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EX-32.2 - EXHIBIT 32.2 - SONIC AUTOMOTIVE INCq22018exhibit322.htm
EX-32.1 - EXHIBIT 32.1 - SONIC AUTOMOTIVE INCq22018exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - SONIC AUTOMOTIVE INCq22018exhibit312ceocertifi.htm
EX-31.1 - EXHIBIT 31.1 - SONIC AUTOMOTIVE INCq22018exhibit311cfocertifi.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________
FORM 10-Q
______________________________________
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
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 ☒    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 ☒    No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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
 
 
 
 
 
 
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  
As of July 25, 2018, there were 30,682,181 shares of the registrant's Class A common stock and 12,029,375 shares of the registrant's Class B common stock outstanding.
 





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,” “estimate,” “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. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2017 and elsewhere in this report, as well as:
the number of new and used vehicles 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 our pre-owned expansion, 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 pre-owned store operations;
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;
the adverse resolution of one or more significant legal proceedings against us or our franchised dealerships or pre-owned stores;
changes in laws and regulations governing the operation of automobile franchises, accounting standards, taxation requirements and environmental laws;
changes in vehicle and parts import quotas, duties, tariffs or other restrictions;
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 retail automotive 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 Securities and Exchange Commission.







SONIC AUTOMOTIVE, INC.
FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2018
TABLE OF CONTENTS






PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

SONIC AUTOMOTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars and shares in thousands, except per share amounts)
Revenues:
 
 
 
 
 
 
 
New vehicles
$
1,238,571

 
$
1,275,069

 
$
2,419,416

 
$
2,447,001

Used vehicles
762,572

 
641,891

 
1,471,618

 
1,276,364

Wholesale vehicles
53,748

 
40,765

 
119,148

 
87,076

Total vehicles
2,054,891

 
1,957,725

 
4,010,182

 
3,810,441

Parts, service and collision repair
346,754

 
361,113

 
698,512

 
713,156

Finance, insurance and other, net
104,104

 
86,908

 
197,829

 
169,971

Total revenues
2,505,749

 
2,405,746

 
4,906,523

 
4,693,568

Cost of Sales:
 
 
 
 
 
 
 
New vehicles
(1,181,303
)
 
(1,212,547
)
 
(2,305,349
)
 
(2,326,201
)
Used vehicles
(725,263
)
 
(601,856
)
 
(1,397,538
)
 
(1,195,497
)
Wholesale vehicles
(57,105
)
 
(42,682
)
 
(126,929
)
 
(90,163
)
Total vehicles
(1,963,671
)
 
(1,857,085
)
 
(3,829,816
)
 
(3,611,861
)
Parts, service and collision repair
(179,703
)
 
(188,043
)
 
(361,833
)
 
(370,742
)
Total cost of sales
(2,143,374
)
 
(2,045,128
)
 
(4,191,649
)
 
(3,982,603
)
Gross profit
362,375

 
360,618

 
714,874

 
710,965

Selling, general and administrative expenses
(277,462
)
 
(293,931
)
 
(582,387
)
 
(586,165
)
Impairment charges
(10,317
)
 
(2,605
)
 
(13,960
)
 
(3,115
)
Depreciation and amortization
(23,949
)
 
(21,911
)
 
(47,692
)
 
(43,065
)
Operating income (loss)
50,647

 
42,171

 
70,835

 
78,620

Other income (expense):
 
 
 
 
 
 
 
Interest expense, floor plan
(11,945
)
 
(9,144
)
 
(22,622
)
 
(17,531
)
Interest expense, other, net
(13,375
)
 
(12,764
)
 
(26,831
)
 
(26,172
)
Other income (expense), net
17

 
7

 
106

 
(14,495
)
Total other income (expense)
(25,303
)
 
(21,901
)
 
(49,347
)
 
(58,198
)
Income (loss) from continuing operations before taxes
25,344

 
20,270

 
21,488

 
20,422

Provision for income taxes for continuing operations - benefit (expense)
(8,222
)
 
(7,956
)
 
(6,380
)
 
(8,128
)
Income (loss) from continuing operations
17,122

 
12,314

 
15,108

 
12,294

Discontinued operations:
 
 
 
 
 
 
 
Income (loss) from discontinued operations before taxes
(297
)
 
(301
)
 
(545
)
 
(1,168
)
Provision for income taxes for discontinued operations - benefit (expense)
80

 
119

 
148

 
465

Income (loss) from discontinued operations
(217
)
 
(182
)
 
(397
)
 
(703
)
Net income (loss)
$
16,905

 
$
12,132

 
$
14,711

 
$
11,591

Basic earnings (loss) per common share:
 
 
 
 
 
 
 
Earnings (loss) per share from continuing operations
$
0.40

 
$
0.28

 
$
0.35

 
$
0.27

Earnings (loss) per share from discontinued operations

 
(0.01
)
 
(0.01
)
 
(0.01
)
Earnings (loss) per common share
$
0.40

 
$
0.27

 
$
0.34

 
$
0.26

Weighted average common shares outstanding
42,662

 
44,570

 
42,725

 
44,680

Diluted earnings (loss) per common share:
 
 
 
 
 
 
 
Earnings (loss) per share from continuing operations
$
0.40

 
$
0.27

 
$
0.35

 
$
0.27

Earnings (loss) per share from discontinued operations
(0.01
)
 

 
(0.01
)
 
(0.01
)
Earnings (loss) per common share
$
0.39

 
$
0.27

 
$
0.34

 
$
0.26

Weighted average common shares outstanding
42,920

 
44,810

 
42,948

 
44,976

Dividends declared per common share
$
0.06

 
$
0.05

 
$
0.12

 
$
0.10


 See notes to condensed consolidated financial statements.

1



SONIC AUTOMOTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
2018
 
2017
 
2018
 
2017
 
(Dollars in thousands)
Net income (loss)
$
16,905

 
$
12,132

 
$
14,711

 
$
11,591

Other comprehensive income (loss) before taxes:
 
 
 
 
 
 
 
Change in fair value of interest rate swap and interest rate cap agreements
1,197

 
42

 
5,203

 
2,144

Provision for income tax benefit (expense) related to
components of other comprehensive income (loss)
(326
)
 
(16
)
 
(1,418
)
 
(815
)
Other comprehensive income (loss)
871

 
26

 
3,785

 
1,329

Comprehensive income (loss)
$
17,776

 
$
12,158

 
$
18,496

 
$
12,920



 See notes to condensed consolidated financial statements.

2



SONIC AUTOMOTIVE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
June 30, 2018
 
December 31, 2017
 
(Dollars in thousands)
ASSETS
Current Assets:
 
 
 
Cash and cash equivalents
$
8,154

 
$
6,352

Receivables, net
347,847

 
482,126

Inventories
1,527,661

 
1,512,745

Other current assets
26,033

 
18,574

Total current assets
1,909,695

 
2,019,797

Property and Equipment, net
1,162,786

 
1,146,881

Goodwill
510,160

 
525,780

Other Intangible Assets, net
72,109

 
74,589

Other Assets
50,064

 
51,471

Total Assets
$
3,704,814

 
$
3,818,518

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
 
 
 
Notes payable - floor plan - trade
$
744,500

 
$
804,238

Notes payable - floor plan - non-trade
720,233

 
709,098

Trade accounts payable
111,128

 
129,903

Accrued interest
12,435

 
12,316

Other accrued liabilities
221,180

 
237,963

Current maturities of long-term debt
37,786

 
61,314

Total current liabilities
1,847,262

 
1,954,832

Long-Term Debt
933,128

 
963,389

Other Long-Term Liabilities
87,558

 
61,918

Deferred Income Taxes
49,886

 
51,619

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; 64,126,133 shares issued and 30,682,181 shares outstanding at June 30, 2018; 63,456,698 shares issued and 31,166,205 shares outstanding at December 31, 2017
641

 
635

Class B common stock, $0.01 par value; 30,000,000 shares authorized; 12,029,375 shares issued and outstanding at June 30, 2018 and December 31, 2017
121

 
121

Paid-in capital
739,212

 
732,854

Retained earnings
638,895

 
625,356

Accumulated other comprehensive income (loss)
5,092

 
1,307

Treasury stock, at cost; 33,443,952 Class A common stock shares held at June 30, 2018 and 32,290,493 Class A common stock shares held at December 31, 2017
(596,981
)
 
(573,513
)
Total Stockholders’ Equity
786,980

 
786,760

Total Liabilities and Stockholders’ Equity
$
3,704,814

 
$
3,818,518


 See notes to condensed consolidated financial statements.

