Good morning, and welcome to the Lithia Motors Second Quarter 2020 Conference Call. All lines have been placed on mute to prevent background noise. After the speakers’ remarks, there will be a question-and-answer session. I would now like to turn the call over to Eric Pitt, Vice President of Investor Relations and Treasurer. Please begin.

Thank you, and welcome to the Lithia Motors second quarter 2020 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 futures 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, lithiainvestorrelations.com, highlighting our second quarter results. With that, I would like to turn the call over to Bryan DeBoer, President and CEO.

Thank you, Eric. Good morning and welcome, everyone. To begin, and as our local communities around the country continue to reopen and adjust, our priority remains to ensure the health and well-being of our team members, customers, and communities. We would like to thank our team members for their strength, adaptability, and courage they have demonstrated navigating the impacts of this pandemic. Earlier today, we reported the highest adjusted second quarter earnings in company history at $3.72 per share, a 26% increase over last year. These results were driven by strong sequential improvement throughout the quarter and all business lines culminating with used vehicle sales increasing 23%, and returning to the year-over-year growth levels experienced pre-COVID-19. Our rapid growth continues to be powered by people and innovation, and our teams remain committed to safely meeting customer’s needs through the entire ownership lifecycle while elevating the experience through affordability, transparency, and convenience. Our omni-channel strategy led us to another quarter of record earnings and a step closer to our recently shared five-year plan to [equip] $50 billion of revenue and $50 of earnings per share. During the quarter, we experienced one of the lowest monthly new vehicle sales in history, and not only maintain profitability, but achieved the strongest net income levels in our history for both May and June, with net income increasing 44% and 97% respectively over the prior year. As noted in our interim quarterly updates, with sequential improvements we recognized throughout the quarter concluded in June, with total revenues decreasing 2%, and total gross profit increasing 15% for the month. Our declines in revenue were offset by significant improvements in margins that Chris will speak to in just a few minutes. While we focus on executing each day, we are guided by our long-term vision, and will…

Thank you, Bryan. I want to start by recognizing our operational leaders who have lived our mission of growth powered by people and focusing on what they can control and identifying the levers that allowed them to persevere through these unprecedented times. Our team's ability to be agile and nimble lead us to solutions that continue to meet our customer needs safely and conveniently, resulting in one of the most profitable quarters in the company's history. With that, I'd like to discuss our same store quarterly results. For the three months ended June 30, 2020, total same store sales were down 18% led by a 24% decrease in new vehicle sales, a 1% increase in used vehicle sales, a 7% decrease in F&I revenue, and 21% decrease in service body and parts revenues. As previously reported, results improved throughout the quarter with total same store sales improving for June to a decrease of only 6% compared to the prior year. The new vehicle business line was down 24% for the entire quarter, but improved to a decrease of 13% for the month of June. For the quarter, our average selling price increased 5% and unit sales decreased 27%. Gross profit per unit increased to $2,625 compared to $2,095 last year, a $530 increase or 25%. Total new vehicle gross profit per unit, including F&I was $4,291, an increase of $685 per unit or 19%. At approximately $4,300 of gross profit per unit, new vehicles remained highly profitable with a 10.5% margin, similar selling cost per unit as used vehicles and inventory carrying costs that are subsidized by our manufacturer partners. Our OEMs have reopened their factories and adjusted plans to avoid any significant disruption in the availability of new vehicle inventory. As of right now, our stores are positioned with…

Thank you, Chris. For the quarter we generated free cash flows of $96 million. As a result, we ended the quarter with over $750 million in cash and available credit. Earlier this month, we completed an over $250 million syndicated real estate credit facility, bringing our total current cash and available credit to over $1 billion. As of June 30, we had $2.9 billion outstanding in debt of which 1.5 billion was floor plan, used vehicle, and service owner financing. A unique aspect of debt in our industry is the financing of vehicle inventory with floor plan debt. This financing is integral to our operations and collateralized by these assets. The industry treats the associated interest expense as an operating expense in EBITDA, an exclusive set from balance sheet leverage calculations. On adjusted, our total debt-to-EBITDA is overstated at 5.3 times, adjusted to treat these items as an operating expense our net debt-to-adjusted EBITDA is 1.8 times. Additionally, this week we filed an equity shelf registration statement allowing us to issue equity periodically at opportunistic points through various avenues such as an aftermarket equity program or a follow-on equity offering. This will allow us to expand liquidity options within our capital structure and ensure we have the necessary firepower to accelerate and execute our growth plan in any environment. In-line with our overall capital discipline, our intent is to issue equity if and when our share price meets our internal [hurdle rates] and deploy the proceeds quickly to expand our network and in an accretive way. Any offer we make under the registration statements or hurdle rates and deploy the proceeds quickly to expand our network in an accretive way. Any offer we make under the registration statement will be pursuant to a [indiscernible] strategy 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 3% increase in our dividend to $0.31 per share. As Bryan and Chris mentioned earlier, we are well-positioned for continued growth throughout the second half of 2020. We have over 1 billion in available liquidity to deploy in acquisition that meet our strategic objectives and internal hurdle rates. Additionally, in the upcoming year, we plan to pragmatically invest in modernizing the consumer experience through Driveway and building the teams needed to support our growth. Fundamentally, the diversity in our revenue streams growth plan, variable cost structure and continued consumer innovation allow us to be responsive to any economic environment, and position us well as we continue to drive toward our aspirational five-year goal of $15 billion in revenue and $50 of earnings per share. This concludes our prepared remarks. We would now like to open the call for questions. Operator?

