Sonic Automotive, Inc. — Q2 2017 Form 10-Q
Business context and period. This unaudited filing covers the three and six months ended June 30, 2017, compared with the same 2016 periods. Sonic operated 117 franchises, 18 collision repair centers and seven EchoPark stores across 13 states. Results reflect franchised dealerships and its growing stand-alone used-vehicle business, EchoPark. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Change |
|---|---|---|---|
| Revenue | $2,405.7 | $2,382.3 | +1.0% |
| Gross profit | $360.6 | $353.3 | +2.1% |
| Operating income | $42.2 | $57.0 | -26.1% |
| Income from continuing operations | $12.3 | $23.0 | -46.6% |
| Net income | $12.1 | $22.8 | -46.8% |
| Diluted earnings per share | $0.27 | $0.50 | Down $0.23 |
Q2 gross margin was approximately 15.0% versus 14.8% a year earlier; operating margin was approximately 1.8% versus 2.4%. Revenue growth was mainly supported by used vehicles, fixed operations and EchoPark, while lower new-vehicle sales and higher expenses weighed on earnings.
- Six-month results: Revenue was $4,693.6, up 1.7%; operating income was $78.6, down 20.9%; net income was $11.6, down 69.0%; diluted EPS was $0.26 versus $0.80. Results included a $14.6 million debt-extinguishment charge.
- Q2 business trends: Same-store retail new-vehicle revenue fell 3.1% and unit sales fell 3.4%; new-vehicle gross profit per retail unit declined 1.9% to $1,940. Same-store used-vehicle gross profit rose 3.6%, with gross profit per unit up 3.2% to $1,266. Same-store fixed-operations revenue and gross profit increased 1.5% and 1.8%, respectively. Same-store F&I revenue rose 0.7%; F&I gross profit per retail unit increased 2.4% to $1,374.
- Segments: Q2 franchised-dealership segment income was $40.5 million, down 24.3%. EchoPark revenue rose 66.4% to $49.1 million, but its segment loss widened to $7.5 million from $3.2 million. EchoPark’s used-vehicle and F&I gross profit per unit declined year over year.
Cash flow, balance sheet and capital
- Six-month operating cash flow was $92.9 million, versus $106.7 million; investing cash outflow was $120.9 million, primarily capital expenditures. Capital expenditures totaled $121.2 million, including construction, real estate acquisitions and operating assets.
- Cash was $4.4 million at June 30. Reported available liquidity resources totaled $244.6 million, including $194.1 million available under the revolving facility, $23.1 million under floor-plan facilities and a $23.0 million floor-plan deposit. These resources are not equivalent to cash on hand.
- Long-term debt was $954.6 million, compared with $882.7 million at year-end 2016; this excludes floor-plan payables, which totaled approximately $1,481.3 million. Sonic issued $250 million of 6.125% notes due 2027 and used the proceeds principally to retire its 7.0% notes due 2022, recording a $14.6 million extinguishment loss.
- Debt-facility covenant measures were compliant at June 30: liquidity ratio 1.14 versus 1.05 minimum; fixed-charge coverage ratio 1.95 versus 1.20 minimum; lease-adjusted leverage ratio 4.38 versus 5.75 maximum. Revolving-facility availability was $194.1 million.
- Six-month share repurchases were $25.9 million; remaining authorization was $119.1 million. Dividends declared were $0.10 per share for the first half.
Outlook, management commentary and risks
- Management estimated 2017 total new-vehicle industry SAAR of 16.5–17.0 million, versus 16.6 million in Q2 and 16.9 million for the first half. It warned that consumer confidence, financing availability, production and manufacturer incentives could affect results. No company earnings guidance was provided.
- Sonic expected to break ground on approximately 15 EchoPark locations during 2017–2018 in Florida, Georgia, North Carolina, South Carolina and Texas. Management cautioned that expansion and the One Sonic-One Experience initiative may pressure near-term results and require capital.
- Management cited persistent competitive pricing and elevated inventory as pressures on new-vehicle margins, and said the Houston market continued to weigh on sales and gross profit. It anticipated new-vehicle margin pressure could continue through 2017. Higher floor-plan interest rates also increased expense.
- Q2 pre-tax results included approximately $4.6 million of storm-related physical damage expense, $1.0 million of legal accruals, $1.0 million of lease-exit charges and $2.6 million of impairments. The six-month period included approximately $7.0 million of storm-related expense and $3.1 million of impairment charges. Two stand-alone pre-owned stores acquired in 2016 were closed, contributing to impairments and lease-exit charges.
- After quarter-end, storm damage affected vehicle inventory at Ohio stores; preliminary estimated loss not covered by insurance was approximately $1.0 million. Pending legal proceedings are not predictable; Sonic held reserves of approximately $2.7 million and could not estimate potential losses beyond accrued amounts.
- Other risks include variable-rate exposure: Sonic estimated that a 100-basis-point rate change would have changed six-month interest expense by approximately $7.1 million. Management also identified manufacturer relationships, consumer credit, competition, seasonality and legal or regulatory matters as risks. Expected future effective tax rate was 38%–40%, before discrete items or valuation-allowance changes.
Investor verification priorities
- Reconcile the decline in earnings, including the debt-extinguishment loss and storm, legal, lease-exit and impairment charges; assess which costs may recur.
- Track same-store new-vehicle volume and margins, Houston-market recovery, and used-vehicle inventory and gross profit per unit.
- Evaluate EchoPark’s store-level economics, per-unit profitability, start-up losses and planned expansion funding needs.
- Monitor cash generation against capital spending, floor-plan financing, debt service, repurchases and dividends; distinguish cash from reported liquidity availability.
- Check covenant headroom, interest-rate sensitivity, legal contingencies and the final cost of the post-quarter Ohio storm damage.