernizing the consumer experience through Tri Pointe and building teams needed to support our growth.
Fundamentally the diversity in our revenue streams growth plan variable cost structure and continued consumer innovation allow us to be responsive to any economic environment and position us well as we continue to drive toward our aspiration, all five year call of $15 billion and revenue at $50 earnings per share.
This concludes our prepared remarks, I'd now like to open the call for questions operator.
Thank you at this time will not be conducting the question and answer session. If you'd like to ask a question today. Please press star one from your telephone keypad and a confirmation Tony indicate your line is just a question Q.
You mean first start usually like to move your question from the Q. So just instead of using speaker equipment, and maybe necessary to pick up your handset before pressing the star keys. One moment. Please so we pull for questions.
Thank you and our first question is coming from the line of Rick Nelson with Stephens. Please just use your questions.
All right.
Good morning.
Oh, I'm, sorry, <unk> channel.
It is going to be up they.
Driver to achieving these long term goals.
Probably in a few could provide.
More details.
Around that.
That's a major differentiators, who see from other France tightens pillars.
Well, it's the online on <unk>.
Platforms.
Sure Rick That'd be great. It's exciting you were one of the few people that had figured out the driveway name even before today. So congratulations on that on that as well that was that was kind of need that people <unk>. We're able to find that you are l. over the last couple of months I I think that I think the biggest delineation between.
Lithia Motors is that we look at the omni channel strategy to be able to attract.
Consumers by how they look at their financing, Okay, and I think we've built a model that offers a product.
That touch all levels of financing spectrum as well as the associated vehicle inventory to match that as well as the entire life cycle of the consumer meaning that our ability to provide brand impressions to consumers on a semiannual or annual.
Well basis through their service body in parts is our foundation of how we grew as an organization I mean, Lithia motors grew out of a small town in southern Oregon.
Began in 1946 and it was all about the loyalty in the relationship of the customers. So as we designed our product. It was all about being attract being able to attract consumers at all levels of the marketplace early in their buying cycles to be able to have them for the 50 years that they are 60 years that they drive vehicle.
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Great Oh, Oh I couldn't <unk>.
Yeah, but part of a long term.
Hi growth story.
Are you still looking for Underperformers. Some can you describe the.
Current environment or Frac crews <unk> for the pipeline any color around that would be great.
Sure sure Rick or I, I wouldn't say absolutely that value based acquisition strategy is fundamental to who we are.
I I will say that we are looking in that region, four and six which is a the lower Midwest as well as the southeast.
For business partners and people that have a great consumer relationships and in those instances, we do typically have to pay a little bit of a premium to be able to get those much like the Williams acquisitions in Tampa, and Tampa Bay, but the fundamentals of our value based strategy are still there when we think.
Think about $4 billion, an acquisition revenue annually, it's very difficult to be able to buy that much value based strategy. So we had to expand and open up those expectations to be able to by higher performance as well to be able to achieve that a targeted for $4 billion I would.
I also say that the acquisition pipeline, we announced a what about 60 days ago now that we had 14 acquisitions under contract we've since announced a three of those.
So we still have 11 or that will be closing in the coming months.
And we look forward to them, joining our team and expanding our network. The pipeline, it's still continuing to build on top of that we have somewhere between 10 and $15 billion. A of revenues that are under negotiations are in discussions, okay, and it's really a matter of time and price as to whether or not.
We're able to accommodate the needs of of those sellers and and and find the right fit for our network development as an organization.
Just to circle back down.
Tom did you are Oh is there.
It's a.
I'm going to put inventory.
I'm, sorry, I didn't start on transacting business.
Is that tend to be done gradually what Paul your dealers or <unk> Oh warrants.
So, but that's a great question. So we plan on going live with the used vehicle revenue generation stream in Q4.
And that should include a good portion of our inventory we have about 25000 used vehicles in stock our data science is showing that the current pricing that we have on our inventory that 80% of those vehicles will fit the driveway model, meaning that they will sell.