3



SONIC AUTOMOTIVE, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
 
Class A
Common Stock
 
Class A
Treasury Stock
 
Class B
Common Stock
 
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Stockholders
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
(Dollars in thousands)
Balance at December 31, 2017
63,457

 
$
635

 
(32,290
)
 
$
(573,513
)
 
12,029

 
$
121

 
$
732,854

 
$
625,356

 
$
1,307

 
$
786,760

Shares awarded under stock compensation plans
669

 
6

 

 

 

 

 
347

 

 

 
353

Purchases of treasury stock

 

 
(1,154
)
 
(23,468
)
 

 

 

 

 

 
(23,468
)
Change in fair value of interest rate swap and interest rate cap agreements, net of tax expense of $1,418

 

 

 

 

 

 

 

 
3,785

 
3,785

Restricted stock amortization

 

 

 

 

 

 
6,011

 

 

 
6,011

Net income (loss)

 

 

 

 

 

 

 
14,711

 

 
14,711

Cumulative effect of change in accounting principle (1)

 

 

 

 

 

 

 
3,918

 

 
3,918

Dividends declared

 

 

 

 

 

 

 
(5,090
)
 

 
(5,090
)
Balance at June 30, 2018
64,126

 
$
641

 
(33,444
)
 
$
(596,981
)
 
12,029

 
$
121

 
$
739,212

 
$
638,895

 
$
5,092

 
$
786,980

(1) See Note 1, “Summary of Significant Accounting Policies,” of the notes to the condensed consolidated financial statements for further discussion.

 See notes to condensed consolidated financial statements.

4



SONIC AUTOMOTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six Months Ended June 30,
 
2018
 
2017
 
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
14,711

 
$
11,591

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization of property and equipment
47,689

 
43,062

Provision for bad debt expense
283

 
495

Other amortization
310

 
325

Debt issuance cost amortization
1,217

 
1,193

Debt discount amortization, net of premium amortization

 
99

Stock-based compensation expense
6,011

 
5,723

Deferred income taxes
(6,188
)
 
182

Net distributions from equity investee
162

 
190

Asset impairment charges
13,960

 
3,115

Loss (gain) on disposal of dealerships and property and equipment
(41,439
)
 
(67
)
Loss (gain) on exit of leased dealerships
2,564

 
1,827

Loss (gain) on retirement of debt

 
14,607

Changes in assets and liabilities that relate to operations:
 
 
 
Receivables
151,391

 
144,029

Inventories
(73,100
)
 
(51,637
)
Other assets
500

 
(19,837
)
Notes payable - floor plan - trade
(59,738
)
 
(48,282
)
Trade accounts payable and other liabilities
(20,225
)
 
(13,732
)
Total adjustments
23,397

 
81,292

Net cash provided by (used in) operating activities
38,108

 
92,883

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of land, property and equipment
(99,602
)
 
(121,222
)
Proceeds from sales of property and equipment
12,584

 
291

Proceeds from sales of dealerships
122,404

 

Net cash provided by (used in) investing activities
35,386

 
(120,931
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net (repayments) borrowings on notes payable - floor plan - non-trade
11,135

 
3,722

Borrowings on revolving credit facilities
514,915

 
44,017

Repayments on revolving credit facilities
(572,519
)
 
(44,017
)
Proceeds from issuance of long-term debt
21,072

 
282,458

Debt issuance costs
(131
)
 
(4,512
)
Principal payments and repurchase of long-term debt
(18,344
)
 
(11,051
)
Repurchase of debt securities

 
(210,914
)
Purchases of treasury stock
(23,468
)
 
(25,948
)
Issuance of shares under stock compensation plans
353

 
46

Dividends paid
(4,705
)
 
(4,481
)
Net cash provided by (used in) financing activities
(71,692
)
 
29,320

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
1,802

 
1,272

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
6,352

 
3,108

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
8,154

 
$
4,380

 
 
 
 
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
 
 
 
Change in fair value of interest rate swap and interest rate cap agreements (net of tax expense of $1,418 and $815 in the six months ended June 30, 2018 and 2017, respectively)
$
3,785

 
$
1,329

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid (received) during the period for:
 
 
 
Interest, including amount capitalized
$
48,355

 
$
44,897

Income taxes
$
18,682

 
$
12,664



 See notes to condensed consolidated financial statements.

5

SONIC AUTOMOTIVE, INC.
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 six months ended June 30, 2018 and 2017 are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and applicable rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The accompanying 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 historically has contributed less operating profit than the second, third and fourth quarters. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2017.
Recent Accounting Pronouncements – In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2014-09 as well as several subsequent amendments to amend the accounting guidance on revenue recognition. The amendments to the revenue recognition accounting guidance are included in Accounting Standards Codification (“ASC”) 606, “Revenue from Contracts with Customers,” and are intended to provide a more robust framework for addressing revenue issues, improve comparability of revenue recognition practices and improve disclosure requirements. The amendments to this standard must be applied using either of the following transition methods: (1) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients; or (2) a modified retrospective approach with the cumulative effect of initially adopting the standard recognized at the date of adoption (which requires additional footnote disclosures). These amendments are effective for reporting periods beginning after December 15, 2017. On January 1, 2018, Sonic adopted ASC 606 (the “new revenue standard”) using the modified retrospective transition approach applied to contracts not completed as of the date of adoption. We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earnings. The comparative financial information has not been restated and continues to be reported under the accounting standards in effect for that period. We do not expect the adoption of the new revenue standard to have a material impact on our net income on an ongoing basis.
Under the new revenue standard, revenue is recognized when a customer obtains control of promised goods or services and in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. The principles apply a five-step model that includes: (1) identifying the contract(s) with the customer; (2) identifying the performance obligation(s) in the contract(s); (3) determining the transaction price; (4) allocating the transaction price to the performance obligation(s) in the contract(s); and (5) recognizing revenue as the performance obligation(s) are satisfied. The standard also requires disclosure of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Sonic does not include the cost of obtaining contracts within the related revenue streams. Sonic has elected the practical expedient to expense the costs to obtain a contract when incurred.

During the implementation process, management evaluated its established business processes, revenue transaction streams and accounting policies, and generally expects similar performance obligations to result under the new revenue standard as compared with prior U.S. GAAP. Management identified its material revenue streams to be (1) the sale of new vehicles; (2) the sale of used vehicles to retail customers; (3) the sale of wholesale used vehicles at third-party auctions; (4) the arrangement of vehicle financing and the sale of service and other insurance contracts; and (5) the performance of vehicle maintenance and repair services and the sale of related parts and accessories. As a result of this evaluation during the implementation process, management expects the amounts and timing of revenue recognition to generally remain the same, with the exception of the timing of revenue recognition related to: (1) service and collision repair orders that are incomplete as of a reporting date (“work in process”) and (2) certain retrospective finance and insurance revenue earned in periods subsequent to the completion of the initial performance obligation (“F&I retro revenues”), both of which are subject to accelerated recognition under the new revenue standard. Work in process revenues are recognized over time based on the completed work to date and F&I retro revenues are estimated each reporting period based on the expected value method using historical and projected data. F&I retro revenues can vary based on a variety of factors, including number of contracts and history of cancellations and claims. Accordingly, Sonic utilizes this historical and projected data to constrain the consideration to the extent that it is probable that a significant reversal in the amount of cumulative revenue will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
Generally, performance conditions are satisfied when the associated vehicle is either delivered or returned to a customer and customer acceptance has occurred. Sonic does not have any revenue streams with significant financing components as payments are typically received within a short period of time following completion of the performance obligation(s).

