You should read the following discussion in conjunction with Item 1. "Business," Item 1A. "Risk Factors" and our Consolidated Financial Statements and Notes thereto.

Overview

We are a leading operator of automotive franchises and retailer of new and used vehicles and services. As of March 16, 2009, we offered 27 brands of new vehicles and all brands of used vehicles in 92 stores in the United States and over the Internet. 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.

While the U.S. has not experienced a slower auto retail environment in 50 years, in January and February 2009, traffic in our stores was up over our December 2008 traffic. In addition, we believe that we are realizing success from our recent marketing efforts and our continuing cost cutting initiatives to help mitigate the slowing sales environment.

We believe that adhering to strict cost-cutting measures and improving our balance sheet by reducing debt and preserving cash, while still focusing on satisfying our customers, should enable us to come through the tough economic times as a stronger, more viable company. However, no assurances can be given that industry sales will not experience a further decline, or that our restructuring plan will be of sufficient magnitude to guarantee success in a declining market.

Economic Environment During 2008

As discussed in Overview in Item 1, "Business," above, during 2008, overall macroeconomic issues have reduced consumers' desire and ability to purchase automobiles. An additional factor negatively impacting auto sales has been a reduction in available options for consumer auto loans. The manufacturers' captive financing companies have suffered additional pressure as the financial crisis has raised their cost of funds and reduced their access to capital. This has prevented them from offering as many incentives designed to drive sales, such as subsidized interest rates and the amount of loan to value they are willing to advance on vehicles.

The number of customers visiting our stores has significantly declined from prior years. We believe one of the reasons showroom traffic has suffered is that customers are assuming that financing is not available or that they would not qualify for vehicle financing. One of the main objectives of our recent advertising has focused on overcoming this obstacle and communicating that consumer vehicle financing continues to be available. This is evidenced by the fact that we were still able to arrange financing on approximately 73% of the vehicles we sold during the fourth quarter of 2008, although at substantially lower volumes.

In addition, both new and used vehicle sales have been impacted in 2008 by declining valuations for most used vehicles. Fewer customers are trading in their used vehicles as the value many could receive is less than what they currently owe. This has negatively affected our new vehicle sales as many potential customers are not able to obtain financing to absorb the amount owed on their trade in as well as the cost of the new vehicle.

Restructuring and Cost-Cutting Initiatives

As the economic environment continued to deteriorate in the second half of 2008, we continued to take steps to achieve profitably in the current adverse market conditions, as well as to position ourselves for our long-term growth objectives. The restructuring plan we announced on June 2, 2008 was subsequently expanded to include additional initiatives. As of March 16, 2009, we identified a total of 31 stores for divestiture and, as of this date, 12 of these stores had been sold, 4 had been closed, and 15 remained for sale, one of which had a preliminary agreement signed for its sale. These actions will reduce our store count by approximately one-fourth and will move us closer to our goal of a long term 50/50 domestic/import new vehicle sales mix.

Our restructuring plans also included the following cost cutting measures:

• Re-aligning store management personnel and duties;

• Reducing non-production headcount across the company;

• Reducing non-essential store expenses;

• Consolidating vendors and negotiating favorable payment terms;

• Reducing all corporate level expenses where possible; and

• Further centralizing offices by region.

In addition to the store divestitures discussed above, the following restructuring actions are underway to help preserve capital and improve profitability:

• Deferring all uncommitted capital expenditures;

• Selling certain development property and other assets, including aircraft and excess land;

• Financing certain unfinanced real estate;

• Postponing acquisitions until prices stabilize; and

• Adjusting inventory levels to meet consumers' shift in demand for new and used vehicles.

The above actions have allowed us to achieve approximately $43 million of annualized savings through December 31, 2008 and we will continue to identify additional cost savings in the future without impacting customer service.

