Sonic Automotive Inc (SAH) 2003 Q3 法說會逐字稿

Welcome to the Sonic Automotive third-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this call is being recorded today, October 28, 2003.

At this time I would like to refer to the Safe Harbor statement for the Private Securities Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information, or expectations about the company's products or markets, or otherwise make statements about the future. Such statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These risks and uncertainties are detailed in the company's filings with the Securities and Exchange Commission. Thank you.

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

Welcome to our third-quarter 2003 conference call. I'm Theo Wright, the company's president. Joining me on this 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 will cover financial highlights briefly, industry trends, and our strategic initiatives, then turn the call over to Lee Wyatt to cover financial information in greater detail, followed by Jeff Rachor to cover operating highlights.

Earnings per share for the quarter were 41 cents, compared to 73 cents for the same quarter a year ago. After considering the impact of costs associated with refinancing of our subordinated debt, as detailed in our press release, earnings for the quarter were 64 cents. On a comparable basis, earnings per share were down 10 percent, compared to the quarter a year ago; and 6 percent compared to the second quarter of 2003.

The positive trends in performance we experienced in the second quarter of this year did not continue in Q3 of 2003. We will comment extensively on both why positive trends did not continue and our plans to return to a higher standard of performance. Our company has consistently communicated its intention to grow market share and our willingness to sacrifice current margin to ensure the long-term growth of our business. In particular, growth in our highly profitable service and parts departments, as well as continued support for our acquisition strategy by manufacturers.

The trend in our same-store sales performance versus the industry has been positive for the last several quarters. With our luxury and import (technical difficulty) this strategy has been successful and is delivering the desired results. In the quarter we outperformed the industry in new vehicle same-store sales in luxury and import brands, with a same-store new vehicle sales increase of over 14 percent, and an increased same-store profit contribution of 5 percent with these brands. We sacrificed some margin, but overall grew the profits in units and operation to benefit our service and parts business in the long run.

Our performance in the domestic volume lines, most notably Ford, Chrysler, Jeep, and Doge, diverged sharply, and the divergence was even greater than in prior periods. With these brands we underperformed the industry in same-store (technical difficulty) and profits declined more than sales. Our performance in these brands is largely responsible for the shortfall from expectations.

Automotive retailing is a difficult business, but simple. We have long maintained that the keys to our business are quite simply products and people. People meaning qualified store-level personnel. In our domestic stores, we aggressively managed our inventory days supply, and in many cases cut off shipments entirely early in the year. We also aggressively wholesaled new vehicle inventory to other dealers.

We did a great job of getting our inventory days supply down; in fact too good a job. As model changeover approached and systemwide inventories declined in domestic brands, we found ourselves with little high-quality salable inventory. We still had an adequate supply of undesirable productlines. Our inventory offering was not competitive in the marketplace. This contributed to compression of margins, excessive sales compensation, and sales shortfalls. These sales shortfalls were on top of the sales declines these brands are experiencing in the market as a whole.

As an example, in September we had limited inventory of 2003 F-150 trucks. With huge incentives on the 2003 models, these vehicles sold well overall in the market. We were forced to compete with aggressive 2003 model pricing with our 2004 model inventory. To quantify the difference between our inventory position and the market, at September 30, F-series days supply for the industry, using selling days, was 75 days. At September 30, our days supply for F-series, using selling days, was 39 days. At September 30, our overall new vehicle days supply was 36 days, versus 55 days for the industry.

As we have examined our domestic brand dealerships over the last several months, we have also identified weaknesses in our people. Because of a growth strategy focused on import and luxury brands, we have unintentionally starved our domestic brand dealerships of the best quality people. As an example, with a high-quality promotion candidate we have been more likely to direct that person to an import-branded dealership.

Virtually all of our regional operating personnel have a background principally in import-branded dealerships. We do not have the quality of personnel in all of these domestic-branded dealerships to deliver a quality performance. In addition our domestic-branded dealerships are concentrated in some of our more challenging markets in Ohio, Oklahoma, and Texas.

Over the last several months, we have worked to improve our inventory mix at our domestic dealerships and have already improved our position. We have relaxed our inventory guidelines in these dealerships, to enable ordering to support a normalized selling rate, while continuing to manage down our days supply of slow-moving products. We expect to have domestic brand inventories in good shape by the end of Q4 2003, although total days supply of new vehicle inventory will likely increase. Over the course of the fourth quarter, we will become better positioned to compete in the marketplace with these brands.

Our personnel challenges will take longer to address and are likely to persist into early 2004. We have taken the most important step in recognizing these challenges, and acting quickly to address deficiencies. Mr. Rachor will have further comments on this area.

To comment on industry trends, the new vehicle industry performed well, with unit volumes down only 2 percent against a tough comparison in the quarter a year ago. Incentive spending levels continue to be high with no signs of abating.

Changes in currency exchange rates have not had an impact on pricing to date, and we do not anticipate significant pricing changes at current exchange rates.

We expect industry sales levels in the 16 million unit and above SAR range for the remainder of the year and all of next year. A number of new model introductions are underway which are benefiting our gross margins and provide continued sales momentum for the industry. Examples include the Cadillac SRX and XLR, and the BMW 5 series. Average prices per unit sold continue their long-term upward trend. A notable example is our Ford dealership; price per vehicle sold rose $869 a unit from a year ago. The strongest brands and performance trend for us were Honda, Toyota, Nissan, Lexus, Volvo, and Infiniti.

