Good morning and welcome to the Sonic Automotive Third Quarter 2023 Earnings Conference Call. This conference call is being recorded today, Thursday, October 26, 2023. Presentation materials which accompany management's discussion on the conference call can be accessed at the company's website at ir.sonicautomotive.com. At this time, I would like to refer to the Safe Harbor statement under the Private Securities and Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information or expectations about the company's products or market or otherwise make statements about the future. Such statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These risks and uncertainties are detailed in the company's filings with the Securities and Exchange Commission. And in addition, management may discuss certain non-GAAP financial measures as defined by the Securities and Exchange Commission. Please refer to the non-GAAP reconciliation tables in the company's current report on Form 8-K filed with the Securities and Exchange Commission earlier today. I would now like to introduce Mr. David Smith, Chief Executive Officer of Sonic Automotive. Mr. Smith, you may begin your conference.

Thank you very much, and good morning everyone, and welcome to the Sonic Automotive Third Quarter 2023 Earnings Call. As he said, I'm David Smith, the company's Chairman and CEO. Joining me on today's call is our President, Jeff Dyke; our CFO, Heath Byrd; our EchoPark Chief Operating Officer, Tim Keen; and our Vice President of Investor Relations, Danny Wieland. Earlier this morning, Sonic Automotive reported third quarter financial results including record third quarter total revenues of $3.6 billion, a 6% increase from last year. Third quarter EPS was $1.92 per share, which includes the effect of certain charges related to the previously announced store closures in the second quarter. Excluding these items, adjusted EPS was $2.02 per share, a decrease from $2.23 in the prior year, due primarily to normalizing new vehicle margins and higher floor plan interest rates. We are very proud of our team's performance in the third quarter and we remain focused on leveraging our diversified business model to adapt to changing market dynamics in the near term, while positioning Sonic to achieve our long-term strategic goals. We believe our strong relationships with our teammates, manufacturer and lending partners and guests are key to our future success. I would like to thank them all for their continued support. Turning now to third quarter trends. We continue to see improvement in new vehicle production and inventory levels across our brand portfolio, despite headline risk related to the UAW strike. As expected, new vehicle gross profit per unit declined sequentially to $4,678 per unit on a same-store basis, in line with our projection to exit 2023 in the low to mid $4,000 range. This steady decline in new vehicle GPUs should continue into 2024, but we continue to believe that the normal level of new vehicle GPU will remain structurally higher than pre-pandemic levels in the $2,000 range. Furthermore, our luxury weighted portfolio generally runs a lower inventory day supply and our luxury manufacturer partners have been disciplined in inventory production to date, potentially minimizing new GPU compression relative to industry trends which would continue to benefit the earnings power of our franchise business. In the used vehicle business, wholesale auction prices for three-year-old vehicles decreased 5% in the third quarter, following a 6% decline in the second quarter. October to date, the three-year-old Manheim Index declined another 3.6%, despite headlines indicating that blended used car prices across all age and mileage bands have begun to rise again. While used retail prices remain elevated, contributing to affordability concerns amid the high interest rate environment, the downward trends we are seeing in used vehicles and used vehicle wholesale pricing are positive for our business and in the fourth quarter and beyond. Few release turn-ins at our franchise dealerships continued to limit our used vehicle volume in the third quarter, but we were able to maintain higher-than-expected used GPUs at $1,668 per unit on a same-store basis to somewhat offset the effects of lower volume. Our team remains focused on driving incremental inventory acquisition and retail sales opportunities in the fourth quarter and into 2024, driving upside in this line of the business alongside the expected normalization of used car pricing and volumes over time. Despite an elevated consumer interest rate environment, our F&I performance continues to be a strength. Our franchise dealerships' F&I penetration rates were stable quarter-to-quarter and we reiterate our previously issued guidance for full year 2023 franchise F&I GPU at or above $2,400 per unit. Our parts and service or fixed