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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
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 (I.R.S. Employer
Incorporation or Organization) Identification No.)
5401 EAST INDEPENDENCE BOULEVARD
P.O. BOX 18747
CHARLOTTE, NORTH CAROLINA
28212
(Address of Principle Executive Offices) (Zip Code)
(704) 532-3320
(Registrant's telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Class A Common Stock, $.01 Par Value New York Stock Exchange
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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. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting common stock held by
non-affiliates of the registrant was approximately $165,950,000 based upon the
closing sales price of the registrant's Class A common stock on March 29, 1999
of $14.25 per share. As of March 29, 1999, there were 12,155,963 shares of Class
A common stock, par value $.01 per share, and 12,400,000 shares of Class B
common stock, par value $.01 per share, outstanding. Unless otherwise indicated,
all other share and share price information contained herein takes into account
the effect of the two for one stock split effected as of January 25, 1999 in the
form of a 100% stock dividend payable to stockholders of record as of January 4,
1999 (the "Stock Split").
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FORM 10-K TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business .................................................................................. 3
Item 2. Properties ................................................................................ 10
Item 3. Legal Proceedings ......................................................................... 12
Item 4. Submission of Matters to a Vote of Security Holders ....................................... 12
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters ................. 13
Item 6. Selected Financial Data ................................................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ..... 15
Item 7a. Quantitative and Qualitative Disclosures About Market Risk ................................ 24
Item 8. Financial Statements and Supplementary Data ............................................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ...... 24
PART III
Item 10. Directors and Executive Officers of the Registrant ........................................ 25
Item 11. Executive Compensation .................................................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and Management ............................ 32
Item 13. Certain Relationships and Related Transactions ............................................ 34
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .......................... 39
SIGNATURES ....................................................................................... 42
INDEX TO FINANCIAL STATEMENTS .................................................................... F-1
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements (including the Notes thereto) appearing
elsewhere herein. Statements in this Annual Report on Form 10-K that reflect
projections or expectations of future financial or economic performance of
Sonic Automotive, Inc., and statements of Sonic's plans and objectives for
future operations, including those contained in the "Business," "Legal
Proceedings" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" sections or relating to Sonic's future acquisitions,
are "forward-looking" statements within the meaning of Section 27A of the
Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Words such as
"expects," "anticipates," "believes," "intends," and "hopes," variations of such
words and similar expressions are intended to identify such forward-looking
statements. No assurance can be given that actual results or events will not
differ materially from those projected, estimated, assumed or anticipated in any
such forward- looking statements. Important factors that could result in such
differences, in addition to the other factors noted with such forward-looking
statements, include: general economic conditions in Sonic's markets, including
inflation, recession, interest rates and other economic factors; the ability of
Sonic to finance its acquisition efforts on acceptable terms; and other factors
that generally effect the business of automobile retail companies.
2
PART I
ITEM 1. BUSINESS
Sonic Automotive, Inc. (together with its subsidiaries, "Sonic" or "we")
was incorporated in the State of Delaware in February 1997. Sonic originally
consisted of five automotive dealerships affiliated through the common
ownership and control of Mr. O. Bruton Smith, Sonic's Chairman and Chief
Executive Officer. These five dealerships became wholly-owned subsidiaries of
Sonic on June 30, 1997 pursuant to a reorganization in which Sonic exchanged
approximately 12.5 million shares of its Class B common stock, par value $.01
per share for the common stock or membership interests of the five dealerships.
On November 12, 1997, Sonic completed an initial public offering of 10.0
million shares of its Class A common stock, par value $.01 per share.
Sonic is one of the top five automotive retailers in the United States, as
measured by total revenue, operating 45 dealerships and 17 collision repair
centers in 11 metropolitan areas of the southeastern, southwestern and
midwestern United States. We sell new and used cars, light trucks and
replacement parts and provide vehicle maintenance, warranty, paint and repair
services. We also arrange related financing and insurance ("F&I") for our
automotive customers. As of March 30, 1999, Sonic operates dealerships in the
following metropolitan markets:
o Atlanta o Columbus o Montgomery
o Birmingham o Daytona Beach o Nashville
o Charlotte o Greenville/Spartanburg o Tampa/Clearwater
o Chattanooga o Houston
In several of our markets, our dealerships have a significant market share for
new cars and light trucks.
We sell the following 28 domestic and foreign brands:
o Acura o Chevrolet o Hyundai o KIA o Mitsubishi o Subaru
o Audi o Chrysler o Infiniti o Lexus o Oldsmobile o Toyota
o BMW o Dodge o Isuzu o Lincoln o Plymouth o Volkswagen
o Buick o Ford o Jeep o Mercedes o Porsche o Volvo
o Cadillac o Honda o Mercury o Range Rover
GROWTH STRATEGY
o ACQUIRE SELECTED DEALERSHIPS. We believe that attractive acquisition
opportunities exist for dealership groups with significant equity capital and
experience in identifying, acquiring and professionally managing dealerships.
The automotive retailing industry is highly fragmented, with the largest 100
dealer groups generating approximately 10% of the industry's $673 billion of
total sales in 1997 and controlling less than 5% of all new vehicle dealerships
in the United States. We believe that these factors, together with the
increasing capital costs of operating automobile dealerships, the lack of
alternative exit strategies (especially for larger dealerships) and the aging
of many dealership owners provide attractive consolidation opportunities. We
believe our "hub and spoke" acquisition strategy will allow us to capitalize on
economies of scale, offer a greater breadth of products and services and
increase brand diversity. Generally, we retain the management of a well-run
dealership in order to benefit from its market knowledge, name recognition and
local reputation. In addition, we selectively acquire dealerships that have
underperformed the industry average but which carry attractive product lines or
have attractive locations and which would benefit from our existing
infrastructure.
o INCREASE SALES OF HIGHER MARGIN PRODUCTS AND SERVICES. Sonic intends to
pursue opportunities to increase its sales of higher-margin products and
services by, for instance, expanding its collision repair business and
increasing sales of used vehicles. Our collision repair business provides
favorable margins and is not significantly affected by economic cycles or
consumer spending habits. Our strategy is to acquire and develop collision
repair businesses near our dealerships in order to capitalize on relationships
with existing customers and insurance companies.
We also believe that significant opportunities exist to improve our used
vehicle departments, which historically have generated higher margins on sales
than our new vehicle departments, by (1) increasing the number of used vehicles
sold and (2) increasing gross profit margins on sales of used vehicles. For
example, our ability to manage inventory levels more effectively created
increased gross profit margins on sales of used vehicles to 10.7% for the year
ended December 31, 1998 from 8.6% for the year ended December 31, 1997.
3
o CONTROL COSTS. We are focused on controlling expenses and expanding
margins at the dealerships we acquire and integrate into our organization.
Approximately 73% of our operating costs for the year ended December 31, 1998
were variable. We are able to adjust these expenses as the operating or
economic environment impacting our dealerships changes. We manage these
variable costs, such as floor plan (8%), advertising (10%) and compensation
(50%) expenses, so that they are generally related to vehicle sales and can be
adjusted in response to changes in vehicle sales volume. In addition,
management compensation is tied to individual dealership profitability and
stock price appreciation through stock options. This incentive compensation
focuses all levels of our organization on cost reduction. We also focus on
controlling components of fixed cost. For example, Sonic has reduced its
property and casualty and workers' compensation insurance costs due to the
benefits of economies of scale.
o ENHANCE PROFIT OPPORTUNITIES IN FINANCE AND INSURANCE. Sonic offers a
wide range of financing and leasing alternatives for the purchase of vehicles,
as well as credit life, accident and health and disability insurance and
extended service contracts. As a result of our size and scale, we have
negotiated increased commissions on the origination of customer vehicle
financing and insurance policies, which resulted in incremental F&I commissions
exclusive of acquisitions of $2.1 million for the year ended December 31, 1998.
o TRAIN, DEVELOP AND MOTIVATE QUALIFIED MANAGEMENT. We believe that our
well trained dealership personnel is key to our long-term prospects. We require
all of our employees, from service technicians to regional vice presidents, to
participate in in-house training programs. We believe that our comprehensive
training of all employees and the institution of a decentralized, multi-tiered
management structure to supervise effectively our dealership operations provide
us with a competitive advantage over other dealership groups. This training and
organizational structure enables high-level supervision over the dealerships,
accurate financial reporting and the ability to maintain good controls as Sonic
expands. In order to motivate management, we employ an incentive compensation
program for each officer, vice president and dealer/operators, a portion of
which is provided in the form of Sonic stock options with additional incentives
based on the performance of individual profit centers. We believe that this
organizational structure, together with the opportunity for promotion and for
equity participation, serve as a strong motivation for our employees.
o ACHIEVE HIGH LEVELS OF CUSTOMER SATISFACTION. We focus on maintaining
high levels of customer satisfaction. Our personalized sales process is
designed to satisfy customers by providing high-quality vehicles in a positive,
"consumer friendly" buying environment. Some manufacturers offer specific
performance incentives, on a per vehicle basis, if certain customer
satisfaction index ("CSI") levels (which vary by manufacturer) are achieved by
a dealer. Manufacturers consider CSI scores in approving acquisitions. In order
to keep management focused on customer satisfaction, we include CSI results as
a component of our incentive compensation program.
DEALERSHIP MANAGEMENT
Operations of the dealerships are overseen by Regional Vice Presidents,
who report to Sonic's Chief Operating Officer. Each of our dealerships is
managed by a dealer/operator who is responsible for the operations of the
dealership and the dealership's financial and customer satisfaction
performance. The dealer/operator is responsible for selecting, training and
retaining dealership personnel. All dealer/operators report to Sonic's Regional
Vice Presidents, who in turn report to Sonic's senior management on a regular
basis.
Each dealer/operator is generally complemented by a team which includes
two senior managers who aid in the operation of the dealership. The general
sales manager is primarily responsible for the operations, personnel, financial
performance and customer satisfaction performance of the new vehicle sales,
used vehicle sales, and finance and insurance departments. The parts and
service director is primarily responsible for the operations, personnel,
financial and customer satisfaction performance of the service, parts and
collision repair departments (if applicable). Each of the departments of the
dealership typically has a manager who reports to the general sales manager or
parts and service director.
NEW VEHICLE SALES
As of December 31, 1998, the Company sold 23 brands of cars, light trucks
and sport utility vehicles. The products have a broad range of prices from
lower priced, or economy vehicles, to luxury vehicles. We believe that our
brand, product and price diversity reduces the risk of changes in customer
preferences, product supply shortages and aging products. Approximately 14.1%
of new vehicle sales in 1998 were luxury brands (for example, BMW, Cadillac,
Infiniti and Volvo).
4
The following table presents information with respect to Sonic's new
vehicle sales:
NEW VEHICLE SALES
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YEAR ENDED DECEMBER 31,
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(DOLLARS IN THOUSANDS)
1994 1995 1996 1997 1998
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Unit sales .............. 9,686 10,273 11,693 15,715 41,592
Sales revenue ........... $ 164,970 $ 186,859 $ 233,979 $ 343,941 $ 962,939
Gross profit ............ 12,103 13,926 18,001 26,427 75,494
Gross profit margin ..... 7.3% 7.5% 7.7% 7.7% 7.8%
New vehicle sales include retail lease transactions and lease-type
transactions, both of which are arranged by Sonic. New vehicle leases generally
have short terms. Lease customers, therefore, return to the new vehicle market
more frequently. Leases also provide a source of late-model, generally low
mileage, vehicles for our used vehicle inventory. Generally, leased vehicles
are under warranty for the entire lease term, which allows us to provide repair
service to the lessee throughout the term of the lease.
