O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Live Green Putting Exceptional Customer Service to Work. Financial Highlights In thousands, except earnings per share data and operating data y e a r s e n d e d d e c e m b e r 3 1 2 0 0 5 2 0 0 4 2 0 0 3 2 0 0 2 2 0 0 1 Product Sales Operating Income Net Income(a) Working Capital Total Assets Long-Term Debt Shareholders' Equity Net Income Per Common Share (assuming dilution)(a) Weight-Average Common Share (assuming dilution) $2,045,318 $1,721,241 $1,511,816 $1,312,490 $1,092,112 252,524 164,266 424,974 190,458 117,674 479,662 165,275 100,087 441,617 138,301 81,992 483,623 1,713,899 1,432,357 1,157,033 1,009,419 25,461 1,145,769 100,322 947,817 120,977 784,285 190,470 650,524 113,831 66,352 429,527 856,859 165,618 556,291 1.45 1.05 0.92 0.76 0.63 113,385 111,423 109,060 107,384 105,572 Stores At Year-End Same-Store Sales Gain 1,470 7.5% 1,249 6.8% 1,109 7.8% 981 3.7% 875 8.8% 2005 was another outstanding year for Team O'Reilly. We reached our sales goal originally set back in 2002 of having $2 billion in sales by 2005. This is a direct result of the commitment of over 19,000 team members working together as one team. earnings per share (a) (assuming dilution) net income (a) (in thousands) operating income (a) (in thousands) 5 4 . 1 5 0 . 1 2 9 . 0 6 7 . 0 3 6 . 0 6 6 2 , 4 6 1 4 7 6 , 7 1 1 7 8 0 , 0 0 1 2 9 9 , 1 2 8 5 3 , 6 6 4 2 5 , 2 5 2 8 5 4 , 0 9 1 5 7 2 , 5 6 1 1 0 3 , 8 3 1 1 3 8 , 3 1 1 01 02 03 04 05 01 02 03 04 05 01 02 03 04 05 Earnings per share increased 38.1% over 2004 to $1.45 per share. On June 15, our Board of Directors declared a 2-for-1 stock split as a result of our continued strong financial performance and their expectations for our future growth. Net income increased 39.6% in 2005 as a result of our continued focus on customer service and drive to make O'Reilly Auto Parts the number one distributor of auto parts in all of our markets. With our continued efforts to control expenses while also driving sales, our operating margin increased to 12.3% in 2005 which is the highest level in company history. (a) 2004 figures are based on income before cumulative effect of accounting change. O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Living GreenGreen Culture can’t be selected or scripted, it must be consistently practiced. The O’Reilly Culture is more than a slogan or a short-term program, it’s a way of life … something we live and breathe. Day in and day out, our culture comes alive in our stores and clearly differentiates us from the competition. 1 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Enthusiasm Approach every job responsibility with enthusiasm. O’Reilly teamteam members O’Reilly members truly WeWe taktake e pride pride in for each for ensuring a a positive in ensuring customers. each ofof o our ur customers. truly have have a a passion passion for experience positive experience ice. for seservrvice. 2 2 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Hard Work Work harder and smarter than your competition. model of of doing Our Our unique unique model to to be be veveryry successful Our Our commitment successful over over time commitment to to our our customers doing business proven business has has proven time … … butbut it it is is notnot easyeasy. . ensure that that need it.it. customers is is to to ensure they need when they need when we we have have the the partpart they they need Professionalism Take pride in being a “Professional Parts Person.” WeWe vow withwith i indust vow to to provide ndustryry-l-leading provide each eading knowledge customer each andand everevery y customer expertise. knowledge andand expertise. customers partners withwith our our customers WeWe view view ourselves ourselves as as partners continue to to be be the andand wewe w willill continue have grown they have resource they resource the valuable valuable trust. grown to to trust. 3 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Dedication Do everything that you can to help O’Reilly continue to be successful. beyond the Going above Going the exception the above andand beyond exception withwith T Team teamteam m members embers is is the the callcall of of duty O’Reilly.y. T The he daily duty is is the eam O’Reill than rather than rule rather dedication of of ourour the rule daily dedication in creating value creating value the driving driving force shareholders. for our our shareholders. for force in Teamwork Be a part of the team. business O’Reilly business success of of the the contributions embers. W We e believe the O’Reilly contributions of of allall of of our our that t the he believe that The he time time-tested tested success model requires model requires the 9,000 teamteam m members. 19,000 effort of of everevery y single effort essential to to the essential ofof T Team single teamteam member member i is s overall success the overall success O’Reilly.y. eam O’Reill 4 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Safety Practice safe work habits and maintain a safe environment for all team members and customers. WeWe firmly firmly believe believe that that safety safety a a way way of of life safety safety is is never life by by integrating never an an accident. integrating it it inin t the he way way we we accident. WeWe makmake e manage andand conduct manage business. conduct our our business. 