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
As discussed in Overview in Item 1, "Business" above, we are a leading operator of automotive franchises and retailer of new and used vehicles and services. As of February 22, 2013, we offered 27 brands of new vehicles and all brands of used vehicles in 87 stores in the United States and online at Lithia.com. We sell new and used cars and trucks and replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing, service contracts, protection products and credit insurance.

We continue to believe that the fragmented nature of the automotive dealership sector provides us with the opportunity to achieve growth through consolidation. We seek exclusive franchises for acquisition and target mid-sized and regional markets for domestic and import franchises and metropolitan markets for luxury franchises. We have completed over 100 acquisitions since our initial public offering in 1996. Our acquisition strategy has been to acquire dealerships at prices that meet our internal investment targets and, through the application of our centralized operating structure, leverage costs and improve store profitability. We believe the current economic environment provides us with attractive acquisition opportunities.

We also believe that we can continue to improve operations at our existing stores. By promoting entrepreneurial leadership within our general managers and department managers, we strive for continual improvement to drive sales and capture market share in our local markets. Our goal is to retail an average of 75 used vehicles per store per month and we believe we can make additional improvements in our used vehicle sales performance by offering lower-priced value vehicles and selling brands other than the new vehicle franchise at each location. Our service, body and parts operations provide important repeat business for our stores. We continue to grow this business through increased marketing efforts, competitive pricing on routine maintenance items and diverse commodity product offerings. In 2012, we continued to experience organic growth through increasing market share and maintaining a lean cost structure.

We believe our cost structure is aligned with current industry sales levels and positioned to be leveraged if vehicle sales levels continue to improve. We target selling, general and administrative ("SG&A") expense as a percentage of gross profit in the high 60% range as vehicle sales improve. As we focus on maintaining discipline in controlling costs, we continue to target retaining, on a same store pre-tax basis, 50% of each incremental gross profit dollar after deducting SG&A expense.

Critical Accounting Policies and Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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. Certain 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 those related to goodwill and franchise value, long-lived assets, deferred tax assets, service contracts and other insurance contracts, and lifetime oil change and self-insurance programs. We also have other key accounting policies for valuation of accounts receivable, expense accruals and 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 materially from these estimates.

Goodwill and Franchise Value
We are required to test our goodwill and franchise value for impairment at least annually, or more frequently if conditions indicate that an impairment may have occurred. We have determined that we operate as one reporting unit for evaluating goodwill. We have the option to qualitatively or quantitatively assess goodwill for impairment and, in 2012, evaluated our goodwill using a quantitative assessment process. We test goodwill for impairment using the Adjusted Present Value method ("APV") to estimate the fair value of our reporting unit. Under the APV method, future cash flows are based on recently prepared budget forecasts and business plans and are used to estimate the future economic benefits that the reporting unit will generate. An estimate of the appropriate discount rate is utilized to convert the future economic benefits to their present value equivalent.

The quantitative goodwill impairment test is a two-step process. The first step identifies potential impairments by comparing the calculated fair value of a reporting unit with its book value. If the fair value of the reporting unit exceeds the carrying amount, goodwill is 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 is then compared with the carrying amount to determine if an impairment loss should be recorded.

As of December 31, 2012, we had $32.0 million of goodwill on our balance sheet. The first step of our annual goodwill impairment analysis, which we perform as of October 1 of each year, did not result in an indication of impairment in 2012, 2011 or 2010. The fair value of the reporting unit as of December 31, 2012, using the APV method, was 109% greater than the carrying value at December 31, 2012.

We have determined the appropriate unit of accounting for testing franchise rights for impairment is on an individual store basis. We have the option to early adopt an amendment that allows us to qualitatively assess indefinite-lived intangible assets for impairment. In 2012, we evaluated our indefinite-lived intangible assets using a quantitative assessment process. We estimate the fair value of our franchise rights primarily using the Multi-Period Excess Earnings ("MPEE") model. The forecasted cash flows used in the MPEE model contain inherent uncertainties, including significant estimates and assumptions related to growth rates, margins, general operating expenses, and cost of capital. We use primarily internally-developed forecasts and business plans to estimate the future cash flows that each franchise will generate. We have determined that only certain cash flows of the store are directly attributable to the franchise rights. We estimate the appropriate interest rate to discount future cash flows to their present value equivalent taking into consideration factors such as a risk-free rate, a peer group average beta, an equity risk premium and a small stock risk premium.

We also may use a market approach to determine the fair value of our franchise rights. These market data points include our acquisition and divestiture experience and third-party broker estimates.

