Sonic Automotive, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; comparative periods ended September 30, 2013. Unaudited. Sonic operated 120 franchises across 13 states and 18 collision repair centers, organized as 101 stores, in one reportable operating segment.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $2,355.6m | $2,242.2m | $6,845.3m | $6,527.8m |
| Gross profit | $341.5m | $326.1m | $1,017.4m | $962.9m |
| Operating income | $56.9m | $57.8m | $171.1m | $175.3m |
| Income from continuing operations | $24.6m | $24.7m | $71.6m | $55.1m |
| Net income | $24.7m | $23.3m | $71.1m | $53.5m |
| Diluted EPS | $0.47 | $0.44 | $1.34 | $1.00 |
- Q3 revenue grew 5.1% and gross profit 4.7%, but operating income declined 1.5%. Gross margin was approximately 14.5%, versus 14.5% a year earlier; SG&A rose 6.1% and increased to 79.1% of gross profit from 78.1%.
- Nine-month revenue and gross profit increased 4.9% and 5.7%, respectively, while operating income declined 2.4%. Net income growth primarily reflected the prior-year $28.2m charge for extinguishing the 9.0% notes in 2013, not equivalent growth in operating income.
- Q3 new-vehicle revenue rose 5.3%, but gross profit fell 4.7% and gross profit per unit fell 7.9%. Used-vehicle revenue and gross profit increased 4.2% and 5.8%. Fixed Operations revenue increased 5.2%, while its gross margin declined 50 basis points to 47.7%. F&I revenue rose 12.0%, with reported gross profit per retail unit up 8.3%.
- For the nine months, new-vehicle revenue rose 3.3% and gross profit 1.6%; used-vehicle revenue rose 7.5% and gross profit 4.2%; Fixed Operations revenue rose 6.6% and gross profit 5.1%; F&I revenue rose 9.8%. Wholesale vehicle operations remained loss-making, though the loss narrowed.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $155.5m, versus $180.6m; investing cash outflow was $47.0m, versus $214.5m; financing cash outflow was $109.9m, versus $39.5m. Cash ended at $1.7m, down from $3.0m at year-end 2013.
- Capital expenditures were $89.9m, down from $127.5m. Investing cash flow included $15.3m for acquisitions and $51.4m of proceeds from property and dealership sales. Financing activity included $39.5m of treasury-stock purchases and $40.4m of mortgage debt issuance.
- At September 30, total debt reported in the long-term-debt note was $783.5m, including $24.0m current maturities; this excludes vehicle floor-plan payables. Floor-plan debt was $1,093.4m ($630.7m trade and $462.7m non-trade). Total debt therefore should not be assessed from the long-term-debt figure alone.
- Reported liquidity resources totaled $261.0m: $105.2m revolving-credit availability, $46.7m used-floor-plan availability, and a $107.5m floor-plan deposit, plus $1.7m cash. The deposit is classified in other current assets, not cash, and is not intended as a floor-plan prepayment.
- The amended credit facilities mature August 15, 2019. Revolver availability was $105.2m after $9.8m borrowings and $29.2m letters of credit. Sonic reported compliance with debt covenants; actual liquidity, fixed-charge coverage, and lease-adjusted leverage ratios were 1.22, 1.74, and 4.14, respectively, against required thresholds of 1.05, 1.20, and a maximum 5.50.
Changes, outlook and risks
- On July 23, 2014, Sonic amended and extended its revolving and floor-plan facilities to August 2019; the combined floor-plan commitment increased to $800m, subject to borrowing-base limits and possible conditional expansion.
- Sonic acquired two franchises for $15.3m and disposed of five franchises during the nine months, generating approximately $30.1m net cash. Two franchises were disposed of in Q3. Disposal gains and lease-exit adjustments affected reported results; the filing also reports storm-related damage costs partly offset by dealership-sale gains.
- Management expected to begin sales at its first EchoPark pre-owned location in Denver in Q4 2014. The One Sonic-One Experience initiative was being piloted at a Charlotte Toyota dealership. Management said it expected sufficient cash flow for debt service and operating needs for the next 12 months and foreseeable future; this is a forecast, not a guarantee. No specific earnings guidance was provided.
- Management expected a 38%–40% effective tax rate in future quarters. Its stated strategic initiatives, including EchoPark and One Sonic, contributed to higher SG&A as a percentage of gross profit during the period.
- Interest-rate exposure is material: variable-rate instruments, after swaps, totaled approximately $900.2m; a 100-basis-point rate change would have changed nine-month interest expense by approximately $6.6m. Interest-rate swaps had a net fair-value liability of about $10.6m.
- Risks include vehicle demand, manufacturer supply and incentives, consumer credit availability, pricing competition, interest rates, execution of new initiatives, and legal or regulatory matters. Sonic reported pending legal proceedings and could not estimate reasonably possible losses beyond accrued reserves; reserves for proceedings totaled approximately $2.3m. Certain sale-related indemnifications had maximum stated exposure of $16.8m, although their estimated fair value was not material.
- Basic controls were reported effective at September 30, 2014, with no material change in internal control over financial reporting during the quarter.
Investor verification points
- Assess whether operating profit and margins can recover as revenue grows, particularly new-vehicle gross profit per unit and rising SG&A burden.
- Separate recurring performance from the 2013 debt-extinguishment charge, dealership-sale gains, and lease-exit adjustments when comparing earnings.
- Reconcile liquidity resources, especially the floor-plan deposit, borrowing-base availability, and the very low cash balance; monitor covenant headroom and floor-plan obligations.
- Track the returns and costs of EchoPark and One Sonic, and whether improved F&I and used-vehicle results persist.
- Review variable-rate exposure, hedge maturities and fair values, pending litigation and indemnities, and the timing and funding of committed construction projects.