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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549



FORM 10-K

 
/x/
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended: December 31, 1999

OR

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

Commission File Number: 000-21789


LITHIA MOTORS, INC.
(Exact name of registrant as specified in its charter)

Oregon   93-0572810
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 
360 E. Jackson Street, Medford, Oregon
 
 
 
97501
(Address of principal executive offices)   (Zip Code)

541-776-6899
(Registrant's telephone number including area code)

Securities registered pursuant to Section 12(b) of the Act:
Class A Common Stock, without par value

Securities registered pursuant to Section 12(g) of the Act: None
(Title of Class)


    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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. /x/

    The aggregate market value of the voting stock held by non-affiliates of the Registrant is $55,307,991 as of February 29, 2000 based upon the last sales price ($14.94) as reported by the New York Stock Exchange.

    The number of shares outstanding of the Registrant's Common Stock as of February 29, 2000 was: Class A: 8,027,890 shares and Class B: 4,087,000 shares.

Documents Incorporated by Reference

    The Registrant has incorporated into Part III of Form 10-K, by reference, portions of its Proxy Statement for its 2000 Annual Meeting of Shareholders.




LITHIA MOTORS, INC.

1999 FORM 10-K ANNUAL REPORT


TABLE OF CONTENTS

 
   
  Page
PART I
 
Item 1.
 
 
 
Business
 
 
 
2
 
Item 2.
 
 
 
Properties
 
 
 
12
 
Item 3.
 
 
 
Legal Proceedings
 
 
 
12
 
Item 4.
 
 
 
Submission of Matters to a Vote of Security Holders
 
 
 
12
 
 
PART II
 
Item 5.
 
 
 
Market for Registrant's Common Equity and Related Stockholder Matters
 
 
 
13
 
Item 6.
 
 
 
Selected Financial Data
 
 
 
14
 
Item 7.
 
 
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
15
 
Item 7A.
 
 
 
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
20
 
Item 8.
 
 
 
Financial Statements and Supplementary Data
 
 
 
21
 
Item 9.
 
 
 
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
 
 
21
 
 
PART III
 
Item 10.
 
 
 
Directors and Executive Officers of the Registrant
 
 
 
22
 
Item 11.
 
 
 
Executive Compensation
 
 
 
22
 
Item 12.
 
 
 
Security Ownership of Certain Beneficial Owners and Management
 
 
 
22
 
Item 13.
 
 
 
Certain Relationships and Related Transactions
 
 
 
22
 
 
PART IV
 
Item 14.
 
 
 
Exhibits, Financial Statement Schedules and Reports on Form 8-K
 
 
 
22
 
Signatures
 
 
 
29

1



PART I

Item 1. Business

Forward Looking Statements and Risk Factors

    This Form 10-K contains forward-looking statements. These statements are necessarily subject to risk and uncertainty. Actual results could differ materially from those projected in these forward-looking statements. These risk factors include, but are not limited to, the following:


    See Exhibit 99 to this Form 10-K for a more complete discussion of risk factors.

General

    Lithia is a leading operator and retailer of new and used vehicles and services through a well developed franchise system with its auto manufacture partners. As of March 6, 2000, we offer 25 brands of new vehicles, through 101 franchises in 45 locations in the western United States and over the internet. We currently operate 15 dealerships in California, 13 in Oregon, 3 in Washington, 6 in Colorado, 4 in Nevada and 4 in Idaho. Lithia sells new and used cars and light trucks, sells replacement parts, provides vehicle maintenance, warranty, paint and repair services, and arranges related financing and insurance for its automotive customers.

    Lithia Motors, Inc. was founded in 1946 and its two senior executives have managed Lithia for nearly 30 years. Management has developed and implemented its acquisition and operating strategies, which have enabled Lithia to successfully identify, acquire and integrate dealerships, achieving financial performance superior to industry averages. Lithia has achieved compounded annual growth rates over the last three years of 105% per year for annual revenues, 94% per year for net income and 45% per year for earnings per share. Since December 1996 when we completed our initial public offering, we have acquired or opened 40 dealerships and are actively pursuing additional acquisitions.

    According to industry data, the number of franchised automobile dealerships has declined from more than 36,000 dealerships in 1960 to under 22,000 in 1999. As of the end of 1998, the largest 100 dealer groups generated less than 12% of total industry sales and controlled approximately 5% of all franchised automobile dealerships. Based on our current annual revenue run rate of over $1.5 billion, we believe that we are one of the 15 largest automobile retailers in the country.

    Further consolidation of the automotive retailing industry is expected due to:


Growth Strategy

    Lithia has become a leading acquirer and operator of automobile dealerships in the western and inter-mountain United States. We target acquisitions in markets where we have the opportunity to build a significant market presence. We generally try to acquire an entire group at one time (a "Platform") or acquire one or two stores at a time ("Fill-ins"). Lithia's current core markets are South-Central Oregon, Northern California, South-Central Valley, California, Northern Nevada, Eastern Washington, Denver,

2


Colorado and Boise, Idaho. Lithia's acquisition pricing discipline has played a key role in its acquisition activities. Lithia's strict discipline in purchasing stores, combined with its ability to improve profitability by implementing the Lithia operating model into acquired stores, has effectively allowed Lithia to build its own dealership groups in each area.

    Since our initial public offering in December 1996, we have completed the purchase of 37 dealerships with the following revenues at the time of acquisition:

Year

  Number of
dealerships acquired

  Revenues (in millions of dollars)
1996   2   $ 60
1997   10     300
1998   11     310
1999   13     585
2000   1     73
   
 
Total   37   $ 1,328
   
 

Operating Strategy

    After acquiring a new store, Lithia implements its proven operating model to maximize the overall franchise value of each location. Lithia's operating strategy consists of the following elements:

    Value Partnership with Manufacturers.  Lithia recognizes that the manufacturers are true partners through the franchise system. They are all large well-developed companies with enormous resources committed to the franchise as the method of retailing their products. They lend support in training Lithia's employees; in allocating vehicles; in designing systems for operations; in selling slower-moving inventories through incentives and rebates; and in advertising through regional and national sources. Lithia relies on this help and encourages their assistance as a welcome partner. Lithia cooperates in facility design, in marketing efforts and in program support.

    Provide a Broad Range of Products and Services.  Lithia offers a broad range of products and services including a wide selection of new and used cars and light trucks, vehicle financing and insurance and replacement parts and service.

    Lithia seeks to increase customer traffic and meet specific customer needs by offering new and used vehicles and an array of complementary services at each of its locations. We believe that offering numerous new vehicle brands appeals to a variety of customers, minimizes dependence on any one manufacturer, and reduces our exposure to supply problems and product cycles.

    Emphasize Sales of Higher Margin Products and Services.  Lithia generates substantial incremental revenue and net income by arranging the financing for the sale of vehicles and by selling insurance, extended service contracts and vehicle maintenance. In 1999, Lithia arranged financing for 73% of its new vehicle sales and 74% of its used vehicle sales, compared to 46% and 51%, respectively, for the average automobile dealership in the United States (1998 NADA data).

    Employ Professional Management Techniques.  Each dealership is its own profit center and is managed by an experienced general manager who has primary responsibility for inventory, advertising, pricing and personnel. In order to provide additional support towards improving performance, each dealership has available to it a team of specialists in new vehicle sales, used vehicle sales, finance and insurance, service and parts, and back office administration. Lithia compensates its general managers and department managers based on the profitability of their dealerships and departments, respectively. Senior management monitors each dealership's sales, profitability and inventory on a regular basis.

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    Focus on Customer Satisfaction and Loyalty.  Lithia emphasizes customer satisfaction and works to develop a reputation for quality and fairness. Lithia trains its sales personnel to identify an appropriate vehicle for each of its customers at an affordable price.

    Lithia's "Priority You" customer centered plan attempts to provide:


    We believe that "Priority You" helps differentiate us from other dealerships.

    We believe the application of this operating strategy provides us with a competitive advantage over many dealerships and it is critical to our ability to achieve levels of profitability superior to industry averages.

    Lithia has received a number of dealer quality and customer satisfaction awards from various manufacturers this year and in the past. These include; Chrysler's highest recognition for dealer excellence, the Five-Star Certification, as well as Toyota's President's Cup, Dodge's National Charger Club membership, Volkswagen of America's Wolfsburg Crest Club Award, and Isuzu's Sendai Cup & President's Cup, each recognizing high sales volume and customer satisfaction.

Dealership Operations

    Lithia owns and operates 45 dealership locations, 15 dealerships in California, 13 in Oregon, 3 in Washington, 6 in Colorado, 4 in Nevada and 4 in Idaho. Each of Lithia's dealerships sell new and used vehicles and related automotive parts and services.

    Lithia's dealerships, brands sold and percentage of current annual revenues are as follows:


 
Oregon Stores (13)

  Franchises (40)

  24%

 

 
Lithia Honda Suzuki   Honda, Suzuki      
Lithia Volkswagen Isuzu   Volkswagen, Isuzu      
Lithia Toyota Lincoln Mercury   Toyota, Lincoln/Mercury      
Lithia Dodge Chrysler Plymouth Mazda Jeep   Dodge, Dodge Truck, Chrysler/Plymouth, Mazda, Jeep      
Saturn of Southwest Oregon   Saturn      
Lithia Nissan BMW   Nissan, BMW      
Lithia's Grants Pass Auto Center   Dodge, Dodge Truck, Chrysler/Plymouth, Jeep      
Lithia Dodge of Eugene   Dodge, Dodge Truck      
Lithia Toyota of Springfield   Toyota      
Lithia Nissan of Eugene   Nissan      
Lithia ford Lincoln Mercury Nissan of Roseburg   Ford, Lincoln/Mercury, Nissan      
Lithia Dodge Chrysler/Plymouth Jeep of Roseburg   Dodge, Dodge Truck, Chrysler/Plymouth, Jeep      
Lithia Klamath Falls Auto Center   Toyota, Dodge, Dodge Truck, Chrysler/Plymouth, Jeep      

4


 

 
 
California Stores (15)   Franchises (21)   25 %

 
Lithia Toyota of Vacaville   Toyota      
Lithia Dodge of Concord   Dodge, Dodge Truck      
Lithia Volkswagen of Concord   Volkswagen, Isuzu      
Lithia Ford of Concord   Ford      
Lithia Ford Lincoln Mercury of Napa   Ford, Lincoln/Mercury      
Lithia Chevrolet of Redding   Chevrolet      
Lithia Toyota of Redding   Toyota      
Lithia Nissan of Bakersfield   Nissan      
Lithia BMW of Bakersfield   BMW      
Acura of Bakersfield   Acura      
Lithia Jeep of Bakersfield   Jeep      
Lithia Ford of Fresno   Ford      
Lithia Mazda Suzuki of Fresno   Mazda, Suzuki      
Lithia Nissan of Fresno   Nissan      
Lithia Jeep Hyundai of Fresno   Jeep, Hyundai      
 

 
 
Nevada Stores (4)   Franchises (8)   9 %

 
Lithia Reno   Suzuki, Audi, Lincoln/Mercury, Isuzu      
Lithia Volkswagen of Reno   Volkswagen      
Lithia Sparks (satellite of Lithia Reno)   Suzuki, Lincoln/Mercury, Isuzu      
Lithia Reno Subaru Hyundai   Subaru, Hyundai      
 

 
 
Washington Stores (3)   Franchises (6)   8 %

 
Lithia Camp Chevrolet   Chevrolet      
Lithia Camp Imports   Subaru, BMW, Volvo      
Lithia Dodge of Tri-Cities   Dodge, Dodge Truck      
 

 
 
Colorado Stores (6)   Franchises (19)   23 %

 
Lithia Centennial Chrysler Plymouth Jeep   Chrysler/Plymouth, Jeep      
Lithia Cherry Creek Dodge   Dodge, Dodge Truck      
Lithia Colorado Chrysler Plymouth Kia   Chrysler/Plymouth, Kia      
Lithia Foothills Chrysler Suzuki Hyundai   Dodge, Dodge Truck, Chrysler/Plymouth, Suzuki, Hyundai, Jeep      
Lithia Colorado Jeep   Jeep      
Lithia Colorado Springs Jeep Chrysler Plymouth   Jeep, Chrysler/Plymouth      
 

 
 
Idaho Stores (4)   Franchises (7)   11 %

 
Roundtree Chevrolet   Chevrolet      
Roundtree Lincoln-Mercury Isuzu   Lincoln/Mercury, Isuzu      
Lithia Ford Chrysler of Boise   Ford, Chrysler      
Roundtree Daewoo of Boise   Daewoo      
 

 
 
45 Stores   101 Franchises—25 Brands   100 %

 

5


    Since Lithia's initial public offering in December 1996, it has completed the purchase of 37 dealerships with the following revenues at the time of acquisition:

Year

  # of
dealerships acquired

  Revenues (in millions of dollars)
1996   2   $ 60
1997   10     300
1998   11     310
1999   13     585
2000   1     73
   
 
Total   37   $ 1,328
   
 

    In addition, we separated the Bakersfield, California BMW/Acura dealership into two stores and the Medford, Oregon, Lithia Honda Volkswagen Isuzu and Suzuki dealership into two stores. Finally, in Boise, Idaho, we added a new Daewoo store. Combined with the five original stores, the 37 acquisitions and 3 additions bring our total number of stores to 45.

    New Vehicle Sales.  In 1999, Lithia sold 24 domestic and imported brands ranging from economy to luxury cars, sport utility vehicles, minivans and light trucks. The following table sets forth, by manufacturer, the percentage of new vehicle sales by Lithia during 1999.

