UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
- --------------------------------------------------------------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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 E. Independence Blvd., Charlotte, North Carolina 28212
(Address of principal executive offices) (Zip Code)
(704) 566-2400
(Registrant's telephone number, including area code)
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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.
Yes X No
--- ---
As of May 10, 2002, there were 30,718,116 shares of Class A Common Stock and
12,029,375 shares of Class B Common Stock outstanding.
INDEX TO FORM 10-Q
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements (Unaudited) 3
Consolidated Statements of Income - Three-month periods
ended March 31, 2001 and March 31, 2002
Consolidated Balance Sheets -
December 31, 2001 and March 31, 2002
Consolidated Statement of Stockholders' Equity -
Three-month period ended March 31, 2002
Consolidated Statements of Cash Flows - Three-month periods
ended March 31, 2001 and March 31, 2002
Notes to Unaudited Consolidated Financial Statements
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 27
PART II - OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K 29
SIGNATURES 30
2
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements.
SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars and shares in thousands except per share amounts)
(Unaudited)
Three Months Ended
March 31,
2001 2002
----------- -----------
Revenues:
New vehicles $ 863,774 $ 952,971
Used vehicles 291,833 283,872
Wholesale vehicles 115,427 109,867
----------- -----------
Total vehicles 1,271,034 1,346,710
Parts, service and collision repair 187,607 211,286
Finance & insurance and other 40,832 47,557
----------- -----------
Total revenues 1,499,473 1,605,553
Cost of sales 1,273,003 1,353,191
----------- -----------
Gross profit 226,470 252,362
Selling, general and administrative expenses 176,077 200,103
Depreciation 1,699 2,090
Goodwill amortization 4,438 --
----------- -----------
Operating income 44,256 50,169
Other income / (expense):
Interest expense, floor plan (12,102) (5,549)
Interest expense, other (10,005) (8,390)
Other income 59 109
----------- -----------
Total other expense (22,048) (13,830)
----------- -----------
Income from continuing operations before taxes 22,208 36,339
Provision for income taxes (8,664) (13,810)
----------- -----------
Net income from continuing operations 13,544 22,529
Discontinued operations:
Loss from operations of discontinued dealerships
(including loss on disposal of $262 at March 31, 2002) (99) (730)
Income tax benefit 38 280
----------- -----------
Net loss from discontinued operations (61) (450)
----------- -----------
Net income $ 13,483 $ 22,079
=========== ===========
Basic net income per share:
Net income per share from continuing operations $ 0.33 $ 0.55
Loss per share on discontinued operations $ -- $ (0.01)
----------- -----------
Net income per share $ 0.33 $ 0.54
=========== ===========
Weighted average common shares outstanding 41,271 40,627
=========== ===========
Diluted net income per share:
Net income per share from continuing operations $ 0.33 $ 0.53
Loss per share on discontinued operations $ -- $ (0.01)
----------- -----------
Net income per share $ 0.33 $ 0.52
=========== ===========
Weighted average common shares outstanding 41,473 42,563
=========== ===========
See notes to unaudited consolidated financial statements.
3
SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
March 31,
December 31, 2002
2001 (Unaudited)
----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 127,943 $ 125,599
Receivables, net 134,968 150,598
Inventories 664,258 896,790
Other current assets 29,127 44,385
----------- -----------
Total current assets 956,296 1,217,372
Property and Equipment, net 98,972 102,772
Goodwill, net 738,103 885,266
Other Assets 12,555 16,375
----------- -----------
Total Assets $ 1,805,926 $ 2,221,785
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable - floor plan $ 587,914 $ 796,066
Trade accounts payable 44,802 54,959
Accrued interest 9,676 6,400
Other accrued liabilities 92,275 117,094
Current maturities of long-term debt 2,586 2,275
----------- -----------
Total current liabilities 737,253 976,794
Long Term Debt 511,877 620,691
Other Long-Term Liabilities 5,836 10,374
Payable to the Company's Chairman 5,500 5,500
Deferred Income Taxes 28,199 28,662
Stockholders' Equity:
Class A Common Stock, 34,850,738 shares issued at December 31, 2001
and 36,719,905 shares issued at March 31, 2002 348 367
Class B Common Stock, 12,029,375 shares issued and outstanding
at December 31, 2001 and March 31, 2002 121 121
Paid-in capital 343,256 384,947
Retained earnings 232,893 254,972
Accumulated other comprehensive income -- 762
Treasury Stock, at cost (6,330,264 shares held at December 31, 2001
and 6,415,264 shares held at March 31, 2002) (59,357) (61,405)
----------- -----------
Total stockholders' equity 517,261 579,764
----------- -----------
Total Liabilities and Stockholders' Equity $ 1,805,926 $ 2,221,785
=========== ===========
See notes to unaudited consolidated financial statements.
4
SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Dollars and shares in thousands)
(Unaudited)
Accumulated
Class A Class B Other Total
Common Stock Common Stock Paid-In Retained Treasury Comprehensive Stockholders'
Shares Amount Shares Amount Capital Earnings Stock Income Equity
-------- -------- ------- ------- -------- -------- --------- ----------- -------------
Balance at December 31, 2001 34,851 $ 348 12,029 $ 121 $343,256 $ 232,893 $(59,357) $ -- $517,261
Comprehensive Income:
Net Income 22,079 22,079
Fair value of interest rate swap
agreement, net of tax of $487 762 762
--------
22,841
Total comprehensive income, net of tax --
Shares awarded under stock
compensation plans 398 4 3,706 3,710
Issuance of Class A Common Stock for
acquisitions 1,471 15 37,985 38,000
Purchase of Treasury Stock (2,048) (2,048)
-------- -------- -------- -------- -------- -------- -------- -------- --------
Balance at March 31, 2002 36,720 $ 367 12,029 $ 121 $384,947 $ 254,972 $(61,405) $ 762 $579,764
======== ======== ======== ======== ======== ======== ======== ======== ========
See notes to unaudited consolidated financial statements.
5
SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Three Months Ended
March 31,
2001 2002
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 13,483 $ 22,079
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 6,176 2,090
Deferred income taxes -- 76
Equity interest in (earnings) losses of investees 165 (124)
(Gain)/Loss on disposal of assets (27) 323
Changes in assets and liabilities that relate to operations:
Receivables 10,263 (9,775)
Inventories 69,465 (33,343)
Other assets 2,181 (4,614)
Notes payable - floor plan (88,057) 24,864
Trade accounts payable and other liabilities 4,058 22,483
--------- ---------
Total adjustments 4,224 1,980
--------- ---------
Net cash provided by operating activities 17,707 24,059
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of businesses, net of cash acquired (25,733) (131,233)
Purchases of property and equipment (11,323) (13,905)
Proceeds from sales of property and equipment 865 10,036
Proceeds from sale of dealerships 7,042 2,945
--------- ---------
Net cash used in investing activities (29,149) (132,157)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings on revolving credit facilities 19,182 104,505
Proceeds from long-term debt -- 289
Payments on long-term debt (575) (702)
Redemptions of Preferred Stock (251) --
Purchases of Class A Common Stock (12,569) (2,048)
Issuance of shares under stock compensation plans 232 3,710
Repayments from affiliated companies (203) --
--------- ---------
Net cash provided by financing activities 5,816 105,754
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (5,626) (2,344)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 109,325 127,943
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 103,699 $ 125,599
========= =========
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
Class A Common Stock issued for acquisitions $ -- $ 38,000
Change in fair value of cash flow hedging instrument
(net of tax of $487) $ -- $ 762
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 26,602 $ 17,215
Cash paid for income taxes $ 245 $ 7,719
See notes to unaudited consolidated financial statements.
6
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation -- The accompanying unaudited financial information
for the three months ended March 31, 2002 and 2001 has been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission. All
significant intercompany accounts and transactions have been eliminated. These
unaudited consolidated financial statements reflect, in the opinion of
management, all material adjustments (which include only normal recurring
adjustments) necessary to fairly state the financial position and the results of
operations for the periods presented. The results for interim periods are not
necessarily indicative of the results to be expected for the entire fiscal year.
These interim financial statements should be read in conjunction with the
audited consolidated financial statements of Sonic Automotive, Inc. ("Sonic")
for the year ended December 31, 2001.
Revenue Recognition -- Sonic records revenue when vehicles are delivered to
customers, when vehicle service work is performed and when parts are delivered.
Sonic arranges financing for customers through various financial
institutions and receives a commission from the lender equal to the difference
between the interest rates charged to customers over the predetermined interest
rates set by the financing institution. Sonic also receives commissions from the
sale of various insurance contracts to customers. Sonic may be assessed a
chargeback fee in the event of early cancellation of a loan or insurance
contract by the customer. Finance and insurance commission revenue is recorded
net of estimated chargebacks at the time the related contract is placed with the
financial institution.
Sonic also receives commissions from the sale of non-recourse third party
extended service contracts to customers. Under these contracts the applicable
manufacturer or third party warranty company is directly liable for all
warranties provided within the contract. Commission revenue from the sale of
these third party extended service contracts is recorded net of estimated
chargebacks at the time of sale. Commission expense related to finance and
insurance commission revenue is charged to selling, general and administrative
expenses upon recognition of such revenue.
Derivative Instruments and Hedging Activities - Sonic utilizes derivative
financial instruments for the purpose of hedging the risks of certain
identifiable and anticipated transactions. In general, the types of risks being
hedged are those relating to the variability of future earnings and cash flows
caused by fluctuations in interest rates. Sonic documents its risk management
strategy and hedge effectiveness at the inception of and during the term of each
hedge. The only derivatives currently being used are interest rate swaps used
for the purpose of hedging cash flows of variable rate debt. These derivatives
are used only for that purpose, not for speculation. The derivatives, which have
been designated and qualify as cash flow hedging instruments, are reported at
fair value. The gain or loss on the effective portion of the hedge is initially
reported as a component of other comprehensive income. (See Note 5).
Recent Accounting Pronouncements -- Sonic has adopted the provisions of
Statement of Financial Accounting Standard ("SFAS") No. 141: Business
Combinations. SFAS No. 141 prohibits the pooling-of-interests method of
accounting and requires the use of the purchase method of accounting for all
business combinations initiated after June 30, 2001. Additionally, acquired
intangible assets should be separately recognized if the benefit of the
intangible asset is obtained through contractual or other legal rights, or if
the intangible asset can be sold, transferred, licensed, rented or exchanged,
regardless of the acquirer's intent to do so.
