O REILLY AUTOMOTIVE INC annual report, FY2012

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

Reporting period: Fiscal year ended December 31, 2012; filed February 28, 2013. The filing includes quarterly information for fiscal 2012 and 2011, including the fourth quarter.

Business Context

O’Reilly is a U.S. specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories serving do-it-yourself and professional service provider customers. At year-end, the Company operated 3,976 stores in 42 states, 24 distribution centers and 240 Hub stores. Approximately 59% of 2012 sales came from DIY customers and 41% from professional service providers.

Opened 180 net new stores and acquired 56 stores through the VIP Parts, Tires & Service asset purchase, which added locations in Maine, New Hampshire and Massachusetts.
Employed 53,063 Team Members at year-end; the filing separately reports 53,615 employees as of January 31, 2013.
Management operates the business as one reportable segment.

Financial Performance and Metrics

Metric	2012	2011	Change
Sales	$6.182 billion	$5.789 billion	+7%
Gross profit	$3.097 billion	$2.837 billion	+9%
Gross margin	50.1%	49.0%	+110 bps
Operating income	$977.4 million	$866.8 million	+13%
Operating margin	15.8%	15.0%	+80 bps
Net income	$585.7 million	$507.7 million	+15%
Net margin	9.5%	8.8%	+70 bps
Diluted EPS	$4.75	$3.71	+28%
Comparable store sales	+3.8%	+4.6%	Decelerated

Operating expenses were $2.120 billion, or 34.3% of sales, compared with 34.1% in 2011.
The effective income tax rate was 37.8% in both 2012 and 2011.
Fourth-quarter 2012 sales were $1.488 billion, operating income was $223.0 million, net income was $132.8 million and diluted EPS was $1.14. Fourth-quarter comparable store sales increased 4.2%.
Cash provided by operating activities was $1.252 billion, compared with $1.119 billion in 2011. Capital expenditures were $300.7 million, producing reported free cash flow of $950.8 million.
Cash and cash equivalents were $248.1 million at year-end, compared with $361.6 million in 2011.
Total assets were $5.749 billion. Working capital was $460.1 million, down from $1.028 billion, primarily because of higher accounts payable and vendor financing.

Debt, Liquidity and Capital Allocation

Total debt was approximately $1.096 billion, consisting primarily of $500 million of 4.875% senior notes due 2021, $300 million of 4.625% senior notes due 2021 and $300 million of 3.800% senior notes due 2022. The Company had no borrowings under its $660 million unsecured revolving credit facility.
Outstanding letters of credit were approximately $57.3 million, reducing revolving facility availability.
The fixed-charge coverage ratio was 4.95 times and adjusted debt to adjusted EBITDAR was 1.83 times, compared with covenant requirements of 2.00 times and 3.00 times, respectively. The Company reported compliance with all debt covenants.
Current ratio was 1.20:1 and quick ratio was 0.20:1, compared with 1.65:1 and 0.39:1, respectively, in 2011.
The Company issued $300 million of 3.800% senior notes in August 2012. Proceeds were intended for offering costs, general corporate purposes, potential revolving-facility repayment and share repurchases.
The Company repurchased 16.2 million shares in 2012 for approximately $1.445 billion at an average price of $89.20. The remaining authorization was $578.6 million at December 31, 2012. Through February 28, 2013, an additional 2.1 million shares were repurchased for approximately $185.6 million.
No cash dividends have been declared since the Company became public, and management did not anticipate paying dividends in the foreseeable future.
Total contractual cash obligations were $3.604 billion, including $1.546 billion of long-term debt principal and interest, $1.843 billion of operating and capital lease payments, $122.9 million of self-insurance reserves and $89.3 million of construction commitments.

Material Changes Versus the Prior Comparable Period

Sales growth reflected 3.8% comparable store sales growth, stores opened during 2011 and 2012, and the VIP acquisition. Growth was partially offset by pressured DIY transaction counts.
Gross margin expanded because of distribution-center efficiencies, improved acquisition costs and lower inventory shrinkage. Management identified an approximately 20-basis-point benefit from capitalized distribution costs that was not expected to recur.
SG&A increased in dollars as the store base expanded and staffing levels were maintained, while SG&A as a percentage of sales increased slightly.
Net income and EPS benefited from higher operating income and substantially fewer weighted-average shares. The diluted share count declined to 123.3 million from 137.0 million, primarily reflecting share repurchases.
Cash flow from operations increased, aided by higher earnings and greater vendor financing. Accounts payable to inventory increased to 84.7% from 64.4%.
Shareholders’ equity declined to $2.108 billion from $2.845 billion, primarily because of share repurchases, partially offset by net income and stock-option activity.
2011 included nonrecurring financing charges and a former CSK officer clawback; 2012 did not include comparable items. The filing presents non-GAAP adjusted 2011 diluted EPS of $3.81 versus reported 2012 diluted EPS of $4.75.

Guidance, Outlook, Risks and Unusual Items

Management planned approximately 190 net new stores in 2013. The Company expected the Lakeland, Florida distribution center to open in the first quarter of 2014 and add capacity for approximately 300 stores.
Management remained confident in gaining market share through the dual-market strategy, customer service, expense control, store expansion, acquisitions and distribution investments.
Demand is influenced by miles driven, vehicle registrations, vehicle age, unemployment, fuel prices, consumer spending and weather. The filing noted that DIY transaction counts remained pressured by macroeconomic conditions and that newer vehicles require fewer repairs, although repairs can be more expensive.
Key risks include intense competition, failure to achieve profitable store growth, integration of acquisitions, vendor concentration and supply disruptions, distribution-center or information-system interruptions, adverse weather, employee retention, increased debt, credit-rating downgrades, labor and healthcare costs, environmental regulation, data breaches and litigation.
The Company had a $13.7 million reserve at December 31, 2012 for potential CSK-related indemnification obligations and legal costs. Management believed the ultimate outcome, after reserves and insurance, should not materially affect consolidated results, but stated that the matter remained uncertain.
Unrecognized tax benefits, including interest and penalties, totaled approximately $59.3 million. The filing expected a reduction of approximately $6.9 million during the following year through settlement or expiration of statutes of limitation.
The Company had no interest-rate swaps at year-end and no outstanding variable-rate revolver borrowings. Fixed-rate debt was approximately $1.10 billion, with estimated fair value of $1.20 billion.
Management and Ernst & Young reported effective internal control over financial reporting and issued unqualified audit opinions.

Investor Verification Checklist

Verify the sustainability of 2012’s 50.1% gross margin, including the disclosed approximately 20-basis-point nonrecurring distribution-cost benefit.
Assess whether professional-service-provider growth can offset weaker DIY transaction trends and the lower margin associated with commercial sales.
Reconcile operating cash flow with working-capital changes, particularly the increased reliance on vendor financing and the 84.7% accounts-payable-to-inventory ratio.
Review the effect of the $1.445 billion 2012 share repurchase program on EPS, leverage, liquidity and equity.
Evaluate the planned 190-store expansion, VIP integration and the timing and capital requirements of the Lakeland distribution center.
Review debt maturities, covenant calculations, lease commitments and the $57.3 million of outstanding letters of credit.
Monitor the $13.7 million CSK-related legal reserve, uncertain tax positions, self-insurance reserves and other litigation contingencies.
Test whether macroeconomic, weather, competitive, vendor and technology risks could materially alter projected sales, margins or cash generation.