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Executives

Scott Smith - Co-Founder, President and CSO

Heath Byrd - CFO

Jeff Dyke - EVP, Retail Operations

C. G. Saffer - CAO

Analysts

Rick Nelson - Stephens

Ejay Gering - Morgan Stanley

Scott Stember - Sidoti & Company

Elizabeth Lane - Bank of America/Merrill Lynch

Aditya Oberoi

Rahul Chadha - UBS

Sonic Automotive Inc. (SAH) Q1 2013 Earnings Call April 23, 2013 11:00 AM ET

Operator

Good morning and welcome to the Sonic Automotive First Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer period. (Operator Instructions). As a reminder ladies and gentlemen, this call is being recorded today, Tuesday April 23, 2013.

Presentation materials, which management will be revealing on the conference call can be accessed on the Company’s website at www.sonicautomotive.com by clicking on the Investor Relations under Our Company and choosing Webcasts & Presentations on the right side of the page.

At this time, I would like to refer to the Safe Harbor statement under the Private Security 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 risk 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. Scott Smith, President and Chief Strategic Officer of Sonic Automotive. Mr. Smith you may begin your conference.

Scott Smith

Great, thank you. Good morning and welcome to Sonic Automotive’s first quarter 2013 earnings conference call. I'm Scott Smith the company’s Co-Founder, President and Chief Strategic Officer. Joining me on the call today is Heath Byrd, the Company’s new Chief Financial Officer; Mr. Jeff Dyke, the Company’s Executive Vice President of Retail Operations; Mr. C. G. Saffer, the Company’s Chief Accounting Officer; and Mr. David Smith, the Company’s Vice Chairman. I will begin the call with a brief review of the quarter and then I will turn the call over to Heath for a financial recap and then Jeff will give an operational recap. After some summary comments from me, we will open the call for your questions.

At this time, please turn to the slide titled Overall Results. We are pleased with the results in the first quarter. Our revenue was up 8.1% and we outpaced the new vehicle industry for the quarter with volume of 7.4% being up.

Our pre-owned volume is up 3.9%, F&I was up 13.7% and fixed ops was up 1.4%, with two last fixed days. SG&A was 78.5%. Income from continuing ops was $21.7 million, up 2.6% our EPS in first quarter was $0.41, up 13.9%.

With that, I’ll now turn the call over to Heath for some financial color. Heath?

Heath Byrd

Thank you, Scott. Good morning everyone. As Scott mentioned please turn to the next slide of Q1 results. As Scott mentioned, revenue was up 8% at a record level of a little over $2 billion, driven primarily with improvements in all the business but specifically in variable ops, new retail revenue up 11.7%, used revenue up 4.8%.

We believe the implementation of (inaudible) was helping the fuel to grow through our top line and we expect that to continue as all locations are not fully implemented. This growth in revenue resulted in gross profit of $330 million, which is an increase of 3% from last year and diluted EPS in continuing ops of $0.41, up 14% from last year.

Next slide, please. SG&A growth slide, as you can see here, SG&A was up 40 basis points to 78.5% from last year. However, we are trending to hit our target at 77% SG&A for the full year. Expenses issue will include our continuing investment in technology and training and in addition we will have incremental expense related to strengthening our internal control over financial reporting.

As we disclosed in March, management did identify control deficiencies related to our dealership level accounting process. It’s important to note that these findings did not resolve in any material misstatements and we did receive a clean opinion on our financial statements for 2012. However, it does not minimize the need to correct these issues and showing the effectiveness of our control environment is a top priority for this year and into 2014.

We’ve added additional resources and invested in technologies to address all deficiencies as well as enhance the overall environment. I am very pleased with our current progress and I expect full resolution of all issues.

Next slide, please. Capital spend, you can see through slide, our total CapEx for Q1 was $59 million. This included an acquisition of 4 properties. With the mortgage outset, total cash fees was $40 million. Estimates for the year are $67 million for real estate and a $105 million for facilities, stroll (ph) other CapEx and IT spend.

Next slide, so debt covenants again. This slide shows that we are compliant with all of our covenants from our credit facility and we do expect to be so going forward.

Next slide, please. Share repurchases. On this slide you can see the activity for Q1 at 390,000 shares and we do have additional authorization of $137 million for share repurchases. So overall I feel like it's a very good quarter with continued organic growth and as you can see we continue our focus on investing in the core business, own enough properties and improving the capital structure. Based on Q1 results and our forecast, we are reaffirming our guidance of a $1.93 to $2.03 EPS.

