Greetings, and welcome to the Sonic Automotive Fourth Quarter 2023 Earnings Conference Call. This conference call is being recorded today, Wednesday, February 14, 2024. 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, Chairman and Chief Executive Officer of Sonic Automotive. Mr. Smith, you may begin your conference.

Thank you, and good morning, everyone, and welcome to the Sonic Automotive fourth quarter 2023 earnings call. Joining me today are our President, Jeff Dyke; our CFO, Heath Byrd; our EchoPark Chief Operating Officer, Tim Keen; and our VP of Investor Relations, Danny Wieland. Earlier this morning, Sonic Automotive reported fourth quarter and full-year financial results, including fourth quarter total revenues of $3.6 billion and all-time record annual revenues of $14.4 billion, up 3% from the previous year. Fourth quarter GAAP EPS was $1.11 per share, which includes the effect of non-cash impairment charges and tax items. Excluding these items, adjusted EPS was $1.63 per share, a decrease from $2.61 in the prior year due primarily to continued normalization of new vehicle GPU and higher interest rates. We are very proud of our team's performance in the fourth quarter and we remain focused on leveraging our diversified business model to adapt to changing market dynamics in the near term while positioning Sonic to achieve our long-term strategic goals. We believe our strong relationships with our teammates, manufacturer and lending partners and guests are key to our future success. I'd like to thank them all for their continued support. Turning now to fourth quarter franchise dealership trends. We continue to see expansion of new vehicle inventory levels across our brand portfolio, ending the year with a 37 days’ supply of inventory, up from 33 days at the end of the third quarter and 24 days at the end of 2022. As a result, new vehicle gross profit per unit continued its sequential decline to $4,289 per unit in the fourth quarter, in line with our previous guidance to exit 2023 in the low to mid $4,000 range. This steady decline in new vehicle GPUs should continue throughout 2024, but we continue…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is come from the line of Daniel Imbro with Stephens. Please proceed with your questions.

Hey, guys. This is Joe Enderlin on for Daniel. Thanks for taking the questions.

Good morning, Joe.

Good morning. On the franchise side, your SG&A assumption of low-70s margin was a little higher than we expected. Could you maybe bucket out what drives these costs higher? And maybe is this where you expect long-term margin to shake out? Or do you expect leverage after 2024 and we return to a more normal GPU guidance? Thanks.

Yes. Hey. This is Heath Byrd. A couple of things. Obviously, SG&A as a percent of gross is heavily dependent on gross, right? And in our guidance of a low 70% range, we also have about $1,200 degradation in the frontend GPU. You just take that degradation on a flat unit basis, that's $130 million of gross. That's leading the numerator in that calculation. We do have about a 1% increase in units in there that does offset some of that loss in gross. And so the biggest component is that $130 million give or take decrease in gross. If you look at the expenses, the variable expenses are leveraging as they should as gross is going down. Fixed expenses, there are some that are higher than normal, insurance coverage, trying to get coverage with property and casualty is going up across the country. Also, loan expense is higher because our Fixed Ops business is growing at such a good pace. And we have manufacturer requirements to use EVs as loaners. And the depreciation of those are higher than ICE vehicles. And so that impacts our loaner expense. And some IT expenses and investments for future optimization. There's definitely upside potential in that SG&A gross. The GPU degradation may be slower than we expected, but I think it's pretty standard across the peer group that in that range of about 1,200 loss for the year. Our portfolio could outperform the SAR. The expectations out there are from 1% to 4%. We have a low single-digit expectation in the units that we sell. And obviously, we've got potential in the F&I and fixed gross to offset that loss in new gross. We also have plans to have some structural changes in our expense structure, which could also impact that number. So we definitely see opportunity to beat that number, but looking at the math and the things that we see out there, we think a low 70% range is appropriate.

Got it. That's helpful. As a follow-up, just given the weakness in the used market as a whole, do you have any updated thoughts on what gives you confidence in the long-term operating model of EchoPark? Do you may be increasingly think that consolidation of assets is going to play a considerable role in returning to that peak profitability?

