Sonic Automotive, Inc. — Form 10-Q Summary
Reporting period: Third quarter and nine months ended September 30, 2013; filed November 8, 2013. Comparisons are with the corresponding 2012 periods unless stated otherwise. Amounts are in U.S. dollars.
Business context
Sonic operated 123 franchises across 14 states and 20 collision repair centers, grouped into 102 stores. The company reports one operating segment. Its business includes new and used vehicle sales, parts and service, collision repair, and finance, insurance and other products.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $2,242.2 million | $2,127.7 million | $6,527.8 million | $6,176.7 million |
| Gross profit | $326.1 million | $304.4 million | $962.9 million | $921.0 million |
| Operating income | $57.8 million | $57.8 million | $175.3 million | $175.4 million |
| Income from continuing operations | $24.7 million | $12.3 million | $55.1 million | $62.5 million |
| Net income | $23.3 million | $10.0 million | $53.5 million | $58.7 million |
| Diluted EPS | $0.44 | $0.18 | $1.00 | $1.00 |
- Q3 revenue increased 5.4%; nine-month revenue rose 5.7%. Q3 gross margin was approximately 14.5%, versus 14.3%; nine-month gross margin was 14.8%, versus 14.9%.
- New vehicle revenue grew 5.5% in Q3 and 7.0% year to date. Same-store new unit sales rose 2.2% and 3.4%, respectively. Used vehicle revenue increased 6.0% and 3.9%; Q3 same-store used gross profit per unit rose 9.8%.
- Fixed operations revenue increased 7.8% in Q3 and 4.4% year to date. Its gross margin declined to 48.2% in Q3 from 48.9%, partly due to a greater mix of lower-margin wholesale parts.
- Finance, insurance and other revenue rose 6.8% in Q3 and 9.5% year to date. Same-store gross profit per retail unit improved 3.7% and 6.5%, respectively.
- Wholesale vehicle operations remained loss-making: Q3 gross loss was $3.2 million; nine-month gross loss was $6.3 million, versus $4.4 million a year earlier.
- SG&A rose 8.2% in Q3 and 5.1% year to date. SG&A as a percentage of gross profit increased 80 basis points in Q3 and 40 basis points year to date.
Cash flow, balance sheet and capital
- For the nine months, operating cash flow was $180.6 million, compared with $35.4 million in 2012. Investing used $214.5 million, including $88.2 million for acquisitions and $127.5 million of capital expenditures. Financing provided $39.5 million. Cash increased $5.6 million to $9.0 million.
- Management cautions that floor-plan funding source classifications affect reported cash-flow categories. Including trade and non-trade floor-plan changes as operating activity, operating cash flow would have been approximately $142.8 million in 2013 and $49.3 million in 2012.
- At September 30, current assets were $1.575 billion and current liabilities $1.454 billion; cash was $9.0 million and inventory $1.229 billion. The filing reports a 1.16 consolidated liquidity covenant ratio, against a 1.05 minimum.
- Long-term debt was $734.1 million, excluding $18.0 million of current maturities. Total debt including current maturities was $752.1 million, up from $629.4 million at year-end 2012. Floor-plan notes payable totaled approximately $1.139 billion.
- Revolver borrowing availability was approximately $109.4 million after letters of credit. The company was in compliance with its credit-facility covenants. Cash-flow swaps had a net liability fair value of approximately $20.3 million.
- Capital expenditures were $127.5 million for the nine months, including $63.0 million for facility construction and $46.8 million for real estate acquisitions. Construction commitments were approximately $22.3 million.
- Sonic repurchased approximately 0.6 million shares for $14.5 million during the nine months. Remaining repurchase authorization was $135.1 million. Dividends declared were $0.025 per share per quarter.
Material changes and unusual items
- In May 2013, Sonic issued $300 million of 5.0% notes due 2023 and used part of the proceeds to repurchase all $210 million of its 9.0% notes. The repurchase cost approximately $237.2 million, including accrued interest, and generated a $28.2 million extinguishment loss. The refinancing reduced the stated coupon on that debt.
- Q3 net income improved substantially year over year, in part because Q3 2012 included a $17.3 million loss on extinguishment of convertible notes. Nine-month 2013 earnings were lower, reflecting the $28.2 million 9.0% note extinguishment loss; 2012 included separate convertible-note extinguishment charges.
- Sonic acquired two franchise operations and related assets, including real estate, for $88.2 million net of cash acquired. Purchase-price allocations are preliminary and include $20.0 million of franchise intangibles and $24.7 million of goodwill.
- The company changed the timing of its annual goodwill and other intangible impairment tests to the first day of the fourth quarter, prospectively. Management said the change was not intended to delay, accelerate or avoid an impairment charge.
- No dealerships were held for sale at September 30, 2013. Discontinued operations recorded a $1.6 million net loss for the nine months, improved from a $3.8 million loss in 2012.
Outlook, risks and contingencies
- Management expects to generate sufficient cash flow for debt service, working capital and operating needs over the next 12 months and foreseeable future. No specific revenue or earnings guidance is provided.
- Management expects a 38%–40% effective tax rate in future quarters. The Q3 2013 continuing-operations rate was 36.3%, helped by favorable resolution of prior tax matters.
- Management cited seasonality, vehicle demand, manufacturer incentives and allocations, consumer credit availability, competition, interest rates, and the ability to fund investment and service debt as risks. A 100-basis-point rate increase would have changed nine-month interest expense by approximately $5.2 million.
- Disclosure controls were deemed ineffective at September 30, 2013 because of a previously identified material weakness in internal control over financial reporting. Remediation was ongoing; the CEO and CFO stated the financial statements fairly present the company’s financial position and results in all material respects.
- Sonic is involved in legal and administrative proceedings; outcomes cannot be predicted, and the company could not estimate reasonably possible losses beyond recorded reserves. Indemnifications related to dealership sales had maximum exposure of approximately $14 million, with an immaterial estimated fair value.
Important facts for investors to verify
- Whether the True Price strategy sustains improvements in vehicle volumes and per-unit profitability after its initial transition effects.
- How acquisition integration and final purchase accounting affect reported results, goodwill and future cash generation.
- Debt service, covenant headroom, floor-plan borrowing availability and sensitivity to interest rates, given low cash balances and substantial floor-plan obligations.
- Progress and testing of remediation for the material weakness in internal controls.
- Whether planned construction spending, remaining commitments, repurchases and dividends remain consistent with liquidity, covenant restrictions and management’s cash-flow expectations.