Good morning, and welcome to the Sonic Automotive Second Quarter 2022 Earnings Conference Call. This conference call is being recorded today, Thursday, July 28, 2022. 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.

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 so much, and good morning, everyone, and welcome to the Sonic Automotive second quarter 2022 earnings call. As she said, I'm David Smith, the company's CEO. Joining me on the call today is our President, Mr. Jeff Dyke; our CFO, Mr. Heath Byrd; our EchoPark Automotive Chief Operating Officer, Mr. Tim Keen; our Chief Digital Retail Officer, Mr.

Steve Wittman; and our Vice President of Investor Relations, Mr. Danny Wieland. On behalf of our entire leadership team, we want to sincerely thank our guests, teammates, manufacturer partners and communities we serve for helping us achieve another quarter of outstanding financial performance.

To briefly recap, during the second quarter 2022, Sonic generated all-time record quarterly revenues of $3.7 billion, up 9% year-over-year and net income of $94.8 million or $2.33 per diluted share. Excluding a $4.4 million onetime charge, we reported adjusted net income of $99.2 million or $2.45 per diluted share.

Despite ongoing supply chain disruptions, rising inflation and higher interest rates, in the second quarter, our team continued to execute at historically high levels and deliver another quarter of new vehicle GPU expansion, steady customer lead volume and continued growth in our parts and service business.

These results are also indicative of persistent consumer demand, both in-store and throughout our digital network despite a growing concern that macroeconomic -- about macroeconomic headwinds.

This is not the first time Sonic has experienced such business conditions, and we recognize the importance of being prudent and adaptable in our approach to achieving our growth and profitability targets during such times.

To bolster our short-term position and prepare for a range of potential economic conditions, we are very focused on maintaining our strong liquidity and balance sheet position, identifying additional cost management measures and balancing our growth plans. Beginning with our Franchised Dealerships segment results.

Second quarter 2022 revenues were $3 billion, up 8% from the prior year. Segment income was $162.1 million, down just 2%, and segment adjusted EBITDA was $216.3 million, up 9%.

On a same-store basis, franchised dealerships revenues were down 12% year-over-year, while gross profit was lower by 2% due primarily to a 20% decrease in industry new vehicle volume as a result of ongoing vehicle production constraints.

Parts and service gross profit was up 4% on a same-store basis, improving as vehicle miles driven recover towards normal levels. With an 11% increase in customer pay gross profit, offset partially by a 10% decrease in warranty gross profit.

Same-store F&I gross profit was down 14% due to lower retail unit volumes despite all-time record F&I per unit of $2,472 in our franchised dealerships segment, which was up 17% year-over-year.

Franchised Dealerships segment adjusted SG&A as a percentage of gross profit was 59.9%, up 180 basis points year-over-year, but remained structurally lower than pre-pandemic levels due to the strategic actions we have taken over the past two years to better optimize our cost structure.

Similar to the last few quarters, we continue to see limited new vehicle production and inventory levels due to supply chain disruptions and strong consumer demand for new vehicles.

This contributed to a 33% decrease in same-store retail new vehicle unit sales volume higher than the industry retail SAAR decline of 20% due to our luxury and import weighted brand mix, which continued to have lower days supply of inventory than domestic brands.

Offsetting the lower sales volume, though, same-store retail new vehicle gross profit per unit was $6,905, a 77% increase year-over-year and 2% sequential increase from the first quarter. As of June 30, our new vehicle day supply at our franchised dealerships was just 18 days, up from 15 days supply at the end of the first quarter.

While production is improving somewhat, demand for new vehicles remain strong as evidenced by stable new car pricing and continued expansion of new vehicle GPU. Our Franchised Dealerships segment used vehicle inventory had approximately 31 days supply, down from 33 days at the end of the first quarter.

We continue to be disciplined in managing our used inventory, volume and pricing in the face of recent declines in wholesale market pricing and the current macroeconomic outlook. Turning now to EchoPark. We reported all-time record quarterly revenues of $665.6 million, up 12% from the prior year.

