Sonic Automotive, Inc.
Q3 2008 Earnings Call Transcript

Published: 4 Nov 2008

[Operator:]

Welcome to the Sonic Automotive third 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) As a reminder ladies and gentlemen this call is being recorded today Tuesday, October 28th, 2008. 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 For Investors tab and choosing webcast and presentations on the left side of the monitor. 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, 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. I would now like to introduce Mr. Scott Smith, President and Chief Strategic Officer of Sonic Automotive.

[B. Scott Smith:]

I’m Scott Smith, Co-Founder, President and Chief Strategic Officer of Sonic Automotive. Welcome to Sonic Automotive’s third quarter 2008 conference call. Joining me on the call today are the company’s Vice Chairman and Chief Financial Officer, Mr. Dave Cosper; our Executive Vice President of Operations, Jeff Dyke; Rachel Richards, our Vice President of Retail Strategy; and Greg Young, our Vice President of Finance. If you’ll please turn to our first slide, Sonic Automotive Q3 2008, Conference Call Topics, today we’ll be discussing an overview of the quarter, our vision and strategy and investments principles along with some color on the quarter then I’ll turn the call over to Jeff Dyke for an operating review and the priorities and specific strategies that he’s working on. Then Dave Cosper will follow Jeff with a financial review of the quarter and dive a little deeper into the numbers and then I’ll wrap up with a summary. If you’ll please turn to the slide, Building for the Long-Term, the Quarter in Review, during the last three months Sonic Automotive faced the toughest operating conditions in our ten year history. We faced a hurricane, gas shortages in the Southeast, historically low consumer confidence levels, last but not least, a credit crisis. I’m not sure if anybody paid attention to the Safe Harbor statement but there’s a lot of uncertainties that are out there obviously in the market these days. The combination of these forces resulted in the lowest SAR since the early ‘90s. Today we’re reporting an EPS loss of $0.57 for the third quarter. Included in the loss is $0.76 of non-cash impairment charges. EPS from continuing operations excluding Hurricane Ike impact and the impairment charges was $0.33 or $0.04 ahead of consensus. The majority of our impairment charge which Dave Cosper will discuss further in review of the financial results consisted primarily of the write down of the franchise asset values assigned to a handful of stores along with the write down of fixed assets at those dealerships. I don’t view these write downs as particularly surprising given the profitability of certain brands in recent years and the fact that we’re required under the accounting rules to review this on a regular basis. We’ve also reviewed our plans for several dealership properties that we are no longer using and have decided to sublease these properties rather than investing additional cap ex dollars to utilize them for other purposes. As a result we’ve had to record some lease sales associated with these properties. I actually view this as a positive step in reducing future capital expenditures and operational risk. In addition as we continue to challenge ourselves on the need for capital expenditures and projects in today’s environment we took some additional projects off the table and wrote off design and engineering costs we had already incurred on those projects. I view this also as positive relative to our future cap ex dollars. Many of you have followed our company or been shareholders since our IPO in 1997. While it may not be obvious from the outside over the last year and a half that I’ve been back leading our company we’ve truly evolved both as a strategic and operational perspective. I believe our current operational and finance team is the best that we’ve ever had. It doesn’t mean that we’re not going to make some strategic errors along the way, we’ve certainly made some in the past and as the company’s Co-Founder and Chief Strategic Officer for most of the company’s history I take full responsibility. I don’t promise you that we’re not going to continue to make some mistakes in the future because we’re not perfect, but I believe that if we’re not making mistakes then we’re not swinging at the ball. I’m convinced that because of the clear investment principles that we’ve developed the strategic discipline we now possess and a strong cohesive management team to guide us that these mistakes will be fewer and farther between. Moving on to a more positive note I’m pleased to report that Mr. Jeff Dyke has been promoted to Executive Vice President of Retail Operations. Jeff has full oversight over all of the Sonic dealership operations. In a few moments you’ll hear directly from Jeff on the many operating initiatives that he’s pursuing. David Smith, my brother, was appointed by the Board of Directors to fill a vacancy left by Jeff [Rocker]. In addition David was promoted to the position of Executive Vice President of the company. On the litigation front Sonic Automotive is pleased with the North Carolina Department of Motor Vehicles ruling on the Beck Imports vs. Mercedes Benz USA. The DMV found that Mercedes’ objection to Sonic's proposed acquisition of Beck Imports of the Carolinas wasn’t effective and that Sonic’s acquisition of the dealership can be completed. This ruling by the DMV is consistent with what had been the company’s viewpoint all along. If you’ll please turn to the next slide, Building for the Long-Term, Vision and Strategy, this slide shows our Creed Card. Our vision is to achieve industry leadership in automotive retailing. It always has been and always will be. But what does it mean? To me it means a couple of things. First and foremost it means that Sonic will become the employer of choice in the automotive dealership community. This is a people business, you’ve heard