Markets that performed well during the quarter included North Carolina and South Carolina, Georgia, Tennessee, Washington D.C., San Diego, Las Vegas, and Dallas. The San Jose Silicon Valley market area actually showed an increase in new vehicle same-store sales for the quarter of 17 percent. The Northern California area was up in new vehicle same-store sales, over 10 percent. Our weaker markets include Alabama, Florida, Ohio, Oklahoma, and Houston. Weak performance was more indicative of brand mix than market conditions, consistent with our comments last quarter as well.

Our sales in California are off to a slow start for the quarter. It appears the vehicle transfer tax recently enacted is putting downward pressure on sales. Dealers and manufacturers are responding to the issue through incentives; and marketing and sales in California have improved over the course of the month. We also have several dealerships shut down in Southern California due to fires.

Used vehicles continued their trend to more stable conditions, with wholesale prices firming and credit availability stabilizing. We do not expect a sharp improvement in used vehicle retail sales. However, we do not anticipate further deterioration. One market with a high dependence on subprime financing, Oklahoma, was responsible for virtually all of our decline in used car sales on a same-store basis for the quarter.

Service and parts growth reaccelerated in the quarter, reflecting the benefit of a number of our initiatives, as well as the anniversary of a number of negative events affecting our service and parts operations. On a same-store basis, service and parts gross margin dollars increased nearly 5 percent, in line with our long-term expectations. Warranty as a percentage of service and parts revenues has held steady, at just over 20 percent of total service and parts revenues. Our investment in new and enhanced facilities, additional capacity, is benefiting our service and parts business currently and in the long-term.

To comment on acquisition activity, we continue to pursue a small number of acquisition transactions with a continuing emphasis on luxury and import brands and improving the position of our Chrysler, Jeep, and Dodge stores through Project Alpha. Divestiture activity is minimal.

Our earnings targets for the full-year 2003 are from $2.20 to $2.25, excluding the effects of a cumulative effect of accounting change in retirement of debt. Our targets for the remainder of 2003 are based on a SAR of approximately 16 million units for Q4, and our expectation that we will continue to modestly outperforming industry overall in new vehicle sales. Used vehicle same-store sales for the quarter down 3 to 5 percent. Service and parts same-store sales increases of to 2 to 4 percent. Finance and insurance per unit unchanged from Q3 2003. No share repurchases, acquisitions, or divestitures beyond those announced today.

For 2004 our earnings targets are from 265 to 285. These targets are based on the same basic assumptions as just described above, except used vehicle same-store sales that we expect to be up 2 to 4 percent for the full year 2004.

The company was pleased to announce today approval of a dividend of 10 cents per share for the fourth quarter of 2003. This dividend amount is unchanged from the third quarter. It is a pleasure to be able to return cash to shareholders in the form of tax advantaged dividends. We expect to recommend to the Board dividend payments in future quarters. Now I will turn the call over to Mr. Wyatt. Lee?

Thank you, Theo. The net income reported for quarter three included charges related to the early retirement of our 11 percent subordinated notes, related to the call premium and the write-off of debt issuance costs and discounts. This equaled 21 cents per share. The net income also included incremental interest cost during the thirty-day call period on the notes; and that equaled approximately 2 cents per share.

Quarter three of 2002 included a 2-cent per share gain on the repurchase of debt. The benefit of the new bond issue should be approximately 5 cents per share for each of the next five years.

During the quarter revenue grew 5.3 percent. New vehicle growth was 6.8 percent. Used vehicle growth was 1.3 percent. Parts, service, and collision grew at a 7.6 percent rate; and F&I per unit was $863. Gross margin declined to 14.8 percent from 15.2 percent last year, with new and used vehicles declining to 6.8 percent and 11.1 percent respectively, compared to 7.6 percent and 11.3 percent last year. The new vehicle margin rates reflect our strategy to grow market share through aggressive pricing. Parts, service, and collision gross margin rate improved 60 basis points, to 48.1 percent. In total, gross profit grew 2.5 percent in the quarter.

The SG&A rate as a percentage of gross margin was 79.6 percent in the quarter, compared to 78.8 percent in quarter two, and 76.4 percent last year. The SG&A spending reflects a $4.8 million spending rate increase in selling compensation and advertising aimed at growing the dealership volume. This spending had mixed results, as will be described more fully.

The SG&A spending also reflects 1.8 million in rent and facilities related expense increases, for existing and remodeled and relocated stores. Much of this is an investment to create capacity for growth, attract new customers, and foster better manufacturer relationships. The spending also reflects a $1.6 million reduction in fixed compensation for support and fixed operations in the field. This is the result of previously announced cost reduction programs.

Other SG&A increases include 4.2 million in fixed expenses for acquired stores; and 3.5 million in variable expenses due to higher gross margin dollars. Non floor plan interest expense was flat with last year, with the current quarter including a $700,000 or 2 cents per share impact of negative interest carry during the thirty-day call period for the retired 11 percent notes.

Our tax rate was consistent with prior quarters at 36.1 percent. Our diluted share count for the quarter was 43 million shares, versus approximately 42 million in quarter two; and reflects an increasing stockprice, increased dilution from stock options, and modest share repurchases. This increase in fully diluted shares reduced quarter three EPS by 1.5 shares from quarter two. During quarter three we repurchased 221,000 shares at an average price of $26, leaving $20 million remaining under our Board repurchase authorization.

Our balance sheet management remains consistent. The quarter three balance sheet reflects a debt to ratio of 49.5 percent, and a net debt to capital ratio of 48.1 percent. These ratios are within our stated 50 percent target. Availability under our revolver is $147 million, with 35 million of cash on the balance sheet at the end of the quarter.