EchoPark retail sales volume for the quarter was 16,608 units, down 22% year-over-year, but up 11% from the first quarter. As we guided on our April earnings call, second quarter EchoPark segment loss of $34.9 million was flat compared to the first quarter.

But showed monthly improvement exiting the quarter as the effect of strategic shifts in inventory mix and sourcing began to benefit the bottom line. Beyond these operating results, we continued the nationwide expansion of EchoPark, opening three new EchoPark locations during the second quarter, including two retail hub locations in Raleigh and St.

Louis, and remain on pace to reach 50% of U.S. population by the end of this year and 90% coverage by 2025. Beyond our fiscal footprint in June, we completed the rollout of our proprietary new e-commerce platform to 100% of our nationwide traffic at echopark.com.

The new platform continues to produce positive results in consumer and customer feedback accounting for 19% of our retail volume during the second quarter with a 30% increase in our website conversion rate and out-of-market buyers representing 69% of our e-commerce sales.

Going forward, we intend to continue EchoPark's expansion in a targeted strategic manner. With our current rate of expansion and the success of our new e-commerce platform, we remain very confident in EchoPark's long-term prospects once the used vehicle market eventually reverts to historical norms.

In the interim, we have taken deliberate action to expand our inventory offering to include 5-plus-year-old vehicles, which enables us to reach additional customer segments, improves consumer affordability and allows us to source more vehicles from non-auction sources, benefiting profitability.

In the second quarter, we increased our non-auction sourcing mix to 25% of EchoPark sales volume. And in July to date, 57% of our acquired inventory has come from non-auction sources.

With this improvement in sourcing, we are seeing better front-end and combined GPU going into the third quarter, which we expect to drive an improvement in EchoPark losses in the second half of the year.

In addition, we have taken steps to adjust our headcount and expense structure at EchoPark to better align with current volume levels and our near-term growth point. We remain confident in EchoPark's long-term prospects.

However, the current market has caused us to adjust our projected revenue growth and push back our previously stated financial targets beyond 2025.

Once we have gained more clarity on future used vehicle market conditions and the effects of the strategic adjustments we have made at EchoPark, we will then provide an updated EchoPark model and guidance. Lastly, on EchoPark at this time, we are concluding the previously announced formal review process for EchoPark.

Together with our advisers, we carefully evaluated a range of alternatives and our Board has determined the timing and current market conditions do not align with our value creation objectives for the business.

We will continue to execute on our expansion plans for EchoPark, and we will continue to monitor market conditions and periodically consider potential opportunities to maximize long-term shareholder value as they arise. Now turning to our balance sheet.

We ended the second quarter with $755 million in available liquidity, including $453 million in cash and floor plan deposits on hand.

Our consistently strong sales performance, cash flow generation and balanced capital allocation strategy have all contributed to our solid financial position, enabling Sonic to return capital to shareholders through its quarterly dividend and share repurchases.

During the second quarter, we bought back approximately 1.4 million shares of the company's stock for an aggregate purchase price of $59.4 million. Year-to-date, we have repurchased approximately 5% of shares outstanding at December 31, 2021.

To that end, today, we announced that Sonic's Board of Directors increased the company's share repurchase authorization by $500 million, to a total of $633 million in remaining authorization.

Further, I'm pleased to report that our Board of Directors approved a quarterly cash dividend of $0.25 per share payable on October 14, 2022, to all stockholders of record on September 15, 2022. In closing, our second quarter results demonstrated another period of solid and consistent financial performance despite macro headwinds.

Moving ahead, we will continue to execute on our strategic growth plans for Sonic and EchoPark capitalizing on the strength of our business model and flexibility to adapt in the short term, so we continue towards our longer-term goals.

By following this course, we are confident in our long-term ability to deliver revenue growth, increase profitability and build greater value for our guests, teammates and stockholders. This concludes our opening remarks, and we look forward to answering any questions you may have. Thank you..

