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Sonic Automotive, Inc. (NYSE:SAH)

Q4 2011 Earnings Call

February 28, 2012; 11:00 am ET

Executives

Scott Smith - Co-Founder & President

David Smith - Executive Vice President

Dave Cosper - Chief Financial Officer

Jeff Dyke - Executive Vice President of Operations

Analysts

Elizabeth Lane - Bank of America

Aditya Oberoi - Goldman Sachs

Rick Nelson - Stephens

Scott Stember - Sidoti & Company

Colin Langan - UBS

John Evans - Edmunds White Partners

Clint Fendley - Davenport

Operator

Good morning and welcome to the Sonic Automotive, fourth quarter earnings 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).

Presentation materials which management will be reviewing on the conference call can be accessed on the company’s website at www.sonicautomotive.com, by clicking on the Investor Relations tab under Our Company and choosing Webcast and Presentations.

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, 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 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, Co-Founder and President of Sonic Automotive. Mr. Smith, you may begin your conference.

Scott Smith

Thank you. Good morning and welcome to Sonic Automotive’s fourth quarter earnings call. I’m Scott Smith, the company’s President and Co-Founder. Joining me on the call today are David Smith, the company’s Executive Vice President; Dave Cosper, our CFO; Jeff Dyke, our Executive Vice President of Operations; and Greg Young, our Vice President of Finance.

I’ll start the call today with an overview of the quarter and I’ll turn the call over to Dave for his review of our financial results, followed by Jeff, with a look at our operating results. We’ll then have closing comments and open the call for your questions.

We’ll turn to the slide, overall results. We are pleased to have wrapped up one of the strongest quarters in the company’s history. Our adjusted EPS from continuing operations was up 43% for the quarter to $0.43 per share and up 40% for the year at $1.39. These results were driven by strong growth in all lines of our business.

New car retail volume is up 15% for the quarter compared to an industry growth of just 10%. Our dedicated focus on our playbooks has allowed us to consistently take market share and grow our new car business faster than the overall market recovery every quarter this year. This is the 11th quarter in a row that we’re reporting double-digit growth in our pre-owned volume, that’s almost three years in a row.

Our pre-owned playbook rollout strategy implementation over the last several years has proven that we can consistently grow our base business through the implementation of predictable, repeatable and sustainable processes. This volume growth in our vehicle business has generated growth in our parts and service departments, where revenues were up 2.5% for the quarter, 5% for the year, along with growth in our F&I business, which is up 19% for the quarter and 21% for the year. Our adjusted SG&A to gross profit declined 220 basis points in the quarter and the full year to 76.6% for Q4 and 78.2% for the full year.

I’m proud of our team and what they’ve accomplished this year. I’ve talked a lot in the past quarters regarding our focus on both our people and our culture and your seeing how the softer side of our strategy is consistently translating into the industry leading growth for our company.

I’ll now turn the call over to Dave. Dave.

Dave Cosper

Good morning everyone. Scott mentioned we grew revenue in all parts of our business and this slide shows very clearly the leverage of increased sales on the bottom line. In the fourth quarter revenue was up 12%, operating profit was up 19% and adjusted profit after tax was up 46%. The story is essentially the same for the full year.

Jeff will talk more about this later, but as the new vehicle industry recovers further and our execution gets even better, you can expect to see more of this favorable leverage. For the year adjusted earnings per share was $1.39, up 40% from 2010. Next slide please.

This slide shows our SG&A performance and the leverage of increased sales, as well as the focus on our costs are shown here as well. Adjusted SG&A as a percent of growth was 76.6% for the quarter, an improvement of 220 basis points from the prior year. The same improvement was achieved for the full year.

I’m pleased we are able to achieve these results as we are continuing to invest heavily in our people and our processes with training and technology. I’m very comfortable with the investments we are making, because the payback for both our people and the business is fast and it’s really showing up in our results.

Next slide. This slide shows capital spending for 2011 and 2012 and both years are fairly investment years for us, with significant investment in property and buildings that we now own. Owning our property is one of our key priorities and this trends going to continue in the future.

In 2012 the spending for two new luxury stores and a Japanese import store is all that we own and as I mentioned, we have substantial IT investment, including iPads for many of our frontline associates.

