Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Scott Smith - President, CSO

Dave Cosper - Vice Chairman, CFO

Jim Evans - COO

Jeff Dyke - COO

Greg Young - VP, Finance

Analysts

Rick Nelson - Stephens

Rich Kwas - Wachovia

Matthew Fassler - Goldman Sachs

Colin Langan - UBS

Scott Stember - Sidoti & Company

Sonic Automotive Inc. (SAH) Q2 2008 Earnings Call Transcript July 29, 2008 11:00 AM ET

Operator

Good morning, and welcome to the Sonic Automotive second quarter 2008 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) As a reminder, ladies and gentlemen, this call is being recorded today, Tuesday, July 29, 2008. Presentation materials, which management will be reviewing on the conference call can be accessed on the Company's website at www.sonicautomotive.com. Click on the For Investors tab and choose Webcasts and Presentations on the right side of your monitor.

At this time, I would like to refer to the Safe Harbor statement under Private Securities Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information or expectations about the Company's products or market, or otherwise make statements about the future. Such statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made.

These risks and uncertainties are detailed in the Company's filings with the Securities & Exchange Commission. Thank you.

I would now like to introduce Scott Smith, President and Chief Strategic Officer of Sonic Automotive. You may begin your conference.

Scott Smith

Thank you, Cynthia. Good morning, ladies and gentlemen, and fellow shareholders. I am Scott Smith, President and Chief Strategic Officer. Welcome to Sonic Automotive's second quarter 2008 conference call. Joining me on the call today are the Company's Vice Chairman and Chief Financial Officer, Dave Cosper, our Divisional Chief Operating Officers, Jeff Dyke and Jim Evans, Rachel Richards, our Vice President of Retail Strategy, and Greg Young, our Vice President of Finance.

I will provide some color on the quarter and then turn the call over to Dave, and we will take a deeper dive into the numbers, then we will wrap up the call, and open it up for you questions. If you will please turn to Slide number one, Building for the Long Term. Despite a difficult economic environment, I am pleased our team delivered another great quarter. We outperformed the industry in both new and used volume, managed to expand our customer pay parts and service revenue, and increased our F&I per unit.

Bottom line, we made money, and we generated cash. Culturally, we talk about 75% sales, and 25% expense control. We are constantly taking costs out, and we are not focused on cutting expenses to make a quarterly number. We believe that nothing happens until we sell a car, and first and foremost that we are a sales organization. With that said, we have plans in place to reduce advertising and service loaner expense. Our overall store-level personnel costs are in-line, and I am pleased with our productivity levels.

As many of you have heard, we have restructured our regional teams. The purpose of this regional realignment was to enable us to react quicker to the needs of the front line, and to eliminate inefficiencies and duplications. As I stated in the past, we are in the people business, and our people are our most valuable assets.

Virtually all of our associates affected by the reorganization took open variable comp positions within our dealerships. Only five associates decided to move on to other opportunities. We remain committed to our long-term strategies that include associate training, e-commerce, enhanced customer experience, focus on higher margin segments of our business, sound spending principals, portfolio enrichment, and growing our business.

Next slide, please. By now, I am sure that this slide looks familiar to most of you. We feel it is important to update you on the progress we have made on our strategic initiatives, and to emphasize our commitment to the future. There is no doubt that 2008 is going to be a tough year, not only for the automotive industry, but for the country.

We laid out our strategic focus at the beginning of the year, and plan to stick to it, and invest in these areas. Keep in mind that Sonic Automotive is a very young company, particularly when compared to others listed in the Fortune 300. For us to abandon our plans due to a tough year would be short-sighted, and I hope that you all expect more from us. We are building for the long term.

During the second quarter, we continued forward with our company-wide training initiatives. We continued to see excellent results. First, in the two markets that we focused our initial stages of training, we have seen a 97% associate retention rate. Second, we have roughly doubled spending on training, to have approximately four times as many training hours as last year, so the program is proving to be highly efficient, and also building a stronger and more stable group of associates. We will continue to invest in our people.

This past quarter we executed on the first phase of our two-year e-commerce strategy. Our specific actions include launching an all new customer centric websites, which are now aligned with the automotive manufacture brands, and optimize customer search via major search portals, MSN, Yahoo!, and Google, and we increased our online advertising. These actions alone have driven year-over-year internet traffic increases to our dealership of over 17%.

In May, we began the launch of a customer experience initiative called the Sonic Edge. The Edge includes the offering of differentiated products and services to our customers, which is an exclusive offer from our dealerships. This initiative is still new. However, we are obtaining and expect to continue to see improvement in our gross margin, increased revenues, and an increase in customer loyalty from this very exciting initiative.

