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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
      the Fiscal Year Ended: December 31, 2003
      OR
  [  ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-14733

LITHIA MOTORS, INC.

(Exact name of registrant as specified in its charter)
     
Oregon
(State or other jurisdiction of incorporation
or organization)
  93-0572810
(I.R.S. Employer
Identification No.)
     
360 E. Jackson Street, Medford, Oregon
(Address of principal executive offices)
  97501
(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]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X ] No [  ]

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant was $111,194,525, computed by reference to the last sales price ($16.17) as reported by the New York Stock Exchange for the Registrant’s Class A common stock, as of the last business day of the Registrant’s most recently completed second fiscal quarter (June 30, 2003).

The number of shares outstanding of the Registrant’s common stock as of March 8, 2004 was: Class A: 14,871,528 shares and Class B: 3,762,231 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 2004 Annual Meeting of Shareholders.



 


TABLE OF CONTENTS

PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Financial Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accountant Fees and Services
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
SIGNATURES
EXHIBIT 10.15.1
EXHIBIT 10.16.3
EXHIBIT 21
EXHIBIT 23
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2
EXHIBIT 99.1


Table of Contents

LITHIA MOTORS, INC.
2003 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

             
        Page
  PART I        
Item 1.
  Business     2  
Item 2.
  Properties     13  
Item 3.
  Legal Proceedings     13  
Item 4.
  Submission of Matters to a Vote of Security Holders     14  
  PART II        
Item 5.
  Market for Registrant’s Common Equity and Related Stockholder Matters     14  
Item 6.
  Selected Financial Data     15  
Item 7.
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     16  
Item 7A.
  Quantitative and Qualitative Disclosures About Market Risk     28  
Item 8.
  Financial Statements and Supplementary Data     29  
Item 9.
  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure     30  
Item 9A.
  Controls and Procedures     30  
  PART III        
Item 10.
  Directors and Executive Officers of the Registrant     30  
Item 11.
  Executive Compensation     30  
Item 12.
  Security Ownership of Certain Beneficial Owners and Management     30  
Item 13.
  Certain Relationships and Related Transactions     30  
Item 14.
  Principal Accountant Fees and Services     31  
  PART IV        
Item 15.
  Exhibits, Financial Statement Schedules and Reports on Form 8-K     31  
Signatures     35  

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PART I

Item 1. Business

Forward Looking Statements and Risk Factors

Some of the statements under the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this Form 10-K constitute forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” and “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-K involve known and unknown risks, uncertainties and situations that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Some of the important factors that could cause actual results to differ from our expectations are discussed in Exhibit 99.1 to this Form 10-K.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements.

Where You Can Find More Information

We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”). You can inspect and copy our reports, proxy statements, and other information filed with the SEC at the offices of the SEC’s Public Reference Rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Rooms. The SEC maintains an Internet Web site at http://www.sec.gov/ where you can obtain most of our SEC filings. In addition, you can inspect our reports and other information at the offices of the New York Stock Exchange at 20 Broad Street, New York, NY 10005. We also make available free of charge on our website at www.lithia.com our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after they are filed electronically with the SEC. You can also obtain copies of these reports by contacting Investor Relations at 541-776-6591.

Overview

We are a leading operator of automotive franchises and retailer of new and used vehicles and services. As of March 1, 2004, we offered 25 brands of new vehicles through 152 franchises in 79 stores in the Western United States and over the Internet. As of March 1, 2004, we operated 16 stores in Oregon, 13 in California, 11 in Washington, 8 in Texas, 7 in Idaho, 7 in Colorado, 6 in Nevada, 4 in Alaska, 2 in South Dakota, 2 in Nebraska, 2 in Montana and 1 in Oklahoma. We sell new and used cars and light trucks; sell replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing, service contracts, protective products and credit insurance for our automotive customers.

We achieve gross margins above industry averages by selling a higher ratio of retail used vehicles to new vehicles and by arranging finance and extended warranty contracts for a greater percentage of our customers. In 2003, we achieved a gross margin of 16.0%.

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We were founded in 1946 and incorporated in 1968. Our two senior executives have managed the company for more than 30 years. Since our initial public offering in 1996, we have grown from 5 to 79 stores, primarily through an aggressive acquisition program, increasing annual revenues from $143 million in 1996 to $2.5 billion in 2003. In addition, since our initial public offering through December 31, 2003, we have achieved compound annual growth rates of 51% per year for revenues, 45% per year for net income and 21% per year for earnings per share, together with a 4.1% average annual same store sales increase.

The Industry

At approximately $1.0 trillion in annual sales, automotive retailing is the largest retail trade sector in the United States and comprises roughly 10% of the GDP. The industry is highly fragmented with the 100 largest automotive retailers generating approximately 16% of total industry revenues in 2002. The number of franchised stores in the U.S. has declined in the last 20 years from approximately 25,000 stores in 1983 to approximately 22,000 in 2003. In addition to these new vehicle outlets, used vehicles are sold by approximately 53,000 independent used vehicle dealers and through casual (person to person) transactions. New vehicles can only be sold through automotive retail stores franchised by auto manufacturers. These franchise stores have designated trade territories under state franchise law protection, which limits the number of new stores that can be opened in any given area.

Consolidation is expected to continue as many smaller automotive retailers are now considering selling or joining forces with larger retailer groups, given the large capital requirements necessary to operate in today’s retail environment. With many owners reaching retirement age, often without clear succession plans, larger, well-capitalized automotive retailers provide an attractive exit strategy. We believe these factors provide an attractive environment for continuing consolidation.

Unlike other retailing segments, automotive manufacturers provide unparalleled support to the automotive retailer. Manufacturers often bear the burden of markdown risks on slow-moving inventory as they provide aggressive dealer and customer incentives to clear aged inventory in order to free the inventory pipeline for new purchases. In addition, an automotive retailer’s cash investment in inventory is relatively small, given floorplan financing from manufacturers. Furthermore, manufacturers provide low-cost financing for working capital and acquisitions and credit to consumers to finance vehicle purchases, as well as pay retail prices to their dealers for servicing vehicles under manufacturers’ warranties.

Sales in the automotive sector are affected by general economic conditions including rates of employment, income growth, interest rates and general consumer sentiment.

New vehicle sales usually decline during a weak economy; however, the higher margin service and parts business typically benefits in the same environment because consumers tend to keep their vehicles longer. Strong sales of new vehicles in recent years have provided a population of vehicles for future service and parts revenues. Automotive retailers benefit from their designation as an exclusive warranty and recall service provider of a manufacturer. For the typical manufacturer’s warranty, this provides an automotive retailer with a period of at least 3 years of repeat business for service covered by warranty. Extended warranties can add two or more years to this repeat servicing period.

Automotive retailers’ profitability varies widely and depends in part on product mix, effective management of inventory, marketing, quality control and responsiveness to customers. In 2002, new vehicles accounted for an estimated 59.6% of industry revenues. The remaining 40.4% of revenues were derived from used vehicles sales of 28.6%, and service and parts sales of 11.8%. Finance and insurance sales are included in the new and used vehicle sales numbers. Gross margins on new vehicles were 5.6% in 2002.

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Automotive retailers have much lower fixed overhead costs than automobile manufacturers and parts suppliers. Variable and discretionary costs, such as sales commissions and personnel, advertising and inventory finance expenses, can be adjusted to match new vehicle sales. Variable and discretionary costs account for an estimated 60-65% of the industry’s total expenses. Moreover, an automotive retailer can enhance its profitability from sales of higher margin products and services. Gross margins for the parts and service business are significantly higher at approximately 47%, given the labor-intensive nature of the product category. Gross margins for finance and insurance are virtually 100% as they are fee driven income items. These supplemental, high margin products and services provide substantial incremental revenue and net income, decreasing reliance on the highly competitive new vehicle sales.

Store Operations

Each store 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 for improving performance, we make available to each store a team of specialists in new vehicle sales, used vehicle sales, finance and insurance, service and parts, and back-office administration.

The following tables set forth information about our stores as of March 1, 2004:

                         
                    Percent of
    Number of   Number of   Total Revenue
State
  Stores
  Franchises
  in 2003
Oregon
    16       32       19 %
Washington
    11       19       17  
California
    13       23       15  
Texas
    8       17       13  
Colorado
    7       14       10  
Idaho
    7       13       8  
Nevada
    6       13       5  
South Dakota
    2       3       4  
Alaska
    4       7       3  
Montana
    2       7       2  
Nebraska
    2       2       3  
Oklahoma
    1       2       1  
 
   
 
     
 
     
 
 
Total
    79       152       100 %
 
   
 
     
 
     
 
 
             
            Year
            Opened/
Location
  Store
  Franchises
  Acquired
CALIFORNIA
           
Concord
  Lithia Dodge of Concord   Dodge, Dodge Truck   1997
 
  Lithia Ford of Concord   Ford   1997
 
  Lithia Volkswagen of Concord   Volkswagen   1997
Fresno
  Lithia Ford of Fresno   Ford   1997
 
  Lithia Nissan Hyundai of Fresno   Nissan, Hyundai   1998
 
  Lithia Mazda Suzuki of Fresno   Mazda, Suzuki   1997
Redding
  Lithia Chevrolet of Redding   Chevrolet   1998
 
  Lithia Toyota of Redding   Toyota, Scion   1998
Vacaville
  Lithia Toyota of Vacaville   Toyota, Scion   1996
Burlingame
  Lithia Chrysler Jeep Dodge of Burlingame   Chrysler, Dodge, Dodge Truck, Jeep   2002
Salinas
  Chevrolet of Salinas   Chevrolet   2003
Santa Rosa
  Lithia Dodge of Santa Rosa   Dodge, Dodge Truck   2003
Fairfield
  Lithia Dodge of Fairfield   Dodge, Dodge Truck   2003

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            Year
            Opened/
Location
  Store
  Franchises
  Acquired
OREGON
           
Eugene
  Lithia Dodge of Eugene   Dodge, Dodge Truck   1996
 
  Lithia Nissan of Eugene   Nissan   1998
 
  Saturn of Eugene   Saturn   2000
Grants Pass
  Lithia's Grants Pass Auto Center   Dodge, Dodge Truck, Chrysler, Jeep   Pre-IPO
Klamath Falls
  Lithia Klamath Falls Auto Center   Toyota, Dodge, Dodge Truck, Chrysler, Jeep   1999
Medford
  Lithia Chrysler Jeep Dodge   Dodge, Dodge Truck, Chrysler, Jeep   Pre-IPO
 
  Lithia Honda   Honda   Pre-IPO
 
  Lithia Nissan   Nissan   1998
 
  Medford BMW   BMW   1998
 
  Lithia Toyota   Toyota   Pre-IPO
 
  Lithia Volkswagen   Volkswagen   Pre-IPO
 
  Saturn of Southwest Oregon   Saturn   Pre-IPO
Oregon City
           
(Portland)
  Lithia Subaru of Oregon City   Subaru   2002
Roseburg
  Lithia Ford Lincoln Mercury of Roseburg   Ford, Lincoln, Mercury   1999
 
  Lithia Chrysler Jeep Dodge of Roseburg   Dodge, Dodge Truck, Chrysler, Jeep   1999
Springfield (Eugene)
  Lithia Toyota of Springfield   Toyota   1998
             
COLORADO
           
Aurora (Denver)
  Lithia Dodge of Cherry Creek   Dodge, Dodge Truck   1999
 
  Lithia Colorado Chrysler Jeep   Chrysler, Jeep   1999
Colorado Springs
  Lithia Colorado Springs Jeep Chrysler   Jeep, Chrysler   1999
Englewood (Denver)
  Lithia Centennial Chrysler Jeep   Chrysler, Jeep   1999
Fort Collins
  Lithia Foothills Chrysler   Dodge, Dodge Truck, Chrysler, Jeep   1999
 
  Lithia Foothills Hyundai   Hyundai   1999
Thornton (Denver)
  Lithia Volkswagen of Thornton   Volkswagen   2002
             
WASHINGTON
           
Bellevue (Seattle)
  Chevrolet Hummer of Bellevue   Chevrolet   2001
 
      Hummer   2002
Issaquah (Seattle)
  Chevrolet of Issaquah   Chevrolet   2001
Kennewick
  Honda of Tri-Cities   Honda   2000
 
  Lithia Dodge of Tri-Cities   Dodge, Dodge Truck   1999
Renton
  Lithia Chrysler Jeep Dodge of Renton   Chrysler, Jeep, Dodge, Dodge Truck   2000
 
  Lithia Hyundai of Renton   Hyundai   2002
Richland
  Lithia Ford of Tri-Cities   Ford   2000
Seattle
  BMW Seattle   BMW   2001
Spokane
  Lithia Camp Chevrolet   Chevrolet, Cadillac   1998
 
  Lithia Camp Imports   Subaru, BMW, Volvo   1998
 
  Mercedes-Benz of Spokane   Mercedes   2003
             
IDAHO
           
Boise
  Lithia Ford of Boise   Ford   2000
 
  Chevrolet of Boise   Chevrolet   1999
 
  Lithia Lincoln-Mercury Isuzu of Boise   Lincoln, Mercury, Isuzu   1999
Caldwell
  Chevrolet of Caldwell   Chevrolet   2001
Pocatello
  Honda of Pocatello   Honda   2001
 
  Lithia Chrysler Dodge Hyundai of   Chrysler, Dodge, Dodge Truck, Hyundai   2001
 
  Pocatello        
Twin Falls
  Chevrolet Cadillac of Twin Falls   Chevrolet, Cadillac   2003
             
NEVADA
           
Reno
  Lithia L/M/Audi Isuzu of Reno   Audi, Lincoln, Mercury, Isuzu   1997
 
  Lithia Reno Hyundai   Hyundai   1997
 
  Lithia Reno Subaru   Subaru   1999
 
  Lithia Volkswagen of Reno   Volkswagen   1998
 
  Lithia Chrysler Jeep of Reno   Chrysler, Jeep   2004
Sparks
  Lithia Sparks (satellite of Lithia Reno)   Suzuki, Lincoln, Mercury, Isuzu   1997

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            Year
            Opened/
Location
  Store
  Franchises
  Acquired
SOUTH DAKOTA
           
Sioux Falls
  Chevrolet of Sioux Falls   Chevrolet   2000
 
  Lithia Dodge of Sioux Falls   Dodge, Dodge Truck   2001
             
ALASKA
           
Anchorage
  Lithia Chrysler Jeep of Anchorage   Chrysler, Jeep   2001
 
  Lithia Dodge of South Anchorage   Dodge, Dodge Truck   2001
 
  Lithia Hyundai of Anchorage   Hyundai   2003
Fairbanks
  Chevrolet Cadillac of Fairbanks, Alaska   Chevrolet, Cadillac   2003
             
TEXAS
           
San Angelo
  All American Chrysler Jeep Dodge of   Dodge, Dodge Truck, Jeep, Chrysler   2002
 
  San Angelo        
 
  Honda of San Angelo   Honda   2002
 
  All American Chevrolet of San Angelo   Chevrolet   2002
Odessa
  All American Chrysler Jeep Dodge   Dodge, Dodge Truck, Jeep, Chrysler   2002
 
  of Odessa        
 
  All American Chevrolet of Odessa   Chevrolet   2002
Midland
  All American Dodge-Hyundai of Midland   Dodge, Dodge Truck, Hyundai   2002
 
  All American Chevrolet of Midland   Chevrolet   2002
Grapevine
  Lithia Dodge of Grapevine   Dodge, Dodge Truck   2003
             
NEBRASKA
           
Omaha
  Lithia Ford of Omaha   Ford   2002
 
  Mercedes-Benz of Omaha   Mercedes   2002
             
MONTANA
           
Missoula
  Lithia Auto Center of Missoula   Chrysler, Dodge, Dodge Truck, Lincoln,   2003
 
      Mercury    
Billings
  Lithia Dodge of Billings   Dodge, Dodge Truck   2003
             
OKLAHOMA
           
Broken Arrow
  Lithia Dodge of Broken Arrow   Dodge, Dodge Truck   2003

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New Vehicle Sales

In 2003, we sold 25 domestic and imported brands ranging from economy to luxury cars, sport utility vehicles, minivans and light trucks.

                 
            Percent of
            New
    Percent of   Vehicle
    Total   Sales in
Manufacturer
  Revenue
  2003
DaimlerChrysler (Chrysler, Dodge, Jeep, Dodge Trucks)
    21.7 %     37.9 %
General Motors (Chevrolet, Saturn, Cadillac and Hummer)
    13.9       24.3  
Ford (Ford, Lincoln, Mercury)
    5.3       9.2  
Toyota, Scion
    4.4       7.7  
BMW
    2.2       3.9  
Hyundai
    2.0       3.4  
Subaru
    1.7       3.0  
Honda
    1.6       2.9  
Volkswagen, Audi
    1.5       2.6  
Nissan
    1.4       2.4  
Mercedes
    0.7       1.1  
Mazda
    0.4       0.8  
Suzuki
    0.3       0.5  
Isuzu
    0.1       0.2  
Volvo
    0.1       0.1  
 
   
 
     
 
 
 
    57.3 %     100.0 %
 
   
 
     
 
 

Our unit and dollar sales of new vehicles from continuing operations were as follows:

                                         
    Year Ended December 31,
    2003
  2002
  2001
  2000
  1999
New vehicle units
    53,804       46,929       37,190       34,349       26,045  
New vehicle sales (in thousands)
  $ 1,441,000     $ 1,218,364     $ 926,981     $ 833,107     $ 615,617  
Average selling price
  $ 26,782     $ 25,962     $ 24,926     $ 24,254     $ 23,637  

We purchase our new car inventory directly from manufacturers, who allocate new vehicles to stores based on the number of vehicles sold by the store on a monthly basis and by the store’s market area. Accordingly, we rely on the manufacturers to provide us with vehicles that consumers desire and to supply us with such vehicles at suitable locations, quantities and prices. We attempt to exchange vehicles with other automotive retailers to accommodate customer demand and to balance inventory.

We post the manufacturer’s suggested retail price (MSRP) on every vehicle, as required by law. We negotiate the final sales price of a new vehicle individually with the customer, selling many vehicles at a special marketing offered price called “Promo Price,” which is typically less than MSRP.

Used Vehicle Sales

At each new vehicle store, we also sell used vehicles. Retail used vehicle sales are an important part of our overall profitability. In 2003, retail used vehicle sales generated a gross margin of 13.8% compared with a gross margin of 7.7% for new vehicle sales. To enhance our sales efforts, we employ a used vehicle manager at each location.

Retail used vehicle sales are an important part of our overall profitability. In 2003, retail used vehicle sales generated a gross margin of 13.8% compared with a gross margin of 7.7% for new vehicle sales.

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Our used vehicle operations give us an opportunity to:

    generate sales to customers financially unable or unwilling to purchase a new vehicle;
 
    increase new and used vehicle sales by aggressively pursuing customer trade-ins; and
 
    increase service contract sales and provide financing to used vehicle purchasers.

In 2003, we sold approximately 0.8 retail used vehicles for every new vehicle sold.

In addition to selling late model used cars, as do other new vehicle dealers, our stores emphasize sales of used vehicles three to ten years old. These vehicles sell for lower prices, but generate greater margins. We believe that selling a larger number of used vehicles makes us less susceptible to the effects of changes in the volume of new vehicle sales that result from economic conditions.

We acquire most of our used vehicles through customer trade-ins, but we also buy them at “closed” auctions, attended only by new vehicle automotive retailers with franchises for the brands offered. These auctions offer off-lease, rental and fleet vehicles. We also buy used vehicles at “open” auctions of repossessed vehicles and vehicles being sold by other automotive retailers.

In addition to selling used vehicles to retail customers, we sell vehicles in poor condition and vehicles that have not sold promptly to other automotive retailers and to wholesalers.

Our used vehicle sales from continuing operations were as follows:

                                         
    Year Ended December 31,
    2003
  2002
  2001
  2000
  1999
Retail used units
    41,451       40,781       35,845       29,866       22,430  
Retail used unit sales (in thousands)
  $ 603,096     $ 594,256     $ 480,848     $ 392,017     $ 292,516  
Average selling price
  $ 14,550     $ 14,572     $ 13,415     $ 13,126     $ 13,041  
Wholesale used units
    25,982       24,475       18,081       15,967       12,751  
Wholesale used unit sales (in thousands)
  $ 122,451     $ 121,504     $ 83,201     $ 70,055     $ 58,378  
Average selling price
  $ 4,713     $ 4,964     $ 4,602     $ 4,387     $ 4,578  
Total used units
    67,433       65,256       53,926       45,833       35,181  
Total used units sales (in thousands)
  $ 725,547     $ 715,760     $ 564,049     $ 462,072     $ 350,894  

Vehicle Financing, Extended Warranty and Insurance

We believe that arranging financing is critical to our ability to sell vehicles and related products and services. We provide a variety of financing and leasing alternatives to meet customer needs. Offering customer financing on a “same day” basis gives us an advantage, particularly over smaller competitors who do not generate enough sales to attract our breadth of financing sources.

