Sonic Automotive Inc (SAH) 2003 Q4 法說會逐字稿

Welcome to the Sonic Automotive fourth-quarter and year-end results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Tuesday, February 24, 2004.

At this time, I would like to refer to the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information or expectations about the Company's products or markets, or otherwise make statements about the future, which 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.

I would now like to turn the conference ever to Theo Wright. Please go ahead, sir.

Good morning, and welcome to our fourth-quarter and year-end 2003 conference call. I am Theo Wright, the Company's President. Joining me on the call are Jeff Rachor, the Company's Chief Operating Officer, and Lee Wyatt, the Company's Chief Financial Officer. I will cover revisions to our long-term strategies, industry trends and 2004 estimates, then turn the call over to Lee Wyatt to cover financial information in greater detail, followed by Jeff Rachor to cover operating highlights.

2003 was a year of challenges, although we had a number of significant accomplishments. Same-store sales growth was positive in new vehicles, in both units and dollars for the year, the first year since the year 2000 with positive same-store growth in new vehicles. We took market share in our local markets, and dramatically improved our standing with our manufacturer partners. We completed a number of refinancing transactions, creating a stable platform for the future, and reduced our leverage. We continue to improve our brand mix. We reignited growth in our service and parts departments, with same-store growth rates returning to our expected long-term growth rate of 3 to 5 percent. We achieved our highest-ever levels of customer satisfaction. We completed initial stages of back-office consolidation, resulting in reduction in fixed overheads of approximately $8 million annually. However, over the last five quarters, our financial performance has been volatile, and generally not met our or the market's expectations, and it has lagged the peer group. Because of our long-term track record of outperforming the peer group, particularly in creating shareholder value, we have been reluctant to alter our strategies. However, our continued underperformance has caused us to clearly determine the underlying causes of our underperformance, reconsider these strategies and make fundamental changes where necessary.

First off, our acquisition strategy is focused on acquisition of underperforming dealership assets. Even when we acquire performing dealerships, we do not retain former owners as part of our management structure. We believe our acquisition approach remains valid, and has been responsible for attractive long-term returns on investment and creation of substantial shareholder value. Even in 2003, adjusted for discontinued operations and one-time items, our return on equity was 15.7 percent, better than many in our peer group.

However, this strategy by its nature is management intensive. Given our current scale, it is no longer realistic that we can sustain our growth pace. The demands our rapid growth pace, at large scale, have placed on personnel capabilities has overstressed our management infrastructure and eliminated our available bench of qualified personnel to fulfill key management roles. Accordingly, we have altered our acquisition strategy going forward, and are setting acquisition growth targets of a maximum of 10 percent annually. This represents a dramatic reduction in our acquisition growth rates from historical levels. For an organization like ours, which started in 1997 with 300 million in annual revenues, this change in strategy represents a traumatic transition. Our rapid growth has allowed our stock price to appreciate over 280 percent since our late 1997 IPO, despite earnings multiple contraction. However, we recognize the necessity of this transition, and believe this transition is typical for fast-growing growing, entrepreneurial organizations.

To comment on our near-term acquisition strategy, we have closed on previously disclosed acquisitions representing approximately 400 million in annual revenues in the fourth quarter of 2003 and first quarter of 2004. We expect to close on approximately 450 million in annual revenues in Q2 2004. These acquisitions are predominantly luxury brands, including Lexus, BMW, Volvo, Audi, et cetera, where we have a proven track record of exceptional performance, even in recent quarters.

Also noteworthy, dealership-level management in virtually all of these acquisitions have been, or will be, retained. We do not expect to complete any other acquisitions in 2004, and will reevaluate our acquisition approach later in 2004, to assess our capability to manage additional acquisition growth in 2005. Our reduced acquisition pace will enable us to maintain our dividend and share repurchase activities while, at the same time, gradually reducing our leverage. We have historically targeted debt to total capital net of cash at 50 percent. Currently, we are at approximately 47 percent debt to total capital net of cash. We are revising our targets to 45 percent by the end of 2004, and 40 percent longer term.

Late in the fourth quarter, we thoroughly reviewed our dealership portfolio in relation to long-term return potential, our demonstrated management capabilities and current personnel challenges. Based on that review, we added 12 stores to our discontinued operations. These decisions, combined with decisions taken to liquidate related real estate holdings, resulted in $2.5 million in write-downs included within discontinued operations for the fourth quarter. These discontinued operations have performed poorly for a long period, and we are realistically assessing our capabilities to amend performance deficiencies. Included in discontinued operations are all stores which had significant operating losses in 2003. We believe our remaining portfolio represents dealerships with brands and operating profiles where we have the opportunity to earn returns on both financial and human capital.

Turning to the new vehicle portion of our business, in our third-quarter 2003 conference call, we commented on challenges we faced with our inventory mix in new vehicles. As we expected at that time, by the end of the fourth quarter, those issues have been addressed, and our inventory is now adequate and in general represents competitive product mix. In the fourth quarter, North Carolina, South Carolina, Georgia, Tennessee, Florida, Michigan and the DC metro areas were our strongest regions. Our weaker regions were Dallas, Houston, Oklahoma and Southern California. Southern California was negatively impacted by vehicle taxes and fires. Those were clearly temporary phenomena, and this area has recovered strongly.

Our strongest brands for the quarter were BMW, Lexus, Volvo, Audi, Infiniti and Acura. Our top brands were as follows -- General Motors, including Cadillac, 24 percent; Honda, 13 percent; Toyota, 13 percent; BMW, 12 percent; Ford, 10 percent; Lexus, 5 percent; Volvo, 5 percent; and Mercedes, 4 percent. We expect 2004 industry new vehicle sales of approximately 16.5 million units, and we expect new vehicle prices per transaction to continue to rise. Gross margins on new vehicle sales work in sales will continue to be under pressure. However, we believe we will be able to maintain new vehicle gross margins of at least 7 percent, compared to our 7.2 percent new vehicle gross margin in Q4 2003.

