UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-K/A

Amendment No. 1

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

For the Fiscal Year Ended: December 31, 2005

o 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		93-0572810
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

360 E. Jackson Street, Medford, Oregon		97501
(Address of principal executive offices)		(Zip Code)

541-776-6899

(Registrant’s telephone number including area code)

Securities registered pursuant to Section 12(b) of the Act:

Class A common stock, without par value

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

(Title of Class)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:

Yes o No x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act: o

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 o

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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer x Non-accelerated filer o

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant was $432,119,137, computed by reference to the last sales price ($28.85) 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, 2005).

The number of shares outstanding of the Registrant’s common stock as of March 1, 2006 was: Class A: 15,726,772 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 2006 Annual Meeting of Shareholders.

EXPLANATORY NOTE

This Amendment No. 1 on Form 10-K/A amends our annual report on Form 10-K for the year ended December 31, 2005, which was filed on March 8, 2006.

The amendment is a result of the restatement of our consolidated financial statements for the years ended December 31, 2001, 2002, 2003, 2004 and 2005. The amendment is also being made to revise unaudited quarterly financial information for the quarters ended 2005 and 2004.

We are restating our previously reported financial information for these periods to correct an error in those financial statements relating to our derivative accounting under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities.” In addition, we are restating for other errors that were previously deemed to be immaterial. The restatements are described in more detail in Note 2 of Notes to Consolidated Financial Statements included elsewhere in this report.

We also will be filing amended Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2006 and June 30, 2006 to reflect the restatements, which include comparative quarterly information for comparable periods in 2005.

We have amended each item of our Annual Report on Form 10-K for the year ended December 31, 2005 that has been affected by the restatement. This Amendment No. 1 does not reflect events occurring after the March 8, 2006 filing of our Form 10-K or modify or update the disclosures set forth therein in any way, except as required to reflect the effects of the restatement.

We have reassessed our disclosure controls and procedures as shown in Item 9A related to the material weakness in our internal control over financial reporting with respect to accounting for derivative instruments and the application of hedge accounting under the “short cut” method.

LITHIA MOTORS, INC.

2005 FORM 10-K/A ANNUAL REPORT

TABLE OF CONTENTS

		PART II

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 Data

Item 9A.		Controls and Procedures

		PART IV

Item 15.		Exhibits and Financial Statement Schedules

Signatures

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,” Note 2 “Restated Results of Operations and Balance Sheets” of 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, (1)
(In thousands, except per share amounts)	2005			2004			2003			2002			2001
	(Restated)			(Restated)			(Restated)			(Restated)			(Restated)
Consolidated Statement of Operations Data:
Revenues:
New vehicle	$	1,676,607		$	1,541,102		$	1,407,874		$	1,218,364		$	926,981
Used vehicle	816,963			736,694			717,474			716,061			564,352
Finance and insurance	109,408			96,990			85,845			75,163			59,302
Service, body and parts	309,494			280,894			244,858			215,600			172,626
Fleet and other	22,947			7,680			6,539			44,247			43,003
Total revenues	2,935,419			2,663,360			2,462,590			2,269,435			1,766,264
Cost of sales	2,429,814			2,215,143			2,068,615			1,912,370			1,477,492
Gross profit	505,605			448,217			393,975			357,065			288,772
Selling, general and administrative	370,991			338,256			307,514			281,826			226,131
Depreciation and amortization(2)	14,234			12,750			9,475			7,192			8,690
Income from operations	120,380			97,211			76,986			68,047			53,951
Floorplan interest expense	(18,533		)	(12,517		)	(12,065		)	(11,475		)	(17,039		)
Other interest expense	(12,030		)	(8,873		)	(6,055		)	(5,985		)	(7,546		)
Other income, net	1,178			919			1,094			1,203			882
Income from continuing operations before income taxes	90,995			76,740			59,960			51,790			30,248
Income taxes	(35,375		)	(29,725		)	(23,816		)	(20,072		)	(11,676		)
Income from continuing operations	55,620			47,015			36,144			31,718			18,572
Income (loss) from discontinued operations, net of tax	(1,993		)	(1,403		)	(269		)	(45		)	646
Net income	$	53,627		$	45,612		$	35,875		$	31,673		$	19,218
Basic income per share from continuing operations	$	2.90		$	2.50		$	1.98		$	1.84		$	1.39
Basic income (loss) per share from discontinued operations	(0.10		)	(0.07		)	(0.02		)	0.00			0.05
Basic net income per share	$	2.80		$	2.43		$	1.96		$	1.84		$	1.44
Shares used in basic per share	19,175			18,773			18,289			17,233			13,371
Diluted income per share from continuing operations	$	2.64		$	2.34		$	1.95		$	1.80		$	1.36
Diluted income (loss) per share from discontinued operations	(0.10		)	(0.07		)	(0.02		)	0.00			0.05
Diluted net income per share	$	2.54		$	2.27		$	1.93		$	1.80		$	1.41
Shares used in diluted per share	21,807			20,647			18,546			17,598			13,612

	As of December 31,
(In thousands)	2005		2004		2003		2002		2001
	(Restated)		(Restated)		(Restated)		(Restated)		(Restated)
Consolidated Balance Sheet Data:
Working capital	$	156,446	$	124,277	$	158,682	$	125,637	$	104,379
Inventories	606,047		535,347		444,130		445,743		275,285
Total assets	1,452,714		1,255,720		1,101,767		942,049		662,944
Flooring notes payable	530,452		450,860		435,229		427,635		280,947
Current maturities of long-term debt	6,868		6,565		14,299		4,466		10,203
Long-term debt, less current maturities	290,551		267,310		178,467		104,712		95,830
Total stockholders’ equity	460,231		405,246		357,542		319,323		203,041
Cash dividends declared per common share	0.44		0.31		0.21		—		—

(1)		For detail of the restatements, see Note 2 of Notes to Consolidated Financial Statements included in Item 8. of this report.
(2)		Depreciation and amortization expense in 2001 includes $3.7 million of goodwill amortization, compared to none in the other years.

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

Forward Looking Statements

Some of the statements under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-K/A 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/A 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 Item 1A. to our 2005 Form 10-K, which was filed with the Securities and Exchange Commission on March 8, 2006.

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.

Overview

We are restating our previously reported financial information as of and for the years ended December 31, 2005, 2004 and 2003 to correct an error in those financial statements relating to our derivative accounting under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” In addition, we are restating for other errors that were previously deemed to be immaterial.

We account for our derivative financial instruments in accordance with SFAS No. 133 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. From inception of the hedging program, we applied a method of cash flow hedge accounting under SFAS No. 133 to account for the interest rate swap transactions that allowed us to assume the effectiveness of such transactions (the so-called “short-cut” method). We recently concluded that the interest rate swap transactions did not qualify for the “short-cut” method in prior periods because of the prepayment clauses in the debt agreements. Furthermore, although management believes that the interest rate swaps would have qualified for hedge accounting under SFAS No. 133, hedge accounting under SFAS No. 133 is not allowed retrospectively because the hedge documentation was not in place at the inception of the hedge. Eliminating the application of cash flow hedge accounting reverses the fair value adjustments that were made on our balance sheet in other comprehensive income into floorplan interest expense on our income statement.

Although the swaps do not retrospectively qualify for hedge accounting under SFAS No. 133, there is no effect on cash flows from operating, investing or financing activities for these changes. The effectiveness of the swaps as hedge transactions has not been affected by these changes in accounting treatment.

Our acquisition 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 nine 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 experienced and well-trained staff are all available to facilitate our continued growth as the opportunities develop.

In keeping with this model, we acquired a total of eight stores and twenty-four additional franchises from January 1, 2005 through March 6, 2006 with total estimated annual revenues of nearly $356 million.

Historically, new vehicle sales have accounted for over half of our total revenues but less than one-third of total gross profit. We use a volume-based strategy for new vehicle sales called “Promo Pricing,” that complements the goal of most auto manufacturers, which have continued to offer a high level of cash or other incentives to automotive customers.

For 2006, we expect that manufacturers will continue to offer incentives on new vehicle sales through a combination of repricing strategies, rebates, early lease cancellation programs and low interest rate loans to consumers.

In 2006, we will be introducing a new initiative under which all sales personnel will have interactive personal computers, which will allow the salesperson to quickly and efficiently enter data and interact with the customer to speed up the sales process. Vehicle and customer information will immediately be downloaded onto the appropriate forms necessary to complete the sales process, eliminating, over time, the need for paperwork to be done by hand. The goal of this initiative is to create a simplified and more efficient process for both the salesperson and the customer, speeding up the sales process and improving the customer’s experience. This initiative will be used for both new and used vehicle sales.

Since the beginning of 2002, the used vehicle market has been negatively impacted by strong competition from the new vehicle market, which has benefited from heavy manufacturer incentives in the form of cash rebates, discounted pricing and low interest financing. In the first quarter of 2005, the used vehicle market showed positive signs as a result of constrained industry supply, which led to improvements in retail pricing and margins. In the second and third quarters of 2005, we experienced an increase in trade-ins of quality used vehicles in connection with the domestic manufacturers “employee pricing” programs. We received these trade-ins at good valuations and, in the fourth quarter of 2005, we had a strong used vehicle cycle as we sold much of what we brought into inventory in the previous quarters. We have implemented new procedures in the used vehicle business, which have also demonstrated positive results for our used vehicle business:

· We conduct our own local used vehicle auctions in select markets and manage the disposal of used vehicles at larger auctions. The process is centralized and controlled at the management level.

· We utilize a “Used Vehicle Promo Pricing” strategy, which markets vehicles with a $99 down payment and then groups vehicles by payment level. Vehicles are marked with clear and understandable pricing, which reduces haggling and speeds up the sale process. This strategy clearly addresses the three biggest issues of price, down payment and monthly payment for our customers and our sales personnel.

In addition, as a complement to our ongoing used vehicle operation at each store, we use specialists in our support services group to increase the acquisition of used vehicles. We believe that this will help bolster sales volumes in the 3 to 7 year old vehicle market.

Results of Continuing Operations

Certain revenue, gross profit margin and gross profit information by product line was as follows for 2005, 2004 and 2003:

2005 (Restated)	Percent of Total Revenues		Gross Profit Margin		Percent of Total Gross Profit
New vehicle	57.1	%	8.0	%	26.5	%
Used vehicle(1)	27.9		13.4		21.8
Finance and insurance(2)	3.7		100.0		21.6
Service, body and parts	10.5		48.7		29.8
Fleet and other	0.8		6.4		0.3

2004 (Restated)	Percent of Total Revenues		Gross Profit Margin		Percent of Total Gross Profit
New vehicle	57.9	%	7.9	%	27.0	%
Used vehicle(1)	27.7		12.7		20.9
Finance and insurance(2)	3.6		100.0		21.6
Service, body and parts	10.5		48.3		30.2
Fleet and other	0.3		15.9		0.3

2003 (Restated)	Percent of Total Revenues		Gross Profit Margin		Percent of Total Gross Profit
New vehicle	57.2	%	7.6	%	27.2	%
Used vehicle(1)	29.1		11.6		21.0
Finance and insurance(2)	3.5		100.0		21.8
Service, body and parts	9.9		47.3		29.4
Fleet and other	0.3		34.4		0.6

(1) Includes retail and wholesale used vehicles.

(2) Reported net of anticipated cancellations.

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

	Year Ended December 31,
Lithia Motors, Inc. (1)	2005		2004		2003
	(Restated)		(Restated)		(Restated)
Revenues:
New vehicle	57.1	%	57.9	%	57.2	%
Used vehicle	27.9		27.7		29.1
Finance and insurance	3.7		3.6		3.5
Service, body and parts	10.5		10.5		9.9
Fleet and other	0.8		0.3		0.3
Total revenues	100.0	%	100.0	%	100.0	%
Gross profit	17.2		16.8		16.0
Selling, general and administrative expenses	12.6		12.7		12.5
Depreciation and amortization	0.5		0.5		0.4
Income from continuing operations	4.1		3.6		3.1
Floorplan interest expense	0.6		0.5		0.5
Other interest expense	0.4		0.3		0.2
Other income, net	0.0		0.0		0.0
Income from continuing operations before taxes	3.1		2.9		2.4
Income tax expense	1.2		1.1		1.0
Income from continuing operations	1.9	%	1.8	%	1.5	%

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

The following tables set forth the changes in our operating results from continuing operations in 2005 compared to 2004 and in 2004 compared to 2003:

	Year Ended December 31,						Increase		% Increase
(In Thousands)	2005			2004			(Decrease)		(Decrease)
	(Restated)			(Restated)
Revenues:
New vehicle	$	1,676,607		$	1,541,102		$	135,505	8.8	%
Used vehicle	816,963			736,694			80,269		10.9
Finance and insurance	109,408			96,990			12,418		12.8
Service, body and parts	309,494			280,894			28,600		10.2
Fleet and other	22,947			7,680			15,267		198.8
Total revenues	2,935,419			2,663,360			272,059		10.2
Cost of sales:
New vehicle	1,542,458			1,420,035			122,423		8.6
Used vehicle	707,096			643,298			63,798		9.9
Service, body and parts	158,792			145,349			13,443		9.2
Fleet and other	21,468			6,461			15,007		232.3
Total cost of sales	2,429,814			2,215,143			214,671		9.7
Gross profit	505,605			448,217			57,388		12.8
Selling, general and administrative	370,991			338,256			32,735		9.7
Depreciation and amortization	14,234			12,750			1,484		11.6
Income from operations	120,380			97,211			23,169		23.8
Floorplan interest expense	(18,533		)	(12,517		)	6,016		48.1
Other interest expense	(12,030		)	(8,873		)	3,157		35.6
Other expense, net	1,178			919			259		28.2
Income from continuing operations before income taxes	90,995			76,740			14,255		18.6
Income tax expense	(35,375		)	(29,725		)	5,650		19.0
Income from continuing operations	$	55,620		$	47,015		$	8,605	18.3	%

