SONIC AUTOMOTIVE INC - Quarter Report: 2010 September (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission files number 1-13395

SONIC AUTOMOTIVE, INC.

DELAWARE (State or other jurisdiction of incorporation or organization)		56-2010790 (I.R.S. Employer Identification No.)
6415 Idlewild Road, Suite 109, Charlotte, North Carolina		28212
(Address of principal executive offices)		(Zip 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   ý    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such file).
Yes o    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one).

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o    No ý

As of October 22, 2010, there were 40,707,683 shares of Class A Common Stock and 12,029,375 shares of Class B Common Stock outstanding.

 

 

INDEX TO FORM 10-Q

		Page
PART I – FINANCIAL INFORMATION
ITEM 1.  Condensed Consolidated Financial Statements (Unaudited)			3
Condensed Consolidated Statements of Income – Third Quarter and Nine-month Periods Ended September 30, 2009 and September 30, 2010			3
Condensed Consolidated Balance Sheets – December 31, 2009 and September 30, 2010			4
Condensed Consolidated Statement of Stockholders’ Equity – Nine-month Periods Ended September 30, 2010			5
Condensed Consolidated Statements of Cash Flows – Nine-month Periods Ended September 30, 2009 and September 30, 2010			6
Notes to Unaudited Condensed Consolidated Financial Statements			7
ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk			35
ITEM 4.  Controls and Procedures			36
PART II – OTHER INFORMATION
ITEM 1.     Legal Proceedings			37
ITEM 1A.  Risk Factors			39
ITEM 2.     Unregistered Sales of Equity Securities and Use of Proceeds			42
ITEM 6.     Exhibits			43
SIGNATURES
			45
EX-10.24
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I - FINANCIAL INFORMATION

Item 1: Condensed Consolidated Financial Statements.

SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES

		Third Quarter Ended								Nine Months Ended
		September 30,								September 30,
		2009				2010				2009				2010
Revenues:
New vehicles		$	903,716			$	937,709			$	2,367,236			$	2,611,988
Used vehicles			379,389				453,815				1,081,855				1,339,323
Wholesale vehicles			34,588				47,597				105,451				108,336
Total vehicles			1,317,693				1,439,121				3,554,542				4,059,647
Parts, service and collision repair			268,801				283,741				807,556				842,697
Finance, insurance and other			43,403				47,398				116,558				133,607
Total revenues			1,629,897				1,770,260				4,478,656				5,035,951
Cost of Sales:
New vehicles			(840,173	)			(877,691	)			(2,207,435	)			(2,440,097	)
Used vehicles			(347,187	)			(418,576	)			(986,355	)			(1,231,720	)
Wholesale vehicles			(36,216	)			(49,053	)			(108,275	)			(112,270	)
Total vehicles			(1,223,576	)			(1,345,320	)			(3,302,065	)			(3,784,087	)
Parts, service and collision repair			(132,018	)			(143,141	)			(400,328	)			(421,711	)
Total cost of sales			(1,355,594	)			(1,488,461	)			(3,702,393	)			(4,205,798	)
Gross profit			274,303				281,799				776,263				830,153
Selling, general and administrative expenses			(214,140	)			(226,331	)			(619,560	)			(672,542	)
Impairment charges			(620	)			(87	)			(5,707	)			(132	)
Depreciation and amortization			(8,131	)			(8,731	)			(23,865	)			(25,729	)
Operating income			51,412				46,650				127,131				131,750
Other income (expense):
Interest expense, floor plan			(4,533	)			(5,430	)			(14,925	)			(15,615	)
Interest expense, other, net			(18,277	)			(15,226	)			(57,998	)			(48,024	)
Interest expense, non-cash, convertible debt			7,818				(1,768	)			1,556				(5,175	)
Interest expense, non-cash, cash flow swaps			(2,180	)			(1,484	)			(5,359	)			(5,402	)
Other income (expense), net			2,449				(351	)			2,519				(7,522	)
Total other expense			(14,723	)			(24,259	)			(74,207	)			(81,738	)
Income from continuing operations before taxes			36,689				22,391				52,924				50,012
Income tax provision			(16,510	)			(8,442	)			(23,816	)			(19,905	)
Income from continuing operations			20,179				13,949				29,108				30,107
Discontinued operations:
Loss from operations and the sale of discontinued franchises			(8,551	)			(633	)			(19,203	)			(6,149	)
Income tax benefit (expense)			3,966				(331	)			7,393				1,617
Loss from discontinued operations			(4,585	)			(964	)			(11,810	)			(4,532	)
Net income		$	15,594			$	12,985			$	17,298			$	25,575
Basic earnings per share:
Earnings per share from continuing operations		$	0.47			$	0.26			$	0.70			$	0.57
Loss per share from discontinued operations			(0.10	)			(0.01	)			(0.28	)			(0.09	)
Earnings per share		$	0.37			$	0.25			$	0.42			$	0.48
Weighted average common shares outstanding			42,305				52,311				41,130				52,151
Diluted earnings per share:
Earnings per share from continuing operations		$	0.24			$	0.25			$	0.48			$	0.56
Loss per share from discontinued operations			(0.07	)			(0.02	)			(0.22	)			(0.07	)
Earnings per share		$	0.17			$	0.23			$	0.26			$	0.49
Weighted average common shares outstanding			63,195				65,851				52,529				65,711

See notes to unaudited condensed consolidated financial statements.

SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES

						(Unaudited)
		December 31,				September 30,
		2009				2010
ASSETS
Current Assets:
Cash and cash equivalents		$	30,035			$	10,623
Receivables, net			232,969				166,546
Inventories			795,275				863,917
Assets held for sale			12,167				13,548
Other current assets			14,937				15,582
Total Current Assets			1,085,383				1,070,216
Property and Equipment, net			382,085				392,173
Goodwill			469,482				468,516
Other Intangible Assets, net			80,806				79,563
Other Assets			51,099				61,633
Total Assets		$	2,068,855			$	2,072,101
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Notes payable - floor plan - trade		$	214,871			$	436,444
Notes payable - floor plan - non-trade			548,493				339,117
Trade accounts payable			55,345				47,968
Accrued interest			16,146				10,035
Other accrued liabilities			144,709				145,447
Liabilities associated with assets held for sale - non-trade			3,346				-
Current maturities of long-term debt			23,991				23,704
Total Current Liabilities			1,006,901				1,002,715
Long-Term Debt			552,150				529,632
Other Long-Term Liabilities			141,052				143,631
Stockholders’ Equity:
Class A convertible preferred stock, none issued			-				-
Class A common stock, $.01 par value; 100,000,000 shares authorized; 54,986,875 shares issued and 40,099,559 shares outstanding at December 31, 2009; 55,635,206 shares issued and 40,657,683 shares outstanding at September 30, 2010			550				556
Class B common stock; $.01 par value; 30,000,000 shares authorized; 12,029,375 shares outstanding at December 31, 2009 and September 30, 2010			121				121
Paid-in capital			662,186				666,401
Accumulated deficit			(35,180	)			(9,604	)
Accumulated other comprehensive income (loss)			(22,350	)			(23,703	)
Treasury stock, at cost (14,887,316 Class A shares held at December 31, 2009 and 14,977,523 Class A shares held at September 30, 2010)			(236,575	)			(237,648	)
Total Stockholders’ Equity			368,752				396,123
Total Liabilities and Stockholders’ Equity		$	2,068,855			$	2,072,101

See notes to unaudited condensed consolidated financial statements.

SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES

																														Accumulated
		Class A								Class B																				Other				Total				Compre-
		Common Stock								Common Stock								Paid-In				Accumulated				Treasury				Comprehensive				Stockholders’				hensive
		Shares				Amount				Shares				Amount				Capital				Deficit				Stock				Income (Loss)				Equity				Income
BALANCE AT DECEMBER 31, 2009			54,987				550				12,029				121				662,186				(35,180	)			(236,575	)			(22,350	)			368,752
Shares awarded under stock compensation plans			292				3				-				-				1,185				-				-				-				1,188				-
Purchases of treasury stock			-				-				-				-				-				-				(1,073	)			-				(1,073	)			-
Income tax benefit associated with stock compensation plans			-				-				-				-				636				-				-				-				636				-
Income tax benefit associated with convertible note hedge			-				-				-				-				205				-				-				-				205				-
Fair value of interest rate swap agreements, net of tax benefit of $830			-				-				-				-				-				-				-				(1,353	)			(1,353	)			(1,353	)
Stock-based compensation expense			-				-				-				-				419				-				-				-				419				-
Restricted stock amortization, net of forfeitures			-				-				-				-				1,773				-				-				-				1,773				-
Net income			-				-				-				-				-				25,575				-				-				25,575				25,575
Other			356				3				-				-				(3	)			1				-				-				1				-
BALANCE AT SEPTEMBER 30, 2010			55,635				556				12,029			$	121			$	666,401			$	(9,604	)		$	(237,648	)		$	(23,703	)		$	396,123			$	24,222

See notes to unaudited condensed consolidated financial statements.

SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES

		Nine Months Ended
		September 30,
		2009				2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	17,298			$	25,575
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of property, plant and equipment			24,905				25,938
Provision for bad debt expense			1,255				756
Other amortization			1,242				1,242
Debt issuance cost amortization			9,909				2,702
Debt discount amortization, net of premium amortization			9,957				3,872
Stock - based compensation expense			437				419
Amortization of restricted stock			1,802				1,773
Restricted stock forfeiture			(182	)			-
Deferred income taxes			(2,390	)			(656	)
Equity interest in earnings of investees			(501	)			(585	)
Asset impairment charges			9,116				132
Loss (gain) on disposal of franchises and property and equipment			(226	)			(978	)
Loss on exit of leased dealerships			7,511				2,321
Loss (gain) on retirement of debt			(2,095	)			7,665
Derivative fair value adjustments			(11,300	)			-
Changes in assets and liabilities that relate to operations:
Receivables			68,535				65,667
Inventories			383,205				(82,768	)
Other assets			(24,362	)			(14,706	)
Notes payable - floor plan - trade			(92,597	)			221,573
Trade accounts payable and other liabilities			41,207				(21,886	)
Total adjustments			425,428				212,481
Net cash provided by operating activities			442,726				238,056
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment			(36,048	)			(44,039	)
Proceeds from sales of property and equipment			1,797				979
Proceeds from sale of franchises			22,839				24,644
Distributions from equity investees			300				600
Net cash used in investing activities			(11,112	)			(17,816	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings on notes payable floor plan - non-trade			(369,726	)			(212,722	)
Borrowings on revolving credit facilities			534,585				40,000
Repayments on revolving credit facilities			(584,854	)			(40,000	)
Proceeds from long-term debt			167,039				209,977
Principal payments on long-term debt			(162,948	)			(4,673	)
Increase in restricted cash			(106,913	)			-
Settlement of cash flow swaps			(16,454	)			-
Repurchase of debt securities			-				(233,190	)
Purchase of treasury stock			(61	)			(1,073	)
Income tax benefit associated with stock compensation plans			-				636
Income tax benefit associated with convertible hedge			4,442				205
Issuance of shares under stock compensation plans			-				1,188
Issuance of common stock related to private placement			101,812				-
Dividends paid			(4,893	)			-
Net cash used in financing activities			(437,971	)			(239,652	)
NET DECREASE IN CASH AND CASH EQUIVALENTS			(6,357	)			(19,412	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			6,971				30,035
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	614			$	10,623
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
Change in fair value of cash flow hedging instruments (net of tax expense of $5,859 and tax benefit of $830 for the nine-month period ended September 30, 2009 and 2010, respectively)		$	9,728			$	(1,353	)
Issuance of shares related to debt refinance		$	3,947			$	-
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid (received) during the year for:
Interest, net of amount capitalized		$	90,116			$	74,778
Income taxes		$	(21,229	)		$	(15,289	)

See notes to unaudited condensed consolidated financial statements.

SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES

1. Summary of Significant Accounting Policies

          Basis of Presentation – The accompanying unaudited condensed consolidated financial information for the third quarter and nine-month periods ended September 30, 2009 and 2010 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). 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 normal recurring adjustments) necessary to fairly state the financial position and the results of operations for the periods presented. The results for interim periods are not necessarily indicative of the results to be expected for the entire fiscal year. These interim financial statements should be read in conjunction with the audited Consolidated Financial Statements of Sonic Automotive, Inc. (“Sonic” or the “Company”) for the year ended December 31, 2009, which were included in Sonic’s Annual Report on Form 10-K .

              Recent Developments – On August 18, 2010, Sonic redeemed $20.0 million in aggregate principal amount of its 8.625% Senior Subordinated Notes at the applicable redemption price (101.438% of principal redeemed) plus accrued but unpaid interest. Sonic recorded a loss on extinguishment of debt of $0.4 million related to the redemption. On October 20, 2010, Sonic issued a redemption notice to holders of the 4.25% Convertible Senior Subordinated Notes due 2015 (the “4.25% Convertible Notes”) to redeem the remaining $16.0 million in aggregate principal amount of its outstanding 4.25% Convertible Notes. Sonic will use available cash to redeem the $16.0 million in aggregate principal amount at the applicable redemption price (100.00% of principal redeemed) plus accrued but unpaid interest on November 30, 2010.

          Reclassifications – The Condensed Consolidated Statements of Income for the third quarter and nine-month periods ended September 30, 2009 reflect the reclassification of balances from continuing operations to discontinued operations from the prior year presentation for additional franchises sold and terminated or identified for sale subsequent to September 30, 2009. The Condensed Consolidated Statements of Income for the third quarter and nine-month periods ended September 30, 2009 also reflect the reclassification of balances from discontinued operations to continuing operations for franchises identified for sale as of September 30, 2009, but which Sonic has decided to retain and operate as of September 30, 2010.

