Sonic Automotive Inc (SAH) 2002 Q4 法說會逐字稿

Good afternoon and welcome to the Sonic Automotive fourth-quarter and fiscal year-end earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question at that time, simply press star, then the number 1, on your telephone keypad. To withdraw your question, press star, then the number 2. If you need assistance at any time during this conference, please press star, then zero, and an operator will assist you.

At this time, I would like to refer to the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information, or expectations about the company's products or markets, 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 and with the Securities and Exchange Commission. Thank you.

I would now like to introduce Mr. Theodore Wright, president of Sonic Automotive.

Mr. Wright, you may now begin your conference.

Good morning and welcome. I'm Theo Wright, the company's president. Joining me on the call are Scott Smith (ph), the company's vice-chairman and chief strategic officer, and Jeff Rachor, the company's chief operating officer. Scott will begin the call with an overview. I'll then cover financial highlights and discussion of our growth strategies, and then turn the call over to Mr. Rachor for comments on our operations -- Scott?

Thank you, Theo. Good morning, ladies and gentlemen. We're pleased to have you join us for Sonic Automotive's fourth-quarter and full-year 2002 earnings conference call. I'll cover some highlights and then turn the call back over to Theo, Sonic's president, for additional commentary.

For the full year 2002, our total revenues increased by 20.3% to 7.071 billion. Our net income soared to a record level of 106.6 million, up 34.3%. And our earnings per share climbed 29.3% to $2.47 a share.

For the quarter, same-store gross margin percentages increased from 15.3% to 7 -- 15.7%. We exceeded the revised consensus EPS for the quarter and full year by 1 cent. I'd also like to mention that we exceeded our original guidance for 2002 by 32 cents per share.

This performance is particularly strong not just in light of the current difficult economy, but this performance is strong because it's the fifth consecutive year that we have posted a double-digit increase in earnings per share.

For 2003, we're forecasting another year of double-digit growth in our earnings per share. Sonic's trailing 12 months return on equity continues to be a sector leader at 17.9%.

Our ability to continue to grow earnings per share in 2002 makes Sonic exceptional. Earnings growth in all environments is what defines a growth company. We hope to earn a growth company earnings multiple as we continue to increase our earnings per share in 2003.

We've proven that automotive retailers' earnings are stable and predictable quarter after quarter, year after year - Theo?

Thank you, Scott.

Our earnings per share growth for the year of 29% was driven by strong performance from our acquisitions and strong performance by our luxury and import brands. After adjusting for accounting for goodwill in the prior year, our earnings per share for the year were up 10%. Our earnings growth is being driven by acquisitions, not changes in accounting.

For the fourth quarter, earnings on a comparable accounting basis declined 9 cents per share, largely due to declines in vehicle sales, particularly used vehicles, on a same-store basis, increasing inventory carrying costs, and negative operating leverage in a declining same-store sales environment. We will address each of these issues further in our comments.

Overall, gross margins remained stable for the quarter. We generated 48 million in EBITDA after floor-plan interest costs in the quarter, and 223 million for the year.

EBITDA margins after floor-plan costs were 2.8% for the quarter and 3.15% for the year. Non-floor-plan interest was covered 4.6 times for the quarter and 5.7 times for the year.

Our tax rate on continuing operations for the year was 38.1%, and we expect our tax rate for next year to be similar or lower.

Tax rates will benefit from certain state tax planning strategies executed in 2002.

Diluted share counts declined for Q4 to 42,199,000 shares, from 43,334,000 shares in Q3. During 2002, we issued 2,129,000 shares in the Massey acquisition, and from employee stock option exercises. We also repurchased 1,804,000 shares. For the year, weighted average share counts were up 3.7% from the prior year.

Full-year 2003 earnings will benefit from lower share counts and we expect share counts of 41 million to 41-and-a-half million without additional share repurchases, and assuming similar option dilution to Q4 2002.

Our company continues to reacquire shares in a disciplined manner and the board has recently authorized an additional $20 million for share repurchases.

Non-floor-plan interest costs declined from the third quarter due to lower variable rates and the impact of management of our liabilities. We expect to continue to benefit from lower variable rates.

We have modestly increased our exposure to variable rates through repurchase of our senior subordinated bonds, and convertible bonds. A 100 basis point increase in interest rates would reduce quarterly earnings by approximately 2 cents per share. We are forecasting no increase in interest rates for the remainder of 2003.

Our strongest regions for the quarter were in the Southeast -- Tennessee, Alabama, Georgia, and Florida -- as well as Southern California, Detroit, and Las Vegas. Areas of weakness were Dallas, Houston, Columbus, Charlotte, and Oklahoma.

Brand weakness was a much stronger relative influence than market weakness. In other words, strong brands in weak markets performed reasonably well. Weak brands, even in strong markets, performed poorly.

Ford, Chrysler, Jeep, and Dodge were particularly weak for us. Unfortunately, we are overweighted in the domestic lines, and some of the markets that objectively, based on unemployment data, are weaker. Markets such as Dallas, Houston, Oklahoma, and Charlotte.

Negative trends in used vehicle sales were also most prevalent at our domestic stores.