operations business remained strong with record third quarter fixed ops gross profit at our franchise dealerships, up 8% year-over-year on a same-store basis, driven by 10% growth in our customer pay business. We are very proud of the success our team has had in this area and we believe there are remaining opportunities to optimize our fixed ops business as we progress through the fourth quarter and into 2024. Turning now to the EchoPark segment. As discussed on our second quarter earnings call, we made the difficult but necessary decision to suspend operations at 50% of our EchoPark segment locations back in June and July. We believe that the decision to suspend operations at these stores would substantially improve our near-term financial performance without sacrificing our long-term strategic plan for EchoPark. In the third quarter, our financial results reflect the expected initial benefits of these strategic adjustments to our EchoPark business model. We reported revenues at EchoPark of $627 million, up 6% from the prior year and all-time record EchoPark gross profit of $53 million, up 22% from the prior year. EchoPark segment retail unit sales volume for the quarter was 19,050 units, up 25% year-over-year and up 12% from the second quarter. As discussed on our July earnings call, reducing our store footprint allowed us to better allocate inventory across our platform, driving higher unit sales volume, better GPU, and significantly lower operating losses. Third quarter EchoPark segment adjusted EBITDA was a loss of $5.2 million compared to an adjusted EBITDA loss of $31.8 million in the second quarter and $23.3 million in the third quarter of 2022. Based on recent market trends, we remain confident in our path to breakeven adjusted EBITDA in the first quarter of 2024 and look forward to resuming our disciplined long-term growth plans for EchoPark as used vehicle market conditions continue to improve. Turning now to our powersports segment. The third quarter is the peak seasonal sales period for our powersports portfolio, highlighted by the Sturgis Motorcycle Rally in August. Our team welcomed over 150,000 rally attendees to our Black Hills Harley-Davidson locations selling 550 new and used motorcycles during the rally, making it one of the highest volume events in the dealership's history. Combined with our Texas Powersports stores, this drove $7.9 million in adjusted EBITDA from our powersports segment in the third quarter. We are continuing to identify operational synergies within our growing powersports network and remain optimistic about the future growth opportunities in this adjacent retail sector. Finally, turning to our balance sheet. We ended the third quarter with $797 million in available liquidity including $335 million in combined cash and floor plan deposits on hand. The strength of our balance sheet allowed us to repurchase 1.7 million shares of our Class A common stock in the third quarter for nearly $87 million, bringing our year-to-date share repurchase total to 3.3 million shares or 9% of shares outstanding at the beginning of the year. At the end of the third quarter, our remaining share repurchase authorization was $287 million, representing over 15% of today's equity market cap. Share repurchases are an important part of our capital allocation strategy and we remain focused on opportunistic share repurchases as our liquidity allows. Additionally, I'm pleased to report today that our Board of Directors has approved a 3.4% increase to our quarterly cash dividend to $0.30 per share, payable on January 12th, 2024 to all stockholders of record on December 15th, 2023. In closing, our team remains focused on our near-term execution and adapting to changes in the automotive retail environment and macroeconomic backdrop, while making strategic decisions to maximize long-term returns. Furthermore, we continue to believe our diversified business model provides earnings growth opportunities in our EchoPark and powersports segments that may offset any industry-driven margin headwinds we may face in our franchise business, minimizing the earnings downside to consolidated Sonic results over time. We remain confident that we have the right strategy, the right people, and culture to grow our business and create long-term value for our key stakeholders. This concludes our opening remarks and we look forward to answering any questions you may have. Thank you very much.

Thank you. Our first question comes from Daniel Imbro with Stephens Inc. Please go ahead with your question.

Hey guys, this is Joe Enderlin on for Daniel. Thanks for taking the question. So, at EchoPark you're calling for 1Q EBITDA profitability. But seasonally, 1Q is the biggest quarter for used dealers. Is that comment just about the seasonality, or is the message that we're flipping to positive EBITDA and that should continue for the rest of 2024?