Thank you. [Operator Instructions] Thank you. And our first question is coming from the line of Rick Nelson with Stephens. Please proceed with your questions.

Hi. Good morning.

Good morning, Rick.

[How] omni-channel is going to be a big driver to achieving these long term goals? Bryan, if you could provide, you know, more details around omni-channel, the major differentiators you see from franchise [dealers] as well as the online only platforms?

Sure, Rick, that'd be great. It's exciting. You are one of the few people that had figured out the Driveway name even before today, so congratulations on that as well. That was kind of [indiscernible] that people were able to find that URL over the last couple of months. I think the biggest delineation between Lithia Motors is that we look at the omni-channel strategy to be able to attract consumers by how they look at their financing, okay. And I think we've built a model that offers products that touch all levels of financing spectrum, as well as the associated vehicle inventory to match that, as well as the entire life cycle of the consumer, meaning that our ability to provide brand impressions to consumers on a semi-annual or annual basis through their service body and parts is our foundation of how we grew as an organization. I mean Lithia Motors grew out of a small town in Southern Oregon, began in 1946, and it was all about the loyalty and the relationship of the customer. So, as we designed our product, it was all about being able to attract consumers at all levels of the marketplace early in their buying cycles to be able to have them for the 50 years that they – or 60 years that they drive vehicles.

Great. So, acquisitions, obviously that's a, you know, big part of the long-term growth story here. Are you still looking for under performers? And can you describe the current environment for acquisitions [indiscernible] pipeline? Any call around that would be great.

Sure, Rick. I would say absolutely that value-based acquisition strategy is fundamental to who we are. I will say that we are looking in regions four and six, which is the lower Midwest, as well as the southeast, for business partners and people that have great consumer relationships. And in those instances, we do typically have to pay a little bit of a premium to be able to get those much like the Williams acquisitions in Tampa Bay. But the fundamentals of our value-based strategy are still there. When we think about $4 billion in acquisition revenue annually, it's very difficult to be able to buy that much value-based strategy, so we had to expand and open up those expectations to be able to buy higher performance as well to be able to achieve that targeted $4 billion. I would also say that the acquisition pipeline we announced, what, about 60 days ago now, that we had 14 acquisitions under contract, we've since announced three of those. So, we still have 11 that will be closing in the coming months and we look forward to them joining our team and expanding our network. The pipeline is still continuing to build on top of that. We have somewhere between $10 billion and $15 billion of revenues that are under negotiations or in discussions, okay. And it's really a matter of time and price as to whether or not we're able to accommodate the needs of those sellers and find the right fit for our network development as an organization.

Just to circle back on [driveway.com] [indiscernible] what is the timing to put inventory on the website and start transacting business? And is that going to be done gradually with all your dealers? Or is it all at once?

So, that's a great question. So, we plan on going live with the used vehicle revenue generation stream in Q4, and that should include a good portion of our inventory. We have about 25,000 used vehicles in stock. Our data science is showing that the current pricing that we have on our inventory that 88% of those vehicles will fit the driveway model, meaning that they will sell and clear within 38 days at the price that our current stores have those listed at where we're really expanding our reach as we go about that. We do plan on rolling our strategy out market-by-market and we've modeled into, what, Page 11 of our new investor deck that the roll-out plans are a three-year strategy across the country depending on how big or what that network looks like.

Thanks a lot, very exciting stuff. Good luck, Bryan.

Thanks, Rick.

Thanks, Rick.

Our next question is from the line of Armintas Sinkevicius with Morgan Stanley. Please proceed with your question.

