Sonic Automotive Inc (SAH) 2004 Q3 法說會逐字稿

Good morning and welcome to the Sonic Automotive third quarter earnings conference call.

[OPERATOR INSTRUCTIONS].

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

I would now like to introduce Mr. Jeff Rachor, president of Sonic Automotive. Mr. Rachor, you may begin your conference.

Good morning, ladies and gentlemen. Welcome to Sonic Automotive's third quarter 2004 conference call. Joining me today is the company's Executive Vice President and Chief Financial Officer, Mr. Lee Wyatt. Today I will be covering overall third quarter performance, industry trends and an update on strategy. Then Mr. Wyatt will be reviewing financial results in more detail.

As we communicated in our pre-announcement, the multiple hurricanes and increasingly difficult industry environment prevented us from achieving our previously stated performance targets in the third quarter. Third quarter earnings per share were $0.53 from continuing operations, up from $0.45 in the third quarter of 2003. Year to date continuing operations earnings per share performance through three quarters is $1.79 versus $1.58 in 2003. We anticipate the challenging industry environment will continue. Accordingly, we are revising fourth quarter guidance to a range of $0.41 to $0.44, resulting in full year guidance with a range of $2.20 to $2.23.

Total continuing operations revenue was up 5.1%, while total company gross profit was up 4.5% versus Q3 of 2003. Total continuing operations SG&A, as a percentage of gross profit, was 81.1% for the quarter, up from 78.1% in the third quarter a year ago. Although SG&A expenses were not in line with our previously communicated targets, we are encouraged that variable expenses were managed with discipline during a tough sales environment.

I am confirming once again, that we have no additional acquisition closings planned through the remainder of 2004. Our strategy to limit growth to a maximum of 10% of revenue remains steadfast as we approach 2005. This commitment to a more disciplined growth pace is enabling us to continue to focus on improving our core operations. In addition, a refined acquisition program targeting premium and Asian brands in existing markets, also supports our core operating strategy, and reduces integration risk going forward.

The retail automotive industry dynamics, in the second quarter did not improve from the third quarter. Declining consumer confidence, and a continuation of industry-wide excessive new vehicle inventory levels created a hyper competitive new vehicle landscape. These excess new vehicle inventories and record OEM incentive spending continued to put pressure on the used vehicle market as well. Additionally, used car wholesale pricing remained high on a year-over-year basis, making the retail value differential unattractive to the consumer, when compared to a heavily incented new vehicle.

Now, I will review same store performance by business segment. New vehicle revenue was down 4% versus the third quarter of 2003. While total new vehicle margin was flat compared to the third quarter a year ago, when you adjust for increased fleet sales, gross margins actually showed a slight increase to 7.2% versus 7.1% on a comparable retail basis in third quarter of 2003.

In addition to the hurricanes impact on our Southeastern operations, the difficult end and the difficult industry phenomena, the third quarter presented challenges comps as the company's strategy of a year ago centered on the aggressive pursuit of irrational volume to drive market share in many of our import stores.

Used vehicle same store revenue was down 10.2% versus the third quarter of '03. Used vehicle gross margin was 10% versus 10.2% in the third quarter of 2003. The decline in used margin was largely isolated to our General Motors dealerships. Manufactured certified pre-owned sales made up 33% of Sonic's total used vehicle volume versus 30.2% in the third quarter a year ago.

Sub-prime used vehicle sales comprised 18.5% of our total same store used vehicle volume, compared to just 12.7% a year ago. The company continues to believe, that the manufacturer certified pre-owned and lowered cost segment represent the greatest growth potential in used cars. We are encouraged with some recent traction in our used car operations as the sequential trend improved during the quarter.

Same store F&I per unit, excluding fleet sales, was $922 on a per unit retail basis, up $23 from last year, and improving $13 from last quarter. Service contract and finance penetration continue to be over 35% and 70% respectively. Total same store fixed operations revenue was down 1.8% for the quarter. The pressures on fixed operations performance were highly concentrated.

The company's same store service revenue was virtually flat for the quarter versus Q3 of '03. Same store service gross margin was also flat year over year. Service customer pay sales increased .5% versus third quarter of '03, while warranty sales increased 9.1% versus the third quarter a year ago.

Overall, same store internal and sublet sales were down 6.5% and 9.4% respectively as a result of lower vehicle sales volume. Total same store parts sales were down 3% versus a year ago, while parts gross margin was flat with the same period in 2003. Customer pay part sales were flat, while warranty experienced an increase of 5.2%. Declines came from highly concentrated revisions to wholesale parts strategy in select Sonic dealerships and reduced internal parts sales.

Fixed operations remains a stronghold for Sonic Automotive as fixed absorption overall was 82.5% for the quarter, breaking a succession of record highs. Sonic's brand mix and ongoing development of additional stall capacity contribute to a positive outlook for this high margin segment. Our initiatives to drive certified pre-owned sales, extended service agreement sales and our standard service drive processes will also drive future fixed operations growth.