Manufacturer

  1999 Percentage of New Vehicle Sales
 
Chrysler (Chrysler, Plymouth, Dodge, Jeep, Dodge Trucks)   40.7  
Ford (Ford, Lincoln, Mercury)   14.9  
Toyota   11.3  
General Motors (Chevrolet, Saturn)   8.5  
Volkswagen, Audi   6.1  
Nissan   5.1  
Isuzu   2.7  
Subaru   2.7  
Honda (Acura, Honda)   2.2  
BMW   2.1  
Suzuki   1.1  
Mazda   1.1  
Hyundai   0.9  
Volvo   0.4  
Kia   0.2  
   
 
    100.0 %
   
 

    The following table sets forth Lithia's unit and dollar sales of new vehicles for each of the past five years:

 
  1995
  1996
  1997
  1998
  1999
 
  (dollars in thousands)

Units     2,715     3,274     7,493     17,708     28,645
Sales   $ 53,277   $ 65,092   $ 161,294   $ 388,431   $ 673,339

    Lithia purchases substantially all of its new car inventory directly from manufacturers who allocate new vehicles to dealerships based on the amount of vehicles sold by the dealership and by the dealership's

6


market area. Lithia also exchanges vehicles with other dealers to accommodate customer demand and to balance inventory.

    As is customary in the automobile industry, the final sales price of a new vehicle is generally negotiated with the customer. However, at Lithia's Saturn dealership, the final sales price does not deviate from the posted price.

    Used Vehicle Sales.  Used vehicle sales are an important part of our overall profitability. Lithia retains a used vehicle manager at each of its locations.

    Lithia acquires the majority of its used vehicles through customer trade-ins, but also acquires them at "closed" auctions, which may be attended only by new vehicle dealers with franchises for the brands offered. These auctions offer off-lease, rental and fleet vehicles. Lithia also acquires vehicles at "open" auctions, which offer repossessed vehicles and vehicles being sold by other dealers.

    Lithia sells used vehicles to retail customers and, in the case of vehicles in poor condition, or vehicles that have not sold within a specified period of time, to other dealers and to wholesalers.

    The following table sets forth Lithia's unit and dollar sales of used vehicles for each of the past five years:

 
  1995
  1996
  1997
  1998
  1999
 
  (dollars in thousands)

Retail units     3,302     4,156     7,148     13,645     23,840
Retail sales   $ 36,997   $ 48,697   $ 88,571   $ 174,223   $ 313,449
 
Wholesale units
 
 
 
 
 
1,842
 
 
 
 
 
2,348
 
 
 
 
 
4,990
 
 
 
 
 
9,532
 
 
 
 
 
13,424
Wholesale sales   $ 7,064   $ 9,914   $ 24,528   $ 46,321   $ 62,113
 
Total units
 
 
 
 
 
5,144
 
 
 
 
 
6,504
 
 
 
 
 
12,138
 
 
 
 
 
23,177
 
 
 
 
 
37,264
Total sales   $ 44,061   $ 58,611   $ 113,099   $ 220,544   $ 375,562

    Lithia's "Priority You" offers a 60-day/3,000-mile warranty and a 10-day/500-mile "no questions asked" exchange program on every used vehicle it sells.

    Vehicle Financing and Leasing.  Lithia believes that the availability of financing at its dealerships is critical to its ability to sell vehicles and ancillary products and services. Lithia provides a variety of financing and leasing alternatives to meet the needs of each customer. We believe our ability to offer customer-tailored financing on a "same day" basis provides us with an advantage over many of our competitors, particularly smaller competitors who do not generate sufficient volume to attract the diversity of financing sources that are available to us.

    Because of the high profit margins that are typically generated through sales of F&I products, Lithia seeks to arrange financing for every vehicle it sells. Lithia has arranged financing for a larger percentage of its transactions than the industry average. During 1999, Lithia financed or arranged financing for over 73% of its new vehicle sales and 74% of its used vehicle sales, compared to an industry average of 46% and 51%, respectively (latest 1998 NADA data).

    Lithia maintains close relationships with a wide variety of financing sources that are best suited to satisfy its customers' particular needs and that maximize income. The interest rates available and the required down payment, if any, depend to a large extent, upon the bank or other institution providing the financing and the credit history of the particular customer.

    Lithia generally arranges financing for its customers from third party sources to avoid the risk of default. However, if we believe the credit risk is manageable, we occasionally directly finance or lease the

7


vehicle to the customer. In these cases, Lithia bears the risk of default. Historically, Lithia has directly financed only a limited number of vehicle sales.

    Service, Body and Parts.  Lithia considers its auto service, body, paint and parts operations to be an integral part of its customer service program and an important element of establishing customer loyalty. Lithia provides parts and service primarily for the new vehicle brands sold by its dealerships but may also service other vehicles. In 1999, Lithia's service, body and parts operations generated $120.7 million in revenues, or 9.7% of total revenues. Lithia uses a variable pricing structure designed to reflect the difficulty and sophistication of different types of repairs and the cost and availability of parts.

    The service, body and parts business provides an important recurring revenue stream to the dealerships. Lithia markets its parts and service products by notifying the owners of vehicles purchased at its dealerships when their vehicles are due for periodic service. This practice encourages preventive maintenance rather than post-breakdown repairs. To a limited extent, revenues from the service, body and parts departments are counter-cyclical to new car sales as owners repair existing vehicles rather than buy new vehicles. We believe this helps mitigate the effects of a downturn in the new vehicle sales cycle.

    Lithia operates six collision repair centers, two in Oregon and one each in California, Washington, Colorado and Idaho.

    Ancillary Services and Products.  Lithia's F&I managers market a number of ancillary products and services to every purchaser of a new or used vehicle. Typically, these products and services yield high profit margins and contribute significantly to Lithia's overall profitability.

    Lithia sells third-party extended-service contracts, which cover many designated repairs. While all new vehicles are sold with the automobile manufacturer's standard warranty, service plans provide additional coverage beyond the time frame or scope of the manufacturer's warranty. Purchasers of used vehicles can purchase similar extended-service contracts.

    Lithia offers its customers credit life, health and accident insurance when they finance an automobile purchase. Lithia receives a commission on each policy sold. The Company also offers other ancillary products such as protective coatings, lifetime oil change packages and automobile alarms.

Sales and Marketing

    We believe that our "Priority You" program described earlier helps differentiate us from many other dealerships, thereby increasing customer traffic and developing stronger customer loyalty. Lithia also defines itself as "America's Car and Truck Store."

    Advertising and marketing play a significant role in our success. A large portion of an auto retailers' advertising and marketing expenses are provided for by the automobile manufacturers. The manufacturers also provide Lithia with market research, which assists Lithia in developing its own advertising and marketing campaigns.

    Lithia utilizes most forms of media in its advertising, including television, an internet web site, newspaper, radio and direct mail, which includes periodic mailers to previous customers. Lithia uses advertising to develop its image as a reputable dealer, offering quality service, affordable automobiles and financing for all buyers. In addition, Lithia's individual dealerships sponsor price discounts or other promotions designed to attract customers. By owning a cluster of dealerships in a particular market, we can save money from volume discounts and other media concessions. Lithia also participates as a member of a number of advertising cooperatives or associations whose members pool their resources and expertise together with those of the manufacturer to develop advertising campaigns.

8


    Lithia has dedicated resources to developing and maintaining its web site (www.lithia.com). We believe that our web site is a valuable lead-generation tool and information source for our customers. A visitor to Lithia's web site is able to do the following at each of Lithia's locations:


    We believe that regional and national auto retailers, such as Lithia, are best positioned to take advantage of the internet as an effective marketing tool.

Management Information System

    Lithia's financial information, operational and accounting data, and other related statistical information are consolidated, processed and maintained at its headquarters in Medford, Oregon, on a network of computers and work stations.

    Senior management is able to access detailed information from all of its locations regarding:


    Each dealership's general manager can access the same information. With this information, management can quickly analyze the results of operations, identify trends in the business, and focus on areas that require attention or improvement. We believe that our management information system also allows our general managers to quickly respond to changes in consumer preferences and purchasing patterns, thereby maximizing inventory turnover.

    We believe that our management information system is a key factor in successfully incorporating newly acquired businesses. Following each acquisition, Lithia immediately installs its management information system at the dealership location, thereby quickly making the financial, accounting and other operational data easily accessible throughout the organization. With access to such data, management can more efficiently execute Lithia's operating strategy at the newly acquired dealership.

Relationships with Automobile Manufacturers

    Lithia has, either directly or through its subsidiaries, entered into franchise or dealer sales and service agreements with each manufacturer of the new vehicles it sells.

    The typical automobile franchise agreement specifies the locations within a designated market area at which the dealer may sell vehicles and related products and perform certain approved services. The designation of such areas and the allocation of new vehicles among dealerships are subject to the discretion of the manufacturer, which (except for Saturn) does not guarantee exclusivity within a specified territory.

9


    A franchise agreement may impose requirements on the dealer concerning such matters as:


    Each manufacturer closely monitors compliance with these requirements and requires each dealership to submit monthly and annual financial statements of operations. The franchise agreements also grant the dealer the non-exclusive right to use and display manufacturers' trademarks, service marks and designs in the form and manner approved by each manufacturer.

    Most franchise agreements expire after a specified period of time, ranging from one to five years; however, some franchise agreements, including those with Chrysler, have no termination date. The typical franchise agreement provides for early termination or non-renewal by the manufacturer if there is:


    Each franchise agreement authorizes at least one person to manage the dealership's operations. The manufacturer must approve changes in management or transfers of ownership of the dealership. Lithia has entered into master framework agreements with most of its manufacturers that impose additional requirements on its stores. See Exhibit 99 "Risk Factors" for further details.

Competition

    The automobile business is highly competitive. The automobile dealership industry is fragmented and characterized by a large number of independent operators, many of whom are individuals, families, and small groups. Lithia principally competes with other automobile dealers, both publicly and privately held, in the same general vicinity of its dealership locations. In addition, certain regional and national car rental companies operate retail used car lots to dispose of their used rental cars.

Regulation

    Lithia's operations are subject to extensive regulation, supervision and licensing under various federal, state and local statutes, ordinances and regulations. Various state and federal regulatory agencies, such as the Occupational Safety and Health Administration and the U.S. Environmental Protection Agency, have jurisdiction over the operation of Lithia's dealerships, service centers, collision repair shops and other

10


operations, with respect to matters such as consumer protection, workers' safety and laws regarding clean air and water.

    The relationship between a franchised automobile dealership and a manufacturer is governed by various federal and state laws established to protect dealerships from the generally unequal bargaining power between the parties. A manufacturer may not:


    Manufacturers may object to a sale or change of management based on character, financial ability or business experience of the proposed transferee.

    Automobile dealers and manufacturers are also subject to various federal and state laws established to protect consumers, including so-called "Lemon Laws." A manufacturer must replace a new vehicle or accept it for a full refund within one year after initial purchase if:


    We must provide written disclosures on new vehicles of mileage and pricing information. In addition, financing and insurance activities are subject to credit reporting, debt collection, and insurance industry regulation.

    Imported automobiles are subject to United States customs duties. Lithia may, from time to time, have to pay claims for duties, penalties or other charges.

    Lithia's business, particularly parts, service and collision repair operations involves hazardous or toxic substances or wastes. Lithia has been required to remove storage tanks containing such substances or wastes. Federal, state and local authorities establishing health and environmental quality standards regulate the handling and storage of hazardous materials. These governmental authorities also regulate remediation of contaminated sites, which could be Lithia facilities or sites to which Lithia sends hazardous or toxic substances or wastes for treatment, recycling or disposal. We believe that we do not have any material environmental liabilities and that compliance with environmental regulations will not have a material adverse effect on Lithia's results of operations or financial condition.

Employees

    As of December 31, 1999, we employed approximately 2,851 persons on a full-time equivalent basis. The service department employees at Lithia Dodge and Lithia Ford of Concord, Lithia Sun Valley Isuzu and Lithia Sun Valley Volkswagen are bound by collective bargaining agreements. The Company believes it has a good relationship with its employees.

11



Item 2. Properties

    Lithia's dealerships and other facilities consist primarily of automobile showrooms, display lots, service facilities, three collision repair and paint shops, rental agencies, supply facilities, automobile storage lots, parking lots and offices. We believe our facilities are currently adequate for our needs and are in good repair. Lithia owns some of its properties, but leases many properties, providing future flexibility to relocate its retail stores as demographics change. Lithia also holds some undeveloped land for future expansion.

Item 3. Legal Proceedings

    Lithia is a party to litigation that arises in the normal course of its business operations. We do not believe that we are presently a party to litigation that will have a material adverse effect on our business or operations.


Item 4. Submission of Matters to a Vote of Security Holders

    No matters were submitted to a vote of Lithia's shareholders during the quarter ended December 31, 1999.

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PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

    Lithia's Class A Common Stock began trading on the New York Stock Exchange on January 22, 1999 under the symbol LAD. Prior to that time, the Class A Common Stock traded on the Nasdaq National Market under the symbol LMTR. The quarterly high and low sales prices of the Class A Common Stock for the period from January 1, 1998 through December 31, 1999 were as follows:

 
  High
  Low
1998            
Quarter 1   $ 17.25   $ 12.00
Quarter 2     17.00     13.13
Quarter 3     18.25     10.38
Quarter 4     17.88     9.25
 
1999
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 1   $ 20.50   $ 15.00
Quarter 2     20.50     15.13
Quarter 3     23.56     17.75
Quarter 4     22.94     15.75

    The number of shareholders of record and approximate number of beneficial holders of Class A Common Stock at February 29, 2000 was 1,695 and 1,900, respectively. All shares of Lithia's Class B Common Stock are held by Lithia Holding Company LLC. There were no cash dividends declared or paid in the last two fiscal years and Lithia does not intend to declare or pay cash dividends in the future. Lithia intends to retain any earnings that it may realize in the future to finance its acquisitions and operations. The payment of any future dividends will be subject to the discretion of the Board of Directors and will depend upon Lithia's results of operations, financial position and capital requirements, general business conditions, restrictions imposed by financing arrangements, if any, and legal restrictions on the payment of dividends. Lithia's agreements with Ford Motor Credit Company preclude the payment of cash dividends without the prior consent of Ford Credit.

