Good morning, and welcome to the Lithia and Driveway's Fourth Quarter 2020 Conference Call. [Operator Instructions]. 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 LAD or Lithia and Driveway Fourth 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 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 full reconciliation to comparable GAAP measures. We have also posted an updated investor presentation on our website, lithiainvestorrelations.com, highlighting our fourth 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. Earlier today, we reported the highest fourth quarter earnings in company history at $7.02 per share. Adjusted fourth quarter earnings were $5.46 per share, an increase of 85%, eclipsing last year's record $2.95 per share by a wide margin. Tina will provide details on the pro forma adjustments in a moment. Our full year adjusted EPS was $18.19, a 55% increase over last year's $11.76 per share. These record results were driven by an acceleration in our acquisition engine, including the purchase of nearly $1.8 billion in expected annualized revenues during the fourth quarter, underpinned by strong operational performance in our core business. We saw continued gross profit strength in new vehicles, revenue growth in used vehicles, normalizing of fixed operation sales and leveraging of our cost structure. Combined, we grew revenue by 3.6% for the year in an industry that was down over 14% and continue to carry the momentum and focus into 2021. Now that our unique strategy and associated 50-50 plan are well underway, we look forward to utilizing our strengths of execution to continue to establish Lithia and Driveway as the consumer channel of choice. I want to start by congratulating our LAD Partners Group, or LPG winners, for their exceptional performance in 2020. Recognition as an LPG member is a highly coveted award and represents the pinnacle of our mission, Growth Powered by People. Though high performance resides throughout LAD, these stores demonstrate a relentless and elevated focus on culture, customer experiences and continuous improvement to create impressive results. We aspire that all locations within our network rise to a partner level. Thank you to our entire team and well done in 2020. During the quarter, total revenue grew 21% and total gross profit increased 30%. New…

Thank you, Bryan. As we enter 2021, our Lithia operations team continues to build on the success of last year and find ways to exceed customer expectations, increase market share and improve profitability. The demand from our consumers for both in-home and in-network solutions continues to grow and has shifted the mindset of our teams, which includes accelerating the adoption of Driveway throughout our network. Our store leaders are also challenging their teams to maximize performance by setting individual departmental goals to achieve their 2021 annual operating plans or AOP. These AOPs are a key foundation in defining the specific actions necessary to continue to drive the highest levels of performance throughout the network. Following is a discussion about our quarterly results and is on a same-store basis. For the 3 months ended December 31, 2020, total same-store sales increased 3%, driven by a slight increase in new vehicle sales, a 9% increase in used vehicle sales, a 4% increase in F&I revenue and a 3% decrease in service body and parts revenues. The new vehicle business line increased slightly for the entire quarter and improved to an increase of 4% for the month of December. For the quarter, our average selling price increased 6% and unit sales decreased 5%. Gross profit per unit increased to $3,023 compared to $2,263 last year, a $760 increase or up 34%. Total new vehicle gross profit per unit, including F&I, was $4,814, an increase of $897 per unit or 23%. At approximately $4,800 of gross profit per unit, new vehicles remain highly profitable with an 11% margin. Similar selling cost per unit as used vehicles and inventory carrying costs that are subsidized by our manufacturer partners. For used vehicles, we saw a 9% increase in revenues for the quarter. Gross profit per unit…

Thank you, Chris. As Bryan mentioned earlier, our fourth quarter unadjusted earnings per share was $7.02 compared to an adjusted earnings per share of $5.46. The difference was related to $1.19 unrealized gain in our investment in Shift Technologies, which went public in the fourth quarter through a SPAC transaction, and a $0.41 gain from the sale of stores as we continued to optimize our network. These gains were offset by acquisition expenses of $0.04. For the quarter, we generated nearly $250 million of adjusted EBITDA and over $123 million of free cash flow, defined as adjusted EBITDA plus stock-based compensation less the following items paid in cash: interest, income taxes, dividends and capital expenditures. As a result, we ended the quarter with $1.4 billion in cash, available credit and unfloored new vehicle inventory. In addition, our unfinanced real estate could provide additional liquidity of approximately $471 million for a combined $1.8 billion of liquidity. As of December 31, we had $3.9 billion outstanding in debt, of which $1.9 billion was floor plan, used vehicle and service loaner financing. The remaining portion of our debt is primarily related to the financing of real estate associated with owning over 85% of our physical network. 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 and EBITDA and excludes this debt from the balance sheet leverage calculations. Unadjusted, our total debt-to-EBITDA is overstated at 5.1x. Adjusted to treat these items as an operating expense, our net debt to adjusted EBITDA is 1.8x. This means we could add over $900 million in additional debt, which equals acquiring $3.6 billion in annualized revenues…

[Operator Instructions]. Our first question is from Rick Nelson with Stephens.

I wanted to ask you, Bryan, about the acquisition pace and pipeline. It sounds like you've got $3 billion lined up soon to close. The release and the call today, it sounds like $7 billion in acquired revenue might be a more realistic expectation of 2021. If you could clarify that, that'd be helpful.

