UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended June 30, 2005
OR
Commission file number 1-13395
SONIC AUTOMOTIVE, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(704) 566-2400
(Registrant’s telephone number, including area code)
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 ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
As of July 29, 2005, there were 28,176,101 shares of Class A Common Stock and 12,029,375 shares of Class B Common Stock outstanding.
INDEX TO FORM 10-Q
ITEM 1.Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Statements of Income – Three and six-month periods ended June 30, 2004 and June 30, 2005
Condensed Consolidated Balance Sheets – December 31, 2004 and June 30, 2005
Condensed Consolidated Statement of Stockholders’ Equity – Six-month period ended June 30, 2005
Condensed Consolidated Statements of Cash Flows – Six-month periods ended June 30, 2004 and June 30, 2005
Notes to Unaudited Condensed Consolidated Financial Statements
ITEM 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 3.Quantitative and Qualitative Disclosures About Market Risk
ITEM 4.Controls and Procedures
ITEM 1.Legal Proceedings
ITEM 2.Unregistered Sales of Equity Securities and Use of Proceeds
ITEM 4.Submission of Matters to a Vote of Security Holders
ITEM 6.Exhibits
SIGNATURES
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PART I - FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements.
SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars and shares in thousands except per share amounts)
(Unaudited)
Three Months Ended
June 30,
Six Months Ended
Revenues:
New vehicles
Used vehicles
Wholesale vehicles
Total vehicles
Parts, service and collision repair
Finance, insurance and other
Total revenues
Cost of sales
Gross profit
Selling, general and administrative expenses
Depreciation and amortization
Operating income
Other income / (expense):
Interest expense, floor plan
Interest expense, other, net
Other income / (expense), net
Total other expense
Income from continuing operations before income taxes
Provision for income taxes
Income from continuing operations
Discontinued operations:
Loss from operations and the sale of discontinued franchises
Income tax benefit
Loss from discontinued operations
Net income
Basic earnings (loss) per share:
Earnings per share from continuing operations
Loss per share from discontinued operations
Earnings per share
Weighted average common shares outstanding
Diluted earnings (loss) per share:
Dividends declared per common share
See notes to unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
Current Assets:
Cash
Receivables, net
Inventories
Assets held for sale
Other current assets
Total current assets
Property and equipment, net
Goodwill, net
Other intangible assets, net
Other assets
Total assets
Current Liabilities:
Notes payable - floor plan
Trade accounts payable
Accrued interest
Other accrued liabilities
Liabilities associated with assets held for sale
Current maturities of long-term debt
Total current liabilities
Long-term debt
Other long-term liabilities
Deferred income taxes
Commitments and contingencies
Stockholders’ Equity:
Class A Common Stock; $.01 par value; 100,000,000 shares authorized; 39,979,567 shares issued and 29,631,703 shares outstanding at December 31, 2004; 40,327,853 shares issued and 29,742,489 shares outstanding at June 30, 2005
Class B Common Stock; $.01 par value; 30,000,000 shares authorized; 12,029,375 shares issued and outstanding at December 31, 2004 and June 30, 2005
Paid-in capital
Retained earnings
Accumulated other comprehensive loss
Deferred compensation related to restricted stock
Treasury Stock, at cost (10,347,864 Class A shares held at December 31, 2004 and 10,585,364 Class A shares held at June 30, 2005)
Total stockholders’ equity
Total liabilities and stockholders’ equity
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CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Dollars and shares in thousands)
Class A
Common Stock
Class B
Paid-InCapital
Retained
Earnings
Treasury
Stock
TotalStockholders’
Equity
Balance at December 31, 2004
Comprehensive Income:
Change in fair value of interest rate swap, net of tax expense of $496
Total comprehensive income, net of tax
Shares issued under stock compensation plans
Restricted stock amortization
Income tax benefit associated with stock compensation plans
Dividends declared
Purchases of treasury stock
Balance at June 30, 2005
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by / (used in) operating activities:
Depreciation and amortization of property and equipment
Debt issue cost amortization
Debt discount / (premium) amortization, net
Equity interest in earnings of investee
(Gain) / Loss on disposal of assets, including franchises
Changes in assets and liabilities that relate to operations:
Receivables
Trade accounts payable and other liabilities
Total adjustments
Net cash provided by / (used in) operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of businesses, net of cash acquired
Purchases of property and equipment
Proceeds from sales of property and equipment
Proceeds from sales of franchises
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings on revolving credit facilities
Proceeds from long-term debt
Payments on long-term debt
Issuance of shares under stock compensation plans
Dividends paid
Net cash (used in)/provided by financing activities
NET DECREASE IN CASH
CASH, BEGINNING OF PERIOD
CASH, END OF PERIOD
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES:
Change in accrual for purchases of property and equipment
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
Restricted stock issuance
Long-term debt assumed in purchase of businesses, including premium of $7,254
Change in fair value of cash flow hedging instruments (net of tax expense of $1,296 and $496 for the six months ended June 30, 2004 and 2005, respectively)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest, net of amount capitalized
Cash paid for income taxes
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANTACCOUNTING POLICIES
Basis of Presentation - The accompanying unaudited financial information for the three and six months ended June 30, 2005 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 condensed 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 for the year ended December 31, 2004, which were included in Sonic’s Annual Report on Form 10-K.
Stock-Based Compensation - Sonic accounts for stock-based compensation plans under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. In accordance with those provisions, because the exercise price of all options granted under those plans equaled the market value of the underlying stock at the grant date, no stock-based employee compensation cost is recorded in the accompanying unaudited condensed consolidated financial statements. Using the Black-Scholes option pricing model for all options granted, the following table illustrates the effect on net income and earnings per share if Sonic had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation:
Net income as reported
Fair value compensation cost, net of tax benefits of $1,284 and $956, for the three months ended June 30, 2004 and 2005, respectively, and $2,431 and $1,840 for the six months ended June 30, 2004 and 2005, respectively
Pro forma net income
Basic earnings per share:
Earnings as reported
Fair value compensation cost, net of tax benefit
Pro forma earnings per share
Diluted earnings per share:
Reclassifications - Loss from operations and the sale of discontinued franchises for the three and six month periods ended June 30, 2004 reflects reclassifications from the prior year presentation to include additional franchises sold and terminated or identified for sale subsequent to June 30, 2004 which had not been previously included in discontinued operations and excludes franchises which had been identified for sale as of June 30, 2004 but which Sonic has decided to retain and operate as of June 30, 2005. In addition, in order to maintain consistency and comparability between periods, certain other amounts in Sonic’s accompanying unaudited condensed consolidated financial statements have been reclassified from previously reported balances to conform to the current period classification. These reclassifications primarily relate to the presentation of assets and liabilities for franchises classified as held for sale and real estate and construction costs expected to be sold in one year in sale-leaseback transactions in the accompanying unaudited condensed consolidated balance sheets.