Great. Thank you for taking the question. Congrats on the quarter and the announcement with some great detail here. A question around the core growth, you know, you mentioned a 10% CAGR here. You know, if I look at the same store sales over the last, you know, several years, you know, 6% in 2019, 1% 2018, 2%, in 2017, you know, can you provide us with the moving parts to get to that 10% CAGR for the core business?

Sure, Armintas. So, our model is actually at nine, just under we rounded it up. So, we looked at what you looked at and believe that our 2020 trend rate was pushing over 10% in regards to where we were at. We also are finding that best practices within our traditional core network is starting to gain momentum and I'm sure Chris can share some of that information in the following questions, but we are seeing that best practices in behavioral shifts within our traditional network is creating greater customer attraction through more transparent and simple experiences within the traditional channel as well. We thought it was still fairly conservative being that's what our run rate has really averaged to be able to model that in and it's something that we're pretty confident that we're going to be able to achieve. We also believe that we can achieve [65%] SG&A gross profit within the traditional channel and for those that are new to this – to the company, we were achieving that pre-growth. So about 50% of our business we've acquired over the last five to seven years and as most of you know that the acquisitions are of lower performing high SG&A of around 85% and it usually takes five years for those parts of the network to season, so we are at steady state. We really believe that a 65% SG&A is achievable. For the month of June, I believe we were at 57%, which is, where our – you know our benchmarked top stores really perform at and maybe provide the guiding light for us to be able to continue to find leverage within our cost structure as well.

Okay, great. And then on the Driveway side, the $9 billion by year five, you know, can you walk us through some of the key drivers to getting to that $9 billion?

Sure. So I would say the fundamental opportunity is the ability to procure inventory and our company has shown the ability to procure inventory, not only from trade, which about 50% of our vehicles come from trade and they generate approximately $1,200 higher front-end gross margin than vehicles purchased at auctions. We also get that new vehicle trade. So, we believe that competitive advantage in terms of cost can help us grow that portion of the business. We also modeled in an additional $1,000 per unit on top of the $300 traditional that we spend on marketing dollars. That combined with the SEO and SEM through the My Driveway Portal, we believe gives us a massive cost advantage against competitors in regards to going to market. So if we need to buy market, we have not only the $1,300 to be able to drive national branding or local branding, but we also have a lower cost to market for consumers to be able to compete in price, as well as the four other business lines that create massive margins to be able to fight in the battleground of used vehicles, which we really believe that's where any battles are going to be fought because there really is no barriers to entry to used vehicles. Whereas new vehicles and certified used vehicle service body and parts, where we play has massive barriers to entries because you have to buy a franchise. So, we like how we built the model and we believe that our ability to grow is really based of that ability to compete and procure inventory.

Great. Thank you for taking the question.

You bet, Armintas.

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

Good morning and congrats on the strong profitability and also appreciate the additional detail on driveway and the medium-term targets et cetera. First, I want to start just on Slide 11, you lay all kind of the targets for Driveway. It implies lower EBITDA margin, but better net margin [five years out] can you walk through the puts and takes of profitability in the core legacy dealership business versus online?

Sure, Ryan. I can give you a little bit of color on that. So within the Driveway channel, we believe that SG&A can get below 60%. I think we were at, what, 57%, 58%, Tina, in our model, okay. The key driver in differentiation is in the core model. We – our primary cost and SG&A is personnel costs at about $1,600 a unit and within the Driveway channel, we really have that going down to about $1,000 a unit or about a $600 savings, that is the primary cost difference within the model, okay. We will have to ramp up in Internet sales center, which we've had in Medford for the last 10 years or so, but that team will ramp up on a negotiation free basis as well, so that is part of the replacement of some of the personnel costs. We also have the VCEs or the Virtual Centers of Excellence in those three disciplines, but that takes some cost that we’ll be paying our personnel in the field for the expertise plus paying the expertise – the non-experiential knowledge in those [valets] or that lower cost functions that's customer facing to be able to achieve that leverage and those synergies within those channels. That's really the biggest difference on how we've thought about the logic and then there's nuances in marketing a little bit. And obviously, in terms of facility costs, we're only utilizing – if you extrapolate our 24 hours of availability in your shop space or your service department, we're currently utilizing about 25% of our capacity within our network. We're utilizing about 50% of our capacity in terms of storage for vehicle sales, okay. And if you comp that against some of the competitors, our actual physical network costs are running at about the same price per dollar of revenue than what our competitors are, but if you look at it on dollars per growth, our cost for our network is much lower than the independent used car retailers.

