Q3 2022 Lithia & Driveway Earnings Call
Good morning, and welcome to the Lithia and driveway third quarter 2022 conference call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question and answer session I would now like to turn the call over to your host I met My wife Director of Investor Relations. Thank you you may begin.
Thank you with me today are Bryan Deboer, President and CEO , Chris Holzschuh, Executive Vice President and C O O.
Tina Miller, senior Vice President and CFO Chuck fleets.
Vice President of driveway finish 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 this we disclose these 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 <unk>.
Investors that lithia driveway dot com, highlighting our third quarter results with that I would like to turn the call over to Bryan Deboer, President and CEO . Thanks.
Thanks, Amit and good morning, everyone and we appreciate you joining us today.
We can look forward to updating you on our business growth and progress towards achieving our 2025 plan and beyond.
Earlier today, we reported third quarter results growing revenues by 18% to seven 3 billion from $6 2 billion in the third quarter of 2021.
Same store sales numbers were solid with total revenue increasing 4% new vehicles were up 1% used were up three 5% while service body and parts were up 10%.
This was driven by continued focus on operational excellence at our Lithia stores expansion of our ecommerce platform driveway.
Measured growth of Dfc and integration of stores acquired over the past year we.
We reported adjusted third quarter earnings per share of $11.08 adjusted for foreign currency EPS was $11.62 compared to $10 and 21 per diluted share in the same period of 2021.
Foreign currency was a negative headwind, reducing EPS by 54 cents.
Cyclical inflationary pressures tempering vehicle gross profit and SG&A, along with investments that drive land Dfc impacted results.
We're building an agile platform that combines our experienced knowledgeable workforce with our own inventory inefficiency of distributed physical network.
Our footprint has doubled over the past couple of years with diversification across products brands geographies and channels.
This is a competitive advantage that allows us to be a flexible retailer quickly responding to consumer preferences and market conditions.
Digital customer traffic across our platform was up 35% as we continue to make investments in our digital platforms.
The driveway and green cars provide industry, leading customer experiences and educate drivers on various transportation options, helping them find the right fit for their needs.
Gross profit per unit were mixed in the quarter.
New vehicle Gpus, including F&I were $8080 per unit compared to $82 44 last year, and 70 410, a year ago used vehicle Gpus, including F.
F&I were 44 96 down $452 from the 49 48 in the second quarter and 5097 of a year ago.
F&I per unit rose to nearly $2200.
Average price of new and used vehicles rose rose, 10% on average from the third quarter of a year ago.
Shifting to day supply at the end of September we reported new and used vehicles at 39, and 65 days up from 24, and 48 days from the third quarter of 'twenty one.
[noise] driveway closed out Q3, averaging over 2 million unique monthly visitors.
In the third quarter driveway retail than wholesale to over 10300 units contributing over $290 million or almost 4% of our total revenue.
Year to date driveway revenues have totaled more than $650 million. This accounts for both shop transactions and subsequent retail and wholesale transactions of sale transactions.
Year to date, we retailed over 30700 vehicles across lithium driveway e-commerce tools.
Congratulation to the driveway and Lithia teams on the progress we've made across our Omnichannel strategies.
Shifting to our captive finance arm driveway finance or Dfc during the third quarter, we originated over 17100 loans totaling $552 million.
At the end of September the total Dfc loan portfolio was over $1 6 billion and our outstanding receivables penetration.
Penetration rate was 11, 4% at the end of September check will be providing some additional color around dsc's growth performance in a moment.
Moving on to M&A, we had another busy quarter, our valuation discipline is paying off and our returns on invested capital continued to perform well year to date, we have acquired $3 1 billion in revenues and a total of $13 3 billion in annualized revenue since initiating our 2025.
Plan in the middle of 2020.
I think it's important that we highlight our consistent track record of acquiring stores, adding incremental value, which has translated into consistent returns throughout the business cycle.
We're well equipped and the market remains robust to continue this trend.
As the leader in the auto retailer space, our Optionality effectively leverages, our existing network and infrastructure during the quarter, we acquired a portfolio in Wisconsin from the Wild group the.
The stores are projected to generate 625 million in annualized revenues.
In October with the also acquired six locations in the Pacific Northwest with Airstream Adventures, the leading seller of air streams in the United States.
The outlook for M&A opportunities remains constructive stakes had been raised for retailers with shifts towards direct to consumer and omni channel commerce combined with liquidity constraints of sellers.
We are well positioned to capitalize on the many opportunities presented to us.
Stepping back for a moment I want to provide an update on our 2025 plan.
Despite some of the rebalancing taking place in the auto industry and cross currents in the macro economy. We're confident our strategy is durable and we have the necessary levers to achieve our $50 billion revenue target translating into $55 to $60 in EPS, our portfolio mix and.
Focus on profitability will set us up so $1 billion in revenue will generate $1.20 in EPS up from our historical level of a dollar in EPS.
The achievement of our 2025 plan will be driven by a few factors, let me take a moment to outline our strategy to hit these targets.
First we plan to accelerate the drive towards operational efficiency and leverage across our platform.
Margins will improve as we integrate retail stores with our online platform, reducing the friction and costs of purchasing vehicles.
Heading into 2023, we're taking proactive measures to rightsize, our cost structure at the stores and ecommerce divisions, while growing our credit portfolio.
We are prioritizing our profitability growth goals, rather than volume to breakeven in our ecommerce and captive finance divisions combined this will help drive SG&A as a percentage of gross profits towards 60%.
Enhance our liquidity and continued strong cash generation.
As a reminder, it was only a little more than two years ago. When we produced $12 billion in annual revenue, resulting in $12 in EPS.
Second we're targeting dfc to grow meaningfully out into 2025.
