Sonic Automotive, Inc. — 2011 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; comparative periods ended September 30, 2010. Amounts below are in millions except per-share data, percentages, and where noted. Sonic operated 136 dealership franchises at 119 locations in 15 states, plus 24 collision repair centers.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $1,992.8 | $1,770.3 | $5,800.5 | $5,036.0 |
| Gross profit | $302.9 | $281.8 | $903.8 | $830.2 |
| Operating income | $53.8 | $46.7 | $161.9 | $131.8 |
| Income from continuing operations | $19.3 | $13.9 | $57.3 | $30.1 |
| Net income | $19.4 | $13.0 | $55.7 | $25.6 |
| Diluted EPS | $0.33 | $0.23 | $0.94 | $0.49 |
| Net cash from operating activities | — | $193.7 | $238.1 |
- Revenue grew 12.6% in Q3 and 15.2% year to date; net income increased 49% and 118%, respectively.
- Gross margin was approximately 15.2% in Q3 and 15.6% year to date, down from 15.9% and 16.5%. Operating margin improved to approximately 2.7% and 2.8%, from 2.6% in both comparative periods.
- Q3 new-vehicle revenue rose 12.9%, with unit sales up 7.9%; new-vehicle gross profit per unit increased 5.7%. Used-vehicle revenue rose 17.0%, but gross profit per unit fell 14.1%. Fixed-operations revenue rose 5.0%, while its gross margin declined 90 basis points to 48.7%. Finance and insurance revenue increased 19.8%.
- SG&A increased 5.5% in Q3 and 5.8% year to date, but declined as a share of gross profit to 78.8% and 78.7%, respectively.
Balance sheet, debt and liquidity
- At September 30, cash was $28.0 million; current assets were $1.067 billion and current liabilities $1.044 billion, a current ratio of about 1.02. Inventory was $815.6 million, down from $903.2 million at year-end 2010.
- Long-term debt, including current maturities, was $570.9 million. The filing reports total indebtedness of approximately $1.3 billion, including $757.8 million of floor-plan debt. Stockholders’ equity was $505.3 million.
- The July 2011 amended credit facilities extend to August 2016. The revolving facility had $88.2 million available at quarter-end after $18.0 million in borrowings and $40.3 million in letters of credit. Availability depends on borrowing-base assets and pledged Speedway Motorsports shares.
- Sonic reported compliance with credit-facility covenants. Actual liquidity, fixed-charge coverage and lease-adjusted leverage ratios were 1.11, 1.63 and 4.21, respectively; required thresholds then were at least 1.05, at least 1.15 and no more than 5.50.
- Operating cash flow was $193.7 million, down from $238.1 million. Investing used $134.5 million, principally for $135.9 million of property and equipment purchases; financing used $53.0 million. Cash increased $6.2 million to $28.0 million. Management notes that floor-plan classification between operating and financing cash flows can materially affect reported categories; treating all floor-plan changes as operating would yield $143.1 million of operating cash flow in 2011.
- Capital expenditures included $75.2 million to buy five previously leased dealership properties; $54.4 million of subsequent mortgage funding reduced the net expenditure. Contractor commitments for construction were $5.4 million.
Changes, outlook and risks
- Growth reflected higher vehicle volume and stronger finance-and-insurance results. New-vehicle unit growth exceeded the reported industry SAAR increase of 6.9% in Q3 and 10.6% year to date.
- The March 2011 Japan earthquake and tsunami disrupted Japanese-brand vehicle supply, affecting sales mix, new-vehicle revenue, used-vehicle sourcing and margins. Allocations were beginning to improve, but the timing of normalization and effects in Q4 and beyond remained uncertain.
- Management expected the continuing-operations effective tax rate to range from 38% to 41%. It said it expected to remain in compliance with credit covenants for the foreseeable future. No broader earnings or revenue guidance is provided in the supplied filing text.
- Interest-rate exposure remained material: variable-rate debt after swaps was approximately $436.2 million; a 100-basis-point rate change was estimated to change nine-month interest expense by about $3.5 million. Interest-rate swaps had a $39.3 million fair-value liability. The company estimated $9.2 million of net swap expense would be reclassified into earnings over the next 12 months.
- Legal contingencies include customer claims alleging improper sales of finance-and-insurance products. A federal court vacated an arbitration class-certification award in August 2011; claimants appealed, and the arbitration remained stayed pending a ruling. Sonic could not estimate a reasonably possible loss range; an adverse outcome could be material. Reserves for pending proceedings were $1.8 million at September 30.
- Other notable items: Sonic redeemed the remaining $42.9 million of 8.625% notes in August and repurchased about $7.4 million principal of convertible notes in Q3, recognizing a $0.7 million repurchase loss. Lease-exit accruals were $41.1 million. The company paid or declared dividends of $0.025 per share quarterly, subject to debt covenants and board discretion.
- Management identified seasonality, vehicle demand, manufacturer supply and incentives, consumer credit, competition, interest rates, economic conditions, and legal proceedings among factors that could affect results. Disclosure controls were assessed as effective; no material change in internal control was reported.
Investor verification priorities
- Track restoration of Japanese-brand supply and the effects on new-vehicle volume, used-vehicle acquisition costs and margins.
- Reconcile operating cash flow with floor-plan financing classifications and assess cash conversion against substantial capital spending.
- Monitor revolving-credit availability, borrowing-base collateral, covenant headroom, debt maturities and variable-rate exposure.
- Follow the customer class-action appeal and any change in the company’s ability to estimate or reserve for potential losses.
- Verify whether margin pressure in used vehicles and fixed operations persists, and whether the stated tax-rate outlook and dividend policy remain applicable.