	Year Ended December 31,				Increase			% Increase
	2005		2004		(Decrease)			(Decrease)

New units sold	59,956		54,839		5,117			9.3	%
Average selling price per new vehicle	$	27,964	$	28,102	$	(138	)	(0.5	)%

Used units sold	67,455		63,172		4,283			6.8	%
Average selling price per used vehicle	$	12,111	$	11,662	$	449		3.9	%

Finance and insurance sales per retail unit	$	1,059	$	1,014	$	45		4.4	%

	Year Ended December 31,						Increase			% Increase
(In Thousands)	2004			2003			(Decrease)			(Decrease)
	(Restated)			(Restated)
Revenues:
New vehicle	$	1,541,102		$	1,407,874		$	133,228		9.5	%
Used vehicle	736,694			717,474			19,220			2.7
Finance and insurance	96,990			85,845			11,145			13.0
Service, body and parts	280,894			244,858			36,036			14.7
Fleet and other	7,680			6,539			1,141			17.4
Total revenues	2,663,360			2,462,590			200,770			8.2
Cost of sales:
New vehicle	1,420,035			1,300,865			119,170			9.2
Used vehicle	643,298			634,525			8,773			1.4
Service, body and parts	145,349			128,935			16,414			12.7
Fleet and other	6,461			4,290			2,171			50.6
Total cost of sales	2,215,143			2,068,615			146,528			7.1
Gross profit	448,217			393,975			54,242			13.8
Selling, general and administrative	338,256			307,514			30,742			10.0
Depreciation and amortization	12,750			9,475			3,275			34.6
Income from operations	97,211			76,986			20,225			26.3
Floorplan interest expense	(12,517		)	(12,065		)	452			3.7
Other interest expense	(8,873		)	(6,055		)	2,818			46.5
Other expense, net	919			1,094			(175		)	(16.0	)
Income from continuing operations before income taxes	76,740			59,960			16,780			28.0
Income tax expense	(29,725		)	(23,816		)	5,909			24.8
Income from continuing operations	$	47,015		$	36,144		$	10,871		30.1	%

	Year Ended December 31,				Increase			% Increase
	2004		2003		(Decrease)			(Decrease)
New units sold	54,839		52,605		2,234			4.2	%
Average selling price per new vehicle	$	28,102	$	26,763	$	1,339		5.0	%

Used units sold	63,172		66,537		(3,365		)	(5.1	)%
Average selling price per used vehicle	$	11,662	$	10,783	$	879		8.2	%

Finance and insurance sales per retail unit	$	1,014	$	918	$	96		10.5	%

Revenues

Total revenues increased 10.2% and 8.2%, respectively, in 2005 compared to 2004 and in 2004 compared to 2003.

The increase in 2005 compared to 2004 was primarily a result of acquisitions and a 1.8% increase in same-store sales, which was driven by an increase in units sold. The increase in same store sales was driven by same-store sales increases across all business lines. The “employee pricing” programs offered by the domestic manufacturers during the second and third quarters of 2005, as well as a mix shift away from trucks and SUVs, resulted in a decrease in average selling prices which led to increases in new units sold, the combination of which resulted in higher same-store new vehicle sales. The same programs also contributed to improvements in same-store used vehicle sales due to the large number of good quality used vehicle trade-ins associated with the high volume of new vehicle purchases.

The increase in 2004 compared to 2003 was primarily a result of acquisitions, as well as increases in the average new and used vehicle sales prices in 2004 compared to 2003. The 2004 increase was offset in part by a same-store sales decline of 2.4%. Our new vehicle same store sales were down in 2004 compared to 2003 because of a slower sales environment in our markets and a difficult comparison from the prior year, which experienced a 6.2% increase. Used vehicle same store sales were negatively

affected in 2004 compared to 2003 due to continued manufacturer incentives on new vehicles which led to continued weakness in the used vehicle market.

Same-store sales percentage increases (decreases) were as follows:

	2005 compared to 2004		2004 compared to 2003
New vehicle retail, excluding fleet	0.8	%	(1.9	)%
Used vehicle, including wholesale	3.8		(5.8	)
Total vehicle sales, excluding fleet	1.8		(3.2	)
Finance and insurance	1.4		2.0
Service, body and parts	2.5		3.3
Total sales, excluding fleet	1.8		(2.4	)

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

Penetration rates for certain products were as follows:

	2005		2004		2003
Finance and insurance	76	%	77	%	75	%
Service contracts	43		43		41
Lifetime oil change and filter	38		36		34

The decrease in the finance and insurance penetration rate in 2005 compared to 2004 was due to reduced availability of manufacturer subsidized low-interest rate loans during the second and third quarters of 2005 when the manufacturers offered their employee pricing programs.

The improvements in same-store service, body and parts revenue in both 2005 compared to 2004 and in 2004 compared to 2003 were a result of our continued focus on service-advisor training and our Lifetime Oil Program. In addition, pricing and cost saving initiatives across the service, body and parts business lines contributed to the improvement in 2005 compared to 2004.

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.

Gross Profit

Gross profit increased $57.4 million in 2005 compared to 2004 and increased $54.2 million in 2004 compared to 2003 due primarily to increased total revenues, as well as increases in our overall gross profit margin.

Gross profit margins achieved were as follows:

	Year Ended December 31,				Lithia
(Restated)	2005		2004		Margin Change*
New vehicle	8.0	%	7.9	%	10	bp
Retail used vehicle	15.7		14.5		120
Wholesale used vehicles	2.7		3.1		(40	)
Finance and insurance	100.0		100.0		0
Service, body and parts	48.7		48.3		40
Overall	17.2		16.8		40

	Year Ended December 31,				Lithia
(Restated)	2004		2003		Margin Change*
New vehicle	7.9	%	7.6	%	30	bp
Retail used vehicle	14.5		14.0		50
Wholesale used vehicles	3.1		(0.2	)	330
Finance and insurance	100.0		100.0		0
Service, body and parts	48.3		47.3		100
Overall	16.8		16.0		80

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

In the new vehicle business, margins improved slightly in 2005 compared to 2004 and improved in 2004 compared to 2003 as a result of strategic initiatives and internal directives in 2004 and early 2005 that increased gross profit per vehicle sold. These margin raising initiatives were partially offset in 2005 by manufacturers’ “employee pricing” programs, which created a higher volume, lower margin environment during the second and third quarters of 2005. This compares to a higher volume, lower margin strategy that was in place in 2003.

Retail used vehicle margins improved in 2005 compared to 2004 as a result of a stronger pricing and retail environment for used vehicles in combination with a large quantity of good quality used vehicle trade-ins in recent quarters. In 2004, we were able to improve the margins on our used vehicle sales compared to 2003 primarily because of the strategies discussed earlier regarding the auctioning of undesired used vehicles and our “Used Vehicle Promo Pricing” for our retail sales.

Margins in our wholesale used vehicle business declined in 2005 compared to 2004, as a result of aggressive wholesaling in the third and fourth quarters of 2005 designed to clear inventories going into the seasonally slower winter months. Gross profits per unit remained positive. We continue to hold our own local used vehicle auctions and manage the disposal of our units at larger auctions, which has contributed to improvements in gross profit per vehicle, partially offsetting the declines due to the aggressive wholesaling.

The service, body and parts business has benefited from our focus on service advisor training, which has led to gains in the sale of higher margin service items in 2005 compared to 2004 and in 2004 compared to 2003. In addition, we also instituted a number of pricing and cost saving initiatives across the entire service, body and parts business. Higher penetration rates for our lifetime oil change and filter service have also contributed to our gross profit margin increase in 2005.

The increase in the overall gross profit margin in 2004 compared to 2003 was also affected by the increase in our high-margin service and parts revenue as a percentage of total revenue.

The increase in same store revenues in 2005 compared to 2004 and the improved gross profit margins in 2005 compared to 2004, as well as in 2004 compared to 2003, led to increases in total same-store gross profit of 3.1% and 2.4%, respectively, in 2005 compared to 2004 and in 2004 compared to 2003.

Selling, General and Administrative Expense

Selling, general and administrative expense (“SG&A”) 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 $32.7 million in 2005 compared to 2004 and increased $30.7 million in 2004 compared to 2003. SG&A as a percentage of revenue improved by 10 basis points in 2005 compared to 2004 and declined by 20 basis points in 2004 compared to 2003.

The increases in dollars spent in 2005 compared to 2004 and in 2004 compared to 2003 were due to increased selling, or variable, expenses related to the increases in acquisition revenues and the number of locations. In addition, the 2004 increase also related to increased costs for compliance with the Sarbanes-Oxley Act of 2002. More importantly, however, SG&A as a percentage of gross profit is an industry standard and a better gauge for measuring performance relative to SG&A expense. SG&A as a percentage of gross profit improved by 210 basis points and 260 basis points, respectively, in 2005 compared to 2004 and in 2004 compared to 2003 as we continue to realize the positive results of multiple cost saving initiatives at our corporate headquarters and in the stores.

Depreciation and Amortization

Depreciation and amortization increased $1.5 million and $3.3 million, respectively, in 2005 compared to 2004 and in 2004 compared to 2003 due to the addition of property and equipment primarily related to our acquisitions, as well as leasehold improvements to existing facilities.

Income from Operations

Operating margins in 2005 improved by 50 basis points to 4.1% compared to 3.6% in 2004 and by 50 basis points in 2004 from 3.1% in 2003. The increases were primarily because of improved overall gross profit margins as discussed above. In addition, in 2005, operating expenses as a percentage of revenue improved by 10 basis points compared to 2004. In 2004 compared to 2003, however, the improvement in gross profit margins was partially offset by a 30 basis point increase in operating expenses as a percentage of revenue.

Floorplan Interest Expense

Floorplan interest expense increased $6.0 million in 2005 compared to 2004. Increases in the average interest rates on our floorplan facilities resulted in increases to floorplan interest expense of $8.3 million. In addition, our average outstanding balance on these facilities increased $49.6 million, which contributed $1.5 million to the overall increase. These increases were partially offset by a $3.7 million decrease related to our interest rate swaps.

Floorplan interest expense increased $0.5 million in 2004 compared to 2003. Increases in the average interest rates on our floorplan facilities resulted in increases to floorplan interest expense of $0.7 million. In addition, our average outstanding balance on these facilities increased $49.2 million, which contributed $1.4 million to the overall increase. These increases were partially offset by a $1.6 million decrease related to our interest rate swaps.

Other Interest Expense

Other interest expense includes interest on our convertible notes, debt incurred related to acquisitions, real estate mortgages, our used vehicle line of credit and equipment related notes.

Other interest expense increased $3.2 million in 2005 compared to 2004. Changes in the weighted average interest rate on our debt in 2005 compared to 2004 increased other interest expense by approximately $1.4 million and changes in the average outstanding balances resulted in an increase of approximately $1.8 million. Interest expense related to the $85.0 million of convertible notes that were issued in May 2004 totals approximately $764,000 per quarter, which consists of $611,000 of contractual interest and $153,000 of amortization of debt issuance costs.

Other interest expense increased $2.8 million in 2004 compared to 2003. Changes in the weighted average interest rate on our debt in 2004 compared to 2003 increased other interest expense by approximately $550,000 and changes in the average outstanding balances resulted in an increase of approximately $2.2 million.

For all debt, including floorplan notes payable, our average interest rate in 2005 increased at only about half the pace of market interest rates due to our interest rate hedging strategies.

Income Tax Expense

Our effective tax rate was 38.9% in 2005 compared to 38.7% in 2004 and 39.7% in 2003. 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. The increase in our effective tax rate in 2005 compared to 2004 was due primarily to an increase in revenue in some of our higher tax rate states.

Income from Continuing Operations

Income from continuing operations as a percentage of revenue increased in 2005 compared to 2004 as a result of improvements in gross profit margins and operating expenses as discussed above.

Income from continuing operations as a percentage of revenue increased in 2004 compared to 2003 as a result of improvements in gross profit margins that were partially offset by increased operating expenses and interest expense as discussed above.

Discontinued Operations

We continually monitor the performance of each of our dealerships and make determinations to sell based primarily on return on capital criteria. Once a determination to dispose of a dealership is made, the results of operations are reclassified into discontinued operations. All dealerships included in discontinued operations have been, or will be, eliminated from our on-going operations upon completion of the sale.

During 2005, we sold a building we had held for sale at December 31, 2004, sold one dealership and classified two additional dealerships as discontinued operations, which are held for sale at December 31, 2005. During 2004, we disposed of the franchises included with a dealership we had held for sale at December 31, 2003. During 2003, we sold one of our dealerships classified as discontinued operations. We expect that the dealerships held for sale at December 31, 2005 will be sold during 2006.

Certain financial information related to discontinued operations was as follows (in thousands):

Year Ended December 31,	2005			2004			2003

Revenue	$	45,881		$	116,411		$	143,584
Pre-tax income (loss)	(3,328		)	(2,591		)	(1,068		)
Gain (loss) on disposal of discontinued operations, net of tax	28			302			621
Amount of goodwill and other intangible assets disposed of	4,406			1,629			1,712

Interest expense is allocated to stores classified as discontinued operations for actual flooring interest expense directly related to the new vehicles in the store. Interest expense related to the used vehicle line of credit is allocated based on total used vehicle inventory of the store, and interest expense related to the equipment line of credit is allocated based on the amount of fixed assets.

Assets held for sale included the following (in thousands):

December 31,	2005		2004
Inventories	$	22,703	$	—
Property, plant and equipment	817		135
Goodwill	2,368		—
Other intangible assets	1,523		—
	$	27,411	$	135

Liabilities held for sale of $22.4 million at December 31, 2005 represented new vehicle flooring notes payable related to the two dealerships held for sale.

Selected Consolidated Quarterly Financial Data

The following tables set forth our unaudited restated quarterly financial data(1). The restatements are described in more detail in Note 2 of Notes to Consolidated Financial Statements included elsewhere in this report.

