Good morning, welcome to the Lithia & Driveway third quarter 2021 conference call. All lines have been placed on mute to prevent background noise. After the speaker's remarks, there will be a question-and-answer session. I would now like to turn the call over to Jack Evert, Director of FP&A. Please begin.
Thank you, and welcome to the Lithia & Driveway third quarter 2021 earnings call. Presenting today are Bryan DeBoer, President and CEO, Chris Holzshu, Executive Vice President and COO, and Tina Miller, Senior Vice President and CFO. Today's discussions may include statements about future events, financial projections, and expectations about the company's products, markets, and growth. Such statements are forward-looking and subject to risks and uncertainties that could cause actual results to differ materially from the statements made. We disclose those risks and uncertainties we deem to be material in our filings with the Securities and Exchange Commission.
We urge you to carefully consider these disclosures and not to place undue reliance on forward-looking statements. We undertake no duty to update any forward-looking statements which are made as of the date of this release. Our results discussed today include references to non-GAAP financial measures. Please refer to the text of today's press release for a reconciliation to comparable GAAP measures. We have also posted an updated investor presentation on our website, investors.lithiadriveway.com, highlighting our third quarter results. With that, I would like to turn the call over to Bryan DeBoer, President and CEO.
Thank you, Jack. Good morning, and welcome everyone. Earlier today, we reported the highest adjusted third quarter earnings in company history at $11.21 per share, a 63% over last year's strong results. Record revenues of $6.2 billion were primarily driven by successful navigation of the abnormal supply and demand environment and contributions from acquired businesses. During the quarter, total revenue grew 70%, while total gross profit increased 83%. On a same-store basis, used vehicles led our revenue growth up 40%, followed by a 22% increase in F&I income, a 7% increase in service body and parts revenues, and a relatively modest 3% decrease in new vehicle revenues. Additionally, same-store gross profit increased 23%.
Our operational teams executed our best-in-class used inventory procurement model to source and recondition a large volume of used vehicles in a highly cost-effective manner. Our ability to reposition vehicles within our nationwide network and our Driveway procurement technology allowed for optimal inventory levels throughout the quarter. On the new vehicle side, increased GPUs more than offset the decline in volume. Chris will be providing additional details on our same-store sales, inventory levels, and operational highlights in a few moments. Through our omnichannel strategy and expanding our network by acquiring new vehicle franchises, we have rapidly increased our size and scale, further growing our significant capital engine.
In the third quarter, we generated $530 million in Adjusted EBITDA, greater than any full- year in our history before 2019, providing us additional capital to deploy towards network expansion and Driveway, while also accelerating our continued exploration into adjacencies. The robust customer demand we saw in the third quarter was driven by high levels of household savings, government subsidies, lower interest rates, and increased equity in trade-ins. Elevated demand and margins are likely to be sustainable into the next few quarters due to the continued strength from these drivers, coupled with tight new vehicle supply and accelerating miles driven as consumers return to work and continue to travel using their vehicles. As our industry transitions towards electrification and more convenient and empowered mobility solutions, LAD will anticipate and adapt to execute and proactively lead this change.
Our plan to reach $50 billion in revenue and exceed $50 in EPS by the year 2025, from here on referred to as our 2025 Plan, was designed with these and other consumer trends in mind. Lithia & Driveway's full lifecycle offerings and adjacencies are evolving to respond to changing preferences. Beyond the Lithia & Driveway channels, our complex, expansive, and difficult to replicate design that we have incrementally unveiled over the past 15 months today includes GreenCars, the foremost educational marketplace for sustainable vehicles, a quickly growing fintech Driveway Finance, growing fleet and leasing operations, and a Canadian presence to establish the seeds for international growth longer term. We look forward to continuing to share further elements of our design and how our digital solutions can be applied to similar mobility industries and further adjacencies to create a broad-based, highly diversified, multi-sector disruptive company.
Our traditional Lithia business are now evolving their offerings. Given our decentralized culture and belief that our stores know their local markets best, they operate as local brands with the autonomy to implement e-commerce solutions that meet their customers' needs. When designing our omnichannel strategy, careful consideration was given to the existing end-to-end digital solutions that many of our Lithia stores' omnichannel offerings already utilized. While continuing to grow these Lithia experiences, LAD established Driveway as a unique independent brand with dedicated leadership, engineering and marketing teams developing proprietary software and a complete life cycle of in-home experiences to attract incremental consumers to LAD. This also provided consumer solutions that are broader and lower- cost than any of our used-only e-commerce retail peers.
In conjunction with the acceleration of consumer demand for in-home retail experiences, we are seeing the massive benefits of having consumer optionality for both Driveway and Lithia in-store and online experiences. Our initial design and early learnings from Driveway continue to guide and expand how our Lithia businesses interact with consumers. While our attentions were turned to Driveway's completely incremental revenue growth, we've been remiss in sharing that our Lithia business continues to provide digital experiences through its 300- plus local, regional, and Lithia websites. For the third quarter, these Lithia websites and associated online shopping experiences connected with 11.5 million quarterly unique visitors. These Lithia e-commerce customers accounted for 36,600, or 25% of all units retailed in the quarter, and simply estimated at $5.9 billion of annualized revenues attributed to the e-commerce portion of our traditional Lithia channel.
These Lithia e-commerce sales are in addition to Driveway's growing successes that we will share in just a few moments. To put this into perspective, these e-commerce sales as a percentage of monthly unique visitors represents a 0.32% or what we call a golden ratio. This performance level is similar to other established digital-only used retailers. To further illustrate the strength of our omnichannel strategy, when our LAD total sales are compared to unique visitors from all channels, our golden ratio is 1.46%, nearly 5x more successful than our digital used-only peers. Lastly, it's important to note that we are not incurring incremental spending on our store's e-commerce tools as we are leveraging third-party vendors similar to our new vehicle franchise peers' e-branding efforts.