Sonic also adopted the provisions of SFAS No. 142: Goodwill and Other
Intangible Assets. Among other things, SFAS No. 142 no longer permits the
amortization of goodwill, but requires that the carrying amount of goodwill be
reviewed and reduced against operations if it is found to be impaired. This
review must be performed on at least an annual basis (with an initial review
within six months of adopting the new standard), but must also be performed upon
the occurrence of an event or circumstance that indicates a possible reduction
in value. SFAS No. 142 does require the amortization of intangible assets other
than goodwill over their useful economic lives, unless the useful economic life
is determined to be indefinite. These intangible assets are required to be
reviewed for impairment in accordance with SFAS No. 144: Accounting for
Impairment or Disposal of Long-Lived Assets. Intangible assets that are
determined to have an indefinite economic life may not be amortized and must be
reviewed for impairment in accordance with the terms of SFAS No. 142.
The adoption of SFAS No. 142 on January 1, 2002 resulted in the elimination
of approximately $22.1 million of annual goodwill amortization. Sonic is still
in the process of performing its initial impairment test of goodwill, and has
not yet determined the impact of any potential impairment on our consolidated
financial statements.
Sonic adopted the provisions of SFAS No. 144: Accounting for the Impairment
or Disposal of Long-Lived Assets as of January 1, 2002. SFAS No. 144 establishes
a single accounting model for assets to be disposed of by sale whether
previously held and used or newly acquired. SFAS No. 144 requires certain
long-lived assets to be reported at the lower of carrying amount or fair value,
7
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
less cost to sell, and provides guidance on asset valuation and measuring
impairment. The adoption of this standard resulted in a net loss of $0.1 million
and $0.5 million being classified as discontinued operations on the unaudited
consolidated statements of income for the three month period ended March 31,
2001 and 2002, respectively.
Use of Estimates -- The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates particularly related to allowance for credit losses,
realization of inventory, intangible asset and deferred tax asset values,
reserves for future chargebacks, insurance reserves and certain accrued
expenses.
Segment Information -- Sonic sells similar products and services (new and
used vehicles, parts, service and collision repair services), use similar
processes in selling our products and services, and sell our products and
services to similar classes of customers. As a result of this and the way we
manage our business, we have aggregated our results into a single segment for
purposes of reporting financial condition and results of operations.
Reclassifications -- In order to maintain consistency and comparability of
financial information between periods presented, certain reclassifications have
been made to Sonic's prior year financial statements to conform to the current
presentation. These reclassifications relate primarily to manufacturer
incentives and certain other amounts that have been reclassed from sales
revenues to cost of sales. Additionally, all finance and insurance sales
commissions have been reclassed from cost of sales to selling, general and
administrative expenses to conform to the industry classification of such
amounts.
2. BUSINESS ACQUISITIONS AND DISPOSITIONS
Completed Acquisitions
Sonic generally seeks to acquire larger, well managed multiple franchise
dealerships or multiple dealership groups located in metropolitan or high growth
suburban markets. Sonic also looks to acquire smaller, single franchise
dealerships that will allow Sonic to capitalize on professional management
practices and provide greater breadth of products and services in our markets.
Occasionally, Sonic acquires dealerships that have under performed the industry
average, but represent attractive franchises or have attractive locations that
would immediately benefit from its professional management.
On March 18, 2002, Sonic acquired five dealerships owned by Don Kott (the
"Kott Acquisition") for approximately $19.6 million in cash. The dealerships are
located in the metropolitan area of Los Angeles, California and sell the
following brands of new vehicles: Ford, Lincoln, Mercury, Chrysler, Jeep, Mazda
and Isuzu/Hino.
On March 25, 2002, Sonic acquired 15 dealerships owned directly or
indirectly by Donald E. Massey (the "Massey Acquisition") for approximately
$114.5 million in cash and 1,470,588 shares of Class A common stock valued at
approximately $38.0 million, based on the average closing price as quoted by the
New York Stock Exchange for the three days before and after the date the
acquisition was announced. The acquired dealerships are located in California,
Colorado, Florida, North Carolina, Michigan, Tennessee and Texas, and sell the
following brands of new vehicles: Buick, Cadillac, Chevrolet, GMC, Oldsmobile,
Pontiac, Rolls Royce/Bentley and Saab.
In addition to the Kott and Massey Acquisitions, Sonic also acquired the
following dealerships during the three months ended March 31, 2002 for a
combined purchase price of approximately $4.6 million in cash:
o On January 21, 2002, Sonic acquired Park Place Audi located in Dallas,
Texas;
o On March 18, 2002, Sonic acquired Philpott Hyundai located in the
metropolitan area of Houston, Texas.
The total purchase price for all of the above acquisitions was based on
Sonic's internally determined valuation of the dealerships and their assets. The
cash portion of the purchase price was financed by cash generated from Sonic's
existing operations and by borrowings under Sonic's senior revolving credit
facility.
The results of operations of each of the acquisitions listed above have
been included in the accompanying unaudited consolidated financial statements
from their respective dates of acquisition. The following unaudited pro forma
financial information presents a summary of consolidated results of operations
as if the above acquisitions, as well as the acquisitions completed during 2001,
as discussed in our Annual Report on Form 10-K, had occurred at the beginning of
the year in which the acquisitions were
8
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
completed, and at the beginning of the immediately preceding year, after giving
effect to certain adjustments, including interest expense on acquisition debt
and income taxes. The pro forma results have been prepared for comparative
purposes only and are not necessarily indicative of the results of operations
that would have occurred had the acquisitions actually been completed at the
beginning of the periods presented. These results are also not necessarily
indicative of the results of future operations.
Three Months Ended March 31,
----------------------------
2001 2002
---------- -----------
Total revenues $2,445,312 $1,843,816
Gross profit $ 333,870 $ 283,584
Net income $ 19,056 $ 23,522
Diluted net income per share $ 0.46 $ 0.55
Sale of Dealership Subsidiaries
During the first quarter of 2002, Sonic disposed of four franchises,
resulting in the closing of three dealerships, and approved, but had not
completed the sale of, two additional franchises, which will result in the
closing of one dealership. These were generally smaller dealerships with
unprofitable operations. These dealerships disposed of and held for sale
generated combined revenues of $4.3 million in the first quarter of 2002 and
$12.4 million in the first quarter of 2001, and incurred pre-tax losses of $0.7
million in the first quarter of 2002 and $0.1 million in the first quarter of
2001. In accordance with the provisions of SFAS No. 144, the results of
operations of these dealerships, including gains or losses on disposition, which
were not material, have been included in the loss on operations of discontinued
dealerships in the accompanying unaudited consolidated statements of income.
Assets and liabilities of the two franchises being held for sale at March 31,
2002 totaled approximately $2.2 million and $1.6 million, respectively, as of
March 31, 2002 and have been classified as assets or liabilities held for sale
included in other current assets and other accrued liabilities, respectively, in
the accompanying unaudited consolidated balance sheet. Assets held for sale are
comprised of inventory and fixed assets, and liabilities held for sale are
comprised of floor plan notes payable. We believe the disposal of these assets
held for sale may take three months or longer to complete.
In addition to the dispositions discussed above, during the year ended
December 31, 2001, Sonic sold or otherwise disposed of assets from 15 other
dealership franchises, resulting in the closing of nine dealerships. These
dealerships generated combined revenues of $34.3 million and incurred pretax
losses of $1.8 million in the three months ended March 31, 2001. The results of
operations of these dealerships have been included in income from continuing
operations in the accompanying unaudited consolidated statements of income.
Subsequent to March 31, 2002, Sonic's board of directors approved the
disposition of nine additional dealership franchises and a collision repair
center. The assets and liabilities to be disposed of consist of inventory, fixed
assets and floor plan notes payable. These assets and liabilities totaled $35.4
million and $29.6 million, respectively, at March 31, 2002. We believe the
disposal of these assets may take three months or longer to complete.
3. INVENTORIES
Inventories consist of the following:
December 31, March 31,
2001 2002
------------ ---------
New vehicles $478,077 $651,668
Used vehicles 111,656 157,671
Parts and accessories 48,705 55,815
Other 25,820 31,636
-------- --------
Total $664,258 $896,790
======== ========
9
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
4. PROPERTY AND EQUIPMENT
Property and equipment is comprised of the following:
December 31, March 31,
2001 2002
------------ ---------
Land $ 10,863 $ 2,887
Building and improvements 34,387 36,289
Office equipment and fixtures 29,492 32,772
Parts and service equipment 21,917 23,747
Company vehicles 7,078 8,166
Construction in progress 16,003 22,753
-------- --------
Total, at cost 119,740 126,614
Less accumulated depreciation (20,768) (23,842)
-------- --------
Property and equipment, net $ 98,972 $102,772
======== ========
In addition to the amounts classified above as construction in progress,
Sonic incurred approximately $12.0 million in construction costs in the first
three months of 2002 and $18.0 million in 2001 on facilities that are expected
to be completed and sold within one year in sale-leaseback transactions.
Accordingly, these costs are included in other current assets on the
accompanying consolidated balance sheets. Under the terms of the sale-leaseback
transactions, Sonic sells the properties to a third party entity and enters into
long-term operating leases on the facilities. Sonic has no continuing
obligations under these arrangements other than lease payments.
5. DERIVATIVE FINANCIAL INSTRUMENTS
In order to reduce its exposure to market risks from fluctuations in
interest rates, Sonic entered into an interest rate swap agreement on January
15, 2002 to effectively convert a portion of its LIBOR-based variable rate debt
to a fixed rate. The swap has a notional principal amount of $100 million and
matures on October 31, 2004. Under the terms of the swap agreement, Sonic
receives interest payments on the notional amount at a rate equal to the one
month LIBOR rate, adjusted monthly, and makes interest payments at a fixed rate
of 3.88%. Incremental interest expense incurred (the difference between interest
earned and interest incurred) as a result of this interest rate swap was $0.4
million for the three months ended March 31, 2002 and has been included in
interest expense, other in the accompanying unaudited consolidated statements of
income.
The interest rate swap has been designated and qualifies as a cash flow
hedge and, as a result, changes in the fair value of the interest rate swap have
been recorded in other comprehensive income, net of related income taxes, in our
statement of stockholders' equity. The fair value of the interest rate swap as
of March 31, 2002, recorded in other assets on the accompanying unaudited
balance sheet, and the amount of the related hedging gain deferred and recorded
in other comprehensive income for the three months ended March 31, 2002 was
approximately $1.2 million ($0.8 million net of tax). Because the critical terms
of the interest rate swap and the underlying debt obligation were the same, no
ineffectiveness was recorded.
6. IMPACT OF CHANGE IN ACCOUNTING FOR INTANGIBLE ASSETS
The following table shows the pro forma effect on net income and net income
per share for the three months ended March 31, 2001, compared to net income and
net income per share for the three months ended March 31, 2002, as if the
provisions of SFAS No. 142 eliminating goodwill amortization had been applied as
of January 1, 2001:
10
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Three Months Ended
March 31,
2001 2002
------- -------
Net Income $13,483 $22,079
Goodwill amortization, net of tax 3,273 --
------- -------
Pro forma net income $16,756 $22,079
======= =======
Pro forma net income per share
Basic $ 0.41 $ 0.54
Diluted $ 0.40 $ 0.52
Goodwill amortization from dealerships included in discontinued operations
during the first three months ended March 31, 2001 was not material.