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Item 6. Selected Financial Data

 
  Year Ended December 31,
 
 
  1995(1)
  1996(1)
  1997
  1998
  1999
 
 
  (In thousands, except per share amounts)

 
Consolidated Statement of Operations Data:                                
Revenues:                                
New vehicles   $ 53,277   $ 65,092   $ 161,294   $ 388,431   $ 673,339  
Used vehicles     44,061     58,611     113,099     220,544     375,562  
Service, body and parts     10,961     13,197     29,828     72,216     120,722  
Other revenues     5,897     5,944     15,574     33,549     73,036  
   
 
 
 
 
 
Total revenues     114,196     142,844     319,795     714,740     1,242,659  
Cost of sales     92,054     117,025     265,049     599,379     1,043,373  
   
 
 
 
 
 
Gross profit     22,142     25,819     54,746     115,361     199,286  
Selling, general and administrative     16,333     19,830     40,625     85,188     146,381  
Depreciation and amortization     1,907     1,756     2,483     3,469     5,573  
   
 
 
 
 
 
Income from operations     3,902     4,233     11,638     26,704     47,332  
Floorplan interest expense     (957 )   (697 )   (2,179 )   (7,108 )   (11,105 )
Other interest expense     (433 )   (656 )   (824 )   (2,735 )   (4,250 )
Other income, net     1,215     1,349     862     921     74  
   
 
 
 
 
 
Income before minority interest and income taxes     3,727     4,229     9,497     17,782     32,051  
Minority interest     (778 )   (687 )            
   
 
 
 
 
 
Income before income taxes(1)   $ 2,949     3,542     9,497     17,782     32,051  
   
                         
Income tax (expense) benefit           813     (3,538 )   (6,993 )   (12,877 )
         
 
 
 
 
Net income         $ 4,355   $ 5,959   $ 10,789   $ 19,174  
         
 
 
 
 
 
Pro Forma Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before taxes and minority interest, as reported   $ 3,727   $ 4,229                    
Pro forma provision for taxes(2)     (1,430 )   (1,623 )                  
   
 
                   
Pro forma net income     2,297   $ 2,606                    
   
 
                   
Basic net income per share(3)   $ 0.50   $ 0.56   $ 0.85   $ 1.18   $ 1.72  
   
 
 
 
 
 
Diluted net income per share(3)   $ 0.47   $ 0.52   $ 0.82   $ 1.14   $ 1.60  
   
 
 
 
 
 
 
  As of December 31,
 
 
 
 
 
 
1995(1)

 
 
 
1996(1)

 
 
 
1997

 
 
 
1998

 
 
 
1999

 
 
 
  (In thousands)

 
Consolidated Balance Sheet Data:                                
Working capital   $ 10,626   $ 25,431   $ 23,870   $ 53,553   $ 74,999  
Total assets     44,117     68,964     166,526     294,398     506,433  
Short-term debt     22,300     22,000     85,385     132,310     215,535  
Long-term debt, less current maturities     10,743     6,160     26,558     41,420     73,911  
Total shareholders' equity     3,716     27,914     37,877     91,511     155,638  

(1)
Effective January 1, 1997, the Company converted from the LIFO method of accounting for inventories to the FIFO method. Accordingly, the 1995 and 1996 data has been restated to reflect this change. See Note 1 of Notes to Consolidated Financial Statements.
(2)
The Company was an S Corporation and accordingly was not subject to federal and state income taxes during the periods indicated. Pro forma net income reflects federal and state income taxes as if the Company had been a C Corporation, based on the effective tax rates that would have been in effect during these periods. See "Company Restructuring and Prior S Corporation Status" and Notes 1 and 8 to the Company's Consolidated Financial Statements.
(3)
The per share amounts are pro forma for 1995 and 1996 and actual for 1997, 1998 and 1999.

14



Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

General

    In 1999, Lithia generated record revenues, EBITDA (earnings before interest, taxes, depreciation and amortization), net income and unit sales of new and used vehicles as follows (dollars in thousands):

 
  1998
  1999
  % Increase
 
Revenues   $ 714,740   $ 1,242,659   73.9 %
EBITDA   $ 31,094   $ 52,979   70.4 %
Cash flow from operations   $ 9,346   $ 22,381   139.5 %
Net income   $ 10,789   $ 19,174   77.7 %
Unit sales:                  
New     17,708     28,645   61.8 %
Retail used     13,645     23,840   74.7 %

    The following table shows selected condensed financial data expressed as a percentage of total revenues for the periods indicated for the average automotive dealer in the United States.

 
  Year Ended December 31,
 
 
  1998
  1999
 
Average U.S. Dealership Statement of Operations Data:          
Revenues:          
New vehicles   59.0 % 59.9 %
Used vehicles   29.4   28.9  
Parts and service, other   11.6   11.2  
   
 
 
    100.0 % 100.0 %
Gross profit   12.9   12.6  
Total dealership expense   11.2   10.8  
Income before taxes   1.7 % 1.8 %

Source: NADA Industry Analysis Division

    The following table sets forth selected condensed financial data for Lithia expressed as a percentage of total revenues for the periods indicated below.

Lithia Motors, Inc.

 
  Year Ended December 31,
 
 
  1997
  1998
  1999
 
Revenues:              
New vehicles   50.4 % 54.3 % 54.2 %
Used vehicles   35.4 % 30.9 % 30.2 %
Service, body and parts   9.3 % 10.1 % 9.7 %
Other revenues   4.9 % 4.7 % 5.9 %
   
 
 
 
Total revenues   100.0 % 100.0 % 100.0 %
Gross profit   17.1 % 16.1 % 16.0 %
Selling, general and administrative expenses   12.7 % 11.9 % 11.8 %
Income from operations   3.6 % 3.7 % 3.8 %

15


1999 Compared to 1998

    Revenues.  Revenues increased $527.9 million, or 73.9% to $1.24 billion for the year ended December 31, 1999 from $714.7 million in 1998. Total vehicles sold during 1999 increased by 25,024, or 61.2%, to 65,909 from 40,885 during 1998. Same store sales growth was 6.9% in 1999, with a 17.8% increase in same store finance and insurance revenue. Same store sales growth was 14.7% in 1998. The increases in units sold and revenue from all sources are a result of acquisitions and internal growth.

 
  1999
  1998
  % change
 
Units sold     28,645     17,708   61.8 %
Average selling price   $ 23,506   $ 21,935   7.2 %
 
  1999
  1998
  % change
 
Units sold     23,840     13,645   74.7 %
Average selling price   $ 13,148   $ 12,768   3.0 %

    Gross Profit.  Gross profit increased 72.7% during 1999 to $199.3 million, from $115.4 million in 1998, primarily due to increased revenues as indicated above. Gross profit margins achieved in 1999 and 1998 were as follows:

 
  1999 industry average
  Lithia
1999

  Lithia
1998

  Lithia
% change

 
Overall   12.6 % 16.0 % 16.1 % (0.6 %)
New vehicles   6.4 % 9.5 % 10.1 % (5.9 %)
Retail used vehicles   10.7 % 11.6 % 11.0 % 5.5 %

    The decrease in the new vehicle gross profit percentage is primarily due to the mix of stores added due to acquisitions. These stores have lower selling, general and administrative costs as a percentage of revenues than Lithia's preexisting stores, lending themselves to a high volume, low cost strategy of retailing vehicles. The increase in the retail used vehicle gross profit margin is primarily due to improved inventory management company wide and operational improvements at its newly acquired stores, as the Lithia model was implemented. Sales of used vehicles to other dealers and to wholesalers are frequently at, or close to, cost.

    Selling, General and Administrative Expense.  Selling, general and administrative ("SG&A") expense increased $61.2 million, or 71.8%, to $146.4 million (11.8% of total revenues) in 1999 from $85.2 million (11.9% of total revenues) in 1998. The increase in SG&A was due primarily to increased selling, or

16


variable, expense related to the increase in revenues and the number of total locations. The decrease in SG&A as a percent of total revenues is a result of economies of scale gained as the fixed expenses are spread over a larger revenue base and from economies of scale as Lithia consolidates multiple stores in a single market.

    Depreciation and Amortization.  Depreciation and amortization expense increased $2.1 million or 60.7% to $5.6 million (0.4% of total revenues) in 1999 from $3.5 million (0.5% of total revenues) in 1998, primarily as a result of increased property and equipment and goodwill related to acquisitions in 1998 and 1999.

    Income from Operations.  Income from operations increased to $47.3 million (3.8% of total revenues) for the year ended December 31, 1999 compared to $26.7 million (3.7% of total revenues) in 1998. In addition to gaining efficiencies related to economies of scale, Lithia has seen improvements in the operating margins at stores that it has acquired and operated for a full year, bringing them more in line with its pre-existing stores.

    Floorplan Interest Expense.  Floorplan interest expense increased 56.2% to $11.1 million (0.9% of total revenues) in 1999 from $7.1 million (1.0% of total revenues) in 1998. The increase in floorplan interest is a result of increased flooring notes payable related to increased inventories as a result of the increase in stores owned and vehicles sold. Lithia has been able to reduce its floorplan interest expense as a percentage of total revenues by successfully managing inventory levels.

    Income Tax Expense.  Lithia's effective tax rate for 1999 was 40.2% compared to 39.3% for 1998. Lithia's effective tax rate may be affected by the purchase of new dealerships in jurisdictions with tax rates either higher or lower than the current effective rate.

    Net Income.  Net income rose 77.7% to $19.2 million (1.5% of total revenues) for the year ended December 31, 1999 from $10.8 million (1.5% of total revenues) for 1998, as a result of the individual line item changes discussed above.

1998 Compared to 1997

    Revenues.  Revenues increased $394.9 million, or 123% to $714.7 million for the year ended December 31, 1998 from $319.8 million in 1997. Total vehicles sold during 1998 increased by 21,254, or 108%, to 40,885 from 19,631 during 1997. Same store sales growth was 14.7% in 1998 compared to industry growth for new vehicles of 2.9% for 1998. During 1998, the Company's skill in integrating dealerships resulted in 22% sales growth and 44% pre tax income growth at the first ten stores that were purchased since Lithia's initial public offering. Increases in units sold and all sources of revenue were primarily a result of acquisitions and strong internal growth.

 
  1998
  1997
  % change
 
Units sold     17,708     7,493   136.3 %
Average selling price   $ 21,935   $ 21,526   1.9 %

17


 
  1998
  1997
  % change
 
Units sold     13,645     7,148   90.9 %
Average selling price   $ 12,768   $ 12,391   3.0 %

    Gross Profit.  Gross profit increased 111% during 1998 to $115.4 million, compared with $54.7 million for 1997, primarily because of the increase in new and used vehicle unit sales during the period. The overall gross profit margin achieved was 16.1% for 1998 compared to 17.1% for 1997. The decrease in gross profit margin was primarily a result of the acquisition of several new dealerships during 1997 and 1998, which were generating gross margins lower than those of Lithia's pre-existing stores. These stores generally have lower selling, general and administrative costs as well. Lithia's overall gross margin percentage increased throughout 1998 as it integrated its new dealerships into its existing operations. The overall gross margin in the fourth quarter of 1998 was 16.9%. Lithia's gross profit margin continues to exceed the average U.S. dealership gross profit margin of 12.7% for the full year of 1997.

    The gross profit margin achieved on new vehicle sales during 1998 and 1997 was 10.1% and 11.4%, respectively. This compares favorably with the average gross profit margin of 6.4% realized by franchised automobile dealers in the United States on sales of new vehicles in 1997. Excluding wholesale transactions, the gross profit margin on used vehicle sales was 11.0% in 1998 and 11.4% in 1997, as compared to the industry average for 1997 of 10.9%. Sales of used vehicles to other dealers and to wholesalers are frequently at, or close to, cost.

    Selling, General and Administrative Expense.  Selling, general and administrative ("SG&A") expense increased $44.6 million, or 110%, to $85.2 million for 1998 compared to $40.6 million for 1997. SG&A as a percentage of total revenues decreased to 11.9% for 1998 from 12.7% for 1997. The increase in SG&A was due primarily to increased selling, or variable, expense related to the increase in sales and the number of total locations. The decrease in SG&A as a percent of total revenues was a result of economies of scale gained as the fixed expenses were spread over a larger revenue base and from economies of scale as Lithia consolidated multiple stores in a single market.

    Depreciation and Amortization.  Depreciation and amortization expense increased $1.0 million or 40% to $3.5 million for the year ended December 31, 1998 compared to $2.5 million for 1997 primarily as a result of increased property and equipment and goodwill related to acquisitions in late 1997 and 1998. Depreciation and amortization was 0.5% of total revenues in 1998 compared to 0.8% in 1997.

    Income from Operations.  Income from operations increased to $26.7 million (3.7% of total revenues) for the year ended December 31, 1998 compared to $11.6 million (3.6% of total revenues) in 1997. In addition to gaining efficiencies related to economies of scale, Lithia has seen improvements in the operating margins at stores that it has acquired and operated for a full year, bringing them more in line with its pre-existing stores. Income from operations was 4.4% of total revenues in the fourth quarter of 1998.

18



    Interest Expense.  Total interest expense increased $6.8 million, or 228%, to $9.8 million for the year ended December 31, 1998 compared to $3.0 million for 1997, primarily as a result of increased floorplan notes payable related to increased inventories as a result of the increase in stores owned and vehicles sold.

