Sonic Automotive, Inc. (SAH) Earnings Call Transcript

Good morning, and welcome to the Sonic Automotive Third Quarter 2022 Earnings Conference Call. This conference call is being recorded today, Thursday, October 27, 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 findings in the Securities and Exchange Commission. In addition, management may discuss certain non-GAAP financial measures as defined in the Securities and Exchange Commission. Please refer to the non-GAAP reconciliation labels and the company's current record on Form 8-K filed with the Securities and Exchange Commission earlier today. I would now like to introduce Mr. David Smith, Chairman and Chief Executive Officer of Sonic Automotive. Mr. Smith, you may begin your conference.

Thank you very much, and good morning, everyone. Welcome to Sonic Automotive's Third Quarter 2022 Earnings Call. As she said, I'm David Smith, the company's Chairman and CEO. Joining me on today's call is our President, Mr. Jeff Dyke; our CFO, Mr. Heath Byrd; our EchoPark Chief Operating Officer, Mr. Tim Keen, our Chief Digital Retail Officer, Mr. Steve Whittman, and our Vice President of Investor Relations, Mr. Danny Wieland. I'd like to begin by sincerely thanking all of our amazing teammates, customers, manufacturers, vendor partners who're helping Sonic Automotive achieve another period of record-breaking financial performance, including record third quarter revenues, gross profit, net income and earnings per share. Highlights from our quarterly results include record third quarter revenues of $3.4 billion, which is up 12% year-over-year. Sonic also posted record third quarter gross profit of $581 million, up 23% year-over-year. This drove us to achieve record third quarter net income of $87 million or $2.23 per diluted share. During the third quarter, we continued to see strong new vehicle pricing, consistent consumer demand for new vehicles and sustained growth in our parts and service business. While we experienced lower new vehicle sales volume on a year-over-year basis due to ongoing supply chain constraints and limited vehicle inventory, we also continued to see strong new vehicle GPU and a sustained preorder bank. Our used vehicle volume was consistent with industry trends year-over-year reflecting ongoing affordability concerns as a result of near record high used car prices and a rising interest rate environment. I'm happy to say that since quarter end, though, we have continued to see stability in our overall business despite macroeconomic headwinds and concerns around rising interest rates, heightened inflation and ongoing global supply chain constraints. Our financial results reported earlier today demonstrate the fundamental strength of our diversified automotive model as well as our team's unwavering commitment to creating long-term value for our guests, manufacturer partners and stockholders. While we remain optimistic about our long-term prospects and growth trajectory, we realized that we are not operating in a vacuum. As I mentioned on our last earnings call, this is not the first time Sonic has had to navigate through adverse economic cycles. Our team is well aware of the current challenges we are all facing and is monitoring our operations daily to adjust for any near-term obstacles related to the overall industry and economic environment while maintaining a long-term strategic view for our business. As such, we remain adamant in maintaining our strong balance sheet position, which we consider to be essential in today's world. Our team remains very focused on maintaining high levels of profitability, generating strong cash flows and proactively managing our cost structure. To this end, we are continuing to take a strategic measured approach to our expansion plans, both with our franchise dealerships as well as with EchoPark as we balance our commitment to long-term growth with our current priority to maintain a strong liquidity position in light of uncertain macroeconomic outlook. Turning now to our franchise dealership segment results. Third quarter 2022 revenues were $2.8 billion, up 18% from the prior year period. Segment income was $146 million, up 1% year-over-year and segment adjusted EBITDA was $198 million, up 10% from the prior year. On a same-store basis, franchise dealership revenues were up 3% from the prior year, while gross profit was up 5%. Parts and service gross profit increased by 10% year-over-year, with same-store customer pay gross profit up 12% and same-store warranty gross profit up 7%. Same-store F&I gross profit was down 5% on lower unit sales volume despite an all-time record quarterly franchise dealership segment F&I gross profit per retail unit of $2,473 which was up 7% from prior year. Despite persistent new vehicle demand, sales volumes during the quarter continued to be impacted by ongoing vehicle production constraints. Same-store retail new vehicle unit to sales volume was down 6%, even as same-store retail vehicle gross profit per unit was up 28% year-over-year to $6,571. Same-store retail used vehicle unit sales volume was down 12% while same-store retail used vehicle gross profit per unit was lower by 9% year-over-year to $1,669. As of September 30, our franchise dealership segment had approximately 18 days supply of new vehicle inventory, unchanged from the second quarter. Production continues to improve slowly, while demand for new vehicles remained strong, which continues to drive strong new vehicle GPU. Our franchise dealership segment had approximately 31 days supply of used vehicle inventory, again, unchanged from the second quarter. Given ongoing new vehicle inventory constraints, recent declines in wholesale market pricing and our current macroeconomic outlook, we continue to be disciplined in managing our used vehicle inventory