For used vehicles, we expect used vehicle unit volume to be up modestly, 3 to 5 percent for the year on a same-store basis. We are emphasizing sale of lower-cost units that are less affected by new vehicle pricing and incentives. With this emphasis on lower-cost vehicles, we anticipate gross margin on a percentage basis will increase slightly. We also expect used vehicle department profitability to improve modestly.

Service and parts -- our service and parts revenues continue to grow strongly, with steadily improving margins. We are benefiting from our investments in facilities, our emphasis on certified pre-owned unit sales, our emphasis on the sale of extended warranties and our achievement of high levels of customer satisfaction. We expect the benefits of these strategies to accelerate over time, and are forecasting continued 3 to 5 percent growth in service, parts and collision center revenues.

For selling, general and administrative expenses, we are basing our 2004 forecast on minimal change in selling, general and administrative expense rates for the full year. However, we're establishing the following targets for SG&A, as a percentage of gross profits, as a mechanism to hold ourselves accountable for addressing controllable expenses. In Q1 2004, SG&A expenses as a percentage of gross profit of 80 percent; Q2 2004, 77 percent; for Q3 2004, 77 percent; and for Q4 2004, 78 percent; and for the full year 2005, 76.5 percent. We believe, although not fully reflected in our forecast, these are highly achievable standards of performance, and are rates we have achieved in the past. Mr. Rachor will comment further on the actions taken to achieve these targets.

Our overall estimates for 2004 are $2.65 to $2.80 from continuing operations. Although we are no longer providing quarterly guidance, we do expect Q1 2004 earnings from continuing operations to improve modestly from 2003.

A comment on finance and insurance performance. We would like to discuss rate spread or dealer reserve earned by dealerships, a topic which has been widely discussed recently. Rate spread is another term for the commission earned by our dealerships for arranging vehicle financing for consumers. The amount of the commission is in some cases nothing, in some cases a flat fee and in other cases an actual spread between the rate charged to the consumer and the rate provided by the direct financing source, bank, credit union or manufacturer's captive. In 2003, Sonic's average rate spread was a modest 1.02 percent. Including credit unions, over 40 percent of our financings were for no fee or a flat dollar fee. In 2002, our Company put in place caps on the amount of potential rate spread our dealerships could earn with all of our finance sources. We also put in place caps on the amount of profit that can be earned on sale of other products in our finance and insurance departments. In 2003, we also eliminated certain products which distracted from our focus on sale of extended warranties that tie consumers to our service departments for the long term.

We have already experienced any negative consequences to profits that would result from controlling the profit potential in finance and insurance on individual transactions. To the extent we earn rate spread, this represents value to the consumer. Our income earned on high-quality credit customers is minor. Keep in mind that the customer can cancel this financing arranged by us if they find a lower-cost alternative, or they can come to the store with alternative financing if they have alternatives. Many customers need our assistance to arrange financing because there is lower-cost subvented financing available only from the manufacturer's captive, and through its franchise dealers. There are lease financing alternatives available only from manufacturer's captives or other finance sources available only through franchise dealers. Customers have deficient credit and don't have direct access to potential sources of subprime financing; customers have significant negative equity that can't be addressed without our assistance. Our finance penetration rate is 70 percent, indicating the majority of our customers believe the financing provided by dealership is the best available alternative for them.

I will now turn the call over to Lee Wyatt. Lee?

Earnings per share in the fourth quarter was 32 cents, and earnings per share from continuing operations was 45 cents. Earnings per share for the year of 2003 was $1.69, and earnings per share from continuing operations was $2.07. Earnings per share from continuing operations of 45 cents included charges of 4 cents for a pre-2003 self-insurance reserve adjustment, and 1 cent for accelerated depreciation. Absent these charges that totaled 5 cents in the quarter, earnings per share from continuing operations would have been 50 cents rather than 45 cents. Earnings per share of 32 cents included charges of 4 cents for the self-insurance reserve adjustment, 4 cents for real estate and franchise value write-downs on discontinued stores and 1 cent for the accelerated depreciation. Absent these charges that totaled 9 cents in the quarter, earnings per share would have been 41 cents rather than 32 cents.

EPS from continuing operations for the year in 2003 was $2.07, and included the charges of 5 cents from the fourth quarter, previously discussed, and 23 cents from the third-quarter redemption of the 11 percent subordinated notes discussed in our third-quarter conference call. Absent these charges that totaled 28 cents for the year, earnings per share from continuing operations in 2003 would have been $2.35, rather than $2.07. Earnings per share for the year in 2003 of $1.69 would increase to $2.15 using the same analysis. These calculations will appear on the Sonic Website.

In considering 2004 guidance of $2.65 to $2.80, begin with earnings per share from continuing operations of $2.07 and add back the 28 cents previously discussed to reach $2.35. To this, add 18 cents from acquisitions and 12 cents from lower interest cost. The result represents the low end of our 2004 earnings guidance of $2.65. Growth in core operating earnings would increase these results to the top end of the range. Loss from discontinued operations in 2004 is estimated in the range of 5 to 10 cents, subject to the timing of the sales and gain on the sales of the 15 dealerships.