Though we are pacing significantly ahead of our 2025 Plan, we remind everyone that our revenues have experienced drag from inventory constraints and earnings are greatly inflated from vehicle margins. Finally, we are pleased to report that every channel and adjacency is considerably ahead of plan. We remain humble and mindful that the elevated earnings levels of the past few quarters are driven by factors outside of our control and remain poised to capture every possible revenue and margin available to us in this market. As a reminder, the 2025 Plan assumes a pre-COVID business environment, margins, and growth rates. Internally, we view the 2025 Plan as a base case, and our leaders are focused on taking our execution to the next level and delinking $1 billion of revenue to produce more than $1 of EPS.
Key drivers of this are no further equity capital raises, meaning no further dilution to EPS, leveraging our underutilized network to support a two to three times increase in vehicle sales, and four times increase in parts and service sales through the existing network. Further improvements in personnel productivity, economies of scale in marketing from national brand awareness, an investment-grade credit rating to reduce borrowing costs, and most importantly, further adjacencies with higher margins and structurally lower SG&A costs. The adjacency we're furthest along with is Driveway Finance or DFC that has experienced rapid growth since expanding in spring of 2020. During the quarter, DFC originated 6,200 loans and now has a portfolio of $530 million.
We are planning to enter the ABS term market by the end of the year, which will allow us to quickly and profitably scale future consumer offering and lending volumes. Important to note is that a loan originated with Driveway Finance earns three times the amount earned when we arrange financing with a third-party lender on a fully discounted basis. We believe that Driveway Finance can penetrate 20% of our financed retail unit sales. This percentage is lower than used-only peers' finance companies as subvented leases and finance contracts with our manufacturer captives will always account for a sizable portion of our new and certified businesses. The frontloading of our M&A provides a larger base for Driveway Finance to draw from and increases the potential contribution above what our current 2025 Plan includes.
We are excited about the continued growth of Driveway and the interest and engagement it's seeing from our consumers. Driveway generated over 530,000 monthly unique visitors in September, a 68% increase over June. 96% of our customers were incremental and had never transacted with Lithia or Driveway before. Monthly shop transactions increased 86% during the quarter. Strong Google and Facebook reviews and a Net Promoter Score of 90 indicate Driveway is building an online reputation for exceeding consumer expectations for a fully digital, frictionless experience. We recently launched Driveway marketing in Las Vegas and Phoenix, our 9th and 10th markets. Continued improvement in our existing markets improved our overall Driveway golden ratio, even with the early dilution from these two new markets.
We anticipate entering further new markets soon and remain on pace to expand to nationwide marketing by the end of next year. To support consumer demand, we accelerated the opening of our third Driveway care center in Dallas, which occurred in September. In addition, we have ramped hiring at all three time zones' care centers and believe we are well-positioned to support the increased volume of traffic we expect to see in the coming months. Driveway is on track for its 2021 target of 15,000 annual transaction run rate exiting December. Looking forward to 2022, we are forecasting 40,000 transactions with a 2.2 to 1 sell to shop ratio. Driveway's dedicated management operation engineering and marketing teams are continuously testing and learning as they enhance the Driveway website and consumer experiences recently deploying another powerful new feature.
Driveway now offers consumers the ability to sort by distance. This enables consumers to see which vehicles are in the closest proximity to them and delivered the fastest with the lowest or no shipping fee. This new feature will decrease delivery times and increase our golden ratio. Viewing our dealership's omnichannel tools and Driveway together, we are well-positioned to retain our existing dealership customers by interacting with them in new ways that are aligned with their ever-evolving preferences. Additionally, we believe our digital infrastructure will enable us to conquest market share from competitors that lack the resources to invest in technologies and or nationwide network or choose not to commit to a transparent, empowered, negotiation-free experiences to effectively attract incremental customers. Acquisition growth, the backbone of our strategy, continues to expand our physical network to support all of our business lines, whether in- store or in- home.
In our future state, we expect our optimal physical network to be approximately 500 stores across the U.S., placing us within 100 mi of all U.S. consumers. This enables us to offer timely, convenient and affordable in-home solutions while realizing the economies of scale that will come from a nationwide footprint and brand. While several large deals were announced recently, the automotive retail industry remains highly fragmented and unconsolidated with the market share of the 10 largest groups at only about 10%. We have nearly $1.5 billion in annual revenue commitments, as well as over $12 billion in the pipeline, which excludes our peers large transactions. We remain confident in our ability to find deals that best fit our regional network strategy and are priced at our disciplined 15%-30% of revenues and 3-7 times EBITDA.
This ensures we meet our after-tax return threshold of 15% in a post-pandemic profit environment. Lithia & Driveway are known in the industry as the buyer of choice, obtaining manufacturer approval, timely and certain closing of transactions, and retaining over 95% of the employees. During the quarter, we completed acquisitions that are expected to generate $1.7 billion in annualized revenues, and year to date, we have completed $6.2 billion. Included in the total, we made our first international acquisition, partnering with Pfaff Automotive in Canada. With a strong presence in Toronto, Canada's largest market, we are excited to have Chris Pfaff and his high-performing team join us. In addition to its stores, Pfaff operates a leasing business, furthering our learnings of synergistic adjacencies. We also expanded our U.S. footprint, particularly in the Southeast region 6, entering the Atlanta, Georgia, and Mobile, Alabama markets.
