Sonic Automotive Inc (SAH) 2005 Q3 法說會逐字稿

Good morning and welcome to the Sonic Automotive third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. [OPERATOR INSTRUCTIONS] As a reminder, this call is being recorded today Tuesday October 25th, 2005.

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 like to introduce Mr. Jeff Rachor, President and Chief Operating Officer of Sonic Automotive. You may begin your conference.

Thank you. Good morning, ladies and gentlemen. Welcome to Sonic Automotive's third quarter 2005 conference call. Joining me on the call today are the Company's Vice Chairman and Chief Strategic Officer, Mr. Scott Smith, and our Chief Accounting Officer, Mr. Greg Young.

Today I will review the third quarter results update you on acquisitions, and discuss the outlook for the remainder of the year. At the conclusion of my prepared comments, we will take your questions. I'm pleased to report third quarter earnings per share from continuing operations were $0.65 compared to $0..51 last year, an increase of $0.14, or 27.5%. Losses due to hurricane disruption and other less significant charges were approximately $0.07 to $0.09 in both periods. Loss from discontinued operations for the quarter was negative $0.04, a one penny improvement compared to a year ago.

Net EPS for the quarter was $0.61, up $0.15, or 32.6% from last year. Earnings were driven by strong same-store sales growth in all business lines, along with margin expansion in used vehicles and fixed operations. In a moment, I will discuss same-store results in more detail.

Revenue from continuing operations was 2.1 billion, an increase of 9.5%, while total gross profit was up 10.4% to $315 million. Gross margin for the quarter was 15.1%, up from 15% last year. New vehicle retail margins were flat at 7.3%. Used vehicle retail margins improved 70 basis points to 10.8%. Total fixed operations margin was 49.4%, up from 48.8% last year. SG&A expenses were 77% of gross profit, down from 80.2% in 2004. Excluding the previously discussed hurricane disruption and less significant charges, SG&A for the quarter would have been 75.8% this year, compared to a comparably adjusted rate of 78.7% a year ago.

We continue to target an SG&A rate of 78% for the full year, which represents a 100 basis point improvement from our annual 2004 rate. Floor plan interest expense increased 3.4 million compared to last year. This is due to higher interest rates, offset by lower inventory levels. Other interest expense increased 0.7 million compared to last year. The effect of higher interest rates, was partially offset by a lower balance on our revolving credit facility.

During the quarter, we did not execute any share repurchase activity. Year-to-date, we have expended approximately $5 million on share repurchases. $28 million is available currently under our existing share repurchase authorization. Our debt-to-cap ratio, net of cash was 45.1% at quarter end. The availability under the revolving credit facility was $229 million at the end of the quarter. In addition, we continue to meet all covenants under our revolving agreement.

Gross capital expenditures were $13 million, and year-to-date CapEx is $52 million. We anticipate that roughly 16 million of the year-to-date capital expenditures will be recaptured through sale/leaseback transactions.

As the domestic employee pricing campaigns lost steam in the quarter, demand at our import brands grew even stronger and drove our same-store sales performance. Overall same-store revenue was up 6%. New vehicle revenue was up 6.6% versus Q3 of '04, as we outperformed the industry in retail unit volume for the quarter. New retail vehicle gross margin was 7.3%, flat with last year. Same-store used vehicle revenue was up 5.9%. Same-store used vehicle margins were 10.8%, up from 10.2% last year, and total unit retail volume improved 5.9%.

Certified pre-owned unit sales were up 14.4%, and comprised a record 36.6% of the total used vehicle retail unit volume during the quarter. Subprime or value used vehicle sales were up 22.3% from last year, and accounted for 20.2% of the total same-store used vehicle retail volume. We continue to believe that the certified pre-owned and subprime segments of the used vehicle market, represent the strongest growth opportunities.

Total same-store fixed operations revenue was up 3.8% for the quarter. Total customer pay revenue was up 6.9%, and overall fixed operations gross margin was 49.2%, up from 48.7% last year. Parts and service revenue was up 4.2%, while body shop revenue was down 2.4%. Most of the decline in our collision repair performance, was due to the fact that we closed a body shop in one of our Tennessee locations.

Our luxury import and nonluxury import brands experienced fixed operations revenue increases of 7.9% and 7.3% respectively for the quarter. Overall, fixed absorption was a record 84.8% for the quarter. Fixed absorption in our luxury stores was 94.5% in the third quarter. At the close of the quarter, new vehicle day supply was at 37 days. We believe our inventory position is advantageous heading into the fourth quarter. The domestic day supply is below the national levels, and the ending day supply at our import dealerships, while in-line with the industry, was lower than we would like, due to high demand and tight availability.