Days supply of new vehicles was 45 days; used vehicles were 38 days; and parts were 47 days. Calculated on a selling days basis, the day supply for new vehicle would drop to 36 days; and again we think this is industry-leading inventory management.

We continued to meet all covenants under our credit agreement. And excluding onetime charges, interest coverage for the quarter is 5.5 times. Long-term debt to EBITDA is 3.2 times; and return on equity is 14.5 percent.

Capital expenditures in quarter three were $13 million. We expect over 50 percent of these to ultimately be recovered through sale leaseback transactions. During the third quarter we received $12 million in proceeds for sale and leaseback transactions. Year-to-date cash from operating activities was $86 million.

With that, I will turn it over to Jeff Rachor, our Chief Operating Officer.

Thank you, Lee. I will be reviewing the company's operating performance by productline. First, new vehicle revenues were up 2.9 percent versus third quarter 2002, on a slight increase in new vehicle unit volume. As previously stated, our luxury and nonluxury import dealerships validated our sales growth strategy, by taking market share, posting a combined 14.2 percent increase in new vehicle revenue versus 2002, while domestic stores lagged with an 8.4 percent decline in new vehicle revenue versus prior year.

The company's focus on sales growth, a competitive marketplace, and unfavorable domestic merchandise mix continued to put pressure on new vehicle gross margins, which declined to 6.8 percent from 7.6 per cent in third quarter 2002. While we are committed to aggressive pricing and strategic dealerships to grow market share, we have already made adjustments in the broader organization which are yielding sequential improvement in new vehicle gross margins. In September gross margin in new vehicles increased to 7 percent through yesterday; that positive trend is continuing in October.

Used vehicle revenue was down 3 per cent versus third quarter 2002 on unit volume that performed consistent with the industry, with stable gross margins. Sonic's initiative to grow manufacturer certified preowned or CPO used vehicle sales continued its momentum, recording a 67 percent increase in units for the quarter, compared to a 9 percent increase for the industry. Last year CPO sales made up 17.2 percent of Sonic's total vehicle used retail sales, versus 29.2 percent in the third quarter of 2003. Wholesale pricing stability and continued disciplined management of used vehicle inventories led to a 46 percent decrease in used vehicle wholesale losses for the quarter.

Strong performance in certified preowned sales had an impact on finance and insurance income, which was down $33 or 3.8 percent versus third quarter 2002. CPO vehicles include an extended factory warranty as part of the vehicle purchase. This extended warranty component would normally be offered as a product in our finance and insurance departments. The net effect is very positive; 67.4 percent of every used vehicle sold in a Sonic dealership is covered by an extended warranty. This supports our strategy to drive future high-margin service parts and collision repair business.

Fixed operations continued their robust performance, as sales increased 3.6 percent versus third quarter 2002, and total gross profit increased 4.8 percent. Combined service, parts and collision repair gross margin increased to 48.1 percent versus 47.5 percent in 2002. Total service sales increased 6 percent; while total service gross profit increased 6.9. Gross margin in service increased 56 basis points.

Technician productivity is up 6 percent versus a year ago. While significant investments were made in facilities, resulting in higher fixed cost, fixed absorption was actually up slightly in the quarter; and service sales in our new facilities were up 15 percent for the quarter. Parts sales were up 2.4 percent; while total parts gross profit was up 2.3 percent for the quarter on flat gross margins.

Consistent with our previous communication over the past several quarterly conference calls, Sonic has remained committed to our strategy to grow retail volume, take market share, and improve operating performance while creating and installed customer base for units and operation to drive future high-margin parts, service, and collision repair business.

In Q3 2003 our aggressive pricing posture on new vehicles created a decline in total new vehicle gross profit, contributing to higher SG&A when measured as a percentage of gross profit. This compounded the expense conditions in advertising and variable compensation. It should be noted that our second-quarter headcount reduction initiatives are working as clerical, supervision, and fixed operation personnel expense showed significant declines in the quarter. Moreover, employee productivity is up, with employee turnover continuing on a downward trend.

Once again our focus on growing market share led to a conscious increased investment in marketing and sales incentives. This strategy earned strong returns in our import and luxury lines, both significantly outperforming the market in sales. Top-line import growth propelled increased total gross profit, offsetting the incremental SG&A, resulting in strong probability growth in these dealerships.

However, we failed to capitalize on the same strategy in our domestic stores. Despite heavy investment in both advertising and sales compensation, our portfolio of domestic stores did not generate increased volume or gross profit, leading to high SG&A as a percentage of gross profit. This was largely due to a non-competitive merchandising mix and local management execution in some select markets.

Evaluating the operating performance in Sonic dealerships requires differentiation on a brand by brand, market by market, and dealership by dealership basis. We will continue our pressure on growing volume and share in markets where we see a growth opportunity through strategic investment in pricing, marketing, and sales incentives. Conversely we are implementing targeted adjustments to our operating model in select dealerships to improve gross margin and control SG&A expense.

In addition, we have reallocated senior-level resources to put intensive focus on supporting improved performance in our domestic dealerships. This includes centralized inventory planning to rebuild a competitive inventory balance, marketing assistance, and on-site training. Moreover, we are realigning the field management structure to better support the geographic concentration of our domestic dealerships.

Finally, personnel development and recruiting efforts have been redirected to make our domestic dealerships' needs the highest priority. In summary our operating strategy's execution has been exemplary in both our luxury and non luxury import brand stores. I am confident that through management's targeted intervention and human resource realignment, domestic dealership performance will begin to show improved sales and profitability over the next several quarters. That concludes our prepared comments today; and at this time management will be glad to field questions.

