UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-13395
SONIC AUTOMOTIVE, INC.
(Exact name of registrant as specified in its charter)
Delaware
56-2010790
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
4401 Colwick Road
Charlotte, North Carolina
28211
(Address of principal executive offices)
(Zip Code)
(704) 566-2400
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of October 26, 2015, there were 37,781,160 shares of Class A common stock and 12,029,375 shares of Class B common stock outstanding.
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2015
INDEX
Page
PART I – FINANCIAL INFORMATION
3
Item 1.
Financial Statements (unaudited)
Condensed Consolidated Statements of Income
Condensed Consolidated Statements of Comprehensive Income
4
Condensed Consolidated Balance Sheets
5
Condensed Consolidated Statement of Stockholders’ Equity
6
Condensed Consolidated Statements of Cash Flows
7
Notes to Condensed Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
21
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
40
Item 4.
Controls and Procedures
41
PART II – OTHER INFORMATION
42
Legal Proceedings
Item 1A.
Risk Factors
43
Unregistered Sales of Equity Securities and Use of Proceeds
44
Item 6.
Exhibits
45
Signatures
47
Exhibit Index
48
2
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended September 30,
Nine Months Ended September 30,
2015
2014
(Dollars and shares in thousands, except per share amounts)
Revenues:
New vehicles
$
1,368,029
1,327,837
3,865,639
3,773,234
Used vehicles
652,058
583,570
1,904,594
1,747,254
Wholesale vehicles
37,971
41,433
120,760
127,797
Total vehicles
2,058,058
1,952,840
5,890,993
5,648,285
Parts, service and collision repair
350,520
325,740
1,019,878
973,646
Finance, insurance and other, net
85,830
77,024
242,792
223,340
Total revenues
2,494,408
2,355,604
7,153,663
6,845,271
Cost of Sales:
(1,302,594
)
(1,258,811
(3,671,919
(3,563,342
(610,328
(542,325
(1,781,323
(1,627,842
(40,452
(42,519
(126,126
(130,290
(1,953,374
(1,843,655
(5,579,368
(5,321,474
(180,783
(170,460
(523,531
(506,361
Total cost of sales
(2,134,157
(2,014,115
(6,102,899
(5,827,835
Gross profit
360,251
341,489
1,050,764
1,017,436
Selling, general and administrative expenses
(280,041
(270,144
(835,564
(803,031
Impairment charges
(37
(208
(16,698
(215
Depreciation and amortization
(17,250
(14,235
(50,953
(43,047
Operating income (loss)
62,923
56,902
147,549
171,143
Other income (expense):
Interest expense, floor plan
(5,364
(4,406
(15,488
(13,941
Interest expense, other, net
(12,361
(12,893
(38,635
(40,576
Other income (expense), net
-
(1
102
98
Total other income (expense)
(17,725
(17,300
(54,021
(54,419
Income (loss) from continuing operations before taxes
45,198
39,602
93,528
116,724
Provision for income taxes for continuing operations - benefit (expense)
(18,095
(15,045
(36,944
(45,122
Income (loss) from continuing operations
27,103
24,557
56,584
71,602
Discontinued operations:
Income (loss) from discontinued operations before taxes
(999
254
(2,200
(838
Provision for income taxes for discontinued operations - benefit (expense)
401
(99
869
327
Income (loss) from discontinued operations
(598
155
(1,331
(511
Net income (loss)
26,505
24,712
55,253
71,091
Basic earnings (loss) per common share:
Earnings (loss) per share from continuing operations
0.54
0.47
1.12
1.36
Earnings (loss) per share from discontinued operations
(0.01
(0.03
Earnings (loss) per common share
0.53
1.09
1.35
Weighted average common shares outstanding
50,456
52,070
50,697
52,333
Diluted earnings (loss) per common share:
1.11
0.52
1.08
1.34
50,769
52,553
51,086
52,808
Dividends declared per common share
0.025
0.075
See notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Other comprehensive income (loss) before taxes:
Change in fair value of interest rate swap agreements
(4,221
4,037
(4,271
5,223
Provision for income tax benefit (expense) related to
components of other comprehensive income (loss)
1,604
(1,534
1,623
(1,985
Other comprehensive income (loss)
(2,617
2,503
(2,648
3,238
Comprehensive income (loss)
23,888
27,215
52,605
74,329
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30,
December 31,
ASSETS
Current Assets:
Cash and cash equivalents
2,493
4,182
Receivables, net
299,530
371,994
Inventories
1,422,433
1,311,702
Other current assets
99,459
81,081
Total current assets
1,823,915
1,768,959
Property and Equipment, net
859,855
799,319
Goodwill
472,613
475,929
Other Intangible Assets, net
81,937
83,720
Other Assets
54,088
55,208
Total Assets
3,292,408
3,183,135
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable - floor plan - trade
762,031
711,618
Notes payable - floor plan - non-trade
521,924
551,118
Trade accounts payable
113,527
132,405
Accrued interest
12,485
12,409
Other accrued liabilities
214,900
208,654
Current maturities of long-term debt
31,711
30,802
Total current liabilities
1,656,578
1,647,006
Long-Term Debt
795,871
742,610
Other Long-Term Liabilities
73,984
69,200
Deferred Income Taxes
72,815
57,601
Commitments and Contingencies
Stockholders' Equity:
Class A convertible preferred stock, none issued
Class A common stock, $0.01 par value; 100,000,000 shares authorized;
62,456,603 shares issued and 37,899,038 shares outstanding at
September 30, 2015; 62,046,966 shares issued and 38,890,533 shares
outstanding at December 31, 2014
625
620
Class B common stock; $0.01 par value; 30,000,000 shares authorized;
12,029,375 shares issued and outstanding at September 30, 2015
and December 31, 2014
121
Paid-in capital
707,419
697,760
Retained earnings
427,819
376,353
Accumulated other comprehensive income (loss)
(9,072
(6,424
Treasury stock, at cost; 24,557,565 Class A shares held
at September 30, 2015 and 23,156,433 Class A shares
held at December 31, 2014
(433,752
(401,712
Total Stockholders' Equity
693,160
666,718
Total Liabilities and Stockholders' Equity
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
Accumulated
Class A
Class B
Other
Total
Common Stock
Treasury Stock
Paid-In
Retained
Comprehensive
Stockholders'
Shares
Amount
Capital
Earnings
Income (Loss)
Equity
(Dollars and shares in thousands)
Balance at December 31, 2014
62,047
(23,156
12,029
Shares awarded under stock
compensation plans
389
1,834
1,839
Purchases of treasury stock
(1,402
(32,040
Income tax benefit associated
with stock compensation plans
416
Fair value of interest rate swap
agreements, net of tax
benefit of $1,623
Restricted stock amortization
7,409
Dividends ($0.075 per share)
(3,787
Balance at September 30, 2015
62,457
(24,558
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization of property, plant and equipment
50,948
43,042
Provision for bad debt expense
1,633
331
Other amortization
487
987
Debt issuance cost amortization
1,456
1,654
Debt discount amortization, net of premium amortization
127
Stock - based compensation expense
6,203
Deferred income taxes
16,837
21,273
Equity interest in earnings of investee
(278
(221
Asset impairment charges
16,698
215
Loss (gain) on disposal of dealerships and property and equipment
(699
(11,646
Loss (gain) on exit of leased dealerships
1,485
(272
Changes in assets and liabilities that relate to operations:
Receivables
76,888
96,778
(110,732
Other assets
(20,532
(53,589
50,413
(50,363
Trade accounts payable and other liabilities
(15,953
(22,054
Total adjustments
76,187
84,451
Net cash provided by (used in) operating activities
131,440
155,542
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of businesses, net of cash acquired
(15,288
Purchases of land, property and equipment
(127,098
(89,930
Proceeds from sales of property and equipment
1,256
6,406
Proceeds from sales of dealerships
1,250
51,391
Distributions from equity investee
225
400
Net cash provided by (used in) investing activities
(124,367
(47,021
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings on notes payable - floor plan - non-trade
(29,194
(101,371
Borrowings on revolving credit facilities
309,409
97,847
Repayments on revolving credit facilities
(306,163
(88,068
Proceeds from issuance of long-term debt
65,075
40,420
Debt issuance costs
(2,956
Principal payments on long-term debt
(14,280
(15,134
(39,536
Income tax benefit (expense) associated with stock compensation plans
336
Issuance of shares under stock compensation plans
2,552
Dividends paid
(3,824
(3,963
Net cash provided by (used in) financing activities
(8,762
(109,873
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(1,689
(1,352
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
3,016
CASH AND CASH EQUIVALENTS, END OF PERIOD
1,664
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
Change in fair value of cash flow hedging instruments (net of tax benefit of $1,623 and
expense of $1,985 in the nine months ended September 30, 2015 and 2014, respectively)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid (received) during the period for:
Interest, including amount capitalized
53,694
54,267
Income taxes
21,718
34,278
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Basis of Presentation – The accompanying condensed consolidated financial statements of Sonic Automotive, Inc. and its wholly-owned subsidiaries (“Sonic,” the “Company,” “we,” “us” and “our”) for the three and nine months ended September 30, 2015 and 2014, are unaudited and have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information and applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These unaudited condensed consolidated financial statements reflect, in the opinion of management, all material normal recurring adjustments necessary to fairly state the financial position, results of operations and cash flows for the periods presented. The operating results for interim periods are not necessarily indicative of the results to be expected for the entire fiscal year or future interim periods, because the first quarter normally contributes less operating profit than the second, third and fourth quarters. These interim financial statements should be read in conjunction with the audited consolidated financial statements included in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014.
Recent Accounting Pronouncements – In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03 to simplify the presentation of debt issuance costs. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts and premiums. The ASU also requires that the amortization of debt issuance costs be reported as interest expense. For public companies, this ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015 (early adoption is permitted). The adoption of this ASU will impact the presentation of certain items in Sonic’s consolidated financial position and other disclosures.
Also in April 2015, the FASB issued ASU 2015-05 related to customer’s accounting for fees paid in a cloud computing arrangement. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after
December 15, 2015 (early adoption is permitted). Sonic does not expect this ASU to have a significant impact on its consolidated financial position, results of operations or cash flows.
In July 2015, the FASB issued ASU 2015-11 to clarify the subsequent measurement of inventory. This ASU requires an entity to measure inventory within the scope of this update at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The ASU excludes inventory measured using last-in, first-out and the retail inventory method. For public companies, this ASU is effective for fiscal years beginning after December 15, 2016 (early adoption is permitted). Sonic does not expect this ASU to have a significant impact on its consolidated financial position, results of operations or cash flows.