And clear within 38 days.
At the price that our current stores have those listed that where we're really expanding our reach as we go about that we do plan on rolling our strategy out market by market and we've modeled into a web page 11 of our new investor deck.
That the rollout plans are a three year strategy across the country, depending on on how big or what that the network looks like.
Alright, Thanks, a lot prior to signing stuff Oh good luck.
Thanks, Rick Rick.
Our next question is from the line of I mean, just seeing judicious with Morgan Stanley. She was your question.
Great. Thank you for taking my question congrats on the quarter and.
And with some great detail here.
A question around the the core growth.
You mentioned, a 10% cagar here.
Yes.
Look at the same store sales over the last several years.
6% 2019, 1% 20 seem to present in 2017 can can you provide us with the moving parts to get to that 10% I'm eager for the core business.
Sure I meant there so our models actually at <unk> at at nine just vendor we rounded up so we looked at what you looked at and believe that are 2020 trend rate, what's pushing over 10% in regard to where we were at.
We also are finding the best practices within our traditional core network, it's starting to gain momentum and I'm sure Chris can share some of that information in the following questions, but we are seeing that best practices and behavioral shift within our traditional network is creating greater greater customer a track.
Action through more transparent and simple experiences within the traditional channel as well we thought it was still fairly conservative being that's what our run rate has really averaged out to be able to model that in and it's it's it's something that we're pretty confident that we're going to be able.
To be able to achieve we also believe that that we can achieve 60, <unk>, 5% SGN <unk> gross profit within the traditional channel enough for those that are new to this to the company.
We were achieving that pre growth so about 50% of our business.
We've acquired over the last.
Five to seven years and as as most of you know that the acquisitions are a lower performing highest DNA of around 85% and it usually takes five years for those parts of the network to season. So we are at steady state, we really believe that 65%.
SGN a is achievable.
For the for the month of June I believe we were at 57%, which is where are you know our benchmarks top stores really perform at and maybe provide the guiding light for us to be able to continue to find a leverage within our cost structure as well.
Okay, Great and then on me.
Hi, Wayside 9 billion by year.
As you walk us through some of the that the key drivers to getting to that 9 billion.
Sure. So I would say the fundamental opportunity is the ability to procure inventory.
And our company has shown the ability of procure inventory not only from trade, which about 50% of our vehicles come from trade and they generate approximately $1200 higher front end gross margin then vehicles purchase option options. We also get that new vehicle trade. So we believe the competitive advantage in terms.
As of cost can help us grow that portion of the business. We also model then Uh huh.
An additional $1000 per unit on top of the $300 traditional that we spend on marketing dollars.
That combined with the FDIC NFC m. through the my driveway portal, we believe gives us a massive cost advantage against competitors in regards to going to market. So if we need to buy market. We have not only the $1300 to be able to drive national branding or local branding, but we also have a lower.
Our cost the market for consumers to be able to compete in price.
As well as the for other business lines that create massive margins to be able to pipe in the battle ground of used vehicles, which we really believe that's where any battles are going to be fine because there really is no barriers to entry to used vehicles, whereas new vehicles and so.
Certified used vehicles serviced body in parts, where we play has massive barriers to entry because you have to buy a franchise. So we like how we built the model and we believed that our ability to grow is really based off that ability to compete and procure inventory.
Great. Thank you for taking the question.
You bet Armintas.
Our next question is from the line of Ryan Macdonald with Craig Hallum Capital. Please proceed with your question.
Good morning, and congrats on the strong profitability and also appreciate the additional detail on driveway and the medium term targets et cetera.
First want to start just on slide 11, you lay out kind of the targets for driveway and implies lower EBITDA margin, but better net margin a five year. So can you walk through the puts and takes.
Puts and takes of profitability.
Core legacy dealership business versus online.
