INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF
ECONOMY CARS, INC.
CHATTANOOGA, TENNESSEE
We have audited the accompanying balance sheet of Economy Cars, Inc.,
d/b/a Economy Honda Cars (the "Company"), as of December 31, 1997, and the
related statements of income, stockholders' equity, and cash flows for the year
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1997, and
the results of its operations and its cash flows for the year then ended in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Charlotte, North Carolina
May 11, 1998
1
ECONOMY HONDA CARS
BALANCE SHEETS
December 31, 1997 and March 31, 1998
December 31, March 31,
1997 1998
-------------- --------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................ $ 3,834,184 $ 5,396,805
Accounts receivable (net of allowance for doubtful accounts of $13,505
at December 31, 1997) .............................................. 842,907 502,165
Note receivable (Note 2) ............................................. 238,960 231,115
Inventories (Note 3) ................................................. 6,541,972 5,552,280
Other current assets ................................................. 4,477 4,477
----------- -----------
Total current assets ............................................... 11,462,500 11,686,842
PROPERTY AND EQUIPMENT, NET (Note 4) .................................. 1,791,974 1,759,082
----------- -----------
TOTAL ASSETS .......................................................... $13,254,474 $13,445,924
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable ............................................... $ 148,073 $ 175,090
Income taxes payable (Note 6) ........................................ 251,237 78,781
Deferred income taxes (Note 6) ....................................... 173,511 173,511
Other taxes payable .................................................. 215,619 269,489
Accrued payroll and bonuses .......................................... 105,174 298,430
Liability for finance chargebacks .................................... 95,550 82,889
Other accrued liabilities ............................................ 6,879 2,447
----------- -----------
Total current liabilities .......................................... 996,043 1,080,637
----------- -----------
DEFERRED INCOME TAXES (Note 6) ........................................ 78,449 78,449
----------- -----------
STOCKHOLDERS' EQUITY:
Common stock (no par, 2,000 shares authorized, 500 shares issued and
450 shares outstanding) ............................................ 50,000 50,000
Retained earnings .................................................... 12,329,982 12,436,838
Treasury stock (50 shares) ........................................... (200,000) (200,000)
----------- -----------
Total stockholders' equity ......................................... 12,179,982 12,286,838
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................ $13,254,474 $13,445,924
=========== ===========
See notes to financial statements.
2
ECONOMY HONDA CARS
STATEMENTS OF INCOME
Year ended December 31, 1997 and the three months ended March 31, 1997 and 1998
Three months
Year ended ended March 31,
December 31, -----------------------------
1997 1997 1998
--------------- -------------- -------------
(Unaudited)
REVENUES:
Vehicle sales ................................... $41,032,638 $10,367,163 $ 9,896,091
Parts, service and collision repair ............. 5,855,509 1,487,811 1,347,767
Finance and insurance ........................... 1,383,106 428,935 272,379
----------- ----------- -----------
Total revenues ................................ 48,271,253 12,283,909 11,516,237
COST OF SALES .................................... 41,291,627 10,255,797 10,026,232
----------- ----------- -----------
GROSS PROFIT ..................................... 6,979,626 2,028,112 1,490,005
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ..... 5,393,705 1,413,387 1,352,217
DEPRECIATION ..................................... 130,996 23,259 35,021
----------- ----------- -----------
OPERATING INCOME ................................. 1,454,925 591,466 102,767
----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest expense -- floor plan (Note 3) ......... (2,791) (842) (1,593)
Interest income ................................. 75,852 614 38,151
Other income .................................... 119,261 10,358 33,053
----------- ----------- -----------
Total other income ............................ 192,322 10,130 69,611
----------- ----------- -----------
INCOME BEFORE INCOME TAXES ....................... 1,647,247 601,596 172,378
PROVISION FOR INCOME TAXES (Note 6) .............. 626,062 228,660 65,522
----------- ----------- -----------
NET INCOME ....................................... $ 1,021,185 $ 372,936 $ 106,856
=========== =========== ===========
See notes to financial statements.
3
ECONOMY HONDA CARS
STATEMENTS OF STOCKHOLDERS' EQUITY
Year Ended December 31, 1997 and the three months ended March 31, 1998
Total
Common Retained Treasury Stockholders'
Stock Earnings Stock Equity
---------- -------------- -------------- --------------
BALANCE AT DECEMBER 31, 1996 .............. $50,000 $11,308,797 $ (200,000) $11,158,797
Net income ............................... -- 1,021,185 -- 1,021,185
------- ----------- ---------- -----------
BALANCE AT DECEMBER 31, 1997 .............. 50,000 12,329,982 (200,000) 12,179,982
Net income (unaudited) ................... -- 106,856 -- 106,856
------- ----------- ---------- -----------
BALANCE AT MARCH 31, 1998 (unaudited) ..... $50,000 $12,436,838 $ (200,000) $12,286,838
======= =========== ========== ===========
See notes to financial statements.