In terms of car and truck, our light truck inventory entered the quarter at 35 day supply, while our car inventory was strategically higher at 41 days supply. Used vehicle day supply ended the quarter at 37 days. The strongest regional platforms during the third quarter were Las Vegas, Washington D.C., Florida, Alabama, Tennessee, Los Angeles, and Dallas. Our Colorado, North Carolina, and Michigan platforms underperformed, while Houston's performance was hindered by Hurricane Rita.

In terms of total revenue, our top brands were General Motors including Cadillac, 21.5%, Toyota including Lexus, 16.5%, Honda including Acura, 15.3%, BMW, 15%, and Ford, 8.2%. Our strategy of portfolio enrichment is yielding an improved brand mix. Import brands comprised 67.1% of total revenues this year, compared with 61% a year ago. We're pleased to report with the results of the quarter, the extension of consistent performance trends. The execution of our strategy, put us in a position to take advantage of the strong industry dynamics during the quarter.

A quick update on our operating priorities. First, retail unit volume. We posted a continuation of the first half strong same-store sales growth, by successfully outperforming the industry in new vehicle retail unit volume, eight out of nine months this year. Additionally, our used vehicle volume was at or above nationally franchised dealer performance each month of the quarter. Number two, our continued focus on SG&A. We're on-track for our annual target.

Number three, leadership development, including the consolidation of our northern California platforms, and progress on further reducing associate turnover. Number four, the continued standardization of processes, supported by our single DMS conversion. National payroll consolidation, E-commerce, showroom technology, used vehicle processes, just to name a few.

Number five, growing the high margin fixed operations by adding capacity and maintaining high customer satisfaction standards. We will complete the addition of 132 incremental productive stalls this year, and plan to add another 195 stalls next year.

Number six, consistent industry leading inventory management. Number seven, commitment to our revised disciplined acquisition strategy of portfolio enrichment. This strategy has been further validated by the recent industry brand trends. And finally, we improved our debt-to-cap ratio in the third quarter, and remain focused of obtaining our target of 40% by mid-2006.

So far this year, we've closed on three luxury brand dealerships accounting for $240 million in revenue. We are very pleased with the smooth integration of these dealerships, as they have already adapted our standard processes, and are contributing high operating margins.

Furthermore, we expect to close on three additional luxury and import nameplate dealerships in the late fourth quarter, or early first quarter timeframe. These additional dealerships represent $245 million in revenue.

As we enter the fourth quarter, there's no question that the near-term outlook for the industry is somewhat cloudy. I'm sure you've all read about the difficult October industry environment. In addition, rising energy costs and interest rate increases are putting a damper on consumer conference.

However, while October is starting out tough, it's too early to determine how the fourth quarter will be impacted, or how manufacturers will respond. As a result, we're reaffirming our full-year EPS from continuing operations guidance of $2.25 to $2.35 a share. This is based on an estimated SAR of 16.9 million units.

Regardless of business conditions, we remain dedicated to growing sales in every business segment, while improves gross margin and controlling SG&A. As our portfolio enrichment execution continues to mature, our repositioned brand mix should help mitigate our risk to a market downturn, and improve overall operating margins. We believe there is potential upside in the used vehicle market, in terms of both volume and pricing, if the new vehicle manufacturers do not respond to lower new vehicle volumes with enhanced incentives.

In addition, our outlook for the higher margin parts and service business remains very positive. Finally, dividends will remain unchanged at $0.12 a share, payable on January 15th, 2006 for shareholders of record as of December 15, 2005.

Before closing, I never want to miss an opportunity to thank all of the Sonic associates. They're the reason that we had a successful quarter.

At this time, myself and the rest of our management team, will be glad to take your questions.

[OPERATOR INSTRUCTIONS] We'll pause for a moment to compile the roster. Your first question is from the line of John Murphy with Merrill Lynch.

Good morning.

Good morning John.

A question on the parts and service business. Gross margin increased pretty dramatically there in the quarter, and was impressive. I was just wondering how that's being achieved, and what the capacity utilization rate is in your bays currently?

It's being achieved in two ways. One improved execution of our standard sales processes in the service drive. And also the benefit of brand mix.

And in terms of stall utilization, it varies by brand. We have very high utilization in our luxury stores, well over 70%, and an on overall basis, it's more like 60%.

There's still a fair amount of room there?

Yes, there is. And some of that is the benefit of additional capacity that's been added. That investment in additional capacity takes a period of maturation from when you actually add those additional stalls, to when you're able to grow into 100% utilization of those productive stalls.