(OPERATOR INSTRUCTIONS) Rick Nelson with Stephens.

How much revenue are we talking about, Theo, with these lagging Ford and Chrysler dealers?

Domestic revenue represents approximately (technical difficulty). I'm sorry, can you hear?

I can hear; there is another line open, I think.

Domestic revenues in total represent 45 per cent of our total. That includes Cadillac, which historically we have actually done quite well with. But for the quarter on a same-store basis, Ford was 13 dealerships representing 330 million in sales. And then our other brand that has been the most challenging, Chrysler brands represented 112 million in revenues. We don't have Chevrolet broken out separately from Cadillac; but GM represented 262 million in total sales for the quarter on a same-store basis.

Was all of the shortfall from plan confined to these (technical difficulty)?

Yes, overall the shortfall was entirely related to these dealerships. I am sorry; I read the 2002 column; let me give you the 2003 numbers. 96 million with Chrysler; 284 million with Ford; and 247 with GM, and that actually does include Cadillac. But yes, the answer is the shortfall is on an aggregate basis entirely in these brands.

Can you talk about your inventory targets that you have in mind for these domestic dealers?

Yes, we can. What we have done is take a look at the information that the manufacturers provide us on market share; and evaluated what our market share position should be. We are trying to build inventory levels so that we have a sixty-day supply of inventory based on what we believe are a more normalized selling rate for these brands.

That is also done on a productline basis, where we have struggled. As an example that I gave with F-150 is, overall, our days supply with Ford was in line with our target; a little inside of our target actually. But that represented an excessive days supply in a number of undesirable products, and a shortage of inventory in some of the commodity type products like the F-series.

So what we have done is not change our standard, which is sixty-days supply. (multiple speakers) I'm sorry there is someone who is on an open line; if the operator could close that line? Excuse me. We are targeting a sixty-days supply, the same as we have in the past; but not on our historical selling rate, but rather selling rates that we anticipate we should be able to achieve in those dealerships. So that we have a competitive mix of inventory.

(multiple speakers) the year-over-year revenue changes in those domestic dealerships; can you share EBITDA or some sort of profit numbers for the quarter and the prior year?

We want to be a little careful about ending up in a position where we are reporting separately on domestic and imports. However, I can share that the domestic brands were down, as we said, over 8 percent in sales, 8.6 percent. And the profitability performance was considerably worse than that, down about 30 percent. As I said, that does explain essentially all of our shortfall versus expectations.

(inaudible) You were going to fall short of the First Call?

I'm sorry I couldn't hear that question.

(technical difficulty) did it become evident that you were going to fall sort of the First Call estimate? And why didn't you put out a preannouncement?

We have established a practice of providing annual guidance as opposed to quarterly guidance. It was not evident that we are going to fall short of our own guidance for the full year until we completed September.

September was considerably worse than the prior two months?

Yes.

How about October?

Preliminary indications are that outside of California the trends in October are much better than in September; although we do have the issues that we have discussed in our prepared comments in California. Although the issue of the vehicle transfer tax does appear to be abating somewhat.

Thank you.

Ross DeMotte with Sidwood Capital.

Theo, a couple months ago you were able to talk in terms of ROI for stock repurchases at different stock prices; and then compare this to sort of ROIs of acquisitions. Can you sort of review where you are on that?

We are going to continue to evaluate the respective returns on investment for acquisitions versus share repurchases. As a general rule we have said in the past that as stock prices trend down towards $20 per share, at that point share repurchases become, relatively speaking, more attractive.

We have not looked at the breakeven recently versus acquisitions. But that breakeven has historically been around $18 a share. We also have to consider the amount of capital that we are going to devote to acquisitions, managerial resources, and other considerations. So we will be carefully evaluating share repurchases over the next quarter.

As a follow-up, can you give a little color on what you're seeing in the acquisition environment out there? Are there plenty of deals to be done at the (inaudible) where you like to do deals at?

We have seen a very consistent acquisition market over the last several years. We do see many acquisition opportunities at multiples and potential returns on investment that meet our criteria. We have not seen any significant change in the acquisition environment.

Okay, thanks very much.

Jordan Hymowitz with Level (ph) Advisors.

We have talked about this in the past, but at what point are you going to basically turn off the acquisition spigot, and focus just on improving the operations that you have? You have grown the most through acquisitions than anyone, and it has resulted in the lowest P than anyone. There's really no reason you guys should not sell at a low double-digits P, except the acquisitions keep (technical difficulty) issue. So I guess, can you give a declarative statement on what your acquisition policy is in the near future?

Yes, I think we can; and it was reflected in my comments. Our acquisition activity, beyond what has been announced, currently is minimal. That would be the first statement. A handful of transactions that are in late stages of negotiation. Beyond that, we have little acquisition (technical difficulty). Our longer-term targets for growth through acquisition, in the 10 to 15 percent range; which will mean that acquisition growth in the future will be at a much lower rate on a percentage basis than in the past.

So to answer your question, short-term we are not shutting off acquisitions completely; because we have some transactions in process. In the medium-term, over the next six to nine months, there will be little acquisition activity beyond what I just described. Longer-term we anticipate a slower growth rate through acquisition than we have achieved in the past; more in the 10 to 15 percent range.

Darret Wanger (ph), Jefferies and Company.

Just some (technical difficulty) detail. I will give you the questions first. The pretax impact of the early retirement of the debt, both the loss and gain on the retirement and the extra interest? Then the capital expenditure level for the quarter, and the outlook for the entire year? Then just the number of shares outstanding, A and B.