Because of greater profit margins from sales of finance and insurance products, we try to arrange financing for every vehicle we sell. Our finance and insurance managers possess extensive knowledge of available financing alternatives and receive training in determining each customer’s financing needs so that the customer can purchase or lease a vehicle. The finance and insurance managers work closely with financing sources to quickly determine a customer’s credit status and to confirm the type and amount of financing available to each customer.

In 2003, we had finance and insurance penetration for 78% of our new vehicle sales and 73% of our retail used vehicle sales. Our average finance and insurance revenue per vehicle totaled $945 in 2003.

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We earn a portion of the financing charge by discounting each finance contract we write and subsequently sell to a lender. In 2003, many automobile manufacturers continued to offer zero percent financing as sales incentives to new vehicle purchasers. Zero percent financing reduces, but does not eliminate, our per unit fee income from arranging financing, as we receive a fixed payment from the manufacturers in connection with such financing. Many customers do not qualify for zero percent financing, either because of their credit standing or because they require longer financing terms than offered for zero percent financing. Incentive financing programs, including zero percent programs, usually offer cash rebates as an alternative to reduced interest rates. A majority of eligible customers elect to receive cash rebates instead of incentive financing, usually using the cash rebate as a down payment to complete the purchase of a new vehicle with little or no cash out of pocket. We have been able to increase finance and insurance revenue per vehicle, despite zero percent financing, due to higher penetration of other finance and insurance products.

We usually arrange financing for customers by selling the contracts to outside sources on a non-recourse basis to avoid the risk of default. During 2003, we directly financed less than 0.01% of our vehicle sales.

Our finance and insurance managers also market third-party extended warranty contracts and insurance contracts to our new and used vehicle buyers. These products and services yield higher profit margins than vehicle sales and contribute significantly to our profitability. Extended warranty contracts provide additional coverage for new vehicles beyond the duration or scope of the manufacturer’s warranty. The service contracts we sell to used vehicle buyers provide coverage for certain major repairs.

We also offer our customers third party credit life and health and accident insurance when they finance an automobile purchase and receive a commission on each policy sold. We also offer other products, such as protective coatings and automobile alarms.

Service, Body and Parts

Our automotive service, body and parts operations are an integral part of establishing customer loyalty and contribute significantly to our overall revenue and profits. We provide parts and service primarily for the new vehicle brands sold by our stores, but we also service other vehicles. In 2003, our service, body and parts operations generated $251.3 million in revenues, or 10.0% of total revenues. We set prices to reflect the difficulty of the types of repair and the cost and availability of parts.

The service, body and parts businesses provide important repeat revenues to the stores. We market our parts and service products by notifying the owners of vehicles when their vehicles are due for periodic service. This encourages preventive maintenance rather than post-breakdown repairs. We offer a lifetime oil and filter service, which, in 2003, was purchased by 34.0% of our new and used vehicle buyers. This service helps us retain customers, and provides opportunities for repeat parts and service business. Revenues from the service, body and parts departments are important during economic downturns as owners tend to repair their existing used vehicles rather than buy new vehicles during such periods. This limits the effects of a drop in new vehicle sales.

We operate nineteen collision repair centers: four in Texas, three each in Oregon and Idaho; two in South Dakota and one each in California, Washington, Montana, Colorado, Nevada, Alaska and Nebraska.

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Marketing

We market ourselves as “America’s Car & Truck Store” and as “Driving America.” We use most types of advertising, including television, newspaper, radio, direct mail, and an Internet web site. Advertising expense, net of manufacturer credits, was $20.1 million during 2003, with 41% of the total amount used for print media, 18% for television, 13% for radio and 28% for direct mail, Internet and other. We advertise to develop our image as a reputable automotive retailer, offering quality service, affordable automobiles and financing for all buyers. The automobile manufacturers pay for many of our advertising and marketing expenditures. The manufacturers also provide us with market research, which assists us in developing our own advertising and marketing campaigns. In addition, our stores advertise discounts or other promotions to attract customers. By owning a cluster of stores in a particular market, we save money from volume discounts and other media concessions. We also participate as a member of advertising cooperatives and associations, whose members pool their resources and expertise with manufacturers to develop advertising campaigns.

We maintain a web site (www.lithia.com) that generates leads and provides information for our customers. We use the Internet site as a marketing tool to familiarize customers with us, our stores and the products we sell, rather than to complete purchases. Although many customers use the Internet to research information about new vehicles, nearly all ultimately visit a store to complete the sale and take delivery of the vehicle. Our web site enables a customer to:

    locate our stores and identify the new vehicle brands sold at each store;
 
    view new and used vehicle inventory;
 
    schedule service appointments;
 
    view Kelley Blue Book values;
 
    visit our investor relations site; and
 
    view employment opportunities.

We emphasize customer satisfaction and strive to develop a reputation for quality and fairness. We train our sales personnel to identify an appropriate vehicle for each of our customers at an affordable price.

We believe that our “Driving America” customer-oriented plan differentiates us from other automotive retail stores.

Management Information System

We consolidate, process and maintain financial information, operational and accounting data, and other related statistical information on centralized computers at our headquarters. We have a fully operational intranet with each store directly connected to headquarters. Our systems are based on an ADP platform for the main database, and information is processed and analyzed utilizing customized financial reporting software from Hyperion Solutions. Senior management can access detailed information from all of our locations regarding:

    inventory;
 
    cash balances;
 
    total unit sales and mix of new and used vehicle sales;
 
    lease and finance transactions;
 
    sales of ancillary products and services;
 
    key cost items and profit margins; and
 
    the relative performance of the stores.

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

Our management information system is particularly important to successfully operating new stores. Following each acquisition, we immediately install our management information system at each location. This quickly makes financial, accounting and other operational data easily available throughout the company. With this information, we can more efficiently execute our operating strategy at the new store.

Franchise Agreements

Each of our store subsidiaries signs a franchise (or dealer sales and service) agreement 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 store may sell vehicles and related products and perform certain approved services. The designation of such areas and the allocation of new vehicles among stores are at the discretion of the manufacturer. Franchise agreements do not guarantee exclusivity within a specified territory, but do have some protection under state laws.

A franchise agreement may impose requirements on the store with respect to:

    the showroom;
 
    service facilities and equipment;
 
    inventories of vehicles and parts;
 
    minimum working capital;
 
    training of personnel; and
 
    performance standards for sales volume and customer satisfaction.

Each manufacturer closely monitors compliance with these requirements and requires each store to submit monthly and annual financial statements. Franchise agreements also grant a store the right to use and display manufacturers’ trademarks, service marks and designs in the manner approved by each manufacturer.

Most franchise agreements are generally renewed after one to five years, and, in practice, have indefinite lives. Some franchise agreements, including those with DaimlerChrysler, have no termination date. Historically, all of our agreements have been renewed and we expect that manufacturers will continue to renew them in the future. In addition, state franchise laws limit the ability of manufacturers to terminate or fail to renew automotive franchises. Each franchise agreement authorizes at least one person to manage the store’s operations. The typical franchise agreement provides for early termination or non-renewal by the manufacturer upon:

    a change of management or ownership without manufacturer consent;
 
    insolvency or bankruptcy of the dealer;
 
    death or incapacity of the dealer/manager;
 
    conviction of a dealer/manager or owner of certain crimes;
 
    misrepresentation of certain information by the store, dealer/manager or owner to the manufacturer;
 
    failure to adequately operate the store;
 
    failure to maintain any license, permit or authorization required for the conduct of business; or
 
    poor sales performance or low customer satisfaction index scores.

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We sign master framework agreements with most manufacturers that impose additional requirements on our stores. See Exhibit 99.1 “Risk Factors” for further details.

Competition

The retail automotive business is highly competitive, consisting of a large number of independent operators, many of whom are individuals, families and small retail groups. We compete primarily with other automotive retailers, both publicly and privately-held, near our store locations. In addition, regional and national car rental companies operate retail used car lots to dispose of their used rental cars.

Vehicle manufacturers have designated specific marketing and sales areas within which only one dealer of a vehicle brand may operate. In addition, our franchise agreements typically limit our ability to acquire multiple dealerships of a given brand within a particular market area. Certain state franchise laws also restrict us from relocating our dealerships or establishing new dealerships of a particular brand within any area that is served by another dealer with the same brand. Accordingly, to the extent that a market has multiple dealers of a particular brand, as many of our key markets do, we are subject to significant intra-brand competition.

We are larger and have more financial resources than most private automotive retailers with which we currently compete in most of our regional markets. We compete directly with retailers like ourselves in our metropolitan markets like Denver, Colorado, Seattle, Washington and Concord, California. As we enter other markets, we may face competitors that are larger or have access to greater financial resources. We do not have any cost advantage in purchasing new vehicles from manufacturers. We rely on advertising and merchandising, sales expertise, service reputation and location of our stores to sell new vehicles.

In addition to competition for the sale of vehicles, we expect increased competition for the acquisition of other stores. We have faced only limited competition with respect to our acquisitions to date, primarily from privately-held automotive retailers. Other publicly-owned automotive retailers with significant capital resources may enter our current and targeted market areas in the future.

Regulation

Our business is subject to extensive regulation, supervision and licensing under federal, state and local laws, ordinances and regulations. State and federal regulatory agencies, such as the Department of Motor Vehicles, the Occupational Safety and Health Administration, the EEOC (Equal Employment Opportunity Commission) and the U.S. Environmental Protection Agency, have jurisdiction over the operation of our stores, service centers, collision repair shops and other operations. They regulate matters such as consumer protection, workers’ safety and air and water quality.

Laws also protect franchised automotive retailers from the unequal bargaining power held by the manufacturers. Under those laws, a manufacturer may not:

    terminate or fail to renew a franchise without good cause; or
 
    prevent any reasonable changes in the capital structure or financing of a store.

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

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Automotive retailers and manufacturers are also subject to laws to protect consumers, including so-called “Lemon Laws.” Most “Lemon Laws” require a manufacturer to replace a new vehicle or accept it for a full refund within a set time period after initial purchase if:

    the vehicle does not conform to the manufacturer’s express warranties; and
 
    the automotive retailer or manufacturer, after a reasonable number of attempts, is unable to correct or repair the defect.

We must provide written disclosures on new vehicles of mileage and pricing information. Financing and insurance activities are subject to credit reporting, debt collection, truth-in-lending and insurance industry regulation.

Our business, particularly parts, service and collision repair operations, involves hazardous or toxic substances or wastes, such as motor oil, waste motor oil and filters, transmission fluid, antifreeze, Freon, waste paint and lacquer thinner, batteries, solvents, lubricants, degreasing agents, gasoline and diesel fuels. Federal, state and local authorities establishing health and environmental quality standards regulate the handling, storage, treatment, recycling and disposal of hazardous substances and wastes and remediation of contaminated sites, both at our facilities and at sites to which we send hazardous or toxic substances or wastes for treatment, recycling or disposal. We are aware of contamination at certain of our current and former facilities, and we are in the process of conducting investigations and/or remediation at some of these properties. Based on our current information, any costs or liabilities relating to such contamination, other environmental matters or compliance with environmental regulations are not expected to have a material adverse effect on our results of operations or financial condition. There can be no assurances, however, that (i) additional environmental matters will not arise or that new conditions or facts will not develop in the future at our current or formerly owned or operated facilities, or at sites that we may acquire in the future, or that (ii) these matters, conditions or facts will not result in a material adverse effect on our results of operations or financial condition.

Employees

As of December 31, 2003, we employed approximately 5,130 persons on a full-time equivalent basis. Employees in the service and parts departments at our Dodge, Ford and Volkswagen stores in Concord, California are represented by union collective bargaining agreements. We believe we have good relationships with our employees.

Item 2. Properties

Our stores and other facilities consist primarily of automobile showrooms, display lots, service facilities, nineteen 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. We own some of our properties, but also lease many properties, providing future flexibility to relocate our retail stores as demographics change. Most leases give us the option to renew the lease for one or more lease extension periods. We also hold some undeveloped land for future expansion.

Item 3. Legal Proceedings

We are party to numerous legal proceedings arising in the normal course of our business. While we cannot predict with certainty the outcomes of these matters, we do not anticipate that the resolution of these proceedings will have a material adverse effect on our business, results of operations, financial condition, or cash flows.

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

No matters were submitted to a vote of our shareholders during the quarter ended December 31, 2003.

PART II

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

Our Class A common stock trades on the New York Stock Exchange under the symbol LAD. The following table presents the high and low sale prices for our Class A common stock, as reported on the New York Stock Exchange Composite Tape for each of the quarters in 2002 and 2003:

                 
    High
  Low
2002
               
Quarter 1
  $ 25.99     $ 17.40  
Quarter 2
    31.20       22.27  
Quarter 3
    26.60       16.42  
Quarter 4
    18.49       14.55  
2003
               
Quarter 1
  $ 16.05     $ 10.92  
Quarter 2
    17.35       10.81  
Quarter 3
    24.20       15.55  
Quarter 4
    25.95       19.75  

The number of shareholders of record and approximate number of beneficial holders of Class A common stock at February 27, 2004 was 1,389 and 3,900, respectively. All shares of Lithia’s Class B common stock are held by Lithia Holding Company LLC.

Our Board of Directors approved the following dividends on our Class A and Class B common stock in 2003:

                         
    Quarter   Payable to               Total
Month   dividend is   shareholders of       Amount   amount of
declared
  based on
  record on
  Date paid
  per share
  dividend
July 2003
  second   August 8, 2003   August 22, 2003   $ 0.07     $1.3 million
October 2003
  third   November 7, 2003   November 21, 2003   $ 0.07     $1.3 million

We currently intend to continue paying quarterly dividends similar to those paid in 2003. The payment of any dividends is subject to the discretion of our Board of Directors. Pursuant to our $200 million credit agreement with DaimlerChrysler Services, total dividends and repurchases of our common stock cannot exceed $18.0 million over the term of the agreement. To date, over the term of the agreement, we have paid dividends and repurchased stock totaling $2.8 million. This credit agreement expires February 2006.

Information regarding securities authorized for issuance under equity compensation plans is included in Item 12.

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Item 6. Selected Financial Data

You should read the Selected Financial Data in conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our Consolidated Financial Statements and Notes thereto and other financial information contained elsewhere in this Annual Report on Form 10-K.

                                         
    Year Ended December 31,
(In thousands, except per share amounts)   2003
  2002
  2001
  2000
  1999
Consolidated Statement of Operations Data:
                                       
Revenues:
                                       
New vehicles
  $ 1,441,000     $ 1,218,364     $ 926,981     $ 833,107     $ 615,617  
Used vehicles
    725,547       715,760       564,049       462,072       350,894  
Service, body and parts
    251,316       216,382       173,114       149,963       106,992  
Finance and insurance
    89,982       77,776       62,856       52,394       41,606  
Fleet and other
    5,657       43,114       40,593       57,491       26,265  
 
   
 
     
 
     
 
     
 
     
 
 
Total revenues
    2,513,502       2,271,396       1,767,593       1,555,027       1,141,374  
Cost of sales
    2,110,393       1,913,704       1,478,528       1,303,800       959,386  
 
   
 
     
 
     
 
     
 
     
 
 
Gross profit
    403,109       357,692       289,065       251,227       181,988  
Selling, general and administrative
    313,289       280,310       224,501       182,591       133,651  
Depreciation and amortization
    9,593       7,192       8,690       7,125       5,102  
 
   
 
     
 
     
 
     
 
     
 
 
Income from operations
    80,227       70,190       55,874       61,511       43,235  
Floorplan interest expense
    (13,997 )     (10,775 )     (13,652 )     (16,532 )     (10,212 )
Other interest expense
    (6,081 )     (5,985 )     (7,546 )     (7,629 )     (4,063 )
Other income (expense), net
    (951 )     (589 )     (298 )     803       201  
 
   
 
     
 
     
 
     
 
     
 
 
Income from continuing operations before income taxes
    59,198       52,841       34,378       38,153       29,161  
Income taxes
    (23,561 )     (20,480 )     (13,270 )     (14,690 )     (11,716 )
 
   
 
     
 
     
 
     
 
     
 
 
Income from continuing operations
    35,637       32,361       21,108       23,463       17,445  
Income (loss) from discontinued operations, net of tax
    (90 )     (45 )     646       850       1,729  
 
   
 
     
 
     
 
     
 
     
 
 
Net income
  $ 35,547     $ 32,316     $ 21,754     $ 24,313     $ 19,174  
 
   
 
     
 
     
 
     
 
     
 
 
Income per basic share from continuing operations
  $ 1.95     $ 1.88     $ 1.58     $ 1.72     $ 1.52  
Income (loss) per basic share from discontinued operations
    (0.01 )           0.05       0.06       0.15  
 
   
 
     
 
     
 
     
 
     
 
 
Basic net income per share
  $ 1.94     $ 1.88     $ 1.63     $ 1.78     $ 1.67  
 
   
 
     
 
     
 
     
 
     
 
 
Shares used in basic per share calculations
    18,289       17,233       13,371       13,652       11,506  
 
   
 
     
 
     
 
     
 
     
 
 
Income per diluted share from continuing operations
  $ 1.92     $ 1.84     $ 1.55     $ 1.70     $ 1.45  
Income per diluted share from discontinued operations
                0.05       0.06       0.15  
 
   
 
     
 
     
 
     
 
     
 
 
Diluted net income per share
  $ 1.92     $ 1.84     $ 1.60     $ 1.76     $ 1.60  
 
   
 
     
 
     
 
     
 
     
 
 
Shares used in diluted per share calculations
    18,546       17,598       13,612       13,804       11,998  
 
   
 
     
 
     
 
     
 
     
 
 
                                         
    As of December 31,
(In thousands)   2003
  2002
  2001
  2000
  1999
Consolidated Balance Sheet Data:
                                       
Working capital
  $ 160,066     $ 126,308     $ 104,834     $ 98,917     $ 74,999  
Inventories
    445,281       445,908       275,398       314,290       268,281  
Total assets
    1,102,782       942,049       662,944       628,003       506,433  
Flooring notes payable
    435,228       427,635       280,947       314,137       243,903  
Current maturities of long-term debt
    14,299       4,466       10,203       5,342       7,132  
Long-term debt, less current maturities
    178,467       104,712       95,830       72,586       38,411  
Total stockholders’ equity
    358,926       319,993       203,497       181,775       155,638  

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

You should read the following discussion in conjunction with Item 1. “Business,” our Consolidated Financial Statements and Notes thereto and Exhibit 99.1 “Risk Factors.”

Overview

Our auto-retail model is focused on acquiring average performing new vehicle franchised stores and then integrating and improving them. Our goal is to maximize the operations of all four departments of every store we acquire. We have had success with this strategy since our initial public offering in late 1996. While our strategy has not changed over the last seven years, our ability to integrate and improve the stores that we acquire has increased dramatically. We have also developed a better process for identifying acquisition targets that fit our operating model. Our cash position, substantial lines of credit, plus an extremely competent and well-trained staff are all available to facilitate our continued growth as the opportunities develop.

In keeping with this model, we acquired 11 stores with 23 franchises during 2003 with total estimated annual revenues of approximately $330 million.

During an economic downturn, customers tend to shift towards the purchase of more modestly priced new vehicle models or used vehicles. Many customers decide to delay purchasing a new vehicle and instead repair existing vehicles. In addition, manufacturers typically offer increased dealer and customer incentives during an economic downturn in order to support new vehicle sales volume. These factors generally lead to less volatility in earnings for automobile retailers than for automobile manufacturers.

Historically, new vehicle sales have accounted for approximately 50% of our total revenues but less than 30% of total gross profit. In 2003, we continued with a volume-based strategy in new vehicle sales that we initiated in 2002. Through an advertising campaign called “Driving America” that is centered on “Promo Pricing,” we were able to gain new vehicle market share in many of our markets. This strategy complemented the approach taken by the auto manufacturers, which had continued to offer a high level of customer incentives.

In 2004, we expect that manufacturers will continue to incentivize new vehicle sales through a combination of rebates and low interest rate loans to consumers. We plan to continue with our volume-based new vehicle strategy in most of the markets where we operate. As the economy and the incentive environment change, we will adjust our new vehicle sales strategy accordingly to take advantage of any new conditions.