Sure, Rick. This is Bryan. I think first and foremost, we did a fair amount of acquisitions in 2020 and actually had a record year in terms of growth from -- in our network. But we expect 2021 to be much more robust than that. And as you mentioned, we do have $3 billion under definitive contract. We completed the almost $2 billion that we had previously announced on our Q3 call and our offering calls. As well as on top of that, we have additional transactions that are now in the under LOI state. And the $7 billion to $10 billion bucket of revenue that's in negotiations are priced right, it's still sitting out there. So we do think that it's going to be a historic year once again. And I would remind everyone that Lithia's practices historically have been that we don't confirm or deny acquisitions until they're completed. So a little bit different than many people do but we think it's usually best for our network and the people in our acquisition or partnerships to be able to stay focused on their customers during any transitions that occur.

Great. Curious about the approval process on acquisitions, how that's going. Are there any major challenges that you're coming up against with the OEMs?

Yes. Great question, Rick. It's Bryan again. I think if you think about the track record of almost, what, 2.5 decades now of being public and being acquisitive, we have had definitive agreements on 254 transactions over our history and we've completed 251 of those. So somewhere around 99% success rate, which would give indications of our ability to gain manufacturer approval. But our experience in that arena and partnerships with our manufacturers are strong and really don't have major limitations during any of the next 5 years or 50-50 plan, which gets us into about 3%, 3.5% new car market share. We're still only at probably 20% to 30% capacity of what the restricted manufacturers that have national limitations would allow us to get to. So keep that in mind that, that's not really an issue, but also remember that one of the major differentiators of Lithia's model has always been to buy value-based investments that underperform. And you can always refer to what we have on Page 20, which shows the lift in new vehicle sales, which shows the lift from below-average performance to above-average performance in terms of owner loyalty and retention. And I think that bond with our manufacturer partners has always been viewed as Lithia and Driveway as being a high-performing company that they want to buy stores and add value to the experiences for their consumers.

Great. Finally, if I could ask you about digital penetration, where that stood in the fourth quarter and with this rollout now to these major markets, where you see that going in 2021?

Sure, Rick. Bryan once again. If we think about the fourth quarter rollout of our digital initiative or Driveway, which is an in-home e-commerce solution, really, that didn't go live in an end-to-end solution until the -- towards the end of the quarter so there's no real material results in that sense. I will share with you that January was our first full month of having sell-and-shop functionality on Driveway in an end-to-end solution. And we did see almost 300 transactions in that first month. Now I would also caveat that in that, we are still hyper early stages. I mean I think it's important to remember that we're in the iterative state where not only our care centers are learning but our engineers are learning and iterating each and every day. And we're adjusting and have already had 2 releases in 2021 that's added functionality or modified workflows for the consumers or for our valets to be able to adjust things. So keep that in mind as we think about our actual results in those arenas. We are expecting in 2021 to have about 15,000 transactions in both shop and sell in the Driveway application. So -- and we're well on our way to be able to establish that. Lastly, in terms of the market rollouts, some of you may recall that we were discussing being in 6 of the -- 5 or 6 of the top 10 markets by the end of 2021. We now will be in 4 of the top 10 markets by April, okay? Hyper important acceleration of the strategy that came from demand from the network, okay? And also the ability to procure more used cars as well as sell those vehicles through either channel, okay? And we will have 12 major markets now released by the end of 2021. We think that may still be a slightly conservative number because a lot of what we're asking is just to be able to accelerate the level of valet services rather than having 1 or 2 in each store that we have today. We're asking to have a full robust valet team because the marketing dollars, when we do those 12 major market rollouts, we have to beef up the valet services in those markets because marketing dollars do attract consumers more readily within that specific locality or within that region. And obviously, we'll be -- have good density in every region really other than Region 3, which is the upper Midwest and a little bit of light coverage still in the Southeast, which is Region 6 for us.

Our next question is from Rajat Gupta with JPMorgan.

Just had one clarification and a couple of follow-ups. On the SG&A to gross, if I heard correctly, did you say it is expected to be around 67% for 2021? Was that -- did I hear that right?

Yes. Hey, Rajat, this is Chris. Yes, that's exactly right. What we're seeing right now is really a tailwind from the incremental gross profits that we're seeing on new and used vehicles, given some of the supply constraints that carried through the quarter. And so when we anticipate and look forward into 2021, I think normalizing some of the gross profit margins that we expect to see, that's going to put some pressure on our variable cost structure, which then, by in turn, means that we're going to see an increase in our SG&A to gross. And so for us to outrun the increase in expenses that will come -- or increase the SG&A to gross calculation, we'll have to see about a 5% lift in gross on a same-store basis, just to keep parity at that 67%, and we're going to work hard to do that.

Got it. And this does not assume or take into account the $3 billion that you expect to close in early 2021, right? Or does that take -- is it inclusive of that?

Rajat, this is Bryan. No, it doesn't include future acquisitions. That's just a base and the acquisitions that we did last year, okay? And what we've been kind of saying is that, that 67% is really our jump-off point for the remaining 4.5 years of our 5-year plan, where ultimately, in the 5-year plan, we get to low 60 percentile SG&A, okay? And that will come through each of the different channels, performing at certain levels, ultimately with the core getting back to that mid-60 percentile range that it was in 2014 and 2015 before we began to accelerate acquisitions with lower performance. Now on the new acquisitions, most of them are performing in the 65% to 70% range, about 3/4 of them. So we are buying higher-quality businesses than what we typically had or had been purchasing in the past. So keep that in mind, where there's only 1/4. They're really those value investments that start out in the high 80 percentile SG&A, and it takes us 4, 5 years to get those really into the sub-70 percentile range.

