Sonic 1Q07 Earnings: Seven Metrics

In 2006, about sixty cents out of every $10 in same store sales in Sonic's (SAH) service and parts segment came from collision and repair (their 37 body shops). And I suspect the profits generated from these body shops were closer to $1 out of every $10 in total service and repair profits. With Sonic ranked as the sixth largest collision and repair chain in America (Romans-Group survey cited above), I think it might be helpful for Sonic shareholders to understand what is happening in the collision market.

But you are probably more interested in hearing my thoughts on Sonic's first quarter earnings they announced Tuesday. To begin, we briefly need to remind ourselves of the need Sonic is filling, and how they try to fill it. "Just get to the numbers Jerry" you might be thinking to yourself. I'd love to.

However, if you don't step back every three to six months and ask yourself: "what is the need? And how is this company trying to fulfill the need?" you find yourself waking up 3 - 5 years later caught up on a bunch of return metrics that are pretty irrelevant because something in the market has shifted.

Last week I said franchised auto retailers like Sonic (unlike any of the other companies in the index) have the distinct characteristic of trying to fill almost all of the needs associated with personal transportation (auto retail) under one roof.

They sell new and used vehicles, arrange the financing for the vehicle sales (as well as any other warranty and finance type products), and also sell the parts and fix the vehicles when they break down. And I pointed out that according to the Automotive News 2006 rankings, Sonic is the third largest retailer of new vehicles in the United States.

On Sonic's website, I think they do a pretty good job of flashing across how they try to accomplish this (need fulfillment). I won't go into all of the tactics (new vehicle selection, service commitment, etc). But I think the first three items that flash across the website do a pretty good job of summing up what Sonic is trying to accomplish in the market place:

1) First and Foremost: Guest Satisfaction

2) Vision: Retail Automotive Industry Leadership

3) Values: "Take the High Road"

1) "first and foremost: guest satisfaction" flashes across the company's website
Given the guest satisfaction objective, I think it would be helpful if Sonic management started providing (at least directionally) some metrics of customer satisfaction. Although I appreciate there are some problems with customer satisfaction scores, especially all of the "coaching" (telling customers how to score them) that goes on in the industry.

But based on management's comments Tuesday, it sure sounds like they are seeing improvements in customer satisfaction, particularly in the area of service and parts.

2) I am not sure what Retail Automotive Industry Leadership means (or entails)
I don't think the company with the most market share is always the industry leader. "I want to be #1 with the customer" Jim Press (Toyota's North American Chief) appropriately said to a CNBC reporter during the Detroit Auto Show when asked about if Toyota (TM) wants to be #1 in U.S. market share.

Market share and probably any other type of "leadership" metric seems like a byproduct of being the best at filling consumer wants/needs. So if "retail automotive industry leadership" means having the most satisfied customers because they have created a culture and value system based on always "taking the high road" in how people (customers, employees, manufacturer partners, etc) are treated, then I suspect shareholders will be handsomely rewarded.

3) "Take the high road"
I know it sounds like a lot of "corporate speak" that companies put out to make themselves feel or look better (that they always want their employees to do the right thing). "But what they really care about are the numbers I produce" an employee might be thinking to themselves.

Sonic's senior management still has a lot of work to do in moving the "take the high road" culture and philosophy out to the district and store level. They acquired a large group of dealerships over a very short order and now are in the process of integrating them.

However, after having spent a couple days at Sonic's dealer academy several years ago (and subsequent meetings with management and such), I can tell you that it is a philosophy (value system) and approach to the business that is felt and shared by almost every senior management member I have come to know over the years at Sonic.

And frankly as I began to learn (and see in action), it was the "take the high road" philosophy/approach to the business, I became more encouraged with the company's prospects (some people forget there was a time on Wall Street when I was pretty critical of Sonic's leadership). I just think if you try to do what is in the best interest of your employees and customers, over time it shows up in the numbers.

"It was one of the big selling points for me to join Sonic" stated David Cosper (Sonic's CFO and Vice Chairman) "Me too" (echoed divisional Chief Operating Officer Jeff Dyke) when the "take the high road" philosophy came up in our meeting last month.