me say it many times, that if we have the right people we’ll be successful and it’s our people that sell and repair cars, not buildings. I take very seriously our responsibility to provide a thriving and growing business where our people can be successful in their careers. Secondly, and this is probably most important to you, is that it’s our goal to produce well for our shareholders which includes me as well as the Smith family. We do this by continuing to focus on what we can control which is the consistent execution of our strategies. Despite what the current market might be saying I remain convinced that the automotive retailing model works. Our revenue is based on more than just new vehicle sales and as you’re going to hear from Jeff Dyke we’ve been working on our operating initiatives that will allow us to take market share even in a down economy. Our expense structure is highly variable, it may be difficult to see that currently given the impact of the hurricane and the impairment charges but the variability is there. We’ve realigned our regional management team, we’ve reduced advertising expenses, we’ve adjusted our dealership personnel to reflect a lower vehicle demand. There are more of these levers that we can pull as we go forward. Over the past year we’ve added some risk management resources to our corporate team whose sole mission in life is to reduce our costs of insurance programs, both from a claims and a premium perspective. We’ll continue to reduce advertising if the downturn extends longer than currently expected and our IT team which I’m very proud of continues to take steps to reduce our future IT spend. Cost control is an area that we pay attention to every day but I just want to reiterate what we said in the last call, that we’re 80/20. 80% of our time is focused on revenue generation and 20% of our time we focus on cost control. We also add value to our shareholders by sticking to our investment principles. We continue to move away from leasing our dealership properties. In the past year we’ve converted over $120 million in leases to mortgages. Although mortgages increase our on balance sheet debt to capital ratio this is a strategy that every shareholder should fully support. As I’ve already discussed we continue to eliminate any questionable capital expenditure projects. For the time being we are holding off on acquiring dealerships in order to concentrate on retiring the bonds that will be due in 2009 and 2010. Jeff and Dave will have more to add on our expense management and capital allocation plans in a few minutes. If you’ll please turn to Building for the Long-Term, Investment Principles, this slide lays out the detail of our investment principles that I mentioned a few moments ago. I’d like to take a moment just to run through them. We want to invest money where we make money. We now have strict return thresholds in place to evaluate if a project will return for us. Proper approvals, we put safeguards in place to insure that the proper due diligence and review has taken place. All senior members take place in the final decision. We’re sticking to our strategies. We allocate capital carefully as capital is limited. We want to make sure that we rank projects appropriately. We want to own our land and facilities and probably most of all we want to use good judgment which I think can be argued in the past just by the fact that most of our land was leased rather than owned might indicate a lack of good judgment there. Like our Creed Card we take these principles very seriously, they serve us now in our decision making process [break in audio]. If you will turn to Building for the Long-Term slide, the 2008 Strategic Focus please, most of you have been exposed to this slide for several quarters now but I wanted you to understand that this is how we evaluate the strategic decisions of our company every day. Everything that we do gets bumped up against these principles to make sure that any actions we take are consistent with our long term strategies. It’s important to point out again that our strategic focus is not built solely around new vehicle sales. Allow me to share a quick story with you that truly reflects what we’re trying to build here at Sonic Automotive. When our associates walked through the damage caused by Hurricane Ike 22 Sonic families found that they had lost their homes and all of their possessions, everything was gone, completely washed off the face of the Earth. The remainder of the 1,600 families in Texas rallied to help each other and there was no power, no gas, no cash, the ATM machines were out, no water, no groceries, no baby supplies, you can get the picture. From Charlotte we had a team rallying with those folks, we dispatched two tanker trucks of gasoline to Houston, our fellow associates drove to each other’s homes to take gasoline to them so that they could make it to the dealership, so they had gasoline for their generators and not to fix cars or to sell cars, but so they could get the basic staples such as food, water and cash. We paid our associates’ wages equal to their vacation pay so they wouldn’t have to worry about they were going to pay their bills. On the ground associates rallied to take trucks and trailers full of supplies to our dealerships for our associates. They trucked in supplies from other states as most everything was gone for hundreds of miles and we supplied 60 generators to the families who needed them at their homes. Why did we do this and why did our associates rally to help each other and help the company? It’s simple, because it’s the right thing to do. Our associates were so grateful that to show their gratitude they opened several of our dealership service departments for 24 hours a day on their own accord just to help our customers in need and we’re all about people at Sonic Automotive. At this point if you’ll allow me to turn the call over to Jeff Dyke he will review our operational initiatives and then on to Dave Cosper for a review of our financial results.