Principles of Consolidation – All of Sonic’s dealership and non-dealership subsidiaries are wholly-owned and consolidated in the accompanying condensed consolidated financial statements, except for one 50% - owned dealership that is accounted for under the equity method. All material intercompany balances and transactions have been eliminated in the accompanying condensed consolidated financial statements.
Lease Exit Accruals – Lease exit accruals relate to facilities Sonic has ceased using in its operations. The accruals represent the present value of the lease payments, net of estimated or actual sublease proceeds, for the remaining life of the operating leases and other accruals necessary to satisfy the lease commitment to the landlord. These situations could include the relocation of an existing facility or the sale of a dealership whereby the buyer will not be subleasing the property for either the remaining term of the lease or for an amount of rent equal to Sonic’s obligation under the lease. See Note 12, “Commitments and Contingencies,” of the notes to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014 for further discussion.
A summary of the activity of these operating lease exit accruals consists of the following:
(In thousands)
18,962
Lease exit expense (1)
Payments (2)
(4,671
15,776
(1)
Expense of approximately $0.1 million is recorded in interest expense, other, net, expense of approximately $0.2 million is recorded in selling, general and administrative expenses and expense of approximately $1.2 million is recorded in income (loss) from discontinued operations before taxes, in the accompanying condensed consolidated statements of income.
(2)
Amount is recorded as an offset to rent expense, with approximately $0.5 million in selling, general and administrative expenses, and $4.2 million in income (loss) from discontinued operations before taxes, in the accompanying condensed consolidated statements of income.
Income Tax Expense – The overall effective tax rate from continuing operations was 40.0% and 39.5% for the three and nine months ended September 30, 2015, respectively, and was 38.0% and 38.7% for the three and nine months ended September 30, 2014, respectively. The effective tax rate in the three and nine months ended September 30, 2015 was higher than the prior year periods primarily due to a discrete tax benefit in the three months ended September 30, 2014. Sonic’s effective tax rate varies from year to year based on the distribution of taxable income between states in which Sonic operates and other tax adjustments. Sonic expects the effective tax rate in future periods to fall within a range of 38.0% to 40.0% before the impact, if any, of changes in valuation allowances related to deferred income tax assets or unusual discrete tax adjustments.
2. Business Acquisitions and Dispositions
Acquisitions – Sonic did not acquire any franchises during the nine months ended September 30, 2015. Sonic acquired one mid-line import franchise during the three months ended September 30, 2014 and one luxury franchise during the nine months ended September 30, 2014 for a combined aggregate purchase price of approximately $15.3 million.
Dispositions – As discussed in Note 1, “Description of Business and Summary of Significant Accounting Policies,” of the notes to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014, the FASB issued ASU 2014-08 which amended the definition of and reporting requirements for discontinued operations. Sonic elected to adopt and apply this guidance beginning with its Quarterly Report on Form 10-Q for the period ended June 30, 2014. The results of operations for those dealerships that were classified as discontinued operations as of March 31, 2014 are included in income (loss) from discontinued operations in the accompanying condensed consolidated statements of income and will continue to be reported within discontinued operations in the future. Revenues and other activities associated with dealerships classified as discontinued operations were as follows:
Income (loss) from operations
(383
(900
(1,029
(1,670
Gain (loss) on disposal
148
201
Lease exit accrual adjustments and charges
(616
1,006
(1,171
631
Pre-tax income (loss)
9
Beginning with disposals occurring after March 31, 2014, only the operating results of disposals that represent a strategic shift that has (or will have) a major impact on Sonic’s results of operations and financial position will be included in the income (loss) from discontinued operations in the accompanying condensed consolidated statements of income. Sonic disposed of one franchise during the nine months ended September 30, 2015 that generated net cash of approximately $1.3 million. Sonic disposed of two franchises during the three months ended September 30, 2014 and disposed of five franchises during the nine months ended September 30, 2014. These disposals generated net cash from disposition in those periods of approximately $14.9 million and $30.1 million, respectively.
Revenues and other activities associated with disposed dealerships that remain in continuing operations were as follows:
(707
(441
(2,166
(344
(542
3,111
414
10,734
Property impairment charges
(10,096
(1,249
2,670
(11,848
10,390
36
39,778
11,602
195,558
3. Inventories
Inventories consists of the following:
September 30, 2015
December 31, 2014
998,481
924,818
247,260
214,015
Service loaners
115,517
112,520
Parts, accessories and other
61,175
60,349
Net inventories
4. Property and Equipment
Property and equipment, net consists of the following:
Land
252,939
224,124
Building and improvements
637,356
582,261
Office equipment and fixtures
177,450
151,165
Parts and service equipment
75,763
68,248
Company vehicles
9,228
8,958
Construction in progress
72,832
81,180
Total, at cost
1,225,568
1,115,936
Less accumulated depreciation
(365,713
(316,617
Property and equipment, net
In the three and nine months ended September 30, 2015, capital expenditures were approximately $44.2 million and $127.1 million, respectively, and in the three and nine months ended September 30, 2014, capital expenditures were approximately $41.3 million and $89.9 million, respectively. Capital expenditures for the three and nine months ended September 30, 2015 and 2014 were primarily related to real estate acquisitions, construction of new dealerships and EchoPark® stores, building improvements and equipment purchased for use in Sonic’s dealerships and EchoPark® stores.
Impairment charges for the three months ended September 30, 2015 were immaterial and for the nine months ended September 30, 2015 were approximately $16.7 million. Impairment charges for the three and nine months ended September 30, 2015 include the
10
write-off of goodwill, intangible assets, property and equipment as part of the disposal of a franchise, the write-off of certain costs associated with website and software development projects as well as abandonment of certain construction projects.
5. Goodwill and Intangible Assets
The change in the carrying amount of franchise assets and goodwill for the nine months ended September 30, 2015 is as follows:
Franchise
Assets
Net
77,100
Prior year acquisition allocations
1,100
(870
Reductions from dispositions
(2,400
(2,446
75,800
Net of accumulated impairment losses of $796,725.
At December 31, 2014, Sonic had approximately $6.6 million of definite life intangibles related to favorable lease agreements. After the effect of amortization of the definite life intangibles, the balance recorded at September 30, 2015 was approximately $6.1 million and is included in other intangible assets, net, in the accompanying condensed consolidated balance sheets.
6. Long-Term Debt
Long-term debt consists of the following:
2014 Revolving Credit Facility (1)
3,246
7.0% Senior Subordinated Notes due 2022 (the "7.0% Notes")
200,000
5.0% Senior Subordinated Notes due 2023 (the "5.0% Notes")
300,000
Notes payable to a finance company bearing interest from 9.52% to 10.52% (with
a weighted average of 10.19%)
1,689
4,367
Mortgage notes to finance companies-fixed rate, bearing interest from 3.51% to 7.03%
170,621
147,554
Mortgage notes to finance companies-variable rate, bearing interest at 1.25 to 3.50
percentage points above one-month LIBOR
148,954
118,368
Net debt discount and premium (2)
(1,633
(1,761
4,705
4,884
Total debt
827,582
773,412
Less current maturities
(31,711
(30,802
Long-term debt
The interest on the 2014 Revolving Credit Facility was 2.25% above LIBOR at September 30, 2015 and December 31, 2014.
September 30, 2015 includes a $1.3 million discount associated with the 7.0% Notes and a $0.3 million discount associated with mortgage notes payable. December 31, 2014 includes a $1.5 million discount associated with the 7.0% Notes, a $0.1 million premium associated with notes payable to a finance company and a $0.4 million discount associated with mortgage notes payable.
2014 Credit Facilities
On July 23, 2014, Sonic entered into agreements to amend and restate its syndicated revolving credit agreement and syndicated new and used vehicle floor plan credit facilities. The amended and restated syndicated revolving credit agreement (the “2014 Revolving Credit Facility”) and the amended and restated syndicated new and used vehicle floor plan credit facilities (the “2014 Floor Plan Facilities” and, together with the 2014 Revolving Credit Facility, the “2014 Credit Facilities”) are scheduled to mature on August 15, 2019.
11
Availability under the 2014 Revolving Credit Facility is calculated as the lesser of $225.0 million or a borrowing base calculated based on certain eligible assets, less the aggregate face amount of any outstanding letters of credit under the 2014 Revolving Credit Facility (the “Revolving Borrowing Base”). The 2014 Revolving Credit Facility may be increased at Sonic’s option up to $275.0 million upon satisfaction of certain conditions. Based on balances as of September 30, 2015, the Revolving Borrowing Base was approximately $179.5 million. As of September 30, 2015, Sonic had approximately $3.2 million of outstanding borrowings and $23.7 million in outstanding letters of credit under the 2014 Revolving Credit Facility, resulting in total borrowing availability of $152.6 million under the 2014 Revolving Credit Facility. See Note 6, “Long-Term Debt,” of the notes to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014 for further discussion.
7.0% Senior Subordinated Notes
On July 2, 2012, Sonic issued $200.0 million in aggregate principal amount of unsecured senior subordinated 7.0% Notes which mature on July 15, 2022. The 7.0% Notes were issued at a price of 99.11% of the principal amount thereof, resulting in a yield to maturity of 7.125%. Interest on the 7.0% Notes is payable semi-annually in arrears on January 15 and July 15 of each year. See Note 6, “Long-Term Debt,” of the notes to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014 for further discussion.
5.0% Senior Subordinated Notes
On May 9, 2013, Sonic issued $300.0 million in aggregate principal amount of unsecured senior subordinated 5.0% Notes which mature on May 15, 2023. The 5.0% Notes were issued at a price of 100.0% of the principal amount thereof. Interest on the 5.0% Notes is payable semi-annually in arrears on May 15 and November 15 of each year. See Note 6, “Long-Term Debt,” of the notes to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014 for further discussion.
Notes Payable to a Finance Company
Three notes payable (due October 2015 and August 2016) were assumed in connection with an acquisition in 2004 (the “Assumed Notes”). At September 30, 2015, the outstanding principal balance on the Assumed Notes was approximately $1.7 million.
Mortgage Notes
At September 30, 2015, Sonic had mortgage financing totaling approximately $319.6 million related to approximately 30% of its operating properties. These mortgage notes require monthly payments of principal and interest through their respective maturities and are secured by the underlying properties. Maturity dates range between 2015 and 2033. The weighted average interest rate was 3.66% at September 30, 2015.
