B. Scott Smith - Sonic Automotive, Inc. Jeff Dyke - Sonic Automotive, Inc. Heath R. Byrd - Sonic Automotive, Inc..

Rick Nelson - Stephens, Inc. John J. Murphy - Bank of America Merrill Lynch William R. Armstrong - C.L. King & Associates, Inc. Paresh B. Jain - Morgan Stanley & Co. LLC Michael Montani - Evercore ISI.

Good morning and welcome to the Sonic Automotive Third Quarter 2016 Earnings Conference Call. This conference call is being recorded today, Tuesday, November 1, 2016.

Presentation materials, which management will be reviewing on the conference call, can be accessed at the company's website at www.sonicautomotive.com by clicking on Our Company, then Investor Relations, then Webcasts & Presentations.

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. I would now like to introduce Mr.

Scott Smith, Co-Founder and CEO of Sonic Automotive. Mr. Smith, you may begin your conference..

Thank you, Carmen. Good morning and welcome to Sonic Automotive's third quarter 2016 earnings call. I'm Scott Smith, the company's Chief Executive Officer and Co-Founder. Joining me on the call today are David Smith, our Vice Chairman; Heath Byrd, our CFO; Jeff Dyke, our Executive Vice President of Operations; and C.G.

Saffer, our Chief Accounting Officer. I trust everyone has read the documents released earlier this morning and I'll provide some brief comments before opening the call for your questions. For the quarter, we generated $0.42 per share from continuing operations on a GAAP basis and $0.47 per share on an adjusted basis.

Please see our earnings release for a discussion of the non-GAAP adjustments in the quarter. As many of our competitors have already explained, the third quarter was operationally challenging, given the GPU pressures in both new and used vehicles.

Record performances in pre-owned, fixed ops, and F&I areas served to lessen the effect of lower gross generated from the front-end of our business.

We believe the impact of stop-sales vehicles affecting both new and used vehicles, continued weakness in our Houston market and overall BMW brand performance negatively impacted earnings during the quarter.

We are cautiously optimistic about fourth quarter, as our luxury mix historically has made the last quarter of the year much more profitable than the other quarters.

We're extremely excited about the opening of our Mercedes-Benz store in McKinney, Texas, a suburb just outside of Dallas, and expect our second Nissan store in the Chattanooga market area to open in the fourth quarter. Finally, we're also in the final stages of construction of an open-point Audi store in Pensacola, Florida.

We expect this store to open by March of 2017. Once these three stores are fully operational, we believe the combined group will conservatively generate annual revenues in excess of $180 million. We continue to replace leased property with owned properties and, at the end of the quarter, we owned 40% of our dealership properties.

We expect to be at 43% by the end of 2017. We're also excited about the operations of EchoPark. The two new stores in the Denver market grew consistent with expectations and the other three stores combined were cash flow positive at the store operating level for the quarter.

By the end of the first quarter of 2017, we'll have another Denver market store opened in Colorado Springs, and we will have begun construction in our Texas market stores.

The rollout of One Sonic-One Experience technology continues to occur in our Birmingham, Chattanooga, and LA markets, and that continued throughout the quarter and we plan to roll out the program to our first BMW store in the first quarter of 2017 in Greenville, South Carolina.

In addition to our dividend declaration during the quarter of $0.05 per share, we invested approximately $10 million in share repurchases to repurchase 579,000 shares, bringing the total year-to-date investment to $97.5 million for 5.4 million shares.

We plan to continually evaluate our repurchase program as we identify windows of opportunity to reduce our share count and enhance our shareholder value. I'd also like to provide additional color on earnings guidance for the rest of the year. As we've seen with others in the peer group, we also experienced reduction in new vehicle margins.

This coupled with the uncertainty related to the incentive environment, particularly BMW, has made it difficult to forecast fourth quarter results at a level of precision we have in the past. Due to this uncertainty, our range is wider than usual.

Based on our current estimates, we believe diluted earnings per share from continuing operations for the fourth quarter to be between $0.59 and $0.69, which translates into $1.95 to $2.05 on an adjusted basis for the year.

As noted in the press release, this guidance range does not include the effects of any anticipated settlement with VW, which is expected to be finalized by the end of the year. At this point, we'd like to open the call to your questions..

Your first question comes from the line of Rick Nelson with Stephens..

Thanks a lot. Good morning..

