Good morning, and welcome to the Sonic Automotive Third Quarter 2019 Earnings Conference Call. This conference call is being recorded, Thursday, October 24th, 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 8-K 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..

Thanks very much. Good morning and welcome to Sonic Automotive's third quarter 2019 earnings call. I'm David Smith, the company's CEO. And joining me on the call today are our President, Mr. Jeff Dyke; our CFO, Mr. Heath Byrd; and our Executive VP of Operations, Mr. Tim Keen. We are very excited to share the results with you all.

First, we would like to thank our teammates, customers, and vendors, and manufacturer partners for helping us achieve an outstanding third quarter. Sonic Automotive increased diluted earnings per share from continuing operations in the third quarter by over 83% compared to the prior year quarter.

Earnings per share from continuing operations were $0.66 per diluted share compared to $0.36 per diluted share in the prior year quarter. EchoPark continued to build upon its success from the prior quarter and we believe revenues will now exceed $1.2 billion for the full year of 2019, which would represent a 71% increase over 2018 annual revenues.

EchoPark's revenue for the third quarter of $312.2 million increased $126.3 million, which is up 67.9% compared to the third quarter of 2018. This increase was driven by a retail unit sales improvement of 71.6%.

EchoPark also improved its pretax profits during the third quarter of 2019 by $7.6 million or up 138.9% compared to the third quarter of 2018. As we continue to grow our topline revenues, absent the effect of new store openings, we expect a disproportionate amount of gross profit to flow through the bottom-line.

It's very important to note that the EchoPark growth story is not just about the number of traditional bricks-and-mortar locations, through our proprietary EchoPark technology and our Echopark.com website, we are drawing customers from over 140 markets across the United States to our only eight existing locations.

Our customers have shown they're very happy to travel to our EchoPark locations for our industry-leading guest experience.

While we believe our existing EchoPark stores have much more revenue and profit growth potential as they mature, we are also very excited to announce we'll be ramping up our growth strategy as we open EchoPark locations in major metro markets in California, Georgia, and Florida that will give us a nationwide footprint by the end of 2020.

Our core franchise stores also had an outstanding third quarter. Our franchise stores benefited from overall higher gross profit from used vehicles, fixed operations, and F&I during the quarter. Notably, F&I gross profit improved $14.1 million from the third quarter of 2018.

This was an improvement of $217 per unit retail, up 15.2% compared to the prior year quarter. These increases in gross coupled with active expense management resulted in a $10.3 million increase in franchised store pretax income, which is up 36.8%.

Some other highlights for the third quarter of 2019 on a total Sonic consolidated basis include an all-time quarterly record pre-owned unit sales of 42,453 units; an all-time quarterly record F&I gross per retail unit of $1,771; an all-time quarterly record F&I gross of $126.8 million, an increase of $28.8 million or 29.3% from the third quarter of 2018.

Our same store fixed operations gross increased 7.3% during the third quarter 2019. SG&A to gross profit ratio of 76.7% in the third quarter of 2019, an improvement of 350 basis points compared to 80.2% in the prior year period. Inventory days' supply for new units was only 63 days.

Inventory days' supply for pre-owned units was just 27 days, down four days from the prior year quarter. Lastly, we are also pleased that our Board of Directors approved a quarterly cash dividend of $0.10 per share payable on January 15th, 2020 to all stockholders of record on December 13th, 2019.

At this point, we would like to open the call to questions..

[Operator Instructions] And your first question is from the line of John Murphy with Bank of America. Please go ahead..

Good morning guys..

Good morning..

First question on F&I, it sounds like it's a point of strength because you're focusing on it, but it seems like there's some incremental opportunity there.

I'm curious if you think about F&I, PVR or sort of best case scenario, what is sort of the highest that you think you get on any individual transaction on average? So we can understand maybe sort of the headroom there and maybe what the components of it are.

I mean it's like $300 or $400 on origination fee, but there's a lot of other stuff going into this number. I'm trying to understand the origin..

This is Jeff Dyke. The warranty penetration is what drives a big piece of that and there's a lot of upside left. I mean AutoNation is sitting out there and they haven't quarter. Last quarter, they were $1,900. We're sitting at $1,771 I think was the number we announced. So, I certainly could see a $2,000 number. I mean there's plenty of upside there.