Sure I I can give you a little bit of color on that so within the drive wave channel. We believe that as she in a can get below 60% I think we were at 50, 758% DNA in our model. Okay. The key driver in differentiation is isn't in the core model.
We.
Our primary costs and ask DNA is personnel costs at about $1600, a unit and within the derive way channel, we really have that going down to about a thousand dollars a unit or about a 600 dollar savings that is the primary cost difference within the model. Okay. We will have to re.
Ramp up in Internet sales center, which we've had in Medford for the last 10 years, or so but that team or ramp up on a negotiation free basis as well. So that is part of the replacement of some of the personnel costs. We also have the VC ease of the virtual centers of excellence in those three disciplines.
That takes some costs it will be paying our personnel in the field for the expertise plus paying the expertise to the non experiential knowledge in those vallese or that lower costs functions that customer facing to be able to achieve that leverage and those synergies within those channels. That's why.
Really the biggest difference on how we've thought about the logic and then there's some nuances in and marketing a little bit and obviously in terms of facility costs were only utilizing if you extrapolate out 24 hours of availability in your shop space or your service Department word currently use utilizing about 25% of our.
Capacity within our network, we're utilizing about 50% of our capacity in terms of storage for vehicle sales, Okay, and if you comp that again some of the competitors are axa physical network costs are running at about the same price per dollar of revenue than what our competitors are but if you look at it.
$1 per growth our cost for our network is much lower than the independent used car retailers.
That's helpful and then as it relates to driveway and then shift it's coming public spec merger. It's anything you can share on what your plans are for your full financial investment there and then any current and future operational partnerships going forward.
Sure. So driveway is entirely separate from shift a shift is a wonderful little company that we share best practices with we share a portion of our network within in on the <unk> five corridor and we look to continue with that partnership we loved what they've done and Dave.
Taught us a lot about what consumers are demanding and how to look at it and more pure sense I think it was three years ago, we began.
To reinvent ourselves and think about how we could be more things to more people and began to talk about that strategy of going to market wherever whenever and however, our consumers desire and I think ship was a big part of us understanding that purity of what consumers are looking for him that modernization wasn't an occurring at a faster rate.
It is we really needed that do it internally and I think we'll continue to be able to share those best practices and and the execution.
Of both organizations.
Great one more more for me and then I'll turn it over so very tight supply of new used vehicles going on right now how do you feel about your current inventory levels by category. I know you talked a lot about kinda trade ins and kind of high procure but how do you feel about your inventory today. Thanks.
Yeah, Hey, Ryan this is Chris good morning.
Right now I think from an inventory perspective on new Oh, we feel like we do have some pockets of inventory that a very tight.
We have certain inventory that we have plenty of and I think as you look at the production Thats coming down the pipeline with manufacturers that are really trying to keep up with the demand that we're seeing based on the shutdowns that they had due to coded we feel like we'll have more normalize new car inventories in kind of August September timeline.
But for the folks part we have the inventory that we need to meet consumer demand on the used car side, you know with the increases that we've seen.
Right now I guess, we said, we could never have enough inventory because.
The with the demand that we're seeing right now in our model, especially in that core and value auto product, which you know that's difficult to procure we're really working to make sure that we backfill the improvements that we're seeing especially in June with our new car used car sales up 19% and make sure that we have plenty of used vehicles moving past August because.
We are right now positioned well for July and we're seeing great trends and used car sales in July.
Great. Thanks, guys. Good luck.
Thanks Ryan.
Next question is in line of Fries yet.
JP Morgan So she is your question.
Hi, good morning, everyone.
Perhaps in the quarter and the launch just add a couple of follow ups from the previous questions.
You gave us the economics of dry rig going forward and well be SGN April five might look like but.
Just on the advertising side.
I mean, you're roughly at $250 per unit steady state you talked about 300 for dry rig.
I mean, you have use online digital gears no spending up upwards of 2000 1500 per unit.
And maybe how does how do investors get comfortable that you will need to.