	Three Months Ended,
	March 31			June 30			September 30			December 31
	(in thousands, except per share data)
	(Restated)
2005
Revenues:
New vehicle	$	359,619		$	438,375		$	510,541		$	368,072
Used vehicle	197,322			200,769			226,518			192,354
Finance and insurance	24,616			27,204			32,462			25,126
Service, body and parts	74,265			75,417			80,786			79,026
Fleet and other	3,104			9,064			8,548			2,231
Total revenues	658,926			750,829			858,855			666,809
Cost of sales	541,793			623,817			716,096			548,108
Gross profit	117,133			127,012			142,759			118,701
Selling, general and administrative	89,132			93,323			98,588			89,948
Depreciation and amortization	3,388			3,406			3,624			3,816
Income from operations	24,613			30,283			40,547			24,937
Floorplan interest expense	(1,768		)	(7,865		)	(3,405		)	(5,495		)
Other interest expense	(2,805		)	(3,036		)	(3,037		)	(3,152		)
Other, net	284			247			187			460
Income from continuing operations before income taxes	20,324			19,629			34,292			16,750
Income taxes	(7,892		)	(7,781		)	(14,034		)	(5,668		)
Income before discontinued operations	12,432			11,848			20,258			11,082
Discontinued operations, net of tax	(486		)	(430		)	(485		)	(592		)
Net income	$	11,946		$	11,418		$	19,773		$	10,490

Basic income per share from continuing operations	$	0.65		$	0.62		$	1.05		$	0.57
Basic loss per share from discontinued operations	(0.02		)	(0.02		)	(0.02		)	(0.03		)
Basic net income per share	$	0.63		$	0.60		$	1.03		$	0.54

Diluted income per share from continuing operations	$	0.59		$	0.57		$	0.95		$	0.53
Diluted loss per share from discontinued operations	(0.02		)	(0.02		)	(0.03		)	(0.03		)
Diluted net income per share	$	0.57		$	0.55		$	0.92		$	0.50

	Three Months Ended,
	March 31			June 30			September 30			December 31
	(in thousands, except per share data)
	(Restated)
2004
Revenues:
New vehicle	$	342,802		$	387,977		$	436,414		$	373,909
Used vehicle	184,986			179,074			193,850			178,784
Finance and insurance	22,333			23,700			26,841			24,116
Service, body and parts	66,772			69,223			72,422			72,477
Fleet and other	1,164			1,381			3,385			1,750
Total revenues	618,057			661,355			732,912			651,036
Cost of sales	514,904			548,724			611,135			540,380
Gross profit	103,153			112,631			121,777			110,656
Selling, general and administrative	81,716			85,439			87,790			83,311
Depreciation and amortization	2,850			2,998			3,156			3,746
Income from operations	18,587			24,194			30,831			23,599
Floorplan interest expense	(5,594		)	3,060			(7,107		)	(2,876		)
Other interest expense	(1,721		)	(2,147		)	(2,300		)	(2,705		)
Other, net	179			273			204			263
Income from continuing operations before income taxes	11,451			25,380			21,628			18,281
Income taxes	(4,485		)	(9,898		)	(8,436		)	(6,906		)
Income before discontinued operations	6,966			15,482			13,192			11,375
Discontinued operations, net of tax	(455		)	(306		)	(14		)	(628		)
Net income	$	6,511		$	15,176		$	13,178		$	10,747

Basic income per share from continuing operations	$	0.37		$	0.83		$	0.70		$	0.60
Basic loss per share from discontinued operations	(0.02		)	(0.02		)	(0.00		)	(0.03		)
Basic net income per share	$	0.35		$	0.81		$	0.70		$	0.57

Diluted income per share from continuing operations	$	0.36		$	0.77		$	0.64		$	0.55
Diluted loss per share from discontinued operations	(0.02		)	(0.02		)	(0.00		)	(0.03		)
Diluted net income per share	$	0.34		$	0.75		$	0.64		$	0.52

(1) Quarterly data may not add to yearly totals due to rounding.

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 in certain of our markets and the reduced number of business days during the holiday season. As a result, financial performance is expected to be lower during the first and fourth quarters than during the second and third 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. Acquisitions have also been a 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 and private debt 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 the next 24 months from December 31, 2005.

Our inventories increased to $606.0 million at December 31, 2005 from $535.3 million at December 31, 2004 due primarily to acquisitions, as well as a decision to take on additional inventory in December 2005 due to attractive incentives from certain of our manufacturer partners. As a result, our new and used flooring notes payable increased to $530.5 million at December 31, 2005 from $450.9 million at December 31, 2004. New vehicles are financed at approximately 100% and used vehicles can be financed up to approximately 80% of cost. Our days supply of new vehicles increased by approximately 19 days at December 31, 2005 compared to December 31, 2004, primarily due to the purchase of additional inventory in December 2005 mentioned above. We believe this inventory level will provide us with strong inventories at attractive prices going into the seasonally strong spring selling season. Our new vehicle inventories are 28 days above our average historical December 31 balances. Our days supply of used vehicles decreased by approximately 2 days at December 31, 2005 compared to December 31, 2004. Used vehicle inventories at December 31, 2005 were 3 days below average levels for December 31. We believe that our inventory of good-quality used vehicles, which were brought purchased at favorable prices, will benefit our used vehicle business in 2006.

Assets held for sale of $27.4 million at December 31, 2005 include primarily inventories, fixed assets, goodwill and other intangible assets related to two dealerships 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.

Liabilities held for sale of $22.4 million at December 31, 2005 represented new vehicle flooring notes payable related to two dealerships held for sale.

Goodwill and other intangibles increased $21.9 million to $311.1 million at December 31, 2005, compared to $289.2 million at December 31, 2004. Store and franchise acquisitions increased goodwill and other intangibles by $30.3 million. This increase was partially offset by a $4.4 million decrease in goodwill and other intangibles related to dealership disposals and by $3.9 million being classified as assets held for sale at December 31, 2005. Cash paid for acquisitions, net of cash received, in 2005 was $51.7 million.

Our Board of Directors declared a dividend of $0.08 per share on our Class A and Class B common stock for the fourth quarter of 2004 and for the first quarter of 2005, which were paid in the first two quarters of 2005 and totaled approximately $1.5 million each. For the second, third and fourth quarters of 2005, our Board of Directors declared a $0.12 per share dividend on our Class A and Class B common stock that totaled approximately $2.3 million each. The dividend related to the second quarter of 2005 was paid during the third quarter of 2005 and the dividend for the third quarter of 2005 was paid in the fourth quarter of 2005.

The dividend related to the fourth quarter of 2005 will be paid in the first quarter of 2006. 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 December 31, 2005, we have purchased a total of 60,231 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.

We have a working capital and used vehicle flooring credit facility with DaimlerChrysler Services North America LLC and Toyota Motor Credit Corporation, totaling up to $150 million, which expires May 1, 2008. This credit facility is cross-collateralized and secured by cash and cash equivalents, new and used vehicles on a subordinated basis to the extent not specifically financed by other lenders, parts inventories, accounts receivable, intangible assets and equipment. We pledged to DaimlerChrysler Services and Toyota Motor Credit the stock of all of our dealership subsidiaries except entities operating BMW, Honda, Nissan or Toyota stores. The commitments under this credit agreement may be withdrawn under various events of default or certain changes in control.

The financial covenants in our agreement with DaimlerChrysler Services and Toyota Motor Credit 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, 2005, we were in compliance with all of the covenants of this agreement.

Ford Motor Credit, General Motors Acceptance Corporation and Volkswagen Credit have agreed to floor all of our new vehicles for their respective brands with DaimlerChrysler Services North America LLC 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. Vehicles financed by lenders not directly associated with the manufacturer are classified as floorplan notes payable: non-trade and is included as a financing activity in our statements of cash flows. Vehicles financed by lenders directly associated with the manufacturer are classified as floorplan notes payable and is included as an operating activity.

We have a credit facility with U.S. Bank N.A., which provides for a $50.0 million revolving line of credit for leased vehicles and equipment purchases and expires May 1, 2007. The financial covenants in our agreement with U.S. Bank N.A. require us to maintain compliance with, among other things, (i) a specified current ratio; (ii) a specified fixed charge coverage ratio; (iii) a minimum total net worth; and (iv) a minimum tangible net worth. At December 31, 2005, we were in compliance with all of the covenants of this agreement. The commitments under this credit agreement may be withdrawn under various events of default or certain changes in control of Lithia.

We expect to be in compliance with the covenants for all of our debt agreements in the foreseeable future. In the event that we are unable to meet such requirements, and any available cure period has passed, the lender may require an acceleration of payment, increase the interest rate or limit our ability to borrow.

Interest rates on all of the above facilities ranged from 5.9% to 7.1% at December 31, 2005. Amounts outstanding on the lines at December 31, 2005, together with amounts remaining available under such lines were as follows (in thousands):

	Outstanding at December 31, 2005		Remaining Availability as of December 31, 2005
New and program vehicle lines	$	530,452	$	*
Working capital and used vehicle line	—		150,000
Equipment/leased vehicle line	50,000		—
	$	580,452	$	150,000

* There are no formal limits on the new and program vehicle lines with certain lenders.

We also have outstanding $85.0 million of 2.875% senior subordinated convertible notes due 2014. We will also pay contingent interest on the notes during any six-month interest period beginning May 1, 2009, in which the trading price of the notes for a specified period of time equals or exceeds 120% of the principal amount of the notes. The notes are convertible into shares of our Class A common stock at a price of $37.69 per share upon the satisfaction of certain conditions and upon the occurrence of certain events as follows:

· if, prior to May 1, 2009, and during any calendar quarter, the closing sale price of our common stock exceeds 120% of the conversion price for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the preceding calendar quarter;

· if, after May 1, 2009, the closing sale price of our common stock exceeds 120% of the conversion price;

· if, during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of notes for each day of such period was less than 98% of the product of the closing sale price of our common stock and the number of shares issuable upon conversion of $1,000 principal amount of the notes;

· if the notes have been called for redemption; or

· upon certain specified corporate events.

A declaration and payment of a dividend in excess of $0.08 per share per quarter will result in an adjustment in the conversion rate for the notes if such cumulative adjustment exceeds 1% of the current conversion rate. We declared a dividend of $0.12 per share in July 2005, October 2005 and February 2006. The affect of such dividends does not yet reach the 1% threshold amount and no adjustment in the conversion rate is currently required.

The notes are redeemable at our option beginning May 6, 2009 at the redemption price of 100% of the principal amount plus any accrued interest. The holders of the notes can require us to repurchase all or some of the notes on May 1, 2009 and upon certain events constituting a fundamental change or a termination of trading. A fundamental change is any transaction or event in which all or substantially all of our common stock is exchanged for, converted into, acquired for, or constitutes solely the right to receive, consideration that is not all, or substantially all, common stock that is listed on, or immediately after the transaction or event, will be listed on, a United States national securities exchange. A termination of trading will have occurred if our common stock is not listed for trading on a national securities exchange or the NASDAQ stock market.

Our earnings to fixed charge coverage ratio, as defined in the senior subordinated convertible notes, was 3.39 for the year ended December 31, 2005.

Contractual Payment Obligations

A summary of our contractual commitments and obligations as of December 31, 2005 was as follows (in thousands):

	Payments Due By Period
Contractual Obligation	Total		2006		2007 and 2008		2009 and 2010		2011 and beyond
Floorplan Notes	$	530,452	$	530,452	$	—	$	—	$	—
Lines of Credit and Long-Term Debt	297,419		6,868		101,388		32,944		156,219
Interest on Scheduled Debt Payments	58,280		9,685		17,478		11,128		19,989
Capital Commitments	21,828		21,828		—		—		—
Operating Leases	126,709		20,931		37,541		27,566		40,671
	$	1,034,688	$	589,764	$	156,407	$	71,638	$	216,879

Our capital commitments of $21.8 million at December 31, 2005 were for the construction of five new facilities, additions to two existing facilities and the remodel of two facilities. Three of the new facilities will be for our Toyota dealerships in Springfield, Oregon, Klamath Falls, Oregon and Odessa, Texas. The other two new facilities are for our Dodge dealership in Sioux Falls, South Dakota and for our Mercedes dealership in Spokane, Washington. We have already incurred $5.4 million for these projects and anticipate incurring the remaining $21.8 million in 2006. 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, lifetime oil change contracts and other various insurance contracts that are terminated early by the customer. At December 31, 2005, this reserve totaled $13.1 million. Based on past experience, we estimate that the $13.1 million will be paid out as follows: $7.9 million in 2006; $3.5 million in 2007; $1.3 million in 2008; $0.3 million in 2009; and $0.1 million thereafter.

Critical Accounting Policies and Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted 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, discretionary bonus 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.

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, 2005 and 2004, this reserve totaled $12.2 million and $11.2 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, which 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, 2005 and 2004, this reserve totaled $343,000 and $258,000, respectively, and is included in accrued liabilities on our consolidated balance sheets.

Workers’ Compensation Insurance Premium Accrual

Insurance premiums are paid for under a three-year 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 and, as of December 31, 2005 and 2004, the accrual was $2.3 million and $2.6 million, respectively, and is included in accrued liabilities and other long-term liabilities on our consolidated balance sheets. 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.

Discretionary Bonus Accrual

We make certain estimates, judgments and assumptions regarding the likelihood of our attainment, and the level thereof, of the annual bonus criteria under our Discretionary Bonus Program in order to record bonus expense on a quarterly basis. We accrue the estimated year-end expense on a pro-rata basis throughout the year based on bonus attainment expectations. We use this same methodology for our 401(k) matching contribution and our years-of-service bonus programs. These estimates, judgments and assumptions are made quarterly based on available information and take into consideration the historical seasonality of our business and current trends. If actual year-end results differ materially from our estimates, the amount of bonus expense recorded in a particular quarter could be significantly over or under estimated. The bonus accrual at the end of any given year is accurate and reflective of actual results attained and amounts to be paid.