Yes. The message is that we're flipping to positive EBITDA and that should continue from here on out. If you look at the second quarter and the decisions that we made, that certainly helped bolster the bottom line increased volume because our great buying team didn't buy the right mix for the smaller number of stores. You're going to see improvement from the third quarter to the fourth quarter, volume may be about the same but EBITDA should continue to improve as more of the SG&A moves that we made sink in. We should be EBITDA positive in the first quarter and then from here on out, as we move to the rest of 2025. And the used car market is going to continue to get better. Prices are going to drop. New car inventories as we can also here building, that's going to make a difference in used car valuations. Right now, we're buying cars between $24,500 and $25,000. We think that that needs to sink below $23,000 before the real big volume that we're used to at EchoPark returns. And we think that's 18 to 24 months of kind of choppy water. And those left standing at the end of all that I think will enjoy and reap the rewards of the hard work, and the dedication and we certainly plan on intending to be one of those as we move forward. So, bluer skies ahead from an EchoPark perspective, we're very excited about that.

Got it. That's helpful. Thanks for the clarification there. Looking more at EchoPark just as a follow-up. With the increase in unit sales despite the footprint moderation, does this change your long-term view of EchoPark and the build-out opportunity? Do you think you might want larger selling hubs just in the biggest metros? Are you sticking to the original plan? How are you thinking about the footprint after you've made these changes, given the positive results?

Yes. We've learned a lot there. It's Jeff, again. And more than likely, we'll have the larger hubs as we move forward in markets but we're going to be very disciplined about opening the next stores. I think that's an incredibly important point here. We're going to open stores when the inventory is back, when the pricing is back and we can in a disciplined way and in a profitable way open locations and markets, that will get us to the 90% coverage of the country. We still reiterate that too. We're still focused on that. But it's got to be done in a disciplined way. The used car market and the inventory is too topsy-turvy. We've learned that over the last couple of years. Who knows what happens next, but we're prepared for it. Right now, we're very comfortable with those 17 stores that are open from EchoPark perspective. We know we can get those EBITDA positive and we'll grow in a disciplined way and approach as the market allows us to do so.

And this is David. I want to emphasize that once we made the decision to restructure EchoPark, we understood that the market would only permit us to acquire a limited number of cars at the appropriate prices that align with the EchoPark model. Therefore, it wasn't unexpected for us that after the restructuring, we could effectively stock the remaining stores and that sales would increase. The results were anticipated by our team. It's crucial to acknowledge that we are familiar with the model and, as mentioned, we will implement it in a careful manner as the market permits.

And this is Steve. I want to add one more point. I think we all believe that it's going to be an 18 to 24 months to get back to what we used to see pre-COVID. But we all believe, and I think everyone understands that that used market will come back and we see that. And as Jeff mentioned, our growth plan will be disciplined and we'll open when the market dictates the time to open new stores.

Yeah, that is all for us. Thank you guys, for the color.

Thank you.

Thank you.

Our next question comes from the line of Rajat Gupta with JPMorgan. Please proceed with your question.

You may be on mute.

Sorry, can you hear me, okay?

Yes, we can hear you now.

Great. Sorry about that. I just have a follow up on EchoPark. Can you give us a sense of how you plan to navigate some of the shortages around the later modeled used vehicles? You did talk about trying to increase our mix in some of the older vehicles. But, how do you navigate that challenge when it comes to just training your salespeople, changing the reconditioning practices, et cetera, because it feels like you would need to meaningfully take share in that cohort of the older vehicle like greater than five greater six-year-old vehicle to meet some of these targets including getting to profitability? And I have a follow-up. Thanks.

Yes. This is Tim Keen. We made that move to higher mileage and longer year, probably starting at the beginning of the year. That's one of the reasons we've been able to grow the volume with the shortage in one to five- and one to three-year-old cars. And we've perfected selling those different models. So we'll continue to take share where we can.

And this is Jeff. Currently, 15% to 20% of our total volume comes from this segment. I expect it to remain within that range, though it may reach 25%, but I don't anticipate it going beyond that. As prices decline, our EchoPark model focuses on one to five-year-old cars with under 50,000 miles. We can offer these cars at competitive prices in the market, often alongside a warranty for about the same price or even lower than our competitors, which boosts our volume and enables us to promote that lower price. It does introduce some complexity, which is a valid point. However, I believe Tim and the team have done an outstanding job training our staff. We draw on our experience from the franchise side, which constitutes about 30% of our business. This experience has been beneficial for EchoPark, and Tim Keen and his team are exceptional in this area. This is something we will continue to build on as we progress. I want to emphasize that I don't expect it to exceed 25% of our overall mix, and we would consider ourselves fortunate if we achieve that.