In reviewing the fourth quarter in more detail, revenue grew 8 percent. New vehicles grew 10.2 percent. Used vehicles declined 3.2 percent. Parts, service and collision grew 9.9 percent, and F&I declined 80 basis points. The overall gross margin rate for the fourth quarter was 15.2 percent, a decline from 15.8 percent last year. New vehicle gross margin was 7.2 percent, a decline from 7.9 percent last year, but an increase from 6.8 in the third quarter. Used vehicle gross margin declined to 10.2 percent from 10.6 percent last year. The service, parts and collision gross margin rate continued to grow, as it increased 50 basis points to 48.6 percent. The overall gross margin rate was negatively impacted by a higher mix of new vehicle sales, which increased to over 62 percent of total revenue. SG&A as a percent of gross profit was 82.4 percent in the fourth quarter, compared to 78.1 percent last year.

The 430 basis point increase in rate is primarily attributed to two issues. The first was 8.1 million in spending rate increases in variable selling compensation and advertising expense. The second cause was a 2.7 million increase to our self-insurance reserve for general liability insurance programs for periods back to 1999.

Diluted share count for the fourth quarter was 42.8 million shares. During the fourth quarter, we purchased 286,000 shares, at an average price of $22.75. For the year, we purchased approximately 1.3 million shares, at an average price of $19.26. As of today, we have $30 million remaining under our share repurchase authorization. Depending on share price, this remaining authorization should support 2004 share repurchases at a level similar to that of 2003.

During the quarter, we paid a dividend of 10 cents per share, and today announced another quarterly dividend of 10 cents per share, payable on April 15th. We continue to believe that the dividend program brings value to the Company and to our shareholders.

The year-end balance sheet and fourth-quarter results reflect the benefits of financing initiatives completed in 2003, and a shift in debt leverage strategy. Non-floor plan interest expense decreased by $2 million in the quarter from 2002, reflecting the benefits of these refinancing activities. The year-end balance sheet reflects a net debt to capital ratio of 46.8 percent.

Net of year-end cash balances, availability under the revolving credit facility was $274 million at year end. This level of availability is a high point for the Company.

Days supply of new vehicle inventory was 74 days, used vehicles was 42 days and parts was 48 days. Calculated on selling days, the days supply for new vehicle inventory would decline to 53 days. These results were below industry averages.

Excluding one-time charges and discontinued operations, LTM interest coverage was 5.7 times, long-term debt to EBITDA was 3.1 times, and return on equity was 15.7 percent.

Gross capital expenditures for the year were $96 million. We anticipate that 65 million of these will ultimately be recovered through sale-leaseback transactions. The resulting net capital expenditure for the year would be $31 million. We anticipate that net capital expenditures for 2004 will continue in the $25 to $30 million range. We anticipate that no significant capital expenditures will be needed from the announced acquisitions.

Cash from operating activities was equal to last year, at $138 million. We continue to meet all covenants under our revolving credit agreement.

Jeff Rachor, our Chief Operating Officer, will now review operating issues.

Thank you, Lee. I'll start with the review of same-store performance by business segment. New vehicle revenue was up 3.6 percent, while new vehicle volume was down 1.3 percent versus Q4 2002. New vehicle gross margin was down from 7.9 percent to 7.3 percent versus a year ago. However, the trend over third quarter 2003 is positive, moving from 6.8 percent gross margin to 7.3 percent quarter over quarter on a same-store basis. We continue to face competitive margin pressure in some brand segments, and remain committed to an aggressive pricing posture to protect market share. Used vehicle revenue was down 2.9 percent on a 6.3 percent decline in unit volume. Used vehicle gross margin declined to 10.1 percent versus 10.6 percent in Q4 2002. Manufacturer certified pre-owned unit volume was up 41 percent versus Q4 2002. Our service, parts and collision repair business continues to be strong, with 4.1 percent growth in revenue driving 5 percent growth in total gross profit, on gross margin that improved from 47.9 percent in Q4 2002 to 48.3 percent in Q4 2003.

The fourth quarter of 2003 was a transitional period in the area of human resources. 27 dealer-operator positions were filled, and 4 of 12 regions are now under new regional Vice President oversight. This key personnel turnover was disruptive but necessary, and we expect the key personnel structure to stabilize in Q1. This quarter, we implemented a disciplined hiring process, to better screen dealer-operators and regional position candidates. The slower growth pace will also provide stability, allowing us to slow the pace of internal transfers and promotions, leaving key managers in one place longer, to develop their effectiveness and provide stable leadership to the rank and file. The human resource transition and related distractions described in my earlier comments prevented us from executing on the control of selling expenses in Q4. Our advertising budget process has been completely restructured effective January '04, giving senior management complete control of the allocation of advertising dollars. The effectiveness of this new process has already been validated in the first 30 days.

Personnel stability is also the key to executing on salesperson compensation expense control. The solution here is completing the rollout of a standardized salesperson pay plan framework as soon as practical. The transition was initiated this quarter, but this is a difficult and management-intensive process that could take several quarters to achieve 100 percent compliance. But the benefits are significant and ongoing.

I thought it might be helpful to give you an actual example of a successful standardized pay plan implementation, and the corresponding results. For many years, our organization has recommended that our dealerships implement a best-practice-based finance and insurance manager pay plan, but ultimately gave store-level management autonomy over this decision. After accepting partial implementation of the pay plan for years, senior management mandated 100 percent compliance, which took several months to execute in the fourth quarter. Compliance was achieved, with 100 percent of Sonic dealerships having the standardized pay plan in place January 1, 2004.

The results are compelling. January finance and insurance on a per-retail-unit basis was up $55 over December '03. January extended service agreement penetration was up over 12 percent, an all-time record for Sonic versus December of '03. And finally, January finance and insurance compensation was down almost 9 percent, as a result of the total variability built into the plan versus December of '03. This type of 100 percent variable standardized pay plan frame framework, tied to key performance metrics, will drive sales, gross profit and customer satisfaction, while reducing overall sales compensation payout.

