Business Context and Reporting Period
O’Reilly Automotive, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2010. The company operated 3,536 automotive aftermarket stores in 38 states, including O’Reilly, Checker, Schuck’s and Kragen locations. Results include the July 2008 CSK acquisition and its ongoing integration.
Key Financial Metrics
Amounts are in thousands except per-share data.
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Sales | $1,425,887 | $1,258,239 | $4,087,195 | $3,673,365 |
| Gross profit | $693,415 | $610,555 | $1,984,395 | $1,756,994 |
| Gross margin | 48.6% | 48.5% | 48.6% | 47.8% |
| Operating income | $199,031 | $149,196 | $548,640 | $412,207 |
| Operating margin | 14.0% | 11.9% | 13.4% | 11.2% |
| Net income | $116,542 | $87,225 | $313,613 | $235,575 |
| Net margin | 8.2% | 6.9% | 7.7% | 6.4% |
| Diluted EPS | $0.82 | $0.63 | $2.23 | $1.71 |
- Comparable-store sales increased 11.1% in the quarter and 8.6% for the nine-month period.
- Net cash provided by operating activities was $592,563 for the first nine months, compared with $288,980 in the prior-year period.
- Capital expenditures were $276,463, producing approximate operating cash flow less capital expenditures of $316,100.
- Cash and cash equivalents totaled $43,193 at September 30, 2010, compared with $26,935 at December 31, 2009.
- Total debt and capital lease obligations were $431,252, including $104,698 of current maturities, compared with $790,748 at December 31, 2009.
- Credit-facility borrowings were $325,000, with $673,700 available for additional borrowing after letters of credit. The company complied with its leverage covenant.
Material Changes Versus the Prior Comparable Period
- Sales rose 13% in the third quarter and 11% year to date, primarily from higher comparable-store sales, new stores and converted CSK locations.
- Gross margin improved modestly because of lower shrinkage at converted CSK stores, improved product mix and lower product acquisition costs. Commercial sales grew faster than DIY sales and carried lower margins.
- SG&A increased in dollars but declined to 34.3% of sales in the quarter from 36.7%, reflecting sales leverage.
- Operating income increased 33% in both the quarter and nine-month period; net income increased 34% and 33%, respectively.
- Operating cash flow improved substantially as inventory investment was significantly lower than during the 2009 CSK integration period.
- The company repaid $353,800 of revolving-credit borrowings on a net basis during the first nine months and terminated the $125 million FILO tranche.
- The store count increased from 3,421 at December 31, 2009, to 3,536 at September 30, 2010, including 121 new stores and substantial conversions to the O’Reilly brand.
Guidance, Outlook, Risks and Unusual Items
- Management planned approximately 150 net new stores in 2010, including approximately 29 additional stores during the remainder of the year, and approximately 170 new stores in 2011.
- Management expected commercial sales to continue growing faster than DIY sales, creating fourth-quarter pressure on gross margin. Distribution-center inefficiencies related to new employees and the CSK integration also remained a margin risk.
- The company recorded a $5.9 million third-quarter charge and $20.9 million year-to-date charge related to the legacy CSK Department of Justice investigation. The total DOJ-related reserve was $21.4 million at September 30, 2010, based on an agreement in principle that remained subject to final documentation.
- Excluding the DOJ charge, adjusted diluted EPS was $0.86 for the quarter and $2.37 for the nine months, versus GAAP EPS of $0.82 and $2.23.
- The $100 million CSK exchangeable notes were exchangeable during the fourth quarter. Management intended to redeem the notes in December 2010 using available credit-facility borrowings. After quarter-end, holders exchanged $11 million of principal for $11 million in cash and 92,855 common shares.
- All $325 million of outstanding variable-rate credit-facility borrowings were covered by interest-rate swaps at September 30, 2010; $250 million remained swapped after certain swaps matured on October 17, 2010.
- Remaining CSK-related indemnification reserves were $18.8 million. Government investigations, civil litigation and related indemnification obligations could produce material effects in a particular period, although management did not expect a material adverse effect after reserves and insurance.
- Management identified competition, product demand, economic conditions, consumer debt, weather, employee retention, acquisition integration and regulatory matters as key forward-looking risks. No material changes to previously disclosed risk factors were reported.
Important Facts for Investors to Verify
- Confirm completion and cash funding of the planned December 2010 redemption of the CSK exchangeable notes.
- Monitor the final DOJ resolution, the $21.4 million reserve, and any additional CSK litigation or indemnification costs.
- Assess whether commercial-sales growth and distribution-center inefficiencies reduce future gross margins.
- Verify continued progress in CSK conversions, store openings and integration-related operating leverage.
- Review liquidity after debt repayment, the remaining credit-facility availability, covenant compliance and the post-October swap coverage.
- Distinguish GAAP results from management’s non-GAAP results excluding DOJ-related charges.