Risk Factors
Our significant indebtedness could materially adversely affect our financial
health and prevent us from fulfilling our financial obligations.
As of March 31, 2001, our total outstanding indebtedness was
approximately $1,150.9 million, including the following:
. $373.0 million under a revolving credit agreement with Ford Motor Credit
Company ("Ford Motor Credit") and Chrysler Financial Company, LLC
("Chrysler Financial") (the "Revolving Facility") with a borrowing limit
of $500 million, subject to a borrowing base calculated on the basis of
our receivables, inventory and equipment and a pledge of certain
additional collateral by an affiliate of Sonic;
. $481.7 million under a standardized secured inventory floor plan
facility (the "Ford Floor Plan Facility") with Ford Motor Credit;
. $110.2 million under a standardized secured floor plan facility (the
"Chrysler Floor Plan Facility") with Chrysler Financial;
. $52.1 million under a standardized secured floor plan facility (the
"GMAC Floor Plan Facility" and together with the Ford Floor Plan
Facility and the Chrysler Floor Plan Facility, the "Floor Plan
Facilities") with General Motors Acceptance Corporation ("GMAC");
. $121.3 million in 11% Senior Subordinated Notes due 2008 representing
$125.0 million in aggregate principal amount less unamortized discount
of approximately $3.7 million; and
. $12.6 million of other secured debt, including $4.6 million under a
revolving real estate acquisition and new dealership construction line
of credit (the "Construction Loan") and a related mortgage refinancing
facility (the "Permanent Loan" and together with the Construction Loan,
the "Mortgage Facility") with Ford Motor Credit.
As of March 31, 2001 we had approximately $60.1 million available for
additional borrowings under the Revolving Facility, based on a borrowing base
calculated on the basis of our receivables, inventory and equipment and
certain additional collateral pledged by an affiliate of Sonic. We also had
approximately $95.4 million available for additional borrowings under the
Mortgage Facility for real estate acquisitions and new dealership
construction. We also have significant additional capacity under the Floor
Plan Facilities. In addition, the indentures relating to our senior
subordinated notes and other debt instruments allow us to incur additional
indebtedness, including secured indebtedness.
The degree to which we are leveraged could have important consequences to
the holders of our securities, including the following:
. our ability to obtain additional financing for acquisitions, capital
expenditures, working capital or general corporate purposes may be
impaired in the future;
. a substantial portion of our current cash flow from operations must be
dedicated to the payment of principal and interest on our senior
subordinated notes, borrowings under the Revolving Facility and the
Floor Plan Facilities and other indebtedness, thereby reducing the funds
available to us for our operations and other purposes;
. some of our borrowings are and will continue to be at variable rates of
interest, which exposes us to the risk of increased interest rates;
. the indebtedness outstanding under our credit facilities is secured by a
pledge of substantially all the assets of our dealerships; and
. we may be substantially more leveraged than some of our competitors,
which may place us at a relative competitive disadvantage and make us
more vulnerable to changing market conditions and regulations.
In addition, our debt agreements contain numerous covenants that limit our
discretion with respect to business matters, including mergers or
acquisitions, paying dividends, incurring additional debt, making capital
expenditures or disposing of assets.
1
Our future operating results depend on our ability to integrate our operations
with recent acquisitions.
Our future operating results depend on our ability to integrate the
operations of our recently acquired dealerships, as well as dealerships we
acquire in the future, with our existing operations. In particular, we need to
integrate our systems, procedures and structures, which can be difficult. Our
growth strategy has focused on the pursuit of strategic acquisitions that
either expand or complement our business. We acquired 19 dealerships in 1998,
72 during 1999, 11 in 2000 and three in the first quarter of 2001.
We cannot assure you that we will effectively and profitably integrate the
operations of these dealerships without substantial costs, delays or
operational or financial problems, including as a result of:
. the difficulties of managing operations located in geographic areas
where we have not previously operated;
. the management time and attention required to integrate and manage newly
acquired dealerships;
. the difficulties of assimilating and retaining employees; and
. the challenges of keeping customers.
These factors could have a material adverse effect on our financial
condition and results of operations.
Risks associated with acquisitions may hinder our ability to increase revenues
and earnings.
The automobile retailing industry is considered a mature industry in which
minimal growth is expected in industry unit sales. Accordingly, our future
growth depends in large part on our ability to acquire additional dealerships,
as well as on our ability to manage expansion, control costs in our operations
and consolidate both past and future dealership acquisitions into existing
operations. In pursuing a strategy of acquiring other dealerships, we face
risks commonly encountered with growth through acquisitions. These risks
include, but are not limited to:
. incurring significantly higher capital expenditures and operating
expenses;
. failing to assimilate the operations and personnel of the acquired
dealerships;
. entering new markets with which we are unfamiliar;
. potential undiscovered liabilities at acquired dealerships;
. disrupting our ongoing business;
. diverting our limited management resources;
. failing to maintain uniform standards, controls and policies;
. impairing relationships with employees, manufacturers and customers as a
result of changes in management;
. causing increased expenses for accounting and computer systems, as well
as integration difficulties; and
. failure to obtain a manufacturer's consent to the acquisition of one or
more of its dealership franchises.
We may not adequately anticipate all of the demands that our growth will
impose on our systems, procedures and structures, including our financial and
reporting control systems, data processing systems and management structure.
If we cannot adequately anticipate and respond to these demands, our business
could be materially harmed.
Failure to retain qualified management personnel at any acquired dealership
may increase the risk associated with integrating the acquired dealership.