volume and pricing. Now let's turn to EchoPark. For the third quarter of 2022, we reported revenues of $608 million, down 8% from the prior year. Despite this, we reported record third quarter EchoPark gross profit of $49 million, up 88% year-over-year. EchoPark retail sales volume for the quarter was 15,422 units down 27% from the prior year as we continue to focus on executing our strategic adjustments to include 5-plus-year-old vehicles in EchoPark inventory. Digging a little deeper here, 5-plus-year-old vehicles represented 19% of EchoPark retail used vehicle unit sales volume in the third quarter, which was up from 9% in the second quarter of 2022, and our non-auction sourcing mix grew from 25% in the second quarter to 32% of sales in the third quarter. As we expected from the third quarter, we reported EchoPark segment loss of $29.9 million compared to $34.9 million in the second quarter and $32.9 million in the prior year quarter. EchoPark reported an adjusted EBITDA loss of $21.4 million in the third quarter, an improvement from a loss of $27.9 million in the second quarter and a loss of $28.5 million in the year ago period. This sequential improvement from the second quarter demonstrates the benefits of strategic shifts in inventory mix and sourcing that I mentioned earlier. At the end of September, our EchoPark segment had approximately 57 days supply of used vehicles. For EchoPark branded locations though, the days supply was just 40 days, excluding new locations opened during the third quarter, positioning us well as we head into the fourth quarter. During the third quarter, we continued to strategically expand EchoPark's distribution network, including a new vehicle or a new delivery center opening in Tulsa, Oklahoma, and retail hub opening near Sacramento, California. Including our new location openings during the quarter, the EchoPark brand now reaches over 50% of U.S. population on its way to 90% of U.S. population by 2025. In addition to growing geographically, we have also continued to expand EchoPark's digital footprint with the continued success of our new e-commerce platform, which was successfully rolled out this past June to 100% of our nationwide traffic at echopark.com. For the third quarter, omnichannel sales through our new e-commerce platform, accounting for 31% of EchoPark's retail unit sales volume, compared to 19% in the second quarter. Further 7% of EchoPark volume during the quarter was sold end-to-end online as guests continued to utilize our enhanced omnichannel purchase experience with out-of-market buyers representing 60% of our e-commerce sales. We continue to monitor EchoPark's performance and remain confident in the segment's long-term growth prospects once the used vehicle market returns to normalized conditions in due course. In the interim, we continue to take steps to adjust our structure at EchoPark to better align with the current environment and target a return to breakeven EBITDA in the second quarter of 2023. We are already seeing the benefits of expanding our inventory offering to include 5-plus-year-old vehicles, enabling us to reach additional customer segments, improve consumer affordability and to source more vehicles from non-auction sources, which will improve profitability. We began to see the benefits of these actions this past quarter and expect to see further improvement in EchoPark losses during the remainder of the year. We are still in the early stages of these initiatives. Once we have further visibility on future used vehicle market conditions and the effects of the strategic adjustments we have made at EchoPark, we will provide an updated EchoPark model and guidance. As an update on our share repurchase activity, during the third quarter, we bought back approximately 3.1 million shares of the company's stock for approximately $151.5 million. Year-to-date, we repurchased 5.2 million shares, representing 13% of shares outstanding as of the end of 2021 for approximately $245 million. As previously reported, in July, Sonic's Board of Directors increased the company's share repurchase authorization by $500 million. Taking this into account with our recent repurchase activity, this results in a total of $481 million in remaining share repurchase authorization, representing over 25% of Sonic's current market cap. Now turning to our balance sheet. We ended the second quarter with $488 million in available liquidity, including $171 million in cash and floor planned deposits on hand. The decrease in liquidity from the end of 2021 was driven primarily by the share repurchase activity I just mentioned. Additionally, I'm pleased to report today that our Board of Directors has approved to increase our quarterly cash dividend to $0.28 per share, payable on January 13, 2023, to all stockholders of record on December 15, 2022. Our strong sales performance, cash flow generation and balanced capital allocation strategy continues to allow Sonic to return capital to shareholders through its quarterly dividend and share repurchases. In summary, our third quarter results reflect another quarter of record financial performance in spite of growing macroeconomic concerns. Looking forward, we will continue to advance our strategic growth plans for both our Sonic franchise dealerships and our EchoPark business, taking the necessary steps in the short term to maintain our strong balance sheet so we can continue to reach our longer-term goals while still benefiting from the strength of our diversified business model. We remain confident in reaching these goals and look forward to delivering further revenue growth, increased profitability and generating long-term value for our stockholders. This concludes our opening remarks, and we look forward to answering any questions you may have. Thank you very much.