At this point, we do not expect very much along the line of acquisition activity. Multiples are too high, and are not in-line with economic reality at this time. We believe the recent downturn will provide buying opportunities in the future, and we plan on growing and investing where it makes sense. Right now, our best investment is in our infrastructure, our people, and buying our own property, moving from leasing to owning. These moves will shore up the foundation for years to come.

I would now like to turn the call over to Dave Cosper. Dave?

Dave Cosper

Thank you, Scott and good morning, everyone. It clearly was a challenging quarter for the automotive industry, but as Scott indicated, overall we are pleased with our performance, and there are several bright spots. Total revenue for the quarter was just under 2 billion, down slightly from last year.

Gross profit was down only 3 million, and gross margin was actually up 10 basis points to 15.7%. For as tough as the quarter was, I was pleased to see an operating profit margin of 3%, which is reasonably strong.

EPS from continuing operations was $0.49, excluding the $2 million hail loss we suffered. EPS for the quarter was $0.52, down 16% from last year.

Please turn to the next slide. There is a substantial loss in discontinued operations that I would like to talk about. First, it is important to note that nearly two-thirds of the loss is non-cash, primarily asset impairments and loss on disposal, nearly 60% of this loss relates to termination of a Cadillac franchise in California. We plan to use the location to build a new state-of-the-art facility for our Beverly Hills BMW store. Basically consolidating 11 leased facilities today into 1, and we are to have substantially more service bays along it with.

The next largest piece relates to loss on sale of our Chrysler, Dodge, and Jeep franchises in Ohio. This transaction actually generated substantial cash for us, as it included the sale of land that we owned in the area, and we recovered our full investment on this.

In total, we have 12 operations remaining in discontinued operations, and hope to sell them shortly for over 30 million in cash.

Next slide, please. This slide shows the strong correlation between consumer confidence and auto sales. Increasing gas prices, housing lows, and general economic uncertainty, drove down consumer confidence, resulting in massive changes in vehicle demand, and buying preferences almost overnight.

As you can see from the graph, truck sales were off 28% in the month of June, and were down 23% for the quarter. This shift was abrupt, it took most manufacturers and dealers off-guard. The shift in demand to new cars and even used cars, was muted somewhat by limited supply.

Next slide, please. We ended the quarter with a 60-day supply of new vehicles, a few days better than the industry as a whole. As you can see our domestic brands are in pretty good shape, while our import stores are in-line with the industry. Our luxury inventory is a bit high, with the majority of the increase driven by a slow down in sales from Cadillac, Land Rover, and Lexus, and we are working through these issues.

In terms of car and truck mix, 48% of our new vehicle inventory is car, and 52% is light truck, with crossovers making up the largest piece of the truck. We are very pleased with the way our team has managed used inventory. We ended June with a 30-day supply of used vehicles. Additionally, only 36% of the inventory was SUVs, which we feel great about, considering how many SUVs we took in on trade, we bought them right and sold them quickly.

Next slide, please. Obviously high supply and weak demand lead to margin compression. And this slide shows how our margins were impacted in the quarter. I think we did a good job in maintaining our new vehicle margins. They were actually up 10 basis points from both the first quarter and last year. However, with a very high industry-day supply of new trucks, and a shortage of hot-selling vehicles, especially cars, we feel new margins will continue to be under pressure.

I would like point out that in California, new-car margins were actually up 30 basis points, and were flat in Florida. On used vehicles, we had an 80 basis point decline in margin, and we see three main factors accounting for this. First, we had fewer trades coming in, and had to go more to auctions to purchase vehicles, and the margin on these vehicles are typically not as good as on our trades.

Second, over 40% of our used retail sales were CPO, and although these vehicles have great dollar grosses, they tend to have lower percentage margins than non-CPO vehicles, and finally, truck and SUV prices plunged, and we gave up some margin to move these vehicles. We feel this was very prudent, and have seen used margins improve somewhat in July.

Our fixed ops bip margin was 50%, it was up 30 basis points from the first quarter, but down 80 basis points from last year. And I will talk more about this in a few moments.

Next slide, please. This slide shows our same-store sales performance, excluding wholesale, overall same-store revenue declined 7.2% for the quarter. Total new revenue was down 11.7%, and we were impacted most by a decline in light truck sales, which were off 23%, similar to the industry.