          Lease Exit Accruals – Lease exit accruals relate to facilities Sonic has ceased using in its operations. The accruals represent the present value of the lease payments, net of estimated sublease proceeds, for the remaining life of the operating leases and other accruals necessary to satisfy the lease commitment to the landlord. A summary of the activity of these lease exit accruals consists of the following:

		(dollars in thousands)
Balance, December 31, 2009		$	47,825
Lease exit expense			2,321
Payments			(6,567	)
Balance, September 30, 2010		$	43,579

          Income Tax Expense – The overall effective tax rates for the third quarter and nine-month periods ended September 30, 2009 and 2010 are higher than federal statutory rates due to the effect of state income taxes. The overall effective tax rate from continuing operations was 37.7% and 39.8% for the third quarter and nine-month periods ended September 30, 2010, respectively. The overall effective tax rate from continuing operations was 45.0% for both the third quarter and nine-month periods ended September 30, 2009. The effective rate for the third quarter and nine-month periods ended September 30, 2010 was lower than the prior year periods due to the shift in the distribution of taxable income between states in which Sonic operates, lower expense effects related to tax positions as a result of “Accounting for Uncertainty in Income Taxes” in the ASC, and the effect of gross receipts tax structures in certain states.

2. Discontinued Operations

          Dispositions – The operating results of franchises held for sale are included in the loss from discontinued operations in Sonic’s Condensed Consolidated Statements of Income. Assets to be disposed of in connection with franchises held for sale but not yet sold have been classified in assets held for sale in Sonic’s Condensed Consolidated Balance Sheets along with other assets held for sale. At September 30, 2010 there were no dealership franchises held for sale. The held for sale balance

of property and equipment, net, is comprised of real estate held for sale by non-dealership entities. Assets held for sale consist of the following:

		(dollars in thousands)
		December 31,				September 30,
		2009				2010
Inventories		$	4,528			$	-
Property and equipment, net			4,838				13,548
Goodwill			2,801				-
Assets held for sale		$	12,167			$	13,548

          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 Sonic’s balance sheets. Revenues and other activities associated with franchises classified as discontinued operations were as follows:

		(dollars in thousands)
		Third Quarter Ended September 30,								Nine Months Ended September 30,
		2009				2010				2009				2010
Loss from operations		$	(3,302	)		$	(1,773	)		$	(8,548	)		$	(5,920	)
Gain (loss) on disposal of franchises			(103	)			829				(572	)			2,182
Lease exit charges			(5,146	)			311				(6,675	)			(2,411	)
Property impairment charges			-				-				(1,822	)			-
Goodwill impairment charges			-				-				(1,586	)			-
Pre-tax loss		$	(8,551	)		$	(633	)		$	(19,203	)		$	(6,149	)
Total Revenues		$	74,018			$	9,473			$	245,935			$	55,127

          Lease exit charges recorded for the third quarter and nine-month periods ended September 30, 2009 and 2010 relate to the revision of estimates on previously established lease exit accruals and the establishment of lease exit accruals in the third quarter ended September 30, 2009. The lease exit accruals are calculated by either discounting the remaining lease payments, net of estimated sublease proceeds, or estimating the amount necessary to satisfy the lease commitment to the landlord. See Note 4 for a discussion of property impairment charges and see Note 5 for a discussion of goodwill impairment charges.

          Sonic allocates interest expense to discontinued operations based on the net assets of the discontinued operations group. Interest allocated to discontinued operations for the third quarter ended September 30, 2009 was $0.6 million. Interest allocated to discontinued operations for the third quarter ended September 30, 2010 was immaterial. Interest allocated to discontinued operations for the nine-month periods ended September 30, 2009 and 2010 was $2.1 million and $0.2 million, respectively.

3. Inventories

          Inventories consist of the following:

		(dollars in thousands)
		December 31,				September 30,
		2009				2010
New vehicles		$	557,319			$	607,742
Used vehicles			138,401				149,890
Parts and accessories			51,470				50,702
Other			52,613				55,583
		$	799,803			$	863,917
Less inventories classified as assets held for sale			(4,528	)			-
Inventories		$	795,275			$	863,917

4. Property and Equipment

          Property and equipment consists of the following:

		(dollars in thousands)
		December 31,				September 30,
		2009				2010
Land		$	61,886			$	64,870
Building and improvements			322,632				320,389
Office equipment and fixtures			75,801				77,939
Parts and service equipment			54,981				55,910
Company vehicles			8,440				8,151
Construction in progress			40,000				51,557
Total, at cost			563,740				578,816
Less accumulated depreciation			(176,817	)			(173,095	)
Subtotal			386,923				405,721
Less assets held for sale			(4,838	)			(13,548	)
Property and equipment, net		$	382,085			$	392,173

              In both the third quarter and nine-month periods ended September 30, 2010, Sonic recorded fixed asset impairment charges of $0.1 million, which was recorded in continuing operations. In the third quarter and nine-month periods ended September 30, 2009, Sonic recorded fixed asset impairment charges of $0.4 million and $4.3 million, respectively, of which $0.4 million and $2.5 million were recorded in continuing operations, respectively.

5. Goodwill And Intangible Assets

		(dollars in thousands)
		Franchise								Accumulated
		Agreements				Gross Goodwill				Impairment				Net Goodwill
Balance, December 31, 2009		$	64,835			$	1,266,207			$	(796,725	)		$	469,482
Reductions from sales of franchises			-				(3,767	)			-				(3,767	)
Reclassification from assets held for sale, net			-				2,801				-				2,801
Balance, September 30, 2010		$	64,835			$	1,265,241			$	(796,725	)		$	468,516

          In the third quarter and nine-month periods ended September 30, 2009, Sonic recorded goodwill impairment charges of $0.2 million and $2.7 million, respectively, of which $0.2 million and $1.1 million were recorded in continuing operations, respectively. The impairment charges recorded were based on the determination that recorded values were not recoverable under asset disposal agreements entered into during the nine-month period ended September 30, 2009. Sonic recorded franchise asset impairment charges of $2.1 million in continuing operations in the nine-month period ended September 30, 2009.

          At December 31, 2009, Sonic had $16.0 million of definite life intangibles recorded relating to favorable lease agreements. After the effect of amortization of the definite life intangibles, the balance recorded at September 30, 2010 was $14.7 million and was included in other intangible assets, net, in the accompanying Condensed Consolidated Balance Sheets.

6. Long-term Debt

          Long-term debt consists of the following:

		(dollars in thousands)
		December 31,				September 30,
		2009				2010
2010 Revolving Credit Facility (1)		$	-			$	-
Senior Subordinated Notes bearing interest at 9.0%			-				210,000
Senior Subordinated Notes bearing interest at 8.625%			275,000				42,855
Convertible Senior Notes bearing interest at 5.0%			172,500				172,500
Convertible Senior Subordinated Notes bearing interest at 4.25%			17,045				16,000
Notes payable to a finance company bearing interest from 9.52% to 10.52% (with a weighted average of 10.19%)			17,778				16,180
Mortgage notes to finance companies-fixed rate, bearing interest from 4.50% to 7.03%			78,424				84,341
Mortgage notes to finance companies-variable rate, bearing interest at 1.25 to 3.30 percentage points above one-month LIBOR			38,251				30,842
Net debt discount and premium (2)			(29,199	)			(25,506	)
Other			6,342				6,124
		$	576,141			$	553,336
Less current maturities			(23,991	)			(23,704	)
Long-term debt		$	552,150			$	529,632

(1) Interest rate was 2.00% above one-month LIBOR at September 30, 2010.