The momentum acquisition integration in Houston continues to go smoothly, with high retention of local management and associates. That, combined with successful implementation of Sonic best practices yielded improved profitability during the quarter. The strongest performing regions for the quarter were the Mid-South, the Midwest, the Mid-Atlantic and Northern California.

The Oklahoma region is experiencing a noteworthy comeback, while Dallas, Denver, Florida and Southern California under performed. In terms of total revenue, our strongest brands were General Motors at 26.5%, BMW at 13.7%, Honda at 11.7%, Toyota at 10.3% and Ford at 9.5%. The luxury and premium brands continue to outperform for Sonic Automotive.

Execution in the retail automotive business is dependent on strong, experienced, local management. It is in that spirit that I am pleased to welcome Mr. Jim Evans as our divisional vice president for our Western division. Jim brings a wealth of experience and a proven track record of successful platform management. Most recently, Mr. Evans served as president of the Northwest District for AutoNation, where he had responsibility for almost $3 billion in revenue, much of it concentrated in California.

Jim's appointment and the related realignment in our Western division will improve execution of our operating initiatives in two of our key under performing markets - Southern California and Denver. We are continuing to develop our geographic oversight infrastructure and will look to add bench strength opportunistically in the months ahead.

In closing, I think it's important to renew our contention that our strategy is sound and has helped minimize the damage of another quarter of difficult industry conditions. We are controlling the controllables. Number one - SG&A expenses. Issues are isolated to our under performing regions. Number two - overall, new vehicle retail margins and F&I per unit are up year over year.

Number three - used vehicle margins. The declines, again, are isolated. Number four - inventories, both new and used, are in good shape. Number five - the limited acquisition strategy will allow us to continue to focus on our core operations. Number six - management development and key personnel stability is improving. And number seven - we remain committed, strategically, to a long-term reduction and net debt to capital with a target of 40%. Mr. Wyatt will discuss further.

Sonic Automotive is committed to the continued execution of our strategy through the fourth quarter and beyond, while we'll be doubling our efforts on rebuilding revenue growth. I'm also pleased to confirm that the dividend program will remain unchanged with $0.12 a share payable on January 15 of 2005. At this time, I will turn the call over to Mr. Lee Wyatt to review third quarter financial information in more detail. Lee?

Thank you, Jeff. Earnings per share from continuing operations in the third quarter of 2004 was $0.53, an increase of $0.08 compared to $0.45 in the third quarter of last year. Earnings per share from discontinued operations in the third quarter of '04 was a loss of $0.07 compared to a loss of $0.04 in the third quarter of last year. Net earnings per share was $0.46 in the third quarter of 2004 compared to $0.41 in the third quarter of last year.

Earnings per share from continuing operations for the first nine months of 2004 was $1.79, an increase of $0.21 compared to $1.58 last year. Earnings per share from discontinued operations for the first nine months of 2004 was a loss of $0.11 compared to the loss of $0.07 last year. Net earnings per share was $1.68 in the first nine months of 2004 compared to $1.37 last year. In reviewing the third quarter in more detail, total revenues grew $95 million or 5.1%. New vehicle revenue grew 4.5%. Total used vehicle revenue grew 4.6%. Parts, service and collision revenue grew 10%. And F&I revenue declined by 2%.

The overall gross margin rate for the third quarter was 14.9%, generally flat with last year. New vehicle gross margin rate was 7%, the same as last year, while used vehicle retail gross margin rate was 9.8%, a decline from (inaudible) to a rate of 48.6%. In the first and second quarter, we met or exceeded our SG&A expense targets, and improved on the prior year expense ratios.

The SG&A improvement in the first half of 2004 was primarily the result of controlling the spending rate on advertising and selling expenses, while achieving growth in gross profit dollars. During the third quarter of 2004, we continued to control advertising and selling expense, but the declines in same store sales volume and gross margin rates drove an overall increase in the SG&A rate. In addition, property damage from hurricanes and related disruption and a hail storm in Colorado, and to a lesser extent, an increase in legal reserves in Sarbanes-Oxley accounting fees, increased third quarter expenses.

We remain committed to controlling expenses, and see the current expense increase as a temporary condition. Diluted share count for the third quarter was 42.2 million shares. During the third quarter, we expended $5.5 million to repurchase 280,000 shares at an average price of $19.74. During the first nine months of 2004, we expended $21 million to repurchase 952,000 shares. Thirty-three million dollars is currently available under our existing share repurchase authorization.

Our debt to total capital ratio was 49.9% for the third quarter. This rate reflects the July acquisitions of the BMW dealerships in Houston. Since no other acquisitions are planned for the remainder of 2004, debt to total capital ratio should be 46-48% by year end. We remain focused on reducing the long-term ratio to 40%. Availability under the revolving credit facility was $175 million at quarter end. Non-floor plan interest expense decreased by 600,000 in the third quarter compared to 2003. This reflects the benefits of the previous refinancing activities.

