Sonic Automotive Inc (SAH) 2003 Q1 法說會逐字稿

Good afternoon, and welcome to the Sonic Automotive first quarter 2003 earnings conference call. All lines are 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-2. If you need assistance at any time during the call, press star-0 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 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 company's filing with the Securities & Exchange Commission. Thank you.

I would now like to introduce Mr. Theodore Wright, president of Sonic Automotive. You may begin your conference.

Good morning, and welcome to Sonic Automotive's first quarter 2003 conference call. I'm Theo Wright, the company's president. Joining me are Scott Smith, the company's vice-chairman and chief strategic officer and Jeff Rachor, the Chief Operating Officer. Also is Lee Wyatt, and recent addition as Chief Financial Officer. I'll cover financial highlights and discussion of our growth strategies and then turn the call over to Mr. Rachor for comments on our operations.

Earnings per share from continuing operations were 43 cents in Q1, 2003, compared to 55 cents in Q1, 2002. Earnings per share before cumulative effect change in accounting were 42 cents this year, compared to 52 cents a year ago. For the quarter, the company recorded a cumulative effect of a change in accounting of $5.6 million, or 14 cents per share. The cumulative effect adjustment was required based on recently issued guidance from the emerging issues task force of the financial accountings board. This guidance effected how we account for nonrefundable cash payments for the company for floor plan and advertising assistance for advertisers. This adjustment is not expected to have a significant impact on future results of operations.

Our tax rate for quarter was 36.9%, we expect a similar tax rate for remained earth of the year, we are benefiting from a number of state tax planning. Diluted share counts were 41,750,000. We expect share counts in Q2 and Q4 to decline modestly, assuming no significant increase in share price, which would cause option delusion to increase. We have reacquired 567,000 shares year to date at an average price of $15.13, and have 30 million remaining under our authorization. We continue to execute share repurchases at times when we believe pricing is favorable in relation to alternative uses of capital.

Non-floor plan interest cost declined 7% or 750,000 from fourth quarter due to lower variable rates and moderately high erection exposure to higher rates. A 100 basis point increase in interest rate would reduce quarterly earnings two cents per share. We are forecasting no increase in interest rates in the remainder of 2003.

Our strongest regions for the quarter were Alabama, Tennessee, Florida, Georgia and South Carolina, San Diego and California and Las Vegas. Our weakest regions were Dallas, Houston, Oklahoma, Columbus, Ohio and Charlotte. The central part of the country was particularly weak and this element of the business represents approximately 25% of our total revenues.

Our strongest brands were Hyundai, Infinity, Lexus,, BMW, Mercedes and Volvo. Notably among these, Honda, our largest brand had a particularly strong performance in the quarter.

Our weakest brands were Ford, Chevrolet and Dodge Chrysler Jeep. Unfortunately, our exposure to these brands is greatest in Texas and Oklahoma, these brands have also been disproportionately affected by weakness in used car consumer financing.

Turning to balance sheet debt to total capital 50.8% and net debt to total capital was 49.9%, in line with our targets. Cash and available amounts under our credit line were approximately $170 million, combined with cash flows we expect from operations, we have sufficient capital to execute our strategies.

Debt maturities now average 4.4 years and we have no financing requirements prior to late 2006. Total capital expenditures for the quarter were $18 million, with $7 million of this total not expected to be refunded with future sales or sale leasebacks. We've expect full year capital expenditures not ultimately refunded to total $20 million consistent with our previous guidance.

We revised our earnings targets for the full year from 245 to 270. We revised targets to reflect first quarter results, continued uncertainty about levels of consumer demand, particularly in used cars, and reductions in our assumption of same-store service and parts growth. Our targets are based on new vehicle, same-store sales declines of 5% or a [SAR] of approximately $16 million.

Used vehicles down 8% on same-store basis. Service and parts sales up 1 to 2%, reduction in growth from our earlier guidance. Insurance per unit unchanged, no share repurchases, acquisitions or divestures beyond those announced today.

Looking forward we were pleased to see the consumer confidence rebound in late March and April. We've long held consumer confidence in new vehicle trends are correlated and believe this correlation was demonstrated in Q1 and early in Q2 of this year. Our results improved dramatically in March compared to January and February, and we expect positive performance trends to continue into April.