Spend that much higher where your advertising expense might not need to move higher here in order to get that kind of growing because.
The 9 billion in five years, just seem pretty aggressive.
From a gateway perspective, so just curious as to how you manage that spending I'm sure sure Roger that that's a great question. So I, we might have got our wires cross just a little bit so we spend $300 in traditional advertising in our in our core business.
Weve throttled in our model the ability to add another thousand dollars per unit or $1300 a unit to be able to compete head to head with whoever we need to it that is in the model. Okay. So remember that the other thing to remember is our 5 million impressions that we currently have with our service by.
I'd in parts of customers annually.
We believe that the efficiency of our marketing because of the add code that we built which is basically a way to move that up page on search through impressions, which impressions are built off of the time people spend on your web sites. So the my driveway portal will reside under.
For the core traditional hundred 90 local brands as our customer portal. So the scheduling of appointments in service body in parts of the payments of service body in parts. The looking at your vehicle and that in the history of of your maintenance the pay.
Half of your vehicles, when you look to trade it our ability to communicate directly with the consumers is going to be done through that portal, which is all going to reside under dr. way dot com. Okay. So we believed that the efficiencies of our $1300 may have a two to three magnitude.
Improvement over what the efficiencies of other retailers may be because they're impressions are really only relative to those shopping or those ended up buying and if you think about when consumers by it's not very often okay and I think it's a key nuance on making sure that when.
You build a model you have to be able to pay for things that yield returns in perpetuity, rather than just by a market.
That's helpful and just in terms of.
The expenses or.
You've taken with regard to building out the platform you know just the I'd infrastructure and no related to that.
As most of that behind you or.
I I do we expect to lever up your answer this through this through this ramp up phase.
Sure sure Roger to being a traditional retailers moving into a new channel of digital Oh, we didn't really understand the ideas of capitalization of R&D and this type of things until a few months ago. So about 60% of our cost before we get to an editor of.
Stayed on our on our digital solutions is already spent going forward throughout the rest of 2020 as we finish out the MVP products of each of those different components.
We will be capitalizing a fairly good portion of it but you won't see impact in terms of SGN a because the organization is growing at a fast enough rate and maintains cost control through our operational savvy to be able to ensure that this is not a cash burn or cash drain going forward.
Got it. Thanks, that's helpful and really getting quarterly updates on revenue profit from dry made going forward or is this.
Moreover, I mean, I'm, just curious like isn't going to be a different segment or you're going to be intertwined with the overall company like how are you going to.
Give us like details here going forward.
It's a great question, Roger and I would say that at some point, we may break out the individual revenues of drive way.
But at this stage, we really look at the the 22% used car lift that we had free covered in the 23% post covert now as seeing the improvements that are coming through sharing of best practices as well as digital solutions. So it's hard to really.
Delineate at this stage, but we're going to do our best to transparently be able to portray what's occurring within both channels, Okay, and we'll work on that in the coming quarters to be able to share that we would also share. This with you in terms of new vehicle margins as well.
It's important to remember, though automotive new vehicle retailers show, a 5% to 6% margin on very high dollar revenue products.
We also make another 4.5% enough and I. So our actual margins on new vehicles are 10.5%, including F and I and the only way you get the F and I have to sell the vehicle. So for us as we think about modeling or we think about the strategy. There is a nuance that new.
Cars that have to grow as well because it is the catalyst to be able to drive all the downstream business of trade and certified service body in parts. So remember that as you think about the strategy. We also produced almost 16.5% a little more than 16.5% margins and used cars. When we include RF.
I am those products as well because the cars that Lithia motors procure and the model that we built for the last 25 years. It's all about zero to 20 year old vehicles that are hyper scarce, it's not cars that new entrance into the space or digital retailers that are looking to grow revenues can can.
Board to get because they're highly competitive you have to get those is downstream you have to have technicians and so on and so on to be able to do that just a little bit more color as to how you think about the aggregated model Raj it, but we understand and we will continue to try to provide you insights as to how.