Strong brands included BMW, Cadillac, luxury generally, Honda, which was very strong, and Toyota. Volvo also showed improvement. Nissan has disappointed, given the strong product enhancements recently as Nissan has not been aggressive with pricing.

Turning to our earnings targets, we've reaffirmed our 2003 earnings targets up from $2.70 per share to $2.80 per share. Our targets for the year are based on new vehicle same-store sales down 5% or approximately a 16 million unit industry sales rate for the full year.

Used vehicle same-store sales down a further 7% against weak comparisons. Service and parts same-store sales up 5%. Finance and insurance same-store sales per unit flat. We're not including acquisitions that have not been announced to date. We're including completion of divestitures currently under contract. We're not including share repurchases beyond those completed to date. As a side note, our forecast EBITDA would be approximately $230 million for the year.

Mr. Rachor will comment on our used car operations. I'd like to provide some concrete information on the credit environment for used car purchases.

For the four-month period October 2002 through January of 2003, our financing contract volume with our principal providers of sub-prime used vehicle financing declined 21% and credit standards are being raised across the board. Our contract volume with Ford credit for the same period dropped 48%, or 4,177 contracts.

Much of this decline was used vehicle financing, including some sub-prime contract volume. Our experience is not unusual. Clearly, the used vehicle consumer financing market is attracting less capital. This decline in financing availability is reducing consumer demand and pressuring used car prices downward.

We are seeking to counteract these forces by expanding our sources of used car and sub-prime financing. However, we believe the trend of reduction in available financing will continue, and have reflected this expectation in our forecasts.

January and February do, however, appear somewhat better than the fourth quarter. Consensus industry forecasts are more optimistic and we believe our used forecast is conservative by comparison.

Turning to the new vehicle environment, incentives are in economic substance, adjustments to price. Manufacturers' prices to dealers are not adjusted, frequently, and incentives are how manufacturers adjust price to consumers.

Incentives, even dealer incentives, have little impact on dealership new vehicle gross margins. Trends and incentives are upward. GM announced even stronger incentives for March. Toyota is getting more aggressive. The Koreans have jumped into the 0% game. We expect manufacturers to continue to be aggressive on price as the major manufacturers are currently profitable.

We also believe this is a long-term trend, with domestic production capacity expanding. Toyota, Nissan and Hyundai are adding substantial U.S. capacity. BMW has expanded U.S. production. Of our major brands, only Volvo lacks significant U.S. capacity.

Pricing pressure will continue. Incentives are and will be a fact of life in the automotive business.

Our current sales trends in new vehicles are accurately reflected by the industry sales numbers reported yesterday, adjusted for the impact of fleet sales.

February was unquestionably a difficult month, with several of our markets experiencing severe weather conditions. We don't normally complain about the weather, but weather did affect ourselves and the industry in February.

We expect manufacturers to respond aggressively with pricing. Some already have. And we expect March sales, absent commencement of hostilities in Iraq, to improve. March will also benefit from five Saturdays during the month.

Sonic and other companies in our sector are demonstrating the strength of our business model. We talked about this model generally but I wanted to give a clear, concrete example.

In January of 2003, the industry as a whole sold 1,090,784 units. On an annualized, not seasonally adjusted, basis, January represented a 13.1 million unit sales rate. We were profitable in January with store-level margins exceeding the industry average for dealerships for all of 2002, including the better seasonal parts of the year. February sales indicate a 14-and-a-half million unit sales rate, with a very short service month, and again we generated substantial profits.

This is performance without aggressive adjustment of cost because of the expected seasonal uptrend. Our company and automotive retail clearly can deliver substantial profits at industry sales rates far lower than can be reasonably expected.

Turning to our balance sheet and growth strategies, we recently announced the expansion and enhancement of our revolving credit facility. Currently, we have approximately 180 million available under our credit line. We have adequate capital available to support our growth strategies. None of our significant debt instruments matures prior to October of 2006.

We'd like to provide investors some information on how we view allocation of this capital. We look at allocation of available capital a number of ways, not just quantitatively but qualitatively, considering management capacity, manufacturers' relations and other issues.

At the current time, the following is the implied after-tax return on investment from various alternative uses. Paying down our revolver, 2-and-a-half percent, re-purchasing bonds, 6%, purchasing dealerships at five times EBITDA 12%, purchasing dealerships at four times EBITDA 15%, re-purchasing shares at $18 a share 15%, re-purchasing stock at $15 a share 18%.

For the last two years, on a cash basis, our return on invested capital was 14%. We consider these relative returns but are not intending to discontinue all acquisition activity. We believe we're a growth company and devoting all of our capital to share repurchases would not position us well for the long term.

Acquisitions clearly remain value-creating transactions for our company, and are a key part of our long-term growth strategy.

We continue to seek acquisition opportunities where we can create fundamental value by improving performance in sales, gross margins, expense control, or some combination of these three.

We expect to acquire dealerships in 2003 with at least 500 million in annual revenues, as we better integrate the substantial acquisitions from 2002, our acquisition pace may re-accelerate. We're currently pursuing a number of attractive acquisitions, including some larger dealership groups.

Pricing is attractive with opportunities valued generally in the four to four-and-a-half times EBITDA multiple range.