And with that I'll turn the call over to Jeff Dyke.

Jeff Dyke

Thanks Heath. Good morning everyone, I appreciate the opportunity to share the Sonic Automotive 2013 first quarter operating results. Before I start on I'll take a moment to welcome Heath Byrd as our new CFO. He's going to do a terrific job and I look forward to partnering with him for many years to come as we continue to build one of America's greatest companies to work and shop.

With this slide let's take a look at the numbers. New retail revenues you heard was up 11.7%, while volume was up 7.4% as we recorded our largest new car volume first quarter in company history. We completed our true price roll out and the stores are getting comfortable with our new processes and pricing culture. New car PUR volumes were 20.42. We're very satisfied with this performance given the significant pricing change with True Price that we put the stores through, they've done a remarkable job.

We believe that that we have upside to new car PUR as our True Price process becomes more stabilized. A little brand color, BMW, many led the way for us up almost 25%, Honda, up almost 2%, Ford up almost 9%, Mercedes was up 1%, Audi 7%, Lexus pushing 9%, Cadillac almost 8%, Land Rover up 10%, General Motors up little under 2% and Ford up just over 12%. New vehicle base supply ended the quarter at 56 days.

Next slide, please. Our pre-owned business continues to improve as well, Q1 of 2013 was our largest pre owned volume first quarter in company history, up 4% over last year's record quarter. We sold 88 units per store in the first quarter. That was our largest per store volume quarter in company history, March was the largest pre-owned volume month in company history hitting 94 units per store also a record, as we continue to make of achieving our 100 unit volume on our per store per month goal which I think we'll do in the second half of the year.

Pre-owned volume PUR was $14.37, up $68 sequentially and our best PUR since Q1 of last year. We expect to continue to see pre-owned PURs improve now at all pricing from pre-owned is controlled centrally and we've locked that down through our SIMS system and our trade center management team. Pre-owned day supply into the quarter at 27.9 days as we continue to efficiently manage our pre-owned inventory.

Next slide please. As you can see from this slide, fixed operations revenue was up 1.4% and gross was up 1%. If you adjust for two less fixed days in the quarter, we were up 4.2% in gross, an outstanding fixed quarter and another fixed gross record for Q1.

Customer paid revenue was up 1.5%, while customer paid gross was up 1.4%. Warranty gross was up 4%, led by several recalls, a trend we do not expect to continue. Overall warranty was 15% of our revenues, which is about flat to our prior year.

I would like to take this opportunity to thank our team for another great record breaking first quarter. Your dedication and hard work is something that I admire very much. They get all the credit for helping us build one of America’s greatest companies to work and shop. Many thanks to you team.

And now I will turn the call back over to Scott. Scott?

Scott Smith

Thank you, JD. Again we had record revenues in the quarter and record move, and used retail volumes. We’ve had 14 consecutive quarters or 3.5 years of quarter-over-quarter revenue growth without any acquisition. We've enjoyed double digit EPS growth of 14% in the quarter. The business environment continues to be favorable for us. Therefore we are maintaining our full year earnings guidance of the $1.93 to $2.03 in earnings per share.

And before we open the call to take your questions, I’d like to thank our Sonic associates, our manufacture and vendor partners are making Sonic Automotive one of America's greatest companies to work and shop. It is an honor and privilege to lead our great company.

And with that, we'll open the call for your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Rick Nelson, with Stephens.

Rick Nelson - Stephens

I’d like to ask about fixed ops, the decline, that we saw in internal and sublet in the quarter, is that something, what was the driver there, the expectation as we go forward?

Jeff Dyke

Yes, Rick, this is Jeff Dyke. We have heavy inventories coming out in December. So a lot of that internal number ended up in the fourth quarter. I expect the internal numbers that you’ve been seeing year-over-year is, the growth sort of narrows and it's not huge a double digit to narrow as well. But I don’t expect it to be negative as we move forward. It should continue to be equal or up with our used car businesses.

Rick Nelson - Stephens

Also, I like to ask about the F&I, if you could give us a rough breakdown between what is rate and what would be product and do you see any risk from the CFPB actions?

Jeff Dyke

First of all, I don’t see any risk whatsoever. Our F&I business has been growing nicely. We will give you the actual rate to product breakdown here in just one second. But we have been very pleased with the growth in F&I. Our team has been doing a really nice job and we have been steadily growing our PUR. So we feel real comfortable with where we are; no risk whatsoever.