The 132 bays you're adding, and the 195 you're adding next year, what kind of percent is that, just in flat stalls?

I will get you that number. If we can get back to you on that, I don't have that handy.

And on the warranty versus customer pay split. I think you mentioned it, I just missed that.

Yes. Warranty was about 22%. Let me get the customer pay number for you. I believe it was somewhere in the 65% range.

I'm sorry, that's the split between parts and service, the mix.

Yes, it's about 65% CP and about 22% warranty and the rest would be made of up of internals.

Got you. Is that better or worse than you had last year?

That's improving. Warranty's about flat. A little improvement in customer pay.

Then just on the used car business. You're driving in that direction pretty aggressively. It seems to make a lot of sense, given the weakness in new cars. What are the specific initiatives you have there in used cars that's driving that?

Two of the initiatives we've been focused on strategically for some time are targeting the manufacturer-certified preowned segment, as well as targeting the lower cost of sales segment that's generally supported by subprime financing. You can see, I think, if you go back to previous quarters that we've been able to grow those segments consistently, and obviously both of those initiatives are driven by inventory management.

We have very disciplined inventory management, and we're leveraging a variety of used car inventory management technologies. We're presently piloting three different used car management technologies, and we'll likely choose a common used car inventory management technology, as we head into next year.

In addition, we are implementing a number of Best Practice based tactical processes at the dealership, to ensure that we not only have the right inventory mix, but the appropriate merchandising, advertising, pricing, reconditioning, et cetera. And we're already see early returns and we are in the process of further refining that strategy, and expect to come back to you in early '06, to talk more in detail about a real commitment to accelerating our used car business.

One last question on incentives. Really, what are you seeing during the course of the month. Are you seeing incentive activity ramping up, as we're hearing about weak sales and what do you think of GM's value-pricing strategy?

Sure. Well, for the third quarter obviously we saw a decline in overall industry incentive spending of about 16%. And as you know, to start the quarter, both GM and Ford launched their value-pricing strategies. October got off to a tough start in the industry. Both manufacturers came back with some incremental enhancements about mid-month.

In terms of the effectiveness of value pricing, and I'll use General Motors as an example, it's been very effective, on their new hot product, the HHR, the H3 Hummer, the Impala. Those vehicles are selling very, very well. In fact, demand is exceeding supply in most cases with the value-pricing concept.

The value pricing has not taken hold as quickly on some of their more-aged product lines, however, we're very enthusiastic that General Motors has a very robust pipeline of exciting new product, that will be introduced over the next several quarters. And we think as that more contemporary product hits the marketplace, that the value pricing will be effective in marketing those vehicles.

Very helpful. Thank you very much.

Your next question comes from Rick Nelson with Stephens.

Thank you and good morning.

Good morning, Rick. How are you?

Good. Thank you. If you could provide some color on October, in terms of store traffic and sales, and how that might differ between the domestic dealers and the imports and your guidance, what that would assume about November and December?

Sure, Rick. Obviously everybody's seen the industry reports. October, the first two weeks of October particularly got off to a very, very slow start. As the domestics experienced a more extreme whiplash, in terms of the correction related to pull ahead. The domestics started out extremely slow. We also saw some of that bleeding into the import brands, the first couple weeks of the month.

We have seen some improvement in showroom traffic since the 15th of the month. As the domestics have added some incremental incentives, and the import dealerships are mainly being impacted now by very tight availability of product. So it's difficult to gauge what the import stores will actually do for the month, Rick, based on the arrival of shipments, et cetera. In a nutshell, we see the domestic business very, very difficult in October. It is improving from the early traffic patterns in the first half of the month.

We see the imports remaining strong, particularly Honda and Toyota, but somewhat handicapped by a lack of availability, and we see the luxury brands very stable in the month of October.

In term of our guidance, our full year guidance assumes a $16.9 million annual SAR. I hope that that addresses your question and again, we still have another week of October to go, a week that's normally the biggest week of the month as retailers. It's just very difficult to determine this early in the quarter, how the October industry environment could impact the overall quarterly results, and potentially even the annual SAR.

Got it. Can you update us, Jeff, on your search for a CFO?

Certainly, Ken. We're very pleased with the process. We've engaged one of the premier search firms. They have already brought a number of outstanding candidates to the table. We're going to be very, very careful and go through an extensive and disciplined process to get a perfect fit. We expect to have that position filled by the end of the year, Rick.

In the interim, I should note that Greg Young, our Chief Accounting Officer, has taken over a number of the CFO responsibilities. We've got a deep bench in our financial organization, a great infrastructure, and we haven't missed a beat, it's business as usual, in terms of our financial support at Sonic Automotive.