Got it. Got it. That's helpful. A follow-up was just on parking services. You have a lot of California exposure, which obviously has greater electric vehicle adoption. You had some really good growth in your service business overall. I'm curious if you could share any insights on how the service activity has been on some of the earlier electric vehicles that you're servicing? Like one of the rental car companies Hertz this morning made a comment that they're having to spend twice as much to service to repair damaged electric vehicles versus an equivalent ICE vehicle. Curious if you are seeing something like that as well. Any more insight you could share would be helpful. Thanks.

Yes, thanks. It's Jeff again. We're exactly seeing that. Our average dollars or gross dollars are up 30% on electric vehicles than an ICE vehicle. That's a nice surprise for us. Yes. We're all smiling - and so I keep bringing that on. The fixed operations business for us across the country is just fantastic. We expect to see it continue to grow. You see that in our numbers. We've had an amazing year and that's going to continue on into 2024 with more cars on the road and more customers using our service shops. So it's been a very nice surprise. More electric vehicles coming through with higher grosses in terms of our average or old channel.

Got it. Got it. Great. Thanks for the color. I’ll jump back in the queue.

You got it. Thank you.

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

Hi. Good morning guys. Just a first question on sort of time and capital. Now that you're kind of investing maybe a little bit less in EchoPark on time and capital, do you see the opportunities for making dealership acquisitions on the new side as maybe a higher priority and something that might be more attractive now?

Yes, John, this is David Smith. Thank you for the question. We are going to look at what’s best for the overall business opportunistically, keeping all our shareholders in mind. As I mentioned in my opening comments, we believe our shares represent a great value. The opportunities in the franchise business and franchise stores are still extremely valuable. We have seen great opportunities for growth in our powersports business, as we have discussed. We will be open-minded about where we allocate our capital, but it must benefit the overall business; that is the key. We will evaluate it from a total ROI perspective. Heath, do you have anything to add?

As part of our capital allocation one of the big pieces right now is investing back into our business. We talked about EV a little bit before you'd be shocked if the requirements and the capital that we have to spend to prepare for EV and manufacture requirements. So that's going to be a part of our capital allocation and technology. We've just started our path down AI and continuing our robotic process automation and there will be huge efficiency gains from those two investments. And as David said, returning capital to shareholders, we increased our dividend and bought back 9% of the outstanding shares so far this year. So those are some of the main drivers but I agree with David. We'll continue to look at the opportunities both in the franchise and in powersports for good acquisition makes sense.

Okay. I have a second question, likely for Jeff regarding EchoPark in the long term. The fluctuations we're observing in the new vehicles within the one to five-year-old category seem increasingly cyclical. As vehicle sales have decreased over the past five years, we've hit a low point, resulting in fewer vehicles available for retail. Given this trend, we should see an improvement in the next couple of years. Thus, it makes sense to ramp up EchoPark at that time. However, looking further ahead, over the next five to ten years, we might encounter another downturn with these vehicles. Would it be more beneficial to have a flexible model that can operate within the one to ten-year-old category, adjusting as necessary? This approach seems reasonable, especially since established operators like CarMax are currently grappling with similar challenges related to the air pocket in the one to five or one to six-year-old vehicles they emphasize. Even with their efforts, they are struggling to address this issue. So, can you adapt the model to be more flexible moving forward to avoid these complications?

That's a great question. We discuss this frequently. Yes, we can certainly adjust and increase our margins. We will approach store construction differently in the future because our stores are designed for high volume. Pre-pandemic, we averaged 550 units per store, but now that number has dropped to around 300, and we are working our way back to 500. However, our structure is not designed for lower volume; it is built for significant volume. Over the next 18 to 24 months, the market will be unpredictable, but we expect new inventory to grow and for electric vehicles to enter the market, which will enhance the volume of used vehicles. We are aware of these factors and will consider the flexibility you mentioned as we move forward with building stores. We have streamlined our stores to ensure we can achieve positive EBITDA and profitability. For instance, our Denver store is now generating $800,000 a month and is performing well within our profitable stores. We recognize the need to expand our range to mitigate potential downturns, and we will take this into account when planning future store constructions or renovations.

