Quarterly report pursuant to Section 13 or 15(d)

Summary of Significant Accounting Policies

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Summary of Significant Accounting Policies
3 Months Ended
Mar. 31, 2020
Accounting Policies [Abstract]  
Summary of Significant Accounting Policies Summary of Significant Accounting Policies
Basis of Presentation The accompanying unaudited condensed consolidated financial statements of Sonic Automotive, Inc. and its wholly owned subsidiaries (“Sonic,” the “Company,” “we,” “us” or “our”) for the three months ended March 31, 2020 and 2019 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 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 historically has contributed less operating profit than the second, third and fourth quarters. Additionally, the continued magnitude and impact of COVID-19 pandemic could impact earnings in the second, third and fourth quarters of 2020. The accompanying unaudited 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, 2019.
COVID 19 – The COVID-19 pandemic negatively impacted the global economy. As of March 31, 2020, the impact on the economy is primarily affecting demand as many countries around the world and states in the United States ("U.S.") have mandated restrictions on citizen movements (stay-at-home orders) or on retail trade at physical locations. As a result, many businesses have curtailed operations and furloughed or terminated many positions. In the U.S., the government passed several measures through the legislature that were signed by the President and enacted into law. Those measures include the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and the Families First Coronavirus Response Act. Both Acts attempt to provide short-term relief to families and businesses as a result of the economic impacts of the COVID-19 pandemic.
Specifically related to Sonic, all our stores have been impacted by the crisis. As of March 31, 2020, the majority of our stores are not permitted to conduct retail sales of new and used vehicles at our physical locations. Those locations can offer virtual sales transactions with “contactless” delivery to customers. Due to the critical nature of automotive repair, our fixed operations have been deemed “essential” by governmental agencies and were able to continue to conduct business, but must maintain certain local standards for “social distancing”. As a result, in the last several weeks of March of 2020, we experienced 30%-50% declines in unit sales of new and used vehicles (as compared to the prior year period) and 15%-30% reductions in repair order activity in fixed operations. These trends have continued into April of 2020 and are expected to continue until at least through mid-May of 2020.
Based on these events, we evaluated our long-lived assets for impairment. This evaluation included reviews of fixed assets and related right-of-use assets, franchise assets and goodwill. As a result of this evaluation, we determined the carrying values of all long-lived assets to be recoverable at March 31, 2020 with the exception of goodwill related to our franchised dealership reporting unit. One of the primary factors which contributed to the conclusion that goodwill was impaired was the market value of Sonic's stock between the announcement date of the pandemic on March 11, 2020 to March 31, 2020. See Note 5 for further discussion.
The effects of the COVID-19 pandemic continue to evolve. While we currently expect to begin to see recovery in the last half of 2020, the outbreak may cause changes in customer behaviors, including a potential reduction in consumer spending for vehicles and automotive repairs. This may lead to increased asset recovery and valuation risks, such as impairment of additional long-lived assets. The uncertainties in the global economy may negatively impact our suppliers and other business partners, which may interrupt our supply chain and require other changes to our operations. These and other factors may adversely impact our revenues, operating income and earnings per share financial measures.
As a result of the pandemic and related stay-at-home orders, we have transitioned many of our teammates to remote work arrangements. In situations where the role does not permit remote work (ie. technicians), we have implemented staggered work hours and other social distancing measures to promote the health and safety of our teammates and guests. As a result of the systems and infrastructure we had in place prior to the pandemic, we have been able to effectively maintain our back-office operations, financial reporting and internal control processes with minimal disruption.
Recent Accounting Pronouncements – In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments - Credit Losses (Accounting Standards Codification (“ASC”) Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendment in this update replaced the previous incurred loss impairment methodology of recognizing credit losses when a loss is probable, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to assess credit
loss estimates. This ASU is effective for fiscal years beginning after December 15, 2019. We adopted this ASU as of January 1, 2020 and the effects of this ASU did not materially impact our unaudited condensed consolidated financial statements.
Principles of Consolidation All of our dealership and non-dealership subsidiaries are wholly owned and consolidated in the accompanying unaudited 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 unaudited condensed consolidated financial statements.
Revenue Recognition – 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. ASC Topic 606, “Revenue from Contracts with Customers,” applies 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. We do not include the cost of obtaining contracts within the related revenue streams since we elected the practical expedient to expense the costs to obtain a contract when incurred.
Management has evaluated our established business processes, revenue transaction streams and accounting policies, and identified our 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, warranty and other insurance contracts; and (5) the performance of vehicle maintenance and repair services and the sale of related parts and accessories. Generally, performance conditions are satisfied when the associated vehicle is either delivered or returned to a customer and customer acceptance has occurred, or over time as the maintenance and repair services are performed. We do 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). Certain retrospective finance and insurance revenue is earned in periods subsequent to the completion of the initial performance obligation (“F&I retro revenues”).
F&I retro revenues are recognized when the product contract has been executed with the end customer and are estimated each reporting period based on the expected value method using historical and projected data, which results in the acceleration of revenue recognition. F&I retro revenues, which represent variable consideration, subject to constraint, are to be included in the transaction price and recognized when or as the performance obligation is satisfied. F&I retro revenues can vary based on a variety of factors, including number of contracts and history of cancellations and claims. Accordingly, we utilize 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.
We record revenue when vehicles are delivered to customers, when vehicle service work is performed and when parts are delivered. Conditions for completing a sale include having an agreement with the customer, including pricing, and the sales price must be reasonably expected to be collected.
Receivables, net in the accompanying unaudited condensed consolidated balance sheets as of March 31, 2020 and December 31, 2019 include approximately $3.6 million and $5.1 million, respectively, related to work in process and contract assets related to F&I retro revenues of approximately $5.2 million and $12.9 million, respectively. Changes in contract assets from December 31, 2019 to March 31, 2020 were primarily due to ordinary business activity, including the receipt of cash for amounts earned and recognized in prior periods. Please refer to Note 1, “Description of Business and Summary of Significant Accounting Policies,” to the consolidated financial statements in Sonic’s Annual Report on Form 10-K for the year ended December 31, 2019 for further discussion of our revenue recognition policies and processes.
Income Tax Expense – The overall effective tax rate from continuing operations was 18.2% for the three months ended March 31, 2020, and 31.0% for the three months ended March 31, 2019. Income tax expense for the three months ended March 31, 2020 includes a $51.3 million benefit, including the effect of non-deductible amounts, related to the $268.0 million goodwill impairment charge, a $0.5 million discrete benefit related to vested or exercised stock compensation awards, offset partially by a $0.1 million discrete charge related to changes in uncertain tax positions. Income tax expense for the three months ended March 31, 2019 includes a $1.5 million discrete charge for non-deductible executive officer compensation related to executive transition costs, a $0.2 million discrete charge related to changes in uncertain tax positions, and a $0.2 million discrete charge related to vested or exercised stock compensation awards. Sonic’s effective tax rate varies from year to year based on the level of taxable income, the distribution of taxable income between states in which the Company operates and other tax adjustments.
Earnings Per Share The calculation of diluted earnings per share considers the potential dilutive effect of restricted stock units, restricted stock awards and stock options granted under Sonic’s stock compensation plans (and any non-forfeitable dividends paid on such awards).