We're also working aggressively in cooperation with Chrysler Corporation to better position our Chrysler, Jeep, and Dodge franchises and complete Project Alpha (ph), wherever possible. Project Alpha allows in certain situations, a combination of Chrysler, Jeep and Dodge, in one location. This increases throughput per outlet, allowing the dealer sufficient earnings opportunity to provide the best location, the best facilities, and the best people.

Divestiture activity continues as well. We're reducing our exposure to Ford, Chrysler, Jeep, and Dodge, and we expect this trend to continue other than our work on Project Alpha.

A weaker vehicle sales market has caused us to press forward more aggressively with divestitures so we can redeploy capital in better-returning investments. We expect to generate approximately 30 million in cash from divestitures in 2003, which will benefit our balance sheet, earnings, and margins.

Capital expenditures for the full year were 92 million, with 42 million already refunded during the year via sales or sale/leaseback financing. We had approximately 40 million in real property lease holds and construction in progress. We expect to sell -- or sell and lease back in the near future.

We expect net capital expenditures for the year 2002 to be approximately $20 million.

Depreciation for the year was 8-and-a-half million. We expect full-year 2003 capital expenditures, after completion of sale/leasebacks to total approximately 20 million, with forecast depreciation of approximately 10 million.

We continue to invest in facilities, particularly to add service capacity. We added approximately 180 service bays to existing dealerships in 2002, and we expect to add 130 more in 2003. These expansions will support long-term growth in service and parts.

Please keep in mind our capital expenditures include replacements. Often we are constructing a new superior facility to replace an older, inferior facility. The result is an increase in rental expense partially offset by a reduction in rental expense from expiring leases or facilities that are sold.

With those comments, I'll turn the call over to Jeff Rachor -- Jeff?

Thank you, Theo.

I'd like to begin by providing some color on fourth-quarter same-store sales performance. Then I will cover a number of key strategic operating initiatives that will be our focus in 2003.

First, used vehicle sales. In anticipation of a lower than normal seasonally adjusted used vehicle wholesale values driven by the ongoing hangover of 0.0% new car financing, and further compounded by geopolitical and economic uncertainties, we made the conscious decision to lower our used vehicle days supply to a 30-day target in the fourth quarter of 2002.

This conservative approach to inventory management achieved our objective of mitigating wholesale losses, which were down 16% for the quarter versus fourth quarter 2001. However, this strategy also put pressure on used vehicle retail volume. Used vehicle retail sales continued to be impacted by diminishing availability of sub-prime financing sources and tighter credit standards from all lenders, which particularly hurt the lower cost of sale unit segment.

This is validated by an increase of $844, or 5.73%, on retail used unit pricing in the quarter.

Finally, manufacturers new vehicle incentives continued to squeeze the sale of late-model pre-owned vehicles, but this was offset in part by our organization's increased commitment to OEM certified pre-owned programs, which I'll expand on in just a moment.

With the support of a recently launched model inventory technology, we have been rebuilding our used vehicle inventories with discipline and our dealerships are well-positioned with fresh inventory as we move into the spring selling season.

Fixed operations have always been a key component in Sonic's success model and the fourth quarter 2002 showed strong results, once again, as total operations generated gross profit dollars that were up 3% versus fourth quarter 2001.

This fixed operations performance is particularly noteworthy as it is up against the tough comps of 2001, which included the Firestone recall.

Same-store service sales were up almost 4% versus fourth quarter 2001, while total service gross profit was up 6.42%.

While same-store parts sales were down slightly versus fourth quarter 2001, the declines were isolated to our Ford wholesale operations in Houston, Texas, where Ford Motor Company recently opened a parts distribution center, and attributed to warranty sales decreases directly related to last year's Firestone recall.

After adjusting for the impact of these unique phenomena, fourth-quarter 2002 same-store parts sales and total parts gross profit were up 2% versus fourth quarter 2001.

The implementation and execution of best practices in our fixed operations departments yielded overall gross profit margin increases from 46.5% in fourth quarter 2001 to 48.1% in fourth quarter 2002. Fixed absorption improved from 77.81% in fourth quarter 2001 to 79.7% in fourth quarter 2002.

Growing our high margin non-cyclical service, parts and collision repair business will continue to be among Sonic Automotive's highest priorities.

In fourth quarter 2002, we experienced a buildup of new vehicle inventories, in part as a result of certain domestic manufacturers accelerating wholesale shipments to our dealerships. However, Sonic's traditional asset management discipline maintained key inventory assets at the following levels as we ended the fourth quarter of 2002.

New vehicles, a 64 day supply with only 1.6% of inventory over 180 days old. Used vehicles, a 34-day supply, with 9% over 60 days old, most of which is concentrated in our luxury brand inventory to support certified pre-owned programs. And parts inventory, a 50-day supply.

I'll quickly note that we ended January 2003 at the following levels -- new vehicles maintained a 64-day supply; used vehicles strategically building to a 37-day supply; and parts maintaining a 50-day supply.

Our continued focus on new vehicle aging and used vehicle inventory modeling will produce the freshest, fastest-turning merchandise, ultimately supporting our same-store sales growth initiatives. We are confident that new vehicle inventories will be in line with our historical industry-leading standards as we enter the second quarter of 2003.