5 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Excellent Customer Service Never forget that our customers are our bosses, and they pay our wages; treat them accordingly. WeWe w willill never never settle customer serservice customer accept accept l less. settle f for or anything vice andand would anything butbut t the he ververy y highest would never Nothing is is more more critical never e expect ess. Nothing uccess. critical t to o ourour s success. highest l levelevel o of f customers toto xpect our our customers 6 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Expense Control Think about controlling expenses at all times. remain serious WeWe remain customers andand shareholders. customers serious about about our our responsibility shareholders. Our Our decisio weeds outout waste rices to to our our customers responsibility to to our our making decision-n-making that we we can waste so so that can provide customers andand provide shareholders. for our our shareholders. returns for process aggressively process aggressively weeds lower p prices offer lower offer exceptional returns exceptional Respect Treat others as you would like to be treated. Respect i is s the Respect the foundation foundation of of each customers andand fellow kind andand courteous withwith our our customers Being kind Being each interaction have interaction we we have members. fellow teamteam members. courteous to to others standard. absolute standard. others is is our our absolute 7 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Honesty Be honest in your dealings with O’Reilly, your fellow team members and our customers. customers andand fellow Our Our customers honesty atat a allll times. honesty fellow teamteam m members build lifetime always fulfilling times. W We e build customers by by always deserve ve embers deser relationships lifetime relationships the fulfilling the withwith customers commitments we we makmake.e. commitments 8 At O’Reilly, we are very aware that our customers must succeed in order for us to be successful. That’s why our team members are providing “better parts at better prices … everyday.” Our customers and fellow team members deserve honesty at all times. We build lifetime relationships with customers by always fulfilling the commitments we make. O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Win-Win Attitude Make an effort to help everyone succeed. At At O’Reilly, O’Reilly, we we are are ververy y aware mustmust succeed succeed in in order order for hat’s why why our our teamteam m members That’s better prices parts at at better “better parts “better customers that our our customers aware that successful. for us us to to be be successful. embers are are providing providing yday.”.” prices … … evereveryday 9 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Letter to Shareholders 2005 was truly a momentous year for Team O’Reilly. increase over 2004, and net income, before the cumulative We again realized significant expansion in our store base effect of accounting change, increased 39.6% to $164.3 through aggressive growth in existing and new markets million in 2005. Our comparable store sales growth of 7.5% and the successful acquisition and integration of Midwest was among the best in the industry, continuing the tradition Auto Parts Distributors. Due to the dedication of our of market leadership by O’Reilly. Our overall operating team members, we were able to overcome the extreme margin improved to 12.3% in 2005, the best level ever for challenges presented by the Gulf Coast hurricanes with the Company. This performance was made possible by very little disruption to the service that we provide to our initiatives such as our improved wholesale pricing system customers. We are also pleased to report that we have and refinement of our merchandising mix, as well as ongoing reached the milestone of $2 billion in sales this year, incremental improvements in our merchandise acquisition which was our “2-4-Your Future” goal that we set in costs which have been facilitated by our growth. 2002 to reach $2 billion in sales within four years. In addition to achieving the exceptional financial The achievement of our “2-4-Your Future” goal was performance that our shareholders have come to expect, the result of the continued dedication from our Professional our stock price has continued to climb and set new records Parts People working together as one team, striving for one in 2005. In May, our Board of Directors declared a two- goal. Product sales rose to $2.05 billion in 2005, an 18.8% for-one stock split as a result of our continued financial performance and their confidence in our future success. The acquisition of Midwest has proven to be an excellent fit for O’Reilly, both geographically and operationally. The Midwest acquisition provides O’Reilly a presence in Minnesota, Montana, North Dakota, South Dakota, Wisconsin and Wyoming. These six Northern Plains states are a bolt-on growth area to our existing territory and expand our presence to 25 contiguous states. We are excited about the opportunities these new markets present and we are well along the way in evaluating sites for 1 0 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T product sales (in billions) $ 2.25 2.0 1.75 1.5 1.25 1.0 0.75 0.5 0.25 0 95 96 97 98 99 00 01 02 03 04 05 A mix of quality inventory and value pricing matched with our Professional Parts People lets our customers trust in their local O'Reilly store for all of their car care needs. This relationship created by our team members has resulted in us reaching our long-time goal of $2 billion in sales for 2005. throughout 2006 as we relocate or renovate stores based upon our evaluation of market size, store location and competition. We also will complete the changeovers of the product lines in the Midwest stores which will allow us to serve our customers with a better merchandise assortment. We also are planning to roll out our new point of sale computer system which will allow our team members to more efficiently process customer transactions and speed up team member training. Our team excelled in meeting numerous challenges in 2005 by living the O’Reilly Culture, which serves as the theme for this year’s Annual Report. This was never more evident than in the response by Team O’Reilly to the expansion. Midwest’s operations have also proven to difficult circumstances created by the Gulf Coast hurricanes. be a complement to our business model. Midwest had With our team beside us, we are excited about the prospects