Next slide. This slide shows our compliance with our covenants at year end 2011, also shown as a step up in covenant effective at the end of March. Our year-end status complies with this stepped up level also. As we said so many times, our top priorities at Sonic are the base business, which means growing organically, owning our property and third reducing debt. We focused on all three of these priorities and making good progress in all of them.

In 2011 we reduced our public debt by $60 million and ended the debt with $365 million of public debt. We added over $50 million of new mortgage debt in 2011, but we view this as good debt as it replaces higher cost leases and owning our property provides so many other operational benefits.

With that, I’ll turn the call over to Jeff.

Jeff Dyke

Thanks Dave and good morning everyone. I appreciate the opportunity to share the Sonic Automotive fourth quarter operating results. We continue to be excided about the success of our new vehicle playbook rollout. As you can see on this slide, we continue to outperform the industry. We had the highest market share in the company’s history in 2012, which is a direct result of our new car playbook.

The new car playbook has been installed in roughly 50% of the company, with the balance being completed this year. As with our experience in other areas of playbook execution, it really begins to mature in it’s third full year, so we’ve got a lot of upside to look forward to.

New car retail revenue is up 16.2% for the quarter and 17.4% for the year. New car retail volume was up 14.5% for the quarter and 15.5% for the year. New car retail growth was up a little over 11% for the quarter and 13.5% for the year.

We expect the 2012 SAAR to be in the range of 13.5 million units as Japanese inventory levels continued to improve and the industry continues it’s slow, but steady recovery. New vehicle base supply ended the year at 37.5 days, which breaks out in the following: domestic at 63.8, import at 29.2 and luxury at 34.3. Our Japanese brands were at 26.9 days, up from 24.5 ending September. Next slide please.

This marks our 11th consecutive quarter of double digit volume and revenue growth in pre-owned as our team continues it’s march towards averaging 100 retail units sold per store per month. As you can see on the chart, we were up 11.4% in volume for the quarter and we are at 13.9% for the year.

Pre-owned front and related total gross was up 10.6% for the quarter and 11.1% for the year. Our day supply was 31 days and certified pre-owned was approximately 30% of our sales mix, which is right in line with our strategy. Next slide please.

As you can see on the slide, we have another record pre-owned volume here breaking the 100,000 pre-owned unit volume level; our first in the company’s history at just under 103,000 units. I want to take this time to congratulate our entire pre-owned team on a job well done.

Since the implementation of our pre-owned playbook, our compounded annual growth rate has been 11% over a six-year period and as we’ve said previously, it takes about three years for playbook to mature. As a result our compounded annual growth rate since this time is about 15%.

We continue to make excellent progress on achieving our target of 100 units per store per month. As you can see on the slide, we reached an average of 79 units in 2011 and we look forward to making more progress in ’12 towards this very important goal for us. Next slide please.

As you can see on the chart, fixed operations revenue was up 2.5% for the quarter and 4.8% for the year. Gross profit grew nearly 2% for the quarter and 3.2% for the year despite significantly lower warranty levels. Customer pay revenue was up 5% for the quarter and 3.2% for the year. Customer pay gross was up 4.2% for the quarter and 1.5% for the year.

Warranty revenue was down 15% for the quarter and 1.5% for the year, while warranty gross was down 15.5% for the quarter and 1% for the year. Warranty was 14.4% of the fixed revenue mix in the quarter and that’s down from 17.4% last year, same quarter and warranty was about 15.5% of the fixed revenue mix for the year, down from about 16.5% prior year. Next slide please.

2011 was the largest revenues in gross year and fixed operations in company history. I want to congratulate our fixed operations team on a job well done. We began to install playbook in fixed operations in 2009 and as a result we’ve grown our fixed revenue over 10% since this base year. As you could see on the chart, we’ve grown our revenue on average $34 million each year for the last five years, with a dip in 2009 just due to the economy. Next slide please.

In summary, the fourth quarter was another record quarter and 2011 was another record year for Sonic Automotive. We continue to demonstrate that our strategy of reducing turnover, increasing associate satisfaction and playbook execution is creating positive growth in our performance versus the industry. We had record market share, pre-owned revenue in volume, fixed operations revenue and gross for the year.

