Sonic Automotive, Inc. — Q3 2018 Form 10-Q
Business context and reporting period. This unaudited filing covers the three and nine months ended September 30, 2018, compared with the same periods in 2017. Sonic operated franchised dealerships and stand-alone used-vehicle stores under the EchoPark brand; at quarter-end it had 107 new-vehicle franchises, 15 collision repair centers, and seven EchoPark stores.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $2,470.8 million | $2,505.7 million | $7,377.4 million | $7,199.3 million |
| Gross profit | $360.5 million | $362.6 million | $1,075.4 million | $1,073.6 million |
| Operating income | $48.1 million | $55.8 million | $119.0 million | $134.4 million |
| Income from continuing operations | $15.3 million | $19.7 million | $30.4 million | $32.0 million |
| Net income | $15.1 million | $19.4 million | $29.8 million | $31.0 million |
| Diluted earnings per share | $0.35 | $0.44 | $0.69 | $0.70 |
- Q3 gross margin was approximately 14.6%; nine-month gross margin was approximately 14.6%. SG&A equaled 80.2% of gross profit in Q3, versus 78.3% a year earlier; it was 81.0% for both nine-month periods.
- Operating cash flow was $155.5 million for the first nine months, versus $188.1 million. Investing activities provided $1.2 million, largely reflecting dealership sale proceeds; financing activities used $155.5 million. Ending cash was $7.6 million.
- At September 30, cash was $7.6 million and total available liquidity resources were $219.7 million, including $192.8 million of revolving-credit availability. Current assets were $1,864.0 million and current liabilities $1,812.9 million.
- Long-term debt, including current maturities, totaled $990.6 million, excluding floor-plan balances. Trade and non-trade floor-plan notes totaled approximately $1,407.0 million. The revolving facility had $13.5 million drawn and $192.8 million available after letters of credit.
- Quarter-end stockholders’ equity was $803.8 million. The company declared a $0.06-per-share quarterly dividend and repurchased approximately 1.2 million shares for $24.1 million during the nine-month period.
Material changes versus prior comparable periods
- Q3 reported revenue fell 1.4% and operating income fell 13.7%; nine-month revenue rose 2.5%, while operating income fell 11.5%. Nine-month results included dealership-disposition gains and substantial EchoPark compensation charges.
- In Q3, same-store new-vehicle revenue declined 4.2% and unit sales declined 6.5%. Same-store used-vehicle revenue rose 6.3% and units rose 7.8%, but used-vehicle gross profit per unit fell 7.1%. Same-store fixed-operations gross profit increased 2.8%, and F&I revenue increased 2.1%.
- For the first nine months, EchoPark revenue increased to $497.6 million from $148.0 million, but its segment loss widened to $46.7 million from $17.6 million. The 2018 loss included $32.5 million of long-term compensation-related charges.
- Sonic disposed of six franchised dealerships during the first nine months, generating approximately $121.9 million in net cash. It also terminated one luxury franchise and ceased operations at three EchoPark stores. Dispositions and store changes affect year-over-year comparability.
- Floor-plan interest expense increased: Q3 expense was $12.2 million versus $8.9 million, and nine-month expense was $34.8 million versus $26.4 million, reflecting higher balances and rates.
Outlook, management commentary, and risks
- Management estimated 2018 total new-vehicle industry SAAR of 16.8–17.0 million; its reported average analyst expectation was approximately 16.8 million. This is an industry estimate, not company earnings guidance.
- Sonic expected to open two additional EchoPark stores in North Carolina and Texas by year-end 2018. Management cautioned that EchoPark expansion may weigh on near-term results as it uses capital and management resources.
- Management cited improvement in BMW and Honda new-vehicle gross profit per unit during Q3, but levels remained below historical performance. It was optimistic that manufacturer support and BMW model releases in Q4 could support demand and profitability.
- Management expected an annual effective tax rate of 26%–28%, before valuation-allowance changes or discrete tax items. Adoption of the new revenue standard had a $3.9 million opening retained-earnings benefit; the company did not expect a material ongoing net-income impact. The company expected lease-accounting changes effective January 1, 2019 to materially affect balance-sheet presentation and certain cash-flow and income-statement disclosures; the quantitative impact was not yet provided.
- Key risks include vehicle demand and pricing, manufacturer incentives and inventory allocations, consumer credit availability, competition, interest-rate exposure, EchoPark execution and financing needs, and legal proceedings. A 100-basis-point interest-rate increase would have changed nine-month interest expense by approximately $10.0 million, after considering interest-rate caps.
- Pending legal matters carried reserves of approximately $2.3 million. Sonic said it could not estimate a reasonably possible loss range beyond recorded reserves. Dealership-sale indemnification exposure was estimated at a maximum of $14.0 million; its recorded fair value was not material. Lease guarantees and other contingencies may also create exposure.
Important facts for investors to verify
- Whether EchoPark can grow unit sales while improving per-unit economics and reducing operating losses, particularly after the significant compensation charges.
- How much reported earnings depended on dealership-sale gains, and whether ongoing franchised-dealership performance supports earnings without such gains.
- Used-vehicle gross-profit trends, wholesale losses, and the effect of pricing and inventory strategies on margins and cash generation.
- Floor-plan and other variable-rate debt exposure, covenant headroom, and the sustainability of liquidity given low cash balances and planned capital spending.
- The eventual quantified balance-sheet impact of lease-accounting adoption, as well as outcomes and potential costs of legal, lease, and indemnification contingencies.