So in an industry that is clearly struggling, if a corporate leadership is really focused on doing what is right for its employees and customers, one of the things you have to do (both for your employees and customers) is increase productivity. And a big measurement in productivity is employee and store productivity.

At December 31, 2000, Sonic had 9,400 employees. Well, I should add that an industry participant appropriately pointed out to me that prior to the large public dealer groups going to common payroll systems, measuring total employees was not the best. So you should keep in mind that these are only approximations. But if I assume Sonic had a similar (approximate) number of employees at March 31, 2001 (so only three months later), I can come up with some employee revenue and profit figures.

Based on this headcount, I calculate Sonic sold roughly $161,000 worth of stuff (new and used vehicles, repairs and parts, and finance and insurance products) in January, February and March of 2001 (first quarter) per employee. As of March 1, 2007, Sonic's 10k said they had roughly 11,200 employees. So if I take the revenues (stuff they sold/fixed) in the first three months of 2007 (first quarter results the company reported yesterday), I see Sonic sold/fixed about $174,500 worth of stuff for each person that was employed by the company.

Also, if I subtract out what Sonic sold the product for (sales price) minus the cost of the product or labor in the case of service (what was paid for it), I come up with the gross profit. In the first quarter 2007, Sonic had a gross profit per employee of $27,720, better than the $24,282 they had per employee in the first quarter of 2001.

Finally, if I subtract out all of the operating expenses (air conditioning, accounting, management, etc). and the floor plan interest expense I come up with an operating income figure. And given the above mentioned employment levels, this means Sonic's Operating income per employee has improved to $4,294 (over the last three months) from $3,410 in the first quarter of 2001.

As a reminder, on Tuesday I told you AutoNation (AN) increased its gross profit per employee to $29,324 in the first quarter of 2007 from $23,800 in the first quarter of 2001. And AutoNation has improved operating profit (including floor plan interest expense) to $6,184 from $3,452 in the first quarter of 2001. I might not be a big fan of AutoNation's management, but I have to admit, even folks like Sonic need to pay attention to them, because AutoNation is clearly moving faster on the employee productivity front.

On the store productivity front, Sonic had roughly 135 "rooftops" at the end of the first quarter 2007. I don't know how many dealership groups the company had in discontinued operations so you have to keep this in mind when comparing operating income from continuing operations versus last year (on a store over store productivity level). But in Sonic's 10k the company said they had 152 dealership locations (roof tops) as of March 1, 2006.

So, taking those two roof top figures, I come up with about $14.5 million in sales per location, $2.3 million in gross profits per store, and $356,200 in operating income (including floor plan interest expense) in the first three months of 2007 per store. And $12.4 million in sales, $1.96 million in gross profits, and $312,500 in operating income (including floor plan) per store in the first three months of 2006.

I don't know how many store locations Sonic had in the first three months of 2001, but I can tell you that based on the number of franchises it had (165) as of March 20, 2001, they generated about $9.2 million in sales, $1.38 million in gross profits, and $194,300 in operating income (including floor plan) per franchise in the first quarter of 2001. You can have multiple franchises in a single store at times (i.e. Jeep, Chrysler, Dodge).

In the first quarter of 2007, Sonic had 175 franchises, which means they generated $11.2 million in sales per franchise, $1.8 million in gross profits per franchise, and $274,800 in operating income per franchise.

And I won't take you through all of the details for AutoNation, but I calculate they have improved their operating profit per franchise (including floor plan) to $473,000 in the first three months of 2007, up considerably from the $285,000 of operating profit they were generating per franchise in the first quarter of 2001.

I've thrown a lot at you. Keep in mind you have different brand mixes and geographies that influence these employee and store productivity figures. That's why I prefer to focus on the year over year (and even longer) trends versus the absolute dollar figures of one company versus another.

But I hope it helps you understand the industry a little better. I just want to leave you with the seven key metrics for Sonic now that we have the actual (versus my estimate) results. I should point out that since I discussed operating profit per store above I left that metric out and instead replaced it with the byproduct (return) figure.