4
ECONOMY HONDA CARS
STATEMENTS OF CASH FLOWS
Year ended December 31, 1997 and the three months ended March 31, 1997 and 1998
Three months ended
Year ended March 31,
December 31, ----------------------------
1997 1997 1998
------------- ------------- -------------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .............................................................. $1,021,185 $ 372,936 $ 106,856
---------- ---------- ----------
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation .......................................................... 130,996 23,259 35,021
Loss on disposal of fixed assets ...................................... 2,258 -- --
Deferred income taxes ................................................. (39,266) -- --
Changes in assets and liabilities that related to operations:
(Increase) decrease in accounts receivables .......................... (432,900) (537,205) 340,742
Decrease in inventories .............................................. 789,447 5,905 989,692
Decrease in prepaids and other current assets ........................ 330,940 258,449 --
Increase in trade accounts payable and accrued liabilities ........... 142,753 440,166 84,595
---------- ---------- ----------
Total adjustments ................................................... 924,228 190,574 1,450,050
---------- ---------- ----------
Net cash provided by operating activities ........................... 1,945,413 563,510 1,556,906
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ..................................... (196,016) (35,521) (2,130)
Proceeds from sale of assets ............................................ 4,685 -- --
Principal collected on notes receivable ................................. 47,358 13,925 7,845
---------- ---------- ----------
Net cash provided by (used in) investing activities ................. (143,973) (21,596) 5,715
---------- ---------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS ................................ 1,801,440 541,914 1,562,621
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ........................... 2,032,744 2,032,744 3,834,184
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................. $3,834,184 $2,574,658 $5,396,805
========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
-- Cash paid during the period for:
Interest ................................................................ $ 89,984 $ 14,028 $ 8,717
Income taxes ............................................................ $ 258,869 $ 13,311 $ 237,978
See notes to financial statements.
5
ECONOMY HONDA CARS
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Business -- Economy Honda Cars (the "Company") operates
an automotive dealership, service department, body shop and parts and
accessories department in Chattanooga, Tennessee. The Company sells new and
used cars and light trucks, sells replacement parts and accessories, provides
vehicle maintenance, warranty, paint and repair services and arranges related
financing and insurance. The Company sells new vehicles manufactured by Honda.
Revenue Recognition -- The Company records revenue when vehicles are
delivered to customers, and when vehicle service work is performed. Finance and
insurance commission revenue is recognized principally at the time the contract
is placed with the financial institution.
Dealer Agreements -- The Company purchases substantially all of its new
vehicles from the manufacturer at the prevailing prices charged by the
manufacturer to its franchised dealers. The Company's sales could be
unfavorably impacted by the manufacturer's unwillingness or inability to supply
the dealership with an adequate supply of new vehicle inventory.
The Company operates under a dealer agreement with the manufacturer. The
Company's dealer agreement does not give it the exclusive right to sell the
manufacturer's product within a given geographic area. The Company could be
materially adversely affected if the manufacturer awards franchises to others
in the same market where the Company is operating. A similar adverse affect
could occur if existing competing franchised dealers increase their market
share in the Company's market. The ability of the Company to acquire additional
franchises from a particular manufacturer may be limited due to certain
restrictions imposed by manufacturers. Additionally, the Company's ability to
enter into significant acquisitions may be restricted and the acquisition of
the Company's stock by third parties may be limited by the terms of the
franchise agreement.
Cash and Cash Equivalents -- The Company considers contracts in transit
and all highly liquid debt instruments with an initial maturity of three months
or less to be cash equivalents. Contracts in transit represent cash in transit
to the Company from finance companies related to vehicle purchases and was
$919,251 at December 31, 1997.
Inventories -- Inventories of new and used vehicles, including
demonstrators and parts and accessories, are valued at the lower of specific
cost or market. Cost is determined using the last-in, first-out method ("LIFO")
for new vehicles and parts and accessories.
Property and Equipment -- Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. The range of estimated useful lives is as follows:
Useful Lives
-------------
Buildings and improvements ............. 7-31.5
Office equipment and fixtures .......... 5-7
Parts and service equipment ............ 5-10
Company vehicles ....................... 5
Expenditures for maintenance and repairs are expensed as incurred.
Significant betterments are capitalized.
Income Taxes -- The provision for income taxes includes federal and state
taxes currently payable and deferred taxes. Deferred taxes are determined
utilizing an asset and liability approach as required by Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes. This method gives
consideration to the future tax consequences associated with differences
between financial accounting and tax basis of assets and liabilities. This
method gives immediate effect to changes in income tax laws upon enactment. A
valuation allowance is established when necessary to reduce deferred tax assets
to the amounts expected to be realized.
Concentrations of Credit Risk -- Financial instruments which potentially
subject the Company to concentrations of credit risk consist principally of
cash deposits. At times, amounts invested with financial institutions may
exceed FDIC insurance limits.
