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

Thank you. Presenting today are Bryan DeBoer, President and CEO; Tina Miller, Senior Vice President and CFO; Chuck Lietz, Vice President of Driveway Finance. Chris Holzshu, Executive Vice President and COO, is traveling in Canada with the FAF team. Today's discussion may include statements about future events, financial projections and expectations about the company's products, markets and growth. Such statements are forward-looking and subject to risks and uncertainties that could cause actual results to materially differ from the statements made. We disclose those risks and uncertainties we deem to be material in our filings with the Securities and Exchange Commission. We urge you to carefully consider these disclosures and not place undue reliance on forward-looking statements. We undertake no duty to update any forward-looking statements, which are made as of the date of this release. Our results discussed today include references to non-GAAP financial measures. Please refer to the text of today's press release for a reconciliation to comparable GAAP measures. We have also posted an updated investor presentation to our website investors.lithiadriveway.com, highlighting our second quarter results. With that, I would like to turn the call over to Bryan DeBoer, President and CEO.

Thanks, Amit, and welcome to the team. Good morning, everyone. Thank you for joining us today, and we look forward to updating you on business growth and substantial progress towards our 2025 strategic plan. Earlier, we reported second quarter adjusted earnings per share of $12.43 adjusted for foreign currency or a 12% increase compared to $11.12 per diluted share in the same period of 2021. We grew revenues to $7.2 billion, a 21% increase year-over-year, driven by continued performance of our Lithia stores, Driveway and contributions from our newly acquired stores. Our second quarter results reaffirm our ability to leverage the value of our network to expand market share. Customers have the option of visiting our Lithia stores or websites or accessing our e-commerce channels of Driveway and GreenCars, improving our ability to drive efficiencies in our operations. We continue to see elevated GPUs with slight normalization in used vehicles this quarter. Combined with our strong performance in aftersales, we generated over $558 million in adjusted EBITDA in the quarter. With the continued strong performance, our investments in Driveway and Driveway Finance were accelerated. We remain on track to hit our $50 billion in revenue and $55 to $60 in EPS by 2025. Despite the recent volatility in capital markets and concerns around the impact of macroeconomic uncertainty, we're confident about our ability to deliver on our outlook. Now on to a few highlights from the quarter. Total revenue increased 21% year-over-year, driven by growth across all our segments, with all channels performing strongly and successfully navigating market dynamics. On a same-store basis, total revenues and gross profit were down slightly, driven by continued new vehicle inventory availability issues. Our teams navigated the current vehicle supply environment by maintaining strong vehicle gross profit per unit and growing volumes. Total vehicle gross profit per unit increased by 14.7%, and our same-store used-to-new ratio was 1.3:1 in the quarter. In addition, we sold 90 used vehicles per month per location, quickly approaching our 100-unit goal. We ended the quarter with new and used vehicle day supply of 32 and 62 days, up 39% and 5% year-over-year, respectively. Driveway received 2.3 million monthly unique visitors in the month of June. In the second quarter, Driveway retailed or wholesaled over 12,000 units that contributed over $233 million or 3% to our total revenue. We are on track to achieve our target $1 billion in incremental revenue through Driveway for the year. This represents shop transactions and subsequent retail and wholesale sale transactions, similar to what is reported by our e-commerce peers. In the quarter, Lithia & Driveway combined retailed nearly 32,000 vehicles, where our customers interacted with us using one of our many e-commerce tools. Representing approximately $1.3 billion, our integration of optionality in our e-commerce tools allows us to serve a diverse and evolving set of consumer interests. Driveway Finance also continued to grow, originating over 14,500 loans totaling $483 million in the second quarter. As of the end of June, the portfolio was nearly $1.3 billion. Finally, acquisitions for the first half of '22 totaled $2.1 billion in annualized revenues acquired. Our team has done a tremendous job generating value and developing a track record of integrating acquisitions the past couple of years. We've also managed to launch DFC, a flourishing captive financing division and Driveway and GreenCars e-commerce offerings that continue to gain momentum. We are well positioned to continue generating value across our entire network and all business lines. Historically, our company has operated with $1 billion in revenues, generating $1 of EPS. The design and execution of our 2025 plan in a normalized market will improve this ratio to $1 billion in revenues, generating up to $1.20 in EPS. The 10 assumptions behind our guidance can be divided into three distinct groups to follow. Starting with efficiency and operating leverage, we assume: achieving a blended market share of 2.6% in the U.S. across new and used vehicles; total vehicle GPUs returning to pre-pandemic levels or around $2,100 per vehicle; lowering SG&A as a percentage of gross profit towards 60% through operational improvements, resulting in greater efficiency across our footprint. Secondly, our expansion plans target acquiring an incremental $9 billion to $10 billion in annual revenue to complete the build-out of our North American footprint of 400 to 500 locations; integrating Driveway into an omnichannel solution and reaching profitability; continued headwinds around DFC's profitability due to building CECL reserves as we scale towards a 15% penetration rate on our loan portfolio; contributions from adjacencies with higher pretax margins and operating leverage resulting in a lower base of SG&A-related expenses. Lastly, we model the following around financial discipline and capital management: no further equity capital raises; removing the overhang of dilution to earnings; an investment-grade credit rating translating into a lower cost of capital; flexibility and headroom in our capital allocation plan to allow for opportunistic share buybacks, taking advantage of divergences in valuation. I want to remind