6

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The cumulative effect of the adjustments to our June 30, 2018 condensed consolidated statements of income and January 1, 2018 condensed consolidated balance sheet for the adoption of ASC 606 were as follows:
 
Pre-ASC 606 Results
 
Effects of Adoption of ASC 606
 
As Reported
 
Three Months Ended
 
 
Three Months Ended
Income Statement
June 30, 2018
 
 
June 30, 2018
 
(In thousands)
Revenues:
 
 
 
 
 
Parts, service and collision repair
$
349,489

 
$
(2,735
)
 
$
346,754

Finance, insurance and other, net
100,737

 
3,367

 
104,104

Total revenues
$
450,226

 
$
632

 
$
450,858

Cost of Sales:
 
 
 
 
 
Parts, service and collision repair
$
(180,994
)
 
$
1,291

 
$
(179,703
)
Selling, general and administrative expenses:
 
 
 
 
 
Compensation
$
(198,045
)
 
$
404

 
$
(197,641
)
 
 
 
 
 
 
Operating income (loss):
$
48,319

 
$
2,328

 
$
50,647

 
Pre-ASC 606 Results
 
Effects of Adoption of ASC 606
 
As Reported
 
Six Months Ended
 
 
Six Months Ended
Income Statement
June 30, 2018
 
 
June 30, 2018
 
(In thousands)
Revenues:
 
 
 
 
 
Parts, service and collision repair
$
700,824

 
$
(2,312
)
 
$
698,512

Finance, insurance and other, net
193,906

 
3,923

 
197,829

Total revenues
$
894,730

 
$
1,611

 
$
896,341

Cost of Sales:
 
 
 
 
 
Parts, service and collision repair
$
(362,837
)
 
$
1,004

 
$
(361,833
)
Selling, general and administrative expenses:
 
 
 
 
 
Compensation
$
(383,045
)
 
$
367

 
$
(382,678
)
 
 
 
 
 
 
Operating income (loss):
$
67,853

 
$
2,982

 
$
70,835

Balance Sheet
December 31, 2017
 
Effects of Adoption of ASC 606
 
January 1, 2018
 
 
 
(In thousands)
 
 
Assets:
 
 
 
 
 
Receivables, net
$
482,126

 
$
4,590

 
$
486,716

Contract Assets (1)

 
2,082

 
2,082

Liabilities:
 
 
 
 
 
Other accrued liabilities
$
237,963

 
$
(1,286
)
 
$
236,677

Deferred income taxes
51,619

 
(1,468
)
 
50,151

Stockholders’ Equity:
 
 
 
 
 
Retained earnings
$
625,356

 
$
(3,918
)
 
$
621,438

(1)
Contract assets are included in receivables, net in the accompanying condensed consolidated balance sheets.
Receivables, net at June 30, 2018 includes approximately $3.3 million related to work in process and a contract asset of approximately $6.0 million related to F&I retro revenues. Changes in contract assets from January 1, 2018 to June 30, 2018 were primarily due to ordinary business activity.
In February 2016, the FASB issued ASU 2016-02 to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The amendments in this ASU require that leases are classified as either finance or operating leases, a right-of-use asset and lease liability is recognized in the statement of financial position and repayments are classified within operating activities in the statement of cash flows. The amendments in this ASU are to be applied using a modified retrospective approach and are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 (early adoption is permitted). We plan to

7


SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

adopt this ASU effective January 1, 2019. While management is still evaluating the impact of adopting the provisions of this ASU, management expects that upon adoption of this ASU, the presentation of certain items in our consolidated financial position, cash flows and other disclosures will be materially impacted, primarily due to the recognition of a right-of-use asset and an associated liability and a change in the timing and classification of certain items in our results of operations as a result of the derecognition of the lease liability.
In August 2017, the FASB issued ASU 2017-12 which amends the hedge accounting recognition and presentation requirements in ASC 815. This ASU expands and refines hedge accounting for both non-financial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. It also includes certain targeted improvements to simplify the application of current guidance related to hedge accounting. For public companies, this ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 (early adoption is permitted). We do not believe the effects of this ASU will materially impact our consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, which allows the reclassification of stranded tax effects, as a result of the Tax Cuts and Jobs Acts of 2017, from accumulated other comprehensive income to retained earnings. For public companies, this ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 (early adoption is permitted). We are currently in the process of evaluating the effects of this ASU on our consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07 to expand the scope of ASC Topic 718, Compensation - Stock Compensation, to include share-based payment transactions for acquiring goods and services from non-employees. For public companies, this ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 (early adoption is permitted). We are currently in the process of evaluating the effects of this ASU on our consolidated financial statements.
Principles of Consolidation All of our 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.
Income Tax Expense – Beginning January 1, 2018, the federal income tax rate changed from 35.0% to 21.0% along with other tax provision changes that affect the deductibility of certain expenses.  Sonic has considered these items in its calculation of income tax amounts as of June 30, 2018 and for the three and six months ended June 30, 2018. The overall effective tax rate from continuing operations was 32.4% and 29.7% for the three and six months ended June 30, 2018, respectively, and 39.3% and 39.8% for the three and six months ended June 30, 2017, respectively. Income tax expense for the three months ended June 30, 2018 includes a $0.6 million discrete charge for non-deductible book goodwill related to dealership dispositions during the period. Income tax expense for the six months ended June 30, 2018 includes a $0.9 million discrete benefit related to vested or exercised stock compensation, offset partially by a $0.2 million discrete charge related to changes in uncertain tax positions and a $0.6 million discrete charge for non-deductible book goodwill related to dealership dispositions during the period. Income tax expense for the three and six months ended June 30, 2017 includes a benefit of approximately $0.2 million and $0.5 million, respectively, as a result of the adoption of ASU 2016-09 which requires all book-tax differences related to the exercise of stock options or vesting of restricted stock or restricted stock units to flow through the provision for income taxes. 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 annual effective tax rate in future periods to fall within a range of 26.0% to 28.0% before the impact, if any, of changes in valuation allowances related to deferred income tax assets or discrete tax adjustments.
2. Business Acquisitions and Dispositions
Acquisitions Sonic did not acquire any businesses during the three and six months ended June 30, 2018 and 2017.
Dispositions Sonic disposed of six franchised dealerships during the six months ended June 30, 2018 that generated net cash of approximately $122.4 million. In addition to these dispositions, Sonic terminated one luxury franchised dealership and ceased operations at one of our pre-owned stores. Sonic did not dispose of any businesses during the six months ended June 30, 2017.

8


SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Revenues and other activities associated with disposed dealerships classified as discontinued operations were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
Income (loss) from operations
$
(191
)
 
$
(162
)
 
$
(330
)
 
$
(441
)
Lease exit accrual adjustments and charges
(106
)
 
(139
)
 
(215
)
 
(727
)
Pre-tax income (loss)
$
(297
)
 
$
(301
)
 
$
(545
)
 
$
(1,168
)
Total revenues
$

 
$

 
$

 
$

Revenues and other activities associated with disposed dealerships that remain in continuing operations were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
Income (loss) from operations
$
739

 
$
(829
)
 
$
(5,505
)
 
$
(2,289
)
Gain (loss) on disposal
38,422

 

 
39,613

 
(24
)
Lease exit accrual adjustments and charges
2

 

 
(18
)
 

Pre-tax income (loss)
$
39,163

 
$
(829
)
 