[Operator Instructions] Our first question comes from the line of Daniel Imbro with Stephens. Please go ahead..

Hi, good morning guys. Thanks for taking my questions..

Good morning..

I want to start on the EchoPark side and really what's going on in the unit. I think it makes sense, affordability is a challenge. But trying to parse out how much of the unit weakness is due to softening demand in this backdrop? And how much of it is maybe due to a lack of supply.

Are you able to see that within your business? Do you think demand still exceeds supply there? Just trying to figure out kind of the drivers of that unit softness there?.

Yes. This is Jeff Dyke. 100%, the demand is there. I mean we pulled the business back just because we couldn't buy 1- to 4-year-old vehicles, they're just very hard to get. And so as we announced in the first quarter, we retooled and said that it would take us four or five months to bring the 5-plus-year-old vehicles in the inventory.

We're doing that now and starting to see some great results from that. I can refer you to Slide 18. If you look at our Houston market, 32% of the vehicles that we sold are over 5-plus year old cars in June of '22. That's just continuing to improve as we move into the third quarter.

And if you look, we did Denver and we did Dallas in July, in those markets that we're losing money in previous quarters are now going to be at least breakeven Denver market should make in the $300,000 range in July. All of this is from the moves that we've made with the inventory.

So the demand is there, but the demand is not there for a $640 monthly payment for preowned that's what you're getting and you're selling a 1- to 4-year car right now at $30,000, $31,000. And so retooling to the 5-year-old-plus cars, we're able to get that monthly payment back down into the $400 range, which is historically where it needs to be.

So consumers are buying a little higher amount car at a lower payment. And we've been able to continue to keep our warranty penetration up there. So not concerned at all about preowned demand.

The bigger concerns are just the availability of inventory, and we're procuring much more as a percentage of our inventory off the street now and through trades than we were before. It was a really low number in the previous years. Now that number is over 50%, which is great.

We'll continue to see that growth as we move into the third and fourth quarter, and we bolster our bottom line. Our bottom line is going to get better in Q3 than it was in Q1 and Q2, and then we expect Q4 to be better than Q3.

As we move into the first, second and third quarters of next year, we expect EBITDA to be back to breakeven or to profitability is moving forward..

Yes. And this is Heath. I would just like to add, if you look at Slide 18, I think it's important to note that the pretty dramatic impact that, that change has made on profitability. As Jeff mentioned, that Houston market was the first market we transitioned the 5-plus vehicles.

And you can see they were from losing $1.1 million to June 2022, they're losing 300,000. And we're seeing the same thing at the other locations as we transition. So I agree with Jeff's to have a big impact on the profitability of the EchoPark going forward..

Yes. And Daniel, this is David. One of the things to remember, too, is our guest experience. Our team, our EchoPark team is delivering just the world-class guest experience. So the demand from those guests from people out there wanting a 5-plus year old car to be able to buy one from EchoPark, we've seen that increase drastically as well.

And I think that it's important to note to remember that this transition to retooling the inventory is a 4- to 5-month process. And we started that in the middle of May, as we told you we would do in the first -- coming out of the first quarter's call. And so a few more months. We've got Houston done, we've got Dallas done, we've got Denver done.

And we'll start adding the 5-plus cars to the other markets. You're retooling technicians and reconditioning processes and all kinds of things, advertising and pricing to get to a more traditional type of model.

And we'll ride this way until the 1- to 4-year-old market comes back, and we have inventory that we can buy either at auction off the street in that category..

Really, really helpful color. And a follow-up on that, the profitability is higher, and it sounds like a big portion of it is non-auction sourced volume. How much of that do you think is sustainable? And I guess, the thought being, it's easier to buy a car off the street to a consumer when they have positive equity in the car right now.

But as vehicle values normalize and the consumers back to negative equity, it's probably a lot harder to buy them out of that car without attaching a sale to it.