USED VEHICLE SALES
Sonic sells a broad variety of makes and models of used cars, vans, trucks
and sport utility vehicles. We obtain used vehicles through customer trade-ins,
at "closed" auctions which may be attended only by new vehicle dealers and
which offer off-lease, rental and fleet vehicles, and at "open" auctions which
offer repossessed vehicles and vehicles sold by other dealers. We sell our used
vehicles to retail customers and, in the case of vehicles in poor condition or
vehicles which remain unsold for a specified period of time, to other dealers
or wholesalers. Sales to other dealers or wholesalers are frequently close to
or below cost and therefore negatively affect our gross margin on used vehicle
sales.
The following table sets forth information on Sonic's used vehicle sales:
USED CAR SALES
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YEAR ENDED DECEMBER 31,
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(DOLLARS IN THOUSANDS)
1994 1995 1996 1997 1998
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Retail unit sales ........................ 4,374 5,172 5,488 6,712 24,591
Retail sales revenue ..................... $ 47,537 $ 60,766 $ 68,054 $ 85,132 $324,740
Retail gross profit ...................... 5,182 5,792 5,748 7,294 34,826
Retail gross profit margin ............... 10.9% 9.5% 8.4% 8.6% 10.7%
Wholesale unit sales ..................... 4,656 5,009 5,344 7,287 21,886
Wholesale sales revenue .................. $ 16,062 $ 20,025 $ 25,642 $ 38,785 $119,351
Wholesale gross profit/(loss) ............ 43 (45) (23) (599) (1,166)
Wholesale gross profit/(loss) margin ..... 0.3% (0.2)% (0.1)% (1.5)% (1.0)%
Total unit sales ......................... 9,030 10,181 10,832 13,999 46,477
Total sales revenue ...................... $ 63,599 $ 80,791 $ 93,696 $123,917 $444,091
Total gross profit ....................... 5,225 5,747 5,725 6,695 33,660
Total gross profit margin ................ 8.2% 7.1% 6.1% 5.5% 7.6%
SERVICE AND PART SALES
Sonic provides service and parts at each of our franchised dealerships. We
also provide maintenance and repair services at each of our franchised
dealerships, offering both warranty and non-warranty services. Service and
parts sales provide higher gross margins than vehicle sales.
5
The following table sets forth information regarding Sonic's service and
parts sales:
SERVICE AND PARTS
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YEAR ENDED DECEMBER 31,
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(DOLLARS IN THOUSANDS)
1994 1995 1996 1997 1998
------------ ------------ ------------ ------------ --------------
Sales revenue .............. $ 30,298 $ 31,958 $ 37,132 $ 51,033 $ 146,456
Gross profit ............... 10,344 11,033 12,593 18,118 62,152
Gross profit margin ........ 34.1% 34.4% 33.9% 35.5% 42.4%
COLLISION REPAIR
As of December 31, 1998, Sonic operated collision repair centers, or body
shops, at fourteen of our dealership locations. Our collision repair business
provides favorable margins and, similar to service and parts, is not
significantly affected by business cycles or consumer preferences. In addition,
because of the higher cost of used vehicles, insurance adjusters are more
hesitant to declare a vehicle a total loss, resulting in more significant, and
higher cost, repair jobs.
The following table sets forth information regarding Sonic's collision
repair operations:
COLLISION REPAIR SALES
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YEAR ENDED DECEMBER 31,
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(DOLLARS IN THOUSANDS)
1994 1995 1996 1997 1998
----------- ----------- ----------- ----------- ------------
Sales revenue ............... $ 3,686 $ 3,903 $ 4,942 $ 6,504 $ 16,204
Gross profit ................ 1,870 1,956 2,452 3,092 8,114
Gross profit margin ......... 50.7% 50.1% 49.6% 47.5% 50.0%
FINANCE AND INSURANCE
Sonic offers its customers a wide range of financing and leasing
alternatives for the purchase of vehicles. In addition, as part of each sale,
we also offer customers credit life, accident and health and disability
insurance to cover the financing cost of their vehicle, as well as extended
service contracts.
We assign our vehicle financing contracts and leases to other parties,
instead of directly financing sales, which reduces our exposure to loss from
financing activities. We receive a commission from the lender for originating
and assigning the loan or lease, but are assessed a chargeback fee by the
lender if a loan is canceled, in most cases, within 120 days of making the
loan. Early cancellation can result from early repayment because of refinancing
of the loan, the sale or trade-in of the vehicle, or default on the loan. We
establish a reserve to absorb estimated chargebacks and refunds. Finance and
insurance commission revenue is recorded net of such chargebacks. Commission
expense related to finance and insurance commission revenue is charged to cost
of sales upon recognition of such revenue.
The following table sets forth information regarding Sonic's finance and
insurance operations:
FINANCE AND INSURANCE
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YEAR ENDED DECEMBER 31,
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(DOLLARS IN THOUSANDS)
1994 1995 1996 1997 1998
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Commission revenue .......... $ 5,181 $ 7,813 $ 7,118 $ 10,606 $ 34,011
Gross profit ................ 4,359 6,561 6,043 8,856 28,022
Gross profit margin ......... 84.1% 84.0% 84.9% 83.5% 82.4%
SALES AND MARKETING
Sonic's marketing and advertising activities vary among our dealerships
and among our markets. We advertise primarily through television, newspapers,
radio and direct mail and regularly conduct special promotions designed to
focus vehicle buyers on our product offerings. We also utilize computer
technology to aid sales people in prospecting for customers. Under arrangements
with certain manufacturers, we receive a subsidy for a portion of our
advertising expenses incurred in connection with a manufacturer's vehicles.
6
RELATIONSHIPS WITH MANUFACTURERS
Each of Sonic's dealerships operates under a separate franchise or dealer
agreement which governs the relationship between the dealership and the
manufacturer. In general, each dealer agreement specifies the location of the
dealership for the sale of vehicles and for the performance of certain approved
services in a specified market area. The designation of such areas generally
does not guarantee exclusivity within a specified territory. In addition, most
manufacturers allocate vehicles on a "turn and earn" basis which rewards high
volume. A dealer agreement requires the dealer to meet specified standards
regarding showrooms, the facilities and equipment for servicing vehicles,
inventories, minimum net working capital, personnel training, and other aspects
of the business. The dealer agreement with each dealership also gives the
related manufacturer the right to approve the dealership's general manager and
any material change in management or ownership of the dealership. Each
manufacturer may terminate a dealer agreement under certain circumstances, such
as a change in control of the dealership without manufacturer approval, the
impairment of the reputation or financial condition of the dealership, the
death, removal or withdrawal of the dealership's general manager, the
conviction of the dealership or the dealership's owner or general manager of
certain crimes, the failure to adequately operate the dealership or maintain
wholesale financing arrangements, insolvency or bankruptcy of the dealership or
a material breach of other provisions of the dealer agreement.
Many automobile manufacturers are still developing their policies
regarding public ownership of dealerships. We believe that these policies will
continue to change as more dealership groups sell their stock to the public,
and as the established, publicly-owned dealership groups acquire more
franchises. To the extent that new or amended manufacturer policies restrict
the number of dealerships which may be owned by a dealership group, or the
transferability of Sonic's common stock, such policies could have a material
adverse effect on us.
In the course of acquiring Jaguar franchises in Chattanooga and
Greenville, Jaguar declined to consent to our proposed acquisitions of these
franchises. In settling legal actions brought against Jaguar by the seller of
the Chattanooga Jaguar franchise, Sonic agreed with Jaguar not to acquire any
Jaguar franchise until August 3, 2001.
Under Sonic's agreement with Ford, Ford may force the sale of Sonic's Ford
franchises if any investor acquires 15% or more of Sonic's voting securities.
Under Sonic's Dealer Agreements with Toyota and Infiniti, Toyota and Infiniti
have the right to approve any ownership or voting rights of Sonic of 20% or
greater by any individual or entity. Honda may force the sale of Sonic's Honda
franchise if any person or entity, other than the current holders of our Class
B common stock and their lineal descendants and affiliates, acquires 5% or
greater Sonic's common stock (10% or greater if such entity is an institutional
investor), and Honda deems such person or entity to be unsatisfactory.
Volkswagen has approved the sale of no more than 25% of the voting control of
Sonic, and any future changes in ownership or transfers among Sonic's current
stockholders that could effect the voting or managerial control of Sonic's
Volkswagen franchisee subsidiaries requires the prior approval of Volkswagen.
Similarly, Chrysler has approved of the public sale of only 50% of Sonic's
common stock and requires prior approval of any future sales that would result
in a change in voting or managerial control of Sonic. Mercedes requires 60 days
advance notice to approve any acquisition of 20% or more of Sonic's voting
securities.
Certain state statutes in Florida and other states limit manufacturers'
control over dealerships. Under Florida law, notwithstanding any contrary terms
in a dealer agreement, manufacturers may not unreasonably withhold approval for
the sale of a dealership. Acceptable grounds for disapproval include material
shortcomings in the character, financial condition or business experience of
the proposed transferee. In addition, dealerships may challenge manufacturers'
attempts to establish new dealerships in the dealer's markets, and state
regulators may deny applications to establish new dealerships for a number of
reasons, including a determination that the manufacturer is adequately
represented in the area. Manufacturers must have "good cause" for any
termination or failure to renew a dealer agreement, and an automaker's license
to distribute vehicles in Florida may be revoked if, among other things, the
automaker has forced or attempted to force an automobile dealer to accept
delivery of motor vehicles not ordered by that dealer.
Under Texas law, despite the terms of contracts between manufacturers and
dealers, manufacturers may not unreasonably withhold approval of a transfer of
a dealership. It is unreasonable under Texas law for a manufacturer to reject a
prospective transferee of a dealership who is of good moral character and who
otherwise meets the manufacturer's written, reasonable and uniformly applied
standards or qualifications relating to the prospective transferee's business
experience and financial qualifications. In addition, under Texas law and the
laws of other states, franchised dealerships may challenge manufacturers'
attempts to establish new franchises in the franchised dealers' markets, and
state regulators may deny applications to establish new dealerships for a
number of reasons, including a determination that the manufacturer is
adequately represented in the region. Texas law limits the ability of
manufacturers
7
to terminate or fail to renew franchises. In addition, other laws in Texas and
elsewhere limit the ability of manufacturers to withhold their approval for the
relocation of a franchise or require that disputes be arbitrated. In addition,
a manufacturer's license to distribute vehicles in Texas may be revoked if,
among other things, the manufacturer has forced or attempted to force an
automobile dealer to accept delivery of motor vehicles not ordered by that
dealer.