How much each other three channels of core network growth and and drive way are producing over the long haul.
Got it sorry, just sorry, one last one of you gave some color on the inventory situation. It just how July was tracking any any quantification of.
Like how the volumes look like here for used at new and just just spots and service activity.
Ended the first three weeks here.
Sure sure Raj It I know, it's a it's a really it's a tough environment Theres No question and we had shared that we were really noticing that there was a direct tie in with the the shelter at home orders and then we noticed or after that that it was not just shelter on home.
But it was severity of outbreak where we are seeing a.
A little bit more severity across the country, where its broad spread. However, we are seeing similar trends in July to what we saw in June. Okay. I would also note that in service we were down 2% in June keep in mind that we did have two extra days, so as you're doing your modeling on.
On service, we had two extra days in June, which you can probably kick back another 8% or so into that service and we were really down probably 10% on a year over year monthly basis.
No that's super helpful. Thanks, Thanks, so much and good luck.
Thanks Roger.
Next question comes from Atlanta, Bret Jordan with Jefferies. Please she is your question.
Hey, good morning, guys.
One of the hybrid.
Could you talk a little bit about the a strategy on use sourcing I get sort of are you.
Buying all of your used inventory, where the system as opposed to the U.S manager at the dealership and maybe what you're seeing from a conversion rate. How many of your offers are being accepted by the seller.
So sure. So let me start by saying, we believe that used car procurement start with starts with heavy lifting okay that it's not something that you're going to be able to perfect. In AI, we procure about 8% of our product from the channel.
Direct from consumer Okay, because we're so far upstream we can procure more inventory by being more aggressive in terms of our valuations on trade ins and that is our primary focus now in terms of our AI. We are seeing good adhesion. So when we make offers on vehicles.
We're seeing about a 50% take rate okay. Once they get that offer okay and they can we can do that directly in their home or they bring it into our fulfillment network to be able to procure that we are only spending about $30000 in the Pittsburgh market to be able to procure those.
2000, sorry, $15000, a month to be able to procure those to we're spending about a 300 bucks a car to be able to procure so that gets ramped up about three weeks ago as we've launched the driveway brand in Pittsburgh, which will be one of our two or three launched market.
Okay, and if for those that have followed us the Pittsburgh market in barrel Dot com has been the shelter that we've been building that proprietary procurement technology. Okay. So the air early stages are good we are able to buy vehicles at a slight premium to what we're taking them and on.
Trade for but we are able to procure more vehicles through that channel I believe we moved from 6% to seven or 8%, it's still minimal remember 50% of our vehicles come off trade, but as we begin to push those same star growth rates up we'll have to be able to to procure more through either.
Hi, or networking with manheim or ADESA to be able to track those vehicles or going directly to the rental agencies, which is an easy way to procure as well.
Okay, and I guess I think you said, 80% of your current inventory will be posted on drive way when that when that is live or are you getting they're doing all of your physical product on that or will always be a subset.
Uh Huh, so 88% of our vehicles were intending to show on driveway. Okay. We also are a company that believes in growth powered by people and making decisions closest to the customer and Chris is Chris in our group leaders have spent a considerable amount of time prepping.
In the stores for the behavioral shift of their people not being involved with the sale other than as the valet, which is that the the lower experienced personnel that really just follow the word tracking that's provided on the workflow management systems. Okay. So it is a little bit different for them, but we build.
Leave that will have an 80% to 90% take rate on the stores because they do also have to commit to a seven day return policy. They have to commit the certain certification levels of 140 point inspections. They also need to commit to certain warranty guidelines plus they need to be part of the driveway network.
To be able to be last mile in terms of the logistics of their valet. So they have to train valleys to be able to do that but were way down the road on that and we're really pleased that the the behavioral shift pre cobot, we thought it might take us two to three years and there is why we had a three year rollout.
