Sonic Automotive, Inc. (NYSE:SAH)
2012 J.P. Morgan Auto Conference
August 13, 2012 1:05 PM ET
Dave Cosper – Vice Chairman and CFO
Unidentified Company Representative
So we are going to get started with the next presentation now. I will be happy to have Sonic Automotive here with us today. Sonic operates over 100 new vehicle dealerships across 15 states and represented over 30 automotive brands, I think. Most of their volume relates to luxury or import brands, particularly BMW. The firm generated $8 billion revenue last year, its market cap is just under $1 billion. We are excited to have Dave Cosper with us, representing Sonic today as well as C.G. Saffer in Investor Relations. David is Sonic’s Vice Chairman and Chief Financial Officer. Prior to joining Sonic he worked for Ford Motor and Ford Motor Credit Company for a number of years rising to Vince Chairman and CFO of Ford Credit before coming on over to Sonic.
Dave, thanks for being here and I’ll turn it over to you.
Excellent. So I use to work at Ford but then I wised up and discovered how exiting retail was. Thanks for being here today. It’s strange to look at the backs of those screens and see Sonic backwards. I’ll try to focus on that. I want to flick you through a few slides, tell you a little bit about what we are doing.
This first slide I used just at very high level get across how we are trying to change our industry. In the very bottom of this thing is the culture. Our business, taken as a whole, is a very rough and tumble in your face kind of business. And turnover’s rampened, and if you want to build a professional store, you need a bit of a culture, you need some more professional people and that’s something we undertook several years ago, we train our people, we pay them, we don’t change their pay plans, we promote them, we develop them, we show them how to make money.
And it’s working. Our turnover’s down use to be close to 70% a year, 70% and we’re down to about 25% of run rate now which is still too high but better than what it was. And when you’ve got a stable workforce, our playbooks which are our training or how to run the business, how to make money in the various parts of our business, sticks.
And then you get higher customer satisfaction and what we’re after is a better customer experience because who doesn’t like buying a car. I mean you want to car but buying it’s actually a pain. Takes too long, you know what you want, you have to deal with all our antiquated processes. And so what we’re doing is building the culture, getting the processes in place to make it fund to buy a car and setup a pain and we are using technology to leverage that and kind of leapfrog. And we think if you can pull that off, we’ve done well but we think the upside is even much, much greater than what we’ve seen.
Our principal, strategic focus is three things. Focus on the base business and the things I’ve been talking about. Base business also means we are not acquiring. We don’t think it’s a best use of capital. So we haven’t bought a store a little over four years. We want to reduce our debt. We’ve actually increased it here recently, I’ll tell you about that, but it was for good reasons. And we want to own our properties. We use to own nothing and we own a fair bid close to 20%. And I’ll show you a slide on that.
And these things are good, they are low risk and they are good returns. When you go off acquiring you don’t a, you’re going to overpay because you are buying from a car guy, which is difficult. And b, it’s a tough business and their culture is different than ours. They’re certainly disruptive to the things that we are trying to do.
So we have been pretty good staying focused on this and the results actually have been pretty good. Last year we grew profits 45%. This year we are on track at over 20%. All same-store, we are not acquiring. And no major buyback in there that’s – it’s really just our earning part. So we’ve been impressed with that and how do you do that? Well, you do it by doing well in each part of your business.
And what this slide is, the left bar is Sonic volume increase. The middle bar is the retail industry automotive overall and the right bar is the total industry. So, when we are growing faster than the market, we are taking market share. And we’ve been taking market share for a couple of years. You can’t take share forever, obviously. But you can take it and hold it. And so far, so far of this year we are doing a good job increasing our share. How do you do that, you execute those playable processes. You do better than the other guy. You attract them to your website, you get them into your store, you satisfy them, word of mouths gets out there, they come to you; they drive by the other BMW store to come to one of our stores, because it’s a better experience.