Georgia law provides that no manufacturer may arbitrarily reject a
proposed change of control or sale of an automobile dealership, and any
manufacturer challenging such a transfer of a dealership must provide written
reasons for its rejection to the dealer. Manufacturers bear the burden of proof
to show that any disapproval of a proposed transfer of a dealership is not
arbitrary. If a manufacturer terminates a franchise agreement due to a proposed
transfer of the dealership or for any other reason not considered to constitute
good cause under Georgia law, such termination will be ineffective. As an
alternative to rejecting or accepting a proposed transfer of a dealership or
terminating the franchise agreement, Georgia law provides that a manufacturer
may offer to purchase the dealership on the same terms and conditions offered
to the prospective transferee.
Under Tennessee law, a manufacturer may not modify, terminate or refuse to
renew a franchise agreement with a dealer except for good cause, as defined in
the governing Tennessee statutes. Further, a manufacturer may be denied a
Tennessee license, or have an existing license revoked or suspended if the
manufacturer modifies, terminates, or suspends a franchise agreement due to an
event not constituting good cause. Good cause includes material shortcomings in
the character, financial condition or business experience of the dealer. A
manufacturer's Tennessee license may also be revoked if the manufacturer
prevents or attempts to prevent the sale or transfer of the dealership by
unreasonably withholding consent to the transfer.
Alabama law prohibits manufacturers from terminating or refusing to
continue or renew a franchise agreement except for "good cause." "Good cause"
to discontinue a relationship may exist if, for example, a dealer violates a
material term of, or fails to perform its duties under, a franchise agreement.
In addition, a manufacturer is prohibited from interfering with the transfer of
a dealership unless the transfer is to a person who would not qualify for a
dealer's license under Alabama law. Finally, a manufacturer may not
unreasonably establish a new dealership within the market area of an existing
dealer. A manufacturer who violates Alabama law may be required to pay the
dealer for the damages incurred, as well as the costs of suing the manufacturer
for damages including attorneys fees.
Under Ohio law, a dealer must obtain manufacturer approval before it can
sell or transfer an interest in a dealership. The manufacturer may only
prohibit the sale or transfer, however, for "good cause" after considering,
among other things, the proposed new owner's business experience and financing.
Similarly, a manufacturer may terminate or refuse to continue or renew a
franchise agreement only for "good cause" considering, for example, the
dealership's sales, the dealer's investment in the business, and the dealer's
satisfaction of its warranty obligations. Finally, a manufacturer may not site
a new dealership in a relevant market area without either the consent of the
local dealers or by showing "good cause." Dealers may protest a manufacturer's
actions to the Ohio Motor Vehicle Dealers Board, and eventually the courts, if
there is no "good cause" for the transfer restriction or termination or siting
of a new dealership. If the manufacturer violates Ohio's automobile franchise
law, a dealer may be entitled to double its actual damages, as well as court
costs and attorneys fees, from a manufacturer.
South Carolina law forbids a manufacturer from imposing unreasonable
restrictions on a dealer's rights to transfer, sell, or renew a franchise
agreement unless the dealer is compensated. A manufacturer may not terminate or
refuse to renew a franchise agreement without due cause. Further, although a
dealer must obtain the manufacturer's consent to transfer a dealership, the
manufacturer may not unreasonably withhold its consent. Finally, manufacturers
are generally prohibited from acting in bad faith or engaging in arbitrary or
unconscionable conduct. Manufacturers who violate South Carolina's law may be
liable for double the actual damages incurred by the dealer and/or punitive
damages in limited circumstances.
COMPETITION
The retail automotive industry is highly competitive. Depending on the
geographic market, Sonic competes with both dealers offering the same brands
and product lines as Sonic and dealers offering other automakers' vehicles. We
also compete for vehicle sales with auto brokers and leasing companies. We
compete with small, local dealerships and with large multi-franchise auto
dealerships. Some of our competitors are larger and have greater financial and
marketing resources and are more widely known than us. Some of our competitors
also may utilize various marketing techniques that are not currently used by
us.
8
We also compete with regional and national car rental companies, which
sell their used rental cars, and used automobile "superstores," such as
AutoNation and CarMax. In addition, Ford and GM have announced that they are
entering into joint ventures to acquire dealerships in various cities in the
United States, and Saturn is seeking to acquire its dealerships. In addition,
other manufacturers may directly enter the retail market in the future, which
could have a material adverse effect on us. As we seek to acquire dealerships
in new markets, we may face significant competition (including competition from
other publicly-owned dealer groups) as we strive to gain market share.
We believe that the principal competitive factors in vehicle sales are the
marketing campaigns conducted by automakers, the ability of dealerships to
offer a wide selection of the most popular vehicles, the location of
dealerships and the quality of customer service. Other competitive factors
include customer preference for makes of automobiles, pricing (including
manufacturer rebates and other special offers) and warranties.
In addition to competition for vehicle sales, we also compete with other
auto dealers, service stores, auto parts retailers and independent mechanics in
providing parts and service. We believe that the principal competitive factors
in parts and service sales are price, the use of factory-approved replacement
parts, the familiarity with a dealer's makes and models and the quality of
customer service. A number of regional and national chains offer selected parts
and service at prices that may be lower than our prices.
In arranging or providing financing for our customers' vehicle purchases,
we compete with a broad range of financial institutions. We believe that the
principal competitive factors in providing financing are convenience, interest
rates and contract terms.
Our success depends, in part, on national and regional automobile-buying
trends, local and regional economic factors and other regional competitive
pressures. We sell our vehicles in the Atlanta, Birmingham, Charlotte,
Chattanooga, Columbus, Daytona Beach, Greenville/Spartanburg, Houston,
Montgomery, Nashville and Tampa/Clearwater markets. Conditions and competitive
pressures affecting these markets, such as price-cutting by dealers in these
areas, or in any new markets we enter, could adversely affect us, although the
retail automobile industry as a whole might not be affected.
GOVERNMENTAL REGULATIONS AND ENVIRONMENTAL MATTERS
A number of regulations affect Sonic's business of marketing, selling,
financing and servicing automobiles. Sonic also is subject to laws and
regulations relating to business corporations generally.
Under North Carolina, South Carolina, Tennessee, Florida, Georgia, Texas,
Ohio and Alabama law as well as the laws of other states into which we may
expand, we must obtain a license in order to establish, operate or relocate a
dealership or operate an automotive repair service. These laws also regulate
our conduct of business, including our advertising and sales practices. Other
states may have similar requirements.
Our operations are also subject to certain consumer protection laws known
as "Lemon Laws." These laws typically require a manufacturer or dealer to
replace a new vehicle or accept it for a full refund within one year after
initial purchase if the vehicle does not conform to the manufacturer's express
warranties and the dealer or manufacturer, after a reasonable number of
attempts, is unable to correct or repair the defect. Federal laws require
certain written disclosures to be provided on new vehicles, including mileage
and pricing information.
The imported automobiles purchased by us are subject to United States
customs duties and, in the ordinary course of our business, we may, from time
to time, be subject to claims for duties, penalties, liquidated damages, or
other charges. Currently, United States customs duties are generally assessed
at 2.5% of the customs value of the automobiles imported, as classified
pursuant to the Harmonized Tariff Schedule of the United States.
Our financing activities with customers are subject to federal
truth-in-lending, consumer leasing and equal credit opportunity regulations as
well as state and local motor vehicle finance laws, installment finance laws,
usury laws and other installment sales laws. Some states regulate finance fees
that may be paid as a result of vehicle sales. Federal, state and local
environmental regulations, including regulations governing air and water
quality, the clean-up of contaminated property and the storage and disposal of
gasoline, oil and other materials, also apply to us and our dealership
properties.
We believe that we comply in all material respects with the laws affecting
our business. Possible penalties for violation of any of these laws include
revocation of our licenses and fines. In addition, many laws may give customers
a private cause of action.
As with automobile dealerships generally, and service, parts and body shop
operations in particular, our business involves the use, storage, handling and
contracting for recycling or disposal of hazardous or toxic substances or
wastes and other environmentally sensitive materials. Our business also
involves the past and current operation and/or removal of
9
aboveground and underground storage tanks containing such substances or wastes.
Accordingly, we are subject to regulation by federal, state and local
authorities which establish health and environmental quality standards, provide
for liability related to those standards, and in certain circumstances provide
penalties for violations of those standards. We are also subject to laws,
ordinances and regulations governing remediation of contamination at facilities
we operate or to which we send hazardous or toxic substances or wastes for
treatment, recycling or disposal.
We believe that we do not have any material environmental liabilities and
that compliance with environmental laws and regulations will not, individually
or in the aggregate, have a material adverse effect on our results of
operations or financial condition. However, soil and groundwater contamination
is known to exist at certain properties used by us. Further, environmental laws
and regulations are complex and subject to frequent change. In addition, in
connection with our acquisitions, it is possible that we will assume or become
subject to new or unforeseen environmental costs or liabilities, some of which
may be material. We cannot assure you that compliance with current or amended,
or new or more stringent, laws or regulations, stricter interpretations of
existing laws or the future discovery of environmental conditions will not
require additional expenditures by Sonic, or that such expenditures will not be
material.
EMPLOYEES
As of December 31, 1998, Sonic employed approximately 3,040 people, of
whom approximately 430 were employed in managerial positions, 980 were employed
in non-managerial sales positions, 1,170 were employed in non-managerial parts
and service positions and 460 were employed in administrative support
positions.
We believe that many dealerships in the retail automobile industry have
difficulty in attracting and retaining qualified personnel for a number of
reasons, including the historical inability of dealerships to provide employees
with an equity interest in the profitability of the dealerships. We provide
certain executive officers, managers and other employees with stock options and
all employees with a stock purchase plan and we believe this type of equity
incentive is attractive to our existing and prospective employees.
We believe that our relationship with our employees is good. None of our
employees is represented by a labor union. Because of our dependence on the
manufacturers, however, we may be affected by labor strikes, work slowdowns and
walkouts at the manufacturer's manufacturing facilities.