7. LONG-TERM DEBT
Senior Subordinated Notes
At March 31, 2002, Sonic had $200.0 million in aggregate principal
outstanding of its 11% Senior Subordinated Notes. The Senior Subordinated 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.
The Senior Subordinated Notes are subordinated to all present and future
senior indebtedness of Sonic, including the revolving credit facility discussed
below. Redemption prices during the 12-month periods beginning August 1 are
105.500% in 2003, 103.667% in 2004, 101.833% in 2005 and 100% thereafter. The
discount on the Senior Subordinated Notes is being amortized over the term of
the notes using the effective interest method.
The indentures governing the senior subordinated notes contain certain
specified restrictive and required financial covenants. Sonic has agreed not to
pledge its assets to any third party except under certain limited circumstances.
Sonic also has 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.
Sonic is in compliance with all restrictive covenants as of March 31, 2002.
Sonic's obligations under the notes are guaranteed by its operating
subsidiaries.
5 1/4% Convertible Senior Subordinated Notes
Subsequent to March 31, 2002, we issued $149.5 million of 5 1/4%
Convertible Senior Subordinated Notes at a discount of 3% with net proceeds,
before expenses, of approximately $145.0 million. The notes are unsecured
obligations that rank equal in right of payment to all existing and future
senior subordinated indebtedness, mature on May 7, 2009 and are redeemable at
Sonic's option after May 7, 2005. Sonic's obligations under these notes are not
guaranteed by any of its subsidiaries. The net proceeds were used to repay a
portion of the amounts outstanding under our senior revolving credit facility.
In fiscal quarters after June 30, 2002, the notes are convertible into
shares of Class A common stock, at the option of the holder, if as of the last
day of the preceding fiscal quarter, the closing sale price of our Class A
common stock for at least 20 trading days in a period of 30 consecutive trading
days ending on the last trading-day of such preceding fiscal quarter is more
than 110% of the conversion price per share of Class A common stock on the last
day of such preceding fiscal quarter. If this condition is satisfied, then the
notes will be convertible at any time, at the option of the holder, through
maturity. The initial conversion price per share will equal $46.87, subject to
adjustment for certain distributions on, or other changes in our Class A Common
Stock, if any, prior to the conversion date. In addition, on or before May 7,
2007, a holder also may convert notes into shares of our Class A common stock at
any time after a 10 consecutive trading-day period in which the average of the
trading day prices for the notes for that 10 trading-day period was less than
103% of the average conversion value for the notes during that period. The
conversion value is equal to the product of the closing sale price for our Class
A common stock on a given day multiplied by the then current conversion rate,
which is the number of shares of Class A common stock into which each $1,000
principle amount of notes is then convertible.
11
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
The Revolving Facility
Sonic has a revolving credit facility (the "Revolving Facility") with Ford
Motor Credit Company ("Ford Motor Credit"), Chrysler Financial Company LLC
(Chrysler Financial") and Toyota Motor Credit Corporation ("Toyota Credit") with
a borrowing limit of $600 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 (the borrowing base was
approximately $513.2 million at March 31, 2002). The amounts outstanding under
the Revolving Facility bear interest at 2.50% above LIBOR (LIBOR was 1.88% at
March 31, 2002) and will mature on October 31, 2004 (but may be extended for a
number of additional one year terms to be negotiated with Ford Motor Credit,
Chrysler Financial and Toyota Credit). The Revolving Facility includes an annual
commitment fee equal to 0.25% of the unused portion of the facility. The total
outstanding balance was approximately $405.5 million as of March 31, 2002.
Balances under the Revolving Facility are guaranteed by Sonic's operating
subsidiaries.
We agreed under the Revolving Facility not to pledge any of our assets to
any third party (with the exception of currently encumbered assets of our
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 and default provisions. Financial covenants include specified ratios
of:
Covenant Required Actual
-------- -------- ------
Current ratio Greater than 1.23 1.25
Fixed charge coverage Greater than 1.41 1.66
Interest coverage Greater than 2.00 3.62
Adjusted debt to EBITDA Less than 2.25 1.87
In addition, the loss of voting control over Sonic by O. Bruton Smith,
Chairman and Chief Executive Office, Scott Smith, President and Chief Operating
Officer, and their spouses or immediate family members or our failure, with
certain exceptions, to own all the outstanding equity, membership or partnership
interests in our dealership subsidiaries will constitute an event of default
under the Revolving Facility. We are in compliance with all restrictive
covenants as of March 31, 2002.
The Mortgage Facility
We currently have a revolving real estate acquisition and construction line
of credit (the "Construction Loan") and a related mortgage refinancing facility
(the "Permanent Loan" and collectively with the Construction Loan, the "Mortgage
Facility") with Ford Motor Credit. Under the Construction Loan, our dealership
development subsidiaries can borrow up to $50.0 million to finance land
acquisition and dealership construction costs. Advances can be made under the
Construction Loan until December 2003. All advances will mature on September 22,
2005, bear interest at 2.25% above LIBOR and are secured by Sonic's guarantee
and a lien on all of the borrowing subsidiaries' real estate and other assets.
Borrowings, net of repayments, under the Construction Loan in the first three
months of 2002 were approximately $1.0 million and were primarily used in
construction of dealership facilities. The total outstanding balance under the
Construction Loan as of March 31, 2002 was approximately $7.5 million.
Under the Permanent Loan, we can refinance up to $50.0 million in advances
under the Construction Loan once the projects are completed and can finance real
estate acquisition costs to the extent these costs were not previously financed
under the Construction Loan. Advances can be made under the Permanent Loan until
June 2005. All advances under the Permanent Loan mature on June 22, 2010, bear
interest at 2.00% above LIBOR and are secured by the same collateral given under
the Construction Loan. The total outstanding balance as of March 31, 2002 was
approximately $4.0 million.
The Mortgage Facility allows us to borrow up to $100 million in the
aggregate under the Construction Loan and the Permanent Loan. The Mortgage
Facility is not cross-collateralized with the Revolving Facility; however, a
default under one will cause a default under the other. Among other customary
covenants, the borrowing subsidiaries under the Mortgage Facility agreed not to
incur any other liens on their property (except for existing encumbrances on
property acquired) and not to transfer their property or more than 20% of their
ownership interests to any third party. In addition, the loss of voting control
by O. Bruton Smith, Scott Smith and their spouses or immediate family members,
with certain exceptions, will result in an event of default under the Mortgage
Facility. We are in compliance with all restrictive covenants as of March 31,
2002.
12
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Subsidiary Guarantees
Balances outstanding under Sonic's Revolving Facility and its 11% Senior
Subordinated Notes due 2008 are guaranteed by all of Sonic's operating
subsidiaries. These guarantees are full and unconditional and joint and several.
The parent company has no independent assets or operations and subsidiaries that
are not guarantors are minor. Sonic's obligations under its 5 1/4% Convertible
Senior Subordinated Notes Due 2009 are not guaranteed by any of Sonic's
subsidiaries.
8. RELATED PARTIES
Registration Rights Agreement
Prior to its initial public offering, Sonic signed a Registration Rights
Agreement dated as of June 30, 1997 with Sonic Financial Corporation ("SFC"), O.
Bruton Smith, Scott Smith and William S. Egan (collectively, the "Class B
Registration Rights Holders"). SFC currently owns 8,881,250 shares of Class B
common stock; O. Bruton Smith, 2,171,250 shares; Scott Smith, 956,250 shares;
and Egan Group, LLC, an assignee of Mr. Egan (the "Egan Group"), 20,625 shares,
all of which are covered by the Registration Rights Agreement. The Egan Group
also owns 32,000 shares of Class A common stock to which the Registration Rights
Agreement applies. If, among other things provided in Sonic's charter, offers
and sales of shares of Class B common stock are registered with the Securities
and Exchange Commission, then such shares will automatically convert into a like
number of shares of Class A common stock.
The Class B Registration Rights Holders have certain limited piggyback
registration rights under the Registration Rights Agreement. These rights permit
them to have their shares of Sonic's common stock included in any Sonic
registration statement registering Class A common stock, except for
registrations on Form S-4, relating to exchange offers and certain other
transactions, and Form S-8, relating to employee stock compensation plans. The
Registration Rights Agreement expires in November 2007. SFC is controlled by O.
Bruton Smith.
Payable to Company's Chairman
Sonic has a note payable to O. Bruton Smith in the amount of $5.5 million
(the "Subordinated Smith Loan"). The Subordinated Smith Loan bears interest at
Bank of America's announced prime rate plus 0.5% (prime rate was 4.75% at March
31, 2002) and has a stated maturity date of November 30, 2000. Under the terms
of certain subordination agreements currently in effect, however, all amounts
owed by Sonic to Mr. Smith under the Subordinated Smith Loan are to be paid only
after all amounts owed by Sonic under its 11% Senior Subordinated Notes due 2008
and its 5 1/4% Convertible Senior Subordinated Notes due 2009 are fully paid in
cash. Accordingly, the Subordinated Smith Loan has been classified as
non-current on the accompanying consolidated balance sheets.
9. CAPITAL STRUCTURE AND PER SHARE DATA
Preferred Stock -- Sonic has 3 million shares of "blank check" preferred
stock authorized with such designations, rights and preferences as may be
determined from time to time by the Board of Directors. The Board of Directors
has designated 300,000 shares of preferred stock as Class A convertible
preferred stock, par value $0.10 per share (the "Preferred Stock") which is
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.
There were no shares of Preferred Stock issued or outstanding at March 31, 2002.
Common Stock - Sonic has two classes of common stock. Sonic has authorized
100 million shares of Class A common stock at a par value of 0.01 per share.
Class A common stock entitles its holder to one vote per share. Sonic had
34,850,738 and 36,719,905 shares of Class A common stock issued at December 31,
2001 and March 31, 2002, respectively. Of these issued shares, there were
28,520,474 and 30,304,641 shares outstanding at December 31, 2001 and March 31,
2002, respectively. Sonic has also authorized 30 million shares of Class B
common stock at a par value of $.01 per share. Class B common stock entitles its
holder to ten votes per share, except in certain circumstances. Each share of
Class B common stock is convertible into one share of Class A common stock
either upon voluntary conversion at the option of the holder, or automatically
upon the occurrence of certain events, as provided in Sonic's charter. At
December 31, 2001 and March 31, 2002 there were 12,029,375 shares of Class B
common stock issued and outstanding.