Unused, this is where we’ve had the playbooks out there the longest. We’ve done very well here in module, we’ve been grown a 15% annual rate. Presently, in the triangle there is a number, it’s the number of vehicles per store per month that we sell. We have a target of 100, today we’re at about 85, we’ve hit 89 in one month. And that’s throughput, we’re after a throughput here. Used is very profitable, the market is huge, it’s three times the size of the new car market. It’s less volatile, it’s less competition. And so it’s a good business to be in. And we’ve done a good job managing it.
The nice thing about used and this maybe a little hard to see but it really benefits every part of the business. If you’re good in used, you can make a trade and you can get the guy into a new vehicle.
If you are good in used, you get the used sale, you get F&I profit with every sale and that’s 100% margin business. And when used is coming through we do reconditioning on it to get it fit for sale and that’s another profit stream for us, interestingly the reconditioning business that we call it prepping the used car for sale is as big as our warranty business in the same profitability level.
So it’s – it really energizes every part of our business and has really been a key to our growth over the last several years.
This slide is interesting. F&I, that’s Finance and Insurance products. We really take no risk here whatsoever, it’s arranging financing, for customer it’s a extended service maintenance plans in wheel and tire, things like that. And what the slide shows is our total gross in 2011, eclipsed to what we did in 2007 pre the recession but new car volumes is still 20% lower than where it was and how do you made up the difference that blue line you see is our used volume over that period. It’s really given us that shot at F&I per unit and all the used vehicle plus the new car market share that we are taking.
Fixed operations is the bulk of our business. We’re a little different than other retailers. We sell sweaters, we also repair sweaters. And that makes us different. That repair business is very strong, it’s very high margin. If you do a good job on it customers come back to you. Even though the units in operation is low because of the recession that we’ve had and the new units are down, we’ve done a good job bringing in and holding on the customers, bringing in new customers and customer payee business is that we call that.
We’re growing 4%-5% on the revenue side, 3% to 4% on the gross profit side. And one of the reason margins are falling slightly here we are going after business like tires. Where tires have 20% to 25% of margin our other business is 50% and you say why go after lower margin business because it’s incremental lower margin business. And customers get comfortable in your shop buying tires or wiper blades or whatever, it’s tend to comfortable when you need heart surgery on your BMW. They come back to you, they are comfortable, they like you.
SG&A to gross, this is how we think about it, in our industry there is a numerator and a denominator and you want to chase both, you want to keep cost low and you want revenues and gross profit high. We did a good job last year, down 200 and some odd basis points. We are flat this year.
We’ve targeted to be at 78% for the year, we’re investing pretty heavily in technology at the moment as I had mentioned. So, we are putting iPads in the hands of the service advisors, iPhones in the hands of our sales people, putting in all the wireless access points with used, I mentioned our volume is very high now, we’ve got an inventory management system. They will enable us to get the right inventories in the stores, without them we haven’t (ph) worry about it. Do all the appraisals centrally and do all the pricing for the store centrally and take that out of their hands. Things are moving a little too fast for the stores. When you get into that kind of volume where we are at, and we’ve got some stores approaching 250 units a month.
CarMax probably does 400 units a month on an average in their stores. They have the technology, we’re getting it, you really needed to get that kind of volume.
Unidentified Company Representative
You’re not skipping there?
Owning our properties I’ve mentioned that we own nothing, it use to be 100% sale lease back, it’s very expensive. It makes sense for some big box retailers but we’re highly specialized facilities that we have. And what we’ve been able to do is go in and get financing at 5% or blow and take out leases that are like 9%. And over time, you’re going to own this, it’s just like your house. I use to get frustrated putting on new roof on somebody else’s house. It’s just not good business for us. And so what we’re doing is owning more. We’re close to 20% today, it will work its way to 40 over the next several years. And you really have something of substance on your balance sheet and it’s a good financing play also.