As we increase penetration towards 15% to 20%, we plan to manage our liquidity options and risk.
We've been gradually narrowing the credit risks in our portfolio and being tactful with pricing loans, given the large swings in interest rates.
As Dfc becomes a seasoned issuer of asset back securities. We accept expect spreads and see so reserves to normalize resulting in better economics and visibility and interest margins third we will continue to be the consolidator of choice within our sector. Our 2025 plan seeks to reach 90%.
5% of our customers within 100 miles and we believe this results in a targeted footprint of approximately 500 locations.
This will drive our market share towards two 5% and solidify our presence as the national auto retailer.
Additionally, our physical stores, we will continue integrating our ecommerce platforms driveway and green cars, ultimately leveraging our vast physical network, creating incremental revenue growth.
Fourth our financial discipline and structure is conservative in our capital allocation strategy is focused on the best risk reward for our shareholders. We have lowered the leverage on our balance sheet and do not require equity to fund our growth targets.
We continued to weigh investments that limit friction and have material upside over time, adding to our earnings.
We're maintaining our disciplined pre COVID-19 M&A hurdles and continue to balance this with buybacks to be responsive to any economic environment ahead.
We appreciate the support and feedback we get from our shareholders and maintain our approach we.
We will continue to balance our growth objectives with financial discipline with the goal of maintaining a low cost of capital.
The Lithia and driveways strategy is creating a diversified vehicle transportation network that provides amazing experience for our customers while utilizing the full breadth of our network. We have the right team in place to take advantage of dislocations in the market and we will continue to lead the transformation.
<unk> in our sector with that I'd like to turn the call over to Chuck.
Thank you, Brian we posted another strong quarter of Dfc as we continue to be the number one lender for lithium driveway our portfolio continued to grow at a healthy pace. Despite the shift in the lending markets.
In the third quarter Dfc realized a net interest margin of $17 3 million, which resulted in a pretax loss of $4 2 million at quarter end the portfolio had a weighted average contract yield of seven 8%, which continues to trend upward.
Recent changes in the macro capital market rate environment has driven our year to date average cost of funds to three 3% up approximately 150 basis points from last year.
Dft's penetration rates for the quarter increased to 11, 2% up from nine 7% in the prior quarter, which translates to $552 million and contracts originated in the second quarter. We raised our 2022 full year penetration rate target to 10% and we remain on track to achieve.
That rate, which will result in portfolio assets of approximately $2 billion by the end of 2022.
Over the past year, we have continued to execute our strategy of mitigating credit risk volatility primarily by increasing the FICO scores of our originations, which in the third quarter resulted in a weighted average FICO of 721.
Additionally, we have continued to reduce our loan to values on originations, which for the quarter were at 99% down from 105%. During the same period in 2021 today nearly half the loan portfolio is composed of FICO scores greater than 720.
DSC is reacting to increases in our cost of funds and continues to monitor and raised yields rates to mitigate spread compression.
Current and future rate increases could temper originations growth as we strive to maintain spread rates in a rising interest rate environment.
As expected loan provisions remain a headwind and continue to have a disproportionate impact on Dfc earnings in the near term totaling approximately $25 million year to date.
In the third quarter provisions as a percentage of managed receivables remained stable, averaging two 7% delinquency rates across the industry and for DSC increased in the quarter overall, but dfc did see a decline in September month over month Grace Dfc continues to track well, you'll owe our internal benchmark rates during.
In the quarter.
We continue to expand Dft's capital structure to ensure forward looking liquidity to support our continued growth.
We've increased the size of our short term conduit facilities and will look to increase the cadence and five of our ABS term issuances. In 2023. In addition, Dfc is nearing a point, where bifurcated as ABS term issuances into separate prime and non prime offerings may be feasible, which could result in a capital.
Structure that better aligns with our forward looking portfolio design increase.
Increasing both the size and diversity of the DSC capital structure will serve as a tailwind for lithium balance sheet and earnings growth.
Going into 2023, Dfc will focus our efforts away from accelerating originations grow to achieving a profitable return on the portfolio and improving free cash flow.
As Brian indicated earlier, we are reaffirming our guidance for the future state expectation the Dfc can add $650 million in earnings to lithium driveway again predicated on Dfc portfolio fully seasoning after maintaining a 20% penetration rate on lithia revenues at our 2025 planned levels of 50.
<unk>.
In closing DSC continues to monitor market rates and manage our credit risk, while growing and diversifying our capital structure we.
We are using a disciplined data driven approach to mitigate spread compression without moving down the credit risk curve consistent with our credit risk appetite, which should result in DSV, achieving its financial return goals with that ill now turn the call over to our CFO Tina Miller. Thank you.
You check in the third quarter, we reported adjusted EBITDA of $510 million down approximately 4% from the same period last year. This was primarily a result of our investments in <unk> and DSC and inflationary pressures point or a vehicle gross profit and SG&A line.
During Q3, <unk> advertising and personnel expense was $32 million up $22 million from last year as a percentage of gross profit SG&A was up 380 basis points to 59, 6%.
Year to date, we've generated nearly $930 million in free cash flows up 25% year over year shifting to capital allocation. Thus far in 2022 that has repurchased 225 million shares at a weighted average price of $282 per share during the quarter, we purchased an additional <unk>.
15315 shares at an average cost of $243 per share.
We currently have $77 million remaining for share repurchases, having repurchased seven 6% of our outstanding shares this year.
I want to take a moment to clarify on the direction of our capital allocation program. Overall, we remain comfortable with current strategy and allocations across M&A internal investments and balance towards shareholder return given the shifting macro environment. We have adjusted some of our focus towards improving our operational efficiency to offset some of the near term.
