Sonic Automotive Inc (SAH) 2003 Q2 法說會逐字稿

Good afternoon and welcome to the Sonic Automotive second quarter 2003 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer period. If you would like to ask a question during that time simply press star and the number 1 on your telephone keypad. If you would like to withdraw your question, press star and the number 2. Should anyone need assistance at any time during this conference please press star then 0 and an operator will assist you.

As a reminder, ladies and gentlemen, this call is being recorded today, July 29, 2003. 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's filing with the Securities and Exchange Commission. Thanks you. I would now like to introduce Mr Theodore Wright, President of Sonic Automotive. Mr Wright, you may begin your conference.

Good morning and welcome to Sonic Automotive second quarter 2003 conference call. I'm Theo Wright the company's President. Joining me on the call are Scott Smith, the company's Vice Chairman and Chief Strategic Officer, Jeff Rachor, the company's Chief Operating Officer and Lee Wyatt the company's Chief Financial Officer. I'll cover our newly initiated dividend, industry trends and our strategic initiatives. Then turn the call over to Lee Wyatt to cover financial highlights followed by Jeff Rachor to cover operating highlights. Earnings per share for the quarter were 68 cents compared to 71 cents for the quarter a year ago.

After consideration of a one time casualty loss item, earnings for the second quarter 2003 would have been 70 cents per share. After a difficult fourth quarter of 2002 and first quarter of 2003, our performance improved dramatically, particularly compared to the first quarter of 2003. Earnings per share in Q2 2003 were up 62% compared to Q1 2003. We saw strong positive trends throughout the quarter. We'll have a number of specific comments on trends during this call. We're pleased to announce the Board of Directors has approved the dividend of 10 cents a share for the third quarter of 2003. Our companies consistent cash flows even in challenging times support payment of a dividend providing our shareholders with current tax advantaged income from their holdings in Sonic Automotive.

We expect to recommend to the board, dividend payments in future quarters. Our company has for the last three years returned significant cash to shareholders in the form of share repurchases. Over this time period, share repurchases in total represent 39% of our net income. We're taking advantage of changes in the tax laws to redirect a portion of these returns of capital to dividends. We've managed these substantial returns of capital in the past without impairing our ability to execute our growth strategies or changing our leverage profile. Our earnings per share have grown from $1.27 per share in full year 1999 to $2.47 cents in full year 2002.

Our business is highly fragmented and there are many attractive acquisition opportunities. Availability of human capital, not financial capital, is the greatest constraint to our ability to grow through acquisition and on the same store basis. We do not believe our dividend policy will have any negative impact on our growth rate. We will manage our balance sheet consistent with past practice with debt to total capital targeted at 50%. We'll also continue to execute acquisitions and maintain our access to capital to support our growth. The comment on industry trends, the new vehicle industry was stable for the quarter and the SAR's has been above 16 million units every month but one so far this year.

We expect continued industry sales levels in the 16 million unit plus SAR range for the remainder of the year based on aggressive pricing by manufacturers and outstanding product offerings. These industry sales levels may be below last year's levels for the industry in certain months, but are nevertheless sales rates at which retailers can sustain high levels of profitability overall. The strongest brands for us in both sales and profit trends were Honda, Nissan, Lexus Mercedes, Volvo and Infinity. Honda, Volvo and Infinity were all remarkable performers for the quarter. Our Toyota sales were up sharply but margins were pressured as the number of Toyota's truck products have become more widely available.

Toyota is now more aggressive in pricing through incentives and sales trends remain strong in July. Ford, Chrysler, Jeep, Dodge and Chevrolet were weak. Markets that performed notably well were Las Vegas, Alabama, Georgia and Tennessee. Our Dallas, Oklahoma, Denver and San Jose operations improved against weak comparisons. Markets that performed poorly were principally San Francisco, North Carolina and Los Angeles. Although performance in Los Angeles and North Carolina is more indicative of brand issues than market conditions in my opinion.

In general, northern California remains difficult but fairly stable. The central part of the country, Texas, Oklahoma and Denver is however, showing signs of recovery. Used vehicle sales and prices show signs of meaningful improvement. Auction prices for used vehicles have trended up sequentially for several months indicating improved retail demand as well as wholesale demand. Availability financing for used car purchases by consumers, although not what it was a year or more ago is improving. And our company has added a number of additional sources of used car financing for consumers.

Used vehicles have been the most challenging product line for Sonic by far, confirming in this line will be particularly beneficial to our performance compared to the industry and our peers. Service in parts continues its growth despite the vehicle sales cycle. Our strategies to emphasize brands with high levels of customer retention, products such as used car certification and extended warranties that help us retain customers for the greater portion of a vehicle's life span and capacity expansion are paying dividends now and into the future. Service and parts represented 42% of our total gross profit dollars for Q2 2003. Although vehicle quality is improving, vehicle warranties are longer and repair complexity is often higher. We are not seeing contraction in our warrant repair business.

Warranty repairs as a percentage of total service and parts sales has been virtually unchanged for the last four years. Warranty repairs for the quarter were 19% of our total same store service and parts sales. Warranty gross profit was 19.6% of total same store service and parts gross profit. In other words our warranty gross profit margins are slightly higher than non-warranty gross margins. Turning to our acquisition activities and share repurchases, we've discussed the relative returns from various investments alternatives on prior conference calls. I won't repeat all the details. However, at current stock prices, the most advantageous investment for Sonic is acquisitions. Based on performance of our stock price and virtually an identical situation in 2001, we anticipated the improvement in our stock price and reduced our recent pace of share repurchases during the quarter and increased our focus on pursuit of acquisition opportunities.