In closing, we are acutely focused on executing our omnichannel strategy designed to continue our track record of earnings and revenue growth for decades to come. Though our plan may seem complex, our fast-moving and hyper- proactive team with multiple decades working together is ready for any challenge or competitor. We have grown exponentially while maintaining industry- low leverage of around 2 times for nearly a decade. With our various channels meeting customers wherever, whenever, however they desire, we are well-positioned to gain share, outperform the market, and exceed our 2025 Plan. With that, I'd like to turn the call over to Chris.
Thank you, Bryan. Entering the final quarter of 2021 with another record year already behind us, our store leaders continue to challenge their teams to embrace the future, evolve in all business lines, and achieve the 2025 Plan. This includes ensuring that our 22,000 associates continue to lead the digital transformation of automotive retail in their respective markets while exceeding customer expectations, increasing market share, and improving profitability. As most of you are aware, our manufacturer partners were impacted by microchip shortages and struggled to supply a sufficient volume of new vehicles to meet customer demand during the third quarter. As a result, same-store new vehicle unit sales decreased 3% in revenue and 14% in units, consistent with the nationwide SAAR decrease.
We were able to offset the decreased volume with higher total variable GPUs, averaging $7,446 in the third quarter compared to $6,082 in the second quarter of 2021 and $4,754 in the prior year. As of September 30, we had a 24-day supply of new vehicles on the ground, which excludes in-transits. While the new vehicle day supply environment was challenging, our 58-day supply of used vehicle inventory exiting June 2021 positioned us well for the third quarter, where we saw a 40% increase in revenue on a 13% increase in units. Our 1,000+ procurement personnel did excellent work sourcing vehicles, enabling us to offer customers a wide spectrum of vehicles meeting all levels of affordability.
We currently sit at a 48-day supply of used units and anticipate we will be able to continue to mitigate pressure on the new vehicle supply by maintaining solid used car comps and strong profitability. In the third quarter, we sourced 74% of our used vehicles direct from consumers, such as trade-ins and off-lease, where we as top-of-funnel franchise dealers get first look at the used vehicle inventory pipeline. Only 26% of our vehicles were pro-procured from other channels such as auctions, other dealers or wholesalers. During the third quarter, we earned $3,897 in gross profit on used vehicles sourced from customer channels, which turned in an average of 33 days.
For used vehicles sourced from other channels, on the other hand, we earned $2,696 in gross profit per unit, and those turned in an average of 51 days, which again demonstrates the benefits of an omnichannel strategy for Lithia & Driveway. Our expanding physical network of new vehicle franchises and the benefits of Driveway allow us to offer the most diverse inventory in North America. We offer vehicles that meet all affordability levels, with the largest number of both manufacturer-certified pre-owned vehicles and those priced under $10,000 or over 10 years old. These vehicles also turn the fastest and yield the highest margin percentage.
Additionally, our internal dealer trade network, which creates an opportunity for our own network to have first shot at the 100,000 units we wholesale annually, allows us to cost effectively move vehicles to better match supply and demand and increase our retail versus wholesale mix. Turning to parts and service, same-store revenues increased 7.3% over last year. The growth was distributed across all business lines except warranty. We anticipate a continued tailwind benefiting service into 2022 as the substantial losses in the miles driven rebounds and well positions our highest profit margin business line. With SG&A, we are focused on improving productivity of our personnel, targeting investments in marketing and further leveraging our fixed expenses. These actions will improve our gross profit throughput when margins subside.
We believe that these actions reduce our normalized SG&A levels at least 300 basis points below pre-COVID levels or to approximately 65% of gross profit. As our teams prepare their 2022 annual operating plans, they remain hyper-focused on executing to ensure top- line growth is aligned with further productivity improvements that result from our investment in the omnichannel model, wherever, whenever, and however customers choose. These efforts, along with our exploration of adjacencies, translate to significant potential to increase leverage and drive additional profit as expected in our 2025 Plan. With that, I'd like to turn the call over to Tina.
Thank you, Chris. For the quarter, we generated over $530 million of Adjusted EBITDA, a 104% increase over 2020, and $304 million of free cash flows, defined as Adjusted EBITDA plus stock-based compensation, less the following items paid in cash: interest, income taxes, dividends, and CapEx. We ended the quarter with $1.7 billion in cash and available credit, which, if deployed to support network growth, could purchase up to $6.8 billion in annualized revenues. As of September 30th, we have $3.8 billion outstanding in debt, of which $1 billion was floor plan, and used vehicle, and service loaner financing. The remaining portion of our debt primarily relates to senior notes and financed real estate, as we own over 85% of our physical network.
Our disciplined approach is to maintain leverage between two and three times as part of our commitment to obtaining an investment-grade credit rating, which would be another sizable competitive advantage once obtained. As of quarter end, our ratio of net debt to Adjusted EBITDA is 1.25 times. Our capital allocation priorities for deployment of our annual free cash flows generated remain unchanged. We target 65% investment in acquisitions, 25% internal investment, including capital expenditures, modernization, and diversification, and 10% in shareholder return in the form of dividends and share repurchases. Earlier this morning, we announced a $0.35 per share dividend related to our Q3 performance.
With capital raises completed earlier this year and elevated free cash flows generated as a result of the current environment, we accelerated our investment in Driveway and DFC, incurring over $50 million in SG&A and capital expenditures year-to-date. The personnel costs for our over 500 associates who support the scaling and continued build-out of Driveway and DFC, the marketing investment for Driveway, and IT development costs are current period headwinds, and most importantly, support the build-out of our future state and provide the foundation for a new generation of incremental profitability. We are well- positioned for accelerated disciplined growth on the path toward achieving our plan to reach $50 billion of revenue and exceed $50 of earnings per share by the year 2025. This concludes our prepared remarks. We would now like to open up the call to questions. Operator?
Thank you. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your headset before pressing the star keys. Our first question is from Rick Nelson with Stephens. Please proceed.