Concentrations of credit risk with respect to receivables are limited
primarily to automobile manufacturers and financial institutions. Credit risk
arising from trade receivables from commercial customers is reduced by the
large number of customers comprising the trade receivables balances. Trade
receivables are concentrated in the Company's market area of Chattanooga,
Tennessee.
6
ECONOMY HONDA CARS
NOTES TO FINANCIAL STATEMENTS -- Continued
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES -- Continued
Fair Value of Financial Instruments -- As of December 31, 1997 the fair
value of the Company's financial instruments including accounts and notes
receivables and trade accounts payable approximate their book values.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles 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.
Advertising -- The Company expenses advertising costs in the period
incurred. Advertising expense for 1997 amounted to $531,473.
Interim Financial Information -- The accompanying unaudited financial
information for the three months ended March 31, 1997 and 1998 has been
prepared on substantially the same basis as the audited financial statements,
and include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the financial information set forth
therein. The results of interim periods are not necessarily indicative of
results to be expected for the entire year.
2. NOTE RECEIVABLE
At December 31, 1997, the Company had a note receivable from an unrelated
party totaling $238,960. The note bore interest at 12% per annum and was
payable in monthly installments of $6,293. On April 7, 1998, the note was
purchased for cash by one of the Company's principal stockholders at the
recorded book value of $231,115 at that date.
3. INVENTORIES AND RELATED NOTES PAYABLE -- FLOOR PLAN
Inventories consist of the following:
December 31, March 31,
1997 1998
-------------- --------------
(Unaudited)
New vehicles .................. $ 1,798,172 $2,627,048
Used vehicles ................. 4,902,142 3,171,435
Parts and accessories ......... 365,630 357,095
----------- ----------
7,065,944 6,155,578
LIFO reserve .................. (523,972) (603,298)
----------- ----------
Total ......................... $ 6,541,972 $5,552,280
=========== ==========
Had the Company used the first-in, first-out method of valuing new
vehicles, parts and accessories inventory, pretax earnings would have been
$1,819,742 in 1997.
From time to time certain vehicles are pledged to collateralize floor plan
notes payable to financial institutions. The floor plan notes bear interest,
payable monthly on the outstanding balance at a rate that fluctuates with prime
(8.5% at December 31, 1997). Total floor plan interest expense amounted to
$2,791 in 1997. The notes payable are due when the related vehicle is sold;
however, the Company generally pays floor plan as invoiced for vehicles during
the year. There is no balance outstanding under such floor plan notes at
December 31, 1997.
7
ECONOMY HONDA CARS
NOTES TO FINANCIAL STATEMENTS -- Continued
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 31, March 31,
1997 1998
-------------- ---------------
(Unaudited)
Land .................................. $ 624,430 $ 624,430
Buildings and improvements ............ 1,922,175 1,923,579
Office equipment and fixtures ......... 299,278 300,003
Parts and service equipment ........... 358,961 358,961
Company vehicles ...................... 62,254 62,254
------------ ------------
3,267,098 3,269,227
Less accumulated depreciation ......... (1,475,124) (1,510,145)
------------ ------------
Property and equipment, net ........... $ 1,791,974 $ 1,759,082
============ ============
5. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) plan, whereby substantially all of the employees
of the Company meeting certain service requirements are eligible to
participate. Contributions by the Company in 1997 were approximately $39,000.
6. INCOME TAXES
The provision for income taxes consists of the following components for
the year ended December 31, 1997:
Current:
Federal ................ $ 559,667
State .................. 105,663
---------
665,330
---------
Deferred:
Federal ................ (33,061)
State .................. (6,207)
---------
39,268
---------
Total .................. $ 626,062
=========
The reconciliation of the statutory federal income tax rate with the
Company's federal and state overall effective income tax rate is as follows for
the year ending December 31, 1997:
Statutory federal rate ......... 34.00%
State income taxes ............. 3.98%
Miscellaneous .................. 0.03%
-----
Effective tax rates ............ 38.01%
=====
Deferred income taxes reflect the net tax effects of the temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for tax purposes.
8
ECONOMY HONDA CARS
NOTES TO FINANCIAL STATEMENTS -- Continued
6. INCOME TAXES -- Continued
Deferred income tax assets and liabilities consist of the following at
December 31, 1997:
Deferred tax assets, primarily from differences relating to chargebacks ........... $ 85,528
Deferred tax liabilities, primarily from differences relating to used car inventory
reserve .......................................................................... (337,488)
----------
Net deferred tax liabilities ...................................................... $ 251,960
==========
7. SUBSEQUENT EVENT
On March 16, 1998, the Company entered into an agreement with Sonic
Automotive, Inc. ("Sonic") whereby Sonic will purchase all of the outstanding
capital stock of the Company for a total purchase price of $7.5 million plus an
amount equal to the net book value of the assets of the Company. This purchase
price will be paid in cash and convertible preferred stock of Sonic. Preferred
stock will be issued for 51% of the total purchase price, not to exceed $5.1
million in liquidation preference as of the closing of the acquisition.
9