Got it. That's useful color. And then I had a question on just the used vehicle side of things. The overall volume growth decelerated here in the fourth quarter. You gave some numbers in December. Could you help like just break that apart in terms of like what's the linearity was through the quarter for the used vehicle business? Were there any specific pockets which were more weak, like California or Oregon that might have that number? And then anything you can give us on now how 2021 has started for you would be useful.

Sure, Raj. I think it's important to note that we always balance volume with margins and what supply chains we see in the future. So we do sit at a 65-day supply in used, which is about the same-day supply as we were last year. So our procurement externally to the e-commerce engines as well as with our 500, what we would call, the virtual center of excellent buyers of high-quality used cars, are doing their jobs to get cars in line. And it's really looking at the marketplace and deciding whether you're going to achieve a little bit higher same-stores rate or whether you're going to hold it in terms of margin. And our stores appear to still be choosing to hold margin because though we were up 9% in revenue on a same-store basis in used, as you noted, we were basically flat in unit volumes in a market that was down a little bit. So we think it's still the right answer. We are getting that lift through our e-commerce strategies and we'll continue to see that. But ultimately, we do balance those two initiatives. I will also say, through the quarter, we did see a lapse for almost 2 weeks that started on about November 20, okay, which is right before Black Friday and Cyber Monday, where the wind came out of our sales, and it was primarily due to California and the Northeast going back into lockdowns, okay? So that did affect things and we were fortunate that moving into the early parts of December, that we were able to carry the strength in the quarter to get back to those levels. And I will say that in January, we were up nice mid-single digits, high single digits in both new and used, which is a big comp relative to the fact that COVID really started in March of last year. So if we can start to lapse comps in January and February at those levels, we're going to see nice results moving into the rest of 2021, where the comps are quite nice for Q2 and Q3, where sales were off and service was off pretty substantially.

Got it. That's helpful. Just one quick last one for me on the SG&A side. Just specifically on marketing, ex acquisitions, like will you be able to quantify the amount of dollars that we should expect in terms of just year-over-year or related to Driveway that you're looking to -- looking to spend, also keeping in mind the fact that you're accelerating some of the market rollouts here. That's all for me.

I'm going to let Chris answer that. But I'd also note that if you think about our January volumes, we were coming up, January and February, they were up 22% year-over-year from the previous year in same-store. So to be able to lapse the 22% comp in this kind of market in January, we think, is quite impressive and is right on target with what we were hoping while still having a lot of wind at our back in terms of the vaccinations coming out and stimulus packages. Chris, do you want to answer his specific question on...

Yes. I mean related to marketing, I'd just say that we're spending about $22 million a quarter on a same-store basis, and we picked up about 153 basis points in SG&A to gross benefit. And as we said, as we start to see competitive -- the competitive nature of our inventory come back and -- which is going to drive up pricing, especially on the digital side, we anticipate going up probably about 10% or so in our ad spend on a same-store basis through the rest of the year. So...

Remember, that's in the Lithia channel as well, okay? In terms of the Driveway channel, we're -- that's got its own budgetary standards that are specifically tied to the volume levels that we achieve in Driveway to fulfill our promise that we're going to make sure that every incremental sale in Driveway is incremental EPS. So keep that in mind as well as you dissect the strategy and your planning.

Got it. Got it. So the 10% increase includes -- or does it exclude the Driveway spending? Or that fixed that into account, the total same-store spend, right, and that will include Driveway?

Raj, that's same-store so that would not include Driveway, okay? That's just our existing store base. So our budget for 2021 for Driveway is about $10 million, okay? With the acceleration of the rollout, it does require us to be able to get the Driveway brand name out and to be able to really sell, shop, sell and service and the holistic approach to in-home, e-commerce, transparent, empowered buying solutions, okay? But we believe that the volumes are going to be there in both shop and sell to be able to create enough additional incremental lift to be able to get there. But you know what? Just like always, we'll balance that and ensure that we're effectively doing that.

Our next question is from Nick Jones with Citigroup.

I guess I'd like to drill in a little bit more on Driveway. Is -- I guess the marketing, is that largely brand advertising? Are you -- do you have more kind of lower funnel targeting in mind? I guess can you help me understand how Driveway is going to get marketed to be incremental versus cannibalizing people who otherwise would have gone to the dealership?