Including floor plan debt, approximately 58% of the company's debt is fixed. Based on selling days, the day supply of new vehicle inventory declined 11 days to 48 days. Used vehicles declined three days to 39 days. And parts was consistent at 35 days, all compared to the second quarter. We believe that the inventory levels were managed well in a difficult retail environment and that we are well positioned for the fourth quarter. On a continuing operations basis and excluding one-time items, LTM interest coverage was 5.8 times, long-term debt to EBITDA was 3.4 times and return on equity was 14.2%. We continue to meet all covenants under our revolving credit agreement.

Gross capital expenditures were $27 million for the third quarter, and $73 million year to date. We anticipate that approximately 75% of this amount will be recovered through sale and leaseback transactions. Capital expenditures for the year, net of sale and leaseback transactions, are expected to be 25 to $30 million. Our fourth quarter guidance is 41 to $0.44 from continuing operations. The key assumption in our fourth quarter guidance, is for a continued competitive new and used vehicles sales environment, very similar to the third quarter.

Fifteen dealerships were included in discontinued operations on January 1. We have sold four dealerships and two others are in the final stages of negotiations. Four dealerships currently have strong prospects and we have added two dealerships to the list of discontinued operations in the third quarter. We've maintained a measured pace of dispositions because the improving operating performance should result in higher proceeds when sold. We continue to estimate overall proceeds in the range of $15 million.

At this time, we will take questions.

[OPERATOR INSTRUCTIONS].

Your first question comes from Jordan Hymowitz with Jordan Hymowitz.

Just a couple core questions. As we look to '05, is there any range of guidance you could give at this point and, included in that guidance, could you say what your estimates are for interest rates?

Hi, Jordan. This is Lee Wyatt. What we will do in December is issue our annual guidance for 2005. We'd like to take a little more time to understand the industry in the fourth quarter, how that's going to recover the impacts of presidential election. So, we will publish guidance in December and, when we do that, we will also include interest rate guidance.

OK. Second question is new vehicle gross margins of 6.9 - do you still think, in the fourth quarter, there's stable (ph) of 7%?

Jordan, this is Jeff. Again, on a retail basis, margins were 7.2%, and we do expect the new vehicle market to continue to be hyper competitive. And so, I think that it's a safe expectation that we wouldn't see significant improvement from the current levels.

OK. Thank you very much.

Your next question comes from Rob Schwartz (ph) with J. L. Advisors.

Could you just give us a little more detail on, you know, the impact of the hurricanes and, you know, what you're seeing now? Was it a - it seems to me like, in your industry, it should just be timing difference that should be made up. And then, alternatively, if we could talk about expectations for share repurchase and share count going forward.

Sure. This is Jeff. I'll take the hurricane question and then I'll turn it over to Lee to talk about share repurchase. Obviously, the succession of hurricanes did cause business interruptions in our operations, particularly in Florida and Alabama. We are pleased that business is rebounding to normal levels in those markets in October. The only markets where we've seen what I would call a robust rebound would be those markets that were a direct hit, if you will.

We have two dealerships in the Florida panhandle, and they're experiencing some robust business trends in October as a result of serving some of the pent-up demand, insurance replacement activity, et cetera. But overall, the rebound is really just back to normal levels, and while there is an expectation that we may recover some of the lost new and used vehicle volume in the months ahead, it's difficult to determine when that demand will present itself, and secondly, I would note that many of the lost days in fixed operations are difficult to fully recover.

With that, I'll turn it to Lee for a comment on the share repurchase. Lee?

Yes, in the fourth quarter, we'll continue to the pace that we've established this year. On an annual basis, we've acquired around 24, $23 million annually, so we'll continue that pace in the fourth quarter. In 2005, we anticipate a similar pace, could be adjusted based on acquisition pace during the year, and we'll wait and see how the acquisition pace develops in 2005.

So, given the stock at these levels and the I think $30 million - approximately $30 million left or, $25 million left in the share repurchase, you don't expect to accelerate in the fourth quarter?

Probably not in the fourth quarter.

OK, thanks.

Your next question comes from Rick Nelson of Stephens.

Good morning. Your inventory - a question on inventory. Your days supply does not appear to be heavy. We understand there's a lot of product out there in the industry, and I'm just curious how you see that shaking out and what sort of timeline and when gross margins might return to historical levels?

Rick, this is Jeff. Thank you for the question. Our inventories obviously are in good shape compared to industry averages, however, I do want to acknowledge that we have what we would consider high inventory levels remaining in our domestic brands, specifically, our General Motors and Cadillac brands at this juncture, so we do have some sell through there. And obviously traditionally there's a buildup of inventory at this time because of the seasonality and the production schedules of many of the OEMs.