$
34,090

 
$
(2,313
)
Total revenues
$
30,751

 
$
135,231

 
$
108,777

 
$
266,349

3. Inventories
Inventories consist of the following:
 
June 30, 2018
 
December 31, 2017
 
(In thousands)
New vehicles
$
1,059,010

 
$
1,017,523

Used vehicles
266,429

 
294,496

Service loaners
136,844

 
130,406

Parts, accessories and other
65,378

 
70,320

Net inventories
$
1,527,661

 
$
1,512,745

4. Property and Equipment
Property and equipment, net consists of the following:
 
June 30, 2018
 
December 31, 2017
 
(In thousands)
Land
$
382,310

 
$
370,828

Building and improvements
943,442

 
893,768

Software and computer equipment
127,094

 
147,812

Parts and service equipment
110,027

 
105,123

Office equipment and fixtures
96,358

 
96,066

Company vehicles
9,564

 
9,723

Construction in progress
47,049

 
54,429

Total, at cost
1,715,844

 
1,677,749

Less accumulated depreciation
(549,183
)
 
(527,379
)
Subtotal
1,166,661

 
1,150,370

Less assets held for sale (1)
(3,875
)
 
(3,489
)
Property and equipment, net
$
1,162,786

 
$
1,146,881


9

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)
Classified in other current assets in the accompanying condensed consolidated balance sheets.
In the three and six months ended June 30, 2018, capital expenditures were approximately $33.9 million and $99.6 million, respectively, and in the three and six months ended June 30, 2017, capital expenditures were approximately $45.5 million and $121.2 million, respectively. Capital expenditures in all periods were primarily related to real estate acquisitions, construction of new franchised dealerships and pre-owned stores, building improvements and equipment purchased for use in our franchised dealerships and pre-owned stores. Assets held for sale as of June 30, 2018 consists of vacant land that we expect to dispose of in the next 12 months.
Impairment charges for the three and six months ended June 30, 2018 were approximately $10.3 million and $14.0 million, respectively, which include the write-off of certain costs associated with internally developed software as well as the write-off of capitalized costs associated with the abandonment of certain construction projects. Impairment charges for the three and six months ended June 30, 2017 were approximately $2.6 million and $3.1 million, respectively, which include the write-off of goodwill and property and equipment as part of the closure of two pre-owned stores that were purchased in 2016, and the write-off of capitalized costs associated with the abandonment of certain construction projects.
5. Goodwill and Intangible Assets
The carrying amount of goodwill was approximately $510.2 million and $525.8 million as of June 30, 2018 and December 31, 2017, respectively. The carrying amount of goodwill is net of accumulated impairment losses of approximately $797.6 million as of June 30, 2018 and December 31, 2017. The carrying amount of franchise assets was approximately $67.8 million and $69.9 million as of June 30, 2018 and December 31, 2017, respectively. Changes in the carrying amount of both goodwill and franchise assets are related to the disposition of several franchised dealerships during the six months ended June 30, 2018. At December 31, 2017, Sonic had approximately $4.7 million of definite life intangibles related to favorable lease agreements. After the effect of amortization of the definite life intangibles, the balance recorded at June 30, 2018 was approximately $4.3 million. Both franchise assets and favorable lease agreement assets are included in other intangible assets, net in the accompanying condensed consolidated balance sheets.
6. Long-Term Debt
Long-term debt consists of the following:
 
June 30, 2018
 
December 31, 2017
 
(In thousands)
2016 Revolving Credit Facility (1)
$
17,396

 
$
75,000

5.0% Senior Subordinated Notes due 2023 (the “5.0% Notes”)
289,273

 
289,273

6.125% Senior Subordinated Notes due 2027 (the “6.125% Notes”)
250,000

 
250,000

Mortgage notes to finance companies-fixed rate, bearing interest from 3.51% to 7.03%
229,828

 
199,972

Mortgage notes to finance companies-variable rate, bearing interest at 1.50 to 2.90
   percentage points above one-month or three-month LIBOR
192,767

 
219,719

Debt issuance costs
(12,121
)
 
(13,208
)
Other
3,771

 
3,947

Total debt
$
970,914

 
$
1,024,703

Less current maturities
(37,786
)
 
(61,314
)
Long-term debt
$
933,128

 
$
963,389

(1)
The interest rate on the 2016 Revolving Credit Facility (as defined below) was 225 basis points above the London Interbank Offer Rate ("LIBOR") at both June 30, 2018 and December 31, 2017.
2016 Credit Facilities
On November 30, 2016, Sonic entered into an amended and restated syndicated revolving credit facility (the “2016 Revolving Credit Facility”) and amended and restated syndicated new and used vehicle floor plan credit facilities (the “2016 Floor Plan Facilities” and, together with the 2016 Revolving Credit Facility, the “2016 Credit Facilities”), which are scheduled to mature on November 30, 2021.
Availability under the 2016 Revolving Credit Facility is calculated as the lesser of $250.0 million or a borrowing base calculated based on certain eligible assets, less the aggregate face amount of any outstanding letters of credit under the 2016

10

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Revolving Credit Facility (the “2016 Revolving Borrowing Base”). The 2016 Revolving Credit Facility may be increased at Sonic’s option up to $300.0 million upon satisfaction of certain conditions. As of June 30, 2018, the 2016 Revolving Borrowing Base was approximately $220.9 million based on balances as of such date. As of June 30, 2018, Sonic had approximately $17.4 million of outstanding borrowings and approximately $16.4 million in outstanding letters of credit under the 2016 Revolving Credit Facility, resulting in total borrowing availability of approximately $187.1 million under the 2016 Revolving Credit Facility.
The 2016 Floor Plan Facilities are comprised of a new vehicle revolving floor plan facility (the “2016 New Vehicle Floor Plan Facility”) and a used vehicle revolving floor plan facility (the “2016 Used Vehicle Floor Plan Facility”), subject to a borrowing base, in a combined amount of up to $1.015 billion. We may, under certain conditions, request an increase in the 2016 Floor Plan Facilities to a maximum borrowing limit of up to $1.265 billion, which shall be allocated between the 2016 New Vehicle Floor Plan Facility and the 2016 Used Vehicle Floor Plan Facility as we request, with no more than 30% of the aggregate commitments allocated to the commitments under the 2016 Used Vehicle Floor Plan Facility. Outstanding obligations under the 2016 Floor Plan Facilities are guaranteed by us and certain of our subsidiaries and are secured by a pledge of substantially all of our and our subsidiaries’ assets. The amounts outstanding under the 2016 Credit Facilities bear interest at variable rates based on specified percentages above LIBOR.
We agreed under the 2016 Credit Facilities not to pledge any assets to any third parties (other than those explicitly allowed under the amended terms of the 2016 Credit Facilities), including other lenders, subject to certain stated exceptions, including floor plan financing arrangements. In addition, the 2016 Credit Facilities contain certain negative covenants, including covenants which could restrict or prohibit indebtedness, liens, the payment of dividends, capital expenditures and material dispositions and acquisitions of assets as well as other customary covenants and default provisions. Specifically, the 2016 Credit Facilities permit cash dividends on our Class A and Class B Common Stock so long as no event of default (as defined in the 2016 Credit Facilities) has occurred and is continuing and provided that we remain in compliance with all financial covenants under the 2016 Credit Facilities.
5.0% Notes
On May 9, 2013, Sonic issued $300.0 million in aggregate principal amount of unsecured senior subordinated 5.0% Notes, which are scheduled to mature on May 15, 2023. The 5.0% Notes were issued at a price of 100.0% of the principal amount thereof. The 5.0% Notes are guaranteed by Sonic’s domestic operating subsidiaries. Interest on the 5.0% Notes is payable semi-annually in arrears on May 15 and November 15 of each year. On September 30, 2016, Sonic repurchased approximately $10.7 million of the outstanding 5.0% Notes for approximately $10.6 million in cash, plus accrued and unpaid interest related thereto. Sonic may redeem the remaining outstanding 5.0% Notes, in whole or in part, at any time.
The indenture governing the 5.0% Notes contains certain specified restrictive covenants. Sonic has agreed not to pledge any assets to any third-party lender of senior subordinated debt except under certain limited circumstances. Sonic also has agreed to certain other limitations or prohibitions concerning the incurrence of other indebtedness, guarantees, liens, certain types of investments, certain transactions with affiliates, mergers, consolidations, issuance of preferred stock, cash dividends to stockholders, distributions, redemptions and the sale, assignment, lease, conveyance or disposal of certain assets. Specifically, the indenture governing the 5.0% Notes limits Sonic’s ability to pay quarterly cash dividends on Sonic’s Class A and Class B Common Stock in excess of $0.10 per share. Sonic may only pay quarterly cash dividends on Sonic’s Class A and Class B Common Stock if Sonic complies with the terms of the indenture governing the 5.0% Notes. Sonic was in compliance with all restrictive covenants in the indenture governing the 5.0% Notes as of June 30, 2018.
6.125% Notes
On March 10, 2017, Sonic issued $250.0 million in aggregate principal amount of unsecured senior subordinated 6.125% Notes, which are scheduled to mature on March 15, 2027. The 6.125% Notes were issued at a price of 100.0% of the principal amount thereof. Sonic used the net proceeds from the issuance of the 6.125% Notes (i) to repurchase all of its then outstanding 7.0% Senior Subordinated Notes due 2022 on March 27, 2017 (the “7.0% Notes”) and (ii) for other general corporate purposes. The 6.125% Notes are guaranteed by Sonic’s domestic operating subsidiaries. Interest on the 6.125% Notes is payable semi-annually in arrears on March 15 and September 15 of each year. Sonic may redeem the 6.125% Notes, in whole or in part, at any time on or after March 15, 2022.
The indenture governing the 6.125% Notes contains certain specified restrictive covenants. Sonic has agreed not to pledge any assets to any third-party lender of senior subordinated debt except under certain limited circumstances. Sonic also has agreed to certain other limitations or prohibitions concerning the incurrence of other indebtedness, guarantees, liens, certain types of investments, certain transactions with affiliates, mergers, consolidations, issuance of preferred stock, cash dividends to stockholders, distributions, redemptions and the sale, assignment, lease, conveyance or disposal of certain assets. Specifically, the indenture governing the 6.125% Notes limits Sonic’s ability to pay quarterly cash dividends on Sonic’s Class A and Class B Common Stock in excess of $0.12 per share. Sonic may only pay quarterly cash dividends on Sonic’s Class A and Class B Common