Debt issuance. We’ve had a target of reducing our debt, ever since 2008, 2009 we had some issues with closed markets and debt that wasn’t maturing. And we wanted to get a convertible note out that we had. Originally it was $173 million, 5% in coupon, which was nice, but it had a strike price of $1338 million and it was – it’s been in the money. And there was 10 million shares of potential dilution on this thing recently. And with the way the high-yield market was and the way our stock was trading and the way we got the debt down to a certain level we said, let’s go ahead and see if we can take it out.
So we borrowed $200 million of long-term debt, 10 years, 7% and we undertook a tender offer for this note. We were successful, we got, if you read our press release, in this appraisals approximately 99.9963% of it came out.
That was a little tiff with the lawyers and slightly less than a 100. So this is gone. It’s a good thing for the company in my view. We – I think this next – oops, how do I make that go back, there we go. This maybe a little tough to see but that top set of bars is our shares and pre-crisis we had $40 million. We had to issue $10 million and change as part of a restructuring and then we had this convert to top of it. And we’ve slowly taken it out, today we’re at about 57 million shares. We actually issued some shares, 4 million shares roughly as part of this transaction. We also have $60 million odd cash that came onto the balance sheet and we recently got authorization for $100 million of authority for stock buyback.
So we’re going to be targeting lower equity here. It’s our plan to reduce that. When I look at our valuation versus the other peer group or versus anything else we can be doing with our capital. It’s sort of leads me to we should be investing in ourselves because we know ourselves, we’re not priced very high versus what you can acquire stores for.
Debt, you look on the bottom set, we’ve been as high I think as $700 million to $800 million in debt. This shows us in 2008 at $500 million and something. Worked our way down below $400 million. We did lever up a little bit here to get this deal done but with our cash generation, our EBITDA, this debt level 7%, 10 year maturity, we feel very good about our balance sheet now. It’s easy to understand. Our next maturity is in 2018, that’s a ways out there. And we make target to lower leverage here. I’m showing that, it’s not today’s issue in my view.
The balance sheet looks good. On the debt side, we’re more interested in our base business and taken some equity off the table.
So in summary, the new car market, I am sure you’ve heard it continues its little steady improvement which is just fine for us. We don’t like big spikes, it tends to disrupt things, but it’s growing 1 million units a year as for the last several years. I think one of our strategic advantages is having a plan, sticking to it and implementing it. We’re taking new car share, we are growing used, we’re investing in technology to go further there. The F&I and Fixed operations are benefiting both from the used and the increase in new. We’re going to be spending in technology. We’ve taken some hit on this, we think it’s the right time. We want – we think we can leapfrog a lot of the others out there. And it’s all about the consumer and you look at our business, it has not been consumer focused at all, it’s been vehicle and process focused. And we think there’s a real opportunity to do something special with the customer.
Capital structure is simplified, feel good about that. So we’ve got the strategy. We’re executing on it and we’re going to stick with it. And I think that’s been one of our strengths is having the discipline to stay on our strategy.
So I kind of zip though that. So we can open it up to any questions if you might have. New seven series in anybody’s future. Five?
Hi, thanks. I know you are not in all the areas of the country but I am curious if you’re seeing any geographical differences in some regions that you’re selling to that are stronger than others? And then, just sort of lastly too, a lot of the automakers reported that sales were encouragingly accelerating as July were on and kind of the exit run rate might have been better. I was wondering if you were encouraged by that trend too?
Okay. Yeah, we’re – we describe ourselves as in the smile belt, heavy on the west coast, although we were frowning for quite a while. California has done well, Southern Cal in particular strong. And it gets a little hard to know what’s the economy and what’s us. Because we had been lagging there and our operations are much better but I think overall that’s doing well. Northern Cal is a little softer but starting to com e on. Texas never waver through the whole during thing, it’s been just rock solid. We’re big in Huston. We’re in a little bit in Florida but more mid not in the southern piece. And that’s doing okay.
Mid-south is pretty strong too. Tennessee, Georgia, they did really didn’t get many hiccups. So we’re pretty good across the board geographically. No real weak areas. Some in self inflected which you always going to get because of our people.