Acquisitions take time to develop. But we expect to announce a number of acquisitions in the near future. Acquisitions we are pursuing are largely in markets where we already have operations and can take advantage of our existing management infrastructure to aid in integration and create efficiencies. We fully expect to announce acquisitions representing at least $500 million in annual revenues this year and believe more is possible. These acquisition activities focus principally on brands that are taking market share, and where we have a track record of solid performance, luxury and import brands. We expect our growth through acquisition to accelerate from recent levels. However our growth pace is also expected to be more moderate than it has been at times in the past in order to aid us in effective integration and utilization of our limited management resources. Our commitment to growing new vehicle market share is critical to our continued positive relationships with our manufacturer partners and our long term growth.

Because of our commitment to new vehicle market share, we believe we are well positioned to obtain the support of virtually all key manufacturers for our acquisition strategy. Our willingness to focus on acquiring underperforming dealerships and dealerships requiring relocation and facility enhancements has benefited these relationships and provides opportunities for us to work collaboratively with manufacturers. At current share prices our share repurchase activities will continue at much lower levels largely to mitigate the impact of option delusion. Obviously we will continue to monitor relative returns of investment alternatives and adjust our capital allocation at the time. Our earnings targets for the full year of 2003 are from $2.45 a share to $2.60 a share excluding the impact of changes in accounting. Our targets are based on a SAR of approximately 16 million units for the industry and our expectation we will continue to modestly outperform the industry for the remainder of the year in new vehicle sales. Used vehicle same store sales decline a 5-day percent for the full year.

Service and parts same store sales increases in 1 to 2%. Finance and insurance per unit unchanged from current year levels. No share repurchases, acquisitions or dispositions beyond those announced today. Our team has worked diligently to position us to return to earnings growth in margins more reflective of our historical performance in the second half of 2003. We've taken aggressive and difficult actions to improve our inventory position, staffing levels and infrastructure. July appears to continue the positive trends in both sales and profit we saw over the course of the second quarter. We're excited about the remainder of this year and look forward to the year ahead. Now I'll turn the call over to Mr. Wyatt. Lee?

Thank you, Theo. One trend that should be noted for the second quarter is that operating results not only improved from the first quarter but also generally improved throughout the quarter. Revenues on both an absolute and same store basis showed consistent improvement as did SG&A expenses. Total revenue for the quarter grew 5.7%. With new vehicle growth over 9%. Used vehicle growth around 1%. Parts, service and collision, and finance and insurance each grew over 8%. Gross margins declined at 15.1%, from 15.4% last year.

With new and used vehicles declining to 6.9% and 10.9% respectively compared to 7.8% and 11.6% last year. These margin rates reflect our strategy to drive market share through aggressive pricing and particularly in markets where we have an opportunity to take market share. The parts service and collision gross margin rate improved 50 basis points to 48.4%. The SG&A rate as a percent of gross profit improved from the 82.7% in the first quarter to 78.8% in the second quarter. The improved rate reflects partial benefit of the 7% head count reduction implemented during March and April. We are continuing to review the compensation plans to ensure that we have the highest possible mix of variable expense. SG&A expense included a $1 million casualty loss for hailstorm damage in the Texas region.

This loss exceeded our maximum deductible. So any inventory losses for the balance of 2003 will be covered by insurance. The earning per share impact was approximately 2 cents for the quarter. We are experiencing some increases in fixed cost as we invest in new facility. These new facility create capacity for growth, bring new customers into our stores and foster better manufacturing relations. Non-floor plan interest expense increased 2% for the first quarter due to higher outstanding balances but were partially offset by lower rates. Our tax rate for the quarter was 36.1%. We expect a similar rate for the balance of 2003 as we benefit from a number of recently implemented state tax planning strategies. Diluted share count for the quarter was 42,071,000 shares and reflected increased dilution from stock option exercise and modest share repurchases. During the second quarter we purchased 231,000 shares at an average price of $17.74. This leaves 25 million remaining under our board authorization.

The second quarter balance sheet reflects a debt to capital ratio of 48.5%. Availability under the revolving credit facility is 164 million, with $32 million of cash on the balance sheet. Inventory management continues to be a priority for the company, and continues to lead the industry. With days supply of new vehicles at 54 days and used vehicles at 38 days. Domestic day supply for new vehicles is 75 days. And import and luxury brands was 41 days. If we started calculating days supply for new vehicles using selling days as some of the sectors have started the day supply would drop to 45 days. Capital expenditures in the second quarter were $15 million.

We expect approximately $10 million of these to ultimately be recovered through sale and lease back transactions. Year to date cash from operating activities, $79 million, showed an increase of 23 million from last year. Now I would like to turn it over to Jeff Rachor, our Chief Operating Officer.

Thank you, Lee. Management is pleased to report solid improvement in dealership operations or the second quarter. I'll be reviewing our second quarter operating performance by business segment and unless otherwise noted, my commentary will be reported on the same store basis versus the second quarter of 2002. Total new vehicle revenues were up 2.1% on a slight increase in retail unit volume led by our import brands and outperforming the industry as a whole. Unit sales were even stronger when viewed sequentially, rebounding from a decline in a tough April to significant increases in both May and June.

Eight out of 11 of the major brands we represent showed increases in retail unit volume, and took market share. Strategically and tactically, Sonic continues to focus on increasing new vehicle sales to drive growth and local market share, earning manufacturer support and creating units in operation to propel a virtual annuity of future service and parts income. Sonic Automotive continues to enjoy above average market share with all of our major brands. The strategy to take market share in a difficult market, combined with the moderation and demand for certain new model entries from last year did result in lower new vehicle gross margin. Lower margins can also be explained by the company's pressure on reducing excessive new vehicle inventories with some brands.