    Income Tax Expense.  Lithia's effective tax rate for 1998 was 39.3% compared to 37.3% for 1997. Lithia's effective tax rate may be affected by the purchase of new dealerships in jurisdictions with tax rates either higher or lower than the current effective rate.

    Net Income.  Net income rose 81% to $10.8 million (1.5% of total revenues) for the year ended December 31, 1998 compared to $6.0 million (1.9% of total revenues) for 1997, as a result of the individual line item changes discussed above.

Liquidity and Capital Resources

    Lithia's principal needs for capital resources are to finance acquisitions and capital expenditures and for working capital. Lithia has relied primarily upon internally generated cash flows from operations, borrowings under its credit facilities and the proceeds from public equity offerings to finance its operations and expansion.

    Ford Motor Credit Company, Toyota Motor Credit Corporation, Chrysler Financial Corporation and General Motors Acceptance Corporation have agreed to floor all of Lithia's new vehicles for their respective brands with Ford Credit serving as the primary lender for all other brands. There are no formal limits to these commitments for new vehicle wholesale financing.

    Ford Credit has also extended a $85 million revolving line of credit for used vehicles and a $115 million acquisition line of credit to purchase dealerships of any brand. These commitments have an expiration date of December 1, 2002, with interest due monthly. Lithia also has the option to convert the acquisition line into a five-year term loan. In addition, U.S. Bank N.A. has extended a $10 million revolving line of credit for leased vehicles and a $15 million line of credit for equipment purchases.

    The lines with Ford Credit are cross-collateralized and are secured by inventory, accounts receivable, intangible assets and equipment. The other new vehicle lines are secured by new vehicle inventory of the relevant dealerships.

    The Ford Credit lines of credit contain financial covenants requiring Lithia to maintain compliance with, among other things, specified ratios of (i) total debt to tangible base capital; (ii) total adjusted debt to tangible base capital; (iii) current ratio; (iv) fixed charge coverage; and (v) net cash. The Ford Credit lines of credit agreements also preclude the payment of cash dividends without the prior consent of Ford Credit. Lithia was in compliance with all such covenants at December 31, 1999.

    Interest rates on all of the above facilities ranged from 7.33% to 8.08% at December 31, 1999. Amounts outstanding on the lines at December 31, 1999 were as follows (in thousands):

New and Program Vehicle Lines   $ 208,403
Used Vehicle Line     35,500
Acquisition Line     0
Leased Vehicle Line     4,880
Equipment Line     6,605
   
    $ 255,388
   

    The $9.0 million related party payable at December 31, 1999 relates to additional purchase price for the Moreland acquisition as a result of contingent payouts that were earned during 1999. In addition to the $9.0 million of cash, the Company had accrued for the issuance of $4.5 million of its Class A Common

19


Stock and $4.5 million of its Series M Preferred Stock to satisfy the contingent payout requirements. The cash was paid and the stock was issued in the first quarter of 2000.

    Lithia anticipates that it will be able to satisfy its cash requirements at least through December 31, 2000, including its currently anticipated growth, primarily with cash flow from operations, borrowings under available credit facilities and cash currently available.

Seasonality and Quarterly Fluctuations

    Historically, Lithia's sales have been lower in the first and fourth quarters of each year largely due to consumer purchasing patterns during the holiday season, inclement weather and the reduced number of business days during the holiday season. As a result, financial performance may be lower during the first and fourth quarters than during the other quarters of each fiscal year. Management believes that interest rates, levels of consumer debt, consumer buying patterns and confidence, as well as general economic conditions, also contribute to fluctuations in sales and operating results. The timing of acquisitions may cause substantial fluctuations of operating results from quarter to quarter.

Year 2000

    Lithia has not experienced any significant year 2000 problems with its products, internal systems and processes or suppliers. Lithia spent approximately $1.1 million to help ensure year 2000 compliance. Lithia does not expect to incur any additional cost related to year 2000 issues.

Recent Accounting Pronouncement

    In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 137"). SFAS 137 is an amendment to Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS 137 establishes accounting and reporting standards for all derivative instruments. SFAS 137 is effective for fiscal years beginning after June 15, 2000. Lithia does not currently have any derivative instruments and, accordingly, does not expect the adoption of SFAS 137 to have an impact on its financial position or results of operations.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

    Lithia's only financial instruments with market risk exposure are variable rate floor plan notes payable and other credit line borrowings. At December 31, 1999 Lithia had $255.4 million outstanding under such facilities at interest rates ranging from 7.33% to 8.08%. An increase or decrease in the interest rates would affect interest expense for the period accordingly.

20



Item 8.  Financial Statements and Supplementary Financial Data

    The financial statements and notes thereto required by this item begin on page F-1 as listed in Item 14 of Part IV of this document. Quarterly financial data for each of the eight quarters in the two-year period ended December 31, 1999 is as follows:

 
  1st Quarter
  2nd Quarter
  3rd Quarter
  4th Quarter
 
  In thousands, except per share data

1998                        
Total revenues   $ 146,198   $ 173,541   $ 195,914   $ 199,087
Gross profit     22,946     27,098     31,752     33,565
Income before income taxes     2,466     3,629     5,965     5,722
Income taxes     947     1,407     2,307     2,333
Net income     1,519     2,222     3,658     3,390
Basic net income per share     0.22     0.24     0.36     0.33
Diluted net income per share     0.21     0.24     0.35     0.32
 
1999
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total revenues   $ 224,145   $ 307,753   $ 357,369   $ 353,392
Gross profit     35,200     48,786     57,245     58,055
Income before income taxes     5,005     7,779     9,924     9,343
Income taxes     1,976     3,202     4,071     3,628
Net income     3,029     4,577     5,853     5,715
Basic net income per share     0.30     0.42     0.50     0.49
Diluted net income per share     0.29     0.40     0.47     0.43

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

    None.

21



PART III

Item 10.  Directors and Executive Officers of the Registrant

    Information required by this item is included under the captions Election of Directors, Executive Officers and Section 16(a) Beneficial Ownership Reporting Compliance, respectively, in the Company's Proxy Statement for its 2000 Annual Meeting of Shareholders and is incorporated herein by reference.


Item 11.  Executive Compensation

    The information required by this item is included under the caption Executive Compensation in the Company's Proxy Statement for its 2000 Annual Meeting of Shareholders and is incorporated herein by reference.


Item 12.  Security Ownership of Certain Beneficial Owners and Management

    The information required by this item is included under the caption Security Ownership of Certain Beneficial Owners and Management in the Company's Proxy Statement for its 2000 Annual Meeting of Shareholders and is incorporated herein by reference.


Item 13.  Certain Relationships and Related Transactions

    The information required by this item is included under the caption Certain Relationships and Related Transactions in the Company's Information Statement for its 2000 Annual Meeting of Shareholders and is incorporated herein by reference.


PART IV

Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)  Financial Statements and Schedules

    The Consolidated Financial Statements, together with the report thereon of KPMG LLP, are included on the pages indicated below:

 
  Page
Report of Independent Public Accountants   F-1
Consolidated Balance Sheets as of December 31, 1999 and 1998   F-2
Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997   F-3
Consolidated Statements of Changes in Shareholders' Equity—December 31, 1999, 1998 and 1997   F-4
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997   F-5
Notes to Consolidated Financial Statements   F-6

    There are no schedules required to be filed herewith.

(b)  Reports on Form 8-K

    The Company did not file any reports on Form 8-K during the quarter ended December 31, 1999.

22


(c)  Exhibits

    The following exhibits are filed herewith and this list is intended to constitute the exhibit index:

Exhibit
   
  Description
3.1       Restated Articles of Incorporation of Lithia Motors, Inc., as amended May 13, 1999.
3.2   (a)   Bylaws of Lithia Motors, Inc.
4   (a)   Specimen Common Stock certificate
10.1   (b)   Agreement for Purchase and Sale of Business Assets between Rodway Chevrolet Co. and Lithia Motors, Inc., dated March 19, 1998.
10.2   (b)   Stock Purchase Agreement between William N. Hutchins, Hutchins Eugene Nissan, Inc. and Hutchins Imported Motors and Lithia Motors, Inc., dated June 18, 1998.
10.2.1   (c)   First, Second and Third Addenda to Stock Purchase Agreement by and between William N. Hutchins, Hutchins Imported Motors, Inc. and Hutchins Eugene Nissan, Inc. and Lithia Motors, Inc., dated June 18, 1998.
10.3   (d)   Restated Stock Purchase Agreement, by and between Phil S. Camp, Jerry W. Camp, Jr., Julie A. Camp McKay, Chris E. Camp, Travis W. Camp, Carter B. Camp and Camp Automotive, Inc. and Lithia Motors, Inc., dated August 1, 1998.
10.4   (e)   Agreement and Plan of Reorganization dated January 1, 1999 by and between Lithia Motors, Inc. and Moreland Auto Limited Partnership, RLLLP and G. Michael Downey and Moreland Auto Corp.(1)
10.5   (e)   Agreement and Plan of Reorganization dated January 1, 1999 by and between Lithia Motors, Inc. and L.A.H. Automotive Limited Partnership, RLLLP and L.A.H. Automotive Enterprises, Inc.
10.6   (e)   Agreement and Plan of Reorganization dated January 1, 1999 by and between Lithia Motors, Inc. and William D. Limited Partnership, RLLLP and James Jannicelli and William D.Corp.
10.7   (e)   Agreement and Plan of Reorganization dated January 1, 1999 by and between Lithia Motors, Inc. and Cherry Creek Dodge Limited Partnership, RLLLP and Cherry Creek Dodge, Incorporated.
10.8   (e)   Agreement and Plan of Reorganization dated January 1, 1999 by and between Lithia Motors, Inc. and Colorado Springs Jeep Eagle Limited Partnership, RLLLP and Alex Jannicelli and Colorado Springs Jeep/Eagle,  Inc.,
10.9   (e)   Agreement and Plan of Reorganization dated January 1, 1999 by and between Lithia Motors, Inc. and Foothills Automotive Plaza Limited Partnership, RLLLP and Jerry Cash and Foothills Automotive Plaza,  Inc.
10.10   (e)   Agreement and Plan of Reorganization dated January 1, 1999 by and between Lithia Motors, Inc. and Reno Auto Sales Limited Partnership, RLLLP and Reno Auto Sales, Inc.,
10.11   (a)   1996 Stock Incentive Plan
10.11.1   (b)   Amendment No. 1 to the Lithia Motors, Inc. 1996 Stock Incentive Plan
10.12.   (a)   Form of Incentive Stock Option Agreement
10.12.1   (a)   Form of Non-Qualified Stock Option Agreement
10.12.2   (a)   Form of Incentive Stock Option Agreement
10.13   (f)   1997 Non-Discretionary Stock Option Plan for Non-Employee Directors
10.14   (g)   Employee Stock Purchase Plan

23


10.15   (a)   Chrysler Corporation Sales and Service Agreement Additional Terms and Provisions
10.15.1       Chrysler Corporation Chrysler Sales and Service Agreement, dated September 28, 1999, between Chrysler Corporation and Lithia Chrysler Plymouth Jeep Eagle, Inc. (Additional Terms and Provisions to the Sales and Service Agreements are in Exhibit 10.15)(1)
10.16   (a)   Mercury Sales and Service Agreement General Provisions(2)
10.16.1   (g)   Supplemental Terms and Conditions agreement between Ford Motor Company and Lithia Motors, Inc. dated June 12, 1997.
10.16.2   (g)   Mercury Sales and Service Agreement, dated June 1, 1997, between Ford Motor Company and Lithia TLM, LLC dba Lithia Lincoln Mercury (general provisions are in Exhibit 10.16)(3)
10.17   (g)   Volkswagen Dealer Agreement Standard Provisions *
10.17.1       Volkswagen Dealer Agreement dated September 17, 1998, between Volkswagen of America, Inc. and Lithia HPI, Inc. dba Lithia Volkswagen. (standard provisions are in Exhibit 10.17)(4)
10.18   (a)   General Motors Dealer Sales and Service Agreement Standard Provisions
10.18.1       Supplemental Agreement to General Motors Corporation Dealer Sales and Service Agreement, dated January 16, 1998.
10.18.2   (h)   Chevrolet Dealer Sales and Service Agreement dated October 13, 1998 between General Motors Corporation, Chevrolet Motor Division and Camp Automotive, Inc.(5)
10.19       Omitted
10.19.1       Omitted
10.19.2       Omitted
10.20   (a)   Toyota Dealer Agreement Standard Provisions
10.20.1       Toyota Dealer Agreement, between Toyota Motor Sales, USA, Inc. and Lithia Motors, Inc., dba Lithia Toyota, dated February 15, 1996.(7)
10.21       Omitted
10.21.1       Omitted
10.22   (g)   Nissan Standard Provisions
10.22.1       Nissan Public Ownership Addendum, dated August 30, 1999 (identical documents executed by each Nissan dealership).
10.22.2   (g)   Nissan Dealer Term Sales and Service Agreement between Lithia Motors, Inc., Lithia NF, Inc., and the Nissan Division of Nissan Motor Corporation In USA dated January 2, 1998. (standard provisions are in Exhibit 10.22)(9)
10.23       Omitted
10.24       Omitted
10.24.1       Omitted
10.25       Omitted
10.26   (g)   Saturn Distribution Corporation Retailer Agreement, dated June 16, 1997, between Saturn Distribution Corporation and Saturn of Southwest Oregon, Inc.

