O’Reilly Automotive, Inc. — 2010 Form 10-K Summary
Business context and reporting period
The filing covers the fiscal year ended December 31, 2010. O’Reilly operates specialty retail stores selling automotive aftermarket parts, tools, supplies, equipment and accessories to do-it-yourself customers and professional service providers. At year-end, the company operated 3,570 stores in 38 states, supported by 23 distribution centers.
- Approximately 62% of 2010 sales came from DIY customers and 38% from professional service providers.
- The company completed conversion of all CSK stores to O’Reilly systems in November 2010. Store rebranding was expected to be completed by the end of the second quarter of 2011.
- A holding-company reorganization was completed on December 29, 2010, with no change to shareholders’ economic interests or the company’s NASDAQ trading symbol.
Financial performance and key metrics
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Sales | $5.398 billion | $4.847 billion | Up 11% |
| Gross profit | $2.621 billion | $2.327 billion | Up 13% |
| Gross margin | 48.6% | 48.0% | Up 60 basis points |
| Operating income | $712.8 million | $537.6 million | Up 33% |
| Operating margin | 13.2% | 11.1% | Up 210 basis points |
| Net income | $419.4 million | $307.5 million | Up 36% |
| Net margin | 7.8% | 6.3% | Up 150 basis points |
| Diluted EPS | $2.95 | $2.23 | Up 32% |
| Comparable-store sales | Up 8.8% | Up 4.6% | Improved |
Sales growth was driven primarily by a $417 million increase in comparable-store sales, contributions from stores opened in 2009 and 2010, and modest non-store sales growth. Management attributed comparable-sales improvement to stronger inventory availability, expanded product selection, customer demand for vehicle maintenance, improved commercial sales in acquired CSK markets and higher average ticket values.
Gross-margin expansion reflected improved product mix, lower product acquisition costs, reduced shrinkage at converted CSK stores and vendor purchasing leverage. These benefits were partly offset by the growing commercial-sales mix, which generally carries lower margins, and reduced distribution-center cost leverage.
SG&A increased 6% to $1.887 billion, but declined to 35.0% of sales from 36.9% due primarily to fixed-cost leverage. Interest expense decreased to $39.3 million from $45.2 million.
Cash flow, liquidity and debt
- Cash provided by operating activities was $703.7 million, compared with $285.2 million in 2009.
- Cash used in investing activities was $351.3 million, including $365.4 million of capital expenditures.
- Cash used in financing activities was $349.6 million, principally reflecting debt repayments.
- Cash and cash equivalents were $29.7 million at December 31, 2010.
- Working capital was $1.072 billion, compared with $1.008 billion in 2009; the current ratio was 1.87:1.
- Total debt and capital lease obligations declined to $358.7 million from $790.7 million. Debt-to-equity declined to 0.11 from 0.29.
- Borrowings under the prior secured credit facility were $356 million at year-end, with $644 million of additional availability after letters of credit.
- Adjusted debt to adjusted EBITDAR improved to 1.6x from 2.4x, using the company’s non-GAAP calculation.
Management stated that operating cash flow and borrowing availability were expected to fund near-term and long-term capital and liquidity needs, although future cash generation was not assured. The company planned approximately $365 million of 2011 capital expenditures and approximately 170 net new stores; estimated average new-store investment was $1.4 million to $1.6 million, subject to leasing arrangements.
Material changes versus the prior comparable period
- Comparable-store sales accelerated to 8.8% from 4.6%, while the store base increased by 149 locations to 3,570.
- Operating and net margins expanded despite a $20.9 million charge related to the legacy CSK Department of Justice investigation.
- Operating cash flow more than doubled, largely because 2009 included substantial inventory investment to improve CSK-store availability.
- Total debt declined by approximately $432 million as strong operating cash flow funded repayments.
- The $100 million CSK exchangeable senior notes were fully retired on December 21, 2010 through cash payments and issuance of 1,032,167 common shares.
- Commercial sales grew faster than DIY sales, improving market penetration but creating ongoing gross-margin pressure.
Unusual items, outlook and risks
- The company recorded a $20.9 million charge for the anticipated DOJ resolution of CSK’s legacy accounting investigation. The total related reserve was $21.4 million at year-end.
- The company recorded an $11.6 million non-operating gain from settlement of a note receivable acquired from CSK.
- On an adjusted, non-GAAP basis, operating income was $733.7 million, adjusted net income was $433.1 million and adjusted diluted EPS was $3.05. These measures exclude the DOJ charge and note-settlement gain.
- O’Reilly and the DOJ had agreed in principle to a non-prosecution agreement, subject to final documentation. Related indemnification matters and government litigation remained unresolved, with an additional $18.8 million reserve for indemnification obligations.
- On January 14, 2011, the company issued $500 million of unsecured 4.875% senior notes due 2021 and entered into a $750 million unsecured revolving credit facility. Proceeds repaid the prior secured credit facility; the new Revolver had no borrowings at closing.
- On January 11, 2011, the board authorized a share-repurchase program of up to $500 million over three years. No repurchases occurred during fiscal 2010.
- Management expected operating margins achieved in 2010 to be sustainable, but noted that increasing commercial sales could continue to pressure gross margins.
- Key risks include competition, economic conditions, consumer spending and vehicle miles driven, weather and regional concentration, CSK integration and profitability, debt covenants and interest rates, distribution-center disruptions, vendor dependence, labor and personnel retention, environmental regulation and unresolved CSK-related litigation.
- The company had BBB- and Baa3 credit ratings, each with a stable outlook, from Standard & Poor’s and Moody’s, respectively.
- The company paid no cash dividends and did not anticipate paying dividends in the foreseeable future.
Important facts for investors to verify
- Reconcile 2010 GAAP results with adjusted results and separately assess the recurring nature of the DOJ charge and note-receivable gain.
- Confirm the final resolution, payment and any additional costs associated with the CSK DOJ investigation and indemnification obligations.
- Assess whether CSK stores reach the profitability levels of legacy O’Reilly stores after system conversion and rebranding.
- Monitor the effect of rising commercial sales on gross margin and distribution-center productivity.
- Review the post-year-end refinancing, senior-note covenants, Revolver availability and future interest expense.
- Evaluate the planned 170 net new stores and approximately $365 million of 2011 capital expenditures against operating cash flow.
- Consider the company’s limited cash balance, substantial lease commitments of approximately $1.508 billion and construction commitments of approximately $64.8 million.
- Verify the status and potential exposure from ongoing CSK-related SEC, DOJ and civil proceedings, as well as tax, self-insurance and other legal reserves.