Hey, Rick..

Morning, Rick..

Could you discuss the Houston market, in particular how that may have impacted volume and margin?.

Yeah. Hey Rick, it's Jeff Dyke. There's no question that, for us, Houston's a big double whammy because you not only have the energy sector issues that are going on there, but also we've got a lot of high-line stores there, in particular BMW, two big, big stores that generate a lot of profitability for us that are suffering as part of that.

And so, when you add on the amount of volume that they do, the stop-sale cars and in particular on used cars, Houston was a bit of a train wreck for us for the quarter. That market has certainly been tough.

But we've all been in this business for a long time, we go through cycles, and that market goes through them, and we've enjoyed our great, great years there, and that's going to bounce back. This is a short-term issue that will resolve itself and those stores will be back to making the profitability that we're used to..

I think, Jeff, you also mentioned you thought the BMW challenge was going to be a short-term issue.

How do you see that resolving itself?.

Well, if you look and you study what they've done with incentives along about June, they've really stopped a lot of their incentives. And so, so goes BMW, so goes Sonic Automotive. I mean, it's over 30% of our profit. BMW and Honda represent almost 41% of our revenue, or our unit sales.

So when they make shifts in their business model like that, it can – because we have so many eggs in that basket, it can wreak havoc for us. So they stopped some of the big incentive programs that they had.

The great news is, is that they had an adder bonus for us in October that will add on to a November-December bonus structure that they put together, which is a perfect fit for us.

It takes us right into the holidays and so we're looking forward to getting back to some of those incentive programs that'll allow us to recoup some of the profitability that we're missing out on our BMW stores..

Thanks.

And if I could shift over to EchoPark, the Manheim test that you are doing, if you could provide some color and update there, how that's progressing? As well as the sites for Texas, where you stand?.

Yeah. Great. Thanks for the question. EchoPark is really doing well. We're very excited. The volume's great, and we opened two new stores in the quarter and they're ramping up quicker than the stores – as a matter of fact, they're already at the volume that the two original neighborhood stores were running maybe six, seven months in.

So we're very excited that the brand is growing in the marketplace. And as Scott said in his notes, the original stores are cash flow positive now, which is just fantastic. So that gives us a lot of energy going into Texas. That'll be Dallas, Waco, Austin and San Antonio.

We should break ground in the first quarter in the Dallas market, maybe even San Antonio. We're working on that this week, and so we're very excited about that.

And the Carolinas are going to come right behind that, along with – we made a purchase of a group of used car stores in Georgia and Florida called AutoMatch and we'll begin converting those next year as well and EchoPark, so we're ramping EchoPark up as quickly as we can.

The results early on have been great and I think it gets validated by some of the other players that are entering the market. So we're real excited about it and look forward to bringing more and more results to you as the quarters go on..

And so AutoMatch is – how many stores is that? And is that additive to what you've been discussing previously for Texas and North Carolina (10:28)?.

It's four stores and it's not additive at this moment for EchoPark. We'll roll that into EchoPark as we convert them..

Got you.

And the Manheim test, with their fulfillment, how is that progressing?.

That's a work in progress. We certainly made a lot of progress in the last quarter as we learned how to recondition cars together. But they're fully committed to it and so are we. And I'll keep you updated, but I would just identify that right now at this time, it is a work in progress..

Got you. Hey, thanks a lot and good luck..

Thanks, Rick. Appreciate the questions..

And your next question comes from the line of John Murphy with Bank of America Merrill Lynch..

Good morning, guys..

Hey, John..

Just a sort of a follow-up question on BMW, sort of from two angles.

I mean, first, is there just really a mix issue going on here where they're just too heavy on pass (11:32) cars and they don't have enough crossovers? And secondarily, as you go to this One Sonic-One Experience, I'm just curious if they weigh in on how you interact with consumers just given that the brand image and the dealership experience is really so critical to these luxury brands..

I mean, look, we can use crossover – or sport utility vehicles across all of the model lines, so I don't really think it's any bigger of a mix issue than it was with BMW. They started out the year with way too many cars on the ground for all the dealers. I mean, we started out the year with over 7,000 BMWs on the ground, and today we have 4,300.

So, it's too much inventory and then the whack that we're getting in Texas, along with a couple of major projects that we have going on with our BMW stores facility-wise kind of slowed us down in the California and Denver markets – Southern Cal and Denver markets.