24


10.26.1   (g)   Supplemental Agreement to Saturn Retailer Agreement, dated August 26, 1997, between Saturn of Southwest Oregon, Inc., Lithia Motors, Inc., Sidney B. DeBoer, Lithia Holding, LLC, and Saturn Distribution Corporation.
10.27       Hyundai Standard Provisions
10.27.1   (g)   Hyundai Motor America Dealer Sales and Service Agreement, dated January 26, 1998, between Hyundai Motor America and Lithia JEF, Inc.(13)
10.28       Omitted
10.28.1       Omitted
10.29       Omitted
10.30       Omitted
10.31   (h)   $75,000,000 Credit Agreement dated November 23, 1998 between Ford Motor Credit Company and Lithia Motors, Inc.
10.31.1       Amendment No. 1 dated December 1, 1999 to $75,000,000 Credit Agreement dated November 23, 1998 between Ford Motor Credit Company and Lithia Motors, Inc.
10.32   (h)   $60,000,000 Credit Agreement dated November 23, 1998 between Ford Motor Credit Company and Lithia Motors, Inc.
10.32.1       Amendment No. 1 dated December 1, 1999 to $60,000,000 Credit Agreement dated November 23, 1998 between Ford Motor Credit Company and Lithia Motors, Inc.
10.33   (j)   $10.0 million vehicle lease line and $15.0 million equipment line of credit Loan Agreement between Lithia Financial Corporation, Lithia Motors, Inc. and Lithia SALMIR, Inc. and U.S. Bank National Association
10.34       Lease Agreement between Moreland Properties, LLC and Lithia Real Estate, Inc., dated May 14, 1999, relating to properties located at 350 S. Havana, Aurora, CO.(15)
10.35       Sublease between Moreland Properties, LLC and Lithia Real Estate, Inc. dated May 14, 1999, relating to properties located at 4940 S. Broadway and 50 E. Chenango, Englewood, CO.(16)
10.36       Lease Agreement between CAR LIT, L.L.C. and Lithia Real Estate, Inc. relating to properties in Medford, OR.(17)
10.37   (a)   Form of Commercial Lease, effective January 1, 1997, between Lithia Real Estate and various dealership affiliates.(18)
10.38       Lease and Sublease Agreement between Camp Investments, LLC and Lithia Real Estate, Inc. dated October 15, 1998.
10.39       Commercial Lease between William and Suzanne Hutchins and Lithia Real Estate, Inc., dated November 2, 1998.
10.40       Lease Agreement between Bruce Properties, LLC and Lithia Real Estate, Inc,. dated August 30, 1999.
10.41       Lease Agreement with Capital Automotive, L.P. and Roundtree of Idaho, Inc., dated related to properties located at 9411 W. Fairview, Boise, ID.
10.41.1       Assignment of Lease between Roundtree of Idaho, Inc. and Lithia Real Estate, Inc.
10.42   (k)   Lease Agreement and assignment thereof, among George Valente and Lena E. Valente as trustees of the George and Lena E. Valente Trust, Sun Valley Ford, Inc. and Lithia Motors, Inc. dated August 4, 1997.

25


10.43   (g)   Lease Agreement among Paul H. Snider and Dick Donnelly Automotive Enterprises, Inc. dated October 17, 1989
10.44   (g)   Lease Agreement among Richard M. Donnelly and Susan K. Donnelly and Lithia Real Estate, Inc. dated October 1, 1997
10.45   (g)   Lease Agreement among BR Enterprises and Lithia Motors, Inc. dated September 3, 1997
10.46   (g)   Real Property Lease Agreement among James D. Plummer and Lithia Real Estate, Inc. dated October 14, 1997
10.47   (g)   Lease Agreement among Teddy Bear Havas Motors, Inc. and United American Funding, Inc. dated July 28, 1992
21       Subsidiaries of Lithia Motors, Inc.
23       Consent of KPMG LLP
27       Financial Data Schedule
99       Risk Factors


(a)
Incorporated by reference from the Company's Registration Statement on Form S-1, Registration Statement No. 333-14031, as declared effective by the Securities Exchange Commission on December 18, 1996.
(b)
Incorporated by reference from the Company's Form 10-Q for the quarter ended June 30, 1998 as filed with the Securities and Exchange Commission on August 13, 1998.
(c)
Incorporated by reference from the Company's Form 10-Q for the quarter ended September 30, 1998 as filed with the Securities and Exchange Commission on November 12, 1998.
(d)
Incorporated by reference from the Company's Form 8-K dated October 15, 1998 as filed with the Securities and Exchange Commission on October 28, 1998.
(e)
Incorporated by reference from the Company's Form 10-Q for the quarter ended March 31, 1999 as filed with the Securities and Exchange Commission on May 12, 1999.
(f)
Incorporated by reference from the Company's Registration Statement on Form S-8, Registration Statement No. 333-45553, as filed with the Securities Exchange Commission on February 4, 1998.
(g)
Incorporated by reference from the Company's Form 10-K for the year ended December 31, 1997 as filed with the Securities and Exchange Commission on March 31, 1998.
(h)
Incorporated by reference from the Company's Form 10-K for the year ended December 31, 1998 as filed with the Securities and Exchange Commission on March 31, 1999
(i)
Omitted
(j)
Incorporated by reference from the Company's Form 10-Q for the quarter ended September 30, 1999 as filed with the Securities and Exchange Commission on November 12, 1999.
(k)
Incorporated by reference from the Company's Form 8-K/A as filed with the Securities Exchange Commission on October 14, 1997.

(1)
Substantially identical agreements exist between Chrysler Corporation and Lithia Chrysler Plymouth Jeep Eagle, Inc., dba Lithia Chrysler Plymouth Jeep, relating Plymouth and Jeep, dated September 28, 1999; Lithia Centennial Chrysler Plymouth Jeep, Inc., relating to Chrysler, Plymouth and Jeep dated May 26, 1999; Lithia Cherry Creek Dodge, Inc., relating to Dodge sales and service (dated May 26, 1999; Lithia Colorado Chrysler Plymouth, Inc., dba Lithia Chrysler Plymouth Kia relating to Chrysler and Plymouth sales and service, dated May 26, 1999; Lithia Colorado Jeep, Inc., relating to Jeep sales and service, dated May 26, 1999; Lithia Colorado Springs Jeep Chrysler Plymouth, Inc., relating to Chrysler, Plymouth and Jeep sales and service, dated May 26, 1999; Lithia DE, Inc., dba Lithia Dodge of Eugene, relating to Dodge sales and service dated March 4, 1999; Lithia Dodge, L.L.C., dba Lithia Dodge, relating to Dodge sales and service, dated October 14, 1999;

26


(2)
Substantially identical agreements exist with Ford Motor Company for its Ford and Lincoln lines.
(3)
Substantially identical agreements exist between Ford Motor Company and Lithia TLM, LLC., relating to Lincoln sales and service, dated June 1, 1997; Lithia FMF, Inc., dba Lithia Ford of Fresno, relating to Ford sales and service, dated December 17, 1997; Lithia FN, Inc., dba Lithia Ford Lincoln Mercury of Napa, relating to Ford, Lincoln and Mercury sales and service, dated June 30, 1997; Lithia FVHC, Inc., dba Lithia Ford of Concord, relating to Ford sales and service, dated August 11, 1997; Lithia Rose-FT, Inc., dba Lithia Ford Lincoln Mercury of Roseburg, relating to Ford, Lincoln and Mercury sales and service, dated August 30, 1999 (except that these agreements are for 2 year terms); Roundtree Lincoln-Mercury, Inc., Lincoln and Mercury sales and service, dated December 9, 1999 (except that these agreements are for 2 year terms); Lithia SALMIR, Inc., dba Lithia Lincoln Mercury of Reno, relating to Lincoln and Mercury sales and service, dated 1/14/2000 (terminating on November 30, 2000).
(4)
Substantially identical agreements exist between Volkswagen of America, Inc. and Lithia SALMIR, Inc., dba Lithia Volkswagen of Reno, dated June 9, 1999; and Lithia VWC, Inc., dba Lithia Volkswagen of Concord, dated October 30, 1998; and Audi of America, Inc., a division of Volkswagen of America, Inc., and Lithia SALMIR, Inc., relating to Audi sales and service, dated January 1, 1998.
(5)
A substantially identical agreement exists between Chevrolet Motor Division, GM Corporation, and Lithia CIMR, dba Lithia Chevrolet of Redding relating to Chevrolet sales and service, dated June 15, 1998.
(6)
Omitted
(7)
Substantially identical agreements exist (except the terms are all 2 years) between Toyota Motor Sales, USA, Inc. and Lithia TKV, Inc. dba Lithia Toyota of Vacaville, dated August 26, 1998; Lithia TR, Inc., dba Lithia Toyota of Redding, dated June 26, 1998; Lithia Klamath, Inc., dba Lithia Toyota of Klamath Falls, dated May 27, 1999; Hutchins Imported Motors, Inc., dba Lithia Toyota of Springfield, dated November 3, 1998.
(8)
Omitted
(9)
Substantially identical agreements exist between Nissan Motor Corporation and Lithia NB, Inc., dba Lithia Nissan of Bakersfield, dated October 2, 1997; Hutchins Eugene Nissan, Inc., dba Lithia Nissan of Eugene, dated April 2, 1998; Lithia BNM, Inc., dba Lithia Nissan, dated February 13, 1998; Lithia Nissan of Roseburg, Inc, dated August 30, 1999.
(10)
Omitted
(11)
Omitted
(12)
Omitted
(13)
Substantially identical agreements exist between Hyundai Motor America and Lithia Foothills Chrysler, Inc., dba Lithia Foothills Hyundai, dated May 26, 1999; Lithia Reno Sub-Hyun, Inc., dba Lithia Reno Hyundai, dated April 16, 1999.

(14)
Omitted
(15)
Substantially identical leases of the same date exist between: Moreland Properties L.L.C and Lithia Real Estate, Inc. relating to property in Aurora, CO located at 505 S. Havana (except that monthly

27


(16)
Substantially identical subleases of the same date exist between Moreland Properties L.L.C and Lithia Real Estate, Inc.; relating to property in Aurora, CO, located at 501 S. Havana (monthly rent is $20,800 and lease terminates May 30, 2002); relating to property in Colorado Springs, CO, located at 1250 S. Nevada (term is month-to-month and rent is $14,180); between Cherry Creek Investment Associates, LLC and Lithia Real Estate, Inc. relating to property in Colorado Springs, CO, located at 15 E Arvada (terminates October 30, 2005 and monthly rent is $12,594), at 25 W Arvada (terminates October 30, 2005 and monthly rent is $11,000) and at 35 W Arvada (terminates October 30, 2005 and monthly rent is $11,000); and between Cash Moreland, LLC and Lithia Real Estate, Inc. relating to property in Fort Collins, CO, located at 3701 S College (terminates January 30, 2003 and monthly rent is $20,800).
(17)
Tract (1): 700 & 822 N. Central Ave, 217 & 220 N. Beatty St., 710 & 815 Niantic St., 713 & tax lot 13900 on Maple St., tax lot 13700 on Putnam, 527, 531, 533 & 613 N. Bartlett, collectively at a annual lease rate of $284,741; Tract (2): 400 N. Riverside at an annual lease rate of $117,900; Tract (3): 325 & 360 E. Jackson St., 400 N. Central Ave., 315, 321, 334, 341, 343 & 345 Apple St., 440 Front St., 401 & 405 E. 4th St., 326 & 344 N. Bartlett, 309, 315 & 333 N. Riverside collectively at an annual lease rate of $521,463; Tract (4): 322 E. 4th, 315 & 324 E. 5th St., 225, 319 & 323 E. 6th, tax lot 8000 at 6th & Riverside, 129 & 201 N. Riverside, 220, 224 & 235 N. Bartlett, tax lot 4700 at 4th and N. Bartlett, tax lots 4400 & 4500 on Maple, collectively at an annual lease rate of $472,716; Tract (5): 400, 705, 712 & 717 N Riverside, 712 Pine St., collectively at an annual lease rate of $172,291; Tract (6); relating to properties located in Grants Pass, Oregon at 1421 NE 6th St and 1470 NE 7th St, collectively at an annual lease rate of $260,292.
(18)
Substantially identical lease agreements also exist between Lithia Real Estate, Inc. and (i) Lithia FVHC, Inc. relating to the properties in Concord, California, located at 1260 Diamond Way and 2285 Diamond Way; (ii) Lithia BB, Inc., relating to the property in Bakersfield, California, located at 3201 Cattle Drive; (iii) Lithia DE, Inc., relating to properties in Eugene, Oregon, located at 2121 Centennial Boulevard and 80 Centennial Loop; (iv) Lithia TKV, Inc. relating to the property in Vacaville, California, located at 100 Auto Center Drive; (v) Lithia Auto Services, Inc. relating to the property in Medford, Oregon, located at 2665 Bullock Road; (vi) Lithia FN, Inc. relating to the property in Napa, California, located at 300 Soscol Avenue; (vii) Lithia NB, Inc. relating to the properties in Bakersfield, California, located at 3101 and 3201 Cattle Drive and 2800 and 2808 Pacheco Road; (viii) Lithia MMF, Inc. relating to the properties in Fresno, California, located at 155 and 165 East Auto Center Drive; (ix) Lithia FMF, Inc. relating to the properties in Fresno, California, located at 175 and 195 East Auto Center Drive; (x) Lithia DC, Inc. relating to the property in Concord, California, located at 4901 Marsh Drive; (xi) Lithia SALMIR, Inc. relating to the properties in Reno, Nevada, located at 7063 and 7175 South Virginia Street and the property in Sparks, Nevada, located at 40 Victorian Avenue; and (xii) Lithia NF, Inc., relating to the property in Fresno, California, located at 5580 North Blackstone Avenue.

28



SIGNATURES

    Pursuant to the requirements of Section 13 or 15(d) 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.

Date: March 29, 2000   LITHIA MOTORS, INC.
 
