Good morning, and welcome to the Sonic Automotive Second Quarter 2019 Earnings Conference Call. This conference call is being recorded today, Thursday, July 25, 2019.

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 the 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.

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 8K filed with the Securities and Exchange Commission earlier today. I would now like to introduce Mr.

David Smith, Sonic and EchoPark's Chief Executive Officer. Mr. Smith, you may begin your conference..

all-time quarterly record pre-owned unit sales of 41,458 units; all-time quarterly record F&I gross per retail unit of $1,710; all-time quarterly record F&I gross of $118.3 million, an increase of $14.2 million, or 13.7%, from the second quarter of 2018; new vehicle gross per unit of $2,000, up $146, or 7.8%, from the second quarter of 2018.

Same store fixed operations gross increased 6.4% during the second quarter of 2019, with customer pay being up 7.9%.

SG&A to gross profit ratio of 77.2% in the second quarter of 2019, an improvement of 330 basis points compared to 80.5% in the prior year period when adjusting for the items of interest noted in the press release affecting the prior year quarterly period. Inventory day supply for new units was 64 days, down two days from the prior year quarter.

Inventory day supply for pre-owned units was just 28 days, down one day from the prior year quarter. Lastly, we're also pleased that our Board of Directors approved a quarterly cash dividend of $0.10 per share. The dividend will be payable in cash for our stockholders of record on September 13, 2019. The dividend will be payable on October 15, 2019.

At this point, we would like to open the call to question. Thank you..

[Operator Instructions]. Our first question comes from John Murphy from Bank of America Merrill Lynch..

This is Yarden Amsalem on for John. First question on -- you guys posted really strong used vehicle unit comps this quarter, but margins or GPUs were a little bit weaker.

Can you maybe talk about what's driving the performance there and whether that reflects the inclusion of EchoPark? And at what point do you expect those margins to recover, if at all?.

This is Jeff Dyke. That's just a blend of EchoPark and Sonic Automotive that's driving that. So we expect it to continue to be in this range. Remember, our strategy at EchoPark is a little different than you would see in the traditional environment, where our front-end margins are a lot lower, with high back-end margins.

And as I said in the first quarter, we look at the margin combined between front and back anyway, and so those blended margins are right -- in terms of our forecasts are right in line. So we're satisfied.

And we're up in terms of our EchoPark margin year-over-year, so we're in real good shape there both on an F&I perspective and a front-end margin perspective. So we expect it to continue to be in that range and are not concerned about it at all..

Okay. That's helpful. Thank you. And then in your cost performance, it seems like you guys are really starting to see the benefit of your restructuring actions from earlier this year.

How much more do you think you have left to take out cost? And how do you think about SG&A I guess over the longer term, especially given your continued investment in EchoPark?.

You can see this is quarter especially we started really leveraging our SG&A with the increasing gross. When we look at our initiatives, we implemented back in September of '18 cost reductions not only at the store level, but at the corporate level. And so we still see some opportunities. You can actually see it.

Especially, in the EchoPark segment, I think our incremental flow-through was 54% for this quarter and consolidated throughput was 85%. So we see it continuing to leverage and we think that the same -- we are at, what, 77.2%, which was 310 basis points lower. And so we feel like that we're doing a really good job on our cost reductions..

This is David Smith. Also as our stores -- they're going to grow organically. There's a lot more growth we had in our current eight EchoPark locations. So that will especially help to offset the SG&A..

The other thing too is, is in the franchise stores we see that there's more opportunity from an expense management perspective. So I think we will continue to drive expenses down as we perform. So there's still more to come in that arena for us..

And lastly, we talked about in the last call that we really have started focusing on the core business. We had a lot of projects in 2018. We have eliminated all of that - the shiny objects and we're just focusing on the core business, which obviously reduces our expenses..

Yes. Thank you. That's great. My last question is on finance and insurance for vehicle retailed.

Can you maybe talk about what's driving the improvement there and especially given the higher mix of used vehicles? And over the longer term, how much long do you think you have to push F&I PVR even further?.

Well, I mean you look at our friends over at AutoNation. They're running at $1,900 plus the coffee and we're at $1,710 all-in. So it seems like there's more room there. Our EchoPark stores are north of $2,200 I think, somewhere in that level. We're over $1,500 at the store level when it comes to the Sonic store. So there's plenty of upside.