Treasury Stock - Sonic's Board of Directors has authorized Sonic to expend
up to $100 million to repurchase shares of its Class A common stock or redeem
securities convertible into Class A common stock. As of March 31, 2002, Sonic
has repurchased 6,415,264 shares of Class A common stock for $61.4 million and
has also redeemed 13,801.5 shares of Class A convertible preferred stock at a
13
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
total cost of approximately $13.8 million. We have limited our stock repurchase
activity recently and anticipate that we will continue to limit such activity to
utilizing option exercise proceeds to repurchase shares on an opportunistic
basis.
Per Share Data -- The calculation of diluted net income per share considers
the potential dilutive effect of options and shares under Sonic's stock
compensation plans, Class A common stock purchase warrants, and Class A
convertible preferred stock. The following table illustrates the dilutive effect
of such items on net income per share:
For the Three Months Ended March 31, 2002
-------------------------------------------------------------------------------
Net Income Net Loss
From Continuing From Discontinued
Operations Operations Net Income
-------------------- ------------------ --------------------
Per Share Per Share Per Share
Shares Amount Amount Amount Amount Amount Amount
------ ------- --------- ------ --------- ------- ---------
Basic Net Income Per Share 40,627 $22,529 $ 0.55 $(450) $ (0.01) $22,079 $ 0.54
Effect of Dilutive Securities:
Stock Compensation Plans 1,934
Warrants 2
------
Diluted Net Income Per Share 42,563 $22,529 $ 0.53 $(450) $ (0.01) $22,079 $ 0.52
====== ======= ======= ===== ======= ======= =======
For the Three Months Ended March 31, 2001
-------------------------------------------------------------------------------
Net Income Net Loss
From Continuing From Discontinued
Operations Operations Net Income
-------------------- ------------------ --------------------
Per Share Per Share Per Share
Shares Amount Amount Amount Amount Amount Amount
------ ------- --------- ------ --------- ------- ---------
Basic Net Income Per Share 41,271 $13,544 $ 0.33 $ (61) $ (0.00) $13,483 $ 0.33
Effect of Dilutive Securities:
Stock Compensation Plans 161
Warrants 18
Convertible Preferred Stock 23
------
Diluted Net Income Per Share 41,473 $13,544 $ 0.33 $ (61) $ (0.00) $13,483 $ 0.33
====== ======= ======= ===== ======= ======= =======
14
SONIC AUTOMOTIVE INC AND SUBSIDIARIES
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion and analysis of the results of operations and
financial condition should be read in conjunction with the Sonic Automotive,
Inc. and Subsidiaries Unaudited Consolidated Financial Statements and the
related notes thereto appearing elsewhere in this report.
Overview
We are one of largest automotive retailers in the United States, as
measured by total revenue, operating 185 dealership franchises at 135 locations
and 44 collision repair centers throughout the United States as of May 3, 2002.
We own and operate franchises for 34 different brands of cars and light trucks,
providing comprehensive services including sales of both new and used cars and
light trucks, replacement parts and vehicle maintenance, warranty, paint and
repair services. We also arrange extended warranty contracts and financing and
insurance for our automotive customers.
The following table depicts the breakdown of our new vehicle revenues by
brand for the first quarter of 2002 compared to the first quarter of 2001:
Percentage of New
Vehicle Revenues for the
Three Months Ended
March 31,
2001 2002
------ ------
Brand(1)
Ford ......................... 14.4% 15.7%
General Motors(2) ............ 11.0% 14.7%
Honda ........................ 14.4% 14.3%
Toyota ....................... 11.0% 12.0%
BMW .......................... 11.5% 11.3%
Chrysler(3) .................. 10.0% 7.3%
Lexus ........................ 6.1% 5.4%
Nissan ....................... 6.2% 4.9%
Other(4) ..................... 15.4% 14.4%
----- -----
Total ........................ 100.0% 100.0%
===== =====
(1) Amounts reflect certain reclassifications in order to make
Sonic's presentation more consistent with peer group and revised
accounting standards regarding manufacturer incentives.
(2) Includes Buick, Cadillac, Chevrolet, GMC, Oldsmobile, and
Pontiac
(3) Includes Chrysler, Dodge, Jeep, and Plymouth
(4) Includes Acura, Audi, Hyundai, Infiniti, Isuzu, KIA, Land Rover,
Lincoln, Mercedes, Mercury, Mitsubishi, Porsche, Subaru,
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 financing and
insurance and sales of third party extended warranties for vehicles. In
connection with vehicle financing, warranty and insurance contracts, we receive
a commission from the provider for originating the contract. If, within 90 days
of origination, the customer cancels or defaults on the contract, the provider
will assess a charge (a "chargeback") for a portion of the original commission.
The amount of the chargeback depends on how long the related contract was
outstanding. As a result, we have established reserves based on our historical
chargeback experience.
Sales of new and used vehicles are cyclical and historically have
experienced periodic downturns, characterized by oversupply and weak demand.
Many factors affect vehicle sales including general economic conditions and
consumer confidence, the level of discretionary personal income, interest rates,
manufacturer incentives and available credit. In the first quarter of 2002,
industry-wide selling rates of new vehicles were modestly below 2001 levels.
However, our dealerships in Northern California and Dallas continue to
experience significant declines in revenue run rates due to the depressed
economic conditions in those markets
15
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
compared to the rest of the country. 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. These products and services include our parts,
service and collision repair businesses, none of which are dependent upon
near-term new vehicle sales volume.
Our cost of sales and profitability are also affected by the allocations of
new vehicles that 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. These sales are frequently at or below
cost and, therefore, reduce our overall gross margin on vehicle sales.
Salary expense, benefits costs, facility rent and advertising expenses
comprise the majority of our selling, general and administrative expenses.
Approximately 62.1% of our selling, general and administrative expenses for the
quarter ended March 31, 2002 were variable. We are able to adjust these expenses
as the operating or economic environment impacting our dealerships changes. We
manage these variable expenses, such as advertising (7.4% of selling, general
and administrative expenses) and non-salaried sales compensation (50.3%)
expenses, so that they are generally related to vehicle sales and can be
adjusted in response to changes in vehicle sales volume. Salespersons, sales
managers, service managers, parts managers, service advisors, service
technicians and all other non-clerical dealership personnel are paid either a
commission or a modest salary plus commissions. Many of our compensation plans
our based on net profit at the dealership or regional level, after floor plan
interest, and therefore may not properly reflect compensation as a percentage of
reported gross profits during periods of significant flooring interest
fluctuations.
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. Our floor plan expenses are substantially offset by amounts
received from manufacturers, in the form of floor plan assistance. These
payments are credited against our cost of sales. During the three months ended
March 31, 2002, the amounts we received from floor plan assistance exceeded our
floor plan interest expense by approximately $2.4 million. As a result, the
effective rate incurred under our floor plan financing arrangements was reduced
to 0% after considering these incentives.
We sell similar products and services (new and used vehicles, parts,
service and collision repair services), use similar processes in selling our
products and services, and sell our products and services to similar classes of
customers. As a result of this and the way we manage our business, we have
aggregated our results into a single segment for purposes of reporting financial
condition and results of operations.
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. Our unaudited consolidated financial statements discussed below
reflect the results of operations, financial position and cash flows of each of
our dealerships acquired prior to March 31, 2002. As a result of the effects of
our acquisitions and of other potential factors in the future, 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 which
would have resulted had such acquisitions occurred at the beginning of the
periods presented, nor is it indicative of future results of operations,
financial position and cash flows.
Use of Estimates and Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. Certain of our accounting policies employing the use of significant
estimates are as follows:
Accounts receivable - Our accounts receivable consist primarily of amounts
due from the manufacturers for repair services performed on vehicles with a
remaining factory warranty and amounts due from third parties from the sale of
parts. We believe that there is minimal risk of uncollectability on warranty
receivables. We evaluate parts and other receivables for collectability based on
the age of the receivable, the credit history of the customer and past
collection experience. The allowance for doubtful accounts we have recorded for
accounts receivable is not significant. As of March 31, 2002, we also had
outstanding notes receivable from finance contracts of $15.5 million (net of an
allowance for credit losses of $2.1 million). These notes have average terms of
approximately 30
16
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
months and are secured by the related vehicles. The assessment of our allowance
for credit losses considers historical loss ratios and the performance of the
current portfolio with respect to past due accounts.
Inventories - Inventories of new and used vehicles, including
demonstrators, are stated at the lower of specific cost or market. Inventories
of parts and accessories are accounted for using the "first-in, first-out"
("FIFO") method of inventory accounting and are stated at the lower of FIFO cost
or market. Other inventories, which primarily include rental and service
vehicles, are stated at the lower of specific cost or market.
We assess the valuation of all of our vehicle and parts inventories and
maintain a reserve where the cost basis exceeds the fair market value. In making
this assessment for new vehicles, we primarily consider the age of the vehicles
along with the timing of annual and model changeovers. For used vehicles we
consider recent market data and trends such as loss histories along with the
current age of the inventory. Parts inventories are assessed considering
primarily excess quantity and continued usefulness of the part. The risk with
parts inventories is minimized by the fact that, generally, excess or obsolete
parts can be returned to the manufacturer. We have not recorded any significant
reserves on any of our inventory balances.
Income taxes - We provided for deferred taxes at currently enacted tax
rates for the tax effects of carry forward items and temporary differences
between the tax basis of assets and liabilities and their reported amounts in
the financial statements. A valuation allowance is established when management
determines it is more likely than not that taxable income will not be sufficient
to fully realize the benefits of deferred tax assets. We currently have not
established any valuation allowance on our deferred tax assets.
Goodwill -- Goodwill represents the excess purchase price over the
estimated fair value of the tangible and separately measurable intangible net
assets acquired. As of March 31, 2002, the carrying amount of goodwill was
$885.3 million and represented 39.8% of total assets and 152.7% of total
stockholders' equity. As of December 31, 2001, the carrying amount of goodwill
was $738.1 million and represented 40.9% of total assets and 142.7% of total
stockholders' equity.
Pursuant to the provisions of SFAS No. 142, goodwill acquired in business
combinations is no longer amortized, but the carrying amount will be reviewed
and reduced against operations if it is found to be impaired. The provisions of
FAS 142 became effective January 1, 2002 and resulted in the elimination of
approximately $22.1 million of annual goodwill amortization. We are still in the
process of performing our initial impairment test of goodwill, and have not yet
determined the impact of any potential impairment on our consolidated financial
statements.
The results of operations for the three months ended March 31, 2001 include
goodwill amortization expense of $3.3 million, net of tax. Diluted net income
per share for the first quarter of 2001 would have been $0.40 after the
elimination of the tax-effected goodwill amortization.
Accruals - Various accruals, such as reserves for contingencies and
reserves for incurred but not reported claims under various insurance programs,
require management to make estimates in determining the ultimate liability we
may incur. The ultimate cost of these insurance reserves are estimated by
management and by actuarial evaluations based on historical claims experience,
adjusted for current trends and changes in claims processing procedures.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 141: Business Combinations.
SFAS No. 141 prohibits the pooling-of-interests method of accounting and
requires the use of the purchase method of accounting for all business
combinations initiated after June 30, 2001. Additionally, acquired intangible
assets should be separately recognized if the benefit of the intangible asset is
obtained through contractual or other legal rights, or if the intangible asset
can be sold, transferred, licensed, rented or exchanged, regardless of the
acquirer's intent to do so.
We also adopted SFAS No. 142: Goodwill and Other Intangible Assets. Among
other things, SFAS No. 142 no longer permits the amortization of goodwill, but
requires that the carrying amount of goodwill be reviewed and reduced against
operations if it is found to be impaired. This review must be performed on at
least an annual basis (with an initial review within six months of adopting the
new standard), but must also be performed upon the occurrence of an event or
circumstance that indicates a possible reduction in value. SFAS No. 142 does
require the amortization of intangible assets other than goodwill over their
useful economic lives, unless the useful economic life is determined to be
indefinite. Intangible assets determined to have a finite life are required to
be reviewed for impairment in accordance with SFAS No. 144: Accounting for
Impairment or Disposal of Long-Lived Assets. Intangible assets that are
determined to have an indefinite economic life are not amortized and must be
reviewed for impairment in accordance with the terms of SFAS No. 142. The
adoption of SFAS No. 142 on January 1, 2002 resulted in the elimination of
approximately
17
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
$22.1 million of annual goodwill amortization. We are still in the process of
performing our initial impairment test of goodwill, and have not yet determined
the impact of any potential impairment on our consolidated financial statements.
We adopted the provisions of SFAS No. 144: Accounting for the Impairment or
Disposal of Long-Lived Assets as of January 1, 2002. SFAS No. 144 establishes a
single accounting model for assets to be disposed of by sale whether previously
held and used or newly acquired. SFAS No. 144 requires certain long-lived assets
to be reported at the lower of carrying amount or fair value, less cost to sell,
and provides guidance in asset valuation and measuring impairment. The adoption
of this resulted in a net loss of $0.1 million and $0.5 million being classified
as discontinued operations on the unaudited consolidated statements of income
for the three months ended March 31, 2001 and 2002, respectively.
Results of Operations
During the first quarter of 2002, we sold or otherwise disposed of assets
from four of our dealership franchises, resulting in the closing of three
dealerships, and had approved, but not completed the sale of two additional
franchises, which will result in the closing of one dealership. These
dealerships disposed of and held for sale generated combined revenues of $4.3
million in the first quarter of 2002 and $12.4 million in the first quarter of
2001, and incurred pretax losses of $0.7 million in the first quarter of 2002
and $0.1 million in the first quarter of 2001. In accordance with the provisions
of SFAS No. 144, the results of operations of these dealerships, including gains
or losses on disposition, which were not material, have been included in the
loss on operations of discontinued dealerships in the accompanying unaudited
consolidated statements of income. Assets and liabilities of the two franchises
being held for sale at March 31, 2002 totaled approximately $2.2 million and
$1.6 million, respectively, as of March 31, 2002 and have been classified as
assets or liabilities held for sale included in other current assets and other
accrued liabilities, respectively, in the accompanying unaudited consolidated
balance sheet. Assets held for sale are comprised of inventory and fixed assets,
and liabilities held for sale are comprised of floor plan notes payable. We
believe the disposal of these assets held for sale may take three months or
longer to complete.
In addition to the dispositions discussed above, during the year ended
December 31, 2001, we sold or otherwise disposed of assets from 15 other
dealership franchises, resulting in the closing of nine dealerships. These
dealerships generated combined revenues of $34.3 million and incurred pretax
losses of $1.8 million in the three months ended March 31, 2001. The results of
operations of these dealerships have been included in income from continuing
operations in the accompanying unaudited consolidated statements of income.
In order to make the comparison of our results of ongoing operations for
the three months ended March 31, 2002 to the three months ended March 31, 2001
more meaningful, we have disregarded the effect on operations of all dealerships
disposed of or designated for sale during the year ended December 31, 2001 and
the three months ended March 31, 2002. The table below provides information
regarding the operations of these dealerships which we disposed of during 2001
and those dealerships still being operated as of March 31, 2002.
18
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
For the Three Months Ended March 31, 2001 For the Three Months Ended March 31, 2001
----------------------------------------- -----------------------------------------
As Disposed in Ongoing As Disposed in Ongoing
Reported(1) 2001(2) Dealerships Reported(1) 2001(2) Dealerships
----------- ----------- ----------- ----------- ----------- -----------
(dollars in thousands)
Revenues:
New vehicles $ 863,774 $16,392 $ 847,382 $ 952,971 $ -- $ 952,971
Used vehicles 291,833 7,290 284,543 283,872 -- 283,872
Wholesale vehicles 115,427 4,368 111,059 109,867 -- 109,867
---------- ------- ---------- ---------- -------- ----------
Total vehicles 1,271,034 28,050 1,242,984 1,346,710 -- 1,346,710
Parts, service and collision repair 187,607 5,510 182,097 211,286 -- 211,286
Finance & insurance and other 40,832 776 40,056 47,557 -- 47,557
---------- ------- ---------- ---------- -------- ----------
Total revenues 1,499,473 34,336 1,465,137 1,605,553 -- 1,605,553
Cost of sales 1,273,003 29,570 1,243,433 1,353,191 -- 1,353,191
---------- ------- ---------- ---------- -------- ----------
Gross profit 226,470 4,766 221,704 252,362 -- 252,362
Selling, general and administrative expenses 176,077 6,058 170,019 200,103 -- 200,103
Depreciation 1,699 92 1,607 2,090 -- 2,090
Goodwill amortization 4,438 71 4,367 -- -- --
---------- ------- ---------- ---------- -------- ----------
Operating income 44,256 (1,455) 45,711 50,169 -- 50,169
Other income and expense:
Interest expense, floor plan 12,012 392 11,710 5,549 -- 5,549
Interest expense, other 10,005 3 10,002 8,390 -- 8,390
Other income 59 8 51 109 -- 109
---------- ------- ---------- ---------- -------- ----------
Total other expense 22,048 387 21,661 13,830 -- 13,830
---------- ------- ---------- ---------- -------- ----------
Income from continuing operations before taxes $ 22,208 (1,842) $ 24,050 $ 36,339 $ -- $ 36,339
========== ======= ========== =========== ======== ==========
(1) As reported on the accompanying unaudited consolidated statement of income
(2) Results of operations of those dealerships disposed during the year ended December 31, 2001
Revenues
In the first quarter of 2002, total revenues increased $106.1 million, or
7.1%, over the same period last year. Dealerships disposed of during the year
ended December 31, 2001, which have been included in income from continuing
operations on the accompanying unaudited consolidated statements of income,
generated $34.3 million in total revenue during the first quarter of 2001. Total
revenues from ongoing dealerships increased $140.4 million, or 9.6% over the
same period last year, reflecting increases in new vehicle revenues; parts,
service, and collision repair revenues; and finance and insurance revenues,
offset slightly by decreases in used and wholesale vehicle revenues. The overall
increase from ongoing dealerships was due to acquisitions, which contributed
$184.7 million of revenues during the first quarter 2002. This increase was
offset by lower revenues from dealerships owned longer than one year ("same
store") of approximately $44.3 million, or 3.1%, during the first quarter of
2002. The majority of this decline was due to our Northern California region and
Dallas market, which accounted for $44.3 and $13.4 million, respectively, of the
same store revenue decrease. These two markets have experienced depressed
economic conditions compared to the rest of the country. These declines were
partially offset by an increase in revenues in our Southern California market of
$18.0 million.
New Vehicles: Revenues from the sale of new vehicles increased $89.2
million, or 10.3%, over the same period last year. Dealerships disposed of
during the year ended December 31, 2001, which have been included in income from
continuing operations on the accompanying unaudited consolidated statements of
income, generated $16.4 million in new vehicle revenues during the first quarter
of 2001. Revenues from ongoing dealerships increased approximately $105.6
million, or 12.5%, in the first quarter of 2002 compared to the same period last
year, reflecting an increase in units sold of approximately 8.9%, or 2,881
units, and a slight increase in the average new vehicle selling price of
approximately $853, or 3.3%. The impact of dealerships acquired during 2001 and
in the first quarter of 2002 resulted in an additional 4,316 units sold during
the first quarter 2002, but was partially offset by a decline in same store unit
sales of 1,435 units, or 4.6%. Same store unit sales were negatively affected by
weaker economic conditions in our Northern California region where same store
unit sales declined by 1,348 units or 18.2%, representing 93.9% of the total
decline in same store sales. We also saw relatively significant declines in same
store unit sales in our Dallas and Charlotte markets of 13.6% and 9.3%,
respectively, which were offset by significant increases in unit sales in our
Houston market and Southern California region of 12.9% and 10.7%, respectively.
Used Vehicles: Revenues from retail sales of used vehicles decreased $8.0
million, or 2.7%, from the same period last year. Dealerships disposed of during
the year ended December 31, 2001, which have been included in income from
continuing operations on the accompanying unaudited consolidated statements of
income, generated $7.3 million in retail used vehicle revenues during the first
quarter of 2001. Revenues from ongoing dealerships remained relatively flat
during the first quarter of 2002 compared to the same period last year with unit
sales decreasing only approximately 0.4% and average used unit prices increasing
only 0.2%. Dealerships acquired contributed 2,005 units during the first quarter
of 2002, which was offset by same store declines of 2,085 units. The most
significant factor negatively impacting same store unit sales has been the
withdrawal of certain key lenders, particularly in the sub prime category, as
well as tightened credit standards from remaining lenders which have affected
consumers' ability to finance used vehicle purchases and have thus reduced
retail activity.
19
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
Wholesale Vehicles: Revenues from wholesale vehicles decreased $5.6
million, or 4.8%, from the same period last year. Dealerships disposed of during
the year ended December 31, 2001, which have been included in income from
continuing operations on the accompanying unaudited consolidated statements of
income, generated $4.4 million in wholesale used vehicle revenues during the
first quarter of 2001. Revenues from ongoing dealerships decreased 1.1% during
the first quarter 2002 compared to the same period last year. The majority of
the decline was due to a reduction in same store revenue of $8.0 million,
partially offset by an increase from acquisitions of $6.8 million. The majority
of the decline in same store sales resulted from a lower selling price of $333
per unit and a decrease in units of 491 during the first quarter 2002. The
decrease in average price per unit was caused by the declines in values of used
units at the wholesale level.