 
 
 
 
By
 
 
 
/s/ 
SIDNEY B. DEBOER   
Sidney B. DeBoer
Chairman of the Board and
Chief Executive Officer

    Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 29, 2000:

Signature
  Title
 
 
 
 
 
 
/s/ SIDNEY B. DEBOER   
Sidney B. DeBoer
  Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
 
/s/ 
BRIAN R. NEILL   
Brian R. Neill
 
 
 
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
 
 
/s/ 
M. L. DICK HEIMANN   
M. L. Dick Heimann
 
 
 
 
 
Director, President and Chief Operating Officer
 
 
/s/ 
R. BRADFORD GRAY   
R. Bradford Gray
 
 
 
 
 
Director and Executive Vice President
 
 
/s/ 
THOMAS BECKER   
Thomas Becker
 
 
 
 
 
Director
 
 
/s/ 
W. DOUGLAS MORELAND   
W. Douglas Moreland
 
 
 
 
 
Director
 
 
/s/ 
WILLIAM J. YOUNG   
William J. Young
 
 
 
 
 
Director

30


Independent Auditors' Report

The Board of Directors and Shareholders
Lithia Motors, Inc. and Subsidiaries:

    We have audited the accompanying consolidated balance sheets of Lithia Motors, Inc. and Subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

    We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lithia Motors, Inc. and Subsidiaries as of December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles.

KPMG LLP

Portland, Oregon
February 14, 2000

F-1


LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands)

 
  December 31,
 
  1999
  1998
Assets            
Current Assets:            
Cash and cash equivalents   $ 30,364   $ 20,879
Trade receivables     25,683     17,287
Notes receivable, current portion, net of allowance for doubtful accounts of $677 and $714     2,777     3,074
Inventories, net     268,281     157,455
Vehicles leased to others, current portion     3,000     861
Prepaid expenses and other     3,815     1,933
Deferred income taxes     724     2,707
   
 
Total Current Assets     334,644     204,196
Property and Equipment, net of accumulated depreciation of $5,683 and $3,907     52,368     32,933
Notes Receivable, less current portion     4,095     7,173
Vehicles Leased to Others, less current portion     2,808     5,647
Goodwill, net of accumulated amortization of $3,073 and $1,180     110,677     42,951
Other Non-Current Assets, net of accumulated amortization of $143 and $103     1,841     1,498
   
 
Total Assets   $ 506,433   $ 294,398
   
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities:            
Notes payable   $   $ 515
Flooring notes payable     208,403     124,167
Current maturities of long-term debt     7,039     7,601
Current portion of capital leases     93     27
Trade payables     11,873     6,313
Payable to related party     9,000    
Accrued liabilities     23,237     12,020
   
 
Total Current Liabilities     259,645     150,643
Long-Term Debt, less current maturities     73,715     38,994
Long-Term Capital Lease Obligation, less current portion     196     2,426
Deferred Revenue     2,262     2,076
Other Long-Term Liabilities     5,456     1,606
Deferred Income Taxes     9,521     7,142
   
 
Total Liabilities     350,795     202,887
   
 
Shareholders' Equity:            
Preferred stock—no par value; authorized 15,000 shares; issued and outstanding; none        
Convertible, redeemable Series M preferred stock; authorized 15 shares; issued and outstanding 10.4 and 0     6,216    
Class A common stock—no par value; authorized 100,000 shares; issued and outstanding 7,824 and 6,105     102,333     70,871
Class B common stock authorized 25,000 shares; issued and outstanding 4,087 and 4,110     508     511
Additional paid-in capital     7,428     150
Retained earnings     39,153     19,979
   
 
Total Shareholders' Equity     155,638     91,511
   
 
Total Liabilities and Shareholders' Equity   $ 506,433   $ 294,398
   
 

See accompanying notes to consolidated financial statements.

F-2


LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(In thousands, except per share amounts)

 
  Years Ended December 31,
 
 
  1999
  1998
  1997
 
Revenues:                    
New vehicle sales   $ 673,339   $ 388,431   $ 161,294  
Used vehicle sales     375,562     220,544     113,099  
Service, body and parts     120,722     72,216     29,828  
Other revenues     73,036     33,549     15,574  
   
 
 
 
Total revenues     1,242,659     714,740     319,795  
Cost of sales     1,043,373     599,379     265,049  
   
 
 
 
Gross profit     199,286     115,361     54,746  
Selling, general and administrative     146,381     85,188     40,625  
Depreciation and amortization     5,573     3,469     2,483  
   
 
 
 
Income from operations     47,332     26,704     11,638  
Other income (expense)                    
Floorplan interest expense     (11,105 )   (7,108 )   (2,179 )
Other interest expense     (4,250 )   (2,735 )   (824 )
Other income, net     74     921     862  
   
 
 
 
      (15,281 )   (8,922 )   (2,141 )
   
 
 
 
Income before income taxes     32,051     17,782     9,497  
Income tax expense     (12,877 )   (6,993 )   (3,538 )
   
 
 
 
Net income   $ 19,174   $ 10,789   $ 5,959  
   
 
 
 
 
Basic net income per share
 
 
 
$
 
1.72
 
 
 
$
 
1.18
 
 
 
$
 
0.85
 
 
   
 
 
 
 
Diluted net income per share
 
 
 
$
 
1.60
 
 
 
$
 
1.14
 
 
 
$
 
0.82
 
 
   
 
 
 

See accompanying notes to consolidated financial statements.

F-3


LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity

(In thousands)

 
   
   
  Common Stock
   
   
   
 
  Series M Preferred Stock
   
   
   
 
  Class A
  Class B
   
   
   
 
  Additional Paid In Capital
  Retained Earnings
  Total Shareholders' Equity
 
  Shares
  Amount
  Shares
  Amount
  Shares
  Amount
Balance December 31, 1996     $   2,500   $ 24,172   4,110   $ 511   $   $ 3,231   $ 27,914
Net income                           5,959     5,959
Underwriters' overallotment option         375     3,783                   3,783
Compensation for stock option issuances                       59         59
Issuance of stock in connection with employee stock plans         51     162                   162
   
 
 
 
 
 
 
 
 
Balance at December 31, 1997         2,926     28,117   4,110     511     59     9,190     37,877
Net income                           10,789     10,789
Issuance of Class A Common Stock, net of offering expenses of $594         3,151     42,498                   42,498
Compensation for stock option issuances                       78         78
Tax benefit of disqualifying dispositions                       13           13
Issuance of Class A Common Stock in connection with acquisition         13     125                   125
Issuance of stock in connection with employee stock plans         15     131                   131
   
 
 
 
 
 
 
 
 
Balance at December 31, 1998         6,105     70,871   4,110     511     150     19,979     91,511
Net income                           19,174     19,174
Issuance of Class A Common Stock in connection with acquisitions         1,611     30,638           4,500         35,138
Issuance of stock in connection with employee stock plans         85     821                           821
Compensation for stock option issuances                       78         78
Conversion of Class B Common Stock into Class A Common Stock         23     3   (23 )   (3 )              
Issuance of Series M Preferred Stock in connection with acquisition   10,360     6,216                 2,700         8,916
   
 
 
 
 
 
 
 
 
Balance at December 31, 1999   10,360   $ 6,216   7,824   $ 102,333   4,087   $ 508   $ 7,428   $ 39,153   $ 155,638
   
 
 
 
 
 
 
 
 

See accompanying notes to consolidated financial statements.

F-4


LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

 
  Years Ended December 31,
 
 
  1999
  1998
  1997
 
Cash flows from operating activities:                    
Net income   $ 19,174   $ 10,789   $ 5,959  
Adjustments to reconcile net income to net cash flows provided by operating activities:                    
Depreciation and amortization     5,573     3,469     2,483  
Compensation related to stock option issuances     78     78     59  
(Gain) loss on sale of assets     (4 )   30     (1 )
(Gain) loss on sale of vehicles leased to others     253     33     (286 )
Deferred income taxes     (1,673 )   565     336  
Equity in income of affiliate     (61 )   (7 )   (102 )
(Increase) decrease, net of effect of acquisitions, in:                    
Trade and installment contract receivables, net     2,940     (6,714 )   (5,087 )
Inventories     (20,094 )   (17,614 )   (9,009 )
Prepaid expenses and other     845     (1,614 )   (678 )
Other noncurrent assets     (378 )   204     (486 )
Increase (decrease), net of effect of acquisitions, in:                    
Floorplan notes payable     16,012     21,425     9,122  
Trade payables     (13,570 )   (2,759 )   1,440  
Accrued liabilities     4,492     2,500     4,252  
Other liabilities     8,794     (1,039 )   (2,274 )
   
 
 
 
Net cash provided by operating activities     22,381     9,346     5,728  
Cash flows from investing activities:                    
Notes receivable issued     (806 )   (639 )   (249 )
Principal payments received on notes receivable     6,977     3,456     304  
Capital expenditures     (14,586 )   (3,934 )   (8,801 )
Proceeds from sale of assets     1,779     223     16  
Expenditures for vehicles leased to others     (8,102 )   (9,322 )   (6,750 )
Proceeds from sale of vehicles leased to others     7,805     8,481     5,330  
Cash paid for acquisitions, net of cash acquired     (35,020 )   (36,531 )   (25,220 )
Distribution from affiliate     1,268         204  
   
 
 
 
Net cash used in investing activities     (40,685 )   (38,266 )   (35,166 )
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net borrowings (repayments) on lines of credit     31,380     (15,500 )   15,500  
Principal payments on long-term debt     (13,175 )   (39,083 )   (15,917 )
Proceeds from issuance of long-term debt     9,781     43,287     28,951  
Payments on capital lease obligations     (1,018 )        
Proceeds from issuance of common stock and minority interest     821     42,641     3,945  
   
 
 
 
Net cash provided by financing activities     27,789     31,345     32,479  
   
 
 
 
Increase in cash and cash equivalents     9,485     2,425     3,041  
Cash and cash equivalents:                    
Beginning of period     20,879     18,454     15,413  
   
 
 
 
End of period   $ 30,364   $ 20,879   $ 18,454  
   
 
 
 
Supplemental disclosures of cash flow information:                    
Cash paid during the period for interest   $ 15,330   $ 9,728   $ 3,206  
Cash paid during the period for income taxes     11,469     6,482     3,011  
Supplemental schedule of noncash investing and financing activities:                    
Stock issued in connection with acquisitions   $ 36,854   $ 125   $  
Assumption of mortgages related to acquisitions     2,808     1,345      
Termination of capital lease     2,431          

See accompanying notes to consolidated financial statements.

F-5


LITHIA MOTORS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1999, 1998 and 1997

(Dollar and share amounts in thousands, except per share amounts)

(1) Summary of Significant Accounting Policies

    Lithia Motors is one of the larger retailers of new and used vehicles in the western United States, offering 25 domestic and imported makes of new automobiles and light trucks at 45 locations and over the internet. Lithia currently operates 15 dealerships in California, 13 in Oregon, 6 in Colorado, 4 in Nevada, 3 in Washington and 4 in Idaho. As an integral part of its operations, the Company arranges related financing (non-recourse) and insurance and sells parts, service and ancillary products. The Company has grown primarily by successfully acquiring and integrating dealerships and by obtaining new dealer franchises. The Company's strategy is to become a leading acquirer and operator of dealerships in the western United States.

    At its 45 locations, the Company offers, collectively, 25 makes of new vehicles including Dodge, Dodge Trucks, Chrysler, Plymouth, Jeep, Ford, Lincoln-Mercury, Toyota, Volkswagen, Audi, Isuzu, Chevrolet, Saturn, Nissan, Honda, Acura, BMW, Mazda, Suzuki, Hyundai, Subaru, Volvo, Kia and Daewoo.

    The accompanying financial statements reflect the results of operations, the financial position, and the cash flows for Lithia Motors, Inc. and its directly and indirectly wholly-owned subsidiaries. All significant intercompany accounts and transactions, consisting principally of intercompany sales, have been eliminated upon consolidation.

    For purposes of reporting cash flows, the Company considers contracts in transit and all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents.

    The Company accounts for inventories using the specific identification method for vehicles and the first-in first-out (FIFO) method for parts (collectively, the FIFO method).

    Property, plant and equipment are stated at cost and being depreciated over their estimated useful lives, principally on the straight-line basis. The range of estimated useful lives are as follows:

Building and improvements   40 years
Service equipment   5 to 10 years
Furniture, signs and fixtures   5 to 10 years

    The cost for maintenance, repairs and minor renewals is expensed as incurred, while significant renewals and betterments are capitalized. When an asset is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts, and any gain or loss is credited or charged to income.

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    Leased property meeting certain criteria is capitalized and the present value of the related lease payments is recorded as a liability. Amortization of capitalized leased assets is computed on a straight-line basis over the term of the lease and is included in depreciation expense.

    The Company has a 20% interest in Lithia Properties, LLC, of which the other members are Sidney DeBoer (35%), M. L. Dick Heimann (30%) and three of Mr. DeBoer's children (5% each). The investment is accounted for using the equity method, with a carrying value of $481 and $476 at December 31, 1999 and 1998, respectively.

    Accruals for environmental matters, if any, are recorded in operating expenses when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Accrued liabilities are exclusive of claims against third parties and are not discounted.

    In general, costs related to environmental remediation are charged to expense. Environmental costs are capitalized if the costs increase the value of the property and/or mitigate or prevent contamination from future operations.