11

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Stock if Sonic complies with the terms of the indenture governing the 6.125% Notes. Sonic was in compliance with all restrictive covenants in the indenture governing the 6.125% Notes as of June 30, 2018.
Mortgage Notes
During the six months ended June 30, 2018, Sonic obtained approximately $21.1 million in mortgage financing related to three of its operating locations. As of June 30, 2018, the weighted average interest rate was 4.53% and the total outstanding mortgage principal balance was approximately $422.6 million. These mortgage notes require monthly payments of principal and interest through their respective maturities, are secured by the underlying properties and contain certain cross-default provisions. Maturity dates for these mortgage notes range between 2018 and 2033.
Covenants
Under the 2016 Credit Facilities, Sonic agreed not to pledge any assets to any third parties (other than those explicitly allowed under the amended terms of the 2016 Credit Facilities), including other lenders, subject to certain stated exceptions, including floor plan financing arrangements. In addition, the 2016 Credit Facilities contain certain negative covenants, including covenants which could restrict or prohibit indebtedness, liens, the payment of dividends, capital expenditures and material dispositions and acquisitions of assets as well as other customary covenants and default provisions.
Sonic was in compliance with the covenants under the 2016 Credit Facilities as of June 30, 2018. Financial covenants include required specified ratios (as each is defined in the 2016 Credit Facilities) of:
 
Covenant
 
Minimum
Consolidated
Liquidity
Ratio
 
Minimum
Consolidated
Fixed Charge
Coverage
Ratio
 
Maximum
Consolidated
Total Lease
Adjusted Leverage
Ratio
Required ratio
1.05

 
1.20

 
5.75

June 30, 2018 actual
1.13
 
1.43
 
5.05
The 2016 Credit Facilities contain events of default, including cross defaults to other material indebtedness, change of control events and other 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 2016 Credit Facilities.
After giving effect to the applicable restrictions on the payment of dividends under its debt agreements, as of June 30, 2018, Sonic had approximately $142.5 million of net income and retained earnings free of such restrictions. Sonic was in compliance with all restrictive covenants under its debt agreements as of June 30, 2018.
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 under the guarantee agreement are identical to those under the 2016 Credit Facilities with the exception of one financial covenant related to the ratio of EBTDAR to Rent (as defined in the guarantee agreement) with a required ratio of no less than 1.50 to 1.00. As of June 30, 2018, the ratio was 3.49  to 1.00.
Derivative Instruments and Hedging Activities
Sonic has interest rate cap agreements designated as hedging instruments to limit its exposure to increases in LIBOR rates above certain levels. Under the terms of these interest rate caps, interest rates reset monthly. The fair value of these interest rate cap positions at June 30, 2018 was a net asset of approximately $8.0 million, with approximately $6.7 million included in other assets and approximately $1.3 million included in other current assets in the accompanying condensed consolidated balance sheets. During the six months ended June 30, 2018, Sonic terminated all of its previously outstanding interest rate cash flow swap agreements for net cash proceeds of approximately $4.8 million, which will be amortized into income as a reduction of interest expense, other, net on a ratable basis over the original term of these agreements (through July 1, 2020). The fair value of the outstanding interest rate swap and interest rate cap positions at December 31, 2017 was a net asset of approximately $4.7 million, with approximately $5.1 million included in other assets and approximately $0.9 million included in other current assets in the accompanying condensed consolidated balance sheets, offset partially by approximately $1.0 million included in other accrued liabilities and approximately $0.3 million included in other long-term liabilities in the accompanying condensed consolidated balance sheets.

12

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Under the terms of the interest rate cap agreements, Sonic will receive and pay interest based on the following:
Notional
Amount
 
Pay Rate (1)
 
Receive Rate (2)
 
Start Date
 
End Date
(In millions)
 
 
 
 
 
 
 
 
$
250.0

 
2.000%
 
one-month LIBOR
 
September 1, 2017
 
June 30, 2018
$
375.0

 
2.000%
 
one-month LIBOR
 
July 1, 2018
 
June 30, 2019
$
375.0

 
3.000%
 
one-month LIBOR
 
July 1, 2018
 
June 30, 2019
$
312.5

 
2.000%
 
one-month LIBOR
 
July 1, 2019
 
June 30, 2020
$
250.0

 
3.000%
 
one-month LIBOR
 
July 1, 2019
 
June 30, 2020
$
225.0

 
3.000%
 
one-month LIBOR
 
July 1, 2020
 
June 30, 2021
$
150.0

 
2.000%
 
one-month LIBOR
 
July 1, 2020
 
July 1, 2021
$
250.0

 
3.000%
 
one-month LIBOR
 
July 1, 2021
 
July 1, 2022
(1)
Under these interest rate cap agreements, no payment to or from the counterparty will occur unless the stated receive rate exceeds the stated pay rate, in which case a net payment to Sonic from the counterparty based on the spread between the receive rate and the pay rate will be recognized as a reduction of interest expense, other, net in the accompanying condensed consolidated statements of income.
(2)
The one-month LIBOR rate was approximately 2.090% at June 30, 2018.

The interest rate caps are designated as cash flow hedges, and the changes in the fair value of these instruments are recorded in other comprehensive income (loss) 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 interest rate caps and interest rate swaps was approximately zero and $0.1 million for the three and six months ended June 30, 2018, respectively, $0.7 million and $1.9 million for the three and six months ended June 30, 2017, respectively, and is included in interest expense, other, net in the accompanying condensed consolidated statements of income, and the interest paid amount is disclosed in the supplemental disclosures of cash flow information in the accompanying condensed consolidated statements of cash flows. The estimated net benefit expected to be reclassified out of accumulated other comprehensive income (loss) into results of operations during the next 12 months is approximately $1.8 million.
7. Per Share Data and Stockholders’ Equity
The calculation of diluted earnings per share considers the potential dilutive effect of stock options and shares under Sonic’s stock compensation plans and Class A Common Stock purchase warrants. Certain of Sonic’s non-vested restricted stock awards 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 tables illustrate the dilutive effect of such items on earnings per share for the three and six months ended June 30, 2018 and 2017:
 
Three Months Ended June 30, 2018
 
 
 
Income (Loss)
 
Income (Loss)
 
 
 
 
 
 
 
From Continuing
Operations
 
From Discontinued
Operations
 
Net
Income (Loss)
 
Weighted
Average
Shares
 
Amount
 
Per
Share
Amount
 
Amount
 
Per
Share
Amount
 
Amount
 
Per
Share
Amount
 
(In thousands, except per share amounts)
Earnings (loss) and shares
42,662

 
$
17,122

 

 
$
(217
)
 

 
$
16,905

 

Effect of participating securities:

 

 

 

 

 

 

Non-vested restricted stock

 
(3
)
 

 

 

 
(3
)
 

Basic earnings (loss) and shares
42,662

 
$
17,119

 
$
0.40

 
$
(217
)
 
$

 
$
16,902

 
$
0.40

Effect of dilutive securities:

 

 

 

 

 

 

Stock compensation plans
258

 

 

 

 

 

 

Diluted earnings (loss) and shares
42,920

 
$
17,119

 
$
0.40

 
$
(217
)
 
$
(0.01
)
 
$
16,902

 
$
0.39


13

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Three Months Ended June 30, 2017
 
 
 
Income (Loss)
 
Income (Loss)
 
 
 
 
 
 
 
From Continuing
Operations
 
From Discontinued
Operations
 
Net
Income (Loss)
 
Weighted
Average
Shares
 
Amount
 
Per
Share
Amount
 
Amount
 
Per
Share
Amount
 
Amount
 
Per
Share
Amount
 
(In thousands, except per share amounts)
Earnings (loss) and shares
44,570

 
$
12,314

 

 
$
(182
)
 

 
$
12,132

 

Effect of participating securities:

 

 

 

 

 

 

Non-vested restricted stock

 
(9
)
 

 

 

 
(9
)
 

Basic earnings (loss) and shares
44,570

 
$
12,305

 
$
0.28

 
$
(182
)
 
$
(0.01
)
 
$
12,123

 
$
0.27

Effect of dilutive securities:

 

 

 

 

 

 

Stock compensation plans
240

 

 

 

 

 

 

Diluted earnings (loss) and shares
44,810

 
$
12,305

 
$
0.27

 
$
(182
)
 
$

 
$
12,123

 
$
0.27

 
Six Months Ended June 30, 2018
 
 
 
Income (Loss)
 
Income (Loss)
 
 
 
 
 
 
 
From Continuing
Operations
 
From Discontinued
Operations
 
Net
Income (Loss)
 
Weighted
Average
Shares
 
Amount
 
Per
Share
Amount
 
Amount
 
Per
Share
Amount
 
Amount
 
Per
Share
Amount
 
(In thousands, except per share amounts)
Earnings (loss) and shares
42,725

 
$
15,108

 

 
$
(397
)
 

 
$
14,711

 

Effect of participating securities:

 

 

 

 

 

 

Non-vested restricted stock

 
(5
)
 

 

 

 
(5
)
 

Basic earnings (loss) and shares
42,725

 
$
15,103

 
$
0.35

 
$
(397
)
 
$
(0.01
)
 
$
14,706

 
$
0.34

Effect of dilutive securities:

 

 

 

 

 

 

Stock compensation plans
223

 

 

 

 

 

 

Diluted earnings (loss) and shares
42,948

 
$
15,103

 
$
0.35

 
$
(397
)
 
$
(0.01
)
 
$
14,706

 
$
0.34

 
Six Months Ended June 30, 2017
 
 
 
Income (Loss)
 
Income (Loss)
 
 
 
 
 
 
 
From Continuing
Operations
 
From Discontinued
Operations
 
Net
Income (Loss)
 
Weighted
Average
Shares
 
Amount
 
Per
Share
Amount
 
Amount
 
Per
Share
Amount
 
Amount
 
Per
Share
Amount
 
(In thousands, except per share amounts)
Earnings (loss) and shares
44,680

 
$
12,294

 

 
$
(703
)
 

 
$
11,591

 

Effect of participating securities:

 

 

 

 

 

 

Non-vested restricted stock

 
(9
)
 

 

 

 
(9
)
 

Basic earnings (loss) and shares
44,680

 
$
12,285

 
$
0.27

 
$
(703
)
 
$
(0.01
)
 
$
11,582

 
$
0.26

Effect of dilutive securities:

 

 

 

 

 

 

Stock compensation plans
296

 

 

 

 

 

 

Diluted earnings (loss) and shares
44,976

 
$
12,285

 
$
0.27

 
$
(703
)
 
$
(0.01
)
 
$
11,582

 
$
0.26

    

14

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

8. Commitments and Contingencies
Lease Exit Accruals
The majority of our dealership properties are leased under long-term operating lease arrangements. When leased properties are no longer utilized in operations, we record lease exit accruals. These situations could include the relocation of an existing facility or the sale of a dealership when the buyer will not be subleasing the property for either the remaining term of the lease or for an amount equal to our obligation under the lease, or situations in which a store is closed as a result of the associated franchise being terminated by us or the manufacturer and no other operations continue on the leased property. The lease exit accruals represent the present value of the lease payments, net of estimated sublease rentals, for the remaining life of the operating leases and other accruals necessary to satisfy lease commitments to the landlords. As of June 30, 2018, we had approximately $7.6 million accrued for lease exit costs. In addition, based on the terms and conditions negotiated in the sale of dealerships in the future, additional accruals may be necessary if the purchaser of the dealership does not assume any associated lease, or we are unable to negotiate a sublease with the buyer of the dealership on terms that are identical to or better than those associated with the original lease.
A summary of the activity of these operating lease exit accruals consists of the following:
 
(In thousands)
Balance at December 31, 2017
$
6,478

Lease exit expense (1)
2,564

Payments (2)
(1,488
)
Balance at June 30, 2018
$
7,554

(1)
Expense of approximately $2.3 million is recorded in selling, general and administrative expenses and expense of approximately $0.1 million is recorded in interest expense, other, net in the accompanying condensed consolidated statements of income. In addition, expense of approximately $0.2 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 recorded in selling, general and administrative expenses in the accompanying condensed consolidated statements of income and approximately $1.0 million recorded in income (loss) from discontinued operations before taxes in the accompanying condensed consolidated statements of income.
Legal and Other Proceedings
Sonic is involved, and expects to continue to be involved, in various 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 business, financial condition, results of operations, cash flows or prospects.
Included in other accrued liabilities and other long-term liabilities at June 30, 2018 was approximately $4.7 million and $0.2 million, respectively, in reserves that Sonic was holding for pending proceedings. Included in other accrued liabilities and other long-term liabilities at December 31, 2017 was approximately $3.0 million and $0.2 million, respectively, for such reserves. 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 and facility relocations, certain of Sonic’s 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 sublessee does not perform. In the event an assignee or a sublessee does not perform

15

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

its obligations, Sonic remains liable for the lease payments. See Note 12, “Commitments and Contingencies,” to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2017 for further discussion.
In accordance with the terms of agreements entered into for the sale of Sonic’s dealerships, Sonic generally agrees to indemnify the buyer from certain liabilities and costs arising subsequent to the date of sale, including environmental exposure and exposure resulting from the breach of representations or warranties made in accordance with the agreements. 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 $17.0 million and $5.0 million at June 30, 2018 and December 31, 2017, respectively. These indemnifications typically 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 June 30, 2018.
Sonic also guarantees the floor plan commitments of its 50%-owned joint venture, the amount of which was approximately $2.8 million at both June 30, 2018 and December 31, 2017.
Earnout Consideration
In association with the acquisition of a business in the three months ended September 30, 2017, Sonic entered into an earnout agreement whereby the seller may be entitled to certain variable earnout payments, subject to certain restrictions, based on the acquired business achieving specified earnings targets over a 10-year period, not to exceed a maximum aggregate earnout payment of $80.0 million. Sonic will recognize the accrual of any such variable earnout payments as compensation expense as earned. Sonic had recorded approximately $23.3 million in earnout accruals as of June 30, 2018, with approximately $7.7 million and $15.6 million recorded in other accrued liabilities and other long-term liabilities, respectively, in the accompanying condensed consolidated balance sheets.
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 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, including Sonic’s stock or public bonds.
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.

