Sonic Automotive, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; filed April 27, 2012. Unless stated otherwise, amounts below are in U.S. dollars.
Business context
Sonic operated 118 dealerships across 15 states, representing 28 brands, and 24 collision repair centers. Its businesses include new and used vehicle sales, parts and service, collision repair, and finance and insurance products.
Financial performance
- Revenue: $1.988 billion, up 9.3% from $1.818 billion in Q1 2011. New vehicle revenue rose 9.5%, used vehicle revenue 9.0%, parts/service/collision revenue 5.1%, and finance, insurance and other revenue 20.7%.
- Gross profit and margins: Gross profit was $311.9 million, up 8.6%; gross margin was approximately 15.7%, slightly below the prior-year period. SG&A was $247.5 million, up 8.1%, and declined to 79.4% of gross profit from 79.7%.
- Operating and net income: Operating income was $53.3 million, up 10.4%. Income from continuing operations was $19.5 million versus $15.7 million. Net income was $20.5 million versus $15.0 million; diluted EPS was $0.35 versus $0.26. Q1 2012 included $1.0 million of after-tax income from discontinued operations.
- Cash flow: Operating cash flow was negative $39.2 million, versus positive $18.4 million a year earlier, primarily reflecting a $130.8 million inventory cash outflow. Investing activities provided $9.2 million, including dealership-sale proceeds; financing activities provided $30.5 million. Cash ended the quarter at $2.4 million. Management notes that floor-plan financing classification affects reported operating cash flow; including both trade and non-trade floor-plan changes, operating cash use would have been approximately $16.1 million.
- Debt and liquidity: Total debt was $557.1 million, excluding approximately $912.0 million of trade and non-trade floor-plan notes; the filing describes total indebtedness, including floor plan, as approximately $1.5 billion. Current assets were $1.263 billion and current liabilities $1.202 billion. Revolver borrowing availability was approximately $129.7 million after letters of credit. The company reported compliance with debt covenants: liquidity ratio 1.16 versus a 1.05 minimum, fixed-charge coverage 1.64 versus a 1.20 minimum, and lease-adjusted leverage 3.95 versus a 5.50 maximum.
- Other metrics: The company declared a $0.025-per-share quarterly dividend. Capital expenditures were approximately $12.0 million, with $23.0 million of construction commitments outstanding at quarter-end.
Material changes versus Q1 2011
- U.S. industry new-vehicle sales (SAAR) increased 12.4%. Sonic’s new-vehicle unit sales rose 7.5%, while retail new-vehicle volume excluding fleet increased 11.2%. Used-vehicle units rose 6.6%; finance and insurance gross profit per retail unit increased 10.7%.
- Fixed-operations gross profit increased 3.9%, but its gross margin declined 60 basis points to 48.7%. Wholesale results improved from a gross loss to a small gross profit.
- Operating cash flow weakened substantially, largely because of inventory investment; inventories increased to $986.1 million from $863.1 million at year-end 2011.
- Three dealerships were disposed of for approximately $20.0 million in cash, producing a reported $5.7 million gain on disposal before related lease-exit charges. No dealerships were held for sale at March 31.
Outlook, risks and unusual items
- Management expected Japanese import brands’ performance in the remaining 2012 quarters to compare favorably with the corresponding 2011 periods, citing recovering Honda and Toyota supply; Lexus had not yet rebounded. This was an expectation, not formal earnings guidance.
- Management forecast a 38%–40% effective tax rate for continuing operations. It provided no numerical revenue or earnings guidance.
- A March 2012 chemical-plant fire in Germany disrupted production of resin used in vehicle brake- and fuel-line tubing; the effect on manufacturers’ production and vehicle availability was uncertain. The filing also discusses lingering supply-chain effects from Japan’s earthquake and tsunami and Thailand’s flooding.
- After quarter-end, Sonic repurchased approximately $20.2 million principal amount of its 5.0% Convertible Notes. Holders could convert those notes from April 1 through June 30, 2012; any conversion settlement could be in cash, shares, or both, at Sonic’s election. Cash settlement could pressure liquidity and covenant compliance.
- On April 19, 2012, the credit-facility liquidity covenant was amended to remain at a 1.05 minimum, rather than increase to 1.10. The company said it was in compliance at quarter-end and expected continued compliance.
- Interest-rate swaps had a reported net fair-value liability of approximately $34.8 million. A 100-basis-point rate change was estimated to affect quarterly interest expense by approximately $1.3 million after swaps.
- A customer class-action dispute involving finance-and-insurance products had a settlement agreement in principle, subject to formal documentation and court approval. Sonic reported $7.3 million of reserves for pending proceedings but could not estimate potential losses beyond recorded reserves. Lease and sale-related indemnifications also remain relevant contingencies.
- Management said disclosure controls were effective. During the quarter, it implemented changes to address a material weakness identified during the year-end audit concerning reclassification of negative book cash balances and review of related period-end journal entries.
Important facts for investors to verify
- Whether inventory growth converts into sales and operating cash flow, and how much reported cash flow is affected by floor-plan classification.
- Current revolver availability, covenant headroom, and the effect of the amended liquidity covenant and any future debt maturities or put rights.
- The cash-versus-share settlement of the convertible-note repurchase and any further conversions or repurchases after quarter-end.
- Progress on Japanese vehicle supply recovery, potential effects of the German resin disruption, and corresponding impacts on sales and margins.
- Final documentation and court approval of the customer litigation settlement, and any change in reserves or other contingencies.
- Whether remediation of the identified internal-control weakness remains effective in subsequent filings.