Sonic Automotive Inc (SAH) 2005 Q2 法說會逐字稿

Good morning, and welcome to the Sonic Automotive Second 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 market, or otherwise make statements about the future.

Such statements are forward-looking, and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These risks and uncertainties are detailed in the Company’s filings with the Securities and Exchange Commission. Thank you. I would now like to introduce Mr. Jeff Rachor, President and Chief Operating Officer of Sonic Automotive. Mr. Rachor, you may begin your conference.

Good morning ladies and gentlemen. Welcome to Sonic Automotive’s Second Quarter 2005 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 second quarter performance, industry trends, and an update on our acquisition strategy. Then Mr. Wyatt will review financial results in more detail. At the conclusion of our prepared comments, we will both take questions.

Strong industry dynamics, including better than expected consumer confidence in innovative manufacture incentives, created a robust new vehicle sales environment in the second quarter, countering the contradictory forces of rising interest rates and oil pricing. Second quarter earnings per share were $0.66 from continuing operations.

Total revenues were up 13.7% to $2,051,641,000, an all time Sonic record. Total gross profit was up 10.5% to $308,499,000, also an all time Company record. Same store revenue experienced strong growth in every business segment. Total gross margin from continuing operations was 15.0% compared to 15.5% last year.

Total continuing operations SG&A as a percentage of gross profit was 76.8% for the quarter, outperforming our stated full year target of 78.0%. Operating profit, before interest and taxes, increased 3.9%. As I suggested during our Q1 earnings call, new vehicle margin pressure and rising interest rates continued to impact bottom line profitability.

During the quarter, we experienced floor plan interest increases of 61% and other interest increases of 9.3%. These interest expense increases account for $0.04 of the difference in year over year earnings per share. Mr. Wyatt will comment further.

Now I would like to review same store performance for the quarter. Total same store revenue was up 8.6%. New vehicle revenue was up 9.1% versus Q2 2004 as we outperformed the industry in all three months in retail new unit volume. New vehicle retail gross margin was 7.4%, down from 7.8% last year. However, new vehicle margins on a retail basis remain unchanged sequentially from Q1.

Used vehicle revenue was up 6.1%. Once again, Sonic used vehicle departments outperformed the industry’s franchise new vehicle dealers in used unit volume for the second quarter. Used vehicle margins were flat at 10.8%. This actually reflects improvement as our brand mix shifts to a higher concentration of luxury import vehicles, which yield lower used car margins, but higher gross profit per unit.

Sonic continues to successfully execute our used car strategy, targeting two growth segments. Certified pre-owned sales were a record 36.4% of Sonic’s total used vehicle sales, compared to an industry average of just 8.6% for the quarter. Sub-prime or value used vehicle sales comprised 20.5% of our total same store used vehicle revenue volume, compared with 17.6% in Q2 2004.

Total same store fixed operations revenue was up 5.4% for the quarter. Same store customer pay sales increased 6%. Total fixed operations gross margin was 48.8%, down 20 basis points from last year. Total same store service revenue was up 5.4%, while service margin was 70.0%, up from 69.3% last year. Total same store parts revenue was up 5.9%.

Total parts gross margin declined from 33.3% last year to 32.5% this year. The decline in parts gross margin was due to a single dealership’s wholesale parts liquidation, and increased customer paid tire sales, which are sold at lower conquest margins.

Fixed absorption was a record 84.5% for the quarter. As we pursue our long-term strategy of portfolio enrichment, with a focus on luxury important brands, it might be helpful to share a few fixed operations facts from our luxury business. Sonic luxury import brand same store fixed operations revenue grew 11.3%. Sonic luxury brand combined fixed operations gross margin was 51.7%. And fixed absorption in our luxury import portfolio was 98.6% for the quarter.