[Jeff Dyke:]

Thanks to all of the Sonic associates that continue to lead the way in creating the best automotive company in the industry to work for. Today I’m going to provide an overview of a few operational focus areas so our investors understand what we’re doing to take advantage of today’s marketplace. As Scott indicated there’s always opportunity to grow and prosper even in more challenged times so let’s take a look. Please turn to the page titled Operating Priorities, Used Vehicle Strategy. This is a slide that you’ve seen before which summarizes our used vehicle process. Phase I focuses on changing the culture in our stores to become more retail focused and less wholesale focused. Phase II focuses on optimizing inventory, putting the right car at the right location for the right price. Phase III envisions a national used vehicle virtual store. This virtual lot will have its own unique branding, consumer controlled shopping and transactional elements. Phase I is being completed in all of our Sonic dealerships, however, we need to add some focus to our West Coast stores to guarantee execution of this process. This started in September of 2008. We’re in the process of finalizing Phase II in our Alabama/Tennessee/Georgia region and the results are very encouraging. We are finding that vehicles processed through the Sonic Trade Desk on average turn 10 days faster and are averaging $800 more in gross. At the end of the fourth quarter we expect to have the Trade Desk implemented in our Texas region and by the end of the first quarter 2009 we’ll begin to implement Phase II in our dealerships in North Carolina, South Carolina, Virginia, Maryland and Florida. Phase III of our Sonic Virtual Store that will be named at a later date will be a unique offering for customers all over the US. Overall we’re very pleased with our progress in used cars. We once again outperformed the national franchise dealers in year-over-year volume performance. Additionally the execution of our used vehicle process reduced our exposure to greater gross compression that occurred in the market this quarter as well as helped us manage our inventories effectively. Our used day supply at the end of the quarter was 32 days and 66% of our inventory was comprised of cars. Next slide please. This slide is titled Operating Priorities, Fixed Operations Strategy. As we discussed on the previous call we told investors we would redouble our focus on fixed operations. This slide provides you a snapshot of our areas of focus and the timeline in which we plan to accomplish our goals. Phase I of our process includes standardization of our selling menus that will support our service drive process and the service sales writers as they work to exceed our customer expectations. Phase I also includes an overhaul of our grid pricing and flat rate hour multipliers. These adjustments will allow Sonic to maximize effective labor rates and margins while providing competitive pricing to our customer base. Phase II focuses our efforts on training in the service drives provided by our world class training organization Sonic University and will feature merchandising of high volume, high margin items that are supported by our manufacturer and vendor partners. Phase III of our effort ties our fixed process together by introducing a new technology similar to auto exchange and pre-owned. This technology will allow Sonic to review service writer, technician, store-to-store and brand-to-brand performances so the Sonic national service team can focus its efforts where needed the most in real time format throughout each month. Next slide please. It’s titled Operating Priorities, Internet Lead Strategy. This slide provides you an overview of the steps we have taken this year to significantly enhance our Internet strategy. In the beginning of the second quarter we started to introduce our new websites. Our strategy is already showing signs of being very beneficial as Internet leads are up on a year-to-date basis and nearly 75% of all Sonic customers have visited our sites prior to coming to the stores. During a difficult quarter we continued to take new car market share and outperform the industry in pre-owned. Our new sites are engaging, consumer friendly and provide our stores with the ability to adjust inventory, pricing, merchandising and promotions in a real time basis. This is key in today’s automotive industry as the consumer base of today requires a different level of communication and Sonic Automotive is ahead of the curve and our investment in this area is paying off. We have accomplished each of the first three steps in this strategy and in the third quarter of 2008 we began in-store training to help our store structure handle the significant increase in leads without increasing personnel cost. Each brand and store provides a different set of challenges as we widen our virtual doors and drive more traffic to Sonic. The key will be how we train and structure the stores to handle this traffic and adjust our teams to the consumer demands of tomorrow. Our Sonic University training organization is poised to make this happen by the end of the fourth quarter of 2009. Next slide please. It’s titled Operating Priorities, F&I – Same Store. Roughly 18 months ago we installed our electronic F&I menus at dealerships across the country and this graph displays how effectively our processes and strategies have worked. F&I is a critical part of our business and provides our consumer base with many options to help protect their automotive investment. While it’s important to maintain our current levels we do not see much upside in our F&I profits. We are comfortable with a target of $1,000 per unit. Next slide please. It’s titled Operating Priorities, Expense Management. We continue to remain focused on controlling the controllable expenses as Scott said earlier. Here are a few areas that we’ve attacked recently given the economic environment. As Scott Smith always says people are our most important asset. On an overall basis store level personnel costs are not out of line. Sonic has always supported the thought of fewer associates making more money and we continue to right size our business as necessary to support the needs of our associates and our shareholder interests. As you can see on this slide we’ve reduced store and regional expenses by nearly $12 million on an annualized basis and will start receiving these benefits in the fourth quarter. You will not be hearing about Sonic cutting pay plans. However, you will hear that our team is focused on associate satisfaction and customer satisfaction both of which I’m very proud to announce are at an all time high. Our goal is to right size when necessary but more important retain and attract the very best associates and business as we continue to strive to be the company of choice both to work and shop. Our inventory controls continue to pay off as we again will outperform the industry in both new and used vehicle day supply. We’re also very comfortable with our parts day supply. For the quarter our advertising spend was down $2.8 million or 16.2%. Spend is down not only in absolute dollars but in terms of gross percentage as well. We are concentrating on the effectiveness of each and every dollar we spend at Sonic. Sonic has always been an industry leader in SG&A control and will continue to be as we work our way through this difficult economic environment. Next slide please. It’s titled Geographic/Brand Review, New Vehicle. I wanted to give you a feel for what we’re seeing in the marketplace in terms of new vehicle revenue. California represents 30% of our total vehicle revenue. The market continues to be somewhat softer than other parts of the country. Our high line brands continue to excel even in the tough market and while our domestic and import brands have been challenged we recently have seen some stabilization in volume as the manufacturers provide incentives to support our industry like to add a 0% program. In Texas we’re very pleased to see that our BMW, Chevy and Ford dealerships outperformed their market. These three brands represent nearly 55% of our new vehicle revenue in the state of Texas. Our Honda and Toyota brands in Texas kept pace with the market. In fact we’re having a solid performance in September but the Hurricane slowed our business down as we were closed for about 10 days. We expect this business to pick up as the Houston market gets back on line. In Florida the market remains difficult but we’ve seen an improvement in our Honda and Toyota business. As we’ve mentioned before on calls we have one Toyota store in the region that has had performance issues due to operational disruptions related to construction of a new facility. The construction is now complete, we have a new management team in place that is making tremendous progress and we look forward to providing more detailed results when we present on the fourth quarter. Our Northern and Southern regions that cover from Michigan to Georgia are performing well in this environment and seem to be not as impacted as some of the other areas. However we did experience gas outages during the final couple of weeks of the quarter which did impact performance. Those issues now seem to be resolved. New cars are still being sold and as this downturn plays itself out over the next few months or even the next year or so Sonic is positioned to handle the lower SAR. Our processes in F&I, pre-owned, fixed, Internet, marketing and our expense control capabilities give us a competitive edge. To review the quarter in detail I am now turning the call over to Dave Cosper.

[David P. Cosper:]