Sales volume seasonally adjusted for April appears similar to March and we expect the SAR to exceed 16 million units. Used vehicle trends improved markedly over the course of the quarter as well. We continue to pursue acquisitions and have an active pipeline. Much of our activity is in existing markets as acquisitions we announced today demonstrate. However, we continue to evaluate transactions in new markets as well, and are comfortable we will easily a achieve the targets we have stated for full year 2003 acquisition activity of $500 million in acquired revenue, with $170 million announced to date.

Related to acquisition strategy, we continue to believe growth opportunities are tremendous. Automotive retail market remains largely unconsolidated. We will focus on long-term growth in driving our strategy based on view that growth opportunities will continue for many years. We are developing meaningful economies of scale as we expand, it's worth noting all the large consolidatetors, both public and private, have results that dramatically out outperform industry averages.

Technology is an area we are seeing increasing economies of scale and opportunities to gain competitive advantage. Many of our tools are not available to individual dealers, and we are expanding our use of technology cost effectively because of our scale. Jeff will have further comments in this area.

Because of our commitment to long-term growth and our relations with manufacturers, we are defending market share. Particularly with those brands we want to grow with and particularly in markets where objective data indicates we have opportunities to take market share. This aggressiveness about did impact gross and net margins with we performed well in new vehicle sales in the industry and you take out impact of fleet. Especially considering some of the under performing markets, northern California, Houston, Dallas, Denver, et cetera, that we operate in. We also believe in the long-term selling cars is the key to the service and parts business and we may have to periodically sacrifice short-term margins for long-term growth and profitability.

We also continue to invest in facilities, trading the capacity to support further growth. This investment has caused our fixed expenses for facilities to increase, but we believe over the long-term these investments will support our growth and help ensure the manufacturers' support of our growth strategies.

The third quarter of 2000 was the last quarter of sustained positive trends in industry new vehicle sales. We are entering our third year of declines in new vehicle sales for the industry and the first quarter of 2003 was the most difficult quarter in our history as a public company. I think it's worth taking a minute to review where we, Sonic in the industry were right and where we wouldn't we weren't in automotive detailing in a down cycle. We were right about the non-cyclical nature of the service and parts. Our company in the sector performed well in service and parts with growing profitability through the down cycle. Dealers collectively are taking market share despite improving product quality. We are finding additional tools to take market share with certified preowned extended warrants, maintenance arrange arrangements, et cetera.

We were wrong about new vehicle sales. These sales have proven to be less volatile than we expected, in my opinion the impact of consumer leasing has been underestimated. We have underestimated the challenge in managing new vehicle inventory and have had to invest in improving our systems and we've had to become more aggressive. We can manage well but the manufacturers, particularly domestic manufacturers, distribution systems create impediment to managing inventories as quickly as we would like. With the investment and technology in processes, we dramatically outperform the industry in most of our peers, in this area.

We were wrong about used vehicle volatility. We experienced a consumer credit bubble in the used car financing area, unlike in any previous cycles. We have responded to this bubble, but this is the greatest area of uncertainty. Fortunately, used cars are an opportunity for Sonic as they have not been significant contributors to our overall profitability. For Sonic, improving used car trends represent an opportunity to improve both profitability and margins.

We were right about the variability and controllability of costs but yupd estimated the time necessary for adjustment of personnel costs. We are taking more aggressive actions to ensure selling and other expenses are in line and Mr. Rachor will comment further.

Most importantly, we were right about the ability to grow in down cycles as we have for the last several years. The industry has proven its business model overall, and has outperformed most sectors of the economy. The long-term opportunity has proven to be as represented, and as we have effectively executed acquisition, grown our portfolio and addressed the many challenges presented by the market. Our group continues to grow. Our pipeline is full, and we see incredible opportunities for our future.

With those comments, I'll turn it over to Mr. Rachor. Jeff?

Thank you, Theo. Today I'll be covering same-store sales, SG&A, inventory status, and key operating initiatives.

Despite the handicaps of geography and weather, same-store sales were solid in every business segment. First, new vehicle same-store sales were down 4.9%, versus first quarter 2002, which outperformed industry retail trends of a 6% decline. Used vehicle same-store sales were down 12.6%, versus first quarter 2002, which compares favorably to the fourth quarter decline of 17.1% when company management made their strategic decision to adjust used vehicle inventories downward to mitigate wholesale pricing risk.

The used car performance shows even stronger improvement trends when analyzed sequentially by month during the quarter. January used vehicle same-store sales were down 17.8%, February used vehicle same-store sales improved to a 9.8% decline. March used vehicle same-store sales improved again to a 7.6% decline. This also reflects a conscious effort to ramp up used vehicle inventories to prepare for the seasonally stronger selling months.