everyone that in addition to our strategy of growing through acquisitions, our strategy incorporates new businesses and adjacencies that will continue to expand our value creation well beyond our 2025 targets. We believe the growth in our business beyond the 2025 plan with the full execution of our vision and a steady state, we could produce up to $2 per share in earnings for every $1 billion in revenue. To put some context behind this statement, we assume the following: Driveway and GreenCars generating 15% to 20% of our total revenue; up to 20% of all vehicles sold by Lithia & Driveway will be financed through DFC, building out our complementary profit stream without any additional spend to acquire customers. We also assume penetration rates for our used and new vehicles are at 40% and 10%, respectively; contributions from adjacent business lines requiring relatively small amounts of capital. This includes fleet and lease management, charging infrastructure for electric vehicles, consumer insurance, and business lines that leverage our network of stores, proprietary software and regional footprints. With the scale of our revenue and previous adjacencies, we expect SG&A will be below 50% of gross profits. The framework we have presented above is designed with the ultimate goal of developing the most diversified vehicle transportation organization with simple, convenient customer experiences, fully leveraging the value of our network and infrastructure. I would like to shift the discussion to our network development or M&A strategy and provide an update on our progress acquiring and integrating new stores within the Lithia & Driveway family. Before we dive into the details, I want to step back and review the key attributes of our strategy. First, we look at locations that build out our network to achieve a target of being within 100 miles of a consumer, allowing us to conveniently reach and serve large pools of customers for their full ownership life cycle and efficiently utilize our network for vehicle distribution, restoration, and warehousing. Today, our network is made up of approximately 300 locations within 250 miles of 95% of the population in the United States and 60% of our customer base being within 100 miles of those locations. That's a considerable competitive advantage versus any of our peers. At the end of the day, we're able to service our customers quicker at lower costs and provide an in-house financing solution in-store or online. That's a powerful combination. During Q2, we acquired $1.4 billion in annualized revenues. In the first half of 2022, we acquired $2.1 billion in annualized revenues, marking 63% of our total revenues targets in our 2025 plan. We are excited to welcome all of our new team members to the Lithia & Driveway family. In the past month, we have noticed an increase in queries from investors regarding the M&A climate and pipeline for our new opportunities. Investors have been trying to understand our valuation framework, given the macro headwinds and normalization of GPUs. I want to reiterate, we are disciplined and methodical about our strategy and our pipeline of opportunities remains quite robust. A few final thoughts on M&A. One, we are a seasoned team with a track record of finding assets that fit into our investment profile and integrating new leaders into our culture. We remain disciplined in our pricing hurdle rates, targeting prices of 15% to 30% of revenues, 3x to 7x EBITDA based on normalized earnings and generating a minimum of 15% after-tax returns. We continue to achieve over 25% historic returns on our acquisitions. Since launching our 2025 plan just two years ago, our M&A activity has contributed to nearly $1 billion in adjusted EBITDA and $12.6 billion in revenue, a noteworthy achievement. Our approach has been highly accretive to shareholders while consistently earning above our capital cost. Alongside our strong network across North America, we see significant opportunity to build leverage through expanding verticals, which drive revenue opportunities and horizontals representing adjacencies that increase profitability. Our e-commerce business vertical, Driveway, builds our online presence by integrating our physical infrastructure and logistics to develop a premier omni-channel business. We reported another strong quarter of Driveway performance, demonstrating how we are making inroads finding new customers, while many of our competitors are having to reexamine their own growth strategies. Driveway is well positioned to become the premier choice in e-commerce automotive retailing. And we remain confident with our plan to profitability in the near future. GreenCars continues to gain traction as we attract consumers with our sustainable vehicle learning center and marketplace powered by Driveway. During the second quarter, online activity on GreenCars grew to over 384,000 MUVs in June. Higher fuel prices have boosted consumer interest in all types of electric vehicles, and GreenCars provides a wealth of information on sustainable options from BEVs to hydrogen propulsion solutions centered around affordability for all customers. To date, we have installed 600 chargers supporting the adoption of sustainable vehicles. We're also training our technicians and increasing our breadth of services to provide the same level of service for sustainable vehicles provided to our traditional fleet of vehicles. Driveway Finance Corp., or DFC, our most developed horizontal posted another strong quarter, making inroads as the primary lending option for Lithia & Driveway customers. At its future state, we believe DFC can contribute approximately $650 million in incremental profits a year and is a key contributor to driving SG&A as a percentage of gross profit down to 50%. I'm pleased with the pace of growth and our ability to not sacrifice near-term growth at the expense of adding risk to our portfolio. While remaining nimble, our conviction in the Lithia & Driveway strategy remains strong, and I'm confident we're well positioned to deliver on our 2025 plan and beyond. Our portfolio mix, acquisition strategy and all sales verticals are performing ahead of expectations. We're rapidly growing market share and generating some of the best returns on capital in all of retail. Our capital allocation strategy is balanced, and we're ready to take advantage of dislocations in the marketplace. We have the right team in place to respond and find opportunities in changing market conditions. We will continue to lead the growth, transformation and consolidation of our industry, the largest retail sector in the world. With that, I'd like to turn the call over to Chuck.