At the close of the quarter, new vehicle inventories were at 45 day supply as a result of the General Motors employee incentives acceleration of the ’05 sell down. But this is an industry phenomenon, not a Sonic phenomenon. In fact, Sonic domestic day supply was at or above industry levels at quarter end.

Used vehicle day supply was well managed at 40 days. The strongest regional platforms for the quarter were Las Vegas, Washington, D.C., Florida, Alabama/Tennessee, Los Angeles, and continued momentum in the turnaround of our Dallas/Oklahoma platform. Platforms in Colorado, Houston and Ohio under-performed during the quarter. In terms of total revenue, our top brands for the quarter were General Motors, including Cadillac, at 23.9%, Toyota, including Lexus, at 16%, BMW at 14.6%, Honda, including Acura, at 14.5%, and Ford at 9%.

Now a brief update on acquisitions. Consistent with our revised acquisition strategy, driven by portfolio enrichment, we closed on Simonson Mercedes Benz in Santa Monica, California late in the quarter. Simonson is one of the largest Mercedes Benz dealerships in the United States, with annual revenues of over $160 million. This represents our second significant acquisition this year, exemplifying our revised discipline acquisition criteria for brand, scale, geography, fixed absorption and integration risk.

The disposition side of the portfolio rotation is progressing nicely, with five dealerships sold during the quarter, and four others pending. We project additional acquisitions, reflective of this strategy, to close by year-end, in the 100 to 250 million annual revenue range.

Overall, we are very pleased with improved execution in the second quarter, and continue to be confident in our ability to improve year over year operating performance in the second half of 2005. Several industry uncertainties temper our optimism -- the anticipated payback for the June/July pull-ahead; shortages of 2005 new vehicle inventory industry-wide, especially General Motors; the new employee pricing incentives impact on late model used vehicle supply and valuation; rising interest rates and energy cost; the successful launch of the General Motors 2006 net pricing strategy, and uncertainty surrounding new vehicle margin pressure.

However, our strategy was validated in the second quarter. Focus on associate stability resulted in a 26% decline in year over year associate turnover. We posted a continuation of the first quarter’s strong same store sales growth, completing six months in a row of retail unit volume increases that out-performed the industry.

SG&A is improving, and is on track for our annual target. Fixed operations rebounded nicely during the quarter, and will continue to benefit from the brand mix rotation and planned facility investments, yielding 400 new service stalls in the next 12 months. Our inventory management highlights our operating discipline. Our portfolio enrichment acquisition strategy is progressing at a purposeful pace, and will yield compelling long-term improvements in all operating metrics. Finally, we’re committed to a net debt to cap of 40%.

For the remainder of 2005, we will strive for continuous improvement, through growing each business segment with a parallel priority of improving gross margins, and controlling SG&A, ultimately driving EPS and higher returns for shareholders. Dividends will remain unchanged at $0.12 a share, paid on October 15, 2005 for shareholders of record as of September 15, 2005.

Finally, I never want to miss an opportunity to thank all of the Sonic associates for their collective commitment and hard work during the quarter. This is a people business. And our progress is a direct result of their efforts. At this time, I will turn the call over to Mr. Lee Wyatt to review second quarter financial information in more detail. Lee?

Thank you Jeff. Earnings per share from continuing operations in the second quarter of 2005 was $0.66, a decrease of $0.04 from the same quarter of last year. Earnings per share from discontinued operations in the second quarter of 2005 was a loss of $0.04. In the second quarter, total revenues were $248 million, or 13.7%. New vehicle revenues grew 14.6%. Used retail vehicle revenue grew 11.3%. Parts, service and collision revenue grew 11.9%. F&I revenue grew 7.8%.

The overall gross margin rate for the second quarter was 15.0%. New vehicle gross margin rates declined 30 basis points from last year to a rate of 7.2%. Used retail vehicle gross margin rates declined 20 basis points from last year to 10.4%. The parts, service and collision gross margin rate was basically flat at 48.8%.