Yeah. This is Jeff. Certainly, the reduction in store count has helped us and our buying team buy cars for fewer stores, and that's proving out in the numbers as we called out in the second quarter and the third quarter. We're, we're seeing excellent growth across the remaining 18 stores that we have. And with the manufacturers putting more and more inventory out on the street, it's going to just naturally, common sense, it's going to drop pricing. We're seeing that. Average wholesale prices are dropping. We're buying cars now in the mid-23 range. I expect that to continue to drop, in particular, after we get out of the March or kind of April selling timeframe. And that'll continue to improve as we move throughout the year. With that, we're going to sell more cars. We're gaining confidence with where we were with EchoPark back in 2019. And then we can start looking at strategic growth for EchoPark, being very conservative, but getting back on the bicycle and growing the brand again. And so we've just been waiting. Certainly, as we called out in the third quarter, turbulent waters for the used car business. We think there's another 16 months, 18 months of that, but progressively getting better as we move throughout the year.

Got it. Thank you, guys. That's all for us.

Thank you.

Thank you.

Thank you. Our next question has come from the line of John Murphy with Bank of America. Please proceed with your questions.

Good morning, guys. I just wanted to follow up on that, that, that used question. Jeff, it seems like what we're seeing is demand for vehicles is continuing to slowly improve. And I'm just curious, as you think of what's going on the used side versus the new, is there's this substitution where folks are just tripping into buying new vehicles as opposed to used vehicles? But we also have this dynamic of sort of a still shrinkage of the one to six-year-old used fleet. So there's a lot of moving parts that are going on here. And we're kind of hearing cross currents in different ways about used being weak, but it doesn't seem like it jives necessarily with the idea that vehicle demand is improving. I just -- I don't know if you could expand on that or tell us kind of what you're seeing generally, maybe in the new stores, but then also in EchoPark?

Yeah. Sure. I mean, I don't agree with the statement that the used vehicle is getting weak. I mean, if anything, it's flattening out and starting to get better. And so, in the coming months, with the amount of new cars that the manufacturers are putting on the road, we're going to trade for more cars, we're going to trade for more one to five-year-old cars. And that's certainly helping both the franchised used vehicle departments and EchoPark. And you can see it in EchoPark. I mean, you see the numbers. Our EchoPark volume is expanding greatly. We're selling, more cars now out of 18 stores than we were selling out of 45 stores before. So -- and we expect that to continue. I think the used vehicle business gets stronger, as the year goes on. And that's because wholesale prices are going to drop and wholesale prices are going to drop because the manufacturers can't help themselves. They're just putting more and more cars on the road. Some are doing a better job than others. But the -- and then we've got the electric vehicle piece that's coming in. We don't have any to say used-vehicle electric vehicles. That's going to start becoming a part of the picture as we move into the mid-summer months as some of the off-lease cars start coming back. So I just see nothing but upside from a used vehicle perspective. And that's why we're very confident in our first quarter breakeven EBITDA call out for EchoPark. And we ought to be in great shape for the year. The business -- the used car business is strong. It's always been strong. We've just been short on the one to five-year-old model for EchoPark, and that, that caused some turbulent times over the last couple of years. That's dissipating. And as we move throughout '24, it's just going to get stronger and stronger. And that bodes well for the EchoPark model. It's an offset to what goes on from a franchise perspective, for us. And so we're expecting just a tremendous year from an EchoPark perspective.

Okay. That's very helpful. Just, just one follow-up on the F&I PVR $2,400 roughly, you guys are looking at. It seems like we're through the worst of times, knock on wood on rates rising and sort of the negative headwinds that you might have there. There might be some offset of revenue per unit or ATP is going down a bit in '24. But is there a potential that there could be some real upside there, in '24 or maybe structured over time is you get good -- better penetration of some of the good product that you guys have developed there and the industry has developed?

Yeah, absolutely. And especially as we get to the back half of the year, rates come down a little bit. Certainly, with retail pricing dropping, there's less margin on the F part of F&I. But there's nothing but upside. Look, we are typically one or two in the category -- or excuse me, two or three in the category. And I think AutoNation is out there with a much higher F&I PVR, we believe we can perform at that level or higher. Our EchoPark stores perform at that level are higher. And I think you'll see that along with improving frontend margin at EchoPark, as we move throughout the first quarter and to the, and to the rest of the year. So that's a good call out. I think there is opportunity for F&I improvement as we move forward.

Thank you very much, guys.

Thank you.

Thank you. [Operator Instructions] Our next question comes from the line of Rajat Gupta with JPMorgan. Please proceed with your question.

