Sonic Automotive Inc

NYSE:SAH

Earnings Call Transcript 2018-Q1

[Operator]

Good morning, and welcome to the Sonic Automotive First Quarter 2018 Earnings Conference Call. This conference call is being recorded today, Thursday, April 26, 2018.

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

At this time, I would like to refer to the safe harbor statement under the Private Securities and Litigation Reform Act of 1995.

During this conference call, management may discuss financial projections, information or expectations about the company’s products or market or otherwise make statements about the future. Such statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These risks and uncertainties are detailed in the company’s filings with the Securities and Exchange Commission.

I would now like to introduce Mr. Scott Smith, Co-Founder and CEO of Sonic Automotive. Mr. Smith, you begin your conference.

[Scott Smith, Co-Founder and Chief Executive Officer]

Thank you. Good morning, and welcome to Sonic Automotive’s First Quarter 2018 Earnings Call. I’m Scott Smith, the company’s CEO and Co-Founder. Joining me today on the call are David Smith, our Executive Vice Chairman and Chief Strategic Officer; Mr. Heath Byrd, our CFO; and Jeff Dyke, our Executive Vice President of Operations. I’ll provide some brief comments, and then turn the call over for questions.

We’re pleased with the results of the quarter, which were in line with our internal expectations. Our operations have continued to drive top line growth, with record-breaking results and generating $2.4 billion in revenue and $352.5 million in gross profit. We were able to maintain GPU on the new vehicle side in a very competitive environment. Growth in F&I was outstanding, with an increase of 12.8%. Fixed ops also performed well, generating first quarter record amount of gross of $169.6 million on one less selling day in 2018. We sold 33,739 pre-owned vehicles in the quarter, more than any other quarter, and the pre-owned segment, represented by our EchoPark brand, made up of over 5,500 of those units.

During the quarter, we made the decision to reduce the number of pre-owned vehicles we had on hand and aggressively dispose of inventory to achieve a lower days of supply. This decision negatively affected pre-owned GPU during the quarter, which we believe is now behind us. We expect the remaining quarters to be more consistent with our historical GPU. Days supply for the pre-owned vehicles dropped nearly four days, and was 31 days at the end of the quarter. Our growth strategy continues to be concentrated on increasing the footprint of our pre-owned business. We’ll open at least three additional new EchoPark locations later this year.

At this point, we’d like to open the call up for your questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Rick Nelson with Stephens.

[Rick Nelson, Stephens]

Thanks, good morning. I’d like to follow up on EchoPark. If I look at the financials, you lost $0.10 with EchoPark this year, $0.07 a year ago and this add back compensation-related expense, if you could address what that add back is?

[Scott Smith, Co-Founder and Chief Executive Officer]

I’m not sure I caught your question, Rick.

[Heath Byrd, Chief Financial Officer]

I can answer the add back on the compensation. That is a burnout portion of an acquisition that we did in Dallas in the third quarter of 2017.

[Scott Smith, Co-Founder and Chief Executive Officer]

And then in terms of performance, obviously, we’re opening more stores so there’s more expense that goes along with that. But the – our original stores have ramped up nicely. And our expectations are that we’ll see profitability in EchoPark as we move towards the end of the year.

[Rick Nelson, Stephens]

Got you. So the prior guide, I think, had incorporated a full year loss of $0.08 to $0.12? Are you still comfortable with that?

[Scott Smith, Co-Founder and Chief Executive Officer]

We are.

[Rick Nelson, Stephens]

Okay, good. So Texas, I’m curious on the franchise side, how that is performing relative to the rest of the chain?

[Jeff Dyke, Executive Vice President-Operations]

Yes. Hey Rick, Jeff Dyke. So yes, it’s getting much better, actually. Obviously, oil prices are helping as they’re moving up. And we’ve got a lot of BMW stores there, so the BMW brand is improving. January and February, as you’ve heard all throughout all the calls were tougher months this year. But March was spectacular and Texas led the way for us. So just a fantastic month and it’s nice to have the market and, in particular, the Houston market coming back online and being a strong portion of our profit mix.

[Rick Nelson, Stephens]

And is that strength in March, is that carrying into April as well?

[Scott Smith, Co-Founder and Chief Executive Officer]

Yes, so that’s true. Hopefully, the January type of performance is behind us all. But yes, April was carrying forward. We had a, obviously, very good margin in April. We’re having a decent April as well. So – and the same comments for Houston in the month of April as well.

[Rick Nelson, Stephens]

And used car margin erosion, do you think that’s behind you?

[Scott Smith, Co-Founder and Chief Executive Officer]

100%. Look, the – there’s just some – between the off-lease cars coming and the drop in used valuations in Q4, we just weren’t comfortable with the level of the days supply that we had. We were just running too high a days supply. So if you just look at the Franchise segment, the franchise is running 27- to 28-day supply now. We sold about 10,000 pre-owned cars in March and about 8,500 cars online. That’s our sweet spot. That’s what we typically have shown over the last five, six, seven years. We’ll continue to do that. Margins have stabilized, volumes good. We’re having another great month in April from a pre-owned perspective, so yes, that’s behind us.