Finally, total floor-plan expense in fourth quarter 2002 was down 7.2% versus the fourth quarter of 2001.

Now I'd like to review our key operating initiatives for 2003.

This year, increasing same-store sales and, more importantly, increasing market share are the company's number one priority. Sonic dealerships already enjoy above-average market share. Market share trends are stable to positive, with the exception of two manufacturers.

Sonic Automotive leadership has strategically resolved that we will not allow overemphasis on maximizing short-term profitability at the expense of sacrificing retail sales volume or market share.

It is our belief that protecting and taking market share is the key to propelling growth in our high-margin fixed operations, and ultimately realizing the full longer-term earnings potential of the auto retailing model.

For 2003, we've announced two other key sales initiatives that will ultimately contribute to service and parts growth and maximizing long-term profitability. First, we will focus on increasing sales of extended service agreements through our professional finance and insurance departments. Extended service agreements offer great value for the consumer, finance and insurance gross profit on the front-end sale, and, most importantly, extended service contracts virtually guarantee an annuity of service and parts gross profit in the future.

Next, manufacturers' certified pre-owned programs create a similar and very compelling sales story. Certified pre-owned programs are exclusive to franchise new vehicle dealers, creating a competitive advantage over independent dealers. A certified pre-owned department is almost like having a second franchise, if executed properly.

Once again, certified pre-owned vehicles provide great value for the customer, higher front-end gross profits, and certified pre-owned programs feature the extension of manufacturer warranties, tying the customer to our service departments for up to a 100,000 miles of ownership, and providing the annuity of future service and parts gross profit.

Sonic Automotive has long been committed to exceeding our customers' expectations by raising the bar of professionalism in auto retailing. I'm pleased to report that Sonic dealerships ended the fourth quarter of 2002 with two-thirds of our dealerships exceeding the manufacturer's survey standards for customer satisfaction. In addition, many Sonic dealerships were recognized by our manufacturer partners with their highest annual awards for customer satisfaction.

We view our commitment to deliver a superior customer experience as being another key differentiating driver of increasing same-store sales, market penetration, and a key to building customer for life annuities for our fixed operations' profitability model.

The single most important element in retail automotive sales is attracting, training, motivating, and retaining a high-caliber professional sales force and management team. We have validated the success of our Sonic dealer academy through reduced dealer/operator turnover and graduates' improved performance. This education model was the genesis for our recently launched Sonic University, the most comprehensive training and career development initiative in retail automotive history.

Using Sonic's laboratory of dealerships, we have identified best business practices as the foundation for standardized processes. Sonic University's first priority is rolling out a standardized retail sales process to be trained and implemented across the enterprise. The conventional human process will be married to a common customer relationship management technology.

As Sonic University evolves, we plan to offer regional classroom and distance learning modules to virtually every position in the dealership.

We believe standardization is the long-term solution to creating a competitive advantage and same-store vehicle sales and market penetration. As we continue to promote from within, transfer employees, and manage employee turnover, we will reduce transition risk as Sonic employees will quickly confirm to Sonic's common processes.

I will close my comments on operating initiatives today by expressing our management team's commitment to controlling SG&A expense in these uncertain times. For months, we've been evaluating every opportunity to reduce cost. Action has been taken in many areas of our business, most notably personnel expense, and remains ongoing. Dealership-level headcount and productivity analyses, including evaluating support to productive employee ratios, restructuring and reducing our divisional and regional oversight expense, continued focus on reducing employee overtime, the reduction of demonstrator vehicle fleets, and even tighter centralized advertising expense controls.

Our expense reduction actions will offset the higher cost of employee benefits and insurance that are plaguing corporate America. These efforts will be aggressive and ongoing.

That concludes management's prepared comments and at this time we'll be glad to entertain questions -- Operator?

At this time, I would like to remind everyone, if you would like to ask a question, press star, then the number 1, on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Rick Nelson (ph).

Thank you. Good morning, guys.

Good morning.

Hey, Rick.

You're two-thirds of the way now through the first quarter. I don't see any EPS guidance. I'm wondering if you could comment on trends. It appears inventories are in relatively good shape, relative to your peers, and expense initiatives seem to be underway.

Rick, this is Theo. We have elected not to provide ongoing quarterly guidance not just for this quarter but forward quarters as well and provide annual guidance, which is a trend we're seeing overall and is consistent with what some other companies in our sector do. But based on the inventory position that we ended the year with, as well as sales trends in the quarter, we do anticipate a reasonably good quarter.

I will point out, though, that we were negatively affected by weather in the Dallas metro area, Washington, D.C., Columbus, Ohio, Charlotte, North Carolina, in the first quarter, and again, we don't normally complain about weather, but these were unusual situations for us.

The other point I would make is that roughly half of our profits on an historical basis for the first quarter have been earned in the month of March, and I think there is a lot of uncertainty about the market currently and market trends and so it's a little difficult to see March earnings with any clarity.

We do have the benefit, as we mentioned in our prepared comments, of five Saturdays during the month. However, we had five Saturdays in the month of March last year as well.

Okay. Thank you. Service and parts same-store sales, I'm wondering if there was a difference between your domestic name plates and your import name plates?

