Sonic Automotive, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. The filing covers the three and six months ended June 30, 2018. Sonic operated 107 new-vehicle franchises, 15 collision repair centers and nine pre-owned stores, including six EchoPark locations in Colorado. Results are affected by dealership dispositions and the ongoing expansion of the pre-owned business; same-store measures are often the more comparable operating indicator.
Key financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $2,505.7m | $2,405.7m | $4,906.5m | $4,693.6m |
| Gross profit | $362.4m | $360.6m | $714.9m | $711.0m |
| Operating income | $50.6m | $42.2m | $70.8m | $78.6m |
| Income from continuing operations | $17.1m | $12.3m | $15.1m | $12.3m |
| Net income | $16.9m | $12.1m | $14.7m | $11.6m |
| Diluted EPS | $0.39 | $0.27 | $0.34 | $0.26 |
- Q2 gross margin was approximately 14.5% versus 15.0% a year earlier; operating margin was approximately 2.0% versus 1.8%. For the first half, gross margin was approximately 14.6% versus 15.1%, and operating margin was approximately 1.4% versus 1.7%.
- Q2 same-store revenue trends were mixed: new vehicles +1.6%, retail used vehicles +8.9%, fixed operations -0.2%, and finance, insurance and other (F&I) +12.3%. Same-store new-vehicle gross profit declined 6.3%; wholesale vehicle losses widened.
- Q2 same-store F&I gross profit per retail unit rose 8.4% to $1,481. Same-store fixed-operations gross margin improved 60 basis points to 48.4%.
- Pre-owned-store growth was substantial, but the segment reported a $27.3m loss in Q2 and $41.7m for the first half. Q2 same-store combined used-vehicle and F&I gross profit per unit fell 21.9% to $1,483.
Cash flow, debt and liquidity
- First-half operating cash flow was $38.1m, down from $92.9m. Investing activities provided $35.4m, including $122.4m of net proceeds from dealership sales, while financing activities used $71.7m. Cash ended at $8.2m.
- At June 30, long-term debt was $970.9m, excluding floor-plan financing. Floor-plan notes totaled approximately $1,464.7m. Total available liquidity resources were $211.6m, including $187.1m of revolving-credit availability.
- Current assets were $1,909.7m and current liabilities $1,847.3m. The revolving facility matures in November 2021; the 5.0% notes mature in 2023 and the 6.125% notes in 2027.
- Sonic reported compliance with debt covenants. Actual consolidated liquidity ratio was 1.13 against a 1.05 minimum; fixed-charge coverage was 1.43 against a 1.20 minimum; lease-adjusted leverage was 5.05 against a 5.75 maximum.
- First-half capital expenditures were $99.6m. Sonic repurchased $23.5m of stock and declared dividends of $0.12 per share for the first half.
Changes, outlook and notable items
- Reported first-half revenue increased 4.5%, while continuing-operations pretax income rose 5.2%. Comparisons include material unusual items and changes in the store portfolio; reported results should not be read as purely organic performance.
- Dealership dispositions generated a net gain of approximately $39.2m in the first half, including $38.0m in Q2. Sonic also recorded $14.0m of first-half impairment charges and non-recurring pre-owned-segment compensation charges of $32.5m ($23.3m in Q2). These items materially affect comparisons.
- Management estimated 2018 total U.S. new-vehicle SAAR of 16.8m–17.0m, versus an analyst average cited in the filing of about 16.8m. It expected to open three to four additional EchoPark stores in North Carolina and Texas by year-end 2018.
- Management anticipated BMW and Honda new-vehicle margin pressure through Q3, while expressing optimism about manufacturer support and new BMW models in Q4. It described the pre-owned pricing and inventory strategy as in transition; lower front-end margins were intended to support higher unit volumes and F&I gross.
- Revenue standard ASC 606 was adopted January 1, 2018 using the modified retrospective method. The filing says adoption increased operating income by $2.3m for Q2 and $3.0m for the first half; comparative periods were not restated. Management expected the new lease standard, planned for adoption in 2019, to materially affect balance-sheet presentation, primarily through lease assets and liabilities.
- Key risks include vehicle demand and pricing, availability and cost of consumer credit, manufacturer incentives and inventory allocation, higher interest rates, competition, dealership lease obligations, and potential tariffs or other import restrictions. A 100-basis-point rate increase would have added approximately $6.8m to first-half interest expense before considering other effects.
- Pending legal proceedings are not predictable; $4.9m was reserved at June 30, and Sonic could not estimate reasonably possible losses beyond accrued amounts. Dealership-sale indemnification exposure was estimated at up to $17.0m.
Most important facts for investors to verify
- How much of reported profit improvement depended on dealership-sale gains, and what underlying earnings look like excluding gains, impairments, storm/legal costs and compensation charges.
- Whether EchoPark can improve per-unit economics and reduce segment losses as new stores mature, without sacrificing sustainable gross profit for volume.
- Whether new-vehicle margin pressure at BMW and Honda eased as management anticipated, and whether wholesale losses and used-vehicle pricing stabilized.
- Whether operating cash generation, liquidity and covenant headroom remain adequate given floor-plan debt, capital spending, dividends and repurchases.
- The effects of interest-rate changes, lease accounting adoption, legal matters and possible trade restrictions on future results and obligations.