Fixed Operations: Revenues from parts, service and collision repair
increased $23.7 million, or 12.6%, over the same period last year. Dealerships
disposed of during the year ended December 31, 2001, which have been included in
income from continuing operations on the accompanying unaudited consolidated
statements of income, generated $5.5 million in parts, service and collision
repair revenues during the first quarter of 2001. Revenues from ongoing
dealerships increased approximately 16.0% in the first quarter of 2002 compared
to the same period last year, of which approximately 80.8% resulted from
acquisitions with the remaining 19.2% coming from same store sales. Same store
revenues increased $5.6 million, or 3.2%, resulting in part from investments in
real estate and construction projects on collision facilities, which allowed us
to increase our overall service and parts capacity; partially offset by declines
in wholesale parts revenues at one dealership of 24.3% as well as decreases in
revenues due to one less service day in the first quarter 2002 as compared to
the first quarter 2001.
Finance and Insurance: Finance and insurance revenue increased $6.7
million, or 16.5%, over the same period last year. Dealerships disposed of
during the year ended December 31, 2001, which have been included in income from
continuing operations on the accompanying unaudited consolidated statements of
income, generated $0.8 million in finance and insurance revenues during the
first quarter of 2001. Revenues from ongoing dealerships increased approximately
18.7% in the first quarter of 2002 as compared to the same period last year
resulting primarily from increases in revenues from the retail sale of new
vehicles in 2002. The total increase from ongoing dealerships in the first
quarter 2002 of $7.5 million was due to acquisitions of $7.6 million, partially
offset by decreases from same store sales of $0.1 million. Finance and insurance
revenue per unit increased $98 per unit in the first quarter 2002. In addition,
despite a decrease in retail vehicle same store sales of approximately 3.8% in
the first quarter 2002 compared to the first quarter 2001, finance and insurance
revenues from those dealerships declined only 0.2%, reflecting an increase in
finance and insurance revenues per unit of 7.4%. The increase in per unit
revenue reflects our continued focus on training programs for finance and
insurance sales people along with our ability to negotiate higher commissions on
the origination of customer vehicle financing, insurance polices and extended
warranty contracts.
Gross profit and gross margins
Gross profit increased $25.9 million, or 11.4%, over the same period last
year. Dealerships disposed of during the year ended December 31, 2001, which
have been included in income from continuing operations on the accompanying
unaudited consolidated statements of income, generated $4.8 million in gross
profits during the first quarter of 2001. Gross profit from ongoing dealerships
increased $30.7 million, or 13.8%, in the first quarter 2002 compared to the
same period last year, primarily as a result of acquisitions of $28.7 million.
Ongoing dealership gross profit as a percentage of related revenues ("gross
margins") increased to 15.7% from 15.1% due primarily to an increase in the
percentage of revenues contributed by parts, service, collision repair services
and finance and insurance products, which earn higher margins than vehicles
sales. Parts, service and collision repair revenues from ongoing dealerships as
a percentage of total ongoing dealership revenues increased to 13.2% in the
first quarter of 2002 from 12.4% in the first quarter of 2001. Ongoing
dealership finance and insurance revenues as a percentage of total ongoing
dealership revenues increased to 3.0% in the first quarter of 2002 from 2.7% in
the first quarter of 2001. In addition, the gross profit percentage earned on
our parts, service, and collision repair and finance and insurance products from
ongoing dealerships increased to 56.6% in the first quarter of 2002 from 55.2%
in the first quarter of 2002.
Selling, general and administrative expenses
Selling, general and administrative expenses increased $24.0 million, or
13.6% over the same period last year. Dealerships disposed of during the year
ended December 31, 2001, which have been included in income from continuing
operations on the accompanying unaudited consolidated statements of income,
incurred $6.1 million in selling, general and administrative expenses during the
first quarter of 2001. Selling, general and administrative expenses from ongoing
dealerships increased 17.7% in the first quarter of 2002 compared to the same
period last year, with approximately 79.9% of the increase coming primarily from
acquisitions. Total selling, general, and administrative expenses from ongoing
dealerships as a percentage of gross profit increased to 79.3% in the first
quarter of 2002 from 76.7% in the first quarter 2001. Of our selling, general
and administrative expenses from ongoing dealerships, approximately 62.1% were
variable, comprised primarily of non-salaried sales compensation and
advertising, and approximately 37.9% were fixed, comprised primarily of fixed
compensation and rent expense. Variable selling, general and administrative
expenses are generally tied to vehicle sales and can be adjusted in response to
changes in sales volume or gross profits. As a percentage of gross profits from
ongoing dealerships, related variable expenses increased to 49.3% in the first
quarter 2002 from 48.7% in the first quarter 2001. This is primarily due to
increases in compensation expense as a percentage of gross profits to 39.9% in
the first quarter 2002, from 38.9% in the first quarter 2001. Our compensation
plans are based on net profit at the dealership or regional level, after floor
plan interest. Therefore, due to the decrease in floor plan interest expense in
the first quarter of 2002, if we classify floor plan interest expense as a
component of cost of sales, selling, general and administrative expenses from
ongoing operations as a percentage of related gross profit
20
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
would have actually declined 2.0%. Variable expenses from ongoing dealerships
also increased due to an increase in advertising expense as a percentage of
gross profits of 5.9% in the first quarter 2002 from 5.6% in the first quarter
2001, resulting from our same store sales initiative whereby the corporate home
office provides supplemental marketing funds to certain under performing
dealerships to create incremental sales motivation. Fixed expenses from ongoing
dealerships increased as a percentage of gross profits to 30.0% in the first
quarter 2002 from 28.0% in the first quarter 2001, primarily as a result of
significant investments in human resources and infrastructure in advance of
completing the Massey acquisition, as well as other acquisitions in order to
support our acquisition growth and integration plans. These expenses as a
percentage of gross profits are expected to stabilize in future quarters as
increased gross profits are realized as a result of these investments. In
addition, increases in healthcare costs and worker's compensation insurance also
negatively impacted the first quarter 2002 as compared to the same period last
year.
Depreciation and amortization
Depreciation expense, excluding goodwill amortization, increased $0.4
million, or 23.0% over the same period last year. Depreciation expense,
excluding goodwill amortization, from ongoing dealerships increased
approximately 30.0% in the first quarter 2002 compared to the same period last
year. During the last 12 months ending March 31, 2002, the balance of gross
property and equipment, excluding land and construction in process, increased
approximately $24.3 million, or 31.6%, of which approximately $20.2 million
resulted from dealership acquisitions and approximately $10.3 million from
additional capital expenditures; partially offset by $6.2 of disposals and other
adjustments. As a percentage of total revenues, depreciation expense was 0.1% in
both the first quarter of 2002 and 2001.
In accordance with SFAS No. 142, there is no amortization expense on
goodwill in 2002. Goodwill amortization expense as a percentage of total
revenues was 0.3% in the first quarter 2001.
Floor plan interest expense
Floor plan interest expense decreased $6.6 million, or 54.2% from the same
period last year. Dealerships disposed of during the year ended December 31,
2001, which have been included in income from continuing operations on the
accompanying unaudited consolidated statements of income, incurred $0.3 million
in floor plan interest expense during the first quarter of 2001. Floor plan
interest expense from ongoing dealerships decreased by $6.2 million, or 52.6% in
the first quarter 2002 compared to the same period last year. As a percentage of
total revenues, floor plan interest expense from ongoing dealerships decreased
to 0.3% in the first quarter 2002 from 0.8% in the first quarter 2001. The
change reflects a same store decrease of $6.9 million offset by an increase due
to acquisitions of $0.8 million. Of the same store decrease, $5.9 million was
due to a decrease in the average floor plan interest rate to 3.6% in the first
quarter 2002 from 7.6% in the first quarter 2001. The remainder of the same
store decrease was due to a decrease in the average floor plan liability to
$494.8 million in the first quarter 2002 from $607.8 million in the first
quarter 2001. Contributing to a lower floor plan liability was a decrease in our
average days supply of new vehicles in inventory to approximately 55.9 days at
March 31, 2002 from 63.5 days at March 31, 2001.
Other interest expense
Other interest expense decreased by $1.6 million, or 16.1% in the first
quarter 2002 compared to the same period last year. The decrease was caused by
lower interest expense on our Revolving Facility of approximately $4.5 million,
offset by a $2.2 million increase in interest incurred on an additional $75.0
million of 11% Senior Subordinated Notes issued November 2001. Of the decrease
in interest incurred under our revolving facility, approximately $3.6 million
was due to the decrease in the average interest rate incurred to 4.5% in the
first quarter 2002 from 8.5% in the first quarter 2001, and approximately $0.9
million was due to a decrease in the average outstanding balance to $282.8
million in the first quarter 2002 from $362.1 million in the first quarter 2001.
This decrease resulted from the refinancing of a portion of our Revolving
Facility using proceeds from the issuance of our additional $75.0 million in 11%
Senior Subordinated Notes due 2008. This decrease, however, was offset by the
effective conversion of $100.0 million of our variable rate debt to a fixed rate
through an interest rate swap agreement entered into on January 15, 2002 whereby
we receive interest payments based on a variable rate of LIBOR and make interest
payments at a fixed rate of 3.88%. This resulted in an additional $0.4 million
in interest expense in the first quarter of 2002.
Provision for income taxes
Income tax expense increased $5.1 million, or 59.3% over the same period
last year. Our effective income tax rate decreased to 38% in the first quarter
2002 from 39% in the first quarter 2001 as a result of the elimination of
goodwill amortization.
21
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
Liquidity and Capital Resources
We require cash to finance acquisitions and fund debt service and working
capital requirements. We rely on cash flows from operations, borrowings under
our various credit facilities and offerings of debt and equity securities to
meet these requirements.
Floor Plan Facilities:
We finance our new vehicle inventory through standardized floor plan credit
facilities with the following:
Outstanding Balance
2002 ------------------------------------
Lender Availability March 31, 2002 December 31, 2001
- ---------------------------------------------- ------------ -------------- -----------------
Chrysler Financial Company, LLC $750 million $147.8 million $142.6 million
General Motors Acceptance Corporation ("GMAC") $290 million $198.0 million $ 51.7 million
Ford Motor Credit Company $650 million $428.9 million $377.2 million
Toyota Motor Credit Corporation $100 million $ 21.4 million $ 16.4 million
Amounts outstanding under the Chrysler Financial and Toyota Credit floor
plan facilities bear interest at 1.25% above LIBOR (LIBOR was 1.88% at March 31,
2002). Amounts outstanding under the Ford Motor Credit and GMAC floor plan
facilities bear interest at the prime rate (prime was 4.75% at March 31, 2002),
subject to certain incentives and other adjustments. The weighted average
interest rate for our floor plan facilities was 7.6% and 3.6% for the three
month periods ended March 31, 2001 and 2002, respectively. Our floor plan
interest expense is substantially offset by amounts received from manufacturers,
in the form of floor plan assistance, which is recorded as a reduction of cost
of sales. In the first three months of 2002 we received approximately $8.0
million in manufacturer assistance, which resulted in an effective borrowing
rate under our floor plan facilities of 0%. Interest payments under each of our
floor plan facilities are due monthly, but we are not required to make 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, excluding franchise
agreements, of the relevant dealership subsidiary. The floor plan facilities
contain a number of covenants, including among others, covenants restricting us
with respect to the creation of liens and changes in ownership, officers and key
management personnel. We were in compliance with all restrictive covenants as of
March 31, 2002.