The SG&A rate as a percentage of gross profit for the second quarter was 76.8%. The SG&A rate reflects the following trends -- the negative impact of lower overall gross margin rates. Fixed expenses, including rent, were flat as a percentage of gross profit. Rent increased 60 basis points as a percent of gross profit, compared to last year. The rent expense rate reflects a continued investment in facilities, primarily to expand fixed operations.

Certain variable expenses, many of which have been negatively impacted by lower gross margins and higher interest rates, increased in the second quarter compared to last year. Advertising expense was flat as a percent of gross profit.

We continue to target an SG&A rate of 78.0% for the year. This represents 100 basis points decline from the annual 2004 rate of 79%. Diluted share count for the second quarter was 45.4 million shares. This share count includes 2.8 million shares that could be issued in the future under contingently convertible notes.

During the second quarter, we expended $3.4 million to repurchase shares. Year to date, we’ve expended approximately $5 million on share repurchases. $28 million is currently available under our existing share repurchase authorization.

Our debt to total capital net of cash ratio was 48.0% at quarter end. This ratio reflects the recent acquisition of the Mercedes Benz store in Santa Monica, California. We continue to target a 40% debt to total capital ratio in 2006.

Availability under the revolving credit facility was $171 million at quarter end. Floor plan interest expense in the second quarter increased by $3.8 million from last year, due to higher interest rates, despite a lower day supply of new vehicle inventory. Non-floor plan interest expense increased by $1 million in the second quarter compared to last year, with approximately 80% of the increase driven by higher interest rates.

Based on selling days, the day supply of inventory was new vehicles declined to 45 days, compared to 56 days last year; used vehicles declined to 40 days, compared to 42 days last year; and part supply was steady, around 36 days.

On a continuing operations basis, and excluding one-time items, LTM interest coverage was 4.7 times; long-term debt to EBITDA was 3.4 times; and return on equity was 12.3%. And we continue to meet all covenants under our credit agreement.

Gross capital expenditures were $16 million for the second quarter. Year to date gross capital expenditures were $37 million. We anticipate that $20 million of the $37 million year to date capital expenditures will be recaptured through sale and leaseback transactions. We continue to target an annual net CapEx at $25-30 million.

Our guidance for 2005 is $2.25 to $2.35 from continuing operations. This guidance reflects the assumption that the impact of recent incentive programs are not creating significant incremental annual sales, but just pulling sales forward within the year.

Expectations for the second half of this year include improvement from last year, based on the following -- continued integration of acquisitions; continued operating process improvement. Last year’s second half comps are less difficult than the first half comps. And we estimate that we will acquire annual revenues of between $300 million and $500 million for the year.

16 dealerships were included in discontinued operations at quarter end. During the second quarter, 5 dealerships were added, and 5 were sold, and 4 dealerships are currently under a sales contract or letter of intent. Year to date revenues of dealerships in discontinued operations was $289 million.

A key element of development consistent operating performance at our dealerships is the decision to convert to one DMS vendor. We completed standardization of data structure and began conversions of stores to ADP in June. We’ve converted 9 stores at this time, and expect to complete all dealerships by mid-2006. At this time, we’ll take questions.

[OPERATOR INSTRUCTIONS.] [John Murphy] of Merrill Lynch.

Good morning. First, I just wanted to touch on your allusion to margin pressures. I just wanted to figure out what the biggest drivers there were. Is it the increased incentive activity? Is it the expectation that sales are going to fall off, or there’s going to be some payback in the coming quarter? I was just wondering if you could put some color around that.

Sure John. I’ll be glad to comment. This is Jeff Rachor. In the month of June, the employee pricing incentives did negatively impact our General Motors margins about 50-60 basis points. And as far as looking forward, the new margin picture is somewhat uncertain. Rumors suggest that General Motors may continue their program through August. There’s a lot of speculation that now that Ford and Chrysler have come on board with simile programs in July, that they may too extend. And so it’s difficult to assess how those programs will continue to impact margins.