As part of our restructuring plan, the investment in additional L2 locations was placed on hold as we were unwilling to continue to absorb the expected startup losses. After we placed the initiative on hold, certain personnel associated with the project were terminated and others were re-assigned to other areas.

The existing L2 stores have been integrated into the Lithia platform and we are utilizing all of the Lithia systems in the locations. We closed our Loveland L2 location in June 2008 and are currently using the facility in a re-formatted used car operation. In September 2008, we completed the sale of our Cedar Rapids L2 location. We closed our Amarillo L2 location in November 2008 and are currently using the facility in a re-formatted used car operation. We currently operate an L2 location in Lubbock, Texas. However, the Lubbock location has been revamped to essentially operate as a traditional Lithia store to gain operational efficiencies and to unify selling systems across the organization.

We did not incur any material severance, lease termination or other restructuring charges related to any of these restructuring actions in 2008.

Manufacturer Information

Historically, manufacturers have offered incentives on new vehicle sales through a combination of repricing strategies, rebates, lease programs, early lease cancellation programs and low interest rate loans to consumers. Through the first half of 2008, this strategy continued. However, in response to tightening in credit markets, in the third quarter of 2008, we saw a shift away from leasing and subsidized financing to dealer and consumer rebates and repricing strategies.

In July 2008, Chrysler Financial announced the termination of its lease program. We have not seen a significant impact due to this change as the majority of our transactions with Chrysler Financial are retail installment contracts, not leases. We have received additional retail incentives as a result of the termination of its lease program and may receive additional incentives in the future.

In October 2008, the domestic automakers approached Congress seeking government assistance. As part of these hearings, each manufacturer provided an update on their current financial situation as well as their outlook for 2009 and beyond. In the course of the hearings, it became clear that without immediate assistance, both Chrysler and General Motors ("GM") faced the possibility of insolvency as early as January 2009.

In December 2008, the federal government provided $17.4 billion in bridge loans to both Chrysler and GM. Stipulated with the loans was the condition that both manufacturers return to the Treasury in February 2009 and provide a restructuring plan.

At the time of this filing, both Chrysler and GM have provided their plans to the Treasury requesting up to $39 billion in total support, including the $17.4 billion already provided, and are acting on those plans. However, the response by the federal government to these strategies remains unknown. We believe that in the event either or both plans are rejected, a Chapter 11 bankruptcy filing would occur. We have developed contingency plans to respond in the event of such a filing. No assurances can be given that our contingency plans will be adequate to address the magnitude of these scenarios.

Goodwill and Other Asset Impairment Charges

Our financial results for 2008 included $301.0 million of goodwill and other asset impairment charges included as a component of operating loss and an additional $70.1 million as a component of discontinued operations. See Notes 1, 5, 6 and 19 of Notes to Consolidated Financial Statements for additional information.

Gain on Early Retirement of Senior Subordinated Convertible Notes

During the third and fourth quarters of 2008, we redeemed a total of half, or $42.5 million principal amount, of our senior subordinated convertible notes at a discount, which resulted in a gain on early retirement of $5.2 million, which was included as a component of other income, net on our consolidated statement of operations. As of December 31, 2008, $42.5 million of our senior subordinated convertible notes remained outstanding.

Pro Forma Results of Operations

On a non-GAAP basis, the elimination of the effect of the non-cash impairment charges and the gain on early retirement of debt would have resulted in a net improvement of our net loss before taxes by approximately $295.8 million to net income before taxes of $4.9 million in 2008. In addition, excluding the non-cash impairment charges and the gain on early retirement of debt of $(10.10) per share in continuing operations and $(12.28) per share including discontinued operations, on a non-GAAP basis we had income of $0.15 per diluted share from continuing operations, and a loss of $(0.34) per diluted share including discontinued operations. The loss recorded under GAAP was $(9.95) per diluted share from continuing operations and $(12.62) per diluted share including discontinued operations. For a reconciliation of the non-GAAP financial data, see "Pro Forma Reconciliations," below. The financial tables contain certain non-GAAP financial measures as defined under SEC rules, such as net income and diluted earnings per share from continuing operations, adjusted in each case to exclude certain disclosed items. As required by SEC rules, we have provided reconciliations of these measures to the most directly comparable GAAP measures, which are set forth herein. We believe that the non-GAAP financial measures improve the transparency of our disclosure, provide a meaningful presentation of our results from our core business operations excluding the impact of items not related to our ongoing core business operations, and improve the period-to-period comparability of our results from our core business operations.

