Exhibit 99.1
RISK FACTORS
Our significant indebtedness could materially adversely affect our
financial health and prevent us from fulfilling our financial obligations.
As of September 30, 2001, our total outstanding indebtedness was
approximately $1,008.8 million, including the following:
. $312.4 million under a revolving credit agreement (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;
. $368.4 million under a standardized secured inventory floor plan
facility (the "Ford Floor Plan Facility") with Ford Motor Credit;
. $115.6 million under a standardized secured floor plan facility (the
"Chrysler Floor Plan Facility") with Chrysler Financial;
. $11.5 million under a standardized secured floor plan facility (the
"Toyota Floor Plan Facility") with Toyota Credit;
. $61.8 million under a standardized secured floor plan facility (the
"GMAC Floor Plan Facility" and together with the Ford Floor Plan
Facility, the Toyota Floor Plan facility and the Chrysler Floor Plan
Facility, the "Floor Plan Facilities") with General Motors Acceptance
Corporation ("GMAC");
. $121.5 million in 11% Senior Subordinated Notes due 2008 representing
$125.0 million in aggregate principal amount less unamortized discount
of approximately $3.5 million; and
. $17.6 million of other secured debt, including $10.7 million under a
revolving real estate acquisition and new dealership construction line
of credit (the "Construction Loan") and a related mortgage refinancing
facility (the "Permanent Loan" and together with the Construction
Loan, the "Mortgage Facility") with Ford Motor Credit.
As of September 30, 2001, we had approximately $229.2 million available for
additional borrowings under the Revolving Facility, based on a borrowing base
calculated on the basis of our receivables, inventory and equipment and certain
additional collateral pledged by an affiliate of Sonic. We also had
approximately $89.3 million available for additional borrowings under the
Mortgage Facility for real estate acquisitions and new dealership construction.
We also have significant additional capacity under the Floor Plan Facilities. In
addition, the indentures relating to our senior subordinated notes and other
debt instruments allow us to incur additional indebtedness, including secured
indebtedness.
The degree to which we are leveraged could have important consequences to
the holders of our securities, including the following:
. our ability to obtain additional financing for acquisitions, capital
expenditures, working capital or general corporate purposes may be
impaired in the future;
. a substantial portion of our current cash flow from operations must be
dedicated to the payment of principal and interest on our senior
subordinated notes, borrowings under the Revolving Facility and the
Floor Plan Facilities and other indebtedness, thereby reducing the
funds available to us for our operations and other purposes;
. some of our borrowings are and will continue to be at variable rates
of interest, which exposes us to the risk of increased interest rates;
. the indebtedness outstanding under our credit facilities is secured by
a pledge of substantially all the assets of our dealerships; and
. we may be substantially more leveraged than some of our competitors,
which may place us at a relative competitive disadvantage and make us
more vulnerable to changing market conditions and regulations.
In addition, our debt agreements contain numerous covenants that limit our
discretion with respect to business matters, including mergers or acquisitions,
paying dividends, incurring additional debt, making capital expenditures or
disposing of assets.
Our future operating results depend on our ability to integrate our operations
with recent acquisitions.
Our future operating results depend on our ability to integrate the
operations of our recently acquired dealerships, as well as dealerships we
acquire in the future, with our existing operations. In particular, we need to
integrate our systems, procedures and structures, which can be difficult. Our
growth strategy has focused on the pursuit of strategic acquisitions that either
expand or complement our business. We acquired 19 dealerships in 1998, 72 during
1999, 11 in 2000 and 10 to date in 2001.
We cannot assure you that we will effectively and profitably integrate the
operations of these dealerships without substantial costs, delays or operational
or financial problems, including as a result of:
. the difficulties of managing operations located in geographic areas
where we have not previously operated;
. the management time and attention required to integrate and manage
newly acquired dealerships;
. the difficulties of assimilating and retaining employees; and
. the challenges of keeping customers.
These factors could have a material adverse effect on our financial
condition and results of operations.
Risks associated with acquisitions may hinder our ability to increase revenues
and earnings.
The automobile retailing industry is considered a mature industry in which
minimal growth is expected in industry unit sales. Accordingly, our future
growth depends in large part on our ability to acquire additional dealerships,
as well as on our ability to manage expansion, control costs in our operations
and consolidate both past and future dealership acquisitions into existing
operations. In pursuing a strategy of acquiring other dealerships, we face risks
commonly encountered with growth through acquisitions. These risks include, but
are not limited to:
. incurring significantly higher capital expenditures and operating
expenses;
. failing to assimilate the operations and personnel of the acquired
dealerships;
. entering new markets with which we are unfamiliar;
. potential undiscovered liabilities at acquired dealerships;
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. disrupting our ongoing business;
. diverting our limited management resources;
. failing to maintain uniform standards, controls and policies;
. impairing relationships with employees, manufacturers and customers as
a result of changes in management;
. causing increased expenses for accounting and computer systems, as
well as integration difficulties; and
. failure to obtain a manufacturer's consent to the acquisition of one
or more of its dealership franchises.
We may not adequately anticipate all of the demands that our growth will
impose on our systems, procedures and structures, including our financial and
reporting control systems, data processing systems and management structure. If
we cannot adequately anticipate and respond to these demands, our business could
be materially harmed.
Failure to retain qualified management personnel at any acquired dealership
may increase the risk associated with integrating the acquired dealership.