Headwinds facing our sector, namely higher interest rates and normalizing vehicle gross profit levels were proactively working to refine our cost structure in response to these trends with curbing discretionary spending and realigning compensation plan, given the likely GPU and volume decline in the months ahead, we think it's prudent to strengthen our liquidity and maintained.
Quality of our balance sheet.
We expect opportunities for M&A to remain strong we regularly assess the risk adjusted returns over time and compare them against opportunities across our portfolio for long term goal is to expand our market share to two 5% based on downside model scenarios. We are comfortable our business will generate free cash flows that support achievement of our <unk>.
125 plan.
Our omnichannel presence as a foundation to our international strategy, coupled with our captive finance arm.
Combined we think these levers give us plenty of optionality to reach $50 billion in revenue by the mid decade.
As we work through the normalization in our market, we will apply a conservative approach towards managing our buyback program the dynamics of higher interest rates and rising market risk premium could potentially weigh on the returns.
It used to generating an equity we have the experience and ability to expand our earnings and free cash flows over time.
In Q3, we continued with a conservative level of leverage leverage and current ratios rose marginally to one eight and $1 five times, respectively. This was a result of normalization trends in Gpus.
In conclusion, we're confident we have the right instruments and liquidity to work through the macroeconomic environment and shifting consumer dynamics underway balancing growth and returning capital to shareholders. Our key pillars towards achieving our 2025 plan of $50 to $60 and earnings per share.
This concludes our prepared remarks with that I'll turn the call over to the audience for questions operator.
Thank you at this time, we'll be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad it.
A confirmation tone will indicate your line is in the question queue. You May press star two if you'd like to remove your question from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys, one moment, please while we poll for questions.
Our first question comes from Daniel Merrill with Stephens. Please proceed with your question.
Hi, guys. This is Joe <unk> on for Daniel.
Hi, Joe.
So you noted driveway finance penetration was 11, 4% at the end of September while the end of June penetration was 12, 9%.
I'm just wondering if these last three months change how you're thinking about desired penetration next year or at least the cadence as delinquencies are increasing.
Thank you Jeff for your question this is Chuck.
Our current sort of viewpoint on penetration is in light of the current economic environment, we wanted to sort of stay in that 10% to 15% range and feel pretty comfortable with that as we continue to derisk. The portfolio. However, looking forward to next year, we still believe that that 15% to 20% range is still our target that we have.
Could achieve in 2023.
Got it. Thank you that's super helpful. As a follow up just wondering sourcing vehicles has gotten more challenging as wholesale prices are depreciating.
I was wondering if you're still sourcing the same amount from consumers or if your activity in the auction lanes is picked up at all.
Yeah.
Hi, Joe This is Brian we were up a little bit in the auction lanes I think he moved from 13% to about 16% of our of our inventory mix was procured from auctions.
Our main source of inventory procurement as we all know is from our consumers and that dropped from I believe 75 at a peak to around 74% of our total inventory procurement.
Great that is all for us. Thank you guys.
Thanks, Joe.
Our next question comes from John Murphy with Bank of America. Please proceed with your question.
Hi, good morning, guys.
Has there been any sort of anecdotal stories of demand weakness in new and used but because supply is so tight it's really kind of tough to gauge how true those are.
What's exactly going on Brian .
Look at your stores, both on the new and used side.
From ops or showroom traffic and what Youre seeing on your driveway.
Traffic.
What is your take on the general state of the consumer and demand for new and used vehicles at the moment.
Good question John .
I think most importantly, the demand and lookers is big were up 35% and our digital traffic as a whole year over year, which is a big number. Unfortunately, the inventory doesn't match that and we're really sitting at a point on new vehicles that we're really we don't have the bigger backlogs.
We used to have its really more of a just in time inventory today, but we are starting to see some manufacturers are mainly the domestics that are starting to have a better inventories are where were our domestics were up almost 10% in unit sales for the quarter year over year, which is a.
Pretty pretty good number and the Koreans that we mentioned had pretty good supply as well were up a couple percentage points. So all in all in new vehicles, we're starting to see.
The inventory is starting to loosen a little bit.
We also as I noted you know our our Gpus were down about $164, an unused which is the first in a few quarters. So we should see that us to start to subside as well on used vehicles I think it's important to note, where we're basically back to pre COVID-19 level.
Front end margins are vehicle margins, okay, but the real win on both the items is that F&I is still remaining strong we're not seeing weakness in fact in the quarter. We were up almost $100 per unit, which is a nice number that helps offset some of the you know that.
The declines in Gpus, and obviously the big thing is as is as that inventory begins to loosen up we think that theyre starting to we're starting to see some correlation between you know those drop in Gpus with inventory loosening and hopefully.
Volume increases as well.
Okay. That's helpful. And then just a second question Bryan as you think about stress testing your model go forward.
And not using a specific year, but I mean, just thinking about.
Sort of the downside risks in the model.
Not a lot of room.
On new vehicle unit volume as you just kind of alluded inventories is tight and we are already a recession level volumes, but how do you think about stress testing your model and <unk>.
If you would venture a guess on what sort of downside EPS could be or if there is that much downside.
Open ended question, but if you could maybe frame up how you're thinking about it and maybe even sure. John I think we are at Lithia and driveway tend to play.
The long game and look take a longer view of things and look at that what we're seeing over the next few quarters as there is a more normalization of Gpus.
That it's just a short term part of the game and we do know that our original design was basically built on the fact that we are a lower margin business with a little bit higher SG&A costs and a lot of businesses and you know.
Our 2025 plan is there to redesign things and now we're going into a little bit more volatile environment, where we have a few more balls to juggle, but ultimately the outcome of what we've designed with with driveway financial with driveway Dot com that can obviously have lower SG&A costs and a traditional busy.