Great. Thanks for taking the questions. I just wanted to, first reconcile, some of the comments on the used car market. I think Jeff, I think earlier in the call, you mentioned that the backdrop is likely to remain tough for 16 months to 18 months. But then to John's question earlier, I think you mentioned that you're seeing improvement. I'm just curious like, how should we reconcile those comments? And then would you be able to put a finer point on expectations for used car volumes, both at EchoPark and the franchise business for 2024? And I have a quick follow-up on SG&A. Thanks.

Yeah. I think over the next 16 months to 18 months, it's not going to return to 2019 levels, but it's progressively going to get better. And the way that I would look at volume for EchoPark is in and around the same amount of volume that we did, that we did last year with a lot fewer stores for six months of the year. And then we are projecting low single-digit growth for used car volume increases from a used car perspective on the franchise side. So, look, we're not out of the troubled waters, but it's not anywhere near as choppy as it was. And with the wholesale market prices dropping, it's just progressively going to get better, as we move throughout '24 and into the beginning first quarter of '25. And that's why we're just so confident about EchoPark and where we are. We told you guys this in the second quarter. We made our moves. We saw what happened in the third quarter. We saw what happened in the fourth quarter with our volumes. That's continuing in January. We're seeing it -- it continued in January. We'll see it -- we're seeing it again in February. And we expect the rest of the year to progressively get better as we move forward. Did we lose you?

He might be muted.

Can you hear me, sorry?

Yeah. We can hear you now.

We can hear you.

Yeah. So just on SG&A to gross, the low 70% number for the full year, I mean if -- I mean if you compare that to 2019, it's obviously, below your 77% in 2019, you're guiding to 72%. But that, that, that 72%, 73% for this year is still on a higher than 2019 in new car GPU number, on a blended basis. So, is there any change in thought process around, where the normalized SG&A to gross would go to? Because presumably, 2025 is going to see another step down in the new car GPU. So, should we expect that franchise SG&A to grow to settle even higher than low-70s, eventually or, how should we think about that? And hopefully the question makes sense. Thanks.

Yeah. This is Heath. Yeah, we absolutely think that in the out period that there's the opportunity to decrease that level of SG&A as a percent of gross. We're doing some structural changes from an expense perspective, as well as some changes in our F&I products that we're offering, and those things will help replace that degradation in the new gross and/or actually will help the SG&A as a percent of gross. So we do not think that this is going to be staying in the 70s going forward. We think there's opportunities to get back in the high-60s. But at this point, based on the data that we're seeing, we believe that that low-70% range is appropriate for 2024.

This is Jeff. The other thing too is we added a 100 net gain of 108 technicians last year. Our target is to add an additional 300 net gain of technicians this year. We still have to do that. But at the end of the day, that's going to create incremental gross to help offset what we see from a frontend gross degradation on new car. And that, too, will help push the margin, SG&A percentage gross down below the 72% number that we're calling out. And look, at the end of the day, we'll see the street -- some of our competitors are calling out 150 basis point, 200 basis point increase in expenses, we're in that 400 basis point to 500 basis point range. It's still early in the year, but we're all calling out basically $300 a quarter in frontend margin degradation. And that's a lot of gross reduction. And we'll see, kind of who is right when this is all said and done with. There's a long way to go in the year. We certainly believe that we can improve upon the number that we're giving you. But like Heath said, based on where we are right now, that, that low-70s range, we feel is a good number to begin the year with and we'll work our tails off to improve from there. But there's a long way to go. And, and, and what the manufacturers do with new cars and new car day supply is going to play a big role in all of this. Along with what percentage of your overall sales is going to be electric vehicle, that's running around 10% right now. That had almost a $400 degradation to our frontend margin in the fourth quarter. High Line drove a lot of that. Mercedes Benz was $235 of that degradation alone, primarily driven from California. That's -- we've got to get control of that. That's a big focus point for us with our manufacturer partners, as we move forward. And I know that we're not the only ones experiencing that. So there's a lot of moving pieces at play here. But safe to say, in that low 70% range for now, and hopefully, as we move through the quarters, that becomes a better number.

And one technical point, too, on the degradation, it's not going to be linear. We're going to have -- for that GPU frontend degradation, you're going to have a larger portion going from Q4 into Q1 and then it levels out to about 300 a quarter going forward.