Inventory levels and our market share strategy led management to consciously overinvest in incentive based compensation for dealership sales personnel during the quarter. Sonic sales department continue to benefit from an ongoing commitment to higher levels of standardization in discipline showroom accountability and sales processes based on proven best practices. Installation of a common customer relationship management technology in all Sonic dealerships is already paying dividends. This shift to standardization is largely being facilitated by our Sonic University training initiative. Sonic dealerships capitalized on the recent firming in the used vehicle market. While used vehicle revenues decreased 4.9% versus the second quarter of 2002, the story for Sonic is trend.

On a sequential basis, used vehicle same store sales were as follows for the quarter. April down 13.9%. May, down just 66 basis points. And June, up 75 basis points. The used car trend is even more compelling when we look back sequentially over the last three quarters. Fourth quarter of 2002, down 17.1%. First quarter of 2003, down 12.6%. And again, in the second quarter of 2003, down just 4.9%. Early results month to date in July show an even stronger year over year trend. Hence, we have a positive outlook on the used car business going forward.

In our first quarter call, we articulated Sonic Automotive's strategy to focus on manufacture certified preowned programs or CPO used vehicle sales. I am excited to report early success in this initiative, as certified preowned sales were up 62.5% versus the second quarter of 2002. That compares to the industry's increase of just 20%. Moreover, CPO sales made up 26% of Sonic's total preowned sales for the quarter, versus just 15% for the same quarter a year ago. Once again, certified preowned sales offered great value to consumers, often attracting first time brand intenders. These units are reconditioned to the highest standards and yield retail per unit gross profits that average $250 more than our conventional used unit sales. Most importantly, the extended factory warranty component of CPO sales create a loyal customer relationship that ties consumers to Sonic shops providing a guaranteed stream of future high margin service and parts revenue.

Finance and insurance gross margin increased slightly, driven by a 3.5% increase in the per unit retail average. Sonic's consistent performance in this segment is a reflection of an early commitment to best practice base training at 100% menu selling. It is important to note a recent decision to realign our F&I product offerings to put increased emphasis on extended service agreements sales positioning Sonic to capture the full long term residual benefit of future high margin service and parts growth. Total fixed operation sales increased 1.6% for the quarter while total gross profit was up 2.7% as total gross margin expanded 50 basis points to 48.3% versus a year ago. This strong showing produced fixed absorption of 80.7% versus 79.6% a year ago.

Confirming the ROI benefit of Sonic's substantial investment in new facilities and expanded work style capacity. Service sales led the way with a 4.1% sales increase. Service gross profit was up 6.3% as service gross margins expanded almost 100 basis points. Despite a challenging collision repair market, Sonic body shops posted a 4.0% increase in sales, and a 7% increase in gross profit. We've recently modified our management structure to bring specialized focus to this high margin, none cyclical segment and look for continued improvement as a result of the reallocation of resources to support this business.

Sonic's first quarter variable expense reduction efforts paid off as SG&A expense as a percentage of gross profit dropped from 79.8% in the first quarter of 2003 to 76.1% in the second quarter of 2003. However, SG&A expense increased from 74.2% in the second quarter of 2002. Sales commissions, rent and employee benefits were the concentrated source of this increase. All other personnel categories showed improved variability versus both the second quarter of last year and the first quarter of this year. As previously stated, the sales compensation expense is a direct result of the company's intense focus on stimulating sales to take market share and reduce inventories, both of which worked in Q2.

This investment, along with our commitment to providing industry leading employee benefits earned early returns as total employee turnover is down more than 15% in the second quarter. Salesperson turnover is down over 12% while salesperson productivity is up over 11% for the quarter. Management is continuing to develop standardized compensation schemes aimed at increased productivity with a more variable cost structure.

In closing, our outlook is positive. We are encouraged by the traction in the economy, the industry and Sonic Automotive's operating results. The company has gained meaningful momentum in both new and used vehicle sales. Inventories are in great shape. Head count has been adjusted to the cycle. So all the elements are in place to continue the second quarter's positive trend. That concludes our prepared comments. At this time we would like to thank you for your participation in today's call and the management team will entertain questions.

At this time, I would like to remind everyone, in order to ask a question, press star and then the number one on your telephone key pad. We'll pause for a moment to compile the q-and-a roster. Your first question comes from the line of Rick Nelson with Stephens, Inc

Thank you. Good morning.

Good morning.

How did the quarter come in relative to your internal targets, Theo?

The quarter came in in line with the middle of the range for our targets and not at the high end of the range, which is the principal reason we brought down the high end of the range of our targets for this year.

That was my follow-up to that. That that relates to the second quarter performance as to why you put it in the high end?

Yes.

And on the used vehicle side of the business, what are your compact expectations as we look forward, and how did margins respond as the comps improved during the second quarter?

Let me just address the comparison expectations. The comparison expectations that are embedded in our forecast we gave previously which are consistent with the comparisons year-to-date. I do think there is a potential upside in those comparisons, because of the trend that we're seeing over the last several months. However, a couple of strong months is not enough evidence, we believe, at this point, to cause us to significantly raise our expectations in the used vehicle sales arena. But the trend in July, as Jeff mentioned, is considerably better than we had anticipated. And we are hopeful that we're going to continue to see improvement, relative improvement, in our performance in used cars which has been an area of weakness for us. We are going up against some fairly easy comparisons. And we believe improvement in our used vehicle performance could particularly benefit some of the brands where we've struggled, namely the domestic brands. In terms of gross margin over the course of the quarter, I don't -- I'll ask -- we may have to confirm to you later. I don't believe there was any significant change in gross margin on used vehicles over the course of the quarter month by month.

