ORLY

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2008, for O'Reilly Automotive, Inc., a leading specialty retailer of automotive aftermarket parts. The reporting period is significantly impacted by the completion of the acquisition of CSK Auto Corporation on July 11, 2008. This transaction added 1,342 stores across 22 states, expanding O'Reilly's footprint to 3,277 stores in 38 states. The financial results include CSK's operations from the acquisition date forward.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Sales increased 68% in the third quarter and 28% for the nine-month period compared to 2007, driven primarily by the inclusion of CSK sales ($398.7 million in Q3) and organic growth.
• Profitability: While gross profit dollars increased significantly, Net Income for the nine months ended September 30, 2008, decreased 6% to $143.5 million from $153.4 million in the prior year. This decline is attributed to one-time acquisition costs and increased interest expense.
• Expense Structure: Selling, General, and Administrative (SG&A) expenses rose 97% in Q3 and 41% for the nine months, largely due to the integration of CSK's higher expense structure and amortization of acquired intangible assets.
• Debt Levels: Total debt increased by approximately $565 million year-over-year. The company entered a new $1.2 billion asset-based revolving credit facility to fund the CSK acquisition and refinance existing debt.
• Comparable Store Sales: Consolidated comparable store sales decreased 0.8% in Q3 but increased 0.5% for the nine-month period. O'Reilly legacy stores saw a 1.5% increase, while CSK stores saw a 4.3% decrease for the partial quarter.

Guidance, Outlook, and Risks

Management Commentary: Management expects the impact of current economic conditions on consumer demand to be temporary. The company plans to fund store expansion and CSK integration through operating cash flows and the new credit facility. They anticipate opening approximately 150 net new stores in 2008 (excluding CSK consolidation).

Unusual Items: The third quarter included significant one-time charges related to the CSK acquisition, including:

• $7.2 million in debt prepayment costs.
• $4.2 million in interim facility commitment fees.
• $3.1 million in tax liability adjustments.
• Non-cash amortization of CSK trade names and trademarks.

Risks and Contingencies:

• Integration Risk: Significant challenges exist in integrating CSK's operations, systems, and culture. Failure to integrate successfully could harm future results.
• Legal Proceedings: O'Reilly is resolving pre-acquisition governmental investigations (SEC and DOJ) regarding CSK's historical accounting practices. While management does not currently expect a material adverse effect, the outcome remains uncertain.
• Debt Servicing: Increased debt levels expose the company to interest rate fluctuations and restrict flexibility. The company has entered into interest rate swaps to hedge $400 million of its variable-rate debt.

Investor Verification Checklist

• Verify the status and potential financial impact of the ongoing SEC and DOJ investigations into CSK's pre-acquisition accounting practices.
• Monitor the progress of CSK store integration, specifically the conversion of store brands and distribution network upgrades, to assess synergy realization.
• Review the utilization of the $1.2 billion credit facility and the company's ability to meet debt covenants given the increased leverage.
• Track comparable store sales trends for the combined entity to determine if the "trade-down" consumer behavior mentioned by management persists.
• Assess the accuracy of the preliminary purchase price allocation for CSK, particularly regarding goodwill and intangible assets, as adjustments may occur within the one-year allocation period.