ITEM 2: PROPERTIES
Sonic's principal executive offices are located at 5401 East Independence
Boulevard, Charlotte, North Carolina 28212, and our telephone number is (704)
532-3320. These executive offices are located on the premises leased by Town &
Country Ford. The following table identifies each of the properties utilized by
Sonic's operations and their respective locations:
ATLANTA MARKET
o Dyer & Dyer Volvo, 5260 Peachtree Industrial Blvd., Atlanta, GA
o Global Imports, 500 & 550 Interstate North Parkway, N.W., Atlanta, GA(1)
BIRMINGHAM MARKET
o Tom Williams Buick, 401 S. 20th Street, Birmingham, AL(1)
o Tom Williams Cadillac, 325 S. 20th Street, Birmingham, AL(1)
o Tom Williams Imports, 2200 34d Avenue South, Birmingham, AL(1)
o Tom Williams Lexus, 300 S. 22nd Street, Birmingham, AL(1)
CHARLOTTE MARKET
o Fort Mill Chrysler-Plymouth-Dodge, 3310 Hwy. 51, Fort Mill, SC
o Fort Mill Ford, 788 Gold Hill Rd., Fort Mill, SC
o Frontier Oldsmobile-Cadillac, 2501 Roosevelt Blvd., Monroe, NC
o Lake Norman Chrysler-Plymouth-Jeep, Chartwell Center Dr., Cornelius, NC
o Lake Norman Dodge, I-77 & Torrence Chapel Rd., Cornelius, NC
o Town & Country Chrysler-Plymouth-Jeep of Rock Hill, 803 North Anderson Rd.,
Rock Hill, SC
o Town & Country Ford, 5401 East Independence Blvd., Charlotte, NC
o Town & Country Toyota, 9101 South Blvd., Charlotte, NC
10
CHATTANOOGA MARKET
o BMW/Volvo of Chattanooga, 5949 Brainard Rd., Chattanooga, TN
o Cleveland Chrysler-Plymouth-Jeep, 717 South Lee Hwy., Cleveland, TN
o Dodge of Chattanooga, 402 West Martin Luther King Blvd., Chattanooga, TN
o Economy Honda, Hwy. 153 at Shallowford Rd., Chattanooga, TN(1)
o Infiniti of Chattanooga, 5915 Brainard Rd., Chattanooga, TN
o KIA/VW of Chattanooga, 6015 International Dr., Chattanooga, TN
o Town & Country Ford of Cleveland, 2496 South Lee Hwy., Cleveland, TN
COLUMBUS MARKET
o Hatfield Hyundai & Hatfield Isuzu & Hatfield Subaru, 1400 Automall Dr.,
Columbus, OH
o Trader Bud's Westside Chrysler-Plymouth-Jeep, 3700 West Broad St., Columbus,
OH
o Hatfield Lincoln Mercury, 1495 Automall Dr., Columbus, OH
o Toyota West, 1500 Automall Dr., Columbus, OH
o Trader Bud's Westside Dodge, 4000 West Broad St., Columbus, OH
o Hatfield KIA/Volkswagen West & Jeep Eagle West, 1455 Automall Dr., Columbus,
OH
DAYTONA BEACH MARKET
o Halifax Ford-Mercury, 1307 N. Dixie Hwy., New Smyrna Beach, FL
o Higginbotham Automobiles, 1720 Mason Ave., Daytona Beach, FL
o Higginbotham Chevy-Olds, 1919 N. Dixie Hwy., New Smyrna Beach, FL
o HMC Finance, 3741 S. Nova Rd., Port Orange, FL
o Sunrise Auto World, 241 Ridgewood Ave., Holly Hill, FL
GREENVILLE/SPARTANBURG MARKET
o Century BMW, 2752 Laurens Rd., Greenville, SC
o Heritage Lincoln Mercury, 2424 Laurens Rd., Greenville, SC
HOUSTON MARKET
o Casa Ford, 4701 I-10 East, Baytown, TX
o Lone Star Ford, 8477 North Freeway, Houston, TX
o Ron Craft Chevrolet-Cadillac-Oldsmobile-Geo, 3401 N. Main, Baytown, TX
o Ron Craft Chrysler Plymouth Jeep, 5221 I-10 East, Baytown, TX
MONTGOMERY MARKET
o Capitol Chevrolet, 711 Eastern Blvd., Montgomery, AL
o Capitol Hyundai & Capitol Mitsubishi, 190 Eastern Blvd., Montgomery, AL
o Capitol KIA, 845 Eastern Blvd., Montgomery, AL
NASHVILLE MARKET
o BMW of Nashville, 4040 Armory Oaks Drive, Nashville, TN
o VW of Nashville, 630 Murfreesboro Pike, Nashville, TN
o Rally Mitsubishi, 1620 West End Ave., Nashville, TN(1)
TAMPA/CLEARWATER MARKET
o Clearwater Collision Center, 2300 Drew Street, Clearwater, FL
o Clearwater Mitsubishi, 21699 US Hwy 19N, Clearwater, FL
o Clearwater Toyota, 21799 US Hwy 19N, Clearwater, FL
o Freedom Ford, 24825 US Hwy. 19 North, Clearwater & 3925 Tampa Rd., Oldsmar,
FL
o Tampa Volvo, 6008 N. Dale Mabry, Tampa, FL
- ---------
(1) Represents an acquisition that was completed in the first quarter of 1999.
Our dealerships are generally located along major U.S. or interstate
highways. One of the principal factors considered by Sonic in evaluating an
acquisition candidate is its location. We prefer to acquire dealerships located
along major thoroughfares, primarily interstate highways with ease of access,
which can be easily visited by prospective customers.
At December 31, 1998 we owned the properties of Fort Mill Ford and Town
and Country Toyota. All other properties utilized by our dealership operations
were leased. In January 1999, we sold the properties of Fort Mill Ford and Town
and Country Toyota to MMR Holdings, LLC, a limited liability company owned by
Bruton Smith ("MMR Holdings"), and are currently leasing these properties back
from MMR Holdings.
On July 9, 1998, Sonic entered into a strategic alliance agreement with
Mar Mar Realty Trust, a real estate investment trust ("MMRT"). MMRT owns or
will own, through its expected acquisition of MMR Holdings, certain real estate
11
associated with various automobile dealerships, automotive aftermarket
retailers and other automotive related businesses and leases such properties to
the business operators located thereon. Bruton Smith, Sonic's Chairman and
Chief Executive Officer, serves as the chairman of MMRT's board of trustees.
Under the terms of our franchise agreements, Sonic must maintain an
appropriate appearance and design of its facilities and is restricted in its
ability to relocate its dealerships.
ITEM 3: LEGAL PROCEEDINGS
On March 1, 1999, a civil complaint was filed in the Circuit Court of
Montgomery County, Alabama in a matter styled "FRANK E. MCGOUGH V. SONIC
AUTOMOTIVE, INC., CAPITOL CHEVROLET AND IMPORTS, INC., ET AL." (the "McGough
Complaint"). This action arises from Sonic's acquisition by merger of Capitol
Chevrolet and Imports, Inc. from plaintiff, who was its former stockholder. The
McGough Complaint alleges that Sonic untimely delivered an erroneous
post-closing balance sheet to settle outstanding accounts among the parties to
the merger and that Sonic made misrepresentations concerning the preparation of
this post-closing balance sheet. Plaintiff states that these allegations
entitle him to declaratory judgement allowing him to receive all funds escrowed
by Sonic for the resolution of post-merger accounts or, alternatively,
rescission of the merger. Sonic denies the allegations of the McGough Complaint
and will defend itself vigorously. Sonic believes that its post-closing balance
sheet was properly prepared and that plaintiff is not entitled to the relief
sought. Furthermore, the merger agreement at issue specifically provides for
the arbitration of disputes concerning the post-closing balance sheet, and,
consequently, Sonic believes that the McGough Complaint was improperly filed.
From time to time, Sonic is named in claims involving the manufacture of
automobiles, contractual disputes and other matters arising in the ordinary
course of our business. Currently, no legal proceedings, other than the
proceeding described above, are pending against or involve the Company that, in
the opinion of management, could reasonably be expected to have a material
adverse effect on our business, financial condition or results of operations.
Because of their vehicle inventory and nature of business, automobile
retail dealerships generally require significant levels of insurance covering a
broad variety of risks. Sonic's insurance includes an umbrella policy as well
as insurance on our real property, comprehensive coverage for our vehicle
inventory, general liability insurance, employee dishonesty coverage and errors
and omissions insurance in connection with our vehicle sales and financing
activities.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of stockholders held on December 3, 1998, William P.
Benton, William I. Belk and Bryan Scott Smith were elected directors by Sonic's
stockholders. Directors whose terms of office continued after the meeting were
O. Bruton Smith, Theodore M. Wright, Nelson E. Bowers, II and William R.
Brooks. In addition to the election of three directors, the stockholders
approved an amendment to increase the authorized number of shares of Class A
common stock issuable under the Sonic Employee Stock Purchase Plan from 300,000
to 600,000, approved the adoption of the Sonic Formula Stock Option Plan for
Independent Directors, approved and ratified the issuance of up to 600,000
shares of Sonic's Class A convertible preferred stock, par value $.10 per share
and ratified the appointment of Deloitte & Touche LLP as Sonic's independent
public accountant for the fiscal year ending December 31, 1998.
VOTES
VOTES FOR VOTES AGAINST ABSTAINED UNVOTED
------------ --------------- ----------- ------------
Election of William P. Benton ................................... 68,439,855 41,350 679,616
Election of William I. Belk ..................................... 68,439,855 41,350 679,616
Election of Bryan Scott Smith ................................... 68,439,855 41,350 679,616
Approval of amendment to Sonic Employee Stock Purchase Plan ..... 67,295,719 576,250 111,015 1,177,837
Approval of adoption of Sonic Formula Stock Option Plan ......... 67,514,644 357,400 110,940 1,177,837
Approval of issuance of Preferred Stock ......................... 67,946,611 33,635 2,738 1,177,837
Appointment of Deloitte & Touche LLP ............................ 68,479,530 750 925 679,616
12
PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Sonic's Class A common stock is currently traded on the New York Stock
Exchange ("NYSE") under the symbol "SAH."
As of December 31, 1998, with giving effect to the Stock Split, 11,959,274
shares of Class A common stock and 12,400,000 shares of Sonic's Class B common
stock were outstanding. As of March 29, 1999, there were 30 record holders of
the Class A common stock and four record holders of the Class B common stock.
As of March 29, 1999, the closing stock price for the Class A common stock was
$14.25.
Sonic intends to retain future earnings to provide funds for operations
and future acquisitions. As a holding company, Sonic will depend on dividends
and other payments from its subsidiary dealership operations to pay cash
dividends to stockholders, as well as to meet debt service and operating
expense requirements.
We do not anticipate paying any dividends in the foreseeable future. Under
an Indenture dated as of July 1, 1998 (the "Indenture") among Sonic and U.S.
Bank Trust National Association, as trustee, and under the credit agreement
between Sonic and Ford Motor Credit Company ("Ford Motor Credit"), no dividends
may be paid by Sonic. Any decision concerning the payment of dividends on the
common stock will depend upon the results of operations, financial condition and
capital expenditure plans of Sonic, as well as other factors as the Board of
Directors, in its sole discretion, may consider relevant.
The following table sets forth the high and low closing sales prices for
Sonic's Class A common stock for each calendar quarter during the periods
indicated as reported by the NYSE Composite Tape, as adjusted to reflect the
Stock Split. Prior to November 10, 1997, Sonic was privately held and there was
no public market for the Class A common stock.
1998 HIGH LOW
- ------------------------------------------------ ----------- ----------
First Quarter ......................... 8 5/8 4 7/8
Second Quarter ........................ 9 3/8 7 11/16
Third Quarter ......................... 11 15/16 8 1/4
Fourth Quarter ........................ 17 9/16 6 11/32
1997 HIGH LOW
- ----------------------------------------------- ----------- ----------
Fourth Quarter (from November 10, 1997
through December 31, 1997) .......... 5 31/32 4 13/16
Set forth below is certain information as to all equity securities sold by
Sonic during the periods discussed that were not registered under the
Securities Act. As to all such transactions, an exemption was claimed under
Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated
thereunder ("Regulation D") as transactions not involving a public offering in
view of sophistication of the purchasers, their access to material information
about Sonic, the disclosures actually made to them by Sonic, the absence of any
general solicitation or advertising, the status of the purchasers as
"accredited investors" as that term is defined in Rule 501 (a) of Regulation D
and the filing by Sonic of the appropriate forms in connection therewith. All
such private sales of Sonic's equity securities were made to the owners of
assets associated with, or the capital stock of, automobile dealerships
acquired by Sonic as a part of Sonic's dealership acquisition strategy.