EPS for the quarter for continuing operations was a loss of $0.24 down from a profit of $0.68 last year. Included in the results are the impact of Hurricane Ike that hit our Houston stores and non-cash impairment charges. The Hurricane disrupted operations for about 10 days in September and reduced diluted EPS by $0.08. Impairment charges for the quarter totaled $0.49 for continuing operations and $0.27 for discontinued operations and these largely reflect franchise and fixed asset impairments and lease exit costs. Given the dramatic changes in the business environment in general and in our business and the market value in particular we undertook evaluation analysis of goodwill recorded on our books. We concluded there is not an impairment of goodwill. As part of this analysis however we also reviewed franchise assets and fixed assets at the store level and we concluded there were some impairments concentrated heavily in our domestic stores. Excluding these charges we earned $0.25 a share in the third quarter and $0.33 a share excluding the Hurricane impacts. I want to note that our reported EPS numbers may move slightly when we file our 10-Q as we nail down the impact of our 2002 converts in the EPS calculation. This does not impact the $0.25 and $0.33 a share numbers I just discussed. I kind of view the quarter in three parts, first in July and August we were profitable with an operating margin of 3% essentially a continuation of what we saw in the second quarter. Second in September it was a tough month given the hurricanes and frankly a further drop in sales volumes but operationally we made a small profit. Third the impairment charges taken in the quarter which essentially are non-cash valuation adjustments reflecting the awful business environment. Business in October has improved and looks a lot like July and August. I’ll talk more on actions we’re taking on some later slides. Next slide please. Our discontinued operations loss was roughly $14 million and as you can see on the slide about $12 million of this relates to non-cash impairments including at least exit accruals at two dealerships, one in California and the other in Georgia. Operationally there was a loss of $2 million and while still a loss it’s an improvement from the prior year. In total we have 12 operations remaining in discontinued operations and hope to sell them over the next year for roughly $20 million to $30 million. Next slide please. This slide shows same store sales performance for the quarter. Total same store revenue declined 16.4% compared with last year and within that wholesale revenue declined nearly 29% as we continue to keep more of our trades. New retail revenue was down $224 million or nearly 19% and accounted for two-thirds of the overall revenue decline. New retail volume was down 19.2% compared to the industry decline of just over 23%. Used retail revenue was off approximately $28 million and principally was volume related. While our overall used retail volume was down our CPO performance continues to be a bright spot up 15.5% for the quarter. CPO was 41% of our total used retail volume. Our F&I story also continues to be a good one. On a per unit basis F&I was up $16 or 1.7%. Our standard menu and our focus on customer satisfaction and reduced turnover have really paid off for us. Due to retail volume declines total F&I revenue was down 13.6% for the quarter. Fixed operations revenue was also down and lower warranty continues to be the largest factor in this decline. The customer pay revenue was also down as well and I’ll expand on this in a moment. Next slide please. SG&A as an expense as a percent of gross was 93.8% for the quarter and obviously this includes the impairment charge. It also includes the impact of Hurricane in Houston. Excluding both of these factors SG&A was 79.8% of gross up from 77.9% in the second quarter. In July and August SG&A averaged 78% which essentially was the same rate that we ran in the second quarter. With all the cost improvement actions we’re taking I would expect to run below this level even with the depressed volume and we’ll be poised for a sharp profit improvement as volume comes back. Please turn to the next slide. As you can see on the slide customer pay revenue was down 2.8% for the quarter. Within this our quick lube business was up 33% while our traditional customer pay levels were off. The decline was most pronounced in our domestic stores which accounted for 80% of the customer pay decline. Our domestic customers are putting off major repairs and resisting up-selling. In contrast we experienced increases in customer pay revenue with Toyota, Mercedes, Lexus, BMW and Honda. Same store warranty revenue was off 7.3%. While many brands experienced declines our Mercedes stores accounted for nearly half of the overall decline in warranty. For the quarter same store fixed operations gross profit was down 5.2% reflecting lower volume in margin. Although margins were down 70 basis points from last year they’ve held steady for the last three quarters and we expect them to remain flat in the near term. Next slide please. We ended the quarter with a 60 day supply of new vehicles almost 10 days better than the industry as a whole. As you can see our domestic brands are in good shape and our import stores are in very good shape. Luxury inventory is a bit high for us although we improved from June and were better than the industry. The majority of the issue is slow sales for Cadillac, Land Rover and Lexus and we’re working through this. In terms of current truck mix 52% of our new vehicle inventory is car and 48% is light truck. In June truck, was 51% of our mix. We’ve lowered both truck and SUV inventory. We’re very pleased with the way the team is managing used inventory and we ended September with a 32 day supply. Additionally only 28% of the inventory was SUVs which we feel great about considering how many we took in on trade. We bought them smart and sold them quick. Next slide please. On this and the next several slides I’m going to talk about cash, liquidity and debt status obviously important issues for all businesses these days. The most important point on this slide is the increase in mortgage funding. During the quarter we closed on $39 million of cost effective long term financing with BMW Financial and Toyota Motor Credit. We also reduced our total debt during the quarter by $8 million. The increase in our debt to cap ratio reflects the impact of the non-cash impairment charge taken in the quarter. Next slide please. This slide shows our revolver balance and revolver availability for June and September. As you can see, our borrowing on the revolver declined by $46 million from $115 million in June to $69 million in September. As I mentioned we closed on $39 million of mortgages in the quarter and we generated additional cash as well despite the weak sales environment. We used these funds to pay down our revolver. In lock step with this our availability on the revolver increased $43 million to $153 million. As I’ve indicated several times now we have two principal alternatives to refinance our $130 million of convertible notes due next May. One using the public market should an attractive window open or two using our revolver if the credit markets are difficult. During the third quarter we purchased $5 million of the $130 million of notes in the market and we bought them at a discount. Earlier this month we purchased an additional $20 million of the notes so as of today we have $105 million of the notes outstanding. The debt markets remain essentially closed so I’m very pleased with the way our team has managed its cash and liquidity ensuring sufficient availability on the revolver to retire the debt. Next slide please. As noted on the slide we’re in full compliance with all of our debt covenants. Note that our current ratio improved in the quarter to 1.23 a reflection of us paying down the revolver. We expect to remain in full compliance with all our debt covenants through 2008 and 2009 as we retire the remaining $105 million of debt due next May. In fact we’ve stress tested our ratios for various economic scenarios and we have plenty of room. Next slide please. I added this slide because we’ve received several questions about our capital spending and the impact of owning versus leasing our properties. As you can see in the first nine months of the year we had $122 million of capital spending of which $70 million was on land and building to be financed with mortgages. In other words we’ll own these properties and we will not do sale and lease back financing. Note that we closed $57 million of mortgages in the first nine months providing low cost financing for these assets. Traditional capital spending was $52 million for the first nine months and only $12 million in the third quarter. Our team has been working very hard to prioritize, re-calendarize and reduce our spending. We expect spending to remain low this quarter as well as into 2009. Cash is king in this market. Next slide please. We don’t foresee things improving materially in the fourth quarter and we do not expect the typical sales surge in December. Factoring this together with the great economic uncertainty we’re facing we’re providing EPS guidance of $0.10 to $0.20 for the fourth quarter. We feel that margins will continue to be tough for both new and used vehicles. We believe that new margins will remain soft but will begin to stabilize this quarter. Industry-wide inventory levels are still on the high side but stock is coming more in line with consumer demand and this should help. For used typically we source the majority of our vehicles through trades but with low new vehicle volume we’re relying more on auction purchases which typically result in lower margins. Also we’re going to continue to grow our CPO business and as you all know gross is good on these vehicles but margins are lower. We expect F&I to be flat for the quarter and fixed operations volume and margin to be essentially flat as well basically more of the same. On the very bright side we’re making money and generating cash and the actions we’re taking to improve the business provide some good opportunity for us. With that I’ll turn the call back to Scott.