Industry-wide used vehicle sales continued to experience substantial weakness throughout all of 2003. The competition from highly incentivized new vehicles with low interest rate financing and high rebates had a strong negative impact on the used vehicle market. The industry also experienced a large number of lease-returns that negatively impacted used vehicle pricing throughout the year.

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Results of Continuing Operations

Certain revenue, gross margin and gross profit information by product line was as follows for 2003 and 2002:

                         
    Percent of   Gross   Percent of Total
2003
  Total Revenues
  Margin
  Gross Profit
New vehicles
    57.3 %     7.7 %     27.4 %
Retail used vehicles(1)
    24.0       13.8       20.7  
Service, body and parts
    10.0       47.2       29.4  
Finance and insurance(2)
    3.6       99.7       22.3  
Fleet and other
    0.2       19.1       0.3  


(1)   Excludes wholesale used vehicle sales, representing 4.9% of total revenues, and a negative gross margin contribution of 0.1%.
 
(2)   Reported net of anticipated cancellations.
                         
    Percent of   Gross   Percent of Total
2002
  Total Revenues
  Margin
  Gross Profit
New vehicles
    53.6 %     8.5 %     28.9 %
Retail used vehicles(1)
    26.2       12.5       20.7  
Service, body and parts
    9.5       48.0       29.1  
Finance and insurance(2)
    3.4       99.4       21.6  
Fleet and other
    1.9       2.1       0.3  


(1)   Excludes wholesale used vehicle sales, representing 5.4% of total revenues, and a negative gross margin contribution of 0.6%.
 
(2)   Reported net of anticipated cancellations.
                         
    Percent of   Gross   Percent of Total
2001
  Total Revenues
  Margin
  Gross Profit
New vehicles
    52.4 %     9.1 %     29.1 %
Retail used vehicles(1)
    27.2       13.1       21.9  
Service, body and parts
    9.8       46.6       27.9  
Finance and insurance(2)
    3.6       98.8       21.5  
Fleet and other
    2.3       2.8       0.4  


(1)   Excludes wholesale used vehicle sales, representing 4.7% of total revenues, and a negative gross margin contribution of 0.8%.
 
(2)   Reported net of anticipated cancellations.

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

                         
    Year Ended December 31,
Lithia Motors, Inc. (1)
  2003
  2002
  2001
Revenues:
                       
New vehicles
    57.3 %     53.6 %     52.4 %
Used vehicles
    28.9       31.6       31.9  
Service, body and parts
    10.0       9.5       9.8  
Finance and insurance
    3.6       3.4       3.6  
Fleet and other
    0.2       1.9       2.3  
 
   
 
     
 
     
 
 
Total revenues
    100.0 %     100.0 %     100.0 %
Gross profit
    16.0       15.7       16.4  
Selling, general and administrative expenses
    12.5       12.3       12.7  
Depreciation and amortization
    0.4       0.3       0.5  
Income from operations
    3.2       3.1       3.2  
Floorplan interest expense
    0.6       0.5       0.8  
Other interest expense
    0.2       0.3       0.4  
Other expense, net
    0.0       0.0       0.0  
Income from continuing operations before taxes
    2.4       2.3       1.9  
Income tax expense
    0.9       0.9       0.8  
Income from continuing operations
    1.4       1.4       1.2  


(1) The percentages may not add due to rounding.

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The following tables set forth the changes in our operating results from continuing operations in 2003 compared to 2002 and in 2002 compared to 2001:

                                 
    Year Ended            
    December 31,
  Increase   %
Increase
    2003
  2002
  (Decrease)
  (Decrease)
Revenues:
                               
New vehicle sales
  $ 1,441,000     $ 1,218,364     $ 222,636       18.3 %
Used vehicle sales
    725,547       715,760       9,787       1.4  
Service, body and parts
    251,316       216,382       34,934       16.1  
Finance and insurance
    89,982       77,776       12,206       15.7  
Fleet and other
    5,657       43,114       (37,457 )     (86.9 )
 
   
 
     
 
     
 
     
 
 
Total revenues
    2,513,502       2,271,396       242,106       10.7  
Cost of sales
    2,110,393       1,913,704       196,689       10.3  
 
   
 
     
 
     
 
     
 
 
Gross profit
    403,109       357,692       45,417       12.7  
Selling, general and administrative
    313,289       280,310       32,979       11.8  
Depreciation and amortization
    9,593       7,192       2,401       33.4  
 
   
 
     
 
     
 
     
 
 
Income from operations
    80,227       70,190       10,037       14.3  
Floorplan interest expense
    (13,997 )     (10,775 )     (3,222 )     29.9  
Other interest expense
    (6,081 )     (5,985 )     (96 )     1.6  
Other expense, net
    (951 )     (589 )     (362 )     61.5  
 
   
 
     
 
     
 
     
 
 
Income from continuing operations before income taxes
    59,198       52,841       6,357       12.0  
Income tax expense
    23,561       20,480       3,081       15.0  
 
   
 
     
 
     
 
     
 
 
Income from continuing operations
  $ 35,637     $ 32,361     $ 3,276       10.1 %
 
   
 
     
 
     
 
     
 
 
                                 
    Year Ended            
    December 31,
  Increase   %
Increase
    2003
  2002
  (Decrease)
  (Decrease)
New units sold
    53,804       46,929       6,875       14.7 %
Average selling price per new vehicle
  $ 26,782     $ 25,962     $ 820       3.2 %
Used units sold – retail
    41,451       40,781       670       1.6 %
Average selling price per retail used vehicle
  $ 14,550     $ 14,572     $ (22 )     (0.2 )%
Used units sold – wholesale
    25,982       24,475       1,507       6.2 %
Average selling price per wholesale used vehicle
  $ 4,713     $ 4,964     $ (251 )     (5.1 )%
Finance and insurance sales per retail unit
  $ 945     $ 887     $ 58       6.5 %
                                 
    Year Ended            
    December 31,
  Increase   %
Increase
    2002
  2001
  (Decrease)
  (Decrease)
Revenues:
                               
New vehicle sales
  $ 1,218,364     $ 926,981     $ 291,383       31.4 %
Used vehicle sales
    715,760       564,049       151,711       26.9  
Service, body and parts
    216,382       173,114       43,268       25.0  
Finance and insurance
    77,776       62,856       14,920       23.7  
Fleet and other
    43,114       40,593       2,521       6.2  
 
   
 
     
 
     
 
     
 
 
Total revenues
    2,271,396       1,767,593       503,803       28.5  
Cost of sales
    1,913,704       1,478,528       435,176       29.4  
 
   
 
     
 
     
 
     
 
 
Gross profit
    357,692       289,065       68,627       23.7  
Selling, general and administrative
    280,310       224,501       55,809       24.9  
Depreciation and amortization
    7,192       8,690       (1,498 )     (17.2 )
 
   
 
     
 
     
 
     
 
 
Income from operations
    70,190       55,874       14,316       25.6  
Floorplan interest expense
    (10,775 )     (13,652 )     2,877       (21.1 )
Other interest expense
    (5,985 )     (7,546 )     1,561       (20.7 )
Other expense, net
    (589 )     (298 )     (291 )     97.7  
 
   
 
     
 
     
 
     
 
 
Income from continuing operations before income taxes
    52,841       34,378       18,463       53.7  
Income tax expense
    20,480       13,270       7,210       54.3  
 
   
 
     
 
     
 
     
 
 
Income from continuing operations
  $ 32,361     $ 21,108     $ 11,253       53.3 %
 
   
 
     
 
     
 
     
 
 

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    Year Ended            
    December 31,
  Increase   %
Increase
    2002
  2001
  (Decrease)
  (Decrease)
New units sold
    46,929       37,190       9,739       26.2 %
Average selling price per new vehicle
  $ 25,962     $ 24,926     $ 1,036       4.2 %
Used units sold – retail
    40,781       35,845       4,936       13.8 %
Average selling price per retail used vehicle
  $ 14,572     $ 13,415     $ 1,157       8.6 %
Used units sold – wholesale
    24,475       18,081       6,394       35.4 %
Average selling price per wholesale used vehicle
  $ 4,964     $ 4,602     $ 362       7.9 %
Finance and insurance sales per retail unit
  $ 887     $ 861     $ 26       3.0 %

Revenues

Total revenues increased 10.7% in 2003 compared to 2002 as a result of acquisitions and 1.2% growth in same store retail sales. Same store sales percentage increases (decreases) were as follows:

                 
    2003 vs. 2002
  2002 vs. 2001
New vehicles
    6.2 %     6.1 %
Retail used vehicles
    (9.3 )     (7.6 )
Service, body and parts
    0.7       (1.0 )
Finance and insurance
    5.1       0.2  
Total retail sales
    1.2       1.1  

Same store sales are calculated by dealership comparing only those months that contain full-month operating data.

The automotive retailing industry reported declines in new vehicle sales of approximately 1.0% in 2003 compared to 2002 and 2% in 2002 compared to 2001. The industry has reported an approximately 3.4% decrease in sales of domestic brands in 2003 compared to 2002, while we achieved a 6.8% same store increase in sales of our domestic brands, which represented 71.4% of our total new vehicle sales in 2003. Our same-store Chrysler sales, which represents our largest brand, have increased approximately 7.2% in the same period. We have same-store sales increases in 2003 compared to 2002 for all domestic brands, which is counter to national trends. We are able to generate positive sales trends that run contrary to industry and specific brand trends due to our operating model that is focused on increasing market share through the use of promotional pricing at our stores. Additionally, we believe that the market dynamics of smaller, non-metropolitan, western markets support more stable domestic truck and SUV sales.

Slowing economies in our markets and higher than normal new vehicle inventories at the end of 2002, coupled with a strong new vehicle incentive environment, spurred our aggressive approach to new vehicle sales in 2003. During both 2003 and 2002, we utilized an aggressive company-wide marketing campaign based on the “Driving America” theme that is aimed at increasing market share by competitively pricing new vehicles in order to secure a long-term customer base for future parts and service business and repeat and referral business. The increases in new vehicle sales also led to increases in same-store finance and insurance sales, as we have been able to maintain our high penetration rate for such sales.

The industry used vehicle business was weak in 2003 and 2002 due to competition from highly incentivized new vehicles within the overall weaker total vehicle market. Our used vehicle gross profit demonstrated improvement throughout 2003, achieving retail used vehicle gross margins of 13.0%, 13.9%, 14.6% and 13.6%, respectively, in the first through fourth quarters of 2003. The improvements in used vehicle margins in 2003 more than offset the declines in same-store sales resulting in positive same-store gross profit growth for 2003 compared to 2002.

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The service and parts business has been negatively impacted in the past couple of years by substantial improvements in the quality of domestic vehicles, resulting in less warranty work, offset in part by increases in the customer-pay portion of the business. However, in the second half of 2003, we saw positive trends with the decline in domestic warranty repairs slowing in comparison to declines in previous quarters and customer-pay service and parts growth increasing 4.1% in 2003, on a same store basis, compared to 2002.

Fleet and other sales include both fleet sales and fees received for delivering vehicles on behalf of the manufacturer, the U.S. military, rent-a-car companies or leasing companies. In 2003 we decided to deemphasize fleet sales due to their low margins. This has resulted in a decrease in total fleet and other sales, but an increase in the gross margin percentage due to a higher percentage of fee income compared to fleet income.

Penetration rates for certain products were as follows:

                         
    2003   2002   2001
   
 
 
Finance and insurance
    75 %     75 %     75 %
Service contracts
    41       40       39  
Lifetime oil change and filter
    34       30       29  

During 2003 and 2002, manufacturers offered, and are continuing to offer, incentives, including low interest rates and rebates, in order to attract new vehicle buyers. The availability of cash rebates and zero percent and low interest rate financing have enhanced our ability to sell finance, warranty and insurance products and services in both 2003 and 2002.

Gross Profit

Gross profit increased $45.4 million in 2003 compared to 2002 and increased $68.6 million in 2002 compared to 2001 due primarily to increased total revenues. Gross margins achieved were as follows:

                         
    Year Ended December 31,        
   
  Lithia
    2003   2002   Margin Change*
   
 
 
New vehicles
    7.7 %     8.5 %     (80 )bp
Retail used vehicles
    13.8       12.5       130  
Service and parts
    47.2       48.0       (80 )
Finance and insurance
    99.7       99.4       30  
Overall
    16.0       15.7       30  
                         
    Year Ended December 31,        
   
  Lithia
    2002   2001   Margin Change*
   
 
 
New vehicles
    8.5 %     9.1 %     (60 )bp
Retail used vehicles
    12.5       13.1       (60 )
Service and parts
    48.0       46.6       140  
Finance and insurance
    99.4       98.8       60  
Overall
    15.7       16.4       (70 )


*   “bp” stands for basis points (one hundred basis points equals one percent).

Our overall gross margin increased in 2003 compared to 2002 due primarily to increases in margins achieved on used vehicle sales as a result of selling older aged vehicles which carry a higher margin and improved inventory management. These increases in the used vehicle gross margin also contributed to a same store increase in total gross profit dollars per used vehicle sold.

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The improvements in our gross margin in 2003 were offset by the following factors:

    A significant shift towards our lowest margin new vehicle business as a result of the strong incentive environment;
 
    Lower floorplan interest credits from the manufacturers on new vehicles due to lower market rates; and
 
    Aggressive pricing of new vehicles in order to gain market share, which resulted in lower new vehicle margins.

The decrease in the overall gross margin in 2002 compared to 2001 was primarily a result of four factors:

    A significant shift towards our lowest margin new vehicle business with the strong incentive environment;
 
    Lower floorplan interest credits from the manufacturers on new vehicles due to lower market rates;
 
    Aggressive pricing of new vehicles in order to gain market share, which resulted in lower new vehicle margins; and
 
    A mix shift in used vehicle sales to the lower margin, one to three-year old vehicles, which have lower margins than the older used vehicles.

These factors were partially offset by an increase in the gross margin achieved in our parts and service business in 2002 compared to 2001.

Selling, General and Administrative Expense

Selling, general and administrative expense includes salaries and related personnel expenses, facility lease expense, advertising (net of manufacturer cooperative advertising credits), legal, accounting, professional services and general corporate expenses. Selling, general and administrative expense increased $33.0 million in 2003 compared to 2002 and increased $55.8 million in 2002 compared to 2001 due to increased selling, or variable, expenses related to the increase in revenues and the number of locations. The increase as a percentage of revenue in 2003 compared to 2002 is due partially to higher advertising and sales compensation expenses related to our aggressive new vehicle marketing. The decrease as a percentage of revenue in 2002 compared to 2001 was due to expense leverage on higher sales.

Depreciation and Amortization

Depreciation and amortization increased $2.4 million in 2003 due to the addition of property and equipment primarily related to our acquisitions. Depreciation and amortization expense decreased $1.5 million in 2002 compared to 2001 primarily as a result of the adoption of SFAS No. 142 “Goodwill and Other Intangible Assets” in the first quarter of 2002, offset by additions to property and equipment primarily related to acquisitions. SFAS No. 142 requires that goodwill and other intangibles with indefinite useful lives no longer be amortized. Goodwill and other intangibles amortization expense totaled $3.6 million in 2001.

Income from Operations

Operating margins improved by 10 basis points to 3.2% in 2003 from 3.1% in 2002. The increase is due to the improved overall gross profit margin as discussed above, partially offset by higher operating expenses as a percentage of revenue. Operating margins decreased 10 basis points in 2002 compared to 2001 due to the decrease in the overall gross margin percentage, offset in part by lower operating expenses as a percentage of revenue.

Floorplan Interest Expense

The $3.2 million increase in floorplan interest expense in 2003 compared to 2002 is primarily due to an approximately $2.8 million increase in expense as a result of an increase in the average outstanding balances of our floorplan facilities, mainly due to acquisitions. In addition, increased

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expense from interest rate swaps was responsible for $1.1 million of the increase. These increases were offset in part by a decrease in the LIBOR and the prime rates in 2003 compared to 2002.

The decrease in floorplan interest expense in 2002 compared to 2001 was primarily due to approximately $8.4 million in savings as a result of decreases in the effective interest rate on the floating rate credit lines, offset in part by a $4.1 million increase in expense as a result of an overall average increase in the outstanding balances of our floorplan facilities, mainly due to acquisitions. In addition to the interest expense on our flooring lines of credit, floorplan interest expense includes the interest expense related to our interest rate swaps.

Other Interest Expense

Other interest expense includes interest on debt incurred related to acquisitions, real estate mortgages, our used vehicle line of credit and equipment related notes. Changes in the weighted average interest rate on our debt in 2003 compared to 2002 decreased other interest expense by $259,000. Changes in the average outstanding balances in 2003 compared to 2002 resulted in increases to other interest expense of $355,000.

The $1.6 million decrease in other interest expense in 2002 compared to 2001 resulted from $3.2 million of savings due to lower interest rates in 2002 compared to 2001 and approximately $3.0 million in savings due to the pay-down of $78.0 million on our lines of credit in March 2002, following our equity offering. These decreases were offset in part by less capitalized interest on construction projects in progress in 2002 compared to 2001 and by an increase in the outstanding balances due to acquisitions and the financing of previously unfinanced real estate during 2002. The lower interest rates in 2002 are due in part to the refinancing of $15.2 million of fixed interest rate mortgage loans since November 2001, utilizing floating rate loans with Toyota Motor Credit and Ford Motor Credit.

Income Tax Expense

Our effective tax rate was 39.8% in 2003 compared to 38.8% in 2002 and 38.6% in 2001. Our effective tax rate may be affected in the future by the mix of asset acquisitions compared to corporate acquisitions, as well as by the mix of states where our stores are located.

Income from Continuing Operations

Income from continuing operations as a percentage of revenue remained flat in 2003 compared to 2002 as a result of improvements in gross margins being offset by increased operating expenses.

Net Income

Net income as a percentage of revenue increased 20 basis points in 2002 compared to 2001 as a result of increased revenues and lower operating expenses and interest expense, offset by a lower gross margin percentage.

Discontinued Operations

During 2003, we decided to sell certain of our stores and related franchises. We recognized a net gain on the sale of one of our stores classified as discontinued operations totaling $374,000, net of tax, in 2003, which is netted with loss from discontinued operations on our consolidated statement of operations. At December 31, 2003, we had $20.4 million of assets classified as assets held for sale on our balance sheet related to one store we intend to sell during 2004. The assets primarily include inventory and property, plant and equipment. We did not recognize any gain or loss on disposal of discontinued operations during 2002 or 2001.

We continually monitor the performance of each of our stores and make determinations to sell based on return on capital criteria.

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Selected Consolidated Quarterly Financial Data

The following tables set forth our unaudited quarterly financial data for the quarterly periods presented.