Nick, this is Bryan again. So it is a combination of holistic brand marketing as well as targeted by shop sell and service, with the focus on shop and sell primarily as the service componentry will be driven by F&I subscriptions as well as the network converting to in-home fulfillment over the next 2 years, okay? So when we think about those marketing budgets, it's specifically by those 12 markets, major metropolitan areas in the country where we will specifically be pushing SEO and SEM within those markets. Our web crawlers will be attached to those marketing dollars to ensure that our keyword searches are there as well as our organic, which includes the MyDriveway portal will be driving that -- those marketing dollars to make them as effective as we possibly can, okay? It is about $1,300 a unit that we're assuming, which is the majority of our 57% SG&A costs within our Driveway strategy. So it is a lot of money, okay? And we -- but we plan on having it be effective. And so far, in the Portland and Pittsburgh market, it's been hyper effective and we've been able to build brand traction. Lastly, I would say that by having those 12 major markets in all 6 of the regions, we should have a, I'll call it, a semi-national presence that at the end of '21, our brand name should be out there to most of the population, okay, meaning that there will be awareness on the brand and the offerings as well as the guarantees and the effectiveness of the Driveway solutions. So we think that it's a good strategy. It's a way to ensure that it's incremental because Driveway isn't branded through the Lithia network. It's branded independently as an e-commerce solution. And I think…

Great. Can I ask a follow-up then, maybe just on the SEO component? So if most of the cars are kind of staying local, how do you kind of build an advantage in SEO versus maybe companies providing nationwide industry selection, and then also kind of having an upper funnel content strategy, which drives more organic traffic? So I guess maybe there's two parts. Kind of one, like is the SEO optimization in-house, are you outsourcing that? How do you get leverage kind of nationwide if most of the cars are staying local because that seems like that would limit kind of the SEO capabilities.

Nick, let me go back through some -- so everything is done in-house, okay? So remember that. All of our engineering is done in-house, all our web crawlers are built in-house. We've done everything from scratch. Today, we have 90 engineers sitting in our Driveway innovation center up in Portland, okay? So more importantly than that, we need to go back to what is inventory and what are consumers buying, okay? If you think about the scarcity of a used vehicle, okay, and why I say that 80% of vehicles stay within a 100-mile reach, okay, is for a reason that those vehicles are plentiful, okay? And they may move further than that today because the world isn't that efficient or flat or transparent. So people could be looking for a transparent experience and they don't have 1 in their local market. So they may buy what's called a lower mid-demand scarcity car, okay? Whereas our inventory is much scarcer. In fact, 78% of the Lithia and Driveway inventory today is over 4 years old. It's 4 years and older, okay? It's much different than our used car e-commerce competitors that have a lot of 1- to 5-year-old vehicles. We believe that even in the 1- to 5-year-old bucket, those aren't scarce vehicles. So if a consumer can find those, they can find 50 to 100 of them within a 20-mile radius. Why would they pay to ship a car? Because everyone is charging now logistics costs for some range, okay? So when we thought about our logistics pricing, we basically said within 100 miles, it's free, okay, from the vehicle. And remember, our inventories are more distributed, okay? And then we basically charge an extra 2 99 if it's within the region, which could be up to 400 or…

Our next question is from Ryan Sigdahl with Craig-Hallum Capital Group.

Just wanted to dig in on Driveway a little bit more. I know a lot has been asked, and I know it's early on the new side as well, a few weeks here. But anything you can dissect out of that on kind of buying interest, conversion rates, et cetera, on new vehicles on Driveway versus used?

Sure. I'd love to, Ryan. This is Bryan again. I think first and foremost, if you go back to the discussion that we just had with Nick about scarcity, new cars are the same everywhere, okay? So let's remember that. Now there are scarce products in every product line, whether it's a Toyota Tacoma or whether it's a Jeep Wrangler, now a Ford Bronco or other products, there is scarcity that occurs that can create a more disparate distribution of vehicles, okay? But ultimately, new vehicles don't have that ability to have a lot of demand outside that reach. So it is going to be more about what we would call affordability, okay? And that affordability, we believe, will be the catalyst for expanded reach in new vehicles, okay? Our affordability is primarily driven off the fact that 85% or so of the consumers on new vehicles finance, okay? Our ability to now have leasing, which you can go online today on Driveway and you can perfect the lease and it's all done automatically, okay? And that's something that we are the first to have. Leasing affordability in most mainstream cars is about 60% the monthly cost of what purchasing is because the leasing value helps cut into that payment because you're not responsible for a good portion, the leasing value of the vehicle. So you have that advantage, which we believe that leasing is an instrumental part of affordability, okay? And you will find that we will be pushing leasing over the coming quarters as well as captive manufacturer financing. So new vehicles are sold and financed about 50% of the time by the captive manufacturer, primarily because of incentives or subvented interest rates, okay? And those subvented interest rates, everyone has the same basic model, it's just how…

Sure. Yes, that's helpful. And then just one follow-up for me. You talked quite a bit about financing, et cetera. You mentioned, I think in your prepared remarks, you want to grow kind of your in-house captive financing fintech to 20% of your Driveway transactions? Did I catch that right? And then can you remind me what your percent of kind of captive financing is today out of your brick-and-mortar?

Sure. So that was 20% of our entire business stream, okay? Now our manufacturer partners, our captive finance companies with our manufacturers are hyper important to our relationship, and they give you the subvented rates, which are hyper important in leasing and financing. So we don't plan on attacking that at all. It's really in the noncertified used cars and the older vehicles where we believe that, that prime customer or even that sub or deep prime customer is something that we could look at, which today, our focus is really prime and subprime, okay? We have been in the deep prime and subprime business for over a decade in Southern Cascades Financial. And what we really did is build all our decisioning models over the last 2 years to move into the prime business, which is a hyper low-risk type of environment. So we think that it's approximately 10 to 15 of incremental profit dollars as an entire company in lift. And if you look at some of our competitors, somewhere between 30% and 45% of their profits are coming specifically from their captive finance company, okay? And you can take the 1,100 units each of the last 3 months and divide that into our unit sales and get you what our penetration rates are today. But we think ultimately, it's more around 20% of our total volume that we can achieve to then realize about 10% profit lift in our overall profitability model.