Hi. Thanks. Good morning. Congrats on a nice, another nice quarter.
Thank you
Wanted to ask you about new car inventory in 24 days supply at the end of the quarter, you know, carry us, you know, where we go from here. Do things get tighter or do we start to build inventory levels? Your confidence, I guess, in the fourth quarter, you know, that some of the trends we saw in Q3 can continue into the fourth quarter?
Sure. Sure, Rick. I do believe that those trends should continue into the fourth quarter. I think we're looking at a few more quarters of strength, but I also know that a lot of this is gonna be dependent upon what happens with the stimulus packages. Because if they renew those child credits, now all of a sudden we have, you know, more income in that middle income and lower- income pockets, which could be a catalyst for continued demand for maybe throughout 2022. Chris, do you have some specifics for us?
Yeah, Rick, good morning. I mean, I think part of this is the line of sight on inventories is still a bit murky, and, you know, we're kind of, you know, day by day, manufacturer by manufacturer, on kind of what's going on. You know, as you said, we had a 24-day supply, which was actually up one day from last quarter. However, you know, our day supply uses a 30-day look back. When you're looking at that trend, we have, you know, declining sales volumes, which, you know, would indicate that a 24-day supply isn't apples to apples when you compare to last quarter. You know, obviously, more inventory in the pipeline is great.
The flip side of that is we do have a 48-day supply of used vehicles, and I think the benefits of being a top-of-funnel franchise dealer when it comes to used cars is really evident when you see the massive sales comps that we had, you know, up year-over-year at 18% in volume and 40% in revenue, you know, are some of the benefits that we see that we can kind of outrun, outpace, you know, some of the trends that we're feeling across the industry right now in new cars.
Thanks for that color. Also like to follow up on the F&I. We've saw big, nice uptick there per unit, you know, despite a mix shift away from new toward used. Curious about that and how will Drive DFC, Driveway Finance is impacting F&I per unit or how you expect it to impact in the future?
All right. Yeah, Rick, this is Chris again. Good morning. You know, as far as F&I is concerned, I mean, this has been a focus that we've talked about for the last several years, obviously lagging some of our competitors as far as where those F&I trends came out. We continue to see the progress of focusing on people, process, products, and obviously our comp plans around you know, driving that performance up. You know, we are seeing some benefits from you know, obviously the economic indicators that Bryan mentioned in his prepared remarks as well as valuations that are coming in in used vehicles that give our customers a chance to invest in you know, protection products that support their vehicle purchase.
As far as Driveway is concerned, you know, we're seeing probably about right now as they ramp up their business, somewhere around a $50 per unit impact on the overall finance transaction. You know, as they continue to see record revenue, record deals coming into the Driveway Finance portfolio, we're confident that over time, you know, the benefits of having a captive company, a captive finance company, are definitely gonna outweigh, you know, some of the headwinds that we're seeing right now today.
Great. Thanks very much, and good luck as we push forward.
Thanks, Rick.
Thanks.
Our next question is from Ryan Sigdahl with Craig-Hallum Capital Group. Please proceed.
Good morning, guys. Congrats on another really strong quarter.
Hi, Ryan.
Curious about M&A. You guys talk confidently about, you know, a lot of opportunities still out there, and it seems like your peers have followed suit, rather late, but a lot of increased activity, multiples going higher there. Does that change some of the negotiations you guys are having and the confidence in continuing the M&A at good valuations?
Yeah, Ryan, this is Bryan. I think most importantly, let's keep our eye on the $20 billion that we set out to achieve in the 50/50 plan, okay? Now referred to as the 2025 Plan, where we were really targeting to get to that 500 store locations to be able to deliver services and products to consumers within about a two-hour or about 100 mi reach. That's our ultimate goal. We're very fortunate that we were able to book almost $10 billion worth of revenue over the last 15, 16 months at very attractive multiples in that middle of our 3-7 times EBITDA range. Now we're looking at multiples in especially those two larger deals that were, you know, close to probably double on a pre-COVID or a post-COVID multiple range as to what we paid for those assets.
I think what you know about Lithia & Driveway is that we're very disciplined, okay? We have enough in the funnel that we can still find the gems in that, you know, in the opportunities of now around $12 billion, and that's assuming that the two major deals close with our two-peer group and wish them the best on that.
Then on GPU, it seemed like Q2 was exceptionally strong and things couldn't get better, then you trump new by well over $1,000 into Q3. You mentioned strength in margins continuing for the next several quarters, you know, lack of new inventory, that's obvious out there. Do you think these Q3 levels are sustainable, or is it kind of a blend between the two? Any kind of directional help would be helpful.
I think as Chris mentioned, we believe that we've troughed in terms of inventory and probably at least 50% of the manufacturers , and you know, the remaining 50%, they're troughing, you know, either now or in the next 30 days. We really believe that once inventories start to return, that we should be sitting at, you know, I would say more like Q2 levels and maybe at some point even Q1. It's really hard to predict. I mean, we could have never predicted another $1,600-$1,700 in margins and $7,400, you know, new vehicle margins, including F&I are, you know, now pushing, what, 16.5% total margins on new. That's pretty massive when pre-COVID we were flirting with, you know, just below 10%.
You know, it is, it is somewhat supply-based, but we would also say and remind you that this is a demand-based dilemma that's being caused more than anything. Day supply isn't really an indicative measure of what margins are gonna do long term because we have many manufacturers we've run at these 20-day supply levels for decades , and you know, the margins aren't there. in the short term, yeah, there's the disconnect, but hopefully we can constructively, you know, have lower day supply, but it doesn't translate into automatic substantial profit increases.
Nice job, guys. I'll turn it over to the others. Thanks.
Thanks, Ryan.
Thanks, Ryan.