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

I just had a first question on inventory restocking and grosses. And because you guys have a much heavier luxury and import mix than most dealer groups, I'm just curious what, you're hearing there. And it kind of sounds like domestics might be catching up a little bit faster than luxury import brands, but maybe not. I'm just trying to understand what you think is going to happen there and when we get back to normal and what that normal means?

John, it's Jeff Dyke. Yes, the import brands, in particular, and Honda in particular, obviously, the day supplies are really low, 3, 4, 5 days. And we expect that to continue for the foreseeable future. The high line brands are getting better, Mercedes, BMW, our stay supply in total is growing there, not as quickly as we'd like, but certainly, it's growing. I think it's going to continue to get better as we move through the first and second quarter. I think the manufacturers are doing a great job there busting their bucks, getting inventory to us, but they still have supply chain issues, chips are still a problem. And that's going to weigh on the industry for the foreseeable future. But days supply as we look into next year, if we're sitting at 18 days today, they supply next year, we're hopeful that 25 days, I don't think it gets to 30 days, but keep our fingers crossed because that's going to drive and will continue to drive pre-owned pricing down, and that's a big piece of the puzzle for us from an EchoPark perspective.

And Jeff, what do you think that means for grosses? I mean, is that -- I mean, it's still -- I mean, 18 to 25 days is still pretty damn tight relative to the history. Does that mean grosses are still reasonably strong? Or are they faded just a bit?

Yes. We're seeing just a little compression in this quarter, but not a lot. I mean, I think the grosses certainly from a pre-COVID perspective are going to be really high. If we were running $2,200, $2,300 a copy then, we're well north of $6,000 now. Maybe a return to norm is in the $4,500 to $5,000 range, but I don't see that's certainly not going to happen this quarter. I don't see it happening in the first and second quarter of next year. Grossers are continue to remain high from a front-end perspective.

And you guys made mention of measured approach to growth. Yet when I think you just -- you kind of cited the EchoPark expansion by 2025, it didn't sound like there was much, throttling back at all there. I'm just curious, particularly around EchoPark, how you think about this macro backdrop of what's going on in the used car market where it's -- it seems like it's going to be shrinking in supply for a number of years to come because we just sold some few new vehicles that it might be challenging to grow in absolute terms, and you're really going to have to go after market share pretty heavily there. Just curious how you think about maybe tapping the brakes a little bit on EchoPark growth or maybe not, and this might be a great opportunity to go after some competitors that might be flailing and not have the capital resources that you do?

Yes. No, this is David Smith. As it relates to EchoPark and our future expansion, we're going to -- I know some of our teammates here will jump in on this as well. But we're going to have a very disciplined approach to that. We're going to get back on track and we're seeing, as we mentioned, some huge progress in some of our EchoPark stores, that Tim Keen and the team have been working on and Jeff Dyke, but we're going to see that to fruition before we start rolling out a bunch of other additional locations.