So, just sort of a little bit of a perfect storm for us, but nothing that I'm looking at saying this is going to be going on long term. I think this is a short-term issue. BMW is a great brand, they're going to rebound and the incentives will certainly help. They've had their struggles too, and it's just a cycle we're going through.

They've got new product line-up coming, so we'll bounce (12:48) through the cycle and move forward.

What was your other question?.

Just on the One Sonic-One Experience implementation in the BMW dealership, I'm just curious how the automakers view that, particularly as you get into luxury because the experience in the dealership is so paramount to the brand identity..

Yeah. So BMW is actually pushing us to put it into the BMW store, which we're working with them closely on. They're very anxious to see how the guest experience works under this model.

And I just returned from Japan at a Lexus meeting, and Lexus and their executives were on stage, touting Lexus Plus, their new pricing, one-price model, and their guest experience, which is very, very similar to One Sonic-One Experience, if not almost exact. And so, we're all going in this direction.

You heard Mike Jackson talk about it when they opened up AutoNation U.S.A. megastores and their used car dealerships, and how they're going to be one-price and they're going to be using an iPad and one person doing the transaction. The whole industry is going to move in this direction.

It's just a matter of how fast you can move and who's equipped well enough to move that fast..

Okay. That's helpful. And just a second question. It looks like wholesale sales were up a tremendous amount.

I'm just curious what's driving that? Is that just a big surge we're seeing in vehicles coming off lease? And as we see the increase in vehicles coming off lease, is there more opportunity to really feed your used vehicle business, in particular on the CPO side?.

Well, there is, but a lot of that, John, is stop-sale vehicles and older, higher model, what we call C-car vehicles that we would retail at $14,000, $13,000, $12,000 and under that we just can't get a fix for. And we're going ahead and wholesaling.

It's a car that we typically retail and that's putting some margin pressure because it's a real high margin vehicle for us – a high volume, high margin vehicle for us. And so that's what's driving a lot of that. And they're going to clear out.

We're down to – I've got 800 cars on the ground right now that are stop-sale, unfixed vehicles, and maybe another 1,000 that are fixed, so I'm not too concerned that's coming to an end..

Okay.

And then just lastly, I mean, as we look at this gross margin pressure on the new vehicle side, I mean, how much of it do you think is sort of structural or cyclical and how much of it do you think is sort of fleeting? And as you look at this, what are the opportunities to offset some of this through SG&A reduction? And if you look at the buckets there, is there anything specifically that you would target just in case this gross pressure persists?.

Yes, we would. We're looking at it. Here's the issue. The issue is we don't have a revenue and/or a unit volume issue given the market and what's going on in our share. We have a margin issue. And that continued into October, no question. I see it. I expect it to lighten up as the stop-sale vehicles kind of move forward.

And for our brand mix – I'm not speaking for the industry, but for our brand mix, as BMW improves, our margin is going to significantly improve. It doesn't take a lot, given the size of our business, to move that margin and BMW and Audi and those guys play a big role in that. And so we've sort of suffered there, but again, I think this is cyclical.

I don't think this is a long-term issue and I think we're going to be just fine. We've all seen it. If you've been in this business for any amount of time, you better be leathered up to this kind of stuff because it's going to happen. And it happened across all the publics, you could see it happen at different severity levels.

And for us, BMW plays – like I said earlier, plays a big role and we got hit by that along with Houston where we've got 19 stores, 20 in Texas now, so that's a whack for us and that's okay. I mean, it's nothing that we haven't seen before or can't overcome..

But it really is on the SG&A side? There's nothing material that you're going after (16:54) or any other kind of initiatives that you'd be pulling back on? You really do think you're going to manage this on the gross side as opposed to the cost side?.

I'd like to. I mean, I've worked with the team – here's the problem. You got a certain amount of head count you have to have for day-to-day operations.

And then given the volume that we're doing, if our volume was going backwards, we've got KPIs in place that says here's how many sales managers we have to have for the number of units that we sell for a particular store, how many F&I managers. And I don't have a volume issue, so I still need that head count. And so, we're working diligently.

Now there's probably some other places that our team is looking at to cut some SG&A. We'll see how those projects go over the next couple of months. Obviously, if the market turns down, we're prepared to make the kind of cuts that we need to make and we always have those plans in place..

Okay. Thank you very much..