We also continue to show that our strategy of reinvesting in our current store base and reinvesting in our associates is paying off, allowing our stores revenue, gross, profit and earnings per share to grow as fast or faster on a same store basis as many of our competitors grow on a total store basis. These performances are allowing Sonic to invest in state of the art technologies that are beginning to have significant impact on our customer experience, in establishing one of the America’s greatest companies to work and shop.

We expect the recovery to continue steadily in 2012 and our strategy and playbook execution will allow Sonic to continue to grow and take advantage of the recovery. I’d like to take this moment to thank our team for their hard work and dedication to our strategy. A great year everyone; I look forward to an even bigger 2012.

And now I’ll turn the call back over to our leader Mr. Scott Smith.

Scott Smith

Thank you Jamie (ph). We appreciate the time that you’ve given us today to review our quarter. We are very pleased with the results of this quarter and the benefits we are seeing from our continued execution of our various operational and financial strategies.

We look forward to 2012 as we are expecting new vehicle industry volume of 13.5 million units. We expect our pre-owned vehicle volume to grow in the high single digits. Fixed operation should grow in the low to mid single digits, with the overall revenue growing in the high single digits.

We are currently targeting 2012 diluted EPS from continuing operation from $1.55 to $1.65. This represents a 12% to 19% growth over adjusted EPS of $1.39 in 2011.

Before we open the call, I just want to take a minute to thank all of our associates and vendor partners who join together everyday to help us build one of America’s greatest company to work and to shop. Thank you everyone.

Lets go ahead and open the call for your questions then.

Question-and-Answer Session

Operator

(Operator Instructions) Your first audio question comes from the line of Elizabeth Lane with Bank of America.

Elizabeth Lane - Bank of America

Good morning guys and congrats on the good quarter.

Scott Smith

Thank you.

Elizabeth Lane - Bank of America

So your 2012 outlook of $1.55 to $1.65 is based on industry sales of 13.5 million. I was wondering if you have a general rule of thumb for what a 1 million-unit increase in SAAR adds to your EPS.

Dave Cosper

Yes, this is Dave and I’ll give you the number for 500,000, because I was just looking at it. About $0.07 or $0.08 per 500,000, so you just double that to get to 1 million.

Elizabeth Lane - Bank of America

Okay great, thanks. And what is the company’s priorities for cash at this point, because I know the strategy has been to reinvest in the business and not necessarily in acquisitions, but are there any opportunities out there in the market that would make you reconsider that strategy?

Dave Cosper

Well, this is Dave again. I work really hard to keep us of focused on our three priorities of the base business and we are investing heavily there. Property, owning our property is also very important and taking our data out is as well.

Now if something beautiful presented itself, would we consider it? Yes, absolutely, but we’re really not actively looking. Because as long as we can continue to grow our business organically, as fast as the rest of the market is growing, going out and buying dealerships, it makes a lot of sense to continue to reinvest in our people, in the current facilities that we have. There’s just still a lot of upside opportunity in what we’ve got and it’s very low risk and it’s not like…

Elizabeth Lane - Bank of America

Okay great and just one more. Are you doing any additional hiring at this point or increasing incentive compensation materially as the new vehicle sales environment continues to improve and what portion of your SG&A is variable and should we expect it to creep back up versus more permanent or sticky cost reductions?

Scott Smith

Oh boy! A lot of questions there. First, really, we are not doing any additional hiring. We believe we’ve got the right staffing levels to handle the business, even if it grows past the 14 million mark. The technologies that we’re deploying today are going to allow our associates to be more effective and efficient, meaning more sales per associate than what we’ve experienced in the industry and what we’ve experienced with Sonic in the past. So we’re pushing up the throughput through our individual associates more now than ever before.

We want fewer people making more money. We’ve not really adjusted compensation plans that would comp as a percent of gross change and I don’t see that happening at all this year and next. We’ve got very, very good plans in place and they are producing the results that we are looking for, so…

Greg

Hey Liz, this is Greg. On your SG&A question, we looked at it kind of broadly and at the two ends of that spectrum there’s probably about 10% of our cost that are truly fixed, 10% to 15%. Then there’s probably somewhere in the neighborhood of 25% or so that’s truly variable, that is going to move as the business moves and then the big mix in the mid always, what we refer to as the semi variable, where we are able to control it, we are able to move it if we want to, things such as advertising and those types of things, but the truly purely variable is probably around 25% or so.