Yes. So we opened Tulsa and Sacramento in the third quarter, great expansion for us. We're now over 50% of the market. We don't see a problem getting to 90% of the market by the end of '25, but we're not going to open any stores for the remainder of the fourth quarter, first quarter, second quarter, but we're at an average retail -- we're at an average wholesale price right now, down from $31,500 to just below $26,000 that we're buying in the auction lanes. We expect that to continue to drop, John. That's going to -- the rental car companies are out of the auction lanes. Some other competitors are struggling. So we have access to inventory. And as prices drop EchoPark, this is a great time for us because the recession happens, it doesn't happen, but things are slowing down, and that's when EchoPark really thrives. So these prices are going to drop. I think that by the middle of next year, we'll be buying in the auction lanes maybe in the $23,000 to $24,000 range. And that's where the average monthly payment gets back down to where it was pre-COVID somewhere in that $450 range. Last quarter, we -- our average customer paid $630 with warranties and everything wrapped in. It's still too close to the new car payment. So we'll tap the brakes here for a couple of quarters, get back to really focusing on the EBIT situation at EchoPark. And what's going to create the positive EBITDA is just that average price and the monthly payment for the consumer to continue to drop. We're really excited. We had an EchoPark senior management team the other day. The team has bumped up. We see the volume coming back. Our big store in Thornton in the month of September made right at $900,000 profit. I don't think there's another single point used car store in the country that was doing that. We sold 700 cars out of that store. We'll do over 800 cars in October. So the business for EchoPark is coming back. And we always said that it would. We were right on track with where we said we'd be. We'll see an improvement in EBITDA from the third quarter and the fourth quarter. We're already seeing that in October. So we feel like really exciting times as we move forward, but we're cautiously optimistic we're going to manage our capital properly and we'll tap the brakes here for a couple of quarters, not open any stores. And let's see what happens in the back half of next year, which will also include our thoughts on spinning our branding -- starting our branding campaign and really driving EchoPark. We really never advertised EchoPark. It's sort of a price-driven company. And so we've got that on our plate, too. But we're going to be smart, late, and we'll see what happens with the pricing in the wholesale market. I would expect that the 1- to 4-year-old category comes back stronger in the next couple of quarters. We probably will sell less plus-5-year-old cars as a percentage, but it's certainly helping the bottom line.

Something Jeff mentioned -- this is David. Something that Jeff mentioned there is advertising. And our word-of-mouth advertising really couldn't be better. It's something we're really proud of is that our guest experience is really an industry-leading 5-star guest experience at EchoPark that we don't want to sacrifice that as we get back to growth. We've got some stores that are -- we've got some of our experienced guys as we call them, some of our sales people are selling north of 50 cars and delivering on that guest experience. And so we want to make sure that we have the proper training and hiring processes as we continue to roll these stores on.

Yes, John, another good point is prior to COVID, our average experienced guide sold 25 cars a month. And we're now at about 23. And some of our stores are just being overrun, averaging 30 to 35 cars a month. So we're starting to hire experienced guys again. The business is coming back, and it's a lot of fun for us. Obviously, been a tough year from an EBIT perspective. But we've had measured growth this year. We'll be smart about that over the next couple of quarters, and we're excited about where we stand with EchoPark, especially in comparison to a lot of the competitive set that's sitting out there with real heavy days supply and struggling in an environment like this.

Yes, tough when you have 99 physical lots that you can't use. But anyway, I appreciate it -- not for you guys and your competitors.

Yes, we get it. We're watching it real close...

Thank you for clarifying this.

Yes, yes. Definitely not you. Somebody else there. I'll leave it there.

Our next question comes from Joe Enderlin with Stephens.

So on capital allocation, share repurchase came in ahead of our expectations. Just wondering if you think we can expect some continued elevated buyback. Or how are you thinking about priority here versus the M&A environment given you're tapping the brakes on EchoPark growth?