This is Theo again. The answer is yes. Growth in customer pay and really all the components of service and parts was stronger in our import name plates, and as we mentioned in warranty the significant declines we experienced in our Ford dealerships related to recalls a year ago. So we are seeing a clear divergence in trend, although even in our domestic lines, customer pay service and parts revenues on a same-store basis did increase.

And, Theo, your pipeline of acquisition opportunities, are they more foreign name plates or domestic?

They're principally foreign name plates. As I mentioned, exposure to Ford and Chrysler Jeep is likely to diminish. We're divesting and not acquiring in those brands, except for some actions that we're taking specifically to complete Project Alpha, and those, we think, are transactions that are going to benefit our company and our brand portfolio generally.

We will pursue some domestic convictions and wouldn't rule them out, but our pipeline right now is principally import name plates.

I would also point out that we view Cadillac differently from the rest of the domestic name plates. We consider that more of a luxury brand. In fact, if you look at the average price of vehicles sold and define luxury by vehicles that are priced over 40,000 a unit, Cadillac was actually the largest luxury brand in the U.S. market. So we do view Cadillac differently and we think there's some terrific positive trends at Cadillac.

Great. Thank you.

Thank you.

Your next question comes from Morris Dejean (ph).

Thank you. My question is about the new model inventory program that you have for used cars. Can you tell us how it's different or better or improved from what you were doing before?

Yeah. This is Jeff Rachor. I'll be glad to address that question.

We have long had a very disciplined approach to managing used vehicle inventories, and have really been leaders in the sector, and in asset management, but in the third and forth quarter of 2002, we piloted an asset management software for used and new vehicles that is driven by developing a model inventory for each of our dealerships. In other words, identifying which units sell the fastest off of each unique dealership's lots. And we are now rolling that out nationally, and are getting the benefit already of that technology and of the reporting capabilities that are available through that software, and simply it's just allowing us to get the right models, the right colors, the right equipment in our used vehicle inventories so that they turn faster and this is a tool that helps our dealerships make better decisions about purchasing and which trade-ins will be a match for their model inventories.

Thank you.

Your next question comes from Mark Lowe (ph).

Good morning, everyone.

Good morning, Mark.

I was just curious, you mentioned some of the contraction going on in the sub prime used market. Can you talk a little bit about what the options are for some of these folks, perhaps in the new market? You know, how many of these people do or do not qualify for some of the, you know, Ford Motor credit or GMAC type financing, and then, you know, if that's a large percentage that don't, do they typically, you know, refer them to local banks or other types of companies?

This is Theo. I'll take that question.

The typical sub-prime customer does not qualify for a new vehicle purchase at all, and certainly under the 0% and other sub-vented rate programs offered by the manufacturers, those consumers would not meet the requirements and would not get that financing.

They also would not, under ordinary circumstances, qualify for financing from a bank or other source of financing. Those customers will do two things. One, they will defer their purchase of a used vehicle, which I believe is the predominant trend currently, or, two, they will go to what are known in the industry as buy here/pay here type of operations which finance consumers in a tier that's even below the traditional sub prime financing tier. But in my opinion, most of those consumers who are not qualifying for a financing are deferring their purchases. Often by deferring their purchase and saving a little cash, they can then qualify at a later date, but generally speaking, I think those are not customers that are getting financed through a source outside of our dealership.

Okay. So outside of the comments on used, it should really have no impact on the new car sales rates?

Yes, that's correct. Sub-prime financing is a very, very small -- really insignificant -- part of new vehicle sales, at least in our dealerships.

Thank you.

Thank you.

Your next question comes from Adrian Dell (ph).

Hi. Thank you. I just had some questions about the bond repurchase. For the 11% sub notes, what was the average price that you paid to repurchase those?

We'll need to get back to you with a precise price, but I believe the average price that we paid was somewhere in the 3 and a half range.

Okay.

We'll try to get a precise price and call that out later, but it was in that range.

All right. And do you have any plans to make further repurchases in this half of the year?

We would not plan to repurchase bonds at the levels where they're currently trading. We will opportunistically look at repurchases where we can get those repurchases at the types of prices that we'd like to see, which we have not seen lately. We have not completed any repurchases of either our subordinated or convertible bonds since the end of the year.

Okay. And now that they are trading up around the call price, have you evaluated the option of calling the bonds?

We will evaluate that option, among many options, but there is a nearly 200 basis point differential between the first call price and the second call price that we will consider in that evaluation.

Okay. Great. Thank you very much.

Thank you.

Your next question comes from Ian Ellis (ph).

Gentlemen, good morning.

Good morning.

And congratulations on a good quarter in a tough environment.

Can you just talk about F&I here, which obviously was strong for the quarter? What was driving this? Was it increased level of financing penetration or was it more on the extended warranty side? And any trends that you see beyond, obviously, the already-held discussion about the absence of sub-prime credit.

Yes, Ian. This is Jeff Rachor. Good morning. I'd like to comment on that.