Elizabeth Lane - Bank of America

Okay great, that’s very helpful. Thanks guys.

Scott Smith

Thank you.

Operator

Your next audio question comes from the line of Aditya Oberoi with Goldman Sachs.

Aditya Oberoi - Goldman Sachs

Congratulations on a good quarter.

Scott Smith

Thank you.

Aditya Oberoi - Goldman Sachs

I just wanted to follow-up, can you talk a little bit about your regional performance in the fourth quarter? Which pockets did you see some better strength versus the others?

Dave Cosper

Yes, first of all, the fourth quarter was solid across the board for us, but if you want to pick some of the front runners, Texas was very solid, Southern California was solid, Alabama, Tennessee, sort of the DC area, all of those were very solid from a revenue and volume perspective.

Aditya Oberoi - Goldman Sachs

Got it and I just wanted to kind of dwell a little bit on the question on SG&A. Like your guidance says you’ll be below 78%. I think this is the first time in Sonic’s recent history for the, I would say last few years that you guys will be below, we’ll be running at that kind of a run rate. Now when we think about additional leverage, how much more flexing do you think there is or how much is low hanging fruit versus what you have to like really go for in terms of reducing your SG&A further.

Dave Cosper

This is Dave. I don’t know that I would look at is as low hanging fruit. I think our strategy is we’ve been talking about investing in our people and our processes and training, what have you, so if we pull back on that I think there’s more leverage, but frankly we are investing there because it’s working and then I think the leverage comes from the success and our ability to sell and execute our playbooks; that’s really where the leverage is versus slashing costs.

Jeff Dyke

This is Jeff Dyke. One of the great things about what we’ve done is, we didn’t go out in ’08, ’09, ’10 or ’11 and cut headcount. We didn’t cut any pay plans. So we didn’t leverage the bottom line or expense structure that way. We leveraged it by growing top line and by growing our gross and so as a result we’ve got industry leading, low turnover, high associate satisfaction and its paying off for us and its really just begging to start paying off. I mean we see a lot of upside here and I think that SG&A range is a good number for 2012.

Aditya Oberoi - Goldman Sachs

Got it. And one last one if I may; you’re use to new ratio kind of tapered a little bit from 0.79 in Q4 ’10 to 0.77 in ’11. How we do we think about it in 2012? Do you think the normalized rate could be more like 0.75-ish or do you think you will kind of go back to the levels we saw in 2010.

Scott Smith

Yes. No, we’ll go back. If you study historically, it didn’t have anything to do with October or November, its all December. We are heavily weighted high line and we just have sell a lot of high line new vehicles in the month of December and if you study the previous year, the same thing happens every year.

January and February up, where one to one or 0.95 to 1 are use to new and I expect to see that all throughout this year. Then go back to December, we’ll probably have the same phenomena happen again and its just our brand mix cause that and we do everything we can. Another things is, what helps us is when we sell a lot of new cars in December we take a tone of trade. So it makes us better than one to one in January typically and that’s exactly what happened this year.

So I expect this to continue to range in the 0.95 to 1 ratio throughout the entire year and December just isn’t -- a little bit of different twist in terms of our brand mix.

Aditya Oberoi - Goldman Sachs

Got it, very helpful. Thank you so much guys.

Scott Smith

Thank you.

Operator

Your next audio question comes from the line of Rick Nelson with Stephen.

Rick Nelson - Stephens

Good morning. My congratulations as well. I’d like to ask you about SAAR guidance of 13.5 million units, it’s a little more conservative and we are carrying from some of the other companies. If you could comment on sales trends that you are seeing in early 2012 on the new car side as well as the used would be helpful.

Dave Cosper

Yes Rick, this is Dave and you know we’ve got a pattern of budgeting or targeting based on conservative assumptions and then if the gravy is there, we will certainly take it. And I think that strategy has served us well over the last couple years and I think it’s appropriate. But having said that, we are off to bang up start this year and Jeff why don’t you talk about that.