Installing new computer systems has disrupted existing operations in the past
as management and salespersons adjust to new technologies. We cannot assure
you that we will overcome these risks or any other problems encountered with
either our past or future acquisitions.
2
Automobile manufacturers exercise significant control over our operations, and
we are dependent on them to operate our business.
Each of our dealerships operates pursuant to a franchise agreement with the
applicable automobile manufacturer or manufacturer authorized distributor. We
are significantly dependent on our relationships with these manufacturers.
Without a franchise agreement, we cannot obtain new vehicles from a
manufacturer.
Vehicles manufactured by the following manufacturers accounted for the
indicated approximate percentage of our new vehicle revenue for the year ended
December 31, 2000 and the three months ended March 31, 2001:
Percentage of New Percentage of New
Vehicle Revenue for Vehicle Revenue for
The Year Ended the Three Months
December 31, 2000 Ended March 31, 2000
Honda........................ 14.4% 13.6%
Ford......................... 13.5% 16.7%
Chrysler..................... 12.0% 9.6%
BMW.......................... 10.7% 11.1%
General Motors............... 10.7% 11.0%
Toyota....................... 8.3% 11.5%
Nissan....................... 6.5% 5.8%
Lexus........................ 5.3% 5.6%
No other manufacturer accounted for more than 5% of our new vehicle sales
during these periods. A significant decline in the sale of
Ford, Honda, Chrysler, General Motors ("GM"), BMW, Toyota, Nissan or Lexus new
vehicles could have a material adverse effect on our revenue and
profitability.
Manufacturers exercise a great degree of control over the operations of our
dealerships. Each of our franchise agreements provides for termination or non-
renewal for a variety of causes, including any unapproved change of ownership
or management and other material breaches of the franchise agreements.
Manufacturers may also have a right of first refusal if we seek to sell
dealerships. We believe that we will be able to renew at expiration all of our
existing franchise agreements.
. We cannot assure you that any of our existing franchise agreements will
be renewed or that the terms and conditions of such renewals will be
favorable to us.
. If a manufacturer is allowed under state franchise laws to terminate or
decline to renew one or more of our significant franchise agreements,
this action could have a material adverse effect on our results of
operations.
. Actions taken by manufacturers to exploit their superior bargaining
position in negotiating the terms of renewals of franchise agreements or
otherwise could also have a material adverse effect on our results of
operations.
. Manufacturers allocate their vehicles among dealerships generally based
on the sales history of each dealership. Consequently, we also depend on
the manufacturers to provide us with a desirable mix of popular new
vehicles. These popular vehicles produce the highest profit margins and
tend to be the most difficult to obtain from the manufacturers.
. Our dealerships depend on the manufacturers for certain sales
incentives, warranties and other programs that are intended to promote
and support dealership new vehicle sales. Manufacturers have
historically made many changes to their incentive programs during each
year. A reduction or discontinuation of a manufacturer's incentive
programs may materially adversely affect our profitability. Some of
these programs include:
. customer rebates on new vehicles;
. dealer incentives on new vehicles;
. special financing or leasing terms;
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. warranties on new and used vehicles; and
. sponsorship of used vehicle sales by authorized new vehicle dealers.
Adverse conditions affecting one or more manufacturers may negatively impact
our profitability.
The success of each of our dealerships depends to a great extent on the
manufacturers':
. financial condition;
. marketing;
. vehicle design;
. production capabilities;
. management; and
. labor relations.
Nissan, Dodge (a Chrysler brand) and Volvo have had significant difficulty
in the U.S. market in the recent past. If any of our manufacturers,
particularly Ford, Honda, Chrysler, GM, BMW, Toyota, Nissan, or Lexus were
unable to successfully design, manufacture, deliver and market their vehicles,
the manufacturer's reputation and our ability to sell the manufacturer's
vehicles could be adversely affected.
Events such as strikes and other labor actions by unions, or negative
publicity concerning a particular manufacturer or vehicle model, may
materially and adversely affect our results of operations. Similarly, the
delivery of vehicles from manufacturers later than scheduled, which may occur
particularly during periods when new products are being introduced, can reduce
our sales. Although we have attempted to lessen our dependence on any one
manufacturer by establishing dealer relationships with a number of different
domestic and foreign automobile manufacturers, adverse conditions affecting
manufacturers, Ford, Honda, Chrysler, GM, BMW, Toyota, Nissan or Lexus in
particular, could have a material adverse effect on our results of operations.
For example, in June 1998, the United Auto Workers went on strike at two GM
facilities in Flint, Michigan. The strike lasted 53 days, causing 27 GM
manufacturing facilities to shut down during the strike and severely affecting
production of GM vehicles during the strike. In the event of another strike,
we may need to purchase inventory from other automobile dealers at prices
higher than we would be required to pay to the affected manufacturer in order
to carry an adequate level and mix of inventory. Consequently, strikes or
other adverse labor actions could materially adversely affect our
profitability.
Manufacturer stock ownership/issuance restrictions limit our ability to issue
additional equity to meet our financing needs.
Standard automobile franchise agreements prohibit transfers of any ownership
interests of a dealership and its parent and, therefore, often do not by their
terms accommodate public trading of the capital stock of a dealership or its
parent. Our manufacturers have agreed to permit trading in Sonic's Class A
common stock. A number of manufacturers impose restrictions on the
transferability of the Class A common stock.
. Ford may cause us to sell or resign from one or more of our Ford,
Lincoln or Mercury franchises if any person or entity (other than O.
Bruton Smith and any entity controlled by him) acquires or has a binding
agreement to acquire securities having 50% or more of the voting power
of Sonic's securities.
. GM and Infiniti may force the sale of their respective franchises if 20%
of more of Sonic's voting securities are similarly acquired.