[B. Scott Smith:]

Many of you have been trying to understand what our industry and more specifically what Sonic Automotive looks like if the SAR stays around $12 million to $13 million for several years. We’ve been dealing with these same questions internally as we model out our company for the long term. Although we think the operating environment will begin to rebound as we head into 2010 we’re prepared to operate as if it won’t. If this downturn continues for an extended period of time we believe that several things will happen. First the number of dealerships in the industry will shrink as smaller dealerships begin to close so the sales per dealership will remain steady or go down slightly maintaining throughput. The brand mix will continue to migrate towards the import and luxury segments of the business as domestic manufacturers continue to reduce capacity and we believe that this benefits Sonic Automotive given our mix of dealerships. Parts and service business will begin to stabilize as customers can run but they can’t hide from repairs and needed maintenance. In the short term but eventually these vehicles will need the maintenance. We’ve already learned in the current environment that our parts and service business is not nearly as volatile as the new vehicle sales and our expense structure will continue to decline as we discussed in the beginning of the call. We’ve run several scenarios assuming the SAR stays around $12 million and have come to the conclusion that at these levels we’ll be able to sustain a net profit of $25 million to $50 million per year. As Dave discussed we have plenty of room on our EBITDA base debt covenants and I’m confident that we’re making much better decisions for the long term and have adopted sound investment principals. We’ve emerged from the quarter with a stronger and more secure future and before we take your questions as always I want to give my sincerest thanks to our Sonic associates. Their continued hard work and dedication are carrying through this challenging time. Thank you team. It’s an honor and a privilege to lead our company. Lastly the Directors of the company review the dividend quarterly and will act accordingly in the best interest of the company and shareholders. The dividend will remain unchanged for the quarter at $0.12 per share payable on January 15th, 2009 for shareholders of record as of December 15th, 2008. At this time if you promise not to ask questions about our telephones we’ll open the call.

[Operator:]

(Operator Instructions) We will pause for just a moment to compile the Q&A roster. Your first question comes from Rick Nelson – Stephens Inc.

[Rick Nelson:]

You referred to improvement in October, looking more like July and August. What is contributing to that? Is it Houston bouncing back or is it other factors?

[B. Scott Smith:]

It’s certainly improving a little bit for September, Rick, and I think that was the nature of my comments. It’s close but maybe a little soft in what we saw in July, but more like a July, August run rate. Houston is picking up, our service is very strong there. Jeff, you may want to comment on new sales there.

[Jeff Dyke:]

Rick, the Houston market is certainly making a difference both from a new perspective and used cars. We’ve got pent up demand in the Texas market and that’s starting to play out a little bit. We expect that to continue to play out as we go across the fourth quarter.

[Rick Nelson:]

Dave, in terms of market [inaudible], are your covenants going to prevent you from doing much more in terms of buying out some of the leases?

[David P. Cosper:]

Not the covenants per se, there is an overall basket capped at $200 million in the credit facility that we negotiated with the syndicate. We’re at $115 million, $120 million, something like that so there’s a fair bit of headway to go so I don’t see that being an issue.

[Rick Nelson:]

The cost cuts of $12 million, that’s an annualized run rate I take it. How much of that would show up here in the fourth quarter?

[B. Scott Smith:]

About 25% or 30% of that.

[David P. Cosper:]

Actually the regional structure.

[B. Scott Smith:]

The regional structure is done and that would be probably, it’s still 25% or 30% because we did it in the middle of the year. We’ll pick half of the regional structure redo for the last six months of the year.

[David P. Cosper:]

But all for the fourth quarter.

[B. Scott Smith:]

Yes.

[Rick Nelson:]

The asset impairments, can you identify the dealers that those are associated with? Are they primarily domestic stores?

[David P. Cosper:]

They are in fact, yes, across the board.

[Rick Nelson:]

In terms of service and parts, are you seeing any evidence that the consumer is trading down to shopping less expensive alternatives to the dealer?

[Jeff Dyke:]

We are. What we’re seeing is they’re spending less and less money on big ticket items and more and more money on quick lube items, oil changes and things like that and it’s our ability and the processes that we’re putting together to up-sell off of that. As we expand on our fixed operations processes over the next few months hopefully we can take advantage of those customers coming into our shops.

[Rick Nelson:]

Finally, in terms of finance, we’re reading about the fine among the big institutions. Is that beginning to show up in terms of auto loans and your credit providers?

[B. Scott Smith:]

It is somewhat. I think it’s more consumer confidence than it is anything else. As consumer confidence comes back I think we’ll see that we’re able to get financing. It’s more in the subprime markets on pre-owned where we’re experiencing that affect and that business has dried up for us. We’ve had stores, especially in the Oklahoma area that have focused a lot on subprime financing. We’re going in and changing processes there to get them to focus in other areas of our business. We are experiencing some of that but it’s more subprime than it is anything else.

[David P. Cosper:]

Rick, I would add to that, that for our luxury brands and import brands the captains have done yeoman’s job in supporting us and their share is up sharply. Some of the banks have cut back.

[Operator:]

Your next question comes from Scott Stember – Sidoti & Company, LLC.

[Scott Stember:]

Do you ever talk about your floor plan syndicate and maybe just give us a quick overview of where you stand? It sounds like you guys are in pretty good shape, particularly with the cap.

[David P. Cosper:]

We’ve got a syndicate in place with 11 or 12 banks. Bank of America is the lead on that. It’s a $750 million facility. It also has $150 million used capacity in it. It’s operating fine, there’s no issues. Maturity date is 2010, February I think. We’ll probably start talking with the bank the middle of next year on that. We’ve not experienced any issues with that whatsoever.

[Scott Stember:]

Do you have any open lines right now with any of the big three [inaudible]?

[Greg D. Young:]

Yes, Scott. We do have some. We have a few silos with Ford Credit and GMAC. We also have some silos with BMW Finance and Mercedes Finance.

[David P. Cosper:]

And Honda.

[Greg D. Young:]

And again, as Dave said, those seem to be moving along. We’ve seen a little bit of rate increase from some of the domestics but nothing overly substantial. I think as we get further out and start to talk to our syndicated facility we’ll plan for the long term as to what we want to do with those silos.

[Scott Stember:]

I think I missed part of the call but did you say that you paid down $30 million worth of the convert that’s coming due in May?

[David P. Cosper:]

$25 million to date, Scott. $5 million in the third quarter and $20 million earlier this month. The balance now is $105 million.

[Scott Stember:]

The plan would be to pay down as much as you can before you have to make a decision on how to finance that?