Sonic has privately issued its Class A common stock in the following
dealership acquisition transactions:
On September 18, 1998, Sonic issued 970,588 shares of its Class A common
stock to acquire the assets of HMC Finance Corporation, Inc., Halifax
Ford-Mercury, Inc., Higginbotham Automobiles, Inc., Higginbotham Chevrolet-
Oldsmobile, Inc., and Sunrise Auto World, Inc. with a value of approximately
$8.3 million.
Sonic has also privately issued its Class A convertible preferred stock,
par value $.10 per share (the "Preferred Stock") in dealership acquisition
transactions. The Preferred Stock is divided into three series: the Series I
Preferred Stock, the Series II Preferred Stock and the Series III Preferred
Stock. Each share of Preferred Stock is convertible into shares of Class A
common stock at the holder's option at specified conversion rates. After the
second anniversary of the date of issuance, any shares of Preferred Stock which
have not yet been converted are subject to mandatory conversion to
13
Class A Common Stock at the option of Sonic. No fractional shares of Class A
common stock will be issued upon conversion of any shares of Preferred Stock.
Instead, Sonic will pay cash equal to the value of such fractional shares.
Generally, each share of Preferred Stock is convertible into that number
of shares of Class A common stock that has an aggregate Market Price at the
time of conversion equal to $1,000 (with certain adjustments for Series II and
Series III Preferred Stock). "Market Price" is defined generally as the average
closing price per share of the Class A common stock on the New York Stock
Exchange for twenty trading days immediately preceding the date of
determination. Before the first anniversary of the date of issuance of the
Preferred Stock, each holder of Preferred Stock is unable to convert without
first giving Sonic ten business days' notice and an opportunity to redeem such
Preferred Stock at the then applicable redemption price.
Sonic has privately issued Preferred Stock in the following dealership
acquisition transactions:
On March 24, 1998, Sonic issued 3,960 shares of its Series III Preferred
Stock to acquire the assets of M&S Auto Resources, Inc. (d/b/a Clearwater
Toyota), Clearwater Auto Resources, Inc. (d/b/a Clearwater Mitsubishi) and
Clearwater Collision Center, Inc. with a value of approximately $3.9 million.
On July 8, 1998, Sonic issued 14,025 shares of its Series I Preferred
Stock to acquire the assets of Hatfield Jeep Eagle, Inc., Hatfield Lincoln
Mercury, Inc., Trader Bud's Westside Dodge, Inc., Toyota West, Inc., and
Hatfield Hyundai, Inc. with a value of approximately $12.5 million.
On July 14, 1998, Sonic issued 400 shares of Series II Preferred Stock to
acquire the assets of Fairway Management Company d/b/a Heritage Lincoln-Mercury
with a value of approximately $0.4 million.
On July 31, 1998, Sonic issued 2,166.5 shares of Series II Preferred Stock
to acquire the assets of Century Auto Sales, Inc. d/b/a Century BMW with a
value of approximately $2.3 million.
On July 31, 1998, Sonic issued 381.3 shares of Series I Preferred Stock
and 3,813 shares of Series II Preferred Stock to acquire the outstanding
capital stock of Capitol Chevrolet and Imports, Inc. with a value of
approximately $4.0 million.
On July 31, 1998, Sonic issued 2,313 shares of Series III Preferred Stock
to acquire the outstanding capital stock of Casa Ford of Houston, Inc. with a
value of approximately $2.5 million.
On December 15, 1998, Sonic issued 3,675 shares of Series II Preferred
Stock to acquire the outstanding capital stock of Ron Craft Chevy-Olds with a
value of approximately $3.7 million.
In addition, Sonic has privately issued warrants to purchase Class A
common stock in the following dealership acquisition transactions:
On January 15, 1998, Sonic issued warrants to purchase 88,782 shares of
its Class A common stock at an exercise price of $6 per share. These warrants
are currently exercisable at the option of the holder and expire on January 15,
2003. These warrants were issued as consideration paid by us to acquire the
assets of Dyer Volvo having an aggregate fair value of approximately $266,000.
On July 31, 1998, Sonic issued warrants to purchase 150,000 shares of its
Class A common stock at an exercise price of $10.40 per share. These warrants
are currently exercisable at the option of the holder and expire on July 31,
2003. These warrants were issued as consideration paid by us to acquire the
assets of Century BMW having an aggregate fair value of approximately $450,000.
On November 30, 1998, Sonic issued warrants to purchase 4,000 shares of
its Class A common stock at an exercise price of $11.27 per share. These
warrants are currently exercisable at the option of the holder and expire on
November 30, 2003. These warrants were issued as consideration paid by us to
acquire the assets of Tampa Volvo having an aggregate fair value of
approximately $12,000.
14
ITEM 6: SELECTED FINANCIAL DATA
The selected consolidated statement of operations data for the years ended
December 31, 1994, 1995, 1996, 1997 and 1998 and the selected consolidated
balance sheet data as of December 31, 1995, 1996, 1997 and 1998 are derived
from Sonic's audited financial statements. The selected consolidated balance
sheet data as of December 31, 1994 are derived from Sonic's unaudited financial
statements. In the opinion of management, these unaudited financial statements
reflect all adjustments necessary for a fair presentation of its results of
operations and financial condition. All such adjustments are of a normal
recurring nature. This selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and
related notes included elsewhere herein.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1994 1995 1996(1) 1997(1) 1998(1)
----------- ------------ ------------ -------------- ---------------
(DOLLARS AND SHARES IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Consolidated Statement of Operations Data:
Revenues:
Vehicle sales ...................................... $228,569 $ 267,650 $ 327,674 $ 467,858 $ 1,407,030
Parts, service, and collision repair ............... 33,984 35,860 42,075 57,537 162,660
Finance and insurance .............................. 5,181 7,813 7,118 10,606 34,011
-------- --------- --------- ---------- -----------
Total revenues ....................................... 267,734 311,323 376,867 536,001 1,603,701
Cost of sales ........................................ 233,833 272,130 332,122 473,003 1,396,259
-------- --------- --------- ---------- -----------
Gross profit ......................................... 33,901 39,193 44,745 62,998 207,442
Selling, general and administrative expenses ......... 23,810 28,091 32,602 46,770 150,130
Depreciation and amortization ........................ 838 832 1,076 1,322 4,607
-------- --------- --------- ---------- -----------
Operating income ..................................... 9,253 10,270 11,067 14,906 52,705
Interest expense, floor plan ......................... 3,001 4,505 5,968 8,007 14,096
Interest expense, other .............................. 443 436 433 1,199 9,395
Other income ......................................... -- 106 355 298 426
-------- --------- --------- ---------- -----------
Income before income taxes and minority interest ..... 5,809 5,436 5,021 5,998 29,640
Provision for income taxes ........................... 2,118 2,176 1,924 2,249 11,083
-------- --------- --------- ---------- -----------
Income before minority interest ...................... 3,691 3,260 3,097 3,749 18,557
Minority interest in earnings of subsidiary .......... 15 22 114 47 --
-------- --------- --------- ---------- -----------
Net income ........................................... $ 3,676 $ 3,238 $ 2,983 $ 3,702 $ 18,557
======== ========= ========= ========== ===========
Diluted net income per share ......................... $ 0.27 $ 0.74
Weighted average number of shares outstanding ........ 13,898 24,970
Consolidated Balance Sheet Data:
Working capital ...................................... $ 13,246 $ 18,140 $ 19,780 $ 44,098 $ 79,155
Total assets ......................................... 69,061 79,462 110,976 291,450 576,103
Long-term debt ....................................... 3,773 3,561 5,286 38,640 131,337
Total liabilities .................................... 57,274 62,956 84,367 207,085 433,674
Minority interest .................................... 177 200 314 -- --
Stockholders' equity ................................. 11,610 16,306 26,295 84,365 142,429
- ---------
(1) Selected Financial Data for the years ended December 31, 1996, 1997, and
1998 include the results of operations of certain dealerships acquired
during those periods. All such acquisitions were accounted for using the
purchase method of accounting and, as a result, the results of operations
prior to the date of acquisition have been excluded. Accordingly, the
actual financial data for periods after the acquisitions may not be
comparable to data presented for periods prior to the acquisitions.
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the results of operations and financial
condition as of December 31, 1998 should be read in conjunction with the Sonic
Automotive, Inc. and Subsidiaries Consolidated Financial Statements and the
related notes thereto included elsewhere herein.
15
OVERVIEW
Sonic is one of the top five automotive retailers in the United States,
operating 38 dealerships and 14 collision repair centers in the southeastern,
southwestern and midwestern United States. We sell new and used cars and light
trucks, sells replacement parts, provide vehicle maintenance, warranty, paint
and repair services and arrange related F&I for its automotive customers. Our
business is geographically diverse, with dealership operations in the Atlanta,
Charlotte, Chattanooga, Columbus, Daytona Beach, Greenville/Spartanburg,
Houston, Montgomery, Nashville, and Tampa-Clearwater markets. Sonic sells 23
domestic and foreign brands, which consist of Acura, BMW, Cadillac, Chevrolet,
Chrysler, Dodge, Ford, Honda, Hyundai, Infiniti, Isuzu, Jeep, KIA, Lincoln,
Mercedes, Mercury, Mitsubishi, Oldsmobile, Plymouth, Subaru, Toyota, Volkswagen
and Volvo.
New vehicle revenues include both the sale and lease of new vehicles. Used
vehicle revenues include amounts received for used vehicles sold to retail
customers, other dealers and wholesalers. Other operating revenues include
parts and services revenues, fees and commissions for arranging F&I and sales
of third party extended warranties for vehicles. In connection with vehicle
financing contracts, Sonic receives a finance fee from the lender for
originating the loan. If, within 90 days of origination, the customer pays off
the loans through refinancing or selling/trading in the vehicle or defaults on
the loan, the finance company will assess a charge (a "chargeback") for a
portion of the original commission. The amount of the chargeback depends on how
long the related loan was outstanding. As a result, Sonic has established
reserves based on its historical chargeback experience. Sonic also sells
warranties provided by third-party vendors, and recognizes a commission at the
time of sale.
While the automotive retailing business is cyclical, we sell several
products and services that are not closely tied to the sale of new and used
vehicles. Such products and services include our parts and service and
collision repair businesses, both of which are not dependent upon near-term new
vehicle sales volume.
Our cost of sales and profitability are also affected by the allocations
of new vehicles which our dealerships receive from manufacturers. When we do
not receive allocations of new vehicle models adequate to meet customer demand,
we may purchase additional vehicles from other dealers at a premium to the
manufacturer's invoice, reducing the gross margin realized on the sales of such
vehicles. In addition, we follow a disciplined approach in selling vehicles to
other dealers and wholesalers when the vehicles have been in our inventory
longer than the guidelines set by us. Such sales are frequently at or below
cost and, therefore, reduce our overall gross margin on vehicle sales. Sonic's
salary expense, employee benefits costs and advertising expenses comprise the
majority of our selling, general and administrative expenses. Sonic's interest
expense fluctuates based primarily on the level of the inventory of new
vehicles held at our dealerships, substantially all of which is financed
through floor plan financing, as well as the amount of indebtedness incurred
for acquisitions.