<unk>.
The other businesses that we're thinking about are there to really help relieve some of the stresses of a low margin business now that doesn't really answer your question of what happens over the next few quarters I think that's where our operational expertise is quite good.
And that and that's where our ability to navigate through different type of environments is where where we seem to shine you know and I think you know our ability to do that is going to help drive us towards that $55 to $60 in EPS by 2025, and I think though we've you know we breached.
That probably the $40 in EPS target that was caused by market conditions that I believe werent expected in our original 2025 plan that was announced two and a half years ago. Okay that wasn't contemplated I mean, what we have built for is a five year plan that can achieve that 55.
$60 in EPS or about $1 20.
Of EPS production for every billion dollars of revenue with the steady state future goal to get to $2 of EPS for every billion dollars of revenue and I think that's maybe.
Maybe a little different way to look at it but you know on a quarter over quarter basis, that's not really the game that we're playing even though we are experts at managing through the dynamics of current market conditions.
Okay, and then just lastly, I mean, you are generating a lot of capital reallocating to growing the network.
Historically Oems have been sort of roadblocks, but now it seems like they are receptive to you building out this network and even almost encouraging you to in some ways I am just curious if you can characterize sort of that relationship to the automakers and how receptive or <unk>.
Encouraging they are to you to build out the <unk>.
Network and how that's changed over time.
Sure John I think it's important to remember that we really haven't ever took our foot off the accelerator in terms of growth and it's primarily because our relationships with our manufacturers are the key foundation of how we built things basically grow market share and earn the loyalty of the customers for the long term and that creates an environment.
<unk>, where the manufacturers are supportive and I think I think most retailers have times, where there are <unk>.
<unk> and not but most of the time, we're approvable with almost every manufacturer meaning that we're usually there. When there is a group that has a mix of franchises that we're able to buy and others typically arent and as we noted in the prepared remarks, I mean, we've done $3 $1 billion, thus far this year and that's.
Coming off the back of a $6 $7 billion.
Year in M&A and you know the year before that was $3 seven and then we had a little bit of a pause a year before that as we were in our design theory, and really building out our digital strategies and encoding all those great products for our driveway finance driveway dot com and green cars.
Okay, great. Thank you very much.
John .
Our next question comes from Ryan signal with Craig Hallum Capital. Please proceed with your question.
Good morning, Thanks for taking my questions.
Hi, Ryan.
I want to start on used inventory.
So current composition of kind.
Kind of the core value versus CPO that you have and where youre seeing the biggest pricing or margin risk kind of as you look out currently and then over the next several months.
Okay.
Let me just get this Chris wants to jump in you got that yeah. I don't think we've seen any major changes right. Now this is Chris on what our composition looks like I would say that one of the big benefits that we have having kind of this omnichannel environment, especially with driveway is about 10% of the used vehicles that we have in stock right now came.
From a channel that we didn't have previously and so I think we continue to work the multiple channels that we have weather, obviously trade ins are huge being top of funnel as a new car dealer and having the opportunity to be first in line for any trades that are coming in in a more difficult environment and then after that using the <unk>.
Traditional secondary sources, but the third source now driveway being 10% of our inventory.
Knock the cells. It's used so we'll continue to work that up going going forward.
Yes.
Yeah, more or less I guess, what are you seeing.
I get the structural advantages you guys have been procuring curious in the inventory you have where you skew more to value in core versus others that skew more to CPO and kind of those newer late model lower mileage vehicles, where you're seeing more of the pricing pressure and more of the margin pressure given the current dynamics with the consumer.
Today.
Yeah, no not a major shift in overall value auto is its about 10 or 20% of our used inventory today I think that generally speaking just because of asps and where pricing has been all of those stats are up at a higher ASP and inventory carrying costs and they've been historically.
But again I was carrying a 60 day supply of inventory means that we have already returned through 25% of the inventory we were carrying it at quarter end and so.
I think the dynamics in and the sources Hasnt changed and then the dynamics and what we have.
In carrying costs and inventory pricing is going to continue to fall as the market adjusts Chris Thanks for giving me a little breather, Hey, one other thing just to add to what Chris said on a positive note our value inventory, which is probably the least exposure to market swings because they are lower priced and are typically the highest scarcity. Okay.
It's up about 16%.
And day supply or in our total mix of what we are which is a real positive sign and I think you know.
On the opposite side is you have your CPO, which is probably the most volatile as new car inventories return to some level of normality and you know it.
As manufacturers begin to think about how to incentivize you know over oversupply in those type of things in the coming quarters.
Thanks.
What I was getting at.
One more for me just as you think about capital allocation M&A opportunity. How do you think about dealership expansion, which I know is a priority but is there also an opportunity to acquire technology and how it's more in that regard.
A great question Ryan.
I mean, we obviously are focused on the network growth, both domestically and internationally, but I think as we begin to think about the different verticals and horizontals that are built into our design thesis the idea of sharing data across the different adjacencies is quite important to us. So when we begin to think about.
Our growth and our ability to whether we whether we buy or whether we build I think there's a there's a good argument to be made that we could you know look at CRM systems, or possibly Dms systems of those type of things to glu things together, a lot cleaner and to be able to share data on both customer platforms and other stuff too.
To really maximize the experiences throughout the lifecycle of the consumer and I think where we're really at the forefront of that knowing that we do know how to build things already okay. We got 140 engineers are so on staff and know that their abilities are quite high and it's really <unk>.
The steps of what are the most important and critical things to be able to do that and you know referring back to M&A. There may be a chance that we could we could find parts of that at some point or maybe a holistic approach that could help accelerate our growth and really maximize the design value that we have that.
We're creating.