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

I got on a little bit late so I apologize if this is a little duplicative. But I mean, when you're talking about $1.4 billion of liquidity -- the $1.4 billion of liquidity. Dumb guy's math. You say you're buying at 20% of revenue, maybe it's a little bit higher than that, maybe it's a little bit lower than that, that would equate to the $7 billion you're talking about in 2021. So it implies that you're probably going to do another capital raise. Is that the right way to think about it, that you might go out there and do another equity deal, given where your stock is? Seems like it would make sense.

Great. Yes. Great question, John. Let me just clarify. So the $1.4 billion, the $7 billion related to that or 20% purchase price to revenue isn't a target for 2021. It's illustrating that at $1.4 billion, you could buy $7 billion. Now we did also comment that we have $3 billion plus some additional transactions under contract in LOI. So you can get to that assumption, but we aren't targeting $7 billion in 2021, even though we believe that, that's achievable because you do still bump up against leverage ratios. And I think that's what's going to determine really whether or not we have to go back to the market and reissue equity or debt to be able to cover that. And we really target that 2 to 3x leverage. And I think if you watch that, and we'll make sure to be able to let you know where we always stand on that so you can see that. But it would make sense that if you take the $3 billion that we've now announced that's under contract and a little bit more, you are starting to put to work the original $1.3 billion that we got, and we're probably at around 2/3 of deployment of that capital, which is great. I would also remind everyone that whatever our volume is in acquisitions or network growth, this is what Lithia Motors has done for 25 years and it's what we're built to do. People in integration, in our mind, is the core competency of Lithia Motors and is much different than most companies out there. So whether we do $3 billion or whether we do $10 billion, to us, it's just a matter of accretion and the ability to control leverage below that 3x.

Yes. I would also note that you're buying stuff that's got earnings, so I mean, it helps to leverage when you're making the acquisition. But that's -- you're right, it all kind of depends there.

You nailed it, you nailed it. I mean we don't do acquisitions that aren't accretive typically out of the chute. And obviously, on the high-performing ones, we're really targeting 12 to 18 months to get them to seasoned level, whereas that other 25% that's our typical value investing does take 3 to 5 years. So keep that in mind as you're thinking about forecasting, and we'll try to give you good insights on that.

Yes. And sort of another so -- I mean maybe a left deal question. I mean the $7 billion revenue number just happens to equate to roughly what Asbury did in 2020. And if you're going after big acquisition years like this, it does kind of lead us to think that at some point, you might do some kind of big acquisition like that or even a large private group. I mean is something in one fell swoop like that possible? I'm just curious, I mean I know you mentioned framework and you have room there. Just trying to understand like what the actual targets could be, if there's one of this and two of these are just not going to get you there.

Yes. That's a great question, John. And I think what we think about is the $7 billion to $10 billion that I was disclosing in the question before is not including any publics, okay? We do believe that the best way to combat the entire industry is that the public should roll up, okay? And whether or not that can or can happen, we will tell you this, it's not restricted from framework agreements. We believe that we have strong relationships, and our national limitations in those 3 or 4 manufacturers that do have a ceiling established doesn't preclude us from buying any of the other public or joining forces. I do also like the fact that many of them appear to be replicating some of the strategies that we've been focused on over the last 3 years. And we're pleased to see that because I believe that the new car retailers, if we can cut off the stream of used vehicles to the used car new entrants in the space, and all they can really get is auction cars or late-model cars, the margins that we can make in the over 3-year-old cars are massive that the new car dealers could have a stronghold on the space for decades to come, even if electrification changes thing or connectivity or all the other things that are in all -- in the back of all of our minds over the coming quarters, years and decades.

Yes. And given your multiple on your stock right now, which at least by our estimates, is a little bit of a premium to others, I mean, stock-for-stock deal could be possible. Is that correct?

That is correct. And I would say that we really respect the 3 people that we believe geographically fit nicely with the LAD network and would round out our network almost at full capacity fairly quickly, where we could be even more discerning in terms of our network growth beyond that. So to us, it's more of how do the new car groups rally to ensure even further stability, now be able to do that on their own. But we think it's more constructive to have scale now because the one thing that we don't do in our 50-50 plan is that is a base case, okay? It's not an aspirational case that would include something like you're talking about, which is really a best practices or really leveraging the fact that you would have 100-mile density within the network a lot sooner, where you could start constructively managing costs and national marketing budgets and those type of things at scale that isn't even something that's built into that 5-year plan. So really great thoughts, John, and I think it is something. And I really wish that our peers would feel the same way and would see the value in us joining forces. And I will say this, that Chris and our operational teams are ready for it if we can do that. And we could still do the hypothetical $10 billion to $13 billion, which is under contract, under LOI or in that $7 billion to $10 billion of negotiation or price right ideas. So we did -- we spent the last 3 years reorging -- redesigning the organization to do everything, okay? So understand that. And when we're buying better deals, our risk of integration is even lower than the 80% success rate we've had on these underperforming acquisitions.