We have accounted for all of our dealership acquisitions using the
purchase method of accounting and, as a result, we do not include in our
financial statements the results of operations of these dealerships prior to
the date they were acquired by us. The Consolidated Financial Statements of
Sonic discussed below reflect the results of operations, financial position and
cash flows of each of our dealerships acquired prior to December 31, 1998. As a
result of the effects of our acquisitions, the historical consolidated
financial information described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" is not necessarily indicative of
the results of operations, financial position and cash flows of Sonic in the
future or the results of operations, financial position and cash flows which
would have resulted had such acquisitions occurred at the beginning of the
periods presented in the Consolidated Financial Statements.
The automobile industry is cyclical and historically has experienced
periodic downturns, characterized by oversupply and weak demand. Many factors
affect the industry including general economic conditions and consumer
confidence, the level of discretionary personal income, interest rates and
available credit.
Sonic's profit margins are primarily impacted by changes in the percentage
of revenues attributed to new vehicle sales.
16
RESULTS OF OPERATIONS
The following table summarizes, for the periods presented, the percentages
of total revenues represented by certain items reflected in Sonic's statement
of operations.
PERCENTAGE OF TOTAL REVENUES FOR
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
---------- ---------- ----------
Revenues:
New vehicle sales ........................... 62.0% 64.2% 60.0%
Used vehicle sales .......................... 24.9% 23.1% 27.8%
Parts, service and collision repair ......... 11.2% 10.7% 10.1%
Finance and insurance ....................... 1.9% 2.0% 2.1%
Total revenues .............................. 100.0% 100.0% 100.0%
Cost of sales ............................... 88.1% 88.2% 87.1%
Gross profit ................................ 11.9% 11.8% 12.9%
Selling, general and administrative ......... 8.9% 9.0% 9.6%
Operating income ............................ 2.9% 2.8% 3.3%
Interest expense ............................ 1.7% 1.7% 1.5%
Income before taxes ......................... 1.3% 1.5% 1.8%
TWELVE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO TWELVE MONTHS ENDED
DECEMBER 31, 1997
REVENUES. Revenues grew in each of Sonic's primary revenue areas for 1998
as compared with 1997, causing total revenues to increase 199% to $1.6 billion.
This increase was due primarily to revenues contributed by our acquisitions
completed in 1997 and 1998 of approximately $994.4 million. New vehicle sales
revenue increased 180% to $962.9 million in 1998, compared with $ 343.9 million
in 1997. The increase was due primarily to an increase in new vehicle unit
sales of 165% to 41,592, as compared with 15,715 in 1997 resulting principally
from 24,922 units contributed by the acquisitions completed during 1997 and
1998. The remainder of the increase was due to a 6% increase in the average
selling price of new vehicles resulting principally from sales of higher priced
luxury and import vehicles contributed by Sonic's acquisitions.
Used vehicle revenues from retail sales increased 281% to $324.7 million
in 1998 from $85.1 million in 1997. The increase was due primarily to an
increase in used vehicle unit sales of 266% to 24,591, as compared with 6,712
in 1997, resulting from additional unit sales contributed by the acquisitions
completed in 1997 and 1998. The remainder of the increase was due to a 4%
increase in the average selling price of used vehicles, resulting principally
from sales of higher priced luxury and import vehicles contributed by our
acquisitions, along with an increase in used vehicle revenues from stores owned
for longer than one year of 23% in 1998 over 1997.
Sonic's parts, service and collision repair revenue increased 183% to
$162.7 million in 1998 compared to $57.5 million in 1997, due principally to
our acquisitions. Finance and insurance revenue increased $23.4 million, or
221%, due principally to increased new vehicle sales and related financing
contributed by the acquisitions completed in 1997 and 1998.
GROSS PROFIT. Gross profit increased 229% to $207.4 million in 1998 from
$63.0 million in 1997 due principally to increases in revenues contributed by
our acquisitions. Gross profit as a percentage of sales increased to 12.9% from
11.8% due to increases in new vehicle gross margins from 7.7% to 7.8% resulting
from sales of higher margin import vehicles contributed by our acquisitions, as
well as improved gross margins of used vehicles from 8.6% to 10.7% resulting
from efforts made to improve management of used vehicle inventories. In
addition, because gross margins from used vehicle revenues are higher than
gross margins from new vehicle revenues, an increase in used vehicle revenues
as a percentage of total revenues from 23.1% in 1997 to 27.8% in 1998, and a
decrease in new vehicle revenues as a percentage of total revenues from 64.2%
in 1997 to 60.0% in 1998, also contributed to the overall increase in gross
profits as a percentage of total revenues.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses, including depreciation and amortization, increased
222% to $154.7 million in 1998 from $48.1 million in 1997. Such expenses as a
percentage of revenues increased to 9.6% from 9.0% due principally to expenses
inherent with the rapid growth and formation of Sonic. In addition, because
sales compensation, which comprises over 50% of total selling, general, and
administration
17
expenses, is based on gross profits as opposed to revenues, the increase in
gross profit margins resulted in an increase in total selling, general, and
administrative expenses as a percent of total revenues.
INTEREST EXPENSE, FLOOR PLAN. Interest expense, floor plan increased 76%
to $14.1 million from $8.0 million, due primarily to floor plan interest
incurred by our acquisitions. As a percentage of total revenues, floor plan
interest decreased from 1.5% to 0.9% due to decreased interest rates under
Sonic's floor plan financing arrangements, as well as improvement in turnover
rates.
INTEREST EXPENSE, OTHER. Interest expense, other increased to $9.4 million
from $1.2 million, due primarily to interest incurred on Sonic's senior
subordinated notes and on acquisition-related indebtedness.
NET INCOME. As a result of the factors noted above, Sonic's net income
increased by $14.9 million in 1998 compared to 1997.
TWELVE MONTHS ENDED DECEMBER 31, 1997 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1996
REVENUES. Revenues grew in each of Sonic's primary revenue areas for 1997
as compared with 1996, causing total revenues to increase 42.2% to $536.0
million. New vehicle sales revenue increased 47.0% to $343.9 million, compared
with $233.9 million. New vehicle unit sales increased from 11,693 to 15,715,
accounting for 34.4% of the increase in vehicle sales revenues. The remainder
of the increase was primarily due to a 9.4% increase in the average selling
price resulting from changes in vehicle prices, particularly a shift in
customer preference to higher cost light trucks and sport utility vehicles, and
additional revenues from our 1997 acquisitions.
Used vehicle revenues from retail sales increased 25.1% from $68.0 million
in 1996 to $85.1 million in 1997. The increase in used vehicle revenues was due
principally to additional revenues contributed from dealerships acquired in the
fourth quarter of 1997.
Sonic's parts, service and collision repair revenue increased 36.7% to
$57.5 million from $42.1 million, and declined as a percentage of revenue to
10.7% from 11.2%. The increase in service and parts revenue was due principally
to increased parts revenue, including wholesale parts, from our Lone Star Ford
and Fort Mill Ford locations and additional revenues from our acquisitions in
the fourth quarter of 1997. F&I revenue increased $3.5 million, due principally
to increased new vehicle sales and related financings.
GROSS PROFIT. Gross profit increased 40.8% in 1997 to $63.0 million from
$44.7 million in 1996 due to increases in new vehicle sales revenues
principally at our Lone Star Ford and Fort Mill Ford locations and additional
revenues from our acquisitions in the third and fourth quarter of 1997. Parts
and service revenue increases also contributed to the increase in gross profit.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses, including depreciation and amortization, increased
42.8% from $33.7 million to $48.1 million. These expenses increased due to
increases in sales volume as well as expenses inherent with the initial growth
and formation of Sonic.
INTEREST EXPENSE, FLOOR PLAN. Interest expense, floor plan increased 34.2%
to $8.0 million from $6.0 million, primarily due to our 1997 acquisitions. As a
percentage of total revenues, floor plan interest decreased from 1.6% to 1.5%.
INTEREST EXPENSE, OTHER. Interest expense, other increased 176.9% from
$0.4 million to $1.2 million. The increase in interest expense was due to
interest incurred on acquisition related indebtedness.
NET INCOME. As a result of the factors noted above, Sonic's net income
increased by $0.7 million in 1997 compared to 1996.
LIQUIDITY AND CAPITAL RESOURCES
Sonic's principal needs for capital resources are to finance acquisitions,
and fund debt service and working capital requirements. Historically, we have
relied on internally generated cash flows from operations, borrowings under its
various credit facilities, and borrowings and capital contributions from our
stockholders to finance our operations and expansion. On November 10, 1997,
Sonic completed its initial public offering of its Class A common stock,
providing approximately $53.7 million of additional capital resources for the
consummation of certain acquisitions. On July 31, 1998, Sonic completed its
private placement of $125 million of its 11% senior subordinated notes which
provided an additional $120.6 million of capital resources for the consummation
of certain acquisitions, for repayment of borrowings under our revolving line
of credit and for future acquisitions.
18
Sonic currently has a standardized floor plan credit facility with Ford
Motor Credit for all its dealership subsidiaries (the "Floor Plan Facility")
used to finance purchases of new and used vehicle inventory. As of December 31,
1998, there was an aggregate of $228.2 million outstanding under the Floor Plan
Facility. The Floor Plan Facility at December 31, 1998 had an effective rate of
prime less 1.1% (6.65%) subject to certain incentives and other adjustments.
Typically new vehicle floor plan indebtedness exceeds the related inventory
balances. The inventory balances are generally reduced by the manufacturer's
purchase discounts which are not reflected in the related floor plan liability.
These manufacturer purchase discounts are standard in the industry, typically
occur on all new vehicle purchases, and are not used to offset the related
floor plan liability. These discounts are aggregated and generally paid to
Sonic by the manufacturer on a quarterly basis. The related floor plan
liability becomes due as vehicles are sold.
The Floor Plan Facility includes an available credit line for the purchase
of used vehicle inventory. Sonic's general practice is to utilize used vehicle
floor plan indebtedness only when purchasing large quantities of used vehicles
in bulk. As of December 31, 1998, there was approximately $18.5 million
available under Sonic's used vehicle credit line of which approximately $17.4
million was unused. Amounts outstanding under used floor plan indebtedness are
due when vehicles are sold.
Sonic makes monthly interest payments on the amount financed under the
Floor Plan Facility but is not required to make loan principal repayments prior
to the sale of the vehicles. The underlying notes are due when the related
vehicles are sold and are collateralized by vehicle inventories and other
assets of the relevant dealership subsidiary. The Floor Plan Facility contains
a number of covenants, including among others, covenants restricting Sonic with
respect to the creation of liens and changes in ownership, officers and key
management personnel.
Sonic generated net cash of $29.8 million from operating activities
in 1998, compared to $6.1 million in 1997. The increase was attributable
principally to increased net income and decreases in inventory levels.
Cash used for investing activities, excluding amounts paid in
acquisitions, was approximately $2.7 million for the year ended December 31,
1998 and related primarily to acquisitions of property and equipment. Cash used
in investing activities was $6.7 million, $86.8 million and $74.9 million in
1996, 1997 and 1998, respectively, including $1.9 million, $2.0 million and
$4.3 million of capital expenditures during such periods. Sonic's principal
capital expenditures typically include building improvements and equipment for
use in our dealerships. Of the capital expenditures in 1998, 0.6 million
related to the construction of new dealerships and a body shop which upon
completion is expected to be sold to an affiliate of MMRT and subsequently
leased back.