Jeff Dyke

Yes, with February and January being great Rick, both on the new and the used car side, so we are very, very comfortable with our guidance. And I’ll tell you, if you go all the way back to ‘09, ‘10, ’11, our SAAR guidance has been right in line. I mean there’s nothing that we really missed.

I think the SAAR ended up being for 2011, 12.7 something like that and our guidance was 12.5 at the beginning of the year. We are projecting 13.5 and if it’s higher than that, we are going to do better than the numbers we are calling out. But I think it’s a good conservative number and based on our previous two or three years of projecting these number, they are fairy accurate, unless something just really changes in the industry.

Scott Smith

Jeff mentioned this in this comments, but I think it’s really important that the industry was up 10% last year and we’re up closer to 15%. I mean that’s the base on (inaudible). It really makes a different in our new car volume. If we can keep that even on a 13.5 SAAR, we are doing pretty well.

Rick Nelson - Stephens

Thanks for that. Also, I’d like to follow up on the SG&A. Is there any structural reason why the SG&A, the gross that you delivered this quarter, 76.6% can’t be maintained in 2012. I guess especially as we move into seasonally bigger periods like Q3 and Q2.

Jeff Dyke

Hey Rick, it’s Jeff Dyke. The thing is, is in December mix plays a big role in that. We make a bunch of money in our highline stores and it just plays a big role, plus the incentives that we get back from the manufacturers at the end of the fourth quarter is large, so more larger than other quarters. That’s why it’s pronounced as it is in Q4 and I think you see that amongst some of our competitive set as well. But it will fluctuate in and around I think the 78% number that we gave for the quarter, for the year, for the first three quarters and then be sizably better in Q4.

Rick Nelson - Stephens

And finally if I could ask you, on service and parts side, when do you feel that you anniversary the tough comparison warranty.

Jeff Dyke

Top comparison, did you say – I didn’t hear you Rick. Did you say warranties?

Rick Nelson - Stephens

In the warranty, yes. Is that the re-calls is what’s causing the declines in warranty.

Jeff Dyke

Well it is. Its major declines in Q4, both in Lexus and in Toyota. Lexus warrant gross is off 64% in the fourth quarter and Toyota warrant gross is off 43%, that’s the majority of it. And look, the great news is that we were able to grow our customer pay 14% and 5% in those two brands during the quarter. So we are doing what we need to offset the warranty gross reduction. We had a really nice quarter from a fixed customer pay perspective and we expect that to continue on. It was a record setting year for us in fixed and it’s going to be again in 2012. I’m not really worried about warranty.

Rick Nelson - Stephens

The Toyota, Lexus recall, the compares get easier now as we move forward.

Scott Smith

Yes, they do. Just naturally, because they are just less and less recalls. And it’s such – it’s moved to a 14% of our overall revenue mix I think in Q4. It’s getting to be a smaller and smaller number and in terms of our internals are almost the same. It’s just not something that bothers us. We sort of run the gammon on warrant and as it continues to decrease, its fine. We are going to do a much better job executing our customer paying internal grosses and make up the difference.

Rick Nelson - Stephens

Thanks a lot and good luck.

Scott Smith

Thank you very much.

Operator

Your next audio question comes from the line of Scott Stember with Sidoti & Company.

Scott Stember - Sidoti & Company

Good morning.

Scott Smith

Hi Scott.

Scott Stember - Sidoti & Company

Can you talk about, may be how some of your brands did in the quarter, versus the industry, namely BMW or Mercedes. And maybe talk about Toyota and Honda and the win that you have at your back with supply improving.

Scott Smith

Sure, BMW and many obviously just fantastic, the business was up, 16.3% for us for the quarter and about 16.9% for the year on a year-over-year basis in terms of revenue contribution. Honda as well has just been excellent, even though we’ve been short of inventory. We’ve been selling everything we’ve got. Our day supplies is really low but it’s kept margins up and Honda has done a great job getting us inventory and it’s just been fantastic and we expect to see that continue.

Mercedes Benz for us in the fourth quarter really grew, which is great. You guys have read that we settled our disagreement with them and the relationship is continuing to grow stronger and stronger as we saw in the fourth quarter, our business was just really good, up about 15% in terms of revenue contribution from that brand on a year-over-year bases.