Great. Thanks, Bryan Chris.
Thanks Ryan.
Our next question is from Rajat Gupta with Jpmorgan. Please proceed with your question.
Hi, good morning, Thanks for taking the question maybe.
Maybe just wanted to follow up on <unk>.
John's question earlier.
You know if the economy does slide into recession used car demand has already slowed down considerably.
Maybe you guys demand does not improve from current levels.
In a scenario, where new vehicle Saar is closer to say 13, $30 5 million and Gpus and normalize.
Would there be any boundaries you would draw on your earnings power.
Is there a trough level of EPS in <unk>.
<unk> should keep in mind or any any any boundaries or any other metrics that you could help us think about maybe SG&A to gross or for parts and services. We recognize that you can help us think about.
And argue like maybe just reset expectations for next year and I have a follow up.
Sure sure Roger I think the way that we look at 2023, we really believed that because of the pent up inventory that we're really looking at the environment. Most likely scenario is about a 3% to 5% increase in both new and used Saar levels, Okay, which is <unk>.
Gonna put gender little over $14 million and a little over $42 million unused and really basing our expectations on that now when you begin to stress tests like you're indicating if gpus drop and we sit at a 13 to 13, 5% I think that's where the expertise of Lithia motors is there.
Air and it it doesn't change how we think about the world. Okay. Because ultimately we know where we're going very clearly in our.
Blip for a quarter or two we know that the demand and the other the other macro drivers.
Mobility are there I mean peoples average cars or more aged and they were pre COVID-19 by about 18 months. Okay. We know that the affordability of cars has went up dramatically and most likely the decon tenting of cars are going to come into play and there's a lot of other moving parts that I think.
You know we try to focus on the things that we can control and I and I and I'd love to be able to tell you that it's X EPS level on X revenue.
I just know that I believe that we're leaning more towards a positive saar increase rather than a negative and I think beyond that I think gpus will subside probably by mid year.
It may be a little bumpy getting there, okay and that's important.
Okay, F&I, we're going to hope it stays strong I mean, it is the anomaly thats out there and it has it has.
We carved what what the profit profile looks like in <unk>.
And obviously, we're going to do the best that we can in terms of managing SG&A and that's something that Chris and our operational teams are quite savvy and Tina and our support teams here here in Medford and throughout the country are quite savvy on and we're going to deploy our resources in the best way possible no matter what the market.
You know delivers us.
Maybe just as a follow up on the SG&A.
Chief people officer, how are you thinking about.
The composition.
And compensation at a store level going forward or do you expect that to change.
I mentioned that you're already starting to proactively.
You'll make some changes.
Just in light of the macro.
Just if you could elaborate a little bit more on that and what's going on.
How should.
Our store level will look like going forward, which is the way in which we pandemic.
And maybe if you could tie that in June into any boundaries around SG&A to gross as well that would be helpful. Thanks.
Sure Raj I'd love to do that maybe that'll help put your put the parts together a little better for you too.
We're so glad to have a.
Gary Glandon also joined our team a couple of years ago and be able to grow into that chief people officer, and really guide our future because as everyone knows our mission is growth powered by people and <unk>.
Gary understands our culture and you know the ability that we lead people to things that no one could imagine could be accomplished and it's a fun time for him. When we think back about the SG&A of the stores I think it's important to remember going into the recession, we were in the high 60 percentile range.
We did have some constructive cuts in personnel our personnel makes up about two thirds of our SG&A cost, okay, and that's primarily a variable departments. The sales departments personnel costs because remember in service that's a cost of labor. So there's another part of our personnel costs that are in.
The cost of labor, Okay. Ultimately the 300 basis points was cut out of that okay, but we also know that there's many other synergies that we've worked on today. So I think I think.
Once.
Level of GPU levels normalize to some extent and we can all guess as to what that may be and what the impacts are on F&I I think we're looking at somewhere between a 61% and 64% SG&A as a percentage of gross add.
At a normalized level and Chris did some really cool work a few days ago on our spreads on stores, we have stores in our top our top one top 10% of size of stores have a fair amount lower SG&A costs and what.
Our smallest stores have and it's something that we've come to realize over the last three years of growth buying bigger stores, but those top 10% have around 43% SG&A as a percentage of growth and a normalized times. It looks like it's a sub 50% and this is before we even begin to think about.
Overlaying, the Horizontals and the efforts that Dfc and Chuck are participating which is an additional 20% profit which is about an 800 basis point reduction in SG&A, okay to compare and contrast on the other side of the spectrum. So the smallest 10% of stores have about 75% SG&A as a percentage.
Gross okay overlay the the Dfc efforts overlay some of the other horizontals hopefully the E Commerce a.
Leverage that we get from our inventory our people and our network and you get to some really really nice numbers long term and you know that hopefully gives you a little bit better perspective on on where we're going in the future long term Raj that I think we've said.
We're really looking we believe that in the design that we've developed and the execution of the strategy and normalized state you're talking about the entire company being sub 50% levels. Okay sub 50% SG&A as a percentage of growth now that future state has to be steady state and we don't have the drags of seasonal reserves and D.
S C or burn rates and drive layer the other things in the economy that are occurring.
Got it.
Helpful color, Thanks, and good luck.
Sure. Thanks Roger.
Our next question comes from Ali Farquhar with Guggenheim Partners. Please proceed with your question.
Good morning, and thanks for taking my questions.
My first question is on the SG&A to gross profit it's great to hear you can keep it in the low 60% range, even in a normal GPU environment. That's a big improvement from where you were pre Covid I guess, what gives you confidence that these cost cuts are actually structural and won't be competed away. It seems like a lot of it is driven by head count reductions over the.