    Basic earnings per share (EPS) and diluted EPS are computed using the methods prescribed by Statement of Financial Accounting Standard No. 128, Earnings per Share (SFAS 128). Following is a reconciliation of basic EPS and diluted EPS:

 
  Year Ended December 31,
 
  1999
  1998
  1997
 
  Income
  Shares
  Per Share Amount
  Income
  Shares
  Per Share Amount
  Income
  Shares
  Per Share Amount
Basic EPS                                                
Income available to Common Shareholders   $ 19,174   11,137   $ 1.72   $ 10,789   9,147   $ 1.18   $ 5,959   6,988   $ 0.85
             
           
           
Effect of Dilutive Securities                                                
Stock Options       364             323             315      
Contingent issuances       128                              
Series M Preferred Stock       369                              
   
 
       
 
       
 
     
Diluted EPS                                                
Income available to Common Shareholders   $ 19,174   11,998   $ 1.60   $ 10,789   9,470   $ 1.14   $ 5,959   7,303   $ 0.82
             
           
           

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    34, 108 and zero shares issuable pursuant to stock options have not been included in the above calculations for 1999, 1998 and 1997, respectively, since they would have been antidilutive.

    The carrying amount of cash equivalents, trade receivables, trade payables, accrued liabilities and short term borrowings approximate fair value because of the short-term nature of these instruments. The fair values of long-term debt and notes receivable for leased vehicles accounted for as sales-type leases were estimated by discounting the future cash flows using market interest rates and do not differ significantly from that reflected in the financial statements.

    Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

    The Company expenses production and other costs of advertising as incurred. Advertising expense was $11,189, $5,749 and $2,678 for the years ended December 31, 1999, 1998 and 1997, respectively.

    Goodwill, which represents the excess purchase price over fair value of net assets acquired, is amortized on the straight-line basis over the expected period to be benefited of forty years. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operation. The assessment of the recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved.

    Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base.

    Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash deposits. The Company generally is exposed to credit risk from balances on deposit in financial institutions in excess of the FDIC-insured limit.

    The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes to financial statements. Changes in such estimates may affect amounts reported in future periods.

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    Revenue from the sale of vehicles is recognized upon delivery, when the sales contract is signed, down payment has been received and funding has been approved from the lending agent. Fleet sales of vehicles whereby the Company does not take title are shown on a net basis in other revenue.

    Finance fees represent revenue earned by the Company for notes placed with financial institutions in connection with customer vehicle financing net of estimated chargebacks. Finance fees are recognized in income upon acceptance of the credit by the financial institution. Insurance income represents commissions earned on credit life, accident and disability insurance sold in connection with the vehicle on behalf of third party insurance companies. Commissions from third party service contracts are recognized upon sale. Insurance commissions are recognized in income upon customer acceptance of the insurance terms as evidenced by contract execution. Finance fees and insurance commissions, net of charge-backs, are classified as other operating revenue in the accompanying consolidated statements of operations.

    The Company purchases substantially all of its new vehicles and inventory from various manufacturers at the prevailing prices charged by the auto maker to all franchised dealers. The Company's overall sales could be impacted by the auto maker's inability or unwillingness to supply the dealership with an adequate supply of popular models.

    The Company enters into agreements (Dealer Agreements) with the manufacturers. The Dealer Agreements generally limit the location of the dealership and retain auto maker approval rights over changes in dealership management and ownership. The auto makers are also entitled to terminate the Dealer Agreements if the dealership is in material breach of the terms.

    The Company's ability to expand operations depends, in part, on obtaining consents of the manufacturers for the acquisition of additional dealerships.

    The Company accounts for its stock-based compensation plan under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). The Company adopted the disclosure option of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). SFAS 123 requires that companies which do not choose to account for stock-based compensation as prescribed by this statement shall disclose the pro forma effects on earnings and earnings per share as if SFAS 123 had been adopted. Additionally, certain other disclosures are required with respect to stock compensation and the assumptions used to determine the pro forma effects of SFAS 123.

    The Company adopted Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information for the year ended December 31, 1998. Based

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upon definitions contained within SFAS 131, the Company has determined that it operates in one segment, auto retailing.

    Certain items previously reported in specific financial statement captions have been reclassified to conform with the current presentation.

(2) Inventories and Related Notes Payable

    The new and used vehicle inventory, collateralizing related notes payable, and other inventory were as follows:

 
  December 31,
 
  1999
  1998
 
  Inventory Cost
  Notes Payable
  Inventory Cost
  Notes Payable
New and program vehicles   $ 198,812   $ 208,403   $ 112,990   $ 124,167
Used vehicles     56,292     35,500     34,599     5,000
Parts and accessories     13,177         9,866    
   
 
 
 
Total inventories   $ 268,281   $ 243,903   $ 157,455   $ 129,167
   
 
 
 

    The inventory balance is generally reduced by manufacturer's purchase discounts. Such reduction is not reflected in the related floor plan liability.

    All new vehicles are pledged to collateralize floor plan notes payable to financial institutions. The floor plan notes payable bear interest, payable monthly on the outstanding balance, at a rate of interest determined by the lender, subject to incentives. The floor plan notes are due when the related vehicle is sold. As such, these floor plan notes payable are shown as a current liability in the accompanying consolidated balance sheets.

    Used vehicles are pledged to collateralize an $85,000 line of credit.

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(3) Property, Plant and Equipment

 
  December 31,
 
 
  1999
  1998
 
Buildings and improvements   $ 26,165   $ 17,107  
Service equipment     6,953     5,566  
Furniture, signs and fixtures     8,413     5,077  
   
 
 
      41,531     27,750  
Less accumulated depreciation     (5,683 )   (3,907 )
   
 
 
      35,848     23,843  
Land     12,872     8,648  
Construction in progress     3,648     442  
   
 
 
    $ 52,368   $ 32,933  
   
 
 

(4) Vehicles Leased to Others and Related Lease Receivables

 
  December 31,
 
 
  1999
  1998
 
Vehicles leased to others   $ 6,696   $ 7,267  
Less accumulated depreciation     (888 )   (759 )
   
 
 
      5,808     6,508  
Less current portion     (3,000 )   (861 )
   
 
 
    $ 2,808   $ 5,647  
   
 
 

    Vehicles leased to others are stated at cost and depreciated over their estimated useful lives (5 years) on a straight-line basis. Lease receivables result from customer, employee and fleet leases of vehicles under agreements that qualify as operating leases. Leases are cancelable at the option of the lessee after providing 30 days written notice.

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(5) Notes Receivable Under Sales-Type Leases

    At one of its locations, the Company leases vehicles to customers under sales-type leases. The following lists the components of the net investment in sales-type leases, classified as notes receivable in the consolidated balance sheets.

 
  December 31,
 
 
  1999
  1998
 
Total minimum lease payments to be received   $ 7,376   $ 11,796  
Allowance for uncollectible notes and repossession losses     (209 )   (599 )
   
 
 
      7,167     11,197  
Unearned interest income     (1,039 )   (1,960 )
   
 
 
    $ 6,128   $ 9,237  
   
 
 

    Future minimum lease payments to be received on the notes receivable after December 31, 1999 are as follows:

Year ending December 31,

   
2000   $ 2,836
2001     2,570
2002     1,516
2003     377
2004     77
   
Total   $ 7,376
   

(6) Lines of Credit and Long-Term Debt

    Ford Motor Credit Company, Toyota Motor Credit Corporation, Chrysler Financial Corporation and General Motors Acceptance Corporation have agreed to floor all of Lithia's new vehicles for their respective brands with Ford serving as the primary lender for all other brands. There are no formal limits to these commitments for new vehicle wholesale financing.

    Ford Credit has also extended an $85,000 revolving line of credit for used vehicles and a $115,000 acquisition line of credit to purchase dealerships of any brand. These commitments have an expiration date of December 1, 2002 with interest due monthly. Lithia also has the option to convert the acquisition line into a five-year term loan. In addition, U.S. Bank N.A. has extended a $10,000 revolving line of credit for leased vehicles and a $15,000 line of credit for equipment purchases.

    The lines with Ford Credit are cross-collateralized and are secured by inventory, accounts receivable, intangible assets and equipment. The other new vehicle lines are secured by new vehicle inventory of the relevant dealerships.

    The Ford Credit lines of credit contain financial covenants requiring Lithia to maintain compliance with, among other things, specified ratios of (i) total debt to tangible base capital; (ii) total adjusted debt to

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tangible base capital; (iii) current ratio; (iv) fixed charge coverage; and (v) net cash. The Ford Credit lines of credit agreements also preclude the payment of cash dividends without the prior consent of Ford Credit. Lithia was in compliance with all such covenants at December 31, 1999.

    Interest rates on all of the above facilities ranged from 7.33% to 8.08% at December 31, 1999. Amounts outstanding on the lines at December 31, 1999 were as follows (in thousands):

New and Program Vehicle Lines   $ 208,403
Used Vehicle Line     35,500
Acquisition Line     0
Leased Vehicle Line     4,880
Equipment Line     6,605
   
    $ 255,388
   

    Long-term debt consists of the following:

 
  December 31,
 
 
  1999
  1998
 
Lease vehicle line of credit   $ 4,880   $ 4,000  
Acquisition line of credit     0     0  
Used vehicle flooring line of credit     35,500     5,000  
Mortgages payable in monthly installments of $173, including interest between 8.18% and 9.375%, maturing fully December 2019; secured by land and buildings     19,893     9,499  
Notes payable in monthly installments of $144 plus interest calculated daily at LIBOR plus 2.20%, maturing fully November 2003; secured by equipment     6,605     8,328  
Notes payable in monthly installments of $197 plus interest between 7.21% and 8.50%, maturing at various dates through 2004; secured by vehicles leased to others     4,514     7,584  
Notes payable related to acquisitions, with interest rates between 7.00% and 9.00%, maturing at various dates between December 2000 and November 2008     9,342     12,679  
Note payable in monthly installments of $3, including interest at 10.25%, maturing fully August 2000     20     20  
   
 
 
      80,754     47,110  
Less current maturities     (7,039 )   (8,116 )
   
 
 
    $ 73,715   $ 38,994  
   
 
 

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LITHIA MOTORS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 1999, 1998 and 1997

(Dollar and share amounts in thousands, except per share amounts)

(6) Lines of Credit and Long-Term Debt (Continued)

    The schedule of future principal payments on long-term debt after December 31, 1999 is as follows:

Year ending December 31,

   
2000   $ 7,039
2001     10,426
2002     40,441
2003     3,047
2004     1,019
Thereafter     18,782
   
Total principal payments   $ 80,754
   

(7) Shareholders' Equity

    The shares of Class A common stock are not convertible into any other series or class of the Company's securities. However, each share of Class B common stock is freely convertible into one share of Class A common stock at the option of the holder of the Class B common stock. All shares of Class B common stock shall automatically convert to shares of Class A common stock (on a share-for-share basis, subject to the adjustments) on the earliest record date for an annual meeting of the Company shareholders on which the number of shares of Class B common stock outstanding is less than 1% of the total number of shares of common stock outstanding. Shares of Class B common stock may not be transferred to third parties, except for transfers to certain family members and in other limited circumstances.

    Holders of Class A common stock are entitled to one vote for each share held of record, and holders of Class B common stock are entitled to ten votes for each share held of record. The Class A common stock and Class B common stock vote together as a single class on all matters submitted to a vote of shareholders.

    In May 1998, the Company closed an offering of 3,151 newly issued shares of its Class A Common Stock for net proceeds of $42,498.

    In 1999, the Company authorized 15 shares of Series M, Redeemable, Convertible Preferred Stock ("Series M Preferred Stock"). In May 1999, in connection with the acquisition of Moreland Automotive Group, the Company issued 10.4 shares of Series M Preferred Stock. The Series M Preferred Stock votes with Class A Common Stock on an as if converted basis. The Series M Preferred Stock is convertible at the option of the Company at any time and at the option of the holder under limited circumstances. The Series M Preferred Stock converts into Class A Common Stock based on a formula that divides the average Class A Common Stock price for a certain 15-day period into one thousand and then multiplies by the number of Series M Preferred Shares being converted. The Series M Preferred Stock does not have a dividend preference, but participates in any dividends on an as if converted basis. The Series M Preferred Stock has a $1 per share liquidation preference.

    In the fourth quarter of 1999 the Company accrued for the issuance of $4,500 of its Class A Common Stock and $4,500 of its Series M Preferred Stock with a fair value of $2,700 to satisfy contingent payout

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requirements related to the Moreland acquisition. The stock was issued in the first quarter of 2000 and totaled 304 Class A shares and 0.3 Series M Preferred shares.

(8) Income Taxes

    The Company is taxed as a C Corporation in accordance with SFAS 109, Accounting for Income Taxes. Income taxes for 1999, 1998 and 1997 are as follows:

 
  December 31,
 
  1999
  1998
  1997
Current:                  
Federal   $ 10,382   $ 5,387   $ 2,967
State     1,979     1,041     444
   
 
 
      12,361     6,428     3,411
   
 
 
Deferred:                  
Federal     411     436     114
State     105     129     13
   
 
 
      516     565     127
   
 
 
Total   $ 12,877   $ 6,993   $ 3,538
   
 
 

    Individually significant components of the deferred tax assets and liabilities are presented below:

 
  December 31,
 
 
  1999
  1998
 
Deferred tax assets:              
Allowance and accruals   $ 2,457   $ 1,425  
Deferred revenue     2,931     1,282  
   
 
 
Total deferred tax assets     5,388     2,707  
   
 
 
Deferred tax liabilities:              
LIFO recapture and acquired LIFO inventories differences     (8,657 )   (4,398 )
Employee benefit plans     (625 )    
Goodwill     (2,797 )   (735 )
Property and equipment, principally due to differences in depreciation     (2,106 )   (2,009 )
   
 
 
Total deferred tax liabilities     (14,185 )   (7,142 )
   
 
 
Total   $ (8,797 ) $ (4,435 )
   
 
 

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    The reconciliation between the statutory federal income tax expense at 35% in 1999 and 1998 and 34% in 1997 and the Company's income tax expense for 1999, 1998 and 1997 is shown in the following tabulation.