Credit Facilities:
The Convertible Senior Subordinate Notes: On May 7, 2002, we issued $149.5
million of 5 1/4% convertible senior subordinated notes at a discount of 3% with
net proceeds, before expenses, of approximately $145.0 million. The notes are
unsecured obligations that rank equal in right of payment to all existing and
future senior subordinated indebtedness, mature on May 7, 2009 and are
redeemable at Sonic's option after May 7, 2005. Sonic's obligations under these
notes are not guaranteed by any of its subsidiaries.
In fiscal quarters after June 30, 2002, the notes are convertible into
shares of Class A common stock, at the option of the holder, if as of the last
day of the preceding fiscal quarter, the closing sale price of our Class A
common stock for at least 20 trading days in a period of 30 consecutive trading
days ending on the last trading-day of such preceding fiscal quarter is more
than 110% of the conversion price per share of Class A common stock on the last
day of such preceding fiscal quarter. If this condition is satisfied, then the
notes will be convertible at any time, at the option of the holder, through
maturity. The initial conversion price per share will equal $46.87, subject to
adjustment for certain distribution, or changes in our Class A common stock, if
any, prior to the conversion date. In addition, on or before May 7, 2007, a
holder also may convert his notes into shares of our Class A common stock at any
time after a 10 consecutive trading-day period in which the average of the
trading day prices for the notes for that 10 trading-day period was less than
103% of the average conversion value for the notes during that period. The
conversion value is equal to the product of the closing sale price for our Class
A common stock on a given day multiplied by the then current conversion rate,
which is the number of shares of Class A common stock into which each $1,000
principle amount of notes is then convertible.
The net proceeds were used to repay a portion of the amounts outstanding
under our Revolving Credit Facility.
22
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
The Revolving Facility: Sonic has a revolving credit facility (the
"Revolving Facility") with Ford Motor Credit, Chrysler Financial and Toyota
Credit with a borrowing limit of $600 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 (the borrowing base
was approximately $513.2 million at March 31, 2002). The amounts outstanding
under the Revolving Facility bear interest at 2.50% above LIBOR (LIBOR was 1.88%
at March 31, 2002) and will mature on October 31, 2004 (but may be extended for
a number of additional one year terms to be negotiated with Ford Motor Credit,
Chrysler Financial and Toyota Credit). The Revolving Facility includes an annual
commitment fee equal to .25% of the unused portion of the facility. The total
outstanding balance was approximately $405.5 million as of March 31, 2002. On a
pro-forma basis, after applying the net estimated proceeds from the issuance of
our 5 1/4% convertible senior subordinated notes due 2009 on May 7, 2002, the
outstanding balance under our Revolving Facility was $279.7 million. Balances
under our Revolving Facility are guaranteed by Sonic's operating subsidiaries.
We agreed under the Revolving Facility not to pledge any of our assets to
any third party (with the exception of currently encumbered assets of our
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 and default provisions. Financial covenants on the Revolving Facility
are as follows:
Covenant Required Actual
-------- -------- ------
Current ratio Greater than 1.23 1.25
Fixed charge coverage Greater than 1.41 1.66
Interest coverage Greater than 2.00 3.62
Adjusted debt to EBITDA Less than 2.25 1.87
In addition, the loss of voting control over Sonic by O. Bruton Smith,
Chairman and Chief Executive Officer, Scott Smith, President and Chief Operating
Officer, and their spouses or immediate family members or our failure, with
certain exceptions, to own all the outstanding equity, membership or partnership
interests in our dealership subsidiaries will constitute an event of default
under the Revolving Facility. We were in compliance with all restrictive
covenants as of March 31, 2002.
The Mortgage Facility: We currently have a revolving real estate
acquisition and construction line of credit (the "Construction Loan") and a
related mortgage refinancing facility (the "Permanent Loan" and collectively
with the Construction Loan, the "Mortgage Facility") with Ford Motor Credit.
Under the Construction Loan, our dealership development subsidiaries can borrow
up to $50.0 million to finance land acquisition and dealership construction
costs. Advances can be made under the Construction Loan until December 2003. All
advances will mature on September 22, 2005, bear interest at 2.25% above LIBOR
and are secured by Sonic's guarantee and a lien on all of the borrowing
subsidiaries' real estate and other assets. Borrowings, net of repayments, under
the Construction Loan in the first three months of 2002 were approximately $1.0
million and were primarily used in construction of dealership facilities. The
total outstanding balance under the Construction Loan as of March 31, 2002 was
approximately $7.5 million.
Under the Permanent Loan, we can refinance up to $50.0 million in advances
under the Construction Loan once the projects are completed and can finance real
estate acquisition costs to the extent these costs were not previously financed
under the Construction Loan. Advances can be made under the Permanent Loan until
June 2005. All advances under the Permanent Loan mature on June 22, 2010, bear
interest at 2.00% above LIBOR and are secured by the same collateral given under
the Construction Loan. The total outstanding balance as of March 31, 2002 was
approximately $4.0 million.
The Mortgage Facility allows us to borrow up to $100 million in the
aggregate under the Construction Loan and the Permanent Loan. The Mortgage
Facility is not cross-collateralized with the Revolving Facility; however, a
default under one will cause a default under the other. Among other customary
covenants, the borrowing subsidiaries under the Mortgage Facility agreed not to
incur any other liens on their property (except for existing encumbrances on
property acquired) and not to transfer their property or more than 20% of their
ownership interests to any third party. In addition, the loss of voting control
by O. Bruton Smith, Scott Smith and their spouses or immediate family members,
with certain exceptions, will result in an event of default under the Mortgage
Facility. We are in compliance with all restrictive covenants as of March 31,
2002.
The Senior Subordinated Notes: We currently have an aggregate principal
balance of $200 million in senior subordinated notes outstanding which mature on
August 1, 2008 and bear interest at a stated rate of 11.0%. The notes are
unsecured and are redeemable at our option after August 1, 2003. Sonic's
obligations under these notes are guaranteed by its operating subsidiaries.
23
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
Interest payments are due semi-annually on February 1 and August 1. The notes
are subordinated to all of our present and future senior indebtedness, including
the Revolving Facility. Redemption prices during the 12-month periods beginning
August 1 are 105.500% in 2003, 103.667% in 2004, 101.833% in 2005 and 100%
thereafter.
The indentures governing the senior subordinated notes contain 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 have also 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. We were in compliance with all
restrictive covenants as of March 31, 2002.
Dealership acquisitions and dispositions:
On March 18, 2002, Sonic acquired five dealerships owned by Don Kott (the
"Kott Acquisition") for approximately $19.6 million in cash. The dealerships are
located in the metropolitan area of Los Angeles, California and sell the
following brands of new vehicles: Ford, Lincoln, Mercury, Chrysler, Jeep, Mazda
and Isuzu/Hino.
On March 25, 2002, Sonic acquired 15 dealerships owned directly or
indirectly by Donald E. Massey (the "Massey Acquisition") for approximately
$114.5 million in cash and 1,470,588 shares of Class A common stock valued at
approximately $38.0 million, based on the average closing price as quoted by the
New York Stock Exchange for the three days before and after the acquisition was
announced. The acquired dealerships are located in California, Colorado,
Florida, North Carolina, Michigan, Tennessee and Texas, and sell the following
brands of new vehicles: Buick, Cadillac, Chevrolet, GMC, Oldsmobile, Pontiac,
Rolls Royce/Bentley and Saab.
In addition to the Kott and Massey Acquisitions, Sonic acquired the
following dealerships during the three months ended March 31, 2002 for a
combined purchase price of approximately $4.6 million in cash:
o On January 21, 2002, Sonic acquired Park Place Audi located in Dallas,
Texas;
o On March 18, 2002, Sonic acquired Philpott Hyundai located in the
metropolitan area of Houston, Texas.
The total purchase price for all of the above acquisitions was based on
Sonic's internally determined valuation of the dealerships and their assets. The
cash portion of the purchase price was financed by cash generated from Sonic's
existing operations and by borrowings under Sonic's revolving credit facility
with Ford Motor Credit, Chrysler Financial and Toyota Credit.
During the first quarter of 2002, we disposed of four franchises, resulting
in the closing of three dealerships, and approved, but had not completed the
sale of, two additional franchises, which will result in the closing of one
dealership. These were generally smaller dealerships with unprofitable
operations. These dealerships disposed of and held for sale generated combined
revenues of $4.3 million in the first quarter of 2002 and $12.4 million in the
first quarter of 2001, and incurred pre-tax losses of $0.7 million in the first
quarter of 2002 and $0.1 million in the first quarter of 2001. In accordance
with the provisions of SFAS No. 144, the results of operations of these
dealerships, including gains or losses on disposition, which were not material,
have been included in the loss on operations of discontinued dealerships in the
accompanying unaudited consolidated statements of income. Assets and liabilities
of the two franchises being held for sale at March 31, 2002 totaled
approximately $2.2 million and $1.6 million, respectively, as of March 31, 2002
and have been classified as assets or liabilities held for sale included in
other current assets and other accrued liabilities, respectively, in the
accompanying unaudited consolidated balance sheet. Assets held for sale are
comprised of inventory and fixed assets, and liabilities held for sale are
comprised of floor plan notes payable. We believe the disposal of these assets
held for sale may take three months or longer to complete.
In addition to the dispositions discussed above, during the year ended
December 31, 2001, we sold or otherwise disposed of assets from 15 other
dealership franchises, resulting in the closing of nine dealerships. These
dealerships generated combined revenues of $34.3 million and incurred pretax
losses of $1.8 million in the three months ended March 31, 2001. The results of
operations of these dealerships have been included in income from continuing
operations in the accompanying unaudited consolidated statements of income.
Subsequent to March 31,2002, Sonic's board of directors approved the
disposition of nine additional dealership franchises and a collision repair
center. The assets and liabilities to be disposed of consist of inventory, fixed
assets and floor plan notes payable. These assets and liabilities totaled $35.4
million and $29.6 million, respectively, at March 31, 2002. We believe the
disposal of these assets may take 3 months or longer to complete.
24
SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
Investments in Unconsolidated Affiliates:
We currently have 50% joint venture investments in North Point Volvo, LLC,
a Volvo automobile dealership in the greater Atlanta area, and Fort Myers
Collision Center, LLC, located in Florida, in which we initially invested
$900,000 and $100,000, respectively. The partners in these joint ventures are
not affiliated with Sonic. These entities are not consolidated into Sonic's
financial statements because we do not have operating control of the entities.