Great. Just one last question. That [ad finite] per unit I see declined year-over-year, $910 a unit. Any color there would be helpful.

Sure. I think we were down what, about $29, and that was 100%-driven by a slight deterioration in finance penetration, and 100% of that shortfall was in reserve. We actually grew and improved product sales, and that's what we want to do, is sell more of the extended service agreements and other value-added products, give consumers more value, and in the case of extended service agreements, tie them back into our higher margin service and parts operations.

We've done a lot of internal analysis on that trend, and part of it seems to be driven by our increase year-over-year in the number of sales we're doing drive from internet leads. Oftentimes it's difficult to control the financing on that activity, and we believe that that may have impacted our short-term trends in financing penetration. But we're already seeing things stabilize and bounce back there, Rick, and we don't see any risk of material deterioration at these levels of F&I income.

Good. Thanks, Jeff.

Your next question comes from Peter Siris with Guerrilla Capital.

How are you doing?

Terrific.

I have two questions, the first one is how -- what is your free cash flow so far for the year, or your cash flow for the year? That was one number I didn't see.

Hang on, just a minute, Peter. This is Greg, let me see if I can find that number for you.

Give me your second question, and Greg will look for that number.

While he's looking for cash flow, the second question is -- how far are you on the -- from where you started to where you want to be, in terms of the operations of the company? In other words, a couple of years ago you said, we've got to make improvements, we're starting to see improvements. Are we 20% of the way, or 90% of the way, in terms of the improvements we're seeing?

I think the last time we discussed this, we kind of broke it into two pieces. One was really management and leadership stability in the field, particularly. And I would tell you that I'm very pleased with our progress there, and in my view, we're 90% of the way there, in terms of strengthening our bench, adding a strong infrastructure in the field, and upgrading in some cases our leadership in the field.

In terms of standardization of process, which was the other piece of our focus on improvements, we are making significant strides, obviously, we have announced our commitment to convert to a single DMS. That's progressing nicely. We've already completed a number of conversions across the organization and that will give us a common technology platform, that will really allow us to drive efficiencies in the future. That DMS conversion will take about 18 months to be 100% complete. So we have all that upside to look forward to.

In addition, as I mentioned in my prepared comments, we are making progress in terms of standardization on a number of fronts. I think you can see we continue to have industry leading discipline surrounding inventory management. We think that will only get better with a common technology platform. We are consolidating payroll, we've done a number of regional back office administrative consolidations out in the field.

We are improving our E-Commerce and showroom process and technology, with a variety of standardized operating processes, and we're in the early stages of development, and really realizing the benefits of the work we've done in used cars. And we look for that to be a big focus, and a lot of upside in the 2006 year. So we're very pleased with our progress in terms of operational improvement.

And again, there were two pieces, one was really the human capital side, the other piece is continuing to standardize process, and more importantly, improve the execution on the Best Practice-based processes that we already had in place.

That basically says there's still significant room for margin improvement?

Yes, sir. We believe that's correct.

And did we find the cash flow number yet?

About 90 million year-to-date through September, and it will probably be in the neighborhood of 115 to 120 million for the full year.

Then the question I would like to -- this is the second year in the row that you have generated a lot of cash flow. I'm just curious, why you picked 40% as the debt to equity ratio, given the strong cash flow. Why not 50 or 60% and be more aggressive on either acquisition or stock buybacks or dividends?

The debt-to-capital ratio really drives from the revised acquisition strategy. We think there is some more integration risk with the fast-paced growth that we've had in the prior years. So as a result of slowing down, or better defining the acquisition strategy, the natural outflow of that is more cash flow to be used for debt buybacks, and reducing the debt to capital. I think the marketplace responds a lot better, as it's been demonstrated in the sector, to a lower debt to capital ratio.

I agree, but if you generate $115 million of cash flow a year, at some point, you're going to have to do something else with the money.

I think we've got some time to decide what to do with that money. Right now, we just focus on our acquisition strategy and integration strategies, and get those right, and then we can worry about what to do with all the cash later.

It's a high-class problem. Thanks for your answers.

[OPERATOR INSTRUCTIONS] Your next question is from Jerry Marks, Raymond James.

Good morning.

Good morning, Jerry.

Two questions, the depreciation, if I'm doing this right, it looks like you have 9% fewer franchises than a year ago, but you have 22% increase in your depreciation of the $4.8 million. How come that happened?

That's really just a factor, Jerry, of our facility construction program, and what we keep online versus what we do in sale leaseback transactions. As Jeff said in his prepared comments, we're continuing to focus on some of the service bays, and adding capacity there.