Our warranty penetrations could get even better than they are today. We've got plenty of upside there. We run almost 40% penetration on the franchised side and we're running mid-50s on the EchoPark side. So, as we train better with Ally and JMNA [ph] and our partners, we'll get better. There's plenty of upside there for product penetration.

It's not so much on the rate that we're getting that sort of settled in, but the product penetration is where the opportunity is and there's plenty of upside there for us..

Okay, that's very helpful. When you -- and then second question on EchoPark. I mean when you look at new markets you're heading into, I think it was slide 23 of the deck you guys put out this morning, you show medium and large stores. When you identify a new market going into, I think Long Beach, California is what you talked about as the next market.

I mean how are you identifying that market? And it would seem you want to be go into new markets where you're doing the larger format stores because you're getting better profits and returns there. I'm trying to understand the nexus of sort of the decision-making process and how you're thinking about this growth..

Number one, it's data-driven. When you look at the Long Beach market or L.A. market, that's the largest zero to four-year old market in the country. So, it's a huge opportunity for us. Our market share continues to grow in these markets. And we sort of started off at 4%, 5%, 6% market share.

Now we're seeing double-digit share in sort of our more mature stores. So, we're going where that zero to four-year-old market is. And the markets David called out earlier, those are big, big potential markets for us, but there's plenty more across the country.

And those markets for us are just a stepping point to reach out to other markets all over the country. We're selling now in those eight locations into 140-plus markets across the country, so this just gives us a great footprint across the U.S. to continue to drive that percentage higher..

And the format of the store on slide 23, you have large versus medium. I mean why would you consider doing a medium as your sort of Greenfield facilities, if you have--.

Opportunities come around when we have to be able to buy real estate. So, that drives a little bit of it as well and the speed in which we can move to get that done..

Okay. And just I'll follow on this.

When you look at EchoPark versus your used vehicle business inside of your existing new vehicle franchise dealers, have you found any sort of cannibalization or any kind of conflict that you come across maybe less than optimal? Or something you can share that can be showed as really not a big issue here at all between the two?.

Not at all. I mean it's a huge job because all the freights--. It's the opposite of all the trades we're taking at EchoPark, we push those cars that are older than four years old into the Sonic stores, and we're selling a lot more cars.

For example, that is our store in Denver, Colorado is selling well over 300 cars now, a lot from trades that are coming from the EchoPark stores. It's been a huge help for us to have the EchoPark stores and markets where Sonic stores are located..

Okay. And then lastly a random question. I mean has there been any change in the relationship you're seeing with the automakers? It just seems I mean there's some sort of change -- kind of you talked about in Nissan and their dealer support.

But is there anything else going on in the relationship between automakers and dealers that is either good or bad? Do you see that in the last quarter or two or is it more status quo?.

No, it's actually I think getting better that. I mean I think the manufacturers are thinking outside of the box are not so focused on these huge facilities, much more technology and efficiencies. And I participate in a lot of dealer boards and I'll tell you our relationships have never been better.

Our partnerships are great and I think it just keeps getting better. And I see no downside to that as we move forward..

Yes, this is David Smith. I would echo that. It seems like we are working together with the manufacturing partners better than I've ever seen it since we went public with Sonic in 1997..

Do you feel like they're leaning into you as a large -- I mean large, well-run companies are willing to make capital and create a good customer experience any more than they have in the past? And I understand that it might advantage you versus some of the smaller players that can't necessarily keep up..

I certainly think that that is a big opportunity. I mean they're leaning on us on for technology, for guest experience and success breeds that. And when you sell a lot more cars, they become very interested in you. And we're seeing that right now. We're selling a lot more new cars. We're selling certified pre-owned cars. Our service is good.

And so it's all clicking and that makes a good difference..

Okay, great. Thank you very much..

Yes sir..

Your next question is from the line of Rick Nelson with Stephens. Please go ahead..

Thanks. Good morning guys..

Hey Rick..

