ORLY

O'Reilly Automotive, Inc. - 10-Q Summary (Q2 2005)

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2005. O'Reilly Automotive, Inc. operates as a specialty retailer of automotive aftermarket parts, accessories, and maintenance items. As of the reporting date, the Company operated 1,399 stores, an increase from 1,170 stores in the prior year. The period included the acquisition of W.E. Lahr Company and its subsidiary, Midwest Auto Parts Distributors, Inc. ("Midwest"), for $63 million on May 31, 2005, and a two-for-one stock split effective June 15, 2005.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Product sales increased 19.8% in Q2 and 17.8% YTD compared to 2004. Growth was driven by the opening of 41 net new stores in Q2 (78 YTD) and comparable store sales increases of 9.6% (Q2) and 8.4% (YTD).
• Profitability: Net income for Q2 increased 27.4% to $42.9 million. However, YTD net income decreased 7.0% to $76.1 million, primarily due to a one-time cumulative effect of an accounting change of $21.9 million recorded in the prior year's YTD period.
• Expense Management: Operating, selling, general, and administrative (OSG&A) expenses increased in absolute dollars but decreased as a percentage of sales (30.9% in Q2 2005 vs. 31.1% in Q2 2004) due to economies of scale and improved labor productivity.
• Cash Flow: Operating cash flow decreased YTD by $34.1 million compared to 2004, attributed to a smaller increase in accounts payable following extended payment terms negotiated in the prior year. Investing cash outflows increased significantly due to the $63 million Midwest acquisition and $102.5 million in property and equipment purchases.

Guidance, Outlook, and Risks

• Expansion Plans: The Company plans to open 72 additional stores for the remainder of 2005. Estimated costs for new store openings range from $900,000 to $1.1 million, while acquisitions average approximately $400,000 (excluding inventory).
• Liquidity: The Company maintains a $150 million revolving credit facility (renewed July 2005 as a $100 million five-year facility). As of June 30, 2005, no borrowings were outstanding, with $126.0 million available after letters of credit. $75 million in private placement notes are due in May 2006.
• Accounting Changes: The Company expects to adopt SFAS 123R (Share-Based Payment) effective January 1, 2006. This will require recognizing stock-based compensation as an expense, which is currently not recorded under the intrinsic value method. Pro forma net income for the six months ended June 30, 2005, would have been $72.7 million under the fair value method.
• Risks: Key risks include competition, sensitivity to regional economic and weather conditions (28% of stores are in Texas), integration risks from acquisitions, and dependence on key personnel.

Investor Verification Checklist

• Acquisition Integration: Verify the pro forma impact and integration progress of the Midwest Auto Parts Distributors acquisition.
• Store Economics: Confirm the average cost per new store and the timeline for achieving profitability on the 72 planned openings for the remainder of 2005.
• Debt Maturity: Review the repayment strategy for the $75 million private placement notes due in May 2006.
• Stock-Based Compensation: Assess the potential impact of SFAS 123R adoption in 2006 on future net income and EPS.
• Seasonality: Monitor Q3 and Q4 performance given the historical seasonality where Q2 and Q3 are typically stronger than Q1 and Q4.