Thank you, Bryan. DFC continues to be Lithia & Driveway's largest lender as we accelerated our growth in originations. For the second quarter, DFC's penetration rate increased to 9.7%, up from 6.2% in the prior quarter with an active rate of 12.9% in June. For 2022, we are revising our full year penetration rate to between 9% and 10%, up from 7% we communicated last quarter. This would not have been possible without our stores' continued focus on retail readiness. Retail readiness is critical for DFC to realize our value proposition to maximize the revenue potential of our existing customers rather than incurring the frictional cost of new customer acquisition. We continue to maintain an appropriate fully risk-adjusted return on the finance contracts we originate which, on average, is 3x as profitable as loans originated by third-party lending partners. As Bryan indicated earlier, we are reaffirming our guidance of the future state expectation that DFC will contribute $650 million in earnings to Lithia & Driveway. This will be predicated on DFC maintaining a seasoned and mature portfolio after consistently achieving penetration rates of 20% of all Lithia & Driveway sales with a minimum base of $50 billion in revenues. From a credit quality perspective, DFC was able to increase our weighted average FICO score by 28 basis points from 690 in our first quarter this year origination to a weighted average FICO of 718 as we continue to leverage the top-of-funnel potential of being a true captive. The increase in credit quality is particularly noteworthy as we look to mitigate any potential negative impact of economic and industry fluctuations. Last, in the second quarter, we experienced a modest compression on both interest margin and spread rates primarily attributable to the higher credit quality of our originations and the impacts of a rising interest rate environment, respectively. We continue to monitor market rates on a real-time basis and will increase DFC's yield rates by maintaining our internal risk-adjusted total rate targets balanced against market conditions. Increases in yield rates will mitigate spread compression in the short term without sacrificing our ability to achieve our portfolio and risk-adjusted financial targets.

Thank you, Chuck. In the second quarter, SG&A as a percentage of gross profit for the quarter was 58%. Our investments across Driveway and Driveway Finance were the main drivers of the reduction in margins with Driveway-related advertising contributing 160 basis points. We're confident in our ability to gain operating leverage across our platform and utilize our performance management and reporting insights to enable our teams to take the necessary steps to lower costs across their network. We are still realizing the favorable benefit of positive operating leverage due to elevated GPUs, which, over time, we see normalizing to 60% SG&A as a percentage of gross profit in our 2025 plan. In the second quarter, we generated $558 million in adjusted EBITDA, a 14% increase over the same period last year and $192 million in free cash flow. We define free cash flow as adjusted EBITDA plus stock-based compensation, less the following items paid in cash: interest, income taxes, dividends, and capital expenditures. As a reminder, this number does not include a pro forma of the full EBITDA contribution of acquisitions purchased within the last 12 months. Year-to-date, we have generated nearly $653 million in free cash flow. We were opportunistic in the quarter, repurchasing 1.9 million shares or 6.5% of our outstanding shares at an average price of $284 per share. We have just under $100 million available on our authorization. Our capital allocation strategy continues to balance acquisitions, internal investments such as DFC and Driveway, and shareholder return. Our approach is a durable strategy that positions us well to be a leader in the personal transportation space for years to come. Shifting to the balance sheet. We continue to maintain our investment-grade discipline. At the end of the quarter, our net debt to adjusted EBITDA was 1.7x. Our team's ability to allocate capital and manage risk effectively puts us in an attractive position, particularly around liquidity and generating returns for our shareholders. In conclusion, we are poised to take advantage of possible volatility of the macroeconomic environment and hypothetical changes underway in the auto sector. Our balanced approach towards growth and returning capital sets us up to achieve our 2025 plan of $50 billion in revenue and $55 to $60 in EPS with significant runway into the future. This concludes our prepared remarks. We would now like to open the call to questions from the audience.