Sales were soft in California, and accounted for nearly half of our retail volume decline. We continue to perform well with used vehicle, same-store used revenue was up 2.7% from last year, more than accounted for by a 4.3% increase in volume. Same-store CPO unit volume was up 24%, and CPO volume reached over 40% of our retail used volume.

Note that wholesale revenue is down nearly 19%. We continue to work on keeping our trades, and selling them at a profit. Same-store F&I revenue was down 2.1% for the quarter. The decline was driven by lower new retail volume as F&I per unit was actually up $27, or 2.7% from last year.

Fixed ops revenue was down 0.8 of a point, driven primarily by lower warranty. Customer pay revenue was up 0.4 point, and same-store body shop revenue expanded as well.

Please turn to the next slide. This slide shows our sales performance versus the industry. And frankly, we are pretty strong both in new, used, and CPO sales. As you can see, sharp increases in used and CPO are helping mitigate the soft demand for new vehicles.

Certified pre-owned sales were up nearly 24%, with a 39% increase at our luxury dealerships. BMW CPO sales were up 47%, and Mercedes CPO sales were up over 37%. For the quarter, our used to new ratio increased to 0.59 from 0.52 a year ago, and given the decline in new sales volume, we expected this ratio to increase, but it is still extremely pleasing to see how this segment of the business is performing. Managing our inventory over the next few months will be key to ensuring this trend continues.

Next slide. Same-store fixed operations revenue was down 0.8 of a point as I mentioned. As you can see we expanded overall customer pay modestly, warranty though, particularly Mercedes, continues to be soft. And frankly, our overall customer pay revenue was not in-line with our expectations. Our Quick Lube business was very strong, up 34%, but our traditional customer pay levels were off, particularly in our domestic brands.

Additionally, our Las Vegas platform was off substantially more than we had anticipated, as economic conditions in that region continue to be challenging. On a positive note, our BMW and Lexus stores were up a combined 6.3% in customer pay revenue, fully in-line with our expectations.

Fixed operations gross profit was down 2.2% for the quarter, reflecting lower sales, and an 80 basis point margin decline from last year. The margin decline reflects sales increases in lower-margin businesses, such as Quick Lube and tires, and we are also seeing customers putting off major repairs, and resisting some up-selling. As Scott mentioned, our fixed-operations team is redoubling its efforts on the basics to ensure ongoing growth.

Next slide, please. SG&A expense as a percentage of growth was 77.9% for the quarter, down 130 basis points from the first quarter, but up 380 basis points from last year. Excluding the hail damage in Texas, SG&A would have been 77.2%, up 310 basis points from last year.

On a same-store basis, SG&A costs were actually down over $3 million for the quarter, including a reduction in absolute dollar expense for personnel of over $4 million.

We believe our stores are modeled well, but the sudden decline in volume did take some time to catch up with. We continue to focus on all costs throughout the organization, and we do see immediate opportunities in advertising and service loaners. We estimate these savings to be around $10 million to $13 million on an annualized basis. As Scott stated, we realigned our regional structure and will realize an immediate benefit from this going forward.

Moving to the next slide. We ended the quarter with a debt to capital ratio of 45.2%, down 1.1 points from the first quarter. Excluding mortgages, our debt to cap was 39.2%. With the closing of a large property in August, we will have mortgages totaling $103 million. I feel we have made great progress on this front in owning our key properties, and are targeting to be close to 130 million of mortgages by year end, which is roughly 10% of our entire land and property that we have in total.

In addition, we are taking active steps to ensure liquidity. To date, we have deferred or thrifted more than 30 million of capital spending for 2008, further we cut back our stock repurchases in the second quarter to just under $4 million, which is actually below the nearly $5 million of cash, we realized from people exercising stock options.

Presently, we don't have any new acquisition targets identified, and we are seeking fair pricing on our dispositions, to facilitate sales and generate cash. We have developed two alternatives to refinance our 130 million of convertible notes due next May.

First, using our revolver, if the credit card markets are difficult, and second, using the public market, should an attractive window open. We are in compliance with all of our debt covenants. I feel very good about how we have managed our cash and our balance sheet.

Next slide, please. Before I hand the call back to Scott, I want to talk about our revised guidance. For a perspective, looking back on things, our initial guidance for 2008 was fairly aggressive. The average of our original guidance range for '08 was $2.43, essentially flat with the 2.45 we earned in 2007. We assumed that reductions in new volume, and cost for new initiatives would be offset by growth in new and fixed-operations.

At the time of the first quarter call, we were beginning to see a more stable atmosphere in California and Florida, and our assumption of a stronger second half still seemed likely, but of course things changed.