Intangible Assets

We review our goodwill and other identifiable non-amortizable 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 unit, 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. We have determined that we operate as one business unit. During 2005 and 2004, we concluded that there was

no impairment. At December 31, 2005 and 2004, goodwill and other identifiable non-amortizable intangible assets totaled $311.1 million and $289.2 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 20 of Notes to Consolidated Financial Statements.

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, variable rate mortgage notes payable and other credit line borrowings subject us to market risk exposure. At December 31, 2005, we had $627.4 million outstanding under such agreements at interest rates ranging from 5.89% to 8.43% per annum. A 10% increase in interest rates would increase annual interest expense by approximately $1.8 million, net of tax, based on amounts outstanding at December 31, 2005.

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.

Based on open market trades, we determined that our $85.0 million of long-term convertible fixed interest rate debt had a fair market value of approximately $82.6 million at December 31, 2005. In addition, at December 31, 2005, we had $115.4 million of other long-term fixed interest rate debt outstanding with maturity dates of between December 2006 and May 2022. Based on discounted cash flows, we have determined that the fair market value of this long-term fixed interest rate debt was approximately $113.1 million at December 31, 2005.

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 payments 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 engage in interest rate speculation using derivative instruments.

As of December 31, 2005, we had outstanding the following interest rate swaps with U.S. Bank Dealer Commercial Services:

· 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

· effective March 9, 2004 – a five year, $25 million interest rate swap at a fixed rate of 3.25% per annum, variable rate adjusted on the 1st and 16th of each month;

· effective March 18, 2004 – a five year, $25 million interest rate swap at a fixed rate of 3.10% per annum, variable rate adjusted on the 1st and 16th 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, 2005 was 4.39% 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 a component of floorplan interest expense. The difference between interest earned and the interest obligation results in a monthly settlement which is also recorded as a component of floorplan interest expense.

Interest savings (additional expense), net of tax, on un-hedged debt as a result of changing interest rates, based on interest rates effective as of January 1, 2003 was approximately $(4.3) million, $(86,000) and $351,000, respectively, in 2005, 2004 and 2003. Interest expense savings, net of tax, on un-hedged debt as a result of decreasing interest rates during 2003, based on interest rates effective as of January 1, 2003 was $351,000. Interest expense, net of tax, on un-hedged debt increased during 2005 and 2004 by approximately $2.1 million and $645,000, respectively, as a result of increasing interest rates during those periods. As of December 31, 2005, approximately 45% of our total debt outstanding was subject to un-hedged variable rates of interest.

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 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, 2005 is included in Item 7.

Item 9A. Controls and Procedures

(a) Background

As discussed in Note 2 to the consolidated financial statements (included in Item 8), we have restated our previously reported financial information for the years ended 2005 through 2003 to correct an error in those financial statements relating to our derivative accounting under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” In addition, we are restating for other errors that individually were previously, and currently are, deemed to be immaterial.

During the third quarter of 2006, we, in consultation with our independent registered public accounting firm, identified that our application of, and documentation related to, the “short-cut” method under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”) for our derivative instruments was incorrect. From inception of the hedging program, we applied a method of cash flow hedge accounting under SFAS No. 133 to account for the interest rate swap transactions that allowed us to assume the effectiveness of such transactions. We have determined that the prepayment clauses in the debt agreements, which had not been identified by us or by our accounting experts at implementation, disqualified us from being able to avoid periodic testing of effectiveness under SFAS no. 133. We are not permitted to retroactively apply an appropriate method of qualifying for hedge accounting treatment for these instruments and, as a result, the changes in the fair value of these derivative instruments during their term will be reflected as a net non-cash gain/loss in flooring interest expense rather than in other comprehensive income in the balance sheet. Following our discovery of the errors in the application and documentation of hedge accounting under SFAS No. 133, we initiated a comprehensive review of all of our determinations and documentation related to hedge accounting under the “short cut” method for our interest rate swaps, as well as our related processes and procedures.

(b) Disclosure Controls and Procedures

We initially evaluated our disclosure controls and procedures (as such term is defined under Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this report under the direction and with the participation of our Chief Executive Officer and Chief Financial Officer. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer initially concluded that our disclosure controls and procedures were effective as of December 31, 2005. In connection with the restatement described above, management concluded that we had a material weakness in our internal control over financial reporting relating to our accounting for derivative financial instruments under SFAS No. 133.

In connection with the aforementioned restatement of financial statements, under the direction of our Chief Executive Officer and Chief Financial Officer, we reevaluated our disclosure controls and procedures. As discussed in Management’s Annual Report on Internal Control Over Financial Reporting (as restated) (Item 9A (c)), we identified a material weakness in internal control over financial reporting with respect to hedge accounting for interest rate swaps.

As a result of this material weakness, we concluded that our disclosure controls and procedures were not effective as of December 31, 2005.

(c) Management’s Annual Report on Internal Control Over Financial Reporting (as restated)

The management of Lithia Motors, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process

designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

A material weakness is a significant deficiency (within the meaning of PCAOB Auditing Standard No. 2), or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2005, based on the framework and criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, filed on March 8, 2006, management concluded that our internal control over financial reporting was effective as of December 31, 2005. However, we subsequently determined that we needed to restate certain of our previously issued financial statements. As a result of such financial statement restatement, management reassessed the Company’s internal control over financial reporting using the COSO criteria and identified the following material weakness in internal control over financial reporting with respect to accounting for interest rate swaps as of December 31, 2005: We lacked adequate technical expertise to ensure the proper application, at inception, of the criteria for the “short-cut” method within the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” for our interest rate swaps. This material weakness resulted in errors in previously issued financial statements and in our restatement of the consolidated financial statements for the years ended December 31, 2005, 2004 and 2003 and for the interim periods in 2005 and 2004.

As a result of this material weakness, our management has revised its earlier assessment and has now concluded that our internal control over financial reporting was not effective as of December 31, 2005.

The Company’s independent auditor, KPMG LLP, a registered public accounting firm, has issued an audit report on our management’s revised assessment of our internal control over financial reporting as of December 31, 2005.

(d) Remediation of Material Weakness:

To remediate the material weakness described above and enhance our internal control over financial reporting, subsequent to the filing of this Form 10-K/A, management will implement the following changes:

• Improve training and education and understanding of hedge accounting requirements in accordance with generally accepted accounting principles for all relevant personnel involved in derivatives transactions.

• Revise our documentation to qualify for hedge accounting in accordance with generally accepted accounting principles with the assistance of outside experts that have been engaged. This includes ongoing monitoring and review to ensure the continuing qualification of hedge accounting.

(e) Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the above evaluation that occurred during the fiscal quarter ended December 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART IV

Item 15. Exhibits and Financial Statement Schedules

Financial Statements and Schedules

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


Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2005 and 2004 (restated)
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003 (restated)
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2005, 2004 and 2003 (restated)
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003 (restated)
Notes to Consolidated Financial Statements (restated)

There are no schedules required to be filed herewith.

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.

4.1	(b)	Specimen Common Stock certificate

4.2	(n)	Indenture dated May 4, 2004, between Lithia Motors, Inc. and U.S. Bank National Association, as Trustee, relating to 2.875% Convertible Senior Subordinated Notes due 2014.

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

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

10.7.1*	(s)	2003 Stock Incentive Plan, as amended and restated

10.7.2*	(s)	Form of Restricted Share Grant for 2003 Stock Incentive Plan, as amended and restated

10.8*	(s)	Summary 2006 Discretionary Support Services Bonus Program

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

Exhibit		Description
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 by and among Lithia Motors, Inc., DaimlerChrysler Services North America LLC, as agent, and various financial institutions that are or become parties thereto (as lenders).

10.15.1	(m)	First Amendment to Credit Agreement between DaimlerChrysler Services North America LLC, as agent, and Lithia Motors, Inc., August 12, 2003

10.15.2	(n)	Second Amendment to Credit Agreement between DaimlerChrysler Services North America LLC, as agent, and Lithia Motors, Inc., dated December 4, 2003

10.15.3	(o)	Third Amendment to Credit Agreement between DaimlerChrysler Services North America LLC, as agent, and Lithia Motors, Inc., dated June 30, 2004

10.15.4	(p)	Fourth Amendment to Credit Agreement between DaimlerChrysler Services North America LLC, as agent, and Lithia Motors, Inc., dated October 31, 2004

10.15.5	(s)	Fifth Amendment to Credit Agreement between DaimlerChrysler Services North America LLC, as agent, and Lithia Motors, Inc., dated February 15, 2006

10.15.6	(s)	Letter Agreement between DaimlerChrysler Services North America LLC, as agent, and Lithia Motors, Inc., dated April 26, 2005

10.16	(j)	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.

10.16.1	(j)	Consent, Waiver and Amendment to Amended and Restated Loan Agreement and Promissory Note dated January 31, 2003 between Lithia Financial Corporation, Lithia Motors, Inc., and Lithia Aircraft, Inc. and U.S. Bank National Association.

10.16.2	(k)	Second Amendment to Amended and Restated Loan Agreement, dated April 2, 2003, between Lithia Financial Corporation, Lithia Motors, Inc., and Lithia Aircraft, Inc. and U.S. Bank National Association

10.16.3	(m)	Third Amendment to Amended and Restated Loan Agreement dated as of February 6, 2004 between Lithia Financial Corporation, Lithia Motors, Inc. and Lithia Aircraft, Inc. and U.S. Bank National Association.

Exhibit		Description
10.16.4	(p)	Fourth Amendment to Amended and Restated Loan Agreement dated December 22, 2004 between Lithia Financial Corporation, Lithia Motors, Inc. and Lithia Aircraft, Inc. and U.S. Bank National Association.

10.16.5	(q)	Fifth Amendment to Amended and Restated Loan Agreement and Amendment to Promissory Notes.

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.

10.17.2	(n)	Modification No. 2 dated November 1, 2003 to Amended and Restated Revolving Loan and Security Agreement and Notes Secured by Deed of Trust.

10.17.3	(n)	Modification No. 3 dated February 20, 2004 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)

10.19	(r)	Summary of 2005 Director Compensation Plan

10.20	(s)	Form of Outside Director Nonqualified Deferred Compensation Agreement

21	(s)	Subsidiaries of Lithia Motors, Inc.

23		Consent of KPMG LLP, Independent Registered Public Accounting Firm

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.

32.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

32.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

(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.
(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 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission on March 15, 2004.
(n)	Incorporated by reference from the Company’s Form 10-Q for the quarter ended March 31, 2004 as filed with the Securities and Exchange Commission on May 10, 2004.
(o)	Incorporated by reference from the Company’s Form 10-Q for the quarter ended June 30, 2004 as filed with the Securities and Exchange Commission on August 6, 2004.
(p)	Incorporated by reference from the Company’s Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission on March 15, 2005.
(q)	Incorporated by reference from the Company’s Form 10-Q for the quarter ended June 30, 2005 as filed with the Securities and Exchange Commission on August 9, 2005.
(r)	Incorporated by reference from the Company’s Form 8-K filed February 23, 2005.
(s)	Incorporated by reference from the Company’s Form 10-K for the year ended December 31, 2005 as filed with the Securities and Exchange Commission on March 8, 2006.

(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.

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:	December 15, 2006	LITHIA MOTORS, INC.


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


		By	/s/ LINDA A. GANIM
		Linda A. Ganim
		Vice President and Chief Accounting Officer
		(Principal Accounting Officer)

Report of Independent Registered Public Accounting Firm

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, 2005 and 2004, 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, 2005. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 financial position of Lithia Motors, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, the Company has restated its consolidated balance sheets as of December 31, 2005 and December 31, 2004 and the related consolidated statements of operations, changed in stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2005.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Lithia Motors, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 3, 2006, except as to the sixth and seventh paragraphs of Management’s Annual Report on Internal Control Over Financial Reporting (as restated), which is as of December 15, 2006, expressed an unqualified opinion on management’s restated assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting as of December 31, 2005.

/s/ KPMG LLP

Portland, Oregon
March 3, 2006, except as to note 2, which is as of December 15, 2006

F-1

Report of Independent Registered Public Accounting Firm

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

We have audited management’s restated assessment, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting (as restated) (Item 9A(c)), that Lithia Motors, Inc. did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effect of the material weakness identified in management’s restated assessment, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Lithia Motors, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of Lithia Motors, Inc.’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s restated assessment as of December 31, 2005: The Company lacked adequate technical

F-2

expertise to ensure the proper application, at inception, of the criteria for the “short-cut” method within the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for its interest rate swaps. This material weakness resulted in errors in previously issued financial statements and in the Company’s restatement of the financial statements for the years ended December 31, 2005, 2004 and 2003 and for the interim periods in 2005 and 2004.

As stated in the seventh paragraph of Management’s Annual Report on Internal Control over Financial Reporting (as restated), management’s assessment of the effectiveness of Lithia Motors, Inc. internal control over financial reporting as of December 31, 2005 has been restated to reflect the impact of the aforementioned material weakness in internal control over financial reporting.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Lithia Motors, Inc. as of December 31, 2005 and 2004, and the related statements of operations, changes in stockholder’s equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2005. The aforementioned material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 consolidated financial statements (as restated) and this report does not affect our report dated March 3, 2006, except as to the restatement discussed in note 2, which is as of December 15, 2006, which expressed an unqualified opinion on those consolidated financial statements (as restated).

In our opinion, management’s restated assessment that Lithia Motors, Inc. did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by COSO. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Lithia Motors, Inc. did not maintain effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by COSO.