(2) December 31, 2009 includes $1.5 million discount associated with the 8.625% Notes, $29.8 million discount associated with the 5.0% Convertible Notes, $0.6 million discount associated with the 4.25% Convertible Notes, $2.5 million premium associated with notes payable to a finance company and $0.2 million premium associated with mortgage notes payable. September 30, 2010 includes $1.4 million discount associated with the 9.0% Notes, $0.2 million discount associated with the 8.625% Notes, $26.0 million discount associated with the 5.0% Convertible Notes, $0.1 million discount associated with the 4.25% Convertible Notes, $2.0 million premium associated with notes payable to a finance company and $0.2 million premium associated with mortgage notes payable.

2006 Credit Facility

          The 2006 Revolving Credit Sub-Facility, the 2006 New Vehicle Floor Plan Sub-Facility and the 2006 Used Vehicle Floor Plan Sub-Facility (collectively the “2006 Credit Facility”) would have matured on February 17, 2010. The 2006 Credit Facility was refinanced on January 15, 2010. See 2010 Credit Facilities discussion below.

2010 Credit Facilities

          On January 15, 2010, Sonic entered into an amended and restated syndicated revolving credit agreement (the “2010 Revolving Credit Facility”) and a syndicated floor plan credit facility (the “2010 Floorplan Facility”). The 2010 Revolving Credit Facility and 2010 Floorplan Facility (collectively the “2010 Credit Facilities”) mature on August 15, 2012.

          The 2010 Revolving Credit Facility, which is subject to a borrowing base, has a borrowing limit of $150.0 million, which may be expanded up to $215.0 million in total credit availability upon satisfaction of certain conditions. The amount available for borrowing under the 2010 Revolving Credit Facility (the “2010 Revolving Borrowing Base”) is reduced on a dollar-for-dollar basis by the aggregate face amount of any outstanding letters of credit under the 2010 Revolving Credit Facility. The borrowing base is calculated based on the value of eligible accounts, eligible inventory, eligible equipment and 5,000,000 shares of common stock of Speedway Motorsports, Inc. (“SMI”) pledged as collateral by one of Sonic’s affiliates, Sonic Financial Corporation (“SFC”).

          As of September 30, 2010, the 2010 Revolving Borrowing Base was approximately $137.6 million. At September 30, 2010, Sonic had no outstanding borrowings and $49.9 million in outstanding letters of credit resulting in total borrowing availability of $87.7 million under the 2010 Revolving Credit Facility.

          Outstanding obligations under the 2010 Revolving Credit Facility are secured by a pledge of substantially all of the assets of Sonic and its subsidiaries, and by the pledge of 5,000,000 shares of common stock of SMI by SFC. The collateral also provides for the pledge of the franchise agreements and stock or equity interests of Sonic’s dealership franchise subsidiaries, except for those dealership franchise subsidiaries where the applicable manufacturer prohibits such a pledge, in

which cases the stock or equity interests of the dealership franchise subsidiary is subject to an escrow arrangement with the administrative agent. Substantially all of Sonic’s subsidiaries also guarantee its obligations under the 2010 Revolving Credit Facility.

          The 2010 Floorplan Facility is comprised of a new vehicle revolving floor plan facility in an amount up to $321.0 million (the “2010 New Vehicle Floorplan Facility”) and a used vehicle revolving floor plan facility in an amount up to $50.0 million, subject to a borrowing base (the “2010 Used Vehicle Floorplan Facility”). Sonic may, under certain conditions, request an increase in the 2010 Floorplan Facility by up to $125.0 million, which shall be allocated between the 2010 New Vehicle Floorplan Facility and the 2010 Used Vehicle Floorplan Facility as Sonic requests, with no more than 15% of the aggregate commitments allocated to the commitments under the 2010 Used Vehicle Floorplan Facility. Outstanding obligations under the 2010 Floorplan Facility are guaranteed by Sonic and certain of its subsidiaries and are secured by a pledge of substantially all of the assets of Sonic and its subsidiaries.

          The amounts outstanding under the 2010 Credit Facilities bear interest at variable rates based on specified percentages above LIBOR according to a performance-based pricing grid determined by Sonic’s Consolidated Total Debt to EBITDA Ratio (as defined in the 2010 Credit Facilities agreement) as of the last day of the immediately preceding fiscal quarter.

Covenants

          The 2010 Credit Facilities contain certain covenants, including covenants which could restrict or prohibit indebtedness, liens, the payment of dividends, capital expenditures and material dispositions and acquisitions of assets as well as other customary covenants and default provisions. Sonic was in compliance with the covenants under the 2010 Credit Facilities as of September 30, 2010 and expects to be in compliance with the covenants for the foreseeable future. Financial covenants include required specified ratios (as each is defined in the 2010 Credit Facilities) of:

Covenant

Consolidated

Consolidated

Consolidated

Fixed Charge

Total Senior

Liquidity

Coverage

Secured Debt to

Ratio

Ratio

EBITDA Ratio

Through March 30, 2011

≥ 1.00

≥ 1.10

≤ 2.25

March 31, 2011 through and including March 30, 2012

≥ 1.05

≥ 1.15

≤ 2.25

March 31, 2012 and thereafter

≥ 1.10

≥ 1.20

≤ 2.25

September 30, 2010 actual

1.15

1.29

1.12

          The 2010 Credit Facilities contain events of default, including cross-defaults to other material indebtedness, change of control events and events of default customary for syndicated commercial credit facilities. Upon the occurrence of an event of default, Sonic could be required to immediately repay all outstanding amounts under the 2010 Credit Facilities.

          In addition, many of Sonic’s facility leases are governed by a guarantee agreement between the landlord and Sonic that contains financial and operating covenants. The financial covenants are identical to those under the 2010 Credit Facilities with the exception of one financial covenant related to the ratio of EBTDAR to Rent (as defined in the lease agreements) with a required ratio of no less than 1.5 to 1.0. At September 30, 2010, the ratio was 1.94 to 1.0.