Built into our model.
But with Kobin coming into play the behavioral shift in our stores in that belief by store personnel that consumers are demanding something that is more convenient and more transmitter parent is creating incremental growth and used cars, even within our traditional network even pre full roll.
Allowed okay. So we are seeing some nice lift in that environment.
Okay, great. Thank you and then one housekeeping question you talked about cost reductions during a pandemic and.
And with some that would be permanent is year SGN a experience on the recovery that.
Consistent with what you were seeing earlier as far as ability to remit keep costs out as volumes come back.
Yeah. Good morning. This is Chris I mean, I think the whole a you know SDMA improvement that we saw in the quarter, you know, culminating with a 57% estimated gross in June as we talked about is really a testament to the variable cost structure that we have in our stores and then as our empowered jams and every single market based on what's happening with them.
Based on market demand.
Our really working to maximize revenue and gross to move as much volume as they can and obviously minimize the cost. So I think the level step that we saw as a result with some significant changes that we that we put in place as a result of the massive dropping in volume going into March and April It is just.
Being nimble and we are seeing that you know as at June 30 were about 20% down in overall headcount still from where we were in March and you know you're seeing a 6% drop in revenues. So.
In our stores are well aware that their largest any items personnel. The next one is advertising so managing those two levers as we move into a recovery and start to see new vehicles come back online parts and service come back online and continue to maintain the benefits that we have.
Our used car volumes right now is critical and as we move forward to target.
You know NSG native gross percentage close to 65%, which we've talked about for years I think it seems a lot more attainable in the near term.
Maybe a did last year, when we talked about it.
Great. Thank you.
Our next questions from the line as John Murphy with Bank of America. Please proceed with your question.
Hi, Good morning, guys I'm just did a first question on dry when I'm just curious what the automaker response has been because I mean in some ways. I mean, just this may seem to make a lot of sensing and seems to be agreed driver of growth, but it could be interpreted it is.
Sort of running into franchise.
Log sort of hurdles or potentially even to framework agreement hurdles on the new vehicle side, obviously that would be indicate necessary for user parts and service, but just curious if there's any kind of response.
Doesn't mean negatively from the automaker partners.
Hey, John This is Bryan again I think.
Our plans consider our framework agreements and the magnitude of those we have no intent to step over the national brands or world brands of our manufacturer partners that is number one it is key why the 190 currently local brands exist if.
When you do exist, we do intend to use the my drive way portal as a way to communicate with our consumers. Okay. We're fortunate that 70% of our manufacturers also allow the utilization of a national brand with in our branding or naming of our dealerships we don't have Intel.
To be did change all the names of our stores, we don't believe that that's crucial because ultimately the relationships that we have locally with our consumers it which is what drives the success of those stores. Okay. So we do think that there could be one or two of each brand.
And possibly some day one in each of the six regions that could also distribute new vehicles within those brands that except that okay, only 30% of our manufacturers have issues regarding.
Use of national brands and at some point, even those manufacturers.
Have relax those standards in the event that your network is built out.
Okay also keep in mind in terms of the six business lines.
New vehicles is only one component. We currently also sell certified vehicles as well as this service business, which is the top of that repaired chain, which allows us to capture the maintenance business for the life of ownership of that customer, okay, which are crucial element that.
Our usually not as big of issues with manufacturers, but we will obviously respect that while we still continue to build strength within those manufacture brands because ultimately it is about loyalty and retention within those partnerships with our brands and were pretty good at adding that that.
Value and I think most of our manufacturers really look at Lithia motors that accompany that added value for them as well. Okay. So everything that we plan on doing will add value to the partnership and not just be for adding value to drive where lithia.
Yes, I mean, it gets their minds sort of bans a little bit in the last downturn with the with it you know the allowance of that national branding by although the mass market not the Lux guys. So just sounds like your minds are pending a little bit more here, because your representing the brands well and servicing the customers wells I'm just curious if they if they.