We do expect pressure on new vehicle margins to continue as an industry phenomena. However, there is generally some lift in the fourth quarter because of the introduction of new models, and we will experience that in some of our brands, but it's hard to predict when we would see a consistent restoration of historical gross margin levels until the macro industry dynamics become more clear. And we think that certainly the picture remains difficult in terms of the industry dynamics for the remainder of fourth quarter. And we'll have to reassess things then and give you a clearer outlook on 2005, as Lee suggested.

Jeff, are the manufactures doing anything with assistance to encourage dealers to keep more inventory?

No, as you know, Rick, many of the manufacturers already have floor-planned financing programs, subvention, if you will, where they provide essentially interest coverage assistance for a period of time, usually a target of 60 days. That's primarily with the domestic lines.

Are they extending those targets.

At this juncture, we've seen no programs introduced from the manufacturers to extend those targets.

OK, how about your mix of '04, '05 new vehicles, and maybe how that compares to where you were a year ago with the '03, '04?

We feel that that's a favorable picture. I've got those numbers in front of me, and we're about 50/50 '04 and '05 at this juncture. And if you remember a year ago, we managed inventories too tightly and we were caught short of '04 product - '03 product, excuse me. And one could argue that we wish we had more this year, but with the uncertainty surrounding the industry dynamics, we feel very comfortable that we have a nice balance of '04 and '05 product, and also a level of days supply that is well below the industry average but is still up significantly from a year ago, up about eight days from a year ago, but down about 11 days from last quarter and still significantly below the industry at large.

And a question, I guess - everybody seems to be in this inventory reduction mode. How does that affect the approval process when you step up the acquisition pace again? I realize you pulled it back, but if you decide to accelerate, does that jeopardize the approval process?

No, our decisions to accept or reject inventory from the manufacturers has no bearing on our approvability process for acquisitions, Rick.

Even if you're losing share to other companies that are more willing to keep inventory?

Well, that is the one area that it is considered in some of the manufacturers' approvals process. And again, I was specifically addressing the inventory allocation process, but clearly we have an obligation to the manufacturers to get our rightful share of the market, and so they do hold us accountable for high standards of market penetration. And obviously we still intend to stock adequate inventories to achieve those market share targets.

We are going to continue to be aggressive in order to compete in the market and maintain adequate standards of market share and try to comply with the manufacturers' requirements relative to the acquisition approval process.

OK, thank you.

Your next question comes from John Murphy of Merrill Lynch.

(inaudible) questions here. The first is, if you could remind us if there is a target for SG&A as a percent of gross out there? The second question is, you mentioned that wholesale values were pretty strong, yet you're having a hard time at retail. I was just wondering how those two values are matching up?

I mean, typically, you'll get a parallel or response through the system there. It must be something going on with the independent dealers that are doing well. The third question is if you guys have any idea on how October sales are going so far? If you could give us -- directionally (ph) how those are going.

And then fourth, on the concentration of your dispositions, what were the new dealerships that got added in discontinued ops, and is there anything specifically in those 15 dealerships brand-wise or location-wise that sort of is the reason for the disposition, or potential disposition?

Hi, John, this is Lee Wyatt. I'll take the first and the last questions.

OK.

The SG&A target that we established at the beginning of the year was 77% for the third quarter, and we obviously missed that. It's the first quarter we've missed our target. Generally, to a large extent, because of margin rates and because of the expenses that came out of the hurricane, the hail damage, those kind of issues.

OK.

Disc ops, the general makeup of our disc ops group is not concentrated geographically. It's fairly well spread. We set this up at the beginning of the year, really the end of last year.

It's more domestic than import in terms of brands, but there's no real concentration in brands there either. We added two stores in the third quarter. We try to review our disc ops list in the third quarter of every year, and we added one small Dodge store and one Mitsubishi store in Colorado. So nothing significant about those two adds.

And let me address the wholesale pricing question if I can. If you look at the Manheim index, wholesale pricing is up in July, August and September versus a year ago. How that trickles down to the retail arena is in two ways. One, obviously, that higher pricing is reflecting a shorter supply of off-lease and op lease vehicles, and that's driving pricing higher. That also makes it difficult for us to source vehicles that would make good retail pieces in our inventory.

Secondly, obviously, that higher wholesale pricing is driving higher retail pricing, making the differential between a late model pre-owned vehicle unattractive versus a heavily incentivized new vehicle. So those are the two ways that pricing is impacting retail sales.

Hence your focus on the CPOs and the older cars, right?

That's correct. And those are the two segments that we're growing in, and we continue to see those two segments as the best way to combat the market dynamics I just described.

OK, and then just on October sales, any word, sort of strong, weak, medium?

Well, I think there's now industry information out that shows that October is tracking for kind of a flat year over year sales trend, and that's consistent with what we're seeing. Again, we are seeing a rebound to what I would characterize as normal business conditions in the areas that were impacted by the hurricanes.