9.0% Senior Subordinated Notes (“9.0% Notes”)

          On March 12, 2010, Sonic issued $210.0 million aggregate principal amount of 9.0% Notes which mature on March 15, 2018. On April 12, 2010, Sonic used the net proceeds, together with cash on hand, to redeem $200.0 million aggregate principal amount of its 8.625% Notes due 2013. The 9.0% Notes are unsecured senior subordinated obligations of Sonic and are guaranteed by Sonic’s domestic operating subsidiaries. Interest is payable semi-annually on March 15 and September 15 each year. Sonic may redeem the 9.0% Notes in whole or in part at any time after March 15, 2014 at the following redemption prices, which are expressed as percentages of the principal amount:

		Redemption
		Price
Beginning on March 15, 2014			104.50	%
Beginning on March 15, 2015			102.25	%
Beginning on March 15, 2016 and thereafter			100.00	%

          In addition, on or before March 15, 2013, Sonic may redeem up to 35% of the aggregate principal amount of the 9.0% Notes at par value plus accrued interest with proceeds from certain equity offerings. The Indenture also provides that holders of 9.0% Notes may require Sonic to repurchase the 9.0% Notes at 101% of the par value of the 9.0% Notes, plus accrued interest if Sonic undergoes a “change of control” as defined in the Indenture.

               The indenture governing the 9.0% Notes contains certain specified restrictive covenants. Sonic has agreed not to pledge any assets to any third party lender of senior subordinated debt except under certain limited circumstances. Sonic also has agreed to certain other limitations or prohibitions concerning the incurrence of other indebtedness, capital stock, guarantees, asset sales, investments, cash dividends to stockholders, distributions and redemptions. Specifically, the indenture governing Sonic’s 9.0% Notes limits Sonic’s ability to pay quarterly cash dividends on Sonic’s Class A and B common stock in excess of $0.10 per share. Sonic may only pay quarterly cash dividends on Sonic’s Class A and B common stock if Sonic complies with the terms of the indenture governing the 9.0% Notes. Sonic was in compliance with all restrictive covenants as of September 30, 2010.

               Balances outstanding under Sonic’s 9.0% Notes are guaranteed by all of Sonic’s operating domestic subsidiaries. These guarantees are full and unconditional and joint and several. The parent company has no independent assets or operations. The non-domestic and non-operating subsidiaries that are not guarantors are considered to be minor as defined by the SEC.

          Sonic’s obligations under the 9.0% Notes may be accelerated by the holders of 25% of the outstanding principal amount of the 9.0% Notes then outstanding if certain events of default occur, including: (1) defaults in the payment of principal or interest when due; (2) defaults in the performance, or breach, of Sonic’s covenants under the 9.0% Notes; and (3) certain defaults under other agreements under which Sonic or its subsidiaries have outstanding indebtedness in excess of $35.0 million.

8.625% Senior Subordinated Notes (“8.625% Notes”)

          The 8.625% Notes are unsecured obligations that rank equal in right of payment to all of Sonic’s existing and future senior subordinated indebtedness, mature on August 15, 2013 and are redeemable at Sonic’s option after August 15, 2008. Of the original $275.0 million principal amount of the 8.625% Notes, Sonic had $42.9 million in aggregate principal amount outstanding at September 30, 2010.

          On April 12, 2010, Sonic used the net proceeds obtained from the issuance of the 9.0% Notes, together with cash on hand, to redeem $200.0 million in aggregate principal amount of the outstanding 8.625% Notes at the then applicable redemption price (102.875% of principal redeemed) plus accrued but unpaid interest. Sonic recorded a loss on extinguishment of debt of approximately $7.0 million related to the redemption which was recognized in the second quarter ended June 30, 2010. During the second quarter of 2010 Sonic repurchased approximately $12.1 million of additional principal amount of the 8.625% Notes and recorded an additional loss on extinguishment of debt of approximately $0.3 million related to these repurchases. During the third quarter Sonic redeemed an additional $20.0 million in aggregate principal amount of the outstanding 8.625% Notes and recorded a loss on extinguishment of debt of approximately $0.4 million related to the redemption.

          The total loss on extinguishment of debt related to repurchases and redemptions of the 8.625% Notes of $7.7 million for the nine-month period ended September 30, 2010 is recorded in other income (expense), net in the Condensed Consolidated Statements of Income.

          The indenture governing the 8.625% Notes contains certain specified restrictive covenants. Sonic has agreed not to pledge any assets to any third party lender of senior subordinated debt except under certain limited circumstances. Sonic also has agreed to certain other limitations or prohibitions concerning the incurrence of other indebtedness, capital stock, guarantees, asset sales, investments, cash dividends to shareholders, distributions and redemptions. Specifically, the indenture

governing Sonic’s 8.625% Notes limits Sonic’s ability to pay quarterly cash dividends on Sonic’s Class A and B common stock in excess of $0.10 per share. Sonic may only pay quarterly cash dividends on Sonic’s Class A and B common stock if Sonic complies with the terms of the indenture governing the 8.625% Notes. Sonic was in compliance with all restrictive covenants as of September 30, 2010.

          Balances outstanding under Sonic’s 8.625% Notes are guaranteed by all of Sonic’s operating domestic subsidiaries. These guarantees are full and unconditional and joint and several. The parent company has no independent assets or operations. The non-domestic and non-operating subsidiaries that are not guarantors are considered to be minor as defined by the SEC.

5.0% Convertible Senior Notes (“5.0% Convertible Notes”)

          Sonic has $172.5 million in aggregate principal amount of 5.0% Convertible Notes outstanding. The 5.0% Convertible Notes bear interest at a rate of 5.0% per year, payable semiannually in arrears on April 1 and October 1 of each year. The 5.0% Convertible Notes mature on October 1, 2029. Sonic may redeem some or all of the 5.0% Convertible Notes for cash at any time subsequent to October 1, 2014 at a repurchase price equal to 100% of the principal amount of the Notes. Holders have the right to require Sonic to purchase the 5.0% Convertible Notes on each of October 1, 2014, October 1, 2019 and October 1, 2024 or in the event of a change in control for cash at a purchase price equal to 100% of the principal amount of the notes.

          Holders of the 5.0% Convertible Notes may convert their notes at their option prior to the close of business on the business day immediately preceding July 1, 2029 only under the following circumstances: (1) during any fiscal quarter commencing after December 31, 2009, if the last reported sale price of the Class A common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter is greater than or equal to 130% of the applicable conversion price on each applicable trading day; (2) during the five business day period after any 10 consecutive trading day period (the “measurement period”) in which the trading price (as defined below) per $1,000 principal amount of notes for each day of that measurement period was less than 98% of the product of the last reported sale price of Sonic’s Class A common stock and the applicable conversion rate on each such day; (3) if Sonic calls any or all of the notes for redemption, at any time prior to the close of business on the third scheduled trading day prior to the redemption date; or (4) upon the occurrence of specified corporate events. On and after July 1, 2029 to (and including) the close of business on the third scheduled trading day immediately preceding the maturity date, holders may convert their notes at any time, regardless of the foregoing circumstances. The conversion rate is 74.7245 shares of Class A common stock per $1,000 principal amount of notes, which is equivalent to a conversion price of approximately $13.38 per share of Class A common stock. None of the conversion features on the 5.0% Convertible Notes were triggered in the nine-month period ended September 30, 2010.