Installing new computer systems has disrupted existing operations in the
past as management and salespersons adjust to new technologies. We cannot assure
you that we will overcome these risks or any other problems encountered with
either our past or future acquisitions.
Automobile manufacturers exercise significant control over our operations and we
are dependent on them to operate our business.
Each of our dealerships operates pursuant to a franchise agreement with the
applicable automobile manufacturer or manufacturer authorized distributor. We
are significantly dependent on our relationships with these manufacturers.
Without a franchise agreement, we cannot obtain new vehicles from a
manufacturer.
Vehicles manufactured by the following manufacturers accounted for the
indicated approximate percentage of our new vehicle revenue for the nine months
ended September 30, 2001:
Percentage of Historical
New Vehicle Revenues for
the Nine Months Ended
Manufacturer September 30, 2001
------------ -------------------
Ford 18.8%
Honda 13.1%
BMW 11.1%
Toyota 11.1%
General Motors 10.8%
Chrysler 8.6%
Nissan 5.3%
Lexus 5.3%
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No other manufacturer accounted for more than 5% of our new vehicle sales
during the first nine months of 2001. A significant decline in the sale of Ford,
Honda, Chrysler, General Motors, BMW, Toyota, Nissan or Lexus new vehicles could
have a material adverse effect on our revenue and profitability.
Manufacturers exercise a great degree of control over the operations of our
dealerships. Each of our franchise agreements provides for termination or non-
renewal for a variety of causes, including any unapproved change of ownership or
management and other material breaches of the franchise agreements.
Manufacturers may also have a right of first refusal if we seek to sell
dealerships. We believe that we will be able to renew at expiration all of our
existing franchise agreements, other than our Oldsmobile and Plymouth franchise
agreements. Daimler Chrysler has phased out the Plymouth division effective
October 1, 2001 and General Motors is in the process of phasing out the
Oldsmobile division. Neither of these actions will materially affect us.
. We cannot assure you that any of our existing franchise agreements
will be renewed or that the terms and conditions of such renewals will
be favorable to us.
. If a manufacturer is allowed under state franchise laws to terminate
or decline to renew one or more of our significant franchise
agreements, this action could have a material adverse effect on our
results of operations.
. Actions taken by manufacturers to exploit their superior bargaining
position in negotiating the terms of renewals of franchise agreements
or otherwise could also have a material adverse effect on our results
of operations.
. Manufacturers allocate their vehicles among dealerships generally
based on the sales history of each dealership. Consequently, we also
depend on the manufacturers to provide us with a desirable mix of
popular new vehicles. These popular vehicles produce the highest
profit margins and tend to be the most difficult to obtain from the
manufacturers.
. Our dealerships depend on the manufacturers for certain sales
incentives, warranties and other programs that are intended to promote
and support dealership new vehicle sales. Manufacturers have
historically made many changes to their incentive programs during each
year. A reduction or discontinuation of a manufacturer's incentive
programs may materially adversely affect our profitability. Some of
these programs include:
. customer rebates on new vehicles;
. dealer incentives on new vehicles;
. special financing or leasing terms;
. warranties on new and used vehicles; and
. sponsorship of used vehicle sales by authorized new vehicle
dealers.
Adverse conditions affecting one or more manufacturers may negatively impact our
profitability.
The success of each of our dealerships depends to a great extent on the
manufacturers':
. financial condition;
. marketing;
. vehicle design;
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. production capabilities;
. management; and
. labor relations.
Nissan, Dodge (a Chrysler brand) and Volvo have had significant difficulty
in the U.S. market in the recent past. If any of our manufacturers, particularly
Ford, Honda, Chrysler, General Motors, BMW, Toyota, Nissan, or Lexus were unable
to design, manufacture, deliver and market their vehicles successfully, the
manufacturer's reputation and our ability to sell the manufacturer's vehicles
could be adversely affected.
Events such as strikes and other labor actions by unions, or negative
publicity concerning a particular manufacturer or vehicle model, may materially
and adversely affect our results of operations. Similarly, the delivery of
vehicles from manufacturers later than scheduled, which may occur particularly
during periods when new products are being introduced, can reduce our sales.
Although we have attempted to lessen our dependence on any one manufacturer by
establishing dealer relationships with a number of different domestic and
foreign automobile manufacturers, adverse conditions affecting manufacturers,
Ford, Honda, Chrysler, General Motors, BMW, Toyota, Nissan or Lexus in
particular, could have a material adverse effect on our results of operations.
In the event of a strike, we may need to purchase inventory from other
automobile dealers at prices higher than we would be required to pay to the
affected manufacturer in order to carry an adequate level and mix of inventory.
Consequently, strikes or other adverse labor actions could materially adversely
affect our profitability.
Manufacturer stock ownership/issuance restrictions limit our ability to issue
additional equity to meet our financing needs.
Standard automobile franchise agreements prohibit transfers of any
ownership interests of a dealership and its parent and, therefore, often do not
by their terms accommodate public trading of the capital stock of a dealership
or its parent. Our manufacturers have agreed to permit trading in Sonic's Class
A common stock. A number of manufacturers impose restrictions on the
transferability of the Class A common stock.
. Honda may force the sale of our Honda or Acura franchises if (1) an
automobile manufacturer or distributor acquires securities having 5%
or more of the voting power of Sonic's securities, (2) an individual
or entity that has either a felony criminal record or a criminal
record relating solely to dealings with an automobile manufacturer,
distributor or dealership acquires securities having 5% or more of the
voting power of Sonic's securities or (3) any individual or entity
acquires securities having 20% or more of the voting power of Sonic's
securities and Honda reasonably deems such acquisition to be
detrimental to Honda's interests in any material respect.