Over a slightly longer-term horizon -- and we’re already seeing it at General Motors -- as those programs create inventory shortages, then there’s some optimism we may see some firming in new vehicle margins. But if the pull ahead has been significant, then you may see the opposite phenomena, where dealers are having to really force retail activity and continuing to be aggressive at the margin to do so.

And what kind of impact do you think these GM, Ford and Chrysler programs are having on margin in other brands? Is there a knock-on effect? Or is it sort of minimal, the impact?

It varies by brand. Obviously they haven’t had a material impact on the luxury segment, because they’re not generally direct competitors, the exception of that being Cadillac. But what the programs have done is created a lot of consumer demand. They’ve increased traffic and interest across all brands, with a lot of cross-shopping activity.

So the net effect has been that it is driving more traffic, and more volume. I think that you’re going to see a very strong July as a result of that, particularly with Chrysler and Ford coming on board. And the [empire ports] [ph] will continue to participate. So I think that, net/net, it’s been very positive for the volume side of the business, and probably has negatively impacted to a degree the margins of some of the true competitors. But again, not as impactful on the luxury segment in general.

On your SG&A reduction, if you could sort of bucket that into the major drivers there that you were able to pull back on, I mean was it comp programs, or is it streamlining with the DMS systems? I mean what was the major driver of the decline in SG&A?

John, this is Lee. I would say there’s primarily two areas that helped us get below our kind of targets. One was advertising leverage. We were actually below LOI as a percentage of gross profit in advertising. That’s a result of two things. One is just a little more targeted ad spend on our part. And the other is co-op. The volume drove increased co-op for us in the quarter. So those two things helped us really leverage our advertising.

You know, at the same time, we were more targeted in advertising. Those stores that gave us a strong business case to increase advertising, we did that. And that’s working well. And you can see that in some of our same store sales results. So we think we’re very pleased with what happened with advertising. The other is fixed cost basically. And we leveraged our fixed costs a little bit better than we thought we were going to. And, as you know, SG&A is a constant battle, and a constant point of focus for us. So, but those were the primary drivers.

And just one last one. On the mix of dealerships that are up for sale and that were sold year to date, are those mostly domestics?

Yeah. The characteristics are basically domestics and small volume, and kind of out of market sometimes, but primarily domestic.

Thank you very much.

Sure.

Rick Nelson of Stephens.

Thank you. Good morning guys.

Good morning Rick.

Jeff, what is the outlook for used cars? It seemed with one price selling on the new car, that it could get more competitive on the used car trade-in.

Well, I believe that is an accurate statement. In fact, if you take a look, we’re already seeing early signs of that. Rick, last month the Manheim Used Vehicle Index dropped to its lowest rate this year. There are reports of the transaction price going down about 2.3% on the average wholesale in the month of June.

We’re beginning to see some modest pressure on our retail business in some of our domestic stores, because, again, with a heavily incented new vehicle, ultimately that’s going to impact late model used car valuations. And there’s at least a temporary oversupply of trade-ins in a number of our General Motor stores. We look for a similar phenomena to occur now at Ford and Chrysler.

So there is some uncertainty surrounding a potential short-term oversupply of used vehicles, and negative impact on what had been very, very strong valuation trends in the used car segment. So we’re going to work very hard to manage our used vehicle inventories aggressively. And the big risk would be, in my view, letting used vehicle inventories age because of that uncertainty as you look out to August and September.

So how do you come back out? You send more cars to auction and they get liquid quicker?

You do it sooner. You send them to auction sooner. You determine immediately whether it’s a wholesale or a retail piece. And we’ve also looked at our mix a little big. Again, this shouldn’t impact our luxury segment as much. And keep in mind that that’s over a third of our business, the luxury import segment.