Our next question is from John Murphy with Bank of America. Please proceed.
Hi, John.
Hi, good morning, everyone. This is TT Fletcher on for John Murphy. Sorry.
Hi, TT.
Thank you for taking my questions. Hi. I guess to start, you guys have kind of touched on this a little bit, but how much of the diverging performance on new and used same-store comps do you attribute to your increasing focus on the used vehicle market and your various initiatives like Value Auto versus typically new vehicle consumers shifting down into the used given the pervasive inventory shortage?
Sure.
You think is more kind of a structural shift versus more transitory?
Sure. TT, this is Bryan again. I think it's important to remember that in the Lithia & Driveway procurement model, we specifically focus on channels of procurement that are a little different than most. We actually hit I would say that is the major driver of our performance is those that can find the vehicles and recondition the vehicles are gonna be the ones that are able to expand their same-store sales at a greater rate. We actually hit an all-time high and procured 74% of our inventory directly from consumers, and much differently than maybe a used-only retailer that we had 58% of our vehicles coming from trade-in. We had another 6% come off lease, and another 10% come from a private party.
Probably the most important thing that we look at is we also had a low ever in auction procurement, which is only 13% of our mix. Chris had mentioned that the importance of the consumer channels is that we don't have to transport cars and pay auction fees both directions. We make about $1,100 more in that channel on that three-quarters of cars, and you can relate that. Now, in terms of what was Driveway's influence on the overall business. Okay, whether it was the shop or sell functionality is important to keep in mind that the sell functionality or creating more inventory is another channel that we haven't really explored until nine months ago. That's quite attractive. We would attribute about 20% of our volume in same-store sale increases coming from that channel at the current time.
Okay. Got it. That makes a lot of sense. Then just a last housekeeping question. Is it fair to assume that the non-cash unrealized loss on investment in the quarter was Shift? Was there any realized or cash loss on investment? How do you think about the nature of that investment over time, whether it be core or non-core to the Lithia & Driveway business model?
There was a large adjustment that was based off the value of Shift of what they traded at, as well as we had a possibility to get other shares of Shift. The stock, the performance of the company didn't reach the level. We basically just adjusted that balance. Tina, anything to add on that?
No, that's correct. It's related to valuation of Shift tied to the stock price. As Bryan mentioned, we had some shares that were held in escrow that didn't meet the performance metrics.
Okay, I understand. Thank you. That's all for me.
Thanks, TT.
Our next question is from Chris Bottiglieri with the BNP Paribas. Please proceed.
Hey, everyone. Thanks for taking the call.
Hi, Chris.
Yeah, I wanted to ask, Hey, Bryan. I wanted to ask about the used business. Your 13.5% used unit growth and two-year CAGR at 9%, I see like the market seen. Can you give us a sense for how that fared monthly throughout the quarter and into October? Has it been relatively consistent? Has it been volatile? Just related, your inventory levels are still pretty strong, but not as strong as they were in Q2. Do you feel good about-
I feel good.
Yeah
We saw consistency throughout the quarter, Chris. And exiting the quarter, even though we're a 10-day lower supply, if you take the increase even quarter-over-quarter, our used car sales were up considerably. That actually 30-day look back, when you take that into account, our actual static inventory numbers were about the same as they were exiting Q2, which we like, and we're continuing to buy more. October's looking pretty good. You know, I would remind everyone that our quarter-over-quarter look back versus 2020, that was a good quarter. It's not we stopped talking about 2019, which was really for that one quarter of Q2 when we had half a quarter where we were basically shut because of regulatory closures.
Gotcha. That's really impressive. My next question is, when you seem to be scaling Driveway, making a lot of incremental investments too, you know, of the $50 million, can you give us a sense for, like, what the split is on SG&A and CapEx? Separately, if I heard you correctly, it sounds like you're becoming more confident in the level of structural cost takeout. It seems like at least 300 basis points of improvement versus pre-COVID. Just want to make sure I heard that correctly. Two, kind of maybe just speak to, you know, what's making you more confident. What are you seeing in the business that's making you think like some of this is structural and that when or if inventory ever normalizes, you'd rather, you know, retain at least the 300.
I think most importantly, Chris, this is an investment in our future in a channel that's growing. Of the $50 million, about one-third or $15 million of it was actual CapEx. The remainder is those 500 associates that are, you know, that we're building into our future for. You know, we think it's the right investment, including the expansion into Phoenix, Arizona, and Las Vegas, Nevada, which is now our 9th and 10th markets because we did see two of our markets. Our initial two markets, Portland and Pittsburgh, have one has actually reached the 0.15 golden ratio, which was our next level of scaling. The other one's trajectory looks eminent in the next month or two. We felt it was an appropriate time to expand that.
We are somewhat fortunate that we are in a hyperinflated gross profit environment, which allows us the flexibility to expand that business at a probably a little more rapid rate than we initially expected, you know, 15 months ago.
Gotcha. Okay. Thank you for the time. Appreciate it.
Thanks, Chris.
Our next question is from Rajat Gupta with JP Morgan. Please proceed.
Oh, hey, great. Thanks for taking the questions. You know, just had a question on, you know, the M&A environment and just capital allocation in general. You raised, you know, $1.5 billion or so in May, you know. You still have a lot more acquisitions to do, you know, just to finish that capital that you raised. Given what you're seeing in the LOI, and you know, what you've closed so far, how quickly do you think you need or how urgent do you think is the need to deploy all of that capital that you raised? If you're not finding the right deals at the right multiples, would there be other sources where that capital or would that capital go into some other uses? I had a follow-up. Thanks.