Heath Byrd

And we are about 40% on the finance side, and rest of it is service contract.

Jeff Dyke

Yes 40% on the financing and the rest of it is product.

Rick Nelson - Stephens

With the SG&A, pay leverage have recognized, part of it is the gross profit declines in both new and used but if you could address that and how the accounting cost may be played into the quarter and your expectations on a go forward base?

Scott Smith

Part of that SG&A in the first quarter was some remediation work they were doing on the control environment. We are estimating that the total spend for the year is going to be around $3 million but we think the overall impact is going to be 0.5 penny to 1 penny overall for the year. We are going to absorb some of that expense by managing other areas of the business. We also had some follow-up expenses from last year’s audit, hitting Q1 and so I think from a SG&A prospective, about $800,000 of that in the first quarter was one-time non-recurring as it relates to the account and remediation.

Rick Nelson - Stephens

And will that be new tier non-recurring expenses and not regarded?

Jeff Dyke

The only thing that is going to be reoccurring going forward in 2014 as we are going to be staffing up to ensure compliance in the field as well as at corporate level and so that will be reoccurring but a lot of the stuff we are doing is one time investment in technology and some professional services that we will start dissipating in ‘13 and will be gone altogether in '14.

Scott Smith

And Rick, one thing, you just mentioned the gross, I am very happy with our car PUR, especially just finishing True Price and then from a pre-owned perspective sequentially, we are up nicely and I expect our PUR for pre-owned to continue to grow as we move through the year. We've been between 1,400 and 1,450 for a while now and we saw a really nice increase in March as we locked down our pricing. And, I think we will see a nice steady increase in PUR may be approaching the 1,500 mark or even a little better as we move forward throughout the year.

Rick Nelson - Stephens

And does that look like to you, that it did improve sequentially.

Scott Smith

Yes it improved nicely, I mean the year over year number it was very high last year. A lot of that had to do with a trade that we took off of the issues that was created by the Tsunami. But other than that, I am very, very pleased with where we are in the Trade Center and SIMS is really starting to make a difference for us. So.

Operator

And your next question comes from the line of Ravi Shanker with Morgan Stanley.

Ejay Gering - Morgan Stanley

This is actually Ejay in from Ravi. My first question is on pricing. So you guys saw a pretty good ASP growth this quarter in both new and used. Sounds like that was driven in part by mix, but could you talk a little bit about what you are seeing in terms of the incentive environment, maybe in particular the J3 and your discussions with them as you see the weaker yen, or I'm sorry do you see the weaker yen having an impact at all on their pricing strategies?

Jeff Dyke

Not yet. I mean maybe it will as we move forward but the incentive certainly for Honda were not as aggressive in the first quarter as they were last year and we have yet to see the big, big Honda press that we have had the last couple of years, especially the Accord program that they had last year. So incentives year-over-year, when you add it all up, they were down just a tad bit, but not enough to slow us down. But for Japanese brands, they were not as aggressive, Toyota being more aggressive than Honda.

Ejay Gering - Morgan Stanley

So would you characterize I guess your ASP growth. Is it mostly because of mix or is there some underlying activity going on there?

Scott Smith

Well I think mix plays certainly has played a role in it.

Jeff Dyke

Yes, BMW made up a greater proportion of our sales in the first quarter this year than the last year and that really drives our sales price. So they are a large percentage of our overall mix and their growth, when you had BMW and Mini together was nearly 25%.

Ejay Gering - Morgan Stanley

Next question on capital allocation, you mentioned last quarter that you’re now more open to acquisition opportunities, Can you comment a bit on what you’re seeing in the M&A environment now and if that’s made you more comfortable with that potential or is it still going to be very much opportunistic and the focus more on share repurchases and lease buybacks?

Scott Smith

Well, I think it’s really important to point out, this is Scott by the way, that our strategy really hasn’t changed. We’re still continuing to invest in our basic business, investing and our infrastructure tools to help us some more efficient, invest in our real estate and strengthen our balance sheet. So we do have considerable amount of authority on stock repurchase which, our aim is to be strategic and opportunistic.

And last year we did sell platform dealership in Oklahoma. We’re actively looking to replace those revenues and we been out in the market looking. We don’t have anything to announce, we don’t have any definitive agreements or anything like that but we are looking in the market be opportunistic there as well.

Operator

And your next question comes from the line of Scott Stember with Sidoti & Company.