When people say, to your next part of your question, it’s 13.5 million or 14.0 sort of run rate, our guys in the field don’t have a clue. They live weekend-to-weekend, I don’t think they can feel that difference. We’ve not seen any letup in traffic. July was good, we get a daily report and we’re well running which is good. Weekends are particularly strong, we just came off a good weekend. We really don’t see any hiccups. A lot of people have asked me, Jesus, you think the elections are going to mess anything up? I doubt it. I think personally the bulk of the carbine public is a little shell shot and warned out from all the news everyday that we look at. And worry about, they kind of unless it’s massive I don’t think it’s going to disrupt things.
In part, because there’s a lot of pan of demand because of the age of the vehicles I think there’s just coming in and gradually growing. So here it needed to be pretty a big deal before I think it disrupts.
Comes a question there.
Thanks. How hard is it to build an inventory management system for used cars? Did you build it from scratch? And what’s your mix of sources to – source from which you acquire the cars in terms of trade-ins versus auctions?
It is a heck of a lot harder than we thought. Jeff Dyke, our operating guy was one of the people at automation when they first undertook CarMax competitor. So he knows the business extremely well, he is one of the best in the business. He had other prior consumer goods, retails experience.
And we decided to build our own and have people (inaudible). We think that’s the way to go long-term. We think it’s competitive advantage. It’s taken longer than we thought. We’ve got a lot of help from the outside in terms of the nuts and bolts of it. And then certainly with the analytics behind it because there is brain, there is a thinking power behind these things about optimal inventory levels, figuring out where the vehicle should go, one store versus another, you may take a trade at the Toyota store but you know that a trade is better out behind a store and we can – we are not smart enough to keep up with that, how to price it, all those things. It’s the single largest bit of technology investment that we have.
We are – we’ve been perfecting it, we are about ready to go live and push it out and not give people a choice. Ultimately, we’ve got regular on my offices room, maybe there is 10 or 12 young people in there and some of them are former CarMax people and other kinds of folks who appraise vehicles. They will do all the appraising for all 108 stores that we’ve got nationwide. We are doing it for about 20 or 30 stores now. They can do an appraisal in three minutes. In the store, typical store you can find the used car manager in three minutes, right. You could be anywhere.
So that does a huge step forward and we will put the right money in it and not at once. We want to make sure the customer is happy. We are putting the best price we can. That’s what CarMax does. We were also set the pricing to get throughput. The volume didn’t go like that by not pricing properly. You have to know what you are doing. You have to manage the inventory and you need to know how to price it. So it gets horribly long answer, I am sorry. Much more difficult than we thought and I think it’s worth its weight in gold that take the – everybody thinks they are an expert out of the equation.
And you are sourcing mix or where you source –
Sourcing mix, with the volume we are at right now, we are doing a fair bit of auction and a fair bit of trade in. I think trade in is over half of it now and as new cars come in more – as long as you are giving the right appraisal, you can get more and more of those. We want to get like 8 to 9 out of 10, we are probably 5 to 6 today. So there is a lot of room to move there and these guys are sitting that room, I was telling you about buy on auctions around the nation for our stores at the same time.
Got it. One more follow-up. Could you talk a little more specifically about things you are doing to make car buying experience more enjoyable and just long-term, how long it takes for that reputation to really become the –
I don’t know how long it takes. I know it takes long time. I know CarMax lost money for 10 years. I know they have the best brand out there and it’s one of their best assets because they have trust. And think about the reputation of dealers. It’s going to take some time. But we are winning the motor and parts and service business. If you treat people well you take care of, you don’t try to take advantage of them and you are service focused.
Then you can turn people around very quickly. You make them happy especially with such a large purchase. So it’s going to take some time. The main thing we are going to try to do is make it customer focused and time frontally. Not three and half hours. That’s just not going to apply with somebody young person who have texted sibling who is ten feet away and that’s how they are operating. They are not going to go through read the paper. It’s going to have to be simple and we think it’s doable.