In May, the improvements we were beginning to see in the first few months of the year, dissipated as cash prices rose, and housing prices fell. The plunge in consumer confidence, coupled with the switch from trucks to small vehicles also took a toll. Further, the luxury buyer who until recently had been insulated from the overall economic downturn began to pull back on major spending.

So what are we assuming now? Well, first, we have lowered our new-volume expectations. The improved industry situation that we had believed for the second half of the year is not going to happen. Further, we believe new margins will remain difficult.

We have increased our used volume projection a bit from original guidance, but as you can see the biggest change is in our fixed operations. Originally, we had assumed growth at a rate very similar, or just slightly under what we saw in 2006 and 2007, but we aren't seeing it at the moment. Concurrent with this, fixed operations margins are soft. Taken all together, we have revised our 2008 guidance to $1.65 to $1.85.

With that I will turn the call back over to Scott.

Scott Smith

Thanks, Dave. While this year is turning out to be rather difficult, our strategy is sound, and we are making money. We are focused in the right areas and disciplined cost control is a must. We are building a company with a solid foundation for future growth. I am confident that we are making much better decisions for the long term, and have adopted sound investment principles.

We are investing where we make money. We are sticking to our strategy, we are allocating capital carefully. We want to own our own land and facilities, and we are using good judgment. With that said, our dividend will remain unchanged at $0.12 per share payable on October 15th, 2008, for shareholders of record as of September 15, 2008.

Before we take questions, I always want to thank our Sonic associates. Their continued hard work and dedication are greatly appreciated. Once again they delivered in a very tough environment, and I thank you team. Finally, I want to thank our manufacturer partners for their support.

At this time, we will open the call and take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Rick Nelson with Stephens.

Rick Nelson - Stephens

Thank you. Can you address areas of regional, areas of strength and weakness, I guess, specifically California, and Florida, and maybe other parts of the country that might be performing well?

Jim Evans

Yes, Rick, this is Jim Evans. We will talk briefly about California, as not unlike the last 12 months, the California challenge is a new-car dynamic primarily. New vehicle car and truck registrations for June were down 19.7%. On a year-to-date basis, 18.3. On the positive side, we have seen margin stability in Northern Southern California. Our used car volume is up 3% for the second quarter. Our fixed operation is down around 2%, with good customer pay growth of plus 3%, and solid F&I performance at 5% up. So, it remains a new car dynamic, as it has for the past 12 months, and we continue to outperform on a new-car basis versus what the registrations indicate statewide.

Rick Nelson - Stephens

And any comments on Florida?

Jeff Dyke

Yes, Rick, this is Jeff Dyke. Florida is the same as what Jim just said. The Florida market has been tough for us over the last few quarters. It continues to be tough, it is stabilizing on a margin basis. Our used vehicle business there is good, our F&I business there is good. We have got a heavier mix of Cadillac in that market, which has put a little bit of pressure on us, but other than that the last couple of quarters have been the same. And in Texas our business there continues to be very strong, so it has really been a good market for us across the board, and across all of the brands.

Rick Nelson - Stephens

Okay. Thank you for that. How about Chrysler's decision on leasing, I realize you don't have many Chrysler dealerships, but how do you see that affecting performance in those stores, and have some of the other domestics adopted similar programs?

Dave Cosper

Yes, Rick. This is Dave. Probably our largest Chrysler stores is down in Texas, and we were looking at that just before the call, and I think they are at, 2% of their volume is related to leasing, which is really low, and that is good for us. We did dispose of three Chrysler franchises during the quarter. So, this isn't really going to have any impact on us at all.

I wouldn't want to speculate on what GMAC and Ford might do, they are in completely different situations. Clearly leasing is a popular way, certainly on the luxury side, the bulk of our luxury is BMW and Mercedes, and they are financially strong. So, I really wouldn't want to comment on what those other guys might do.

Rick Nelson - Stephens

Okay. Where do you see as the place to be here within the market? Is it going to be luxury or high volume imports?

Scott Smith

Well, I think we are positioned well with both of those. I don't see us changing our strategy. We have given that a lot of thought. I think we are poised well, and some of the luxury, of course, with BMW, with Mini there, and the One series, and the C class with Mercedes, I think they are going to do well. I think once things stabilize. I think we are going to be just poised fine. Of course, we have a got a lot of Toyota and Honda as well. So we are diversified well and have our bases covered I feel. And where we do have domestic, they perform reasonably well.