Covenants
Sonic was in compliance with the covenants under the 2014 Credit Facilities as of September 30, 2015. Financial covenants include required specified ratios (as each is defined in the 2014 Credit Facilities) of:
Covenant
Minimum
Consolidated
Liquidity
Ratio
Fixed Charge
Coverage
Maximum
Total Lease
Adjusted Leverage
Required ratio
1.05
1.20
5.50
September 30, 2015 actual
1.78
4.13
The 2014 Credit Facilities contain events of default, including cross-defaults to other material indebtedness, change of control events and events of default customary for syndicated commercial credit facilities. Upon the future occurrence of an event of default, Sonic could be required to immediately repay all outstanding amounts under the 2014 Credit Facilities.
In addition, many of Sonic’s facility leases are governed by a guarantee agreement between the landlord and Sonic that contains financial and operating covenants. The financial covenants are identical to those under the 2014 Credit Facilities with the exception of
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one financial covenant related to the ratio of EBTDAR to Rent (as defined in the lease agreements) with a required ratio of no less than 1.50 to 1.00. As of September 30, 2015, the ratio was 3.76 to 1.00.
Derivative Instruments and Hedging Activities
Sonic has interest rate cash flow swap agreements to effectively convert a portion of its LIBOR-based variable rate debt to a fixed rate. The fair value of these swap positions at September 30, 2015 was a liability of approximately $15.0 million, with $5.6 million included in other accrued liabilities and $9.4 million included in other long-term liabilities in the accompanying condensed consolidated balance sheets. The fair value of these swap positions at December 31, 2014 was a net liability of approximately $11.1 million, with $8.2 million included in other accrued liabilities and $3.5 million included in other long-term liabilities, offset partially by an asset of approximately $0.6 million included in other assets in the accompanying condensed consolidated balance sheets.
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Under the terms of these cash flow swaps, Sonic will receive and pay interest based on the following:
Notional
Pay
Rate
Receive Rate (1)
Maturing Date
(In millions)
2.6
7.100%
one-month LIBOR + 1.50%
July 10, 2017
8.1
4.655%
one-month LIBOR
December 10, 2017
7.1
6.860%
one-month LIBOR + 1.25%
August 1, 2017
6.2
6.410%
September 12, 2017
100.0
2.065%
June 30, 2017
2.015%
200.0
0.788%
July 1, 2016
50.0
(3)
1.320%
July 1, 2017
250.0
(4)
1.887%
June 30, 2018
25.0
2.080%
1.560%
125.0
1.303%
(5)
1.900%
July 1, 2018
(6)
2.320%
July 1, 2019
2.313%
The one-month LIBOR rate was approximately 0.193% at September 30, 2015.
Changes in fair value are recorded through earnings.
The effective date of these forward-starting swaps is July 1, 2016.
The effective date of this forward-starting swap is July 3, 2017.
The effective date of this forward-starting swap is July 1, 2017.
The effective date of these forward-starting swaps is July 2, 2018.
During the nine months ended September 30, 2015, Sonic entered into four forward-starting interest rate cash flow swap agreements with notional amounts of $125.0 million, $125.0 million, $50.0 million and $200.0 million. These interest rate swaps have been designated and qualify as cash flow hedges and, as a result, changes in the fair value of these swaps are recorded in other comprehensive income (loss), net of related income taxes, in the accompanying condensed consolidated statements of comprehensive income.
For the interest rate swaps not designated as cash flow hedges, the changes in the fair value of these swaps are recognized through earnings and are included in interest expense, other, net, in the accompanying condensed consolidated statements of income. For the three and nine months ended September 30, 2015, these items were a benefit of approximately $0.1 million and $0.4 million, respectively, and for the three and nine months ended September 30, 2014, these items were a benefit of approximately $0.2 million and $0.4 million, respectively.
For the cash flow swaps that qualify as cash flow hedges, the changes in the fair value of these swaps have been recorded in other comprehensive income (loss), net of related income taxes, in the accompanying condensed consolidated statements of comprehensive income and are disclosed in the supplemental schedule of non-cash financing activities in the accompanying condensed consolidated statements of cash flows. The incremental interest expense (the difference between interest paid and interest received) related to these cash flow swaps was approximately $1.6 million and $6.2 million for the three and nine months ended September 30, 2015, respectively, and $2.4 million and $8.3 million for the three and nine months ended September 30, 2014, respectively, and is included in interest expense, other, net, in the accompanying condensed consolidated statements of income and the interest paid amount disclosed in the supplemental disclosures of cash flow information in the accompanying condensed consolidated statements of cash flows. The estimated net expense expected to be reclassified out of accumulated other comprehensive income (loss) into results of operations during the next twelve months is approximately $3.5 million.
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7. Per Share Data and Stockholders’ Equity
The calculation of diluted earnings per share considers the potential dilutive effect of options and shares under Sonic’s stock compensation plans. Certain of Sonic’s non-vested restricted stock and restricted stock units contain rights to receive non-forfeitable dividends and thus, are considered participating securities and are included in the two-class method of computing earnings per share. The following table illustrates the dilutive effect of such items on earnings per share for the three and nine months ended September 30, 2015 and 2014:
Three Months Ended September 30, 2015
From Continuing
From Discontinued
Operations
Weighted
Per
Average
Share
(In thousands, except per share amounts)
Earnings (loss) and shares
Effect of participating securities:
Non-vested restricted stock
and restricted stock units
(13
Basic earnings (loss) and shares
27,090
26,492
Effect of dilutive securities:
Stock compensation plans
313
Diluted earnings (loss) and shares
Three Months Ended September 30, 2014
(79
24,478
24,633
483
Nine Months Ended September 30, 2015
Net Income (Loss)
(27
56,557
55,226
15
Nine Months Ended September 30, 2014
(229
71,373
70,862
475
In addition to the stock options included in the table above, options to purchase approximately 0.5 million shares and 0.4 million shares of Class A common stock were outstanding at September 30, 2015 and 2014, respectively, but were not included in the computation of diluted earnings per share because the options were not dilutive.
8. Contingencies
Legal and Other Proceedings
Sonic is involved, and expects to continue to be involved, in numerous legal and administrative proceedings arising out of the conduct of its business, including regulatory investigations and private civil actions brought by plaintiffs purporting to represent a potential class or for which a class has been certified. Although Sonic vigorously defends itself in all legal and administrative proceedings, the outcomes of pending and future proceedings arising out of the conduct of Sonic’s business, including litigation with customers, employment related lawsuits, contractual disputes, class actions, purported class actions and actions brought by governmental authorities, cannot be predicted with certainty. An unfavorable resolution of one or more of these matters could have a material adverse effect on Sonic’s results of operations, financial position or cash flows.
Included in other accrued liabilities and other long-term liabilities in the accompanying condensed consolidated balance sheets was approximately $0.6 million and $0.3 million, respectively, at September 30, 2015, and approximately $2.0 million and $0.3 million, respectively, at December 31, 2014, in reserves that Sonic was holding for pending proceedings. Except as reflected in such reserves, Sonic is currently unable to estimate a range of reasonably possible loss, or a range of reasonably possible loss in excess of the amount accrued, for pending proceedings.
Guarantees and Indemnification Obligations
In accordance with the terms of Sonic’s operating lease agreements, Sonic’s dealership subsidiaries, acting as lessees, generally agree to indemnify the lessor from certain exposure arising as a result of the use of the leased premises, including environmental exposure and repairs to leased property upon termination of the lease. In addition, Sonic has generally agreed to indemnify the lessor in the event of a breach of the lease by the lessee.
In connection with dealership dispositions, certain of Sonic’s dealership subsidiaries have assigned or sublet to the buyer their interests in real property leases associated with such dealerships. In general, the subsidiaries retain responsibility for the performance of certain obligations under such leases, including rent payments, and repairs to leased property upon termination of the lease, to the extent that the assignee or sub-lessee does not perform. In the event the sub-lessees do not perform their obligations under such leases, Sonic remains liable for the lease payments. See Note 12, “Commitments and Contingencies,” of the notes to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014 for further discussion.
In accordance with the terms of agreements entered into for the sale of Sonic’s franchises, Sonic generally agrees to indemnify the buyer from certain exposure and costs arising subsequent to, but that existed prior to, the date of sale, including environmental exposure and exposure resulting from the breach of representations or warranties made in accordance with the agreement. While Sonic’s exposure with respect to environmental remediation and repairs is difficult to quantify, Sonic’s maximum exposure associated with these general indemnifications was approximately $6.8 million and $16.8 million at September 30, 2015 and December 31, 2014,
16
respectively. These indemnifications expire within a period of one to three years following the date of sale. The estimated fair value of these indemnifications was not material and the amount recorded for this contingency was not significant at September 30, 2015. Sonic also guarantees the floor plan commitments of its 50% -owned joint venture, the amount of which was approximately $2.8 million at both September 30, 2015 and December 31, 2014.
9. Fair Value Measurements
In determining fair value, Sonic uses various valuation approaches including market, income and/or cost approaches. “Fair Value Measurements and Disclosures” in the Accounting Standards Codification (“ASC”) establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of Sonic. Unobservable inputs are inputs that reflect Sonic’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that Sonic has the ability to access. Assets utilizing Level 1 inputs include marketable securities that are actively traded.
Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Assets and liabilities utilizing Level 2 inputs include cash flow swap instruments and deferred compensation plan balances.
Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement. Asset and liability measurements utilizing Level 3 inputs include those used in estimating fair value of non-financial assets and non-financial liabilities in purchase acquisitions, those used in assessing impairment of property, plant and equipment and other intangibles and those used in the reporting unit valuation in the annual goodwill impairment evaluation.
The availability of observable inputs can vary and is affected by a wide variety of factors. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment required by Sonic in determining fair value is greatest for assets and liabilities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is disclosed is determined based on the lowest level input (Level 3 being the lowest level) that is significant to the fair value measurement.
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, Sonic’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. Sonic uses inputs that are current as of the measurement date, including during periods when the market may be abnormally high or abnormally low. Accordingly, fair value measurements can be volatile based on various factors that may or may not be within Sonic’s control.
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Assets and liabilities recorded at fair value in the accompanying condensed consolidated balance sheets as of September 30, 2015 and December 31, 2014 are as follows:
Fair Value Based on
Significant Other Observable
Inputs (Level 2)
Assets:
Cash surrender value of life insurance policies (1)
28,683
27,552
Cash flow swaps designated as hedges (1)
618
Total assets
28,170
Liabilities:
Cash flow swaps designated as hedges (2)
13,905
10,251
Cash flow swaps not designated as hedges (3)
1,125
1,469
Deferred compensation plan (4)
15,553
15,863
Total liabilities
30,583
27,583
Included in other assets in the accompanying condensed consolidated balance sheets.
As of September 30, 2015, approximately $5.1 million and $8.8 million were included in other accrued liabilities and other long-term liabilities, respectively, in the accompanying condensed consolidated balance sheets. As of December 31, 2014, approximately $7.5 million and $2.8 million were included in other accrued liabilities and other long-term liabilities, respectively, in the accompanying condensed consolidated balance sheets.
As of September 30, 2015, approximately $0.5 million and $0.6 million were included in other accrued liabilities and other long-term liabilities, respectively, in the accompanying condensed consolidated balance sheets. As of December 31, 2014, approximately $0.7 million and $0.8 million were included in other accrued liabilities and other long-term liabilities, respectively, in the accompanying condensed consolidated balance sheets.
Included in other long-term liabilities in the accompanying condensed consolidated balance sheets.
There were no instances in the three and nine months ended September 30, 2015 which required a fair value measurement of assets ordinarily measured at fair value on a non-recurring basis. Therefore, the carrying value of assets measured at fair value on a non-recurring basis in the accompanying condensed consolidated balance sheets as of September 30, 2015 have not changed since December 31, 2014. These assets will be evaluated as of the annual valuation assessment date of October 1.
As of September 30, 2015 and December 31, 2014, the fair values of Sonic’s financial instruments, including receivables, notes receivable from finance contracts, notes payable – floor plan, trade accounts payable, borrowings under the 2014 Credit Facilities and certain mortgage notes, approximate their carrying values due either to length of maturity or existence of variable interest rates that approximate prevailing market rates.
18
At September 30, 2015 and December 31, 2014, the fair value and carrying value of Sonic’s fixed rate long-term debt were as follows:
Fair Value
Carrying Value
7.0% Notes (1)
211,500
198,669
216,000
198,556
5.0% Notes (1)
290,250
294,000
Mortgage Notes (2)
177,363
152,240
Assumed Notes (2)
1,687
1,696
4,365
4,474
Other (2)
4,425
4,588
As determined by market quotations as of September 30, 2015 and December 31, 2014, respectively (Level 1).
As determined by discounted cash flows (Level 3)
10. Accumulated Other Comprehensive Income (Loss)
The changes in accumulated other comprehensive income (loss) for the nine months ended September 30, 2015 are as follows:
Changes in Accumulated Other Comprehensive
Income (Loss) by Component
for the Nine Months Ended September 30, 2015
Gains and
Losses on
Cash Flow
Hedges
Defined
Benefit
Pension
Plan
(5,973
(451
Other comprehensive income (loss) before reclassifications (1)
(6,683
Amounts reclassified out of accumulated
other comprehensive income (loss) (2)
4,035
Net current-period other comprehensive income (loss)
(8,621
Net of tax benefit of $4,096.
Net of tax expense of $2,473.
See the heading “Derivative Instruments and Hedging Activities” in Note 6, “Long-Term Debt,” for further discussion of Sonic’s cash flow hedges. For further discussion of Sonic’s defined benefit pension plan, see Note 10, “Employee Benefit Plans,” of the notes to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014.
11. Segment Information
As of September 30, 2015, Sonic had two operating segments: Franchised Dealerships and EchoPark®. The Franchised Dealerships segment is comprised of retail automotive franchises that sell new and buy and sell used vehicles, replacement parts and vehicle repair and maintenance services, and finance and insurance products. The EchoPark® segment is comprised of stand-alone pre-owned specialty retail locations that provide customers an opportunity to search, buy, service, finance and sell pre-owned vehicles.
The operating segments identified above are the business activities of Sonic for which discrete financial information is available and for which operating results are regularly reviewed by Sonic’s chief operating decision maker to assess operating performance and allocate resources. Sonic’s chief operating decision maker is a group consisting of the Company’s Executive Chairman, Chief Executive Officer and President and Chief Financial Officer. The Company has determined that its operating segments also represent its reportable segments.
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Reportable segment revenue and segment income are as follows:
Franchised Dealerships
2,472,357
7,094,951
EchoPark®
22,051
58,712
Total consolidated revenues
Segment income (loss) (1):
61,104
56,349
145,888
166,040
(3,545
(3,853
(13,827
(8,838
Total segment income
57,559
52,496
132,061
157,202
Segment income (loss) for each segment is defined as operating income less floor plan interest expense.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Sonic Automotive, Inc. condensed consolidated financial statements and related notes thereto appearing elsewhere in this report, as well as the audited financial statements and related notes thereto, “Item 1A: Risk Factors” and “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in our Annual Report on Form 10-K for the year ended December 31, 2014.
Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, we present the discussion in Management’s Discussion and Analysis of Financial Condition and Results of Operations on a consolidated basis.
As a result of the way we manage our business, as of September 30, 2015, we had two operating segments: Franchised Dealerships and EchoPark®. The Franchised Dealerships segment is comprised of retail automotive franchises that sell new and buy and sell used vehicles, replacement parts and vehicle repair and maintenance services, and finance and insurance products. The EchoPark® segment is comprised of stand-alone pre-owned specialty retail locations that provide customers an opportunity to search, buy, service, finance and sell pre-owned vehicles.
Overview
We are one of the largest automotive retailers in the United States. As of September 30, 2015, we operated 117 franchises in 13 states (representing 25 different brands of cars and light trucks) and 18 collision repair centers. For management and operational reporting purposes, we group certain franchises together that share management and inventory (principally used vehicles) into “stores.” As of September 30, 2015, we operated 99 franchised dealership stores and three EchoPark® stores.
Our dealerships provide comprehensive services including (1) sales and purchases of both new and used cars and light trucks; (2) sales of replacement parts, performance of vehicle maintenance, manufacturer warranty repairs, paint and collision repair services (collectively, “Fixed Operations”); and (3) arrangement of extended warranties, service contracts, financing, insurance and other aftermarket products (collectively, “F&I”) for our customers.
The following is a detail of our new vehicle revenues by brand for the three and nine months ended September 30, 2015 and 2014:
Percentage of New Vehicle Revenue
Brand
Luxury:
BMW
20.3
%
20.8
21.1
Mercedes
9.1
8.7
9.4
9.0
Lexus
5.5
5.6
5.4
5.1
Audi
4.9
5.0
Cadillac
3.3
4.1
3.2
4.4
Land Rover
3.1
2.5
3.8
2.7
Porsche
2.4
Mini
1.7
2.1
2.0
2.2
Volvo
1.0
0.8
Acura
0.9
Infiniti
0.7
Jaguar
0.6
Smart
0.3
0.0
0.1
Total Luxury
54.1
54.3
55.6
54.6
Mid-line Import:
Honda
16.5
16.0
15.9
15.4
Toyota
11.5
11.3
11.2
10.6
Volkswagen
1.8
2.3
Hyundai
1.6
1.5
Other (1)
1.2
Nissan
Total Mid-line Import
32.8
33.2
31.9
32.3
Domestic:
Ford
7.3
7.0
7.6
General Motors (2)
5.8
Total Domestic
13.1
12.5
(1) Includes Kia, Scion and Subaru.
(2) Includes Buick, Chevrolet and GMC.
Results of Operations
Unless otherwise noted, all discussion of increases or decreases for the three and nine months ended September 30, 2015 are compared to the three and nine months ended September 30, 2014, as applicable. The following discussion of new vehicles, used vehicles, wholesale vehicles, Fixed Operations and F&I are on a same store basis, except where otherwise noted. All currently operating continuing operations stores are included within the same store group in the first full month following the first anniversary of the store’s opening or acquisition.
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New Vehicles
The automobile retail industry uses the Seasonally Adjusted Annual Rate (“SAAR”) to measure the annual amount of expected new vehicle unit sales activity (both retail and fleet sales) within the United States. The SAAR below reflects all brands marketed or sold in the United States. The SAAR includes brands we do not sell and markets in which we do not operate, therefore, our new vehicle sales may not trend directly with the SAAR.
(in millions of vehicles)
% Change
SAAR
17.8
16.7
6.6
17.2
16.3
New vehicle revenues include the sale of new vehicles to retail customers, as well as the sale of fleet vehicles. New vehicle revenues can be influenced by manufacturer incentives for consumers, which vary from cash-back incentives to low interest rate financing. New vehicle revenues are also dependent on manufacturers providing adequate vehicle allocations to our dealerships to meet customer demands and the availability of consumer credit.
Our reported new vehicle results (including fleet) are as follows:
Better / (Worse)
Change
(In thousands, except units and per unit data)
Reported:
Revenue
40,192
3.0
65,435
69,026
(3,591
(5.2
%)
Unit sales
37,493
36,774
719
Revenue per unit
36,488
36,108
380
1.1
Gross profit per unit
1,745
1,877
(132
(7.0
Gross profit as a % of revenue
4.8
5.2
(40
bps
92,405
193,720
209,892
(16,172
(7.7
104,145
103,310
835
37,118
36,523
595
1,860
2,032
(172
(8.5
(60
Our same store new vehicle results (including fleet) are as follows:
Same Store:
1,357,281
1,307,800
49,481
64,860
67,826
(2,966
(4.4
37,147
36,143
1,004
2.8
36,538
36,184
354
1,746
(131
23
3,830,202
3,670,736
159,466
4.3
192,086
204,223
(12,137
(5.9
103,058
100,350
2,708
37,165
36,579
586
1,864
2,035
(171
(8.4
During 2015, we continued to test our new car pricing model. Once the pricing models prove to be efficient and effective, we believe we will become more aggressive in pricing as well as gain market share as customers benefit from the entire complement of our shopping experience.
The increase in new vehicle revenue during the three and nine months ended September 30, 2015 was primarily driven by an increase in new vehicle unit sales volume of 2.8% and 2.7%, respectively. During the three and nine months ended September 30, 2015, excluding fleet sales (which we began to scale back in 2014), our retail new vehicle revenue increased 3.8% and 5.2%, respectively, and our retail new unit sales volume increased 2.5% and 3.7%, respectively. Our Honda, Mercedes and Toyota/Scion dealerships led our retail new vehicle unit sales volume growth with increases of 4.0%, 10.8% and 3.9%, respectively, in the three months ended September 30, 2015. Our Honda, Toyota/Scion and Mercedes dealerships led our retail new vehicle unit sales volume growth with increases of 5.3%, 8.2% and 13.4%, respectively, in the nine months ended September 30, 2015.
Total new vehicle gross profit dollars decreased $3.0 million, or 4.4%, during the three months ended September 30, 2015 and decreased $12.1 million, or 5.9%, during the nine months ended September 30, 2015. Our gross profit per new unit decreased in the three and nine months ended September 30, 2015 by $131 and $171 per unit, respectively, primarily driven by our Toyota/Scion, BMW and Audi dealerships. New fleet vehicle gross profit dollars decreased $0.2 million during the three months ended September 30, 2015, primarily driven by the 18.3% decrease in new fleet vehicle revenue per unit. New fleet vehicle gross profit dollars decreased $1.5 million during the nine months ended September 30, 2015, primarily driven by the 41.7% decrease in new fleet vehicle unit sales volume.
Our luxury dealerships (which include Cadillac) experienced an increase in retail new vehicle revenue of 2.4% and 5.9% during the three and nine months ended September 30, 2015, respectively, primarily due to a retail new unit sales volume increase of 1.5% and 3.9%, respectively. Luxury dealership retail new vehicle gross profit decreased 3.4% and 0.8% during the three and nine months ended September 30, 2015, respectively, primarily driven by gross profit decreases at our BMW, Audi and Cadillac dealerships, offset partially by increases at our Land Rover and Mercedes dealerships. Luxury dealership retail new vehicle gross profit per unit decreased 4.8% and 4.5% during the three and nine months ended September 30, 2015, respectively, primarily driven by our BMW and Audi dealerships. These declines in retail new vehicle gross profit per unit are the result of the transparency of new vehicle pricing and our strategy to maintain and gain market share in these brands to support used inventory acquisition and fixed operations.
Our mid-line import dealerships experienced an increase in retail new vehicle revenue of 2.9% and 4.3% during the three and nine months ended September 30, 2015, respectively, primarily due to a retail new unit sales volume increase of 2.0% and 4.2%, respectively. Mid-line import dealership retail new vehicle gross profit decreased 16.4% and 20.8% during the three and nine months ended September 30, 2015, respectively, primarily driven by gross profit decreases at our Toyota/Scion, Honda and Hyundai dealerships. Mid-line import dealership retail new vehicle gross profit per unit decreased 18.1% and 24.0% during the three and nine months ended September 30, 2015, respectively, primarily driven by our Toyota/Scion, Honda and Hyundai dealerships. These declines in retail new vehicle gross profit per unit are the result of the transparency of new vehicle pricing and our strategy to maintain and gain market share in these brands to support used inventory acquisition and fixed operations.
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Our domestic dealership retail new vehicle revenue increased 12.5% and 4.3% during the three and nine months ended September 30, 2015, respectively, primarily due to a retail new unit sales volume increase of 7.3% and 0.9%, respectively. Domestic dealership retail new vehicle gross profit increased 14.7% during the three months ended September 30, 2015, driven primarily by our Ford dealerships, and decreased 0.7% during the nine months ended September 30, 2015, driven primarily by our General Motors dealerships. Domestic dealership retail new vehicle gross profit per unit increased 7.0% during the three months ended September 30, 2015, driven by our Ford dealerships and decreased 1.6% during the nine months ended September 30, 2015, driven by our General Motors dealerships. Domestic dealership retail new vehicle gross profit per unit increased during the three months ended September 30, 2015, primarily driven by an increase in higher margin retail truck sales. Domestic dealership retail new vehicle gross profit per unit decreased during the nine months ended September 30, 2015, as a result of the transparency of new vehicle pricing and our strategy to maintain and gain market share in these brands to support used inventory acquisition and fixed operations, partially offset by an increase in higher margin retail truck sales.
Used Vehicles
Used vehicle revenues are directly affected by a number of factors, including the level of manufacturer incentives on new vehicles, the number and quality of trade-ins and lease turn-ins, the availability and pricing of used vehicles acquired at auction and the availability of consumer credit.
Our reported used vehicle results are as follows:
68,488
11.7
41,730
41,245
485
30,467
27,536
2,931
21,402
21,193
209
1,370
1,498
(128
6.4
(70
157,340
123,271
119,412
3,859
88,903
83,707
5,196
21,423
20,873
550
1,387
1,427
(2.8
6.5
6.8
(30
Our same store used vehicle results are as follows:
625,760
571,295
54,465
9.5
40,288
40,816
(528
(1.3
29,173
26,902
2,271
8.4
21,450
21,236
214
1,381
1,517
(136
(9.0
25
1,831,379
1,689,958
141,421
119,184
116,749
2,435
85,225
80,900
4,325
5.3
21,489
20,889
600
2.9
1,398
1,443
(45
(3.1
6.9
In the three months ended September 30, 2015, our used vehicle unit volume increased 8.4%, driven primarily by our BMW, Honda and Toyota stores. Used vehicle unit volume increased 5.3% in the nine months ended September 30, 2015, driven primarily by our BMW, Honda and Audi stores. Used vehicle gross profit for the three months ended September 30, 2015 decreased 1.3%, driven primarily by a 9.0% decrease in gross profit per unit, partially offset by an increase in used vehicle unit volume. Used vehicle gross profit for the nine months ended September 30, 2015 increased 2.1%, primarily driven by an increase in used vehicle unit volume, offset partially by a 3.1% decrease in gross profit per unit. As we expand the One Sonic-One Experience initiative to additional stores, we believe we will have the opportunity to experience gains in our used vehicle unit volume and gross profit.
Wholesale Vehicles
Wholesale vehicle revenues are highly correlated with new and used vehicle retail sales and the associated trade-in volume and are also significantly affected by our corporate inventory management policies, which are designed to optimize our total used vehicle inventory.
Our reported wholesale vehicle results are as follows:
(3,462
Gross profit (loss)
(2,481
(1,086
(1,395
(128.5
7,787
7,916
(129
(1.6
4,876
5,234
(358
(6.8
Gross profit (loss) per unit
(319
(137
(182
(132.8
Gross profit (loss) as a % of revenue
(6.5
(2.6
(390
(7,037
(5.5
(5,366
(2,493
(2,873
(115.2
23,574
23,034
540
5,123
5,548
(425
(228
(108
(120
(111.1
(2.0
(240
26
Our same store wholesale vehicle results are as follows:
36,803
40,338
(3,535
(8.8
(2,445
(1,065
(1,380
(129.6
7,463
7,750
(287
(3.7
4,931
5,205
(274
(5.3
(328
(191
(139.4
(6.6
(400
117,037
123,910
(6,873
(4,969
(2,396
(2,573
(107.4
22,622
22,371
251
5,174
5,539
(365
(220
(107
(113
(105.6
(4.2
(1.9
(230
Wholesale vehicle revenue and unit sales volume fluctuations are typically a result of new and used retail vehicle unit volumes that generate additional trade-in vehicle volume that we are not always able to sell as retail used vehicles and choose to sell at auction. Whenever possible, we prefer to sell a used vehicle through retail channels rather than wholesaling the vehicle at auction. In the three and nine months ended September 30, 2015, wholesale unit volume as a percentage of total used unit volume (retail plus wholesale) declined 200 basis points and 70 basis points, respectively. This shift toward retailing a higher percentage of our used inventory contributed to higher levels of gross loss per wholesale unit, as the remaining wholesale vehicles are typically lower in quality/value.
Parts, Service and Collision Repair (“Fixed Operations”)
Parts and service revenue consists of customer requested parts and service orders (“customer pay”), warranty repairs, wholesale parts and collision repairs. Parts and service revenue is driven by the mix of warranty repairs versus customer pay repairs, available service capacity, vehicle quality, customer loyalty and manufacturer warranty programs.
27
Our reported Fixed Operations results are as follows:
Customer pay
147,308
141,458
5,850
Warranty
58,522
48,431
10,091
Wholesale parts
45,832
46,983
(1,151
(2.4
Internal, sublet and other
98,858
88,868
9,990
24,780
80,588
77,546
3,042
3.9
32,337
26,254
6,083
23.2
8,045
8,122
(77
(0.9
48,767
43,358
5,409
169,737
155,280
14,457
9.3
54.7
54.8
(10
55.3
54.2
110
17.6
17.3
30
49.3
48.8
50
48.4
47.7
70
431,479
427,620
169,170
142,072
27,098
19.1
136,693
142,071
(5,378
(3.8
282,536
261,883
20,653
7.9
46,232
4.7
236,551
235,151
1,400
94,776
77,163
17,613
22.8
24,332
24,590
(258
(1.0
140,688
130,381
10,307
496,347
467,285
29,062
55.0
(20
56.0
170
49.8
0
48.7
48.0
28
Our same store Fixed Operations results are as follows:
146,360
139,186
7,174
58,128
47,460
10,668
22.5
45,561
46,041
(480
96,460
87,261
9,199
10.5
346,509
319,948
26,561
8.3
80,053
76,324
3,729
32,216
25,784
6,432
24.9
7,979
7,941
38
0.5
47,440
42,418
5,022
11.8
167,688
152,467
15,221
10.0
55.4
17.5
49.2
48.6
60
426,683
415,998
10,685
167,771
137,297
30,474
22.2
135,643
138,563
(2,920
(2.1
274,892
254,753
20,139
1,004,989
946,611
58,378
234,006
228,983
5,023
94,108
74,684
19,424
26.0
24,114
23,912
202
136,931
126,192
10,739
8.5
489,159
453,771
35,388
7.8
56.1
54.4
49.5
47.9
80
During the three and nine months ended September 30, 2015, our total Fixed Operations customer pay revenue increased 5.2% and 2.6%, respectively. Warranty revenue increased during the three and nine months ended September 30, 2015 by 22.5% and 22.2%, respectively, led by increases in warranty activity, including recalls, at our BMW and Honda dealerships. During the three and nine months ended September 30, 2015, used vehicle reconditioning revenue increased 13.2% and 9.3%, respectively, contributing to the net increase. Fixed Operations customer pay revenue increased 12.0% and 5.9% at our domestic dealerships, 4.8% and 2.7% at our luxury dealerships and 3.0% and 0.6% at our mid-line import dealerships, during the three and nine months ended September 30, 2015, respectively.
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For the three months ended September 30, 2015, an increase in Fixed Operations revenue contributed approximately $12.7 million in additional gross profit and an increase in gross margin rate of 70 basis points contributed to a $2.5 million increase in gross profit. For the nine months ended September 30, 2015, an increase in Fixed Operations revenue contributed approximately $28.0 million in additional gross profit and an increase in gross margin rate of 80 basis points contributed to a $7.4 million increase in gross profit. The gross margin rate increased primarily due to increased warranty activity and rate at our BMW dealerships.
Finance, Insurance and Other, Net (“F&I”)
Finance, insurance and other revenues include commissions for arranging vehicle financing and insurance, sales of third-party extended warranties and service contracts for vehicles and other aftermarket products. In connection with vehicle financing, extended warranties, service contracts, other aftermarket products and insurance contracts, we receive commissions from the providers for originating contracts.
Our reported F&I results are as follows:
(In thousands, except per unit data)
8,806
11.4
Gross profit per retail unit (excludes fleet)
1,274
1,207
67
19,452
1,266
1,208
58
Our same store F&I results are as follows:
84,052
75,797
8,255
10.9
1,279
1,211
68
237,771
217,216
20,555
1,271
1,213
F&I revenues and F&I gross profit per unit increased during the three and nine months ended September 30, 2015, primarily due to improved penetration rates on service contracts and aftermarket products as a result of increased visibility into performance drivers provided by our proprietary internal software applications. In addition, F&I revenues improved due to increases in total new and used retail (excluding fleet) unit volume of 5.0% and 4.4% for the three and nine months ended September 30, 2015, respectively.
Finance contract revenue increased 8.7% and 8.3% for the three and nine months ended September 30, 2015, respectively, primarily due to increases in penetration rates of 170 basis points and 110 basis points, respectively. The increase in finance contract revenue in the three and nine months ended September 30, 2015 was further driven by increases in gross profit per contract of 1.1% and 2.1%, respectively. Finance contract revenue may experience compression if manufacturers offer attractive financing rates from their captive finance affiliates because we tend to earn lower commissions under these programs.
Service contract revenue increased 7.5% and 4.7% in the three and nine months ended September 30, 2015, respectively, driven primarily by a service contract penetration rate increase of 80 basis points and 60 basis points for the three and nine months ended September 30, 2015, respectively.
Other aftermarket contract revenue increased 11.9% and 12.7% in the three and nine months ended September 30, 2015, respectively, driven primarily by other aftermarket contract penetration rate increases of 190 basis points and 470 basis points, respectively.
Segment Results
In the following tables of financial data, total segment income of the operating segments is reconciled to consolidated operating income.
(In thousands, except unit data)
116,753
138,804
5.9
4,755
308
8.0
5,063
9.6
532
1
5,596
14.1
Retail unit sales volume:
66,438
63,837
2,601
920
Total units retailed
67,358
3,521
249,680
3.6
308,392
4.5
(20,152
(12.1
(4,989
(56.4
(25,141
(16.0
1,941
(23,196
(19.9
189,343
184,884
4,459
2,461
191,804
6,920
3.7
31
See the previous headers “New Vehicles,” “Used Vehicles,” “Wholesale Vehicles,” “Parts, Service and Collision Repair” and “Finance, Insurance and Other, Net” for further discussion of the operating results of our Franchised Dealerships segment. The previous analyses include operating results for our EchoPark® segment as the results for EchoPark® are not material to the combined operating results.
We opened the first two EchoPark® locations in November and December 2014, and we opened the third location in January 2015. Our EchoPark® business operates independently from the previously existing new and used sales operations and introduces customers to an exciting shopping and buying experience. During the three months ended September 30, 2015, EchoPark® generated approximately $22.1 million of revenue and gross profit of $2.9 million, driven by the sale of 920 used vehicles, which generated a gross profit per unit of $1,470 and F&I gross profit per unit of $927. EchoPark® incurred a $3.7 million operating loss during the three months ended September 30, 2015. During the nine months ended September 30, 2015, EchoPark® generated approximately $58.7 million of revenue and gross profit of $7.3 million, driven by the sale of 2,461 used vehicles, which generated a gross profit per unit of $1,375 and F&I gross profit per unit of $910. EchoPark® incurred a $14.1 million operating loss during the nine months ended September 30, 2015, which includes a $1.4 million impairment charge primarily related to website development.
Selling, General and Administrative (“SG&A”) Expenses
SG&A expenses are comprised of four major groups: compensation expense, advertising expense, rent expense and other expense. Compensation expense primarily relates to dealership personnel who are paid a commission or a salary plus commission and support personnel who are paid a fixed salary. Commissions paid to dealership personnel typically vary depending on gross profits realized. Due to the salary component for certain dealership and corporate personnel, gross profits and compensation expense do not change in direct proportion to one another. Advertising expense and other expense vary based on the level of actual or anticipated business activity and number of dealerships owned. Rent expense typically varies with the number of dealerships owned, investments made for facility improvements and interest rates. Other expense includes various fixed and variable expenses, including certain customer-related costs, insurance, training, legal and IT expenses, which may not change in proportion to gross profit levels.
The following tables set forth information related to our reported SG&A expenses:
SG&A expenses
Compensation
167,489
163,230
(4,259
Advertising
15,470
14,045
(1,425
(10.1
Rent
18,558
18,145
(413
(2.3
78,524
74,724
(3,800
(5.1
280,041
270,144
(9,897
SG&A expenses as a % of gross profit
46.5
47.8
130
21.7
21.9
77.7
79.1
140
32
497,158
483,493
(13,665
46,160
42,027
(4,133
(9.8
55,058
55,324
266
237,188
222,187
(15,001
835,564
803,031
(32,533
(4.1
47.3
47.5
22.6
79.5
78.9
Overall SG&A expenses increased for the three and nine months ended September 30, 2015, due in part to costs related to our EchoPark®, One Sonic-One Experience and other strategic initiatives, among other cost drivers as discussed below. Overall SG&A expenses as a percentage of gross profit decreased 140 basis points in the three months ended September 30, 2015 and increased 60 basis points during the nine months ended September 30, 2015. Excluding the effect of EchoPark® expenses, total SG&A expenses as a percentage of gross profit decreased 120 basis points and increased 30 basis points for the three and nine months ended September 30, 2015, respectively, compared to the prior year periods.
Compensation costs as a percentage of gross profit decreased 130 basis points and 20 basis points in the three and nine months ended September 30, 2015, respectively, primarily due to higher gross profit levels during 2015, allowing us to better leverage fixed compensation costs.
In the three and nine months ended September 30, 2015, total advertising expense increased in both dollar amount and as a percentage of gross profit due to increased advertising programs for EchoPark® and our One Sonic-One Experience initiative.
Rent expense as a percentage of gross profit decreased 10 basis points and 20 basis points in the three and nine months ended September 30, 2015, respectively, primarily due to higher gross profit levels and the purchase of properties that were previously leased.
Other SG&A expenses increased in dollar amount during the three months ended September 30, 2015, primarily due to higher outside contractor expenses, insurance costs and taxes other than income. As a percentage of gross profit, other SG&A expenses decreased during the three months ended September 30, 2015, due to higher gross profit levels. Other SG&A expenses increased in both dollar amount and as a percentage of gross profit during the nine months ended September 30, 2015, primarily due to IT expenses related to EchoPark® and our One Sonic-One Experience initiative, legal fees and taxes other than income.
Included in other SG&A expenses for the nine months ended September 30, 2015 is approximately $2.3 million of storm-related physical damage and $0.6 million of legal expense, partially offset by gains on disposal of franchise of approximately $0.2 million. Included in other SG&A expenses for the three and nine months ended September 30, 2014 is approximately $2.0 million and $3.0 million, respectively, of storm-related physical damage offset by gain on sale of dealerships of approximately $3.2 million and $10.5 million, respectively. Excluding the effect of these adjustments, total SG&A expenses as a percentage of gross profit decreased 170 basis points and 50 basis points for the three and nine months ended September 30, 2015, respectively. Excluding the effect of these adjustments, Franchised Dealerships SG&A expenses as a percentage of gross profit decreased 150 basis points and 80 basis points for the three and nine months ended September 30, 2015, respectively.
Impairment Charges
Impairment charges decreased approximately $0.2 million and increased approximately $16.5 million during the three and nine months ended September 30, 2015, respectively. Impairment charges for the nine months ended September 30, 2015 include the write-off of goodwill, intangible assets, property and equipment as part of the disposal of a franchise, the write-off of certain costs associated with website and software development projects as well as abandonment of certain construction projects.
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Depreciation and Amortization
Depreciation and amortization expense increased approximately $3.0 million, or 21.2%, and $7.9 million, or 18.4%, during the three and nine months ended September 30, 2015, respectively. The increase is primarily related to completed construction projects that were placed in service subsequent to September 30, 2014.
Interest Expense, Floor Plan
Interest expense, floor plan for new vehicles incurred by continuing operations increased approximately $0.9 million, or 21.8%, and $1.1 million, or 8.3%, in the three and nine months ended September 30, 2015, respectively. The average new vehicle floor plan notes payable balance for continuing operations increased approximately $136.6 million and $67.4 million in the three and nine months ended September 30, 2015, respectively, resulting in an increase in new vehicle floor plan interest expense of approximately $0.5 million and $0.8 million in the three and nine months ended September 30, 2015, respectively. The average new vehicle floor plan interest rate incurred by continuing dealerships was 1.63% and 1.61% in the three and nine months ended September 30, 2015, respectively, compared to 1.50% and 1.58% in the three and nine months ended September 30, 2014, respectively, resulting in an increase in new vehicle floor plan interest expense of approximately $0.4 million and $0.3 million in the three and nine months ended September 30, 2015, respectively.
Interest expense, floor plan for used vehicles incurred by continuing operations increased approximately $0.1 million, or 21.2%, and $0.5 million, or 54.3%, in the three and nine months ended September 30, 2015, respectively. The average used vehicle floor plan notes payable balance for continuing operations increased approximately $20.4 million and $37.7 million in the three and nine months ended September 30, 2015, respectively, resulting in an increase in used vehicle floor plan interest expense of approximately $0.1 million and $0.5 million in the three and nine months ended September 30, 2015, respectively. The average used vehicle floor plan interest rate incurred by continuing dealerships was 1.57% and 1.76% in the three and nine months ended September 30, 2015, respectively, compared to 1.74% and 1.84% in the three and nine months ended September 30, 2014, respectively, which had minimal effect on used vehicle floor plan interest expense.
Interest Expense, Other, Net
Interest expense, other, net, is summarized in the schedule below:
Stated/coupon interest
10,687
10,383
(304
(2.9
Discount/premium amortization
(2
(5.6
Deferred loan cost amortization
645
Cash flow swap interest
1,499
2,148
649
30.2
Capitalized interest
(654
(502
152
30.3
Other interest
166
183
12,361
12,893
34
31,540
31,094
(446
(1.4
113
105
(8
(7.6
1,861
2,059
198
5,813
7,865
2,052
26.1
(1,246
(1,073
173
16.1
554
526
(28
38,635
40,576
Interest expense, other, net, decreased approximately $0.5 million and $2.0 million in the three and nine months ended September 30, 2015, primarily due to a decrease in cash flow swap interest payments due to the expiration of four interest rate swaps during the three months ended September 30, 2015.