So Ford also up about 12% on a revenue contribution basis and they did a really nice job and product mix is good. As a matter of fact, I’d take this time to congratulate all of our manufactured partners, whether Mercedes, BMW in the new three series, the Accord, you name it, the re-skinning of the Civic that’s coming. I mean they are just all doing a great job, the new Camry doing a great job bringing products. The Cadence is good. They are not overproducing or just keeping the margins up and they are just really doing a really nice job with products right now, so …

Scott Stember - Sidoti & Company

Okay and on the fixed operation side, could you give us some of the other buckets as far as like prep work and cohesion business and the distribution, how is that?

Scott Smith

Yes, internal growth, I think if that’s what you mean by preps for the quarter was up about 7% for the quarter and that’s the gross. Revenue was up maybe 3.8% to 4% and so like I said earlier, customer pay was up 4% for the quarter and on an annul basis up 2%. On an annual basis our internal gross is up 8% for the year. So both of those things combining to more than off set the reductions in terms of dollars for warranty and our team just continues to executive.

We are in the middle of introducing our iPad roll out to all of our service drives, which allows our service riders to get into the service lane and do a walk around on the vehicle with the consumer without really having to have, going to an office or sit down at an ADP station, which makes it easier and more effective and efficient.

The consumer likes it and the stores that we put that into, we are just seeing really nice growth and the amount of products that we are seeing per car in the hours that we are riding per car. So our fixed operations business is growing in those two really important sectors customer pay and internal, and we look for that to continue this year.

Scott Stember - Sidoti & Company

Okay, just going back to the SG&A, could you just may be remind us about the buckets that you’ve been successful in producing, leading to this very nice performance in this quarter.

Scott Smith

Well, a lot of it was a leverage. Again we are investing, right, so – and it’s successful in selling and of course it’s a numerator and a denominator where folks are in both. I think the fourth quarter as Jeff mentioned, a lot of the lift was from the strong sales gross that we had. I mean advertising has been one of our big areas where we’ve done lot more on the internet and been affected with compensation. We compensate our people very well, but guess what, they perform and they generate a lot of growth, so that draws that right into line.

The other thing we’ve done is reduced our rent in a number of areas, sub leased a bunch of properties, pulling over our properties, its really across the board. But again, Jeff mentioned the iPads for all our people. That’s some money that we are spending, but I support it, because it generates a lot of revenue and helps our team.

Jeff Dyke

Yes Scott. I think its really important and I know this may be repetitive, but we didn’t cut pay and we didn’t cut headcount in our company over the last three or four years and that’s something we made a big commitment to.

Our turnover was in and around 25% total company for the year. Our General Manger turnover was about 10% for the year and these are all time lows for our company and why our SG&A is low is because we are generating more revenue and we are generating more growth and that’s what’s driving that number down.

We’ve been a little bit different I think from our competitive set all the long saying that, early on you guys along with others kind of had a little bloody nose to begin with, because we weren’t willing to cut our associates back and we just weren’t going to do it or headcount. What we were going to do is focus on generating more revenue and as a result SG&A is coming down nicely now and our top line revenue growth is among the best in the industry. So that’s sort of been our secret for success.

Scott Stember - Sidoti & Company

Got you and the just last questions, how much of your real-estate do you own as of the end of the year.

Scott Smith

It’s about 21%, 22% today, up from zero three years ago.

Scott Stember - Sidoti & Company

Got you. Thanks again guys.

Scott Smith

Thank you.

Operator

Your next audio question comes from the line of Colin Langan with UBS.

Colin Langan – UBS

Great, thanks for taking my question. Can you give any color on where your import inventory stands? I guess you said it was I think 29 days. So is that adequate or do you think you is there more restocking as of the end of February; is it back to where it should be?

Scott Smith

It’s not crawled back to where it should be. If you look at it, Honda is coming back, Toyota is basically back. We are at 29 days with our Japanese imports. It’s Lexes that’s really, really low. We are missing out there, but I’m expecting Honda to be up and running full for us and I don’t want to take anything light. They’ve done a great, great job getting us inventory.