[Rick Nelson, Stephens]

Okay. And finally, if I could ask you about the hailstorms that occurred in some of your markets in 2Q. How do you see that impacting results?

[Scott Smith, Co-Founder and Chief Executive Officer]

Yes. We’ve got one store, our Mercedes store in Dallas, that got hit. The damage, I saw it last night, was about $275,000 in damage. And we’ll work on our way through it. I don’t see it being an impact in the quarter.

[Rick Nelson, Stephens]

Great, thanks for that and good luck.

[Scott Smith, Co-Founder and Chief Executive Officer]

Thanks very much, Rick.

[Operator]

Your next question comes from the line of John Murphy with Bank of America.

[Aileen Smith, Bank of America]

Good morning, guys. This is Aileen Smith on for John. First question on the excess used vehicle inventory that you noted in the press release. How much would you say was related to maybe pulling into some of our major markets to meet replacement demand following natural disasters that might not have necessarily come through expected? And how much would you characterize as more structural in nature with the return of off-lease vehicles and trade-in vehicles from retail?

[Scott Smith, Co-Founder and Chief Executive Officer]

It’s about half and half. I mean, we’ve all loaded up the Houston market with the flood and everybody had to work their way through that. And then it’s not just the excess inventory from off-lease. It’s also price valuation, and we saw adjustments that needed to be made from a pricing perspective as we entered into January. We got real aggressive and made those adjustments and it put pressure on the margin. But was certainly the right thing to do from our perspective, and we’re yielding the benefits of those in March and will continue to do so through April and for the rest of the year. Just the right move for us.

[Aileen Smith, Bank of America]

So it’s fair to say about half of it was more very temporary and short term in nature, and the other half is something that will need to be monitored going forward and adjusted for?

[Scott Smith, Co-Founder and Chief Executive Officer]

Actually, I don’t think that – I think it was all temporary in nature. I mean, the price adjustments is what caused the other half, so I’m not at all worried. Our inventory’s in fantastic shape. Like I said earlier, our franchise days supply is in the 27-, 28-day range. It just doesn’t get any better than that. And margins are good, volume’s great, we’re up nicely in March and up nicely in April, and don’t see anything changing.

[Aileen Smith, Bank of America]

Great. That’s very helpful. And second question. One of the things we’ve heard repeatedly from your peer group is the pressure on the parts and service related to shortages of technicians. Are you turning away parts and service business at all given the labor constraints? Meaning, should the labor markets be supportive, the growth in your parts and service business would theoretically be much higher than what’s being reported now?

[Scott Smith, Co-Founder and Chief Executive Officer]

Yes. So that’s a great statement and we totally agree, we’re short technicians. We’re short service bays and we need that as well, so we’ve got brick-and-mortar opportunities as well. And so it’s a big opportunity for us, and we’re doing lot of different things to focus on parochial schools, different types of opportunities to hire and train technicians as we bring them in. We’re actually working on training some B and C level technicians through our EchoPark franchise that we can move up into our franchise business and making investments there. So yes, I mean, it’s certainly an opportunity for us.

The other big pressure is warranty. There’s just been so much warranty work it’s eating up shop hours, which cuts into customer pay. And that’s been a big problem for us given our brand mix. But hopefully, we overcome a lot of that this year by putting in some stop gaps that allow us to measurably handle the warranty business and to focus more on customer pay.

[Aileen Smith, Bank of America]

Great, understood. And a final question, which is more longer term. You’re fairly overexposed to BMW on your new vehicle business, and it looks like they will be launching fairly aggressively some new products, particularly crossovers, over the next few years. With this product cadence and the interest that you’re seeing from your customer base, would you expect to outperform relative to the rest of the industry in that type of environment?

[Scott Smith, Co-Founder and Chief Executive Officer]

Yes, thank you for that question.

[Heath Byrd, Chief Financial Officer]

That was a softball, yes.

[Scott Smith, Co-Founder and Chief Executive Officer]

We’ve been fighting that for the last couple of years. Just returned from Germany and from the U.S. BMW meeting. From my perspective, from my time in the industry, it’s one of the best manufacturer meetings I’ve ever been to. The product launch was fantastic. The variants that are coming are unbelievable and that’s going to be a big help for Sonic Automotive because it’s over one-third of our profit in the company. So we’re very excited about that leadership, what they’re doing and the products that they’re coming with. Bravo.

[Aileen Smith, Bank of America]

Great, that’s very helpful. That’s it for me. Thanks for the questions.

[Scott Smith, Co-Founder and Chief Executive Officer]

You bet.

[Operator]

[Operator Instructions] And our next question is from the line of Bret Jordan [Jefferies].