It is important to note that these changes in compensation structure do not result in lower pay to individual employees. In fact, most employees have an opportunity to improve their individual compensation through performance. We are committed to attractive, competitive compensation versus industry standards. Other departments and positions are being targeted to achieve similar results over the longer term. Centralized control of advertising expense and the standardized pay plans are just two examples of the change in tone at Sonic Automotive that will improve results going forward.

To close on a positive note, customer satisfaction was at an all-time high for Sonic stores in 2003. 75 percent of Sonic dealerships exceeded the manufacturers' standard for both sales and service customer satisfaction. In addition, 36 Sonic dealerships have already been recognized with the manufacturers' highest annual award for customer satisfaction excellence in 2003, and even more are expected, as specific manufacturers finalize their programs. We anticipate 45 to 50 Sonic dealerships will ultimately receive these honors. This customer satisfaction performance reflects favorably on both customer retention and manufacturer support.

That concludes management's prepared comments. At this time, we will be happy to entertain questions.

(OPERATOR INSTRUCTIONS). Rob Short (ph), JL Advisors.

A couple of quick questions. First, in just going through the 2004 guidance, if you could walk us through what -- I know you said 18 cents from the acquisitions. Can you just walk us through what that assumes, when they close, how you financed those acquisitions? And then, if you can also walk us through any assumptions on interest-rate hikes and that effect? And finally, if we could have a little more detail on first-quarter guidance? Are we expecting new car sales -- are we expecting the margin rate to improve? What type of assumptions are being made there?

I'll answer the question about the timing of the closing of the acquisitions, and then I'll ask Lee Wyatt to address the impact of interest rate changes on our estimates. The acquisition transactions are expected to be financed with debt; that is how we have modeled those transactions. Several of the transactions closed at the end of January, and then we have another group of acquisitions representing approximately 250 million -- or 225 million closing at the beginning of the second quarter, with the remainder of the transactions closing later in the quarter.

So a couple of comments there. One is not all of the transactions are going to close at once, so from a management perspective, we have done a good job of spreading those out, to enable better-quality integration. And we do anticipate that all of the pending transactions will be completed by the end of the second quarter.

Lee, if you will cover interest?

And the 18 cents assumes that they close at those variance times; that's in the guidance already?

That is correct. And so, on a full-year basis, the 18 cents would be, in round numbers, more like 25.

And we should not expect any equity to be issued for any of these transactions?

Based on the current structure of the transactions, you should not expect equity to be issued.

On the interest rate question, we currently have, including floor-plan debt financing, approximately 60 percent of our overall debt is fixed. We calculate that a 100 basis point increase in interest rates would, on an annual basis, reduce our EPS by 8 to 10 cents.

And is there any assumption in the 2.65 to 2.85 for interest rate rise?

We assumed that interest rates would rise between 25 and 50 basis points throughout the year.

And to follow up to your question on first-quarter guidance, our estimate reflects new vehicle gross margins of approximately 7 percent. We do think that we have an opportunity to better that, based on fourth-quarter trends. But our estimates reflect a 7 percent gross margin on new vehicle sales, so we are not expecting continued improvement in new vehicle gross margins.

Are your estimates in line with First Call right now?

Yes, yes they are.

That's 48 cents, I think?

I'm sorry. For the year, they are -- I apologize, for the year --

No, for the first quarter.

We don't give quarterly guidance, so I really can't say. I haven't looked at those estimates.

But we should expect a year-over-year increase in earnings in the first quarter?

Yes.

Alex Gould (ph), Criterion Research.

Just a follow-up on the acquisitions. What is the total dollar amount of those acquisitions?

The total dollar amount of purchase consideration or revenues required?

Purchased consideration.

The total dollar amount of the purchase consideration for those acquisitions is approximately $125 million to 140 million; it depends on working capital requirements at the time of closing, but that's a rough estimate, based on the acquisitions that we expect to close.

Also, could you give us a little more color on your discontinued operations and what your strategy there is, to either get out of the business quickly or sort of hedge the losses that are currently being generated?

Yes. Our strategy is to get out of the businesses as quickly as we can, reasonably. However, we are conscious of value; these are assets that do have value. So we are not going to do anything that would impair the value, so we're going to continue to try to improve the performance, the fundamental performance of those operations, and expect to make progress there, even in the time prior to sale. So it is a two-prong strategy -- one, move as quickly as we can, assuming that there is a readily available market, which there is in most cases; and, if not, do everything we can to improve the operating performance of those assets.

And is it possible for you to quantify the kinds of numbers you are looking for, as you seek to dispose of those dealerships?

We did quantify in the press release that we expect those divestitures to generate at least $20 million in additional cash.

Adam Comura (ph), Intrust Capital.

A couple of quick questions, just on what you guys are going to be doing what the free cash flow next year. It looks like, if cash flow from ops is equal to what it was in 2003, and I take out that net CapEx, it looks like we're going to have 120 of cash flow, and then the 20 from the discontinued ops gets me to 140. Just how are we thinking about it currently right now, in terms of share repurchase versus debt paydown? How much is available on the share repurchase?

The share repurchase is -- currently, we have $30 million authorization remaining from the Board.

And, Adam, our thoughts going forward, as I mentioned in my prepared comments, is that later in 2004, we will reevaluate our acquisition integration capabilities, and reconsider our capital allocation at that time. But I would anticipate, for the remainder of the year, that we would certainly use the $30 million in availability for share repurchases, assuming prices remain attractive. We may allocate additional capital to that use. We will expect to continue to maintain and possibly increase our dividend over the course of the year, and then the remainder of our cash available will go to pay down debt. I would add to your analysis of cash available for other uses the significant expected cash flows associated with sale-leaseback financing of real estate projects that are underway. There are additional cash flows that we expect there. It's so hard to predict the timing of those, but it's probably net another $25 or $30 million that we will have available.