Is there an impairment at EchoPark that was not added back, that the adjusted results were even better than what you printed this morning?.

Rick, this is Heath Byrd. That is accurate. We had about a $1.1 million impairment related to real estate..

Got it. And EchoPark, I'm looking at the expense ratio, 75.3%. We're seeing a decline in SG&A per store from a dollar standpoint. Is that accurate? I guess what is creeping out of the--.

Rick, this is Heath. I didn't hear everything. But it is accurate that SG&A is improving because of leverage you can get on the EchoPark stores compared to the franchised stores..

And is SG&A per store actually lower?.

At EchoPark than it is at Sonic stores, yes..

But at EchoPark, you're also seeing declines in SG&A per store?.

Yes, the gross is also up, so that's driving part of that..

That's correct..

Okay, got you..

And as we have more locations obviously, there's not a lot of expense creep on the management company side. So, that's pretty -- stayed the same regardless of how many stores that we opened. Therefore, it will help SG&A as a percent of gross..

Yes, we opened these next three markets; we're not going to add, if any to the operating company. So, you just have better flow-through and more efficiencies. That's part of the model..

And Rick, this is David. And I would say this, our team has gotten a lot better and more efficient about the speed and the time that it takes to get a new location open and getting it up and running and profitable has changed it a ton over the last four, five years since we started it..

Would you expect Long Beach to be dilutive in the fourth quarter?.

Not a lot. I mean some. There's going to be some carrying costs, but maybe the fourth quarter a little bit and the first quarter, right? It's sort of $1 million on the front of the opening and about $1 million worth of drag once we get it opened for a couple of months.

So, there's going to be some dilution in the fourth quarter and then on into the first quarter..

And I'm curious about the share count also. From 2Q to 3Q, it was up about 1 million shares..

That's correct. We didn't buy any back as you can see on the slides. And so it does increase because of where we are from an incentive compensation standpoint at the current time. So, we had to start going in accounting for the additional shares..

As we open more markets for EchoPark, you can expect each market to have about a $2 million drag. So, $6 million to $8 million is what you should sort of target for 2020 as we move into next year and open these new markets in terms of drag for the new locations..

And is the plan still three stores for next year?.

Yes, three markets. And right now you're in the three rooftop range. That doesn't mean there won't be some other opportunities for us. We'll see. But -- then the current store base will continue to grow in profitability. And we've seen that each quarter this year, which has been just great.

We can't really understand that mark with existing stores have a lot of runway left to grow. We're at about half maturity somewhere is what we're thinking. So, we've got a lot of upside in the eight locations we have, and selling into more markets.

Again, we're selling into over 140 markets in those eight locations, and that number is going to continue to grow. It grew 20 markets the last time we had a call. And just to be clear, that's three additional stores on top of Long Beach, so a total of four..

Right, right.

And how many stores do you think over the long haul for EchoPark? How many do you need to--?.

Yes, it's not really rooftop count that we want you to focus on. It's just that what we can penetrate and where we strategically place those rooftops. Again, there's just a lot of throughput that you can get out of these locations. And so who knows? I mean the number could be 25, it could be 100.

Who knows? It just depends on our penetration as we open up strategically locations around the country, so that we can penetrate out further and further from the base markets that we put the stores on. And that's really important -- that's a real important fact as we move forward.

It's not rooftop count, it's how many markets we can penetrate using the technologies that we have and the great incredible guest experience that we have. And guests are saying, hey, we'll travel a long way to come to you because we like what you're doing so much..

Great, and--.

Rick, this is David. The key to that is they really -- our customers would prefer to come and see the car before they actually complete the transaction and that's what they're telling us..

Thanks a lot and good luck..

Thank you..

Your next question is from the line of Armintas Sinkevicius with Morgan Stanley. Please go ahead..

Great. Thank you. Appreciate you taking the question here. When I look at your GPU and the F&I you're getting at EchoPark, roughly 2,200. And I compare that to the online-only competitors here running at about 3,000 last quarter, your growth being comparable to them.

It's interesting to see the profitability here and what surprises me is your SG&A as a percentage of growth is significantly lower here. And I think -- in the conference, that 55% to 60% SG&A to gross.