And some of it is also due to our shift towards the luxury brands. Some of those are more expensive dealership facilities, and facility image programs, along those lines.

Okay. I'm sorry, I didn't catch. The definition of free cash flow for that $90 million. How are you defining free cash flow?

Taking a very quick calculation, backing out the $52 million year-to-date CapEx, and factor in some things for the fourth quarter around expected capital expenditures.

It's basically cash flow from operations less CapEx?

That's right.

We've all been asking you questions about the industry, and you alluded to the manufacturers, no one knows quite what they're going to do. Ford's testing out that something for nothing program in Chicago, do you have any thoughts if we see another big promotional -- I like to call gimmick, like what GM did with the employee discounts. Do you have any thoughts of some of the auto makers trying to do something like that in December?

It's too early to tell, Jerry, but obviously I think that to a certain degree, when they change direction in their incentive strategy, the way they have, it's somewhat of an experiment, and obviously they're watching their daily sales numbers. They're getting feedback from the showrooms, and they've got to keep those factories running and keep shipping cars.

And so I think that everybody right now is communicating that they are committed to value pricing, but I think they're also evaluating supplementary programs, on a per model basis. As I noted in my earlier comments, value pricing seems to be working very, very well on some of the new competitive and hot products that they're launching.

It doesn't seem to be taking hold as quickly, on some of the more aging product lines. But I would just tell you that, you know, based on my experience in the industry, come December, the manufacturers are going to do what they need to do to sell cars. Hopefully the strategies they have in place will get it done. If not, I believe that they're going to reevaluate and invest in whatever makes sense, without being irrational, to drive volume.

Okay. I heard you mention you've made a lot of progress with your DMS rollout. It's going to take you about 18 months in total. What percent are on the same DMS systems right now, and is it a mid-2007 target you have then, to finish up, completely go on ADP?

The 18 months would be the entire project timeline. We're 3 months into that. When we started back of the envelope, we were about 50% ADP, we're now a little over 60%. We can expect to have that completed by the end of 2007 -- excuse me, by the end of 2006, Jerry.

Okay, great, thanks.

Your next question comes from Mark Irizarry with Goldman Sachs.

Hey, guys. Thanks. Just a question on your SG&A expenses. If you look at the buckets where you saw the most improvements. First was that other category. Can you help me understand what's in there, and how sustainable some of those cost cuts are?

Secondly if you look at your advertising on a per car basis, it was down in the third quarter, how much, if any, of that was due from what we saw from the OEMs in terms of their promotions, and should we expect that to tick up here?

On the other fixed, I'll take the first one Mark, and let Jeff talk about the advertising. On the other, that's a combination of other fixed and other variable expenses that we have, and the reason for the decline was a combination of a lot of offsetting items. We had some increases in employee benefit-type expenses, and then we also had some decreases in some of our other insurance lines.

So the net result as you see and as you spoke to was a decrease, and I think that some of that is sustainable over the long-term.

And on the other insurance line, is any of that from last year due to hurricane-related stuff?

No, that does not include any of the hurricane-related items.

And on the advertising front?

In terms of advertising, this is Jeff. We have managed advertising near these levels now for several quarters. Volume does obviously benefit our net ad spend, because of the way we receive some cooperative funds from manufacturers. What I would say is that a strong new vehicle, same-store sales performance in the third quarter, did give us some leverage on the ad spend, but we're comfortable we can continue to manage this 5.5% of gross margin range on advertising.

Okay, great. Then, just one question if I may on your used business. You talked about what looks like a barbell strategy. On the lower side of the spectrum, I believe you guys have kind of a buy-here, pay-here model, if I remember correctly. Can you tell me on the low end of the used car kind of barbell, what are you seeing in terms of that customer, and the impact from gas prices?

We are finding that gas prices and really overall consumer sentiment is not impacting that lower cost of sales segment, as much as it is the newer vehicles, and particularly the large SUVs. Remember, in that segment, many of these peoples are acquiring vehicles for basic transportation, to get to and from their jobs, and so forth. We have actually seen demand very, very strong in that segment. We believe that that segment will be relatively resilient to any macro economic or industry trends, that might come about.

You mentioned our buy-here, pay-here strategy. We do have a small financing subsidiary that does some buy-here, pay-here lending on a complete arm's length basis, with some individual dealership markets that we have identified, where it's a match for their demographics. But that represents just 6.4% of our total retail unit volume at this time.

Okay, great. Thanks guys.

[OPERATOR INSTRUCTIONS] There are no further questions. Mr. Rachor, do you have any further remarks?

No, thank you for your participation.

This concludes today's teleconference, you may now disconnect.