O REILLY AUTOMOTIVE INC quarterly report, Q2 FY2010

O’Reilly Automotive, Inc. — Form 10-Q Summary

Business context and reporting period

O’Reilly Automotive is a specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories serving do-it-yourself customers and professional installers. This unaudited Form 10-Q covers the three and six months ended June 30, 2010, compared primarily with the same periods in 2009. The company operated 3,492 stores in 38 states at quarter-end, including 3,066 O’Reilly-branded stores and converted CSK locations.

The company opened 73 stores during the first six months and planned approximately 150 net new stores for 2010, including approximately 79 additional stores during the remainder of the year.

Financial performance and key metrics

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Sales	$1.381 billion	$1.251 billion	$2.661 billion	$2.415 billion
Gross profit	$672.6 million	$603.8 million	$1.291 billion	$1.146 billion
Gross margin	48.7%	48.2%	48.5%	47.5%
Operating income	$181.2 million	$149.7 million	$349.6 million	$263.0 million
Operating margin	13.1%	12.0%	13.1%	10.9%
Net income	$99.6 million	$85.5 million	$197.1 million	$148.4 million
Diluted EPS	$0.71	$0.62	$1.40	$1.08

Sales increased 10% in both the quarter and year-to-date period. Comparable-store sales increased 7.9% in the quarter and 7.4% year to date.
Gross margin benefited from lower shrinkage at converted CSK stores, improved product mix and lower product acquisition costs. Commercial sales grew faster than DIY sales and generally carry lower margins.
SG&A increased 5% in both comparison periods, but declined as a percentage of sales to 34.5% from 36.3% in the quarter and to 34.8% from 36.6% year to date.
The effective tax rate increased to 41.9% in the quarter and 40.3% year to date, principally because the $15 million CSK DOJ accrual is not expected to be tax deductible.
Excluding the DOJ accrual, management reported adjusted Q2 operating income of $196.2 million, adjusted operating margin of 14.2% and adjusted diluted EPS of $0.81. These are non-GAAP measures.

Cash flow, balance sheet, debt and liquidity

Operating cash flow for the first six months was $355.7 million, up from $152.8 million in 2009, primarily due to higher earnings and substantially lower inventory investment.
Capital expenditures were $182.3 million, compared with $231.2 million in the prior-year period. Net investing cash use was $180.6 million.
Financing activities used $170.5 million, primarily reflecting $478.5 million of repayments on the asset-based revolving credit facility, partially offset by $277.0 million of borrowings.
Cash and cash equivalents were $31.6 million at June 30, 2010, compared with $26.9 million at December 31, 2009.
Total debt and capital lease obligations were $584.4 million, down from $790.7 million at December 31, 2009. Current maturities were $105.2 million and long-term debt less current maturities was $479.2 million.
The $1.2 billion asset-based credit facility had $477.3 million outstanding, a $1.197 billion borrowing base and approximately $646.5 million of additional borrowing availability after letters of credit. The facility matures July 10, 2013, is secured by substantially all company assets and includes a leverage covenant that the company was complying with at quarter-end.
Interest-rate swaps covered $450 million of credit-facility debt. Approximately $27.3 million of credit-facility borrowings were not covered by swaps at June 30, 2010.
Total shareholders’ equity was $2.930 billion, compared with $2.686 billion at December 31, 2009. Total assets were $4.917 billion.

Material changes versus the prior comparable period

Revenue rose $130 million, or 10%, in Q2 and $246 million, or 10%, for the first six months.
Operating income increased 21% in Q2 and 33% year to date; net income increased 16% and 33%, respectively.
Diluted EPS increased 15% to $0.71 in Q2 and 30% to $1.40 year to date, despite higher diluted share counts.
Operating cash flow more than doubled year to date, while capital expenditures declined as major CSK integration-related distribution-center spending moderated.
Revolving-credit borrowings declined substantially, resulting in a $207 million decrease in total outstanding debt from December 31, 2009.
The company recorded a new $15 million accrual in Q2 for the legacy CSK DOJ investigation. The total reserve for that investigation was $16.5 million at June 30, 2010.
The legacy CSK exchangeable senior notes became exchangeable by holders from July 1 through September 30, 2010. O’Reilly intended to redeem the $100 million principal amount in December 2010 using available credit-facility borrowings.

Guidance, outlook, risks and unusual items

Management expected approximately 150 net new stores in 2010 and planned to fund expansion from operating cash flow.
Management expected gross-margin pressure in the second half of 2010 because commercial sales were expected to continue growing faster than DIY sales and because recently opened distribution centers were not yet operating at full efficiency.
Management cited miles driven, vehicle age, new-vehicle sales, deferred maintenance, product mix, economic conditions, weather and consumer spending as key demand drivers. Miles driven had declined slightly during the first five months of 2010.
The DOJ investigation into CSK’s pre-acquisition accounting practices remained unresolved. Management stated that criminal charges against CSK were probable absent an agreed resolution, and the ultimate costs could exceed recorded reserves.
O’Reilly also had a $17.8 million reserve for indemnification obligations related primarily to former CSK employees and had incurred related legal costs.
Ordinary-course litigation was not expected by management to have a material adverse effect after consideration of insurance and reserves, but the governmental investigations and indemnification matters could materially affect a particular period if resolved unfavorably.
Interest-rate risk remained because of variable-rate debt, although swaps substantially mitigated exposure. A 100-basis-point rate change was estimated to affect annualized interest expense by approximately $0.3 million before tax.
The filing states that interim results are not necessarily indicative of full-year results. The business is seasonal, with historically higher sales and profits in the second and third quarters.

Important facts for investors to verify

Whether the CSK DOJ investigation is resolved within the $16.5 million recorded reserve and whether additional settlement, legal or indemnification costs arise.
The timing and funding of the planned December 2010 redemption or exchange of the $100 million CSK exchangeable notes.
Progress toward the 2010 store-opening plan and the operational efficiency of converted CSK stores and new distribution centers.
Whether commercial-sales growth causes sustained gross-margin pressure in the second half of 2010.
Credit-facility availability, leverage-covenant compliance and refinancing or repayment needs before the July 2013 maturity.
Cash generation relative to store expansion, capital expenditures, debt reduction and the planned note redemption.
The sustainability of comparable-store sales growth amid macroeconomic, fuel-price, weather and consumer-spending risks.