Okay. So you're talking about, when you said before that for 2003, the gross CapEx was 96 and you were planning for 65 million of sale-leasebacks, you're saying there is still another 25 or 30 of that 65 to go?

Yes.

John Tomlinson, Prudential Equity Group.

Can you comment on the brand mix of the 12 dealerships that you placed in discontinued operations in the quarter? Was there any concentration of one brand, or brand mix?

The majority of those are Ford and Chrysler, Jeep -- the Dodge brands.

The domestic brands?

The domestic brands; that's correct.

And is that kind of an indication of the performance in your portfolio of dealerships with your remaining brands, as well? Are the import brands performing better than the domestics, currently?

Yes, they are. There is a clear differentiation in our performance between the import brands and the domestic brands, which we have commented on in several previous conference caused. I do want to emphasize, though, on behalf of our manufacturer partners, that that is more of a Sonic issue than a specific issue associated with those brands. We just have not performed as well representing those brands, those domestic brands, as we have performed with others.

And I also went to make an important distinction that there is a significant difference in our performance within domestic brands between Cadillac and the more volume-oriented domestic brands. Cadillac is a luxury brand, a true luxury brand, and we actually perform quite well with Cadillac.

A couple of follow-ups, if you don't mind. Can you also comment on how new vehicle sales volumes have trended in February?

I think at this point in the month, the way sales are distributed over the course of the month, it's very difficult to make a prediction about the trend of sales for the month of February. Sales in every month, they tend to be back-loaded, along with advertising dollars. But I would say, as a general comment, the tone of business in both new and used vehicles is solid. We have seen no significant fall-off or change in trend to date.

And one other question. Have you seen any change in the incentive support from the transplant and/or luxury brands over the beginning of the year?

We are seeing -- by transplants, if you are referring to Toyota and Honda specifically --

Exactly.

-- we are seeing more aggressiveness there, in the area of incentives on some products. With those brands, the incentives are targeted generally narrowly to specific products, but we are seeing more incentives with those brands. And in the luxury arena, there are incentives again, but highly targeted. Other than with the luxury brands, it's quite common to have subvented lease rates, and that's a pretty consistent part of their incentive programs.

Rick Nelson, Stephens.

Theo, you mentioned that you are retaining the management team in the recent acquisitions you have made. I am wondering if you are rethinking your strategies about putting Sonic people into those dealerships and not retaining the team, as you have done in the past?

I'm not sure that we are fundamentally rethinking our strategies, Rick. I would say that it just happens that with these particular brands, we actually have pretty good quality dealership level management. But I also went to emphasize in both cases the owner, the former owner, is not staying with our management team, and that we have always made every effort to retain onsite dealership-level management, simply not the former owners, who sometimes are and sometimes are not actively involved in the day-to-day management of the business.

A question on the GM turnover, 27 new GM's. Are these transfers from inside the Sonic organization, or has that come from outside?

It's a combination of internal promotions and outside hires.

But I'd follow on with that by saying that we are being much more cautious with internal promotions and transfers, because often those create two locations with a disruption to operations, not just one. So a fair number of the recent GM positions have been filled from outside of our organization.

And Jeff, you sound like The Godfather today.

I'm nursing a sore throat.

Why the changes in the balance sheet leverage targets? Why not step up buybacks and retain the old targets?

One reason for the change is that we do believe it's important to maintain access to low-cost debt capital to support our strategies over the long term. And we think in the debt markets that debt to total capital is an important consideration, so part of our motivation is related to concerns expressed in that part of our market where we also participate. The second reason is that, given a lower acquisition growth pace, we have to make decisions about capital allocation. And it creates an opportunity to reduce our leverage, reduce the risk profile over all of our business. And we believe, based on analysis of our peer group, that in terms of earnings multiple, we have an opportunity for an expansion, if we can demonstrate a lower risk profile for our business overall. So that we have to consider as an offset to the potential benefits of additional share repurchase. And I just would emphasize again that we don't intend to discontinue share repurchases; that will continue to be a part of our capital allocation strategy.

Gary Steiner, Awad Asset Management.

The first question I had is on the F&I. I saw your same-store comps in the quarter were down 5.4 percent. Can you just maybe flesh that out a little bit? That is obviously a very high-margin area, an area of growth, I think, for the future. Was that restrained at all by any of the recent publicity on the regulatory side?

I'll take that question. Our finance and insurance departments continue to adjust to a modified product offering, and restrictions on both rate and profit caps that Mr. Wright mentioned in his comments. And I do believe that the publicity in the quarter had a negative impact in some locations, but the standardized performance-based compensation plan that I mentioned in my earlier comments, along with further development of our menu selling process should drive a return to historical standards of finance and insurance performance in 2004. And in my earlier comments, I highlighted a significant improvement January over December. So we really think that the impact of the publicity is largely behind us, and again, the combination of an orientation to our new product portfolio, continued training in the area of menu selling and our compensation plan will drive results in '04.

I would just add to that response that the transition in compensation schemes also had an effect on personnel during that time period of transition, which was in the fourth quarter, not surprisingly. And I also believe that that affected performance during the fourth quarter, and now that the transition and compensation scheme is completed, I believe that that influence will be behind us.

Jeff, could you maybe just repeat the improvement in the January over December numbers? I was trying to write that down, and I just didn't get it.

That was a very isolated example of F&I. We improved per-unit retail F&I income by $55, we improved extended service agreement penetration by 12 percent, and as a result of the variable comp plan, total comp payout in F&I was down almost 9 percent.