Derivative Instruments and Hedging Activities - In the second quarter of 2005, Sonic canceled all interest rate swaps which pay a floating rate, receive a fixed rate and were designated and qualified as fair value hedges of Sonic’s Senior Subordinated 8.625% Notes (collectively, the “Cancelled Variable Swaps”). The Cancelled Variable Swaps had a collective notional value of $150.0 million, received a fixed rate of 8.625%, paid a variable rate equal to the six month LIBOR rate in arrears (as determined on February 15 and August 15 of each year) plus a spread ranging from 3.50% to 3.84% (with a weighted average spread of 3.64%) and would have expired on August 15, 2013. The Cancelled Variable Swaps had a collective mark-to-market liability of $0.4 million at
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cancellation which has been classified as long-term debt and will be amortized over the remaining life of the Senior Subordinated 8.625% Notes. In connection with this cancellation, Sonic entered into five separate new interest rate swaps with identical terms to the Cancelled Variable Swaps except that Sonic pays a variable rate equal to the six month LIBOR rate which will be fixed on February 15 and August 15 of each year plus a spread ranging from 3.825% to 3.85% (with a weighted average spread of 3.83%) (collectively, the “New Variable Swaps”). The New Variable Swaps have been designated and qualify as fair value hedges and, as a result, changes in the fair value of the New Variable Swaps of $1.2 million have been recorded against the associated fixed rate long-term debt with offsetting amounts of $1.2 million recorded as a derivative asset within other assets as of June 30, 2005.
Recent Accounting Pronouncements - In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment” which replaces SFAS No. 123 and supercedes APB 25. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award (usually the vesting period). Tax benefits associated with share-based payments will be recognized as an addition to paid-in capital. Cash retained as a result of these tax benefits will be presented in the statement of cash flows as financing cash inflows. Sonic is currently evaluating the provisions of SFAS No. 123R, which will be effective for the first quarter of 2006, and has not determined the impact on Sonic’s consolidated operating results, financial position and cash flows.
In July 2005, the FASB staff issued a draft of proposed FASB Staff Position (“FSP”) FAS 13-b, Accounting for Rental Costs Incurred during a Construction Period, for comments. As drafted, FSP FAS 13-b would require companies to expense real estate rental costs under operating leases during periods of construction beginning with periods commencing after September 15, 2005 with no requirement for retroactive application. Sonic is currently evaluating the draft provisions of FSP FAS 13-b and has not determined the impact on Sonic’s consolidated operating results, financial position and cash flows if FSP FAS 13-b is finalized.
2. BUSINESS ACQUISITIONS AND DISPOSITIONS
Acquisitions:
The aggregate purchase price for franchises acquired during the first six months of 2005 totaled approximately $52.3 million in cash, net of cash acquired, and was funded by cash from operations and borrowings under the revolving credit facility. The unaudited condensed consolidated balance sheet as of June 30, 2005 includes preliminary allocations of the purchase price of these acquisitions to the assets and liabilities acquired based on their estimated fair market values at the date of acquisition and are subject to final adjustment. As a result of these allocations, Sonic has recorded the following:
Dispositions:
During the first six months of 2005, Sonic sold ten franchises. These disposals generated cash of $6.5 million and resulted in a net loss of $1.0 million, which is included in discontinued operations in the accompanying unaudited condensed consolidated statement of income for the six months ended June 30, 2005.
In conjunction with franchise dispositions, Sonic generally agrees to indemnify the buyers from certain liabilities and costs arising from operations or events that occurred prior to sale but which may or may not be known at the time of sale, including environmental liabilities and liabilities associated from the breach of representations or warranties made under the agreements. The additional exposure associated with dispositions in the six month period ended June 30, 2005 related to subleases was $10.4 million. Sonic’s maximum exposure associated with general indemnifications increased by $9.4 million as a result of these dispositions. These indemnifications generally expire within a period of one to three years following the date of the sale. The estimated fair value of these indemnifications was not material.
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In addition to the dispositions described above, as of June 30, 2005, Sonic has identified 26 additional franchises that were held for sale. These franchises have been identified as held for sale because of unprofitable operations or various strategic considerations. These franchises are expected to be sold within one year from June 30, 2005. The operating results of these franchises are included in discontinued operations in the accompanying unaudited condensed consolidated statements of income. Assets to be disposed of in connection with franchises not yet sold, which have been classified in assets held for sale in the accompanying unaudited condensed consolidated balance sheets, consist of the following:
2005
Goodwill
Franchise assets
Liabilities to be disposed in connection with these dispositions are comprised primarily of notes payable – floor plan and are classified as liabilities associated with assets held for sale on the accompanying unaudited condensed consolidated balance sheets. Revenues associated with franchises classified as discontinued operations were $135.6 million and $173.3 million for the three month periods ended June 30, 2005 and 2004, respectively, and $289.4 million and $378.6 million for the six month periods ended June 30, 2005 and 2004, respectively. The pre-tax losses (before gains or losses on the sale of disposed franchises) associated with franchises classified as discontinued operations were $2.6 million and $1.0 million for the three month periods ended June 30, 2005 and 2004, respectively, and $5.4 million and $0.7 million for the six month periods ended June 30, 2005 and 2004, respectively.
3. INVENTORIES
Inventories consist of the following:
Parts and accessories
Other
Less inventories classified as assets held for sale
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4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 31,
2004
Land
Building and improvements
Office equipment and fixtures
Parts and service equipment
Company vehicles
Construction in progress
Total, at cost
Less accumulated depreciation
Subtotal
Less assets held for sale
Less other current assets - construction in progress held for sale
Amounts classified as other current assets – construction in progress held for sale represent dealership facilities that are or were 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 unaudited condensed consolidated balance sheets. Under the terms of the sale-leaseback transactions, Sonic sells the dealership facilities to unaffiliated third parties and enters into long-term operating leases on the dealership facilities. During the first six months of 2005, Sonic sold dealership facilities with a carrying value of $1.9 million in sale-leaseback transactions. Gains and losses from these sale-leaseback transactions were not material.