/s/KPMG LLP

Portland, Oregon

March 3, 2006, except as to the sixth and seventh paragraphs of Management’s Annual Report on Internal Control over Financial Reporting (as restated), which are as of December 15, 2006

F-3

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

	December 31,
	2005			2004
	(Restated)			(Restated)
Assets
Current Assets:
Cash and cash equivalents	$	48,566		$	28,869
Contracts in transit	52,453			42,913
Trade receivables, net of allowance for doubtful accounts of $406 and $436	53,990			42,045
Inventories, net	606,047			535,347
Vehicles leased to others, current portion	6,296			5,494
Prepaid expenses and other	8,800			6,888
Deferred income taxes	685			—
Assets held for sale	27,411			135
Total Current Assets	804,248			661,691

Land and buildings, net of accumulated depreciation of $11,358 and $8,110	255,372			226,356
Equipment and other, net of accumulated depreciation of $31,622 and $25,922	77,805			73,275
Goodwill	260,899			244,532
Other intangible assets, net of accumulated amortization of $89 and $63	50,247			44,649
Other non-current assets	4,143			5,217
Total Assets	$	1,452,714		$	1,255,720

Liabilities and Stockholders’ Equity
Current Liabilities:
Floorplan notes payable	$	476,322		$	400,084
Floorplan notes payable: non-trade	54,130			50,776
Current maturities of long-term debt	6,868			6,565
Trade payables	30,917			26,800
Accrued liabilities	57,177			51,579
Liabilities held for sale	22,388			—
Deferred income taxes	—			1,610
Total Current Liabilities	647,802			537,414

Real estate debt, less current maturities	154,046			139,702
Other long-term debt, less current maturities	136,505			127,608
Other long-term liabilities	10,440			10,611
Deferred income taxes	43,690			35,139
Total Liabilities	992,483			850,474

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 15,629 and 15,142	224,775			215,335
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	2,559			1,811
Unearned compensation	(1,132		)	—
Retained earnings	233,561			187,632
Total Stockholders’ Equity	460,231			405,246
Total Liabilities and Stockholders’ Equity	$	1,452,714		$	1,255,720

See accompanying notes to consolidated financial statements

F-4

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

	Year Ended December 31,
	2005			2004			2003
	(Restated)			(Restated)			(Restated)
Revenues:
New vehicle sales	$	1,676,607		$	1,541,102		$	1,407,874
Used vehicle sales	816,963			736,694			717,474
Finance and insurance	109,408			96,990			85,845
Service, body and parts	309,494			280,894			244,858
Fleet and other	22,947			7,680			6,539
Total revenues	2,935,419			2,663,360			2,462,590
Cost of sales	2,429,814			2,215,143			2,068,615
Gross profit	505,605			448,217			393,975
Selling, general and administrative	370,991			338,256			307,514
Depreciation - buildings	3,690			2,716			2,057
Depreciation and amortization - other	10,544			10,034			7,418
Operating income from continuing operations	120,380			97,211			76,986
Other income (expense):
Floorplan interest expense	(18,533		)	(12,517		)	(12,065		)
Other interest expense	(12,030		)	(8,873		)	(6,055		)
Other income, net	1,178			919			1,094
	(29,385		)	(20,471		)	(17,026		)
Income from continuing operations before income taxes	90,995			76,740			59,960
Income taxes	(35,375		)	(29,725		)	(23,816		)
Income before discontinued operations	55,620			47,015			36,144
Loss from discontinued operations, net of income tax benefit of $1,307, $886 and $178	(1,993		)	(1,403		)	(269		)
Net income	$	53,627		$	45,612		$	35,875

Basic income per share from continuing operations	$	2.90		$	2.50		$	1.98
Basic loss per share from discontinued operations	(0.10		)	(0.07		)	(0.02		)
Basic net income per share	$	2.80		$	2.43		$	1.96

Shares used in basic per share calculations	19,175			18,773			18,289

Diluted income per share from continuing operations	$	2.64		$	2.34		$	1.95
Diluted loss per share from discontinued operations	(0.10		)	(0.07		)	(0.02		)
Diluted net income per share	$	2.54		$	2.27		$	1.93

Shares used in diluted per share calculations	21,807			20,647			18,546

See accompanying notes to consolidated financial statements

F-5

LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statments of Changes in Stockholders’ Equity and Comprehensive Income
For the years ended December 31, 2003, 2004 and 2005
(In thousands, except share data)

														Accumulated
														Other
														Compre-
	Common Stock								Additional					hensive						Total
	Class A					Class B			Paid In		Unearned			Income			Retained			Stockholders’
	Shares		Amount			Shares	Amount		Capital		Compensation			(Loss)			Earnings			Equity
														(Restated)			(Restated)			(Restated)
Balance at December 31, 2002	14,298,742		$	203,579		3,762,231	$	468	$	929	$	—		$	(8	)	$	114,354		$	319,322
Comprehensive income:
Net income	—		—			—	—		—		—			—			35,875			35,875
Unrealized gain on investments, net	—		—			—	—		—		—			8			—			8
Issuance of stock in connection with employee stock plans	413,485		4,825			—	—		—		—			—			—			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 common stock	(19,400	)	(215		)	—	—		—		—			—			—			(215		)
Balance at December 31, 2003	14,692,827		208,189			3,762,231	468		1,231		—			—			147,654			357,542
Comprehensive income:
Net income	—		—			—	—		—		—			—			45,612			45,612
Issuance of stock in connection with employee stock plans	449,847		7,159			—	—		—		—			—			—			7,159
Repurchase of Class A common stock	(600	)	(13		)	—	—		—		—			—			—			(13		)
Compensation for stock option issuances and tax benefits from option exercises	—		—			—	—		580		—			—			—			580
Dividends paid	—		—			—	—		—		—			—			(5,634		)	(5,634		)
Balance at December 31, 2004	15,142,074		215,335			3,762,231	468		1,811		—			—			187,632			405,246
Comprehensive income:
Net income	—		—			—	—		—		—			—			53,627			53,627
Issuance of stock in connection with employee stock plans	434,534		7,992			—	—		—		—			—			—			7,992
Issuance of restricted stock to employees	59,640		1,645								(1,645		)							—
Amortization of unearned compensation	—		—			—	—		—		241									241
Shares forfeited by employees	(9,873	)	(272		)		—				272
Repurchase of Class A common stock	(231	)	(10		)	—	—		—		—			—			—			(10		)
Compensation for stock and stock option issuances and tax benefits from option exercises	3,200		85			—	—		748		—			—			—			833
Dividends paid	—		—			—	—		—		—			—			(7,698		)	(7,698		)
Balance at December 31, 2005	15,629,344		$	224,775		3,762,231	$	468	$	2,559	$	(1,132	)	$	—		$	233,561		$	460,231

See accompanying notes to consolidated financial statements

F-6

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

	Year Ended December 31,
	2005			2004			2003
	(Restated)			(Restated)			(Restated)
Cash flows from operating activities:
Net income	$	53,627		$	45,612		$	35,875
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	14,234			12,750			9,475
Depreciation and amortization from discontinued operations	264			393			820
Compensation expense related to stock option issuances	490			240			185
(Gain) loss on sale of assets	525			889			(586		)
Gain on sale of franchise	(28		)	(883		)	(919		)
Deferred income taxes	5,286			10,939			10,235
Equity in loss of affiliate	—			—			13
(Increase) decrease, net of effect of acquisitions:
Trade and installment contract receivables, net	(11,864		)	1,175			(777		)
Contracts in transit	(9,540		)	1,796			(3,080		)
Inventories	(60,474		)	(28,656		)	35,284
Vehicles leased to others	(1,633		)	(846		)	(1,436		)
Prepaid expenses and other	(1,682		)	(1,493		)	2,788
Other non-current assets	909			(2,441		)	552
Increase (decrease), net of effect of acquisitions:
Floorplan notes payable	71,772			25,663			(13,360		)
Trade payables	4,117			2,245			4,785
Accrued liabilities	7,026			7,342			5,243
Other long-term liabilities and deferred revenue	(411		)	2,393			(3,397		)
Net cash provided by operating activities	72,618			77,118			81,700

Cash flows from investing activities:
Principal payments received on notes receivable	—			585			—
Capital expenditures:
Non-financeable	(21,093		)	(13,156		)	(10,678		)
Financeable	(32,196		)	(40,931		)	(32,448		)
Proceeds from sale of assets	11,652			2,124			441
Cash paid for acquisitions, net of cash acquired	(51,713		)	(79,395		)	(63,799		)
Proceeds from sale of dealerships	6,696			8,756			3,542
Distribution from affiliate	—			—			33
Net cash used in investing activities	(86,654		)	(122,017		)	(102,909		)

Cash flows from financing activities:
Flooring notes payable: non-trade	3,354			(7,782		)	970
Net borrowings (repayments) on lines of credit	9,314			(120,332		)	58,317
Principal payments on long-term debt and capital leases	(7,454		)	(13,326		)	(4,631		)
Proceeds from issuance of long-term debt	28,233			142,279			22,845
Debt issuance costs	—			(2,550		)	—
Repurchase of common stock	(10		)	(13		)	(215		)
Proceeds from issuance of common stock	7,994			7,083			4,802
Dividends paid	(7,698		)	(5,634		)	(2,575		)
Net cash provided by (used in) financing activities	33,733			(275		)	79,513

Increase (decrease) in cash and cash equivalents	19,697			(45,174		)	58,304

Cash and cash equivalents at beginning of period	28,869			74,043			15,739
Cash and cash equivalents at end of period	$	48,566		$	28,869		$	74,043

Supplemental disclosures of cash flow information:
Cash paid during the period for interest	$	35,318		$	25,499		$	20,733
Cash paid during the period for income taxes	23,463			18,775			9,596

Supplemental schedule of non-cash investing and financing activities:
Debt issued in connection with acquisitions	$	—		$	12,000		$	324
Flooring debt assumed in connection with acquisitions	39,542			51,884			45,884
Acquisition of capital lease	—			540			—
Assets acquired with debt	—			3,680			—
Assets acquired through real estate exchange	—			—			1,987
Debt extinguished through refinancing	—			—			12,350
Debt paid by purchaser in connection with dealership disposals	6,550			—			—
Flooring debt paid in connection with dealership disposals	25,554			8,975			6,123
Common stock received for the exercise price of stock options	428			—			—

See accompanying notes to consolidated financial statements.

F-7

LITHIA MOTORS, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2005, 2004 and 2003

(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, 2005, we offered 25 brands of new vehicles through 188 franchises in 94 stores in the Western United States and over the Internet. As of December 31, 2005, we operated 16 stores in Oregon, 14 in Texas, 12 in Washington, 12 in California, 7 in Idaho, 7 in Colorado, 7 in Alaska, 7 in Montana, 6 in Nevada, 3 in Nebraska, 2 in South Dakota and 1 in New Mexico. 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 the following:

· from customers for vehicles and service and parts business;

· from manufacturers for factory rebates, dealer incentives and warranty reimbursement; and

· 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. A rollforward of our allowance for doubtful accounts was as follows (in thousands):

Year Ended December 31,	2005			2004			2003
Balance, beginning of period	$	436		$	462		$	702
Bad debt expense	750			613			459
Write-offs	(1,796		)	(1,356		)	(1,422		)
Recoveries	1,016			717			723
Balance, end of period	$	406		$	436		$	462

Inventories

Inventories are valued at the lower of market value or cost, using the specific identification method for vehicles and parts. The cost of new and used vehicle inventories includes the cost of any equipment added, reconditioning and transportation.

F-8

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.

Assets Held for Sale

At December 31, 2005, assets held for sale of $27.4 million related to two dealerships held for sale and were recorded on our balance sheet at the lower of book value or estimated fair market value, less applicable selling costs. Assets held for sale of $135,000 at December 31, 2004 related to a building held for sale, which was sold during 2005. See also Note 19.

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 becomes a part of the cost of the depreciable asset and is depreciated according to the estimated useful lives as previously stated. Capitalized interest totaled $946,000, $480,000 and $260,000, respectively, in 2005, 2004 and 2003.

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 term of the lease, unless the lease transfers title or it contains a bargain purchase option, at which time, it is amortized over the useful life, and is included in depreciation expense. Leasehold improvements made at the inception of the lease or during the term of the lease are amortized over the shorter of the life of the improvement or the remaining term of the lease. The payments on the lease liability are amortized over the term of the lease.

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 represent the franchise value of stores acquired since July 1, 2001, non-compete agreements and customer lists. Except for our non-compete agreements and customer lists, all of our other identifiable intangible assets have indefinite useful lives.

F-9

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, except under extraordinary circumstances, 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 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,” goodwill and other identifiable intangible assets with indefinite useful lives are not amortized, but 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. We have determined that we operate as one reporting unit. 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 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, 2005 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.

Unearned Compensation

Unearned compensation includes the value of restricted stock issued to employees for which vesting provisions have not yet been met. The unearned compensation will be recognized over the vesting periods of up to five years. We expect to expense approximately $0.3 million per year related to our unearned compensation recorded as of December 31, 2005.

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,

F-10

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.

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 $5.2 million, $6.3 million and $5.9 million, was $19.3 million, $17.4 million and $19.4 million for the years ended December 31, 2005, 2004 and 2003, 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 limited 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.

Income Taxes

Income taxes are accounted for under the asset and liability method as prescribed by 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.

F-11

Computation of Per Share Amounts

Following is a reconciliation of the income from continuing operations and weighted average shares used for our basic earnings per share (“EPS”) and diluted EPS (in thousands, except per share amounts).

Year Ended December 31,	2005 (Restated)						2004 (Restated)						2003 (Restated)
	Income from Continuing Operations		Shares	Per Share Amount			Income from Continuing Operations		Shares	Per Share Amount			Income from Continuing Operations		Shares	Per Share Amount
Basic EPS
Income from continuing operations available to common stockholders	$	55,620	19,175	$	2.90		$	47,015	18,773	$	2.50		$	36,144	18,289	$	1.98
Effect of Dilutive Securities
2 7/8% convertible senior subordinated notes	1,845		2,255	(0.20		)	1,231		1,485	(0.11		)	—		—	—
Stock options and unvested restricted stock	—		377	(0.06		)	—		389	(0.05		)	—		257	(0.03		)
Diluted EPS
Income from continuing operations available to common stockholders	$	57,465	21,807	$	2.64		$	48,246	20,647	$	2.34		$	36,144	18,546	$	1.95

Antidilutive Securities
Shares issuable pursuant to stock options not included since they were antidilutive			272						324						342

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 22.1% and 22.0%, respectively, of total accounts receivable at December 31, 2005 and 2004. Included in the 22.1% is one manufacturer who accounted for 11.9% of the total accounts receivable balance at December 31, 2005. Included in the 22.0% is one manufacturer who accounted for 10.1% of the total accounts receivable balance at December 31, 2004.