Good, helpful. And then, as it relates to, you know, Driveway, and then Shift is coming public, you know, SPAC merger, just anything you can share on what your plans are for your financial investments there, and then any current and future operational partnerships going forward?

Sure. So Driveway is entirely separate from Shift. Shift is a wonderful little company that we share best practices with. We share a portion of our network within – on the I-5 corridor and we look to continue with that partnership. We love what they've done and they've taught us a lot about what consumers are demanding and how to look at it in more peer sense. I think it was three years ago, we began to reinvent ourselves and think about how we could be more things to more people and began to talk about that strategy of going to market wherever, whenever and however our consumers desire. And I think Shift was a big part of us understanding that purity of what consumers are looking for and that modernization wasn't occurring at a faster rate as we really needed it to, internally, and I think we'll continue to be able to share those best practices and the execution of both organizations.

Great. One more for me and then I'll turn it over. So very tight supply of new and used vehicles going on right now, how do you feel about your current inventory levels by category? I know you talked a lot about kind of trade-ins and kind of how you procure, but how do you feel about your inventory today? Thanks.

Hey, Ryan, this is Chris. Good morning. You know, right now, I think from an inventory perspective on new, we feel like we do have some pockets of inventory that are very tight. We have certain inventory that we have plenty of and I think as you look at the production that's coming down the pipeline with manufacturers that are really trying to keep up with the demand that we're seeing based on the shutdowns that they had due to COVID, we feel like we'll have more normalized new car inventories in kind of August-September timeline, but for the most part, we have the inventory that we need to meet consumer demand. On the used car side, you know, with the increases that we've seen right now, I guess we'd say we could never have enough inventory because with the demand that we're seeing right now in our model, especially in that core and value auto product, which, you know, it's difficult to procure, we're really working to make sure that we backfill the improvements that we're seeing, especially in June with our new car – used car sales up 19% and make sure that we have plenty of used vehicles moving past August because we are, right now, positioned well for July and we're seeing great trends in used car sales in July.

Great. Thanks, guys. Good luck.

Thanks, Ryan.

The next question is from the line of Rajat Gupta with JPMorgan. Please proceed with your question.

Good morning, everyone, and congrats on the quarter and the launch. Just had a couple of follow-ups from the previous questions. You know, you gave us the economics of Driveway going forward, and you know, what the SG&A profile might look like. But just on the advertising side, I mean, you're roughly at $250 per unit steady state, you talked about $300 for Driveway. I mean, you have these online digital peers, you know, spending upwards of [$1,000, $1,500] per unit and like, how does – how do investors get comfortable that you will need to spend that much higher or your advertising expense might not need to move higher here in order to get that kind of growth because the $9 billion in five years just seem pretty aggressive from a CAGR perspective, so just curious as to like how you manage that spending? And I do have a follow-up. Thank you.

Sure, Raj. That's a great question. So, we might have got our wires crossed just a little bit, so we spend $300 in traditional advertising in our core business. We've throttled in our model the ability to add another $1,000 per unit or $1,300 a unit to be able to compete head-to-head with whoever we need to, that is in the model, okay, so remember that. The other thing to remember is our 5 million impressions that we currently have with our service body and parts customers annually. We believe that the efficiency of our marketing, because of the [ad curve] that we’ve built, which is basically a way to move us [up page] on search through impressions, which impressions are built off of the time people spend on your website. So, the My Driveway Portal will reside under the core traditional 190 local brands as our customer portal. So, the scheduling of appointments in service body and parts, the payments of service body and parts, the looking at your vehicle and the history of your maintenance, the pay-offs of your vehicles, when you look to trade it, our ability to communicate directly with the consumers is going to be done through that portal, which is all going to reside under driveway.com, okay. So, we believe that the efficiencies of our $1,300 may have a two to three magnitude improvement over what the efficiencies of other retailers may be because their impressions are really only relative to those shopping or those ended up buying. And if you think about when consumers buy, it's not very often, okay, and I think it's a key nuance on making sure that when you build a model, you have to be able to pay for things that yield returns in perpetuity rather than just buy a market.

Got it, that's helpful. And in – just in terms of the expenses or you've taken with regard to, you know, building out the platform, you know, just the [IT] infrastructure, and you know, related to that, is most of that behind you? Or I mean how do we expect that to lever up here through this ramp up phase?

