Sonic Automotive, Inc. — Q2 2016 Form 10-Q
Business context and period: Unaudited results for the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. Sonic operated 114 franchises in 13 states, 18 collision repair centers, and five EchoPark stores at quarter-end. Dollar figures below are in millions unless noted.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $2,382.3 | $2,423.7 | $4,616.9 | $4,659.3 |
| Gross profit | $353.3 | $355.6 | $698.5 | $690.5 |
| Operating income | $57.0 | $43.1 | $99.4 | $84.6 |
| Net income | $22.8 | $14.8 | $37.4 | $28.7 |
| Diluted EPS | $0.50 | $0.29 | $0.80 | $0.56 |
| Operating cash flow | — | $106.7 | $54.3 |
- Revenue fell 1.7% in Q2 and 0.9% in the first half. Gross profit was nearly flat in Q2 and rose 1.1% for the half. Calculated gross margin increased to approximately 14.8% in Q2 and 15.1% year to date, from 14.7% and 14.8%, respectively.
- Operating income rose 32.3% in Q2 and 17.4% year to date; operating margin was approximately 2.4% and 2.2%, respectively. Lower impairment charges versus 2015 contributed to the improvement.
- Q2 SG&A was $277.2 million, down 2.6%; first-half SG&A was $561.6 million, up 1.1%. Impairment charges were $0.2 million for the first half, compared with $16.7 million in 2015.
- First-half cash from operations of $106.7 million was more than offset by $108.1 million of investing outflows, primarily $109.0 million of capital expenditures. Financing cash flow was $0.2 million; cash declined $1.2 million to $2.4 million.
- At June 30, cash was $2.4 million and reported available liquidity resources totaled $242.1 million, including $175.8 million of revolver availability, $38.9 million of used-vehicle floor-plan availability, and a $25.0 million floor-plan deposit.
- Long-term debt was $878.3 million, excluding floor-plan notes payable of $1,442.4 million. Debt balances include $500 million of senior subordinated notes. Total assets were $3,511.2 million and stockholders’ equity was $674.9 million.
- First-half capital expenditures were $109.0 million; $76.3 million was financed with mortgages. The company reported $33.8 million of construction commitments.
Material changes and operating trends
- Same-store retail new-vehicle units declined 3.3% in Q2 and 3.0% year to date. Q2 retail new-vehicle gross profit per unit improved 4.7% to $1,977, but first-half new-vehicle gross profit declined 2.7%.
- Same-store retail used-vehicle revenue declined 4.2% in Q2 and 1.1% for the half. Gross profit per unit fell 4.8% in Q2 and 5.4% year to date, amid elevated inventory and used-vehicle supply.
- Same-store fixed-operations revenue rose 3.0% in Q2 and 5.9% for the half. However, warranty gross profit fell 8.5% and 1.2%, respectively, and total fixed-operations gross margin contracted.
- Same-store F&I revenue increased 2.9% in Q2 and 6.2% for the half; F&I gross profit per retail unit rose 5.7% and 6.9%, respectively.
- EchoPark revenue rose 40.5% in Q2 to $29.5 million and 46.0% for the half to $53.5 million. It remained loss-making, with a Q2 operating loss of $3.0 million and first-half operating loss of $6.2 million.
- First-half share repurchases totaled $87.5 million for approximately 4.9 million shares, reducing outstanding shares by approximately 9.7% from year-end. Remaining authorization was $57.5 million. The quarterly dividend was $0.05 per share.
Outlook, risks, and unusual items
- Management estimated 2016 total U.S. new-vehicle SAAR at 17.3–17.6 million; this is an industry estimate, not company earnings guidance. Analysts’ average industry expectation cited was approximately 17.7 million.
- Management expected downward pricing pressure and elevated inventory to continue to affect new-vehicle gross margins during 2016. It also described near-term costs from EchoPark expansion and the One Sonic-One Experience rollout, while pursuing longer-term benefits.
- Open safety recalls restricted sales of approximately 500 new and 4,200 used vehicles at quarter-end. Management said these stop-sale vehicles increased inventory, days’ supply, and floor-plan interest and could continue to weigh on sales and results until parts became available.
- Approximately $6.0 million of first-half SG&A expense related to hail and flood damage in Texas. Q2 results also reflected lower prior-year physical-damage and legal costs. The filing reported no acquisitions in the first half of 2016.
- Interest-rate exposure remained material: a 100-basis-point increase would have increased first-half interest expense by approximately $5.9 million, including $5.1 million from floor-plan facilities. Interest-rate swaps had a reported fair-value liability of approximately $17.5 million.
- Sonic was in compliance with credit-facility covenants at June 30. Actual ratios versus requirements were: liquidity 1.17 versus minimum 1.05; fixed-charge coverage 1.76 versus minimum 1.20; lease-adjusted leverage 4.24 versus maximum 5.50. Legal proceedings are numerous; beyond recorded reserves, the company said it could not estimate a reasonably possible loss range.
- Management expected an effective tax rate of 38%–40%, before valuation-allowance changes or unusual discrete tax adjustments. The filing cautions that results are seasonal and interim results are not necessarily indicative of full-year performance.
Investor verification priorities
- Track clearance of stop-sale inventory, related floor-plan costs, and resulting retail volumes and margins.
- Assess whether used-vehicle gross profit per unit and fixed-operations margins stabilize, and whether F&I gains persist.
- Evaluate EchoPark expansion costs, store openings, unit economics, and progress toward profitability.
- Reconcile liquidity, floor-plan financing, debt maturities, mortgage funding, construction commitments, and covenant headroom.
- Review the cash-flow impact and sustainability of share repurchases and dividends alongside capital spending.
- Monitor legal proceedings, Texas hail/flood costs, swap liabilities, interest-rate sensitivity, and the company’s industry SAAR assumptions.