. Toyota may force the sale of one or more of Sonic's Toyota or Lexus
dealerships if (1) an automobile manufacturer or distributor acquires
securities, or the right to vote securities by proxy or voting
agreement, having more than 5% of the voting power of Sonic's
securities, (2) any individual or entity acquires securities, or the
right to vote securities by proxy or voting agreement, having more than
20% of the voting power of Sonic's securities, (3) there is a material
change in the composition of Sonic's
4
Board of Directors that Toyota reasonably concludes will be materially
incompatible with Toyota's interests or will have an adverse effect on
Toyota's reputation or brands in the marketplace or the performance of
Sonic or its Toyota and Lexus dealerships, (4) there occurs an
extraordinary transaction whereby Sonic's shareholders immediately prior
to such transaction own in the aggregate securities having less than a
majority of the voting power of Sonic or the successor entity, or (5)
any individual or entity acquires control of Sonic, Sonic Financial
Corporation or any Toyota or Lexus dealership owned by Sonic.
. Honda may force the sale of our Honda or Acura franchises if (1) an
automobile manufacturer or distributor acquires securities having 5% or
more of the voting power of Sonic's securities, (2) an individual or
entity that has either a felony criminal record or a criminal record
relating solely to dealings with an automobile manufacturer, distributor
or dealership acquires securities having 5% or more of the voting power
of Sonic's securities or (3) any individual or entity acquires
securities having 20% or more of the voting power of Sonic's securities
and Honda reasonably deems such acquisition to be detrimental to Honda's
interests in any material respect.
. Chrysler 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.
. 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 affect the voting or managerial
control of Sonic's Volkswagen franchise subsidiaries requires the prior
approval of Volkswagen.
Other manufacturers may impose similar or more limiting restrictions.
Our lending arrangements also require that holders of Sonic's Class B common
stock maintain voting control over Sonic. We are unable to prevent our
stockholders from transferring shares of our common stock, including transfers
by holders of the Class B common stock. If such transfer results in a change
in control of Sonic, it could result in the termination or non-renewal of one
or more of our franchise agreements and a default under our credit
arrangements. Moreover, these issuance limitations may impede our ability to
raise capital through additional equity offerings or to issue our stock as
consideration for future acquisitions.
Manufacturers' restrictions on acquisitions could limit our future growth.
We are required to obtain the consent of the applicable manufacturer before
the acquisition of any additional dealership franchises. We cannot assure you
that manufacturers will grant such approvals, although the denial of such
approval may be subject to certain state franchise laws. Jaguar declined to
consent to our proposed 1997 acquisitions of franchises associated with
dealerships in Chattanooga, Tennessee and Greenville, South Carolina, and we
subsequently agreed with Jaguar not to acquire any Jaguar franchise before
August 3, 2001.
Obtaining manufacturer consent for acquisitions could also take a
significant amount of time. Obtaining manufacturer approval for our completed
acquisitions has taken approximately three to five months. We believe that
manufacturer approvals of subsequent acquisitions from manufacturers with
which we have previously completed applications and agreements may take less
time, although we cannot provide you with assurances to that effect. In
addition, under an applicable franchise agreement or under state law, a
manufacturer may have a right of first refusal to acquire a dealership in the
event we seek to acquire that dealership franchise.
If we experience delays in obtaining, or fail to obtain, manufacturer
approvals for dealership acquisitions, our growth strategy could be materially
adversely affected. In determining whether to approve an acquisition, the
manufacturers may consider many factors, including:
. our management's moral character;
5
. the business experience of the post-acquisition dealership management;
. our financial condition;
. our ownership structure; and
. manufacturer-determined consumer satisfaction index (CSI) scores.
In addition, a manufacturer may seek to limit the number of its dealerships
that we may own, our national market share of that manufacturer's products or
the number of dealerships we may own in a particular geographic area. These
restrictions may not be enforceable under state franchise laws.
. In September 1999, Ford and Sonic signed a new framework agreement. The
agreement places the following restrictions on our ability to acquire
Ford or Lincoln Mercury dealerships:
. We may not acquire additional Ford or Lincoln Mercury dealerships
unless we continue to satisfy Ford's requirement that 80% of our
Ford dealerships meet Ford's performance criteria. Beyond that, we
may not make an acquisition that would result in our owning Ford or
Lincoln Mercury dealerships with sales exceeding 5% of the total
Ford or total Lincoln Mercury retail sales of new vehicles in the
United States for the preceding calendar year.
. We may not acquire additional Ford or Lincoln Mercury dealerships in
a particular state if such an acquisition would result in our owning
Ford or Lincoln Mercury dealerships with sales exceeding 5% of the
total Ford or total Lincoln Mercury retail sales of new vehicles in
that state for the preceding calendar year.
. We may not acquire additional Ford dealerships in a Ford-defined
market area if such an acquisition would result in our owning more
than one Ford dealership in a market having a total of three or less
Ford dealerships or owning more than 25% of the Ford dealerships in
a market having a total of four or more Ford dealerships. An
identical market area restriction applies for Lincoln Mercury
dealerships.
. In December 2000, Toyota and Sonic entered into a new framework
agreement that limits the number of Toyota and Lexus dealerships that we
may own on a national level, in each Toyota-defined geographic region or
distributor area, and in each Toyota or Lexus-defined metropolitan
market. Nationally, the limitations on Toyota dealerships owned by us
are for specified time periods and are based on specified percentages of
total Toyota unit sales in the United States. In Toyota-defined
geographic regions or distributor areas, the limitations on Toyota
dealerships owned by us are specified by the applicable Toyota regional
limitations policy or distributor's policy in effect at such time. In
Toyota-defined metropolitan markets, the limitations on Toyota
dealerships owned by us are based on Toyota's metro markets limitation
policy then in effect, which currently provides a limitation based on
the total number of Toyota dealerships in the particular market. For
Lexus, we may own no more than one Lexus dealership in any one Lexus-
defined metropolitan market and no more than three Lexus dealerships
nationally.