In addition, in 2005, 2004 and 2003, 35.5%, 36.8% and 35.6%, respectively, of our total revenue was derived from the sale of new 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.

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, 2005 we had $580.5 million outstanding under such facilities at interest rates ranging from 5.9% to 7.1% per annum, $530.5 million of which was outstanding under our floorplan facilities. An increase or decrease in the interest rates would affect interest expense for the period accordingly.

F-12

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. If we refinanced at market rates in effect at December 31, 2005, we would pay an additional $4.8 million in interest expense over the remaining lives, which is represented in the table below as the difference between book value and fair value at December 31, 2005. 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 materially above market rates. The book value of our fixed rate debt and the fair value, based upon open market trades or on discounted cash flows, was as follows at December 31, 2005 and 2004 (in thousands):

December 31,	2005		2004
Book value of fixed rate debt	$	200,446	$	178,282
Fair value of fixed rate debt	$	195,645	$	173,997

We also subject our self to credit risk and market risk by entering into interest rate swaps. See below and also Note 8. 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

We enter into interest rate swap agreements to reduce our exposure to market risks from changing interest rates on our 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.

We account for our derivative financial instruments in accordance with 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. See also Notes 2 and 8.

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, discretionary bonus, environmental matters and warranty.

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.

Revenue from parts and service is recognized upon delivery of the parts or service to the customer.

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.

F-13

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 anticipated cancellations, as finance and insurance revenue upon execution of the insurance contract.

Commissions from third party service contracts are recognized, net of 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 new or used vehicle sales, and have therefore not provided for an allowance for new or used vehicle sales returns. Historically, we have not experienced sales returns. We 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.

Debt Issuance Costs and Loan Origination Fees

Debt issuance costs and loan origination fees paid, including incremental direct costs of completed loan agreements, are deferred and amortized over the life of the debt to which it relates and are shown as an increase to the related interest expense.

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 claim cost per vehicle based on past experience. Each year, we analyze the warranty charges related to our used vehicle sales and update our per used vehicle warranty estimate. The estimated warranty is added to cost of sales upon sale of the related vehicle. At December 31, 2005 and 2004, accrued warranty totaled $176,000 and $198,000, respectively, and is included in other current liabilities on the consolidated balance sheets. A roll-forward of our warranty liability for the years ended December 31, 2005, 2004 and 2003 was as follows (in thousands):

Year Ended December 31,	2005			2004			2003
Balance, beginning of period	$	198		$	220		$	525
Warranties issued	2,429			2,574			2,935
Reductions for warranty payments made	(2,434		)	(2,562		)	(2,918		)
Adjustments and changes in estimates	(17		)	(34		)	(322		)
Balance, end of period	$	176		$	198		$	220

Comprehensive Income

Comprehensive income includes the unrealized gain or loss on investments.

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 (the “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.

F-14

Stock-Based Compensation

Through December 31, 2005, we account for stock options using the intrinsic value method as prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” Pursuant to SFAS No. 148 “Accounting for Stock-Based Compensation - Transition and Disclosure,” we have computed, for pro forma disclosure purposes, the impact on net income and net income per share as if we had accounted for our stock-based compensation plans in accordance with the fair value method prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation” as follows (in thousands, except per share amounts):

Year Ended December 31,	2005			2004			2003
	(Restated)			(Restated)			(Restated)
Net income, as reported	$	53,627		$	45,612		$	35,875
Add - Stock-based employee compensation expense included in reported net income, net of related tax effects	303			148			111
Deduct - total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects	(2,480		)	(3,313		)	(3,140		)
Net income, pro forma	$	51,450		$	42,447		$	32,846
Basic net income per share:
As reported	$	2.80		$	2.43		$	1.96
Pro forma	$	2.68		$	2.26		$	1.80
Diluted net income per share:
As reported	$	2.54		$	2.27		$	1.93
Pro forma	$	2.44		$	2.13		$	1.79

See Note 20 for a discussion of the adoption, effective January 1, 2006, of SFAS No. 123R, “Share-Based Payment: an amendment of FASB Statements No. 123 and 95,” which requires companies to recognize in their income statement the grant-date fair value of stock options and other equity-based compensation issued to employees.

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,	2005		2004		2003
Employee Stock Purchase Plan
Risk-free interest rates	2.32	%	0.93% - 1.71	%	0.89% - 1.22	%
Dividend yield	1.23	%	0.99% - 1.45	%	0.00% - 1.27	%
Expected lives	3 months		3 months		3 months
Volatility	28.18	%	28.11% - 47.31%		42.59% - 50.14	%

Option Plans
Risk-free interest rates	3.58% - 3.71	%	2.80	%	2.50 - 3.00	%
Dividend yield	1.16% - 1.20	%	1.04	%	n/a
Expected lives	5.4 years		5.4 years		7.7 - 8.0 years
Volatility	41.92% - 42.04	%	43.32	%	46.24% - 46.79	%

The weighted average fair value of options granted during 2005, 2004 and 2003, before estimated forfeitures, was $6.35, $8.55 and $3.84 per share, respectively. The fair value 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.

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

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” individual dealerships sold, terminated or classified as held for sale are required to be reported as discontinued operations. During 2005, we completed the disposal of one dealership and, as of

F-15

December 31, 2005, had approved, but not yet completed, the disposition of two additional dealerships. In accordance with the provisions of SFAS No. 144, the results of operations of these dealerships were reported as discontinued operations for all periods presented. If, in future periods, we determine that a dealership should be either reclassified from continuing operations to discontinued operations, or from discontinued operations to continuing operations, previously reported consolidated statements of income will be reclassified in order to reflect the current classification.

During the first quarter of 2005, we reclassified bank fees and bank card charges, net of cash discounts earned, from other income (expense) to selling, general and administrative expense. The effect on 2004 and 2003 was to decrease other expense by $2.6 million and $2.1 million, respectively, and increase selling, general and administrative by like amounts.

In addition, in order to maintain consistency and comparability between periods, certain other amounts in our consolidated financial statements have been reclassified from previously reported balances to conform to the current year presentation.

(2) Restatement

Although the swaps do not retrospectively qualify for hedge accounting under SFAS No. 133, there is no effect on cash flows from operating, investing or financing activities for these changes. The effectiveness of the swaps as economic hedge transactions has not been affected by these changes in accounting treatment.

In addition, we are restating our previously reported financial information for other items that were individually deemed, and are currently deemed, to be immaterial. Because the interest rate swap adjustment has required a restatement, we have elected to record these adjustments in the proper periods.

These adjustments include the following:

· Payroll related expense: We recorded adjustments for accrued liabilities and selling, general and administrative expenses as a result of unrecorded commission expense.

· Intra-company gross profit elimination: We recorded adjustments to inventory and cost of sales in order to reflect the elimination of intra-company gross profit recognized on service work performed on new vehicle inventory.

· Income tax expense: We recorded an adjustment to accrued liabilities and income tax expense related to a tax contingency reserve.

F-16

· Deferred taxes: We recorded a reclassification between current and non-current deferred income taxes to reflect correct classifications.

The following tables detail the restatements (in thousands, except per share amounts):

	December 31, 2005
	As Originally Reported		Adjustments			As Restated
Accrued liabilities	$	57,775	$	(598	)	$	57,177
Accumulated other comprehensive income	3,316		(3,316		)	—
Retained earnings	229,647		3,914			233,561
Total stockholders’ equity	459,633		598			460,231

	December 31, 2004
	As Originally Reported		Adjustments			As Restated
Inventories	$	536,510	$	(1,163	)	$	535,347
Accrued liabilities	52,042		(463		)	51,579
Deferred income taxes, current	410		1,200			1,610
Deferred income taxes, non-current	36,339		(1,200		)	35,139
Accumulated other comprehensive income	789		(789		)	—
Retained earnings	187,545		87			187,632
Total stockholders’ equity	405,946		(700		)	405,246

	December 31, 2002
	As Originally Reported			Adjustments			As Restated
Accumulated other comprehensive income	$	(2,517	)	$	2,509		$	(8	)
Retained earnings	117,536			(3,182		)	114,354

	Year Ended December 31, 2005
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	2,430,977	$	(1,163	)	$	2,429,814
Floorplan interest expense	22,614		(4,081		)	18,533
Income tax expense	33,958		1,417			35,375
Net income	49,800		3,827			53,627
Basic net income per share	2.60		0.20			2.80
Diluted net income per share	2.37		0.17			2.54

	Year Ended December 31, 2004
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	2,214,995	$	148		$	2,215,143
Selling, general and administrative	339,519		(1,263		)	338,256
Floorplan interest expense	16,243		(3,726		)	12,517
Income tax expense	27,825		1,900			29,725
Net income	42,671		2,941			45,612
Basic net income per share	2.27		0.16			2.43
Diluted net income per share	2.13		0.14			2.27

	Year Ended December 31, 2003
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	2,067,600	$	1,015		$	2,068,615
Selling, general and administrative	307,344		170			307,514
Floorplan interest expense	13,715		(1,650		)	12,065
Other income, net	1,095		(1		)	1,094
Income tax expense	23,679		137			23,816
Loss from discontinued operations	270		(1		)	269
Net income	35,547		328			35,875
Basic net income per share	1.94		0.02			1.96
Diluted net income per share	1.92		0.01			1.93

F-17

	Quarter Ended March 31, 2005 (unaudited)
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	541,694	$	99		$	541,793
Floorplan interest expense	5,102		(3,334		)	1,768
Other income, net	285		(1		)	284
Income tax expense	6,614		1,278			7,892
Net income	9,990		1,956			11,946
Basic net income per share	0.52		0.11			0.63
Diluted net income per share	0.48		0.09			0.57

	Quarter Ended June 30, 2005 (unaudited)
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	623,584	$	233		$	623,817
Floorplan interest expense	6,000		1,865			7,865
Income tax expense	8,622		(841		)	7,781
Net income	12,675		(1,257		)	11,418
Basic net income per share	0.66		(0.06		)	0.60
Diluted net income per share	0.60		(0.05		)	0.55

	Quarter Ended September 30, 2005 (unaudited)
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	717,591	$	(1,495	)	$	716,096
Floorplan interest expense	5,534		(2,129		)	3,405
Other income, net	186		1			187
Income tax expense	12,551		1,483			14,034
Loss from discontinued operations	484		1			485
Net income	17,632		2,141			19,773
Basic net income per share	0.92		0.11			1.03
Diluted net income per share	0.83		0.09			0.92

	Quarter Ended December 31, 2005 (unaudited)
	As Originally Reported		Adjustments			As Restated
Floorplan interest expense	$	5,978	$	(483	)	$	5,495
Income tax expense	6,171		(503		)	5,668
Loss from discontinued operations	593		(1		)	592
Net income	9,503		987			10,490
Basic net income per share	0.49		0.05			0.54
Diluted net income per share	0.45		0.05			0.50

	Quarter Ended March 31, 2004 (unaudited)
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	514,780	$	124		$	514,904
Selling, general and administrative	82,370		(654		)	81,716
Floorplan interest expense	3,508		2,086			5,594
Other income, net	177		2			179
Income tax expense	5,072		(587		)	4,485
Net income	7,479		(968		)	6,511
Basic net income per share	0.40		(0.05		)	0.35
Diluted net income per share	0.39		(0.05		)	0.34

	Quarter Ended June 30, 2004 (unaudited)
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	548,406	$	318		$	548,724
Selling, general and administrative	85,814		(375		)	85,439
Floorplan interest expense	3,992		(7,052		)	(3,060		)
Other income, net	276		(3		)	273
Income tax expense	7,127		2,771			9,898
Net income	10,840		4,336			15,176
Basic net income per share	0.58		.23			.81
Diluted net income per share	0.54		.21			.75

F-18

	Quarter Ended September 30, 2004 (unaudited)
	As Originally Reported		Adjustments			As Restated
Cost of sales	$	611,447	$	(312	)	$	611,135
Selling, general and administrative	88,065		(275		)	87,790
Floorplan interest expense	4,402		2,705			7,107
Other income, net	201		3			204
Income tax expense	9,259		(823		)	8,436
Net income	14,470		(1,292		)	13,178
Basic net income per share	0.77		(0.07		)	.70
Diluted net income per share	0.70		(0.06		)	0.64

	Quarter Ended December 31, 2004 (unaudited)
	As Originally					As
	Reported		Adjustments			Restated
Cost of sales	$	540,362	$	18		$	540,380
Selling, general and administrative	83,270		41			83,311
Floorplan interest expense	4,341		(1,465		)	2,876
Other income, net	265		(2		)	263
Income tax expense	6,367		539			6,906
Net income	9,882		865			10,747
Basic net income per share	0.52		.05			.57
Diluted net income per share	0.48		.04			.52

(3) Trade Receivables

Trade receivables consisted of the following (in thousands):

December 31,	2005			2004
Trade receivables	$	14,822		$	12,666
Vehicle receivables	14,906			9,971
Manufacturer receivables	23,569			18,694
Other	1,099			1,150
	54,396			42,481
Less: Allowances	(406		)	(436		)
Total receivables, net	$	53,990		$	42,045

Vehicle receivables represent receivables from financial institutions for the portion of the vehicle sales price financed by the customer.

(4) Inventories and Related Notes Payable

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

	2005				2004
	Inventory		Notes		Inventory		Notes
December 31,	Cost		Payable		Cost		Payable
					(Restated)
New and program vehicles	$	491,486	$	530,452	$	425,971	$	450,860
Used vehicles	87,853		—		84,739		—
Parts and accessories	26,708		—		24,637		—
Total inventories	$	606,047	$	530,452	$	535,347	$	450,860

The inventory balance is generally reduced by manufacturer holdbacks and incentives, while the related floorplan liability is reflective of the gross cost of the vehicle. The floorplan 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.