Our first question is from Daniel Imbro with Stephens Inc. Please go ahead with your question.

Good morning, guys. Thanks for taking the questions. Bryan, I want to start on the new unit side. I think a little bit of a surprise there, just the same-store down around 27%, a bit weaker than the industry. Was that driven by any one, maybe OEM in particular? Can you just talk about what you think maybe drove that underperformance for the industry here in the second quarter?

Sure, Daniel. Actually, our franchise mix in relationship to the industry, and we actually measure something called market share. And our manufacturers actually help us do that, which is called MSR sales efficiency. We were actually up year-over-year 5% in market share as compared to our brands, which doesn't show in the read-through of the down 20-plus percent in new vehicles.

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

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

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

Yes, for DFC.

Could you provide an update on your expectations for the credit profile at this stage of the credit cycle? Chuck mentioned that the average FICO score has increased. I'm interested in how you are currently modeling this internally. Additionally, you've reached nearly 13% penetration. Do you have plans to begin disclosing credit metrics like charge-offs or delinquencies? I'm trying to consider how this will impact modeling as it becomes a more significant part of earnings.

Yes. Thank you, Daniel. In terms of our credit profile, our target is really to be on the upper sort of scale of the near-prime portion of the credit spectrum. But as I indicated in my comments, just based on sort of the economic environment, we are clearly looking to move up into the lower tier market. So I would say our weighted average FICO over time should be migrating to the upper 600s, maybe even low 700s. And we just think that, that's prudent in order to achieve our risk-adjusted fully burdened return metrics.

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

Yes. As DFC's portfolio expands, we plan to introduce additional disclosures, likely around the end of the fourth quarter reporting cycle. We already include balance sheet disclosures in our 10-Q, but we anticipate that these will become a more significant part of our disclosures as we approach year-end and the related reporting period.

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

Thanks, Daniel.

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

Thank you for taking my question, and good morning. Bryan, could you discuss how you are preparing for operations if the economy experiences a mild, moderate, or severe recession? Can you provide some insights into what the earnings potential might look like under different scenarios? If we find ourselves in a new vehicle SAAR environment, possibly around 12 million to 13 million during a recession, and if GPUs return to pre-pandemic levels more quickly than anticipated, how would that impact the earnings potential of the business? Additionally, could you share any insights on SG&A to gross in that scenario or F&I? How should we approach this, given that our current starting point is quite different from past downturns? I have a follow-up as well.

Understood, Rajat. This is Bryan. Most importantly, remember that Lithia Motors and Driveway have added $12.5 billion in revenue over the last nearly two years, which helps offset the losses we’ll experience from GPU recessions. We are looking at several different factors in our organization. As Tina mentioned, we incurred nearly 185 basis points or $25 million last quarter on new initiatives. Our initial steps are to scale back some initiatives and possibly slow the growth of DFC a bit. We are also seeing good organic growth from Driveway.com, allowing us to likely reduce our advertising budget and decrease that burn rate from $25 million to around $15 million, which is significant. Additionally, we’ve identified numerous efficiencies within our operations related to personnel costs. Our main focus is to share best practices and streamline processes to boost productivity, which is always a critical factor in what we do. Furthermore, the easing of pricing on transactions gives us the chance to utilize our substantial capital reserves. Even in a lower earnings environment, we expect to generate between $1.2 billion and $1.5 billion in cash flows, which gives us the capacity to acquire between $3 billion and $7 billion in revenue, depending on pricing. There are many avenues we can pursue to achieve that. I would also direct you to Slide 7 of the investor deck. We initially modeled what lower GPUs and a slower market environment might look like. It's marked in a dotted white section for anyone interested, and we’re happy to assist you with those modeling considerations.

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

Thanks for taking the questions. The first question I want to ask is, it looks like you have about $1 billion of unsecuritized auto loan receivables on balance sheet today. I just want to understand kind of what your path to current liquidity for that business is in the current environment? Like when do you expect to return to ABS market? What are your conversations with like ABS bankers telling you in terms of your ability to tap those markets?

Yes. Chris, Chuck answering the question here. In terms of our capital deployment strategy and capacity planning for primarily the Driveway Finance Corporation, it's really a four-pronged strategy. First, obviously, that will require some amount of liquidity. But we really see the primary conduit of our financing as a combination of an ABS warehouse conduit facility for transitory lending and then moving into the ABS term market. And speaking with a lot of our investors as well as other interested parties in the ABS market, I mean, obviously, that market has experienced a fair amount of volatility in terms of rates. However, we do see that starting to taper off as more stability in terms of longer-term yield curves and Fed interest rates start to become more clear and apparent. We still feel like the ABS term market is active. There's plenty of liquidity and investors do have sufficient capital to maintain those markets, both in the short term and midterm. So we do see that as the longest or the highest form of our capital requirement. And then last, we will look for other forms of liquidity, perhaps the forward flow arrangements or both portfolio sales to make sure that we have a robust capital structure to fund DFC.