As of December 31, 2012, we had $62.4 million of franchise value on our balance sheet. Our impairment testing of franchise value did not indicate any impairment in 2012, 2011 or 2010.

We are subject to financial statement risk to the extent that our goodwill or franchise rights become impaired due to decreases in the fair value. A future decline in performance, decreases in projected growth rates or margin assumptions or changes in discount rates could result in a potential impairment, which could have a material adverse impact on our financial position and results of operations. Furthermore, in the event that a manufacturer is unable to remain solvent, we may be required to record a partial or total impairment on the remaining franchise value related to that manufacturer.

See Notes 1 and 5 of Notes to Consolidated Financial Statements for additional information.

Long-Lived Assets
We estimate the depreciable lives of our property and equipment, including leasehold improvements, and review them for impairment when events or circumstances indicate that their carrying amounts may not be recoverable.

We determine a triggering event has occurred by reviewing store forecasted and historical financial performance. A store is evaluated for recoverability if it has an operating loss in the current year and two of the prior three years. Additionally, we may judgmentally evaluate a store if its financial performance indicates it may not support the carrying amount of the long-lived assets. If a store meets these criteria, we estimate the projected undiscounted cash flows for each asset group based on internally developed forecasts. If the undiscounted cash flows are lower than the carrying value of the asset group, we determine the fair value of the asset group based on additional market data, including recent experience in selling similar assets.

We hold certain property for future development or investment purposes. If a triggering event is deemed to have occurred, we evaluate the property for impairment by comparing its estimated fair value based on listing price less costs to sell and other market data, including similar property that is for sale or has been recently sold, to the current carrying value. If the carrying value is more than the estimated fair value, an impairment is recorded.

Although we believe our property and equipment and assets held and used are appropriately valued, the assumptions and estimates used may change and we may be required to record impairment charges to reduce the value of these assets. A future decline in store performance, decrease in projected growth rates or changes in other operating assumptions could result in an impairment of long-lived asset groups, which could have a material adverse impact on our financial position and results of operations.

Due to the adverse change in the business climate and the commercial real estate market, we performed impairment testing on long-lived assets, mainly related to certain property held for future development or investment purposes in 2012, 2011 and 2010. As a result, we recorded impairments related to long-lived assets of $0.1 million, $1.4 million and $15.3 million in 2012, 2011 and 2010, respectively.

See Notes 1 and 4 of Notes to Consolidated Financial Statements for additional information.

Deferred Tax Assets
As of December 31, 2012, we had deferred tax assets of approximately $61.1 million and deferred tax liabilities of $28.5 million. The principal components of our deferred tax assets are related to goodwill, allowances and accruals, capital loss carryforwards, deferred revenue and cancellation reserves. The principal components of our deferred tax liabilities are related to depreciation on property and equipment and inventories.

We consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax-planning strategies in making this assessment.

Based upon the scheduled reversal of deferred tax liabilities, and our projections of future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of the unreserved deductible differences.

As of December 31, 2012, we had an $11.6 million valuation allowance against our deferred tax assets. This valuation allowance was associated with losses from the sale of corporate entities. As these amounts are characterized as capital losses, we evaluated the availability of projected capital gains and determined that it would be unlikely these amounts would be fully utilized. If we are unable to meet the projected taxable income levels utilized in our analysis, and depending on the availability of feasible tax planning strategies, we might record an additional valuation allowance on a portion or all of our deferred tax assets in the future. In the event that a manufacturer is unable to remain solvent, our operations may be impacted and we might record a valuation allowance on a portion or all of the deferred tax assets, which could have a material adverse impact on our financial position and results of operations.

Service Contracts and Other Insurance Contracts We receive commissions from the sale of vehicle service contracts and certain other insurance contracts. The contracts are sold through unrelated third parties, but we may be charged back for a portion of the commissions in the event of early termination of the contracts by customers. We sell these contracts on a straight commission basis; in addition, we may also participate in future underwriting profit pursuant to retrospective commission arrangements, which are recognized as income upon receipt.

We record commissions at the time of sale of the vehicles, net of an estimated liability for future charge-backs. We have established a reserve for estimated future charge-backs based on an analysis of historical charge-backs in conjunction with estimated lives of the applicable contracts. If future cancellations are different than expected, we could have additional expense related to the cancellations in future periods, which could have a material adverse impact on our financial position and results of operations.

At December 31, 2012 and 2011, the reserve for future cancellations totaled $13.5 million and $10.4 million, respectively, and is included in accrued liabilities and other long-term liabilities on our Consolidated Balance Sheets. A 10% increase in expected cancellations would result in an additional reserve of approximately $1.3 million.