. In September 1999, Honda and Sonic signed a new framework agreement.
This framework agreement limits the number of Honda and Acura
dealerships that we may own on a national level, in each Honda and
Acura-defined geographic zone, and in each Honda-defined metropolitan
market. Nationally, the limitations on Honda dealerships owned by us are
based on specified percentages of total Honda unit sales in the United
States. In Honda-defined geographic zones, the limitations on Honda
dealerships owned by us are based on specified percentages of total
Honda unit sales in each of 10 Honda-defined geographic zones. In Honda-
defined metropolitan markets, the limitations on Honda dealerships owned
by us are specified numbers of dealerships in each market, which
numerical limits vary based mainly on the total number of Honda
dealerships in a particular market. For Acura, we may own no more than
(1) two Acura dealerships in a Honda-defined metropolitan market, (2)
three Acura dealerships in any one of six Honda-defined geographic zones
and (3) five Acura dealerships nationally.
. Mercedes restricts any company from owning Mercedes dealerships with
sales of more than 3% of total sales of Mercedes vehicles in the U.S.
during the previous calendar year.
6
. GM currently limits the maximum number of GM dealerships that we may
acquire to 50% of the GM dealerships, by brand line, in a GM-defined
geographic market area having multiple GM dealers.
. Subaru limits us to no more than two Subaru dealerships within certain
designated market areas, four Subaru dealerships within its Mid-America
region and 12 dealerships within Subaru's entire area of distribution.
. BMW currently prohibits publicly held companies from owning BMW
dealerships representing more than 5% of all BMW sales in the U.S. or
more than 50% of BMW dealerships in a given metropolitan market. We
believe we are currently at BMW's national sales limitation.
. Toyota, Honda and Mercedes also prohibit the coupling of a franchise
with any other brand without their consent.
. Honda also prohibits ownership of contiguous dealerships.
As a condition to granting their consent to our acquisitions, a number of
manufacturers required additional restrictions. These agreements principally
restrict:
. material changes in our company or extraordinary corporate transactions
such as a merger, sale of a material amount of assets or change in our
board of directors or management that could have a material adverse
effect on the manufacturer's image or reputation or could be materially
incompatible with the manufacturer's interests;
. the removal of a dealership general manager without the consent of the
manufacturer; and
. the use of dealership facilities to sell or service new vehicles of
other manufacturers.
In addition, manufacturer consent to our acquisitions may impose conditions,
such as requiring facilities improvements by us at the acquired dealership.
If we are unable to comply with these restrictions, we generally:
. must sell the assets of the dealerships to the manufacturer or to a
third party acceptable to the manufacturer; or
. terminate the dealership agreements with the manufacturer.
Other manufacturers may impose other and more stringent restrictions in
connection with future acquisitions.
We own the following number of franchises for the following manufacturers:
Number of
Manufacturer Franchises
- ------------ ----------
Ford.................... 13
Chevrolet............... 11
Honda................... 11
BMW..................... 10
Cadillac................ 10
Nissan.................. 10
Toyota.................. 9
Dodge................... 8
Volvo................... 8
Chrysler................ 7
Jeep.................... 7
Oldsmobile.............. 7
Plymouth................ 7
Mercury................. 5
Volkswagen.............. 5
Number of
Manufacturer Franchises
- ------------ ----------
Lexus................... 4
Lincoln................. 4
Mercedes................ 4
Hyundai................. 3
Isuzu................... 3
Kia..................... 3
Mitsubishi.............. 3
Audi.................... 2
GMC..................... 2
Infiniti................ 2
Pontiac................. 2
Porsche................. 2
Acura................... 1
Land Rover.............. 1
Subaru.................. 1
7
Our failure to meet a manufacturer's consumer satisfaction requirements may
adversely affect our ability to acquire new dealerships and our profitability.
Many manufacturers attempt to measure customers' satisfaction with their
sales and warranty service experiences through systems which vary from
manufacturer to manufacturer, but which are generally known as "CSI." These
manufacturers may use a dealership's CSI scores as a factor in evaluating
applications for additional dealership acquisitions. The components of CSI
have been modified by various manufacturers from time to time in the past, and
we cannot assure you that these components will not be further modified or
replaced by different systems in the future. To date, we have not been
materially adversely affected by these standards and have not been denied
approval of any acquisition based on low CSI scores, except for Jaguar's
refusal to approve our acquisition of a Chattanooga Jaguar franchise in 1997.
However, we cannot assure you that we will be able to comply with these
standards in the future. A manufacturer may refuse to consent to an
acquisition of one of its franchises if it determines our dealerships do not
comply with the manufacturer's CSI standards. This could materially adversely
affect our acquisition strategy. In addition, we receive payments from the
manufacturers based, in part, on CSI scores, which could be materially
adversely affected if our CSI scores decline.
There are limitations on our financial resources available for acquisitions.
We intend to finance our acquisitions with cash generated from operations,
through issuances of our stock or debt securities and through borrowings under
credit arrangements.
. We cannot assure you that we will be able to obtain additional financing
by issuing stock or debt securities.
. Using cash to complete acquisitions could substantially limit our
operating or financial flexibility.