Outlook

We anticipate a continued weak economic environment in 2009. Despite the economic weakness, we believe the actions discussed in Restructuring and Cost-Cutting Initiatives will help mitigate its impact. As retailers, we are able to reduce many variable costs, a majority of which are personnel related, and adjust our inventories relatively quickly. In addition to these variable costs, we have cut fixed costs totaling approximately $43 million annually. We remain committed to quickly and aggressively responding to any further decline in the overall economy or the automotive retail environment and are prepared to continue to reduce costs if current conditions deteriorate.

In 2008, we believe the impact of gasoline prices on the value of trucks and SUVs and reduced industry sales resulted in below normal profit margins on vehicles. We intend to improve our vehicle margins by

improving our inventory mix to meet current demand. This action has resulted in improved margins on both new and used vehicles in the fourth quarter of 2008. We believe that margins in 2009 will be consistent with the margins experienced in the fourth quarter of 2008. We also adjusted our used vehicle inventory mix throughout 2008 and believe that, going into 2009, we are better positioned with a mix of vehicles that customers are currently demanding. Also, as vehicle sales decline, we are emphasizing the more stable, higher-margin service, body and parts business, which improves our overall gross profit margins stated as a percentage of our total revenue.

Results of Continuing Operations

Certain revenue, gross profit margin and gross profit information by product
line was as follows for 2008, 2007 and 2006:



                                                     Gross
                                    Percent of       Profit     Percent of Total
       2008                       Total Revenues     Margin       Gross Profit
       New vehicle                          54.9 %      7.8 %               24.8 %
       Used vehicle, retail                 22.3       11.3                 14.6
       Used vehicle, wholesale               4.6       (3.1 )               (0.8 )
       Finance and insurance(1)              3.7      100.0                 21.3
       Service, body and parts              14.3       47.9                 39.7
       Fleet and other                       0.2       31.9                  0.4

                                                     Gross
                                    Percent of       Profit     Percent of Total
       2007                       Total Revenues     Margin       Gross Profit
       New vehicle                          58.2 %      7.8 %               26.8 %
       Used vehicle, retail                 21.1       14.1                 17.4
       Used vehicle, wholesale               5.1        2.3                  0.7
       Finance and insurance(1)              3.8      100.0                 22.3
       Service, body and parts              11.6       47.7                 32.5
       Fleet and other                       0.2       27.2                  0.3

                                                     Gross
                                    Percent of       Profit     Percent of Total
       2006                       Total Revenues     Margin       Gross Profit
       New vehicle                          58.6 %      7.9 %               27.0 %
       Used vehicle, retail                 21.9       14.9                 19.0
       Used vehicle, wholesale               4.8        2.8                  0.8
       Finance and insurance(1)              3.9      100.0                 22.8
       Service, body and parts              10.6       48.8                 30.0
       Fleet and other                       0.2       28.8                  0.4

(1) Commissions reported net of anticipated cancellations.