Rick Nelson - Stephens

I just wanted to follow-up on service and parts. Do you see any evidence that people are postponing these services, or are they trading down, and shopping less expensive alternatives than the dealers?

Jim Evans

Well, Rick, we are seeing a pullback in heavy repairs. That's a trend we are seeing across the board as far as our owned fixed-operations performance, it is heavily localized in patches and different regions of Florida, the Carolinas, Las Vegas, and Oklahoma, represent the majority of that shortfall. And we are addressing that internally very aggressively over the next two quarters.

Rick Nelson - Stephens

Okay. And what sort of strategies do you have there for…?

Jeff Dyke

Actually, Rick, this is Jeff Dyke. We are sticking with our strategy. We have done a great job in fixed operations over the last couple of years, and between the mix in those markets, where we got a heavier focus or heavier brand mix of Cadillac and General Motors. We have got our fixed operations teams focused on those guys to help drive revenue in the services drives, and other than that sticking with our strategy and focusing on what we do really well is what we will stay focused on.

Rick Nelson - Stephens

Thank you and good luck.

Scott Smith

Thanks, Rick.

Operator

Your next question comes from Rich Kwas with Wachovia.

Rich Kwas - Wachovia

Hi, good morning.

Dave Cosper

Hi, Rich.

Rich Kwas - Wachovia

How are you doing Dave?

Dave Cosper

Good.

Rich Kwas - Wachovia

Jeff or Jim, could you comment on the used-vehicle trade desking that I think was getting implemented in the Southeast this year, and what the progress has been on that?

Jeff Dyke

You bet, certainly playing a role in our overall business, and it is underway in Alabama, Tennessee, and Georgia. Texas was rolled out about three or four weeks ago, so they are coming up online, and prior to the end of the year, we will certainly roll out more regions, our next regions will be the Florida, North Carolina, and South Carolina markets. And obviously that is helping in our results. In particular keeping our inventory, less wholesale loss, and making sure that we get the right product to the right stores. So that is certainly playing a role in our business.

Rich Kwas - Wachovia

What is the truck mix of the inventory right now? I know it turns pretty quickly, but what did you have at the end of the quarter?

Jeff Dyke

It's 41% light truck, and 59% car.

Rich Kwas - Wachovia

Okay. And then on parts and service, it looks like you are looking for similar trends in the back half of the year versus the first half. It seems like you are saying that business is not going to get any worse. Is that a fair conclusion to come to, or how are you seeing that?

Dave Cosper

I think that is right. That is a fair conclusion. And we are not projecting any huge upside there either. I mean, it would be nice if we could perform better than that given the actions that Jeff was talking about.

Rich Kwas - Wachovia

What do you kind of view as the risks of that in the second half of the year on the part of service run? Is it regional, or just the slowdown broadens it a out a little bit, I mean, what are you thinking about in terms of risk?

Dave Cosper

Well, I am not seeing a lot of risk on that. It is more volatility in the marketplace for new and used, strike me as bigger risks.

Jeff Dyke

Yes, there may be some risk. Rich, in terms of Cadillac and some isolated pockets, but again as I said a few minutes ago, we are all over that, and working on the service drives to drive revenue there, so other than that I don't see any major risk in the numbers.

Rich Kwas - Wachovia

Finally, I know you are assuming a 14.5 [SAAR] for the year, that kind of implies the second half doesn't really get materially worse. What is kind of the earning sensitivity that we should think about if we go to 14 million for the year, or below 14 million for the year?

Dave Cosper

Yes, I think our guidance when we developed it, probably covered a 14.2 to 14.5 kind of range. So, I don't think there is going to be much wiggling there.

Rich Kwas - Wachovia

Okay. So, it sounds like you factored in a little bit worse than the 14.5 for the year…?

Dave Cosper

Yes.

Rich Kwas - Wachovia

Okay. Thank you.

Operator

Your next question comes from Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs

Good morning.

Dave Cosper

Good morning.

Matthew Fassler - Goldman Sachs

Can you talk on the expense front, two items, the first is the speed with which you expect that $10 million to $13 million in savings to kick in. I know you said $10 million to $13 million annualized, should we expect that the full run rate will be in place in the second half of the year, in the third quarter, I should say? And then, somewhat related to that, I realize that there are some long-term initiatives that you have got. At the same time the environment has changed substantially. The earnings fell far short of your initial expectations. Are you considering pulling back on some of those discretionary items?

Dave Cosper

Yes, to the first one, it is immediate, and half of that run rate annualized run rate will hit in the second half, which is good. As well as the restructuring, and a whole series of other things that we are working on, and not talking about publicly, but we are always looking at costs at we are probably ramping up it a little bit more than we would have otherwise.