5. GOODWILL AND INTANGIBLEASSETS
The changes in the carrying amount of franchise agreements and goodwill for the six months ended June 30, 2005 were as follows:
Franchise
Agreements
Balance before assets held for sale classification, December 31, 2004
Amount classified as assets held for sale
Balance, December 31, 2004
Additions through current year acquisitions
Reductions from sales of franchises
Prior acquisition allocations
Sub-total, June 30, 2005
Increase in amount classified as assets held for sale
Balance, June 30, 2005
Franchise agreements and definite life intangible assets ($4.1 million and $4.3 million at June 30, 2005 and December 31, 2004, respectively) are classified as other intangible assets, net on the accompanying unaudited condensed consolidated balance sheets.
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6. LONG-TERM DEBT
Long-term debt consists of the following:
$550 million revolving credit facility bearing interest at 2.55 percentage points above LIBOR and maturing October 31, 2006, collateralized by all of Sonic’s assets
Senior Subordinated Notes bearing interest at 8.625%, maturing August 15, 2013, net of net discount of $3,065 and $2,940, respectively
Convertible Senior Subordinated Notes bearing interest at 5.25%, maturing May 7, 2009, net of discount of $2,606 and $2,339, respectively
Notes payable to a finance company bearing interest from 10.52% to 9.52% (with a weighted average of 10.19%), with combined monthly principal and interest payments of $325, maturing November 1, 2015 through September 1, 2016, and collateralized by letters of credit with a commercial bank, including premiums of $6,583 and $6,139, respectively (1)
Offset to variable interest rate swaps net (liability) / asset
Other notes payable (primarily equipment notes)
Less: current maturities
The indenture governing Sonic’s 8.625% senior subordinated notes limits Sonic’s ability to pay quarterly cash dividends in excess of $0.10 per share. Sonic may only pay quarterly cash dividends in excess of this amount if Sonic complies with Section 1009 of the indenture governing these notes, which was filed as Exhibit 4.4 to the Registration Statement on Form S-4 (Reg. No. 333-109426). The indenture governing Sonic’s convertible senior subordinated notes (the “Convertibles”) does not limit Sonic’s ability to pay dividends. Sonic’s credit agreement for the revolving credit facility permits cash dividends so long as no event of default or unmatured default (as defined in the credit agreement) has occurred and is continuing and provided that, after giving effect to the payment of a dividend, Sonic remains in compliance with the other terms and conditions of the credit agreement.
Neither of the conversion features on the Convertibles were satisfied during the six months ended June 30, 2005. Sonic was in compliance with all financial covenants under the above long-term debt and credit facilities as of June 30, 2005.
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7. PER SHARE DATA AND STOCK HOLDERS’ EQUITY
The calculation of diluted net income per share considers the potential dilutive effect of Sonic’s contingently convertible debt and stock options under Sonic’s stock compensation plans. The following table illustrates the dilutive effect of such items:
Basic weighted average number of common shares outstanding
Effect of dilutive securities:
Contingently convertible debt
Stock compensation plans
Weighted average number of common shares outstanding, including effect of dilutive securities
In addition to the stock options included in the table above, options to purchase 2.0 million shares and 1.9 million shares of Class A common stock were outstanding during the six month periods ended June 30, 2004 and 2005, respectively, but were not included in the computation of diluted earnings per share because the options were antidilutive. The total number of stock options outstanding at June 30, 2004 and 2005 were 6.4 million and 7.0 million, respectively.
In the second quarter of 2005, 12,000 restricted shares of Sonic Class A common stock were awarded to an executive officer. This award is subject to the same restrictions and rights as the restricted stock granted to certain executive officers in the fourth quarter of 2004. In addition, in the second quarter of 2005, 16,470 restricted shares of Sonic Class A common stock were awarded to non-employee directors of Sonic’s Board of Directors under the 2005 Formula Restricted Stock Plan for Non-Employee Directors. The restrictions on these shares generally expire one year from the grant date. Holders of these shares have voting rights and receive dividends prior to the time the restrictions lapse if, and to the extent, dividends are paid on Sonic’s common stock.
8. COMPREHENSIVE INCOME
Comprehensive income, comprised of net income and unrealized gains and losses on the fair value of interest rate swaps, was $32.1 million and $27.1 million for the second quarter of 2004 and 2005, respectively. Comprehensive income was $54.2 million and $44.9 million for the first six months of 2004 and 2005, respectively.
9. CONTINGENCIES
Legal Proceedings:
Sonic is involved, and will continue to be involved, in numerous legal proceedings arising in the ordinary course of business, including litigation with customers, employment related lawsuits, contractual disputes, class actions, purported class actions and actions brought by governmental authorities.
Several of Sonic’s Texas dealership subsidiaries have been named in three class action lawsuits against the Texas Automobile Dealers Association (“TADA”) and new vehicle dealerships in Texas that are members of the TADA. Approximately 630 Texas dealerships are named as defendants in two of the actions, and approximately 700 dealerships are named as defendants in the other action. The three actions allege that since 1994, Texas automobile dealerships have deceived customers with respect to a vehicle inventory tax and violated federal antitrust and other laws. In April 2002, in two actions, the Texas state court certified two classes of consumers on whose behalf the actions would proceed. The Texas Court of Appeals subsequently affirmed the trial court’s order of class certification in the state actions, and the Texas Supreme Court issued an order for the second time in September 2004 stating that it would not hear the merits of the defendant’s appeal on class certification. The federal trial court conditionally certified a class of consumers in the federal antitrust case, but on appeal by the defendant dealerships, the U.S. Court of Appeals for the Fifth Circuit reversed the certification of the plaintiff class in October 2004 and remanded the case back to the federal trial court for further proceedings not inconsistent with the Fifth Circuit’s ruling. The plaintiffs have appealed this ruling by the Fifth Circuit.
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In June 2005, Sonic’s Texas dealerships and several other dealership defendants entered into a settlement agreement with the plaintiffs in both the state and the federal cases that would settle each of the cases on behalf of Sonic’s Texas dealerships. The settlements are contingent upon court approval, and the court has not yet scheduled a date for a hearing on that approval. The estimated expense of the proposed settlements is not a material amount to Sonic as a whole, and it includes Sonic’s Texas dealerships issuing coupons for discounts off future vehicle purchases, refunding cash in certain circumstances, and paying attorneys’ fees and certain costs. Under the terms of the settlements, Sonic’s Texas dealerships would continue to itemize and pass through to the customer the cost of the inventory tax. If the TADA matters are not settled, Sonic’s Texas dealership subsidiaries would then vigorously defend themselves and assert available defenses. In addition, Sonic may have rights of indemnification with respect to certain aspects of the TADA matters. However, an adverse resolution of the TADA matters could result in the payment of significant costs and damages and negatively impact Sonic’s Texas dealerships’ ability to itemize and pass through to the customer the cost of the inventory tax in the future, which could have a material adverse effect on Sonic’s future results of operations, financial condition and cash flows.