So curious how you guys think about that trend feeding into next year and the future years, but also obviously impacting the profitability of this ultra-cohort when it's harder to buy that from a consumer..

Yes. Well, when that happens, you're back to traditional used car model, and we'll see 1- to 4-year-old cars begin to drop in valuation and price and we're obviously seeing it, but to begin to drop in the auction lanes and then we're back to buying those vehicles -- sourcing those vehicles, both from off the street and to auction.

And that will bring the volume back from an EchoPark perspective in the wonderful category. Yes, you're going to be down into the -- right now, if you're looking at what we're paying at auction three or four weeks ago, it was at $31,000 price point. Today, you're in the $27,000, $28,000 price range. So it is dropping.

And I expect that to get back down below $25,000, that makes a big deal because your tenor back down into the $400 for a monthly payment for the consumer, and that is what we're looking for. That's the big issue right now for everybody in pre-owned as the monthly payments are too high in the wonderful category..

And Daniel, to add one more point. This is Danny.

I think the other piece of that is when you see that happening, and use pricing starts to come down, you could have the potential for negative equity, you're going to be in a position to where lessees are not buying out their leases at the end of the term as they are to date, which historically has been less than 10% of leases and it's somewhere in the neighborhood of 50%, today.

So that would benefit both the one to four years coming back to auction as well as on the franchise side, kind of the organic inventory sourcing that we're missing out of a lot, particularly in our BMW and Honda brands today..

Yes, if you look at our BMW and Honda brands, they compromise 30% to 35% of our total revenue. And in the second quarter, combined, those two brands were up about 6,000 used cars year-over-year. We were all 4,000 cars of April more than the company was up, and that's 100% coming from off these cars, not coming back to consumer.

And typically, we buy 95% of those off-lease cars back. Today, it's less than 50%, and that's where you see the difference in terms of our overall used car performance on the franchise side being different than everybody else's. It's just those two brands are causing us to have it right now in terms of used car supply coming back off of lease..

Got it. And last one for me, just talking about used pricing normalizing. Are you seeing any lenders tighten in this environment just given prices are so high and maybe are coming down.

Are you seeing any change? I know you guys will take balance sheet risk, but any change in your financing partners or ability for customers to get financing at this point in the cycle?.

Daniel, this is Heath. We haven't seen that, and we get asked that a lot. You see a little bit of crack on the subprime. But above that, we haven't seen any tightening from our lenders, and we keep it in some macro data that actually correlates with that as well.

There is obviously the chance that if we hit a recession, that's too difficult that we may see something that so far advancing that..

Thanks for all the color this morning. And good luck..

Thank you..

Thank you, Mr. Imbro. [Operator Instructions] Our next question comes from the line of Rajat Gupta with JPMorgan. Please go ahead..

Great. Thanks for taking the questions. And David, just wanted to pass on my condolences to you and your family as well..

That's nice. Thank you so much..

Just the first question on EchoPark following up on Daniel's question. You mentioned that the exit rate on those losses were getting better had gotten better in 2Q.

Just curious if you could provide us with any visibility on the trajectory of EchoPark EBITDA in the near term? When can we expect that business to turn to profitability just based on the actions you're taking around mix, the higher GPUs and ultimately cost? And I have a follow-up..

Yes. You bet, Jeff Dyke here. So as we told you in the first quarter, the second quarter was kind of going to mirror the first quarter in terms of EBITDA, and that's exactly what happens almost identical.

As we retool started that in May, I would -- the third quarter is going to be -- we're going to lose less money in the third quarter from an EBIT perspective than we did in the first two will improve again in the fourth quarter from that.

And it would be my guess that in the first or second quarter of '23, if nothing changes and inventory continue to kind of stay in this $27,000, $28,000, $29,000 price range for 1-to 4-year-old cars, and we don't improve from an overall used car availability perspective. But I would tell you, we'll be fully retooled in the next two to three months.

and profitability, at least from a breakeven basis on EBITDA in the first couple of quarters, I'd say, the second quarter of next year, somewhere in that ballpark, if not sooner.