Understood, Rajat. This is Bryan DeBoer again. Obviously, we spend about two-thirds of our capital on the network strategy and the growth of M&A. We had 107 or what, $1.7 billion remaining of the approximately $4 billion that you mentioned, off of the two capital raises plus internal cash flows, which were way more than expected. We do have about $1.5 billion contracted, okay, or under commitments, which is about a third or a quarter of the amount that we would need if we deployed 100% of the $1.7 billion. As Tina Miller mentioned, it's about $6 billion that we could buy with the $1.7 billion based off what we've been paying traditionally. I would also say this, Rajat, we're pretty disciplined at what we do, okay?
The network strategy and what we pay is hyper important to how we value things. If we look at those, maybe those two larger deals that we were active on but maybe not as aggressive because we didn't believe that the network strategy was as good for us as maybe it was for one of our peers, and we wish them all the best in that as well. I think that our ability to deploy the remaining what, let's say about $1.2 billion, probably takes us two to four more quarters.
The environment may change a little bit but also remember that transactions aren't just about how much you pay, it's about what you provide the teams that exist there and what those dealers or those sellers are really looking for their culture and for their succession to achieve the things. Remember, Lithia & Driveway has been an experienced M&A company for the last two decades. It is a core value of our company, okay. That $12 billion that's in the pipeline; there's a good chance that there's plenty of volume there to at least achieve that $6 billion over the coming quarters and years or the remaining $10 billion that we have in the 50/50 plan.
Got it. It looks like M&A is still like the number one priority in terms of the use of that capital.
Absolutely.
I had a question on the 36,600 e-commerce units. Could you just baseline us on like how do you define that transaction?
Sure.
Of the transaction being done online or, like, one part online?
Sure
Just to make it comparable maybe versus some of your peers. Thanks.
Rajat , and I apologize to everyone, this is something that we just assumed was part of our business. When we did the design six years ago, we were at about a 5%-6% of our total volume at that time, and it's since grown through our own proprietary solutions or partners like Roadster, a model that provide end-to-end solutions. The way that we're looking at this is that's digital funnel engagement that created a sale, okay? Much like what we do in Driveway or much like any of our e-commerce retail competitors do. We just had discounted it and said, all right, it's just part of our business, when it's really not. It is a digital e-commerce channel. It's just not aggregated under one umbrella like it is under Driveway.
It's all e-commerce business in the 300 local and regional brands as well as the Lithia direct brand.
Got it. The consumer is not necessarily doing the full transaction online there.
Well, wait.
The sale of the car.
Rajat, let's remember this, okay. The consumers at our competitors that are e-commerce retailers are not either or they wouldn't need 13,000 employees to be able to sell those cars. Remember the funnel efficacy. We're seeing 7% of our consumers in Driveway that are happy path. Remember, that stay within the technology the whole way through, and that's a 100% savvy e-commerce solution, okay. Keep that in mind. Remember this also, that because of this equity, a lot of transactions require human involvement, whether it's through chat, or whether it's through email, or phone calls, to be able to do that. I can sure share if anyone would like some of the Driveway numbers as a comparison to our traditional Lithia channels.
Got it. Just one last one, you know, on the 15% approvability, you know, for financing. It seems a little below, you know, versus what you heard from other peers. Maybe it's not like for like, but what's the customer credit mix that you're seeing there? Is that something that's coming in the way also? Can Driveway Finance help you to reduce that?
Sure
Friction or just help, you know, increase that approvability rate?
Sure. Rajat, there's a difference between 15% approval rate and 7% actually buy rate, okay? Meaning that consumers actually carry forward with the approval that was given them, okay? Keep that in mind. I don't want to confuse any anyone there. In terms of our funnel efficacy in Driveway, we are seeing that the average consumer, and I would also comment a little bit on Driveway Finance Corporation's influence in just a second. The Driveway consumer is averaging exactly 50 points lower on their FICO score. They're at 671 versus a 721 in Lithia. I would accredit that primarily to new car customers, okay? That is a difference that most consumers believe or have the financial wherewithal to be able to buy new, okay? Which will have a higher credit spectrum, okay?
We did finance a higher percentage of customers in Driveway at 75%, and only financed 67% of Lithia customers. There is a little bit of a difference there. Now, in terms of what we would call our golden ratio that we talk about all the time, what we do notice is there is a difference. When we get to the ABS market in the next few months, it could allow us to portfolio lend, okay? That basically means that you're lending at not a one-to-one lending. Meaning you have standards that you lend on, and that individual customer has to meet that standard or not. If they're not above it, they don't get approved, okay? What some of our competitors do is what's called portfolio lending.
Meaning that if they got three customers in a row that were above the standard, and this is just an example of four customers, and one that was below that standard, that one other customer gets approved, okay? That's called portfolio lending, where you're a broad-based lender. We don't technically do that today at Driveway Financial, but we're building the API and the software. It's one of our two major roadmap initiatives on the technology that will require some back-end funneling to specific lenders. If we choose to keep that loan directly in the Driveway Financial, we'll have the ability to do that. It is something that does allow the funnel efficacy from finance approvability to be improved at a pretty dramatic pace.
Remember, Rajat, you have 30 lenders that are API, but remember, it's a one-to-one lending, so you still have that dilemma, okay? I will also say this, there's a different way that people seem to count, okay? What you're getting is pretty raw numbers from us as to how we would look at it in an equitable way from a traditional retailer standpoint like we do at the Lithia business that you're traditionally used to.
I understood. Great. Thanks for all the color and good luck.
You bet. Thanks, Rajat.
Our next question is from Nick Jones with Citigroup. Please proceed.
Great. Thanks for taking the questions. I guess maybe I'll take a like a bigger picture view here or bigger picture question. You've talked about wanting to be around 100 mi, you know, from all U.S. shoppers. Once you kind of build out that footprint, how should we think about consolidation from there? I mean, how are you thinking about the strategy of consolidating the environment which you kind of touched on earlier that like top 10 maybe have 10% share. Once you have the footprint, you know, is there capacity across your footprint to increase volume?