Got you, that's really helpful. I have a somewhat unrelated question, still on credit. Could someone explain how we should consider floor plan interest expense moving forward? Are those rates still based on LIBOR, or have you transitioned to SOFR? I also noticed that the expense decreased quarter-on-quarter despite rising rates. Are there any offsets contributing to that? I believe you have four points of systems, which would reflect in COGS as a contra COGS. I'm trying to understand how to model floor plan interest expense as benchmark rates increase.

Chris, this is Tina. Thanks for the question. So yes, most recently with our amendment to our credit facility, we didn't move to SOFR, so off of LIBOR, and that's the benchmark rate that we'll be using for a majority of our floor plan debt. We have a few captive floor plan silos as well that I think have different rates. I think some are prime. But really SOFR is probably a majority of our floor plan financing to really model off of. And then you're correct. We do get floor plan assistance from some of our manufacturers. A lot of that money actually goes to cost of sale, though, from a presentation perspective. So, I know we've disclosed in our Qs and Ks in the past sort of what that looks like. But just a reminder that the floor plan interest expense is really a pure interest expense number there. The credits actually are within cost of sales. So it's managing through the inventory and the velocity and speed at which our stores are selling through and just managing inventory levels.

Thanks, Chris.

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

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

John, thanks for joining us today. This is Bryan. I think on used vehicle inventory at 62, we're pretty comfortable. That's a real normalized level of where we were pre-COVID. And I think today knowing that we have two additional national brands in GreenCars and Driveway, it's what our efforts are trying to push is the ability to find cars. I think it's also important to note that our ability to grow inventory is quite important because it expands the selection to our customers through all three of our channels. Most importantly, when we're starting to see now some of our e-commerce peers are used-only peers that are really struggling just getting inventory. So we're pretty comfortable at that 61-, 62-day supply and know that there is probably some softness that will come in the market towards late summer. But again, we're talking about a 2-month supply, and we'll adjust things according to what the market conditions are heading into fall and winter.

Okay. And then just a second question around SG&A. I mean, I know the longer-term target is 50% and potentially lower relative to gross. It seems like the majority of that is coming from business mix as DFC ramps up and other efforts ramp up that have lower SG&A burdens. But what could you think is sort of on a store basis, on an actual retail basis, where that could get to and where that could comp down to based on efficiencies through online selling, et cetera? Is that the kind of thing that you could get below 60% materially just on a like-for-like basis?

I would say that it's a 60% to 62% SG&A in operations and what we call the verticals now, okay? That's probably the realistic number. And the disconnect, as you mentioned, really comes from DFC, the fleet and leasing companies and in the other adjacencies, that DFC alone, I believe, is 800 to 1,000 basis points drop in SG&A just from that one horizontal, which is a big part of it. Now obviously, the other horizontals that we're working on, we're still modeling, we're still learning about and they're in beta stages but can obviously be the other large disconnects. When we start to think about the e-commerce platforms, if you remember, originally, we were talking about sub-60% levels in Driveway, okay? We think that, that's still possible but that's going to require us to get to 12 units per associate per month, okay? And today, we sit at a little under 9, okay? But again, we're just under two years into the program, and we have a new CRM system going into place that we've developed and should increase the efficiencies in the care centers as well as be able to expand our penetration rates and our closing ratios.

Okay, that's helpful. And then, Bryan, just lastly, I mean, there's a lot of concern around the consumer and risk of a recession, but you guys have day-to-day contact with your consumers. I'm just curious if you could maybe comment on the state of your new vehicle buyer and your used vehicle buyer. Because I mean, it just seems like with this pricing and grosses, that your consumer is still pretty strong and wanting more vehicles than you can even get for them. So I mean, there's a lot of crosscurrents here, but it seems like the new and used vehicle buyer is still relatively healthy. I just wanted to get your take and your view of where this is going.

Well said, John. I mean, there's still a backlog in most manufacturers in new vehicles. Our used vehicles are still turning at quite a high rate. I'm going to guess on this but we probably added five to seven days supply just from buying vehicles in other parts of the country and then getting them to reconditioning centers that are a little further away because we've had to expand the fine vehicles. So I think when we think about the consumer impact on days supply, the demand is strong, okay? I mean, we were down, what, about $200 in GPUs and years, but that's still considerably higher than normalized states, and we still see that as quite healthy. Obviously, on new, we're still at peak levels and the backlog of vehicles are quite high. Just a couple of highlights. Our domestic days supply on new is around 60 days. So we have pretty good flow even though there's some in-transit on that. Really our softness in days supply, which is where we really are selling every car that we get about as quick as we can get them is in our imports, which we're sitting at a 16-day supply and our luxuries are sitting at about a 29-day supply.