We estimate that as of March 31, 2001, we had approximately $60.1 million
available for additional borrowings under the 2000 Revolving Facility, based
on a borrowing base calculated on the basis of our receivables, inventory and
equipment and a pledge of certain additional collateral by an affiliate of
Sonic (which borrowing base was $433.0 million of the $500.0 million facility
at March 31, 2001).
. If we are unable to obtain financing on acceptable terms, we may be
required to reduce the scope of our presently anticipated expansion,
which could materially adversely affect our growth strategy.
In addition, we are dependent to a significant extent on our ability to
finance our inventory. Automotive retail inventory financing involves
significant sums of money in the form of "floor plan financing." Floor plan
financing is how a dealership finances its purchase of new vehicles from a
manufacturer. The dealership borrows money to buy a particular vehicle from
the manufacturer and pays off the loan when it sells that particular vehicle,
paying interest during this period. We must obtain new floor plan financing or
obtain consents to assume such financing in connection with our acquisition of
dealerships.
Substantially all the assets of our dealerships are pledged to secure this
floor plan indebtedness. In addition, substantially all the real property and
assets of our subsidiaries that are constructing new dealerships are pledged
under our newly obtained mortgage facility with Ford Motor Credit. These
pledges may impede our ability to borrow from other sources.
Finally, because Ford Motor Credit is associated with Ford, any
deterioration of our relationship with one could adversely affect our
relationship with the other. The same is true of our relationships with
Chrysler and Chrysler Financial, as well as GM and GMAC.
Although our officers and directors have previously facilitated our
acquisition financing, we cannot assure you that these individuals will be
willing or able to assist in our financing needs in the future.
O. Bruton Smith, our Chief Executive Officer and Chairman of the Board,
previously guaranteed our credit facilities and other financing arrangements
to facilitate our acquisitions. Mr. Smith may be unwilling to make any such
commitments in the future if such commitments are needed.
8
Mr. Smith initially guaranteed obligations under the Revolving Facility.
Such obligations were further secured with a pledge of shares of common stock
of Speedway Motorsports, Inc. ("SMI") owned by Sonic Financial Corporation, a
corporation controlled by Mr. Smith ("SFC"), having an estimated value at the
time of pledge of approximately $50.0 million (the "Revolving Pledge"). When
the Revolving Facility's borrowing limit was increased to $75.0 million in
1997, Mr. Smith's personal guarantee of Sonic's obligations under the
Revolving Facility was released, although the Revolving Pledge remained in
place. Mr. Smith was also required by Ford Motor Credit to lend $5.5 million
(the "Subordinated Smith Loan") to Sonic to increase our capitalization
because the net proceeds from our November 1997 initial public offering were
significantly less than expected. In August 1998, Ford Motor Credit released
the Revolving Pledge. In November 1999, Ford Motor Credit further increased
the borrowing limit under the 1999 Revolving Facility to $350.0 million
subject to a borrowing base calculated on the basis of our receivables,
inventory and equipment and a pledge by SFC of five million shares of SMI
common stock. The 2000 Revolving Facility is subject to a similar borrowing
base, including SFC's continuing pledge of SMI stock.
Before our acquisition of FirstAmerica, Mr. Smith guaranteed the obligations
of FirstAmerica under FirstAmerica's new acquisition line of credit with Ford
Motor Credit. FirstAmerica obtained this new financing to enable it to
complete its then pending acquisitions. The borrowing limit on this credit
facility was approximately $138 million. Mr. Smith had guaranteed
approximately $107 million of this amount, which guarantee was secured by a
pledge of 5.0 million shares of SMI common stock owned by SFC. We assumed
FirstAmerica's obligations to Ford Motor Credit under our 1999 Revolving
Facility when we acquired FirstAmerica. Mr. Smith's secured guarantee in favor
of Ford Motor Credit guaranteed a portion of our obligations under the 1999
Revolving Facility. Under the 2000 Revolving Facility, Mr. Smith did not
provide a guarantee in favor of the lenders, but SFC continues to pledge SMI
stock as collateral. We cannot assure you that Mr. Smith will be willing or
able to provide similar guarantees or credit support in the future to
facilitate Sonic's future acquisitions.
Automobile retailing is a mature industry with limited growth potential in new
vehicle sales, and our acquisition strategy will affect our revenues and
earnings.
The United States automobile dealership industry is considered a mature
industry in which minimal growth is expected in unit sales of new vehicles. As
a consequence, growth in our revenues and earnings is likely to be
significantly affected by our success in acquiring and integrating dealerships
and the pace and size of such acquisitions.
High competition in automobile retailing reduces our profit margins on vehicle
sales. Further, the use of the Internet in the car purchasing process could
materially adversely affect us.
Automobile retailing is a highly competitive business with approximately
21,600 franchised automobile dealerships in the United States at the end of
2000. Our competition includes:
. Franchised automobile dealerships selling the same or similar makes of
new and used vehicles that we offer in our markets and sometimes at
lower prices than we offer. Some of these dealer competitors may be
larger and have greater financial and marketing resources than we do;
. Other franchised dealers;
. Private market buyers and sellers of used vehicles;
. Used vehicle dealers;
. Internet-based vehicle brokers that sell vehicles obtained from
franchised dealers directly to consumers;
. Service center chain stores; and
. Independent service and repair shops.
Our F&I business and other related businesses, which provide higher
contributions to our earnings than sales of new and used vehicles, are subject
to strong competition from various financial institutions and other third
parties. This competition is increasing as these products are now being
marketed and sold over the Internet.