16

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Assets and liabilities recorded at fair value in the accompanying condensed consolidated balance sheets as of June 30, 2018 and December 31, 2017 are as follows:
 
Fair Value Based on
Significant Other Observable
Inputs (Level 2)
 
June 30, 2018
 
December 31, 2017
 
(In thousands)
Assets:
 
 
 
Cash surrender value of life insurance policies (1)
$
33,996

 
$
33,747

Cash flow swaps and interest rate caps designated as hedges (2)
8,013

 
5,968

Total assets
$
42,009

 
$
39,715

 
 
 
 
Liabilities:
 
 
 
Cash flow swaps and interest rate caps designated as hedges (3)
$

 
$
1,286

Deferred compensation plan (4)
19,454

 
18,417

Total liabilities
$
19,454

 
$
19,703

(1)
Included in other assets in the accompanying condensed consolidated balance sheets.
(2)
As of June 30, 2018, approximately $1.3 million and $6.7 million were included in other current assets and other assets, respectively, in the accompanying condensed consolidated balance sheets. As of December 31, 2017, approximately $0.9 million and $5.1 million were included in other current assets and other assets, respectively, in the accompanying condensed consolidated balance sheets.
(3)
As of December 31, 2017, approximately $1.0 million and $0.3 million were included in other accrued liabilities and other long-term liabilities, respectively, in the accompanying condensed consolidated balance sheets.
(4)
Included in other long-term liabilities in the accompanying condensed consolidated balance sheets.

There were no instances during the six months ended June 30, 2018 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 sheet as of June 30, 2018 has not changed since December 31, 2017. These assets will be evaluated as of the annual valuation assessment date of October 1, 2018 or as events or changes in circumstances require.
As of June 30, 2018 and December 31, 2017, 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 revolving credit facilities and certain mortgage notes, approximated their carrying values due either to length of maturity or existence of variable interest rates that approximate prevailing market rates.
At June 30, 2018 and December 31, 2017, the fair value and carrying value of Sonic’s significant fixed rate long-term debt were as follows:
 
June 30, 2018
 
December 31, 2017
 
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
 
(In thousands)
5.0% Notes (1)
$
276,979

 
$
289,273

 
$
279,148

 
$
289,273

6.125% Notes (1)
$
235,625

 
$
250,000

 
$
248,750

 
$
250,000

Mortgage Notes (2)
$
233,373

 
$
229,828

 
$
203,031

 
$
199,972

Other (2)
$
3,602

 
$
3,771

 
$
3,760

 
$
3,947

(1)
As determined by market quotations as of June 30, 2018 and December 31, 2017, respectively (Level 1).
(2)
As determined by discounted cash flows (Level 3).

17

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

10. Accumulated Other Comprehensive Income (Loss)
The changes in accumulated other comprehensive income (loss) by component for the six months ended June 30, 2018 are as follows:

Gains and
Losses on
Cash Flow
Hedges
 
Defined
Benefit
Pension
Plan
 
Total
Accumulated
Other
Comprehensive
Income (Loss)
 
(In thousands)
Balance at December 31, 2017
$
1,750

 
$
(443
)
 
$
1,307

Other comprehensive income (loss) before reclassifications (1)
3,664

 

 
3,664

    Amounts reclassified out of accumulated
       other comprehensive income (loss) (2)
121

 

 
121

Net current-period other comprehensive income (loss)
3,785

 

 
3,785

Balance at June 30, 2018
$
5,535

 
$
(443
)
 
$
5,092

(1)
Net of tax expense of $1,373.
(2)
Net of tax expense of $45.
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,” to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2017.
11. Segment Information
As of June 30, 2018, Sonic had two operating segments comprised of: (1) retail automotive franchises that sell new vehicles and buy and sell used vehicles, sell replacement parts, perform vehicle repair and maintenance services, and arrange finance and insurance products (the “Franchised Dealerships Segment”) and (2) stand-alone pre-owned vehicle specialty retail locations that buy and sell used vehicles, perform vehicle repair and maintenance services, and arrange finance and insurance products under the EchoPark and other pre-owned brands (the “Pre-Owned Stores Segment”).
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 of three individuals consisting of: (1) the Company’s Chief Executive Officer and President; (2) the Company’s Executive Vice President and Chief Financial Officer; and (3) the Company’s Executive Vice President of Operations. Sonic has determined that its operating segments also represent its reportable segments.
Reportable segment revenues and segment income (loss) for the three and six months ended June 30, 2018 and 2017 are as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
Franchised Dealerships Segment
$
2,325,583

 
$
2,356,692

 
$
4,594,852

 
$
4,602,717

Pre-Owned Stores Segment
180,166

 
49,054

 
311,671

 
90,851

Total consolidated revenues
$
2,505,749

 
$
2,405,746

 
$
4,906,523

 
$
4,693,568


18

SONIC AUTOMOTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
Segment income (loss) (1):
 
 
 
 
 
 
 
Franchised Dealerships Segment (2)
$
66,049

 
$
40,598

 
$
89,885

 
$
74,067

Pre-Owned Stores Segment (3)
(27,347
)
 
(7,571
)
 
(41,672
)
 
(12,978
)
Total segment income (loss)
38,702

 
33,027

 
48,213

 
61,089

Interest expense, other, net
(13,375
)
 
(12,764
)
 
(26,831
)
 
(26,172
)
Other income (expense), net
17

 
7

 
106

 
(14,495
)
Income (loss) from continuing operations before taxes
$
25,344

 
$
20,270

 
$
21,488

 
$
20,422

(1)
Segment income (loss) for each segment is defined as operating income (loss) less interest expense, floor plan.
(2)
For the three months ended June 30, 2018, the above amount includes a benefit of approximately $38.0 million of net gain on the disposal of franchised dealerships and approximately $2.6 million of lease exit benefit, offset partially by approximately $3.1 million of storm-related physical damage and legal costs and approximately $10.3 million of impairment expense. For the three months ended June 30, 2017, the above amount includes approximately $5.6 million of storm-related physical damage and legal costs and approximately $0.3 million of lease exit charges.
For the six months ended June 30, 2018, the above amount includes a benefit of approximately $39.2 million of net gain on the disposal of franchised dealerships, offset partially by approximately $4.6 million of storm-related physical damage and legal costs, approximately $2.2 million of lease exit charges and approximately $14.0 million of impairment expense. For the six months ended June 30, 2017, the above amount includes approximately $6.9 million of storm-related physical damage and legal costs and approximately $0.3 million of lease exit charges.
(3)
For the three months ended June 30, 2018, the above amount includes approximately $23.3 million of non-recurring compensation-related charges. For the three months ended June 30, 2017, the above amount includes approximately $0.7 million of lease exit charges.
For the six months ended June 30, 2018, the above amount includes approximately $32.5 million of non-recurring compensation-related charges. For the six months ended June 30, 2017, the above amount includes approximately $0.7 million of lease exit charges.