And John, this is David Smith. Something to keep in mind is we have evolved the EchoPark brand and model over the years it's been 10 years and a lot of R&D. And one of the things as you look down the road and Jeff mentioned that the Colorado market, the brand awareness in the Colorado market because we've been there longer than anywhere else, it's far greater than anywhere else in the country. And we've got our Chief Marketing Officer, Dino Bernacchi here and he may want to chime in. But I believe if you look down the road our brand awareness for EchoPark is going to be far greater. That's going to help us get into a lot of more areas and drive our revenue if we do hit one of those air pockets you talked about.

And we started branding in Houston in March of this year and our brand awareness there is growing like wildfire. So that's great. But we haven't been unwilling given the current economic circumstances to push that beyond the Houston market. But as we get better and stronger from a P&L perspective you're certainly going to find us expand that throughout all of Texas and then the rest of the country. So there's a lot of levers John that we can still pull. But we are very focused in that one to five-year-old category. We will build stores in the future that will give us the flexibility to do it in different ways if we need to.

I'm sorry. Can I sneak in one last one on the inventory side? I mean some of your brands are still pretty inventory constrained operating in I guess maybe mid to mid-single to maybe mid-teens day supply. I'm just curious how much of an impact do you think that's having on your new vehicle sales here in the short run? And do you see any relief on the horizon?

We haven't had over 10,000 units in stock since 2019, and we finally reached that level. We experienced some constraints with Honda and Toyota imports, but luxury brands are performing well. Currently, BMW has about 18 days' supply, and electric vehicles from BMW have 26 days' supply. We have inventory available to sell, which is reflected in our sales. I believe the recent strike situation is starting to ease, as indicated by Forbes' announcement, and I hope it will be resolved by the end of the year. I’m not too worried about inventory, as it will continue to build. We're excited about EchoPark because it's expected to lower used car valuations. Currently, auction sales are around the mid-40% range, indicating that people are holding onto their cars longer, but they will need to start selling, which should help lower prices. We anticipate some recovery in new vehicle inventory, but not too significantly. When we reach our peak, excluding electric vehicles, I expect inventory days to be in the 30-35 day range compared to 65 days pre-pandemic. No manufacturer plans to increase inventory days to excessive levels, which is beneficial for the used car segment. This is sufficient for us to succeed in the pre-owned space at both EchoPark and on the Sonic side. Leasing is on the rise, and we're beginning to see incentives, which should result in leasing a higher percentage of our portfolio. This will take 18 to 24 months to have a significant impact. Inventory is improving overall, but if we had more Hondas and Toyotas available, we would sell more of them. Day supplies for these brands are still below 10 but are improving each month. I expect considerable improvement this quarter for those brands and others, including BMW, which is a major part of our portfolio, as we anticipate receiving more ICE vehicles and SAVs. This will positively influence our new car volume for the remainder of this quarter and into 2024.

Encouraging. Thank you very much, guys.

Yes, sir.

And our next question comes from the line of Michael Ward with The Benchmark Company. Please proceed with your questions.

Thank you very much and good morning, everyone. Two things. On the inventory front, can you provide any details on the used vehicle inventory at both franchise and EchoPark?

In terms of day supply?

Yes. Where it sits?

They're both in the 30-day range. We try to keep 20 days' supply on the lot and 10 days in the pipeline. We're probably a little bit below that on the franchise side maybe 27, 28 days and we're right at 30 in the EchoPark stores only, not including North West Motorsports or eCarOne. And so we're in fantastic shape. Our inventory is young, margins are good. We're in as good a shape as probably anybody out there in terms of our used day supply and our inventory mix.

Yes. Regarding the franchise side with the inventory, you aren't required to seek options outside; you're either accepting cash trade-ins or utilizing priority auctions. Is that what you are considering?