And the July comp in used vehicles is positive?

Based on the information we have today, yes.

How about the weather impact on SG&A during the quarter? The hail damage?

The hail damage I don't believe had any significant impact on SG&A. I'm sorry. On SG&A other than the actual cost of the casualty loss. In other words I don't believe it affected personnel expenses or other expenses. It was simply the cost associate with the damaged vehicles.

And where did that 2 cents show up then?

It would have shown up in SG&A.

In other?

Yes.

Okay. And when do you see SG&A narrowing the percent of gross profit or --

We saw SG&A narrowing compared to the first quarter and the second quarter. And narrowing over the course of the second quarter. And we expect that trend to continue. In the second quarter.

And year over year, in June, did it narrow on the part of your period?

For the month of June, I don't have that answer in front of me, Rick. We'll have to get back to you with that specific answer. I can say, however, that year over year profits for the month of June were up in total.

Okay. Thank you.

Thank you.

You now have a question from the line of Adam Pamora with Intrust capital.

Hi, guys. I just wanted to follow up on that question. It looks to me like so far year to date your used cars comps are down about 9% but there could be some seasonality in there. I'm trying to understand if your full year is down 5 to 8, what are you implying for the back half of the year?

We're implying for the back half of the year fairly similar, slightly better, but fairly similar comparisons over the remainder of the year.

Okay. Even though it sounds like June you were positive, July you're positive, you're still saying sort of down 5 to 8 for the back half of the year.

Yes, and the reason for that is the improving trend is fairly short term. And we're reluctant to --

Fair enough. I don't mind you guys being conservative. Also the second half SAR guidance, if full year is 16 and we're running just above 16, are you implying in your guidance just below 16 million units for the back half?

Yes, right at 16.

Okay. My last question -- one more question on the guidance. When you say that you're not assuming any acquisitions that you have announced, does that mean when you say that your target is $500 million, $500 million is assumed in the second half in the guidance?

No. We're saying that the guides for the second half only includes those specific acquisitions that we had previously announced.

Okay. So the additional $400 million or so would probably be an addition.

Yes.

My last question is, you guys have a September bond issue of about $200 million that's callable, is that right?

It is $182 million outstanding and our first call date is August 1.

Okay. Any plans to refinance that? It seems like you guys could be getting a better interest rate on it?

We're evaluating those options right now in lieu of our acquisition strategy for the second half of the year and going forward. We are evaluating it.

Terrific. Thanks a lot.

Thank you.

You now have a question from the line of Paul Ross with Inghent.

Hi,.

Hello.

Could you tell us about the plan to dispose of dealerships, what has happened in the second quarter and what might happen in the second half, talking about proceeds in revenue reductions and relative contributions or loss of those dealerships, please.

We disposed of a number of dealerships in the second quarter of the year. And the proceeds, I believe, are detailed in the press release of approximately $24 million. We do have a number of additional dealerships that are pending divestiture. These dealerships are now at this time, three dealerships. And based on our existing portfolio of dealerships, we believe that that will essentially complete our divestiture activities. We expect proceeds from these additional three dealerships to amount to approximately $10 million. The earnings for loss contribution of these dealerships in their entirety is not significant. What is significant is that we have the opportunity to redirect both capital and management resources to operations where we can earn attractive returns on investment.

Theo, do you have any residyou'll liability to any of the leases on any of the dealership properties after you sold them?

In some cases we do have residual liability to the leases in the dealerships we have sold. Generally speaking, we do not. Again, these leases are associated with the sale of operating businesses that continue in operation and pay those lease payments.

And how do you account for those lease payments that are continuing?

I'm not going to cite the correct accounting standard here from memory. But there is recent guidance on any guarantees and how they be accounted for that are entered into currently -- they would have to be accounted for based on the fair value of those guarantees. And the amount of any guarantees also has to be disclosed in our 10-q or 10 K.

Can you put a corral around this and tell us what type of dollar exposure there might be in the event these dealers went out of business? As it relates to the disposals in 2003?

I don't have that number in front of me. We'll need to get back to you with a quantification. Again, those amounts are detailed and will be required to be detailed as a disclosure item in our 10 Q.

Thanks Theo.

Thank you.

Gentlemen, we now have a question from the line of Michael Millman with Hillman Research.

Thank you. That's actually Millman Research. I guess a couple of questions. Can you talk about your sequential experience April through July? Compare that, more on market share, compare that with SAR numbers which might give us a different view? And also, could you talk a little bit about what your improvement is in recently purchased dealers? Maybe one year same store sales compared with two and three year same store sales. So we can get some ideas what kind of improvements take place in the purchase dealers and how important that is to the total. Thank you.

Okay. In terms of performance over the course of the quarter in relation to the industry our SAR numbers, I believe that based on the reported industry sales numbers not I think not SAR numbers, you get a more valid comparison. Because we don't adjust our monthly numbers internally in anyway for seasonality. So comparing our internal numbers to the SAR number is an inaccurate comparison. But comparing to the industry reported numbers, we did not perform well in April, but we significantly outperformed in May and in June. June, a month when the industry was down compared to a year ago, not necessarily on a SAR basis, but an absolute basis. In terms of the improvement in performance of the acquired dealerships, generally speaking, the performance improves, particularly in the area of service and parts margins, where -- and service and parts generally where we outperformed the industry by a wide margin. Finance and insurance as well. We have seen dramatic improvement in the dealerships that have recently acquired -- on previous conference calls we've provided some specific examples of the Massey dealership acquisition we did a year or so ago. But generally speaking, our performance is better than the industry's performance by about 50%. And that is indicative of the relative improvement and performance that we've seen in our acquired dealerships as a whole, given the number of dealerships we've acquired, we do, of course, have some that don't perform at that level. We also acquire many dealerships that are breaking even or even losing money. In many cases dramatically improved the performance of those dealerships.