          To recognize the equity component of the convertible borrowing instrument, upon issuance of the 5.0% Convertible Notes in September 2009, Sonic recorded a debt discount of $31.0 million and a corresponding amount (net of taxes of $12.8 million) to equity. The debt discount is being amortized to interest expense through October 2014, the earliest redemption date of the 5.0% Convertible Notes.

4.25% Convertible Senior Subordinated Notes (“4.25% Convertible Notes”)

          Sonic had approximately $16.0 million aggregate principal amount of 4.25% Convertible Notes outstanding at September 30, 2010 classified in current maturities of Long-Term Debt in the accompanying Condensed Consolidated Balance Sheet. Sonic repurchased approximately $1.0 million of the aggregate principal amount of the 4.25% Convertible Notes during the second quarter of 2010 at amounts close to par. On October 20, 2010, Sonic issued a redemption notice to redeem the remaining $16.0 million in aggregate principal amount. Sonic will use available cash on November 30, 2010 to redeem the $16.0 million in aggregate principal amount at the applicable redemption price (100.00% of principal redeemed) plus accrued but unpaid interest on November 30, 2010.

          The 4.25% Convertible Notes bear interest at an annual rate of 4.25% until November 30, 2010 and 4.75% thereafter. The 4.25% Convertible Notes are unsecured obligations that rank equal in right of payment to all of Sonic’s existing and future senior subordinated indebtedness, mature on November 30, 2015 and are redeemable by Sonic or the holders on or after November 30, 2010. Sonic’s obligations under the 4.25% Convertible Notes are not guaranteed by any of Sonic’s subsidiaries. Holders of the 4.25% Convertible Notes may convert them into cash and shares of Sonic’s Class A common stock at an initial conversion rate of 41.4185 shares per $1,000 of principal amount, subject to distributions on, or other changes in Sonic’s Class A common stock, if any, prior to the conversion date.

          The 4.25% Convertible Notes are convertible into cash and shares of Sonic’s Class A common stock if prior to October 31, 2010, during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of 4.25% Convertible Notes was less than 103% of the product of the closing price of Sonic’s Class A common stock and the applicable conversion rate for the 4.25% Convertible Notes; if Sonic calls the 4.25% Convertible Notes for redemption; upon the occurrence of certain corporate transactions; or on or after October 31, 2010. Upon conversion of the 4.25% Convertible Notes, Sonic will be required to deliver cash equal to the lesser of the aggregate principal amount of the 4.25% Convertible Notes being converted and Sonic’s total conversion obligation. If Sonic’s total conversion obligation exceeds the aggregate principal amount of the 4.25% Convertible Notes being converted, Sonic will deliver shares of Class A common stock to the extent of the excess amount, if any. None of the conversion features on the 4.25% Convertible Notes were triggered in the third quarter ended September 30, 2010. The conversion features were triggered on October 20, 2010 when Sonic called the 4.25% Convertible Notes for redemption.

Notes Payable to a Finance Company

          Three notes payable (due October 2015 and August 2016) were assumed in connection with an acquisition in 2005 (the “Assumed Notes”). Sonic 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. As a result of calculating the fair value, a premium of $7.3 million was recorded and is being amortized over the lives of the Assumed Notes. As of September 30, 2010, the remaining unamortized premium was $2.0 million.

Mortgage Notes

          Sonic has mortgage financing related to many of its dealership properties. These mortgage notes require monthly payments of principal and interest through maturity and are secured by the underlying properties. Maturity dates occur between June 2013 and December 2029. The weighted average interest rate was 5.18% at September 30, 2010.

Derivative Instruments and Hedging Activities

          At September 30, 2010 Sonic had interest rate swap agreements (the “Fixed Swaps”) to effectively convert a portion of its LIBOR-based variable rate debt to a fixed rate. The fair value of these swap positions at September 30, 2010 was a liability of $40.0 million included in other long-term liabilities in the accompanying Condensed Consolidated Balance Sheets. Under the terms of the Fixed Swaps, Sonic will receive and pay interest based on the following:

Notional Amount					Pay Rate		Receive Rate (1)		Maturing Date
(in millions)
$	200.0				4.935%		one-month LIBOR		May 1, 2012
$	100.0				5.265%		one-month LIBOR		June 1, 2012
$	3.6				7.100%		one-month LIBOR		July 10, 2017
$	25.0		(2)		5.160%		one-month LIBOR		September 1, 2012
$	15.0		(2)		4.965%		one-month LIBOR		September 1, 2012
$	25.0		(2)		4.885%		one-month LIBOR		October 1, 2012
$	11.4				4.655%		one-month LIBOR		December 10, 2017
$	8.8				6.860%		one-month LIBOR		August 1, 2017
$	7.0				4.330%		one-month LIBOR		July 1, 2013
$	100.0		(3)		3.280%		one-month LIBOR		July 1, 2015
$	100.0		(3)		3.300%		one-month LIBOR		July 1, 2015

(1) One-month LIBOR was 0.256% at September 30, 2010.

(2) After December 31, 2009 changes in fair value are recorded through earnings.

(3) The effective date of these forward-starting swaps is July 2, 2012.

          During the first quarter ended March 31, 2009, Sonic settled two $100.0 million notional fixed swaps with a payment to the counterparty of $16.5 million. This settlement loss was deferred and is being amortized into earnings over the swaps’ initial remaining term.

          During the second quarter ended June 30, 2010, Sonic entered into two $100.0 million notional forward-starting interest rate swap agreements which become effective in July 2012 and terminate in July 2015. These interest rate swaps have been designated and qualify as cash flow hedges and, as a result, changes in the fair value of these swaps will be recorded in other comprehensive income (loss), net of related income taxes, in the Condensed Consolidated Statements of Stockholders’ Equity.

          As a result of the refinancing of Sonic’s 2006 Credit Facility and the new terms of the 2010 Credit Facilities, at December 31, 2009 it was determined that it was no longer probable that Sonic would incur interest payments that match the terms of certain Fixed Swaps that previously were designated and qualified as cash flow hedges. Of the Fixed Swaps (including the two $100.0 million notional swaps which were settled in 2009), $565.0 million of the notional amount had previously been documented as hedges against the variability of cash flows related to interest payments on certain debt obligations. At September 30, 2010, Sonic estimates that under the new 2010 Credit Facilities and other facilities with matching terms, it is probable that the expected debt balance with interest payments that match the terms of the Fixed Swaps will be $400.0 million. As a result, for the third quarter and nine-month periods ended September 30, 2010, non-cash charges of approximately $1.5 million and $5.4 million, respectively, related to the Fixed Swaps and amortization of amounts in accumulated other comprehensive income (loss) related to other existing and terminated cash flow swaps were included in interest expense, non-cash, cash flow swaps in the accompanying Condensed Consolidated Statements of Income.