Sure, Raj. So being a traditional retailer moving into a new channel of digital, we didn't really understand the ideas of capitalization of R&D and those type of things until a few months ago. So, about 60% of our costs before we get to an [indiscernible] state on our digital solutions is already spent. Going forward throughout the rest of 2020, as we finish out the [MVP] products of each of those different components, we will be capitalizing a fairly good portion of it, but you won't see impacts in terms of SG&A because the organization is growing at a fast enough rate and maintains cost control through our operational savvy to be able to ensure that this is not a cash burn or cash drain going forward.

Got it, that's helpful. And will we be getting like quarterly updates on revenue, profits from Driveway going forward? Or is this more – I mean, I'm just curious like is it going to be a different segment or like is it going to be intertwined with the overall company like how are you going to give us like details here going forward?

It's a great question, Raj. And I would say this, at some point, we may break out the individual revenues of Driveway, but at this stage, we really look at the 22% used car lift that we had pre-COVID and the 23% post-COVID now as seeing the improvements that are coming through sharing our best practices, as well as digital solutions. So it's hard to really delineate at this stage, but we're going to do our best to transparently be able to portray what's occurring within both channels, okay, and we'll work on that in the coming quarters to be able to share that. We would also share this with you, in terms of new vehicle margins as well, it's important to remember that though automotive new vehicle retailers show a 5% to 6% margin on very high dollar revenue products, we also make another 4.5% in F&I. So, our actual margins on the vehicles are 10.5%, including F&I and the only way to get the F&I is to sell the vehicle. So, for us, as we think about modeling or we think about the strategy, there is a nuance that new cars have to grow as well because it is the catalyst to be able to drive all the downstream business of trade-in certified service, body and parts. So remember that as you think about the strategy, we also produce almost 16.5%, a little more than 16.5% margins in used cars, when we include our F&I on those products as well because the cars that Lithia Motors procure and the model that we’ve built for the last 25 years is all about zero to 20-year old vehicles that are hyper scarce. It's not cars that new entrants into the space or digital retailers that are looking to grow revenues can afford to get because they're highly competitive. You have to get those as downstream. You have to have technicians and so on and so on to be able to do that. Just a little bit more color as to how you think about the aggregated model, Rajat, but we understand and we will continue to try to provide you insights as to how much each of the three channels of core network growth and Driveway are producing over the long haul.

Got it. So, I just had one last follow-up, you gave some color on, you know, the inventory situation and just how July was tracking, any quantification of like how the volumes have looked like here before used and new and just parts and service activity into the first three weeks here? Thanks.

Sure, Rajat. I know it's a really – it's a tough environment. There's no question and we had shared that we were really noticing that there was a direct tie-in with the shelter-at-home orders. And then, we noticed after that, that it was not just shelter and home, but it was severity of outbreak where we are seeing a little bit more severity across the country where it's broad spread. However, we are seeing similar to trends in July to what we saw in June, okay. I would also note that in service, we were down 2% in June. Keep in mind that we did have two extra days, so as you're doing, your modeling on service, we had two extra days in June, which you can probably kick back another 8% or so into that service that we were really down, probably 10% on a year-over-year monthly basis.

No, that’s super helpful. Thanks so much, and good luck.

Thanks, Rajat.

The next question comes from the line of Bret Jordan with Jefferies. Please proceed with your question.

Hey, good morning, guys.

Good morning, Bret.

Hi, Bret.

Could you talk a little bit about the AI strategy on used sourcing? I guess sort of, are you buying all of your used inventory with a system as opposed to the used manager at the dealership? And maybe what you're seeing from a conversion rate, you know, how many of your offers are being accepted by the seller?

So, sure. So, let me start by saying, we believe that used car procurements starts with heavy lifting, okay, that it's not something that you're going to be able to perfect in AI. We procure about 8% of our products from the channel of direct from consumer, okay. Because we're so far upstream, we can procure more inventory by being more aggressive in terms of our valuations on trade-ins and that is our primary focus. Now, in terms of our AI, we are seeing good adhesion. So when we make offers on vehicles, we're seeing about a 50% take rate, okay, once they get that offer, okay, and they can – we can do that directly in their home or they bring it into our fulfillment network to be able to procure that. We are only spending about $30,000 in the Pittsburgh market to be able to procure this -- $15,000 sorry, $15,000 a month to be able to procure those. So, we're spending about $300 a car to be able to procure, so that gets ramped up about three weeks ago as we launched the Driveway brand in Pittsburgh, which will be one of our two or three launch markets, okay. And for those that have followed us, the Pittsburgh market and barrel.com has been the shelter that we've been building that proprietary procurement technology, okay. So, the early stages are good. We are able to buy vehicles at a slight premium to what we're taking them in on-trade for, but we are able to procure more vehicles through that channel. I believe we moved from 6% to 7% or 8%. It's still minimal. Remember, 50% of our vehicles come off-trade, but as we begin to push those [same store] growth rates up, we'll have to be able to procure more through either AI or networking with Mannheim or ADESA to be able to track those vehicles or going directly to the rental agencies, which is an easy way to procure as well.