How are you driving that lower SG&A gross if we compare it to the online platform where you would expect the SG&A to be lower because it is effectively call center reps versus employee at the store level? If you can compare the two, just where are you able to see more efficiencies on the SG&A line?.

I mean our operating platform is a lot cheaper to operate and way less complicated. We don't have a whole bunch of people going around trying to deliver cars to individual clients. That creates a lot of expense and a lot of complexity. We don't have those complexities in our model, and the customer's coming to us.

So, it's a heck of a lot easier to operate. We don't spend ad dollars or anywhere close to the ad dollars. And we sell -- our technology allows us to sell a lot more cars through our associates. And our average sales associate or experience guides as what we call them, is approaching 20 units per associate. The industry average is around nine.

So, our efficiencies are a lot higher. Our model is a lot less complex and a lot more effective from our perspective. We just don't see how -- I'm not saying it's not going to be part of the model as we move forward, but we don't see ever us delivering each individual unit all over the country.

That operating model is very, very expensive, very, very complex. And we're going to always be able to operate at a much lower SG&A, from my perspective, because of the least amount of complexity that we have in our operating model. And we built the model that way. So, the throughput as you see in these eight stores, and we had our best throughput yet.

That's going to continue to get better. That doesn't mean we're going to have drag on stores we opened because as we said, that would be $6 million to $8 million next year, but a much more effective and efficient model from our perspective in what we're trying to accomplish..

And ironically to add to that, it's not in the SG&A section, but our CapEx is a lot lower than theirs as well..

Okay. What I'm hearing from you here is you don't have the logistics cost. You don't have the advertising expense.

If I look at their model and last quarter results, I back out advertising, back out logistics and back out some more logistics because some of it is included in their cost of goods sold, I'm running at call it 73% of SG&A as a percentage of gross profit. You're still optimizing 55% to 60%.

Just -- coming down there and see it in person in September, I really appreciate the efficiency of the model. Maybe you can talk to is it on the cost/benefit side where the employees are more efficient? Is it on the reconditioning side? Maybe just a couple of other nuggets here to better understand the SG&A gross dynamic..

We have a lot less people. We're doing a lot more with a lot less people and our technologies are allowing that to happen. And so--.

It looks it was like a third of the number of people..

That they have..

That we have..

Yes, we have a third of the number of people that they have. And so it's -- it doesn't cost us much to sell a car in our model as it costs them to sell a car. I'm not saying their model is not going to work for them. We're cheering for them. We want them to be successful because it helps the overall industry.

But at the end of the day, it costs us a whole lot less. And we also try to figure out what we can say no to, to keep our expenses down. we're really, really focused on making sure that our model stays really effective and really efficient, so we can provide our customer with a really low price point that keeps them coming to us.

And that's really important. Our prices are incredibly competitive and that makes a big difference. We got to keep that lower price point down to drive that traffic. Amount of leads we're getting at these stores is astronomical. Our Dallas store, we're seeing over 10,000 individual leads a month. That's unheard of in our industry.

So, our operating model is simply less complex, less expensive to run and more efficient..

Great. Much appreciated..

Yes, sir. Thank you. Appreciate the question..

Your next question is from the line of Brett Jordan with Jefferies. Please go ahead..

This is Mark Jordan on for Brett. Good morning..

Good morning..

Thinking of EchoPark, I believe it was mentioned previously that around 90% of the inventory is sourced from auctions, and the remainder is primarily sourced off The Street and from CarCash.

So, I am wondering that mix still stand? And if so, should we expect the mix of vehicles sourced at auctions to decline over time? What sort of impact will that have on front end margins?.

Yes, yes, and impact on margin is going to go up. That's the great thing is we haven't even scratched the surface yet. CarCash, our app just launched in one location here in Charlotte on the new car side and we are beginning to work with the app to drive more cars coming to us from off the streets.

So, the mix is below 10% now, but you should expect that to grow as time goes on and our app becomes more efficient. And that app, we're using not only for consumer, but providing it for a competitive set as well so other dealers are now beginning to use the app for us to appraise vehicles for them. We are also doing that in Camping World.