But on an overall basis, the market remains difficult, and again, based on an industry piece as early as this morning, it appears that the month is tracking for about a 16.4 million SAR, which is pretty flat with a year ago. It does look like October sales are tracking to be slightly below September on an industry-wide basis.

Great, thank you very much, guys.

Your next question comes from Charles Scrum (ph) of J.P. Morgan.

Hi, this is Paul Trusso on behalf of Charles. How are you doing, guys?

Good, Paul.

Just if you can elaborate just a little bit more on what happened over the next two weeks that led you to lower your fourth quarter guidance? How conservative would you say you were being?

Hi, Paul, this is Lee Wyatt. When we went out with our prerelease, we set a pretty broad range because we hadn't accounted, completely accounted, for the third quarter at that point, so we went with a $2.20, $2.30 range, and with a little broader range. Now that we have more information, we just lowered it to the lower end of that range, primarily because looking at October to date, as Jeff just mentioned, while the hurricane areas seem to be coming back to more normal levels, the balance of the country for us in the overall business environment has not improved significantly.

So, with that in mind and that uncertainty, we just wanted to be at the bottom end of that range, candidly. I would characterize our guidance as middle of the road, not extremely conservative, not optimistic, but middle of the road.

OK, thanks. And with your - what about an SG&A to gross profit margin target, just for the fourth quarter and kind of longer term now? You still have a 76.5% target level for next year?

That's the goal. We will work through that in more detail when we give guidance in December for 2005 and we'll give you a specific target there. In the fourth quarter of 2003, our SG&A as a percent of gross was 82.4%. We will beat that this year, clearly, and we'll give you a little more guidance on that in the future, but I think we'll be in the 80% range potentially for the fourth quarter.

In an 80% range?

Yes.

OK, all right, thanks, guys.

Your next question comes from Peter Siris of Guerrilla Capital.

Thank you. I have a different sort of question to ask today. If - Lee, if you look at your cash flow for the year, what's the cash flow, roughly?

We think free cash flow generally would be $100 million, ballpark.

OK, and how many shares are there? What?

Forty-two, fully diluted.

OK, so you're talking about $2.30 in free cash flow or something, roughly?

Yes, sir.

Whatever the number is. And likewise, if the Street - if you're slowing down your acquisition pace and the Street isn't paying you for the numbers, then why wouldn't you guys just say, OK, let's raise our dividend to 5% of sales? Let's raise our dividend to $2.00, to $1.70 a share and let investors benefit from the substantial free cash flow generation that your business has?

Peter, that's a good question. You always ask different sorts of questions, and we appreciate that. They're always challenging. And I think on this call what I would say to you, and we can of course follow up individually on a later call, I think why we're not getting very much in the way of a benefit for our growth today, I think much of that has been driven by our lack of consistent performance in our core operations.

One of our focuses now, and one of our primary focuses, is improving that core operating performance, and we're very focused on that and we're starting to see some improvement there, and we think there's a lot of opportunity. So once we improve, and have more consistent operating performance in our core business, then I think doing targeted acquisitions will allow us to continue to grow, and give the investors a growth story, although not at the kind of pace Sonic has historically grown at, but at a reasonable pace. I think we'll then get some of the benefits, and some of the valuation that comes from that growth when it's coupled with consistent operating performance.

So that's the strategy as we see it today, and we can follow up on the more dynamic question of a significant increase in our dividend.

I guess just to follow up my last point, and I don't want to beat a dead horse on this is, that if you guys paid a big dividend out, your stock would be at a much higher price, and then if you wanted to make acquisitions, all you would have to do is raise a little capital. I mean, REITs do that all the time.

And I guess my question for you, and I would ask this question of virtually all your competitors is - and I will ask the question of virtually all of your competitors is - if this industry has such strong free cash flow and the Street is voting not to pay for it up and down the industry, then have you looked at what would happen if you just said, OK, we're going to pay out 80% of our free cash flow in dividends?

We appreciate that, and again, we have tried to take a balanced approach in our strategy. We need to, we understand, improve operating performance, but we will think through your comments. We appreciate it.

OK.

You're always thoughtful and challenging.

OK, I'll talk to you guys later.

Thank you, Peter.

Your next question comes from Adam Comora of EnTrust Capital.

Hey, guys. I had one quick numbers question and then an industry question. The number question is, you guys do a great job of breaking out your SG&A expenses in the four different categories, personnel, advertising, facility, rent, and then there's an other category. What's in that other category, because that looks like where there was a big increase this quarter.

Yes, that's generally our other fixed category that you'll see. There's really three things in there. There's some other variable kind of expenses. There's some facility expenses like real estate taxes that are not rent but they're other facilities. And the bigger piece is just fixed.

And what really comes into there in fixed is all the property losses that we had from hurricanes. It's legal fees, it's accounting fees, it's those kind of things, and those are really what jumped up. Plus, you have to remember there's an absolute dollar increase in those just because we made acquisitions and we added some fixed cost. But the incremental increase was the result of the hurricane issues, the hail damage issues and the related insurance kind of things that happened there.

