Q3 2019 Earnings Call

Third quarter.

Thank you for calling the conferencing centre and operator will be with you momentarily. Please be prepared to provide the conference I'd number and any additional information required by the company hosting the conference.

Hello May have the conference I'd number.

Hello, My 5988 create.

Thank you and its filing the brand for San last name.

First name D.A.B.I.D. David.

The last name beat our old W and wrong.

Inter company name.

A I.E.R.A. a euro.

Thank you. Your line is in progress, although you know what we would like to open the call to question.

Ladies and gentlemen have you would like to ask your question simply press Star then the number one on your telephone keypad.

In press Star one of you would like to ask your question.

And your first question is from the line of John Murphy with Bank of America. Please go ahead.

Good morning, guys.

Hi, good morning.

It first question on F and I.

It sounds like it did the appointment of strength.

Because you're focusing on it but it seems like there's some incremental opportunity there. Mr is as you think about half an eye PVR sort of at best case scenario, what is sort of the highest you think you get on any individual transaction on average. So we can understand maybe sort of the headroom there and maybe what the components of it are I mean, it's like three 400.

Next on origination fee, but there's a lot other stuff going into this number.

I understand this this is Jeff Dyke, yet the warranty penetration is what really drives a big piece of that and there's a lot of upside left I mean, autonation sitting out there and they have an answer quarter last quarter. They were 1900 box. We're sitting at 17 71, I think was the number we announced so.

I certainly could see a 2000 number I mean, there's plenty of upside there our warranty penetrations can get even better than they are.

Today, we've got plenty of upside there, we run almost 40% penetration on the franchise side.

We're running mid Fiftys on the Echopark side, so as we train better with ally and with J. M&A and our partners will get better there's plenty of upside there for product penetration its not so much on the rate or that we're getting that sort of settled in but.

On the product penetration is where the opportunity is and there's still plenty of upside there for us.

Okay. That's very helpful. When you and then second question on Echopark. When you look at new markets that you're heading into I think you slide 20 to 23 of the deck you guys put out this morning.

You should sort of the medium and large stores.

When you out and you identify a new Mark do you going into I think long Beach, California is what you kind of hit and talked about as are the next market. I mean, how are you identifying that marketing it would seem that you'd want to be going into new markets, where you're doing the larger format stores, because you're getting better profits and returns there just trying to understand sort of the nexus of us or the decision making process.

How you how youre thinking about this growth.

Number one is data driven so when you look at long beach market or the L.A. market. It's the largest zero to four year old car market in the country.

So it's a huge opportunity for us.

Our.

Our market share continues to grow in these markets and it was sort of started off at 456% market share now, we're seeing double digit share in some of our more mature stores.

So, we're going where that zero to four year old market is.

In the markets that David called out earlier those are those are big big potential markets for us, but theres, a plenty more across the country.

And those markets for us or just step and point to reach out to two other markets all over the country. We're selling now those eight locations into 140 plus markets across the country and so this just gives us a great footprint.

Across the us too.

Turning to drive that percentage higher.

And the format of the store on Slide 23, and you have larger is medium I mean, why would you ever consider doing a medium is servier greenfielding facilities.

Yes.

Good opportunity opportunities come around when we have to be able to buy real estate. So.

That drives a little bit of it as well and the speed in which we can we can move to get that Doug.

Okay, and then just just a follow up on us when you look at Echopark versus your used vehicle business inside of your existing new Eagle franchise dealers have you find it spend any sort of cannibalization or any kind of conflicts that you come across that had been maybe less than optimal or is there something that you could share that would be show there's really not.

Big issue here at all between the two not at all in its a huge out because all the TCE rates also helps that's the office of all the trades that we are taking at Echopark. We push those cars that are older than four years old into the Sonic stores and we're selling a lot more cars.

Sample that as our Toyota store in Denver, Colorado is selling well over 300 cars now a lot from trades that are coming from the echopark stores. So.

It's made its been a huge help for us to have the echopark stores in markets, where the Sonic stores are located.

Okay, and then just lastly, sort of a sort of more random question. I mean, it has there been any change in a relationship you're seeing with the automakers and it just seems like it I mean, if there's some sort of change it kind of been talking about them and Nissan.

And your dealer support but is there anything else that's going on in the relationship between the automakers and dealers, it's either good or bad you've seen occur in the last quarter or two or is it more status quo.

No. It's actually I think getting better I mean, I think that the manufacturers are thinking outside of the box or not.

So focused on these huge facilities much more technology and efficiencies.

I will participate in a lot of different dealer boards and.