F-19

All new vehicles are pledged to collateralize floor plan notes payable to floorplan providers. The floorplan notes payable bear interest, payable monthly on the outstanding balance, at a rate of interest that varies by provider. The new vehicle floorplan notes are payable on demand and are typically paid upon the sale of the related vehicle. As such, these floorplan notes payable are shown as current liabilities in the accompanying consolidated balance sheets.

At December 31, 2005 and 2004, used vehicles and parts and accessories inventory were pledged to collateralize our used vehicle and working capital credit facility.

(5) Property, Plant and Equipment

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

December 31,	2005			2004
Buildings and improvements	$	150,916		$	129,687
Service equipment	29,152			25,373
Furniture, signs and fixtures	79,453			70,804
	259,521			225,864
Less accumulated depreciation – buildings	(11,358		)	(8,110		)
Less accumulated depreciation – equipment and other	(31,622		)	(25,922		)
	216,541			191,832
Land	109,464			95,583
Construction in progress, buildings	6,350			9,196
Construction in progress, other	822			3,020
	$ 333,177			$	299,631

(6) Goodwill and Other Intangible Assets

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

Year Ended December 31,	2005			2004
Balance, beginning of year	$	244,532		$	207,027
Goodwill acquired and post acquisition adjustments	21,865			37,505
Goodwill included in assets held for sale	(2,368		)	—
Goodwill included in gain or loss on disposal of franchises and discontinued operations	(3,130		)	—
Balance, end of year	$	260,899		$	244,532

The amount of goodwill assigned to a discontinued operation is generally determined based on the subject dealership’s discounted cash flows as it relates to the discounted cash flows of the reporting unit.

At December 31, 2005 and 2004, other intangible assets included the value of franchise agreements and non-compete agreements. At December 31, 2005, it also included customer lists. The value attributed to franchise agreements has an indefinite useful life and non-compete agreements and customer lists are amortized on a straight-line basis over the life of the agreements, typically 3 to 5 years.

F-20

The gross amount of other intangible assets and the related accumulated amortization for non-compete agreements and customer lists were as follows (in thousands):

December 31,	2005			2004
Franchise value	$	50,161		$	44,602

Non-compete agreements and customer lists	175			110
Accumulated amortization	(89		)	(63		)
Net non-compete agreements and customer lists	86			47
Total other intangible assets, net	$	50,247		$	44,649

Amortization expense related to the non-compete agreements and customer lists totaled $26,000, $24,000 and $21,000, respectively, for the years ended December 31, 2005, 2004 and 2003. Amortization of non-compete agreements and customer lists is as follows over the next five years (in thousands):

2006	$	35
2007	15
2008	13
2009	13
2010	10

(7) Trade Payables

Trade payables consisted of the following (in thousands):

December 31,	2005		2004
Trade payables	$	10,450	$	9,275
Lien payables	10,832		8,192
Manufacturer payables	4,744		4,630
Other	4,891		4,703
Total trade payables	$	30,917	$	26,800

Lien payables represent amounts owed to financial institutions for customer vehicle trade-ins.

(8) 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 do not enter into derivative instruments for any purpose other than to manage interest rate exposure. That is, we do not engage in interest rate speculation using derivative instruments.

F-21

As of December 31, 2005, we had outstanding the following interest rate swaps with U.S. Bank Dealer Commercial Services:

· 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;

· effective March 9, 2004 – a five year, $25 million interest rate swap at a fixed rate of 3.25% per annum, variable rate adjusted on the 1st and 16th of each month; and

· effective March 18, 2004 – a five year, $25 million interest rate swap at a fixed rate of 3.10% per annum, variable rate adjusted on the 1st and 16th 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, 2005 was 4.39% 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 currently as a component of floorplan interest expense. The difference between interest earned and the interest obligation results in a monthly settlement, which is also recorded currently in the statement of operations as a component of floorplan interest expense.

See also Note 2. for a discussion of restatements related to our derivative financial instruments.

(9) Lines of Credit and Long-Term Debt

Lines of Credit

Pursuant to our $150 million credit agreement with DaimlerChrysler Services North America LLC and Toyota Motor Credit Corporation, total dividends and repurchases of our common stock cannot exceed $18.0 million over the term of the agreement. Through December 31, 2005, over the term of the agreement, we have paid dividends and repurchased stock totaling $16.6 million. This credit agreement was amended in February 2006 to increase the total allowable dividends and stock repurchases to $25.0 million.

F-22

	Outstanding at December 31, 2005		Remaining Availability as of December 31, 2005
New and program vehicle lines	$	530,452	$	*
Working capital and used vehicle line	—		150,000
Equipment/leased vehicle line	50,000		—
	$	580,452	$	150,000

* There are no formal limits on the new and program vehicle lines with certain lenders.

Senior Subordinated Convertible Notes

In May 2004, we sold $85.0 million of 2.875% senior subordinated convertible notes (the “Notes”) due 2014 through a Rule 144A offering to qualified institutional buyers. We will also pay contingent interest on the Notes during any six-month interest period beginning May 1, 2009, in which the trading price of the Notes for a specified period of time equals or exceeds 120% of the principal amount of the Notes. We subsequently filed a registration statement with the SEC to register the resale of the Notes and shares of the Class A common stock in to which the Notes are convertible. Net proceeds from this offering were approximately $82.5 million. The Notes are convertible into shares of our Class A common stock at a price of $37.69 per share (or 26.53 shares per $1,000 of Notes) upon the satisfaction of certain conditions and upon the occurrence of certain events as follows:

· if, after May 1, 2009, the closing sale price of our common stock exceeds 120% of the conversion price;

· if, during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Notes for each day of such period was less than 98% of the product of the closing sale price of our common stock and the number of shares issuable upon conversion of $1,000 principal amount of the Notes;

· if the Notes have been called for redemption; or

· upon certain specified corporate events.

A declaration and payment of a dividend in excess of $0.08 per share per quarter will result in an adjustment in the conversion rate for the Notes if such adjustment exceeds 1% of the current conversion rate. We declared a dividend of $0.12 per share in July 2005 and again in October 2005. The affect of such dividends does not yet reach the 1% threshold amount and no adjustment in the conversion rate is currently required.

The Notes are redeemable at our option beginning May 6, 2009 at the redemption price of 100% of the principal amount plus any accrued interest. The holders of the Notes can require us to repurchase all or some of the Notes on May 1, 2009 and upon certain events constituting a fundamental change or a termination of trading. A fundamental change is any transaction or event in which all or substantially all of our common stock is exchanged for, converted into, acquired for, or constitutes solely the right to receive, consideration that is not all, or substantially all, common stock that is listed on, or immediately after the transaction or event, will be listed on, a United States national securities exchange. A termination of trading will have occurred if our common stock is not listed for trading on a national securities exchange or the NASDAQ stock market.

Our earnings to fixed charge coverage ratio, as defined in the Notes, was 3.03 for 2005.

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Summary

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

December 31,	2005			2004
Variable Rate Debt:
Equipment and leased vehicle line of credit, expiring May 2007	$	50,000		$	40,686
Mortgages payable in monthly installments of $386, including interest between 6.19% and 8.43%, maturing through April 2024; secured by land and buildings	44,090			52,382
Notes payable in monthly installments of $23, including interest between 0.0% and 7.1%, maturing at various dates through 2006; secured by vehicles leased to others	2,704			2,194
Notes payable related to acquisitions, with interest rate of 7.25%, maturing February 2008	179			331
Total Variable Rate Debt	96,973			95,593
Fixed Rate Debt:
2.875% senior subordinated convertible notes, due May 2014 with interest due semi- annually in May and November of each year	85,000			85,000
Mortgages payable in monthly installments of $797, including interest between 4.00% and 7.29%, maturing fully May 2022; secured by land and buildings	113,702			91,298
Notes payable related to acquisitions, with interest rates between 4.00% and 7.25%, maturing at various dates through May 2009	1,235			1,454
Capital lease obligations, net of interest of $138, with monthly lease payments of $5	509			530
Total Fixed Rate Debt	200,446			178,282
Total Long-Term Debt	297,419			273,875
Less current maturities	(6,868		)	(6,565		)
	$	290,551		$	267,310

The schedule of future principal payments on long-term debt as of December 31, 2005 was as follows (in thousands):

Year Ending December 31,
2006	$	6,868
2007	63,112
2008	38,276
2009	23,435
2010	9,509
Thereafter	156,219
Total principal payments	$	297,419

(10) 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.

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11) Cost of Sales

Cost of sales categorized by revenue category from continuing operations was as follows (in thousands):

Year Ended December 31,	2005		2004		2003
	(Restated)		(Restated)		(Restated)
New vehicle sales	$	1,542,458	$	1,420,035	$	1,300,865
Used vehicle sales	707,096		643,298		634,525
Service, body and parts	158,792		145,349		128,935
Fleet and other	21,468		6,461		4,290
	$	2,429,814	$	2,215,143	$	2,068,615

(12) Income Taxes

Income tax expense from continuing operations was as follows (in thousands):

Year Ended December 31,	2005		2004		2003
	(Restated)		(Restated)		(Restated)
Current:
Federal	$	25,477	$	15,479	$	11,102
State	3,643		2,253		1,649
	29,120		17,732		12,751
Deferred:
Federal	5,514		10,624		9,983
State	741		1,369		1,082
	6,255		11,993		11,065
Total	$	35,375	$	29,725	$	23,816

At December 31, 2005, we had income taxes payable totaling $1.1 million and at December 31, 2004, we had prepaid income taxes totaling $2.6 million.

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

December 31,	2005			2004
Deferred tax assets:
Deferred revenue and cancellation reserves	$	5,366		$	4,801
Allowance and accruals	5,031			4,163
Total deferred tax assets	10,397			8,964

Deferred tax liabilities:
Inventories	(4,677		)	(5,766		)
Interest expense	(3,045		)	(1,856		)
Goodwill	(29,185		)	(22,896		)
Property and equipment, principally due to differences in depreciation	(15,632		)	(14,670		)
Prepaids and property taxes	(863		)	(525		)
Total deferred tax liabilities	(53,402		)	(45,713		)
Total	$	(43,005	)	$	(36,749	)

In 2005, 2004 and 2003, income tax benefits attributable to employee stock option transactions of $584,000, $415,000 and $138,000, respectively, were allocated to stockholders’ equity.

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The reconciliation between amounts computed using the federal income tax rate of 35% and our income tax expense from continuing operations for 2005, 2004 and 2003 is shown in the following tabulation (in thousands):

Year Ended December 31,	2005		2004		2003
	(Restated)		(Restated)		(Restated)
Computed “expected” tax expense	$	31,848	$	26,859	$	20,986
State taxes, net of federal income tax benefit	2,922		2,357		1,792
Other	605		509		1,038
Income tax expense	$	35,375	$	29,725	$	23,816

(13) 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 $1.8 million, $1.3 million and $0.6 million were recognized for the years ended December 31, 2005, 2004 and 2003, respectively. Employees may contribute to the plan as they meet certain eligibility requirements.

(14) Stock Incentive Plans

At our annual shareholders meeting in May 2005, our shareholders approved an amendment to, and restatement of, our 2003 Stock Option Plan in the form of the 2003 Stock Incentive Plan (the “2003 Plan”). As amended in May 2005, the 2003 Plan allows for the granting of up to a total of 2.2 million 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. Beginning in 2004, the term of options granted has been reduced to six years. At December 31, 2005, 2,548,906 shares of Class A common stock were reserved for issuance under the plans, of which 1,321,222 were available for future grant.

Activity under the above plans was as follows (in thousands):

	Shares Available for Grant		Shares Subject to Options		Weighted Average Exercise Price
Balances, December 31, 2002	544		1,498		$	14.25
Options granted	(16	)	16		14.09
Options canceled	133		(151	)	16.54
Options exercised	—		(38	)	10.09
Balances, December 31, 2003	661		1,325		14.10
Additional shares reserved	1,000		—		—
Options granted	(337	)	337		29.14
Options canceled	55		(64	)	18.41
Options exercised	—		(168	)	9.14
Balances, December 31, 2004	1,379		1,430		18.04
Options granted	(105	)	105		27.46
Options canceled	100		(114	)	22.30
Options exercised	—		(193	)	14.21
Non-vested stock issued	(62	)	—		—
Non-vested stock forfeited	9		—		—
Balances, December 31, 2005	1,321		1,228		$	19.06

The weighted average grant date fair value of non-vested stock issued in 2005 was $27.54. The weighted average fair value of options granted pursuant to the 2003 Plan was $10.69, $11.52 and $8.20, respectively, in 2005, 2004 and 2003.

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The following table summarizes stock options outstanding at December 31, 2005:

Options Outstanding					Options Exercisable
Range of Exercise Prices	Number of Shares Outstanding	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price		Number of Shares Exercisable	Weighted Average Exercise Price
$1.00	71,000	5.1	$	1.00	69,000	$	1.00
11.25 - 12.69	137,976	5.0	11.82		136,776	11.82
14.31 - 16.18	221,438	6.6	15.16		45,658	15.18
16.50 - 17.85	249,559	3.8	16.71		225,323	16.70
19.24 - 20.52	172,400	6.0	19.28		40,200	19.24
26.60 - 27.58	103,004	5.2	27.48		11,000	26.60
29.42	272,307	4.2	29.42		6,000	29.42
$1.00 - $29.42	1,227,684	5.0	$	19.06	533,957	$	13.83

At December 31, 2004 and 2003, 513,049 and 527,250 shares were exercisable at weighted average exercise prices of $15.14 and $12.99, 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, have reserved a total of 1.75 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% of their base pay for the purchase of stock up to $25,000 of fair market value of our Class A common stock annually. Prior to April 1, 2005, the purchase price for shares purchased under the Purchase Plan was 85% of the lesser of the fair market value at the beginning or end of the purchase period. Beginning April 1, 2005, the purchase price is equal to 85% of the fair market value at the end of the purchase period. A total of 256,036, 281,357 and 375,988 shares of our Class A common stock were issued under the Purchase Plan during 2005, 2004 and 2003, respectively, and 284,460 remained available for issuance at December 31, 2005.