Sonic's 7 metrics
Metric #1: the return. Sonic said they earned Fifty two cents ($0.52) per share from continuing operations, which is 20.6% of the midpoint ($2.53) management has said they expect to earn in 2007 (range of $2.48 to $2.58). In the first quarter of 2006 Sonic earned 22.7% of what they earned for all of 2006. And in the first quarter of 2005 they earned 19.7% for what they earned in all of 2005.

If Sonic reaches the midpoint of senior management's 2007 earnings goal, it works out to an "earnings yield" of roughly 8.8%, and the company returns about 19% of its earnings to shareholders every year with its dividend ($0.12 a quarter). The dividend alone (1.7% yield) means that for every $100 of stock I buy of Sonic, they send me a check for $1.70 (right now). And if earnings grow, based on the company's current "payout," I tend to get around $0.19 out of every $1.00 the company's earns in a year back in the form of a dividend.

Metric #2: gross profit per new vehicle. I calculate Sonic generated $2,443 in gross profit per new vehicle (retail) for the first quarter of 2007, a little worse than the $2,487 they generated in the first three months of 2006. For all of 2006, Sonic did $2,460 in gross per new vehicle.

Metric #3: gross profit per used vehicle. I calculate Sonic generated $2,005 in gross profit per used vehicle in the first quarter of 2007, a little worse than the $2,075 I calculate they did in the first quarter of 2006. In the first quarter of 2005, Sonic did about $1,925 gross per used and for all of 2006 also generated about $1,925 in gross per used vehicle.

Management is making tremendous strides in rolling out their used vehicle process. And they continue to say the American Auto Exchange software is helping in the roll out of this process. "We are up to a 0.53 used to new vehicle ratio, but the sector average is probably close to 0.64 used vehicles for every new vehicle a dealer sells, so we would like to get there first" when a senior management member was asked on the call if they could ever get to a 1:1 used to new vehicle ratio (I paraphrased a bit to explain the metric).

Metric #4: finance and insurance per vehicle. I should point out the new and used vehicle gross profit figures do not include finance and insurance profit figures. An industry consultant raised a good point to me that in part the reason why the public dealer groups seem to have higher new and used gross profits (even without finance and insurance revenues) is because of differences in how they account and just how good they are at getting things like "hard packs," (I need to understand what these are), documentation fees, and manufacturer incentives.

In any case, I calculate Sonic generated $923 in finance and insurance per vehicle in the first three months of 2007, better than the $886 they did in the first quarter of 2006. In the first quarter of 2005 they did $883 per unit. And for all of 2006 they did $922.

"We have targeted an extra $50 per unit this year, and based on the training process think we can hit $1,000. But we have always been very cautious as we want to make sure that we role this out in the right and compliant way" were comments I jotted down from one of Sonic's senior management members Tuesday when they were asked about how high it could go.

Metric #5: parts and service same-store sales. In the first quarter of 2007, service and parts were up 5.4% on a same store sales basis. Pretty impressive considering they were up against a 7.4% "comp" in same-store sales growth you saw exhibited by this segment in the first quarter of 2006. In the first quarter 2005, service and parts saw same-store sales up 0.9%. And for all of 2006, Sonic's parts and service segment was up 5.2% (same store sales).

"All regions experienced solid increases in customer pay and gross." I heard someone say on the call. And like I said at the beginning I think they are really focused on customer satisfaction in this segment.

Hugh Wiles heads up service and parts and is probably one of the key individuals in the organization that I have met over the years that brought home this idea of "take the high road" when I saw him speak at the Dealer Academy.

Metric #6: Selling, general, and administrative expenses (SG&A) as a percent of gross profits. Sonic spent $77.40 in SG&A for every $100 of gross profits they generate. In the first quarter of 2006, they spent $78.30 (after you adjust for continuing operations), and in the first quarter of 2005 they spent $78.70. For all of 2006, Sonic spent $76.30 for every $100 in gross profits they generated.

Metric #7: Tax rate. Sonic spent $39 in taxes for every $100 in pre-tax profits they generated in the first quarter of 2007. This is a bit higher than the $38.30 (per $100) they spent in the first quarter of 2006, and also above the $37.40 (per $100 in pre-tax profits) they spent in the first quarter of 2005. For all of 2006, Sonic spent $40.40 due to some one time items.

SAH 1-yr chart: