SONIC AUTOMOTIVE INC annual report, FY2014

Sonic Automotive, Inc. — FY 2014 Form 10-K

Reporting period: Fiscal year ended December 31, 2014; the filing was signed February 27, 2015. Although the request references 2014 Q4, this is an annual report. Fourth-quarter figures are summarized separately below. Sonic operated 118 franchises, 100 dealership stores and 19 collision repair centers across 13 states, and opened two Denver EchoPark pre-owned locations in Q4.

Financial performance

Metric	FY 2014	FY 2013	Change
Revenue	$9.197 billion	$8.843 billion	+4.0%
Gross profit	$1.366 billion	$1.302 billion	+4.9%
Operating income	$233.6 million	$234.6 million	-0.4%
Income from continuing operations	$98.6 million	$84.7 million	+16.4%
Net income	$97.2 million	$81.6 million	+19.1%
Diluted EPS	$1.84	$1.53	Higher
Cash flow from operations	$160.7 million	$126.4 million	Higher

• Gross margin improved to 14.9% from 14.7%, while operating margin declined to 2.5% from 2.7%. Continuing-operations net margin was 1.1% versus 1.0%.
• Revenue mix: new vehicles 55.7%, used vehicles 25.1%, parts/service/collision 14.1%, finance and insurance (F&I) 3.3%, and wholesale vehicles 1.8% of total revenue.
• New vehicle revenue rose 2.7%, but gross profit fell 0.3%; reported unit sales were nearly flat. Used vehicle revenue increased 6.2% and gross profit 4.6%. Fixed Operations revenue rose 5.4%, with gross profit up 4.4%; its margin eased to 48.1% from 48.5%. F&I revenue increased 10.1%.
• SG&A rose 6.4% to $1.067 billion, faster than gross profit, and increased to 78.1% of gross profit from 77.1%. Management attributed the pressure partly to EchoPark, One Sonic-One Experience and related strategic investment.
• FY 2014 Q4: revenue was $2.352 billion and gross profit $348.5 million, versus $2.315 billion and $338.7 million in Q4 2013. Net income was $26.1 million, compared with $28.1 million; diluted EPS was $0.50 versus $0.53.

Debt, liquidity and capital allocation

• Total outstanding indebtedness was approximately $2.0 billion, including floor-plan financing. At year-end, floor-plan notes totaled about $1.263 billion and reported long-term debt, including current maturities, was $773.4 million.
• Cash and cash equivalents were $4.2 million. Reported available liquidity resources totaled $249.9 million, including $165.6 million available under the revolving facility, $22.6 million under used-vehicle floor-plan facilities and a $57.5 million floor-plan deposit. The deposit is classified in other current assets, not cash.
• In July 2014, credit facilities were amended, extending maturity to August 2019 and increasing maximum revolving availability to $225 million and combined floor-plan capacity to $800 million. No revolving borrowings were outstanding at year-end; $29.2 million of letters of credit reduced availability.
• Operating cash flow was $160.7 million; investing activities used $108.0 million and financing activities used $51.5 million. Capital expenditures were $146.4 million. The filing notes that the classification of floor-plan changes can materially affect reported operating and financing cash flows.
• Year-end cash dividends declared were $0.10 per share for 2014. Sonic repurchased approximately 2.3 million Class A shares for about $53.0 million during the year; $79.5 million remained under its authorization. Dividends and buybacks are subject to board judgment and debt covenant limits.

Changes, outlook and notable items

• FY 2014 continuing-operations pre-tax income increased 25.3% to $161.7 million. The prior-year comparison included a $28.2 million loss on extinguishment of debt; 2014 had no comparable debt-extinguishment loss. The 2014 effective tax rate increased to 39.1% from 34.4%, partly due to a permanent tax difference related to franchise dispositions.
• Sonic acquired four franchises for $50.9 million and disposed of nine franchises, generating approximately $74.8 million in cash. A net gain on dealership sales of about $10.7 million was included in 2014 SG&A, alongside approximately $4.0 million of storm-related physical damage costs.
• EchoPark generated $5.4 million revenue and a $15.9 million segment loss in 2014, selling 212 vehicles after its Q4 launch. Management anticipated opening up to four additional Denver-area stores in 2015.
• Management estimated 2015 U.S. new-vehicle SAAR of 16.5–17.0 million units; the cited analyst average was approximately 16.75 million. This is an industry-volume estimate, not company earnings or revenue guidance. The filing provides no clear company-specific earnings guidance.
• Management cited customer-experience initiatives and operating playbooks as growth opportunities. One Sonic-One Experience began rollout in Charlotte in the second half of 2014; the stated goal is to enable vehicle transactions in under an hour.
• Q4 2014 net income included approximately $6.4 million of impairment charges, $1.0 million of fire/storm damage charges and $0.9 million of tax expense related to dealership dispositions. For FY 2014, impairment charges totaled $6.6 million, including $2.2 million of franchise impairment and $4.4 million of property/equipment impairment.

Risks and contingencies

• Leverage, floor-plan dependence and restrictive covenants create refinancing and cross-default risk. Year-end covenant ratios were compliant, but actual consolidated adjusted leverage was 4.12 against a maximum of 5.50; fixed-charge coverage was 1.61 against a 1.20 minimum.
• Interest-rate exposure is material: a 100-basis-point rate increase was estimated to raise 2014 interest expense by approximately $9.1 million after swaps. Mortgage notes also include maturities and balloon-payment exposure, beginning in 2015.
• Results depend on manufacturer franchise agreements, vehicle allocations, incentives, warranty reimbursement, consumer credit availability and customer demand. The company’s portfolio is concentrated in luxury and mid-line import brands.
• Legal and administrative proceedings include customer, employment, contract and regulatory matters. Reserves were approximately $2.3 million; Sonic said it could not estimate a reasonably possible loss range beyond amounts accrued.
• Six Northern California dealerships contribute to a multi-employer pension plan in critical status. Increased employer contributions are required; a future withdrawal or plan termination could result in substantial liability.
• Other disclosed exposures include lease obligations and sublease performance, environmental contamination and indemnities, cyber-security incidents, regulatory changes, and potential goodwill impairment. Goodwill was $475.9 million; no goodwill impairment was recorded in 2014.

Investor verification priorities

• Reconcile the company’s stated approximately $2.0 billion total indebtedness with balance-sheet debt and floor-plan balances, and assess floor-plan funding terms and covenant headroom.
• Assess whether improving used-car, F&I and Fixed Operations results can offset pressure on new-vehicle gross profit and rising SG&A.
• Track EchoPark’s store rollout, losses, unit economics and capital requirements against management’s 2015 expansion plan.
• Review cash-flow quality, including floor-plan classification, capital spending commitments, lease obligations and the distinction between cash and the restricted floor-plan deposit.
• Monitor interest-rate sensitivity, near-term mortgage maturities, legal/environmental claims and the underfunded multi-employer pension exposure.