But end of March, April, May, we should be full swing with everybody but Lexus and we are really struggling on getting more and more Lexus inventor. They’ve got some re-scan coming on inventory. So hopefully mid summer the Lexus inventory will be back up where it should be and we can take advantage of that great brand as well. There’s a consumer base out there that wants and we just need more inventory to help support the consumer base.

Colin Langan – UBS

I know during Q2, Q3 you kept your margins on the import side fairly consistent and you were able to get a lot of business for that. Is there still a backlog of customers waiting for some of those vehicles or is that kind of already run off at this point.

Scott Smith

I don’t know that I would call it a backlog. I think that what’s helping for us is the execution of our playbook. I mean, we are very competitive in terms of our pricing there. We have been able to manger margins, but I wouldn’t call it a massive backlog. I don’t think you’re going to see this thing increase in volume due to customers who have been waiting for cars.

I think customer nowadays have a lot of choices and that they’ll go buy inventory when they need it. But its certainly – and particularly with Honda, we’ve been very successful in growth that brand and I think we were up 10%, maybe with the brand being down 5% for the year, maybe those numbers are fairly close and that’s going to continue on. And as inventory levels rise for them, I think our base supply is going to continue to be in the range it is now, because we are just starting the inventory so much faster, but no major pent-up demand, I don’t really see that.

Colin Langan – UBS

Okay. And I’m not sure if I missed this, the outlook for fixed ops, did you say low to mid single digits, and is that warranty down off set by customer pay or…

Scott Smith

That is correct, 35% in warranty is shrinking as it has been and customer paying internal will off set that and then so.

Colin Langan – UBS

And any concern about – I mean the customer pay growth, is that reflecting your playbook strategies or so what do you think of the overall market, because there’s fewer vehicles out there to service over the next couple of years.

Jeff Dyke

Yes, I don’t know. Everybody always says, the fewer cars that you’re selling, the less, but we’re just not seeing that. I mean if you look at our growth, three years in a row we’ve had record revenues and gross and fixed operations and I think our playbook strategy and the stuff that we are doing with iPads and that’s rolled in 20% of our stores and we will be complete by the end of this year is making a very, very dig difference in our ability to get the consumer in and out of our store on a timely manner and serving exactly what they needed. So it’s no questions that our playbook process is helping that.

Scott Smith

Hey Colin, this is Scott. It was pretty cool last year, the third quarter, Apple, that really big company that put out all these iPads and everything, they called us out on their earnings calls right after Mr. Jobs passed away, as one of their leading innovators and they have just been extremely supportive in helping us. So that investment I think will roll out over the next couple years.

Colin Langan – UBS

Okay. I mean are those iPads and the dealers starting today or they are coming in the future?

Scott Smith

No, I mean they are in majority of our Toyota stores, we are working on Honda and General Motor stores now and now the service pads will be rolled out, along with the proprietary application that goes with it between now and the end of the year.

Its expensive, we are spending a lot of money doing it, but we are generating a lot of gross and a lot of revenue and this is the time to make that happen. So you may see fluctuations in SG&A, but we are going to continue to make that investment, because long term it’s going to make a huge difference in how the customer experiences their visit to the Sonic Automotive store.

Colin Langan – UBS

Okay, all right. Thank you very much.

Scott Smith

Thank you.

Operator

Your next audio question comes from the line of John Evans with Edmunds White Partners.

John Evans - Edmunds White Partners

Can you help me understand, I guess your thought process relative to buying back the convert and then also maybe just help us understand if you exclude your mortgage debt, where do you guys what to get debt to.

Scott Smith

Yes, we set an internal target of getting our total debt down to a couple of $100 million and basically if you take the convert out from our balance today, that’s where we would be. The convert is an interesting animal, I don’t like it. It’s expensive. There’s a lot of dilution, there’s a lot of short selling, there’s a lot of confusion and its complex in a way it rolls through the income strip as well, because it’s a 5% convert, but it ends up getting the income strip for like 9% or so. So we don’t like it. We’d like it to be gone and we are focused.

John Evans - Edmunds White Partners

If I may just ask you, if you did buy back or bought a majority of it back, did you contemplate that into your guidance and is that transaction accretive to you?

Dave Cosper

Yes, it’s a tricky calculation. When you buy it back it does reduce your shares. I think we reduced shares something like a million three from perchance that we’ve made on the convert. However there is an offset in the accounting world, there’s Coco (ph) add back. So it doesn’t change our EPS tremendously, it was a slight improvement, but it’s really not as big as you think from a normal buy back of equity out in the market.