First quarter same-store sales and service were up 2.56 %, versus Q1 2002 driven by strong customer paid labor growth, which represented 63% of the total increase. This is impressive considering key Sonic markets lost several business days due to closing temporarily as a result of inclement weather.

Same-store parts sales declined 2.52 %, versus Q1 2002 also impacted by weather. However, after adjusting for a significant decline in wholesale business, at Lone Star Ford in Houston, Texas, resulting from Ford Motor Company's decision to open a local parts depo there, total parts sales would be up for the quarter.

Next, SG&A. SG&A expense increased as a percentage of gross profit from 74.2%, in first quarter 2002, to 78.6% in first quarter 2003. Total compensation expense increased from 44.8 % of gross profit in first quarter 2002, to 45.5% in first quarter 2003. This trend reflects the transition period of adjusting our variable personnel model to a more moderate sales rate.

Accordingly, in the first quarter, Sonic senior management directed our field team to aggressively adjust headcount to reflect realistic sales expectations. This employee productivity initiative is complete and the results are compelling. A total of 784 positions have been eliminated since the beginning of the first quarter, representing a 7.5% reduction in total work force. 553 positions, or over 70% of the total reduction, are nonproductive positions, which do not directly generate revenue. This includes dealership-level managerial, support, clerical, as well as regional personnel. These adjustments bring our ratio of productive to support employees to 65.3%, representative of industry leading benchmarks. The full benefit of these reductions will be realized effective may 1, 2003.

Furthermore, management has ordered a company wide hiring freeze for non-productive employees, requiring senior management approval to add an incremental support employee. Finally, this significant restructuring has been completed without taking any one-time charges.

Next, asset management. New vehicle inventories remained stable at 64-day supply, with just 2% over 180 days old, looking ahead to the strongest seasonal selling quarter. Luxury, including Cadillac, and import inventories, are at benchmark turn rates, while Chrysler, Ford and Chevrolet inventories are higher than our standard.

Used vehicle inventories continue to confirm disciplined management at a 39-day supply. Used vehicle aging has improved markedly with our increase sales rate with less than 5% of our total inventory over 60 days old in first quarter 2003, and most of these units are certified pre-owned inventory in our luxury stores. Wholesale losses for the quarter, decreased 63% compared to the previous quarter. Finally, parts inventories remained tight at a 49-day supply.

Sonic Automotive continues to execute operating initiatives that directly support our strategic conviction of increasing same-store sales and taking market share. The following initiatives are targeted at enhancing revenue and long-term growth. In February, we launched an initiative to build on the company's momentum in manufacturers' certified programs. I'm pleased to report a 34.5% increase in certified pre-owned sales for the quarter versus Q1 2002. This increase is on top of the 88% increase that Sonic posted for the full calendar year of 2002. In the first quarter first quarter 2003, certified repro and r owned sales represented 22.2% of Sonic's total used vehicle sales, compared to 14.6% in 2002, contributing to the quarter's positive used vehicle sales trend.

Certified pre-owned sales continued to enjoy higher gross profit per unit than conventional used car sales, averaging $263 per unit higher than conventional transactions in the first quarter. More importantly, the extended factory warranty, included in manufacturers' certified pre-owned programs, create a long-term bond between the customer and Sonic service departments, serving as an annuity of guaranteed of service and parts income.

Other revenue enhancing catalysts under way are increased focus on extended service agreement penetration. Already up 7%, for the first quarter 2003, versus a year ago. Extended service agreements offer great value for consumers while creating that customer for life service and parts annuity.

Standardization of the sales process remains the highest priority. In the first quarter, we successfully implemented a common show room accountability process and reporting capability, reinforcing best show room practices. Over the next two quarters, all Sonic dealerships will be operational with a common customer relationship management technology, which will be totally integrated with conventional sales processes.

Finally, all of the above initiatives will be reinforced in standardized training modules developed and implemented by our in-house training resources through Sonic University and Sonic dealer academy.

A quick note on acquisition integration and Sonic same-store sales effectiveness. Our portfolio of Cadillac dealerships, including the Massey acquisition, produced total net profit increase of 14.9% for the first quarter 2003, versus the first quarter of 2002. In addition, total Cadillac retail sales for Sonic were up 10.5% for Q1 2003 versus first quarter 2002, keeping pace with Cadillac's national retail sales growth.