That's incredibly helpful. And then just lastly. I mean earlier there's some questions about Driveway cannibalizing just in consumers and all that. But I'm just curious, I mean, as you look at this, you're kind of alluding that you can go out the distance with Driveway a bit further than you might have traditionally. You can go down in vehicle age, right? So you can go deeper into a market. So there's a lot of ways that you can see that this is largely, a lot of it can be very incremental. I'm just curious, as you think about that, if you could dimension those 2 factors, maybe thinking about where traditional dealership reaches and where you could go with Driveway and then how old you could go in the vehicle age spectrum. And maybe, I mean, I think when you talked about your used mix, you said 20% are CPO, so those are newer vehicles. The mid-age vehicles were 58%, and then 8-plus-year old vehicles were 22%. I mean in that spectrum, maybe thinking about -- maybe you could talk about it in that context of that age vector of how deep you could go as well. So distance and age, maybe if you can talk about that.

Sure. I think when you think about comparing and contrasting distance to age, I believe the older a vehicle gets, the scarcer it gets. So in theory, the bigger reach that an older vehicle would have over a 1- to 3-year-old vehicle, which in theory, should have no real reach because supply is there. So yes, I do believe that it's our design thesis 5 years ago that was cemented 3 years ago was all built around the premise of how do we make sure that we get our value auto vehicles or the 8-year-old vehicles and the 4- to 7-year-old vehicles, which is our core product. And just to compare and contrast, the thesis was that we will always be able to price compete in the 1- to 3-year-old vehicles, so long as we have the higher margin vehicles on our lot, okay, which means that we can go head-to-head with the e-commerce retailers because that's what they're going to be able to get. That's what they know how to recondition. Reconditioning is difficult on older vehicles. You have to have the technology, the diagnostic tools and the expertise and technicians. And we sit here with over 3,000 technicians in our network today that understand drivability and how to repair vehicles, not replace parts on vehicles. So just to run through some numbers for everyone that are hyper crucial, our value auto part or over 8-years-old of our current sales volume that will -- that is now deployed through the Driveway channel as well. Though I will give you that condition is more disparate the older a car gets, okay? Meaning that consumers may be more apt to take us up on our 7-day return policy, which is more power to them. We'd love for them to do that. But we also think that they understand that older cars are just going to come at a little lower condition. But today, we sell 20% of our cars are value auto. We sell 58% of our cars are 4- to 7-year-old vehicles or core. So for a total of almost 80% of our vehicles are what we would call mid- and high-demand scarcity vehicles, okay? To keep this in mind, with F&I, our value auto vehicles build a 28% gross margin, 28%; core is around 16% gross margin; and certified, our 1- to 3-year-old are only around 13% to 14% gross margin, okay? So if you're thinking about how do you support making sure we're always price competitive in the plentiful vehicles, which is 1- to 3-year-old vehicles, you do it through selling 4- to 20-year-old vehicles, okay? So that is the dichotomy, and I would still go back to the fact that the scarcer the vehicle is, whether it's new, whether it's certified or whether it's used, the further the reach and impact it would ultimately have to be able to go to market with consumers.

That's incredibly helpful. And maybe if I could just sneak in one last one just on inventories in the short term here. I mean obviously, we're hearing a lot of concern around chip shortages and production disruption as a result of that. What are you guys seeing as far as deliveries and stuff that's on the come or on the trucks on the way to you? And where you think this kind of lands, where, you in the first quarter, you might be even shorter and that could help grosses that you think are kind of normalizing right now but it seems like we're going to hit another short-term shortage here that might be helpful on the growth side?

Yes, you bet. You bet, John. On new vehicles, we were sitting at 71 days' supply at this time last year. We're sitting at 50 days' supply. So it's almost 2 days and that doesn't include in-transit, okay? So we don't think that their inventory is a massive problem on new, okay? We do have shortages in certain manufacturers like General Motors and a few others that are having some microchip issues and may continue to have persistence of microchip issues. So we'll manage that and balance that with margins, okay? Remember, we troughed on new vehicle day supply back in the July, August time frame around low 40s, okay? So it's built since then. But also our delta on our turn rate is also at a low seasonal time of year. Keep that in mind, okay? In terms of new vehicle -- or used vehicles, we're actually sitting at 65 days' supply, which is the same it was last year, okay? So we're pretty pleased with that, which kind of makes it a pretty good deal. And remember, we got -- we're talking about mid- to high single digits growth in January in the first month of the quarter. And we sure hope that with the stimulus package and further vaccinations that, that releases consumers to be able to create greater demand based off that somewhat lesser supply than last year on new vehicles, but really, the same supply on used vehicles. And we're pretty confident that we can keep our used supply nice and strong throughout any environment because we do have those 500 experts out in the field and now a number of Driveway experts that are buying cars at scale and fleets and stuff as well.

Our next question is from Bret Jordan with Jefferies.

In the third quarter call, you talked about reevaluating or maybe changing the process on pricing for the Driveway services. And I was wondering whether or not that is something that you've completed and whether sequentially from third quarter to fourth quarter, you saw real changes in Driveway service bookings in the markets you're in.