And to your point, Rajat -- this is Danny. To your point on the sustainability of structurally higher new GPUs, we still believe that that's a possibility as we go forward, move past 2024. We're already seeing where with some of the domestic manufacturers, they've got an 80-plus days’ supply today, but yet we're making $1,200, up to $2,000 more in GPU than we did in 2019, despite day supply being roughly back at that level. A lot of that has to do with the segment mix shift towards full-size trucks, SUVs that are higher margin business for us. And then across the other brands, where we've got more measured inventory day supply expansion, we're still seeing dramatically elevated new GPUs that while they expect to come down, as we go through this year, we still see a path to where as part of that longer-term SG&A growth structure, we're not going back to a $2,000 blended new GPU and it's somewhere elevated above that. And then you factor in the fact that we're running roughly $800 higher in F&I per unit, the variable GPU associated with those retail unit sales down the road should help us leverage the expense structure more efficiently than we did in 2019.

Got it. That's very clear. Thanks for taking the questions.

Thank you.

Thank you. Our next question is come from the line of Glenn Chin with Seaport Research Partners. Please proceed with your questions.

Good morning. Thanks, gentlemen.

Good morning.

Just circling back to your comments about GPU headwind from EVUs. Is that a...

We lost you.

Sorry, can you hear me?

We can. Ask that again.

Sorry about that. Just circling out to your comment, Jeff, about GPU headwind from EVs at $400. That's a comment relative to year-over-year, correct, not sequential?

That's the headwind in the fourth quarter. So if you look at our blended GPU that we reported for Q4, it reflects a $400 headwind from EV GPUs, running at a lower rate than the remainder of the business.

And, and in some brands, negative margin and significant negative margin, which added, which added to that.

Okay. Very good. And then, historically, fourth quarter is seasonally strongest for earnings for Sonic. Can you just highlight the factor or factors that primarily drove that disruption to that trend this year?

I mean a lot of us -- this is David. We've talked a lot about it, right? There was sort of a window of uncertainty that we saw that really impacted our traffic. And I think that the overall macroeconomic, landscape that people were hesitated a little bit there to do business, and then it came back in, in, in some areas at the close of the year. But I think that was -- again, this is sort of a macro point of saying, hey, we'll just wait and back, let's see, let's see if this storm clears a little bit before we, we going back or that's some of the feedback we've gotten.

Okay.

So the other thing that I would add to that is BMW plays, an enormous role in our overall performance. And our growth on BMW in the quarter was about 1.1%. You compare that to some of our other High Line manufacturers. Lexus were up 76% in the quarter. Audi up almost 23%. Luxury was up 11.4%. But when BMW doesn't have the kind of volume in the quarter that it normally would have, that and the gross erosion associated with that, that certainly did not help during the quarter. And that was really driven by inventory levels. BMW has done an amazing job overall, keeping their days’ supply down, and did that during the fourth quarter. We missed out on some opportunities there. And because the -- we have so many BMW stores, and they're such a big part of our overall revenue mix, that certainly played a role in the overall performance in the quarter.

Okay. I apologize. I hopped on late, so thank you for clarifying.

Okay.

And then just on your outlook. Thank you for the comprehensive look. That's very helpful. I don't suppose you guys would care to venture a range for a potential adjusted EBITDA profitability for EchoPark for 2024?

No. We do have that we forecast being positive EBITDA for the year, but I go far and that's as far as we go.

Okay. And can I ask just what that, what that may be predicated upon? Does it require any more store closures? Or is the footprint you guys have now set?

That's, that's not something we built into it. Is it an additional store closures?

Yeah. I mean, look, the used vehicle business is getting better. The inventory supply is getting better. The average wholesale price is dropping significantly. And when you combine all of those things, that's why we just have such confidence in our EchoPark model and why we stuck it out through those last three very difficult years. It makes for a pretty picture for '24 and even better as the years go on. We're coming out of those turbulent waters, as I said earlier. And it's going to make for a fun year. EchoPark is going to have a great year, and we're very excited about, being back on our bicycle, so to speak, and getting, getting those stores back to selling the kind of volume that, that we built them for and driving the kind of growth that we built them for. And that's upon us now. We've waited a long time, worked really, really hard. Our team has busted their butts to get through all of this, and we're getting ready to, enjoy the rewards from, from the hard work that went into that.

I went into. David, as I mentioned, our opening comments, talking about our diversified business model and being able to weather the storm, we view it, and jokingly here in the office, talk about it's like in the movie Forrest Gump when they survived the storm.