          For the Fixed Swaps which qualify as cash flow hedges, the changes in the fair value of these swaps have been recorded in other comprehensive income (loss), net of related income taxes, in the Condensed Consolidated Statements of Stockholders’ Equity. The incremental interest expense (the difference between interest paid and interest received) related to the Fixed Swaps was $4.4 million and $14.1 million for the third quarter and nine-month periods ended September 30, 2009, respectively, and $4.4 million and $13.1 million for the third quarter and nine-month periods ended September 30, 2010, respectively. This expense is included in interest expense, other, net in the accompanying Condensed Consolidated Statements of Income. The estimated net expense expected to be reclassified out of other comprehensive income (loss) into results of operations during the next twelve months is approximately $12.4 million.

7. Per Share Data and Stockholders’ Equity

          The calculation of diluted earnings per share considers the potential dilutive effect of Sonic’s contingently convertible debt issuances and stock options to purchase shares of Class A common stock under several equity compensation plans. The following table illustrates the dilutive effect of such items on earnings per share for the third quarter and nine-month periods ended September 30, 2009 and 2010:

SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		For the Third Quarter Ended September 30, 2009
						Income								Loss
						From Continuing								From Discontinued
						Operations								Operations								Net Income
		Class A & B								Per Common								Per Common								Per Common
		Shares				Amount				Share Amount				Amount				Share Amount				Amount				Share Amount
		(dollars in thousands except per share amounts)
Earnings (Loss) and Shares			42,305			$	20,179							$	(4,585	)						$	15,594
Effect of Participating Securities:
Unvested Restricted Stock and Stock Units			-				(151	)							-								(151	)
Basic Earnings (Loss) Per Share			42,305			$	20,028			$	0.47			$	(4,585	)		$	(0.10	)		$	15,443			$	0.37
Effect of Dilutive Securities:
Contingently Convertible Debt (2009 6.0% Convertibles)			19,004				(4,720	)							(196	)							(4,916	)
Contingently Convertible Debt (2009 5.0% Convertibles)			981				-								-								-
Contingently Convertible Debt (2002 5.25% Convertibles)			-				(15	)							16								1
Equity compensation plans			905				-								-								-
Diluted Earnings (Loss) Per Share			63,195			$	15,293			$	0.24			$	(4,765	)		$	(0.07	)		$	10,528			$	0.17
		For the Third Quarter Ended September 30, 2010
						Income								Loss
						From Continuing								From Discontinued
						Operations								Operations								Net Income
		Class A & B								Per Common								Per Common								Per Common
		Shares				Amount				Share Amount				Amount				Share Amount				Amount				Share Amount
														(dollars in thousands except per share amounts)
Earnings (Loss) and Shares			52,311			$	13,949							$	(964	)						$	12,985
Effect of Participating Securities:
Unvested Restricted Stock and Stock Units			-				(137	)							-								(137	)
Basic Earnings (Loss) Per Share			52,311			$	13,812			$	0.26			$	(964	)		$	(0.01	)		$	12,848			$	0.25
Effect of Dilutive Securities:
Contingently Convertible Debt (2009 5.0% Convertibles)			12,890				2,498								16								2,514
Equity compensation plans			650				-								-								-
Diluted Earnings (Loss) Per Share			65,851			$	16,310			$	0.25			$	(948	)		$	(0.02	)		$	15,362			$	0.23
		For the Nine Months Ended September 30, 2009
						Income								Loss
						From Continuing								From Discontinued
						Operations								Operations								Net Income
										Per Common								Per Common								Per Common
		Shares				Amount				Share Amount				Amount				Share Amount				Amount				Share Amount
		(amounts in thousands except per share amounts)
Earnings (Loss) and Shares			41,130			$	29,108							$	(11,810	)						$	17,298
Effect of Participating Securities:
Unvested Restricted Stock and Stock Units			-				(224	)							-								(224	)
Basic Earnings (Loss) Per Share			41,130			$	28,884			$	0.70			$	(11,810	)		$	(0.28	)		$	17,074			$	0.42
Effect of Dilutive Securities:
Contingently Convertible Debt (2009 6.0% Convertibles)			10,473				(3,440	)							(149	)							(3,589	)
Contingently Convertible Debt (2009 5.0% Convertibles)			331				-								-								-
Equity compensation plans			595				-								-								-
Diluted Earnings (Loss) Per Share			52,529			$	25,444			$	0.48			$	(11,959	)		$	(0.22	)		$	13,485			$	0.26
		For the Nine Months Ended September 30, 2010
						Income								Loss
						From Continuing								From Discontinued
						Operations								Operations								Net Income
										Per Common								Per Common								Per Common
		Shares				Amount				Share Amount				Amount				Share Amount				Amount				Share Amount
		(amounts in thousands except per share amounts)
Earnings (Loss) and Shares			52,151			$	30,107							$	(4,532	)						$	25,575
Effect of Participating Securities:
Unvested Restricted Stock and Stock Units			-				(295	)							-								(295	)
Basic Earnings (Loss) Per Share			52,151			$	29,812			$	0.57			$	(4,532	)		$	(0.09	)		$	25,280			$	0.48
Effect of Dilutive Securities:
Contingently Convertible Debt (2009 5.0% Convertibles)			12,890				6,709								28								6,737
Equity compensation plans			670				-								-								-
Diluted Earnings (Loss) Per Share			65,711			$	36,521			$	0.56			$	(4,504	)		$	(0.07	)		$	32,017			$	0.49

          In addition to the stock options included in the table above, options to purchase 2.4 million shares and 2.3 million shares of Class A common stock were outstanding at September 30, 2009 and 2010, respectively, but were not included in the computation of diluted earnings per share because the options were not dilutive. In addition, in the event the effect of potentially dilutive shares associated with any of Sonic’s convertible notes were anti-dilutive, the effect of those shares have also been excluded from the computation of diluted earnings per share.

SONIC AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

8. Contingencies

Legal and Other Proceedings:

          Sonic is 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 its 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. Sonic subsequently filed a notice of appeal of the court’s class certification ruling with the Florida Court of Appeals. In April 2007, the Florida Court of Appeals affirmed a portion of the trial court’s class certification, and overruled a portion of the trial court’s class certification. The Florida trial court granted Summary Judgment in Sonic’s favor against Plaintiff Enrique Galura, and his claim has been dismissed. Virginia Galura’s claim is still pending. Sonic currently intends to continue its vigorous appeal and defense of this lawsuit 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.