Cash provided by financing activities of approximately $78.6 million in
1998 primarily reflected proceeds received from the issuance of our senior
subordinated notes, plus borrowings under our revolving credit facility with
Ford Motor Credit (the "Revolving Facility"), less repayments of other debt.
The purpose of these borrowings was to finance acquisitions in 1998.
The Revolving Facility with Ford Motor Credit currently has a borrowing
limit of $100 million. Amounts outstanding under the Revolving Facility bear
interest at a fluctuating per annum rate equal to 2.75% above the 1 month
commercial finance paper rate as reported by the Federal Reserve Board (7.55% at
December 31, 1998).
The Revolving Facility will mature in March 2001, unless Sonic requests
that such term be extended, at the option of Ford Motor Credit, for a number of
additional one year terms to be negotiated by the parties. No assurance can be
given that such extensions will be granted. On July 31, 1998, all amounts
previously outstanding under the Revolving Facility were repaid with a portion
of the net proceeds of the sale of senior subordinated notes. The outstanding
balance of $8.9 million at December 31, 1998 represents amounts borrowed to
finance certain of Sonic's acquisitions completed in 1998. Amounts outstanding
under the Revolving Facility as of March 31, 1999 total approximately $53.7
million which reflects additional borrowings used to finance certain
acquisitions closed subsequent to December 31, 1998. Additional amounts to be
drawn under the Revolving Facility are to be used for the acquisition of
additional dealerships and to provide general working capital needs of Sonic
not to exceed $10 million.
We agreed under the Revolving Facility not to pledge any of our assets to
any third party (with the exception of currently encumbered real estate and
assets of Sonic's dealership subsidiaries that are subject to previous
pledges or liens). In addition, the Revolving Facility contains certain
negative covenants, including covenants restricting or prohibiting the payment
of dividends, capital expenditures and material dispositions of assets as well
as other customary covenants. Additional negative covenants include specified
ratios of
o total debt to tangible base capital (as defined in the Revolving
Facility),
o current assets to current liabilities,
19
o earnings before interest, taxes, depreciation and amortization (EBITDA)
and rent less capital expenditures to fixed charges,
o EBITDA to interest expense,
o EBITDA to total debt and
o the current lending commitment under the Revolving Facility to scaled
assets (as defined in the Revolving Facility).
In addition, the loss of voting control over Sonic by Bruton Smith, Scott
Smith and their spouses or immediate family members or the failure by Sonic,
with certain exceptions, to own all the outstanding equity, membership or
partnership interests in its dealership subsidiaries will constitute an event
of default under the Revolving Facility. Sonic did not meet the specified total
debt to tangible equity ratios required by the Revolving Facility at March 31,
1998 and at June 30, 1998 and obtained a waiver with regard to such requirement
from Ford Motor Credit. In connection with Sonic's offering of its senior
subordinated notes, Sonic and Ford Motor Credit amended the Revolving Facility
to provide that the senior subordinated notes (which are subordinated to the
Revolving Facility) will be treated as equity capital for purposes of this
ratio. Accordingly, Sonic was in compliance with this and all other restrictive
covenants as of December 31, 1998.
On July 31, 1998, Sonic completed its private placement of its senior
subordinated notes in the aggregate principal amount of $125,000,000. The notes
are unsecured, mature on August 1, 2008, and are redeemable at Sonic's option
after August 1, 2003. Interest payments are due semi-annually on February 1 and
August 1, commencing February 1, 1999. The notes are subordinated to all
present and future senior indebtedness of Sonic, including the Revolving
Facility. Redemption prices during 12 month periods beginning August 1 are
105.500% in 2003, 103.667% in 2004, 101.833% in 2005 and 100% thereafter. Net
proceeds after commissions and discounts, including issuance discount of
$937,500, amounted to $120,625,000 and were used to finance certain of our 1998
acquisitions and to repay amounts outstanding under the Revolving Facility. On
December 7, 1998, Sonic completed an exchange offer to exchange the senior
subordinated notes for identical senior subordinated notes registered under the
Securities Act.
The indenture governing the senior subordinated notes contains certain
specified restrictive and required financial covenants. We have agreed not to
pledge our assets to any third party except under certain limited circumstances
(for example, floor plan indebtedness). We also have agreed to certain other
limitations or prohibitions concerning the incurrence of other indebtedness,
capital stock, guaranties, asset sales, investments, cash dividends to
shareholders, distributions and redemptions.
Under Sonic's Amended and Restated Certificate of Incorporation, 3 million
shares of preferred stock are authorized to be issued by Sonic with such
designations, rights and preferences as may be determined from time to time by
our Board of Directors. In March 1998, our Board of Directors designated
300,000 shares of preferred stock as Class A convertible preferred stock (the
"Preferred Stock"), which was divided into 100,000 shares of Series I Preferred
Stock, 100,000 shares of Series II Preferred Stock and 100,000 shares of Series
III Preferred Stock.
The Preferred Stock has a liquidation preference of $1,000 per share. Each
share of Preferred Stock is convertible, at the option of the holder, into that
number of shares of Class A common stock as is determined by dividing $1,000 by
the average closing price for the Class A common stock on the NYSE for the 20
days preceding the date of determination of the shares of Preferred Stock (the
"Market Price"). Conversion of Series II Preferred Stock is subject to certain
adjustments which have the effect of limiting increases and decreases in the
value of the Class A common stock receivable upon conversion by 10% of the
original value of the shares of Series II Preferred Stock. Conversion of
Series III Preferred Stock is subject to certain adjustments which have the
effect of limiting increases in the value of Class A common stock receivable
upon conversion by 10% of the original value of the shares of Series III
Preferred Stock.
The Preferred Stock is redeemable at Sonic's option at any time after the
date of issuance. The redemption price of the Series I Preferred Stock is
$1,000 per share. The redemption price for the Series II Preferred Stock and
Series III Preferred Stock is as follows: (i) prior to the second anniversary
of the date of issuance, the redemption price is the greater of $1,000 per
share or the aggregate Market Price of the Class A common stock into which it
could be converted at the time of redemption, and (ii) after the second
anniversary of the date of issuance, the redemption price is the aggregate
Market Price of the Class A common stock into which it could be converted at
the time of redemption.
Each share of Preferred Stock entitles its holder to a number of votes
equal to that number of shares of Class A common stock into which it could be
converted as of the record date for the vote. Holders of Preferred Stock are
entitled
20
to participate in dividends payable on the Class A common stock on an
"as-if-converted" basis. The Preferred Stock has no preferential dividends.
During 1998, Sonic acquired 19 dealerships for an aggregate purchase price
of approximately $134.0 million. The aggregate purchase price was paid with
approximately $96.2 million in cash, with 970,588 shares of Class A common
stock having an estimated fair value at the time of issuance of approximately
$8.3 million, with 30,733.8 shares of Preferred Stock (14,406.3 shares of
Series I Preferred Stock, 10,054.5 shares of Series II Preferred Stock, and
6,273 shares of Series III Preferred Stock) having an estimated fair value at
the time of issuance of approximately $29.3 million and with warrants to
purchase an aggregate of 154,000 shares of Class A common stock having an
approximate fair value of $0.5 million. The cash portion of the aggregate
purchase price was financed with a combination of cash obtained from the net
proceeds of Sonic's private offering on July 31, 1998 of $125 million in
aggregate principal amount of its 11% senior subordinated notes, cash obtained
from the Revolving Facility, and cash generated from Sonic's existing
operations. In addition, Sonic has issued to the sellers of certain of the
acquired dealerships warrants to purchase an aggregate of 154,000 shares of
Class A common stock having an approximate fair value of $0.5 million. Payables
for acquisitions as of December 31, 1998 on the accompanying consolidated
balance sheet includes $1.7 million of the cash portion of the aggregate
purchase price which was paid subsequent to December 31, 1998.
The difference between the aggregate purchase price of $134.0 million and
amounts paid of $134.3 represents the net of (i) $1.3 million due from a former
owner as a result of a shortage in the actual net book value of assets acquired
compared to the minimum net book value required in the purchase agreement, (ii)
$0.4 million due to a former owner as a result of an excess in the actual net
book value of assets acquired over the minimum net book value required in the
purchase agreement, and (iii) $0.6 million due to a former owner on the first
and second anniversaries of the acquisition date. The $1.3 million due from a
former owner has been included in other current assets on the accompanying
balance sheet. The $0.4 million and $0.6 million due to former owners have been
included in payable for acquisitions on the accompanying balance sheet.
In accordance with terms of certain of the purchase agreements, Sonic may
be required to pay additional consideration contingent upon future earnings of
certain of the dealerships acquired. As of December 31, 1998, Sonic had
recorded approximately $8.0 million relating to such consideration, which has
been accounted for as goodwill. Any additional amounts which may be payable in
the future will also be accounted for as goodwill.
During the first quarter of 1999, Sonic acquired 8 dealerships for
approximately $50.9 million in cash and 34,100 shares of Series III Preferred
Stock having a liquidation preference of $1,000 per share. The cash portion of
the purchase price was financed with a combination of cash borrowed under the
Revolving Facility and cash generated from Sonic's existing operations.
The acquisitions were accounted for using purchase accounting. Sonic may be
required to pay additional amounts based on pre-tax earnings of certain of the
dealerships acquired. Any additional amounts paid will be accounted for as
goodwill.
In connection with the subsequent acquisition of a Honda dealership
located in Chattanooga, Tennessee in March 1999, Sonic sold substantially all
of the assets of its Honda dealership in Cleveland, Tennessee for approximately
$3.6 million.
Sonic has signed definitive agreements to acquire 12 dealerships for
a minimum of approximately $54.9 million in cash, 11,425 shares of Series II
Preferred Stock and 10,525 shares of Series III Preferred Stock having a
liquidation value of $1,000 per share. The aggregate purchase price is subject
to adjustment based on the actual net book value of the assets acquired. The
cash portion of the purchase price will be paid with a combination of borrowings
under the Revolving Facility and with cash generated from Sonic's existing
operations. Sonic may be required to pay additional amounts based on future
pre-tax earnings of certain of these acquired dealerships. These acquisitions
are expected to be consummated in the second and third quarters of 1999.
Sonic incurred a tax liability of approximately $7.1 million in connection
with the change in its tax basis of accounting for inventory from the "last-in,
first-out" method of inventory accounting to the "first-in, first-out" method
of inventory accounting, which is payable over a six-year period beginning in
January 1998. In addition, in connection with certain of our 1998 acquisitions,
we incurred an additional tax liability in the amount of approximately $1.9
million as a result of the change in accounting for the inventory from the
"last-in, first-out" method of inventory accounting to the "first-in,
first-out" method of inventory accounting, which will be payable over a four
year period. As of December 31, 1998, the remaining cumulative balance of this
tax liability was $5.6 million. We expect to pay such obligation with cash
provided by operations.
21
We believe that the net proceeds from the sale of the senior subordinated
notes, together with funds generated through future operations and availability
of borrowings under our floor plan financing (or any replacements thereof) and
our other credit arrangements will be sufficient to fund our debt service and
working capital requirements and any seasonal operating requirements, including
our currently anticipated internal growth, for the foreseeable future. Sonic
expects to fund any future acquisitions from its future cash flow from
operations, additional debt financing (including the Revolving Facility) or the
issuance of Class A common stock, Preferred Stock or other convertible
instruments.