John Evans - Edmunds White Partners

Okay, thank you so much.

Operator

(Operator Instructions) Your next audio question comes from the line of Clint Fendley with Davenport.

Clint Fendley - Davenport

Thank you and congratulations on a nice quarter guys. I wondered if your 2012 EPS guidance was contingent on any specific property purchases in this year and if you can refresh us to some of the impact that these property purchases typical have on your earnings, as well as the capital requirements.

Scott Smith

No, there is really no contingent – now we were comfortable with the 155 to 165 number. The way the math works on that, if you have a $20 million property, we put 20% down, so there’s an inherent delivering. And then typically we’ll save four percentage points, something like that. And the balance, right now our average mortgage rate is just under 5% and our average lease cost is nine roughly. So you would take that difference times the amount of the loan.

Its not huge, but it does add up over time and it really starts to make a difference in your balance sheet and what it looks and that was one of the things that we like about this strategy and then we don’t mind spending money on properties we own.

Clint Fendley - Davenport

Yes, we’ve got $1 billion worth of risk tied out there.

Scott Smith

Yes, your right, your total portfolio is just over $1 billion. I think we’ve got $220 million of properties that we own, with a mortgage balance of 108, and a nice thing about this things is we take $10 million or $11 million of the mortgage principle off every year and pretty soon the mortgage is paid off and we own it. And that’s just a better place to be and that’s why we are headed this way.

Clint Fendley - Davenport

And you’ll own roughly 21%, 22% today. Any expectation for that level by the end of 2012?

Scott Smith

It may pop-up a percentage point or two, but then we start to get into a few years. The leases really start coming due more quickly and I think its like 2016 and 2016 we’ll work our way up to close to 40%.

Clint Fendley - Davenport

Thanks. And then switching gears a bit here. I wondered if you could just comment on where you see the pricing going in the coming year on the used side and the impact that the higher prices might be having on use to new ratio here.

Jeff Dyke

It’s Jeff Dyke. I don’t see it having any impact on the used to new ratio. I mean there’s 40 million used cars sold a year in America and there’s so much upside opportunity in that area. The price is going to move up. Inventories are a little harder to buy now and that’s probably going to be the true story for ‘12 and ‘13 as the new car business comes back. But we are still focused on trading for cars. Instead going to brick-and-mortar auctions and buying cars and then we’ll also, get our retail trade center up and operating by the end of the year.

We really will trade and put valuations on all trades centrally through our home office, so we’ll be more aggressive than the street level or the store level is going to be in making sure that we are taking traders. Today we trade for roughly five out of every 10 cars and I think as we move into the latter part of this year, that number will increase to seven out of 10 and in the future hopefully we are trading nine to 10 out of 10. So it could cost a little bit of margin erosion, but that’s all baked into our numbers. Nothing significant from what we’ve been experiencing in 2011 and 2010.

As I’ve said on previous calls, we are very aggressive in buying inventory and so some of our margins have been running -- traditionally we’d run $1,500, $1,600, $1,700 a car on the front end. Today we are running it the $1,400 range and we’ve been there for that last eight quarters or so and that’s why I think we’ll stay, even given the pressure for used car inventory will be in that ballpark.

Clint Fendley - Davenport

Thanks guys.

Scott Smith

You bet.

Operator

Your next audio question comes from the line Jim Henry with Automotive News.

Jim Henry - Automotive News

Hi. I was a few minutes late to the call and I may have missed this, but have you put out a number for F&I per vehicle. That’s something that I usually see and I don’t see it this time around.

Scott Smith

Actually Jim, that’s not a number that we publish.

Jim Henry - Automotive News

Oh really. Okay.

Scott Smith

On forecast, no.

Jim Henry - Automotive News

Well, I’ll take that up with you off line and see if I could…

Scott Smith

We’ll be happy to take your call and basically see about it, because it’s just not a number that we’d publish.

Operator

There are no audio questions at this time.

Scott Smith

Great, fantastic. Well, thank you everyone so much for your time and have a wonderful day. Thank you.

Operator

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

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