The key driver of continued strong performance in finance and insurance is the implementation of best practices, primarily a hundred percent menu presentation, and supporting those best practices with professional training. And we've long had a comprehensive commitment to training in the area of finance and insurance, but I do have some numbers. We did enjoy a slight improvement in finance penetration. Finance penetration was almost 76% for the quarter, versus 73% for a year ago. And we also had a positive trend in service contract penetration. We were over 35% service contract penetration versus about 33.9% a year ago on a same-store basis, and as we addressed in our prepared comments, we believe we can take that service contract penetration number much higher, and I do think that the fourth-quarter 2002 performance really demonstrates the resiliency of the finance and insurance profitability model, because we achieved that performance despite the existence of a very low rate and even a 0.0% sub-vented financing environment from the OEMs.

All right. Great. That's very helpful. Thanks, Jeff.

Your next question comes from Paul Rolf (ph)

Theo, given the rates of return that you've talked about in your various alternatives, buying, making acquisitions or buying stock, would you go over and tell us what the current authorization is to buy shares and where you are in that program?

And any comments that you'd like to make relative to purchases of your stock in the first quarter?

First off, we have purchased some shares in the first quarter to date. We continue our practice of not purchasing a significant percentage of the daily trading volume. We've repurchased around 400,000 shares, quarter to date.

As of the 28th of February, we had 31 million in authorization remaining, and based on current stock values, I think you can reasonably expect that we will continue to repurchase shares in a manner similar to the manner of the last several quarters.

The only comment I would make that's contrary to that is, if there was a particularly attractive acquisition opportunity or some other compelling need for that cash, we might defer share repurchases for a period of time. But currently, our share repurchase activities continue.

Now, let me clarify that. You said there's $31 million worth of authorization from the board of directors.

Yes, sir.

That's different from what your bank covenants or bond covenants might suggest. What's the most controlling indenture (ph) test as it relates to these type of restricted payments?

The most controlling restriction is the authorization of the board of directors.

Thank you.

Your next question comes from Nate Hudson (ph).

Hey, good morning, everyone.

Good morning, Nate.

First, a question on your SG&A. I was just wondering if you could rate your performance in the fourth quarter, and then kind of looking into the first quarter. You know, assuming a similar level of gross profit, should we expect to see the same kind of performance, or some improvement there?

Starting with -- this is Theo and I'll address part of that question. I think Jeff may want to add comments as well.

But we would expect that the performance in the first quarter is probably going to look fairly similar to the fourth quarter. If you look at the industry sales trends as well as normal seasonality, the fourth -- the first quarter to date actually looks worse, not seasonally adjusted, than the fourth quarter. So you have to consider that factor in looking at SG&A expenses and operating leverage and the impact of fixed costs.

So I would expect trends in the first quarter to be fairly similar.

In terms of rating our performance by category, I think we have not done all that is necessary in the area of personnel costs. That's an area where we have intensive focus at the moment. But you have to balance the desire to adjust those head counts with the fact that human resources are a valuable asset, and when sales trends reverse, as they do normally in this season of the year, you'll need many of those people.

So you have to balance those competing interests, and I think we did a pretty good job of balancing those interests with a 6% reduction in headcount on a same-store basis.

We did a terrific job of controlling advertising expenses. I think we did a good job of controlling our inventory carrying costs. And the -- we did a better job than the numbers reflect because of the way manufacturers, in effect, advance-shipped us orders in the fourth quarter, stuffed the channel to a certain extent, and our inventory balances look worse than they would look if the inventory had been delivered based on the schedule that was originally presented to us by the manufacturers.

So overall, we think we did a pretty good job controlling SG&A expenses in the quarter, considering the environment and the fact that strategically as we mentioned, we're going to continue to protect market share. That's the long-term source of growth in our business. Selling those cars so that they come back to our service and parts business, and benefit us two, three, four, five years from now. So we're not going to focus on SG&A expense today at the expense of our profitability in the future.

Jeff, do you have any comments to that?

I think that was well said and I certainly concur with Theo's assessment.

I will just add that while I think that our SG&A as a percentage of gross profit will look similar in the first quarter because of some of the components that Theo mentioned, I think that we'll be able to show marked improvement as we head into the second quarter and I think, obviously, part of that is seasonal but, in addition, some of the aggressive cost-cutting that we described in our prepared comments will be fully executed and will be able to capture the benefits of those reductions.

And I'd also just mention, as Theo pointed out, that it does require a real balancing act to analyze the reduction of head count, and the way that we do that is we focus on the number of productive employees, those who generate revenue, versus the number of support employees. And we have ratios and benchmarks that we track, and our emphasis will be on reducing nonproductive headcount. Those are support people. We will work hard to preserve and even grow our productive workforce, which includes new and used vehicle sales personnel, and service technicians.

Great. One additional question regarding your capital structure. I was just wondering, Theo, outlined a lot of , you know, high-returning potential investments, be it the stock repurchases or acquisitions. I was just -- to what extent are you comfortable increasing your leverage to take advantage of some of those opportunities?

Nate, our past practice is that we are comfortable for a short period of time increasing our leverage modestly from current levels. We've never been above 55% debt to total capital, and I think it would be our objective to stay below that level. If we saw an attractive acquisition opportunity, our leverage might increase modestly over a short period of time, but then we would use cash generated from operations to reduce leverage back to our target or below our target of 50% debt to total capital.

If you look at our debt to total capital over the last several years, you'll see that when we complete large acquisitions, like First America or Massey, our debt to total capital sneaks up to over 50% and then within a quarter or so, we're back in line with our targets. But we're not going to veer in any material way from our long-held target of 50% debt to total capital.

Conversely, I would say that we're not seeking to dramatically reduce our leverage because we are generating substantial amounts of cash, even in challenging times, and the potential returns from acquisitions and other uses of capital are so attractive that we don't think that we should forego those opportunities in order to reduce leverage at this point.

Great. And then one last detail question. Do you have handy the total revenues that you acquired during the year, and what the cash paid was for those acquisitions?

Nate, why don't we get back to you with some detail, but just to give you some color on the impact of acquisitions, if you take the full-year results, same-store revenues represented 20 -- I'm sorry, 74% of the total revenues for the year, and for the -- I'm sorry. That's for the quarter. Same-store was 74%. And for the year, 78%.

So our revenues for the year, included a significant element of revenues acquired and we'll get back to you with a more detailed breakdown of the revenues acquired.

Great. Thanks very much.

Thank you.

If I could -- before the next question -- be sure we get an answer -- an answer to the question asked about bond repurchases, our average price of the 11's year-to-date for 2003 was 103. The average price of the converts was 75.

Operator Your next question comes from Jeff Minepet (ph).

Theo, it's Peter Schwartzman.

Hey, Peter.

How are you guys doing?

Conceptually, with all the boom in new cars, and when those cars come off lease, does it -- and given that used cars are higher-margin, gross margin, than new cars, is it going to create kind of a -- like a -- for lack of a better word, kind of a boom or a -- provided the relationship doesn't get more favorable to new cars, what would create, I guess, kind of a boom of used car buying at some point? Because you'll have all these off-lease cars coming that are in pretty good shape that will maybe qualify for the pre-owned program? Is that a way to look at it or --

Peter, I don't believe that in the near future, we're going to see a boom in used car sales. First off, leasing as a percentage of consumer financing has been declining over the last several years, and beginning -

Okay.

-- late in this year, the number of vehicles being returned by consumers off lease will start to decline.

Okay.

And then beginning next year, will start to decline more rapidly. And we've seen a significant shift. Leasing has gone from, in round numbers, around 30% to high teens penetration for the market overall. So the supply of off-lease vehicles is actually beginning to diminish and, again, a substantial number of used car purchasers are used car purchasers because they don't qualify for new car purchases.

Okay.

So with the trends we're seeing in the financing arena, we don't anticipate a boom in used cars.

What is happening, though, which will provide a floor to used car sales is that wholesale prices are declining to a point where used cars begin to represent such a compelling value that they'll begin to attract additional demand. If you look at the Mannheim (ph) index, used car values declined about 6% from a year ago, so comparably equipped vehicles in the used market are cheaper, may continue to get cheaper, and at some point that creates a compelling value for consumers who will then seek to buy a car in the used car market.

So if we were to look at the long-term trends in your new versus used sales mix, it's probably going to be stable or might even favor more used cars going forward?

Yeah, I would say that our expectation built into our forecast is, as a percentage, used car sales will decline slightly over the next year, but stabilizing over the course of the year. And that as we emphasize -- as our brand mix changes and as we emphasize certified pre-owned sales more over time, that used cars may take a larger share of our total sales.

All right. And then just a quick follow-on. Are there other comments on the leverage? When you used -- you used debt to cap as your -- as your bogey for the optimal leverage. You also -- you know, and you report in the press release, obviously, debt to EBITDA. Do you use that? Would it be fair to say you're operating at your optimal debt to EBITDA level right now, absent the very opportunistic big acquisition? Is that a way to characterize it?

If you look at it on a debt to EBITDA basis, we've actually improved over time, and I think that that's in line with our optimal level, and if you look at our interest coverage, it's above -- considerably above what we had previously considered optimal, and that is, in our view, the -- simply the result of a more favorable rate environment.

Sure.

And so we're not seeking to increase our leverage at this point just because coverage ratios have improved somewhat. So we're really focused more on the balance sheet aspects and not so much the coverage.

I see. Good. Well, I appreciate it, guys. Thanks.

Thank you, Peter.

Your next question comes from Adam Camora (ph).

Hi, guys.

Hey.

Hey.

A couple of quick questions. The first is, how should we think about the business model in terms of accretion from acquisitions? In other words, if you guys make 500 million of acquisitions at the average, you know, 4-and-a-half times EBITDA, what kind of accretion do you guys usually see from those -- from that type of acquisition level?

Adam, a simple rule of thumb would be kind of for every hundred million in revenues acquired, three cents per share.

The problem with giving more precise guidance is that sometimes we'll buy dealerships where we anticipate it will take a period of time to turn around an operation or relocate an operation, so at a four times EBITDA multiple, you might even do better than that, but kind of a good short hand is to say three cents a share for every hundred million acquired, based on our past experience.

All right. Terrific. That's helpful. The second is, how does the F&I per quarter break down, and do you guys include service contracts in that number?