Great memory and great question, Bret. So actually, on the service side of things, we're seeing initial stages of very little attraction from the consumers in those products. So we didn't redevelop the pricing. It's still sitting at the same level where we have maintenance. We actually raised the pricing back up to where we were and saw very little degradation in volume, which we thought was good, where really today, it's sitting at people that are willing to pay a premium are doing it and those that aren't, aren't really that enamored with it today. We do believe that the easiest way to build volume there, which ultimately drive costs down of our valets, is to be able to sell the F&I subscription services in-home, okay? Remember, that rollout is combined with the in-home service body and parts offerings that will be done in the Lithia network as well as through the Driveway channel. That's a 2- to 3-year rollout, okay? So we believe that the major Driveway in the Driveway service business will come from F&I subscriptions initially to be able to get us the volume necessary to drive down our costs and ultimately have that full life cycle serviceability to a consumer in their home. So it's still there and it's still working, but the revenue dollars that we can generate and incremental EPS dollars are really going to be found in shop and sell.

Okay. Great. And the question that you talked about, pushing leasing more aggressively in '21. I think I used to ask this question years ago, but what is your lease penetration? And is returned lease vehicles improving source of inventory for your used mix? I mean I'd imagine residual assumptions 3 years ago didn't anticipate the spike in used vehicle values. And are you able to source cars by coming in on lease returns?

Yes, Bret, that's a good question. So we lease currently about 25% of our new cars. And we think that, that can grow. And hopefully, we can mirror that on the Driveway side as well and I think the affordability will ultimately drive that. In terms of vehicles coming on lease, it's important for everyone to remember that those vehicles come to dealers before they ever go to auction, meaning that most manufacturers say, if we don't have to ship the car to auction and pay auction fees, we're going to give it to you, which is part of that $1,100 cost advantage, okay? So off-lease vehicles, we still have a $500 to $600 cost advantage of what others end up buying them from fleet agencies or from auctions. So that pipeline is fine. I will also caveat the note that I don't believe that used car values are that inflated anymore. They were inflated in late summer, and they have begun to normalize throughout the winter months as expected. So I think the supply of off-lease vehicles will be close to LEVs as we move into next year. Now in certain manufacturers, we could see overhang effect on 1- to 3-year-old off-lease vehicles, depending on what their supply on new is, okay? So we'll see how that plays out. But this microchip thing looks like it's a Q2 solution. And into Q3, we should see more normalized inventory levels.

Okay. And then one final quick logistics question. I guess you said you're now selling nationally through Driveway in the new side. You found no regional sort of pushback from franchise dealers with you selling from out of state on the new side of the business?

Great question. So though our marketing dollars are at a national scale, they're really only in Portland and Pittsburgh today. It is available -- new cars are available for delivery in-home across our network, which is national and is available, and we saw no pushback from our manufacturer partners because they ultimately are looking at it is, it's really just a Cars.com or CarGuru or TrueCar, which is a lead provider. We ultimately still do delivery with the home and we still do a walk-through with the consumer with a manufacturer specialist that can explain the product to the consumer, okay? So a little different that comes out of the Driveway care center in conjunction with the fulfillment in the stores.

So you could sell a Mercedes in Florida out of a franchise in California and not get pushed back from other Florida Mercedes dealers kind of thing?

No, there's no restrictions of any brand other than Lexus, that Lexus does not allow you to market, market only, to markets that are not contiguous to your own. Meaning that if I'm in L.A., I can only market in L.A., basically, right? One contiguous AOR of responsibility, okay? That doesn't mean I can't sell a car into Florida. I can still sell a car, I just can't market it. Meaning that in Lexus, I won't be able to have national scale marketing most likely within that 1 brand. You used Mercedes as an example. That is the only other manufacturer that limits your ability, through the turn and earn system, meaning that if you sell a car outside your market and you don't cover your own backyard effectively at 90% of average, they won't replenish the car, okay? Now none of our Mercedes stores are below 90% so we get full replenishment even if we sell it outside the market. Every single other manufacturer will replenish your car and has no restrictions in terms of where you market. Now there are manufacturers that limit what you can sell a car for. And there's what's called marketing covenants to say that you can't market a car below cost, okay, or price down, okay, which I think is really important to the health and well-being of our gross margins on the new car side.

Our next question is from Adam Jonas with Morgan Stanley.

Okay, Bryan. Well, first, someone get this dude a Gatorade. This is a long call. You sound fresh.

Oh, my God, it is -- it's an hour. We apologize to everyone on the call.

All right. I mean it's very informative. I'm riveted. Listen, Bryan, just one and then let's wrap this baby up, shall we?

Sounds good, Adam.

What we -- so with like Tesla, I think, we agree, represents, to a large degree, where the industry is going, future of the industry. And they don't use franchises. And when I talk to them, they're like, "We're never going to do it, like ever." Then you talk about all these other up-and-comers, you get Lucid, Fisker, Faraday, Rivian and a lot of others behind that, as you know. And again, maybe there's 1, but why aren't we seeing of these start-ups use the franchise model? They all say, never. Like, not happening, bro, kind of thing. Like what am I missing? Why are they -- maybe I am missing something like, "No, Adam, there's lots of start-ups and we're talking to them." And if I'm wrong, then tell me. But if I'm not, why are they not -- why are they going B2C for now? Are they all fools?