Your next question comes from the line of Bill Armstrong with C.L. King & Associates..

Good morning, gentlemen.

On the BMW incentives that are now coming into play, what's the nature of these incentives? Are these stair-step? Are these cash back for consumers? Or what type of incentives are we looking at?.

No, they're stair-step. If we hit certain target levels of volume, we pick up bonus dollars. And so I've got all those – we had a call with BMW last night, I've got all my volume targets and we're eagerly looking to get into November and December so we can get those targets and pick up those dollar opportunities..

Okay.

So this sounds like these targets are something that in your view are achievable then?.

100% achievable. We just achieved all of the October adder bonus that we got that will add into November and December. We had 100% of our stores achieve that goal..

That's great. That's good to hear. Second question, parts and service margins were down about 140 basis points year-over-year.

What was driving that?.

It's a little mix and us being aggressive on the service driving. I mean, we had a big year that we comped over last year, so our CPU is up just a smidge if you average the days – on a same day basis. So, we were just being aggressive, trying to overcome what was a huge third quarter for us last year, and we just eked that out.

It was a record quarter for us, but not at the level that we had been beating prior year just because we're now starting to comp up against some pretty good numbers from prior year..

Okay.

And then lastly on Texas, do you see trends getting any better or stabilizing? Or do you think it's still going to get weaker before it starts to get better?.

I mean, the volume's just okay, but the margin – I still think that we're going to fight a big battle for the fourth quarter. I watched October and October was great in a lot of our markets, but Texas was really, really tough. And so, as you know, when you study Sonic, that's a big, big part of our business.

And so it made for a little bit of a rougher October than we would have liked and that's – hence our call up that we gave and our wider range that we gave to you guys. Because so goes BMW, really in that market, so goes our business. And those are two very important criteria that we're battling up against.

But given BMW's stair-step and, hopefully, Texas not getting any worse, that's the thing. I don't think it's getting worse, but it certainly plateaued and I don't see it getting better right now. I think we're going to be battling this through the end of the quarter..

Okay. Great. Thanks very much..

Yes.

Carmen, are you there? Hello? Hello?.

One moment.

Can you hear me?.

Yeah, we can hear you now..

Okay. Your next question comes from the line of Paresh Jain with Morgan Stanley..

Good morning, everyone..

Hi Paresh..

Hey. A couple of questions on the list.

So, regarding the deployment in the BMW stores, where is the confidence level around the pricing tool today? And what would be the key metric that you'd be looking at initially to benchmark performance in those stores? Is it going to be similar to the Charlotte stores where there was a lot more focus on market share? I just wanted to understand what's the goal here?.

Yeah, well, first of all, I think – market share and profitability, those are the two pieces of the puzzle that have to come to life. And in Charlotte, our profitability's up about 180% over prior-year, but we're comping against weak prior years, so we're certainly improving.

The pricing tool, I've got more confidence in today, in the work that we've done than I've had to-date. And so, Heath may want to comment on it, but they have done a fantastic job, putting us in a position to begin to use our pricing tools.

So, very, very excited about where we stand right now and we've battled through some pretty difficult times with it.

So, Heath?.

Yeah, I'll just add, I agree. We actually are ahead of schedule in our analytics for Century BMW. So we're very comfortable with that tool being ready by a go-live date of January 3..

Thanks for the color. And just to follow up, Heath, in the initial days of OSOE, the expectation was for it to add about $40 million to the pre-tax line, correct me if I'm wrong.

Do you now see it being lower or higher than that number? And any color on the time period you're looking at to achieve that $40 million number?.

No, I think we're still looking at that same number. The big difference between what we announced and now is that it's taken us a little bit longer. We're about six to nine months longer in our implementation. By the end of 2017, we have road-mapped out, we'll have 50% of the stores in the One Sonic-One Experience and all stores by the end of 2018.

So, we're looking at the same lift. It's just a little bit of delay in getting all the stores in place..

Got it. Thank you..

And your next question is from the line of Mike Montani with Evercore ISA (sic) [ISI]..

Hey Mike..

Hey. Good morning. It's Mike Montani here. I just wanted to ask, if I could, on the front-end GPUs, on the new side first.

If you could just discuss a little bit on BMW, you mentioned a stair-step program, how is that different from the prior programs they may have had in place? And just what gives you the conviction that it's more of a cyclical issue as opposed to just a secular pressure moving forward on new?.