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

                                                                  Year Ended December 31, (1)
                                                                2008           2007        2006
Revenues:
New vehicle                                                       54.9 %         58.2 %     58.6 %
Used vehicle                                                      26.9           26.2       26.7
Finance and insurance                                              3.7            3.8        3.9
Service, body and parts                                           14.3           11.6       10.6
Fleet and other                                                    0.2            0.2        0.2

Total revenues                                                   100.0 %        100.0 %    100.0 %
Gross profit                                                      17.3           17.0       17.2
Goodwill impairment                                               12.7             -          -
Other asset impairments                                            1.1             -          -
Selling, general and administrative expenses                      14.8           13.3       12.9
Depreciation and amortization                                      0.8            0.7        0.5

Operating income (loss)                                          (12.2 )          3.1        3.7
Floorplan interest expense                                        (1.0 )         (0.9 )     (1.0 )
Other interest expense                                            (0.8 )         (0.6 )     (0.5 )
Other income, net                                                  0.3            0.0        0.0

Income (loss) from continuing operations before income taxes     (13.6 )          1.6        2.3
Income tax benefit (expense)                                       4.3           (0.6 )     (0.9 )

Income (loss) from continuing operations                          (9.3 )%         0.9 %      1.4 %

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

The following tables set forth the changes in our operating results from continuing operations in 2008 compared to 2007 and in 2007 compared to 2006:

                                                     Year Ended                                    %
                                                    December 31,               Increase         Increase
(In Thousands)                                 2008             2007          (Decrease)       (Decrease)
Revenues:
New vehicle                                 $ 1,172,807      $ 1,528,246      $  (355,439 )         (23.3 )%
Used vehicle                                    574,373          686,728         (112,355 )         (16.4 )
Finance and insurance                            78,970           99,727          (20,757 )         (20.8 )
Service, body and parts                         306,743          304,302            2,441             0.8
Fleet and other                                   4,911            5,279             (368 )          (7.0 )

Total revenues                                2,137,804        2,624,282         (486,478 )         (18.5 )
Cost of sales:
New vehicle                                   1,081,032        1,408,496         (327,464 )         (23.2 )
Used vehicle                                    523,439          605,890          (82,451 )         (13.6 )
Service, body and parts                         159,944          159,262              682             0.4
Fleet and other                                   3,345            3,845             (500 )         (13.0 )

Total cost of sales                           1,767,760        2,177,493         (409,733 )         (18.8 )

Gross profit                                    370,044          446,789          (76,745 )         (17.2 )
Goodwill impairment                             272,503               -           272,503             n/a
Other asset impairments                          23,402               -            23,402             n/a
Selling, general and administrative             316,183          349,283          (33,100 )          (9.5 )
Depreciation and amortization                    17,732           16,862              870             5.2

Operating income (loss)                        (259,776 )         80,644         (340,420 )        (422.1 )
Floorplan interest expense                      (20,398 )        (24,373 )         (3,975 )         (16.3 )
Other interest expense                          (17,350 )        (15,985 )          1,365             8.5
Other income, net                                 6,673              641            6,032           941.0

Income (loss) from continuing operations
before income taxes                            (290,851 )         40,927         (331,778 )        (810.7 )
Income tax benefit (expense)                     91,703          (16,485 )       (108,188 )        (656.3 )

Income (loss) from continuing operations    $  (199,148 )    $    24,442      $  (223,590 )        (914.8 )%

                                                   Year Ended                                   %
                                                  December 31,               Increase        Increase
                                              2008            2007          (Decrease)      (Decrease)
New units sold                                  40,206          52,512          (12,306 )        (23.4 )%
Average selling price per new vehicle      $    29,170     $    29,103     $         67            0.2
Used retail units sold                          28,853          32,700           (3,847 )        (11.8 )
Average selling price per used retail
vehicle                                    $    16,522     $    16,896     $       (374 )         (2.2 )
Used wholesale units sold                       16,631          20,264           (3,633 )        (17.9 )
Average selling price per used wholesale
vehicle                                    $     5,872     $     6,625     $       (753 )        (11.4 )
Finance and insurance sales per retail
unit                                       $     1,144     $     1,170     $        (26 )         (2.2 )