Responded, saying Hey, listen this is great idea, we appreciate the partnership or not yet I'm. Just curious if there has been any OEM response, specifically on these efforts yet that you've heard.
Right John So we have heard from a one of the three brands that does not allow national branding and they've been very accommodating regarding using a slogan or a drive way experience under the name or in your marketing to be able.
It is still push that in home experience, which is the most important part that we're really trying to accomplish is to be able to go head to head with in trends that are providing and home solutions, whether it's you know it direct to consumer new vehicle manufacturer or new entrants into the used car space I would also say this manufacturers or pay.
Pretty comfortable that our inventories today reside on car gurus cars dot com and through CCAR. Okay. So that's already something that's out there so their perception of it could be more around of the idea that they're getting more exposure for their brands and we imagine that marketing.
It's pretty expansive and it's how bigger reach can you get and this is just one channel to be able to expand the reach of that inventory.
Okay. That's helpful. And then just on on the equity shelf the tenant.
Ill discuss I'm, just curious how much of that could be used to fund the M&A and key owners, maybe larger even smaller groups involved on on the equity side in participation like deals used to get done in the past anything is little bit less of that now, but it sounds like that may come back into Voguish, what you're working on so I mean.
There you are selling the Jewish it still participating and potential upside could these good that equity show kind of indicate that we're we're looking at that and it might not just be just to raise capital and pay somebody cash, but actually the pay.
Some groups in equity.
Hey, John this is Tina.
The equity South Pacific Fed move to be able to have that opportunistic you know.
<unk> out there for us as we think about how we want to execute on this growth plan and how we want to extend the business. He wanted to keep the optionality out there and.
Then we're looking at all of the different internal hurdle rate as we look at it and we will continue to be disciplined it is tied to how we continue to grow that business and wanted to be an accretive source of capital for us continuing to grow.
But that equity issuance Tina will be specific to a transaction or would that just beat you build I'm not just I don't need to be quite that way, but that would that BG. Just raise cash you have a war chest to go out make acquisitions need it just it just very muddied deals b.
It will just be very specific to an actual deal.
I think you follow our overall capital policy right I mean, if you think about where we spend most of our capital to deploy it as on acquisitions and we have to keep that balance.
Okay, and then just lastly on the front end gross is able to $4000 in the quarter, which is is really great and I think you mentioned in June there over 4400, which is quite fantastic and just curious.
What levels, you think or sustainable on this front end gross is going forward setting in the second quarter last year was 3600, which is very good team.
But you know over 4400 ingenious is fantastic any how much of that.
Just Justine Hubble and how much of that can you can you do you think you can control.
Yeah. Good morning, John This is Chris I think when you look at what's going on in the market right now, we're seeing like record incentives coming in from the Oems, which obviously help us for a down payment with consumers in the structure.
The right deal for customers, you're seeing historic interest rates, you're seeing the cash position of consumers a higher than it's ever been a lot of folks that were planning to do big vacations. This summer or deferring those vacations, which is giving them capital to put down into what we're seeing and some of the demand that we're seeing a new and used cars <unk>.
Nobody has never been higher our banks that went through the last recession understand that the risk of default on on the auto loans is very low and so I think all of those things have been really a catalyst for us to be able to.
With with lighter supply you know keep our margins high I'd like to say that will keep it as long as we can and if the market stays strong that's possible, but I think some of this is outside of our control and.
We're going to do what we can to hold the line on margins as long as possible.
Im sorry, one last always thinking on the USAT is the strength and used vehicle demand has been phenomenal is driven pricing up a strong volume up I'm, just curious who you're seeing there as you sort of through the income spectrum well, if there's anything sort of unique to the time in place that we're in right now I'm just trying to understand the sustainability, there and just how broad base.
You can hear anecdotes of.
$10000 or less vehicles being incredibly strong as people are trying to get off public transportation began limited supply of new vehicles. So just trying to understand.