Lifetime Oil Change Self-Insurance
In March 2009, we assumed from a third party the obligation to provide future lifetime oil service for a pool of existing contracts and began to self-insure the majority of the lifetime oil contracts we sell.

Payments we receive upon sale of the lifetime oil contracts are deferred and recognized in revenue over the expected life of the service agreement to best match the expected timing of the costs to be incurred to perform the service. We estimate the timing and amount of future costs for claims and cancellations related to our lifetime oil contracts using historical experience rates and estimated future costs.

If our estimates of future costs to perform under the contracts exceed the existing deferred revenue, we record a charge in the Consolidated Statements of Operations. We perform our loss contingency analysis separately for the pool of assumed contracts and the pool of self-insured contracts sold starting in March 2009. We recorded a charge of $1.0 million in both 2011 and 2010 for expected costs in excess of revenue deferred related to the pool of assumed contracts. We did not record an additional charge in 2012. The analysis on our self-insured sold contracts did not indicate a loss reserve was needed in 2012, 2011 and 2010.

We believe the new vehicle purchase cycle has been delayed for many buyers. If the ownership cycle does not accelerate towards pre-recession levels, our estimate of the number of oil changes to be performed over a vehicle's life may increase, which would adversely affect our financial position and results of operations. In addition, other changes in assumptions about future costs expected to be incurred to service contracts could result in the recognition of additional charges, which could have a material adverse impact on our financial position and results of operations.

A 10% change in expected claims costs per contract for the assumed pool of contracts would result in an additional reserve of approximately $0.7 million. A 10% change in expected claims per contract for the self-insured sold contracts would not require any additional reserve. At December 31, 2012, the remaining deferred revenue related to the assumed obligation and the self-insured sold contracts was $4.0 million and $33.9 million, respectively.

Self Insurance Programs
We self-insure a portion of our property and casualty insurance, medical insurance and workers' compensation insurance. Third-parties are engaged to estimate the loss exposure related to the self-retained portion of the risk associated with these insurances. Additionally, we analyze our historical loss and claims experience to estimate the loss exposure associated with these programs. Any changes in assumptions or claims experience could result in the recognition of additional charges, which could have a material adverse impact on our financial position and results of operations.

At December 31, 2012 and 2011, the total reserve associated with these programs was $12.4 million and $10.4 million, respectively, and is included in accrued liabilities and other long-term liabilities on our Consolidated Balance Sheets. A 10% increase in claims experience would result in an additional reserve of approximately $4.5 million.

Results of Continuing Operations
For the year ended December 31, 2012, we reported income from continuing operations, net of tax, of $79.4 million, or $3.03 per diluted share. For the years ended December 31, 2011 and 2010, we reported income from continuing operations, net of tax, of $55.2 million, or $2.07 per diluted share, and $13.6 million, or $0.52 per diluted share, respectively.

Discontinued Operations
Results for sold or closed stores, qualifying for reclassification under the applicable accounting guidance, have their results presented as discontinued operations in our Consolidated Statements of Operations. As a result, our results from continuing operations are presented on a comparable basis for all periods. Within discontinued operations, we realized a gain, net of tax, of $1.0 million, $3.7 million and $0.1 million for the years ended December 31, 2012, 2011 and 2010, respectively. See Notes 1 and 16 of Notes to Consolidated Financial Statements for additional information.

Key Performance Metrics
Certain key performance metrics for revenue and gross profit were as follows for
2012, 2011 and 2010 (dollars in thousands):

                                                                                                            Percent of
                                                                                                               Total
                                                     Percent of                           Gross Profit         Gross
2012                               Revenues        Total Revenues       Gross Profit         Margin           Profit
New vehicle                       $ 1,847,603                 55.7 %   $      134,447               7.3 %          24.9 %
Used vehicle, retail                  833,484                 25.1            121,721              14.6            22.6
Used vehicle, wholesale               139,237                  4.2              1,414               1.0             0.3
Finance and insurance(1)              112,234                  3.4            112,234             100.0            20.8
Service, body and parts               347,703                 10.5            168,070              48.3            31.1
Fleet and other                        36,226                  1.1              1,414               3.9             0.3
                                  $ 3,316,487                100.0 %   $      539,300              16.3 %         100.0 %