9
Gross profit margins on sales of new vehicles have been generally declining
since 1986. We do not have any cost advantage in purchasing new vehicles from
manufacturers, due to economies of scale or otherwise. We typically rely on
advertising, merchandising, sales expertise, service reputation and dealership
location to sell new vehicles. The following factors could have a significant
impact on our business:
. The Internet has become a significant part of the sales process in our
industry. Customers are using the Internet to compare pricing for cars
and related F&I services, which may further reduce margins for new and
used cars and profits for related F&I services. In addition,
CarsDirect.com and others are selling vehicles over the Internet without
the benefit of having a dealership franchise, although they must
currently source their vehicles from a franchised dealer. CarsDirect.com
has entered into an alliance with United Auto Group to facilitate their
sourcing of vehicles. Also, AutoNation is selling vehicles for its new
car dealerships through its AutoNationDirect.com web site. If Internet
new vehicle sales are allowed to be conducted without the involvement of
franchised dealers, our business could be materially adversely affected.
In addition, other franchise groups have aligned themselves with
Internet car sellers or are spending significant sums on developing
their own Internet capabilities, which could materially adversely affect
our business.
. Our revenues and profitability could be materially adversely affected
should manufacturers decide to directly enter the retail market.
. The increased popularity of short-term vehicle leasing also has
resulted, as these leases expire, in a large increase in the number of
late model vehicles available in the market, which puts added pressure
on new and used vehicle margins.
. Some of our competitors may be capable of operating on smaller gross
margins than we are, and the on-line auto brokers have been operating at
a loss.
. As we seek to acquire dealerships in new markets, we may face
increasingly significant competition as we strive to gain market share
through acquisitions or otherwise. This competition includes other large
dealer groups and dealer groups that have publicly traded equity.
Our franchise agreements do not grant us the exclusive right to sell a
manufacturer's product within a given geographic area. Our revenues or
profitability could be materially adversely affected if any of our
manufacturers award franchises to others in the same markets where we operate,
although certain state franchise laws may limit such activities by the
manufacturers. A similar adverse effect could occur if existing competing
franchised dealers increase their market share in our markets. Our gross
margins may decline over time as we expand into markets where we do not have a
leading position. These and other competitive pressures could materially
adversely affect our results of operations.
The cyclical and local nature of automobile sales may adversely affect our
profitability.
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
credit availability. For example, recent interest rate increases and other
factors have impacted the market and have reduced the seasonally adjusted
annualized selling rate of new cars since the beginning of the year.
Future recessions may have a material adverse effect on our business. In
addition, significant changes in interest rates may significantly impact our
car sales since many car buyers finance their purchases. Furthermore, higher
gasoline prices may lead to a reduction in automobile purchases or a shift in
buying patterns from luxury/SUV models (which typically provide high profit
margins to retailers) to smaller, more economical vehicles (which typically
have lower margins).
Local economic, competitive and other conditions also affect the performance
of dealerships. Our dealerships currently are located in the Atlanta,
Baltimore, Birmingham, Charleston, Charlotte, Chattanooga, Columbia, Columbus,
Dallas, Daytona Beach, Fort Myers, Greenville/Spartanburg, Houston, Las Vegas,
Los Angeles, Mobile/Pensacola, Montgomery, Nashville, San Diego, San
Francisco, San Jose/Silicon Valley,
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Tampa/Clearwater, Tulsa and Washington, D.C. markets. We intend to pursue
acquisitions outside of these markets, but our operational focus is on our
current markets. As a result, our results of operations depend substantially
on general economic conditions and consumer spending habits in the Southeast
and Northern California and, to a lesser extent, the Houston and Columbus
markets. Sales in our Northern California market represented 16.3% of our
sales for the year ended December 31, 2000. Our results of operations also
depend on other factors, such as tax rates and state and local regulations
specific to the states in which we currently operate. Sonic may not be able to
expand geographically and any such expansion may not adequately insulate it
from the adverse effects of local or regional economic conditions.
We can offer you no assurances that we will be able to continue executing our
acquisition strategy without the costs of future acquisitions escalating.
Although there are many potential acquisition candidates that fit our
acquisition criteria, we cannot assure you that we will be able to consummate
any such transactions in the future or identify those candidates that would
result in the most successful combinations, or that future acquisitions will
be able to be consummated at acceptable prices and terms. In addition,
increased competition for acquisition candidates could result in fewer
acquisition opportunities for us and higher acquisition prices. The magnitude,
timing, pricing and nature of future acquisitions will depend upon various
factors, including:
. the availability of suitable acquisition candidates;
. competition with other dealer groups for suitable acquisitions;
. the negotiation of acceptable terms;
. our financial capabilities;
. our stock price;
. the availability of skilled employees to manage the acquired companies;
and
. general economic and business conditions.
We may be required to file applications and obtain clearances under
applicable federal antitrust laws before completing an acquisition. These
regulatory requirements may restrict or delay our acquisitions, and may
increase the cost of completing acquisitions.
The operating condition of acquired businesses cannot be determined
accurately until we assume control.
Although we conduct what we believe to be a prudent level of investigation
regarding the operating condition of the businesses we purchase, in light of
the circumstances of each transaction, an unavoidable level of risk remains
regarding the actual operating condition of these businesses. Until we
actually assume operating control of such assets, we may not be able to
ascertain the actual value of the acquired entity.
Potential conflicts of interest between Sonic and its officers could adversely
affect our future performance.
O. Bruton Smith serves as the chairman and chief executive officer of
Speedway Motorsports, Inc. ("SMI"). Accordingly, Sonic competes with SMI for
the management time of Mr. Smith. Under his employment agreement with Sonic,
Mr. Smith is required to devote approximately 50% of his business time to our
business. The remainder of his business time may be devoted to other entities,
including SMI.