Again, and I reiterated this the last several quarters, JM&A and the relationship between us and them has been fantastic. They played a huge role in helping us drive the business. And our finance team is very, very focused operationally speaking.

So we think there's still upside and I think we'll continue to see more and more improvement as we go through the next few quarters..

Our next question comes from Rick Nelson from Stephens..

Nice quarter.

Can you speak to the market that you are targeting for these four new stores? Do you have the locations already identified? And are they going to be large or medium-sized stores in those markets?.

Traditionally speaking, they are all large stores, Rick. But at the end of the day, we're going to open in Long Beach, California. This is a store that will get opened this year. We're repurposing an old Mini store, where we move Mini into the BMW store. So we're very excited about that. That will happen probably late fourth quarter.

The next markets that you can expect us to show up into are Atlanta, the DC area, Orlando and possibly Fort Lauderdale, Miami. So these are our big target markets. We've identified property in Atlanta, obviously have the property in Long Beach, and we're getting close in the other markets.

And then you can expect us to continue to expand EchoPark probably at the tune of three stores, possibly four stores a year as we move forward. But remember, for us it's not about number of rooftops. And we have eight stores selling into over 120 markets so far this year. And so it's just how far out can we reach.

We have a lot of customers coming from all over the country into these eight stores and we expect that trend to continue..

Yes. And this is David. As Jeff mentioned, repurposing a facility in LA. And we did the same thing in Huston and with a huge amount of success. And it doesn't take us long. It's not like we have to build from the ground up every location. It takes a year to open a location..

Yes. I mean we're excited. I mean that's a great point. That Houston store has been opened for six months and it’s going to do north of 600 cars in July. So we're really excited about the progress that we're making there..

So you've cataloged in a forecast kind of -- which you increased up to $1.1 billion, 50,000 cars.

Can you speak to the profitability that you're expecting for this year, for the full year?.

Yes. So sure. Look, we've got -- we made -- $1.7 million I think was our final number there at the store level for the second quarter. And I think our forecast is somewhere in the $6-plus million range, $5 million to $6 million.

A lot of that depends on the drag -- we did not plan on opening -- kind of getting this Long Beach store opened prior to the end of the year, but we've had such great success with EchoPark, we're trying to ramp that up. Long Beach in the LA market is just a -- that's the single largest a year to five year-old car market in the country.

So we're very excited about that. There'll be a little bit of drag opening that store. So $4 million, $5 million, $6 million with huge revenue growth is probably what the numbers are going to be for the year. And then that revenue growth will continue.

As David said earlier, we hope to add $0.5 billion, something like that in revenue for 2020 and grow profitability. Again, we don't have to lose money to do this and that's what I think makes us a special disrupter. We're not out there throwing a bunch of cars out on the street and losing a ton of money. We're making money as we do this.

We have a formula. The formula is working. And we're going to expand EchoPark as a national brand across this country..

And this is Heath. You got to keep in mind that out of the eight stores, we have two that you can call pretty close to maturity. So you got six stores that haven't even reached their maturity from a profitability perspective..

And if you, Rick, look at July from an EchoPark perspective -- I said this last quarter. Just every month I keep pinching myself. We're having -- we're on pace to have another record month this month. And the month is almost over, so we should lock up another record month.

And then five weekends in August, it's going to be a lot of fun in EchoPark world..

And how long do you think it takes to reach maturity with the EchoPark stores?.

We don't know the answer to that quite honestly. I mean our Charlotte store came out of the chute and was profitable immediately and we're doing between 400 and 500 cars there. We think we can do 1,000 cars here. We've been opened for a year. So three years maybe full maturity, somewhere in there, three -- that's what we think, but who knows.

I mean we keep saying that our Dallas store is at full maturity and it just keeps getting bigger and bigger and bigger. Same thing for Denver, it just keeps growing. So we'll see. Right now, we said that we think we can get there in three years..

Yes. Sure.

The long term potential how many store -- EchoPark stores do you think you can operate?.

So we did a five-year model and in our five-year model we have 25 to 28 stores, somewhere in that ballpark. But again, I want to emphasize it's not the number of rooftops for us. It's just where can we put a big rooftop and how far out can we penetrate. And we've got customers that are coming to us from Alaska for crying out loud.

They're coming from all over the country to these stores to buy. So as long as we stay transparent, keep our expenses where we are, stick to our plan, we believe we can control the cost, keep our pricing really low and drive that -- customer traffic is just amazing at these stores. And so we'll see. 25 to 28 stores maybe over the next four years or so.