          Several private civil actions have been filed against Sonic Automotive, Inc. and several of its dealership subsidiaries that purport to represent classes of customers as potential plaintiffs and made allegations that certain products sold in the finance and insurance departments were done so in a deceptive or otherwise illegal manner. One of these private civil actions was filed on November 15, 2004 in South Carolina state court, York County Court of Common Pleas, against Sonic Automotive, Inc. and 10 of Sonic’s South Carolina subsidiaries. The plaintiffs in that lawsuit were Misty J. Owens, James B. Wright, Vincent J. Astey and Joseph Lee Williams, on behalf of themselves and all other persons similarly situated, with plaintiffs seeking monetary damages and injunctive relief on behalf of the purported class. The group of plaintiffs’ attorneys representing the plaintiffs in the South Carolina lawsuit also filed another private civil class action lawsuit against Sonic Automotive, Inc. and 3 of Sonic’s subsidiaries on February 14, 2005 in state court in North Carolina, Lincoln County Superior Court, which similarly sought certification of a multi-state class of plaintiffs and alleged that certain products sold in the finance and insurance departments were done so in a deceptive or otherwise illegal manner. The plaintiffs in this North Carolina lawsuit were Robert Price, Carolyn Price, Marcus Cappeletti and Kathy Cappeletti, on behalf of themselves and all other persons similarly situated, with plaintiffs seeking monetary damages and injunctive relief on behalf of the purported class. The South Carolina state court action and the North Carolina state court action have since been consolidated into a single proceeding in private arbitration before the American Arbitration Association. On November 12, 2008, claimants in the consolidated arbitration filed a Motion for Class Certification as a national class action including all of the states in which Sonic operates dealerships. Claimants are seeking monetary damages and injunctive relief on behalf of this class of customers. The parties have briefed and argued the issue of class certification.

          On July 19, 2010, the Arbitrator issued a Partial Final Award on Class Certification, certifying a class which includes all customers who, on or after November 15, 2000, purchased or leased from a Sonic dealership a vehicle with the Etch product as part of the transaction, but not including customers who purchased or leased such vehicles from a Sonic dealership in Florida. The Partial Final Award on Class Certification is not a final decision on the merits of the action. The merits of Claimants’ assertions and potential damages will still have to be proven through the remainder of the arbitration. The Arbitrator stayed the Arbitration for thirty days to allow either party to petition a court of competent jurisdiction to confirm or vacate the award. Sonic will seek review of the class certification ruling by a court of competent jurisdiction and will continue to press its argument that this action is not suitable for a class-based arbitration. On July 22, 2010, the plaintiffs in this consolidated arbitration filed a Motion to Confirm the Arbitrator’s Partial Final Award on Class Certification in state court in North Carolina, Lincoln County Superior Court. On August 17, 2010, Sonic filed to remove this North Carolina state court action to federal court, and simultaneously filed a Petition to Vacate the Arbitrator’s Partial Final Award on Class Certification, with both filings made in the United Stated District Court for the Western District of North Carolina.

          Sonic intends to continue its vigorous defense of this arbitration and to assert all available defenses. However, an adverse resolution of this arbitration 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.

          Sonic is involved, and expects to continue to be involved, in numerous legal and administrative proceedings arising out of the conduct of its business, including regulatory investigations and private civil actions brought by plaintiffs purporting to represent a potential class or for which a class has been certified. Although Sonic vigorously defends itself in all legal and

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

administrative proceedings, the outcomes of pending and future proceedings arising out of the conduct of Sonic’s business, including litigation with customers, employment related lawsuits, contractual disputes, class actions, purported class actions and actions brought by governmental authorities, cannot be predicted with certainty. An unfavorable resolution of one or more of these matters could have a material adverse effect on Sonic’s business, financial condition, results of operations, cash flows or prospects. Recorded at December 31, 2009 and September 30, 2010 were $9.2 million and $9.0 million, respectively, in reserves that Sonic has provided for pending proceedings.

Guarantees and Indemnification Obligations:

               In connection with franchise dispositions, certain of Sonic’s dealership subsidiaries have assigned or sublet to the buyer its interests in real property leases associated with such dealerships. In general, Sonic’s dealership 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 sub-lessee does not perform. In the event the sub-lessees do not perform under their obligations Sonic remains liable for the lease payments. The total amount relating to this risk was approximately $106.0 million as of December 31, 2009. See Sonic’s Annual Report on Form 10-K for the year ended December 31, 2009 for further discussion.

          In accordance with the terms of agreements entered into for the sale of Sonic’s 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 if the counterparties failed to perform under their contractual obligations was approximately $13.9 million and $16.6 million at December 31, 2009 and September 30, 2010, respectively. These indemnifications generally expire within a period of one to two years following the date of sale. The estimated fair value of these indemnifications was not material.

9. Fair Value Measurements

          In determining fair value, Sonic uses various valuation approaches including market, income and/or cost approaches. “Fair Value Measurements and Disclosures” in the ASC establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of Sonic. Unobservable inputs are inputs that reflect Sonic’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that Sonic has the ability to access. Assets utilizing Level 1 inputs include marketable securities that are actively traded.

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Assets and liabilities utilizing Level 2 inputs include cash flow swap instruments.

Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement. Asset and liability measurements utilizing Level 3 inputs include those used in estimating fair value of non-financial assets and non-financial liabilities in purchase acquisitions, those used in assessing impairment under “Property, Plant and Equipment” in the ASC and those used in the reporting unit valuation in the first step of the annual goodwill impairment evaluation. For instance, certain assets held for sale in the accompanying Condensed Consolidated Balance Sheets are valued based on estimated proceeds to be received in connection with the disposal of those assets.

          The availability of observable inputs can vary and is affected by a wide variety of factors. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment required by Sonic in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is disclosed is determined based on the lowest level input (Level 3 being the lowest level) that is significant to the fair value measurement.

          Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, Sonic’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. Sonic uses inputs that are current as of the measurement date, including during periods when the market may be abnormally high or abnormally low. Accordingly, fair value measurements can be volatile based on various factors that may or may not be within Sonic’s control.

     Assets or liabilities recorded at fair value in the accompanying balance sheet as of September 30, 2010 are as follows:

						Fair Value at Reporting Date Using:
										Significant
						Quoted Prices in				Other				Significant
(dollars in millions)						Active Markets for				Observable				Unobservable
						Identical Assets				Inputs				Inputs
		Total				(Level 1)				(Level 2)				(Level 3)
Cash Flow Swaps (1)		$	40.0				-			$	40.0				-
Total		$	40.0			$	-			$	40.0			$	-

(1) - Included in Other Long-Term Liabilities in the accompanying Condensed Consolidated Balance Sheet.

          As of December 31, 2009 and September 30, 2010, the fair values of Sonic’s financial instruments including receivables, notes receivable from finance contracts, notes payable-floor plan, trade accounts payable, borrowings under the revolving credit facilities and certain mortgage notes approximate their carrying values due either to length of maturity or existence of variable interest rates that approximate prevailing market rates.

          The fair value and carrying value of Sonic’s fixed rate long-term debt was as follows:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		(dollars in thousands)
		December 31, 2009								September 30, 2010
		Fair Value				Carrying Value				Fair Value				Carrying Value
9.00% Senior Subordinated Notes (1)		$	-			$	-			$	219,870			$	208,597
8.625% Senior Subordinated Notes (1)		$	266,750			$	273,455			$	38,998			$	42,658
5.0% Convertible Senior Notes (1)		$	188,072			$	142,743			$	181,125			$	146,506
4.25% Convertible Senior Subordinated Notes (1)		$	16,363			$	16,423			$	16,000			$	15,889
Mortgage Notes (2)		$	78,333			$	78,424			$	84,239			$	84,341
Notes Payable to a Finance Company (2)		$	17,859			$	20,260			$	16,243			$	18,150