Okay. And I guess I think you said 80% of your current inventory will be posted on Driveway when that is live, or are [indiscernible] all of your physical product on that? Or will it always be a subset?

So 88% of our vehicles, we’re intending to show on Driveway, okay. We also are a company that believes in growth powered by people and making decisions closest to the customer and Chris and our group leaders have spent a considerable amount of time prepping the stores for the behavioral shift of their people not being involved with the sale other than as the valet, which is the lower experienced personnel that really just follows the word tracking that's provided on the workflow management systems, okay. So, it is a little bit different for them, but we believe that we'll have an 80% to 90% take rate on the stores because they do also have to commit to a seven-day return policy. They have to commit to a certain certification levels of 140 point inspection. They also need to commit to certain warranty guidelines plus they need to be part of the Driveway network to be able to be last mile in terms of the logistics of their valet, so they have to train valets to be able to do that, but we're way down the road on that and we're really pleased that the behavioral shift pre-COVID we thought might take us two to three years and there is why we had a three-year roll-out built into our model. But with COVID coming into play, the behavioral shift in stores and that belief by store personnel that consumers are demanding something that is more convenient and more transparent is creating incremental growth in used cars even within our traditional network even pre-full roll-out, okay. So, we are seeing some nice lifts in that environment.

Okay, great. Thank you. And then one housekeeping question, you talked about cost reductions during a pandemic and [indiscernible] some that would be permanent, is your SG&A experience on the recovery that is consistent with what you were seeing earlier as far as ability to [indiscernible] costs out as volumes come back?

Yes, good morning. This is Chris. I mean, I think the whole, you know, SG&A improvement that we saw in the quarter, you know, culminating with a 57% SG&A growth in June, as we talked about, is really a testament to the variable cost structure that we have in our stores. And then, as our empowered GMs in every single market based on what's happening with them, you know, based on market demand, are really working to maximize revenue and growth, so move as much volume as they can and obviously minimize the cost. So, I think the level step that we saw as a result of some significant changes that we put in place as a result of the massive drop in volume, you know, going into March and April, it is sustainable and we are seeing that, you know, as of June 30, we're about 20% down in overall headcount still from where we were in March, and you know, you're seeing a 6% drop in revenues. So, you know, our stores are well aware that their largest SG&A item is personnel. The next one is advertising. So, managing those two levers as we move into a recovery and start to see new vehicles come back online, parts and service come back online, and continue to maintain the benefits that we have with our used car volumes right now is critical. And as we move forward, the target, you know, in SG&A, the gross percentage close to 65%, which we've talked about for years, I think it seems a lot more attainable in the near term than maybe it did last year when we talked about it.

Great, thank you.

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

Good morning, guys. Just a first question on Driveway, and I'm just curious what the automaker response has been because I mean, in some ways, I mean, this makes – you know, it seems to make a lot of sense and seems to be a great driver of growth, but it could be interpreted as sort of running into franchise [indiscernible] sort of hurdles or potentially even the framework agreement hurdles on the new vehicle side. Obviously, that wouldn't be the case necessarily for used or parts and service, but just curious if there's any kind of response either positively or negatively from your automaker partners?

Hey, John. This is Bryan again. I think our plans consider our framework agreements and the magnitude of those. We have no intent to step over the national brands or world brand of our manufacturer partners; that is number one. It is key why the 190 currently local brands exist and will continue to exist. We do intend to use the My Driveway Portal as a way to communicate with our consumers, okay. We're fortunate that 70% of our manufacturers also allow the utilization of a national brand within our branding or naming of our dealerships. We don't have intent to change all the names of our stores. We don't believe that that's crucial because ultimately the relationships that we have locally with our consumers is what drives the success of those stores, okay. So, we do think that it could be one or two of each brand or possibly someday one in each of the six regions that could also distribute new vehicles within those brands that accept it, okay. Only 30% of our manufacturers have issues regarding the use of national brands. And at some point, even those manufacturers have relaxed those standards in the event that your network is built out, okay. Also keep in mind, in terms of the six business lines, new vehicles, there's only one component. We currently also sell certified vehicles, as well as the service business, which is the top of that repair chain, which allows us to capture the maintenance business for the life of ownership of that customer, okay, which are crucial elements that are usually not as big of issues with manufacturers, but we will obviously respect that while we still continue to build strength within those manufacturer brands because ultimately, it is about loyalty and retention within those partnerships with our brands and we're pretty good at adding that value. And I think most of our manufacturers really look at Lithia Motors as a company that’s added value for them as well, okay. So everything that we plan on doing will add value to the partnership and not just be for adding value to Driveway or Lithia.