(15) Dividend Payments

For the period January 1, 2003 through December 31, 2005, we declared and paid dividends as follows (total amount of dividend in thousands):

Quarter related to:	Dividend amount per share		Total amount of dividend (in thousands)
2003
Second quarter	$	0.07	$	1,283
Third quarter	0.07		1,291
Fourth quarter	0.07		1,304
2004
First quarter	0.07		1,312
Second quarter	0.08		1,506
Third quarter	0.08		1,512
Fourth quarter	0.08		1,528
2005
First quarter	0.08		1,536
Second quarter	0.12		2,312
Third quarter	0.12		2,322

See also Note 21 for information regarding the declaration of a dividend related to the fourth quarter of 2005.

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(16) Commitments and Contingencies

Leases

We lease certain of our facilities under non-cancelable operating leases. These leases expire at various dates through 2030. Certain lease commitments contain fixed payment increases at predetermined intervals over the life of the lease, while other lease commitments are subject to escalation clauses of an amount equal to the increase in 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. Lease expense is recognized on a straight-line basis over the life of the lease.

Leasehold improvements made at the inception of the lease or during the term of the lease are amortized over the shorter of the life of the improvement or the remaining term of the lease. The payments on the lease liability are amortized over the term of the lease.

The minimum lease payments under the operating leases after December 31, 2005 were as follows (in thousands):

Year Ending December 31,
2006	$	20,931
2007	19,502
2008	18,039
2009	15,001
2010	12,565
Thereafter	40,671
Total minimum lease payments	126,709
Less: sublease rentals	(3,322		)
	$	123,387

Rental expense for all operating leases was $18.7 million, $18.8 million and $18.2 million for the years ended December 31, 2005, 2004 and 2003, respectively.

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 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. Lease rental payments under assigned or sublet leases for their remaining terms totaled approximately $3.3 million at December 31, 2005.

Capital Commitments

We had capital commitments of $21.8 million at December 31, 2005 for the construction of five new facilities, additions to two existing facilities and the remodel of two facilities. Three of the new facilities will be for our Toyota dealerships in Springfield, Oregon, Klamath Falls, Oregon and Odessa, Texas. The other two new facilities are for our Dodge dealership in Sioux Falls, South Dakota and for our Mercedes dealership in Spokane, Washington. We have already incurred $5.4 million for these projects and anticipate incurring the remaining $21.8 million in 2006. 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.

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Charge-Backs for Various Contracts

We have recorded a reserve for our estimated contractual obligations related to potential charge-backs for vehicle service contracts, lifetime oil change contracts and other various insurance contracts that are terminated early by the customer. At December 31, 2005, this reserve totaled $13.1 million. Based on past experience, we estimate that the $13.1 million will be paid out as follows: $7.9 million in 2006; $3.5 million in 2007; $1.3 million in 2008; $0.3 million in 2009; and $0.1 million thereafter.

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.

On November 25, 2003, Aimee Phillips filed a lawsuit in the U.S. District Court for the District of Oregon (Case No. 03-3109-HO) against Lithia Motors, Inc. and two of its wholly-owned subsidiaries alleging violations of state and federal RICO laws, the Oregon Unfair Trade Practices Act (“UTPA”) and common law fraud. Ms. Phillips seeks damages, attorney’s fees and injunctive relief. Ms. Phillips’ complaint stems from her purchase of a Toyota Tacoma pick-up truck on July 6, 2002. On May 14, 2004, we filed an answer to Ms. Phillips’ Complaint. This case was consolidated with the Allen case described below and has a similar current procedural status.

On April 28, 2004, Robert Allen and 29 other plaintiffs (“Allen Plaintiffs”) filed a lawsuit in the U.S. District Court for the District of Oregon (Case No. 04-3032-HO) against Lithia Motors, Inc. and three of its wholly-owned subsidiaries alleging violations of state and federal RICO laws, the Oregon UTPA and common law fraud. The Allen Plaintiffs seek damages, attorney’s fees and injunctive relief. The Allen Plaintiffs’ Complaint stems from vehicle purchases made at Lithia dealerships between July 2000 and April 2001. On August 27, 2004, we filed a Motion to Dismiss the Complaint. On May 26, 2005, the Court entered an Order granting Defendants’ Motion to Dismiss plaintiffs’ state and federal RICO claims with prejudice. The Court declined to exercise supplemental jurisdiction over plaintiffs’ UTPA and fraud claims. Plaintiffs filed a Motion to Reconsider the dismissal Order. On August 23, 2005, the Court granted Plaintiffs’ Motion for Reconsideration and permitted the filing of a Second Amended Complaint (“SAC”). On September 21, 2005, the Allen Plaintiffs, along with Ms. Phillips, filed the SAC. In this complaint, the Allen plaintiffs seek actual damages that total less than $500,000, trebled, approximately $3.0 million in mental distress claims, trebled, punitive damages of $15.0 million, attorney’s fees and injunctive relief. The SAC added as defendants certain officers and employees of Lithia. In addition, the SAC added a claim for relief based on the Truth in Lending Act (“TILA”). On November 14th, 2005 we filed a second Motion to Dismiss the Complaint and a Motion to Compel Arbitration and are now awaiting the Court’s ruling.

On September 23, 2005, Maria Anabel Aripe and 19 other plaintiffs (“Aripe Plaintiffs”) filed a lawsuit in the U.S. District Court for the District of Oregon (Case No. 05-3083-HO) against Lithia Motors, Inc., 12 of its wholly-owned subsidiaries and certain officers and employees of the Company, alleging violations of state and federal RICO laws, the Oregon UTPA, common law fraud and TILA. The Aripe Plaintiffs seek actual damages of less than $600,000, trebled, approximately $3.7 million in mental distress claims, trebled, punitive damages of $12.6 million, attorney’s fees and injunctive relief. The Aripe Plaintiffs’ Complaint stems from vehicle purchases made at Lithia dealerships between May 2001 and August 2005 and is substantially similar to the allegations made in the Allen case.

We intend to vigorously defend all matters and management believes that the likelihood of a judgment for the amount of damages sought in any of the cases is remote.

(17) Related Party Transactions

Mark DeBoer Construction

During 2005, 2004 and 2003, Lithia Real Estate, Inc. paid Mark DeBoer Construction, Inc. $0.8 million, $1.6 million, and $1.6 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 $162,000, $0.7 million and $0.9 million, respectively, paid for subcontractors and materials, $102,000,

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$42,000 and $102,000, respectively for permits, licenses, travel and various miscellaneous fees, and $521,000, $880,000 and $638,000, respectively, for contractor fees. 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.

(18) Acquisitions

The following acquisitions were made in 2005:

· In January 2005, we acquired a Chrysler and Jeep franchise in Concord, California. The franchises were added to our Dodge store in that market. The store is now named Lithia Chrysler Jeep Dodge of Concord.

· In January 2005, we acquired a Chrysler franchise in Eugene, Oregon. The franchise was added to our Dodge store in that market. The stores name is now Lithia Chrysler Dodge of Eugene.

· In February 2005, we acquired a Chrysler, Jeep, Dodge, Dodge Truck store in Omaha, Nebraska. The store has anticipated annualized revenues of $110 million. The store was renamed Lithia Chrysler Jeep Dodge of Omaha.

· In April 2005, we acquired a Chrysler, Dodge, Dodge Truck store in Eureka, California. The store has anticipated annualized revenues of $28 million. The store was renamed Lithia Chrysler Dodge of Eureka.

· In May 2005, we acquired a Chrysler, Jeep, Dodge, Dodge Truck store in Butte, Montana. The store has anticipated annualized revenues of $26 million. The store was renamed Lithia Chrysler Dodge Jeep of Butte.

· In August 2005, we acquired a Chrysler, Dodge, Dodge Truck store in Wenatchee, Washington. The store had annualized revenues of approximately $8 million. The store was renamed Lithia Chrysler Dodge of Wenatchee.

· In October 2005, we acquired a Honda store and Chrysler and Jeep franchises that were added to our existing Dodge store in Midland, Texas. The combined stores and franchises have anticipated annualized revenues of $24 million. The Honda store was renamed Honda of Midland.

· In November 2005, we acquired a Toyota and a Honda store in Abilene, Texas. The stores have anticipated annualized revenues of $60 million. The stores were renamed Lithia Toyota of Abilene and Honda of Abilene.

· In December 2005, we acquired a Dodge store in Corpus Christi, Texas. The store has anticipated annualized revenues of $60 million. The store was renamed Lithia Dodge of Corpus Christi.

The following acquisitions were made in 2004:

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

· In March 2004, we acquired one Chevrolet store in Helena, Montana, which had anticipated annual revenues of approximately $40.0 million. The store has been renamed Chevrolet of Helena.

· In April 2004, we acquired Tony Chevrolet of Anchorage and Tony Chevrolet of Wasilla, Alaska, which had anticipated combined annual revenues of approximately $125 million. The stores have been renamed Chevrolet of South Anchorage and Chevrolet of Wasilla, respectively.

· In June 2004, we acquired the Saab dealership assets of Pacific Motors Group, Inc. The Saab franchise purchased with this acquisition was combined with Chevrolet of South Anchorage.

· In July 2004, we acquired one Toyota store in Odessa, Texas, which had anticipated annual revenues of approximately $20.0 million. The store has been renamed Lithia Toyota of Odessa.

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· In September 2004, we acquired a Chrysler Dodge Jeep and a Honda store in Great Falls, Montana, which had anticipated combined annual revenue of approximately $40 million. The stores have been renamed Lithia Chrysler Dodge Jeep of Great Falls and Honda of Great Falls, respectively.

· In October 2004, we acquired a Chrysler and a Jeep franchise in Santa Rosa, California, which had anticipated annual revenue of approximately $10 million. These franchises have been combined with our existing Dodge store in Santa Rosa. The store is now named Lithia Chrysler Dodge Jeep of Santa Rosa.

· In October 2004, we acquired a BMW store in Anchorage, Alaska, which had anticipated annual revenue of approximately $15 million. The store is now named BMW of Anchorage.

· In November 2004, we acquired a Chrysler Jeep Dodge franchise in Santa Fe, New Mexico, which had anticipated annual revenue of approximately $20 million. The store is now named Lithia Chrysler Jeep Dodge of Santa Fe.

· In November 2004, we acquired a Dodge store in Helena, Montana, which had anticipated annual revenue of approximately $18 million. The store is now named Lithia Dodge of Helena.

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 as of January 1, 2004 were as follows (in thousands, except per share amounts).

Year Ended December 31,	2005		2004
	(Unaudited) (Restated)		(Unaudited) (Restated)
Total revenues	$	3,059,425	$	3,112,860
Net income	54,402		50,453
Basic earnings per share	2.84		2.69
Diluted earnings per share	2.58		2.50

There are no future contingent payouts related to any of the 2004 or 2005 acquisitions and no portion of the purchase price was paid with our equity securities. During 2005 we acquired the eight stores and twenty-four additional franchises discussed above for $51.7 million, which included $21.9 million of goodwill and $8.4 million of other intangible assets. During 2004, we acquired 12 stores for $91.6 million, which included $38.0 million of goodwill and $15.6 million of other intangible assets. The $51.7 million and $91.6 million for 2005 and 2004, respectively, are net of floorplan notes payable which were assumed at the time of acquisition.

Within one year from the purchase date, we may update the value allocated to purchased assets and the resulting goodwill balances based on pending information received regarding the valuation of such assets. All of the goodwill from the above acquisitions is expected to be deductible for tax purposes.

(19) Discontinued Operations

Certain financial information related to discontinued operations was as follows (in thousands):

Year Ended December 31,	2005			2004			2003
							(Restated)
Revenue	$	45,881		$	116,411		143,584
Pre-tax income (loss)	(3,328		)	(2,591		)	(1,068	)
Gain (loss) on disposal of discontinued operations, net of tax	28			302			621
Amount of goodwill and other intangible assets disposed of	4,406			1,629			1,712

F-31

Assets held for sale included the following (in thousands):

December 31,	2005		2004
Inventories	$	22,703	$	—
Property, plant and equipment	817		135
Goodwill	2,368		—
Other intangible assets	1,523		—
	$	27,411	$	135

Liabilities held for sale of $22.4 million at December 31, 2005 represented new vehicle flooring notes payable related to the two dealerships held for sale.

(20) Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment: an amendment of FASB Statements No. 123 and 95,” which requires companies to recognize in their income statement the grant-date fair value of stock options and other equity-based compensation issued to employees. We adopted SFAS No. 123R on January 1, 2006. See Note 1 Summary of Significant Accounting Policies – Stock-Based Compensation above for the pro forma effects of how SFAS No. 123 would have affected results of operations in 2005, 2004 and 2003. We do not expect the results of SFAS No. 123R to be significantly different than those of applying SFAS No. 123.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets.” SFAS No. 153 amends APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” by replacing the exception for exchanges of similar productive assets with an exception for exchanges that do not have commercial substance. A transaction has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 on July 1, 2005 did not have any effect on ourfinancial position, results of operations or cash flow.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections: a replacement of APB Opinion No. 20 and FASB Statement No. 3,” which requires companies to apply most voluntary accounting changes retrospectively to prior financial statements. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Any future voluntary accounting changes made by us will be accounted for under SFAS No. 154 and will be applied retrospectively.

(21) Subsequent Events

Dividend

In February 2006, our Board of Directors approved a dividend on our Class A and Class B common stock of $0.12 per share for the fourth quarter of 2005. The dividend, which will total approximately $2.3 million, will be paid on March 6, 2006 to shareholders of record on February 20, 2006.

Disposition

In February 2006, we disposed of one of our dealerships that was held for sale at December 31, 2005.

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