However, we have guaranteed $6.0 million in indebtedness between North Point
Volvo, LLC and Bank of America, including a $5.5 million revolving floor plan
financing agreement expiring in 2003, of which $2.6 million was outstanding as
of March 31, 2002, and a $0.5 million term loan expiring in 2007. We have
guaranteed no other obligations of either company. The investments are accounted
for under the equity method whereby we record our share of each respective joint
venture's pretax profit or loss. We recorded approximately $0.1 million in net
income in the first three months of 2002 related to these investments. We may
elect to make future investments in these entities.
Sale-Leaseback Transactions:
In an effort to generate additional capital, we typically seek to structure
our operations to minimize the ownership of real property. As a result,
facilities either constructed by us or obtained in acquisitions are typically
sold to third parties in sale-leaseback transactions. The resulting leases
generally have initial terms of 10-15 years and include a series of five-year
renewal options. We have no continuing obligations under these arrangements
other than lease payments. The majority of our sale-leaseback transactions are
done with Capital Automotive REIT ("Capital Automotive). Under our agreement
with Capital Automotive, we have the ability to substitute properties in the
lease portfolio should we decide to dispose of a dealership currently being
leased from Capital Automotive. During the first quarter of 2002 we sold $9.8
million in dealership properties in sale-leaseback transactions.
Capital Expenditures:
Other than construction of new dealerships and collision repair centers,
our capital expenditures generally include building improvements and equipment
for use in our dealerships. Capital expenditures in the first three months of
2002 were approximately $13.9 million, of which approximately $10.3 million
related to the construction of new dealerships and collision repair centers.
Once completed, these new dealerships and collision repair centers are generally
sold in sale-leaseback transactions. We sold approximately $9.8 million of
completed construction projects in sale-leaseback transactions during the first
three months of 2002. There were no material gains or losses on these sales. As
of March 31, 2002, total construction in progress was approximately $22.8
million. In addition, approximately $12.0 million related to construction costs
on facilities, which are expected to be completed and sold within one year in
sale-leaseback transactions have been classified in other current assets on the
accompanying unaudited consolidated balance sheet as of March 31, 2002. We do
not expect any significant gains or losses from these sales. Through May 10,
2002, there have been no additional sale/leaseback transactions.
Stock Repurchase Program:
Sonic's Board of Directors has authorized Sonic to expend up to $100
million to repurchase shares of its Class A common stock or redeem securities
convertible into Class A common stock. As of March 31, 2002, Sonic has
repurchased 6,415,264 shares of Class A common stock totaling approximately
$61.4 million and has also redeemed 13,801.5 shares of Class A convertible
preferred stock at a total cost of approximately $13.8 million. We have limited
our stock repurchase activity recently and anticipate that we will continue to
limit such activity to utilizing option exercise proceeds to repurchase shares
of Class A common stock on an opportunistic basis.
Cash Flows:
For the three month period ended March 31, 2002, net cash provided by
operating activities was approximately $24.1 million, which was generated
primarily by net income plus non-cash items such as depreciation, amortization
and deferred income taxes. A decrease in inventory levels of $33.3 million was
offset by a related decrease in floor plan liabilities of $24.9 million. Cash
used for investing activities in the first three months of 2002 was
approximately $132.2 million, the majority of which was related to dealership
acquisitions. Our other principal investing activities include capital
expenditures and dealership dispositions. In the first three months of 2002, net
cash provided by financing activities was approximately $105.8 million and
primarily related to net borrowings on our revolving credit facilities of
approximately $104.5 million which was used primarily to finance acquisitions
during the quarter.
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SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (Continued)
Future Liquidity Outlook:
We believe our best source of liquidity for future growth remains our cash
flows generated from operations. Our availability of borrowings under our floor
plan financing (or any replacements thereof) and 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 our existing businesses, for the foreseeable future. With forecasted
capital expenditures that will not be funded by sale leaseback financing
transactions of approximately $12 million to $15 million for the year 2002, we
expect to generate substantial "free" cash flow to support our acquisition
strategy.
Seasonality:
Our operations are subject to seasonal variations. The first and fourth
quarters generally contribute less revenue and operating profits than the second
and third quarters. Weather conditions, the timing of manufacturer incentive
programs and model changeovers cause seasonality in new vehicle demand. Parts
and service demand remains more stable throughout the year.
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SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk. Our variable rate floor plan notes payable, revolving
credit facility borrowings and other variable rate notes expose us to risks
caused by fluctuations in the underlying interest rates. The total outstanding
balance of such instruments was approximately $1.2 billion at March 31, 2002 and
approximately $1.0 billion at March 31, 2001. A change of 100 basis points in
the underlying interest rate would have caused a change in interest expense of
approximately $2.1 million in the first quarter 2002 and approximately $2.6
million in the first quarter 2001. Of the total change in interest expense,
approximately $1.3 million in the first quarter 2002 and approximately $1.7
million in first quarter 2001 would have resulted from floor plan notes payable.
Our exposure with respect to floor plan notes payable is mitigated by floor
plan assistance payments received from manufacturers that are generally based on
rates similar to those incurred under our floor plan financing arrangements.
These payments are credited against our cost of sales. During the three months
ended March 31, 2002, the amounts we received from manufacturer floor plan
assistance exceeded our floor plan interest expense by approximately $2.4
million. As a result, the effective rate incurred under our floor plan financing
arrangements was reduced to 0% after considering these incentives. A change in
interest rates of 100 basis points would have had an estimated impact on floor
plan assistance of approximately $1.3 million in the first quarter 2002.
In addition to our variable rate debt, we also have lease agreements on a
portion of our dealership facilities where the monthly lease payment fluctuated
based on LIBOR interest rates. A change of 100 basis points in the underlying
rates would have caused a change in rent expense of approximately $0.6 million
in the first quarter 2002 and $0.5 million in the first quarter 2001.
In order to reduce our exposure to market risks from fluctuations in
interest rates, we entered into an interest rate swap agreement on January 15,
2002 to effectively convert a portion of its LIBOR-based variable rate debt to a
fixed rate. The swap has a notional principal amount of $100 million and matures
on October 31, 2004. Under the terms of the swap agreement, we receive interest
payments on the notional amount at a rate equal to the one month LIBOR rate,
adjusted monthly, and makes interest payments at a fixed rate of 3.88%.
Incremental interest expense incurred (the difference between interest earned
and interest incurred) as a result of this interest rate swap was $0.4 million
for the three months ended March 31, 2002 and has been included in interest
expense, other in the accompanying unaudited consolidated statements of income.
The interest rate swap has been designated and qualifies as a cash flow
hedge and, as a result, changes in the fair value of the interest rate swap have
been recorded in other comprehensive income, net of related income taxes, in our
statement of stockholders' equity. The fair value of the interest rate swap as
of March 31, 2002, recorded in other assets on the accompanying unaudited
balance sheet, and the amount of the related hedging gain deferred and recorded
in other comprehensive income for the three months ended March 31, 2002 was
approximately $1.2 million. Because the critical terms of the interest rate swap
and the underlying debt obligation were the same, no ineffectiveness was
recorded.
While we may enter into additional interest rate swaps in order to hedge
our interest rate cash flow risk and limit volatility created by changing rates,
we believe variable rates will give us the lowest cost of capital long term and
believe some variable rate exposure is a natural hedge in our business to
economic cycles.
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SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
Forward Looking Statements
Certain statements and information set forth in this Quarterly Report on
Form 10-Q constitute "forward-looking statements" within the meaning of the
Private Litigation Securities Reform Act of 1995. These forward looking
statements address our future objectives, plans and goals, as well as our
intent, beliefs and current expectations regarding future operating performance,
and can generally be identified by words such as "may," "will," "should,"
"believe," "expect," "anticipate," "intend," "plan," "foresee," and other
similar words or phrases. Specific events addressed by these forward looking
statements include, but are not limited to:
o future acquisitions;
o industry trends;
o general economic trends, including employment rates and consumer
confidence levels;
o vehicle sales rates and same store sales growth;
o our financing plans;
o our business and growth strategies.
These forward-looking statements are based on our current estimates and
assumptions and involve various risks and uncertainties. As a result, you are
cautioned that these forward looking statements are not guarantees of future
performance, and that actual results could differ materially from those
projected in these forward looking statements. Factors which may cause actual
results to differ materially from our projections include those risks described
in Exhibit 99.1 to this Quarterly Report on Form 10-Q and elsewhere in this
report, as well as:
o our ability to generate sufficient cash flows or obtain additional
financing to support acquisitions, capital expenditures, our share
repurchase program, and general operating activities;
o the reputation and financial condition of vehicle manufacturers whose
brands we represent, and their ability to design, manufacture, deliver
and market their vehicles successfully;
o our relationships with manufacturers, which may affect our ability to
complete additional acquisitions;
o changes in laws and regulations governing the operation of automobile
franchises, accounting standards, taxation requirements, and
environmental laws;
o general economic conditions in the markets in which we operate,
including fluctuations in interest rates, employment levels, and the
level of consumer spending;
o high competition in the automotive retailing industry which not only
creates pricing pressures on the products and services we offer, but
on businesses we seek to acquire;
o our ability to successfully integrate recent and potential future
acquisitions.
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SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
OTHER INFORMATION
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
2.1* Asset Purchase Agreement dated as of January 11, 2002 by and among
Sonic and the Donald E. Massey Revocable Trust (the "Trust")
(incorporated by reference to Exhibit 2.1 to Sonic's Current Report on
Form 8-K filed on April 15, 2002 (the "April 2002 8-K"))
2.2* Stock Purchase Agreement dated as of January 11, 2002 by and among
Sonic and the Trust (incorporated by reference to Exhibit 2.2 to the
April 2002 8-K)
2.3* Stock Purchase Agreement dated as of January 11, 2002 by and among
Sonic and the Trust (incorporated by reference to Exhibit 2.3 to the
April 2002 8-K)
99.1 Risk Factors.
* - Filed previously with the Securities and Exchange Commission.
(b) Reports on Form 8-K
On January 15, 2002, we filed a Current Report on Form 8-K announcing
that we had entered into an agreement to purchase substantially all of
the Don Massey Dealerships. No financial statements were filed with
the report on January 15, 2002.
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SONIC AUTOMOTIVE, INC AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SONIC AUTOMOTIVE, INC.
Date: May 15, 2002 By: /s/ O. Bruton Smith
-------------------------------------
O. Bruton Smith
Chairman and Chief Executive Officer
Date: May 15, 2002 By: /s/ Theodore M. Wright
-------------------------------------
Theodore M. Wright
Vice President, Chief Financial
Officer and Treasurer
(Principal Financial and Accounting
Officer)
30