Sonic Automotive, Inc. — Q1 2017 Form 10-Q
Business context and period. For the three months ended March 31, 2017, Sonic operated 116 franchises in 13 states, 18 collision repair centers, and eight EchoPark stores. Results are compared with Q1 2016; interim results are seasonal and not necessarily indicative of the full year.
Financial performance
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Revenue | $2.288 billion | $2.235 billion |
| Gross profit / gross margin | $350.3 million / 15.3% | $345.2 million / 15.4% |
| Operating income | $36.4 million | $42.3 million |
| Income from continuing operations | $(0.02) million | $14.5 million |
| Net income (loss) / diluted EPS | $(0.5) million / $(0.01) | $14.6 million / $0.31 |
| Operating cash flow | $79.5 million | $104.0 million |
| Capital expenditures | $75.7 million | $41.4 million |
Revenue increased 2.4%, but operating income declined 13.8%. The sharp deterioration in pretax results largely reflects a $14.6 million loss on extinguishing the 7.0% notes, along with higher interest expense and weaker segment income. The effective tax rate on continuing operations was 113.3%, affected by low pretax income and discrete tax items. Reported wholesale vehicle sales generated a gross loss of $1.2 million.
Segments and sales drivers. Franchised Dealerships revenue was $2.246 billion (+1.6%); segment income was $33.5 million, down 14.8%. EchoPark revenue was $41.8 million (+73.9%), with a $5.4 million segment loss versus a $3.4 million loss a year earlier. Same-store retail new-vehicle revenue fell 1.4%; same-store used-vehicle revenue rose 2.8%, while used gross profit fell 1.8%. Fixed Operations revenue rose 1.0% same-store, and same-store F&I revenue was essentially flat.
Balance sheet, debt and liquidity
At March 31, 2017, cash was $6.6 million, total assets $3.608 billion and stockholders’ equity $722.3 million. Total debt was $947.4 million, excluding floor-plan liabilities; current maturities were $50.0 million. Floor-plan payables totaled approximately $1.446 billion. Total available liquidity resources were $287.7 million, including $187.5 million of revolving-credit availability and $70.6 million of floor-plan availability. Operating cash flow was lower year over year, while investment cash use increased to $75.5 million.
In March, Sonic issued $250 million of 6.125% senior subordinated notes due 2027 and used the proceeds to repurchase all $200 million of its 7.0% notes, paying approximately $213.7 million including premium and accrued interest. The company reported compliance with debt covenants; actual covenant ratios were 1.17 liquidity, 1.90 fixed-charge coverage and 4.25 lease-adjusted leverage, against required minimums of 1.05 and 1.20 and a maximum of 5.75, respectively. A 100-basis-point interest-rate increase would have raised quarterly interest expense by approximately $3.0 million, after swaps.
Outlook, risks and unusual items
- Management estimated 2017 U.S. new-vehicle SAAR of 17.0–17.5 million, versus analysts’ average expectation of approximately 17.4–17.6 million.
- Management said Houston’s energy-market downturn continued to pressure vehicle volume and gross profit and could remain a headwind until sustained recovery.
- EchoPark expansion and the One Sonic-One Experience initiative are intended to support longer-term growth but may weigh on near-term results. Sonic expected another Colorado EchoPark opening in the first half of 2017, Florida conversions in the second half, and expansion into additional markets.
- After quarter-end, storms damaged vehicle inventory at stores in Alabama and Texas; preliminary uninsured losses were estimated at approximately $5 million.
- Pending legal and administrative proceedings are not fully quantifiable; reserves were $2.7 million at quarter-end. The filing warns that adverse outcomes could materially affect results.
- Management expected an effective tax rate of 38%–40% in future periods before valuation-allowance changes or discrete adjustments. It also expected revenue-recognition adoption in 2018 to leave amounts and timing generally unchanged; lease-accounting adoption in 2019 is expected to materially affect balance-sheet presentation.
Most important facts to verify
- Whether the $14.6 million debt-extinguishment charge and refinancing effects explain the gap between operating income and near-zero pretax income, and how recurring earnings trend excluding these items.
- Whether operating cash flow, investment spending and available liquidity can support EchoPark expansion, construction commitments of $45.9 million, dividends and any repurchases.
- Whether Houston operations recover and whether used-vehicle gross profit per unit and F&I penetration improve after the product-vendor transition.
- The final insured and uninsured cost of the post-quarter storms, and developments in pending litigation and covenant headroom.