Sonic Automotive, Inc. — Q3 2016 Form 10-Q
Business context and reporting period. The unaudited report covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods. Sonic operated 114 franchises, 18 collision repair centers and 111 stores, including five EchoPark locations, across 13 states. Its two reportable segments are Franchised Dealerships and EchoPark.
Financial performance
Amounts below are in millions of dollars except per-share data. Q3 refers to the three months ended September 30; YTD refers to the nine months ended September 30.
| Metric | Q3 2016 | Q3 2015 | YTD 2016 | YTD 2015 |
|---|---|---|---|---|
| Revenue | $2,557.9 | $2,494.4 | $7,174.9 | $7,153.7 |
| Gross profit | $359.1 | $360.3 | $1,057.5 | $1,050.8 |
| Operating income | $50.9 | $62.9 | $150.3 | $147.5 |
| Continuing-operations income | $19.0 | $27.1 | $56.5 | $56.6 |
| Net income | $18.1 | $26.5 | $55.6 | $55.3 |
| Diluted EPS | $0.40 | $0.52 | $1.20 | $1.08 |
- Q3 revenue increased 2.5%, but gross profit declined 0.3%, operating income fell 19.1%, and net income fell 31.7%. Gross margin was approximately 14.0%, versus 14.4% a year earlier; operating margin was approximately 2.0%, versus 2.5%.
- YTD revenue increased 0.3%, operating income increased 1.9%, and net income increased 0.6%. Gross margin was approximately 14.7% in both periods.
- Q3 SG&A was $282.1 million, up 0.7%; SG&A as a share of gross profit rose to 78.6% from 77.7%. YTD SG&A was $843.7 million, up 1.0%.
- Q3 floor-plan interest expense was $6.7 million, up from $5.4 million; other interest expense was $13.0 million, up from $12.4 million. YTD total other expense was $57.2 million, versus $54.0 million.
- YTD operating cash flow was $241.5 million, compared with $131.7 million; investing cash outflow was $169.9 million, compared with $124.6 million; financing cash outflow was $72.3 million, compared with $8.8 million. Cash at September 30 was $2.9 million.
- Capital expenditures were $155.1 million YTD, including real estate purchases and facility construction. Three used-vehicle dealership businesses and related real estate were acquired for approximately $15.9 million.
Balance sheet, debt and liquidity
- At September 30, total assets were $3,429.2 million and stockholders’ equity was $685.4 million. Current assets were $1,857.5 million and current liabilities were $1,752.8 million; inventory was $1,511.3 million.
- Long-term debt, including current maturities, was $886.1 million, excluding floor-plan liabilities. Floor-plan notes totaled approximately $1,351.5 million. Long-term debt increased from $814.6 million at December 31, 2015; floor-plan liabilities declined from approximately $1,518.8 million.
- Reported available liquidity resources totaled $234.7 million, comprising $2.9 million cash, $171.6 million revolving-credit availability, $50.2 million used-vehicle floor-plan availability and a $10.0 million floor-plan deposit. This compares with $279.9 million at year-end 2015.
- The revolving facility had no borrowings and $21.9 million of letters of credit outstanding; the facility was scheduled to mature in August 2019. Sonic reported compliance with credit-facility covenants. Actual ratios were 1.16 for liquidity (minimum 1.05), 1.70 for fixed-charge coverage (minimum 1.20), and 4.32 for lease-adjusted leverage (maximum 5.50).
- Interest-rate swaps had a reported fair-value liability of approximately $13.1 million. Management estimated that a 100-basis-point rate change would have changed YTD interest expense by approximately $9.2 million, after considering swaps.
Material changes and operating drivers
- New-vehicle same-store unit sales declined 3.2% in Q3 and 2.7% YTD. Same-store new-vehicle gross profit declined 4.7% and 3.2%, respectively, amid competitive pricing and weakness in Houston, which management attributed partly to energy-market challenges.
- Same-store used-vehicle units increased 1.3% in Q3 and 1.7% YTD, while used-vehicle gross profit declined 4.5% and 3.9%. Same-store used-vehicle gross profit per unit fell to $1,310 in Q3 and $1,328 YTD.
- Approximately 1,800 used vehicles were subject to manufacturer stop-sale instructions at quarter-end, adding about five days to used-vehicle supply and contributing to inventory and floor-plan costs. The number had peaked at approximately 4,200 at June 30.
- Same-store Fixed Operations gross profit increased 0.7% in Q3 and 2.8% YTD, but margins contracted. Management cited a shift toward lower-margin sublet work, hail repairs, and lower-margin or less labor-intensive warranty work.
- Same-store F&I gross profit per retail unit increased 5.1% in Q3 to $1,341 and 6.3% YTD to $1,347, supported by improved finance and service-contract penetration.
- EchoPark revenue grew 83.2% in Q3 to $40.4 million and 60.0% YTD to $93.9 million. It recorded segment losses of $3.6 million in Q3 and $10.2 million YTD; management described near-term investment as potentially dilutive while expanding the business.
- Class A share repurchases were approximately $97.5 million YTD, reducing shares outstanding by about 10.2% from year-end. Remaining repurchase authorization was $47.5 million. The quarterly dividend was $0.05 per share.
Outlook, risks and unusual items
- Management estimated 2016 total U.S. new-vehicle SAAR at 17.3–17.6 million vehicles; its cited analyst average was approximately 17.7 million. Management cautioned that new-vehicle gross-margin pressure could continue through 2016 and into 2017.
- Sonic expected to open another Colorado EchoPark store in the first half of 2017 and was preparing expansion into North Carolina, South Carolina and Texas, with operations in some markets expected to begin in 2017. The company also continued rollout of its One Sonic-One Experience initiative.
- Management expected its effective tax rate to be 38%–40%, before potential valuation-allowance changes or unusual discrete tax adjustments.
- Q3 impairment charges were $6.1 million, primarily related to property to be demolished and abandoned construction-project costs. YTD impairment charges were $6.2 million, compared with $16.7 million in 2015. Discontinued operations generated a Q3 loss of $0.9 million after tax.
- Management identified risks including vehicle demand, consumer credit and interest rates, manufacturer relationships and recalls, competitive pricing, Houston-market exposure, EchoPark expansion funding, and legal proceedings. Sonic said it could not estimate a reasonably possible loss range for pending proceedings beyond recorded reserves; approximately $0.6 million was reserved at September 30.
- The company disclosed lease, sale-indemnity and joint-venture floor-plan guarantees. Maximum exposure under general sale indemnifications was approximately $3.5 million; Sonic also guaranteed approximately $2.8 million of a 50%-owned joint venture’s floor-plan commitments.
Investor verification priorities
- Reconcile the Q3 earnings decline with lower franchised-dealership segment income, margin pressure, impairments and higher interest costs.
- Assess whether stop-sale inventory has cleared, and monitor its effects on used-vehicle supply, sales, floor-plan interest and cash conversion.
- Evaluate liquidity and covenant headroom, particularly given low cash, declining reported liquidity resources, capital commitments and sensitivity to interest rates.
- Track whether EchoPark expansion improves unit economics and reduces operating losses, and confirm planned market-opening timing and funding.
- Review the sustainability of share repurchases and dividends relative to capital spending, debt obligations and covenant restrictions.
- Monitor legal and indemnification exposures; the filing does not provide a clear estimate of possible litigation losses beyond amounts accrued.