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

I can say that roughly one-third of our new vehicle inventory is presold, which is a positive sign, especially as it consists largely of high-demand models. The remaining vehicles may be wait-listed but are not presold, meaning we haven't received payment for them yet. This is a fairly strong indication of market interest. Analyzing our website traffic shows that unique visitors are still significantly high, indicating sustained consumer demand for vehicles. It's crucial to note that in terms of affordability, when consumers purchase new vehicles, their trade-in used cars retain high value. This creates a favorable financial situation since the difference between the trade-in value and the new car price, which is generally capped at MSRP, can be quite advantageous for buyers. For instance, there are customers who bought new vehicles from us in the past year or so and have since sold those cars—either through trade-ins or direct sales—for $5,000 to $10,000 more than their purchase price. This demonstrates that consumers are effectively leveraging the market for their transportation needs. It's encouraging to see this benefit for consumers, especially when purchasing new cars priced below MSRP.

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

Thanks, John.

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

Thank you for addressing my questions. I wanted to follow up on your earlier comment. I believe you mentioned that one-third of vehicles are now presold. Has that figure changed? I had assumed that nearly all vehicles required a wait of several months to purchase. Has that situation evolved over the past three to six months? Is it now at 50%?

We don't have the exact data, but we received information from franchises that suggested it was around 50% 90 days ago. Since interest rates have increased, it has impacted things, but the market remains strong where cars are still in high demand. If someone wants to drive a car, there are often multiple others waiting for the same opportunity, creating a competitive atmosphere. We expect this trend to persist through the end of the year, especially since supply chains for most manufacturers are likely to remain constrained until the first or second quarter of next year.

Got it. That's helpful color. I also noticed, I mean, new GPUs still very close to record levels on a nitpick, but they are down slightly from Q1. And I've heard automakers are talking about how they're going to take pricing from the dealers through different mechanisms. Is that starting to happen? Is that driving the slight weakness or is that really sort of a rounding error from your perspective?

I would probably say it's closer to the latter, the rounding error. I believe that manufacturers' transparency on pricing and stabilization on pricing will help stabilize front-end margins at something higher than normal levels. I don't believe that, that's what's occurring quite yet. It's just not how transactions are done, unless a manufacturer chooses to move to a 1-price type model for their network, which we'd probably welcome because it does take away complexity in the relationship with the consumer. When today, we do deal with two different moving parts of a transaction. We deal with finance ability and then we deal with price negotiations. And then throw in a trade and it gets quite complex. And if we can take away that uncertainty about price by having it tighter to actual transaction prices, we're all for moving towards that as manufacturers. I will say this, most manufacturers, though, are tending against that because they fear that they want a fluid market where consumers have been trained for so long that there's a good price and a bad price and I can do better if I negotiate on my own. There's a lot of consumers still think that way, and I think most manufacturers believe that the freedom of pricing is something that can be adjusted that based off markets and regions and states. So, important to know that there's not big pushes in that arena outside one or two of the European manufacturers.

Got it. And just lastly, F&I was down a bit. Is that attributed to the DFC impacting some of those profits? Is that the main driver there or are there other factors involved?

It is. I mean, I think you saw F&I increase as GPUs increase. And I think as GPUs start to subside, you'll see F&I, to some extent, subside that they're both driven off this supply and demand type of environment. I think the difference that you're seeing in the last few quarters is about $130. So as Chuck mentioned, we were pushing 10% penetration rate, which means that now 10% of our business is being taken out of F&I and diluting the F&I number. So it's about $130 per unit. Is that right, Tina and Chuck?

Yes, year-to-date.

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

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

Good morning, guys. On the GPU, I guess, SG&A to gross and your outlook for GPUs returning to pre-pandemic levels, I guess as we look at '25, you're looking at a 60% SG&A to gross. Would you expect sort of materially higher levels in the interim? Obviously, a lot of the development spend continues and you're looking at a return to $2,100 GPUs. As we model it, should we think sort of mid-upper 60s in the shorter term? Or do you manage down some of those investment costs around DFC in the interim?