On the second, we did consider it, and we are not changing our plan on that, and that is kind of what Scott was talking about. We are seeing very good results from it, think it is the right thing to do. The culture of the business is changing. I think it is a game changer for Sonic over time. So, we had a lot of discussion with that internally with the Board, and we are choosing to stick with that as a valuable investment for us.

Matthew Fassler - Goldman Sachs

And what is the magnitude of the dollars that we are talking about there?

Dave Cosper

Training is going to be up $3 million to $3.5 million for the full year. A lot of that was front-end loaded anyway with the development costs for this. We may dial back a little bit, and save 200,000 to 300,000 in the back half of the year from the original plan, but it is really not a change in the intent of the program.

Matthew Fassler - Goldman Sachs

So, the changes that you are making in loaners and advertising, are going to be 3 to 4 times the training increase in annual?

Dave Cosper

It would be, yes, on an annual run rate.

Matthew Fassler - Goldman Sachs

Okay. And then, second or third, I guess, you might have alluded to this a bit, if you could just talk about your new vehicle gross margin experience differentiating cars versus trucks?

Dave Cosper

Yes. On same-store basis, car was up, in total we were up 10 basis points versus a year ago, car was up 20 basis points, and truck was down 40 to 50 basis points.

Matthew Fassler - Goldman Sachs

And as you think about the fact, the change in the environment really was a change in May, probably later in May if you paralleled other experience. Just trying to get a sense you said a couple of things about July that were, I guess a bit encouraging about trends relative to the end of the second quarter. Should we think about the second half as fully baking in, sort of those very tough trends that you saw in the five, six weeks of the quarter, or would it be somewhat more moderate than that?

Dave Cosper

June in particular was very difficult for us on what we saw, and I would say it is probably an average of the quarter going forward. I think we are a little bit better than the last two, three weeks of the quarter, but do you guys agree with that?

Scott Smith

100%. I think that you will see margins stabilizing as we move forward, as inventory gets right-sized throughout all of the different brands.

Matthew Fassler - Goldman Sachs

Got you. Thank you so much.

Operator

Your next question comes from John Murphy with Merrill Lynch.

John Murphy - Merrill Lynch

Good morning, guys.

Dave Cosper

Hi.

Scott Smith

Good morning.

John Murphy - Merrill Lynch

I apologize gentlemen got on the call just a little bit late, but as I was getting on, I think Dave you were talking about consolidating facilities in California, and it sounded like it was pretty impressive as 11 going to 1 is what I thought I heard.

Dave Cosper

Yes. Yes. That was part of the discussion on disc ops. We look a charge as we closed a Cadillac dealership there, and we will be relocating Beverly Hills BMW, which is a highly fragmented operation, and very difficult to run, lot of extra costs, and we are putting up a new facility where this Cadillac dealership was. And it will be a much more efficient state-of-the-art, with much expanded service capability and easier to run.

John Murphy - Merrill Lynch

Basically you are moving the BMW location to where you had the Caddy location?

Dave Cosper

Correct.

John Murphy - Merrill Lynch

Okay. Are there other opportunities for that in the portfolio as you step forward?

Scott Smith

Boy, I don't see, no. I mean, we take them as they come. For instance, Mountain States Toyota, we are near the end of a lease term. We are building a new facility very close by. It will be state-of-the-art, and we leave a lease tail behind, and own the store.

John Murphy - Merrill Lynch

Okay. And just on that ownership of real estate as you move forward here. I mean, how are the real estate values that you are purchasing? I mean you are swapping out these operating leases into the real estate purchases, are you finding that they are what you expected them to be, or are you getting better deals now that real estate has come down quite a bit?

Dave Cosper

I think it is kind of mixed bag. Yes, it is situation specific. If we go to buyout a leased property that we own, it is sort of driven by the lease payment that we are making. Although, we are looking through some sites on a luxury store here, and we are starting to see some favorables, especially in Florida, some favorable pricing there.

John Murphy - Merrill Lynch

And you mentioned that would be 130 million by the end of the year, how far along in the process are we at that point?

Dave Cosper

Hard to know. I think we are going to keep at it. I think we will always have 30% to 40%, something like that leased. We won't be able to get them, especially on the West Coast.

John Murphy - Merrill Lynch

Okay. But as a percent of your total real estate, what portion?

Dave Cosper

We will be at 10% at year end, and maybe, we haven't set a firm target on that, but I could see it approaching 40% over time, and I am skipping ahead four or five years.