[Mark Jordan, Jefferies]

This is Mark Jordan on for Bret. Thanks for taking my call. My line cut out for a second there, but – so I don’t know if this was already asked. But I was looking at the strong F&I in Q1 and kind of thinking about that going forward. It looked like last quarter, I think, we had mentioned a well-above 1,500 metrics or fiscal year 2018, with a longer-term target of 1,600 to 1,700. What are the opportunities kind of driving that? What drove it in Q1? And was it kind of a pickup in the Texas market?

[Scott Smith, Co-Founder and Chief Executive Officer]

No, not at all. I mean, this is – we announced last year at the beginning the year that we had a new relationship with Jim Moran & Associates. That relationship, the training and execution of our playbook, is driving that. We’re now really are doing a much better job on the pre-owned side. EchoPark’s F&I margins are really high. And our warranty penetration is really, really good. It’s in the 50% range on the pre-owned side. So it’s all making a big difference. The training, the relationship with JM&A and our F&I team getting behind our playbook is making a big difference in our performance. And we expect that performance to continue to improve.

[Mark Jordan, Jefferies]

Okay, great. And then how about performance for the San Antonio EchoPark store? Do we have any early reads from that?

[Scott Smith, Co-Founder and Chief Executive Officer]

We do. Best launch yet for us. And we’re very excited, both stores finished their third and fourth full months here last month in March. But our best ramp-up yet, our fastest ramp-up yet and we’re very excited about where we are. And we have a third store that’s going to open in the middle of the summer in that marketplace, and it’s just been a really good start for us.

[Mark Jordan, Jefferies]

Great. And then, I think last quarter also mentioned service locations opening up in Denver EchoPark. Do you have any comments on that as well?

[Scott Smith, Co-Founder and Chief Executive Officer]

We do. They’ve been operating since April 16. We’ve got two. Our shops are full but it’s too early to tell any results yet, so we’ll keep you guys posted next quarter when we get some real data going. But yes, we’re very excited about that. They’re service and sales centers, so the customers can come in and sell their inventory through us. And then the other stores in the Denver market also, like I said earlier, doing very well. We had a great order of 55 – over 5,500 cars for the quarter, and we’re expecting to do better than 25,000 cars this year, which really sets us up for some big, big – much bigger numbers in 2019 in terms of volume. So we’re very excited about where we are with EchoPark and what the future looks like.

[Mark Jordan, Jefferies]

Okay, great. And one last question, thinking about acquisitions going forward. When I look at the market, it looks like there might be a lot of M&A opportunities out there. So are we more focused on growing EchoPark with an eye for maybe for some pre-owned stores that might fit in well? Or are we also kind of taking a look at franchise stores?

[Scott Smith, Co-Founder and Chief Executive Officer]

Yes, this is Scott. I would say that 90% of our focus is on EchoPark. I don’t want to say that we’re completely out of the market because I think, if there were opportunities in markets where we currently exist, that we would be interested in looking at those opportunities. But our primary focus right now is growing EchoPark as quickly as possible. We – Heath and I got out on the road several years ago and said that we thought that there would be an inflection point. We feel like we’re entering that phase.

We’re seeing a lot of good positive traction in our EchoPark model and the pricing models that we’ve got installed now. And we think that at some point in time, in the not-too-distant future, that EchoPark will be substantially larger than our franchise business. There’s no barriers to entry for us. We’ve got the technology, the people, the processes, and we feel that we’ve cracked the code in how to make it predictable, repeatable and sustainable. Now it’s just a matter of building them in the markets and getting them up and running.

[Jeff Dyke, Executive Vice President-Operations]

This is Jeff Dyke. The only other thing I would add is from a franchise perspective, what dictates buying new car dealerships is the amount of money that you have to invest in facilities per our manufacturers’ requirements. And that has gotten, from our perspective, out of control. And so while we want to bring our technologies and processes and the great things from the different brands that are out there, we’re just not going to make absurd and obscene investments in facilities. And so that will slow us down in terms of exactly what franchises we might buy and when we may buy them. It’s just got to be a reasonable return, and we’re managing that to a T.

[Scott Smith, Co-Founder and Chief Executive Officer]

Yes. This is Scott. Jeff makes a really great point on these manufacturer expectations. When we evaluate and weigh our investment opportunities, the new car model, in my mind, as the CEO of this company – the new car model is completely broken right now because of the expectations of what these manufacturers have out there in the cost of this facilities. It doesn’t pencil, the model doesn’t work and something’s got to budge. And right now that’s, in my opinion, devaluing some of these franchises. And certainly, until the manufacturers lower their expectations, I think M&A’s going to slow down.

[Mark Jordan, Jefferies]

Okay, great. Thank you very much for taking my questions today.

[Scott Smith, Co-Founder and Chief Executive Officer]

You bet.

[Operator]

[Operator Instructions] And we have no further questions in queue at this time. And I would like to turn back over to Scott Smith.

[Scott Smith, Co-Founder and Chief Executive Officer]

Great. Well, we’d like to thank everyone for tuning into our call, and we’ll talk to you again next quarter. Have a great one.

[Operator]

Thank you for your participation. This does conclude today’s conference call. You may now disconnect.