19

SONIC AUTOMOTIVE, INC.
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 accompanying condensed consolidated financial statements and related notes thereto, as well as the consolidated 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, 2017.
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 this Management’s Discussion and Analysis of Financial Condition and Results of Operations on a consolidated basis.
Overview
We are one of the largest automotive retailers in the United States (as measured by total revenue). As of June 30, 2018, we operated 107 new vehicle franchises in 13 states (representing 23 different brands of cars and light trucks), 15 collision repair centers and nine pre-owned stores. As a result of the way we manage our business, we had two operating segments as of June 30, 2018: (1) Franchised Dealerships Segment and (2) Pre-Owned Stores Segment. For management and operational reporting purposes, we group certain businesses together that share management and inventory (principally used vehicles) into “stores.” As of June 30, 2018, we operated 96 stores in the Franchised Dealerships Segment and nine stores in the Pre-Owned Stores Segment.
The Franchised Dealerships Segment provides comprehensive services, including (1) sales of both new and used cars and light trucks; (2) sales of replacement parts and performance of vehicle maintenance, manufacturer warranty repairs, and 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 Pre-Owned Stores Segment provides the same services (excluding new vehicle sales and manufacturer warranty repairs) in stand-alone pre-owned vehicle specialty retail locations and includes our EchoPark branded stores. Our pre-owned stores business operates independently from our franchised dealerships business. Sales operations in our first EchoPark market in Denver, Colorado began in the fourth quarter of 2014. As of June 30, 2018, we had six EchoPark stores in operation in Colorado and two EchoPark stores and one additional pre-owned store in Texas. By the end of 2018, we expect to open three to four additional EchoPark stores in North Carolina and Texas. We believe that the expansion of our pre-owned stores business will provide long-term benefits to our Company, our stockholders and our guests. However, in the short term, this strategic initiative may negatively impact our overall operating results as we allocate management and capital resources to this business.
Executive Summary
The U.S. retail automotive industry’s total new vehicle seasonally adjusted annual rate of sales (“SAAR”) increased 3.6% to 17.2 million vehicles in the three months ended June 30, 2018, from 16.6 million vehicles in the three months ended June 30, 2017, according to data from Bloomberg Financial Markets, provided by Stephens Inc. The SAAR increased 1.2% to 17.1 million vehicles in the six months ended June 30, 2018, compared to 16.9 million vehicles in the six months ended June 30, 2017, according to Bloomberg Financial Markets, via Stephens Inc. For 2018, analysts’ average industry expectation for the new vehicle SAAR is approximately 16.8 million vehicles. We currently estimate the 2018 new vehicle SAAR will be between 16.8 million and 17.0 million vehicles. Changes in consumer confidence, replacement demand as a result of natural disasters, availability of consumer financing, manufacturer inventory production levels or incentive levels from the automotive manufacturers could cause actual 2018 new vehicle SAAR to vary from expectations. Many factors, including brand and geographic concentrations as well as the industry sales mix between retail and fleet new vehicle unit sales volume, have caused our past results to differ from the industry’s overall trend. Our current operational focus is to grow our retail new vehicle sales (as opposed to fleet new vehicle sales, which is a minimal part of our business), and, as a result, we believe it is appropriate to compare our new vehicle unit sales volume to the retail new vehicle SAAR (which excludes fleet new vehicle sales). According to the Power Information Network (“PIN”) from J.D. Power, retail new vehicle SAAR was 13.6 million vehicles for the three months ended June 30, 2018, an increase of 0.7% from the prior year period, and 13.5 million vehicles for the six months ended June 30, 2018, a decrease of 0.7% from the prior year period.
As a result of the disposition, termination or closure of several franchised dealership stores since June 30, 2017, the change in consolidated reported amounts from period to period may not be indicative of the actual operational or financial performance of our current group of operating stores. Unless otherwise noted, all discussion of increases or decreases are for the three and six months ended June 30, 2018 and are compared to the same prior year period, as applicable. The following discussion of new vehicles, used vehicles, wholesale vehicles, parts, service and collision repair, and finance, insurance and other, net are on a same store basis, except where otherwise noted. All currently operating continuing operations stores (both our franchised dealerships

20

SONIC AUTOMOTIVE, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


and pre-owned stores) are included within the same store group in the first full month following the first anniversary of the store’s opening or acquisition.
Same store retail new vehicle revenue increased 1.6% and 2.2% during the three and six months ended June 30, 2018, respectively, driven by an increase in average selling prices. New vehicle gross profit decreased 6.3% and 3.9% during the three and six months ended June 30, 2018, respectively, primarily due to lower new vehicle unit sales volume. New vehicle gross profit per unit decreased $98 per unit, or 5.0%, to $1,877 per unit in the three months ended June 30, 2018, and decreased $59 per unit, or 3.0%, to $1,930 per unit in the six months ended June 30, 2018. Beginning in the second quarter of 2018, new vehicle gross profit per unit at our BMW and Honda dealerships was significantly lower than expected due primarily to lower manufacturer-to-dealer incentives on certain models. We believe we will continue to see margin pressure in these brands through the third quarter of 2018; however, we are optimistic that support from our manufacturer partners and highly anticipated new model releases from BMW in the fourth quarter of 2018 will drive consumer demand and increased profitability on new vehicle unit sales.
Same store retail used vehicle revenue increased 8.9% and 6.1% during the three and six months ended June 30, 2018, respectively. Our retail used vehicle unit sales volume increased 7.9% and 5.3% during the three and six months ended June 30, 2018, respectively, primarily driven by increased volumes at our pre-owned stores. Retail used vehicle gross profit increased 0.9% during the three months ended June 30, 2018, primarily driven by an increase in retail used vehicle unit sales volume. Retail used vehicle gross profit decreased 4.3% during the six months ended June 30, 2018, primarily driven by a decrease in retail used vehicle gross profit per unit. Retail used vehicle gross profit per unit decreased $83 per unit, or 6.5%, to $1,197 per unit in the three months ended June 30, 2018 and decreased $118 per unit, or 9.1%, to $1,178 per unit in the six months ended June 30, 2018, driven primarily by a shift in pricing strategy at our pre-owned stores which reduces front-end gross profit per unit but increases unit sales volume and F&I gross, more than offsetting the decrease in front-end gross profit. Same store wholesale vehicle gross loss increased approximately $1.8 million and $5.3 million during the three and six months ended June 30, 2018, respectively, primarily driven by market pricing declines, inventory supply and allocation challenges related to the Houston market that negatively impacted the first quarter of 2018. We focus on maintaining used vehicle inventory days’ supply in the 30 to 40 day range in order to limit our exposure to market pricing volatility. Our used vehicle inventory days’ supply was approximately 29 and 39 days as of June 30, 2018 and 2017, respectively.
Same store Fixed Operations revenue decreased 0.2% during the three months ended June 30, 2018, and increased 0.6% during the six months ended June 30, 2018. Fixed Operations gross profit increased 1.1% and 1.6% during the three and six months ended June 30, 2018, respectively. Fixed Operations gross margin increased 60 basis points, to 48.4%, during the three months ended June 30, 2018 and increased 50 basis points, to 48.3%, during the six months ended June 30, 2018. Although vehicle sales and sales of associated finance, insurance and other aftermarket products are cyclical and are affected by many factors, including overall economic conditions, consumer confidence, levels of discretionary personal income, interest rates and available credit, our parts, service and collision repair services are not closely tied to vehicle sales and are not as dependent upon near-term sales volume. However, significant changes to the level of manufacturer recall and warranty activity could negatively impact our Fixed Operations results in the future.
Same store F&I revenue increased 12.3% and 9.2% during the three and six months ended June 30, 2018, respectively, driven by an 8.4% and 6.5% increase in F&I gross profit per retail unit and a 3.5% and 2.6% increase in combined retail new and used vehicle unit sales volume during the three and six months ended June 30, 2018, respectively. F&I gross profit per retail unit increased $115 per unit, or 8.4%, to $1,481 per unit, for the three months ended June 30, 2018 and increased $89 per unit, or 6.5%, to $1,456 per unit, for the six months ended June 30, 2018. We believe that our proprietary software applications, playbook processes and customer-centric selling approach enable us to maximize gross profit per F&I contract and penetration rates (the number of F&I products sold per vehicle) across our F&I product lines. We believe that we will continue to increase revenue in this area as we refine our processes, train our associates and continue to sell high levels of retail new and used vehicles at our stores.

21

SONIC AUTOMOTIVE, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


The following table depicts the breakdown of our new vehicle revenues from continuing operations by brand for the three and six months ended June 30, 2018 and 2017:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Brand
2018
 
2017
 
2018
 
2017