Last few years, but we're also in a very constrained supply environment with strong demand I guess, what gives you confidence those head count and those costs don't need to come back and what would be a more normal supply demand backdrop.
I think I think that's that's fair insights Ali I mean, we are facing some inflation inflationary pressures that obviously affect salaries as well, but we're pretty confident that the way that we've designed both our back and ecommerce solutions in the way that we're thinking about store operations in the future where we.
Got general managers, you know hopefully running a couple of different stores, Okay, and then spreading those costs and doing the same thing with a simplified consumer model the ability for us to have to negotiate hopefully take some of the complexities out of the model that we think we think over time that is.
It's going to be a simpler model and our ability to have higher productivity in each person. So they can maintain and grow their inventories while the organization still realize benefits in SG&A is an important part of the entire design that we've developed so we're pretty confident that that those are realistic numbers, even with Doj.
<unk>, having some drag for the next few years and I think it's important to remember I mean, we did clean up our network, Okay, and even though you know it may look like our revenues were a little bit off we did sell almost $450 million in revenue and the stores that we sold even in.
Covid based environment, we're pushing 80% SG&A as a percentage of growth. So we had some fat in the model even way back seven eight years ago that we're more efficient now we're more.
We optimize our network a lot better and we find partners that are able to help drive those numbers closer to those bigger store numbers, rather than a smaller store numbers.
Thanks, Brian that that's very helpful color I guess my next question, but unused GPU, it's almost back to 2019 levels, which makes sense since we're no longer in an appreciating used car pricing environment. So I think it was fair to assume your spreads.
I should go back to normal there on the used car side, but what's the risk as used car pricing starts declined more meaningfully in coming quarters that used GPU could overshoot to the downside and perhaps go below 2019 levels for a period of time.
Again, I mean, that's that's.
It's obviously, a likelihood I don't think anyone's ever seen a graph that has a spike in when it comes back it stops at the average level. So I think we're contemplating that on both the new and used car sides.
Think the advantage in our design over many of the used car retailers that really don't have the ability to absorb this equity because I think what we're all saying is at some point, there's going to be a greater amount of this equity in a portion of the consumers now sitting at around a quarter of the consumers have transacted over the last.
Three years that that that this equity is going to push people into new car dealerships, which is a massive advantage and you may ask why but if you remember that this equity has to be absorbed.
In the financing or offset by cash down in today and for the last year or so we've really been in an environment, where the dis equity has been offset by the true cash down and then normalized times.
That's not what's happened pre COVID-19 and normalized times the average consumer about 71% of them had this equity in average this equity of $5100 and only $800 of peer cash down meaning 30. Some hundred dollars has to be transposed into the loan the new loan. Okay. We're sitting you know four or five months.
Go where the average consumer had $2500 down in $2500. This equity they can sell the car to whoever they want and walk into any dealership and buy whatever they want today and in the future in the coming quarters that additional equity. It means they've got to find cars that have more margin to absorb there just equity and that moves you.
Really to new cars that are more of a staple diet not high demand carve. It eventually will have incentives again on them to absorb that this equity. So we like that environment and remember that with you really sell zero to 20 year old cars that zero is there for a lot of this equity in the 20 year old cars or those scared.
Scarce cars that of people that typically.
Have a greater chance of paying full cash or have quite good credit because those cars are sold for substantially over over over atvs or valuations or or Kelley Blue book.
That's helpful, Brian and I guess my my last question here, if I. If you don't mind just on the 2025 target up 55% to $60 of Etfs. It it's great to see that you're reiterating that target, but how did the building blocks changed I'm asking because I think roughly about $10 of that EPS was supposed to come from driveway.
Still have confidence that that's the appropriate target or is the expectation.
That's odd that the building blocks are changed from off from your prior view.
Yeah, I think that when we gave those goals. We're obviously looking out five years and that can be a cloudy crystal ball.
We are reiterating the overall numbers I think you're right there could be some adjustment in terms of where the EPS comes from and definitely where the revenue comes from I think it is important to us, especially knowing where the capital positions with some of the E. Commerce retailers are sitting that we may be.
One of the only people standing at the end and now it's more about proving profitability in a quick manner. Okay. So we probably will turn our attentions to reaching profitability and I think it is still possible to reach profitability by the end of 2024, and then hopefully have a profitable year in 2025 and <unk>.
Most of our metrics are there even though there is a lot of heavy lifting that will come from from Carol Deacon, our senior Vice President that leads our driveway efforts and all the other efforts that we're working to and obviously, we're probably still a touch conservative on the Dfc side in terms of what its.
<unk> could be ultimately, but again, there's capital constraints in the ABS market and those other things that we have to we have to massage and work our way through and I think that's what my management team and I are experts at and though it may seem complex to us. It's just another day at the office.
Thanks, Brian appreciate all that color.
Thanks, Sally good insight.
Our next question is from Colin Langan with Wells Fargo. Please proceed with your question.
Oh, great. Thanks for taking my questions. Just wanted to follow up you mentioned that you thought Saar would rise in a recessionary environment, but I guess I think investors are struggling with inventory did tick up I think you reported about 15 days.
And your volumes look fairly flat quarter over quarter.
So why haven't we seen with the inventory uptick.
<unk> sort of in the near term a volume increase measurement with that and then also I think last quarter. You gave some helpful numbers on pre salt have you seen a decline in the percent of inventory that's pre sold as well.
Okay.
Hi, This is Bryan again, I think we have seen that because last quarter you remember the whole sector was down in same store unit sales.
Between 25 and 27% Okay. This quarter, we're looking at.
New vehicles.
Down where what do I got isn't down 6%, 7%.
Got it new units.
Okay.