There's just a lot of different companies out there that can use the application they're trading for vehicles. So, we expect that to become a bigger percentage of our mix. What that number is, we don't know yet. We'll see over time. But when that does happen, we all know that when you trade for a car at the door, your margins go up.

There's less expense through transportation, auction margin fees, you name it. And so, our margins can improve on the front end by doing that.

That said, our prices can get more competitive because we're always looking for ways to drive that retail price down to offer that consumer that great experience at a really good value, sort of a Costco model, just really low price. And so one way or the other, if the margins stay where they are, the prices will get more competitive.

But we're going to trade for more cars at the door because of the application and we'll keep updating you as time goes on..

Okay, great. And during the prepared remarks, you just mentioned buyers are coming from over 140 markets to visit EchoPark. So, I'm curious if you have the mix between maybe local market buyers and sort of out of market or out of state buyers..

So, the way we're looking at it is the drive time. So, if you look sort of 30 minutes to an hour, that's about 60% to 70% of our business and the balance is outside of that. And then we are defining the market as multiple sales from each market across the country. And we've got customers who come to our Dallas store as far away as Alaska.

And really they're coming from all over the country, but that's kind of how we're looking at it..

Okay, great. Thank you very much..

Yes sir..

[Operator Instructions] Our next question is from the line of Rajat Gupta with JPMorgan. Please go ahead..

Hi, guys. Thanks for taking my question. I appreciate the color on the drag from the new store openings in Q4 and next year. I just had a couple of follow-ups related to that.

Firstly, I mean where are you in terms of the maturity curve of the existing EchoPark stores that you have? And assuming that those should keep getting more profitable in the fourth quarter and next year.

And then with new stores that are going to come up, how quickly can they be profitable versus what you saw in some of your earlier stores that you opened? Basically I'm just trying to get a sense of how much of the drag can be easily offset and what kind of EBITDA run rate should we be looking at going into the fourth quarter and next year? And I have a follow-up.

Thanks..

This is Jeff Dyke. We think our existing stores are at about 50% maturity. And so there's a lot of upside left [Indiscernible] the point David Smith was making earlier, just lots of upside. If you look at our Charlotte store, it's profitable in its first full month of operation. Houston took about six months.

We're thinking within a six-month timeframe, at the outmost, our store can be profitable. So, that's kind of where we guide you to look..

Got it. And so just looking at the fourth quarter, I mean you had $6.4 million EBITDA in the third quarter.

With the Long Beach store coming in, I mean I'm assuming that the fourth quarter run rate would be higher than what you did in the third quarter, given the existing stores -- improve, is that a fair characterization or should we expect a step-down?.

In terms of volumes?.

Just in terms of EBITDA?.

In terms of income?.

EBITDA..

EBITDA, yes I would say flat, sort of flat is the way to look at that for Q3 versus Q4..

Got it. okay..

You've got $1 million drag before we open and $1 million drag after you open for each store on average..

Got it. Okay. And then in terms of funding the new EchoPark store opening next year and potentially down the line. It seems like all of that is going to be funded by the free cash flow from the franchisee stores.

When would you expect just the EchoPark store to generate enough free cash flow to be just self-funding future growth? I mean are we looking at three years down the line or four years down the line? Just trying to get a sense of when it's not a drag on the franchisee free cash flow..

Yes, this is Heath. From an overall capital allocation plan, we're sticking with the exact same plan as EchoPark is still a priority. We will opportunistically look at franchise acquisitions. And again the debt reduction, which we mentioned before, we're kicking off. We kicked off $6.5 million in EBITDA in Q3.

So, we are going to get -- you're still going to have some franchise support into 2020, but after that, I think once the stores mature, we have four new stores on, then EchoPark is going to start supporting its own growth..

Got it. That makes sense. Thanks a lot. And I'll pass it on..

Thank you very much..

And at this time, there are no further questions. I will now turn the call back to Mr. Smith for closing remarks..

Thank you very much. Thank you everyone for your questions. We appreciate your time. Have a great day..

Ladies and gentlemen, this does conclude the Sonic Automotive third quarter 2019 earnings conference call. Thank you for your participation. You may now disconnect..