Income Taxes
The overall effective tax rate from continuing operations was 40.0% and 39.5% for the three and nine months ended September 30, 2015, respectively, and was 38.0% and 38.7% for the three and nine months ended September 30, 2014, respectively. The effective tax rate in the three and nine months ended September 30, 2015 was higher than the prior year periods primarily due to a discrete tax benefit in the three months ended September 30, 2014. The effective tax rate varies from year to year based on the distribution of taxable income between states in which we operate and other tax adjustments. We expect the effective tax rate in future periods to fall within a range of 38.0% to 40.0% before the impact, if any, of changes in valuation allowances related to deferred income tax assets or unusual discrete tax adjustments.
Discontinued Operations
Significant components of results from discontinued operations were as follows:
See the discussion of our adoption of ASU 2014-08 in Note 1, “Description of Business and Summary of Significant Accounting Policies,” of the notes to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2014. We do not expect significant activity classified as discontinued operations in the future due to the change in the definition of a discontinued operation. The results of operations for those dealerships and franchises that were classified as discontinued operations as of March 31, 2014 will continue to be reported within discontinued operations in the future.
Liquidity and Capital Resources
We require cash to fund debt service, operating lease obligations, working capital requirements, facility improvements and other capital improvements, dividends on our common stock and to finance acquisitions and otherwise invest in our business. We rely on cash flows from operations, borrowings under our revolving credit and floor plan borrowing arrangements, real estate mortgage financing, asset sales and offerings of debt and equity securities to meet these requirements. We closely monitor our available liquidity and projected future operating results in order to remain in compliance with restrictive covenants under the 2014 Credit Facilities and other debt obligations and lease arrangements. However, our liquidity could be negatively affected if we fail to comply with the financial covenants in our existing debt or lease arrangements. Cash flows provided by our dealerships are derived from various
35
sources. The primary sources include individual consumers, automobile manufacturers, automobile manufacturers’ captive finance subsidiaries and finance companies. Disruptions in these cash flows could have a material and adverse impact on our operations and overall liquidity.
Because the majority of our consolidated assets are held by our dealership subsidiaries, the majority of our cash flows from operations are generated by these subsidiaries. As a result, our cash flows and ability to service our obligations depends to a substantial degree on the cash generated from the operations of these dealership subsidiaries.
We had the following liquidity resources available as of September 30, 2015 and December 31, 2014:
Availability under our revolving credit facility
152,568
165,560
Availability under our used floor plan facilities
58,153
22,642
Floor plan deposit balance
74,000
57,500
Total available liquidity resources
287,214
249,884
We participate in a program with two of our manufacturer-affiliated finance companies (the floor plan deposit balance in the table above) wherein we maintain a deposit balance with the lender that earns interest based on the agreed upon rate. This deposit balance is not designated as a pre-payment of notes payable – floor plan, nor is it our intent to use this amount to offset principal amounts owed under notes payable – floor plan in the future, although we have the right and ability to do so. The deposit balance of $74.0 million and $57.5 million as of September 30, 2015 and December 31, 2014, respectively, is classified in other current assets in the accompanying condensed consolidated balance sheets. Changes in this deposit balance are classified as changes in other assets in the cash flows from operating activities section of the accompanying condensed consolidated statements of cash flows. The interest rebate as a result of this deposit balance is classified as a reduction of interest expense, floor plan, in the accompanying condensed consolidated statements of income. In the three and nine months ended September 30, 2015, the reduction in interest expense, floor plan, was approximately $0.4 million and $1.1 million, respectively. In the three and nine months ended September 30, 2014, the reduction in interest expense, floor plan, was approximately $0.6 million and $1.5 million, respectively.
Floor Plan Facilities
We finance our new and certain of our used vehicle inventory through standardized floor plan facilities with manufacturer captive finance companies and a syndicate of manufacturer-affiliated finance companies and commercial banks. These floor plan facilities are due on demand and bear interest at variable rates based on either LIBOR or the prime rate. The weighted average interest rate for our new and used floor plan facilities for continuing operations was 1.63% and 1.62% in the three and nine months ended September 30, 2015, respectively, and 1.52% and 1.59% in the three and nine months ended September 30, 2014, respectively.
We receive floor plan assistance from certain manufacturers. Floor plan assistance received is capitalized in inventory and charged against cost of sales when the associated inventory is sold. We received approximately $11.3 million and $30.7 million in floor plan assistance in the three and nine months ended September 30, 2015, respectively, and $10.3 million and $29.3 million in the three and nine months ended September 30, 2014, respectively. We recognized manufacturer floor plan assistance in cost of sales for continuing operations of approximately $10.5 million and $30.1 million in the three and nine months ended September 30, 2015, respectively, and $9.9 million and $28.4 million in the three and nine months ended September 30, 2014, respectively. Interest payments under each of our floor plan facilities are due monthly and we are not required to make principal repayments prior to the sale of the vehicles.
Long-Term Debt and Credit Facilities
See Note 6, “Long-Term Debt,” to the accompanying condensed consolidated financial statements for discussion of our long-term debt and credit facilities and compliance with debt covenants.
Dealership Acquisitions and Dispositions
See Note 2, “Business Acquisitions and Dispositions,” to the accompanying condensed consolidated financial statements.
Capital Expenditures
Our capital expenditures include the purchase of land and buildings, construction of new dealerships, EchoPark® stores and collision repair centers, building improvements and equipment purchased for use in our dealerships and EchoPark® stores. We selectively construct new or improve existing dealership facilities to maintain compliance with manufacturers’ image requirements. We typically finance these projects through new mortgages, or, alternatively, through our credit facilities. We also fund these projects through cash flows from operations.
Capital expenditures in the three and nine months ended September 30, 2015 were approximately $44.2 million and $127.1 million, respectively. Of this amount, approximately $28.3 million and $76.7 million were related to facility construction projects in the three and nine months ended September 30, 2015, respectively. Real estate acquisitions accounted for approximately $9.0 million and $23.2 in the three and nine months ended September 30, 2015, respectively. Fixed assets utilized in our dealership operations accounted for the remaining $6.9 million and $27.2 million of the capital expenditures in the three and nine months ended September 30, 2015, respectively.
Of the capital expenditures in the three and nine months ended September 30, 2015, approximately $19.0 million and $65.0 million, respectively, was funded through mortgage financing and approximately $25.2 million and $62.1 million, respectively, was funded through cash from operations and use of our credit facilities. As of September 30, 2015, commitments for facilities construction projects totaled approximately $63.3 million. We expect investments related to capital expenditures to be partly dependent upon our overall liquidity position and the availability of mortgage financing to fund significant capital projects.
Stock Repurchase Program
Our Board of Directors has authorized us to repurchase shares of our Class A common stock. Historically, we have used our share repurchase authorization to offset dilution caused by the exercise of stock options or the vesting of equity compensation awards and to maintain our desired capital structure. During the three and nine months ended September 30, 2015, we repurchased approximately 0.8 million shares and 1.4 million shares, respectively, of our Class A common stock for approximately $17.3 million and $32.0 million, respectively, in open-market transactions and in connection with tax withholdings on the vesting of equity compensation awards. During the three and nine months ended September 30, 2014, we repurchased approximately 1.2 million shares and 1.7 million shares, respectively, of our Class A common stock for approximately $28.4 million and $39.5 million, respectively, in open-market transactions and in connection with tax withholdings on the vesting of equity compensation awards. As of September 30, 2015, our total remaining repurchase authorization was approximately $47.4 million. Under the 2014 Credit Facilities, share repurchases are permitted to the extent that no event of default exists and we have the pro forma liquidity amount required by the repurchase test (as defined in the 2014 Credit Facilities) and the result of such test has been accepted by the administrative agent.
Our share repurchase activity is subject to the business judgment of our Board of Directors and management, taking into consideration our historical and projected results of operations, financial condition, cash flows, capital requirements, covenant compliance and economic and other factors considered relevant. These factors are considered each quarter and will be scrutinized as our Board of Directors and management determine our share repurchase policy in the future.
Dividends
During the three months ended September 30, 2015, our Board of Directors approved a cash dividend of $0.025 per share on all outstanding shares of Class A and Class B common stock as of September 15, 2015 to be paid on October 15, 2015. Subsequent to September 30, 2015, our Board of Directors approved a cash dividend on all outstanding shares of Class A and Class B common stock of $0.0375 per share for stockholders of record on December 15, 2015 to be paid on January 15, 2016. Under the 2014 Credit Facilities, dividends are permitted to the extent that no event of default exists and we are in compliance with the financial covenants, including pro forma liquidity requirements, contained therein. The indentures governing our outstanding 5.0% Notes and 7.0% Notes contain restrictions on our ability to pay dividends. There is no guarantee that additional dividends will be declared and paid at any time in the future. See Note 6, “Long-Term Debt,” of the notes to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2014.
Cash Flows
In the nine months ended September 30, 2015, net cash provided by operating activities was approximately $131.4 million. This provision of cash was comprised primarily of cash inflows related to operating profits, and a decrease in receivables and an increase in notes payable – floor plan – trade, offset partially by decreases in trade accounts payable and other liabilities and an increase in
37
inventories. In the nine months ended September 30, 2014, net cash provided by operating activities was approximately $155.5 million. This provision of cash was comprised primarily of cash inflows related to operating profits and decreases in receivables and inventories, offset partially by an increase in other assets and a decrease in notes payable – floor plan – trade.
Net cash used in investing activities in the nine months ended September 30, 2015 was approximately $124.4 million. This use of cash was primarily comprised of purchases of land, property and equipment. Net cash used in investing activities in the nine months ended September 30, 2014 was approximately $47.0 million. This use of cash was primarily comprised of purchases of land, property and equipment and the acquisition of two franchise operations, offset partially by proceeds from sales of dealerships.
Net cash used in financing activities in the nine months ended September 30, 2015 was approximately $8.8 million. This use of cash was comprised primarily of cash outflows primarily related to purchases of treasury stock, a decrease in notes payable – floor plan – non-trade and payments on long-term debt, offset partially by proceeds from issuance of mortgage-related long-term debt. Net cash used in financing activities in the nine months ended September 30, 2014 was approximately $109.9 million. This use of cash was primarily related to a decrease in notes payable – floor plan – non-trade and purchases of treasury stock, offset partially by proceeds from issuance of mortgage-related long-term debt.