Yes, I mean, I guess their minds sort of bent a little bit in the last downturn with the – you know the allowance of that national branding by all the mass market not [the lux guys]. So, it just sounds like their minds are bending a little bit more here because you're representing the brands well and servicing the customer well, so I'm just curious if they, you know, have responded and said hey, listen, this is great idea. We appreciate the partnership or not yet. I'm just curious if there hasn't been any OEM response specifically on these efforts yet that you've heard.

Right, John. So, we have heard from one of the three brands that does not allow national branding and they've been very accommodating regarding using a slogan or a Driveway experience under the name or in your marketing to be able to still push that in-home experience, which is the most important part that we're really trying to accomplish is to be able to go head-to-head with entrants that are providing in-home solutions, whether it's, you know, a direct-to-consumer new vehicle manufacturer or new entrance into the used car space. I would also say this, manufacturers are pretty comfortable that our inventories today reside on CarGurus, Cars.com, and TrueCar, okay. So that's already something that's out there. So, their perception of it could be more around the idea that they're getting more exposure for their brands and we imagine that marketing is pretty expansive and it's how bigger reach can you get and it's just one channel to be able to expand the reach of that inventory.

Okay, that's helpful. And then just on the equity shelf that Tina, you know, discussed. I'm just curious how much of that, you know, could be used, you know, to fund M&A and keep owners of maybe large or even smaller groups involved on the equity side and participation like, you know, deals used to get done in the past. I mean, I think it's a little bit less than that now, but it sounds like that may come back into [vogue with] what you're working on. So, I mean that you’re selling the dealership but still participating in potential upside, could these get that equity shelf kind of indicate that we're looking at that and it, you know, might not just be just to raise capital and pay somebody in cash, but actually to pay some groups in equity.

Hey, John. This is Tina. You know, for us the equity shelf was just a good move to be able to have that opportunistic, you know, avenue out there for us as we think about, you know, how we want to execute on this growth plan and how we want to expand the business. We wanted to keep the optionality out there. And, you know, from our perspective, we're looking at all of the different internal hurdle rates, you know, as we look at it, and you know, we will continue to be disciplined it is tied to how we continue to grow the business and want it to be an accretive, you know, source of capital for us to continue to grow.

But that equity issuance, Tina, would be specific to a transaction or would that just be to build, I'm not [indiscernible] that would be to just raise cash to have a war chest to go out and make acquisitions? [Indiscernible] would these deals be very – equity issuance be specific to an actual deal?

I think, you know, it will follow our overall capital policy, right. I mean, if you think about where we spend most of our capital to deploy, it is on acquisitions and, you know, we have to keep that balanced.

Okay. And then just lastly, on the front-end grosses, they were over $4,000 in the quarter, which is really great. And I think you mentioned in June, they were over $4,400, which is quite fantastic. I'm just curious, you know, what levels you think are sustainable on those front-end grosses going forward? But I think in the second quarter of last year, it was $3,600, which is very good too. But, you know, over $4,400 in June is fantastic. I mean, how much of that is sustainable? And how much of that can you – you think you can control?

Yes, good morning, John. This is Chris. I think, you know, when you look at what's going on in the market right now, we're seeing like record incentives coming in from the OEMs, which obviously help us for a down payment with consumers and the structure, you know, the right deal for customers. You're seeing historic interest rates. You're seeing the [cap position] of consumers higher than it's ever been. A lot of folks that were, you know, planning to do big vacations this summer are deferring those vacations, which is giving them capital to put down into, you know, what we're seeing in some of the demand that we're seeing in new and used cars, you know, credit availability has never been higher. Our banks that went through the last recession understand that the risk of default on auto loans is very low. And so, I think all of those things have been really a catalyst for us to be able to, you know, with lighter supply, you know, keep our margins high. I'd like to say that we'll keep it as long as we can. And if the market stays strong, that's possible. But I think some of this is outside of our control. And we're going to do what we can to hold the line on margins as long as possible.