That dynamic of that what appears to be very strong used vehicle demand across the spectrum is if you are seeing anything unique explains isn't how sustainable you think it will be.
Yeah, John It's Chris again, I mean, when you look at the quarter our value auto sales were down about 6% core product was up 5% in our CTO units were actually down 12% and so I.
I think the demand that we're seeing as William that core product, which we talked about for quite some time most difficult to go out and buy but we've had a heavy focus wade prior to coded on getting our stores empowered to run out and use the five channels now six channels to procure more used cars and try to mirror.
More of the national used to new ratio of 22.3 to one when we're sitting at one to one today. So I think if we can keep procuring vehicles, finding new channels to acquire more used cars.
Outside of just typical trades on new and used cars that we sell.
We think we can continue to generate a flywheel in these cars that that's going to continue to.
Grow for quite some time as indicated in some of the models that we laid out in the investor presentation.
Great. Thank you very much guys.
Thank you our final question John Your line is David Watson with Morningstar. Please proceed your question.
Thanks, Good morning.
First on the quarter is it fair to say all the big guests DNA improvement was primarily due to less headcount.
Yes, David Chris we saw in the quarter at 20% reduction and our personnel cost, but we actually saw 40% reduction in our AD spend as well so.
I'd say those two things that have typically been the main drivers divesting any kind of work hand in hand to bring down our estimated gross and much of that we hope to sustainable under the third quarter.
Okay and in terms of this was hyper growth plan laid out.
Your your net debt to adjusted Ebitdas is quite low where are you comfortable taking that for the right deal.
Hi, David This is Brian So we actually look at it so remember in the core we're only talking about high single digit growth, which is where we've been in terms of network development to purchasing of acquisitions. That's a lot of the lift of where it comes from which is something that we've done in the path.
Yes, and then when you move to the driveway channel, it's about procurement and really a growth rate similar to what new entrants into the used car space of experience, but we also have new vehicle revenues that can be pushed through the driveway channel as well as service and parts business. So I think as you keep if you think about that that's a lot of it.
DNA improvements are going to come from top line improvement. So we are looking at a 57% SGN a in the driveway channel and 65% in the core as well as the network growth channel.
Okay and on the <unk>.
I think the slide say three to 5 billion acquired revenue annually, you talked about 4 billion on the call say.
That's that's a huge number from what you guys have done even with the.
DCH I mean as is this coming more just from a huge quantities of deals relative to the past or also some much bigger targets 'cause. It just it doesn't seem is that many large really large groups out there, but you know the market way better than I do.
David I I see would I see what you're asking so let me let me jump back real quick and clarify you were asking about leverage not in terms of expenses in terms of balance sheet.
Our model is shows leverage between a low twos two as high as 3.0.
And we hit that in year three it assumes.
The capital need for about $900 million in terms of equity at some point when its constructive and it matches acquisitions.
So that is how we built that that keeps our our leverage intact everything else is from free cash flow generation within the model, which is massive as we begin to build that momentum in terms of size of acquisitions. This will be a combination of staple diet or value type.
Investing which now most of the organization and there's there's probably 20 to 30 people whether its general managers group leaders or corporate staff that are working on that level of acquisitions.
So that is always there we have mid size groups between 500 in a billion dollars in size and those things over a billion dollars in size, it's really a matter of our ability to constructively aggregate and find partners that believe in our strategy and believe in the network development and the ability.
To leverage the driveway brand name across the United States or possibly even someday in the future moving into other English speaking countries.
Okay. Thank you.
Thank you at this time I'll turn the floor back to Brian Divoire for closing remarks.
Thank you David Haye. Thank you everyone for joining us today, we hope that each and every one of you remain safe and we look forward to updating you again on our third quarter results in October and sharing other incremental information as we continue to roll out our strategies are driveway strategies over the the rest of this year.
Thank you. This will conclude today's conference disconnect. Your lines at this time. Thank you for your participation.