We arrange our inventory floor plan financing through both manufacturer captive finance companies and a syndicate of manufacturer captive finance companies and commercial banks. Our floor plan financed with manufacturer captives is recorded as trade floor plan liabilities (with the resulting change being reflected as operating cash flows). Our dealerships that obtain floor plan financing from a syndicate of manufacturer captives and commercial banks record their obligation as non-trade floor plan liabilities (with the resulting change being reflected as financing cash flows).
Due to the presentation differences for changes in trade floor plan and non-trade floor plan in the condensed consolidated statements of cash flows, decisions made by us to move dealership floor plan financing arrangements from one finance source to another may cause significant variations in operating and financing cash flows without affecting our overall liquidity, working capital or cash flow. Net cash provided by combined trade and non-trade floor plan financing was approximately $21.2 million in the nine months ended September 30, 2015 and net cash used was approximately $151.7 million in the nine months ended September 30, 2014. Accordingly, if all changes in floor plan notes payable were classified as an operating activity, the result would have been net cash provided by operating activities of approximately $102.2 million and $54.2 million in the nine months ended September 30, 2015 and 2014, respectively.
In connection with the operation and disposition of dealership franchises, we have entered into various guarantees and indemnification obligations. See Note 8, “Contingencies,” to the accompanying condensed consolidated financial statements. See also “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 12, “Commitments and Contingencies,” of the notes to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2014.
Future Liquidity Outlook
We believe our best sources of liquidity for operations and debt service remain cash flows generated from operations combined with our availability of borrowings under the 2014 Credit Facilities (or any replacements thereof), real estate mortgage financing, selected dealership and other asset sales and our ability to raise funds in the capital markets through offerings of debt or equity securities. Because the majority of our consolidated assets are held by our dealership subsidiaries, the majority of our cash flows from operations are generated by these subsidiaries. As a result, our cash flows and ability to service debt depends to a substantial degree on the results of operations of these subsidiaries and their ability to provide us with cash. We expect to generate sufficient cash flow to fund our debt service, working capital requirements and operating requirements for the next twelve months and for the foreseeable future.
Off-Balance Sheet Arrangements
See “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements” in our Annual Report on Form 10-K for the year ended December 31, 2014.
Seasonality
Our operations are subject to seasonal variations. The first quarter normally contributes less operating profit than the second, third and fourth quarters. Weather conditions, the timing of manufacturer incentive programs and model changeovers cause seasonality and may adversely affect vehicle demand, and consequently, our profitability. Comparatively, parts and service demand remains stable throughout the year.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk
Our variable rate floor plan facilities, 2014 Revolving Credit Facility and other variable rate notes expose us to risks caused by fluctuations in the applicable interest rates. The total outstanding balance of such variable instruments after considering the effect of our interest rate swaps (see below) was approximately $912.1 million at September 30, 2015. A change of 100 basis points in the underlying interest rate would have caused a change in interest expense of approximately $7.7 million in the nine months ended September 30, 2015. Of the total change in interest expense, approximately $6.8 million would have resulted from the floor plan facilities.
In addition to our variable rate debt, certain of our dealership lease facilities have monthly lease payments that fluctuate based on LIBOR interest rates. An increase in interest rates of 100 basis points would not have had a significant impact on rent expense in the three and nine months ended September 30, 2015 due to the leases containing LIBOR floors which were above the LIBOR rate during the three and nine months ended September 30, 2015.
We also have various cash flow swaps to effectively convert a portion of our LIBOR-based variable rate debt to a fixed rate. Under the terms of these cash flow swaps, interest rates reset monthly. The fair value of these swap positions at September 30, 2015 was a liability of approximately $15.0 million, with $5.6 million included in other accrued liabilities and $9.4 million included in other long-term liabilities in the accompanying condensed consolidated balance sheets. Under the terms of these cash flow swaps, Sonic will receive and pay interest based on the following:
Foreign Currency Risk
We purchase certain of our new vehicle and parts inventories from foreign manufacturers. Although we purchase our inventories in U.S. Dollars, our business is subject to foreign exchange rate risk that may influence automobile manufacturers’ ability to provide their products at competitive prices in the United States. To the extent that we cannot recapture this volatility in prices charged to customers or if this volatility negatively impacts consumer demand for our products, this volatility could adversely affect our future operating results.
Item 4. Controls and Procedures.
Disclosure Controls and Procedures – Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2015. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2015.
Changes in Internal Control over Financial Reporting – There has been no change in our internal control over financial reporting during the three months ended September 30, 2015, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance that the objectives of the control system are met and may not prevent or detect misstatements. In addition, any evaluation of the effectiveness of internal controls over financial reporting in future periods is subject to risk that those internal controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Item 1. Legal Proceedings.
Item 1A. Risk Factors.
In addition to the information set forth in this Form 10-Q, you should carefully consider the risk factors discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014, which could materially affect our business, financial condition or future results.
A decline in the quality of vehicles we sell, or consumers’ perception of the quality of those vehicles, may adversely affect our business.
Our business is highly dependent on consumer demand and preferences. Events such as manufacturer recalls, negative publicity or legal proceedings related to these events may have a negative impact on the products we sell. If such events are significant, the profitability of our dealerships related to those manufacturers could be adversely affected and we could experience a material adverse effect on our overall results of operations, financial position and cash flows.
In September 2015, Volkswagen admitted that certain of its diesel models were intentionally programmed to meet various regulatory emissions standards only during laboratory emissions testing. In addition, the United States Environmental Protection Agency issued a Notice of Violation of the Clean Air Act to the automaker. On September 29, 2015, Volkswagen announced plans to refit the vehicles affected by the emissions violations. The models affected are certain Volkswagen and Audi 2.0L TDI diesel models with model years ranging between 2009 and 2015.
In the event that consumer or other related lawsuits are filed against our Volkswagen dealerships related to this issue, we believe that our dealerships are entitled to indemnification and assumption of defense from Volkswagen Cars North America related to such claims.
We are not aware of other manufacturers using emissions-testing defeat-devices similar to those reportedly implemented by Volkswagen on diesel vehicles, but we cannot guarantee that any of our other brands will not be impacted by a similar issue.
Our business is highly dependent on consumer demand and preferences. Negative publicity and legal proceedings related to events such as the Volkswagen/Audi emissions issue may have a negative impact on the products we sell and the profitability of our dealerships related to those manufacturers could be adversely affected. Depending on the magnitude of the Volkswagen/Audi emissions issue and whether or not other manufacturers have implemented similar technologies, the resulting impact could result in a material adverse effect on our overall results of operations, financial position and cash flows.
As of September 30, 2015, we operated five Volkswagen and five Audi dealerships. During the nine months ended September 30, 2015, these dealerships generated revenues of approximately $471.2 million, representing approximately 6.6% of our total revenues.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
The following table sets forth information about the shares of Class A common stock we repurchased during the three months ended September 30, 2015:
Number
of Shares
Purchased (1)
Price Paid
per Share
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs (2)
Approximate Dollar
Value of Shares
That May Yet Be
Purchased Under
the Plans or Programs
(In thousands, except per share data)
July 2015
64,721
August 2015
548
21.68
52,841
September 2015
21.20
47,447
802
21.53
All shares repurchased
Our active publicly announced Class A common stock repurchase authorization plans do not have an expiration date and current remaining availability is as follows:
February 2013 authorization
100,000
Total active plan repurchases prior to September 30, 2015
(52,553
Current remaining availability as of September 30, 2015
See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional discussion of restrictions on share repurchases and payment of dividends.
Item 6. Exhibits.
Exhibit No.
Description
31.1*
Certification of Principal Financial Officer pursuant to Rule 13a-14(a).
31.2*
Certification of Principal Executive Officer pursuant to Rule 13a-14(a).
32.1*
Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*
Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*
XBRL Instance Document
101.SCH*
XBRL Taxonomy Extension Schema Document
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*
XBRL Taxonomy Definition Linkbase Document
101.LAB*
XBRL Taxonomy Extension Label Linkbase Document
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document
*
Filed herewith.
Uncertainty of Forward-Looking Statements and Information
This Quarterly Report on Form 10-Q contains, and written or oral statements made from time to time by us or by our authorized officers may contain, “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements address our future objectives, plans and goals, as well as our intent, beliefs and current expectations regarding future operating performance, results and events, and can generally be identified by words such as “may,” “will,” “should,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “foresee” and other similar words or phrases.
These forward-looking statements are based on our current estimates and assumptions and involve various risks and uncertainties. As a result, you are cautioned that these forward-looking statements are not guarantees of future performance, and that actual results could differ materially from those projected in these forward-looking statements. Factors which may cause actual results to differ materially from our projections include those risks described in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2014 and elsewhere in this report, as well as:
·
the number of new and used cars sold in the United States as compared to our expectations and the expectations of the market;
our ability to generate sufficient cash flows or obtain additional financing to fund capital expenditures, our share repurchase program, dividends on our common stock, acquisitions and general operating activities;
our business and growth strategies, including, but not limited to, our EchoPark® initiative and One Sonic-One Experience initiative;
the reputation and financial condition of vehicle manufacturers whose brands we represent, the financial incentives vehicle manufacturers offer and their ability to design, manufacture, deliver and market their vehicles successfully;
our relationships with manufacturers, which may affect our ability to obtain desirable new vehicle models in inventory or complete additional acquisitions;
adverse resolutions of one or more significant legal proceedings against us or our dealerships;
changes in laws and regulations governing the operation of automobile franchises, accounting standards, taxation requirements and environmental laws;
general economic conditions in the markets in which we operate, including fluctuations in interest rates, employment levels, the level of consumer spending and consumer credit availability;
high competition in the automotive retailing industry, which not only creates pricing pressures on the products and services we offer, but also on businesses we may seek to acquire;
our ability to successfully integrate potential future acquisitions; and
the rate and timing of overall economic recovery or decline.
These forward-looking statements speak only as of the date of this report or when made, and we undertake no obligation to revise or update these statements to reflect subsequent events or circumstances, except as required under the federal securities laws and the rules and regulations of the SEC.
46
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: October 30, 2015
By:
/s/ B. SCOTT SMITH
B. Scott Smith
Chief Executive Officer and President
/s/ HEATH R. BYRD
Heath R. Byrd
Executive Vice President and Chief Financial Officer
EXHIBIT INDEX