I'd tell you what our relationship never been better.

Our partnerships are great and and I think it just keeps getting better and I see no downside to that as we move forward.

David This.

This is David Smith, and I would echo that that where it seems like we are working together with a manufacturer partners better than I've ever seen it.

Since since we.

Publicly sonic and 97.

Do you feel like you're leaning in to you as as large.

Yes, I mean large well run companies are willing to make capital and create a good customer experience maybe more than they have in the past in the understand that and that might advantage you versus some of the smaller players that can't necessarily keep up.

I certainly think that that that is a big opportunity I mean, there leaning on us for technology for guest experience and success breeds that and so when you sell a lot more cars and they become very interested in you.

And we're seeing that right now we're seeing a lot more new cars or is that a lot more certified pre owned cars or service business is good.

And so it's all clicking and that makes a big difference.

Great. Thank you very much.

Sorry.

Your next question is from the line the rig come Nelson with Stephens. Please go ahead.

Thanks, Good morning, guys.

Correct correct.

Mm Herrmann had echopark not added back said.

Adjusted results would have been better them to present this morning.

Rick This is heath Byrd that is anchored we add up about a 1.1 million dollar impairment related to real estate.

Got it.

Echo Park I'm looking at.

Hey expense ratio.

I was having a 5.3%.

We're seeing as they can line and SGN a per store.

From a dollar standpoint.

Is that.

At accurate and.

I guess what was coming out.

We are kids, a Z that I didnt hear everything, but it is accurate that DSG needs, including because of the leverage that we can get on the echopark stores compared to the franchise stores.

And as asked him a per store actually lower.

At Echopark and it has its own at franchise stores, yes.

By that counterparts, you're also seeing declines.

Yes, Tim <unk> per store.

Yes. The gross is also up so thats driving part of that that's correct.

And as we add as they have more locations, obviously, there's not a lot of expense creep on the management company side. So that's pretty.

Stays the same regardless of how many stores that we open their oil help our as soon as percent of gross yes. We open. These next three markets.

We're not gonna have to add if any.

To the operating company so.

You just have better flow through and more efficiencies that's part of the model.

Yes, and would too and I know and Rick This is David and I would say that our team has gotten a lot better and more efficient about.

At the speed.

The time that it takes to get a new location open and getting it up and running and profitable is changed it tone over the last four or five years since we started this.

Yes.

Packed how long beach.

To be dilutive in the fourth quarter.

<unk>.

I'm not a lot I mean, some there's going to be some carrying costs, but maybe the fourth quarter a little bit in the first quarter right. It's sort of a million on the front of opening at about a million dollars worth a drag once we get it open for a couple of months arm. So theres got to be some dilution.

In the fourth quarter, and then on into the first quarter.

And I'm curious how about.

Share account call. So from two to three two was up about a million shares.

That's correct, leading Bonnie back as you can see from the slides and so it does increase because of where we are familiar.

Incentive compensation standpoint at the current.

Time, so we have to start doing had an accounting for the additional shares.

And Rick This is Jeff as we open more as we open more markets for Echopark you can expect each market to have about a $2 million drag. So six to 8 million is what you should sort of target for 2020 as we move into next year and start opening these other markets.

In terms of drag for the new locations.

And as.

Plans spill over three stores for next year finish so yes, three markets and right now you're in the three rooftop range that doesn't mean that you know there won't be some other opportunities our fourth we'll see but.

But then the current store base will continue to grow and profitability and we've seen that each quarter. This year, which has just been great.

You can't really emphasize that I'm not real quick.

Listing stores have a lot of runway left to grow worried about half maturity somewhere is what we're thinking so we've got a lot of upside in the eight locations that we have in selling into more markets again, we're selling into over 140 markets and those eight locations and that number is just going to continue to grow. It grew 20 markets from the lost.

We we had a call so and just to be clear that's three additional stores on top of long Beach.

Total of four.

Right right.

How many stores he apparent over the long haul fried copart, how many of you need to yeah. You know, it's it's not really rooftop count.

That we wanted to focus on when it's just what we can penetrate and where are we strategically placed those rooftops.

Again, there's just a lot of throughput that we can get out of these locations and so.

No I mean, the number could be 25, it could be 100, who knows it just depends on our penetration as we open up strategically locations around the country.

So that we can penetrate out further and further from from the the base markets that we put the stores up.

And that's real important that's a real important factors, we as we move forward, it's not rooftop count it's how many markets. We can penetrate using the technologies that we have and the great incredible guest experience that we have the guest are saying, Hey will travel a long way to come to you because we like what you're doing so much.