OK, so that's sort of what you're talking about when it cost you 9 cents in the quarter, it's in that number?

A piece of that is in there, yes.

OK. And then my second question is more on the industry perspective. Clearly you guys have done a good job on your inventory, but overall there's too much inventory out there on dealers' lots. How do you think this all gets resolved? Are we ever -- do you think it's going to be from the demand side or the supply side? Can we -- in your discussions with the OEMs, can we expect a normalized environment to come from them cutting production or are we just going to have to wait for all of a sudden one more big demand bump to sort of clean this out?

This is Jeff. Let me take that question. Of course, you're well aware that both Ford and General Motors has already announced production cuts, and so part of it is going to be addressed clearly on the supply side. In addition, obviously there is optimism that as we work through the remainder of the quarter, get some clarity on the macroeconomic picture, the election, et cetera, that there will be some restoration of demand.

In the meantime of course, the OEMs, in our view, are going to continue to be extremely aggressive in the consumer incentive arena to stimulate demand during that period when supply and demand is adjusting. But I think that it's been communicated by a number of industry leaders that the heavy incented new vehicle market is really here to stay, and that the manufacturers are clearly committed to investing in whatever incentives are necessary to protect market share, and keep those plants producing new vehicles at a rate that will allow them to meet their obligations.

So, I don't know if that gives you any insight. I think again, there will be some relief on the supply side. Again, both Ford and General Motors, where some of the industry inventories are the heaviest, have already announced those production adjustments, and then we're all optimistic that as we head into '05, hopefully we will see some stability in demand, and together with the shorter production with a couple of those key domestic manufacturers, we'll see a better balance in the marketplace.

OK. I'm sorry; I just want to sneak in one last one. After you dispose of those other -- the other dealerships, I guess you have, whatever it is, 11, 12, 13 left, do we shift the mix that much in terms imports versus domestic? Where are we at the end of that process?

Actually those stores are included in our disc ops so when you look at our overall sales, you wouldn't see those included...

Got it. Thanks, guys.

Your next question comes from Carla Placella (ph) of JP Morgan.

Hi. I'm wondering, the F&I revenue per unit has continued to tick up. I'm wondering if there's a level at which that is concerning, that you don't want it to get over a certain level.

That's an excellent question and there is a level at which we're uncomfortable. We monitor that on a per store basis, and a per market basis, and we don't see any significant upside from these levels. At our current performance we would be, I believe, in the upper quartile of our industry peers. We think that that is a good place to be.

We can achieve these levels of performance, we believe, without creating undue risk on our commitment to the highest standards of disclosure and compliance in our F&I departments, and that continues to be a priority for our organization. So your assessment is an accurate one.

At these levels, we might have another $50 a car out there in the upside, but we would not be focused on driving F&I performance much higher than kind of another 50, $75 per unit retail. We believe beyond those levels that you could incur additional risk, and we're not prepared to take on any risk in our commitment to compliance, to integrity, to high ethics in our F&I departments across our organization.

OK. And then secondly, can you just talk about with the rising gas prices, what impact that could have on any of your businesses, be it service or on the vehicle sales?

Yes, let me address that. Rising gas prices have begun to have some impact on the large SUV segment, those vehicles obviously that have lower miles per gallon or EPA targets. So we are seeing that first in the used vehicle arena where there is valuation pressure on large SUVs particularly.

And if you think about it that's rational, because obviously that preowned large SUV buyer is somewhat more of an aspirational buyer that's going to be a little more budget conscientious, than a new vehicle buyer. But as an industry we did see a decline in large SUV sales during the quarter in the new vehicle segment as well.

So it would be safe to say that rising oil prices and the trickle down effect to gas prices is having some modest negative impact on those large vehicle segments. And yet when you look at luxury car purchases, for instance, where the market continues to grow, generally that consumer is not going to be overly sensitive to a 50 cent per gallon increase at the pump.

If you look at the industry dynamics last quarter, two of the biggest growth segments were small cars in the new vehicle arena, compacts, which were increasing, and also luxury, and the used vehicle market mirrors that pattern as well. So you are seeing greater demand for cars that have better fuel economy and less demand for vehicles that are in that large SUV category.

OK, great. Thank you.

On pickup trucks, I should note that full size pickups, sales there are holding up very well. Again, those people are very passionate about their vehicles, either for utility or lifestyle choices, and they're less willing to trade to a more fuel-efficient vehicle than somebody who's maybe acquiring that large SUV.

Your next question comes from Adrienne Dell (ph) of CIBC World Markets.

Hi, thank you. First of all I was just wondering if you can give us a sense of the amount of revenue we should see rolling off to pour (ph) all these divestitures going forward.

Yes, Adrienne, this is Lee Wyatt. First of all they're not in our -- the disc ops group sales are not included in our reported sales, so you won't see any change as a result...

But you add to that from time to time, right?