Scott Stember - Sidoti & Company

Could you talk maybe a little bit about the used gross margin decline and how much of that was due to possible disruption from your associate learning and how do you since?

Scott Smith

Yes, now Scott if you think about it sequentially, our USP are growing it was up I think $60 or $68 quarter-over-quarter pushing towards the 14, 15 mark. Last year, we had an unusual first quarter for us in terms of PUR, a lot of that had to do with some of the cheaper inventory we’re able to buy coming out of prior year, given what happened with Tsunami, so forth and so on.

So we expect our used car PURs to sequentially continue to grow. They’re better in April right now than they were in March and I think we’ll see that continuing to grow through the year, but 1500, between 14-15 and 1500 kind of been our target. We may push a little north of that locking down the pricing here at home office and actually managing our pricing and managing our appraisal numbers, I'm seeing a little bit of a bigger uptake in margin. So as we control that better and our environment and culture gets used to that, I think there is probably another $50 and maybe even $100 a quarter there.

Scott Stember - Sidoti & Company

Okay could you just give us the timing on when SIMS will be finished in the Retail Trade Center?

Scott Smith

It is all done. It is complete. We completed it in the first quarter, so we are all set.

Scott Stember - Sidoti & Company

Okay. And on the iPad implementation as well and maybe give us some details on how it's helping the parts and service area?

Jeff Dyke

Yes. Service iPad’s are up. I'm not quite ready to share the growth. I can tell you that when you look at BMW, Honda and our bigger brands, we are seeing very, very nice growth, but again it is a big change in culture, taking a pen and paper out of somebody's hands, putting an iPad in somebody’s hands and teaching them how to use it, we have got some really neat things happening and it is what I said last quarter, I think towards the second half of the year I will be able to give you some real definitive numbers and how all of that is working for us.

Scott Smith

And all dealerships were completed end of this month.

Jeff Dyke

Yes, iPad’s are all rolled out in sales and service. Our next focus will be for technicians.

Scott Stember - Sidoti & Company

Okay and obviously the last year there has been a good $2 million to $3 million of incremental cost for a lot of these items that you have been putting in place. Could you talk about how that could possibly wind down as the year progresses into 2014 or these costs will remain in place?

Jeff Dyke

We have got about $18 million forecasted for capital spend in IT. Of that about 5 million is probably development cost, the rest of it is equipment iPad’s IP telephony and so our development cost is going down as we have got a lot of that completed. We are still working on finalizing our CRM product. But for the iPad apps, iPhone apps that development has started to dwindle. So it will become more of a maintenance rather than custom development going forward. So I do anticipate that the expense on the IT side will be going down into ’13 and ’14.

Scott Stember - Sidoti & Company

Got you and last question, could you just give us an idea of how April has been shaping up from a sales perspective?

Jeff Dyke

Yes no problem; pre-owned in particular very, very nice. We are having a solid performance and new car business is not too bad either depending on the brand that you are looking at. But it is a solid April in comparison to prior year and to what's being going on in the first quarter. When you look at quarter as a breakdown, January was a good January, February was not the February that we had hoped for and March was gang busters. And April has been a good month so far.

Scott Stember - Sidoti & Company

So I guess that just leads to the question of the payroll tax and potential impact, you guys really not seeing all that much?

Jeff Dyke

I think if we saw some with tax increased from the state level in California. California just had a really difficult February which played into little softer February than we would have liked. That seems to have decapitated now because they’re up running again. So I think that certainly played a role in it.

Operator

And you next question comes from the line of John Murphy, Bank of America/Merrill Lynch.

Elizabeth Lane - Bank of America/Merrill Lynch

This is Elizabeth Lane on for John. How should we be thinking about incremental flow through to the bottom line as gross profit theoretically improves its volumes, because if we look at first quarter this year versus last year, gross profit grew 3% and your operating profit actually declined by about 1%. So, there is some negative incremental flow through. And you addressed some of the specific issues in the quarter. But what kind of flow through should we expect going forward on our longer term basis. Is there like benchmark or target level that you hope to achieve overtime.

C. G. Saffer

What we think that we can push through is around 15%. we did has some cost in the first quarter that kind of held us up a little bit and as our grosses grow through the year we make more in the following quarters. We think that you're going to see that push through in the operating profit.

Operator

(Operator Instruction). And you next question comes from the line Aditya Oberoi.

Aditya Oberoi

I had a question on your margins and the fixed operation category. The margins were like at one of the lowest levels you guys have seen for the last few years now. So what was the key driver of that? Was it the factor being internal and sublet being down or was there anything else. And how should we think about them going forward.