In fact, in March, Sonic represented 6.6% of Cadillac's national sales volume, compared to 5.3% for the full calendar year 2002. Sonic's highest Cadillac market share, since acquiring the Massey dealerships. This performance validates Sonic's integration capabilities and same-store sales execution in a difficult industry environment.

In closing, Sonic Automotive's management will continue to focus on improving operating results in our under performing dealerships, while bringing unprecedented intensity to our long-term growth strategy of maximizing sales and local market share, driving the high margin less cyclical fixed operation business segments.

That concludes our prepared comments, and at this time management will be glad to entertain questions.

At this time I would like to remind everyone, if you would like to ask a question, simply press star -1 on your telephone keypad. Again, in order to ask a question, please press star-1 on your telephone keypad. We'll pause to compile the Q & A roster.

Your first question comes from the line of Scott Stember (ph) of Sidoti and Company.

Good afternoon, or good morning guys. Can you talk about the warranty situation, some of your competitors have talked about domestic warranty claims coming down. Can you talk about how that's impacted the same-store numbers in recent quarters and also on the service and parts, any initiatives going in place to try to stimulate that area?

Let me cover -- Scott, this is Theo. Let me cover first the same-store trends by brand, which I think will indicate some of the differential and warranty experience. Particularly in the case of Ford, where there were a number of recalls, our same store parts and service decline there was 12.6%, and that really had a dramatic impact on our overall results and I think that's directly a reflection of improving quality and fewer recalls. If you look at our domestic versus import brands, you'll see an increase in same-store sales on -- in the import lines and a decrease in the domestic lines, not including Cadillac. But overall, our warranty continued to grow with same-store warranty sales up 3.84%, as a total of our business.

As Jeff mentioned in his comments, one location's wholesale parts business had a significant impact on our overall same-store performance, and that parts business is a low gross margin, low net margin business, and our same-store gross profit contribution from service and parts was actually up nearly 2%, so overall a good job. And then in terms of growth, I think the initiatives that you heard on certified pre-owned and extended service contracts, are the main drivers of future growth there.

Okay, can you talk about what you guys did per vehicle and maybe break it out between new and used.

Okay. F&I, per vehicle, on an historical basis, overall, was 898 versus 888 a year ago, an increase of 1.2% per vehicle. Per unit, new, 914, used 868.

Okay. And also, maybe just talk about the balance sheet a little. How you guys are prepared from available costs versus fixed costs standpoint in the term short-term rates start coming up.

Scott, could you clarify that --

Just op the balance sheet. What percentage of your debt at this point is variable versus fixed?

73% is fixed, 27% is variable. And as we mentioned in our comments, we believe a 100 basis point increase in interest rates would cost us approximately 2 cents per share per quarter.

All right. That's all I have. Thanks.

Your next question comes from the line of Azerien Dell (ph) of CIBC World Markets.

I have a few things. First of all, I was wondering what the location was of your disposed dealerships. Did you sell them in the under performing regions?

To be honest, actually, no, those were two under performing dealerships that were not in under performing regions. One was in Las Vegas and the other was on the West coast of Florida.

Okay. And do you have any plans for future dispositions in the second quarter or in '03 in general?

We do. We have a number of divestures that are under contract, expected to close in the second quarter. There are, one, two, three, four divestures expected to close in the second quarter of this year, several more that we're evaluating beyond that time period.

Okay, great. And can you discuss the purchase price for the first quarter acquisitions?

The first quarter acquisitions purchase price is in line with our previously indicated guidance that we expect to earn a return on investment after tax, 15% on those acquisitions once fully integrated. In the case of the acquisition that is we've announced year to date, all of those acquisitions are acquisitions of under performing dealerships and collectively we were they were not generating significant profits.

Okay. And I'm not sure if I missed it. Did you go over your same-store F&I figure? I know you went through the vehicle and sales and parts, but I think I might have missed the F&I number.

On a same-store basis we went from 882 a year ago to 912 this year.

Okay, great. And lastly, can you go over your sales mix in terms of domestics versus imports and luxury?

The sales mix is detailed in the press release by brand.

All right, great. Thank you.

Thank you.

Your next question comes from the line of Michael Milman (ph) of Salomon Smith Barney.

Thank you. I didn't quite get the same-store sale numbers on new and used, but it did sound like they varied kind of in line with what the market looked like, and I was kind of curious about -- and maybe you can give more color about your comment that -- what you found out about the business, at least in this environment, was that new and used car sales were much less volatile than you would than you had expected. And maybe you can also give us a little bit of guidance regarding the current quarter, the second quarter, I think you had said that April was looking good, if I heard you correctly.

