Sonic Automotive, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also presents unaudited quarterly results, including the fourth quarter; it is an annual report, not a standalone Q4 filing.
Business context
Sonic operated 114 new-vehicle franchises across 13 states, 18 collision repair centers and nine pre-owned stores. Its two segments are Franchised Dealerships and Pre-Owned Stores; pre-owned stores generated 2.6% of consolidated revenue. The company continued expanding EchoPark and invested in its One Sonic-One Experience customer initiative.
Key financial metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Revenue | $9.867 billion | $9.732 billion |
| Gross profit / gross margin | $1.458 billion / 14.8% | $1.429 billion / 14.7% |
| Operating income / operating margin | $211.6 million / 2.1% | $232.9 million / 2.4% |
| Income from continuing operations | $94.2 million | $94.5 million |
| Net income | $93.0 million | $93.2 million |
| Diluted EPS | $2.09 | $2.03 |
| Operating cash flow | $162.9 million | $216.4 million |
| Capital expenditures | $234.2 million | $206.2 million |
Revenue rose 1.4%, but income before taxes fell 30.3% to $108.1 million. The effective tax rate fell to 12.9% from 39.1%, principally because a $28.4 million deferred-tax benefit reflected the federal tax-rate reduction. Without that benefit, reported earnings would have been materially lower.
At year-end, total assets were $3.819 billion, cash was $6.4 million and long-term debt, including current maturities, was $1.025 billion. Total outstanding indebtedness, including floor-plan financing, was approximately $2.5 billion. Available liquidity resources were $171.8 million, including $155.3 million available under the revolving facility. Operating lease commitments, net of sublease rentals, totaled $366.1 million.
Material changes versus 2016
- Same-store new-vehicle revenue increased 0.7%, while unit sales declined 0.4%; new-vehicle gross profit was nearly flat.
- Same-store retail used-vehicle revenue declined 0.5% and gross profit declined 3.0%; gross profit per unit fell to $1,240.
- Same-store Fixed Operations revenue was essentially flat, but gross profit increased 1.1% and gross margin improved 50 basis points to 48.3%.
- Same-store F&I revenue rose 2.9%; gross profit per retail unit increased 3.5% to $1,392.
- The Pre-Owned Stores segment’s revenue rose 80.3% to $254.3 million, but its segment loss widened to $21.7 million from $13.6 million. Reported segment growth reflects store openings and acquisitions as well as same-store growth.
- Operating cash flow decreased by $53.5 million. Investing cash outflow increased to $272.1 million, including $234.2 million of capital expenditures and a $76.6 million pre-owned-store acquisition.
- Floor-plan interest expense rose to $36.4 million from $27.7 million, reflecting higher borrowing rates. The average new-vehicle floor-plan rate increased to 2.37% from 1.85%.
Outlook, commentary, risks and unusual items
- Management estimated 2018 U.S. new-vehicle SAAR at 16.75–17.0 million units, below 2017 industry volume of 17.2 million. It expected additional EchoPark openings in North Carolina and Texas during 2018, while noting the expansion could weigh on near-term results.
- Hurricanes Harvey and Irma disrupted operations and caused damage. Harvey temporarily increased Houston replacement-vehicle demand; management did not expect that boost to continue into 2018. The company reported approximately $8.6 million of 2017 storm-related physical-damage expense.
- Sonic issued $250 million of 6.125% notes due 2027 and used proceeds to retire its 7.0% notes. The retirement produced a $14.6 million loss, and overlapping debt caused approximately $0.7 million of double-carry interest.
- 2017 impairment charges totaled $9.4 million, including $3.6 million for franchise assets, $4.9 million for property and equipment, and $0.9 million of goodwill related to closed pre-owned stores. The company reported $525.8 million of goodwill at year-end.
- Key exposures include high indebtedness and covenant requirements, variable interest rates, vehicle-demand cycles, manufacturer and brand concentration, competition and pricing pressure, franchise-renewal requirements, legal and regulatory matters, environmental conditions, and the performance of lease sublessees. Six California dealership subsidiaries contribute to a multiemployer pension plan in critical status, creating potential withdrawal-liability exposure.
- Pending legal proceedings are numerous; reserves were approximately $3.2 million, and the company said it could not estimate a reasonably possible loss range beyond recorded amounts. The 2017 10-K reports effective internal controls and unqualified audit opinions.
- Management expected adoption of the new revenue standard to have no material financial-statement impact, with an estimated $3.0 million after-tax retained-earnings increase at January 1, 2018. Adoption of the new lease standard was expected to materially affect balance-sheet presentation through recognition of lease assets and liabilities.
Most important facts for investors to verify
- Whether the $28.4 million tax benefit and other unusual items obscure underlying earnings trends; compare reported results with recurring performance.
- Whether liquidity and covenant headroom remain adequate given approximately $2.5 billion of total indebtedness, lease commitments and scheduled maturities.
- Whether EchoPark can improve per-unit economics and reduce segment losses as stores mature, and whether planned openings stay within available capital.
- Whether used-vehicle gross profit and wholesale losses stabilize, and whether Fixed Operations and F&I gains offset weaker vehicle margins.
- The eventual costs and outcomes of storm damage, legal matters, pension-plan exposure, environmental matters and lease/sublease obligations.