Sonic Automotive, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Unless noted otherwise, financial amounts below are in millions. Sonic operated 91 franchised-dealership stores and eight EchoPark stores at quarter-end.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $2,702.7 | $2,470.8 | $7,705.9 | $7,377.4 |
| Gross profit | $386.8 | $360.5 | $1,127.1 | $1,075.4 |
| Operating income | $65.2 | $48.1 | $215.5 | $119.0 |
| Income from continuing operations | $29.2 | $15.3 | $98.3 | $30.4 |
| Net income | $29.0 | $15.1 | $97.8 | $29.8 |
| Diluted EPS | $0.66 | $0.35 | $2.25 | $0.69 |
- Q3 revenue grew 9.4%; gross profit rose 7.3%. Gross margin was approximately 14.3%, compared with 14.6% a year earlier. Operating income increased 35.5%.
- Nine-month revenue rose 4.5% and gross profit 4.8%. Operating income more than increased due to the prior-year comparison and current-year dealership-sale gains.
- Q3 net income included $0.2 million of losses from discontinued operations. Nine-month results included $0.4 million of discontinued-operation losses.
- Q3 SG&A was $296.8 million, up 2.7%; it was 76.7% of gross profit versus 80.2% a year earlier. Nine-month SG&A was $838.5 million, down 3.8%, and 74.4% of gross profit versus 81.0%.
Business trends and period comparisons
- EchoPark expanded rapidly: Q3 segment revenue increased 67.9% to $312.2 million and segment income was $2.5 million, versus a $5.0 million loss. Nine-month revenue rose 71.5% to $853.5 million; segment income was $5.2 million versus a $46.7 million loss. Prior-year EchoPark results included $32.5 million of long-term compensation charges. EchoPark had eight stores, including three in Colorado, four in Texas and one in North Carolina.
- Franchised dealerships: Q3 segment revenue rose 4.6% to $2,390.5 million and segment income rose 24.5% to $51.0 million. Nine-month revenue declined 0.4% to $6,852.5 million, while segment income rose 32.1% to $172.9 million.
- New vehicles: Same-store Q3 unit sales increased 3.1% and revenue 6.7%, but gross profit declined 6.2%; gross profit per unit fell 9.0% to $1,825. Over nine months, same-store units decreased 2.4%, while revenue increased 1.7% and gross profit per unit was flat at $1,982.
- Used vehicles and F&I: Franchised-dealership same-store Q3 used-unit sales rose 11.4%, but gross profit per unit declined 7.1% to $1,235. Same-store F&I gross profit per retail unit increased 12.1% to $1,587. EchoPark same-store used-unit sales rose 48.3% in Q3; combined used-vehicle and F&I gross profit per unit increased 10.4% to $2,151.
- Fixed operations: Franchised-dealership same-store revenue and gross profit grew 6.1% and 7.8% in Q3, respectively; gross margin increased 80 basis points to 49.2%. EchoPark fixed-operations gross profit declined, with the company citing its inventory strategy and lower reconditioning per vehicle.
Cash flow, debt and liquidity
- Nine-month operating cash flow was negative $25.6 million, compared with positive $155.5 million in 2018. Investing cash flow was positive $66.3 million, including $130.1 million of dealership-sale proceeds; capital expenditures were $74.5 million. Financing cash flow was negative $44.1 million. Cash declined to $2.4 million from $5.9 million at year-end.
- Management noted that floor-plan financing classifications affect reported operating versus financing cash flow. Combining trade and non-trade floor-plan changes, floor-plan financing used $87.3 million in the first nine months; on an all-floor-plan-operating presentation, operating cash flow would have been negative $34.4 million.
- At September 30, long-term debt, including current maturities, was $909.1 million; vehicle floor-plan notes totaled approximately $1,446.8 million. Lease liabilities totaled approximately $377.0 million. These balances should not be conflated: floor-plan financing funds vehicle inventory, while lease liabilities were recognized following adoption of the new lease standard.
- Reported available liquidity resources were $317.2 million: $2.4 million cash, $202.1 million available under the revolving facility, $7.9 million of used-vehicle floor-plan availability and a $104.9 million floor-plan deposit. The deposit is included in other current assets and is not designated as a floor-plan repayment.
- The revolving facility had no borrowings and $14.6 million of letters of credit outstanding. The company reported compliance with debt covenants; actual covenant ratios included a 1.19 minimum-liquidity ratio, 1.63 fixed-charge-coverage ratio and 3.91 lease-adjusted-leverage ratio, versus required thresholds of 1.05, 1.20 and a maximum 5.75, respectively.
Outlook, risks and unusual items
- Management estimated 2019 U.S. total new-vehicle SAAR at 16.5–17.0 million vehicles; this was an industry-volume estimate, not company earnings guidance. No specific earnings or revenue guidance is provided in the filing.
- The GM strike began September 16, 2019 and had minimal Q3 effect. Sonic warned that a prolonged strike could constrain new-vehicle inventory and parts availability at its nine GM franchises.
- Interest-rate exposure is material: a 100-basis-point increase would have changed nine-month interest expense by approximately $10.5 million, including $9.1 million from floor-plan facilities. Interest-rate caps provide partial protection. Sonic also disclosed uncertainty around LIBOR’s expected post-2021 transition.
- Five franchised dealerships were disposed of during the nine months, generating $130.1 million net cash proceeds and a $46.7 million net gain. Current-year results also included $6.3 million of executive-transition costs and $3.1 million of impairment charges, primarily on real estate at former EchoPark locations. The gain on dispositions is a significant contributor to reported earnings and should be considered when assessing recurring performance.
- ASC 842 lease accounting was adopted January 1, 2019, recognizing right-of-use assets and lease liabilities; the company recorded an after-tax $7.4 million reduction to opening retained earnings related to impairment. Comparative periods were not recast.
- The company faces ongoing legal and administrative proceedings; it held reserves of $1.8 million and could not estimate a reasonably possible loss range beyond recorded reserves. Maximum exposure under general dealership-sale indemnifications was approximately $28.0 million, though recorded fair value was not significant.
- Other stated risks include vehicle demand, consumer credit, manufacturer relationships and incentives, competitive pricing, EchoPark expansion and financing needs, tariffs and import restrictions, and economic conditions. Management said there were no other material changes to the prior annual report’s risk factors.
Key facts for investors to verify
- How much of nine-month earnings and operating improvement is attributable to dealership-sale gains and other nonrecurring items, versus ongoing dealership and EchoPark operations?
- Whether EchoPark can sustain growth and improve profitability while managing wholesale losses and fixed-operations economics.
- Cash conversion, working-capital movements and the effect of floor-plan financing presentation on operating cash flow.
- Liquidity availability and covenant headroom, including the nature and accessibility of the $104.9 million floor-plan deposit.
- Exposure to vehicle-margin compression, interest rates and LIBOR transition, the GM strike, litigation and indemnification obligations.