I'm sorry, one last one, let me take it on the used side. The strength in used vehicle demand has been, you know, phenomenal, it’s driven pricing up, it’s driving volume up. I'm just curious, you know who you're seeing there. Is it sort of through the income spectrum, or is anything sort of unique to the time and place that we're in right now just trying to understand the sustainability there, and just how broad-based, I mean we hear anecdotes of, you know, $10,000 or less vehicles being incredibly strong if we're trying to get off public transportation, but then, you know, limited supply of new vehicles. So, just trying to understand, you know, that, you know dynamic of that what appears to be very strong use vehicle demand across the spectrum, if you're seeing anything unique, you know, that explains it and how sustainable you think it will be.

Yeah, John, it's Chris again. I think when you look at the quarter, our value auto sales were down about 6%, our core product was up 5%, and our CPO units were actually down 12%. And so, I think the demand that we're seeing is really in that core product, which we've talked about for quite some time, it's the most difficult to go out and buy, but we've had a heavy focus, you know, way prior to COVID on, you know, getting our stores empowered to run out and use the five channels, now six channels to procure more used cars, and try to mirror more of the national used to new ratio of 2.3 to 1 when we're sitting at 1 to 1 today. So, I think if we can keep, you know, procuring vehicles, finding new channels to acquire more used cars, outside of just typical trades on new and used cars that we sell, we think we can continue to generate a flywheel on used cars that's going to continue to, you know, grow for quite some time, as indicated in some of the models that we laid out in the investor presentation.

Great, thank you very much, guys.

Thank you. Our final question is from the line of David Whiston with Morningstar. Pleased proceed with your questions.

Thanks. Good morning. First on the quarter, is it fair to say the big SG&A improvement was primarily due to less headcount?

Yeah, David, Chris. You know, we saw in the quarter a 20% reduction in our personnel cost, but we actually saw a 40% reduction in our ad spend as well. So, I'd say those two things that have typically been the main drivers of SG&A kind of worked hand-in-hand to bring down our SG&A to growth and much of that we hope is sustainable under the third quarter.

Okay, and in terms of this hyper growth plan laid out, your net debt adjusted EBITDA is quite low, where are you comfortable taking that for the right deal?

Hi, David, this is Bryan. So, we actually look at it to remember in the core, we're only talking about high single digit growth, which is where we've been. In terms of network development, the purchasing of acquisitions, that's a lot of the lift of where it comes from, which is something that we've done in the past and then when you move to the Driveway channel, it's about procurement and really a growth rate similar to what new entrants into the used car space have experienced, but we also have new vehicle revenues that can be pushed through the Driveway channel as well as service and parts business. So, I think as you keep – as you think about that, that's a lot of it – SG&A improvements are going to come from top line improvements. So, we are looking at a 57% SG&A in the Driveway channel and 65% in the core, as well as the network growth channel.

Okay, and on the – I think the slide say 3 billion to 5 billion acquired revenue annually, you talked about 4 billion on the call today, that's a huge number from what you guys have done even with DCH. I mean, is this coming more just from a huge quantity of deals relative to the past, or also so much bigger targets? Because it just, it doesn't seem there's that many large, really large groups out there, but you know, the market way better than I do.

David, I see what I see what you're asking. So, let me let me jump back real quick and clarify, you were asking about leverage not in terms of expenses in terms of balance sheet. So, our model is, shows leverage between low 2s to as high as 3.0. And we hit that in year three, it assumes the capital need for about $900 million in terms of equity at some point when it's constructive, and it matches acquisitions. So that is how we’ve built that and that keeps our leverage intact. Everything else is from free cash flow; a generation within the model, which is massive as we begin to build that momentum. In terms of size of acquisitions, this will be a combination of [staple diet] or value type investing, which now most of the organization and there's probably 20 to 30 people, whether it's general managers, group leaders or corporate staff that are working on that level of acquisitions. So that is always there, we have mid-sized groups between 500 and a $1 billion in size. And those things over a billion dollars in size, it's really a matter of our ability to constructively aggregate and find partners that believe in our strategy and believe in the network development and the ability to leverage the driveway brand name across the United States or possibly even someday in the future, moving into other English speaking countries.

Okay, thank you.

Thank you. At this time, I'll turn the floor back to Bryan DeBoer for closing remarks.

Thank you, David. Hey, thank you, everyone for joining us today. We hope each and every one of you remain safe and we look forward to updating you again on our third quarter results in October and sharing other incremental information as we continue to roll out our strategies, our Driveway strategies over the rest of this year.

Thank you. This will conclude today's conference. Please disconnect your lines at this time. Thank you for your participation.