Jeff Dyke

Internal and sublet certainly played a role in that. Also we are working on becoming - we are not the lowest in the sector there in terms of margin percentage and we’re studying the last years pricing there on our products and what we can do to drive gross. So there are lot of different thinks that are going on fixed operations. And I’ll point out we still had our best first quarter gross for fixed operation that we’d ever had as a company. So, we’re playing around with that and you should expect margin to move around a little bit as we try to find the right sweet spot for margin for fixed operations.

Aditya Oberoi

Got it, that's helpful and my second question was on just the overall sales performance. Were there any specific pockets from a regional standpoint that performed above average or was the sales performance more broad based?

Jeff Dyke

From a selling performance, pretty good across the country. East Coast is performing a little above what we thought. When you look at California it was not a sales performance for us in February as much as it was a margin performance. Some of that is our team out there getting used to true price and the way we're doing things now, but also, and the economy was just goofy in February there. So sales performance both on new and used pretty steady across our entire enterprise.

Aditya Oberoi

Got it, and one last one, and I think you addressed it a little bit, I'm sorry if I missed it, but in terms of capital allocation, I know you guys want to increase the level of ownerships of your dealerships and the real estate there and at the same time you guys did some buybacks this quarter. So how should we think about the allocation of capital going forward?

Jeff Dyke

Well, I think Scott mentioned it, we're going to stay focused on the core business number one, and the number two priority is owning our own properties and it's all about timing. Those opportunities exist once at least comes to its term and then we'll either negotiate the purchase or essentially move the dealership. So I think in the priorities those two stay at the top and then you get down to making decisions on stock repurchase, acquisitions and other growth opportunities and we're treating those very opportunistically. We want to have right balance with that in each opportunity we evaluate and make decisions. So the ownership of properties stays in the top two.

Operator

And your next question comes from the line of Colin Langan with UBS.

Rahul Chadha - UBS

This is Rahul Chadha for Colin. Most of our questions have been answered. Maybe Heath if you could talk about how your transition into the new role is progressing and what your priorities are sort of over the next six to 12 months.

Heath Byrd

Sure, well number one you know I've been with the company for a little over five years now in another capacity. So the institutional knowledge really helped out with the transition and secondly, the company made the decision and putting me in this position actually back in October. So I was, I had the privilege actually, obviously I worked with Dave for five years and then I had the privilege to work directly with him in this transition for basically six months. So I feel like the transition went very smoothly and feel comfortable that we are ready to move forward.

The priorities really have not changed. If you look at our earnings call and our presentations for the last four years, this was same three components and we don’t expect any change from that core business, owning our own property and ensuring we have good capital structure. The only variance really is looking at acquisitions as they come available. So the focus is really staying the same as you have heard before.

Rahul Chadha - UBS

Any thoughts on a national brand strategy similar to one of your competitors there?

Jeff Dyke

This is Jeff Dyke. AutoNation obviously has blazed a trail in their import and domestic stores. We think that’s great for the industry. We have been working on internal branding for a long time, in terms of our culture and when that translates to external, at some point in time in the future, that’s not something that we are ruling out but certainly not ready to comment, and say hey this is what we are going to do.

Operator

(Operator Instructions). We have a follow-up question from the line of Ravi Shanker with Morgan Stanley.

Ejay Gering - Morgan Stanley

This is Ejay in for Ravi again. Just a quick follow-up on F&I, if I could. I know you guys talked about this a little bit before the breakdown between the finance and the product side. But in terms of the actual growth this quarter, on my numbers, I think you guys grew F&I per vehicle about 8% year-on-year. Could you sort of break that part down by, what was actually driving that growth? Whether it’s the finance bit or the product side?

Jeff Dyke

It’s both. We had growth in finance and products.

Scott Smith

It was primarily in products.

Jeff Dyke

Our service contract penetration has really skyrocketed and we had a big opportunity there and we are doing a much better job there, our service contract penetration gross is up almost 17%-18% on new and oh heck, maybe almost 27% on used.

Scott Smith

Right, the finance side was up between 35% and 40%.

Operator

And this concludes today’s question and answer session. I would like to turn the call back to Scott Smith for closing remarks.

Scott Smith

Great. I would like to thank everyone for taking time to being on our call today and we look forward to talking to you again next quarter. Thank you.

Operator

This concludes today’s conference. You may now disconnect.

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