And there is nothing unusual about the seasonality, January versus December? Those are pretty clean numbers that would be representative of maybe fundamental improvements in the business?

Yes; there is nothing unusual about the seasonality from December to January.

Okay. I just wanted to -- on a different topic, on the stores that are in discontinued operations, is it sort of fair to think about that as over a period of time, you're going to have a certain number of stores that are just going to be underperformers, and you're going to have to pare those back, or sell them off, and that there is just going to be some sort of ongoing earnings drag, whenever the number is, from a certain number of dealers that just underperform others? I mean, when we look at the '04 guidance of 5 to 10 cent loss from discontinued ops before these particular dealerships are sold, is the way to think about that as once these are sold, the costs go away? Or is there going to be a new crop in '05 that would also be a drag?

I'll address that question. I think that our business represents a portfolio of dealerships, and we have had to prune that portfolio of dealerships over time. And those dealerships have represented, over a period of years, a very modest drag on earnings. So I think there is some element of that drag on earnings that you described that we would anticipate on an ongoing basis. However, I would not anticipate the magnitude of the discontinued operations losses that we saw in this recent group of dealerships, and I think they are in a unique situation, not typical of what we have experienced in the past. And I also don't believe that it would be typical of our experience in the future. About half of those are acquisitions that we acquired as part of group acquisitions, as an example. The pace of our growth has had an impact on the number of stores that are included in that group, and we would not anticipate that we would have that number of dealerships -- just focusing on the number, that we would not have that number of dealerships typically included in discontinued operations. I would also say that, as I said in our prepared comments, that those in discontinued operations include all dealerships where we had a significant operating loss in 2003. So as of right now, we don't believe there is any additional stores that are behind the stores that are included as of today.

And just one last question. On the commentary about the new vehicle gross margin percentage being better in the fourth quarter versus the third quarter sequentially, is there any seasonal reason for that? Or is that just a fundamental improvement in the margin in that business?

I don't have a quarterly trend going back enough years in front of me to give you an accurate reflection of that answer, or an accurate answer to that question. I am only going back one year, and bear with me on that part of the question; I'll try to give the best answer I can. If there is a necessary follow-up, I'm glad to do that outside of this call.

Sure. Or maybe, just sort of qualitatively you can -- if you have any thoughts about whether there has been any fundamental improvement in the gross margins of the new vehicle business? It sounds like the environment still remains pretty competitive.

My intuitive answer, rather than one that I can support with the data in front of me, is that our new vehicle gross margin performance did improve modestly in the fourth quarter, that it just was not in its entirety a seasonal adjustment, if it was seasonal at all. And it reflected a number of process improvements that we are initiating in our dealerships, as well as simply management pressure on gross margins. So I do think there was fundamental improvement, but it does continue to be a very competitive market; it's price competitive and, as we said in our earlier comments, we are not anticipating a continuation and positive improvement of new vehicle gross margins in '04.

Adrienne Dale, CIBC World Markets.

My first question has to do with this F&I business again. When, exactly, did you put the cap on the reserves in place? I'm trying to get a feel for when we can expect this year-over-year same-store sale drop to go away.

The caps on finance reserves were put in place initially in August of 2002. I would tell you, in my opinion, that they were rigidly enforced with no exceptions, really, beginning in early 2003, and I would anticipate that this year is when we would anniversary those changes. The reduction in product offerings in our F&I departments was not initiated until the middle part of 2003. So to get truly comparable performance, I think you would have to get to the third quarter of 2004.

And what was your rent expense for the fourth quarter and the full year?

It's $70 million for the full year, and about 19 million in the fourth quarter.

And do you have any expectations yet for next year?

No, we don't forecast individual line items. But rent expense should be up from that level, based on acquisitions, and up modestly based on new facility projects that will be completed.

And then, getting back to Gary's question, I think you had previously been thinking about an increase in new vehicle margins, based on the fact that it's the new model year that you would be selling. Did that increase actually come in in line with your expectations? And what are your thoughts for next year?

I think, in our third quarter conference call comments, we talked about several of our brands that had experienced margin compression, and we thought we would see benefits from new product offerings with those brands. Two brands we mentioned specifically were BMW and Cadillac -- BMW, with the new 5 series introduced in the fall of this year, and Cadillac with the XLR and SRX. And we did experience those positive impacts within those brands. We do, however, still have several of our brands that did not have new product introductions, really, this year at all. And those are Toyota and Honda, and in those brands, we are continuing to see margin compression with those brands or, I should say, margin pressure with those brands that we expect will not be alleviated until they have new products coming late in 2004.

Okay, great. And then, I just wanted to doublecheck. If I remember correctly, I think in the third quarter, you had been basing your '04 guidance on a 16 million unit sales rate. Is that the case? I know now you are saying 16.5.

(technical difficulty) if I can get those conference-call comments out, because I think we spoke about the targets for 2004. We said 2004, yes, that it would be roughly 16 million units for '04, but we also indicated we expected to take modest market share. Based on the latest available information and forecasts provided by third parties, we think at this point that 16.5 million units is a reasonable assumption. I would also tell you frankly that for our estimates, the difference between 16 million and 16.5 million is not that meaningful. We just try to give the market some indication of the type of sales rate for the industry that we expect to experience.

And then, finally, I was trying to get a good sales target for the end of the year. It's kind of hard to back into the numbers, since you are not sure of exactly what the margins were on those underperforming discontinued operations.

Are you asking for a revenue forecast for the full year '04? Is that --?

Yes, because it's hard to figure out exactly how much revenue you will be losing, since we don't have a good feel for what the margins were from those operations that you are getting rid of.

Our revenue forecast for full-year '04, including acquisitions, is approximately $8.2 billion.