Can you talk about the tire initiative. How aggressive you are being – how many stores that’s in and what you are doing differently from the Madison, Pep Boys in?
Oh, on tires.
What we are doing in 10 years is nothing is that complex in our business. The difficult is getting people to do what make sense. So having the inventory merchandizing and pricing is really in selling when they come in. Now when you go into one of our dealerships, odds are 50:50 chance, they got 11 iPad. And you will go around the vehicle with the customer they’re and a quick check on the tires, they can see it and its good, better, best and not just being competitive and fair and goes a long way to securing sales and they are asking for it.
So we have our programs in all our stores. They were growing 20%, 25% because we didn’t have very good base. So it’s really grown up a lot and there is a lot of statistics around if you get a customer comfortable by tires and things like that they will come back for your vehicle. It’s pretty compelling. So it makes money on every front.
Are you hitting on price still?
We are. Yeah, and will show the customer competing prices and we will be close. We may not be dollar for dollar but maybe five, ten bucks. And you are here and I trust you, okay. Service is good, we got Wi-Fi of course and all the other things. And we are going to be competitive on those.
You talked a bit about your investment in technology before. Is that inventory management system the main focus on your spend there or are you looking other areas whether it’s customer relationships at the dealership level or your online presence or is that technology investment pretty much focused on the inventory?
No, it’s everywhere. That’s why I said pretty big number for us. It’s iPads for the service people and about half of stores have that now. Its iPads and phones for the sales force. And the ads are there where we can sell any brand and we probably got 20,000 units and stock new and used at any time. They can sell of that. They can get the customer anything they want of anywhere in the country and we will move it. Just the infrastructure behind at the wireless access points, the connectivity is all there. We’ve got a major data warehouse and data quality initiative underway in order to enable better analysis and just to manage our business with that.
We are doing an in-house CRM as well concurrent with all these. That’s just beginning to get underway. So there, I mean, our business, when I joined – our stores weren’t even on the same underlying system – there were ADP, somewhere ADP, somewhere other systems. So it’s taken awhile to really get into the sentry. We have a lot going on in the IT world. And most of its sketch up and basic for like Wal-Mart and stores like that, you know their inventory, know their pricing every day. So lot of its sketch up but I think we can lead for auto people with this customer experience talking about.
Dave, you guys made a lot of good moves on your mortgages and on your turnover, your headcount. Can you help us compartmentalized, get your head around kind of what are types of savings you are getting there on each of those components?
Yeah. On the mortgages, that’s the easy part and there is a very exclusive piece and then there is a bunch of intangibles that are very real, it’s just difficult to quantify. Our typical rent factor is 9% and we can get a mortgage for 5 or under. So you can just with a simple math four points, 15 million times a lot of stores. So that’s compelling. But the piece you get tougher is you are always freshening. That’s one issue with this business. There is always pressured invests before you recoup your already investments that you have made. A manufacture push around a little bit for new signage and colors, furniture. And when you are making those investments on somebody else’s property it’s tougher.
Because if you do make it and then you want them to roll into the lease you to extent. And then you never get out the damn thing. So we’ve put our foot down and we are not renewing any leases unless we don’t want the property and we are going to stick with that. And plus when you are – when you buy there is an immediate delivering, you put 20% down. There is interest rate savings and then you pay the principle of just like the old dream of owning your American home, right. So we are going to keep after that. That savings is pretty easy. The other one was turnover.
Yeah. Just how much times you wasted you bringing the new employee on training and other stuff?
It’s a staggering amount. I almost incalculable how much it is. 70% was the average for Sonic. For frontline sales people, it’s over 100. And often times it’s the bottom 20% spending continuously. Somebody comes in the business and doesn’t make it or didn’t like it or something happened, something is always going on. And you think about the customer impacts at these things. I mean, if you went into north and somebody treats you poorly, you – it’s you can’t even imagine that, right. It happens all the time. So that needs to go. If you are going to view this as professional organization, hence we are focused on it.