Sonic has in the past and will likely in the future enter into transactions
with Mr. Smith, entities controlled by Mr. Smith or other affiliates of Sonic.
For example, Sonic previously entered into property transactions with MMR
Holdings, L.L.C. and its subsidiaries (the "MMR Group"). The MMR Group was
owned, directly and indirectly, and controlled by Mr. Smith. On August 13,
1999, Mr. Smith and SFC sold the ownership of the MMR Group to CAR MMR L.L.C.
("CAR MMR"), an affiliate of Capital Automotive REIT, which is unaffiliated
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with Sonic or Mr. Smith. The MMR Group owned 50 properties leased to 42 Sonic
dealerships at the time of the MMR Group sale. As a part of the sale of the
MMR Group, Mr. Smith and SFC signed agreements with Sonic to induce Sonic to
sign its agreement with CAR MMR. Mr. Smith and SFC, under these agreements,
paid approximately $2.5 million to Sonic, which amount represented Mr. Smith's
and SFC's profits on the sale of the MMR Group less their expenses in selling
the MMR Group and a 14% annual return on their initial investment in the MMR
Group, net of any advances previously made by Sonic to the MMR Group.
We believe that all of our existing arrangements with affiliates are as
favorable to us as if the arrangements were negotiated between unaffiliated
parties, although the majority of such transactions have neither been
independently verified in that regard nor are likely to be so verified in the
future. Potential conflicts of interest could arise in the future between
Sonic and its officers or directors in the enforcement, amendment or
termination of arrangements existing between them.
Under Delaware law generally, a corporate insider is precluded from acting
on a business opportunity in his individual capacity if that opportunity is
(1) one which the corporation is financially able to undertake,
(2) is in the line of the corporation's business,
(3) is of practical advantage to the corporation, and
(4) is one in which the corporation has an interest or reasonable
expectancy.
Accordingly, our corporate insiders are generally prohibited from engaging
in new dealership-related business opportunities outside of Sonic unless a
majority of Sonic's disinterested directors decide that such opportunities are
not in our best interest.
Sonic's charter contains provisions providing that transactions between
Sonic and its affiliates must be no less favorable to Sonic than would be
available in similar transactions with an unrelated third party. Moreover, any
such transactions involving aggregate payments in excess of $500,000 must be
approved by a majority of Sonic's directors and a majority of its independent
directors. If not so approved, Sonic must obtain an opinion as to the
financial fairness of the transaction to be issued by an investment banking or
appraisal firm of national standing. In addition, the terms of the Revolving
Facility and Sonic's existing senior subordinated notes restrict transactions
with affiliates in a manner similar to Sonic's charter restrictions.
Lack of majority of independent directors could result in conflicts between us
and our management and majority stockholders that may reduce our future
performance.
Independent directors do not constitute a majority of our board, and our
board may not have a majority of independent directors in the future. Without
a majority of independent directors, Sonic's executive officers, principal
stockholders and directors could establish policies and enter into
transactions without independent review and approval, subject to certain
restrictions under our charter. These policies and transactions could present
the potential for a conflict of interest between Sonic and its minority
stockholders and the controlling officers, stockholders or directors.
The loss of key personnel and limited management and personnel resources could
adversely affect our operations and growth.
Our success depends to a significant degree upon the continued contributions
of Sonic's management team, particularly its senior management, and service
and sales personnel. Additionally, manufacturer franchise agreements may
require the prior approval of the applicable manufacturer before any change is
made in franchise general managers. We do not have employment agreements with
most of our dealership managers and other key dealership personnel.
Consequently, the loss of the services of one or more of these key employees
could have a material adverse effect on our results of operations.
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In addition, as we expand we may need to hire additional managers. The
market for qualified employees in the industry and in the regions in which we
operate, particularly for general managers and sales and service personnel, is
highly competitive and may subject us to increased labor costs during periods
of low unemployment. The loss of the services of key employees or the
inability to attract additional qualified managers could have a material
adverse effect on our results of operations. In addition, the lack of
qualified management or employees employed by potential acquisition candidates
may limit our ability to consummate future acquisitions.
Seasonality of the automotive retail business adversely affects first quarter
revenues.
Our business is seasonal, with a disproportionate amount of revenues
received generally in the second, third and fourth fiscal quarters.
Import product restrictions and foreign trade risks may impair our ability to
sell foreign vehicles profitably.
Some of the vehicles and major components of vehicles we sell are
manufactured in foreign countries. Accordingly, we are subject to the import
and export restrictions of various jurisdictions and are dependent to some
extent upon general economic conditions in, and political relations with, a
number of foreign countries, particularly Germany, Japan and Sweden.
Fluctuations in currency exchange rates may also adversely affect our sales of
vehicles produced by foreign manufacturers. Imports into the United States may
also be adversely affected by increased transportation costs and tariffs,
quotas or duties.
Governmental regulation and environmental regulation compliance costs may
adversely affect our profitability.
We are subject to a wide range of federal, state and local laws and
regulations, such as local licensing requirements and consumer protection
laws. The violation of these laws and regulations can result in civil and
criminal penalties against us or in a cease and desist order against our
operations if we are not in compliance. Our future acquisitions may also be
subject to regulation, including antitrust reviews. We believe that we comply
in all material respects with all laws and regulations applicable to our
business, but future regulations may be more stringent and require us to incur
significant additional costs.