Let me start at the end of your question. We're no longer providing quarterly guidance, but would agree with your statement that thus far adjusted for normal seasonality, April does look reasonably good.

In terms of our relative performance when compared to the industry, it's hard to get accurate information about industry performance by market on a timely basis. But if you take out the impact of fleet sales, since we're not major participants in fleet sales, where you can get access to that information and you consider the relative performance in our markets, we think we collectively out outperform the industry in new vehicle sales. Wouldn't make the same assertion about used vehicle sales, but it's much more difficult to get accurate data about used vehicle sales.

And in terms of our view of the volatility of sales in a cycle, I think our observation is that new vehicle sales have been less volatile than we expected, and this cycle -- in this cycle and less volatile than many expect expected, but the used vehicles have been more volatile than would be typical in a down cycle, and our view is that volatility is related to what I think can be described as a consumer financing bubble in used vehicle financing, particularly sub-prime financing of used vehicle purchases.

Thank you.

Your next question comes from Rick Nelson of Stephens.

Thank you, good morning.

Good morning, Rick.

Question about inventories and operate operating expenses. The inventory side, I'm wondering where you're heavy and how does that happen, and how do you correct -- we hear a lot about manufacturer channel stuffing and how do you reduce inventories yet gain the for support of the manufacturers?

Rick, this is Jeff Rachor, I'd be glad to take that question. As I noted in my prepared comments, where we're heavy is clearly in the domestic brands. Presently, those brands were carrying about a 77- day supply, our luxury brands, are at a 31-day supply, and our imports are at a 46-day supply. We're the heaviest with Ford, where there was some aggressive distribution at the wholesale level from Ford, late in the fourth quarter, that has continued to be a challenge. In addition with Ford, they are building out the F-150 model in preparation for the launch of the new model later this year, which is an abnormal phenomena that has caused to us carry higher than normal levels of inventories. And with both Ford, Chrysler, and General Motors excluding Cadillac, those are, as Theo pointed out, the brands where we have not realized the same improvement trends in sales, as we have with some of the luxury and import brands, and part of that is geographic, as our highest concentration of those brands are located in geographic regions where the market is off materially compared to the overall industry average.

In terms of what we do to manage those inventories, we're confident that with the stronger selling season ahead and the recent up ticks in consumer confidence, that we will see positive trends over the next few months. That, and reducing our orders in the pipeline, should enable to us manage those inventories to our traditional standards by the beginning of the next quarterly quarter, and we do work with the manufacturers, we do clearly have the ability to turn down orders. It is more challenging, as Theo open pointed out, with the domestic manufacturers, because they have a longer lead-time from when the order is placed, to when the order is actually shipped and delivered to the dealership.

Jeff, you have to incur higher advertising or SG&A to move that product, or are you just wait for the incentives to work their course?

Well, when we do have an oversupply situation, which we've en cowrnlted over really the last two quarters, it does impact SG&A, in the form of margin compression, which obviously reflects as a higher percent in terms of SG&A as a percentage of gross profit. But we also need to put additional incentives in place for sales people and managers to try and motivate them to move that oversupply of inventory and it does result in some conscious over investment of marketing dollars, although I think if you'll notice that we did maintain overall excellent control of advertising expenses for the quarter.

Follow on to that. On operating expense line, we did see a big widening SG&A as a percent of gross profit and as a percent of revenue. The programs that you discussed, how many dollars -- SG&A dollars are we talking about, and when would you expect those ratios to come in line with your sales expectation?

Well, Rick, again, the dollars associated with the total positions eliminated, including benefits, approached an annual savings of just over $30 million. However, I would direct you to focus on the nonproductive reductions, which would represent a total of about $21 million of that $30 million. Those are the reduction dollars that we expect to stick, because again, these are positions that are in the areas of management support, et cetera, where some of the nonproductive -- excuse me, the productive positions that is we eliminated, will be added back as we go forward. So again, we've adjusted our personnel model to the more moderate sales environment. As I noted in my prepared comments, the full benefit of that will be realized from May 1st forward, and that really reflects adjustments that were necessary to achieve our forecasted performance in this more moderate sales environment.

Thanks a lot.

Rick, this is Theo. Just to follow on. If you look at advertising expenses, as percentage of gross, one of the expenses that we can adjust more quickly, we were right in line there, we do have some increases in facility rent expense and related expense, which I mentioned. Those will not be adjusted down ward. We're going to have to wait for sales levels to return to stronger levels in order to get those expenses in line as a percentage of gross. But in the area of personnel expense, we think by the end of next quarter we will be in line with our historical norms or more in line with our historical norms for control of those personnel expenses.