. Ford may cause us to sell or resign from one or more of our Ford,
Lincoln or Mercury franchises if any person or entity (other than O.
Bruton Smith and any entity controlled by him) acquires or has a
binding agreement to acquire securities having 50% or more of the
voting power of Sonic's securities.
. General Motors and Infiniti may force the sale of their respective
franchises if 20% of more of Sonic's voting securities are similarly
acquired.
. Toyota may force the sale of one or more of Sonic's Toyota or Lexus
dealerships if (1) an automobile manufacturer or distributor acquires
securities, or the right to vote securities by proxy or voting
agreement, having more than 5% of the voting power of Sonic's
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securities, (2) any individual or entity acquires securities, or the
right to vote securities by proxy or voting agreement, having more
than 20% of the voting power of Sonic's securities, (3) there is a
material change in the composition of Sonic's Board of Directors that
Toyota reasonably concludes will be materially incompatible with
Toyota's interests or will have an adverse effect on Toyota's
reputation or brands in the marketplace or the performance of Sonic or
its Toyota and Lexus dealerships, (4) there occurs an extraordinary
transaction whereby Sonic's stockholders immediately prior to such
transaction own in the aggregate securities having less than a
majority of the voting power of Sonic or the successor entity, or (5)
any individual or entity acquires control of Sonic, Sonic Financial
Corporation or any Toyota or Lexus dealership owned by Sonic.
. Chrysler requires prior approval of any future sales that would result
in a change in voting or managerial control of Sonic.
. Mercedes requires 60 days advance notice to approve any acquisition of
20% or more of Sonic's voting securities.
. Volkswagen has approved the sale of no more than 25% of the voting
control of Sonic, and any future changes in ownership or transfers
among Sonic's current stockholders that could affect the voting or
managerial control of Sonic's Volkswagen franchise subsidiaries
requires the prior approval of Volkswagen.
Other manufacturers may impose similar or more limiting restrictions.
Our lending arrangements also require that holders of Sonic's Class B
common stock maintain voting control over Sonic. We are unable to prevent our
stockholders from transferring shares of our common stock, including transfers
by holders of the Class B common stock. If such transfer results in a change in
control of Sonic, it could result in the termination or non-renewal of one or
more of our franchise agreements and a default under our credit arrangements.
Moreover, these issuance limitations may impede our ability to raise capital
through additional equity offerings or to issue our stock as consideration for
future acquisitions.
Manufacturers' restrictions on acquisitions could limit our future growth.
We are required to obtain the consent of the applicable manufacturer before
the acquisition of any additional dealership franchises. We cannot assure you
that manufacturers will grant such approvals, although the denial of such
approval may be subject to certain state franchise laws.
Obtaining manufacturer consent for acquisitions could also take a
significant amount of time. Obtaining manufacturer approval for our completed
acquisitions has taken approximately three to five months. We believe that
manufacturer approvals of subsequent acquisitions from manufacturers with which
we have previously completed applications and agreements may take less time,
although we cannot provide you with assurances to that effect. In addition,
under an applicable franchise agreement or under state law, a manufacturer may
have a right of first refusal to acquire a dealership in the event we seek to
acquire that dealership franchise.
If we experience delays in obtaining, or fail to obtain, manufacturer
approvals for dealership acquisitions, our growth strategy could be materially
adversely affected. In determining whether to approve an acquisition, the
manufacturers may consider many factors, including:
. our management's moral character;
. the business experience of the post-acquisition dealership management;
. our financial condition;
. our ownership structure; and
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. manufacturer-determined consumer satisfaction index scores.
In addition, a manufacturer may seek to limit the number of its dealerships
that we may own, our national market share of that manufacturer's products or
the number of dealerships we may own in a particular geographic area. These
restrictions may not be enforceable under state franchise laws.
. Our framework agreement with Ford places the following restrictions on
our ability to acquire Ford or Lincoln Mercury dealerships:
. We may not acquire additional Ford or Lincoln Mercury dealerships
unless we continue to satisfy Ford's requirement that 80% of our
Ford dealerships meet Ford's performance criteria. Beyond that,
we may not make an acquisition that would result in our owning
Ford or Lincoln Mercury dealerships with sales exceeding 5% of
the total Ford or total Lincoln Mercury retail sales of new
vehicles in the United States for the preceding calendar year.
. We may not acquire additional Ford or Lincoln Mercury dealerships
in a particular state if such an acquisition would result in our
owning Ford or Lincoln Mercury dealerships with sales exceeding
5% of the total Ford or total Lincoln Mercury retail sales of new
vehicles in that state for the preceding calendar year.
. We may not acquire additional Ford dealerships in a Ford-defined
market area if such an acquisition would result in our owning
more than one Ford dealership in a market having a total of three
or less Ford dealerships or owning more than 25% of the Ford
dealerships in a market having a total of four or more Ford
dealerships. An identical market area restriction applies for
Lincoln Mercury dealerships.