And then if we -- if inventories start to become more plentiful, off-lease cars kind of return, consumers start selling this those cars instead of buying them out, that's going to change the valuation process on pre-owned.

We'll get that price point down into the 400 to 450 price point range for the consumer has a monthly payment, the profitability come back a lot faster. So it's kind of a wait and see to see what's going to happen with pricing on pre-owned inventory. But if nothing changes first couple of quarters of next year, at least back to breakeven..

And Rajat, this is Heath. I would just add that we are still fully committed to hitting our goal of 90% coverage by 2025. So we're going to have the infrastructure in place as the market turns. And so the speed of the market returning and us retooling is really going to define that trajectory going forward.

But I think it's important to note that we will be -- the infrastructure will be there as the market turns. We have not backed down on that 90% coverage by 2025.

And if you do look at just sequential month to month, our EchoPark from June to July, we don't even have, but two, three of the markets transitions to this new model, and we're seeing $2 million to $3 million differences in pretax..

Yes. And I would add that -- adding the 5-month inventory is temporary. It's not abandoned the 1- to 4-year program long term. That's still a major part of our plan.

And we think as inventory comes back, it doesn't mean that we won't sell the 5-plus year vehicles, but it just won't be as big a percentage of the mix is going to be right now while we work our way through this inventory time.

I think it's also important to remember, as we said earlier, our Denver market, which we just retooled this month that was losing in the $300,000 to $400,000 a month range. It's going to make $300,000 in the month of July. In our Dallas market that we also retooled this month, it was losing $600,000 is going to be 0 to 100,000 loss.

So massive improvements, and then he talked about Page 18 earlier where we've gone in Houston from $1 million, $1.1 million, maybe even a low of $1.3 million, all the way up to a $300,000 loss and continuing to improve there. It doesn't take long to retool.

It's a few more months, and then EBITDA is just going to continue to get much better than what you've seen in the first two quarters..

And Rajat, this is Heath. I think it's important. That's one of the beauty of having the diversification. We've been doing this on the franchise side for decades. And so we have the capability and the knowledge that we can easily go over EchoPark and this 5-plus we gone and the processes that need to be in place..

Maybe shifting gears to parts and services, the same-store growth was strong, but slightly below what your peers have reported anything to flag there on the drivers? Is it more regional or brand dynamics, perhaps just lower reconditioning because of a weaker new and used units.

Maybe if you could just help us unpack that a bit and what your expectations go out for the remainder of the year?.

Yes. I mean, actually, we're really excited about what we're doing in fixed operations. We're up 11% in customer price, which is for the other peers that have give that data, we're in line with that. And I think brand mix plays a role there. And if you look at Penske and what they're doing, I think our numbers were about the same.

The internals are hurting a little bit because of the used car volume being off. That typically runs about 15% of our overall fixed gross, and then that's all 14% or 15%, so because of the volume being down. And so that's starting to roll in that somewhat. Warranty is offsetting it a little bit.

ut we're very focused on growing our market share by opcode in our service business, and we are gaining market share, particularly in the BMW brand. And I expect that to continue to pay dividends for us as we move through the next few quarters and into next year. So we're very excited about where we are on fixed.

And I think just when you compare to the competitors, the brand mix plays a little bit of a role there versus our brand mix..

Yes. And you can -- this is David. As you can imagine, with the discussion of used cars being more expensive, it will cause customers to keep their existing vehicle and will then help our fixed operations, as Heath mentioned, having the diversification of our business really helps..

Got it. That's helpful color. Thanks a lot..

There are no additional questions waiting at this time. I would like to pass the conference back to David Smith for any closing remarks..

Thank you very much. Thank you, everyone. We appreciate your time, and have a great day..

That concludes the Sonic Automotive second quarter 2022 earnings conference call. I hope you all enjoy the rest of your day. You may now disconnect your lines..