I know you're not providing quarterly guidance, but the SG&A pressures are likely going to continue into the second quarter. Is that fair to assume? And that unfavorable EPS comparison is likely to continue, albeit less than what we saw in the first quarter?

Yeah, I think certainly less than what we saw in the first quarter. And much less, because of the action that is we've taken in this area, we also have grown revenues through acquisition, so we should see receive the positive benefits of that. Share count trending down, other interest costs trending down. Floor plan interest costs will be trending down as well so. There are a number of positive factors that will affect our results, not just in SG&A, but elsewhere. So we're anticipating a much stronger relative performance in the second quarter than in the first quarter. And I would direct you back to the relationship between first quarter 2001 and second quarter 2001, as an indication of what happens to our results of operations in a similar environment.

But then by the end of the second quarter you should have inventories and operating expenses screwed down in the third quarter?

Yeah, in terms of inventories, we are at 65 days new vehicle supply versus 64 days a year ago, so really other than a couple of brand -specific issues, our inventories are in pretty good shape. It won't even take us till the end of the quarter really to have those in line.

And inventory balances, which are what drives floor plan interests, are down, as well as we changed a number of our floor plan interest providers first quarter, which is going to have a beneficial impact on rates. So we're going to see those benefits within the second quarter, not have to wait until the end of the quarter.

Great, thank you.

Thank you, Rick.

Your next question comes from Jerry Marks of Raymond James.

Hi, Theo.

Hey, Jerry.

Just a couple quick questions. You mentioned proprietary technology, but could you give a little detail in terms of what that involves?

Proprietary technology, don't think we necessarily said it that way. I think --

or systems

Systems that the individual dealer can acquire. A couple of specific examples are we have a company wide payroll and human resources system that in financial terms is beyond the capability of an individual dealer to acquire. We have an inventory management tool, data warehouse that enables us to evaluate our inventories and sales performance in both new and used vehicles that is not available to individual dealers, that gives us modeling capabilities where we're taking advantage of particularly in the used vehicle arena. An integrated CRM system that allows us to compare performance across dealerships and across regions is another example. In many cases, these systems are beyond -- even if they are available, are beyond the financial resources of an individual dealer.

Okay. Regarding the -- your kind of personnel expense per unit, is really -- I don't know if you guys look at it that way but it's shot up to 2700. I understand you've been talking about -- you're taking out head counts, but some of your competitors have been talking about changing some of the compensation schemes. It almost sounds like you guys are going the reverse way. You've been [incentivising] them more to sell more vehicles. Is that a correct assessment?

This is Jeff Rachor, I'd be glad to take that question. We have long had compensation schemes that reflect a high degree of variability, and by no pleens we moving to higher levels of fixed compensation. We have invested some, what I would characterize as promotional dollars in order to move these higher levels of inventories over what has been a difficult quarter in terms of sales environment. And we'll see some of that continue over the next quarter, but after that it should normalize and in terms of our overall compensation philosophy, we have always subscribed to at a time highest degree of variability, most of our sales people are on 100% commission, as are obviously technicians, in terms of our management ranks, they all have a very, very small salary or guaranteed compensation component. With a much larger piece of their compensation derived from a performance-based bonus or commission. So we believe that as we go forward and sales trends stabilize, that we'll be able to achieve the same level of variability that you refer to seeing elsewhere in the sector.

Okay. And then finally, I don't know if Jeff or Theo would be good to answer this question, but you know, there's been a lot of talk about inventories. Obviously, that's a difficult thing to manage particularly on the domestic side. Do you guys forecast, I mean I know you report on an historic date supply basis, but do you base your ordering systems on kind of a forward SAR and day supply number or do you try to order by district and those types of issues?

We do base the day supply data that we communicate to you looking backwards. But in terms of preparing our future orders, we do that based off a disciplined realistic forecasting model that we use, and we do that by model, so we forecast sales individually, by model and we manage our inventories by model with discipline, and so in terms -- we try to take into account obviously industry trends in the SAR when we're preparing those forecasts.

And in terms of managing inventories on a geographical basis, one thing that we have done now for some time is look at our inventories across the enterprise by brand, and when it is logistically feasible within a geographic region, we have the ability to move inventories from one dealership, which may be oversupplied in a particular model, to a like brand dealership that may have an under undersupply or more demand for that particular model, and we see that as a competitive advantage associated with our scale.