I'm not sure if you're suggesting that the bulk of the improvement, the same store sale improvement is based upon upon those same store sales that were purchased in the last --

I can clearly answer that question by saying included in our same store sales base are only dealerships that we've owned for more than a year. So the improvement that we often see immediately upon acquisition of dealerships is not reflected in our same store sales performance that we report.

To put it another way -- I hate to keep beating this horse. Then you're suggesting that most of the improvement you get from acquisitions you achieved in the first year then?

I would say that the most dramatic improvement that we see, particularly in the area of profitability is in the first year. There are cases where we see improvement over a longer period of time, particularly in instances where a dealership is relocated or a facility is significantly improved. But in areas such as finance and insurance and service and parts, we typically see a very Rapid improvement in performance after acquisition.

That's great. Thank you.

Thank you.

We now have a question from the line of John Casesa with Merrill Lynch.

Hi, good morning Theo. Follow-up on your comments about [INAUDIBLE] used car prices, are you seeing any evidence that is working its way into firmer new car prices. Secondly, how does your behavior change as used car prices firm? Does it just make it easier to make the trade? Or do you change your strategies in any other ways?

John, this is Jeff Rachor. And first off, some clarity on your question about new car forming in terms of pricing. Are you referring to less aggressive pricing?

No. I'm just wondering if used car -- if residuals -- one of the reasons that I think that new car prices got weak is that used car prices collapsed. I'm wondering if this process in your mind is reversing or not yet.

I haven't seen any indication. As you know,John, you track it closely, the incentive environment is still extremely aggressive. And yet we are seeing over the last couple of months significant positive trends in the used vehicle firming. And I agree with your assessment that a big piece of the wholesale decline in pricing in the used car market was driven by the aggressive incentives and 0.0% financing on new cars. But at this juncture, you're seeing the manufacturers remain aggressive as we are. And we are essentially passing on that aggressive pricing adjustment to the consumer. Your theory that the used car firming could ultimately impact new vehicle pricing certainly has some validity. And we'll just have to watch that in the next few months.

In terms of changing our behavior, firming used car prices, does make it easier for us to take a vehicle in trade. And I think more importantly, the positive trend that we're seeing in used car retail sales, not necessarily prices, makes it easier for us to take a vehicle in and trade that's retailable. And hopefully be more aggressive in the sale of new vehicles. It doesn't necessarily affect price in my opinion. But it may have positive impacts on volume, which probably will ultimately work its way through to price. But at this point, I can say conclusively that it is easier for us to take a car in on trade now than it was three months ago. Because we're less likely to experience a significant wholesale loss and we're more likely to be able to sell that trade-in vehicle at retail to a consumer.

The other positive impact is that that firming and pricing aids the consumer in financing because it gives them a more positive equity position than what they've had over the last 12 months when they've seen pressure on the value of the their used vehicle trade-in.

That makes sense. Well, thank you both.

We now have a question from the line of Peter Schwartzman with Blackdrop.

Good morning, guys.

Hi, Peter.

When you take a picture of the business over the past couple of years, you mention that instead of sort of retaining the profit, you've given it to the consumer, because if you look at the margin -- and you know I'm working on a EBITDA basis. The margin has deteriorated by a substantial growth in sales. Do you guys see the margins stabilizing at this point and the business -- obviously the intuition behind the dividend, is there a certain maturity in the business model? Can you kind of reconcile where you think the margins are going to go and what some of the intuition behind the dividend is?

Peter, I think over the near term that the trend in margin will be positive. Not necessarily in gross margin. But in net margin. And we saw that over the course of the quarter. And again, in the second quarter, over the first quarter. So we believe that that trend will be positive. And I think what we expect to see is that we will be able to continue to generate very high gross margins in the area of service and parts, grow that business. And that will enable us to be somewhat more aggressive in the sale of vehicles to benefit the service and parts operations over the long term. But that overall, our net margins will trend up for the foreseeable future when compared to the last several quarters at least. And hopefully shortly compared to a year ago. We believe that the margin opportunity continues to be significant. I think that we see that margin opportunity in the area of revision to compensation plans that we talked about. But also in the area of increased focus on our fixed expenses where we're taking a number of actions in the area of clerical and other expenses, back office expenses that are beginning to bear fruit. And property taxes and lots of other items that although are not individually significant, accumulatively, they are a significant part of our cost structures. So we see opportunity to improve margins to levels more typical of what we've had in the past and over the long term, beyond what we've seen in the past. In terms of the maturity of our business, we believe there are many attractive growth opportunities. We do not view the decision to take -- to pay a dividend as reducing those growth opportunities because as we said in our prepared comments, the real limiting factor on our ability to grow through acquisition and on a same-store sales basis is really the availability of people. And we believe that we can return capital to share holders in fairly modest amounts and continue to execute our growth strategy. So I don't believe in any way that we have a view that our business is mature and there aren't continued growth opportunities.

You view this time period in the company and in the environment as Jeff mentioned the investing in the market share by giving up the margin in the market share will increase, let's call it the installed base of vehicles out there, enhancing your annuity stream in the future?

Yes. This is Jeff. And just to follow up on the comment, that's exactly our view. And our company has elected a strategy to put tremendous emphasis on growing local market share. Because as Theo noted, we see tremendous growth opportunities and fixed operations. You can see that we continue to enjoy very high margins in those business segments. And so we believe that it is the best long term strategy to potentially forego some short-term margin opportunity and drive volume to further grow that installed base.