No, I don't think they're all fools. I believe that our whole thesis on Driveway is that there's a lack of transparency in the dealer network. So why would they get into a negotiated-type environment, which they shouldn't? Are you following me? And I will also say...

I'm just like pleasantly -- I'm not -- I shouldn't be surprised because -- that you're admitting that. It's just -- it's very refreshing to hear.

I mean I will say this. I mean our whole design around the entire strategy, which includes GreenCars.com is the general thesis that our manufacturer partners are slow movers in terms of empowerment and transparency with our consumers, and I love it. And it's not just them. It's that the dealer councils in our country are the ones that believe that they make all their money through negotiations, okay? And it's not. We make our money because Honda and Toyota and our other manufacturer partners make great cars, okay? And I really believe that. Now I will also tell you this. I believe that all of the future world isn't just about BEV. I believe it's about 0 emission. And I believe if we all look at Massachusetts or California or now General Motors, they're talking about 0 emission less than BEV. And it's because of one thing. I believe affordability will drive change. Now our government and regulatory agencies have also now established a very clear 14-year target for our manufacturer partners, which I believe is the best thing that could happen to our manufacturer partners, okay? It's probably the worst thing that could happen to the BEV companies. Because now if you think about how Tesla grew, they grew off of credits from the traditional manufacturers, okay? It's the majority of what they got. It allowed us now to move to an electrified world at 3% market share in our country. That's wonderful. It's who we are as a company. I believe in that. I want that to continue. But I will also say that any of the new Rivian entrants or these others that you're talking about, they don't have the advantage to be able to protect shareholders' investments with credits that they're going to be buying…

And our final question is from David Whiston with Morningstar.

First, on inventory, on the new side, I mean, the 50 -- given what's going on, 50 days is a pretty good number to report. How are you able to keep getting replenished? How are you able to keep getting product? Are your OEMs delivering on promise to allocation? Because that's been a problem for your industry in the past few months.

I don't know where that comes from but it's -- we've now powered through the entire pandemic, where inventory is believed to be a problem. To me, I believe that we're always looking for something that can go wrong on the new car side. And we forget about those are massive days' supply and any inventory and any other industry that usually can power through cycles, okay? And we all have to remember, new cars still make 11% margins today, and pre-COVID, we're making 10% margins, okay, on a very high dollar vehicle. I'm not sure other than it feels like that because we're a negotiated industry, and it's what we're really trying to transform, is to move into a more transparent industry, there's just a belief that there's got to be something wrong. But the new car industry is a hyper strong, hyper profitable economy-insensitive environment. And I think whether it was 2008 and 2009, where we saw none of these major retailers ever get to losses and now powering through a pandemic, and even in Q2 of last year through this, I believe that this is almost a prophecy that's coming from the external world rather than us as retailers. I don't believe that inventory levels are going to affect us. You're going to see the flexibility in the model, which you saw, okay, and enhanced margins of almost $800 even in Q4 when we were over $1,000 in Q3. You're going to see that ability to adjust the model that if inventories are a little tight, then we're going to make more money on it and more is going to go to the bottom line, which ultimately just stabilizes earnings, okay? And it's nice to see that even one of our peers yesterday had pretty nice earnings relative to things. And there's this idea that 30, 40, 50 days' supply, those are good levels of inventory in most industries. So just keep that relative and we'll be able to share more with you in the coming quarters.

Yes, I agree. I'm really glad to see the publics are not chasing volume and focusing on profitability despite the hit to volume. I think it will work out in the long term. Your -- you talked about the loans you're originating. Are they staying on balance sheet long term?

No, we don't -- we plan on being able to pull those off balance sheet later this year, early next year. But we're going to need $0.5 billion in receivables and some history to be able to show them what the full spectrum of credit looks like before we go to the ABS market to do that. So we do have some data. We can share that with our off-line call with you as well if you'd like to know what our portfolio looks like and stuff as well.

Okay. And then last question. Given a lot being talked about both on your existing 50-50 plan and the well above $3.5 billion acquired revenue. And then you went a step further talking about consolidating amongst the publics. I mean really, it just makes me wonder, maybe your 50-50 goal is actually conservative. I mean we -- is it crazy to be thinking you'd be north of $50 billion by mid-decade?

I will say that we don't want to ever lead our investors or analysts down a pathway that we don't believe has a high probability of success. It's why it took us 3 years to come to the public to share our plans with you, even though if you go back and look, in 2018, Q1, we began to share the plan when we had solidified it. And so that strategy on Page 11 of the investor deck and the 50-50 plan, we do call it a base case. I mean we have our own aspirational case. That's what Chris, Tina, Eric and I are focused on, on a daily basis, and we hope to be able to delight. But we don't also want to overpromise, and we believe that our likelihood of success on the 50-50 plan is fairly high outside macroeconomic issues that are really outside of our control. But even in that space, we think that we've solved for affordability. We think we've solved for changing consumer demand. And we think we've solved for so many other things like electrification or shared autonomous vehicles or those type of things. So maybe with that, David, do you have anything further?

No, that's it.

Okay. Thanks, David.

That concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Thank you, everyone, for joining us today. We hope everyone stays safe and healthy as we close out this pandemic and look forward to updating you on the first quarter in April on Lithia and Driveway results. Thanks, everyone.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.