Sonic Automotive, Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022; unaudited. Comparisons are with the corresponding 2021 periods. Sonic operates franchised dealerships and EchoPark used-vehicle stores. The quarter was the third full quarter to include locations acquired in the December 2021 RFJ Auto acquisition.
Key financial results
| Metric | Q3 2022 | Q3 2021 | First nine months 2022 | First nine months 2021 |
|---|---|---|---|---|
| Revenue | $3,448.1 million | $3,072.8 million | $10,410.5 million | $9,211.9 million |
| Gross profit | $580.7 million | $472.0 million | $1,740.9 million | $1,383.7 million |
| Operating income | $148.9 million | $125.4 million | $458.1 million | $378.7 million |
| Net income | $87.3 million | $84.5 million | $279.4 million | $252.6 million |
| Diluted EPS | $2.23 | $1.95 | $6.90 | $5.82 |
| Adjusted EBITDA | $176.4 million | $150.7 million | $547.7 million | $451.7 million |
Q3 gross margin was approximately 16.8% versus 15.4% a year earlier; operating margin was approximately 4.3% versus 4.1%. Q3 income from continuing operations before tax rose 4% to $116.4 million, while net income increased about 3%. Adjusted EBITDA is a non-GAAP measure.
- Cash flow: Nine-month operating cash flow was $645.4 million, versus $266.4 million in 2021; investing cash use was $276.1 million and financing cash use was $529.7 million. Cash declined $160.4 million to $139.0 million. Operating cash flow included working-capital movements; Sonic notes that floor-plan financing classification can materially shift reported operating versus financing cash flows.
- Liquidity: Reported available liquidity resources were $482.4 million at September 30, including $139.0 million cash, $281.0 million revolver availability, $30.4 million mortgage-facility availability and a $32.0 million floor-plan deposit balance. This compares with $702.8 million at year-end 2021.
- Debt and interest: Total debt was $1,522.4 million, including current maturities, compared with $1,561.3 million at December 31, 2021. Floor-plan notes totaled approximately $1,054.9 million. Q3 floor-plan interest expense was $9.6 million versus $3.3 million; other net interest expense was $22.9 million versus $9.8 million. Sonic cited higher rates and debt issued to finance the RFJ acquisition.
- Capital returns and investment: Sonic repurchased 3.1 million Class A shares for $152.1 million in Q3. Nine-month repurchases were $245.2 million and dividends paid were $25.2 million. Nine-month capital expenditures were $197.6 million, including $101.8 million for EchoPark and $95.8 million for franchised dealerships.
Performance changes and operating context
- Revenue rose 12% in Q3 and 13% year to date, reflecting higher vehicle prices, RFJ acquisition contributions and growth in fixed operations. The filing cautions that acquisition-related changes make reported comparisons less indicative of existing-store performance.
- Franchised Dealerships pretax segment income was $146.3 million in Q3, up 1%; nine-month income was $472.2 million, up 24%. New-vehicle gross profit per unit benefited from constrained supply and higher selling prices. Same-store retail new-vehicle units fell 6% in Q3 and 19% year to date.
- EchoPark reported a Q3 pretax loss of $29.9 million, improving from a $32.9 million loss; its nine-month loss widened to $99.7 million from $45.3 million. Q3 segment revenue fell 8%, and retail used-vehicle units fell 27%. Lower inventory acquisition costs helped raise combined used-vehicle and F&I gross profit per unit to $2,880 from $1,023.
- Franchised same-store used-vehicle gross profit declined 20% in Q3, with per-unit gross profit down 9%. Consolidated wholesale vehicle gross profit was a $2.1 million loss in Q3, versus a $1.2 million profit in 2021, as auction prices declined.
- Fixed Operations revenue increased 19% and gross profit 17% in Q3, but reported gross margin declined to 49.7% from 50.3%. F&I revenue was up 1% consolidated, while per-retail-unit F&I gross profit increased 5%.
- SG&A rose 24% in Q3 to $399.0 million, primarily reflecting RFJ and EchoPark expansion. Other net interest expense and floor-plan interest also increased substantially.
Outlook, risks and unusual matters
- No specific consolidated earnings or revenue guidance is provided. Sonic’s EchoPark plan targets a physical and digital distribution network reaching 90% of the U.S. population by 2025.
- Management expected tight vehicle inventory to continue into 2023. It noted that wholesale prices had been declining while remaining above historical levels, and expected the trend toward improved used-vehicle gross profit per unit to continue through late 2022 and into 2023. These are expectations, not guarantees.
- Key risks include supply-chain and semiconductor disruptions, vehicle availability and pricing normalization, higher interest rates, inflation, recession and consumer-credit conditions, competition, EchoPark execution, and the ability to maintain covenant compliance and liquidity. A 100-basis-point rate change was estimated to affect nine-month interest expense by approximately $13.3 million, mainly through floor-plan facilities.
- Debt covenants were met at September 30, 2022. Revolver availability was $281.0 million; the company also had $30.4 million available under its mortgage facility. An October 7, 2022 credit amendment replaced LIBOR-based reference options with Term SOFR and made other facility changes.
- Control weakness: Sonic reported a material weakness in revenue-recognition controls at one dealership acquired in 2021, relating to principal-versus-agent accounting for fleet sales. It overstated fleet revenue and fleet cost of sales by equal amounts for Q3; management said the misstatement was corrected and the presented financial statements fairly state results. Disclosure controls were deemed ineffective as of September 30. Remediation was underway, with completion expected by December 31, 2022.
- Sonic is involved in ordinary-course legal and administrative proceedings; it could not estimate a reasonably possible loss range beyond recorded reserves. Reserves for pending proceedings were approximately $0.7 million at September 30. It also guaranteed $4.3 million of floor-plan commitments for a 50%-owned joint venture.
Important facts for investors to verify
- Whether the revenue-recognition material weakness was remediated as expected and whether controls are operating effectively.
- EchoPark’s path to reducing losses, inventory days and unit-sales declines while achieving the stated expansion plan.
- How margins and earnings respond to vehicle supply recovery, used-vehicle price normalization and changing auction economics.
- Liquidity and covenant headroom after buybacks, dividends, capital expenditures and debt service; also distinguish cash from the floor-plan deposit included in reported liquidity resources.
- Exposure to variable-rate debt and floor-plan financing, and the effect of the LIBOR-to-SOFR transition.