Jeff, how would we -- the way for us to keep an eye on it, is obviously, the comp growth in service and parts. Hopefully the margin expansion is there as sort of a recurring, nonrecurring revenue stream discussion that follows as well?

Well, I'm not certain that I --

I'm trying to think how else we can keep an eye on it.

I don't know any other way, Peter, besides focusing on the same store performance and service and parts.

Okay.

And I would say a number of the initiatives that we're undertaking such as certified preowned will not show in our performance immediately. It is going to take a year to two years to see the significant benefit of those efforts. But we can foresee a time in the not-to-distance future when half of our used vehicle sales are certified preowned vehicle sales. We already see that with a number of brands. And those are vehicle sales that will enable us to capture a service customer that we've never captured before. So we do think there is going to be benefits from our strategy. But they aren't necessarily all going to appear in the next couple of quarters. They will take longer to be fully realized.

And there are some other positive news there. Many of the luxury manufacturers have included a scheduled maintenance in the manufacturer's warranty. And that is a trend that we are seeing continue. In fact Volvo recently announced that they are going to adopt that same policy. And that is another driver of future service and parts revenue. In fact if you isolate our BMW service business, we had a 25% increase in warranty sales in BMW for the quarter. And much of that is driven by their early adoption of the scheduled maintenance philosophy. And so that will be another driver of service and parts growth in the future.

Okay. Well, thanks very much, guys.

Thank you, Peter.

We now have a question from the line of Jordan Heimowitz with Level Global Advisers.

Congratulations on a good quarter.

Thank you.

A couple quick questions. The $500 million independently, is each $100 million still worth about 2 to 3 cents a share.

In the 3 cents share range is a good estimate. Depending on brand, that could be two with a Nissan dealership and 4 with a luxury brand.

Okay. And second, one month is not a trend made, but is there anyway that you could isolate like the earnings power of the month of July on an annualized basis.

I don't think I would want to isolate the month of july, since it is not over. But if you look at the month of June --

June's fine.

On an analyzed basis, that would be $3 a share.

Where do you see overall net margins after tax -- I'm sorry. One more question for that. In the quarter, you said there were 2 cents of non-recurring within the core number, correct?

Yes.

So within the 66 cents there were 2 cents or in the 68 cents there were 2 cents?

It is both. But the 2 cents is not reflected in discontinued operations.

So the core number, so to speak, is really 70 cents in the quarter?

The total is 70 cents. The continuing operations would be 68 cents.

Okay. And lastly, where do you see margins at this point trending on a net margin basis? In otherwards, if it looks like it is 14 in the quarter, where do you think that would be six months from now?

Well, we think in six months from now, we can return to the kind of margin levels that we had a year or more ago. I'm trying to find an exact example of those types of net margins. But in the third quarter of last year, we were at 1.6%. We've seen in the past in that 1.6, 1.7% range in terms of net margin. We hope over time to also give the benefit of lower interest expense and other costs which should also benefit that net margin.

Super. Thanks so much. And Theo, just give me a call when you get a minute.

Thank you.

Gentlemen, we now have a question on the line from Jeff Black with Lehman Brothers.

Good morning, guys. A couple of questions. First, on the gross margin line for new, we've kind of entered a whole new area there with the 6.9. Yet average selling prices improved. What's baked into the number. And can you break out more clearly how much of this was due to clearing the inventory, how much of it is due to what you ascribed as over investment in compensation and how much might we do to the aggressive push to maintain market share in certain areas? And then I have a follow-up.

I don't know that we can isolate the impact of different elements of our approach to those gross margins. Because often they interact in the same dealership where we see an opportunity to take market share. We may also have a need to reduce our inventory levels in both of those factors can affect pricing. It is important to keep in mind that prices for our organization on vehicle sales are still individually negotiated. So those decisions are made day-by-day at our various locations. It wouldn't be possible to -- in other words we don't mandate a price adjustment corporately. Those decisions are made locally on a car-by-car basis. Really you can't isolate the impact of those items.

Let me ask it another way. With the 6.9 margin, that seems to be where the damage was done. How much inventory have you moved. If it were on a scale of one to ten and ten would be totally clean, ready for the third quarter. One would be nine. Where are you on the scale? And where are you on the comp where you need to be, too, on the same sort of scale?

This is Jeff Rachor. And I can refer to that. Lee wyatt gave you an update on our inventory numbers. They really represent industry leadership. And are consistent with where we were a year ago in the same quarter. And, again, if adjusted for the new metric that a number of our peer group has begun using based on average selling day. We've got a 45-day supply of new vehicles. So I would tell you, in terms of new vehicle inventory, we would be very, very close to the high end of that range. An eight or night on that one out of ten scale. Used vehicle inventory has always been an area where we've managed with discipline. We have a 40-day supply of inventory. That has long been our day supply benchmark. We manage aging with tremendous discipline. So once again I would have to categorize it in a similar fashion. An eight or nine on your simple scale of one to ten. We think that our inventories are tighter than really the industry as a whole, and the majority of our peer group. And that's long been a strength for Sonic. But in the fourth quarter, when a number of manufacturer's aggressively shift inventory ahead of their normal pipeline schedule and business moderated into the first quarter, we did see inventories escalate far outside our normal comfort zone. And that led to us taking very aggressive action in the first and even second quarter to clean up inventories and get them in the great shape they are in today.