SEASONALITY
Sonic's operations are subject to seasonal variations. The first quarter
generally contributes less revenue and operating profits than the second, third
and fourth quarters. Seasonality is principally caused by weather conditions
and the timing of manufacturer incentive programs and model changeovers.
YEAR 2000 COMPLIANCE
GENERAL
Due to the limited memory capacity of older computers, many computer
systems and software applications in earlier years were programmed to store
dates using six digit formats (e.g. mm/dd/yy) versus nine digit formats (e.g.
mm/dd/yyyy). Under the six digit format, most computer systems and software
applications are limited to recognizing dates within the 20th century only,
causing computers to interpret the year "00" as the year "1900" rather than the
year "2000." As we approach the beginning of year 2000, there is widespread
concern that the inability of computer systems to recognize dates beyond the
year 1999 will result in software errors and system failures that could be
disruptive to ordinary business operations.
We recognize the need to ensure that our operations will not be disrupted
by Year 2000 (Y2K) system failures either within our own computer systems or
within the computer systems of our primary lenders and suppliers. Each of our
dealerships has appointed a team comprised primarily of department managers
that, using guides developed by the National Automobile Dealers Association
(NADA), is responsible for assessing and resolving potential Year 2000
problems, and developing contingency plans to mitigate the impact of future
problems on operations.
STATE OF READINESS
INTERNAL DEALERSHIP SYSTEMS: Internal systems supporting the dealership's
daily operations are comprised of four primary systems: (i) the Dealer
Management System (DMS), which supports the critical operations of the
dealership including all vehicle sales, vehicle inventory, financing and
insurance operations, service and parts operations, and accounting functions;
(ii) the Dealer Communication System (DCS), which provides on-line
communication with manufacturers necessary for ordering vehicles and parts
inventory, submitting warranty claims, submitting dealership financial
statements, receiving delivery reports, and receiving technical information
used in service department operations; (iii) personal computer systems (PC
systems) used in providing information to and communicating with the parent
company; and (iv) "embedded systems" which use an electric processor or
computer chip to control, monitor, or assist with the operation of equipment,
machinery, and building management (e.g. building access, security and fire
alarms, automotive diagnostic equipment).
DEALER MANAGEMENT SYSTEM: The DMS systems used by our dealerships are
obtained from one of four primary vendors: Reynolds & Reynolds, Infiniti Net,
ADP and UCS. Each of these vendors has developed upgrades to correct Y2K
problems within the DMS systems, and we have completed the process of
installing such upgrades to our systems. In addition, we have received written
verification from each of these vendors that the DMS systems operating within
dealerships currently owned by Sonic are Y2K certified. With respect to
dealerships being acquired, dealerships using DMS systems which are not Y2K
certified are being transferred to existing systems which are Y2K certified.
DEALER COMMUNICATION SYSTEM: The DCS systems used in our dealerships are
provided by the respective manufacturers with whom the dealerships communicate.
As a result, the manufacturers have assumed responsibility for upgrading DCS
systems to Y2K compliant systems. To date, all but 18 of our dealerships have
received written verification from their respective manufacturer that their DCS
system is Y2K compliant. In addition, we have requested
22
from each manufacturer that status reports be provided to both the dealership
and parent company to inform us of remediation efforts at those dealerships
that are not yet Y2K compliant, and when such remediation efforts are expected
to be completed.
PERSONAL COMPUTER SYSTEMS: Most PC systems currently operating in our
dealerships were installed within the past year and were determined to be Y2K
compliant at the time of installation. PC systems and local and wide area
networks used to communicate with our dealerships were also recently installed,
and were Y2K certified upon purchase. As a precautionary measure, we have
provided all dealerships with diskettes containing programs designed to test PC
systems for Y2K capability. All PC systems that have not met certification
standards for compliance will be upgraded or replaced with systems that are Y2K
compliant.
EMBEDDED SYSTEMS: Embedded systems refer to systems that use some sort of
electronic process or computer chip to track time and date information used in
the operation of that system. For example, security systems, or heating,
ventilation, and air-conditioning systems (HVAC) may be programmed to
automatically be activated or deactivated at a certain time. If a security
system is programmed to lock up a dealership on weekends, then some dealerships
may be locked out on Thursday, January 6, 2000 because the computer interprets
the date as Saturday, January 6, 1900. All facilities are currently conducting
an inventory of such systems, and will contact the manufacturer or supplier to
test such systems and obtain verification of Y2K certification. This process
has not yet been completed, though these systems are not considered critical
and a disruption in these systems is not expected to significantly affect
dealerships' daily operations.
EXTERNAL SYSTEMS: A dealership's operations may be adversely affected if
the lenders, suppliers, or other third parties with whom it regularly conducts
business are affected by Y2K problems within their systems. Other than
automobile manufacturers, we are primarily concerned about Y2K failures with
banks and other financial service providers, companies providing financing and
insurance to our customers, and utilities providing electricity and water. We
have received verification from our primary banks and lenders that their
systems are Y2K compliant and that service is not expected to be interrupted by
Y2K problems. We are still in the process of contacting other key vendors and
suppliers regarding their Y2K remediation efforts.
COSTS
The costs associated with converting our internal systems to Y2K compliant
systems have not been, and are not expected to be, material to our financial
position or results of operations. Costs associated with upgrading and
converting the DMS and DCS systems to Y2K compliant systems were covered by
monthly maintenance contracts with the respective suppliers and were expensed
as incurred. Costs associated with upgrading or replacing PC and embedded
systems have not been material and were expensed or capitalized in accordance
with our capitalization policy.
CONTINGENCY PLANS
We cannot state with certainty whether Year 2000 system failures either
within our own internal systems or within the systems of third-parties with
whom we are involved will have a material adverse impact on our results of
operations. In order to mitigate the potential impact of any future Year 2000
problems, each of our dealerships is in the process of developing contingency
plans which include the following:
1. Use of pre-printed and pre-numbered forms and checks (including repair
orders and parts counter tickets) and manual journals and ledger books to
assist in bookkeeping and accounting functions;
2. Use of hand held, battery operated finance computers in order to
continue providing finance services to our customers;
3. Establishing emergency reserves of supplies in the event that service
from third party lenders and suppliers is disrupted due to Y2K problems
within their systems; and
4. Training of employees to manually perform functions that are currently
performed on computers.
While we believe that we are taking appropriate steps to ensure we are
adequately prepared to deal with Year 2000 problems as they arise, we cannot
make assurances that Year 2000 problems will not have a material adverse affect
on our results of operations or financial condition. In a worst case scenario,
Year 2000 problems may delay our ability to sell vehicles, provide financing
and insurance to our customers, provide parts and repair service to our
customers, complete acquisitions or meet third-party obligations until Year
2000 problems can be resolved in the affected systems.
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SIGNIFICANT MATERIALITY OF GOODWILL
Goodwill represents the excess purchase price over the estimated fair
value of the tangible and separately measurable intangible net assets acquired.
The cumulative amount of goodwill at December 31, 1997 was $75.0 million and at
December 31, 1998 was $182.5 million. As a percentage of total assets and
stockholders' equity, goodwill, net of accumulated amortization, represented
25.5% and 88.1%, respectively, at December 31, 1997, and 31.3% and 126.4%,
respectively, at December 31, 1998. Generally accepted accounting principles
require that goodwill and all other intangible assets be amortized over the
period benefited. We have determined that the period benefited by the goodwill
will be no less than 40 years. Accordingly, we are amortizing goodwill over a
40 year period. Earnings reported in periods immediately following an
acquisition would be overstated if Sonic attributed a 40 year benefit to an
intangible asset that should have had a shorter benefit period. In later years,
Sonic would be burdened by a continuing charge against earnings without the
associated benefit to income valued by management in arriving at the price paid
for the businesses acquired. Earnings in later years also could be
significantly affected if management then determined that the remaining balance
of goodwill was impaired. We periodically compare the carrying value of
goodwill with the anticipated undiscounted future cash flows from operations of
the businesses we have acquired in order to evaluate the recoverability of
goodwill. We have concluded that the anticipated future cash flows associated
with intangible assets recognized in our acquisitions will continue
indefinitely, and these is no pervasive evidence that any material portion will
dissipate over a period shorter than 40 years. We will incur additional
goodwill in future acquisitions.
EFFECTS OF INFLATION
Due to the relatively low levels of inflation in 1996, 1997 and 1998,
inflation did not have a significant effect on Sonic's results of operations
for those periods.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information." This Standard redefines how operating
segments are determined and requires disclosure of certain financial and
descriptive information about a company's operating segments. This Statement
became effective for Sonic's fiscal year ending December 31, 1998. The
implementation of FAS 131 did not have a significant impact on Sonic's
financial statements or related disclosures.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instrument
and Hedging Activities." This Standard establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and hedging activities. The Statement will become
effective for Sonic beginning January 1, 2000. We have elected earlier
application of all of the provisions of this Statement beginning October 1,
1998. The implementation of the provisions of this Statement did not have an
impact on Sonic's financial statements for the year ended December 31, 1998.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK. Sonic's only financial instruments with market risk
exposure are variable rate floor plan notes payable, Revolving Facility
borrowings and other variable rate notes and mortgages. As of December 31,
1998, the total outstanding balance of such instruments was approximately
$243.5 million. A change of one percent in the interest rate would have caused
a change in interest expense for the year ended December 31, 1998 of
approximately $2.1 million. In addition, a decrease or increase in interest
rates would cause a respective increase or decrease in the present value of
Sonic's fixed rate senior subordinated notes, which have a carrying value of
$120.7 million at December 31, 1998.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Financial Statements which appears on page F-1 herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The name, age, present principal occupation or employment and the material
occupations, positions, offices or employments for the past five years of each
Sonic director, director-nominee, and executive officer are set forth below.
O. Bruton Smith, 72, has been the Chairman, Chief Executive Officer and a
director of Sonic since its organization in 1997, and he currently is a
director and executive officer of each of Sonic's dealerships. Mr. Smith has
worked in the retail automobile industry since 1966. Mr. Smith's initial term
as a director of Sonic will expire at the 2000 annual stockholders meeting. Mr.
Smith is also the chairman and chief executive officer, a director and
controlling stockholder of Speedway Motorsports, Inc. ("SMI"). SMI is a public
company traded on the NYSE. Among other things, it owns and operates the
following NASCAR racetracks: Atlanta Motor Speedway, Bristol Motor Speedway,
Lowe's Motor Speedway, Las Vegas Motor Speedway, Sears Point Raceway and Texas
Motor Speedway. He is also the executive officer and a director of each of
SMI's operating subsidiaries. Additionally, Mr. Smith serves as chairman of the
board of trustees of Mar Mar Realty Trust, a privately held real estate
investment trust ("MMRT"), and owns and operates Sonic Financial Corporation
among other private businesses. Under his employment agreement with Sonic, Mr.
Smith is required to devote approximately 50% of his business time to Sonic's
business.
Bryan Scott Smith, 31, has been the President and Chief Operating Officer
of Sonic since April 1997 and a Sonic director since its organization in 1997.
Mr. Smith also serves as a director and executive officer of many of Sonic's
subsidiaries. Mr. Smith, who is the son of Bruton Smith, has been an executive
officer of Town and Country Ford since 1993, and was a m