                                     
        Three Months Ended,
       
        March 31   June 30   September 30   December 31
       
 
 
 
        (in thousands, except per share data)
2003
                               
Revenues:
                               
 
New vehicle sales
  $ 308,494     $ 363,845     $ 411,358     $ 357,303  
 
Used vehicle sales
    172,096       191,092       196,280       166,079  
 
Service, body and parts
    56,485       61,032       67,849       65,950  
 
Finance and insurance
    20,410       22,478       25,071       22,023  
 
Fleet and other
    2,075       1,865       882       835  
 
   
     
     
     
 
   
Total revenues
    559,560       640,312       701,440       612,190  
Cost of sales
    471,073       538,573       588,636       512,111  
 
   
     
     
     
 
Gross profit
    88,487       101,739       112,804       100,079  
Selling, general and administrative
    74,229       79,585       83,904       75,571  
Depreciation and amortization
    2,131       2,254       2,504       2,704  
 
   
     
     
     
 
Income from operations
    12,127       19,900       26,396       21,804  
Flooring interest expense
    (3,546 )     (3,672 )     (3,324 )     (3,455 )
Other interest expense
    (1,388 )     (1,564 )     (1,496 )     (1,633 )
Other, net
    (147 )     (255 )     (243 )     (306 )
 
   
     
     
     
 
Income from continuing operations before income taxes
    7,046       14,409       21,333       16,410  
Income taxes
    (2,731 )     (5,808 )     (8,491 )     (6,531 )
 
   
     
     
     
 
Income before discontinued operations
    4,315       8,601       12,842       9,879  
Discontinued operations, net of tax
    (150 )     (82 )     39       103  
 
   
     
     
     
 
Net income
  $ 4,165     $ 8,519     $ 12,881     $ 9,982  
 
   
     
     
     
 
Basic income per share from continuing operations
  $ 0.24     $ 0.47     $ 0.70     $ 0.54  
Basic income (loss) per share from discontinued operations
    (0.01 )     0.00       0.00       0.00  
 
   
     
     
     
 
Basic net income per share
  $ 0.23     $ 0.47     $ 0.70     $ 0.54  
 
   
     
     
     
 
Diluted income per share from continuing operations
  $ 0.24     $ 0.47     $ 0.69     $ 0.52  
Diluted income (loss) per share from discontinued operations
    (0.01 )     (0.01 )     0.00       0.01  
 
   
     
     
     
 
Diluted net income per share
  $ 0.23     $ 0.46     $ 0.69     $ 0.53  
 
   
     
     
     
 
                                     
        Three Months Ended,
       
        March 31   June 30   September 30   December 31
       
 
 
 
        (in thousands except per share data )
2002
                               
Revenues:
                               
 
New vehicle sales
  $ 252,043     $ 284,264     $ 370,158     $ 311,899  
 
Used vehicle sales
    176,981       180,697       193,565       164,517  
 
Service, body and parts
    48,413       51,670       59,631       56,668  
 
Finance and insurance
    17,006       19,383       21,166       20,221  
 
Fleet and other
    3,399       22,808       12,904       4,003  
 
   
     
     
     
 
   
Total revenues
    497,842       558,822       657,424       557,308  
Cost of sales
    418,742       470,253       557,309       467,400  
 
   
     
     
     
 
Gross profit
    79,100       88,569       100,115       89,908  
Selling, general and administrative
    64,100       69,571       75,795       70,844  
Depreciation and amortization
    1,553       1,697       1,892       2,050  
 
   
     
     
     
 
Income from operations
    13,447       17,301       22,428       17,014  
Flooring interest expense
    (2,244 )     (2,763 )     (2,813 )     (2,955 )
Other interest expense
    (1,559 )     (1,436 )     (1,542 )     (1,448 )
Other, net
    121       (161 )     (216 )     (333 )
 
   
     
     
     
 
Income from continuing operations before income taxes
    9,765       12,941       17,857       12,278  
Income taxes
    (3,769 )     (4,996 )     (6,956 )     (4,759 )
 
   
     
     
     
 
Income before discontinued operations
    5,996       7,945       10,901       7,519  
Discontinued operations, net of tax
    395       (10 )     (172 )     (258 )
 
   
     
     
     
 
Net income
  $ 6,391     $ 7,935     $ 10,729     $ 7,261  
 
   
     
     
     
 
Basic income per share from continuing operations
  $ 0.40     $ 0.44     $ 0.61     $ 0.42  
Basic income (loss) per share from discontinued operations
    0.03       0.00       (0.01 )     (0.02 )
 
   
     
     
     
 
Basic net income per share
  $ 0.43     $ 0.44     $ 0.60     $ 0.40  
 
   
     
     
     
 
Diluted income per share from continuing operations
  $ 0.39     $ 0.43     $ 0.60     $ 0.41  
Diluted income (loss) per share from discontinued operations
    0.03       0.00       (0.01 )     (0.01 )
 
   
     
     
     
 
Diluted net income per share
  $ 0.42     $ 0.43     $ 0.59     $ 0.40  
 
   
     
     
     
 

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Seasonality and Quarterly Fluctuations

Historically, our sales have been lower in the first and fourth quarters of each year 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. We believe that interest rates, levels of consumer debt and consumer confidence, as well as general economic conditions, also contribute to fluctuations in sales and operating results. Historically, the timing, performance and frequency of acquisitions have been the largest contributor to fluctuations in our operating results from quarter to quarter.

Liquidity and Capital Resources

Our principal needs for capital resources are to finance acquisitions and capital expenditures, as well as for working capital. We have relied primarily upon internally generated cash flows from operations, borrowings under our credit agreements and the proceeds from public equity offerings to finance operations and expansion. We believe that our available cash, cash equivalents, available lines of credit and cash flows from operations will be sufficient to meet our anticipated operating expenses and capital requirements for at least twelve months from December 31, 2003.

Our free cash flow in 2003, defined as net income plus depreciation minus dividends and maintenance (unfinanceable) capital expenditures was approximately $31.9 million. In 2002 and 2001, free cash flow was $33.8 million and $26.0 million, respectively. The reconciliation of net income to free cash flow is as follows (in thousands):

                           
Year Ended December 31,   2003   2002   2001

 
 
 
Net income
  $ 35,547     $ 32,316     $ 21,754  
Depreciation
    9,593       7,192       8,690  
Dividends
    (2,575 )            
Maintenance capital expenditures
    (10,678 )     (5,691 )     (4,439 )
 
   
     
     
 
 
Free cash flow
  $ 31,887     $ 33,817     $ 26,005  
 
   
     
     
 

Our inventories decreased slightly to $445.3 million at December 31, 2003 from $445.9 million at December 31, 2002 due primarily to efficiencies gained from the implementation of our new centralized inventory control process, offset by acquisitions. Our new and used flooring notes payable increased to $435.2 million at December 31, 2003 from $427.6 million at December 31, 2002 due to a higher percentage of used vehicles being financed as well as an increase in new vehicle inventory and a decrease in used vehicle inventory. New vehicles are financed at approximately 100% and used vehicles are financed at approximately 80%. Our days supply of new vehicles decreased by approximately 5 days at December 31, 2003 compared to December 31, 2002. Our days supply of used vehicles also decreased by approximately 5 days at December 31, 2003 compared to December 31, 2002. Our used vehicle inventories are at lowest levels for this time of year compared to the last five years. We believe that our new and used vehicle inventories are at appropriate levels at this time.

Assets of discontinued operations held for sale include inventory and property, plant and equipment related to one store held for sale and are recorded on our balance sheet at the lower of book value or estimated fair market value, less applicable selling costs.

Primarily as a result of the acquisition of eleven stores in 2003, our goodwill and other intangibles increased $29.8 million to $236.0 million at December 31, 2003 compared to $206.2 million at December 31, 2002.

In 2003, our Board of Directors approved dividends on our Class A and Class B common stock of $0.07 per share for both the second and third quarters of 2003. The dividends totaled $2.6 million. In February 2004, our Board of Directors approved a dividend on our Class A and Class B common stock

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of $0.07 per share for the fourth quarter of 2003, which will total approximately $1.3 million. We anticipate recommending to the Board of Directors the approval of a cash dividend each quarter.

In June 2000, our Board of Directors authorized the repurchase of up to 1,000,000 shares of our Class A common stock. Through October 2003, we have purchased a total of 59,400 shares under this program and may continue to do so from time to time in the future as conditions warrant. However, the recent change in the tax law tends to equalize the benefits of dividends and share repurchases as a means to return capital or earnings to shareholders. As a result, we believe it is now advantageous to shareholders to have a dividend in place. With the dividend, we are able to offer an immediate and tangible return to our shareholders without reducing our already limited market float, which occurs when we repurchase shares.

In February 2003 we entered into a working capital and used vehicle flooring credit facility with DaimlerChrysler Services North America LLC totaling up to $200 million, which expires in February 2006, with interest due monthly. In December 2003, Toyota Motor Credit joined DaimlerChrysler in syndication on this credit facility. None of the terms of the credit facility were changed.

The credit line with DaimlerChrysler Services is cross-collateralized and secured by cash and cash equivalents, new and used vehicles that are not specifically financed by other lenders, parts inventories, accounts receivable, intangible assets and equipment. We pledged to DaimlerChrysler Services the stock of all of our subsidiaries except entities operating BMW, Honda, Nissan or Toyota stores.

The financial covenants in our agreement with DaimlerChrysler Services require us to maintain compliance with, among other things, (i) a specified current ratio; (ii) a specified fixed charge coverage ratio; (iii) a specified interest coverage ratio; (iv) a specified adjusted leverage ratio; and (v) certain working capital levels. At December 31, 2003, we were in compliance with all of the covenants of this agreement.

Toyota Motor Credit Corporation, Ford Motor Credit and General Motors Acceptance Corporation have agreed to floor all of our new vehicles for their respective brands with DaimlerChrysler Services and Toyota Motor Credit Corporation serving as the primary lenders for substantially all other brands. These new vehicle lines are secured by new vehicle inventory of the relevant brands.

We also have a real estate line of revolving credit with Toyota Motor Credit totaling $40 million, which expires in May 2005. This line of credit is secured by the real estate financed under this line of credit.

In February 2004, our U.S. Bank N.A. credit facility agreement was amended to provide for a $50.0 million revolving line of credit for leased vehicles and equipment purchases, which expires January 31, 2006. Previously, the amount available under this line of credit was $35.0 million and it was set to expire January 31, 2005.

Interest rates on all of the above facilities ranged from 2.62% to 3.87% at December 31, 2003. Amounts outstanding on the lines at December 31, 2003 together with amounts remaining available under such lines were as follows (in thousands):

                 
    Outstanding at   Remaining Availability as
    December 31, 2003   of December 31, 2003
   
 
New and program vehicle lines
  $ 378,961     $   *
Working capital and used vehicle line
    117,000       83,000 **
Real estate line
    9,018       30,982  
Equipment/leased vehicle line
    35,000        
 
   
     
 
 
  $ 539,979     $ 113,982 *
 
   
     
 


*   There are no formal limits on the new and program vehicle lines with certain lenders.
 
**   As limited by the terms of the line regarding the borrowing base.

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Contractual Payment Obligations

A summary of our contractual commitments and obligations as of December 31, 2003 is as follows (in thousands):

                                         
    Payments Due By Period
   
Contractual                   2005 and   2007 and   2009 and
Obligation   Total   2004   2006   2008   beyond

 
 
 
 
 
Floorplan Notes
  $ 435,228     $ 378,961     $ 56,267     $     $  
Lines of Credit and Long-Term Debt
    192,766       14,299       105,097       46,719       26,651  
Capital Commitments
    5,244       5,244                    
Operating Leases
    147,150       19,975       38,031       34,360       54,784  
 
   
     
     
     
     
 
 
  $ 780,388     $ 418,479     $ 199,395     $ 81,079     $ 81,435  
 
   
     
     
     
     
 

Our capital commitments of $5.2 million at December 31, 2003 were for the construction of one new store facility and additions to three existing facilities and the remodel of four facilities. The new facility will be a Hyundai store in Anchorage, Alaska. We have already incurred $7.5 million for these projects. We expect to pay for the construction out of existing cash balances until completion of the projects, at which time we anticipate securing long-term financing and general borrowings from third party lenders for 70% to 90% of the amounts expended.

In addition, we have recorded a reserve for our estimated contractual obligations related to potential charge-backs for vehicle service contracts and lifetime oil change contracts that are terminated early by the customer. At December 31, 2003, this reserve totaled $9.8 million. Based on past experience, we estimate that the $9.8 million will be paid out as follows: $5.5 million in 2004; $2.6 million in 2005; $1.1 million in 2006; $0.4 million in 2007; and $0.2 million thereafter.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires us to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and reported amounts of revenues and expenses at the date of the financial statements. Some of our accounting policies require us to make difficult and subjective judgments on matters that are inherently uncertain. The following accounting policies involve critical accounting estimates because they are particularly dependent on assumptions made by management. While we have made our best estimates based on facts and circumstances available to us at the time, different estimates could have been used in the current period. Changes in the accounting estimates we used are reasonably likely to occur from period to period, which may have a material impact on the presentation of our financial condition and results of operations.

Our most critical accounting estimates include service contract and lifetime oil contract income recognition, finance fee income recognition, workers’ compensation insurance premium accrual, assessment of recoverability of goodwill and other intangible assets, and used vehicle inventory valuations. We also have other key accounting policies, such as our policies for valuation of accounts receivable, expense accruals and other revenue recognition. However, these policies either do not meet the definition of critical accounting estimates described above or are not currently material items in our financial statements. We review our estimates, judgments and assumptions periodically and reflect the effects of revisions in the period that they are deemed to be necessary. We believe that these estimates are reasonable. However, actual results could differ from these estimates.

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Service Contract and Lifetime Oil Change Contract Income Recognition

We receive fees from the sale of vehicle service contracts and lifetime oil contracts to customers. The contracts are sold through an unrelated third party, but we may be charged back for a portion of the fees in the event of early termination of the contracts by customers. We have established a reserve for estimated future charge-backs based on an analysis of historical charge-backs in conjunction with termination provisions of the applicable contracts. At December 31, 2003 and 2002, this reserve totaled $9.8 million and $9.3 million, respectively, and is included in accrued liabilities and other long-term liabilities on our consolidated balance sheets. We may also participate in future underwriting profit, pursuant to retrospective commission arrangements, that would be recognized as income upon receipt.

Finance Fee Income Recognition

We receive finance fees from various financial institutions when we arrange financing for our customers on a non-recourse basis. We may be charged back for a portion of the financing fee income when the customer pays off their loan prior to the guidelines agreed to by the various financial institutions. We have established a reserve for potential net charge-backs and cancellations based on historical experience, which typically result if the customer pays off their loan during the 90 to 180 days after receiving financing. At December 31, 2003 and 2002, this reserve totaled $403,000 and $448,000, respectively, and is included in accrued liabilities on our consolidated balance sheets.

Workers’ Compensation Insurance Premium Accrual

Insurance premiums are paid for under a retrospective cost policy, whereby premium cost depends on experience. We accrue premiums based on our historical experience rating, although the actual experience can be something greater or less than the anticipated claims experience. We expect that the retrospective cost policy, as opposed to a guaranteed cost with a flat premium, will be the most cost efficient over time.

Intangible Assets

We review our goodwill and other identifiable intangible assets for impairment at least annually by applying a fair-value based test using discounted estimated cash flows. Discounted future cash flows are prepared by applying a growth rate to historical revenues. Growth rates are calculated individually for each region with data derived from the U.S. Census Bureau on population growth and the U.S. Department of Labor, Bureau of Labor Statistics for historical consumer price index data. The discount rate applied to the future cash flows is derived from a Capital Asset Pricing Model which factors in an equity risk premium and a risk free rate. The review is conducted more frequently than annually if events or circumstances occur that warrant a review. Our other identifiable intangible assets primarily include the franchise value of the business units, which is considered to have an indefinite life and not subject to amortization, but rather is included in the fair-value based testing. Impairment could occur if the operating business unit does not meet the determined fair-value testing. At such point, an impairment loss would be recognized to the extent that the carrying amount exceeds the assets’ fair value. During 2003 and 2002, we concluded that there was no impairment. At December 31, 2003 and 2002, goodwill and other identifiable intangible assets totaled $236.0 million and $206.2 million, respectively.

Used Vehicle Inventory

Used vehicle inventories are stated at cost plus the cost of any equipment added, reconditioning and transportation. We select a sampling of dealerships throughout the year to perform quarterly testing of book values against market valuations utilizing the Kelly Blue Book and NADA guidelines. Used vehicle inventory values are cyclical and could experience impairment when market valuations are significantly below inventory costs. Historically, we have not experienced significant write-downs on our used vehicle inventory.

Recent Accounting Pronouncements

See Note 17 of Notes to Consolidated Financial Statements.

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Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Variable Rate Debt

We use variable-rate debt to finance our new and program vehicle inventory and certain real estate holdings. The interest rates on our variable rate debt are tied to either the one or three-month LIBOR or the prime rate. These debt obligations therefore expose us to variability in interest payments due to changes in these rates. The flooring debt is based on open-ended lines of credit tied to each individual store from the various manufacturer finance companies. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases.

Our variable-rate flooring notes payable and other credit line borrowings subject us to market risk exposure. At December 31, 2003, we had $575.0 million outstanding under such agreements at interest rates ranging from 2.62% to 5.16% per annum. A 10% increase in interest rates to 2.88% to 5.68%, respectively, would increase annual interest expense by approximately $468,000, net of tax, based on amounts outstanding on the lines of credit at December 31, 2003.

Fixed Rate Debt

The fair market value of our long-term fixed interest rate debt is subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall because we could refinance for a lower rate. Conversely, the fair value of fixed interest rate debt will decrease as interest rates rise. The interest rate changes affect the fair market value but do not impact earnings or cash flows. At December 31, 2003, we had $53.0 million of long-term fixed interest rate debt outstanding with maturity dates of between January 2005 and May 2022. Based on discounted cash flows, we have determined that the fair market value of our long-term fixed interest rate debt was approximately $52.2 million at December 31, 2003.

Hedging Strategies

We believe it is prudent to limit the variability of a portion of our interest payments. Accordingly, we have entered into interest rate swaps to manage the variability of our interest rate exposure, thus leveling a portion of our interest expense in a rising or falling rate environment.

We have effectively changed the variable-rate cash flow exposure on a portion of our flooring debt to fixed-rate cash flows by entering into receive-variable, pay-fixed interest rate swaps. Under the interest rate swaps, we receive variable interest rate payments and make fixed interest rate payments, thereby creating fixed rate flooring debt.

We do not enter into derivative instruments for any purpose other than to manage interest rate exposure. That is, we do not speculate using derivative instruments.

As of December 31, 2003, we have outstanding the following interest rate swaps with U.S. Bank Dealer Commercial Services:

    effective September 1, 2000 – a five year, $25 million interest rate swap at a fixed rate of 6.88% per annum, variable rate adjusted on the 1st and 16th of each month
 
    effective January 26, 2003 – a five year, $25 million interest rate swap at a fixed rate of 3.265% per annum, variable rate adjusted on the 26th of each month
 
    effective February 18, 2003 – a five year, $25 million interest rate swap at a fixed rate of 3.30% per annum, variable rate adjusted on the 1st and 16th of each month

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    effective November 18, 2003 – a five year, $25 million interest rate swap at a fixed rate of 3.65% per annum, variable rate adjusted on the 1st and 16th of each month
 
    effective November 26, 2003 – a five year, $25 million interest rate swap at a fixed rate of 3.63% per annum, variable rate adjusted on the 26th of each month

We earn interest on all of the interest rate swaps at the one-month LIBOR rate. The one-month LIBOR rate at December 31, 2003 was 1.12% per annum.

The fair value of our interest rate swap agreements represents the estimated receipts or payments that would be made to terminate the agreements. These amounts are recorded as deferred gains or losses in our consolidated balance sheet with the offset recorded in accumulated other comprehensive income, net of tax. The amount of deferred gains and (losses) at December 31, 2003 were $0 and $(2.4) million respectively. The difference between interest earned and the interest obligation results in a monthly settlement which is reclassified from accumulated other comprehensive income to the statement of operations as incremental flooring interest expense. The resulting cash settlement reduces the amount of deferred gains and losses. Because the critical terms of the interest rate swaps and the underlying debt obligations are the same, there was no ineffectiveness recorded in interest expense.

If, in the future, the interest rate swap agreements were determined to be ineffective or were terminated before the contractual termination date, or if it became probable that the hedged variable cash flows associated with the variable rate borrowings would stop, we would be required to reclassify into earnings all or a portion of the deferred gains or losses on cash flow hedges included in accumulated other comprehensive income.

Incremental flooring interest expense recognized, net of tax, related to the reclassification of amounts in accumulated other comprehensive income was $2.2 million, $1.5 million and $832,000, respectively, in 2003, 2002 and 2001. Interest expense savings, net of tax, on un-hedged debt as a result of decreasing interest rates, based on interest rates effective as of January 1, 2001 was approximately $12.4 million, $10.0 million and $4.1 million, respectively, in 2003, 2002 and 2001. Interest expense savings, net of tax, on un-hedged debt as a result of decreasing interest rates, based on interest rates effective as of January 1 of each year was $415,000, $139,000 and $4.1 million, respectively, in 2003, 2002 and 2001. As of December 31, 2003, approximately 71.7% of our total debt outstanding was subject to un-hedged variable rates of interest.

At current interest rates, we estimate that we will incur additional interest expense, net of tax, of approximately $2.3 million related to our interest rate swaps during 2004.

Risk Management Policies

We assess interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities.

We maintain risk management control systems to monitor interest rate cash flow attributable to both our outstanding and our forecasted debt obligations as well as our offsetting hedge positions. The risk management control systems involve the use of analytical techniques, including cash flow sensitivity analysis, to estimate the expected impact of changes in interest rates on our future cash flows.

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 15 of Part IV of this document. Quarterly financial data for each of the eight quarters in the two-year period ended December 31, 2003 is included in Item 7.

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

None.

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our President and Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, our President and Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART III

Item 10. Directors and Executive Officers of the Registrant

Information required by this item will be included under the captions Election of Directors, Meetings and Committees of the Board of Directors, Audit Committee Financial Expert, Code of Ethics, Executive Officers and Section 16(a) Beneficial Ownership Reporting Compliance in our Proxy Statement for our 2004 Annual Meeting of Shareholders and is incorporated herein by reference.

Item 11. Executive Compensation

The information required by this item will be included under the captions Director Compensation, Executive Compensation and Compensation Committee Interlocks and Insider Participation in our Proxy Statement for our 2004 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 will be included under the captions Security Ownership of Certain Beneficial Owners and Management and Equity Compensation Plan Information in our Proxy Statement for our 2004 Annual Meeting of Shareholders and is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

The information required by this item will be included under the caption Certain Relationships and Related Transactions in our Proxy Statement for our 2004 Annual Meeting of Shareholders and is incorporated herein by reference.