And the follow-up, I mean, it relates back to the very first question on the call. We're talking about lower expense rate, what you just described as good inventory, higher unit growth really so far than anyone projected. Positive outlook on used. But yet you take the guidance down 10 cents for the range, and yet where is the real myth on your internal projections? What gives you pause that you can't do 270 anymore versus out of the first quarter which even looked more difficult?

Well, the simple answer is one of your questions, which is new vehicle gross margin. We had to sacrifice more gross margin than we anticipated to achieve our sales objectives. And that largely is the story. And we don't -- as I think we just discussed at length based on John Casesa's question. I don't think we have clarity -- we have clarity about the future trend in the new vehicle sales environment and what pricing is going to look like there. So we continue to be conservative in our view of new vehicle gross margins.

Would you say -- can you give us any kind of color -- this is the last question -- on what the margins might look like going forward. Is 6.9, do you think out of the realm a possibility for the third and fourth quarter? Or are we looking at a higher number there given the low inventories?

Our expectation is that as we get into the new model year, it is fairly typical, that those margins should trend up. There is also a number of exciting product launches scheduled for the second half of the year. And those will be a driver of improved margin. If you go back to our earlier comments, part of the pressure on margin was the absence of the high demand we had on certain newer models and certain model entries that had stronger demand a year ago. And once again, there is exciting product cycle with a number of our product lines, Cadillac introducing a new sport utility and the sports car, bmw replacing one of their core models, the five series launching a new X3 model. A number of new products in the pipeline that should contribute to improved margin performance.

Great. Thank you very much for the candor and good luck on the quarter.

We now have a question from the line of Scott Stember with Sidoti & Co., one moment.

-- the area that you start to see firming up in the Dallas and also maybe just talk about some of the trends particular in the quarter, particularly northern California like San Francisco area.

Scott, we couldn't hear the first part of your question, there. It didn't come through clearly.

Yes. Maybe just talk about some of the areas that you have talked about that have firmed up, such as the central part of the country and northern California. Maybe just talk about some of the trends in the quarter.

The trends in the central part of the country were positive over the course of the quarter. And our Oklahoma markets, Oklahoma City and Tulsa, real improvement there over the course of the quarter. Partly due to the market, but probably more due to some changes that we've made in terms of our management structure in those markets. In Dallas we saw a very similar trend. In northern California, we saw a divergent trends to a certain extent. And the San Jose Silicon valley area was fairly strong and other parts of the San Francisco Bay area, which had held up fairly well over the past couple of years were weaker. But on the whole northern California, both North Bay and South Bay was fairly stable. So northern California did not in total have a significant impact on our relative performance. In Houston the trends are not as strongly positive as in Dallas and Oklahoma, but we do see improving performance there. There's been some good economic news out of that area, with improving unemployment rates in Houston.

When you're referring to improving performance, are we talking sales, profitability or a combination of both?

Both sales and profitability.

And just real quick, on the acquisition front, can you maybe talk about pricing trends in general and what you're seeing out there as far as what it is going to cost you guys these days?

We for a number of years now have seen little change in the pricing environment. And we believe we can continue to find attractive acquisition opportunities where we can over the long term meet our return on investment targets at 15% on an after tax cash basis.

And Jeff, earlier, you mentioned F&I per transaction. Can you give us the absolute number this year versus last year.

Yeah. Last year we were 845 a unit. We improved that by about $32 -- by exactly $32 to 877 per unit retail.

That's a combination of new and used?

Yes.

That's all I have. Thanks.

Thank you.

Gentlemen, we now have a question from the line of Nate Hudson from Banc of American Securities..

Good afternoon. Just a couple of quick questions on your service and parts business. Can you give us a sense of how different the revenue trends were for the domestic brands and was there a continuing issue on this quarter with negative comps on the wholesale parts business?

Yes, there was a negative comp in wholesale parts. But that was largely attributed to a single phenomenon that exists in a large Ford dealership that we own in Houston Texas, Lone Star Ford, where Ford Motor Company opened a parts depot there in direct competition with a large wholesale operation that we operated. And I believe that that single item accounted for about 100 basis points in terms of overall parts performance. And did contribute to an overall decline in wholesale parts for the quarter.

And on a comparative basis, same store domestic parts service and collision repair in total down 3.5%. Imports up 6.7%.

You talked about the initiatives you have over the longer term of the service and parts business. What is your level of optimism? You'll see an acceleration in the comps over the second half?

Specifically on wholesale parts or the entire --

Particularly in the service and parts segment?

We're optimistic in terms of overall service and parts growth as we articulated earlier. We're very bullish on that segment of our business. And there are a number of things that will continue to drive consistent growth in our service and parts business.

We will begin continue to receive the benefit of the certified sales that we've made more aggressively over the last year. We expect the same on extended warranties. We also see benefit from our brand mix which you just really detailed there, the differential performance between domestics and imports. So from trends that we saw late last year in the first quarter of this year, we do see a definite improvement in performance. And speaking of the industry as a whole, there is a lot of data that is available. And I think over the last several years it's become more clear that dealers, franchise dealers collectively are taking significant amounts of market share in the service and parts arena.

And we're being aggressive. We now have the benefit of customer relationship management technology that allows us to mine our database and constantly communicate with our installed owner base. And finally, as we noted in our earlier comments, Sonic has been leaders in terms of investing and state of the art facilities. And expanded work style capacity. And we'll continue to identify opportunities to expand work style capacity where we get a very high return on our facility investment dollars. And we have all of that to look forward to as we go forward.

Thank you.

Gentlemen, we now have a follow-up question from the line of Adam Pamora with Intrust Capital.

Just a quick follow-up to that comment to a question earlier where Theo you said based on June you were at a $3 per share earnings run rate. Is that seasonally adjusted at all? Or should I just think that what means 25 cents in June.