We include service contracts in that number. So finance is included as well as insurance products, which would include, in our view, extended warranties, gap type insurance, and other products. So those are all included in finance and insurance. About 50% of our total revenues in finance and insurance are from financing activities, with the remainder from more insurance-type products. And I would point out that the per unit finance and insurance for used cars and new cars for the quarter differed only by $4 a car. So finance and insurance does not differ materially between new and used, in our dealerships.

All right. Terrific. Thanks a lot.

Thank you, Adam.

Your next question comes from Scott Stember (ph).

Good afternoon, guys.

Hey.

What was the F&I per unit, actually, for the quarter versus last year?

For the quarter -- 2001, 856. 2002, 866. But on a same-store basis, we went from 835 to 890.

All right. 890 on a same-store. Okay.

And, Theo, do you have the operating cash flow for the year '02, including working capital changes?

Yes, we do. It was $136 million, approximately. I'm sorry, 139 million. So we generated significant cash from working capital, which is what you'd expect with our disciplined management of inventory and declines in same-store sales, particularly in used cars.

And in that number, you're netting the net of capital expenditures of 20 million?

No. That's a GAAP definition of cash flows provided by operating activities.

Okay.

And you would subtract from that capital expenditures, acquisition activity, et cetera.

Okay. And could you just touch on northern California, how everything is working over there?

Northern California is doing quite well. In fact, believe it or not, relatively speaking, it was one of our stronger markets.

We have some data here where we compared the year 2000 pre-bubble to the full-year 2002, and I think that it's really interesting data. Total revenues declined 21%, and we had a same-store sales decline of new vehicles of 22-and-a-half percent and used vehicles 29%. Our service and parts revenues were actually up for that time period 6%. And profit contribution from those dealerships on a same-store basis declined 17%. So we actually saw a better performance in terms of profitability than we saw in sales with a very significant deadline in sales over a multiple-year period. This is 20 stores, lots of different brands, and I think is a fair indication of what a severe and protracted downturn would look like.

In this case, you do see the benefit, though, of managing to a more stable lower rate of sales. What you don't see is that adjustment period that we have to go through when we have to adjust head counts, inventories, et cetera, to conform to a lower sales rate environment.

Okay. And as far as maybe just the acquisition climate once again, on which side, domestic versus import, pre-Massey you guys were more weighted towards the import side of the business. Obviously it sounds like you guys are starting to move back towards -- towards that. Can you just comment on what the end game is here, where you guys would like to be, barring another very, very large acquisition that you might make?

I think you're going to see the trend continue, and I would tell you we don't really view Cadillac in the same category as the volume domestic brands. Its operating characteristics -- the operating characteristics of those dealerships are consistent with our luxury brand dealerships, so we don't lump Cadillac, for internal purposes, in with the domestics. So if you consider Cadillac as a luxury brand, which we do, you're going to continue to see emphasis on luxury brands. You're going to continue to see a shift away from Ford, Chrysler, Jeep, and Dodge, and to a lesser extent, Chevrolet. We've seen a very significant decline in performance between our Chevrolet dealerships and our Ford and Chrysler/Jeep dealerships over the last year. So we're somewhat more optimistic, I would say, about Chevrolet, although that's not reflected in February's sales numbers for that brand.

Okay. That's all I have. Thanks, guys.

Thank you.

Your next question comes from Jerry Mark (ph).

Hi, Theo.

Hey, Jerry.

Just a quick question. Or two quick questions. Could you repeat for me those return on invested capitals that you achieved for doing acquisitions versus bond buybacks and those type of numbers?

Yeah. Hang on one second. I got to get to the right file.

Okay.

And these are implied after-tax returns and some -- because you -- for share repurchases, that's not really how it works. But paying down revolver 2-and-a-half percent, repurchase bonds, 6%, purchase dealerships at five times EBITDA 12%, purchase dealerships at four times EBITDA 15%, repurchase stock at $18 share price, 15%, repurchase stock at a $15 share price, 18%.

Okay. So I mean if I were to kind of run the -- like a mean or mediate return of that, you know, four times or five times dealership, that would kind of get me down to that 3 cents per every hundred million? Does it kind of work that way or ...

I think if you -- to get to the three cents, that those returns would be somewhat more like the five times EBITDA range.

Five times, okay. And then just lastly, I know you mentioned Charlotte was kind of tough. I understand there's been some changes with Blue Oval where all of the North Carolina dealerships are no longer receiving those payments.

That has both benefited and helped us, potentially. One store we have in the Charlotte market is in North Carolina. Another is in South Carolina. So although it's in the Charlotte metro market, one of our Ford stores here is in South Carolina, and has, in effect, a competitive advantage potentially. But those Blue Oval incentives are just a form of pricing adjustment, and we negotiate the price, we're competing against dealers other than our own that are in the same state that have the same issues, so long-term, we don't anticipate the changes in Blue Oval payments to have a significant impact on our profitability in the Charlotte region.

Okay. Thanks.

Thank you.

At this time, I would like to remind everyone if you would like to ask a question, press star, then the number 1, on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

At this time, there are no further questions.

Mr. Wright, are there any closing remarks?

Thanks, everyone, for listening to our conference call. Thank you.

Thank you very much.

This concludes today's Sonic Automotive fourth-quarter and fiscal year-end conference call. You may now all disconnect.