Great.

Well then Rick. This this is David is that in some of the key to that is that they really.

Our customers would prefer to.

To come and see the car before they actually completed transaction.

That's what that's what they're telling us.

Thanks, a lot.

Good luck.

Thank you.

Your next question is from the line of our metastasis Vcs with Morgan Stanley . Please go ahead.

Great. Thank you appreciate you taking the question here when I look at your your GPU and the nine that you're getting at Echopark roughly 2200.

And I compare that to the online only a competitor here running at about 3000 last quarter, you your growth being comparable to them.

You know, it's interesting to see the profitability here and what surprises me is you know your SGN as a percentage of gross is significantly lower here.

I think that Laguna conference is it 55% to 60% estimated gross how how are you driving.

That that lower actually in a gross if we compare it to the online platform, where you would expect yes, you need to be lower because you know.

Effectively call center reps versus employees at the store level. So if you could compare the two just where are you.

Well to see more efficiencies on the DNA line.

Yes, I mean, our operating platform as a heck of a lot cheaper to operate and wait less complicated we don't have no a whole bunch of people running around front to deliver cars to individual points that creates a lot of expense and a lot of complexity.

We don't have those complexities in our model and the customers coming to us. So it's a heck of lot easier to.

HM two to operate we don't spend the AD dollars or anywhere close to the AD dollars and we sell our technology allows us to sell a lot more cars for associates. So in our average sales associate or experienced Guy does what we call them is approaching 20 units an associate the industry averages around nine so our fish.

Currencies are a lot higher our model is a lot less complex and a lot more effective from our from our perspective.

We just don't see how im not saying that it's not going to be part of the model as we move forward, but but we don't see ever us.

Delivering each individual unit all over the country by operating model is very very expensive very very complex and.

We're going to always be able to operate at a much lower s. DNA from my perspective, because of the least amount of complexity that we have in our operating model and we built the model that way.

So the throughput as you see in these eight stores and we had our best throughput yet.

And that's going to continue to get better it doesn't mean that we're not gonna have drag on stores that we open because as we said that will be $68 million next year, but a much more effective and efficient model from our perspective in what we're trying to accomplish.

And ironically, the add to that it's not in DSC Nate section, but our capex is on a lot lower than theirs as well.

Okay.

What I'm hearing from you here is you don't have the logistics costs, you don't have the advertising spend.

If I look at their model and then last quarter result, I back out the advertising Backout logistics and back out the more logistic because some of it is included in their cost of goods. So I'm running at call. It 73% of Ah you know SDN as a percentage of gross profit you're still optimizing 55% to 60%.

Just just.

Coming down there to see it in person in September I really appreciate the efficiency. The modeled made maybe you could talk to you know is it is it on the comp benefit side, where the employees are more efficient isn't on the reconditioning side, maybe just a couple of other nuggets year to better understand the I see an eight gross dynamic.

Well, what we've a lot less people I mean, we're doing a lot more with a lot less people and our technologies are allowing that to happen then so London I looked like it was like a third of the number of people. They have yeah. Yeah. Yeah. We have a third of the number of people that they have and so it's just so it so it doesn't cost us as much to.

Well the car in our model is it cost under so now I'm not saying that their models not going to work pharma. We're we're carrying Brian and we wanted to be successful because it helps the overall industry, but at the end of the day.

Cost us a whole lot less and we also try to figure out what we can say no to the keep our expenses down were really really focused on making sure that our model stays really effective and really efficient. So we can provide our customer where they really low price point that keeps them coming to us and that's really important or prices are incredibly compelling.

And that makes a big difference you know, we got to keep that lower price point to drive that traffic and the amount of leads that we're getting that these stores is astronomical Dallas stores or season over 10000 individual leads a month, that's unheard of in our in a in our industry. So our operating model is simply less complex less expensive to run in May.

Our vision.

Very much appreciate it.

Yes, Sir Thank you appreciate the question.

Your next questions from the line of bread Jordan with Jefferies. Please go ahead.

This is mark toward non for Brad good morning.

Good morning.

So thinking about Echopark I believe as mentioned previously that around 90% of the inventory is sourced from auctions and the remainder is primarily sourced off the street in from car cash.

I was wondering does that make still stand and and if so should we expect the mix of vehicles source at auctions to decline over time, and and what sort of impact that could have on down front end margins.

Yes, yes, yes, and the impact on margin is going to go up you know that that's the great thing is we haven't even scratched the surface yet par cash our app just launched at one location here in Charlotte on the new car side, and we're beginning to work with the App to drive more cars coming.

