Sonic Automotive, Inc.

Good morning and welcome to the Sonic Automotive fourth quarter 2022 earnings conference call. This conference call is being recorded today, Wednesday, February 15th, 2023. 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 of 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 8K 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.

Thanks very much. Good morning, everyone, and welcome to the Sonic Automotive fourth quarter 2022 earnings call. As you said, I'm David Smith, the company's chairman and CEO. Joining me on the call today is our president, Mr. Jeff Dyke, our CFO, Mr. Heath Bird, our Echo Park chief operating officer, Mr. Tim Keene, our chief digital retail officer, Mr. Steve Whitman, and our vice president of investor relations, Mr. Danny Weiland. Today, Sonic reported another period of record financial results, including record fourth quarter and full-year revenues. Highlights from our fourth quarter performance include all-time record quarterly revenues of $3.6 billion, up 13% year-over-year, and record fourth quarter gross profit of $576 million, up 9% year-over-year. Fourth quarter revenues GAAP EPS reflects a $320 million pretax non-cash impairment charge. Again, that's a non-cash impairment charge resulting in a net loss of $5.22 per share. Excluding the effects of the non-cash impairment charge and other non-recurring items, we reported adjusted earnings per share of $2.61. For the full year, we reported all-time record annual revenues of $14 billion, up 13% year-over-year, and all-time record annual gross profit of $2.3 billion, up 21% year-over-year. Full-year gap EPS was $2.23, including the effects of the previously mentioned non-cash impairment charge. Excluding one-time items, Adjusted EPS was $9.61, our fourth consecutive year of all-time record annual adjusted EPS. I'm extremely proud of our team's performance in the fourth quarter, capping off another incredible year for Sonic Automotive. We could not have achieved these results without the continued support of our guests, teammates, manufacturers, and lending partners. Our team remains committed to delivering a world-class guest experience and executing our long-term strategic plan, and we are excited to carry this momentum into 2023. Before looking ahead to 2023, I'd like to add some color on the fourth quarter. During the quarter, we began to see improvement in new vehicle production, which supported higher new vehicle retail sales volume at our franchise dealerships, outperforming the industry volume change both quarter over quarter and year over year. New vehicle gross profit per unit declined quarter over quarter and year over year, but was offset by higher volumes and incremental F&I gross profit, driving growth in overall new vehicle related gross profit despite GPU compression. Our used vehicle business similarly outperformed the change in industry volume as a result of our diversified business model, despite ongoing affordability concerns for the used vehicle consumer. Used vehicle average selling prices have begun to decline, but still remain well above levels required to return to a monthly payment that is affordable for the average buyer at current interest rates. Despite a rising interest rate environment, F&I performance continues to be a strength, benefiting from higher retail unit volume and near record F&I per retail unit. Our parts and service or fixed operations business remains strong with stable margins and volume and customer pay being complemented by improvements in warranty repair transaction volume. So far in 2023, we have seen sequential declines in new vehicle GPU and volume due in part to the seasonal nature of our business as a result of our luxury brand weighting. We believe this coupled with ongoing macroeconomic uncertainty and concerns around the effect of rising interest rates and elevated inflation on the average consumer could drive volatility in consumer demand and vehicle margins through at least the first half of 2023. However, we believe that our diversified automotive retail model positions us favorably to adapt our business to changes in market conditions as we progress through 2023. As vehicle inventory supply and demand begin to rebalance and new and used vehicle pricing begins to move toward a new normal level, we believe any headwinds we may face in the franchise business should be a tailwind to Echo Park profitability and revenue growth, minimizing the earnings downside to the consolidated results. Coupled with our strong balance sheet and commitment to returning capital to stockholders, we believe we are well positioned to continue to generate returns well above pre-pandemic levels. Turning now to our franchise dealership segment for the fourth quarter, total franchise revenues were an all-time quarterly record of $3 billion, up 14% from the prior year period. Adjusted segment income was $160 million, down 3% year-over-year due to higher interest rates, and segment-adjusted EBITDA was $213 million, which was up 4% from the prior year. On a same-store basis, fourth-quarter franchise dealership revenues were up 12% from the prior year, while gross profit was up 3%. New vehicle gross profit was flat, with a 5% increase in retail unit volume offset by a 6% decrease in new retail GPU to $6,301 per unit. Used vehicle gross profit was down 29%, driven by a 33% decrease in used retail GPU to $1,405 per unit, offset partially by a 6% increase in retail unit volume. Parts and service gross profit increased by 12%, with same-store customer pay gross profit up 14% and same-store warranty gross profit up 15%. Same-store F&I gross profit increased 11% on higher retail unit sales volume and fourth quarter record reported franchise dealership segment F&I gross profit per retail unit of $2,421, up 3% from the prior year. As of December 31st, our franchise dealership segment had approximately 24-day supply of new vehicle inventory, up from 18-day supply at the end of the third quarter, but well below the typical pre-pandemic December level of 55- to 60-day supply. As you're aware, this day's supply figure includes in-transit inventory. Our franchise dealership segment had approximately 26-day supply of used vehicle inventory, down five days from the third quarter and in line with our optimal target level heading into the first quarter. Given ongoing new vehicle inventory constraints, recent declines in wholesale market pricing, and our current outlook, we continue to be disciplined in managing our used