And we'll see how we're penetrating the market. That's going to dictate how many rooftops we believe we need overall..

Our next question comes from Colin Langan from UBS..

This is Gene Vladimirov on for Colin. So within parts and services, warranty was up 9% year-over-year.

Wondering if you could talk about the drivers then there and how you're thinking about that for the rest of the year?.

Yes. Look, warranty is all over the board all the time, right? There's recalls from BMW, Audi, you name it. There's stop sales all over. It's just become a way of life unfortunately. So -- and I think I saw our number at 12%, not 9% on a same store basis, with our customer pay up nearly 8%, I think it's 7.9%. So I expect it to continue.

I mean if you look and go back over the last couple of years, we've had recalls just coming and coming and coming. Warranty keeps kind of driving the number. Mercedes Benz has had recalls. We were in a Mercedes Benz meeting the other day and they were apologizing for the recalls. And it just happens. And so I expect that to continue.

It's certainly more of a part of our life today -- in the last year or two than it has been previously. A lot of new cars coming out, everybody pushing for shares. So I expect that to continue. But I also expect us to be able to continue to grow customer pay in the mid to upper double digit range or to the 10% range. So that opportunity is there.

We've really refocused our fixed operations team this year and they're doing a very good job and have a lot more upside from our perspective..

Got it. Great. And then on the Fed rates, I think you guys are seeing -- you mentioned the sentiment is for a cut.

Do you have any view on the timing of that, like what's embedded in the forecast? And then do you have any color on sensitivity? So let's -- like if it drops 25 bps, some profitability as to that?.

This is Heath. I don't think we have any more insight on the timing other than what you see in the news. Interestingly -- obviously, it helps on the new car side as interest rates -- and used car side. So on the consumer side, there's great benefit.

From a pricing foreplan, it's all based on LIBOR and a lot of that is priced in, so we don't see a lot of impact on foreplan expense because a lot of it is already priced on the LIBOR..

Our next question comes from Rajat Gupta from JPMorgan..

Congrats on the quarter. Just had a question on the balance sheet and M&A.

I mean what do you see -- I mean obviously you have the EchoPark initiative going on parallelly, but outside of that, should we expect any kind of portfolio pruning actions going forward, maybe focusing more on used and EchoPark and de-emphasizing on the new side in some ways? And you had also mentioned early in the year regarding some divestitures that you had planned.

Could you just provide us an update on what's going on there?.

one is to grow EchoPark and one is to reduce our debt. And we are actively involved in both of those on a daily basis. As David mentioned, we are still looking for -- opportunistically to grow the franchise business. And so we look at deals every day. On the dispositions, we look at every single facility.

And when we have a lot of requirements from the manufacturers that just doesn't pencil if we have enhancements that are required or we lose margin money, we do the math and we determine do we want to keep it or not and we make a financial decision.

We don't have anything that's on the radar, but when things pop up, we'll do the math and determine if we should dispose of the store or continue to operate it..

And this is David Smith. We -- and as -- to piggyback off what Heath said, we have a number of things in the works. We're just not ready to announce yet. But we're certainly working towards continuing to improve our balance sheet..

Got it. That's helpful color. And just wanted to also follow up on that -- on CapEx. Obviously, coming down a little bit this year.

What's kind of the run rate we should be expecting going forward keeping in mind the EchoPark expansion you're targeting on an annual basis?.

Yes, I think we actually now have for 2019 $128 million.

And -- is that right?.

Yes..

$128 million is the rest -- for the full year. And we expect that same kind of level. Now as we ramp up EchoPark, you may see approximately $40 million to $50 million increase in 2021 as we open up new EchoPark stores. But as you said, it's dramatically down from '16 and '17 and down from 2018, which was about $143 million..

[Operator Instructions]. Our next question comes from Bret Jordan from Jefferies..

A question on the -- you said EchoPark front-end is improving. Could you talk maybe order of magnitude? And then is that better inventory sourcing or better pricing that drives the better unit profit? And then I....

No. So this is Jeff. At the end of the day what drives that margin is what we're buying, because our pricing is pretty well set in terms of the competitiveness and where we want to be against our competition. So as the market moves up and down, inventory levels grow and it allows us to buy a little cheaper, then the margins go up.

And I think we improved in the 100 -- what was the overall number?.

Well, we actually -- on the EchoPark side the total F&I plus front-end increased 407. And 205 of that was F&I and 202 was front-end..

Yes, there you go..

Okay. Great. And then a question I guess on the franchise side of the business.

We haven't heard in any of the other competitor peer calls so far, any discussion as far as competitive -- I guess promotional level has anything -- has promotional activity decreased year-to-date or is there anything to take note of?.

No, it's the same. It's competitive. I mean I will give shouts out -- BMW has just done a fantastic job this year. Their new products are great and we're up double digit with them in the quarter. And so they've done a great job. Same along the lines with Audi and Mercedes, Honda.

All of them for us are just performing at a really high level and our share in those brands are outperforming in some cases by double of what's going on in our local market. So we're just having a fabulous high line in import year here at Sonic.

But the same level of incentives and the same craziness that's existed for the last four quarters continues..

Our next question comes from Jordan Hymowitz from Philadelphia Financial..

A couple of different topics. One, you guys talked about redeploying certain assets. Well -- and can you -- just in California alone, you have three or four stores that could be worth $700 million, $800 million by themselves.

I mean have you thought at all about either selling some higher priced franchise dealers and redeploying them in EchoPark or highlighting some of the value of your underlying franchise dealers in a different way?.

Yes, you bet. We've already done it in some cases with some of the sales that we've made and the fine earnings that we've been receiving are, you know, way, way above what you would traditionally or normally see. A lot of that is generated -- yes, and we're talking of 15, 16x earnings range.

So a lot of it depends on what the manufacturer is going to require us to do with the facility. But as you noted, we have got a -- and we never included in our liquidity ratios, but -- or in our liquidity as we discuss liquidity. But our liquidity from the real estate, just a book value is somewhere in the $0.5 billion range, $450 million range.

And the franchise value is out there and particularly with Sonic Automotive because we're mostly the high line. There's just tons and tons of opportunity and leverage there if we need it to go grow EchoPark. The beauty of EchoPark, as David said in his opening statement, is, is that it's just not that expensive to open a store.

We can buy a store, buy a facility, refurbished it and be in the business for in or around $15 million, where that same thing is more than double for a big high line store, plus the huge value you'd have the pay to go get it.

And then the returns of EchoPark -- as you know, our big Dallas store, we've had a size -- $2 million in a month in profit and it will do $14 million or so this year in profitability. The Denver store is going to be way up there. The Denver market is making a bunch of money and it's going to be in the $6 million, $7 million, $8 million in profits.

So yes, we're starting getting the EchoPark realm into some of these high line brand realms. So there's plenty of room for us to maneuver if we need to with some of these franchise locations. We're very, very, aware of it and it's a great position to be in..

But the numbers that I've drawn are crazy. It could be $700 million, $800 million just your California stores or just your franchise dealerships.

With real estate, it could be closer to a $2 billion valuation without EchoPark, correct?.

Correct. Yes, you're right on target..

Okay. And one last different topic question is you guys really since a long time ago -- because it's been a long time following your company -- that you had some sort of captive finance operation.

But with EchoPark, is that something that you may look to partner with one of larger lenders against some sort of shared receiving -- or shared incentive, so to speak? Or are you guys getting big enough -- whether that's a possibility, because that could also help narrow the differences and highlight the value there versus what CarMax or what Carvana has done?.

Yes, 100%. And I mentioned JM&A earlier. But I would tell you that Ally on the EchoPark side has done equally as good a job with us. They've just been fantastic.

Great, great partnerships and lots and lots of opportunity as you look at some of the aftermarket products that we sell and enjoying some of the profits that we get on those products, so our warranties, service contracts, so to speak. There's a lot of room there and a lot of cash will be built up over time for us to bring those dollars in.

So Ally is certainly our business partner on the EchoPark side. They've done a fantastic, fantastic job. And there's -- as you're pointing out, Jordan, there's more there to do as we grow the EchoPark model.

Remember, we're really young at -- I mean we're -- I know we've got 50,000 cars being sold and we'll do over $1.1 billion this year and probably in the $1.5 billion to $1.6 billion range next year, but we're relatively young. And as we get bigger, more mature, the brand grows, our partner with Ally-- our partnership with Ally is going to grow too.

And there's just a lot of work to do there with them to help build profitability for both them and us..

But with Ally or with anybody else, are you getting any split of financing specifically right now?.

Yes. But I don't want to go into the details of what that is. That's a little bit of our secret sauce..

Fine. But there already is some split of financing. Okay. Thank you..

Yes, there is. You bet..

Our next question comes from Armintas Sinkevicius from Morgan Stanley..

I believe last year you -- or not last year, last quarter, I apologize, you mentioned some announcements here in the third and fourth quarter around digital initiatives and was just curious to see if there are any updates there, the Digital One Stop..

Yes, we will launch Digital One Stop in November of this year. That's our target date right now. And we'll do that in one location, in our Fort Mill Ford store to get started. And then we also have already launched our CarCash app. And that app is just really being launched at the Fort Mill Ford store as well.

We are working to see can we take some of the EchoPark characteristics and plug them into a new car store and what happens to used car volume. Early on in July, we're seeing a huge increase in our volume from a pre-owned perspective out of that store. We expect Digital One Stop to bolster that.

And we expect our CarCash app, which we're not only providing to the consumer, but we're also providing to our competitive dealers so that our retail trade center can help make offers on vehicles they may not want to trade for or they may want to send to auction.

We can put a little more money into because we have something to do with the vehicle via EchoPark or our Sonic stores. So all of that is coming. We'll officially launch the CarCash app on August 12 for that location. And we'll geofence it in I think a 50-mile radius. So if you want to use the app, you got to use the zip codes.

And then Digital One Stop will become live and you'll be able to finance a car, buy a car, the whole nine yards all online using the CarCash app. So there's no external third-party application to give you a range of value on your trade. We'll -- our retail trade center will give you -- there's no phone calls, there's nothing.

Our retail trade center -- it takes about six minutes for you to put your appraisal in and to get an answer back. And we'll give you a number. And as long as you describe your car right, we'll come get your car and add it into our inventory.

So we think it's a great opportunity, a great way for us to buy more cars off the street, not only from consumers, but also from other dealers..

Okay.

And would -- the Digital One Stop, how much of this is you developing the platform from the ground up? Or are you using existing software such as Drive Motors or Modal to prepare the offering?.

We have about eight different vendor partners from banks to software builders that are joining us in this venture to pull this off. So some of it in terms of our own software. And Capone has done a really good job working with us. Route 1 has done a fantastic job working with us in developing this.

Certainly, Manheim and all of their team has worked with us real hard. BDC, all their team has worked with us real heard. So there -- we've got a lot more than just Sonic Automotive working to help build a platform that's good for the industry..

And this is Heath. We are building the backbone. And then we're just using APIs to utilize all of those vendors' functionalities..

Okay. And I can appreciate you launching at one store. You'll sort of see how it goes.

But what are you looking for as far as milestones or markers whether to decide to expand this further? And how are you thinking about the pace of the expansion of Digital One Stop to the entire footprint?.

Obviously, what percent of our sales comes -- is a part of that. What do we grow incrementally will play a big role in that? What happens to margins on the back-end in F&I. F&I plays such a big role in our overall profitability. Just overall user experience, what are we getting back in terms of customer satisfaction scores.

Our Reputation.com scores are very, very important to us and -- as they are to everybody, but hugely important. It's something that -- it's a first sort of report that we all get at about 4:30 in the morning every morning. And so all of those things have to happen.

If it works really well, if Fort Mill Ford -- true to form for Sonic Automotive, we don't kind of just make a decision and do everything across the country. Maybe it's something we did in the past, but at this point in time we'll look for a couple of other stores probably within the Charlotte market like Fort Mill Ford is and roll it out to those.

And then maybe we'll see how that might work in an EchoPark store. And just take our time to do it. We took our time to get EchoPark right before we started pushing on the gas pedal. We've got that done now. And we'll do the same with this.

It's an important part of our overall offering to the consumer base and it's got to be right so that it enhances our guest experience..

And we think obviously there is a population that wants to buy online. We want to provide that opportunity, but we want to do it profitably..

And this is David Smith. And yes, that's something to highlight in our growth strategy. And as Jeff mentioned, the feedback through Reputation.com and other sources that we get from our customers, they love to -- they still love to come to our stores.

While they do a lot of the transaction online right now, they still love to come and drive the car before they buy it. And it's a big part of the process. And we have gotten no -- I can't recall any feedback from customers where they've said, "Gosh, I would have bought the car from you if I could have done the entire transaction online.".

I'll now turn the call back over to David Smith for closing remarks..

Okay. That's it. Thank you, everyone. We appreciate it and have a great day..

This concludes today's conference. You may now disconnect..