Yes from off the street. So the mix is below 10% now, but you should expect that to grow as time goes on in our at becomes more efficient and that after using not only for the consumer but we're providing it to our competitive set as well. So other dealers are now beginning to use the app for us too.

Praise vehicles for them.

We're also doing that were camping world. There's just a lot of different companies out there that can use the application that are trading for vehicles. So we expect that to become a bigger percentage of our mix what that number is we don't know yet.

We'll see over time, but when that does happen. We all know that when you try to record the door.

You know your margins go up there's less expense.

Through transportation auction fees, you name it and so our margins can improve on the front end by doing that that said or our prices can get more competitive.

Because we're always looking for ways to drive that retail price down to offer that consumer that great experience at a really good value sort of the posco model right just really low price.

And so one way or the other the margins will probably stay where they are the prices might get a little more competitive, but we're going to trade for more cars at the door because of the application.

And we'll keep updating you as time goes on.

Okay great.

And during the prepared remarks has mentioned that buyers are coming from over 140 markets to visit Echopark.

So I was curious if you have the mix between maybe local market buyers and sort of out of market or out of state buyers.

So the way we're looking at it is how the dry fine I'm. So if you look you know sort of 30 minutes to an hour that's about 60% to 70% of our business in the balances outside of that and then we're defining the mark.

As multiple sales from each market across the country and we've got customers that come into our Dallas store from a as far away as Alaska.

And really they're coming from all over the country, but that's kind of how we're looking at it.

Okay, great. Thank you very much yes, sir thanks.

Once again, everyone. If he would like to ask a question simply press Star then the number one the onto a telephone keypad.

Your next questions from the line.

Hi, I'm done with JP Morgan. Please go ahead.

Hey, guys.

As for taking my question.

Appreciate the color on the drag from the new store openings in Fourq you in next year.

Just had a couple of follow us related to that and first thing I mean, where Mary you in terms of you know.

Maturity curve will be existing echopark stores that you have them as you think that those should keep getting more profitable.

Going into fourth quarter and next year, and then with the new stores that are going to tomorrow. How quickly can barely profitable versus you know what you saw in Colombia, and you're still getting up and.

So basically just trying to get a sense of you know how much of the drag and can be easily offset and.

Kind of EBITDA run rate should we be looking at.

At quarter end next year.

Thanks, Yeah. So this is Jeff Dyke, where we think our existing stores at about 50% maturity.

And so there's a lot of upside left and of course and that's the point, David Smith was making earlier just lots and lots of upside. If you look at our Charlotte store was profitable in its first full month of operation on Houston took about six months. So we're thinking within a six month timeframe.

At the out most of our stores will be profitable. So that's kind of where we guide you to to look.

Got it and so it was interesting or the fourth quarter. I mean, you have yet to 6.4 million EBITDA in the third quarter.

We live in the long lead story coming in I mean.

I mean, assuming that the fourth quarter run rate would be higher well then what are you didn't talk wondering given you know the existing sources. There can be an improved is that a fair characterization or.

Good morning to step down.

Oh, just the Denver EBITDA.

In terms of income EBITDA.

Yes, I would say flat you know sort of flat as the way to look at that for Q3 versus Q4.

Got it Okay. I mean again, you've got a million dollars drag before you opened in a million dollar drag after you open for each store on average.

Got it okay.

And then in terms of justice funding, the new anchor or Echopark store openings next year.

Thanks, you down the line.

It seems like all of that is going to be funded by the free cash flow from the franchisee stores.

Well my way why when would you expect you know just the echopark stores to generate enough free cash flow to be just self funding future growth I mean.

Are we looking at three years down the line or four years down the line just trying to get a sense. If you know when you know it's not a drag on the franchisee free cash flow.

Yeah. This is heat from an overall capital allocation plan, we were sticking with the exact same plan as Echopark is still a priority we will opportunistically look at franchise acquisitions and again, the debt reduction, which we've mentioned before.

You know would kick it off we kicked off 6.5 million EBITDA in Q3.

So you're going to get he's doing a had some franchise support into 20, but after that I think once you get a stores mature we have for new stores on been Echopark is going to start supporting its own growth.

Got it.

That makes sense, thanks, a lot bucket on.

Thank you very money.

Yes.

And at this time there are no further questions I'll now turn the call back to Mr. Smith for closing remarks.

Thank you very much. Thank you everyone for your questions I. Appreciate your time have a great there.

Ladies and gentlemen, this does conclude the Sonic automotive third quarter 2019 earnings conference call. Thank you for your participation you may now disconnect.