[David P. Cosper:]

Yes, we’ve had some restrictions on how much we could pay but yes, the plan would be to retire more of that as we can, as we’re able. Because we’re doing it at a discount, a slight discount.

[Scott Stember:]

The way things stand right now you have enough asset you can take that on in your revolver if you had to?

[David P. Cosper:]

That’s correct. That was the one slide I had in there showing how we’ve pumped up our availability with the actions we’ve taken.

[Scott Stember:]

Last question, Scott, I think at the end of your prepared remarks you made a comment about the $12 million SAR I guess for a prolonged period of time. Did you say $25 million to $50 million of net income?

[B. Scott Smith:]

Yes.

[Operator:]

Your next question comes from Matthew Fassler – Goldman Sachs.

[Matthew Fassler:]

Couple questions here, first of all can you just talk about what kind of exposure you think you have on fixed margins to the extent that you see ongoing declines in parts and service business? Do you feel like you bore the brunt of it in Q3 or could there be some more exposure just because of the fixed cost nature of that business?

[B. Scott Smith:]

From what I see, our margins are down versus last year but they’ve been flat for three quarters in a row and I see it stabilizing. If I go in and look at the numbers, customer pay was actually down two-tenths of a point, 20 basis points. That’s a big driver of our business. I don’t see huge risk in our fixed ops market.

[Matthew Fassler:]

What about S&I PVR? One of the things we’re obviously seeing and hearing about is tougher LTV requirements from financing sources and consequently perhaps some of the dollars that might have been around to fund some of the marginal S&I expenditures might not be there these days? Are you seeing any impact from that?

[David P. Cosper:]

Not really. Year-to-year we’re up. We’ve seen some sequential decline and some of our interest rate profit, it’s the captives that picked up shares. It’s hurt us a little bit sequentially but I see that kind of leveling off.

[Jeff Dyke:]

We also are focusing on our products that we’re able to sell in F&I and those products are increasing our products per car penetration is rising up. So we expect our PUR to stay somewhere in that $1,000 area that we talked about in our slides.

[Matthew Fassler:]

Just looking at the covenants on the credit facility, I believe you’ve got a fixed charge coverage ratio and the senior secured leverage ratio. Can you tell us where you stood on each of those at the end of the third quarter please?

[David P. Cosper:]

That’s actually in the slide deck. We had some issues with the call so you may have missed that part. But the fixed charge coverage was 1.65 and it needs to be greater than 1.2. The debt to EBITDA was .82 and it needs to be less than 2.25. There was a lot of room in that.

[Operator:]

Your next question comes from John Murphy – Merrill Lynch.

[John Murphy:]

Just first on debt, Dave, you mentioned something that there was the slug coming due or the convert that’s coming due in May of ’09 but there was also another piece coming due in 2010. Was that just the floor plan facility that you’re talking about?

[David P. Cosper:]

There’s a convertible due at the back end of 2010, November, the 4.25% convert, it’s $160 million.

[John Murphy:]

On this floor plan facility, what we’ve seen in the past is that the captives have often liked to have the floor plan facility in house and given favorable allocations based on that particular, GMAC and Ford Motor Credit. Are you seeing a day and age where there this is changing and that this outside conduit floor plan facility of these other banks is the way you’re going to go and you’re not going to be floor planning with any of the, at least the domestic captives?

[David P. Cosper:]

No, I don’t see that. I think we’ll always have a great relationship with the captives. In fact, some are, depending on the captive, moving more of the floor plan back to the captive. It varies by manufacturer, of course, domestic versus import. But there’s always going to be a strong relationship there.

[John Murphy:]

Do you see that being more selective than has been in the past? We’ve seen some large Chevy dealers lose their lines. Is that something they’re going to be more selective on these days?

[David P. Cosper:]

I assume you’re talking about the GMAC pulling the line with the Heard Group.

[John Murphy:]

This was Bill Heard.

[David P. Cosper:]

I don’t know what drove that, but it’s a highly unusual event in my view.

[John Murphy:]

On the cost cutting that you have in place right now, I was just wondering if that was it or if there might be any more coming in the future? As you’re thinking about setting up that program or potentially future programs, what kind of market are you thinking that we’ll be in next year? What’s your SAR run rate maybe not even next year but even in the fourth quarter? What is your SAR run rate operating base case that you’re using?

[David P. Cosper:]

We’re planning on more of the same, basically flat at $12 million kind of run rate. Jeff may want to talk about this, but as we’re going through the budgets for next year, we’re looking at structural opportunities that we seen in the non-variable arena. Our business is highly variable the way we’ve got it cost structured so a lot of it comes out naturally without tremendous work, but we’re going after structural savings as well.

[Jeff Dyke:]

One of the great things about our company is from an SG&A perspective it’s an ongoing focus item. So while there’s certainly opportunities there, we’ve built all of our budgets using a baseline SAR of $12 million for next year and we’re structuring our cost initiatives around that. Maybe there’s a little more there, but quite honesty I think we’ve been doing a pretty good job from a cost perspective. We had a little out in the third quarter, maybe there’s a little more in the fourth quarter. But as we see it, we’re pretty steady as we move into next year.

[John Murphy:]

When you stress test those levels, what do you think on the downside, as more out of curiosity? It’s a very tough thing to call these days but when you think about stress testing it to the downside and what you may have to do, what are the levels you guys are looking at?

[Jeff Dyke:]

In terms of the SAR?

[John Murphy:]

Yes.

[Jeff Dyke:]

We’re just grabbing at straws here, John. Your guess is as good as mine. Maybe it’s a $10 million or $11 million SAR but we don’t see anything below that.

[John Murphy:]

You’re going through the mechanics of that as you’re going through these cost cutting programs though, correct?

[Jeff Dyke:]

Absolutely.

[John Murphy:]

Lastly, on your cap ex next year if we do go into this sort of draconian scenario of really rough SAR below $12 million, what is your ability to pull back on cap ex and if we had to go to pure maintenance cap and no expansion cap ex at all, what level would we be at?

[David P. Cosper:]

We’re close to that level now operationally. I think we’ve worked extremely hard at seeing what projects we can push and the nice thing about this business is you can stop if you have to. I think maybe $12 million, $15 million would be a normal expense level. It may be a little less than, but the full year if you had to really pull in your horns.