I think it's I think it's high single digits. So it's a pretty it's a pretty long downturn downturn, that's a 17% quarter over quarter sequentially improvement. So I think we are beginning to see that and I think by year end, we're going to see some recovery.
I think remember that a 13 five SAR level is depressed by almost 20%. So you know that that is in itself a recessionary level and if there is a relaxation in pricing I believe that consumers there's enough pent up demand of people that are sitting on the offensive because they were.
Aren't they can't rationalize the idea of paying MSRP for a car that I think that will be a tailwind for us in the future.
Okay.
You also just bring up the 10, 5% sort of same store unit decline.
That is worse than the market I think mark is only down 1%.
Why the large delta.
Of underperformance this quarter as brand mix geographic mix.
Five or something.
Collyn its partially mix, but the market is down more than 10, and I look at your retail numbers as well. So we're down we're up 10% in domestic were off 18% an important and remember we were up two 3% and the and the Korean imports, okay, which means that the Japanese imports are the ones that are off the most.
We were off 10% in luxury.
Okay, So youre, saying retail was.
The retail market was.
Worse than the overall market.
But the industry you can you can probably pull those numbers and take a peek at it okay. Okay.
Okay and then just lastly, you mentioned in a recession F&I. It you said F&I is holding up I mean, how should we think about that in a recession, because I mean, I imagine with interest rates rising customers may start screw.
Scrutinizing, the payment and that sort of slides in there.
You haven't seen any evidence at all or should we kind of anticipate maybe that softened.
Yeah.
Would say call. It I mean, it's important to us to be fair to our consumers, but I also know that when theres volatility uncertainty it usually creates gap in expectations and we're usually able to capitalize on that and I think that's what's really happening. There is such change that people are looking at the opportunity and we're still holding our.
About 2200, I do believe it's if it's a more prolonged recession that I think are normalized level is probably around $800, okay, and whether we get back there next year or the following year.
We ultimately know that Dfc once the seasonal reserves start to you know.
<unk> the spreads on our interest at DSC, it's a massive impact because we know that we made three times the $500 that we currently get from our third party lenders, we make about three times that over the life of the loan okay. When we control the contract ourselves through Dfc. So we will have pretty.
Good tailwind at some point once the growth rates on DSD and don't outrun. The you know the.
This spreads like they are today still.
Okay, all right. Thanks for taking my question.
You bet. Thanks.
Our next question is from Bret Jordan with Jefferies. Please proceed with your question Hey, Good morning, guys.
Right.
Nevada half a dozen RV dealerships recently is that change in strategy at all and how are the valuations on RV dealerships versus automotive.
Yeah Yeah.
Good I think it's really a beta test and we've obviously talked about the idea of all different mobility channels.
Hey, it's here it takes little effort, because it's based out of Portland, its with the best RV manufacturer with the mode with the greatest level of <unk>, It's a really low cost investment in Ted's a wonderful asset that is a dynamic leader that can help us paint pictures of what you know.
Three to five years from now could really look like some of it is just to help our teams understand how to digest this but ultimately these RV.
And many of the other mobility industries are run by car people are or are the same basic model. It was a very small investment and like I said, it's it's an Oregon based company that.
<unk> almost a fifth of all of all are streamed in the country, which is quite a special business in it it has an up fitting business where he modifies.
Eric streams, which are already pretty darn cool with these great captain shares in different types of things and we all know that the world is moved a little bit more domestic in terms of travel and.
The RV space, though it has been cyclical over the decades.
I believe and I think our team believes that the.
The volatility may be a little less impactful than normal because people are spending more time out in the out in the woods and on the roads of America to to create a difference, but again very small focus for the company relative to what we're doing and no real initiative to grow that business other than to.
Really get a feel for what some of these other mobility verticals could look like.
And then a quick follow up on F&I, I guess, given what the FTC's proposing as far as restricting some of the product sales do you see that as something we should worry about or are those products that you werent typically including an F&I transactions in the first place.
Yeah, Brett I think that one thing that we've learned is that transparency in our F&I products is an important part and if certain products are are are eliminated there's usually other products that will be out there in the future for hybrids are for electric.
Calls, where we reconditioning cars or most importantly, we really believe that F&I becomes the conduit for subscription services that help create a bond with the consumer that's in home or that's a more convenient experience than what theyre looking for a coming into dealership and you know whatever happens.
With the CFPB for US you know, we're pretty nimble at at being able to adjust and we will again adjust accordingly, depending on what their final determinations are I think the big keys are always treat everyone fairly in and make sure that we provide them value in what they're looking for in a transparent.
Arent environment.
Great. Thank you.
Thanks Brent.
Yeah.
Our next question comes from Adam Jonas with Morgan Stanley . Please proceed with your question.
Hey, everybody. Thanks.
Hey, Brian So my question on the <unk>.
S. CFPB was taken so I'll just have a couple of quick ones for you.
Have you had the chance or have you made any changes to your loss reserves.
Either on new deals or have you made any true ups to existing deals. That's my first question I just got a brief follow up I'll, let Chuck take that real quick yes, Adam Thanks for your question.
We're definitely looking at our provisions, but they stayed constant at two 7% this quarter relative to the percentage of the total assets under management.
Obviously monitoring that very closely.
Right now I would say, we feel pretty comfortable that thats, the correct amount, but obviously if market conditions continue to deteriorate will certainly increase provisions accordingly.
<unk> done a nice job.
If you remember Adam we're up we're up almost 30 basis points and FICO scores are 30, FICO score points and our average LTV is down a pretty good amount. So he he stayed in front of it as best as possible.
Agreed agreed and just last one that you were asked earlier about the preorder ratio I think last quarter, you said for new.
Oh, it was used to be 50%, but I believe last quarter was about 30%, 30%, yes exactly.