And then just finally obviously cars are getting order but they are getting more sophisticated. Could you give just kind of a trend line in market share in the parts and service fees like who is getting competitive, who is winning, loosing share?
Of our dealers or?
Just in between the dealers, they do with the self shops?
Yeah. Somebody asked me about that earlier today and we’ve done a pretty good job even with the car part (ph) going like this, bringing people back in and some of that frankly was lack of attention. I think by dealers in general. It’s the back end; by the way, it’s the most important part of your business, right? Of course you need to sell in order to generate that. But the money’s made in the back end. A little bit of advertising, attention to the customer, pricing competitively and we actually drop pricing to increase margin. And that sounds counterintuitive but if you’re not selling you’re not getting any margin. You can price it high all day long and not sell.
So we actually brought pricing down, what made sense and then see the volume take off. So I think, all dealers have done a good job there. We’re – very focused on it. We like this part of the used, the reconditioning piece, that’s very good. Warranty has dropped like a rock. It’s down to about 15% of our parts and service business which most people wouldn’t – they would think it’s much, much bigger than that. But it’s not.
So most of it is customer pay and that’s where you develop your relationships, and it happens to be one of our highest margin parts of the business also that customer pay.
David, you’ve done an amazing job with your used vehicle business since the decline in new vehicle sales and I guess that’s a due to a couple of different things right? It’s clearly due to all the great company specific initiatives you’ve taken that you should get credit for. It might also be due to the strong interest in used vehicles. And maybe there’s a school of thought out there too that it could be due in part to the decline interest in new vehicles which is allowed for more space on the lot, for example for used vehicles and maybe too it’s created room for more management focus and attention, right?
So how do you ensure as new vehicle sales, let’s just say they came rip-roaring back which would be an excellent thing for everybody.
Say it goes to $16 million, $16.5 million. How do you keep that focus on used vehicle sales and ensure that you continue to execute very well there?
That is a terrific question. I actually hope it doesn’t jump to $16.5 million. And other people probably shit me for that. But it would be disrupted for us. The toughest part in our business is keeping people focused. You can give them the processes, give them the tools, give them the training but they will tend to wonder over time. And we’ve got a find a way to manage and lead them to keep doing the right thing.
It blows my mind there are people that, if I do this I will get this outcome. And they see it, make the connection and now are making more money in that stuff doing it. It just – you just want to cry sometimes. So you really do need to keep on them a lot, needed to keep reinforcing, keep training them, encouraging them and keep focused. And we have a limited ability to manage numerous different things in our business and that’s why we keep it very – as simple as we can and that’s one of the reason we want to do some of these technology so they don’t have to worry about some of these very important decisions and they can just worry about selling. Because, they do know how to do that. But some of the processes that lead to an effective sell sometime slip. And so we want to centralize those to the extend we can.
How do you think the volatility in Gasoline price is affecting new customer behavior?
Yeah, the Americans are tough. They want to be clean and green and they want to at a 150 miles an hour at the same time. I’ve seen it for years and years and years prices were hard once and then we couldn’t give them away.
I think if gas moves slowly up or down I don’t think it makes a lot of difference. I think customers get accustomed to it, if gas spikes, it’s a problem. And we saw at – especially when there’s shortages customers can get use to paying higher price, but if it’s not there, look out. We are big in catalog, and when there were shortages and prices spike, we couldn’t give them away and you really get hurt.
I think longer-term, things are going to change. I mean, diesels are going to be here. Americans have not liked them in luxury cars, Europeans love them, you can’t tell the difference, you can’t hear own, there’s no funny buttons you need to push like the old days. It run very, very well, turbo diesels.
It’s just a matter of time in getting us acclimated toward here. It’s going to happen. The 40 mile an hour – 40 mile per gallon vehicles are doing very well. So it’s a slow shift and I think it will continue. But I think we are okay unless gas prices really spike.
Unidentified Company Representative
About out of time. Really appreciate it. David Cosper for sonicautomotive.com, we’ll put you in incur you want any time. This should be a note I’m a car guy too. Thank you.