[John Murphy:]

And that’s blacktop and signage basically, right?

[Jeff Dyke:]

Yes and maintenance items, safety items, things like that.

[David P. Cosper:]

What we are looking at, we’ve got a couple major projects that we’d like to proceed with. We’re looking to having basically construction loans put in place so you’re not out the cash, you draw as you go versus waiting to the end when the [inaudible] is up and complete and putting a mortgage on that. So we’re looking at everything that we can do to ensure we have liquidity.

[B. Scott Smith:]

And we’re holding our manufacturers equally accountable on these facility projects. If they’re applying significant pressure to us to increase capacity or what have you, we’re applying the same pressure for them to finance it at a very reasonable rate. If they won’t invest in their own facilities, why would we?

[John Murphy:]

You’re finding those kinds of discussions are a little bit more free form and open than they have been in the past? They’ve been more receptive to that kind of pressure on the push back?

[B. Scott Smith:]

Significantly more receptive.

[Operator:]

Your next question comes from Richard Kwas – Wachovia Capital Markets, LLC.

[Richard Kwas:]

When we’re looking at the $0.10 to $0.20 for the fourth quarter, Scott you talked about $25 million to $50 million in net for the year in a $12 million environment, $0.10 to $0.20 gets you to $0.40 to $0.80 on a run rate basis. Is the major difference between the $25 million to $50 million net and your run rate in the fourth quarter is that you haven’t achieved all the expense savings in that $12 million pool that you’ve identified?

[B. Scott Smith:]

There’s some of that and there’s probably a little dose of conservatism in those numbers frankly given the environment we’re facing and the uncertainty.

[Richard Kwas:]

For the quarter?

[B. Scott Smith:]

Yes, having moved guidance a couple of times, it’s a little tough to set guidance again.

[Jeff Dyke:]

Rich, consumer confidence is so low it’s just very difficult to predict.

[B. Scott Smith:]

Rich, if you go back to Q3 it’s like $0.32 to $0.33 if you make adjustments, pull out impairments, pull out the Hurricane. So the $0.10 to $0.20 looks a little light, doesn’t it versus that?

[Richard Kwas:]

When you look at the franchise impairments, what’s the risk that there’s further impairments on the domestic dealerships? What would cause you to have to take an impairment charge to any of your import or luxury dealerships?

[B. Scott Smith:]

We took a pretty good look at all our stores. We did it store-by-store for franchise and the fixed assets. Greg, do you want to?

[Greg D. Young:]

Rich, I would just add you have to remember the way the accounting rules have changed not all of our domestic dealerships have franchise values associated with them, it’s basically every acquisition we made post-July, 2001. So most of those acquisitions have been more luxury and import oriented. I think we did a pretty good job of scrubbing it this quarter looking at our domestic stores that have been losing some money in recent years and writing those assets off. But the vast majority of our domestic stores don’t have franchise value associated with them.

[Richard Kwas:]

So there’s fairly limited risk going forward?

[Greg D. Young:]

I would tend to think so because the luxury stores are still profitable, they’re still cash flowing. We’ll look at a few of our Cadillac stores over the longer term, but the ones that still have franchise values associated with them have been profitable, even in the current environment.

[Richard Kwas:]

Dave, remind me, I think after the year ends, you can pay down another $25 million of the convert, once we get into 2009. Is that correct?

[David P. Cosper:]

That is correct.

[Richard Kwas:]

So you could reduce that to approximately $80 million when we get into May of next year?

[David P. Cosper:]

Yes, I think it’s very prudent to prefund at a discount, it makes a lot of sense.

[Richard Kwas:]

Finally, on the current ratio if you indeed do use the credit facility how does that affect the current ratio come second quarter of next year? You’re going to have reduced availability on the line of credit and that’s not going to be an add back, so how do we think about that?

[David P. Cosper:]

That is true and we’re looking at a number of ways to approach that and raise funds, but we’re confident that we can navigate through that.

[Richard Kwas:]

So potentially you could have asset sales, divestitures to offset and mitigate the use of the credit facility to fund this maturity?

[David P. Cosper:]

Yes.

[B. Scott Smith:]

We do have some. As Dave said we do have some stores in disc ops, Rich and we’re also sitting on some pieces of non-dealership land and things like that that we can sell going forward.

[Richard Kwas:]

So the expectation is that you wouldn’t necessarily have to use all of that facility to fund this maturity?

[B. Scott Smith:]

Correct.

[Operator:]

Your next question comes from Colin Langan – UBS.

[Colin Langan:]

Looking at your liquidity right now, it looks like you have $160 million when you combine what’s [inaudible] on the revolver and your cash. If you have $105 million due, that leaves you with about $55 million in available cash. How much cash do you actually need to operate your business?

[David P. Cosper:]

About $30 million to $40 million, Colin. That’s probably high but I like some flexibility. I don’t want to get too tight.

[Colin Langan:]

Did you generate positive, operating cash this quarter?

[David P. Cosper:]

We did, we paid down debt, I think $8 million, something like that on top of everything else.

[Colin Langan:]

Any sense of how much, do you have an operating cash flow number?

[David P. Cosper:]

Not in front of me, no.

[Colin Langan:]

Do you expect with lower SAR expectations in the fourth quarter cash flow would be positive as well?

[David P. Cosper:]

Yes, we took a look at what ’09 might be if we stayed flat, what our free cash flow could be and after cap ex at $25 million we think we can generate free cash flow of $40 million to $45 million.

[Colin Langan:]

That’s next year with low SAR?

[David P. Cosper:]

Yes.

[Colin Langan:]

Have you seen any issues with manufacturers’ assistance with the financing? Have they been trying to cut it back?

[David P. Cosper:]

On floor plan financing?

[Colin Langan:]

Yes.

[David P. Cosper:]

Floor plan, no, some lighter rate adjustments, a few little tweaks here and there but nothing substantial.

[Colin Langan:]

Is that a risk going forward? How does that work? It has to be renegotiated or is it an ongoing negotiation?

[David P. Cosper:]

With the manufacturers it’s sort of the program they offer, we don’t really negotiate with them. They offer the same plan to everyone.