Yes. I mean we're buying more and more cars off the street. That percentage is growing with us every month. We're very focused on that. Like I said at EchoPark, I think that those cars are going to be 25% of the mix. It's a much larger percentage mix. On the franchise side, we buy very few cars at auction if any at all. So 90% of our cars are coming from purchase off the street or trade-ins.

Okay. And you kind of alluded to it about the captive subs, finance subs getting back into the game a little bit subsidizing leases and it sounds like they're subsidizing loans as well. Just wonder if you can comment what that does for your business both plus and minuses?

Yes. I mean they've really had to do it on the electric vehicle side, right? So 90% of the electric vehicles we're selling are all leases, just because the MSRPs were too high and customers want. Just don't see the value in paying a difference between electric and an ICE vehicle. But certainly, it's making a difference in the business. You can see it in our new car volume had a great new car volume quarter. We intend to have another one in the fourth quarter and moving forward. And they are 100% back in the game. They're doing a great job. Really, really good job for us. And so we expect that to continue.

Okay. And towards the end they've stepped up leasing, correct?

Yes.

Yes. What is the percentage of leasing for new vehicles, considering you have a higher luxury mix than most?

The interesting point now is that we should start discussing the distinction between internal combustion engine leasing and electric vehicle leasing. The leasing percentage for electric vehicles is between 85% and 90%, and for brands like Mercedes, it is even higher. I believe this trend will persist in the short term, with leasing percentages for luxury brands ranging from 30% to as high as 50%.

Perfect. Thank you. Thank you very much.

Sure.

Our next question comes from Bret Jordan with Jefferies. Please go ahead.

Hey, guys. This is Patrick Buckley on for Bret. Thanks for taking our questions. Taking a look at used GPUs and the strength there. Was there anything specific driving that? It sounded like sourcing has improved a bit as far as getting cars off the street but anything else to call out there?

Yes, 100%. It's disciplined day supply. We've always had that. And in this kind of environment that's going to show up for us. We have a very, very disciplined way that we manage inventory. As I said earlier, 20-day supply front line 10 days in the pipeline. We don't go over that. That might cost us some sales at some points in time. But in this kind of day and time it really does help. And so that's keeping the margin strong for us on the franchise side. And on the EchoPark side, that discipline really does help and it's made a difference in our margins.

Got it. That's helpful. And then we've also heard some talks of a bit of a mismatch between EV production and inventory levels and retail demand there. Are you guys seeing the same thing? And do you guys expect to see some heavier discounting as we enter 2024?

Yeah, it's very interesting. This is David. Depending on the region, I recently had the opportunity to drive one of the new Mercedes electric vehicles, and it was a fantastic experience. The demand for that specific vehicle is certainly higher, especially out West. However, as Jeff mentioned, in some parts of the country, heavy discounts are necessary to actually sell that car. So...

There are many discounts happening right now, and as we are still at the early stages of this, everyone, including manufacturers, is learning. Currently, we have a 26-day supply of BMW electric vehicles and a 58-day supply of Mercedes electric vehicles. Our profit margins on BMWs are currently better than on Mercedes, and BMW's margins are comparable to those of traditional internal combustion engine vehicles. They have managed this well, while Mercedes may have overestimated their inventory levels. The products are excellent, and we are one of the largest sellers of these brands' electric vehicles, especially on the East Coast. However, we do face challenges ahead. Prices remain high, and while the products are great, customers still need to acclimate to them. There's still a lot of work to do, but we will get there over time. Manufacturers will inevitably offer discounts in the upcoming quarters, which will benefit us by enabling us to sell more cars, increase our finance and insurance revenue, and enhance our profitability.

And this is Heath. You've seen probably a lot of manufacturers talk about the market for hybrid vehicles and especially Toyota and that being the transition really from the combustion engine to EV. And so, hybrids are great for us. We love the product and it's really good for service. So we think that's going to be more of a demand like health and EV.

Great. Very helpful. That's all for me. Thanks guys.

And we have reached the end of the question-and-answer session. I'll now turn the call back over to the CEO, David Smith for closing remarks.

Great. Thank you very much. Thank you everyone for joining us and have a great day talk next quarter.

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