Our facilities and operations are also subject to federal, state and local
laws and regulations relating to environmental protection and human health and
safety, including those governing wastewater discharges, air emissions, the
operation and removal of underground and aboveground storage tanks, the use,
storage, treatment, transportation, release, recycling and disposal of solid
and hazardous materials and wastes and the cleanup of contaminated property or
water. We may be required by these laws to pay the full amount of the costs of
investigation and/or remediation of contaminated properties, even if we are
not at fault for disposal of the materials or if such disposal was legal at
the time. People who may be found liable under these laws and regulations
include the present or former owner or operator of a contaminated property and
companies that generated, transported, disposed of or arranged for the
transportation or disposal of hazardous substances found at the property.
Our past and present business operations are subject to environmental laws
and regulations governing the use, storage, handling, recycling and disposal
of hazardous or toxic substances such as new and waste motor oil, oil filters,
transmission fluid, antifreeze, freon, new and waste paint and lacquer
thinner, batteries, solvents, lubricants, degreasing agents, gasoline and
diesel fuels. We are also subject to laws and regulations relating to
underground storage tanks that exist or used to exist at many of our
properties. Like many of our competitors, we have incurred, and will continue
to incur, capital and operating expenditures and other costs in complying with
such laws and regulations. In addition, soil and groundwater contamination
exists at certain of our properties. We cannot assure you that our other
properties have not been or will not become similarly contaminated. In
addition, we could become subject to potentially material new or unforeseen
environmental costs or liabilities because of our acquisitions.
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Environmental laws and regulations, including those governing air emissions
and underground storage tanks, could require compliance with new or more
stringent standards that are imposed in the future. We cannot predict what
other environmental legislation or regulations will be enacted in the future,
how existing or future laws or regulations will be administered or interpreted
or what environmental conditions may be found to exist in the future.
Consequently, we may be required to make substantial expenditures in the
future.
Concentration of voting power and antitakeover provisions of our charter,
Delaware law and our dealer agreements may reduce the likelihood of any
potential change of control of Sonic.
Sonic's common stock is divided into two classes with different voting
rights. This dual class stock ownership allows the present holders of the
Class B common stock to control Sonic. Holders of Class A common stock have
one vote per share on all matters. Holders of Class B common stock have 10
votes per share on all matters, except that they have only one vote per share
on any transaction proposed by the Board of Directors or a Class B common
stock holder or otherwise benefiting the Class B common stock holders
constituting a:
(1) "going private" transaction;
(2) disposition of substantially all of our assets;
(3) transfer resulting in a change in the nature of our business; or
(4) merger or consolidation in which current holders of common stock would
own less than 50% of the common stock following such transaction.
The holders of Class B common stock currently hold less than a majority of
Sonic's outstanding common stock, but a majority of Sonic's voting power. This
may prevent or discourage a change of control of Sonic even if such action
were favored by holders of Class A common stock.
Sonic's charter and bylaws make it more difficult for its stockholders to
take corporate actions at stockholders' meetings. In addition, options under
our 1997 Stock Option Plan become immediately exercisable on a change in
control. Also, Delaware law makes it difficult for stockholders who have
recently acquired a large interest in a company to consummate a business
transaction with the company against its directors' wishes. Finally,
restrictions imposed by our dealer agreements may impede or prevent any
potential takeover bid. Generally, our franchise agreements allow the
manufacturers the right to terminate the agreements upon a change of control
of our company and impose restrictions upon the transferability of any
significant percentage of our stock to any one person or entity who may be
unqualified, as defined by the manufacturer, to own one of its dealerships.
The inability of a person or entity to qualify with one or more of our
manufacturers may prevent or seriously impede a potential takeover bid. These
agreements, corporate documents and laws, as well as provisions of our lending
arrangements creating an event of default on a change in control, may have the
effect of delaying or preventing a change in control or preventing
stockholders from realizing a premium on the sale of their shares upon an
acquisition of Sonic.
Amortization of goodwill from acquisitions could change, resulting in
significant reduction in earnings for future periods.
Goodwill, net of accumulated amortization, represented approximately 38.6%
of our total assets and 151.8% of our stockholders' equity as of March 31,
2001. Goodwill arises when an acquiror pays more for a business than the fair
value of the tangible and separately measurable intangible net assets.
Accounting principles generally accepted in the United States of America require
that this and all other intangible assets be amortized over the period
benefited. We determined that the period benefited by all of the goodwill will
be no less than 40 years. Accordingly, we amortize goodwill over a 40 year
period. Earnings reported in periods immediately following the acquisition would
be overstated if we attributed a 40 year benefit period to an intangible asset
that should have had a shorter benefit period. In later years, we would be
burdened by a continuing charge against earnings without the associated benefit
to income valued by management in arriving at
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the price paid for the businesses. Earnings in later years also could be
significantly affected if management determined then that the remaining
balance of goodwill was impaired. We periodically compare the carrying value
of goodwill with anticipated undiscounted future cash flows from operations of
the businesses we have acquired to evaluate the recoverability of goodwill. We
have concluded that the anticipated future cash flows associated with
intangible assets recognized in the acquisitions will continue indefinitely,
and there is no persuasive evidence that any material portion will dissipate
over a period shorter than 40 years. We will incur additional goodwill in our
future acquisitions.
The Financial Accounting Standards Board recently proposed new rules
relating to the accounting for business combinations and intangible assets.
One aspect of the proposal would not permit amortization of goodwill, but
would require the carrying amount of goodwill to be reduced only if it was
found to be impaired or was associated with assets to be sold or otherwise
disposed. If the proposed rules are adopted, goodwill arising from
acquisitions completed prior to the date of adoption would no longer be
amortized, though reversal of goodwill amortization recognized in prior
periods would not be permitted.
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