The pretax cost of the 11 percent note retirement was a $10 million call premium and 3.9 million in the non-cash write-off of debt issuance cost and discount. The pretax cost on the interest, the thirty-day negative carry during the call period, was around $700,000.

CAPEX for the quarter was $13 million. And we anticipate that the majority of that or well more than 50 percent will be recaptured through sale and leasebacks. We still think that maintenance capital for the entire year will be in the $25 million range.

(multiple speakers) And the share counts on the A and B, and then (technical difficulty) shares?

I am sorry; we were having a hard time hearing the last part of your question, could you repeat that?

Yes, the share count; the amount of shares outstanding for both the A and the B shares.

We will have to get back with you with the A and B shares separately. The fully diluted share count was 43,022,000 shares.

Was the primary the same?

Primary 40,926,000 shares.

Okay. Just to reiterate, the capital expenditures for the year, I appreciate the 25 million of maintenance; but what will the entire figure be?

The entire figure would be, before sale leaseback transactions, would be more in the $50 million range, $60 million range.

50 to 60 million for the calendar year '04?

Yes; '03.

'04, do you have an outlook?

Will be similar.

Okay.

Year-to-date proceeds of sales of property and equipment are $26 million.

Okay.

Adrienne Dale (ph) with CIBC World Markets.

I have a few different questions. First of all, in terms of your expectations for 2004, do you have a breakout in terms of the year-over-year change for import and luxury versus domestic vehicle sales?

We do not have a breakout in our forecast, domestic versus luxury.

In terms of your expectations for used vehicle sales, you have already commented on volume; but could you comment on pricing going forward?

We expect used vehicle pricing to be flat. So we forecasted used vehicle pricing to be up just a few percentage points; and overall same-store sales up 2 to 4 percent for 2004. So a portion of that increase is price.

In terms of rents, I think I heard you say that rent was up a bit. What was the exact number for the quarter? And what is your estimate for the year?

Total rent and utilities and property tax related for the quarter was up in absolute dollars $1.8 million.

So what was that total? What was it last quarter?

I'm sorry; what was that?

You said it was up 1.8 million.

Yes, for the quarter.

Versus last year?

Yes.

And what was last year's?

Last year in the third quarter, rent was $17.2 million; and this year it was 19.5, but that includes acquired stores. The 1.8 million rent increase that I gave you in my comments was excluding acquired stores. It was just the incremental rent.

So then do you have any expectation for the full year and for full year '04?

If you will bear with us while we get the detail of the rent forecast for '04. Have to turn some pages here to find it. We are going to have for the full year, 93 million approximately. For the full year '04. That does include acquisitions. So we would have to give you a breakout on a same-store sales basis, which is a little more detail than ordinarily we would provide.

We don't give a line item forecast. But essentially what we are reflecting is the impact of acquisitions, as well as a number of other completed facilities projects that we expect for 2004. Again, we don't give a line item forecast by expense item.

In terms of your new dealerships you either agreed to purchase or close on in third quarter, could you discuss some mix there? The brand mix.

Yes. The brand mix there, we closed on two Volkswagen stores; one Hyundai; one Mercedes; one BMW; and two Saturn stores in those acquisitions. In terms of a brand mix, predominantly import branded and Saturn. Those are actually the first Saturn stores that we have acquired. And in operating characteristics, Saturn stores tend to more closely track import branded stores as opposed to domestic branded stores. They are a unique brand, although they are domestic.

Okay, great. Thank you very much.

Jeff Black (ph) with Lehman Brothers.

I agree with Theo's earlier comments that the business is pretty simple. But I think it all boils down to expense management. Therein lies the problem here. Your comments about the staffing levels at domestic stores, coupled with the recent acquisitions, lead me to believe that this could be high for a couple of quarters. What are your targets for SG&A expenses as a percent of gross in the near-term? Where would you like to be? Where do you consider that ratio of success? Over what time frame do you think we can get there?

In the fourth quarter I think we are seeing a consistent SG&A rate with the third quarter. I don't think we will see significant improvements there. The other impact here is on SG&A as a percent of gross; obviously as our gross profit. And we will see improvement in that rate as we drive higher gross profits on, for example, new vehicles.

We are actually seeing some improvement in rate in new vehicles for September. And initial indications are we may continue that, or should continue that into October. We will get some improvement in the rate just through better gross margin rates on primarily new vehicles.

We are doing some things in the short-term to reduce SG&A. We have talked about those. We are seeing reductions based on the previously announced programs, in terms of the fixed comp in the field, as it supports the back office and fixed operations.

Long-term we are going to takedown SG&A through standard pay plans and around variable compensation. About 60 percent of our expenses in total are compensation related; and the largest piece of that are variable comp in the field. So we need to -- and we are working on this at this point; we are reviewing and driving a program to develop standard pay plans in the field. But that is a six-month, even though we are working on it now, that is a 6 to 18 month time frame before we really see that fully take hold.

But long-term it is around fixed pay plans in the field. We think a rate at 77 percent, 77.5 is a reasonable rate, once we get standard pay plans.

Just to follow on there and to make sure that we are clear, we are not anticipating a significant decline in SG&A as a percentage of gross profit in the fourth quarter of this year. One factor that has to be considered also is seasonality, as volumes generally decline in the fourth quarter. And therefore fixed expenses as a percentage of total expenses increase. So we are not overall expecting a decline in SG&A expenses as a percentage of gross in the fourth quarter this year.