[Colin Langan:]

You mentioned your fixed operating strategy, how much cash costs will there be next year and where should we see the benefit? Is that more a revenue benefit or will there actually be some margin improvements as a result?

[David P. Cosper:]

There’s no cash costs and it’s both revenue and margin improvement.

[Colin Langan:]

Then we’ll start seeing those the first quarter of next year?

[Jeff Dyke:]

Actually you should start feeling some of the benefit of a few of the things that we’ve done in terms of expense and margin related items in the fourth quarter of this year.

[Colin Langan:]

Are there any covenant restrictions that would prevent you from selling dealerships to raise cash? Is there any rules around that? I know you have some discontinued.

[David P. Cosper:]

No.

[Colin Langan:]

What is the status of the ones that you have in discontinued ops that you’ve sold? How many and how many are left to go?

[David P. Cosper:]

There’s 12 stores there, we’re selling hopefully one today as we speak or tomorrow, this week that will generate $8 million or $9 million of cash. There’s another one closing later, probably in November. I see four fingers coming up. We’ve got three done and a couple others beyond the ones I just mentioned.

[Colin Langan:]

So you have 12 available now and you started the year with how many that you’re trying to sell?

[David P. Cosper:]

We’ve probably sold.

[Greg D. Young:]

We’ve sold three or four I think.

[Colin Langan:]

When is your target to sell the rest? Is that going to be delayed by the weak market?

[David P. Cosper:]

It’s a little bit more but it’s within 12 months.

[Operator:]

Your next question comes from Chris Gassen – Faircourt Valuation.

[Chris Gassen:]

I’m just going to mention two words and maybe you could just tell me whatever pops into your head. Share buy back.

[B. Scott Smith:]

Number one, tempting. I immediately reach for my wallet.

[Chris Gassen:]

Is there anything that you guys could spend money on in terms of capital expenditures, buying dealerships, whatever that would give us a better return than buying back our own stock at $2 and such?

[B. Scott Smith:]

No.

[Chris Gassen:]

Are we going to maybe do something? I’m hearing about all these things.

[B. Scott Smith:]

The company doesn’t have.

[Chris Gassen:]

Buy the land under our dealerships and all that stuff, I’m wondering why we want to buy the land under a dealership instead of just buying back some of our own stock.

[B. Scott Smith:]

Buying back the land under the dealership is really a non-cash event because we come in and put mortgages on top of it. We’re looking at the balance sheet. As we said it’s very tempting to want to buy back the stock right now and that obviously would be the best return to shareholders at this point in time in our view. But we have a broad number of people that we have status by, one of which is we want to maintain our liquidity to take out these notes in 2009. That’s really the main thing.

[David P. Cosper:]

And the ability to take those out. If I personally had the dry powder, I’d go and I’d load the boat.

[Operator:]

Your next question comes from Marshall Picher – Edge Asset.

[Marshall Picher:]

I apologize, I came on the call a little late, if this has already been addressed, Dave looking at your debt covenants, I believe if memory serves, you got a waiver back I think in May, the definition of fixed charges I think included that convertible maturity and if you hadn’t gotten the waiver, you would have been in violation. Is that correct?

[Greg D. Young:]

No, there wasn’t a waiver, Marshall. That was just an amendment to our facility I believe is what you’re referring to and it just clarified for calculation purposes when those notes go into the calculation.

[Marshall Picher:]

So it has been amended, there’s no need for November for that issue to be re-addressed?

[Greg D. Young:]

Right, that was done early in the year just as a kind of a cleanup to the documentation.

[Marshall Picher:]

The timing then for the retirement would be May of ’09?

[Greg D. Young:]

That’s correct.

[Operator:]

Your next question comes from Paul Carey – Fountain Capital.

[Paul Carey:]

I was wondering, Scott, if maybe you could expand a little bit on comments you made earlier discussing the status of the industry as we look at the potential for some of the manufacturers to be merging potentially. I realize that, and that’s primarily a domestic brand issue, but could you talk about how Sonic and more specifically the publicly traded dealers would fare in that environment if we were to see a merger of some brands?

[B. Scott Smith:]

Are you speaking about Chrysler and GM?

[Paul Carey:]

Yes.

[B. Scott Smith:]

I think it’s a possibility that from what I hear that it may happen. We have very low exposure to Chrysler. I think the world of the GM management, I think they’ve had a lot of legacy issues that they’ve had to try to overcome and I believe that the only reason why they would do a merger is because they believe that it’s in the best interests of the company.

[Jeff Dyke:]

One other thing is that if something like that were to occur there’d be fewer stores in the marketplace which would bolster our ability to perform better. That would be a positive coming out of that.

[Paul Carey:]

And maybe coming from exactly the opposite direction if say for example one of your brand manufacturers were to go bankrupt, given franchise laws what is your expectation as to how that process might proceed?

[B. Scott Smith:]

That would be highly speculative but if one of them were to go into bankruptcy, I would imagine that it the company would remain operational. Obviously there would still be dealers to sell them and service their vehicles. Whatever transpired in that restructuring work its way out.

[Paul Carey:]

One last question and that is with some of the impairment charges that you’re taking, there’s been some discussion and I’m not sure if it’s correct or not, that if impairment charges were to continue and I realize you said that there are probably more, if there are any they’re slight if anything but they could have an impact on your covenant calculations. Is that true?

[B. Scott Smith:]

They don’t actually hit our covenant calculations.

[Greg D. Young:]

They’re all add backs for the EBITDA as it’s defined in our debt calculations.

[Operator:]

You have a follow up question from Richard Kwas – Wachovia Capital Markets, LLC.

[Richard Kwas:]

Just quickly, what’s your restricted payments basket, Dave, at the end of the quarter?

[B. Scott Smith:]

Under our indenture, Rich? Is that the one you’re talking about?

[Richard Kwas:]

Yes, whatever you could, if you wanted to repurchase shares what?

[Greg D. Young:]

Yes, I think under the indenture I think we’re still at well over $100 million the last time we looked, Rich.

[David P. Cosper:]

That’s exactly right and we’ve got $40 some odd million authorized.

[Operator:]

There are no further questions at this time.

[B. Scott Smith:]

Thank you ladies and gentlemen.

[Operator:]

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