Sure.
Continue to take share? I guess more broadly, do you think this can consolidate, you know, like maybe like auto insurance where top 10 are closer to 70% or 80%? Thanks.
Sure, Nick. This is Bryan again. I would say that the 100 mi is important to us because of the life cycle of the interactions with your consumers. Let's remember that. When we think about the 500 locations in the country, that gets us to about 3.5%-4% new car market share. We believe that with wonderful customer offerings that are providing solutions where, when, and how consumers choose, that that could be expanded. Now, I would also make this comment that our ability to get much past, I would say, 10% of U.S. market share on new is a little bit restricted by our manufacturer partnerships, which many have a 5%-7% of their national footprint.
If you assume that you could get two times the throughput through those existing stores, then you can get somewhere a little bit north of 10%. Remember that in all, both new and used vehicles in new, they're allocated. Manufacturers do control. It's not like you're greenfielding like an insurance business where the top 10 could get to 80% of the country. If each one of them got to 10%, in theory, but I don't believe that the marketplace is that unified that could ever really do that. Remember also on the used car side, it's all about inventory procurement, those that are further up funnel and have lower cost reconditioning are gonna be the ones that are able to capture more used car market.
Those kinds of go hand in hand to some extent. I could see a day where the top 10 own 20%-30%. Remember, that ability to get there with the manufacturers is all dependent upon performance and relationship with those manufacturers. It's probably fair to say that there's two or three of our peer group that actually are looking at that relationship as long-term, okay, and as collaborative by what they buy and yield performance levels that are in step and stride with those manufacturer partners.
Got it. I guess maybe a follow-up is, as you kind of get towards that objective of being around 100 mi from every consumer, then kind of M&A slows and presumably there's a lot more investment in Driveway and kind of the D2C approach. Is that the right way to think about what will happen?
Well-
Will that kind of naturally?
Yeah, Nick, let me share that obviously the adjacencies domestically can take some of the capital. Part of the strategy in Canada was to start planting seeds that you could now move internationally to be able to deploy capital as well. More importantly than that, we believe that there are opportunities to overlay our digital e-commerce strategies as well as our underlying network strategy into two-wheel mobility and to tractor trailer mobility and into farming mobility. As we begin to grow domestically, that's where you would have the same type of disciplines that are in automotive retail, which is the most proactive in terms of customer desirability. Could be overlaid into those three other industries at some point as well.
I think you'll see us start to plant seeds in those areas domestically because they are based off the same core business strategy, which is new vehicles disposing of the used vehicle through your network, okay? Then having the service body and parts operations much like what we have in new vehicle sales.
Great. Thanks for taking the questions.
You bet, Nick. Thanks.
Our next question is from Bret Jordan with Jefferies. Please proceed.
Hey, good morning, guys.
Hi, Bret.
Have you seen any manufacturer pushback at all on the consolidation? Obviously, you've done a lot. Some of your peers are ramping it up. Is there any conversation as far as or any more complicated conversations involved in the transfer of franchises?
No, there really hasn't been a change. I think that because most of our relationships with our manufacturers are contractual in what's called a framework agreement, that as long as you achieve their performance standards, you have the ability to grow to a certain level. I don't really see that as an impediment, and you know, to us or to others if they're able to get their performance to a level that's broad enough to be able to buy multiple brands, okay, which is usually the hangup when you're buying large groups.
Okay. Then I guess a question on the structural profitability change, you talked about, you know, historic new GPUs a little under 10. You know, I guess from a labor model, is there anything that sort of when you think about going forward in a normal sort of post-2021 environment, is the new GPU a couple 100, few 100 basis points higher forever? Do we, in a cyclical slowdown, go back to the old profit levels?
I want to define that in the 2025 Plan, it's very clearly that it goes back to old profit levels, but we will be updating that in the coming quarter, in February to April. I can give you a little color in some of the areas. There may be margin expansion. We probably won't predict margin expansion even though today the negotiation-free or fixed price models are generating approximately $600 higher sale prices than post-negotiated prices of negotiated dealers, which makes up 98% of the transactions. There is a case that could be made, but I believe, and I think our team believes, that as the world becomes more transparent and more business is transacted through e-commerce, that pricing becomes more transparent with that, which ultimately that gap will most likely go away.
If we're able to compete and buy cars at a lower price and recondition those logistically closer to our customers, then there are ways to be able to expand margins, and we'll be able to give you more color on that, but hopefully that gives you a tidbit of information. Chris, did you have something to add to that?
Just I mean, as a call-out maybe to our own team is that, you know, historically prior to these margin levels, our top 25% of our dealers were running at SG&A levels at where we're seeing things today on average. I think that our expectation is that, you know, as we continue to see margins, you know, return to normalized levels, our focus on personnel marketing and leveraging our facilities to maintain this level of profitability is something that, you know, we've called out 65% as kind of our midterm goal. You know, obviously, we'd like to see it better than that longer- term.
Great. Just a data point, I think in past calls we've talked about the geographic reach of Driveway, how far customers are buying. Do you have that number for the third quarter?
I do. In fact, it's 1 mi further than it was last quarter. It's 931 mi was the average distance. The average shipping fee was actually a little bit higher. It was $576 versus $561 last year. I would say that that continues to grow so long as there's shortages in new and used inventory, okay? Because it's something that we're really thinking about is there, as inventory start to build back, does that reach start to shrink a little bit again? One other piece of information that we do provide is that incrementally, new customers to Lithia & Driveway, it did drop 1 percentage point down to 96% from the 97.8% last quarter, and the quarter before that was actually 95%.