You should think that that means 25 cents in June

And typically, what does June represent as a month for the year?

In terms of sales, seasonally adjusted, it is actually fairly average. It is right at average, in fact.

All right. Sounds good. And it sounds like July is running ahead of June?

Yeah. So far. But that would be a normal seasonal trend, Adam. July is a stronger retail sales month than is June.

Okay. Thanks a lot, guys.

Thank you.

We now have a question from the line of Jerry Marks with Raymond James.

You missed me? I had a quick follow-up regarding jordan's question. With regards to the 68 cents, the way that you look at it is that there was 2 cents in discontinued ops and that brings you down to 66 cents from a continuing operations basis. Then you add back the 2 cents from the hailstorm. Is that the way you look at it?

That is correct.

Okay.

We would say absent the casualty loss, 70 cents in total. 68 cents from continuing operation.

Okay. And when I look at your guidance, you're assuming, then, 68 cents in the second quarter and 43 from continuing ops in the first quarter, or are you assuming 70 cents?

Our guidance is based upon historical reported earnings per share in total, not from continuing operations, but in total, for the first half of the year.

So 41 cents in first quarter. And 68 in the second quarter then?

Yes.

In terms of your outlook, Theo it just seems that you have two quarters of year over year comp, or year over year declined earnings. And as you know, last year in the third quarter, it was extremely strong with $18 million with vehicle SARs. Where are you seeing a lot of the changes? Is it on the operating margin side? Because we can't see from a quarterly basis the sequential improvements month by month. Is that primarily where it starts to show up now, more in the third quarter?

We expect the continued improvement to show up in the third quarter in the operating margin line and also with current trends continued, in our relative performance compared to the industry in new and used vehicle sales.

Relative to -- because you're going up against really strong industry volume.

Right. And what we see is that we're gaining market share on accelerated basis in new vehicle sales. And we think that that trend is going to continue in the third quarter. So even though we are up against difficult industry comps, for the third quarter of this year, we think that we have an opportunity in the third quarter of this year to outperform the industry.

Okay. In terms of your -- so you're assuming some market gains. In terms of the margins, a lot of your competitors are doing similar initiatives, sacrificing a little bit of profitability to keep manufacturer relations and everything. Both seemed inclined to draw the line at 7%. Like Jeff was saying, you broke through that barrier. Is there a line that you have where you stop at?

Well, I'm not sure that there is a hard and fast number, because we have to respond to the market conditions. So I'm not sure that there is a number that we could point to that this is sort of the level below which we will not go. I don't think that that is our view at least. I would just say generally that the kind of margins that we have today with the exception of a couple of brands we're taking significant market share and are in good position with the manufacturer. So we don't have a need to be more aggressive than we are today. So answering -- all things being equal, we don't need to -- if we were looking at the second quarter of this year 2003, we wouldn't need to take those margins to 6.5% to meet our manufacturer's objectives. We're already meeting those objectives. And in virtually in all cases exceeding those.

Final questions, prime lending that seemed to impact you guys greater over the last several quarters, is that part of the reason that you're a little bit more optimistic? Have you gotten Some [INAUDIBLE] lenders back In the used side of the business?

Yes. That's one of the reasons that we're more optimistic about the used vehicle sales part of our business, is that we are finding capital for consumers purchases of used cars. That is a reason that we're more optimistic. And we are also seeing some of the captives who are a significant source of financing, both in new and used cars being somewhat more aggressive as they improved the quality of their portfolio and have an opportunity now to reach a little deeper to try to support their franchise dealers.

Thanks.

Thank you, jerry.

Once again, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone key pad. We'll pause for a moment to recompile the q-and-a roster. We have a final and a follow-up question from the line of Michael Millman with Millman Research.

Thank you. Could you help us better understand the service and parts by possibly give us the unit PV based upon domestic, based upon import, luxury, and maybe even split between car and truck and also add to that the CPO unit? And then maybe you can explain a little bit -- I didn't quite understand that Ford opened a depot, a parts depot in competition with you? Is that something that --

This is Jeff Rachor and I'll try to address those questions. First off, I'm afraid I don't fully understand the term pv.

Present value.

We don't have a metric that enables us to identify a present value of future service business. Again, the best way to track that would be to look at our comps. We do have a number of internal metrics just measuring repair order count and gross margin on each of the different business classes or labor classes within the service departments of the dealership. But what I would recommend is that we do a follow-up call. If you have specific questions, we could get you some more detailed information on the service question. Secondly, on the parts depot. Again, we had a very, very large wholesale parts operation at Lone Star Ford in Houston. And Ford Motor Company essentially had never had a presence there with their own distribution center. So our dealership effectively acted as a warehouse, if you will, or a regional distribution center, selling parts to a number of other local Ford dealers. And when Ford came in and invested in their own distribution depot, then obviously it was equally as convenient and in fact more convenient and more competitive for those dealers to purchase parts from Ford. Accordingly we saw our sales rate drop dramatically, literally overnight. So that has had a significant impact on our overall parts sales comps. And it will take us several more quarters to completely work through that situation, in that isolated dealership.

Is it unusual for a manufacturer to come in and compete with its customers?

I think what is unusual was that Ford did not have a depot there and we were able to, for many, many years, operated the distribution center for Ford dealers. So that was really what was unusual. It was not typical that Ford wouldn't have distribution in a market of that size.

I see. Thank you.

Thank you.

Gentlemen, at this time, there are no further questions. Do you have any closing remarks?

Thank you everyone for your participation.

This concludes today's conference call. You may now all disconnect.