John Murphy - Merrill Lynch

Okay. Great. Thank you very much.

Operator

Your next question comes from Colin Langan with UBS.

Colin Langan - UBS

Great. Thanks for taking my question.

Dave Cosper

Hi, Colin.

Colin Langan - UBS

You commented on how you are going to refinance the convert. How much do you currently have available on the revolver, it seems like it might be getting a little tight going through the rest of the year?

Dave Cosper

It is $111 million as of June 30, and we have got some mortgages we are going to close on a $26 million mortgage here within the next couple of weeks, and a couple of other sale/leaseback activities that are going to provide some additional cash. So, there is some room to navigate in there, but I mean, we are planning it, and we have got two alternatives, as I mentioned to refinance that.

Colin Langan - UBS

And if you were to refinance the debt markets, do you have any idea what kind of rate you would have, it is even available right now for…?

Scott Smith

Everything is available at a price. I don't really find it all that attractive right now. The financial markets are in a tizzy, so I am not real keen to go out and refinance at a rate of in excess of 10%. And that is where they are.

Colin Langan - UBS

Okay.

Scott Smith

Windows come and go, and at the moment the capital markets are tough.

Colin Langan - UBS

Yes. Are you counting on, what did you say, 12 dealerships left that you are looking to divest?

Scott Smith

Yes.

Colin Langan - UBS

Was it 30 million in cash, how much are you expecting to raise in terms of cash in the second half of the year from selling those?

Dave Cosper

I said 30 for the total of all of those dealerships. I think we are going to close on and maybe three, that are very active right now. And there is probably 15 million, something like that.

Colin Langan - UBS

Okay. And how many did you start the year with that you were looking to divest?

Dave Cosper

We have closed on six deals so far this year.

Colin Langan - UBS

And you also shut down some dealerships too?

Dave Cosper

Yes and the Cadillac is in that six.

Colin Langan - UBS

Okay.

Dave Cosper

So, we didn't really get any money for that, but it is going to be a great investment play for us, versus what we have today with the BMW store there.

Colin Langan - UBS

And switching to SG&A, I was little surprised that you have sort of commented on it, maybe I missed at it little bit. I know personnel was actually up, advertising was up, and other was up rather significantly when you look at year-over-year, sales were down and gross product was slightly down, what was really driving that? Were there one-time items in there? I know the hail was a small factor.

Dave Cosper

Yes. Actually in the commentary I pointed out that on a same-store basis they were down 3 million. And what you will see is we did acquire several stores about this time last year. It is a fairly big store, so of that $10 million increase, close to $3.5 million is associated with the new stores. Then you got the hail that is worth $2 million. Some legal costs in there. Some of the service loaner we were talking about. And delivery expense is up, reflecting some of the gas price increases, and we are addressing that as well.

Colin Langan - UBS

How much would you say of your SG&A is fixed versus variable, because I would have expected it to come down a little bit, just the sales came down or…?

Dave Cosper

That is why I was pointing out on a same-store basis our personnel costs were actually down $4 million. It gets a little confusing looking at it year-to-year, when you have got new stores being added, and that is why I was pointing out that our stores are modeled well, because our personnel costs even on a dollar basis, and a percent basis were down on a same-store basis. We typically don't report those publicly, but I felt I wanted to for this very reason.

Colin Langan - UBS

Okay. And you mentioned the hail, is there a reason that is not pulled out as a special one-time item. Are you going to go to reimbursement or insurance for those in the future?

Dave Cosper

No, we are not going to be reimbursed. It happens frequently, and there is certain guidance about what you can call as a one-time thing. It clearly happened, because we suffered the loss and we are talking about it, but you can't really pull it out. I guess if it were 5 times that size we could, but we broke it out on that one page, so you can see it is 70 basis points of cost in our SG&A.

Colin Langan - UBS

All right. And then lastly, you commented that you would expect margins to sort of trend at similar levels going forward. Was that referring to, I know the last couple weeks of the quarter was actually pretty tough, or was that referring to the entire Q2 level?

Dave Cosper

More Q2 level.

Colin Langan - UBS

Okay. So, the second half you should see a little bit of a rebound from the last couple of weeks of Q2, sort of?

Scott Smith

Well, I think so. Yes. In fact, we have seen some of that in used already. In new we were kind of flat or up slightly from year ago, especially on the hot margin cars is an offset to some of the low-margin trucks.

Colin Langan - UBS

Okay. All right. Thank you very much for taking my questions.