Maurice Dayan (ph), Janus Capital.

Can you just comment on used car margins, and the biggest factors that you see moving them in 2004, and again just repeat your inventory position there?

Used car margins and performance in '03 were affected by some of the personnel disruption that I mentioned in my comments. But as Mr. Wright mentioned in his opening comments, we have taken some action steps to focus on lower cost-of-sale used vehicle retail. And that should result in some modest improvement in used vehicle margins going forward. We did see that so far in the quarter, and we anticipate that that will continue going forward, with that increased emphasis on lower cost-of-sale items.

And to follow on to your question regarding days supply, we ended the year with 42 days supply. In January, we had 41 days supply of used vehicles, and that seasonally is right in line with our expectations, because the used vehicle market tends to start to accelerate in February. Tax refunds have an impact on the used vehicle market in particular, and February and March are among the best used vehicle sales months of the year. So we are quite pleased with our used vehicle inventory position, at this point.

So that number, I guess, would go down in the next couple of months, as sales picked up?

That's correct. That's the normal seasonal pattern.

And just on the margins, can you just comment on the one or two biggest industry factors that you are paying attention to that may push around that used car margin this year?

The biggest industry factors that we see are slowing rate of lease term-outs (ph), which we think will have a positive impact on auction prices, particularly at the higher end. So we do see some positive influences on wholesale prices. On the more concerning side, I think the high levels of negative equity that consumers have in used vehicles that they seek to trade -- that is an issue that I think will have an impact, a potentially negative impact, on the used vehicle business. That's another industry issue, not necessarily reflected in margins, more in volume. But I would say those are the two biggest issues that I would see in the used vehicle market in 2004.

Conner McLaughlin (ph), JLF Asset Management.

I just wanted to clarify. On the same-store sales units, I may have misheard that. Can you just give me the new vehicle volume for same-store sales for new and used as well, please, if you don't mind repeating that?

Same-store sales were up 3.6 percent in new unit revenue, volume was down 1.3 percent, and in used vehicles we had a revenue decline of 2.9 percent on a volume decline of 6.3 percent in units.

And also, on the gross margins for the used, did you say it was 10.1? Is that right?

10.1; that's correct.

And that was versus 10.6 from Q4 of '02?

That's correct.

Nate Hudson, Banc of America Securities.

Just a couple of questions. First, on CapEx, you mentioned you expected net CapEx in '04 to be 25 to 30. Where do you see gross CapEx coming in in '04, and then how do you see that trending in '05?

We have been fairly consistent over the last couple of years, with 70 to 90 million in gross, and we would probably see that slowing down a little bit, but being consistently in that pattern of 70 to 90 million.

I would say that that rate of capital expenditures is driven in large part by acquisition activity. Over the last several years, we have acquired many dealerships where part of our acquisition strategy and plan was to relocate those dealerships to better facilities and better locations -- new facilities and better locations. And because of reduced acquisition pace, I think maintenance CapEx on a gross basis is going to trend downward to less than 10 percent of our gross investment. So I think it's going to be -- because we look at more of a 15 to 20 year replacement cycle on dealership buildings. So I think you'll see it trend down to more in the $40 to $60 million range on a gross basis. In 2005, it might still be toward 70 million, but as our acquisition strategy has an impact going into 2006, you'll see that gross CapEx trend down to more like $40 to $60 million. And going out that far, I know it's something of a guess, and it could be influenced by any one large transaction that required facility enhancement. But I would say overall, that's our expectation.

And do you anticipate any change in your basic real estate strategy, given your lower acquisitions and debt reduction targets? Are you going to essentially demand better cap rates from your sale-leasebacks or prop (ph) to keep it on balance sheet?

I think we are unlikely to keep the real estate on our balance sheet. I think that there are advantages to our real estate financing strategy unrelated to price -- advantages in flexibility, particularly on our real estate strategy. So I don't think we will change that strategy, but I will say we are demanding and we are getting much better cap rates on our real estate than we have received in the past.

And one last question. You threw out some of the brand numbers in the quarter, but what was the big three import mix, and how much Cadillac did you have in the quarter?

Cadillac represented approximately 12 percent, and the total big three, including Cadillac, was 37 percent.

Carla Casella, J.P. Morgan.

This is Alfred Nazim (ph), on Carla's behalf. You mentioned that the total purchase price for acquisitions yet to be closed in '04 is $125 million. What is the total revenue associated with this $125 million price tag?

Approximately $700 million in annual revenue.

So if I assume a roughly 3 percent EBITDA margin on this 700, so that would give me a purchase multiple of around six times. Does that sound a little expensive to you? I mean, three to five times of what you've bought in the past (ph) as the acquisition multiple.

I would just suggest that we would not anticipate 3 percent EBITDA margins in Lexus, BMW, Volvo, et cetera dealerships. So I think part of the equation has to be an analysis of the individual brands represented in the specific dealerships, and we would not anticipate six times purchase price on a fully-integrated basis.

Gerry Marks, Raymond James.

1 cent in terms of the accelerated depreciation -- could you give an idea in terms of what is going on there?

That relates to equipment and other assets associated with dealerships that are being relocated.

Is that going to continue on in 2004?

Not in any meaningful way, no.

And then, the 4 cents in terms of the self-insurance -- are those costs through as well, looking into '04?

Yes.

And then, Theo, I thought I heard you say that you were going to a common standardized pay system, and it might take several quarters. Is that in all of your business segments? I know a bunch of your competitors have been trying to do that for years, and it seems kind of aggressive if you're trying to do it in all of your business segments just over a few quarters.