So we’ll continue to do well there, with certified pre-owned cars. But particularly in our domestic stores, where we’ve been taking in some heavier trade-ins, large sport utilities, etc., we’ll move quicker to take some of those cars to the auction. And we’ll also try to reorient our inventory to a lower cost of sale mix, which those cars, the value cars, the lower cost of sale segment, is not going to be as impacted, obviously, by the pricing of new vehicles.

Alright. Got it. On the acquisition front, Jeff, what is pricing like on these high line import dealers?

Pricing is high. Obviously most of the consolidators now are much more selective and focused on the luxury and import segments. That’s not to say that Sonic would rule out the acquisition of a quality domestic asset, because we wouldn’t. But there is a premium price to be paid for the premium brands, particularly the luxury import, and high volume Asian import brands.

And what sort of multiples are they trading at?

They’re in the five to six times range. And again, for a really quality asset, in a major metropolitan area, it’d be on the higher end of that range for a luxury import store. Asian import, four to five times, with the same statement being true. The right market, and a larger scale asset would trade at the high range of that multiple.

Great. Thanks a lot.

[Adrian Dale] of CIBC.

Hi. Thank you. A few things here. First of all, I think we have a good sense of what’s driving the slight weakness in the new vehicle margins. But away from any decrease in inventory, meaning that the slight high in demand issue could help pricing, what can really be done to improve margins there? Or should we really be looking at this as sort of the new standard new vehicle margins here?

Well, we’re going to continue to focus on improving gross margins. A lot of that is really just store level execution, working on standardized sales process, desking processes, optimizing inventory management, and a lot of other tactical steps that we’ll continue to take. But I do think that new vehicle margins generally, in particularly the higher volume brands, continue to be very, very competitive. And so while we’re optimistic we can impact those positively, I’m talking about 20-40 basis points over the longer-term.

Okay great. Thank you. And what would you say is your target inventory level? You’re down now at the 45 plus or minus day range. Would you like to stay there? Or do you think you will -- ? Will it tick back up a bit? What should we think there?

Well, a couple of comments. One, you need to consider our brand mix. We’re 65% import. If you put Cadillac in there as a luxury make, that we believe can operate with a lower inventory than a traditional domestic, we’re 75% luxury and import. So that’s one thing to consider.

Having said that, we are lower than we would like to be at this stage of the model year. But nobody could have anticipated, nor did the industry anticipate the incredible demand created by the GM employee program. So the entire industry is beginning to experience some inventory shortages and some holes within certain higher volume model mix.

And so as an optimum level, overall, with our brand mix, we’d like to be between say 50 to 60 days, depending on the time of year. And again, right now, we’re a little uncomfortable, as is the whole industry, with the shortage of general motors inventory. And that’s highly concentrated in certain models. And obviously we are watching closely to see the impact of the same employee programs at Ford and Chrysler. But we went into the quarter with very good and adequate inventories with both Ford and Chrysler. So at this juncture, they’re less of a concern.

I should also point out, that 45 day number includes Fleet. And just to give everyone on the call a broader understanding of inventory, we went into the quarter, ended the second quarter, with a domestic day supply that was 67 days in terms of our retail stock. And as I noted in my prepared comments, in aggregate we were at or above the domestic brand average for the entire industry. So this short-term shortage is an industry phenomena, not a reflection on Sonic’s strategic or management execution.

Okay great. Thanks. And you’re also concentrating a lot on reducing employee turnover. How exactly are you doing that? Should we expect a slightly increase in wages going forward?

No. I don’t think that it will impact wages. Obviously there is a market to attract and retain high caliber associates. And we’re going to continue to be very competitive and on the high end of that scale. But that shouldn’t result in any long-term incremental increases in spending on personnel.

We’re doing it in a number of ways. Turnover is really the byproduct of a bad hire. So we’re investing in more disciplined hiring and selection process, background checks, due diligence surrounding the hire of an individual, a more comprehensive multi-interview process when we bring an associate candidate on board. We’re focusing on more formal orientation, more targeted training for our associates. And those are really the key drivers.