Yes, ma'am. And we've -- just two stores this quarter. Generally, those divested stores are about -- year to date have been about $325 million in sales, ballpark.

OK, great. And are you seeing any additional pressure, due to some of these recent sales gimmicks? I don't know if you saw the one, where you could buy a truck and get a car for free. Is that impairing the value of any of your comparable cars on your lots?

This is Jeff, and I didn't have any exposure to that particular gimmick, and I couldn't say that we're aware of any impact from those type of merchandising approaches in our industry impacting our business negatively.

OK, great. And then, the big three have made a big deal about some of their new products coming on line this year. Could you just comment on what you're seeing in terms of the new sales of some of these newer models like the Ford 500 and Freestyle and the like?

Well, it's very early in the lifecycle of those vehicles, the 500 and the Freestyle, so we're optimistic about their impact. One of those vehicles brings a very competitive product to a segment where, frankly, we haven't had a strong and competitive product in recent years. And the other one is really a new product for Ford, and we're very optimistic that both of those vehicles are going to add some incremental volume.

There's been a number of other new model launches. Again, we're very, very early in the launch cycle, but obviously we can give you very positive feedback on vehicles like the Honda Odyssey. That's an important vehicle to us with Honda being such a big part of our revenue. We have 15 Honda dealerships, and we do expect some margin lift in our Honda portfolio as a result of the newly redesigned Odyssey.

But overall, the new vehicle launches generally we view as positive, both from a standpoint of potentially driving incremental sales, but also, as I mentioned, improved gross margins to throw into our average to help us be competitive with some of the other more commodity oriented products that we still have to aggressively merchandise to retain market share, and compete with the marketplace at large.

OK, great. Thank you.

Your next question comes from Nate Hudson (ph) of Bank of America Securities.

Hey, good morning. A couple of cleanup items. Did you say what your same store new and used unit sales were for the quarter?

We will give you those. New units were down 7%, used at retail was down 17% -- or 13%, I'm sorry.

OK.

7 and 13, Nate.

All right, thanks. And can you just update us on the rollout of the pay plans. Is that moving forward? Have you hit any glitches there, just give us an update.

The rollout of common element pay plans is largely complete in the stores that we targeted. Again, we targeted the stores that had the most upside or had the most out of line conditions relative to our SG&A targets. And by and large, that's been very successful at driving increased retention of gross profit in those stores, particularly in the fixed operations area.

However, I would acknowledge that that implementation obviously, did result in some turnover, and while some of that turnover is what I would characterize as positive turnover, where we had associates that were unable to achieve productivity levels under our motivational commission-based compensation schemes based on their own production, there was a level of turnover that was not welcome, and that has contributed to some of our execution challenges in select dealerships and markets.

So overall, a success, a tough decision and a price that needed to be paid and particularly successful in fixed operations where there is -- greater sensitivity was on the sales side and in cases where we had unwelcome turnover, we've obviously gone back and tried to make some adjustments to accommodate those handful of dealerships or markets that were negatively impacted.

OK. And you said that Southern California is one of your under performing regions. What would you attribute that to, is it brands, management, or just market conditions?

That would be largely management and execution of our initiatives. I would tell you that that is also a market where we've had unusually high turnover, and did not have smooth execution of some of our initiatives that I just mentioned. But we're very excited about the recently announced management realignment. We have great assets in Southern California, and we have a very positive outlook that we'll be able to improve execution, and bring stable management to that market, and improve results as we go forward.

And one last question, just in regards to your debt reduction target of getting to a 40% debt to cap. Is there any timeframe attached to that or what level of detail can you provide?

Our -- Nate, this Lee. Our overall target is to be there in a couple of years, and if we can get there sooner we will, but a couple of years.

All right. Thanks very much.

Your next question comes from Scott Stemper (ph) of Sedodey (ph).

Good afternoon, guys. Could you maybe talk about some of the foreign products, if you've seen any pressure on some of the higher volume units, such as any Toyota or Honda products?

Well, we have those two -- those are two of the best brands in the business, and we are honored to have a number of Toyota and Honda dealerships. However, that market, like the market at large, is definitely hyper-competitive. We definitely saw margin pressure this year in our Honda stores. I know that Honda dealers at large experienced margin pressure. Much of that was a result of a product line that was long in the cycle.

And again, with a product assault on the horizon led by the recent introduction of the new Odyssey and a number of other outstanding products over the next 18 months, we're optimistic that we'll be able to rebuild margins within our Honda group. The Toyota business is always competitive and it remains competitive. I can't say that there's a significant differential this quarter from recent quarters, but the competitive landscape with Toyota, and really all of the Asian imports, has been at a peak now really throughout the year when you look at a year over year kind of comparison.

All right. The rest of my questions have been answered. Thank you.

Your next question comes from Jerry Marks of Raymond James.

Good morning.

Hi, Jerry.