Let me address that from a process standpoint, and I think Jeff can assess it qualitatively. We have already completed standardization of finance and insurance, so that project is completed. We have also completed that for general manager positions, clerical and many of our other positions are basically hourly. So that's not a consideration. So you already have a significant percentage of the positions that are completed. Then, in addition to that, for sales managers and similar positions, we anticipate that we can get that largely completed within the next several quarters, certainly by the end of the third quarter of this year. But we will always build into those pay plans, Jerry, sufficient flexibility to allow for different levels of pay for different locations. So I would say it would be hard to implement, if what we were doing was mandating here's what a guy gets paid in a particular position. But that's really not what we are doing. What we're doing is ensuring that the pay is based on the performance measures that are important to us, and that the pay is variable. And so we do believe we can achieve that, and we will likely have a handful of dealerships that are high performers already, where we won't find it necessary to adjust people's pay, because their pay is already in line with objective standards today. And we would only then address those issues through attrition and adjustment of pay over time. So if someone got a promotion, then we would fix it at that time, or if they got a significant raise, potentially we would address it at that time.

You are right in saying it is a significant undertaking, but I want to emphasize again that we are not mandating a specific amount of pay. In fact, we would like the pay ultimately for those individuals to go up, based on performance. We're creating a framework for pay for a particular position, and then holding everyone accountable for making sure that pay ends up within the right benchmarks for pay as a percentage of gross profit.

And then finally, in terms of your SG&A as a percentage of growth, your goal, I guess, is to get it down to 80 percent. You guys have been running -- and then for the year, 76.5 percent. This last quarter, you guys were over 82 percent. The prior-year period, in the first quarter, you were over 82 percent. What are you doing to knock that down 200 basis points? Is it just having some of these more standardized pay systems? Because it seems a pretty significant jump.

Well, in the fourth quarter, bear in mind the two items that you already discussed are responsible for more than 100 basis points. So we are really only looking at about a 100 basis point increase. Short term, a lot of that is going to come through better control of advertising, which we talked about, as well as some modest benefits in compensation expense. And then, over time, the benefits will come from advertising, compensation as well as other non-compensation expenses that we are aggressively addressing. We talked about clerical costs or other IT-related costs we're cutting. We could go on and on about individual cost purchasing efforts. But the remainder of those cost reductions will come from compensation and other expenses included within SG&A.

Peter Cyrus (ph), Gruella (ph).

I just have a comment. On the last call, I was not nice to you guys, and I apologize. This was a really outstanding call, and I just wanted to compliment you for biting the bullet and doing the hard work to fix your business. So as a longtime shareholder, I thank you for what you're doing.

Thank you, and I appreciate that compliment.

Charles Grom, J.P. Morgan.

Could you just repeat what your new days supply was at year end for me, and if you have it, what it was at January?

It was 72 days, new vehicle days supply, but when figured on selling days, it was 53 days supply, which is well below industry standards.

And January new vehicle days supply had declined to 71 days. And again, you're going into the better part of the season, so we are quite comfortable with that days supply at the end of January. Selling days is the standard used by the auto industry generally, so if you're comparing our days supply to industry data and automotive news, et cetera, the selling days supply is the comparable number.

I should note that we strategically wanted to broaden our model mix to be more competitive, and we feel that we are positioned perfectly as we had head into the spring selling months, particularly in our higher-volume domestic and high-volume import stores.

The second question is with regards to your tax rate. It looks like it dropped pretty significantly in the quarter. Could you comment on that? And I guess that's a question for Lee. And what are you guys internally modeling for '04?

Internally, we are modeling a rate of around 37 percent for the year of '04. In the fourth quarter, we had some benefits of some state tax refunds that we recorded. We had a similar phenomenon last year in the fourth quarter of '02, so we generally have a lower rate in the fourth quarter. But when we really true up some of our state tax strategies, some of the benefits from those.

And then the third questions -- over the past couple of years, you guys have received, I think, more than $80 million in floorplan credits, which has essentially provided you with 20 to 23 cents of earnings benefit each year. Could you comment on what your expectations are for the next couple of years, and whether or not we should anticipate the same level of assistance going forward?

The credits generally track two things. With the imports, they track units, and the amount of credit is related strictly to the units that are delivered to us. And in the case of the domestic brands, the credits track interest rates that are currently in effect on our floorplan. Therefore, we would expect our floorplan assistance, in general would move in response to changes in interest rates and in response to unit volume. When we talk about the impact of interest rate changes, the numbers that Lee gave you previously, 8 to 10 cents, that included the impact of changes in interest rate on floorplan and floorplan assistance. So on a net basis, we're considering that impact of potential changes in floor plan assistance in our analysis of interest rates.

Scott Stember, Sidoti & Co.

Can you talk about, on the parts and service side, warranty claims? Is that up or down? And can you just quantify between domestic and foreign brands?

Warranty claims are up, but I want to be a little careful in describing that, because we include in warranty extended warranty, CPO, et cetera. So we're anticipating that our warranty claims are going to continue to rise. Warranty in domestic brands have continued their downward trend, and warranty in import brands is trending upward, as you would expect with the increased unit volume sales there.

We're going to have to limit to one more call, due to time constraints.

Adam Comura, Intrust Capital.

I'll slip in a quick one. It's just clarification on the guidance for '04. Does that include any share repurchases? And I think before, you had said that you were anticipating interest rates rising 25 to 50 basis points. Does that mean you are also going to take a little bit of a hit on your floorplan interest income?

Yes, we said 25 to 50 basis point increase in interest rates, and our estimates include the impact of that increase on our long-term debt and floorplan both; it includes both of those, Adam.

And secondly, on the estimates for '04, we do not fully reflect the redeployment of any cash to share repurchases in our estimates.

Good luck on the continued progress in the turnaround efforts.

We appreciate your questions, and that will end our conference.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.