It's back to where Q1 was, which we're really pleased, and I think that's an important notation between our Lithia e-commerce business that has a good portion of repeat business. Our Driveway was specifically designed to get incrementally new customers, and that's holding strong even as we spread our wings and start to overlap with consumers that we've already touched once before. It truly is a new customer that is either needing financial assistance, okay, in getting the vehicle, the correct vehicle for them, or a consumer that's looking for more of a tech type of experience that's they're empowered, it's transparent, and the convenience of the in-home delivery.
Great. Thank you.
You bet, Bret. Thanks for the question.
Our next question is from Ali Faghri with Guggenheim. Please proceed.
Good morning. It's Ali Faghri from Guggenheim. Thanks for squeezing me in.
Hi, Ali.
I just want to confirm I got all the M&A numbers correct. You have one and a half billion in M&A under contract that'll likely close imminently. It sounds like $6 billion you think you can acquire sometime maybe over the next two-four quarters, and then a total pipeline of $12 billion. Do I have all those numbers correct?
You do. Other than the $6 billion, I don't know that that's. We said that we have $1.7 billion in capital that could acquire $6 billion. We're not giving the forward-looking as much anymore other than we believe that we need to add $20 billion-$22 billion in aggregate since the start of July last year, to be able to achieve that network coverage of 100. I would give you confidence that the $6 billion is probably fairly [realistic]. In the $12 billion, there's enough deals, and if you add the two large deals from our peers to the $12 billion, it's more than the $15 billion. We added almost $3 billion in the quarter to that pipeline to get to the $12 billion, which means the market is hyperactive.
There's good deals that are priced out there that either have opportunities or their earnings are similar to COVID levels in many of the parts of the country if they've had personnel problems or those type of things. I think we're always kind of looking for that diamond in the rough to be able to maintain that 15% after-tax return that we've so eloquently accomplished over the last couple decades.
Great. That makes a lot of sense. Just as a follow-up here on Driveway, you talked about 40,000 shop and sell units next year. Is the right way to think about that is the majority of that is incremental to your used car business? I think it implies roughly a 10% lift to your used car volumes next year. Just trying to make sure kind of how you think about those 40,000 transactions.
Sure. I think, you can assume that, the sell to shop ratio is about 2.2 to 1 that we're assuming, okay. Of the shop portion.
Those units will be about, I'd assume 90%-95% new incremental customers. Okay. Chris, did you have something to add on that? Okay. Thanks, Ali.
Our next question is from David Whiston with Morningstar. Please proceed.
Thanks. Good morning. Looking at the GPU between new and used, new was up about 81% on the same store basis and 7% for used, obviously at the time of great imbalance. Was there also maybe a conscious decision on your part on used pricing, or is it used just far more competitive? Just trying to understand the gap there.
Yeah. Good morning, David. This is Chris. I mean, going back to our operating model where we, you know, engage and expect each of our stores to make independent market decisions, it's kind of hard to generically just answer that we did something specifically from corporate on pricing. I mean, each of our stores is reacting to the local market conditions that they're seeing. I think across the country, you know, we're seeing, you know, obviously, you know, good margins in new and used and obviously, you know, a scarcity of new car volume, kind of driven more by domestics than luxury. Overall, those decisions are made at the local level, and we expect that to continue.
Okay. On, I guess a two-part question on inventory procurement. You talked about 74% of your inventory coming from consumers. Is there some extra advertising push that you're doing to get that high of a ratio? On Driveway specifically, how do you ensure that Driveway doesn't get left with the mostly undesirable inventory that the stores don't want?
Two things. Let's remember that Driveway inventory is the store's inventory, that they leverage each other. They would never get left with inventory that they do not want. In terms of our ability to procure cars through the three customer channels, that primarily comes from our ability to buy cars and the valuations that we provide. We don't specifically market in our traditional channel. We do specifically market in our Driveway channel. In fact, mid-quarter, we had actually curtailed the valuations that we were giving on trades, and it affected our sale-to-shop ratio lightly, okay.
We've now, I think, caught up with everyone else, assuming that, you know, the last quarter of the year and early into the first quarter, there is price drops that typically happen this time seasonally, and we're obviously being sensitive to the supply as well to be able to do that. We did adjust those pricing algorithms or valuation algorithms on our sale and Driveway, which does give some guidance into the field as well.
Okay. Finally, compared to, say, a few months ago or earlier this year, when consumers are coming in now, especially if they want a new vehicle, are they more willing to go used than they were a few months ago? Are they more perhaps the other way, more stubborn, saying, "I'm just gonna wait for this chip shortage to end," and they walk out?
We're very fortunate that we do have visibility into our pipeline, especially with the domestic manufacturers, where those cars are spoken for up to 90 to 120 days in advance. That pipeline is full. In terms of the transition from a new vehicle to a used vehicle or a used vehicle to a new vehicle, again, as Chris said, that's an individual decision by individual consumer.
When we look at it in Driveway, we do have those discussions with consumers because obviously a new vehicle has more margin in it typically, which you can see from our GPUs, that does help you deal with financeability on a consumer. Ultimately, as Driveway, you know, reaches national scale by end of next year and that type of framework, we will be converting consumers from used to new. At the current time, our technology isn't able to do that but should be able to by end of year or early next year, as we've disclosed in the past.
Okay. Thank you.
Thanks David.
We have reached the end of our question- and- answer session. I would like to turn the conference back over to management for closing comments.
Thank you, Sherry. I would make this comment. Hold on, we're just getting started. Again, thank you for joining us today, and we look forward to updating you on Lithia & Driveway's fourth quarter results in February, and also a little update on the 50/50 plan. Thanks, all.
Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.