This is Theo. The manufactures' distribution systems do not provide for ordering vehicles at an enterprise or regional level. Their distribution systems are based on individual dealerships and that's really how we have to interact with the distribution systems as they exist today. But we do re allocate units among like-branded dealerships. Generally speaking that's within a region, but we have on occasion put cars on a truck and sent them several hundred miles away to other dealerships. That's not ordinarily a cost-effective decision, however.

Right. So, I mean, I guess some people are trying to -- so you guys don't have a situation where you have maybe a bunch of the stores within your district talk to your district head every month and everybody kind of decide together, even though technically you have to order by store individually that you're kind of ordering collect alternative as a group. You don't do that?

Yes we do have that scenario in a number of districts where we have multiple like-brand dealerships. Our regional vice president and even divisional people will facilitate communication, amongst those like-brand dealerships and make overall strategic ordering decisions based on the needs of the entire group of dealerships within a region, rather than a single dealership's needs.

Okay, thanks.

At this time I would like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone keypad. Your next question comes from the line of Nate Hudson, of Bank of America Securities.

Hey, good morning.

Good morning.

I wonder if you could focus on what you're seeing in your luxury brands and in particular have you seen any weakness in gross margins there and how the used vehicle comps and the parts service comps compare to the rest of the business.

I'd like to comment quickly on margins. We have seen some margin compression in our luxury group, particularly in the BMW line, and that is being driven strictly by supply and demand, historically BMW day supply has always been unable to keep up with the demand, over the last several months, BMW has accelerated production in shipments and to give you an example, March in '02, we had a 22-day supply of BMWs as we ended the quarter. We ended the quarter this year with a 56-day supply of BMW product so that phenomena has had an impact on margins. We do expect with a production cycle, that those inventories are going to continue to come down as we move through the stronger seasonally selling months. And with that we should see some improvement in margin or -- but I've made a note we saw about a 33% decrease in margin in the BMW sport utility vehicle, and that's simply again a figment of supply and demand in a vehicle that had enormous popularity when it was first launched, was innovative vehicle at that time relative to the competition and now the vehicle has some age in terms of the body style and some new competition, hence it is experiencing a natural decline in margin. Theo.

Talk about service and parts trends, collectively our luxury brands had positive service and parts increases. Used vehicle sales outperformed our average. We had a number of brands that actually had significant increases in used vehicle sales associated with the Mercedes, Lexus, and a number of other brands. It's a little difficult to talk about these brands, though weeks the absolute individual level, because in some cases we have just a small simple of stores. But our same-store performance in the luxury brands in every revenue category outperformed our overall average. New, used, service and parts.

Okay. Second question. Can you give us a little more perspective on how significant the weakness that is you're seeing in your Texas and Oklahoma marts markets, is it down 10%, 20s%, and are those numbers comparable for new and used vehicles?

Let me just give you some direct data, that's probably the easiest way to answer that question. In Oklahoma, our total same -store sales were down 20%, with new down 21%, used down 26% there. In Houston, new down 11%, used down 21%. Dallas, new actually held up fairly well, down 2% but used was down 11%. And in part because of the weather we experienced there, we had an unusual change in service and parts, with service and parts down 7%, but we were literally closed there in Dallas for a three- day period. So I think that gives you a perspective on the performance of those brands. I'm sorry, those regions.

One last question. What are you seeing out in the Bay Area at this point in? I know your brand mix is better, but what kind of changes in demand are you seeing?

We're still seeing declines in same-store sales there, and our profitability has generally held up fairly well in that market. But, you know, we have not seen the long awaited rebound in consumer demand in the Bay area. The Bay area, though, is a fairly complex market, and we see differential performance depending on the sub market there with San Jose behaving differently than some other parts of the market, for example, so we have seen some differentiation within that market, but overall the long-awaited recovery in northern California is still awaited.

Thanks very much.

Your next question comes from the line of Maurice Dian of Janus Capital.

I'm sorry, I'm not able to hear.

Can you hear me now?

Yes, I can.

Sorry about that, thank you. Could you expand on your comments about greater vaicialt sources of used car financing, who you have added, maybe, or how it compares to your current stable of providers, how large they are, dollar commitment or what this could mean to you in terms of increasing in financing and potentially sales.