                                                                                                            Percent of
                                                                                                               Total
                                                     Percent of                           Gross Profit         Gross
2011                               Revenues        Total Revenues       Gross Profit         Margin           Profit
New vehicle                       $ 1,391,375                 52.8 %   $      107,150               7.7 %          24.1 %
Used vehicle, retail                  678,571                 25.8             98,214              14.5            22.1
Used vehicle, wholesale               128,329                  4.9                597               0.5             0.1
Finance and insurance(1)               84,130                  3.2             84,130             100.0            18.9
Service, body and parts               315,958                 12.0            152,220              48.2            34.2
Fleet and other                        34,383                  1.3              2,973               8.6             0.6
                                  $ 2,632,746                100.0 %   $      445,284              16.9 %         100.0 %



                                                                                                            Percent of
                                                                                                               Total
                                                     Percent of                           Gross Profit         Gross
2010                               Revenues        Total Revenues       Gross Profit         Margin           Profit
New vehicle                       $ 1,020,883                 50.1 %   $       83,646               8.2 %          23.0 %
Used vehicle, retail                  558,105                 27.4             78,795              14.1            21.7
Used vehicle, wholesale               103,817                  5.1                703               0.7             0.2
Finance and insurance(1)               64,217                  3.2             64,217             100.0            17.7
Service, body and parts               277,945                 13.6            133,942              48.2            36.9
Fleet and other                        11,655                  0.6              1,643              14.1             0.5
                                  $ 2,036,622                100.0 %   $      362,946              17.8 %         100.0 %

(1) Commissions reported net of anticipated cancellations.

Same Store Operating Data
We believe that same store sales are a key indicator of our financial performance. Same store metrics demonstrate our ability to grow our revenue and profitability in our existing locations. As a result, same store sales have been integrated into the discussion below.

A same store metric represents stores that were operating during 2012, and only includes the months when operations occur in both comparable periods. For example, a store acquired in August 2011 would be included in same store operating data beginning in September 2012, after its first full complete comparable month of operation. Thus, operating results for same store comparisons would include only the period of September through December of both comparable years.

New Vehicle Revenues
                                                   Year Ended
                                                  December 31,                               %
(Dollars in thousands)                        2012            2011         Increase       Increase
Reported
Revenue                                    $ 1,847,603     $ 1,391,375     $ 456,228           32.8 %
Retail units sold                               55,666          42,139        13,527           32.1
Average selling price per retail unit      $    33,191     $    33,019     $     172            0.5

Same store
Revenue                                    $ 1,776,896     $ 1,367,176     $ 409,720           30.0 %
Retail units sold                               53,590          41,391        12,199           29.5
Average selling price per retail unit      $    33,157     $    33,031     $     126            0.4



                                                   Year Ended
                                                  December 31,                               %
(Dollars in thousands)                        2011            2010         Increase       Increase
Reported
Revenue                                    $ 1,391,375     $ 1,020,883     $ 370,492           36.3 %
Retail units sold                               42,139          31,945        10,194           31.9
Average selling price per retail unit      $    33,019     $    31,958     $   1,061            3.3

Same Store
Revenue                                    $ 1,295,001     $ 1,005,721     $ 289,280           28.8 %
Retail units sold                               39,506          31,464         8,042           25.6
Average selling price per retail unit      $    32,780     $    31,964     $     816            2.6

New vehicle sales in 2012 improved compared to 2011 primarily due to volume growth as year-over-year same store sales volume increased 29.5% and 25.6%, respectively, in 2012 and 2011.

The number of new vehicles sold in the U.S. in 2012, defined as the seasonally adjusted annual rate, grew approximately 13.4% over 2011. In addition to the overall market recovery, we have increased our share of vehicle sales in several of our markets. Growth in our domestic and import brand sales have outpaced the growth experienced nationally. Our domestic brand same store sales grew 27.2% in 2012 compared to 2011. Same store sales for import brands grew 38.3% in 2012 compared to 2011. Certain of our markets have seen an increase in local market sales volumes exceeding the national average. We remain focused on increasing our share of overall new vehicle sales within our markets.

New vehicle sales improved throughout 2011 compared to 2010 due to a recovery in the U.S. economy and our efforts to increase our share of the new vehicles sold within each local market. Credit availability continued to improve throughout 2011, although, within the sub-prime market, lending remained constrained.

Used Vehicle Retail Revenues
                                              Year Ended
                                             December 31,                             %
(Dollars in thousands)                    2012          2011        Increase       Increase
Reported
Retail revenue                          $ 833,484     $ 678,571     $ 154,913           22.8 %
Retail units sold                          47,965        39,436         8,529           21.6
Average selling price per retail unit   $  17,377     $  17,207     $     170            1.0

Same store
. . .