We expect a trend of improvement to commence in the early part of 2004; and have reflected that in our estimates for the full year 2004. But we don't anticipate returning to what we would consider acceptable levels of SG&A performance until the second quarter of 2004.

And again, not to harp on it, but what is holding you back in these first couple of quarters? We have seen the 7 percent headcount reduction. We've seen a couple of things go on. Is it all related to the domestic store problem?

It is all related to two phenomena. One is the domestic store problem. That is the vast majority of it. And the remainder is the decline in gross margin. If expenses are the same and gross margins on new vehicle sales decline, then expenses as a percentage of gross margins increase.

There are a number of mechanical reasons. I think we could spend some time with you off this call explaining some of the mechanical reasons through pay plans that occurs. The principal one being what are referred to as mini commissions or flat commissions on low gross profit sales of new vehicles.

But as gross margin on new vehicle sales has declined, those expenses have risen as a percentage of gross margins. And the cure for a lot of the issue that we face with SG&A is to increase the gross margins, not necessarily reduce the expenses.

Great, thanks a lot.

Scott Stember with Sidoti and Co.

Could you maybe just talk about -- you made a comment earlier that there has been some issues, that some of the better talent as you said has been focused more on the import and the luxury stores. Could you talk about how that has actually, or the lack of these people on the domestic side, has actually hindered you? Is this through basically inventory management? You specify that you were underprepared in some of the higher performing brands. Can you maybe qualify that?

The real phenomenon that is being driven there is related to our rapid pace of growth. As we have grown, we have a philosophy to first look to develop and promote personnel from within. As we have acquired additional dealerships, we have identified high-performing managers at the dealership level, and other key personnel, that we have promoted or rewarded with additional responsibility in the dealerships that we have acquired.

Many of the recent acquisitions are obviously in the import stores. And there is another phenomena that occurs when you have a change in management of any kind. And that is that in the traditional culture of the retail automotive business, that the change of one key manager often leads to additional employee turnover, a change in elements of the sales process, a change sometimes in compensation structure, and it can also impact inventory management, and marketing strategy, and message.

As Lee indicated in his comments, over the longer-term the fix for that is a continued shift toward standardization in terms of process and compensation plans. Those are some of the elements that contributed to the underperformance in our domestic stores.

Can you maybe mention, we talked about inventories and other controls on a localized basis. How much is controlled centrally? And how much responsibility is given to the individual branches? Can you just (inaudible) give a rough guidance?

First off, all inventory ordering has to ultimately be executed at the individual dealership. That is a manufacturer's policy. However, we now have tools in place, and have had for sometime, the ability to monitor and analyze inventories for each and every dealership on a weekly basis. And do that on a by-model basis. We also have reasonable visibility on pipeline.

What we have done since identifying this overcorrection in our domestic stores' inventory that created the non-competitive merchandise mix is taken our domestic stores, and a handful of other dealerships, and put them on an order-planning process, whereby corporate management resources participate in the approval and forecasting of future inventory needs.

As Theo indicated, right now we are focused on disciplined rebuilding of those domestic inventories, to give us a competitive inventory mix and adequate inventory levels to grow our sales rates to what market potential really is in those markets.

I'm not sure whether you mentioned this or not, but on the used side of the business, what were the gross margins this quarter versus last year?

In the used vehicle business, gross profit per unit was down $71 or 4 percent. However, wholesale losses were down sharply from a year ago. And overall, our used vehicle business produced an increase, a net increase in gross margin dollars of approximately $1.6 million.

So we were down 4 percent in used vehicle gross margin at retail; but our wholesale losses on used vehicle sales were down 49 percent, $1.7 million. So if you look at the used vehicle business in its entirety, we actually had an improvement in our margin performance in used vehicles for the quarter compared to a year ago. And I think that is consistent with a lot of the industry information that is available on the pricing environment at auction for used vehicles. Information available from Mannheim and Odessa (ph) .

Thank you very much.

Nate Hudson, Banc of America Securities.

On the inventory issue at your Ford stores, how much of that was simply a shortage of the old F-150s? And how quickly can you rebuild the inventories of the new one? Are you taking them in significantly faster than you're selling them at this point?

We are taking them in faster than we're selling them at this point. That would be a normal seasonal trend in any event. I think that given the domestic manufacturers penchant for overproduction, we believe we are going to be able to get our inventories in good shape by the end of this quarter; and have already improved our inventory position from where it was during the third quarter of this year.

We do continue, though. to carefully monitor those orders to ensure that we don't end up in a situation where we have excessive day supply in those models that are not selling well.

Is the F-150 the crux of the issue at the Ford stores? Or was it broader than that?

It was broader than that. I chose F-150 as an example simply because I had good industry information available on the F-series as a productline.

What was the impact of the gross margin of the domestic stores due to the shortage of the good inventory? Did you actually get better margins because you had a shortage? Or was there some effective negative impact on that as well?

We did not get better margins as a result of the inventory shortage.

Were your domestic margins down considerably more than your overall margins?

They were down more than our overall margins. I think that is reflective of the fact that we were selling undesirable inventory. We did have inventory on the ground, it is just it wasn't the best inventory; and therefore we took low margins. Our Ford dealerships actually saw the sharpest decrease.

It looks like the timing on some of your acquisitions may have slipped. Is that just purely a timing issue? And when do you expect the bulk of the 800 million you announced at the end of July to close?

Our current forecasts presume that those acquisitions close sometime -- the majority of those acquisitions close sometime during the first quarter of 2004. So there is no impact in 2003 in our estimates; and minimal impact in the first quarter of 2004.

Thank you.

Mark Fife with EnTrust.