 
  For the Year Ended December 31,
 
  1999
  1998
  1997
Statutory federal taxes   $ 11,218   $ 6,224   $ 3,229
State taxes, net of federal income tax benefit     1,311     751     278
Nondeductible goodwill     261        
Other     87     18     31
   
 
 
Income tax expense   $ 12,877   $ 6,993   $ 3,538
   
 
 

(9) Commitments and Contingencies

    The Company is contingently liable to banks for recourse paper assumed at the time of acquisition when the Company does a corporate purchase. Following the acquisition, the Company does not enter into further recourse transactions. The contingent liability at December 31, 1999, 1998 and 1997 was approximately $3,421, $3,824 and $64, respectively.

    The Company's potential loss is limited to the difference between the present value of the installment contract at the date of the repossession and the amount for which the vehicle is resold. Based upon historical loss percentages, an estimated loss reserve of $668, $255 and $0 is reflected in the Company's consolidated balance sheets as of December 31, 1999, 1998 and 1997, respectively. The reserves were established as a purchase price adjustment as the result of several acquisitions.

    Substantially all of the Company's operations are conducted in leased facilities under noncancelable operating leases. These leases expire at various dates through 2012. Beginning in 1998, certain lease commitments are subject to escalation clauses of an amount equal to the cost of living based on the "Consumer Price Index—U.S. Cities Average—All stems for all Urban Consumers" published by the U.S. Department of Labor. The Company also leases certain equipment under capital leases.

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    The minimum lease payments under the operating and capital leases after December 31, 1999 are as follows:

Year ending December 31,

  Operating
  Capital
 
2000   $ 12,670   $ 108  
2001     12,574     86  
2002     12,496     77  
2003     12,111     56  
2004     11,697     0  
Thereafter     76,338     0  
   
 
 
Total minimum lease payments   $ 137,886     327  
   
       
Less amounts representing interest           (38 )
         
 
Present value of future minimum lease payments         $ 289  
         
 

    Rental expense for all operating leases was $9,639, $5,659 and $2,764 for the years ended December 31, 1999, 1998 and 1997, respectively.

    The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity.

(10) Profit Sharing Plan

    The Company has a defined contribution plan and trust covering substantially all full-time employees. The annual contribution to the plan is at the discretion of the Board of Directors of Lithia Motors, Inc. Contributions of $591, $285 and $138 were recognized for the years ended December 31, 1999, 1998 and 1997, respectively. Employees may contribute to the plan under certain circumstances.

(11) Stock Incentive Plans

    The Company's 1996 Stock Incentive Plan, as amended, allows for the granting of up to 1,700 incentive and nonqualified stock options to officers, key employees and consultants of the Company and its subsidiaries. The Company's Non-Discretionary Stock Option Plan for Non-Employee Directors allows for the granting of 15 shares (collectively, the "Plan"). The Plan is administered by the Board or by a Compensation Committee of the Board and permits accelerated vesting of outstanding options upon the occurrence of certain changes in control of the Company. Options become exercisable over a period of up to ten years from the date of grant as determined by the Board, at prices generally not less than the fair market value at the date of grant. At December 31, 1999, 1,623 shares of Class A common stock were reserved for issuance under the Plan and 856 shares were available for future grant.

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    Activity under the Plan is as follows:

 
  Shares Available for Grant
  Shares Subject to Options
  Weighted Average Exercise Price
Balances, December 31, 1996   246   439   $ 3.11
Options granted   (45 ) 45     6.05
Options canceled        
Options exercised     (51 )   3.20
   
 
 
Balances, December 31, 1997   201   433     3.41
Additional shares reserved   415      
Options granted   (155 ) 155     14.65
Options canceled   34   (34 )   16.22
Options exercised     (6 )   3.02
   
 
 
Balances, December 31, 1998   495   548     5.80
Additional shares reserved   615      
Options granted   (257 ) 257     17.84
Options canceled   3   (3 )   14.75
Options exercised     (35 )   3.98
   
 
 
Balances, December 31, 1999   856   767   $ 9.89
   
 
 

    The Company issued non-qualified options during 1998 and 1997 to certain members of management at an exercise price of $1.00 per share. Compensation expense, which is equal to the difference between the market price and the exercise price, is recognized ratably in accordance with the 4-year vesting schedule.

    In 1998, the Board of Directors of the Company and the shareholders approved the implementation of an Employee Stock Purchase Plan (the "Purchase Plan"), and reserved a total of 250 shares of Class A Common Stock for issuance under the Purchase Plan. The Purchase Plan is intended to qualify as an "Employee Stock Purchase Plan" under Section 423 of the Internal Revenue Code of 1986, as amended, and is administered by the Compensation Committee of the Board. Eligible employees are entitled to contribute up to 10 percent of their base pay for the purchase of stock. The purchase price for shares purchased under the Purchase Plan is 85 percent of the lesser of the fair market value at the beginning or end of the purchase period. A total of 50 and 9 shares of the Company's Class A common stock were issued under the Purchase Plan during 1999 and 1998, respectively, and 191 remained available for issuance at December 31, 1999.

    During 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 Accounting for Stock-Based Compensation (SFAS 123), which defines a fair value based method of accounting for employee stock options and similar equity instruments. As permitted under SFAS 123, the Company has elected to continue to account for its stock-based compensation plans under Accounting Principal Board Opinion No. 25 Accounting for Stock Issued to Employees (APB 25), and

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related interpretations. Accordingly, no compensation expense has been recognized for the Plan or the Purchase Plan (collectively the "Plans").

    The Company has computed, for pro forma disclosure purposes, the value of options granted under the Plans, using the Black-Scholes option pricing model as prescribed by SFAS 123, using the weighted average assumptions for grants as follows:

 
  For the Year Ended December 31,
 
  1999
  1998
  1997
Risk-free interest rate   5.50%   5.50%   6.25%
Expected dividend yield   0.00%   0.00%   0.00%
Expected lives   7.0 years   6.7 years   6.8 years
Expected volatility   49.91%   53.41%   45.50%

    Using the Black-Scholes methodology, the total value of options granted during 1999, 1998 and 1997 was $2,910, $1,119 and $320, respectively, which would be amortized on a pro forma basis over the vesting period of the options, typically four to five years. The weighted average fair value of options granted during 1999, 1998 and 1997 was $9.17, $8.61 and $7.20 per share, respectively. If the Company had accounted for its stock-based compensation plan in accordance with SFAS 123, the Company's net income and net income per share would approximate the pro forma disclosures below:

 
  For the Year Ended December 31,
 
  1999
  1998
  1997
 
  As Reported
  Pro Forma
  As Reported
  Pro Forma
  As Reported
  Pro Forma
Net income   $ 19,174   $ 17,965   $ 10,789   $ 10,227   $ 5,959   $ 5,723
Basic net income per share   $ 1.72   $ 1.61   $ 1.18   $ 1.12   $ 0.85   $ 0.82
Diluted net income per share   $ 1.60   $ 1.52   $ 1.14   $ 1.09   $ 0.82   $ 0.79

    The following table summarizes stock options outstanding at December 31, 1999:

Options Outstanding
  Options Exercisable
Range of Exercise Prices
  Number Outstanding at 12/31/99
  Weighted Average Remaining Contractual Life (years)
  Weighted Average Exercise Price
  Number of Shares Exercisable at 12/31/99
  Weighted Average Exercise Price
$ 1.00   28   6.7   $ 1.00   15   $ 1.00
  3.02 - 3.33   350   3.6     3.09   241     3.12
  10.75 - 11.00   25   6.0     10.81   10     10.81
  14.31 - 16.50   241   7.4     15.87   25     15.41
  18.15   24   4.0     18.15      
  18.94 - 20.83   99   8.2     19.59   5     20.83

 
 
 
 
     
$ 1.00 - 20.83   767   5.6   $ 9.89   296   $ 4.60

 
 
 
 
     

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    At December 31, 1998 and 1997, 239 and 151 shares were exercisable at weighted average exercise prices of $3.44 and $3.28, respectively.

(12) Related Party Transactions

    Lithia Properties, LLC, owned certain of the real property on which the Company's business is located. The Company owns a 20% interest in Lithia Properties, LLC. The Company leased such facilities under various lease agreements from Lithia Properties, LLC. Selling, general and administrative expense includes rental expense of $706, $1,464 and $1,442 for the years ended December 31, 1999, 1998 and 1997, respectively relating to these properties.

    In June 1999, Lithia Properties, LLC completed its sale of certain real estate holdings in the Southern Oregon region to Capital Automotive Real Estate Investment Trust ("Capital"), an unrelated party, for $18,300. As a result of this sale, the Company received a distribution for its portion of the realized gain, totaling approximately $1,246, which will be realized ratably over the 12-year life of the new lease. The Company now leases such properties from Capital for amounts that are not materially different from the lease amounts under the previous lease agreements.

    The Company provides management services to Lithia Properties, LLC. Other income includes management fees of $7, $12 and $12 for the years ended December 31, 1999, 1998 and 1997, respectively.

    Lithia Properties, LLC constructed a new body and paint shop for use by the Company, which was completed in April 1997. The Company purchased the facility and improvements together with a 5.3 acre parcel held for future development in Medford, Oregon, in 1997. The purchase price for these properties was $2,700. Lithia Properties, LLC retained and after purchase of the facility, the Company continued to retain, Mark DeBoer Construction, Inc. as the general contractor for the project. Mark DeBoer, the owner of Mark DeBoer Construction, Inc., is the son of Sidney B. DeBoer and is one of the members of Lithia Properties, LLC. The general contractor fee was $128, an arrangement the Company believes is fair in comparison with fees negotiated with independent third parties.

    During 1999 and 1998, Lithia Real Estate, Inc. paid Mark DeBoer Construction, Inc. $2,649 and $314, respectively, for remodeling certain of the Company's facilities. These amounts included $2,252 and $281, respectively, paid for subcontractors and materials, $171 and $7, respectively for permits, licenses, travel and various miscellaneous fees, and $226 and $26, respectively, for contractor fee. The Company believes the amount paid is fair in comparison with fees negotiated with independent third parties.

    In May 1999, the Company purchased certain dealerships owned by W. Douglas Moreland for total consideration of approximately $66,000, at which time, Mr. Moreland became a member of the Company's Board of Directors. During the normal course of business, these dealerships paid $672 to other companies owned by Mr. Moreland for vehicles purchases and recourse paid to a financial lender. The Company also paid rental expense of $1,589 to other companies owned by Mr. Moreland in 1999.

    The terms of the acquisition agreement with Mr. Moreland provided for additional consideration to be paid if the acquired entity results of operations exceeded certain targeted levels in 1999. Targeted levels were set substantially above the historical experience of the acquired entity at the time of acquisition. Such additional consideration was paid in cash and with shares of the Company's stock and was recorded when

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earned in the fourth quarter of 1999 as additional purchase price. Additional consideration totaled $18,000, including $9,000 in cash, $4,500 in Class A Common Stock and $4,500 in Class M Restricted Preferred Stock with a fair value of $2,700.

(13) Acquisitions

    Significant acquisitions in 1999, 1998 and 1997 were as follows:

    In May 1999, the Company acquired all of the stock of seven commonly controlled automotive dealerships constituting the Moreland Automotive Group ("Moreland") for approximately $19,689 in cash (which is net of $16,007 of cash acquired), 1,273 shares of the Company's Class A Common Stock with a value of approximately $24,100 at the time of issuance, and 10 shares of Lithia's newly created Series M Preferred Stock with a value of approximately $6,200 at the time of issuance. At closing, Moreland had approximately $18,200 of used vehicles available for flooring under the Company's used vehicle line of credit, reducing the net investment in the acquired dealerships by that amount to a total of $47,800. See also Note 14 Subsequent Events.

    In October 1998, the Company acquired the net assets of Camp Automotive for total consideration of $11,535, including $8,000 in cash and $3,535 of assumed debt.

    In October 1997, the Company acquired the net assets of Dick Donnelly Lincoln/Mercury, Isuzu, Suzuki and Audi for total consideration of $12,916, including $6,139 in cash and $6,777 of assumed debt. At closing, the Company was able to finance a total of $6,200 of inventory using its lines of credit, reducing the net investment in the acquired dealerships by that amount to $6,700.

    In August 1997, the Company acquired the net assets of Sun Valley Ford, Volkswagen for total consideration of $17,962, including $5,356 in cash and $12,606 of assumed debt. At closing, the Company was able to finance a total of $10,400 of inventory using its lines of credit, reducing the net investment in the acquired dealerships by that amount to $7,600.

    The unaudited pro forma results of operations including Camp Automotive, Inc., Sun Valley Ford, Inc., Dick Donnelly Automotive Enterprises, Inc. and Moreland Automotive are as follows. The results of operations for other acquisitions are not included in the unaudited pro forma information as they are not materially different from actual results of the Company.

 
  Year Ended December 31,
 
  1999
  1998
Total revenues   $ 1,409,404   $ 1,157,345
Net income     21,009     12,176
Basic earnings per share     1.81     1.17
Diluted earnings per share     1.65     1.07

    The unaudited pro forma results are not necessarily indicative of what actually would have occurred had the acquisitions been in effect for the entire periods presented. In addition, they are not intended to be a projection of future results that may be achieved from the combined operations. The 1998 pro forma

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results of operations include bonuses paid by Moreland to its owners. Excluding such bonuses, which would not have been paid under Lithia's ownership, the acquisition would have been accretive to Lithia's 1998 earnings.

    Some purchase price allocations are based on studies and valuations that are currently being finalized. Management does not believe that the final purchase price allocations will produce materially different results than those referenced herein.

(14) Subsequent Event (unaudited)

    In March 2000, the Company acquired the Bob Rice Ford/Chrysler dealership in Boise, Idaho. The dealership had estimated 1999 revenues of approximately $73,000. The Company's net investment in the acquired dealerships totaled approximately $10,900.

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PART I
PART II
PART III
PART IV
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