. Our framework agreement with Toyota limits the number of Toyota and
Lexus dealerships that we may own on a national level, in each Toyota-
defined geographic region or distributor area, and in each Toyota or
Lexus-defined metropolitan market. Nationally, the limitations on
Toyota dealerships owned by us are for specified time periods and are
based on specified percentages of total Toyota unit sales in the
United States. In Toyota-defined geographic regions or distributor
areas, the limitations on Toyota dealerships owned by us are specified
by the applicable Toyota regional limitations policy or distributor's
policy in effect at such time. In Toyota-defined metropolitan markets,
the limitations on Toyota dealerships owned by us are based on
Toyota's metro markets limitation policy then in effect, which
currently provides a limitation based on the total number of Toyota
dealerships in the particular market. For Lexus, we may own no more
than one Lexus dealership in any one Lexus-defined metropolitan market
and no more than three Lexus dealerships nationally.
. Our framework agreement with Honda limits the number of Honda and
Acura dealerships that we may own on a national level, in each Honda
and Acura-defined geographic zone, and in each Honda-defined
metropolitan market. Nationally, the limitations on Honda dealerships
owned by us are based on specified percentages of total Honda unit
sales in the United States. In Honda-defined geographic zones, the
limitations on Honda dealerships owned by us are based on specified
percentages of total Honda unit sales in each of 10 Honda-defined
geographic zones. In Honda-defined metropolitan markets, the
limitations on Honda dealerships owned by us are specified numbers of
dealerships in each market, which numerical limits vary based mainly
on the total number of Honda dealerships in a particular market. For
Acura, we may own no more than (A) two Acura
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dealerships in a Honda-defined metropolitan market, (B) three Acura
dealerships in any one of six Honda-defined geographic zones and (C)
five Acura dealerships nationally. Honda also prohibits ownership of
contiguous dealerships.
. Mercedes restricts any company from owning Mercedes dealerships with
sales of more than 3% of total sales of Mercedes vehicles in the U.S.
during the previous calendar year.
. General Motors currently limits the maximum number of General Motors
dealerships that we may acquire to 50% of the General Motors
dealerships, by brand line, in a General Motors-defined geographic
market area having multiple General Motors dealers.
. Subaru limits us to no more than two Subaru dealerships within certain
designated market areas, four Subaru dealerships within its Mid-
America region and 12 dealerships within Subaru's entire area of
distribution.
. BMW currently prohibits publicly held companies from owning BMW
dealerships representing more than 10% of all BMW sales in the U.S. or
more than 50% of BMW dealerships in a given metropolitan market.
. Toyota, Honda and Mercedes also prohibit the coupling of a franchise
with any other brand without their consent.
As a condition to granting their consent to our acquisitions, a number of
manufacturers required additional restrictions. These agreements principally
restrict:
. material changes in our company or extraordinary corporate
transactions such as a merger, sale of a material amount of assets or
change in our board of directors or management that could have a
material adverse effect on the manufacturer's image or reputation or
could be materially incompatible with the manufacturer's interests;
. the removal of a dealership general manager without the consent of the
manufacturer; and
. the use of dealership facilities to sell or service new vehicles of
other manufacturers.
In addition, manufacturer consent to our acquisitions may impose
conditions, such as requiring facilities improvements by us at the acquired
dealership.
If we are unable to comply with these restrictions, we generally:
. must sell the assets of the dealerships to the manufacturer or to a
third party acceptable to the manufacturer; or
. terminate the dealership agreements with the manufacturer.
Other manufacturers may impose other and more stringent restrictions in
connection with future acquisitions.
As of November 9, 2001, we owned the following number of franchises for the
following manufacturers:
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Number of Number of
Manufacturer Franchises Manufacturer Franchises
- ------------ ---------- ------------ ----------
Chevrolet 13 Lexus 4
Honda 13 Lincoln 4
Ford 12 Mercedes 4
BMW 10 Hyundai 3
Cadillac 10 Isuzu 3
Nissan 10 Mitsubishi 3
Toyota 9 Kia 2
Volvo 9 Audi 2
Dodge 8 Infiniti 2
Chrysler 7 Pontiac 2
Jeep 6 Porsche 2
Mercury 5 GMC 1
Oldsmobile 4 Acura 1
Volkswagen 4 Land Rover 1
Subaru 1
Our failure to meet a manufacturer's consumer satisfaction requirements may
adversely affect our ability to acquire new dealerships and our profitability.
Many manufacturers attempt to measure customers' satisfaction with their
sales and warranty service experiences through systems which vary from
manufacturer to manufacturer, but which are generally known as customer
satisfaction index, or scores. These manufacturers may use a dealership's CSI
scores as a factor in evaluating applications for additional dealership
acquisitions. The components of CSI have been modified by various manufacturers
from time to time in the past, and we cannot assure you that these components
will not be further modified or replaced by different systems in the future. To
date, we have not been materially adversely affected by these standards and have
not been denied approval of any acquisition based on low CSI scores, except for
Jaguar's refusal to approve our acquisition of a Chattanooga Jaguar franchise in
1997. However, we cannot assure you that we will be able to comply with these
standards in the future. A manufacturer may refuse to consent to an acquisition
of one of its franchises if it determines our dealerships do not comply with the
manufacturer's CSI standards. This could materially adversely affect our
acquisition strategy. In addition, we receive payments from the manufacturers
based, in part, on CSI scores, which could be materially adversely affected if
our CSI scores decline.
There are limitations on our financial resources available for acquisitions.
We intend to finance our acquisitions with cash generated from operations,
through issuances of our stock or debt securities and through borrowings under
credit arrangements.
. We cannot assure you that we will be able to obtain additional
financing by issuing stock or debt securities.
. Using cash to complete acquisitions could substantially limit our
operating or financial flexibility.
If we are unable to obtain financing on acceptable terms, we may be
required to reduce the scope of our presently anticipated expansion, which could
materially adversely affect our growth strategy.
We estimate that as of September 30, 2001, we had approximately $229.2
million available for additional borrowings under the Revolving Facility, based
on a borrowing base calculated on the basis of
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our receivables, inventory and equipment and a pledge of certain additional
collateral by an affiliate of Sonic (which borrowing base was $541.6 million of
the $600.0 million facility at September 30, 2001).
In addition, we are dependent to a significant extent on our ability to
finance our inventory with "floor plan financing." Floor plan financing is how a
dealership finances its purchase of new vehicles from a manufacturer. The
dealership borrows money to buy a particular vehicle from the manufacturer and
pays off the loan when it sells that particular vehicle, paying interest during
this period. We must obtain new floor plan financing or obtain consents to
assume existing floor plan financing in connection with our acquisition of
dealerships.
Substantially all the assets of our dealerships are pledged to secure this
floor plan indebtedness. In addition, substantially all the real property and
assets of our subsidiaries that are constructing new dealerships are pledged
under our Mortgage Facility with Ford Motor Credit. These pledges may impede our
ability to borrow from other sources.
Finally, because Ford Motor Credit is associated with Ford, any
deterioration of our relationship with one could adversely affect our
relationship with the other. The same is true of our relationships with Chrysler
and Chrysler Financial, GM and GMAC, and Toyota and Toyota Credit.
Although O. Bruton Smith, our Chairman and Chief Executive Officer, has
previously facilitated our acquisition financing, we cannot assure you that he
will be willing or able to assist in our financing needs in the future.
Mr. Smith initially guaranteed obligations under the Revolving Facility.
Such obligations were further secured with a pledge of shares of common stock of
Speedway Motorsports, Inc. ("SMI") owned by Sonic Financial Corporation ("SFC"),
a corporation controlled by Mr. Smith having an estimated value at the time of
the pledge of approximately $50.0 million (the "Revolving Pledge"). When the
Revolving Facility's borrowing limit was increased to $75.0 million in 1997, Mr.
Smith's personal guarantee of Sonic's obligations under the Revolving Facility
was released, although the Revolving Pledge remained in place. Mr. Smith was
also required by Ford Motor Credit to lend $5.5 million (the "Subordinated Smith
Loan") to Sonic to increase our capitalization because the net proceeds from our
November 1997 initial public offering were significantly less than expected. In
August 1998, Ford Motor Credit released the Revolving Pledge. In November 1999,
Ford Motor Credit further increased the borrowing limit under the Revolving
Facility to $350.0 million subject to a borrowing base calculated on the basis
of our receivables, inventory and equipment and a continuing pledge by SFC of
five million shares of SMI common stock. Presently, the borrowing limit of the
Revolving Facility is $600.0 million, subject to a similar borrowing base,
including SFC's continuing pledge of SMI stock.
Before our acquisition of FirstAmerica Automotive, Inc. ("FirstAmerica")
Mr. Smith guaranteed the obligations of FirstAmerica under FirstAmerica's new
acquisition line of credit with Ford Motor Credit. FirstAmerica obtained this
new financing to enable it to complete its then pending acquisitions. The
borrowing limit on this credit facility was approximately $138 million. Mr.
Smith had guaranteed approximately $107 million of this amount, which guarantee
was secured by a pledge of five million shares of SMI common stock owned by SFC.
We assumed FirstAmerica's obligations to Ford Motor Credit under our Revolving
Facility when we acquired FirstAmerica. Mr. Smith's secured guarantee in favor
of Ford Motor Credit guaranteed a portion of our obligations under the Revolving
Facility until August 2000. After August 2000, Mr. Smith did not provide a
guarantee in favor of the Revolving Facility lenders, but SFC continues to
pledge SMI stock as collateral. We cannot assure you that Mr. Smith will be
willing or able to provide similar guarantees or credit support in the future to
facilitate Sonic's future acquisitions.
Automobile retailing is a mature industry with limited growth potential in new
vehicle sales, and our acquisition strategy will affect our revenues and
earnings.
The United States automobile dealership industry is considered a mature
industry in which minimal growth is expected in unit sales of new vehicles. As a
consequence, growth in our revenues and
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earnings is likely to be significantly affected by our success in acquiring and
integrating dealerships and the pace and size of such acquisitions.
High competition in automobile retailing reduces our profit margins on vehicle
sales. Further, the use of the Internet in the car purchasing process could
materially adversely affect us.
Automobile retailing is a highly competitive business with approximately
21,600 franchised automobile dealerships in the United States at the end of
2000. Our competition includes:
. Franchised automobile dealerships selling the same or similar makes of
new and used vehicles that we offer in our markets and sometimes at
lower prices than we offer. Some of these dealer competitors may be
larger and have greater financial and marketing resources than we do;
. Other franchised dealers;
. Private market buyers and sellers of used vehicles;
. Used vehicle dealers;
. Internet-based vehicle brokers that sell vehicles obtained from
franchised dealers directly to consumers;
. Service center chain stores; and
. Independent service and repair shops.
Our financing and insurance ("F&I") business and other related businesses,
which provide higher contributions to our earnings than sales of new and used
vehicles, are subject to strong competition from various financial institutions
and other third parties. This competition is increasing as these products are
now being marketed and sold over the Internet.
Gross profit margins on sales of new vehicles have been generally declining
since 1986. We do not have any cost advantage in purchasing new vehicles from
manufacturers, due to economies of scale or otherwise. We typically rely on
advertising, merchandising, sales expertise, service reputation and dealership
location to sell new vehicles. The following factors could have a significant
impact on our business:
. The Internet has become a significant part of the sales process in our
industry. Customers are using the Internet to compare pricing for cars
and related F&I services, which may further reduce margins for new and
used cars and profits for related F&I services. In addition,
CarsDirect.com and others are selling vehicles over the Internet
without the benefit of having a dealership franchise, although they
must currently source their vehicles from a franchised dealer.
CarsDirect.com is in an alliance with United Auto Group to facilitate
their sourcing of vehicles. Also, AutoNation, Inc. is selling vehicles
for its new car dealerships through its AutoNationDirect.com web site.
If Internet new vehicle sales are allowed to be conducted without the
involvement of franchised dealers, our business could be materially
adversely affected. In addition, other franchise groups have aligned
themselves with Internet car sellers or are spending significant sums
on developing their own Internet capabilities, which could materially
adversely affect our business.
. Our revenues and profitability could be materially adversely affected
should manufacturers decide to enter the retail market directly.
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. The increased popularity of short-term vehicle leasing also has
resulted, as these leases expire, in a large increase in the number of
late model vehicles available in the market, which puts added pressure
on new and used vehicle margins.
. Some of our competitors may be capable of operating on smaller gross
margins than we are, and the on-line auto brokers have been operating
at a loss.
. As we seek to acquire dealerships in new markets, we may face
increasingly significant competition as we strive to gain market share
through acquisitions or otherwise. This competition includes other
large dealer groups and dealer groups that have publicly traded
equity.
Our franchise agreements do not grant us the exclusive right to sell a
manufacturer's product within a given geographic area. Our revenues or
profitability could be materially adversely affected if any of our manufacturers
award franchises to others in the same markets where we operate, although
certain state franchise laws may limit such activities by the manufacturers. A
similar adverse effect could occur if existing competing franchised dealers
increase their market share in our markets. Our gross margins may decline over
time as we expand into markets where we do not have a leading position. These
and other competitive pressures could materially adversely affect our results of
operations.
The cyclical and local nature of automobile sales may adversely affect our
profitability.
The automobile industry is cyclical and historically has experienced
periodic downturns characterized by oversupply and weak demand. Many factors
affect the industry, including general economic conditions and consumer
confidence, fuel prices, the level of discretionary personal income,
unemployment rates, interest rates and credit availability. We are in the midst
of an industry and general economic slowdown that could materially adversely
effect our business.
New and used vehicle sales substantially slowed immediately following the
terrorist attacks of September 11, 2001. In response, certain manufacturers,
especially of domestic brands, have introduced incentive programs, which have
contributed to a significant increase in the pace of new vehicle sales in
October. In addition, we have seen an increase in used vehicle sales in October
as well as an increase in sales of new vehicles whose manufacturers have not
offered similar incentive programs. We are not able to determine how long the
manufacturers will continue to offer these aggressive incentive programs or how
long the overall increase in demand will continue, but expect that, absent these
incentive programs, vehicle sales may begin to slow again in November and
December and continue slowing into 2002. In addition, we are not able to
determine the long-term consequences the terrorist attacks and subsequent
outbreaks of hostilities will have on general economic conditions, our industry,
or Sonic.
Local economic, competitive and other conditions also affect the
performance of dealerships. Our dealerships currently are located in the
Atlanta, Baltimore, Birmingham, Charleston, Charlotte, Chattanooga, Columbia,
Columbus, Dallas, Daytona Beach, Fort Myers, Greenville/Spartanburg, Houston,
Las Vegas, Los Angeles, Mobile/Pensacola, Montgomery, Nashville, Oklahoma City,
San Diego, San Francisco, San Jose/Silicon Valley, Tampa/Clearwater, Tulsa and
Washington, D.C. markets. We intend to pursue acquisitions outside of these
markets, but our operational focus is on our current markets. As a result, our
results of operations depend substantially on general economic conditions and
consumer spending habits in the Southeast and Northern California and, to a
lesser extent, the Houston and Columbus markets. Sales in our Northern
California market represented 20.6% of our sales for the nine months ended
September 30, 2001. Our results of operations also depend on other factors, such
as tax rates and state and local regulations specific to the states in which we
currently operate. Sonic may not be able to expand geographically and any such
expansion may not adequately insulate it from the adverse effects of local or
regional economic conditions.
We can offer you no assurances that we will be able to continue executing our
acquisition strategy without the costs of future acquisitions escalating.
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Although there are many potential acquisition candidates that fit our
acquisition criteria, we cannot assure you that we will be able to consummate
any such transactions in the future or identify those candidates that would
result in the most successful combinations, or that future acquisitions will be
able to be consummated at acceptable prices and terms. In addition, increased
competition for acquisition candidates could result in fewer acquisition
opportunities for us and higher acquisition prices. The magnitude, timing,
pricing and nature of future acquisitions will depend upon various factors,
including:
. the availability of suitable acquisition candidates;
. competition with other dealer groups for suitable acquisitions;
. the negotiation of acceptable terms;
. our financial capabilities;
. our stock price;
. the availability of skilled employees to manage the acquired
companies; and
. general economic and business conditions.
We may be required to file applications and obtain clearances under
applicable federal antitrust laws before completing an acquisition. These
regulatory requirements may restrict or delay our acquisitions, and may increase
the cost of completing acquisitions.
The operating condition of acquired businesses cannot be determined accurately
until we assume control.
Although we conduct what we believe to be a prudent level of investigation
regarding the operating condition of the businesses we purchase, in light of the
circumstances of each transaction, an unavoidable level of risk remains
regarding the actual operating condition of these businesses. Until we actually
assume operating control of such business assets, we may not be able to
ascertain the actual value of the acquired entity.
Potential conflicts of interest between Sonic and its officers could adversely
affect our future performance.
O. Bruton Smith serves as the chairman and chief executive officer of
Speedway Motorsports, Inc. ("SMI"). Accordingly, Sonic competes with SMI for the
management time of Mr. Smith. Under his employment agreement with Sonic, Mr.
Smith is required to devote approximately 50% of his business time to our
business. The remainder of his business time may be devoted to other entities,
including SMI.
Sonic has in the past and will likely in the future enter into transactions
with Mr. Smith, entities controlled by Mr. Smith or other affiliates of Sonic.
We believe that all of our existing arrangements with affiliates are as
favorable to us as if the arrangements were negotiated between unaffiliated
parties, although the majority of such transactions have neither been
independently verified in that regard nor are likely to be so verified in the
future. Potential conflicts of interest could arise in the future between Sonic
and its officers or directors in the enforcement, amendment or termination of
arrangements existing between them.
Under Delaware law generally, a corporate insider is precluded from acting
on a business opportunity in his individual capacity if that opportunity is
(1) one which the corporation is financially able to undertake,
(2) is in the line of the corporation's business,
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(3) is of practical advantage to the corporation, and
(4) is one in which the corporation has an interest or reasonable
expectancy.
Accordingly, our corporate insiders are generally prohibited from engaging
in new dealership-related business opportunities outside of Sonic unless a
majority of Sonic's disinterested directors decide that such opportunities are
not in our best interest.
Sonic's charter contains provisions providing that transactions between
Sonic and its affiliates must be no less favorable to Sonic than would be
available in similar transactions with an unrelated third party. Moreover, any
such transactions involving aggregate payments in excess of $500,000 must be
approved by a majority of Sonic's directors and a majority of Sonic's
independent directors. If not so approved, Sonic must obtain an opinion as to
the financial fairness of the transaction to be issued by an investment banking
or appraisal firm of national standing. In addition, the terms of the Revolving
Facility and Sonic's existing senior subordinated notes restrict transactions
with affiliates in a manner similar to Sonic's charter restrictions.
Lack of majority of independent directors could result in conflicts between us
and our management and majority stockholders that may reduce our future
performance.
Independent directors do not constitute a majority of our board, and our
board may not have a majority of independent directors in the future. Without a
majority of independent directors, Sonic's executive officers, principal
stockholders and directors could establish policies and enter into transactions
without independent review and approval, subject to certain restrictions under
our charter. These policies and transactions could present the potential for a
conflict of interest between Sonic and its minority stockholders and the
controlling officers, stockholders or directors.
The loss of key personnel and limited management and personnel resources could
adversely affect our operations and growth.
Our success depends to a significant degree upon the continued
contributions of Sonic's management team, particularly its senior management,
and service and sales personnel. Additionally, manufacturer franchise agreements
may require the prior approval of the applicable manufacturer before any change
is made in franchise general managers. We do not have employment agreements with
most of our dealership managers and other key dealership personnel.
Consequently, the loss of the services of one or more of these key employees
could have a material adverse effect on our results of operations.
In addition, as we expand we may need to hire additional managers. The
market for qualified employees in the industry and in the regions in which we
operate, particularly for general managers and sales and service personnel, is
highly competitive and may subject us to increased labor costs during periods of
low unemployment. The loss of the services of key employees or the inability to
attract additional qualified managers could have a material adverse effect on
our results of operations. In addition, the lack of qualified management or
employees employed by potential acquisition candidates may limit our ability to
consummate future acquisitions.
Seasonality of the automotive retail business adversely affects first quarter
revenues.
Our business is seasonal, with a disproportionate amount of revenues
received generally in the second, third and fourth fiscal quarters.
Import product restrictions and foreign trade risks may impair our ability to
sell foreign vehicles profitably.
Some of the vehicles and major components of vehicles we sell are
manufactured in foreign countries. Accordingly, we are subject to the import and
export restrictions of various jurisdictions and are dependent to some extent
upon general economic conditions in, and political relations with, a number of
foreign countries, particularly Germany, Japan and Sweden. Fluctuations in
currency exchange rates may
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also adversely affect our sales of vehicles produced by foreign manufacturers.
Imports into the United States may also be adversely affected by increased
transportation costs and tariffs, quotas or duties.
Governmental regulation and environmental regulation compliance costs may
adversely affect our profitability.
We are subject to a wide range of federal, state and local laws and
regulations, such as local licensing requirements and consumer protection laws.
The violation of these laws and regulations can result in civil and criminal
penalties against us or in a cease and desist order against our operations if we
are not in compliance. Our future acquisitions may also be subject to
regulation, including antitrust reviews. We believe that we comply in all
material respects with all laws and regulations applicable to our business, but
future regulations may be more stringent and require us to incur significant
additional costs.
Our facilities and operations are also subject to federal, state and local
laws and regulations relating to environmental protection and human health and
safety, including those governing wastewater discharges, air emissions, the
operation and removal of underground and aboveground storage tanks, the use,
storage, treatment, transportation, release, recycling and disposal of solid and
hazardous materials and wastes and the cleanup of contaminated property or
water. We may be required by these laws to pay the full amount of the costs of
investigation and/or remediation of contaminated properties, even if we are not
at fault for disposal of the materials or if such disposal was legal at the
time. People who may be found liable under these laws and regulations include
the present or former owner or operator of a contaminated property and companies
that generated, transported, disposed of or arranged for the transportation or
disposal of hazardous substances found at the property.
Our past and present business operations are subject to environmental laws
and regulations governing the use, storage, handling, recycling and disposal of
hazardous or toxic substances such as new and waste motor oil, oil filters,
transmission fluid, antifreeze, freon, new and waste paint and lacquer thinner,
batteries, solvents, lubricants, degreasing agents, gasoline and diesel fuels.
We are also subject to laws and regulations relating to underground storage
tanks that exist or used to exist at many of our properties. Like many of our
competitors, we have incurred, and will continue to incur, capital and operating
expenditures and other costs in complying with such laws and regulations. In
addition, soil and groundwater contamination exists at certain of our
properties. We cannot assure you that our other properties have not been or will
not become similarly contaminated. In addition, we could become subject to
potentially material new or unforeseen environmental costs or liabilities
because of our acquisitions.
Environmental laws and regulations, including those governing air emissions
and underground storage tanks, could require compliance with new or more
stringent standards that are imposed in the future. We cannot predict what other
environmental legislation or regulations will be enacted in the future, how
existing or future laws or regulations will be administered or interpreted or
what environmental conditions may be found to exist in the future. Consequently,
we may be required to make substantial expenditures in the future.
Concentration of voting power and antitakeover provisions of our charter,
Delaware law and our dealer agreements may reduce the likelihood of any
potential change of control of Sonic.
Sonic's common stock is divided into two classes with different voting
rights. This dual class stock ownership allows the present holders of the Class
B common stock to control Sonic. Holders of Class A common stock have one vote
per share on all matters. Holders of Class B common stock have 10 votes per
share on all matters, except that they have only one vote per share on any
transaction proposed by the Board of Directors or a Class B common stockholder
or otherwise benefiting the Class B common stockholders constituting a:
(1) "going private" transaction;
(2) disposition of substantially all of our assets;
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(3) transfer resulting in a change in the nature of our business; or
(4) merger or consolidation in which current holders of common stock would
own less than 50% of the common stock following such transaction.
The holders of Class B common stock currently hold less than a majority of
Sonic's outstanding common stock, but a majority of Sonic's voting power. This
may prevent or discourage a change of control of Sonic even if such action were
favored by holders of Class A common stock.
Sonic's charter and bylaws make it more difficult for its stockholders to
take corporate actions at stockholders' meetings. In addition, options under our
1997 Stock Option Plan become immediately exercisable on a change in control.
Also, Delaware law makes it difficult for stockholders who have recently
acquired a large interest in a company to consummate a business transaction with
the company against its directors' wishes. Finally, restrictions imposed by our
dealer agreements may impede or prevent any potential takeover bid. Generally,
our franchise agreements allow the manufacturers the right to terminate the
agreements upon a change of control of our company and impose restrictions upon
the transferability of any significant percentage of our stock to any one person
or entity who may be unqualified, as defined by the manufacturer, to own one of
its dealerships. The inability of a person or entity to qualify with one or more
of our manufacturers may prevent or seriously impede a potential takeover bid.
These agreements, corporate documents and laws, as well as provisions of our
lending arrangements creating an event of default on a change in control, may
have the effect of delaying or preventing a change in control or preventing
stockholders from realizing a premium on the sale of their shares upon an
acquisition of Sonic.
New accounting pronouncements on business combinations and goodwill could affect
future earnings.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141: Business Combinations.
SFAS 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. In addition, SFAS 141 provides additional
guidance regarding the measurement and recognition of goodwill and other
acquired intangible assets. The provisions of this standard became effective
beginning July 1, 2001. For acquisitions after this, we are required to
classify certain intangible assets, such as franchise rights granted from
automobile manufacturers, as intangible assets apart from goodwill.
In July 2001, the FASB also issued SFAS No. 142: Goodwill and Other
Intangible Assets. Among other things, SFAS 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, but must also be performed
upon the occurrence of an event or circumstance that indicates a possible
reduction in value. SFAS 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 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 142. The provisions of SFAS 142
become effective for us beginning January 1, 2002; however, goodwill and other
intangible assets determined to have an indefinite useful life acquired in
business combinations completed after June 30, 2001 will not be amortized. Early
adoption and retroactive application is not permitted. While we are currently
evaluating the provisions of SFAS 142, we have not yet determined its full
impact on our consolidated financial statements. As of December 31, 2000, the
carrying amount of goodwill was $668.8 million and represented 37.4% of total
assets and 148.3% of total stockholders' equity. As of September 30, 2001, the
carrying amount of goodwill was $689.2 million and represented 40.8% of total
assets and 140.7% of total stockholders' equity.
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In August 2001, the FASB issued SFAS No. 144: Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS 144 establishes a single accounting model
for assets to be disposed of by sale whether previously held and used or newly
acquired. SFAS 144 is effective for fiscal years beginning after December 15,
2001. We are currently evaluating the provisions of SFAS 144 and have not yet
determined the impact on our consolidated financial statements.
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