Yes. I think internally, the way that we think about it is how fast does demand and supply change and how quickly do those GPU levels rescind. I think we're in the camp that if there's a normal rescission where it's quarter-over-quarter declines and not month-over-month declines, I really believe that we will get back to some level that's higher than the normal state of GPUs. Now we were about $2,600, $2,700 pre-pandemic so we're going to shoot in the $3,000 to $3,200 range. It's probably a normalized level if it subsides that in a slow, methodical way. If there's some large economic event or further excessive increases in interest rates that affects demand in a big way, it may be a little harder to manage for a few months. But ultimately, we're pretty confident that we can get our operational part of the business to that 62% SG&A as a percentage of growth with knowing that if Chuck can tone back our growth rates a little bit on DFC, that we can get those to profitability in three to four months typically. And now you start to see the real impacts that can drive SG&A, and we can adjust SG&A in operations to some extent with the horizontal in the finance company.

Okay, great. And then a question. I guess, on Slide 14, you have the mix of value, which has clearly been growing in this environment. But you commented about a $5,100 average negative equity. Do you see an environment where given the spike in values in the last 18, 24 months, that we're going to have to, I guess, swim upstream against negative equity as normal depreciation returns? Or is that reason...

Good insight, Bret. Yes. I mean, I think today, we've calculated that about one-fourth of the consumers haven't transacted in a higher GPU type of environment. But remember also that it was offset by higher trade values, like I mentioned to John. So though we know that, and today, we sit at about 35% of consumers have this equity and it's around $2,000 of this equity, they also have now over $2,000 of cash down, okay, which is a vast difference from what we are normally at pre-pandemic, okay, where we saw 71% of our consumers with this equity averaging $5,100, average cash down of only $1,800. So, you're talking about a $3,500 delta so there's probably 25% of consumers that could have something a little north of that. But remember, that plays well to new car dealers or Driveway and Lithia, most importantly, because of why, the easiest vehicles to absorb this equity on are ultimately new cars and late-model used cars. The best is what we would call mainstream or lower-demand new cars that eventually will have incentives again or will have price variance in them, that allows us to absorb that $5,000 in this equity or that net difference of $3,500 with their cash down to make sure that we can get that. And I think that's very important to note in the model that our ability to find used cars come from trade-in, okay? And those trade-ins are about two-thirds of our inventory in normalized times. And I think that's the advantage of being a new car dealer, that when there is this equity, it means you typically have to trade in your car because you can't clear your debt because you have to carry over some of the debt to the car that you're buying.

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

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

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

Good morning, guys. Curious, just want to dig into DFC a little bit more. So the loss expectation on the year increased from $9 million last quarter for 2022 to $20 million now. Penetration higher, though, so 7% to 9% to 10%. How much of that loss change is from that higher penetration in those CECL reserves versus other assumptions?

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

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

Correct. As we improve our credit quality, our loss reserves as a percentage are decreasing. Even though we are significantly increasing our provision rates because our overall portfolio continues to grow, on a percentage basis, we are either remaining stable or slightly decreasing as we enhance our credit quality.

Great. Then just one on used. So pricing is starting to potentially come down a little bit here. But how do you think your overweight mix of core and value, particularly at the legacy Lithia dealerships, how do those segments position you relative to your peer group?

Good question, Ryan. I know that someday, everyone will sell value auto cars because it makes up about 17% of our business today. I think we all just get enamored with the CPO sales that make up 20% of our business. But our real thrust is in our core business. That's 63% of our volumes today, and that's really the heartbeat that comes from those trade-ins of high-demand vehicles that create better margins and the ability to sell lesser demand cars at a more attractive price than used-only dealers. So I think if we think about what cycles we went through with value auto or the higher aged vehicles, they're always hard to get, okay? And maybe even more importantly than that, they're really hard to recondition. So, when we look at our mix of value auto versus our peers, we're usually sitting at double to triple our mix rates. They're sitting at 5% to 6% typically. The used car retailers, obviously, they don't have the ability to recondition those cars because it typically requires diagnostic tools that are 10 years and older that we still have in our tool rooms to be able to fix those cars and a little bit more experienced technician to be able to do that. Now we don't mind that other people get into that business because most value auto cars are taken in on trade, okay? So we're actually getting those, which means that anyone else that decides to keep the value auto cars typically sends them to us if there's a drivability issue or there's a higher cost repair on the vehicle for them to get it to the front line. A simple example would be a check engine light. The only person that can turn off a check engine light is us, okay? And sometimes that can be $400 to $600 to really just check an O2 sensor and modifies how the flow mass sensors are working or something. So lots of simple things that we are far enough upstream that we get the profits as others begin to move into value autos as well because it is a pretty easy area of the highest demand cars that creates an affordability level that starts that consumer into the Lithia & Driveway life cycle that has really been our mantra for decades.

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

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

Correct.

Okay. So as you go forward, everyone out there is saying that inventory levels on a more normalized basis are going to be, whatever, 30% below historical. In that environment, is there any reason why new vehicle grosses wouldn't be materially higher than they have been in the past?