Just a couple of quick cleanup questions. Your ramp went up both sequentially and year over year, but I believe your franchise count went down by five. How come that happened?

Well, ramp went up because of the acquisitions to about $21 million for the quarter. But I think our franchise count has been similar since this year, around 195 franchises.

Oh, I thought in your guys' press release you said 190 now.

No, sir. I think it's 195.

OK, I'll follow up with you on that. The other question I had was, in terms of your guidance. It looks like third quarter, if I back out or adjust for the hurricane and everything else, you were down about 8% on a comparable basis year over year. Your guidance for the fourth quarter suggests earnings will be down 15% year over year and kind of -- Jeff, you indicated that, at least in the hurricane states, things were rebounding a little bit. How come you're looking for things to get a little bit worse in the fourth quarter?

Well again, my comment was that things are rebounding to normal conditions. Keep in mind that today in the retail automotive industry, normal conditions are difficult conditions, and I think that our outlook going forward is cautious optimism as a result of the overall industry dynamics. Even with our dealerships in the southeast rebounding to kind of normal conditions, again, the normal environment today is a very, very competitive one.

We expect overall industry margin pressures to continue, as a result of the over capacity and high inventory levels that were mentioned. And I think there were some thoughtful comments made recently, that even if our inventories are in relatively good shape, the margin pressures continue, because we're competing with private and public cap (ph) dealers that may have heavier inventories, and therefore, be forced to be even more aggressive at the margin. So those are some of the assumptions that went into our cautious outlook for the fourth quarter.

Lee, do you have anything to add?

Yes, I would just say the drivers are same store sales and gross margin on new and used compared to last year. Those are the issues that are taking earnings down somewhat, relatively speaking.

And then I guess just to kind of follow up on, Jeff, what you were saying in terms of your inventories being in pretty good shape. Last year in the third quarter, as you alluded to, you had some stocking issues with too few '03 versus '04, and this time around you guys sound like you're in a lot better shape.

So, because you had kind of company-specific issues in the third quarter of last year, you'd acquired, added on about 10% of revenues, how come you still had such a big decline in earnings? Was it also because of those personnel issues that you just mentioned where people were leaving?

That's a piece of it. There's really a few pieces here, Jerry. There's certainly the obvious piece with the hurricanes. The other piece is really industry-specific with the overall dynamics. And then, as we've acknowledged, we had execution issues in a handful of our key markets, Southern California, Denver, Dallas, and in Florida obviously compounded by the hurricanes. So, we are working to address those issues.

The recent management realignment in our western division is specifically targeted to address improved execution in two of those four under performing markets. I would also acknowledge that Dallas is a market where we had under performance. We look for that to continue, not just because of opportunities to improve execution, but we feel a general market malaise in Texas overall.

Our Houston operations, in contrast we have had a stable management and execution, very successful integration of our new acquisitions, but both Houston and Dallas could be impacted in the fourth quarter by some fundamental weakness in the economic landscape in Texas overall. So once again, those are all things that contributed to our shortfall this quarter and that are considered in our guidance as we look to the fourth quarter.

OK. And the last question just to kind of follow up on what Peter was talking about in terms of paying out a dividend. To look at it from another angle, given the multiple (ph) you guys have, you can't really raise capital and really haven't been able to for several years. But you are incurring additional costs in SG&A because of Sarbanes-Ox and everything else. At what point do you decide well maybe being out there in the public markets isn't beneficial?

Hey, Jerry, this is Lee. I think our first focus and first priority is to improve core operating performance and focus on that and that's what we're doing. And we're able to do that now because we've slowed down that rapid acquisition pace, as you know.

So I think we have to work through and really build the processes, and the people that allows us to drive core operating improvement, and consistent core operating performance and then we'll decide that. But that's a year or two away. So we're very positive that we can improve operating performance and improve consistency, so I think that's our focus right now.

That's our number one priority, Jerry, is to focus on our core operating strategy before we should consider any of these financial strategies, because a lot of what we believe clearly has kept us from realizing the full value for our shareholders has been the volatility in our performance over the last couple of years, largely resulting from a hyper-rapid growth pace.

And in terms of raising capital, that isn't a priority at this juncture. It's certainly not a necessity. And we have had access to capital over the last few years, but with the limited acquisition pace, that isn't a priority at this time. And certainly with the stock valuation and the entire sector valuation at this juncture, issuing equity would not be prudent.

Jerry, this is Lee again. We, as Jeff said, we don't have a great need to raise capital, but I would say we did raise capital in 2003, 275 million, and we did raise capital in 2002 as well, so we think we can raise capital if we need to. But the slower acquisition pace, coupled with the strong cash flow that we have, really doesn't dictate that we raise capital right now. And we've got reasonable interest rates in our debt, we're 58% fixed, so we think that's all -- the capital structure is all pretty reasonable.

OK, thanks.

At this time there are no further questions. Mr. Rachor, are there any closing remarks?

No. Thank you all for your interest and attention this morning.

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