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Item 14. Principal Accountant Fees and Services

Information required by this item is included under the caption Independent Auditors in the Proxy Statement for our 2004 Annual Meeting of Shareholders and is incorporated herein by reference.

PART IV

Item 15. 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
   
Independent Auditors’ Report
    F-1  
Consolidated Balance Sheets as of December 31, 2003 and 2002
    F-2  
Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001
    F-3  
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2003, 2002 and 2001
    F-4  
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001
    F-5  
Notes to Consolidated Financial Statements
    F-6  

There are no schedules required to be filed herewith.

(b)  Reports on Form 8-K

We filed one report on Form 8-K during the quarter ended December 31, 2003 pursuant to Item 12. Results of Operations and Financial Condition dated September 30, 2003 regarding our financial results for our third quarter of 2003.

(c)  Exhibits

The following exhibits are filed herewith and this list is intended to constitute the exhibit index. An asterisk (*) beside the exhibit number indicates the exhibits containing a management contract, compensatory plan or arrangement, which are required to be identified in this report.

         
Exhibit       Description

     
3.1   (a)   Restated Articles of Incorporation of Lithia Motors, Inc., as amended May 13, 1999.
         
3.2   (b)   Bylaws of Lithia Motors, Inc.
         
4   (b)   Specimen Common Stock certificate
         
10.1*   (b)   1996 Stock Incentive Plan
         
10.2*   (c)   Amendment No. 1 to the Lithia Motors, Inc. 1996 Stock Incentive Plan
         
10.2.1*   (b)   Form of Incentive Stock Option Agreement (1)
         
10.3*   (b)   Form of Non-Qualified Stock Option Agreement (1)
         
10.4*   (d)   1997 Non-Discretionary Stock Option Plan for Non-Employee Directors
         
10.5*   (l)   1998 Employee Stock Purchase Plan, as amended
         
10.6*   (f)   Lithia Motors, Inc. 2001 Stock Option Plan

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Exhibit       Description

     
10.6.1*   (g)   Form of Incentive Stock Option Agreement for 2001 Stock Option Plan
         
10.6.2*   (g)   Form of Non-Qualified Stock Option Agreement for 2001 Stock Option Plan
         
10.7*   (m)   2003 Stock Incentive Plan
         
10.8*   (m)   2003 Executive Bonus Plan
         
10.9   (a)   Chrysler Corporation Sales and Service Agreement General Provisions
         
10.9.1   (h)   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 10.9) (2)
         
10.10   (b)   Mercury Sales and Service Agreement General Provisions
         
10.10.1   (e)   Supplemental Terms and Conditions agreement between Ford Motor Company and Lithia Motors, Inc. dated June 12, 1997.
         
10.10.2   (e)   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 10.10) (3)
         
10.11   (e)   Volkswagen Dealer Agreement Standard Provisions
         
10.11.1   (a)   Volkswagen Dealer Agreement dated September 17, 1998, between Volkswagen of America, Inc. and Lithia HPI, Inc. dba Lithia Volkswagen. (standard provisions are in Exhibit 10.11) (4)
         
10.12   (b)   General Motors Dealer Sales and Service Agreement Standard Provisions
         
10.12.1   (a)   Supplemental Agreement to General Motors Corporation Dealer Sales and Service Agreement dated January 16, 1998.
         
10.12.2   (i)   Chevrolet Dealer Sales and Service Agreement dated October 13, 1998 between General Motors Corporation, Chevrolet Motor Division and Camp Automotive, Inc. (5)
         
10.13   (b)   Toyota Dealer Agreement Standard Provisions
         
10.13.1   (a)   Toyota Dealer Agreement, between Toyota Motor Sales, USA, Inc. and Lithia Motors, Inc., dba Lithia Toyota, dated February 15, 1996. (6)
         
10.14   (e)   Nissan Standard Provisions
         
10.14.1   (a)   Nissan Public Ownership Addendum dated August 30, 1999 (identical documents executed by each Nissan store).
         
10.14.2   (e)   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 10.14) (7)
         
10.15   (j)   Credit Agreement dated February 25, 2003 between DaimlerChrysler Services North America LLC, as agent, and Lithia Motors, Inc.
         
10.15.1       First Amendment dated as of August 12, 2003 to Credit Agreement dated February 25, 2003 between DaimlerChrysler Services North America LLC, as agent, and Lithia Motors, Inc.
         
10.16   (j)   Amended and Restated Loan Agreement dated December 28, 2001 between Lithia Financial Corporation, Lithia Motors, Inc. and Lithia SALMIR, Inc. and U.S. Bank National Association.

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Exhibit       Description

     
10.16.1   (j)   Consent, Waiver and Amendment dated January 31, 2003 to Loan Agreement dated December 28, 2001 between Lithia Financial Corporation, Lithia Motors, Inc., Lithia SALMIR, Inc. and Lithia Aircraft, Inc. and U.S. Bank National Association.
         
10.16.2   (k)   Second Amendment, dated April 2, 2003, to Amended and Restated Loan Agreement, dated December 28, 2001, between Lithia Financial Corporation, Lithia Motors, Inc., Lithia Aircraft, Inc. and Lithia SALMIR, Inc. and U.S. Bank National Association
         
10.16.3       Third Amendment dated as of February 6, 2004 to Amended and Restated Loan Agreement dated December 28, 2001 between Lithia Financial Corporation, Lithia Motors, Inc. and Lithia SALMIR, Inc. and U.S. Bank National Association.
         
10.17   (j)   Amended and Restated Revolving Loan and Security Agreement dated May 10, 2002 between Toyota Motor Credit Corporation and Lithia Real Estate, Inc.
         
10.17.1   (l)   Modification No. 1 dated June 16, 2003 to Amended and Restated Revolving Loan and Security Agreement and Notes Secured by Deed of Trust
         
10.18   (a)   Lease Agreement between CAR LIT, L.L.C. and Lithia Real Estate, Inc. relating to properties in Medford, Oregon.(8)
         
21       Subsidiaries of Lithia Motors, Inc.
         
23       Consent of KPMG LLP
         
31.1       Certification of Sidney B. DeBoer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
         
31.2       Certification of Jeffrey B. DeBoer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
         
32.1       Certification of Sidney B. DeBoer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
         
32.2       Certification of Jeffrey B. DeBoer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
         
99       Risk Factors

(a)   Incorporated by reference from the Company’s Form 10-K for the year ended December 31, 1999 as filed with the Securities and Exchange Commission on March 30, 2000.
 
(b)   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.
 
(c)   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.
 
(d)   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.
 
(e)   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.
 
(f)   Incorporated by reference from Appendix B to the Company’s Proxy Statement for its 2001 Annual Meeting as filed with the Securities and Exchange Commission on May 8, 2001.
 
(g)   Incorporated by reference from the Company’s Form 10-K for the year ended December 31, 2001 as filed with the Securities and Exchange Commission on February 22, 2002.
 
(h)   Incorporated by reference from the Company’s Form 10-Q for the quarter ended September 30, 2001 as filed with the Securities and Exchange Commission on November 14, 2001.
 
(i)   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.
 
(j)   Incorporated by reference from the Company’s Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission on March 31, 2003.
 
(k)   Incorporated by reference from the Company’s Form 10-Q for the quarter ended March 31, 2003 as filed with the Securities and Exchange Commission on May 15, 2003.

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(l)   Incorporated by reference from the Company’s Form 10-Q for the quarter ended June 30, 2003 as filed with the Securities and Exchange Commission on August 14, 2003.
 
(m)   Incorporated by reference from the Company’s Form 8-K filed April 28, 2003.
 
(1)   The board of directors adopted the new stock option agreement forms when it adopted the 2001 Stock Option Plan; and, although no longer being used to grant new stock options, these option agreements remain in effect as there are outstanding stock options issued under these stock option agreements.
 
(2)   Substantially identical agreements exist between DaimlerChrysler Motor Company, LLC and those other subsidiaries operating Dodge, Chrysler, Plymouth or Jeep dealerships.
 
(3)   Substantially identical agreements exist for its Ford and Lincoln-Mercury lines between Ford Motor Company and those other subsidiaries operating Ford or Lincoln-Mercury dealerships.
 
(4)   Substantially identical agreements exist between Volkswagen of America, Inc. and those subsidiaries operating Volkswagen dealerships.
 
(5)   Substantially identical agreements exist between Chevrolet Motor Division, GM Corporation and those other subsidiaries operating General Motors dealerships.
 
(6)   Substantially identical agreements exist (except the terms are all 2 years) between Toyota Motor Sales, USA, Inc. and those other subsidiaries operating Toyota dealerships.
 
(7)   Substantially identical agreements exist between Nissan Motor Corporation and those other subsidiaries operating Nissan dealerships.
 
(8)   Lithia Real Estate, Inc. leases all the property in Medford, Oregon sold to CAR LIT, LLC under substantially identical leases covering six separate blocks of property.

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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 12, 2004   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 12, 2004:

     
Signature   Title

 
/s/ SIDNEY B. DEBOER   Chairman of the Board and

  Chief Executive Officer
Sidney B. DeBoer   (Principal Executive Officer)
     
/s/ JEFFREY B. DEBOER   Senior Vice President and Chief Financial Officer

  (Principal Financial Officer)
Jeffrey B. DeBoer    
     
/s/ LINDA A. GANIM       Vice President and Chief Accounting Officer

  (Principal Accounting Officer)
Linda A. Ganim    
     
/s/ M. L. DICK HEIMANN   Director, President and

  Chief Operating Officer
M. L. Dick Heimann    
     
/s/ R. BRADFORD GRAY   Director and Executive Vice President

   
R. Bradford Gray    
     
/s/ THOMAS BECKER   Director

   
Thomas Becker    
     
/s/ PHILIP J. ROMERO   Director

   
Philip J. Romero    
     
/s/ GERALD F. TAYLOR   Director

   
Gerald F. Taylor    
     
/s/ WILLIAM J. YOUNG   Director

   
William J. Young    

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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, 2003 and 2002, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2003. 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 auditing standards generally accepted in the United States of America. 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, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

As discussed in note 1 to the financial statements, effective July 1, 2001, the Company adopted the provisions of SFAS No. 141, Business Combinations, and certain provisions of SFAS No. 142, Goodwill and Other Intangible Assets, as required for goodwill and intangible assets resulting from business combinations consummated after June 30, 2001. Effective January 1, 2002, the Company adopted the remaining provisions of SFAS No. 142.

/s/ KPMG LLP

Portland, Oregon
February 6, 2004

F-1


Table of Contents

LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands)

                       
          December 31,
         
          2003   2002
         
 
Assets
               
Current Assets:
               
 
Cash and cash equivalents
  $ 74,408     $ 15,932  
 
Contracts in transit
    44,709       41,493  
 
Trade receivables, net of allowance for doubtful accounts of $413 and $455
    42,199       40,680  
 
Notes receivable, current portion, net of allowance for doubtful accounts of $49 and $247
    208       167  
 
Inventories, net
    445,281       445,908  
 
Vehicles leased to others, current portion
    5,747       5,341  
 
Prepaid expenses and other
    3,392       5,707  
 
Assets held for sale
    20,408        
 
Deferred income taxes
    585       550  
 
   
     
 
     
Total Current Assets
    636,937       555,778  
Land and buildings, net of accumulated depreciation of $5,683 and $3,618
    164,676       118,696  
Equipment and other, net of accumulated depreciation of $18,315 and $14,602
    62,637       58,215  
Notes receivable, less current portion
    676       881  
Vehicles leased to others, less current portion
    10       19  
Goodwill
    207,027       185,212  
Other intangible assets, net of accumulated amortization of $351 and $330
    28,946       20,985  
Other non-current assets
    1,873       2,263  
 
   
     
 
     
Total Assets
  $ 1,102,782     $ 942,049  
 
   
     
 
Liabilities and Stockholders’ Equity
               
Current Liabilities:
               
 
Flooring notes payable
  $ 378,961     $ 364,635  
 
Current maturities of long-term debt
    14,299       4,466  
 
Trade payables
    24,402       19,445  
 
Accrued liabilities
    46,164       40,924  
 
Liabilities held for sale
    13,045        
 
   
     
 
     
Total Current Liabilities
    476,871       429,470  
Used Vehicle Flooring Facility
    56,267       63,000  
Real Estate Debt, less current maturities
    80,159       73,798  
Other Long-Term Debt, less current maturities
    98,308       30,914  
Deferred Revenue
    875       1,617  
Other Long-Term Liabilities
    7,235       9,581  
Deferred Income Taxes
    24,141       13,676  
 
 
   
     
 
     
Total Liabilities
    743,856       622,056  
 
   
     
 
Stockholders’ Equity:
               
 
Preferred stock — no par value; authorized 15,000 shares; none outstanding
           
 
Class A common stock — no par value; authorized 100,000 shares; issued and outstanding 14,693 and 14,299
    208,187       203,577  
 
Class B common stock — no par value authorized 25,000 shares; issued and outstanding 3,762 and 3,762
    468       468  
 
Additional paid-in capital
    1,231       929  
 
Accumulated other comprehensive loss
    (1,468 )     (2,517 )
 
Retained earnings
    150,508       117,536  
 
   
     
 
   
Total Stockholders’ Equity
    358,926       319,993  
 
   
     
 
   
Total Liabilities and Stockholders’ Equity
  $ 1,102,782     $ 942,049  
 
   
     
 

See accompanying notes to consolidated financial statements.

F-2


Table of Contents

LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share amounts)

                             
        Year Ended December 31,
       
        2003   2002   2001
       
 
 
Revenues:
                       
 
New vehicle sales
  $ 1,441,000     $ 1,218,364     $ 926,981  
 
Used vehicle sales
    725,547       715,760       564,049  
 
Service, body and parts
    251,316       216,382       173,114  
 
Finance and insurance
    89,982       77,776       62,856  
 
Fleet and other
    5,657       43,114       40,593  
 
   
     
     
 
   
Total revenues
    2,513,502       2,271,396       1,767,593  
Cost of sales
    2,110,393       1,913,704       1,478,528  
 
   
     
     
 
Gross profit
    403,109       357,692       289,065  
Selling, general and administrative
    313,289       280,310       224,501  
Depreciation — buildings
    2,096       2,405       1,261  
Depreciation and amortization — other
    7,497       4,787       7,429  
 
   
     
     
 
   
Income from operations
    80,227       70,190       55,874  
Other income (expense):
                       
 
Floorplan interest expense
    (13,997 )     (10,775 )     (13,652 )
 
Other interest expense
    (6,081 )     (5,985 )     (7,546 )
 
Other income, net
    (951 )     (589 )     (298 )
 
 
   
     
     
 
 
    (21,029 )     (17,349 )     (21,496 )
 
   
     
     
 
Income from continuing operations before income taxes
    59,198       52,841       34,378  
Income taxes
    (23,561 )     (20,480 )     (13,270 )
 
   
     
     
 
Income before discontinued operations
    35,637       32,361       21,108  
Income (loss) from discontinued operations, net of income taxes (benefit) of $59, 30 and $(405)
    (90 )     (45 )     646  
 
   
     
     
 
Net income
  $ 35,547     $ 32,316     $ 21,754  
 
   
     
     
 
Basic income per share from continuing operations
  $ 1.95     $ 1.88     $ 1.58  
Basic income (loss) per share from discontinued operations
    (0.01 )           0.05  
 
   
     
     
 
Basic net income per share
  $ 1.94     $ 1.88     $ 1.63  
 
   
     
     
 
Shares used in basic net income per share
    18,289       17,233       13,371  
 
   
     
     
 
Diluted income per share from continuing operations
  $ 1.92     $ 1.84     $ 1.55  
Diluted income per share from discontinued operations
                0.05  
 
   
     
     
 
Diluted net income per share
  $ 1.92     $ 1.84     $ 1.60  
 
   
     
     
 
Shares used in diluted net income per share
    18,546       17,598       13,612  
 
   
     
     
 

See accompanying notes to consolidated financial statements.

F-3


Table of Contents

LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
For the years ended December 31, 2001, 2002, and 2003
(In thousands, except share data)

                                                 
                    Common Stock
    Series M Preferred Stock
  Class A
  Class B
    Shares
  Amount
  Shares
  Amount
  Shares
  Amount
Balance at December 31, 2000
    14,859     $ 8,915       8,412,087     $ 108,565       4,087,000     $ 508  
Comprehensive income:
                                               
Net income
                                   
Unrealized loss on investments, net
                                   
Cash flow hedges:
                                               
Cumulative effect of adoption of SFAS 133, net of tax effect of $594
                                   
Net derivative losses, net of tax effect of $1,237
                                   
Reclassification adjustment of interest rate swaps, net of tax effect of $(523)
                                   
Total comprehensive income
                                               
Issuance of stock in connection with employee stock plans
                169,492       1,873              
Conversion of Series M Preferred Stock
    (5,183 )     (3,109 )     265,247       3,109              
Conversion of Class B Common Stock
                47,281       6       (47,281 )     (6 )
Compensation for stock option issuances
                                   
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Balance at December 31, 2001
    9,676       5,806       8,894,107       113,553       4,039,719       502  
Comprehensive income:
                                               
Net income
                                   
Unrealized gain on investments, net
                                   
Cash flow hedges:
                                               
Net derivative losses, net of tax effect of $1,234
                                   
Reclassification adjustment of interest rate swaps, net of tax effect of $(963)
                                   
Total comprehensive income
                                               
Issuance of stock in connection with public offering
                4,500,000       77,198              
Issuance of stock in connection with acquisition
                25,000       475              
Issuance of stock in connection with employee stock plans
                352,836       5,067              
Conversion and redemption of Series M Preferred Stock
    (9,676 )     (5,806 )     249,311       7,250              
Conversion of Class B Common Stock
                277,488       34       (277,488 )     (34 )
Compensation for stock option issuances and tax benefits from option exercises
                                   
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Balance at December 31, 2002
                14,298,742       203,577       3,762,231       468  
Comprehensive income:
                                               
Net income
                                   
Unrealized gain on investments, net
                                   
Cash flow hedges:
                                               
Net derivative losses, net of tax effect of $833
                                   
Reclassification adjustment of interest rate swaps, net of tax effect of $(1,442)
                                   
Total comprehensive income
                                               
Issuance of stock in connection with employee stock plans
                413,485       4,825              
Compensation for stock option issuances and tax benefits from option exercises
                                   
Dividends paid
                                   
Repurchase of Class A shares
                (19,400 )     (215 )            
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Balance at December 31, 2003
        $       14,692,827     $ 208,187       3,762,231     $ 468  
 
   
 
     
 
     
 
     
 
     
 
     
 
 

     

[Additional columns below]

[Continued from above table, first column(s) repeated]

                                 
            Accumulated            
            Other            
            Compre-            
    Additional   hensive           Total
    Paid In   Income   Retained   Stockholders’
    Capital
  (Loss)
  Earnings
  Equity
Balance at December 31, 2000
  $ 306     $ 15     $ 63,466     $ 181,775  
Comprehensive income:
                               
Net income
                21,754       21,754  
Unrealized loss on investments, net
          (26 )           (26 )
Cash flow hedges:
                               
Cumulative effect of adoption of SFAS 133, net of tax effect of $594
          (948 )           (948 )
Net derivative losses, net of tax effect of $1,237
          (1,963 )           (1,963 )
Reclassification adjustment of interest rate swaps, net of tax effect of $(523)
          831             831  
 
                           
 
 
Total comprehensive income
                            19,648  
Issuance of stock in connection with employee stock plans
                      1,873  
Conversion of Series M Preferred Stock
    (20 )                 (20 )
Conversion of Class B Common Stock
                       
Compensation for stock option issuances
    221                   221  
 
   
 
     
 
     
 
     
 
 
Balance at December 31, 2001
    507       (2,091 )     85,220       203,497  
Comprehensive income:
                               
Net income
                32,316       32,316  
Unrealized gain on investments, net
          3             3  
Cash flow hedges:
                               
Net derivative losses, net of tax effect of $1,234
          (1,948 )           (1,948 )
Reclassification adjustment of interest rate swaps, net of tax effect of $(963)
          1,519             1,519  
 
                           
 
 
Total comprehensive income
                            31,890  
Issuance of stock in connection with public offering
                      77,198  
Issuance of stock in connection with acquisition
                      475  
Issuance of stock in connection with employee stock plans
                      5,067  
Conversion and redemption of Series M Preferred Stock
    (11 )                 1,433  
Conversion of Class B Common Stock
                       
Compensation for stock option issuances and tax benefits from option exercises
    433                   433  
 
   
 
     
 
     
 
     
 
 
Balance at December 31, 2002
    929       (2,517 )     117,536       319,993  
Comprehensive income:
                               
Net income
                35,547       35,547  
Unrealized gain on investments, net
          8             8  
Cash flow hedges:
                               
Net derivative losses, net of tax effect of $833
          (1,140 )           (1,140 )
Reclassification adjustment of interest rate swaps, net of tax effect of $(1,442)
          2,181             2,181  
 
                           
 
 
Total comprehensive income
                            36,596  
Issuance of stock in connection with employee stock plans
                      4,825  
Compensation for stock option issuances and tax benefits from option exercises
    302                   302  
Dividends paid
                (2,575 )     (2,575 )
Repurchase of Class A shares
                      (215 )
 
   
 
     
 
     
 
     
 
 
Balance at December 31, 2003
  $ 1,231     $ (1,468 )   $ 150,508     $ 358,926  
 
   
 
     
 
     
 
     
 
 

See accompanying notes to consolidated financial statements.