Sonic is also a defendant in the matter of Galura, et al. v. Sonic Automotive, Inc., a private civil action filed in the Circuit Court of Hillsborough County, Florida. In this action, originally filed on December 30, 2002, the plaintiffs allege that Sonic and Sonic’s Florida dealerships sold an antitheft protection product in a deceptive or otherwise illegal manner, and further sought representation on behalf of any customer of any of Sonic’s Florida dealerships who purchased the antitheft protection product since December 30, 1998. The plaintiffs are seeking monetary damages and injunctive relief on behalf of this class of customers. In June 2005, the court granted the plaintiffs’ motion for certification of the requested class of customers, but the court has made no finding to date regarding actual liability in this lawsuit. On July 1, 2005, Sonic filed a notice of appeal of the court’s class certification ruling with Florida’s Second District Court of Appeal. Sonic intends to continue vigorous defense of this lawsuit, including the aforementioned appeal of the trial court’s class certification order, and to assert available defenses. However, an adverse resolution of this lawsuit could result in the payment of significant costs and damages, which could have a material adverse effect on Sonic’s future results of operations, financial condition and cash flows.
In addition to the TADA matters and a Florida lawsuit described above, Sonic is involved in numerous other legal proceedings arising out of the conduct of Sonic’s business. Sonic’s management does not believe that the ultimate resolution of these other legal proceedings will have a material adverse effect on the Company’s business, financial condition, results of operations, cash flows or prospects. However, the results of these legal proceedings cannot be predicted with certainty, and an unfavorable resolution of one or more of these legal proceedings could have a material adverse effect on Sonic’s business, financial condition, results of operations, cash flows and prospects. Included in other accrued liabilities at December 31, 2004 and June 30, 2005 are $2.9 million and $2.8 million, respectively, in reserves that Sonic has provided for these matters.
Guarantees:
In accordance with the terms of Sonic’s operating lease agreements, Sonic’s dealership subsidiaries, acting as lessees, generally agree to indemnify the lessor from certain exposure arising as a result of the use of the leased premises, including environmental exposure and repairs to leased property upon termination of the lease. In addition, Sonic has generally agreed to indemnify the lessor in the event of a breach of the lease by the lessee.
In connection with franchise dispositions, certain of Sonic’s dealership subsidiaries have assigned or sublet to the buyer their interests in real property leases associated with such dealerships. In general, the subsidiaries retain responsibility for the performance of certain obligations under such leases, including rent payments and repairs to leased property upon termination of the lease, to the extent that the assignee or sublessee does not perform. The total estimated rent payments remaining under such leases as of June 30, 2005 was approximately $63.7 million. However, in accordance with the terms of the assignment and sublease agreements, the assignees and sublessees have generally agreed to indemnify Sonic and its subsidiaries in the event of non-performance. Additionally, in connection with certain dispositions, Sonic has obtained indemnifications from the parent company or owners of these assignees and sublessees in the event of non-performance.
In accordance with the terms of agreements entered into for the sale of our franchises, Sonic generally agrees to indemnify the buyer from certain exposure and costs arising subsequent to the date of sale, including environmental exposure and exposure resulting from the breach of representations or warranties made in accordance with the agreement. While Sonic’s exposure with respect to environmental remediation and repairs is difficult to quantify, Sonic estimates that the maximum exposure associated with these general indemnifications was approximately $16.3 million at June 30, 2005. These indemnifications generally expire within a period of one to three years following the date of sale. The estimated fair value of these indemnifications was not material.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 Condensed Consolidated Financial Statements and the related notes thereto appearing elsewhere in this report, as well as the audited financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in our Annual Report on Form 10-K for the year ended December 31, 2004.
Overview
We are one of the largest automotive retailers in the United States. As of July 29, 2005, we owned dealership subsidiaries that operated 186 dealership franchises, representing 38 different brands of cars and light trucks at 155 locations, and 39 collision repair centers in 15 states. Our dealerships provide comprehensive services including sales of both new and used cars and light trucks, sales of replacement parts, performance of vehicle maintenance, warranty, paint and collision repair services, and arrangement of extended service contracts, financing and insurance, vehicle protection products and other aftermarket products (collectively, “F&I”) for our automotive customers. Our brand diversity allows us to offer a broad range of products at a wide range of prices from lower priced, or economy vehicles, to luxury vehicles. We believe that this diversity reduces the risk of changes in customer preferences, product supply shortages and aging products. In addition, although vehicle sales are cyclical and are affected by many factors, including general economic conditions, consumer confidence, levels of discretionary personal income, interest rates and available credit, our parts, service and collision repair services are not closely tied to vehicle sales and are not dependent upon near-term vehicle sales volume. As a result, we believe the diversity of these products and services reduces the risk of periodic economic downturns.
The following is a detail of our new vehicle revenues by brand for the three and six month periods ended June 30, 2004 and 2005:
Brand (1)
Honda
BMW
Cadillac
General Motors (2)
Toyota
Ford
Lexus
Mercedes
Volvo
Nissan
Chrysler (3)
Hyundai
Volkswagen
Audi
Other Luxury (4)
Other (5)
Total
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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 consolidated financial statements the results of operations of these dealerships prior to the date they were acquired. Our unaudited condensed consolidated financial statements discussed below reflect the results of operations, financial position and cash flows of each of our dealerships acquired prior to June 30, 2005. As a result of the effects of our acquisitions and 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 that 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.
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Results of Operations
Except where otherwise noted, the following discussions are on a same store basis.
Revenues
New Vehicles:
Units or $
Change
%
For the Six Months Ended
New Vehicle Units
Same Store
Acquisitions
Total as Reported
New Vehicle Revenue (in thousands)
New Vehicle Unit Price
New unit sales at our import dealerships increased by 1,858 units, or 8.1%, and 2,877 units, or 6.7%, for the three and six months ended June 30, 2005, respectively, as compared to the same periods last year, which outpaced the industry-wide import new unit sales of 4.7% and 3.8% for the same periods. Our domestic new unit sales increased 1,151 units, or 8.1%, and 948 units, or 3.5% over the same periods. The industry’s domestic unit sales increased 3.5% and 0.6% during the same time periods, respectively. Our GM (including Cadillac) stores showed a significant improvement in unit sales, increasing by 1,229 units, or 15.6%, and 885 units, or 5.9%, for the three and six months ended June 30, 2005, respectively, which can be mainly attributed to the new temporary manufacturer programs which offer employee discounts to all customers. Our Ford stores had the largest decrease in new retail units (excluding fleet) of our domestic brands, decreasing by 435 units, or 14.1%, and 753 units, or 13.1%, for the three and six months ended June 30, 2005, respectively, due primarily to the highly competitive truck and SUV market and the related impact of higher gasoline prices on customer vehicle preference.
Our Ford and GM stores’ unit volume benefited from strong fleet sales in the second quarter of 2005, which increased 400 units, or 18.5%, and 317 units, or 25.8%, respectively. During the six month period ended June 30, 2005, these two brands experienced similar fleet unit volume increases (up 980 units, or 24.1%, and 454 units, or 23.7%, respectively).
Our import dealerships had an average price per unit increase of 2.5% for the three and six month periods ended June 30, 2005. The price increases were primarily due to the change in sales mix for the quarter compared to the same periods in 2004. Specifically, our Honda dealerships had a greater percentage of truck and van sales and our Lexus dealerships had a greater percentage of sales coming from SUVs. Our domestic dealerships had average unit price decreases of 0.4% and 1.3% for the three and six months ended June 30, 2005, respectively, as compared to the prior year. These price decreases were mainly attributable to the manufacturer programs mentioned above and the continuation of competitive market conditions associated with an oversupply of certain domestic brands, primarily GM and Cadillac. Our Ford stores had an average price per unit increase of $867 or 3.7%, and $367 or 1.5%, for the quarter and year to date periods ended June 30, 2005, respectively, which was primarily attributable to price increases for two models.
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Used Vehicles:
Used Vehicle Units
Used Vehicle Revenue (in thousands)
Used Vehicle Unit Price
Used vehicle unit sales increased despite lower activity at our domestic stores, which were down 153 units, or 2.3%, and 605 units, or 4.3%, for the three and six months ended June 30, 2005, respectively. We expect the retail environment for used vehicles to remain challenging to the extent new vehicle incentives and promotions continue to drive new vehicle sales. The increases in the average price per unit of 2.3% and 2.4% for the three and six months ended June 30, 2005, respectively, were mostly attributable to an increase in certified pre-owned (“CPO”) revenue as a percentage of total used vehicle revenue and a continuing shift in our dealership mix towards more luxury dealerships. CPO revenue as a percentage of total used vehicle revenue increased from 43.0% to 48.0% during the three month period and from 43.8% to 48.0% during the six month period ended June 30, 2005, as compared to the same periods in 2004.
Wholesale Vehicles:
Wholesale Vehicle Units
Wholesale Vehicle Revenue (in thousands)
Wholesale Unit Price
Higher revenues realized in the second quarter of 2005 were driven by higher unit sales prices and an increase in unit sales. These results were consistent with the results for the six month period ended June 30, 2005. Favorable wholesale pricing increases followed the increases experienced in used retail sales and were consistent with the industry.
Parts, Service and Collision Repair (“Fixed Operations”):
Fixed Operations Revenue (in thousands)
For the quarter ended June 30, 2005, both parts and service revenue and collision repair revenue increased over the same period last year. For the six month period ended June 30, 2005, parts and service revenue increased and collision repair revenue decreased over the same period last year. Strong customer pay services increased in the quarter ended June 30, 2005 of $5.2 million, or 5.9% were primarily responsible. Luxury imports drove the majority of the increases in customer pay (up $4.0 million, or 14.1%, and $6.1
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million, or 11.2%, for the three and six month periods ended June 30, 2005, respectively). Warranty revenues increased $0.6 million, or 1.3%, and $2.1 million, or 2.3%, for the three and six months periods due to strong increases at our BMW stores which were offset by decreases in the majority of our other brands.
Finance, Insurance and Other:
$
Finance, Insurance and Other Revenue (in thousands)
Total F&I per Unit
Same Store, Excluding Fleet Units
An overall sales volume increase in new vehicles was responsible for a majority of the increase in finance, insurance and other revenues for the quarter ended June 30, 2005 as compared to the same period last year. Also contributing to the overall increase was an increase in the sale of other aftermarket products as a result of a more managed approach with an emphasis on the balanced sale of a broader offering of these products.
Gross Profit and Gross Margins
Overall same store gross profit as a percentage of revenues (“gross margin”) decreased from 15.4% to 14.9% for the quarter ended June 30, 2005 and from 15.6% to 15.2% for the six months ended June 30, 2005, as compared to the same periods last year. For the three and six month periods ended June 30, 2005, new vehicle gross margins decreased 50 bps and 40 bps, respectively, while used vehicle gross margins remained flat. Gross margins related to our Fixed Operations decreased by 20 bps and 10 bps, respectively, for the same periods. We expect new vehicle margins to stabilize to the extent that existing inventories are reduced. Revenue mix (a shift from higher margin products such as Fixed Operations and Finance, Insurance and Other to lower margin products such as vehicle sales) also contributed to the decline in overall gross margin for the three and six month periods ended June 30, 2005 as shown in the following table:
Basis Point
Revenues as a Percentage of Total Revenues
New Vehicles
Used Vehicles
Wholesale Vehicles
Fixed Operations
Finance, Insurance and Other
Total Revenues
Although revenues shifted from our lower margin domestic brands to our higher margin import and luxury brands such as Honda and BMW, these two brands in particular experienced lower new vehicle margins over the three and six month periods ended June 30, 2005, thus minimizing the potential benefit of the brand shift.
Selling, General and Administrative Expenses (“SG&A”)
Reported SG&A expense increased $26.6 million, or 12.6%, and $48.4 million, or 11.7%, for the three and six month periods ended June 30, 2005, respectively. Acquisitions accounted for $11.9 million, or 44.8%, and $27.9 million, or 57.7%, of the increases, while same store dealerships contributed $14.7 million, or 55.2%, and $20.5 million, or 42.3%, for the quarter and year-to-date periods, respectively. As a percentage of reported gross profits, reported SG&A expenses increased 144 bps in the quarter-to-date period and 123 bps in the six-month period.
Same store advertising increased $1.0 million compared to the second quarter last year and $2.7 million compared to the prior year-to-date period. These increases were due primarily to a continued strategy to focus on increasing advertising spending for certain
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brands in selected markets. Compensation at same store dealerships increased $6.7 million and $6.6 million for the three and six month periods, respectively. As a percentage of gross profits, total same store compensation was 41.9% and 42.6% for the quarter and year-to-date periods, respectively. Same store rent expense increased $1.4 million and $2.3 million compared to the quarter and year-to-date periods last year, respectively, due to variable rate leases and facility improvements. Other same store expenses increased $1.0 million and $4.4 million for the quarter and year-to-date periods, respectively. In both the quarter and year-to-date periods, increases in expenses for service loaners, credit cards fees, delivery activities and bad debts contributed to the increase in other expenses. In the year-to-date period, losses on the disposal of fixed assets also contributed to the increase in expense.
Depreciation and Amortization
Reported depreciation and amortization expense increased over the comparable three and six month periods by $0.2 million, or 5.7%, and $0.7 million or 9.8%, respectively. This increase was due to acquisitions, the completion of leasehold improvement projects and other general capital expenditures.
Interest Expense, Floor Plan
The weighted average floor plan interest rate incurred by continuing dealerships was 4.15% for the quarter ended June 30, 2005, compared to 2.64% for the quarter ended June 30, 2004, which increased floor plan interest expense by approximately $3.6 million. The average notes payable-floor plan balance from continuing dealerships increased to $976.0 million during the second quarter of 2005 from $955.9 million during the second quarter of 2004, resulting in increased floor plan interest expense of approximately $0.2 million.
The weighted average floor plan interest rate incurred by continuing dealerships was 3.95% for the six months ended June 30, 2005, compared to 2.60% for the six months ended June 30, 2004, which increased floor plan interest expense by approximately $6.2 million. The average notes payable-floor plan balance from continuing dealerships increased to $960.0 million during the first six months of 2005 from $921.3 million during the first six months of 2004, resulting in increased floor plan interest expense of approximately $0.8 million.
Our floor plan interest expenses are substantially offset by amounts received from manufacturers in the form of floor plan assistance. These payments are credited against cost of sales upon the sale of the vehicle. During the three and six months ended June 30, 2005, respectively, the amounts we recognized in our consolidated statements of income from floor plan interest assistance exceeded our floor plan interest expense by approximately $0.4 million and $0.3 million. In the three and six months ended June 30, 2004, floor plan assistance exceeded floor plan interest expense by approximately $3.5 million and $6.6 million.
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Interest Expense, Other
Changes in interest expense, other in 2005 compared to 2004 are summarized in the table below:
Interest rates –
• Increase in the average interest rate on the Revolving Credit Facility from 3.82% to 5.71% and from 3.86% to 5.52% for the three and six months ended June 30, 2005, respectively
Debt balances –
• (Decrease in balance) / assumption of Notes Payable to a Finance Company
Other factors –
• Decrease in capitalized interest
• Incremental interest savings related to floating to fixed interest rate swaps
• Incremental interest expense related to fixed to floating interest rate swaps
• Increase associated with interest allocated to discontinued operations
• Increase in other expense, net
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.
Because the majority of our consolidated assets are held by our dealership subsidiaries, the majority of our cash flows from operations is generated by these subsidiaries. As a result, our cash flows and ability to service debt depends to a substantial degree on the results of operations of these subsidiaries and their ability to provide us with cash. Uncertainties in the economic environment may, therefore, affect our overall liquidity.
Floor Plan Facilities
The weighted average interest rate for all of our floor plan facilities (both continuing and discontinued operations) was 4.22% and 2.66% for the three months ended June 30, 2005 and 2004, respectively, and 4.02% and 2.64% for the six months ended June 30, 2005 and 2004, respectively. In the second quarter of 2005, we received approximately $10.8 million in manufacturer assistance, which was approximately $0.4 million less than the amount we paid for floor plan interest. In the first six months of 2005, we received approximately $20.0 million in manufacturer assistance, which was approximately $0.9 million less than the amount we paid for floor plan interest. Interest payments under each of our floor plan facilities are due monthly, and we are generally not required to make principal repayments prior to the sale of the vehicles. We were in compliance with all restrictive covenants as of June 30, 2005.
Long-Term Debt and Credit Facilities
The Revolving Credit Facility: At June 30, 2005, our Revolving Credit Facility had a borrowing limit of $550.0 million, subject to a borrowing base calculated on the basis of our receivables, inventory and equipment and a pledge of certain additional collateral by one of our affiliates (the borrowing base was approximately $576.1 million at June 30, 2005). The amount available to be borrowed under the Revolving Credit Facility is reduced on a dollar-for-dollar basis by the cumulative face amount of outstanding letters of credit. At June 30, 2005, we had $60.1 million in letters of credit outstanding and $170.9 million of borrowing availability.
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Notes Payable to a Finance Company: Three notes payable totaling $26.6 million in aggregate principal were assumed with the purchase of franchises during 2004 (the “Assumed Notes”). The Assumed Notes bear interest rates from 10.52% to 9.52% (with a weighted average of 10.19%), have a combined monthly principal and interest payment of $0.3 million and are collateralized by letters of credit with a commercial bank. We recorded the Assumed Notes at fair value using an interest rate of 5.35%. The interest rate used to calculate the fair value was based on a quoted market price for notes with similar terms as of the date of assumption.
At June 30, 2005, the outstanding balance and availability on our long-term debt and credit facilities were as follows (in thousands):
Interest
Rate (1)
Revolving Credit Facility (matures October 2006)
Senior Subordinated Notes (mature August 2013)
Convertible Senior Subordinated Notes (mature May 2009) (2)
Mortgage Facility:
Construction Loan (matures December 2007)
Permanent Loan (matures December 2012)
Notes Payable to a Finance Company (mature November 2015 through September 2016)
We were in compliance with all of the restrictive and financial covenants under all our long-term debt and credit facilities as of June 30, 2005.
Dealership Acquisitions and Dispositions
In the first six months of 2005, we acquired franchises for an aggregate purchase price of $52.3 million in cash, net of cash acquired, using cash from operations and borrowings under the Revolving Credit Facility. During the first six months of 2005, our disposition of ten franchises generated cash of $6.5 million.
Sale-Leaseback Transactions
In an effort to generate additional cash flow, we typically seek to structure our operations to minimize the ownership of real property. As a result, dealership facilities either constructed by us or obtained in acquisitions are typically sold to third parties in sale-leaseback transactions. The resulting operating 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. During the first six months of 2005, we sold $1.9 million in dealership facilities in sale-leaseback transactions.
Capital Expenditures
Our capital expenditures include the construction of new dealerships and collision repair centers, building improvements and equipment purchased for use in our dealerships. Capital expenditures in the first six months of 2005 were approximately $37.1 million, of which approximately $23.5 million related to the construction of new dealerships and collision repair centers. Once completed, these new dealership facilities and collision repair centers are generally sold in sale-leaseback transactions. Capital expenditures incurred during the first six months of 2005 expected to be sold within a year in sale-leaseback transactions or sold in 2005 were $19.7 million. We do not expect any significant gains or losses from these sales. As of June 30, 2005, commitments for facilities construction projects totaled approximately $21.9 million. We expect $17.1 million of this amount to be financed through future sale-leaseback transactions.
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Stock Repurchase Program
As of June 30, 2005, our Board of Directors had authorized our management to expend up to $185.0 million to repurchase shares of our Class A common stock or redeem securities convertible into Class A common stock. In the first six months of 2005, we repurchased 237,500 shares for approximately $4.9 million, which was offset by proceeds received from the exercise of stock options under stock compensation plans of $5.2 million. As of July 29, 2005, we had $27.9 million remaining to repurchase shares under our Board authorization.
Dividends
During the second quarter of 2005, our Board of Directors approved a quarterly cash dividend of $0.12 per share for shareholders of record on June 15, 2005, which was paid on July 15, 2005. Subsequent to June 30, 2005, our Board of Directors has also approved a quarterly cash dividend of $0.12 per share for stockholders of record on September 15, 2005, which will be paid on October 15, 2005.
Cash Flows
For the six months ended June 30, 2005, net cash used in operating activities was approximately $1.3 million, which was comprised of net payments on notes payable-floor plan (offset by a decrease in new vehicle inventories), an increase in used vehicles (which are not financed with notes payable-floor plan) and other working capital accounts offset by net income. These adjustments were offset somewhat by non-cash items such as depreciation and losses on disposals of assets. Cash used in investing activities for the first six months of 2005 was $70.1 million, which consisted mostly of capital expenditures on property and equipment and dealership acquisitions, offset somewhat by proceeds received from dealership dispositions and sale-leaseback transactions. Net cash provided by financing activities for the six months ended June 30, 2005 was $69.7 million, comprised mostly of borrowings under the Revolving Credit Facility of $80.4 million and issuances of stock under our stock compensation plans of $5.2 million, which was offset by the payment of dividends of $10.0 million and purchases of treasury stock of $4.9 million.
Guarantees
In accordance with the terms of our operating lease agreements, our dealership subsidiaries, acting as lessees, generally agree to indemnify the lessor from certain exposure arising as a result of the use of the leased premises, including environmental exposure and repairs to leased property upon termination of the lease. In addition, we have generally agreed to indemnify the lessor in the event of a breach of the lease by the lessee.
In connection with franchise dispositions, certain of our dealership subsidiaries have assigned or sublet to the buyer their interests in real property leases associated with such dealerships. In general, the subsidiaries retain responsibility for the performance of certain obligations under such leases, including rent payments and repairs to leased property upon termination of the lease, to the extent that the assignee or sublessee does not perform. The total estimated rent payments remaining under such leases as of June 30, 2005 was approximately $63.7 million. However, in accordance with the terms of the assignment and sublease agreements, the assignees and sublessees have generally agreed to indemnify Sonic and its subsidiaries in the event of non-performance. Additionally, in connection with certain dispositions, we have obtained indemnifications from the parent company or owners of these assignees and sublessees in the event of non-performance.
In accordance with the terms of agreements entered into for the sale of our franchises, we generally agree to indemnify the buyer from certain exposure and costs arising subsequent to the date of sale, including environmental exposure and exposure resulting from the breach of representations or warranties made in accordance with the agreement. While our exposure with respect to environmental remediation and repairs is difficult to quantify, we estimate our maximum exposure associated with these general indemnifications was approximately $16.3 million at June 30, 2005. These indemnifications generally expire within a period of one to three years following the date of sale. The estimated fair value of these indemnifications was not material.
We expect the maximum exposure of these various guarantees to continue to fluctuate as indemnification periods lapse and we dispose of additional franchises.
Future Liquidity Outlook
We believe our best source of liquidity for future growth remains cash flows generated from operations combined with the availability of borrowings under our floor plan financing (or any replacements thereof) and the Revolving Credit Facility. Though
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uncertainties in the economic environment as well as uncertainties associated with geopolitical conflicts may affect our ability to generate cash from operations, we expect to generate more than sufficient cash flow to fund our debt service, quarterly cash dividends and working capital requirements and any seasonal operating requirements, including our currently anticipated internal growth for our existing businesses, for the foreseeable future. Once these needs are met, we may use remaining cash flow to support our acquisition strategy or repurchase shares of our Class A common stock or publicly-traded debt securities, based on market conditions.
Seasonality
Our operations are subject to seasonal variations. The first and fourth quarters generally contribute less revenue, operating profits and cash flows 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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Item 3: Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk
Our variable rate notes payable–floor plan, 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 $1.4 billion at June 30, 2005 and approximately $1.3 billion at June 30, 2004. A change of 100 basis points in the underlying interest rate would have caused a change in interest expense of approximately $6.8 million in the first six months of 2005 and approximately $6.5 million in the first six months of 2004. Of the total change in interest expense, approximately $4.7 million in the first six months of 2005 and approximately $4.9 million in the first six months of 2004 would have resulted from notes payable–floor plan.
Our exposure to notes payable–floor plan 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 capitalized as inventory and charged against cost of sales when the associated inventory is sold. During the six months ended June 30, 2005, the amounts we paid for floor plan interest expense for both our continuing and discontinued operations exceeded manufacturer floor plan assistance received by approximately $0.9 million. During the six month period ended June 30, 2004, amounts we received from manufacturer floor plan assistance exceeded our floor plan interest expense by approximately $6.6 million. A change of 100 basis points in the underlying interest rate would have caused estimated changes in floor plan assistance of approximately $4.2 million in the first six months of 2005.
In addition to our variable rate debt, approximately one-half of our dealership facility lease agreements’ monthly lease payments fluctuate based on LIBOR interest rates. Many of our lease agreements have interest rate floors whereby our lease expense would not fluctuate significantly in periods when LIBOR is relatively low. A one percent change in LIBOR would change our annual rent expense by approximately $2.7 million.
In order to reduce our exposure to market risks from fluctuations in interest rates, we have one interest rate swap agreement (the “Fixed Swap”) to effectively convert a portion of our LIBOR-based variable rate debt to a fixed rate. The Fixed Swap will mature June 6, 2006 and has a notional principal of $100.0 million. Under the terms of the Fixed Swap, we receive interest payments on the notional amount at a rate equal to the one month LIBOR rate, adjusted monthly, and make interest payments at a fixed rate of 4.50%.
We also have five separate interest rate swaps with a total notional amount of $150.0 million (collectively, the “Variable Swaps”) to effectively convert a portion of our fixed rate debt to a LIBOR-based variable rate debt. Under the Variable Swaps’ agreements, we receive 8.625% on the respective notional amounts and pay interest payments on the respective notional amounts at a rate equal to the forward six month LIBOR (fixed on February 15 and August 15 of each year) plus a spread ranging from 3.825% to 3.85% with a weighted average spread of 3.83%. The Variable Swaps expire on August 15, 2013.
Foreign Currency Risk
We purchase certain of our new vehicle and parts inventories from foreign manufacturers. Although we purchase our inventories in U.S. Dollars, our business is subject to foreign exchange rate risk, which may influence automobile manufacturers’ ability to provide their products at competitive prices in the United States. To the extent this volatility negatively impacts consumer demand through higher retail prices for our products, this volatility could adversely affect our future operating results.
Item 4: Controls and Procedures.
Our management, under the supervision and with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q. There were no changes in our internal control over financial reporting during the past fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 1: Legal Proceedings.
We are involved, and expect to continue to be involved, in numerous legal proceedings arising in the ordinary course of our business, including litigation with customers, employment related lawsuits, contractual disputes, class actions, purported class actions and actions brought by governmental authorities.
Several of our Texas dealership subsidiaries have been named in three class action lawsuits against the Texas Automobile Dealers Association (“TADA”) and new vehicle dealerships in Texas that are members of the TADA. Approximately 630 Texas dealerships are named as defendants in two of the actions, and approximately 700 dealerships are named as defendants in the other action. The three actions allege that since 1994, Texas automobile dealerships have deceived customers with respect to a vehicle inventory tax and violated federal antitrust and other laws. In April 2002, in two actions, the Texas state court certified two classes of consumers on whose behalf the actions would proceed. The Texas Court of Appeals subsequently affirmed the trial court’s order of class certification in the state actions, and the Texas Supreme Court issued an order for the second time in September 2004 stating that it would not hear the merits of the defendant’s appeal on class certification. The federal trial court conditionally certified a class of consumers in the federal antitrust case, but on appeal by the defendant dealerships, the U.S. Court of Appeals for the Fifth Circuit reversed the certification of the plaintiff class in October 2004 and remanded the case back to the federal trial court for further proceedings not inconsistent with the Fifth Circuit’s ruling. The plaintiffs have appealed this ruling by the Fifth Circuit.
In June 2005, our Texas dealerships and several other dealership defendants entered into a settlement agreement with the plaintiffs in both the state and the federal cases that would settle each of the cases on behalf of our Texas dealerships. The settlements are contingent upon court approval, and the court has not yet scheduled a date for a hearing on that approval. The estimated expense of the proposed settlements is not a material amount to our company as a whole, and it includes our Texas dealerships issuing coupons for discounts off future vehicle purchases, refunding cash in certain circumstances, and paying attorneys’ fees and certain costs. Under the terms of the settlements, our Texas dealerships would continue to itemize and pass through to the customer the cost of the inventory tax. If the TADA matters are not settled, our Texas dealership subsidiaries would then vigorously defend themselves and assert available defenses. In addition, we may have rights of indemnification with respect to certain aspects of the TADA matters. However, an adverse resolution of the TADA matters could result in the payment of significant costs and damages and negatively impact our Texas dealerships’ ability to itemize and pass through to the customer the cost of the inventory tax in the future, which could have a material adverse effect on our future results of operations, financial condition and cash flows.
Our company is also a defendant in the matter of Galura, et al. v. Sonic Automotive, Inc., a private civil action filed in the Circuit Court of Hillsborough County, Florida. In this action, originally filed on December 30, 2002, the plaintiffs allege that we and our Florida dealerships sold an antitheft protection product in a deceptive or otherwise illegal manner, and further sought representation on behalf of any customer of any of our Florida dealerships who purchased the antitheft protection product since December 30, 1998. The plaintiffs are seeking monetary damages and injunctive relief on behalf of this class of customers. In June 2005, the court granted the plaintiffs’ motion for certification of the requested class of customers, but the court has made no finding to date regarding actual liability in this lawsuit. On July 1, 2005, we filed a notice of appeal of the court’s class certification ruling with Florida’s Second District Court of Appeal. We intend to continue our vigorous defense of this lawsuit, including the aforementioned appeal of the trial court’s class certification order, and to assert available defenses. However, an adverse resolution of this lawsuit could result in the payment of significant costs and damages, which could have a material adverse effect on our future results of operations, financial condition and cash flows.
In addition to the TADA matters and Florida lawsuit described above, we are also involved in numerous other legal proceedings arising out of the conduct of our business. We do not believe that the ultimate resolution of these legal proceedings will have a material adverse effect on our business, financial condition, results of operations, cash flows or prospects. However, the results of these legal proceedings cannot be predicted with certainty, and an unfavorable resolution of one or more of these legal proceedings could have a material adverse effect on our business, financial condition, results of operations, cash flows and prospects.
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Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
The following table sets forth information about the shares of Class A Common Stock we repurchased during the fiscal quarter ended June 30, 2005.
April 2005
May 2005
June 2005
November 1999
February 2000
December 2000
May 2001
August 2002
February 2003
December 2003
July 2004
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Item 4: Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders held on April 21, 2005, H. Robert Heller and Robert L. Rewey were elected directors by Sonic’s stockholders. Directors whose terms of office continued after the meeting were O. Bruton Smith, B. Scott Smith, Jeffrey C. Rachor, William R. Brooks, Thomas P. Capo, William P. Benton and William I. Belk. In addition to the election of two directors, the stockholders voted in favor of the following:
Election of H. Robert Heller
Election of Robert L. Rewey
Approval of the 2005 Formula Restricted Stock Plan for Non-Employee Directors
Ratification of Deloitte & Touche as independent public auditors
Item 6: Exhibits.
Description
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Forward Looking Statements
This Quarterly Report on Form 10-Q contains numerous “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:
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 of this Form 10-Q and elsewhere in this report, as well as:
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EXHIBIT INDEX
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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.
/s/ O. Bruton Smith
O. Bruton Smith
/s/ E. Lee Wyatt, Jr.
Executive Vice President, Chief Financial
Officer and Treasurer
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