vehicle inventory, volume, and pricing in order to optimize gross profit levels as we go through 2023. Now let's turn to Echo Park results. We reported record fourth quarter revenues of $589 million for Echo Park, up 2% from the prior year, and gross profit of $41 million, flat year over year. Echo Park retail sales volume for the quarter was 17,435 units, up 14% from the third quarter, and 11% year over year. Echo Park average used vehicle selling price decreased 12% from the third quarter, but at $29,500 per unit, still remains well above target affordability levels. We continue to focus on optimizing our inventory sourcing mix and expand our inventory affordability by including five-plus-year-old vehicles in Echo Park inventory. For the fourth quarter, five-plus-year-old vehicles represented 19%, of Echo Park retail used vehicle unit sales volume, which was flat from the third quarter of 2022, and our non-auction sourcing mix was 28% of sales in the fourth quarter compared to 32% in the third quarter. For the fourth quarter, we reported Echo Park segment loss of $33.3 million compared to $31 million in the third quarter and adjusted segment loss of $20.3 million in the prior year. Echo Park reported an adjusted EBITDA loss of $25.4 million in the fourth quarter compared to a loss of $23.2 million in the third quarter and a loss of $14.6 million in the year-ago period. This sequential increase in adjusted EBITDA losses reflects a steeper than anticipated decline in used vehicle pricing during the fourth quarter. which resulted in a $533 per unit decrease in front end used vehicle GPU compared to the third quarter. At the end of December, our Echo Park segment had approximately 40 day supply of used vehicle inventory, which was down from 57 day supply at the end of the third quarter. We believe maintaining a tight day supply of used inventory is critical as we proceed through 2023 with the expectation for further declines in used vehicle pricing in the coming months, benefiting overall affordability and consumer demand, but potentially pressuring GPUs during the transition period. As discussed on our third quarter call, we are continuing to take a strategic measured approach to our Echo Park expansion plans as we balance our commitment to long-term growth with our current priority to improve Echo Park profitability and maintain a strong overall liquidity position in light of an uncertain macroeconomic outlook. In the interim, we believe that the continued evolution of our Echo Park e-commerce platform will allow us to expand Echo Park brand reach without investing the capital to open additional store locations. For the fourth quarter, omnichannel sales through our new e-commerce platform accounted for 38% of Echo Park's retail unit sales volume, compared to 31% in the third quarter. Furthermore, 9% of Echo Park volume during the quarter was sold end-to-end online, up from 7% in the third quarter. As guests continue to utilize our enhanced e-commerce purchase experience, with out-of-market buyers representing nearly 50% of our e-commerce sales, We continue to believe that our omnichannel e-commerce platform combined with measured expansion of our physical footprint over the next two to three years will allow Echo Park to reach 90% of the U.S. population by 2025, supporting our long-term goals for this business. We continue to adapt the Echo Park strategy based on current used vehicle market conditions and remain confident in this segment's long-term growth prospects as the used vehicle market continues to normalize. We are seeing the initial benefits of expanding our inventory offering to include five-plus-year-old vehicles and shift our inventory sourcing away from wholesale auctions and expect adjusted EBITDA losses to improve throughout 2023, now targeting break-even adjusted EBITDA in the first quarter of 2024. As we gain further visibility on our future used vehicle market conditions and the effects of strategic adjustments we've made at Echo Park, we'll provide an updated Echo Park economic model and long-term guidance. As we announced earlier this morning, we are very excited about our newly created power sports operating segment, which further diversifies Sonic's retail portfolio. We are very optimistic about the growth opportunity in this space, And we'd like to welcome the teams from Black Hills Harley-Davidson in Sturgis, South Dakota, Team Mancuso Power Sports in Houston, Texas, and Horny Toad Harley-Davidson in Temple, Texas to the Sonic Automotive family. In partnership with this group of historic power sports brands, we believe we can realize incremental growth opportunities and expand our reach in this adjacent retail sector worth an estimated $34 billion in the U.S. with significant opportunity for consolidation. In 2023, our power sports segment is expected to add approximately $200 million in annual revenues and adjusted EBITDA margins between eight and 10%. Now turning to our balance sheet and capital allocation. We ended the fourth quarter with $805 million in available liquidity, including $501 million in cash and floor plan deposits on hand. As an update on our share repurchase activity, since October 1st, 2022, we repurchased approximately 700,000 shares of the company stock for approximately $35.8 million, or an average of $48.25 per share. In total during 2022, we repurchased 5.6 million shares, representing 14% of shares outstanding as of the end of 2021 for approximately $262 million, or an average of $47.08 per share. As of today, we have a total of $455 million in remaining share revertualization, representing approximately 20% or so of Sonic's current market cap. Additionally, I'm pleased to report today that our Board of Directors approved a quarterly cash dividend of $0.28 per share, payable on April 14, 2023, to all stockholders of record on March 15, 2023. In closing, our team is prepared to continue to execute at a high level in 2023 while remaining adaptable to changes in the automotive retail environment and macroeconomic backdrop. Further, we continue to operate our business with a long-term view and remain committed to a disciplined, return-based balance capital allocation strategy to maximize long-term stockholder returns. This concludes our opening remarks, and we look forward to answering any questions you may have. Thank you.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for your questions. Our first questions come from the line of John Murphy with Bank of America. Please proceed with your question.