We believe that gross profits will continue to be elevated, primarily due to improved price transparency and a stronger capability to develop the market. However, I am unsure if, in a normalized supply and demand scenario, the supply of days directly reflects the gross profits. This is something we will need to observe moving forward. Historically, we have not seen a strong correlation, as we maintained around a teen-day supply for a decade before the pandemic and continue to operate at similar levels today. Therefore, I don't believe there is a direct relationship. I do think that promoting price transparency and minimizing negotiation aspects to facilitate financing, trade values, and consumer interactions in a straightforward manner is advantageous for customers throughout the entire process. Our collaborations with manufacturers aim to emphasize this approach. I believe this will significantly contribute to stabilizing gross profits above normalized levels more than days supply will.

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

I would think that there's value adds for building something specific to what you want. I think most manufacturers, though, have to then deal with their production capacities and their production flexibility. I think most manufacturers are still going to be building a lot of inventory in the United States because we do have facilities to do that and consumers in America like selection. And it's a little different than Western Europe, where there's space constraints and 70% of your cars are typically built to order, where a consumer in America today wants to look at the blue one and wants to look at the one with the cool new electric drive systems and so on. So a little bit different environment here in the United States. I think that they'll still be on-ground inventories for years to come.

Our next question is from Adam Jonas with Morgan Stanley. Please proceed with your question.

It's Adam Jonas actually on for Evan Silverberg. So look, having the really high portion of your new volume being preordered vehicles, gives you some great insight, I think, on forward demand. We never thought to ask car dealers about preorder backlog or the length of that or cancellations. But it's not an irrelevant question, given how much of your businesses is preordered, and you have a good visibility into 3Q and into the back half of the year. So what can you tell us about that? Is there any rate of change on the length of the order to delivery time, rising, falling, stable? Or any kind of comment on cancellations to give us a little color on one data that I'm sure you're tracking daily?

Sure. I think in a normalized environment, Adam, we were probably around 5% to 10% of our new vehicle sales were preorders, typically on things like Wranglers and 911s and BMW M3s, that higher demand type of product, okay? And we are sitting at about one-third of our sales now are order bank. When we did peak a few months ago at probably around 50%, so it's a little bit softer but maybe we end up stabilizing in the 15% to 20% level and more things are built to order. We sure hope they are. I know when consumers have the optionality to do things, the way that their own personality and their own driving habits fit. It's typically a better experience for them as well.

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

Thanks. Good morning. Just going back earlier, you were talking about how demand is still very strong. Consumers still want to spend money on vehicles. Also on the positive side, we've got rising wages, tight labor market. But on the negative macro side, we've got inflation high but falling oil prices and falling copper prices so there's some mixed signals there. I mean, do you think we're heading into a recession? Or do you think maybe the overall economy might be in bad shape but the auto market will remain strong?

David, we try to keep our eye on what we can control, and we obviously have a very proactive field team that runs each individual location, and each part of the country responds differently just as we learned from the Great Recession, where we knew that those that responded at the local levels closest to our customers were the ones that really won the day, and we built an organization and a mission that's Growth Powered by People and rely on them to be able to make those decisions. Now I know that may not have answered your question. I do believe that demand will soften as interest rates and inflation either take hold further or hope to subside. I do believe that this is a supply and demand inflation imbalance that's creating inflation, which is a little different than actual price inflation, okay, that I think we'll see a return to some level of normality. And if we do see a recession, I think Lithia & Driveway are nicely positioned with its adjacency to continue to execute through our strategy that we've developed, to maximize shareholder returns and maximize our ability to grow to become the largest automotive retailer in the country and probably the world.

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

Hi, thanks for sneaking me in here. Just had one for me. Just trying to understand the year-over-year dynamics in used a bit better. Maybe I'm missing something, and I appreciate that GPUs are obviously still elevated from a historical standpoint, but just wanted to see if you could talk through same-store being same-store used 18% higher average selling prices still year-over-year, but GPU down 14% on what looks like kind of flattish used volumes. Is that a function of just added procurement expenses based on some of your previous commentary or how should we think about that?

Sure, Josh, it's Bryan again. The used car market has declined significantly, so maintaining flat performance is actually a strong outcome. We are selling vehicles through various channels like Driveway and GreenCars. However, it is taking us longer to acquire cars since we are sourcing them from farther away from our reconditioning centers. For example, when we purchase cars in the Mid-Atlantic for our BMW and Lamborghini stores, which are about 300 miles away, it can take six to seven days to transport them. After that, reconditioning takes another 72 hours, which adds to the time needed before we can sell the cars. We believe it's better to be cautious about price devaluations within our inventory, which we anticipate is mainly a 60-day concern. We are optimistic about our inventory growth because both Driveway and GreenCars are gaining traction, allowing us to sell in any market condition, especially since gross profit units in used cars remain quite strong.

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

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

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