Scott Smith

Sure, Colin.

Operator

(Operator Instructions) Your next question comes from Scott Stember with Sidoti & Company.

Scott Stember - Sidoti & Company

Good morning.

Dave Cosper

Hi, Scott.

Scott Stember - Sidoti & Company

Could you talk about the new side of the gross margins? You gave some of the breakout between trucks and cars, and your gross margin in that segment was actually up 10 basis points. Was there anything else in there that would lead to that kind of an increase in this tough environment?

Jeff Dyke

No. This is Jeff Dyke. Actually, it is just managing the inventory, and it has to do with the mix of cars and our brand mix. We have seen stabilization in our new car margins in California and Florida, which are certainly helping out. And our avenue PUR on the new car side over the last 15 months, in the month of June really stabilized. We actually had an uptick in our overall gross so on a PUR basis. So, nothing that sticks out there as being abnormal.

Scott Stember - Sidoti & Company

All right. I am not sure if you mentioned this already, but going to the parts and service, could you maybe just drill down on some of the areas that you want to attack to stimulate demand?

Jeff Dyke

Sure, this is Jeff Dyke again. Really, and we said it earlier, it is just a focus on a few key areas. In the Vegas market, Oklahoma, and then the Florida, North Carolina, South Carolina markets where we have got a bigger presence of General Motors vehicles including Cadillac. And that is where you will see us putting most of our efforts, it is what is creating a larger percentage of the decline, versus the forecasts that we had for the quarter.

Scott Stember - Sidoti & Company

So, as you said earlier, a lot of the weakness that you are seeing is in the domestic stores?

Jeff Dyke

Yes.

Scott Stember - Sidoti & Company

Okay. And just real quick on the employee retention, you gave a statistic that some of your efforts are being rewarded. You had a 97% employee retention. Do you have some benchmark versus last year where we were at this point?

Dave Cosper

We are not looking to really get in to start sharing all of that. I can tell you that it was an all-time ever low in total company turnover. And the investment that we are making in our associates we believe is really a long-term strategic initiative that we have, and have the complete support of the Board.

And again, we have doubled our spend for 2008 over 2007. That is in the SG&A, and the feedback that we are getting from the associates is tremendous. I mean, it's not just lip service when we talk about our people being our greatest assets, and I think Roger has demonstrated in his performance, they have got great turnover numbers, and they are performing relatively well. So again, we are investing in our people, and plan on continuing to do so.

Scott Smith

And to add to that, our CSI scores are also at an all-time high. So, your low turnover, high CSI scores, so that investment, certainly is paying off.

Dave Cosper

It is fewer people making more money. Our efficiency rates are pretty outstanding right now.

Scott Stember - Sidoti & Company

Okay. Thank you.

Operator

Your final question today is a follow-up question from Rich Kwas with Wachovia.

Rich Kwas - Wachovia

Just two quick questions. On the disc ops, you mentioned that you expect to get 30 million in proceeds. Is that before year end? Is that the idea?

Dave Cosper

Probably. I would like it all, but we are targeting roughly half of that.

Rich Kwas - Wachovia

And then, you have converts obviously and one is coming due next year, as you mentioned. With the change in FASB rules, how should we think about the potential impact on next year's earnings, knowing that you are going to have at least one convert outstanding during next year. Have you been able to quantify the impact on interest expense?

Greg Young

Yes, Rich, this is Greg. We are working through that. Those rules go into effect on January 1, and we will start to give some more guidance as we get later in to the year on the valuation of the hedging around the convert, that will still be ongoing after we refinance the other one.

Rich Kwas - Wachovia

Okay. It is fair to say, though, that interest expense should go up?

Greg Young

Yes.

Rich Kwas - Wachovia

Okay.

Greg Young

Yes, it will run through interest expense

Dave Cosper

Because it is 4.25 note, and at the time it was issued, unsecured were probably 8.5 to 9, so it is a 5 point difference times the value.

Rich Kwas - Wachovia

Okay. Great. That is kind of roughly how we should think about it then?

Greg Young

Yes, at this point. We will give you some more guidance as we get out later in the year.

Rich Kwas - Wachovia

Okay. Great. Thanks so much.

Operator

At this time, there are no further questions. I would like to turn the call back over to management for closing remarks.

Scott Smith

Great. Well, I would just like to thank all of our shareholders and associates for participating on the call today. Thank you.

Dave Cosper

Thank you.

Operator

Ladies and gentlemen, this concludes today's Sonic Automotive second quarter 2008 earnings conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Sonic Automotive Inc., Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts