Sonic Automotive, Inc.

6415 Idlewild Road, Suite 109
Charlotte, North Carolina 28212
U.S.A.
Telephone: (704) 566-2400
Fax: (770) 536-4665
Web site: http://www.sonicautomotive.com

Public Company
Incorporated: 1997
Employees: 11,600
Sales: $7.4 billion (2004)
Stock Exchanges: New York
Ticker Symbol: SAH
NAIC: 441110 New Car Dealers

Charlotte, North Carolina-based Sonic Automotive, Inc. is the third largest automobile retailer in the United States, a Fortune 300 company, and a member of the Russell 2000 index. It is composed of some 200 dealership franchises and 40 collision repair centers located in 15 mostly Sunbelt states, preferring middle markets where dealerships are cheaper to acquire, profits are higher, and the competition for customers is not as steep. Sonic has grown from just a handful of dealerships in the mid-1990s by adopting a "hub and spoke" approach. Sonic enters a market by acquiring a "hub" dealership, one that is well respected in a market, enjoys strong customer satisfaction, and a strong market share. Underperforming dealerships in the area are then added as spokes, and the expertise of the managers of the hub operation is used to help the underperformers achieve their potential. Overall, Sonic sells more than 35 brands of cars and light trucks. Although a public company listed on the New York Stock Exchange, Sonic is 74 percent owned by Chairman and Chief Executive Officer O. Bruton Smith.

FOUNDER, A 1960S FORD DEALER

Before launching Sonic, Bruton Smith became better known to the public as a leader in the NASCAR racing circuit, the head of publicly traded Speedway Motorsports Inc., which operated several NASCAR racetracks. He first became an automobile dealer with a Ford franchise in Rockford, Illinois, in 1969. He prospered and added two more Ford dealerships, but at the time three was the maximum number of dealerships Ford would allow. Hence, he branched out to open Chrysler, Toyota, BMW, and Mercedes franchises in North Carolina, Texas, and Georgia. Smith moved his operations to Charlotte in 1978. He eventually soured on auto retailing because of manufacturers' rules and the capital-intensive nature of the business. Smith dropped out and concentrated on his racetrack operations, but when automakers loosened their restrictions allowing ownership of multiple stores, he regained his interest in the business.

Automobile retailing was traditionally a highly fragmented industry, dominated by family-owned dealerships spread across the country. As was the case in many industries, however, businessmen, including Wayne Huizenga of Waste Management and Blockbuster Video fame, in the 1990s began looking to consolidate, to build a large portfolio of dealerships and gain a competitive edge through the benefits achieved from economies of scale, especially in terms of advertising. To fuel these ambitions they turned to Wall Street to engineer public offerings, not only to provide cash to buy dealerships but also to have stock to use in lieu of cash for acquisitions. There was also a large pool of willing sellers, families who had established their dealerships in the boom years of the 1940s just after World War II. Many of them lacked a second or third generation willing to carry on the business and were looking for an exit strategy. Cash was welcomed, but so was stock, which at least gave the sellers a chance to cash in at an opportune time.

Bruton Smith was one of those businessmen who wanted to be a consolidator in auto retailing. In February 1997 he incorporated Sonic Automotive, Inc. and began building up its portfolio of dealerships before tapping the equity markets. Smith got a head start with the 1996 purchase of Fort Mill Ford in South Carolina for $5.7 million. Then in June 1997 Sonic paid about $3.7 million for Fort Mill Chrysler-Plymouth-Dodge. More acquisitions followed in the fall of 1997. Sonic paid $18.3 million for Lake Norman Dodge and its affiliates in September. A pair of acquisitions were completed in October: $1.8 million for Williams Motors, Inc. located in Rock Hill, South Carolina, and $25.5 million for Clearwater, Florida-based Ken Marks Ford, Inc. Then, in November 1997, Sonic paid $18 million in cash to acquire Atlanta's Dyer & Dyer Volvo, and another $27.6 million for the Bowers Dealerships and affiliates located mostly in Chattanooga and Nashville, Tennessee.

With 23 dealerships in five states as well as four stand-alone used-vehicle lots and seven collision-repair centers, altogether generating close to $900 million in sales, Sonic went public in November 1997 at $12 a share, with the initial stock offering underwritten by a group of firms led by Merrill Lynch. The stock did not, however, flourish after it began trading, enjoying a high of $12.37 before it soon dipped below the $10 mark. Investors were generally optimistic about Sonic's business plan and respected the ability of Smith and his team, which included his son and heir apparent, Scott Smith, but were mistrustful of the industry in general, believing that car sales were too cyclical. According to Barron's, "IPO investors reasonably ask: How much better will it get over time?" Indeed, Group 1 Automotive, backed by another Wall Street heavyweight in Goldman Sachs, experienced a similar fate after going public two weeks earlier than Sonic.

Despite the tepid response from investors in the aftermarket, Sonic forged ahead with a business plan and continued to apply its "hub and spoke," middle market strategy in 1998. To assuage fears of shareholders concerned that it could not support and control its growth, Sonic beefed up senior management by adding a president and vice-president of retail operations. The company also looked to achieve some geographic diversity, so that it was not vulnerable to downturns in local and regional economies. In 1998 Sonic entered new markets such as Columbus, Ohio; Montgomery, Alabama; Daytona Beach, Florida; and Greenville, South Carolina. Moreover, Sonic diversified its brands, adding balance to the mix to ensure that the company was not overly dependent on any one brand. Over the course of the year Sonic bought dealerships representing brands such as Chevrolet, Mercedes, Hyundai, Subaru, Isuzu, Lincoln, Mercury, and Mitsubishi. All told, Sonic acquired 19 dealerships representing 20 brands. In addition, the acquisitions completed in 1997 were successfully integrated and their operations improved, resulting in a 25 percent increase in operating income for these dealerships over the prior year. Sonic also was beginning to enjoy the benefits of size as interest costs and insurance expenses were lowered, resulting in greater profits and larger dividends to shareholders. For 1998 Sonic generated revenues of more than $1.6 billion, netting $18.6 million, or 74 cents per share. Even before the results were announced, Sonic had clearly outperformed its rivals and gained the respect of Wall Street, which by the end of the year bid up the price to more than $34 a share. Sheldon Sandler, head of investment banking firm Bel Air Partners, told Automotive News, "Sonic has raised the chinning bar for anybody else that wants to be public." The stock price soon topped $36 and in January 1999 the company engineered a 2-for-1 stock split.

COMPANY PERSPECTIVES

Sonic Automotive, Inc., a Fortune 300 Company and member of the Russell 2000 Index, is among the largest automotive retailers in the United States.

Sonic closed the 1990s with another strong year, marked by the largest acquisition, to date, in the history of automotive retailing: FirstAmerica Automotive. The deal provided Sonic entry into the highly coveted, high-growth California market, as well as giving it a coast-to-coast footprint. Moreover, Sonic added several luxury brands and picked up the services of FirstAmerica's talented and seasoned management team. In addition, in 1999 Sonic acquired another 44 dealerships and expanded into ten new metropolitan markets including Las Vegas, Nevada; Washington, D.C.; Mobile, Alabama; Panama City, Florida; Monroe, North Carolina; Florence, South Carolina; and a number of cities in Texas, including Houston, Baytown, Richardson, and Stafford. To help pay the price tag, Sonic raised $85 million in a secondary stock offering held in April 1999 and raised another $280 million in debt financing while increasing its available credit lines by $250 million. As a result of these acquisitions, Sonic's revenues soared to $3.35 billion and net income approached $45 million in 1999.

ACQUISITIONS CONTINUING IN THE NEW CENTURY

In 2000 Sonic acquired 11 dealerships, representing 16 different brands and accounting for nearly $800 million in annual sales. The company also took stock of its dealership portfolio, which included a number of dealerships that were essentially acquisition throw-ins. Many of these were weeded out, resulting in the 2000 sale of eight dealerships representing some $65 million in annual sales. Overall 2000 was a strong year for Sonic, despite sluggish new vehicle sales in the final months of the year.

Sonic continued to expand through acquisitions in 2001, adding a dozen dealerships representing $1 billion in annual sales. These purchases included Buena Park Honda, HarborCity Honda, and Coast Cadillac in the Los Angeles area, and Lawrence Marshall Chevrolet in Houston. Sonic was even more active in 2002, acquiring 31 dealerships representing $1.8 billion in annual sales. The most important deal took place early in the year with the purchase of Michigan-based Don Massey Dealerships, a seven-state chain of 16 dealerships with $1 billion in annual revenue. After the acquisition, Sonic did background checks on Massey personnel and fired 200 of the 1,550 employees. The company's caution was understandable, given that two of its Clearwater dealerships were under investigation in Florida for fraudulent sales practices in the finance and insurance departments, problems the company blamed on rogue employees at some of Sonic's early acquisitions before policies and training were implemented to curb unethical practices.

It was also during 2002 that the 75-year-old Bruton Smith was reported to be on the verge of retirement. In November 2002 Scott Smith was promoted to the post of vice-chairman and chief strategic officer along with other managerial changes that the younger Smith told the press was "really kind of a prelude to our successorship." Bruton Smith quickly told the Charlotte Observer, "I'm not going to retire, period. We have no successorship plan." Scott Smith, according to the Observer, told board member William Belk that he had misspoken. "He was probably forecasting 20 years down the road, not the next year or two," Belk explained.

TAKING STOCK AFTER A DISAPPOINTING 2003

Sonic experienced a disappointing year in 2003, when it failed to keep pace with its peer group and failed to live up to its own expectations. The company continued to grow through acquisitions, adding dealerships in existing markets such as Atlanta, Dallas, San Francisco, and Detroit, many of them representing luxury brands such as Porsche, BMW, Jaguar, and Mercedes. But Sonic's sluggish performance in 2003 prompted management to take stock of its operating strategies, including its aggressive acquisition program. Much of Sonic's success had been based on buying and turning around under-performing dealerships. But such an approach put a great deal of pressure on the managers, who were now buckling under the strain. As a result, management decided to put on the brakes somewhat, limiting acquisitions to no more than 10 percent of annual revenues. Moreover, management looked to improve profitability by better controlling costs, in particular advertising and sales compensation.

KEY DATES

1969:: O. Bruton Smith opens his first car dealership.
1978:: Smith moves operations to Charlotte, North Carolina.
1997:: Sonic is launched in Charlotte and taken public.
1999:: FirstAmerica Automotive is acquired.
2002:: Don Massey Dealerships is acquired.

Many of the recommended changes implemented by Sonic began to show progress in 2004. The company cut back on acquisitions, allowing recent purchases to be integrated into the company. At the same time, management came to the conclusion that acquisitions had to remain a key part of company strategy in light of the automotive industry, which remained highly fragmented and offered great opportunities. Hence, Sonic began to adopt a concept it called "enriching our dealership portfolio." In a nutshell it meant selling off underperforming dealerships and replacing them with other dealerships offering greater long-term potential. They would mostly be luxury and import dealerships that offered higher profits and required lower inventory levels. On other fronts, Sonic was able to cut advertising expenses as a percentage of gross profit from 6.5 percent in 2003 to 5.4 percent in 2004. Concerning sales compensation, Sonic introduced a variable compensation structure tied to key performance metrics, which reduced compensation expense as a percentage of gross profit from 36.4 percent in 2003 to 35.3 percent in 2004. Sonic closed 2004 posting sales of nearly $7.4 billion and net income of $86.1 million. Its founder, now approaching 80 years of age, remained very much in charge.

PRINCIPAL SUBSIDIARIES

FirstAmerica Automotive, Inc.; Don Massey Cadillac, Inc.

PRINCIPAL COMPETITORS

AutoNation, Inc.; CarMax, Inc.; United Auto Group, Inc.

Sonic Automotive, Inc.

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Sonic Automotive, Inc.

6415 Idlewild Road, Suite 109
Charlotte, North Carolina 28212
U.S.A.
Telephone: (704) 566-2400
Fax: (770) 536-4665
Web site: http://www.sonicautomotive.com

Public Company
Incorporated: 1997
Employees: 11,600
Sales: $7.4 billion (2004)
Stock Exchanges: New York
Ticker Symbol: SAH
NAIC: 441110 New Car Dealers