F-4


Table of Contents

LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)

                         
    Year Ended December 31,
    2003
  2002
  2001
Cash flows from operating activities:
                       
Net income
  $ 35,547     $ 32,316     $ 21,754  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization
    9,593       7,192       8,690  
Depreciation and amortization of discontinued operations
    702       621       585  
Compensation expense related to stock option issuances
    185       169       221  
(Gain) loss on sale of assets
    (586 )     77       (43 )
(Gain) loss on sale of vehicles leased to others
    127       58       (20 )
Gain on sale of franchise
    (919 )     (50 )     (352 )
Deferred income taxes
    10,235       4,963       (97 )
Equity in (income) loss of affiliate
    13       (4 )     87  
(Increase) decrease, net of effect of acquisitions:
                       
Trade and installment contract receivables, net
    (695 )     (4,512 )     (1,007 )
Contracts in transit
    (3,080 )     1,626       (8,079 )
Inventories
    38,466       (107,126 )     64,200  
Prepaid expenses and other
    2,794       (1,126 )     654  
Other non-current assets
    347       1,473       (663 )
Increase (decrease), net of effect of acquisitions:
                       
Floorplan notes payable
    (12,390 )     106,583       (58,321 )
Trade payables
    4,785       2,032       3,243  
Accrued liabilities
    6,586       2,539       10,958  
Other long-term liabilities and deferred revenue
    (3,397 )     835       (630 )
 
   
 
     
 
     
 
 
Net cash provided by operating activities
    88,313       47,666       41,180  
Cash flows from investing activities:
                       
Notes receivable issued
    (106 )     (178 )     (902 )
Principal payments received on notes receivable
    365       1,410       2,715  
Capital expenditures:
                       
Non-financeable
    (10,678 )     (5,691 )     (4,439 )
Financeable
    (32,448 )     (32,792 )     (26,247 )
Proceeds from sale of assets
    441       1,672       7,635  
Proceeds from sale of vehicles leased to others
    920       2,219       4,675  
Expenditures for vehicles leased to others
    (6,650 )     (7,372 )     (6,228 )
Cash paid for other investments
          (384 )      
Cash paid for acquisitions, net of cash acquired
    (63,799 )     (81,698 )     (45,496 )
Cash from sale of franchises
    3,542       535       7,060  
Distribution from affiliate
    33              
 
   
 
     
 
     
 
 
Net cash used in investing activities
    (108,380 )     (122,279 )     (61,227 )
Cash flows from financing activities:
                       
Net borrowings (repayments) on lines of credit
    58,317       (28,000 )     24,000  
Principal payments on long-term debt and capital leases
    (4,631 )     (11,223 )     (9,908 )
Proceeds from issuance of long-term debt
    22,845       33,055       17,089  
Repurchase of common stock
    (215 )            
Redemption of Series M Preferred Stock
          (4,366 )      
Proceeds from issuance of common stock
    4,802       82,265       1,853  
Dividends paid
    (2,575 )            
 
   
 
     
 
     
 
 
Net cash provided by financing activities
    78,543       71,731       33,034  
 
   
 
     
 
     
 
 
Increase (decrease) in cash and cash equivalents
    58,476       (2,882 )     12,987  
Cash and cash equivalents:
                       
Beginning of year
    15,932       18,814       5,827  
 
   
 
     
 
     
 
 
End of year
  $ 74,408     $ 15,932     $ 18,814  
 
   
 
     
 
     
 
 
Supplemental disclosures of cash flow information:
                       
Cash paid during the period for interest
  $ 20,733     $ 17,395     $ 24,061  
Cash paid during the period for income taxes
    9,596       16,541       12,657  
Supplemental schedule of noncash investing and financing activities:
                       
Stock issued in connection with acquisitions
  $     $ 475     $  
Debt assumed/issued in connection with acquisitions
    324       3,314        
Termination of capital lease
                58  
Assets acquired with debt
                6,982  
Assets acquired through real estate exchange
    1,987              
Debt extinguished through refinancing
    12,350       4,360       10,840  

See accompanying notes to consolidated financial statements.

F-5


Table of Contents

LITHIA MOTORS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 and 2001

(1) Summary of Significant Accounting Policies

     Organization and Business

     We are a leading operator of automotive franchises and retailer of new and used vehicles and services. As of December 31, 2003, we offered 25 brands of new vehicles through 147 franchises in 78 stores in the Western United States and over the Internet. As of December 31, 2003, we operated 16 stores in Oregon, 13 in California, 11 in Washington, 8 in Texas, 7 in Idaho, 7 in Colorado, 5 in Nevada, 4 in Alaska, 2 in South Dakota, 2 in Nebraska, 2 in Montana and 1 in Oklahoma. We sell new and used cars and light trucks; sell replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing, service contracts, protection products and credit insurance for our automotive customers.

     Principles of Consolidation

     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.

     Cash and Cash Equivalents

     Cash and cash equivalents are defined as cash on hand and cash in bank accounts.

     Contracts in Transit

     Contracts in transit relate to amounts due from various lenders for the financing of vehicles sold and are typically received within five days of selling a vehicle.

     Trade Receivables

     Trade receivables include amounts due from customers for vehicles and service and parts business, from manufacturers for factory rebates, dealer incentives and warranty reimbursement, from insurance companies, finance companies and other miscellaneous receivables. Receivables are recorded at invoice cost and do not bear interest until such time as they are 60 days past due. Reserves for uncollectible accounts are estimated based on our historical write-off experience and are reviewed on a monthly basis. Account balances are charged off against the reserve after all means of collection have been exhausted and the potential for recovery is considered remote. We do not have any off-balance sheet credit exposure related to our customers.

     Inventories

     We account for inventories, using the specific identification method for new and used vehicles and the first-in first-out (FIFO) method for parts. The cost of used vehicle inventories includes the cost of any equipment added, reconditioning and transportation. Inventories are valued at the lower of market value or cost.

     Vehicles Leased to Others and Related Leases Receivable

     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. Vehicles leased to others are classified as current or non-current based on the remaining lease term.

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     Assets and Liabilities Held for Sale

     Assets held for sale include inventory and property, plant and equipment related to one store held for sale and, in accordance with Statement of Financial Accounting Standards (SFAS) No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” are recorded on our balance sheet at the lower of book value or estimated fair market value, less applicable selling costs. Liabilities held for sale include flooring notes payable at contract value related to the store held for sale.

     Property, Plant and Equipment

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

         
Buildings 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. In addition, interest on borrowings for major capital projects, significant renewals and betterments is capitalized. Capitalized interest then becomes a part of the cost of the depreciable asset and is depreciated according to the estimated useful lives as previously stated.

     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.

     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 shorter of the useful life or the term of the lease and is included in depreciation expense.

     Long-Lived Asset Impairment

     Long-lived assets held and used by us and intangible assets with determinable lives are reviewed for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” We evaluate recoverability of assets to be held and used by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Such reviews assess the fair value of the assets based upon estimates of future cash flows that the assets are expected to generate. Long-lived assets to be disposed of by sale are valued at the lower of book value or fair value less cost to sell.

     Goodwill and Other Identifiable Intangible Assets

     Goodwill represents the excess purchase price over fair value of net assets acquired, which is not allocable to separately identifiable intangible assets. Other identifiable intangible assets represents the franchise value of stores acquired since July 1, 2001 and non-compete agreements. Except for our non-compete agreements, all of our other identifiable intangible assets have indefinite useful lives.

     We determined that our franchise agreements have indefinite useful lives based on the following:

  Certain of our franchise agreements continue indefinitely by their terms;

  Certain of our franchise agreements have limited terms, but are routinely renewed without substantial cost to us;

In the established retail automotive franchise industry, we are not aware of manufacturers terminating franchise agreements against the wishes of the franchise owners and we have never had a franchise agreement terminated against our wishes. A manufacturer may pressure a franchise owner to sell a franchise when they are in breach of the

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    franchise agreement over an extended period of time. The franchise owner is typically able to sell the franchise for market value.

  State dealership franchise laws typically limit the rights of the manufacturer to terminate or not renew a franchise unless there has been illegal activity on the part of the franchise owner;

  We are not aware of any legislation or other factors that would materially change the retail automotive franchise system; and

  As evidenced by our acquisition history, there is an active market for automotive dealership franchises within the United States. We attribute value to the franchise agreements acquired with the dealerships we purchase based on the understanding and industry practice that the franchise agreements will be renewed indefinitely by the manufacturer.

     Accordingly, we have determined that our franchise agreements will continue to contribute to our cash flows indefinitely and, therefore, have indefinite lives.

     Pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets,” which was adopted in the first quarter of 2002, goodwill and other identifiable intangible assets with indefinite useful lives are no longer amortized, but, instead, tested for impairment, at least annually, in accordance with the provisions of SFAS No. 142. The impairment test is a two step process. The first identifies potential impairments by comparing the fair value of a reporting unit with its book value, including goodwill and other identifiable intangible assets. If the fair value of the reporting unit exceeds the carrying amount, goodwill and other identifiable intangible assets are not impaired and the second step is not necessary. If the carrying value exceeds the fair value, the second step includes determining the implied fair value through further market research. The implied fair value of goodwill and other identifiable intangible assets is then compared with the carrying amount to determine if an impairment loss is recorded.

     We adopted the provisions of SFAS No. 141 “Business Combinations” effective July 1, 2001. Upon adoption of SFAS No. 142, SFAS No. 141 required that we evaluate our existing intangible assets and goodwill that were acquired in prior purchase business combinations and make any necessary reclassifications in order to conform with the criteria in SFAS No. 141 for recognition apart from goodwill. We did not reclassify any intangibles upon adoption of SFAS No. 142.

     We tested our goodwill and other identifiable intangible assets for impairment utilizing the discounted cash flows method in accordance with the provisions of SFAS No. 142 as of December 31, 2003 and determined that no impairment losses were required to be recognized. Growth rates utilized in the calculation were derived from the U.S. Census Bureau on population growth and the U.S. Department of Labor, Bureau of Labor Statistics for historical consumer price index data. The discount rate applied to the future cash flows was derived from a Capital Asset Pricing Model, which factors in an equity risk premium and a risk free rate.

     The following table discloses what reported net income would have been in the year ended December 31, 2001, which was prior to the adoption of SFAS No. 142, exclusive of amortization expense (including any related tax effects) recognized in that period related to goodwill and other identifiable intangible assets that are no longer being amortized (in thousands, except per share amounts):

         
Net income as reported
  $ 21,754  
Add back amortization of goodwill and other intangible assets, net of tax effect of $(1,414)
    2,250  
 
   
 
 
Adjusted net income
  $ 24,004  
 
   
 
 
Basic net income per share as reported
  $ 1.63  
Adjustment for add back of amortization expense, net of tax effect
    0.17  
 
   
 
 
Adjusted basic net income per share
  $ 1.80  
 
   
 
 
Diluted net income as reported
  $ 1.60  
Adjustment for add back of amortization expense, net of tax effect
    0.16  
 
   
 
 
Adjusted diluted net income per share
  $ 1.76  
 
   
 
 

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     Incentives, Credits and Floor Plan Assistance

     Manufacturers reimburse us for holdbacks, floor plan interest, and advertising credits, which are earned when each vehicle is purchased by us. The manufacturers reimburse us weekly, monthly, or quarterly depending on the manufacturer and the type of program. The manufacturers determine the amount of the reimbursements based on many factors including the value and make of the vehicles purchased. Pursuant to EITF 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” we recognize advertising credits, floorplan interest credits, holdbacks, cash incentives and other rebates received from manufacturers that are tied to specific vehicles as a reduction to cost of goods sold as the related vehicles are sold. When amounts are received prior to the sale of the vehicle, such amounts are netted against inventory until the vehicle is sold.

     We earn certain other cash incentives and rebates from the manufacturer when the vehicles are sold to the customer. The amount of cash incentives and other rebates can vary based on the type and number of models sold.

     Advertising credits that are not tied to specific vehicles are earned from the manufacturer when we submit reimbursement for qualifying advertising expenditures and are recognized as a reduction of advertising expense upon manufacturer confirmation that our submitted expenditures qualify for such credits.

     Parts purchase discounts that we receive from the manufacturer are earned when certain parts or volume of parts are purchased from the manufacturer and are recognized as a reduction to cost of good sold as the related inventory is sold. Given the number of parts purchased, this is estimated using historical experience based on estimated days supply of parts inventory.

     Advertising

     We expense production and other costs of advertising as incurred as a component of selling, general and administrative expense. Advertising expense, net of manufacturer cooperative advertising credits of $6.1 million, $8.2 million and $5.3 million, was $20.1 million, $16.8 million and $14.9 million for the years ended December 31, 2003, 2002 and 2001, respectively.

     Environmental Liabilities and Expenditures

     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 such costs increase the value of the property and/or mitigate or prevent contamination from future operations.

     We are aware of contamination at certain of our current and former facilities, and are in the process of conducting investigations and/or remediation at some of these properties. Based on our current information, we do not believe that any costs or liabilities relating to such contamination, other environmental matters or compliance with environmental regulations will have a material adverse effect on our cash flows, results of operations or financial condition. There can be no assurances, however, that additional environmental matters will not arise or that new conditions or facts will not develop in the future at our current or formerly owned or operated facilities, or at sites that we may acquire in the future, that will result in a material adverse effect on our cash flows, results of operations or financial condition.

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     Income Taxes

     Income taxes are accounted for under the asset and liability method as prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 109 “Accounting for Income Taxes.” Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

     Computation of Per Share Amounts

     Basic earnings per share (EPS) and diluted EPS are computed using the methods prescribed by SFAS No. 128, “Earnings per Share.” Following is a reconciliation of basic EPS and diluted EPS (in thousands, except per share amounts):

                                                                         
Year Ended December 31,
  2003
  2002
  2001
                    Per                   Per                   Per
                    Share                   Share                   Share
    Income
  Shares
  Amount
  Income
  Shares
  Amount
  Income
  Shares
  Amount
Basic EPS
                                                                       
Income available to common stockholders
  $ 35,547       18,289     $ 1.94     $ 32,316       17,233     $ 1.88     $ 21,754       13,371     $ 1.63  
 
                   
 
                     
 
                     
 
 
Diluted EPS
                                                                       
Stock options
            257                     365                     241          
 
   
 
     
 
             
 
     
 
             
 
     
 
         
Income available to common stockholders
  $ 35,547       18,546     $ 1.92     $ 32,316       17,598     $ 1.84     $ 21,754       13,612     $ 1.60  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Shares issuable pursuant to stock options not included since they were antidilutive
            342                                             758          
 
           
 
                     
 
                     
 
         

     Concentrations of Credit Risk

     Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising our customer base. Receivables from all manufacturers accounted for 22.7% and 21.5%, respectively, of total accounts receivable at December 31, 2003 and 2002. Included in the 22.7% is one manufacturer who accounted for 10.5% of the total accounts receivable balance at December 31, 2003. Included in the 21.5% is one manufacturer who accounted for 8.8% of the total accounts receivable balance at December 31, 2002. In addition, in 2003, 35.6% of our total revenue was derived from vehicles from two manufacturers.

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

     Financial Instruments and Market Risks

     The carrying amount of cash equivalents, contracts in transit, trade receivables, trade payables, accrued liabilities and short term borrowings approximates 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.

     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.

     We have variable rate floor plan notes payable and other credit line borrowings that subject us to market risk exposure. At December 31, 2003 we had $540.0 million outstanding under such facilities at interest rates ranging from 2.62% to 3.87% per annum. An increase or decrease in the interest rates would affect interest expense for the period accordingly.

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     The fair market value of long-term fixed interest rate debt is subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. The interest rate changes affect the fair market value but do not impact earnings or cash flows. We monitor our fixed rate debt regularly, refinancing debt that is at an above market rate. The book value of our fixed rate debt and the fair value, based on discounted cash flows, was as follows at December 31, 2003 and 2002 (in thousands):

                 
December 31,
  2003
  2002
Book value of fixed rate debt
  $ 52,978     $ 23,421  
 
   
 
     
 
 
Fair value of fixed rate debt
  $ 52,183     $ 26,210  
 
   
 
     
 
 

     Lithia also subjects itself to credit risk and market risk by entering into interest rate swaps. See below and also Note 6. We minimize the credit or repayment risk on our derivative instruments by entering into transactions with high quality institutions, whose credit rating is higher than Aa.

     Derivative Financial Instruments

     Lithia enters into interest rate swap agreements to reduce its exposure to market risks from changing interest rates on its new vehicle floorplan lines of credit. The difference between interest paid and interest received, which may change as market interest rates change, is accrued and recognized as either additional floorplan interest expense, or a reduction thereof. If a swap is terminated prior to its maturity, the gain or loss is recognized over the remaining original life of the swap if the item hedged remains outstanding, or immediately if the item hedged does not remain outstanding. If the swap is not terminated prior to maturity, but the underlying hedged debt item is no longer outstanding, the interest rate swap is marked to market, and any unrealized gain or loss is recognized immediately.

     Effective January 1, 2001, we adopted the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities-an amendment of FASB Statement No. 133” and SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities” (collectively, “the Standards”). The Standards require that all derivative instruments (including certain derivative instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value, and that changes in the derivatives fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Upon adoption of the Standards, we recorded a liability of $1.5 million and a corresponding, net-of-tax cumulative-effect-type adjustment of $948,000 in accumulated other comprehensive income to recognize, at fair value, all derivatives that are designated as cash-flow hedging instruments. See also Note 6.

     Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.

     Estimates are used in the calculation of certain reserves maintained for charge backs on estimated cancellations of service contracts, life, accident and disability insurance policies, and finance fees from financial institutions. We also use estimates in the calculation of various accruals and reserves including anticipated workers compensation premium expenses related to a retrospective cost policy, estimated uncollectible accounts and notes receivable, environmental matters and warranty.

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     Revenue Recognition

     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 we do not take possession of the vehicles are shown on a net basis in fleet and other revenue.

     Finance fees earned for notes placed with financial institutions in connection with customer vehicle financing are recognized, net of estimated charge-backs, as finance and insurance revenue upon acceptance of the credit by the financial institution.

     Insurance income from third party insurance companies for commissions earned on credit life, accident and disability insurance policies sold in connection with the sale of a vehicle are recognized, net of administration fees and anticipated cancellations, as finance and insurance revenue upon execution of the insurance contract.

     Commissions from third party service contracts are recognized, net of administration fees and anticipated cancellations, as finance and insurance revenue upon sale of the contracts.

     We may also participate in future underwriting profit, pursuant to retrospective commission arrangements, that would be recognized as income upon receipt.

     Sales Returns

     As is typical in the automotive retailing industry, we do not allow for sales returns for our vehicle sales, and have therefore not provided for an allowance for sales returns. Historically, we have not experienced sales returns. We do allow for customer returns on sales of our parts inventory up to 30 days after the sale. Most parts returns generally occur within one to two weeks from the time of sale, and are not significant. We, therefore, have not provided for an allowance for parts sales returns.

     Warranty

     We offer a 60-day limited warranty on the sale of retail used vehicles. We estimate our warranty liability based on the number of vehicles sold and an estimated cost per vehicle based on past experience. During 2003, we analyzed the warranty charges related to our used vehicle sales and updated our per used vehicle warranty estimate. The estimated warranty is added to cost of sales upon sale of the related vehicle. At December 31, 2003 and 2002, accrued warranty totaled $220,000 and $525,000, respectively, and is included in other current liabilities on the consolidated balance sheet. A roll-forward of our warranty liability for the years ended December 31, 2003 and 2002 is as follows (in thousands):

         
Balance, December 31, 2001
  $ 456  
Warranties issued
    2,827  
Reductions for warranty payments made
    (2,758 )
Adjustments and changes in estimates
     
 
   
 
 
Balance, December 31, 2002
    525  
Warranties issued
    2,935  
Reductions for warranty payments made
    (2,918 )
Adjustments and changes in estimates
    (322 )
 
   
 
 
Balance, December 31, 2003
  $ 220  
 
   
 
 

     Comprehensive Income

     Comprehensive income includes the unrealized gain on investments and the fair value of cash flow hedging instruments that are reflected in stockholders’ equity, net of tax, instead of net income.