It all surrounds our human resources process. And we really believe that we can continue to drive turnover down. It was a big driver of some of the inconsistent performance that we experienced as a company over the last couple years. There’s an indisputable correlation between associate stability and consistent performance. And so we’re going to continue to focus on that with a lot of passion, and a lot of resources. And we’ve already seen great dividends as a result of those efforts.

Great. And lastly, on the debt balance, any target time frame for getting down to that 40% target?

Yeah, this is Lee. We’ve historically, and continue the position, that we will get there in 2006. We think sometime early in 2006 we’ll be at 40.

Great. Thanks a lot.

Charles Grom of J.P. Morgan.

Good morning. When you look at the upcoming model change, are you comfortable with your domestic supply, so you don’t run out of stock, similar to a couple years ago? And how do you plan on controlling inventories, particularly on the domestic side?

Well again -- Charles this is Jeff. And this is an entirely different situation than a couple of years ago, when we ran short as a result of internal execution. This is really an industry-wide phenomenon. There’s speculation that General Motors will end the month with less than a 40 day supply. That’s certainly the lowest that I can ever remember in my career in terms of their day supply.

So I don’t believe that we’ll be at a competitive disadvantage as a result of low inventories. We are low. Everybody’s low -- lower than I’m comfortable with. I think that there are already some lost sales as a result of gaps within certain models lines. But I think that you’ll see the domestic manufacturers working hard to accelerate the shipments of ‘06’s. And because there won’t be the normal carry-over of ‘05 models, I think we’ll be able to transition into the ’06 models more effectively.

I think one other phenomenon that should be highlighted, while there’s a short-term pressure starting to show itself on used car valuations, because of this short-term over-supply, and these great deals on new vehicles, that if we see a significant industry-wide shortage of ’05 new vehicles, that we could see that trend quickly reverse itself, and pricing improve, and demand improve on late model pre-owned cars.

Great. Thank you. Ex-fleet, your F&I per car sold was down about $15 year over year. Are you finding it more challenging to pass on some deals? And where, ultimately, do you see this metric leveling out, call it in 2006/2007?

Charles, this is Jeff again. We were off about $14-15 per unit retail. That was largely concentrated -- in fact, it was all concentrated in reserve, and heavily concentrated within a few brands. We do believe that we can improve F&I per retail. But I wouldn’t look for more than $50 to $100 over the long-term. Again, we’re very, very committed to complete transparency.

We’re doing 100% full disclosure menu selling. I think the other thing that is impacting F&I per unit retail gross profit is our brand mix. With a higher concentration of luxury, we’ve got more leasing. And we’ve also got more cash buyers in that high line segment, which obviously negatively impacts F&I per unit retail. But we’re confident that we can certainly stay in this range, and over the longer term potentially increase it $900-950. I don’t think you’ll ever see us over $1,000 per retail.

Okay great. And then last question, given the beat in the quarter, your revised second half forecast appears a bit conservative. Could you walk us through the thought process there, in addition to what you said earlier? And your third quarter compare is very easy, because of the hurricanes last year. And the fourth quarter isn’t too challenging either. If we were to see up side, where could it come from in the second half?

Hey Chuck, this is Lee. You know, again, the premise on the forecast is that the improvement in the second quarter was very much just a pull-forward, because of the GM incentive program. So we basically think we’re just shifting. We’ve tried to be reasonable in terms of our same store sale assumptions for the second half. They’re lower than the first half, candidly.

SG&A, we think, is, we anticipate being on the targeted 78% that we told the marketplace. So could we do better on same store sales? Yes. If there’s a potential to be -- to have up side, it would be on same store sales. New vehicle margins, we’re forecasting the second half to be basically flat with the first half. So if margins improved above the kind of 7.2% that they were in the first half, you could have some up side.