I want to get back to this as a people question again; about the people you have on the dealership floors. You said you need to replace some of these people. So my first question is are you finding qualified people to replace them with? Where are you finding them?

My second question is, obviously, putting the right people in the right seats are one of the most important things senior management does. So what changes are you making at the senior management level, to make sure that you're putting the right people in the right places?

I'll be glad to take that question. First off, in addition to absolute replacement, in many cases we are just realigning management, to come up with a better fit in terms of skill set and experience and position, brand, market, etc. But we are focused on identifying high-caliber personnel with domestic experience, both internally and externally.

You're absolutely right, senior management’s involvement is critical. I am expanding a large percentage of my own time, as well as engaging my most senior divisional vice presidents' and regional vice presidents' support in an aggressive recruiting campaign, both internally and externally, to identify candidates that can add management horsepower; particularly in those domestic dealerships.

Oftentimes it is not that we have absolute quality problems with our management in these stores. But it takes a certain amount of time for them to acquire adequate experience. And again over time through our aggressive growth, really over a period of several years, we have called on a number of our original domestic stores to provide qualified management candidates to support that aggressive growth strategy.

In addition, in our recruiting efforts, both internally and externally, there has been a bias towards our import dealerships historically. Senior management in recent months, having recognized the phenomena that has occurred and the pressure that it has caused on performance in our domestic dealerships, is making recruiting and development of personnel our highest priority in the domestic stores.

In addition, I have recently eliminated a layer of management in the division where we have the highest concentration of domestic dealerships. In the past, I had a layer of management, a divisional vice presidents, between myself and regional managers in Texas and Oklahoma, where we continue to struggle due to a high concentration of domestic stores. I have now added an additional vice president in that area. And the vice presidents in those areas report directly to myself, so that I can get closer to those businesses and play a more significant role in the recruiting and restructuring of human resources in those dealerships.

My last question is about the share repurchase. Theo, you said you're going to slow down acquisitions in 2004. Since in this business I assume the net income pretty much equates to the free cash flow, should we expect more aggressive share repurchases in 2004 than we have seen in the past?

I would say that we are going to continue to use the same analysis tools that we have used in the past, to evaluate share repurchase versus acquisition activity. But presuming that acquisition activity diminishes as I described, it is likely that we are going to be more aggressive in share repurchases in 2004 than we have been, particularly over the last several quarters.

Thank you.

I have a follow-up for Nate Hudson. I got to the right page after you had rung off. Our Ford stores saw a decline in new vehicle gross margin for the quarter from 8 percent a year ago to 6.6 percent considerably worse than the company as a whole and when you combine that with declines in unit volume our new vehicle gross profit in our Ford stores are actually down 28.4 percent. So I do believe that gross margin trends there confirmed the analysis that we have done regarding the quality of our inventory in those Ford dealerships.

Peter Serus (ph) with (ph) Gorilla Capital.

I have been a longtime shareholder so this question is not in anyway meant in a snide way. This is the third time in my memory in the last maybe two years, maybe 2 1/2 years where right around either at the time of the earnings release either on the earnings release or on the conference call, there has been some surprise and that the stock has come down dramatically. I guess what I am wondering is where are we missing here? What is going on that there has been sort of three blowups out of the last 10 quarters? Is it the business, is it the way -- and I guess second question let me just sort of finish up, from these three blowups what have you guys learned that will avoid these things in the future?

The first part of the answer I would give you is that in two of those three cases those blowups as you describe them coincided with what I would describe as significant industrywide changes in sales rate. This quarter would not fit that description but the other two would. I think to a certain extent what you're describing is an industry phenomenon not in this quarter, but in the previous circumstances. The second would be that underlying the issues that we face both in personnel and inventory management et cetera, is the issue of growth and I think there have been some thoughtful questions and comments on that today. But I think that clearly one of the issues that we have become aware of is the rate of growth maintaining a very high percentage rate of growth at a much larger size as an organization obviously puts a great deal of stress on management and our infrastructure. The fact that we have over the last several years had to rearrange our regional oversight infrastructure on many occasions to accommodate growth as well as re-arrange dealership level management structures in many cases which is disruptive, has put a strain on our ability to manage these businesses effectively. In terms of lessons learned if that is what you are looking for I would say that that would be the predominant one. That lesson learned I believe is reflected in the growth rates that we anticipate going forward which should enable us to manage the businesses more efficiently with a lower-level of disruption, lower levels of turnover reassignment et cetera which ultimately lead to disruption.

I appreciate that and I think that is very positive. I just have one comment though. If you look back on the other blowups that we were mentioning they impacted your stock much more than the stock of your competitors. I am not sure I agree that they were industrywide things. I guess my observation is in response to -- I forget who was asking the question maybe it was Rick Nelson earlier -- that you guys maybe have to think about this once a year guidance, and be more communicative so that we do not get to the day of the earnings and suddenly find the stocks down 20 percent or even up 20 percent. But rather that we get to understand a little better what is going on.

We certainly appreciate that commentary and it is an issue that we have struggled with historically. We have given quarterly guidance. There are advantages and disadvantages of both, but it has been our view that given the regulatory environment and the environment of securities litigation, as well as the inherent volatility in our business and automotive businesses general, it has been our view that we are best served by providing annual guidance but we will certainly consider your input and the input of others in evaluating that position.

Thank you.

Jerry Marks with Raymond James.

I just had a quick question, the 800 million that you had announced at the end of July, you said now you are expecting the bulk of it to come in Q1 of '04, is that correct?

In Q1 of '04, yes.