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     Major Supplier and Franchise Agreements

     We purchase substantially all of our new vehicles and inventory from various manufacturers at the prevailing prices charged by auto makers to all franchised dealers. Our overall sales could be impacted by the auto makers’ inability or unwillingness to supply the dealership with an adequate supply of popular models.

     We enter into agreements (Franchise Agreements) with the manufacturers. The Franchise Agreements generally limit the location of the dealership and provide the auto maker approval rights over changes in dealership management and ownership. The automakers are also entitled to terminate the Franchise Agreements if the dealership is in material breach of the terms. Our ability to expand operations depends, in part, on obtaining consents of the manufacturers for the acquisition of additional dealerships. See also “Goodwill and Other Identifiable Intangible Assets” above.

     Stock-Based Compensation

     SFAS No. 123, “Accounting for Stock-Based Compensation,” which establishes a fair value-based method of accounting for stock-based compensation plans and requires additional disclosures for those companies that elect not to adopt the fair value-based method of accounting, was issued in October 1995. We have elected to continue to account for stock options under APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Entities electing to remain with the accounting in APB No. 25 must make pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting defined in SFAS No. 123 had been adopted. In December 2002, SFAS No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure” was issued. SFAS No. 148 amends SFAS No. 123 for certain transition provisions for companies electing to adopt the fair value method and amends SFAS No. 123 for certain financial statement disclosures, including interim financial statements. We adopted SFAS No. 148 in December 2002. We have elected to account for our stock-based compensation plans (which are described in Note 12) under APB No. 25. We have computed, for pro forma disclosure purposes, the impact on net income and net income per share if we had accounted for our stock-based compensation plans in accordance with SFAS No. 123 as follows:

                         
Year Ended December 31,
  2003
  2002(1)
  2001(1)
Net income, as reported
  $ 35,547     $ 32,316     $ 21,754  
Add – Stock-based employee compensation expense included in reported net income, net of related tax effects
    99       103       136  
Deduct - total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects
    (2,478 )     (2,052 )     (1,536 )
 
   
 
     
 
     
 
 
Net income, pro forma
  $ 33,168     $ 30,367     $ 20,354  
 
   
 
     
 
     
 
 
Basic net income per share:
                       
As reported
  $ 1.94     $ 1.88     $ 1.63  
 
   
 
     
 
     
 
 
Pro forma
  $ 1.81     $ 1.76     $ 1.52  
 
   
 
     
 
     
 
 
Diluted net income per share:
                       
As reported
  $ 1.92     $ 1.84     $ 1.60  
 
   
 
     
 
     
 
 
Pro forma
  $ 1.81     $ 1.76     $ 1.52  
 
   
 
     
 
     
 
 

(1)   2002 and 2001 have been restated to reflect adjustments made pursuant to EITF 97-1 “Accounting under Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back Option.”

     We used the Black-Scholes option pricing model and the following weighted average assumptions in calculating the value of all options granted during the periods presented:

                         
Year Ended December 31,
  2003
  2002
  2001
Risk-free interest rate
    2.50% - 3.25 %     4.00 %     4.50 %
Expected dividend yield
    0.00% - 1.70 %     0.00 %     0.00 %
Expected lives – 2001 Plan
  7.7 - 8.0 years   8.0 years   8.0 years
Purchase Plan
  3 months   3 months   3 months
Expected volatility
    44.01% - 46.79 %     46.80 %     46.72 %

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     Using the Black-Scholes methodology, the total value of options granted during 2003, 2002 and 2001 was $1.4 million, $4.9 million and $3.5 million, respectively, which would be amortized on a pro forma basis over the vesting period of the options, typically four to five years for options granted from the 2001 Plan and three months for options granted from the Purchase Plan. The weighted average fair value of options granted during 2003, 2002 and 2001 was $4.01, $7.90 and $8.43 per share, respectively.

     Segment Reporting

     Based upon definitions contained within SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information,” we have determined that we operate in one segment, automotive retailing.

     Reclassifications

     Pursuant to EITF 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” in the second quarter of 2003 we began classifying advertising credits that are tied to specific vehicles as a reduction to cost of goods sold as related vehicles are sold. Accordingly, $1.1 million of credits included in selling, general and administrative costs in the first quarter of 2003 were reclassified as a credit to cost of sales for that period. Amounts for 2002 and 2001 are not significant and have not been reclassified. Net income was not affected by this reclassification.

(2) Discontinued Operations

     During 2003, we decided to sell certain of our stores and related franchises. We recognized a net gain on the sale of one of our stores classified as discontinued operations totaling $374,000, net of tax, in 2003, which is netted with loss from discontinued operations on our consolidated statement of operations. At December 31, 2003, we had $20.4 million of assets classified as assets held for sale on our balance sheet related to one additional store we intend to sell during 2004. The assets primarily include inventory and property, plant and equipment. We did not recognize any gain or loss on disposal of discontinued operations during 2002 or 2001.

     We continually monitor the performance of each of our stores and make determinations to sell based on return on capital criteria.

(3) Inventories and Related Notes Payable

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

                                 
    December 31,
    2003
  2002
    Inventory   Notes   Inventory   Notes
    Cost
  Payable
  Cost
  Payable
New and program vehicles
  $ 355,937     $ 378,961     $ 340,457     $ 364,635  
Used vehicles
    68,747       56,267       85,170       63,000  
Parts and accessories
    20,597             20,281        
 
   
 
     
 
     
 
     
 
 
Total inventories
  $ 445,281     $ 435,228     $ 445,908     $ 427,635  
 
   
 
     
 
     
 
     
 
 

     The inventory balance is generally reduced by manufacturer holdbacks and incentives, while the related floor plan liability is reflective of the gross cost of the vehicle. The floor plan liability, as shown in Notes Payable in the above table, will generally also be higher than the inventory cost due to the timing of the sale of a vehicle and payment of the related 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 new vehicle floor plan notes are due when the related vehicle is sold. As such, these floor plan notes payable are shown as current liabilities in the accompanying consolidated balance sheets.

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     At December 31, 2003 and 2002, used vehicles were pledged to collateralize our used vehicle and working capital credit facility.

(4) Property, Plant and Equipment

     Property, plant and equipment consisted of the following (in thousands):

                 
December 31,
  2003
  2002
Buildings and improvements
  $ 93,455     $ 69,117  
Service equipment
    19,856       16,925  
Furniture, signs and fixtures
    56,742       53,277  
 
   
 
     
 
 
 
    170,053       139,319  
Less accumulated depreciation – buildings
    (5,683 )     (3,618 )
Less accumulated depreciation – equipment and other
    (18,315 )     (14,602 )
 
   
 
     
 
 
 
    146,055       121,099  
Land
    71,592       52,241  
Construction in progress, buildings
    5,312       956  
Construction in progress, other
    4,354       2,615  
 
   
 
     
 
 
 
  $ 227,313     $ 176,911  
 
   
 
     
 
 

(5) Goodwill and Other Intangible Assets

     The roll forward of goodwill is as follows (in thousands):

                 
Year Ended December 31,
  2003
  2002
Balance, beginning of year
  $ 185,212     $ 149,742  
Goodwill acquired and post acquisition adjustments
    25,156       35,860  
Goodwill written off
           
Goodwill included in gain or loss on disposal of franchises and discontinued operations
    (3,341 )     (390 )
 
   
 
     
 
 
Balance, end of year
  $ 207,027     $ 185,212  
 
   
 
     
 
 

     At December 31, 2003 and 2002, other intangible assets included the value of franchise agreements and non-compete agreements. The value attributed to franchise agreements has an indefinite useful life and non-compete agreements are amortized over the life of the agreements, typically 3 to 5 years. The gross amount of other intangible assets and the related accumulated amortization for non-compete agreements were as follows (in thousands):

                 
    December 31,
    2003
  2002
Franchise value
  $ 28,875     $ 20,903  
 
Non-compete agreements
    422       412  
Accumulated amortization
    (351 )     (330 )
 
   
 
     
 
 
Net non-compete agreements
    71       82  
 
   
 
     
 
 
Total other intangible assets, net
  $ 28,946     $ 20,985  
 
   
 
     
 
 

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     Amortization expense related to the non-compete agreements totaled $21,000 and $18,000, respectively, for the years ended December 31, 2003 and 2002. Amortization of non-compete agreements is as follows over the next five years (in thousands):

         
2004
  $ 23  
2005
    23  
2006
    22  
2007
    3  
2008
     

(6) Derivative Financial Instruments

     We have entered into interest rate swaps to manage the variability of our interest rate exposure, thus leveling a portion of our interest expense in a rising or falling rate environment.

     We have effectively changed the variable-rate cash flow exposure on a portion of our flooring debt to fixed-rate cash flows by entering into receive-variable, pay-fixed interest rate swaps. Under the interest rate swaps, we receive variable interest rate payments and make fixed interest rate payments, thereby creating fixed rate flooring debt.

     We do not enter into derivative instruments for any purpose other than to manage interest rate exposure. That is, we do not speculate using derivative instruments.

     As of December 31, 2003, we have outstanding the following interest rate swaps with U.S. Bank Dealer Commercial Services:

  effective September 1, 2000 – a five year, $25 million interest rate swap at a fixed rate of 6.88% per annum, variable rate adjusted on the 1st and 16th of each month

  effective January 26, 2003 – a five year, $25 million interest rate swap at a fixed rate of 3.265% per annum, variable rate adjusted on the 26th of each month

  effective February 18, 2003 – a five year, $25 million interest rate swap at a fixed rate of 3.30% per annum, variable rate adjusted on the 1st and 16th of each month

  effective November 18, 2003 – a five year, $25 million interest rate swap at a fixed rate of 3.65% per annum, variable rate adjusted on the 1st and 16th of each month

  effective November 26, 2003 – a five year, $25 million interest rate swap at a fixed rate of 3.63% per annum, variable rate adjusted on the 26th of each month

     We earn interest on all of the interest rate swaps at the one-month LIBOR rate. The one-month LIBOR rate at December 31, 2003 was 1.12% per annum.

     The fair value of our interest rate swap agreements represents the estimated receipts or payments that would be made to terminate the agreements. These amounts are recorded as deferred gains or losses in our consolidated balance sheet with the offset recorded in accumulated other comprehensive income, net of tax. The amount of deferred gains and (losses) at December 31, 2003 were $0 and $(2.4) million respectively. The difference between interest earned and the interest obligation results in a monthly settlement which is reclassified from accumulated other comprehensive income to the statement of operations as incremental flooring interest expense. The resulting cash settlement reduces the amount of deferred gains and losses. Because the critical terms of the interest rate swaps and the underlying debt obligations are the same, there was no ineffectiveness recorded in interest expense.

     If, in the future, the interest rate swap agreements were determined to be ineffective or were terminated before the contractual termination date, or if it became probable that the hedged variable cash flows associated with the variable rate borrowings would stop, we would be required to reclassify into earnings all or a portion of the deferred gains or losses on cash flow hedges included in accumulated other comprehensive income.

     At current interest rates, we estimate that we will incur additional interest expense, net of tax, of approximately $2.3 million related to our interest rate swaps during 2004.

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(7) Lines of Credit and Long-Term Debt

     We have a working capital and used vehicle flooring credit facility with DaimlerChrysler Services North America LLC totaling up to $200 million, which expires in February 2006, with interest due monthly. In December 2003, Toyota Motor Credit joined DaimlerChrysler in syndication on this credit facility. None of the terms of the credit facility were changed.

     The credit line with DaimlerChrysler Services is cross-collateralized and secured by cash and cash equivalents, new and used vehicle and parts inventories, accounts receivable, intangible assets and equipment. We pledged to DaimlerChrysler Services the stock of all of our subsidiaries except entities operating BMW, Honda, Nissan or Toyota stores.

     The financial covenants in our agreement with DaimlerChrysler Services require us to maintain compliance with, among other things, (i) a specified current ratio; (ii) a specified fixed charge coverage ratio; (iii) a specified interest coverage ratio; (iv) a specified adjusted leverage ratio; and (v) certain working capital levels. In addition, this agreement specifies that total dividends and repurchases of our common stock cannot exceed $18.0 million over the term of the agreement. To date, over the term of the agreement, we have paid dividends and repurchased stock totaling $2.8 million. This credit agreement expires February 2006.

     Toyota Motor Credit Corporation, Ford Motor Credit and General Motors Acceptance Corporation have agreed to floor all of our new vehicles for their respective brands with DaimlerChrysler Services and Toyota Motor Credit Corp. serving as the primary lenders for substantially all other brands. These new vehicle lines are secured by new vehicle inventory of the relevant brands.

     We also have a real estate line of revolving credit with Toyota Motor Credit totaling $40 million, which expires in May 2005. This line of credit is secured by the real estate financed under this line of credit.

     We also have an agreement with U.S. Bank N.A., which provides for a $35.0 million revolving line of credit for leased vehicles and equipment purchases and expires January 31, 2005. (See Note 18).

     Interest rates on all of the above facilities ranged from 2.62% to 3.87% at December 31, 2003. Amounts outstanding on the lines at December 31, 2003 together with amounts remaining available under such lines were as follows (in thousands):

                 
    Outstanding at   Remaining Availability as
    December 31, 2003
  of December 31, 2003
New and program vehicle lines
  $ 378,961     $   *
Working capital and used vehicle line
    117,000       83,000 **
Real estate line
    9,018       30,982  
Equipment/leased vehicle line
    35,000        
 
   
 
     
 
 
 
  $ 539,979     $ 113,982 *
 
   
 
     
 
 


*   There are no formal limits on the new and program vehicle lines with certain lenders.
 
**   As limited by the terms of the line regarding the borrowing base.

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     Long-term debt consisted of the following (in thousands):

                 
December 31,
  2003
  2002
Variable Rate Debt:
               
Equipment and leased vehicle line of credit, expiring January 31, 2005
  $ 35,000     $ 27,500  
Real estate line of credit payable with monthly payments of interest only, expiring May 2005; secured by land and buildings
    9,018       35,681  
Working capital and used vehicle flooring line of credit payable with monthly payments of interest only, expiring February 2006
    117,000       63,000  
Mortgages payable in monthly installments of $225, including interest between 2.92% and 5.16%, maturing fully January 2024; secured vehicles leased to others
    32,949       21,037  
Notes payable in monthly installments of $15 plus interest between 0.0% and 4.4%, maturing at various dates through 2004; secured by vehicles leased to others
    1,607       914  
Notes payable related to acquisitions, with interest rate of 4.0%, maturing February 2008
    481       625  
 
   
 
     
 
 
Total Variable Rate Debt
    196,055       148,757  
Fixed Rate Debt:
               
Mortgages payable in monthly installments of $353, including interest between 4.38% and 8.62%, maturing fully May 2022; secured by land and buildings
    49,837       19,192  
Notes payable related to acquisitions, with interest rates between 7.00% and 8.00%, maturing at various dates through November 2008
    3,141       4,221  
Capital lease obligations, net of interest of $0 and $1, respectively
          8  
 
   
 
     
 
 
Total Fixed Rate Debt
    52,978       23,421  
 
   
 
     
 
 
 
    249,033       172,178  
Less current maturities
    (14,299 )     (4,466 )
 
   
 
     
 
 
 
  $ 234,734     $ 167,712  
 
   
 
     
 
 

     The schedule of future principal payments on long-term debt after December 31, 2003 is as follows (in thousands):

         
Year Ending December 31,
       
2004
  $ 14,299  
2005
    5,648  
2006
    155,716  
2007
    11,858  
2008
    34,861  
Thereafter
    26,651  
 
   
 
 
Total principal payments
  $ 249,033  
 
   
 
 

(8) Stockholders’ Equity

     Class A and Class B Common Stock

     The shares of Class A common stock are not convertible into any other series or class of our securities. Each share of Class B common stock, however, 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 our stockholders 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 stockholders.

     In March 2002, we registered and sold 4.5 million newly issued shares of Class A common stock. Proceeds, net of offering expenses, totaled approximately $77.2 million. In connection with the sale, existing stockholders sold 1.25 million shares of Class A common stock and 121,488 shares of Class B common stock were converted into a like number of shares of Class A common stock.

     In September 2002, 156,000 Class B shares were converted into Class A shares.

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     Series M Redeemable, Convertible Preferred Stock

     In 1999, the Company authorized 15,000 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 10,360 shares of Series M Preferred Stock. The Series M Preferred Stock was convertible into Class A Common Stock at the option of the Company at any time and at the option of the holder under limited circumstances. The Series M Preferred Stock was redeemable at the option of the Company. The Series M Preferred Stock converted into Class A common stock based on a formula that divided the average Class A common stock price for a certain 15-day period into $1,000 and then multiplied by the number of Series M Preferred Stock being converted. The Series M Preferred Stock had a $1,000 per share liquidation preference.

     In the first quarter of 2000, the Company issued 303,542 shares of Class A common stock and 4,499 shares of Series M Preferred Stock in order to satisfy contingent payout requirements related to the Moreland acquisition.

     All shares of Series M Preferred Stock have been converted or redeemed and, as of December 31, 2003 and 2002, no shares of Series M Preferred Stock remained outstanding.

(9) Cost of Sales

     Cost of sales categorized by revenue category is as follows (in thousands):

                         
Year Ended December 31,
  2003
  2002
  2001
New vehicle sales
  $ 1,330,446     $ 1,114,885     $ 842,891  
Used vehicle sales
    642,443       643,712       502,976  
Service, body and parts
    132,653       112,434       92,487  
Finance and insurance
    276       459       732  
Fleet and other
    4,575       42,214       39,442  
 
   
 
     
 
     
 
 
 
  $ 2,110,393     $ 1,913,704     $ 1,478,528  
 
   
 
     
 
     
 
 

(10) Income Taxes

     Income tax expense from continuing operations for 2003, 2002 and 2001 was as follows (in thousands):

                         
Year Ended December 31,
  2003
  2002
  2001
Current:
                       
Federal
  $ 11,413     $ 14,033     $ 12,686  
State
    1,692       1,917       1,980  
 
   
 
     
 
     
 
 
 
    13,105       15,950       14,666  
 
   
 
     
 
     
 
 
Deferred:
                       
Federal
    9,406       4,008       (1,226 )
State
    1,050       522       (170 )
 
   
 
     
 
     
 
 
 
    10,456       4,530       (1,396 )
 
   
 
     
 
     
 
 
Total
  $ 23,561     $ 20,480     $ 13,270  
 
   
 
     
 
     
 
 

     At December 31, 2003, we had income taxes payable totaling $1.8 million and at December 31, 2002, we had income taxes receivable totaling $2.0 million.

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     Individually significant components of the deferred tax assets and liabilities are presented below (in thousands):

                 
December 31,
  2003
  2002
Deferred tax assets:
               
Allowance and accruals
  $ 4,189     $ 5,132  
Deferred revenue and cancellation reserves
    4,398       4,363  
 
   
 
     
 
 
Total deferred tax assets
    8,587       9,495  
 
   
 
     
 
 
Deferred tax liabilities:
               
LIFO recapture and acquired LIFO inventories differences
    (5,177 )     (3,356 )
Employee benefit plans
          (1,282 )
Goodwill
    (15,921 )     (11,392 )
Property and equipment, principally due to differences in depreciation
    (11,045 )     (6,591 )
 
   
 
     
 
 
Total deferred tax liabilities
    (32,143 )     (22,621 )
 
   
 
     
 
 
Total
  $ (23,556 )   $ (13,126 )
 
   
 
     
 
 

     In 2003, 2002 and 2001, income tax benefits attributable to employee stock option transactions of $138,000, $264,000 and $0, respectively, were allocated to stockholders’ equity.