And as -- this is David. As I mentioned in our opening comments, you're talking about our diversified business model and being able to weather the storm. We view it in jokingly here in the office talk about, it's like in the movie Forrest Gump, when they survived the storm, you've seen these other stores -- these other competitors closing. It's not as if the used vehicle market has just been disintegrated forever. It's not -- we think it's going to be stronger there. It's a much larger market than the new vehicle market historically. And we just -- as we said, we see a tremendous opportunity for EchoPark in the future.

Yeah. And one more point to add, this is Danny. Glenn, I think you mentioned in your note this morning that even just going from the $83 million adjusted EBITDA loss at EchoPark in 2023 to zero is north of $1.50 of EPS benefit. And we've called out that we expect to be positive for the full year next year. So there's a big opportunity to offset -- at least somewhat offset the normalization, continued normalization of franchised earnings just by getting back to zero let alone positive EBITDA on the EchoPark segment.

Yeah. Understood. Okay. Thanks. And then just last for me. If you can just comment on the spread between wholesale and retail used pricing, has it normalized and what you guys might see doing for the rest of this year?

No, it's not normalized. I think wholesale prices in the fourth quarter dropped like 9%. Retail dropped 2%. And as you know, there's a seven, eight week lag there. There's still a lot of high percentage of no sales in the auction lanes, I think that's running north of 40%, but down from 50%. And so everybody is still trying to find their way through this, the back edges of the storm. But we expect those two things to catch up with each other as we move into March and April and May. And again, put some wind in the sales of, of EchoPark and the industry. Used vehicle business should be getting better, as we move forward.

So in other words, yes, so, so that spread should be widening, correct?

Yes, that's exactly right.

Yeah. Okay. Very good. Thanks for all the comments.

Thank you. Appreciate the questions.

Thank you. Our next question is come from the line of Michael Ward with Freedom Capital. Please proceed with your questions.

Thanks very much. Good morning, everyone.

Good morning.

Just put that zero in a little bit on EchoPark on the SG&A side. So we've seen a big improvement in SG&A costs second half versus first of 2023. As we go into 2024, I assume the run rate is even lower, as we go into Q1 with getting where of some of the Northwest stores. Is that correct?

Yes, 100%.

Okay.

And I think we called out on the pages that David referenced somewhere in EchoPark SG&A percentage in the 80% range with a mature store being south of 70%. And we expect that as we mature, we expect -- that's where we expect to be. And, and honestly, that's where we were, if not better, prior to COVID hitting. So, all these things are coming back into life for us, which is just fantastic.

Yeah. That's a total segment level. At the store level, we've seen at our more mature stores, both in 2019, are getting back toward a sub-60. I mean they're among the best of our entire portfolio in terms of SG&A to gross and SG&A leverage because of the comp structure in that market.

And what did you end -- how many locations do you have at EchoPark at year-end?

18.

18?

We've had 25 at year-end, but with the seven closures in January today, we sit at 18.

Sorry, I've already forgot about our quest for Motorsports.

Thanks very much.

Thank you. Our next question is come from the line of Bret Jordan with Jeffries. Please proceed with your questions.

Hey. Good morning, guys.

Good morning.

Good morning.

Could you talk about the impact of lease recovery on F&I? Obviously, it's been at a pretty low rate on lease penetration, but it would seem that has less F&I packaged in that transaction. Is that factored into your flat F&I going forward?

Meaning if leases improve and penetration improves?

Yeah.

It's not going to make a difference, I don't think. It is factored in, and we're going to be in that $2,400 range or north of that, I think, is the back half of the year gets here as we continue to improve, especially on a total Company basis because we're seeing great improvement at EchoPark, even in the current margin rate -- current interest rate environment, as we zero in and focus on execution there. There's a lot of topside -- there's a lot of Ops opportunity from our perspective and from an F&I perspective. And we should be able to hit that $2,400 number or higher as we move forward.

Is there any F&I attached to leasing? Or is it pretty much not a cap -- not a thing there?

No, there's F&I in it. It's just not at the level that you would with, with -- when someone is financing a car traditionally.

Okay. And then on the customer pay parts and service side, up 9%, do you -- what was the number between price and traffic in that 9%?

About a third of that. This is Danny. About a third of that comes from higher repair order volume and two-thirds is coming from passing along higher labor costs, higher parts costs, the effects of inflation as we've seen over the last several quarters.

Okay. Great. Thank you.

Thank you. There are no further questions at this time. I'd now like to hand the call back over to David Smith for any closing remarks.

Thank you very much, and thank you, everyone, for participating in the call, and we look forward to speaking with you our next quarter. Thank you.

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.