But again, we’re fairly consistent with our previous guidance at $2.25 to $2.35. And we think it’s reasonable. We don’t think it’s overly conservative. Now we’re confident that we’re making the kind of improvements that are going to get us in that range. So we’re happy and confident about that. But that’s basically the assumptions around it.

Okay. I appreciate it. Thanks a lot. Good luck.

Sure.

[OPERATOR INSTRUCTIONS]. Scott Stember of Sidoti & Company.

Good morning guys. Could you maybe talk about the parts and service? It looks like the gross margin there has flattened out a little bit on a year over year basis. Are there any things in the process that can possibly get that going again?

Yes. I think that one of the positive outlooks on service and parts margins again goes back to our brand strategy. As we rotate luxury revenue into our portfolio, as I stated in my prepared comments, our luxury import dealerships enjoy higher margins. And so we think over the longer term we’ll get positive lift from our acquisition strategy of portfolio enrichment. And some of the brands that we’re rotating out of the portfolio, with the high concentration of domestic, have lower margins. So we look for some lift there.

Again, in terms of our overall fixed operations margins, service was actually up for the quarter. And the pressure came in parts. It was totally concentrated in one wholesale parts operation, and also, a strategic decision to get more aggressive in selling tires on a customer pay basis. And to be competitive there, we’ve got to deep discount those. But it’s a great way to attract and retail customers for life that might otherwise be going to an independent.

Okay. And could you talk about what your capacity is right now as far as on the parts and service side of the business?

Yeah, we’re about 70% utilized. We’ve got many of our shops where we can open on Saturdays. And I mentioned in my comments, at least discussed briefly, but we’re adding capacity. In fact, we’ll complete construction of 419 new stalls by the end of ’05. That gives us about 200 incremental. And we’ll have another 222 that will be completed in ’06. So about 400 new work stalls that will be completed over the next 18 months. And with the exception of one Hummer dealership, which obviously is a luxury mark in its own right, 100% of that investment in fixed operations capacity is in the luxury and import segment.

Okay. So you’re saying another 200 from now until the end of the year, and another 222 in ’06?

That’s correct.

Okay. Alright. And Lee, can you talk about what the interest add-back was for this quarter and last year’s quarter with regards to the convertibles?

Yes. On an after-tax basis, the add back was, for the second quarter of this year, was $1.1 million. That’s after tax. And for last year’s same quarter, it was about the same, $1.1 million after tax.

But for modeling purposes, it’s fair to assume it should be in that range going forward?

Yes sir.

Okay. And last question, Jeff, you gave what the CPO was as a percentage of total used. Can you talk about what it was last year on a comparable basis?

Yeah, I sure can. Give me just a moment. I believe it was in the low 30s. I’ve got that figure right here. 32.2%. So a positive trend. And again, very pleased that our percentage of certified pre-owned was up in every business segment -- domestic, important, and luxury, obviously with luxury leading the way.

And keep in mind that every one of those certified pre-owned cars includes an extended manufacturer warranty of up to 100,000 miles, which is going to link that customer back to our service and parts operations, and drive future revenue growth in that high margin business segment.

I should also point out that when you combine the extended service agreements that we sell in our F&I departments, and the CPO warranties, that 45% of every vehicle that Sonic delivers has some form of an extended warranty that’s going to connect them and really form a bond between them and our fixed operations, that are really going to be a source of revenue growth, and filling those new stalls in the future.

Okay. That’s all I have. Thanks a lot.

[Peter Cyrus] of Gorilla Capital Management.

Hello Jeff. Mr. Wyatt, how are you?

Great Peter. How are you today sir?

Good. I can never understand, I guess last quarter they didn’t like it because you had too much inventory. This quarter they don’t like, you have too little inventory. Is that the way it works? The question actually that I want to ask is in your press release you talked about some of the SG&A efficiencies. And I wonder if you could take us forward two years. How much -- ? Where, how much more SG&A efficiencies are there in the model? And where --? What’s this Company going to look like in two years, say compared to some of your competitors?