     The reconciliation between amounts computed using the federal income tax rate of 35% and our income tax expense from continuing operations for 2003, 2002 and 2001 is shown in the following tabulation (in thousands):

                         
Year Ended December 31,
  2003
  2002
  2001
Computed “expected” tax expense
  $ 20,719     $ 18,494     $ 12,032  
State taxes, net of federal income tax benefit
    1,769       1,580       1,139  
Nondeductible goodwill
                454  
Other
    1,073       406       (355 )
 
   
 
     
 
     
 
 
Income tax expense
  $ 23,561     $ 20,480     $ 13,270  
 
   
 
     
 
     
 
 

(11) 401(k) Profit Sharing Plan

     We have a defined contribution 401(k) plan and trust covering substantially all full-time employees. The annual contribution to the plan is at the discretion of our Board of Directors. Contributions of $0.6 million, $0.9 million and $1.1 million were recognized for the years ended December 31, 2003, 2002 and 2001, respectively. Employees may contribute to the plan as they meet certain eligibility requirements.

(12) Stock Incentive Plans

     At our annual shareholders meeting in May 2003, our shareholders approved an amendment to and restatement of our 2001 Stock Option Plan in the form of the 2003 Stock Incentive Plan (the “2003 Plan”). The 2003 Plan allows for the granting of up to a total of 1.2 million incentive and nonqualified stock options and shares of restricted stock to our officers, key employees and consultants. We also have options outstanding and exercisable pursuant to their original terms pursuant to prior plans. Options canceled under prior plans do not return to the pool of options to be granted again in the future. All of the option plans are administered by the Compensation Committee of the Board and permit accelerated vesting of outstanding options upon the occurrence of certain changes in control. Options become exercisable over a period of up to ten years from the date of grant and at exercise prices as determined by the Board. At December 31, 2003, 1,985,123 shares of Class A common stock were reserved for issuance under the plans, of which 661,500 were available for future grant.

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     Activity under the plans is as follows (in thousands):

                         
    Shares        
    Available for   Shares Subject to   Weighted Average
    Grant
  Options
  Exercise Price
Balances, December 31, 2000
    244       1,189     $ 12.65  
Additional shares reserved
    600              
Option shares canceled upon approval of the 2001 Plan
    (244 )            
Options granted
    (275 )     275       19.24  
Options canceled
          (64 )     16.21  
Options exercised
          (27 )     8.78  
 
   
 
     
 
     
 
 
Balances, December 31, 2001
    325       1,373       14.02  
Additional shares reserved
    600              
Options granted
    (433 )     433       15.80  
Options canceled
    52       (173 )     17.00  
Options exercised
          (136 )     12.00  
 
   
 
     
 
     
 
 
Balances, December 31, 2002
    544       1,497       14.25  
Options granted
    (16 )     16       14.09  
Options canceled
    133       (151 )     16.54  
Options exercised
          (38 )     10.09  
 
   
 
     
 
     
 
 
Balances, December 31, 2003
    661       1,324     $ 14.10  
 
   
 
     
 
     
 
 

     The Board of Directors approved the issuance of non-qualified options during 2000 to certain members of senior management at an exercise price of $1.00 per share. These options were issued with five-year cliff vesting as a means to encourage long-term employment from certain members of the senior management group. Compensation expense, which is equal to the difference between the market price and the exercise price, is recognized ratably in accordance with the vesting schedules.

     The following table summarizes stock options outstanding at December 31, 2003:

                                         
Options Outstanding
  Options Exercisable
            Weighted            
    Number of   Average   Weighted   Number of   Weighted
    Shares   Remaining   Average   Shares   Average
Range of   Outstanding at   Contractual Life   Exercise   Exercisable at   Exercise
Exercise Prices
  12/31/03
  (years)
  Price
  12/31/03
  Price
$1.00
    87,662       6.3     $ 1.00       15,662     $ 1.00  
3.02
    85,055       0.3       3.02       85,055       3.02  
10.75
    14,000       1.2       10.75       14,000       10.75  
10.87 – 12.99
    188,864       6.5       11.89       97,154       11.95  
14.00 – 16.18
    374,253       7.7       15.09       94,004       14.90  
16.50 – 18.94
    342,989       5.1       16.93       178,775       17.02  
19.24 – 20.52
    230,800       7.8       19.35       42,600       19.33  
 
   
 
                     
 
         
$1.00 – $20.52
    1,323,623       6.2     $ 14.10       527,250     $ 12.99  
 
   
 
                     
 
         

     At December 31, 2002 and 2001, 399,810 and 400,533 shares were exercisable at weighted average exercise prices of $11.88 and $10.39, respectively.

     In 1998, the Board of Directors and the stockholders approved the implementation of an Employee Stock Purchase Plan (the “Purchase Plan”), and, as amended in May 2000, 2002 and 2003, have reserved a total of 1.5 million shares of Class A common stock for issuance thereunder. 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 invest up to 10 percent of their base pay for the purchase of stock up to $25,000 of fair market value of our Class A common stock annually. 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 375,988, 217,230 and 142,433 shares of our Class A common stock were issued under the Purchase Plan during 2003, 2002 and 2001, respectively, and 571,853 remained available for issuance at December 31, 2003.

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(13) Dividend Payments

     Our Board of Directors approved the following dividends on our Class A and Class B common stock in 2003:

                                         
    Quarter   Payable to                   Total
Month   dividend is   shareholders of           Amount   amount of
declared
  based on
  record on
  Date paid
  per share
  dividend
July 2003
  second   August 8, 2003   August 22, 2003   $ 0.07     $1.3 million
 
October 2003
  third   November 7, 2003   November 21, 2003   $ 0.07     $1.3 million

(14) Commitments and Contingencies

     Recourse Contracts

     We are contingently liable to banks on certain finance contracts that maintain a recourse guarantee. Although we don’t typically engage in these contracts in our normal course of business, we have assumed this type of contract with certain acquisitions. The contingent liability, net of reserves, at December 31, 2003 and 2002 was approximately $0 and $300,000, respectively.

     Our 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. However, most of these contracts are even further limited by an established dollar threshold. Based upon historical loss percentages, an estimated loss reserve of $15,000 and $443,000 is reflected in our consolidated balance sheets as of December 31, 2003 and 2002, respectively.

     Leases

     We lease certain of our facilities under non-cancelable operating leases. These leases expire at various dates through 2030. 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 Items for all Urban Consumers” published by the U.S. Department of Labor.

     The minimum lease payments under the operating leases after December 31, 2003 are as follows (in thousands):

         
Year Ending December 31,
       
2004
  $ 19,975  
2005
    19,429  
2006
    18,602  
2007
    17,673  
2008
    16,687  
Thereafter
    54,784  
 
   
 
 
Total minimum lease payments
  $ 147,150  
 
   
 
 

     Rental expense for all operating leases was $19.3 million, $17.8 million and $15.1 million for the years ended December 31, 2003, 2002 and 2001, respectively.

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     Primarily in connection with dispositions of dealerships, we occasionally assign or sublet our interests in any real property leases associated with such dealerships to the purchaser. We often retain responsibility for the performance of certain obligations under such leases to the extent that the assignee or sublessee does not perform, whether such performance is required prior to or following the assignment of subletting of the lease. Additionally, we generally remain subject to the terms of any guarantees made by us in connection with such leases. However, we generally have indemnification rights against the assignee or sublessee in the event of non-performance, as well as certain other defenses. We presently have no reason to believe that we will be called upon to perform under any such assigned leases or subleases. Lease rental payments under assigned or sublet leases for their remaining terms totaled approximately $5.4 million at December 31, 2003. We may also be called upon to perform other obligations under these leases, such as environmental remediation of the premises or repairs upon termination of the lease. Although we currently have no reason to believe that we will be called upon to perform any such services, there can be no assurance that any future performance required by us under these leases will not have a material adverse effect on our financial condition or results of operations.

Capital Commitments

     We had capital commitments of $5.2 million at December 31, 2003 for the construction of one new store facility and additions to three existing facilities and the remodel of four facilities. The new facility will be a Hyundai store in Anchorage, Alaska. We have already incurred $7.5 million for these projects, with the remaining $5.2 million expected to be spent in 2004. We expect to pay for the construction out of existing cash balances until completion of the projects, at which time we anticipate securing long-term financing and general borrowings from third party lenders for 70% to 90% of the amounts expended.

Litigation

     We are party to numerous legal proceedings arising in the normal course of our business. While we cannot predict with certainty the outcomes of these matters, we do not anticipate that the resolution of these proceedings will have a material adverse effect on our business, results of operations, financial condition, or cash flows.

(15) Related Party Transactions

     Mark DeBoer Construction

     During 2003, 2002 and 2001, Lithia Real Estate, Inc. paid Mark DeBoer Construction, Inc. $1.6 million, $4.3 million, and $7.9 million, respectively, for remodeling certain of our facilities. Mark DeBoer is the son of Sidney B. DeBoer, our Chairman and Chief Executive Officer. These amounts included $0.9 million, $3.5 million, and $7.1 million, respectively, paid for subcontractors and materials, $102,000, $183,000 and $16,000, respectively for permits, licenses, travel and various miscellaneous fees, and $638,000, $558,000, and $780,000, respectively, for contractor fees. In 2003, we paid more of the subcontractors directly, which reduced the overall payments to Mark DeBoer Construction, Inc. We believe the amounts paid are fair in comparison with fees negotiated with independent third parties and all significant transactions are reviewed and approved by our independent audit committee.

     W. Douglas Moreland

     In May 1999, we purchased certain dealerships owned by W. Douglas Moreland for total consideration of approximately $66.0 million, at which time, Mr. Moreland became a member of our Board of Directors. During the normal course of business, these dealerships paid $1.1 million and $2.5 million in 2002 and 2001, respectively, to other companies owned by Mr. Moreland for vehicle purchases, recourse paid to a financial lender and management fees. We also paid rental expense of $2.6 million and $3.0 million in 2002 and 2001, respectively, to other companies owned by Mr. Moreland. As of October 31, 2002, Mr. Moreland was no longer a member of our Board of Directors.

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(16) Acquisitions

     The following acquisitions were made in 2003:

  In February 2003, we acquired Richardson Chevrolet in Salinas, California, which has anticipated 2003 annual revenues of approximately $35.0 million. This store has been renamed Chevrolet of Salinas.

  In March 2003, we acquired Pacific Hyundai of Anchorage, Alaska, which has anticipated 2003 revenues of approximately $10.0 million. The store has been renamed Lithia Hyundai of Anchorage.

  In March 2003, we acquired Randy Hansen Chevrolet of Twin Falls, Idaho, which has anticipated 2003 annual revenues of approximately $30.0 million. The store has been renamed Chevrolet Cadillac of Twin Falls.

  In April 2003, we acquired Grizzly Chrysler Dodge of Missoula, Montana, which has anticipated 2003 revenues of approximately $25.0 million. The store has been renamed Lithia Auto Center of Missoula.

  In May 2003, we acquired Expressway Dodge of Broken Arrow, Oklahoma, which has anticipated 2003 revenues of approximately $40.0 million. The store has been renamed Lithia Dodge of Broken Arrow.

  In June 2003, we acquired Midland Dodge of Billings, Montana, which has anticipated 2003 revenues of approximately $35.0 million. The store has been renamed Lithia Dodge of Billings.

  In August 2003, we acquired Mercedes Benz of Spokane, Washington, which has anticipated 2003 revenues of approximately $20.0 million. The store has been renamed Mercedes-Benz of Spokane.

  In August 2003, we acquired Santa Rosa Dodge in California, which has anticipated 2003 revenues of approximately $30.0 million. The store has been renamed Lithia Dodge of Santa Rosa.

  In October 2003, we acquired Chevrolet Cadillac of Fairbanks, Alaska, which has anticipated 2003 revenues of approximately $15.0 million. The store name will remain the same; and

  In October 2003, we acquired Grapevine Dodge in Grapevine, Texas, which has anticipated 2003 revenues of approximately $70.0 million. The store has been renamed Lithia Dodge of Grapevine.

  In November 2003, we acquired Fairfield Dodge in Fairfield, California, which has anticipated 2003 revenues of approximately $20.0 million. The store has been renamed Lithia Dodge of Fairfield.

     The following acquisitions were made in 2002:

  In January 2002, we acquired the Lynn Alexander Auto Group, which is comprised of All American Chrysler/Jeep/Dodge and All American Chevrolet located in San Angelo, Texas and All American Chrysler/Jeep/Dodge in Big Spring, Texas. The stores had anticipated 2002 annual revenues of $115.0 million.

  In January 2002, we acquired Premier Chrysler/Jeep/Dodge in Odessa, Texas, which had anticipated 2002 annual revenues of $33.0 million.

  In February 2002, we acquired Thomason Subaru in Oregon City, Oregon, which had anticipated 2002 annual revenues of $20.0 million. The store has been renamed Lithia Subaru of Oregon City.

  In April 2002, we acquired Village Dodge-Hyundai in Midland, Texas, which had anticipated 2002 annual revenues of $35.0 million.

  In May 2002, we opened a newly awarded Hummer franchise in Bellevue, Washington.

  In June 2002, we acquired Jay Wolfe Ford in Omaha, Nebraska, which had anticipated 2002 annual revenues of $55.0 million.

  In June 2002, we acquired Broncho Chevrolet in Odessa, Texas and Sherman Chevrolet in Midland, Texas. The stores had combined anticipated 2002 revenues of $115.0 million. The stores were renamed Chevrolet of Odessa and Chevrolet of Midland, respectively.

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  In July 2002, we acquired Mercedes of Omaha in Omaha, Nebraska, which had anticipated 2002 revenues of $22.0 million.
 
  In August 2002, we acquired Skyline Volkswagen in a suburb of Denver, Colorado, which had anticipated 2002 revenues of $20.0 million.
 
  In December 2002, we acquired Les Vogel Chrysler/Dodge/Jeep in Burlingame, California which had anticipated 2002 revenues of $32.0 million.
 
  In December of 2002, we acquired Sound Hyundai in Renton, Washington which had anticipated 2002 revenues of $8.0 million.

     The following acquisitions were made in 2001:

  In January 2001, we acquired the Johnson Chrysler/Jeep store in Anchorage, Alaska, which had estimated 2000 revenues of approximately $35.0 million.
 
  In February 2001, we acquired two stores in Pocatello, Idaho with the Honda, Dodge/Chrysler and Hyundai brands, which had combined estimated 2000 revenues of approximately $48.0 million.
 
  In July 2001, we acquired Barton Cadillac in Spokane Washington, which was added to Lithia Camp Chevrolet. Barton Cadillac had estimated 2000 revenues of approximately $18.0 million.
 
  In August 2001, we acquired the Lanny Berg Chevrolet store in Caldwell, Idaho, which had anticipated 2001 annual revenues of approximately $22.0 million.
 
  In September 2001, we acquired Ted Tuffy Dodge in Sioux Falls, South Dakota, which had anticipated 2001 annual revenues of approximately $35.0 million.
 
  In September 2001, we acquired BMW of Seattle in Seattle, Washington, which had anticipated 2001 annual revenues of approximately $60.0 million.
 
  In November 2001, Lithia acquired Issaquah Chevrolet in Issaquah, Washington, which had anticipated 2001 annual revenues of approximately $50.0 million.

     In addition to the above acquisitions, in August 2001, we completed the construction of and opened Lithia Dodge of Anchorage.

     The above acquisitions were all accounted for under the purchase method of accounting. Pro forma results of operations assuming all of the above acquisitions occurred at the beginning of the respective periods are as follows (in thousands, except per share amounts).

                         
Year Ended December 31,
  2003
  2002
  2001
Total revenues
  $ 2,756,686     $ 2,726,323     $ 2,232,474  
Net income
    36,9532       34,228       23,620  
Basic earnings per share
    2.02       1.99       1.77  
Diluted earnings per share
    1.99       1.94       1.74  

     There are no future contingent payouts related to any of the above acquisitions and no portion of the purchase price was paid with our equity securities. The purchase price for the above acquisitions was allocated as follows (in thousands):

                         
Year Ended December 31,
  2003
  2002
  2001
Inventory
  $ 53,441     $ 63,192     $ 36,163  
Other current assets
    1,652       5,692       207  
Property and equipment
    23,081       24,637       4,452  
Goodwill
    24,656       30,195       22,825  
Other intangible assets — primarily franchise value
    7,982       13,796       7,107  
Other non-current assets
          100        
 
   
 
     
 
     
 
 
Total assets acquired
    110,812       137,612       70,754  
Flooring notes payable
    45,884       49,225       25,351  
Other current liabilities
    1,252       1,694       49  
Other non-current liabilities
    324       2,548       174  
 
   
 
     
 
     
 
 
Total liabilities acquired
    47,460       53,467       25,574  
 
   
 
     
 
     
 
 
Net assets acquired
  $ 63,352     $ 84,145     $ 45,180  
 
   
 
     
 
     
 
 

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     Within one year from the purchase date, we may update the value allocated to purchased assets and the resulting goodwill balances for new information received regarding the valuation of such assets.

(17) Recent Accounting Pronouncements

     In July 2002, the FASB approved SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including restructuring, or with a disposal of long-lived assets. Exit activities include, but are not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating plant facilities or personnel. SFAS No. 146 specifies that a company will record a liability for a cost associated with an exit or disposal activity only when that liability is incurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expresses only management’s intended future actions and, therefore, does not meet the requirement for recognizing a liability and the related expense. SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. The adoption of SFAS No. 146 on January 1, 2003 did not have any effect on our financial position or results of operations.

     The FASB’s Emerging Issues Task Force (EITF) finalized EITF 00-21 “Accounting for Multiple Element Arrangements” in November 2002. EITF 00-21 requires arrangements with multiple elements to be broken out as separate units of accounting based on their relative fair values. Revenue for a separate unit of accounting should be recognized only if the amount due can be reliably measured and the earnings process is substantially complete. Any units that can not be separated must be accounted for as a combined unit. Our accounting policy is consistent with EITF 00-21 and therefore, the adoption on January 1, 2003 did not have any effect on our financial position or results of operations.

     In March 2003, the EITF issued EITF 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” EITF 02-16 primarily applies to floorplan interest credits and advertising credits received by us from auto manufacturers and specifies the timing of and appropriate classification of such items in our statement of operations. We recognize floorplan interest credits and advertising credits that are tied to specific vehicles as a reduction to the carrying value of the specific inventory and ultimately as a reduction to cost of goods sold as related vehicles are sold and we recognize other advertising credits as a credit to advertising expense. The adoption of EITF 02-16 on January 1, 2003 resulted in the reclassification of certain expenses, but did not have any effect on our net income or financial position (see Note 14).

     In May 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 addresses certain accounting issues related to hedging activity and derivative instruments embedded in other contracts. In general, the amendments require contracts with comparable characteristics to be accounted for similarly. In addition, SFAS No. 149 provides guidance as to when a financing component of a derivative must be given special reporting treatment in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on our financial position or results of operations.

     In May 2003, the FASB approved SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 establishes standards for how to classify and measure financial instruments with characteristics of both liabilities and equity. It requires financial instruments that fall within its scope to be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and, for pre-existing financial instruments, as of July 1, 2003. We do not have any financial instruments that fall under the guidance of SFAS No. 150 and, therefore, the adoption did not have any effect on our financial position or results of operations.

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     In December 2003, the FASB issued Interpretation No. 46R (FIN 46R), “Consolidation of Variable Interest Entities,” which replaces FIN 46. FIN 46R clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46R applies to variable interest entities (VIE’s) created after December 31, 2003, and to VIE’s in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period ending after December 15, 2004 to VIE’s in which an enterprise holds a variable interest that it acquired before January 1, 2004. We do not have any VIEs and, therefore, the adoption of FIN 46R will not have any effect on our financial position, results of operations or cash flows.

     In December 2003, the SEC issued Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104), which updates the previously issued revenue recognition guidance in SAB 101, based on the Emerging Issues Task Force Issue 00-21, Revenue Arrangements with Multiple Deliverables. If the deliverables in a sales arrangement constitute separate units of accounting according to the EITF’s separation criteria, the revenue-recognition policy must be determined for each identified unit. If the arrangement is a single unit of accounting under the separation criteria, the revenue-recognition policy must be determined for the entire arrangement. The issuance of SAB 104 has not had any impact on our financial position, results of operations or cash flow.

(18) Subsequent Events

     Dividend

     In January 2004, our Board of Directors approved a dividend on our Class A and Class B common stock of $0.07 per share for the fourth quarter of 2003. The dividend, which will total approximately $1.3 million, will be paid on March 19, 2004 to shareholders of record on March 5, 2004.

     Acquisition

     In January 2004, we acquired one Chrysler and Jeep store in Reno, Nevada, which has anticipated annual revenues of approximately $55.0 million. The store has been renamed Lithia Chrysler Jeep of Reno.

     U.S. Bank Agreement

     In February 2004, our U.S. Bank N.A. agreement was amended to provide for a $50.0 million revolving line of credit for leased vehicles and equipment purchases, which expires January 31, 2006. Previously, the amount available under this line of credit was $35.0 million and it was set to expire January 31, 2005.

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