You guys gave a number in the press release in terms of how much you have acquired but out of that 800 million, how much remains from that announcement in the press release for you to still close on?

Approximately 550 million of the total.

Okay. So I mean I guess from looking at your debt levels didn't really increase and kind of (indiscernible) coverage and everything, have you given any indication regarding the debt/equity mix and how it is going to play out with the remaining 550 million?

We do not anticipate any change in our debt equity mix over the next several quarters. We may go from 48 percent net of cash to 51 percent but we don't expect any significant change in our mix of debt and equity.

So I guess when we are plugging it through in our forecast to kind of target that 50, 51 percent level and the remainder I guess we would assume would be in increasing share count? Would that be the way to look at it?

The transactions do include issuance of additional shares. The transactions we announced do include the issuance of additional shares so there would be additional share count and additional equity upon completion of those transactions. We don't anticipate our net debt-to-equity position to change significantly.

Okay. It sounds to me like maybe you got a little bit too much control in the third quarter over some of the dealerships and now you are loosening that up. It also seems that the industry environment could be a little bit more difficult when we head into the fourth-quarter. What specifically what controls are you loosening up to allow your managers to not under-order vehicles and what controls are you keeping in place?

I would say that we didn't over-control inventory. I would say that we didn't do a good job of managing the inventories. Our targets and guidelines were correct, its just we did a poor job of managing the mix of the inventory. We did a great job of managing the overall day supply but we didn't manage the mix of inventory well. Our response actually is somewhat higher level of centralization and control where in these dealerships we are not only directing the dealerships to potentially reduce orders if they have an oversupply in the productline -- if they are under-supplied we are directing them to increase their orders of inventory so I would not say that we are loosening controls. Rather we are taking the same controls and trying to use them effectively to ensure that we have an adequate supply of commodity type inventory.

Thanks.

Ross DeMotte with Sidwood Capital.

You mentioned particular weakness in used in Oklahoma and that that was related to the subprime or that product a lot of it goes subprime. Is there something specifically going on subprime either in the financing environment or specific to Oklahoma that you can talk about?

The availability of capital for the subprime market has been a challenge over the last, really the last year and a half. In fact that situation has stabilized over the last several quarters but compared to a year ago subprime financing for consumers is somewhat less available. And Oklahoma particularly in Tulsa for demographic reasons, and reasons that I might describe as cultural in the car business, there have been a high level of used vehicle sales in franchise dealerships in those market. So those markets have been more impacted by the change in availability of financing from subprime providers to consumers. Our Oklahoma dealerships outperform our other dealerships and used vehicle sales compared to new by a huge margin. So it is really just a dealership business model issue as much as anything as well as the local demographics.

Okay, thanks. That is helpful.

Darret Wanger with Jefferies and Company.

To clear up that capital expenditure figure for the third quarter, was that a net item that you gave me, the 13 million? Was that a net item of all those four other items that are normally reported in your cash flow statement? Secondly, when are you permitted to buy back stock?

The 13 million was gross capital expenditures, net of sale leasebacks, it was actually about $1 million net for the quarter. So the 13 million was gross. Not net. In terms of our repurchase of shares that is subject to be the SEC regulations on company purchases that don't necessarily have the same set of rules as for individuals, but we anticipate being in a position to repurchase shares within the next day or so.

Is that 48 hours?

That is our company policy for individuals. That doesn't necessarily apply to the Corporation but in this case we will probably comply with that policy, so yes, it would be 48 hours.

Okay. Thank you.

(OPERATOR INSTRUCTIONS) Adam Comora with EnTrust Capital.

A follow-up on the underperforming stores; typically how long have you owned the underperforming stores?

The underperforming stores we have owned all different time periods. In fact in terms of profit declines year-over-year the largest decline is in a store that we have owned for many, many years. The organization actually has owned that store since the '70s. It is brand related, not obviously something we looked at carefully. It is related to brand, not related to the time of acquisition. We do not see it as an acquisition integration issue, it is really a brand performance without regard to how long we have owned these stores.

It looked like the profitability trends had been improving as the second quarter went along and I think in a previous question you answered that July and August were fine. So how can you account for just the sudden shift in the profitability and the performance of domestic stores?

Largely through the discussion of the inventory issue that we have there as model changeover occurred. The inventory issues were revealed, and our difficulties and competing in the market were more of a challenge. Again I want to be careful; when we talked about our performance compared to forecast, we were referring to our own internal forecast as opposed to external forecast. And through August we felt like we certainly had a realistic shot at making our own forecast for the full quarter.

Okay, thanks.

Natasha Silver (ph) with Deutsche Bank.

Could you talk a little bit more about that vehicle transfer tax and kind of its impact going forward?

In general terms the vehicle transfer tax which was recently enacted in California requires the consumer to make a payment of several hundred dollars additional payment, when the vehicle is transferred, when they purchase the vehicle. The impact has not been so much that the tax exists; rather, there has been a perception created that that transfer may go away very quickly, or there was a perception created that with the change in administration in California that transfer tax would go away very quickly. Therefore, consumers could simply wait a couple of weeks to purchase a vehicle in order to avoid that tax. I think as the month has progressed it has become clear that the transfer tax is not going to go away, at least immediately. We have seen returns to more normal levels of sales and sales traffic in our California dealerships.

Okay. Is it expected to be something that is going to hit other markets in other states?

No, it is not. It is a California specific issue.

Okay, thank you.

At this time, sir, there are no further questions.

Thank you for your participation.

Thank you for participating in today's Sonic Automotive third-quarter earnings conference call. You may now disconnect.