Well, on new – the stair-step program is on new, not on used. So, we didn't have – the last few months, we didn't have any stair-step program. We haven't had it since June. We had it in the first quarter, they ran it all the way through June, stopped it. And so, July, August, September, we had nothing.

In October, they came with an adder program that adds onto your volume in November and December. And so, now we've got our targets to go hit in November and December and I'm very confident. I've seen all the targets, I'm confident we can get to those numbers.

As I stated, we hit – 100% of our stores, all 15 of them hit their targets for October, so I'm confident there. And these manufacturers have their ups and downs with product cycles. This isn't something permanent with BMW. BMW is a fantastic brand.

It's our biggest brand in terms of net contribution and I'm 100% confident that they're going to bounce back. That may take a few months, but I don't think this is some long-term drawn-out issue with BMW. That brand's too big, too strong, and the consumer base is fantastic for it.

So, I have 100% confidence in their capabilities and their product lineup and what they're doing. And, as a result, this company 95% of the time benefits from that.

These have been just a couple of rough months and as they let inventory get higher than it should, and they're a little bit long in the tooth in their product cycle, and that is something that we face with every manufacturer from time to time, and that'll all be corrected as we move forward..

Great. And if I could just ask about the impact of stop-sale today.

and sorry if I missed this earlier in the call, but what percentage of the used units are now on stop-sale and how should we think about the potential impact that may have had to comp unit sales, had they not been on stop-sale?.

Yeah. So, our business for the quarter on unaffected car sales was up about almost 7%, and with affected car sales was actually down a smidge, so you could calculate that there was another 7% on that affected business. And in stock today on the used car side, we had 800 vehicles I think – we have exactly 800 vehicles that have not be repaired.

And I think we have a total universe of about 1,800 cars that are repaired and unrepaired in stock..

But in relation to the total inventory you have unused, I'm sorry?.

In relation to the total inventory, we've got about 12,000 cars, including wholesale cars, so it's less than 10% – a little less than 10%..

Okay, great. And the last one I had was just around the one-price tool. What have you seen there on the gross profit per unit side that gives you conviction that you're gaining traction? Because this quarter, I had seen a 30% hit in EchoPark GPUs, if I'm correct, year-over-year on used.

So I just want to understand, first, what drove the 30% and then also give the opportunity to understand what's exciting on one-price as it relates to...?.

Yeah. That's our pricing tool, making adjustments to generate the most volume and the most gross that we can.

But when you look at it, if you take the margin that we're running on the front, the margin that we're now running on the back, which is about $300, $400, $500 higher than what we'd originally projected, plus what we get out of fixed operations, we're still running a little over $3,000 a car, which was our original model.

So that gives me a lot of conviction that our pricing tool is making the adjustments to keep us driving the kind of volume that we're driving, and to keep our margin sort of in line combined with what's going on in F&I and what we get out of fixed operations. So we're very, very confident that that pricing tool is doing what it's supposed to do.

We are a lot further ahead on our pre-owned pricing tool than we are in our new car pricing tool. And we are, I would say, weeks, maybe a month out from being able to pretty much auto price 75%, 80% of our total inventory across EchoPark without having to have a human element involved, which is fantastic for us.

It leads to auto appraisals and all kinds of different things for us as we move forward managing this inventory..

And sorry, what drove the 30% decline this quarter for the used GPU in EchoPark?.

So, it's just our pricing system saying, listen, in order to generate the most volume and the most gross, you're going to need to adjust your pricing down. It's our system adjusting the pricing on its own. Our system's doing that. And so, it's keeping our gross and our volume where it needs to be. And we're filing the data.

The data is telling us out of the system where we need to price. And if we were six months ago running $1,350 and generating X number of gross, today the system's saying, you need to be in the $1,200 range, but my F&I was running $850 and now it's running $1,200. So the total gross that we're getting out of the cars is the same.

It's just coming at it from a different perspective. If you look at the F&I, F&I is up 30%. So, it's the combination of those things over a period of time. We're still on that same $3,050, $3,100 number..

Okay. Understood. Thank you very much..

There are no further questions at this time, gentlemen.

Do you have any closing remarks?.

We'd just like to thank everyone for joining us on the call today and we look forward to our next call with you. Have a great day..

Thank you for participating in today's conference call. You may now disconnect..