This is Lee. Let me just talk about that. Our SG&A as a percent of gross in ’04 was 79%. We targeted 78% this year. As we look out into the future, we see the possibility for the next 2-3 years to reduce SG&A by 50 basis points to 100 basis points a year. Much of that is driven by standardization and the like, and leveraging some of our current investments in standardization.

We will, for example, complete -- our current estimate is to complete the DMS conversion, one standard DMS system, in mid-2006. That gives us much better and consistent data to manage our business, to understand cost, and to leverage our cost. So we think, literally over the next three years, to answer your question directly, it could be 50 to 100 basis points a year, in that range. So on the outside you get to 75%, if it’s 100 basis points a year for each of the next three years.

I’ll chime in Peter, and also comment that if we continue to successfully execute our portfolio enrichment strategy, and increase, as we have now successfully over the last several quarters, the percentage of our revenue that is derived from the luxury business, from the Asian import makes particularly, we enjoy lower SG&A with those brands.

And so in addition to improved operating process through standardization, and through improved execution as a result of management stability and development in the field, and complimented by our acquisition strategy, we’re optimistic that we can improve it, and get to the peer group -- get below today’s peer group average as a result of those three factors.

Where does that -- ? I mean let’s go out three years and take the mid point of that 75 basis points a year. Where does that bring you in terms of return on equity and earnings per share?

We target about 15% return on equity. As we evaluate investments and process changes, we target 15%. And I think if you look at 100 basis points of SG&A, that’s in the 15-18 cents a year basis. So can you kind of do the math, if we get to 300 basis points. So it’s significant. And again, if you look in the peer group, those peers that really are focused on process improvement, that have an operating structure that’s centralized versus decentralized, they’re getting in that direction.

So we think -- we have some confidence we can get there. It’s just a matter of timing and completing the kind of the projects and the strategy that we’ve got on the table. So those are big numbers if you get to 75% SG&A.

Yeah. I actually came up with higher. The 15 to 18 cents is just with 50 basis point improvement?

I think it’s a little more.

We’d have to do some work on that. But it’s very, very meaningful. And obviously those numbers are considered based on our current revenue.

Right.

So hopefully on a parallel track, as we improve our operating performance, because we’re not going to accelerate growth until we are confident we can perform consistently in terms of operating execution. But we’re encouraged. And so if you consider some growth along with that SG&A improvement, it can get pretty exciting.

One more follow-up Jeff. It’s reasonable to assume that here you’re spending money on process improvements. In other words, there’s -- the SG&A improvement is actually greater than it looks, because you’re spending money on developing SG&A improvements. Did I make myself clear in what I just said?

Yeah. I think you did. And there’s always an investment when you are focused on centralization and standardization of process. Number one, it requires some more personnel infrastructure to facilitate and execute those processes. But I wouldn’t want to express unrealistic optimism that those are cost savings that we can look forward to in the immediate future, because it’s going to take two or three years to have the standardization fully matured. And we’re going to need to continue to invest to get the full benefit of our commitment to standardization and process improvement.

Peter, this is Lee. The other place we are clearly investing that reflects in SG&A is in the rent line. As Jeff pointed out, we are investing in service and parts bays. And that hits your rent line now. But you haven’t optimized your volume there. So --

It takes a couple years to get the full return on that additional capacity. But our data shows that, where we have invested in new facilities over the last couple of years, that we are enjoying stronger same store sales growth. And so we think over the longer term that those investments will pay off. And again, those investment dollars are heavily concentrated in our luxury brands, where we’re experiencing this quarter, for instance, double digit same store sales growth in fixed operations.

Well great. I’ll wait for the $4 a share in EPS. Thanks.

We’ll call you.

You won’t have to. Thanks.

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

We just want to thank everybody for their participation this morning. Thank you very much.