                                                   Year Ended                                   %
                                                  December 31,               Increase        Increase
(In Thousands)                                2007            2006          (Decrease)      (Decrease)
Revenues:
New vehicle                                $ 1,528,246     $ 1,449,012     $     79,234            5.5 %
Used vehicle                                   686,728         660,588           26,140            4.0
Finance and insurance                           99,727          97,036            2,691            2.8
Service, body and parts                        304,302         261,949           42,353           16.2
Fleet and other                                  5,279           5,250               29            0.6

Total revenues                               2,624,282       2,473,835          150,447            6.1
Cost of sales:
New vehicle                                  1,408,496       1,333,906           74,590            5.6
Used vehicle                                   605,890         576,271           29,619            5.1
Service, body and parts                        159,262         134,153           25,109           18.7
Fleet and other                                  3,845           3,740              105            2.8

Total cost of sales                          2,177,493       2,048,070          129,423            6.3

Gross profit                                   446,789         425,765           21,024            4.9
Selling, general and administrative            349,283         319,854           29,429            9.2
Depreciation and amortization                   16,862          13,383            3,479           26.0

Operating income                                80,644          92,528          (11,884 )        (12.8 )
Floorplan interest expense                     (24,373 )       (25,156 )           (783 )         (3.1 )
Other interest expense                         (15,985 )       (12,081 )          3,904           32.3
Other income, net                                  641             798             (157 )        (19.7 )

Income from continuing operations before
income taxes                                    40,927          56,089          (15,162 )        (27.0 )
Income tax expense                             (16,485 )       (21,597 )         (5,112 )        (23.7 )

Income from continuing operations          $    24,442     $    34,492     $    (10,050 )        (29.1 )%



                                                   Year Ended                                   %
                                                  December 31,               Increase        Increase
                                              2007            2006          (Decrease)      (Decrease)
New units sold                                  52,512          52,340              172            0.3 %
Average selling price per new vehicle      $    29,103     $    27,685     $      1,418            5.1
Used retail units sold                          32,700          33,225             (525 )         (1.6 )
Average selling price per used retail
vehicle                                    $    16,896     $    16,298     $        598            3.7
Used wholesale units sold                       20,264          19,244            1,020            5.3
Average selling price per used wholesale
vehicle                                    $     6,625     $     6,187     $        438            7.1
Finance and insurance sales per retail
unit                                       $     1,170     $     1,134     $         36            3.2 %

Revenues

Total revenues decreased 18.5% and increased 6.1%, respectively, in 2008 compared to 2007 and in 2007 compared to 2006.

The decrease in 2008 compared to 2007 primarily resulted from reduced demand and decreased same-store sales, which were brought on by the challenging retail environment, higher fuel prices, tighter credit environment, declines in available home equity, low consumer confidence and the weak economy.

The increase in 2007 compared to 2006 was a result of acquisitions, partially offset by a 3.2% decrease in same-store sales, excluding fleet. 2007 faced a difficult comparison with 2006 when total same-store sales grew by 4.1%. The decrease in same-store sales in 2007 was also impacted by a weak retail sales environment, especially with our domestic brands.

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

                                             2008 compared to 2007            2007 compared to 2006
New vehicle retail, excluding fleet                          (24.1 )%                          (3.6 )%
Used vehicle, retail                                         (15.8 )                           (7.1 )
Used vehicle, wholesale                                      (29.3 )                            3.6
Total vehicle sales, excluding fleet                         (22.3 )                           (4.1 )
Finance and insurance                                        (20.8 )                           (3.1 )
Service, body and parts                                       (0.3 )                            4.0
Total sales, excluding fleet                                 (19.7 )                           (3.2 )

Same-store sales are calculated for stores that were in operation as of December 31, 2007, and only including the months of operations for both comparable periods. For example, a store acquired in June 2007 would be included in same store operating data beginning in July 2007, after its first full complete comparable month of operation. Thus, operating results for same store comparisons would include only the periods of July through December of both comparable years.

Penetration rates for certain products were as follows:

. . .