What is that what's that doing that what is that now which are trending to.
So I made the comment earlier that we're really at adjustment time inventory, but we still have okay. So those high demand vehicles like Broncos in Wranglers and Tacoma is in those vehicles that still have big backlogs. Okay. But we're also now in an environment, where there are free flow and we have a pretty good day supply in many of the domestic products that arent as.
Higher demand.
Okay, we'll follow up after thank you so much thanks Adam.
Our next question comes from David Whiston with Morningstar. Please proceed with your question.
Yeah.
Thanks, Good morning.
Just curious on the M&A environment. If you were to go into Europe , and particularly the U K, we've got very strong dollar, but a lot of macro turmoil over there and I know you are probably more thinking on the long term. So perhaps it's a good time to be maybe a value investor in the UK, but at the same time or you would said more wanting to wait for more stability there.
Yeah, David I think I think when we think about western Europe I think that there are some pretty good read throughs that we're not getting at the front level that you know that two of our competitors are able to get in that group, one and N. Pag that there is some things happening there and those are positive consumer experiences.
There may be read throughs, a decade or so from now as to what that looks like in the United States.
Those western European business, typically have traded at a lot lower multiples than what they trade at.
Dealerships trade out of the United States.
If we can find the right team because of the strong value of the dollar it seems like it's a good time to be able to do that and I know there was some alleged rumors of us working on a project over there and I think we were pretty clear on that.
That was us it was talking about it it wasn't just about the raw dealership assets. It was about the raw dealerships assets as well as some fleet and leasing type of exposure that helps open up a new horizontal and probably most importantly that the ability that they that they may have a dms system, that's that's pretty sad.
Avi and May help us with our $110 million annual cost of our Dms stack today. Okay. That's that's that's a big amount of we can save half of that $50 million or you know of.
A couple of dollars a share so at $50 billion in revenue you can double that so theres, some pretty constructive things that we're looking at but we do believe that a.
Western Europe can give us some pretty good insights into maybe what a a more efficient model can look like and maybe what a what a more streamline consumer experience could look like.
Okay. Thanks for that and then just shifting gears over to omni channel and pure digital transactions.
Over the past 18 months or so have you seen consumers or perhaps more willing to skip the test lives than in the past.
That's a good question I do believe that the world and I don't have the data right here with me, but I do believe that there is becoming a greater portion of the consumers that are getting more comfortable with the idea of a vehicle being delivered to home and I E not having to test drive a car so.
I mean, we're doing pretty good at that we sold 30 30700 vehicles.
Through driveway and our other digital experiences, which a lot of those are without test drives okay, but we also know that there's pockets, where there's strength and comfort with transacting in home and then theres pockets that people arent comfortable with it and I think you know.
Lot of the E. Commerce retailers are the early adopters did help change that environment, which is really really cool and it makes it easier for us and driveway and green cars to be able to penetrate the market a little bit easier you know I think the other thing that helps is we all have a seven day type of return where if the consumer isn't happy.
With it and they do take their first test drive when they own it they want to bring the car back and we take the car back no questions asking keep it quite simple that way.
You mentioned there are some areas where people don't necessarily want to go online or is there a particular area you were talking about a particular customer demographic or.
We noticed early on and we had this basic thesis that Arizona, and Georgia, and some of the southeast where one of the Big E. Commerce retailers began their presence and had been in in a longer period of time had a greater portion of customer.
And it was really in that in that southeast and a little bit of the southwest where we saw a little bit softer underbelly for consumers' propensity to want to be able to transact that way and you know it just takes less marketing dollars to push the market you don't have to explain the story you don't have to sell the guarantees quite as hard.
That's what you do in the in the Snowbelt, where we're really the e-commerce in home experience hasnt quite been as prevalent.
Okay. Thank you very much.
Thanks, David.
Our final question comes from the line of Lee Cooperman with Omega family Office. Please proceed with your question Hey, the opportunity.
And then it'll be cyclical business, which you are obviously in a cyclical business is the concept of peak earnings trough earnings and normalized earnings.
What do you view, what do you view as your trough earnings.
And offline okay.
We get we get to talk Tomorrow morning, right, Yeah, all right.
Forget issue question an open line.
You bet.
So you have a view of your trough earnings.
Yeah.
We'll take it offline.
Offline okay.
And secondly, you obviously you got to be very disappointed and what's going on you know you bought back a ton of stuck 30 plus percent higher than it is now when you're buying less now so assuming the environment is turning out to be a little bit different than you anticipated.
You can take that offline as well.
No no no not at all I mean, I think I think the environment is what we've been talking about for the last year I mean, I don't think anyone expected Gpus to stay at these elevated levels and it was a matter of when they began to normalize and we're starting to see that normalization than we are.
We're quite happy with our results and the execution on our overall strategy.
Really our thinking about what is 25 look like knowing that what happens in the economy isn't something that we can control, okay and I think that is the mantra of lithium driveway that we're going to we're going to do everything in our power to manage our day to day business, while still focusing on the long term.
Our business there.
We're focused on it was neat I was talking with my son yesterday on the on the phone.
Names trend anyway quite insightful. He is taking a international finance course, and he was talking about how how America over the last two decades has turned into this quarterly approach of earnings, whereas most of Western Europe . It takes the long approach and is winning in different areas.
Cuz theyre not quite as reactive in terms of what's happening I'm like Wow, that's really great insights I think thats, how lithia and driveway really thinks about its business.
We look forward to talking tomorrow more than we can get into more specifics.
We have reached the end of the question and answer session I would now like to turn the call back over to admit my Wahaha for closing comments.
Thanks for joining us today, we look forward to meeting with many of you in the next few weeks with that I wish everyone. A good day.
Yeah.
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