I don't want to mention the specific providers, necessarily, but they're generally smaller providers that don't necessarily have national scope. And what we're having to do is work harder to find providers of this financing for consumers, and go to sources of financing that are in many cases regional. We have a couple of sources that we are adding in Texas and Oklahoma, several in California. A couple that do have national scope but aren't as large as some of the preferred providers that we've had historically like household and AMERI Credit. So we're having to adjust and enter into arrangements with some of the smaller providers and in many cases region al providers for this financing.

In terms of the potential impact, I think the potential impact just from the providers that we've added is several -- at least several hundred units monthly, and if you look at that over the course of the year and you look at the quality of those customers, that's a meaningful impact on our operations, once we have identified all the potential sources that I think we can, I think we may see closer to a thousand potential additional units from those sources, of financing. Of but that's a very difficult thing to estimate.

Have they made any dollar commitments, obviously subject to.

No, that's not the way the relationship between an auto retailer and indirect lender really works. They evaluate each individual commission submission, or each individual customer separately so there isn't an absolute commitment to our organization for financing.

And finally, on this subject, is it true to say that your preexisting providers maybe have tightened up their credit, raised their scores some and these guys will kind of fill in where the larger providers have withdrawn from, in that middle tier of credit?

Well, what you said at first is absolutely true, the only thing I would disagree with, it really isn't the middle tier of credit. It's the bottom tier.

Bottom.

And what's happened is our more traditional sources of sub -prime financing have moved in some cases from more the bottom tier to the middle tier or in the case of Ford credit, really moved out of the middle tier, almost any tier in the non-Ford stores with significant provider of used car financing for us.

Thank you very much.

Thank you.

Your next question from Adam Camara (ph) of Interest (ph) Capital.

Questions on the service contracts. What's the penetration on new car sales for those extended service contracts? And then also, on your used car vehicles, what kind of percentage do you guys get for service contracts on those?

Adam, I don't have the numbers broken out by new and used here in front of me. I have several F&I dollars, so we'll have to get back to you with the break-out between new and used service contracts.

Okay, thanks.

In order to ask a question, please press star- 1 on your telephone keypad. Your next question comes from the line of Peter Sirus of Gerlick Capital.

Hi, guys, how you doing?

Good.

I'm curious, a lot of people, you were talking before about the sub-prime business. And with AMERI-Credit and people like that. This over the next couple of years, what happens -- you know, hedge fund business been a little tough. What happens to people like me who have no money who want to buy cars? I'm open to a deal, incidentally.

People who were being financed by sub -prime providers who are not being financed today, have really two alternatives. One is to defer purchase, which I believe many of them are, and then two is to go to what's known in the industry as a buy here, pay here type of a finance source, which is a very high interest rate finance source on a low cost vehicle.

And that market is still widely available to those consumers. It's just not as advantageous a deal for the consumer because it carries a much higher interest rate and the vehicle that they purchase won't be as high standard as the one that was traditionally financed through an AMERI-Credit or something like that.

If you're looking, I mean these guys, you know, have like 50% margin, people like America's car mart, people like that. My question is, if you're looking at least an intermediate term disruption, in that very bottom niche of the market, over the next, you know, couple of years. Doesn't look like anybody is going to fill that void. Does that -- what does that do to used car pricing at the bottom end? Is there an opportunity there somewhere ? Does it stabilize? What do you see happening?

Well, what -- used car pricing and this is a matter of opinion, is declining because you have less consumer demand for the reasons that we talked about relating to financing. So until we have more sources of financing available for consumers, or supply begins to diminish, it's going to be hard for pricing of used vehicles to hold up. On the good side, there, the supply of new -- of used vehicles may begin to diminish later this year when new -- when new vehicle leasing expirations begin to decline. And I think a lot of people are doing just what we're doing, finding alternative source of financing for that low-end customer and trying to fill in that gap. So I think it's possible that prietsing trends will stabilize later this year.

and if --

in terms of the opportunity for us, we do have a very small buy here, pay here subsidiary within our company, which has seen increases in its business level. And that's an element that we see as a possibility to grow over the next several years, as there is this period where it's difficult to get financing for consumers.

And then, the last thing I would say is that our emphasis on certified pre-owned, directs a lot of our used vehicle sales activity away from the sub-prime arena. Those are generally prime type customers or near-prime customers, and those are customers where we typically don't have the same issues with financing.

I mean, do you see buy here, pay here as a growth opportunity? Or is it just too small to mean much?

For us it's too small to mean much.

Thanks.

At this time there are no further questions. Are there any further closing remarks?

Thanks, very much for participating.

Thank you for participating in today's conference call. You may now disconnect.