a track record of success in customer service to both the for 2006. We continue to be encouraged by the fundamentals professional installer and the do-it-yourselfer. This is and prospects for our industry and are confident in our directly in line with our proven dual market strategy. We have been exceptionally pleased with the high degree of dedication and professionalism that characterize the Midwest team members. We are extremely fortunate to have added these team members to our ranks of Professional Parts People. In addition to the 72 stores added in the acquisition of Midwest Auto Parts, we opened 149 new stores in 2005 primarily in the Southeast and Texas. We continued to expand the most extensive distribution network in the industry with the addition of Midwest’s distribution centers in St. Paul, Minnesota and Billings, Montana and total number of stores 1,500 1,350 1,200 1,050 900 750 600 450 300 150 0 95 96 97 98 99 00 01 02 03 04 05 In 2005, we added 221 net, new stores which includes 72 stores we acquired through the acquisition of Midwest Auto Parts Distributors, Inc., which was headquartered in St. Paul, Minnesota. the opening of our distribution center in Atlanta, Georgia. growth opportunities in existing and expansion markets. Building upon our proven and industry-leading As we continue to strive toward our goal of being the growth model, we are planning continued aggressive dominant supplier of auto parts in our market areas, our growth in 2006. We have established a goal to open 170 to key advantage will be the culture that was established by 175 new stores in 2006 and will open our 14th distribution our founders almost 50 years ago. This culture has been center, a 405,000 square foot facility in Indianapolis, fostered ever since those beginnings and is at the heart Indiana. Our integration efforts with Midwest will continue of everything we do as we “Live Green.” David O’Reilly Chairman of the Board Greg Henslee Chief Executive Officer and Co-President Ted Wise Chief Operating Officer and Co-President Jim Batten Executive Vice President of Finance and Chief Financial Officer 1 1 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T 1 2 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T dual market strategy overview do-it-yourselfers professional installers 51.9% 48.1% We believe that our unique ability to successfully service a balance of professional and DIY customers has enabled us to gain market share in many of the communities that we service. C o m p e t i t i v e A d v a n t a g e Dual Market Strategy Our strategy of serving both the professional installer located and provide a large inventory to ensure our and do-it-yourself (DIY) customer is a core competency customers have access to the part they need, when they unmatched in our industry. Maintaining an approximate need it. Our DIY customers benefit from the expertise 50/50 blend between these groups enables us to expand and that our Professional Parts People employ to serve the operate in markets that would not otherwise be large enough professional installer. We make certain that our parts are for a traditional auto parts store. Our dual market strategy competitively priced by consistently conducting reviews of also enables us to take advantage of growth in demand for our competitor’s prices. Our pricing is determined based both customer groups and provides consistent financial per- upon these reviews and internal gross margin targets and formance that is difficult to achieve for competitors that are most of our products are priced at a discount to the primarily reliant on only DIY or professional installer sales. suggested manufacturer’s price. We have established a legacy of service to professional Whether it’s a professional installer needing to keep installers because we consistently provide needed parts faster their bays turning or a do-it-yourselfer needing to get their than our competitors while always providing exceptional car back on the road, our customers know that O’Reilly service and support. We devote the resources to support the has “better parts at better prices … everyday.” professional installer with full-time sales specialists dedicated to developing our relationships with these customers. Our support programs continually update our commercial customers on new developments in automotive technologies and our highly trained Professional Parts People provide an excellent resource. These efforts support our customers by meeting the needs of their business and are what makes us the “First Call” in the markets we serve. Our DIY customers have also grown to rely on our superior customer service. Our stores are conveniently 1 3 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T comparable store sales 15% 12% 9% 6% 3% 0% 95 96 97 98 99 00 01 02 03 04 05 Sales for existing stores open at least one year rose 7.5% in 2005 over 2004, making O’Reilly one of the leaders in the industry. C o m p e t i t i v e A d v a n t a g e Inventory Management & Distribution Systems Our dual market strategy and exceptional customer monitor the flow of products in and out of each of our service are supported by the most extensive and responsive distribution centers. This has allowed us to maximize shelf distribution system in the industry. Our success in space in the distribution centers and position products with serving both the professional installer and DIY markets is the highest demand in the most accessible areas. We are based upon our ability to provide an extremely broad range also continuing to implement “hands free/eyes free” voice of parts to our customers. On average, our stores stock directed picking systems in our distribution centers. These 21,000 stock keeping units (SKUs) with access to more than systems eliminate the need for paper picking documents 100,000 SKUs from one of our 13 distribution centers. Our and improve the efficiency and accuracy of this task. stores are replenished five days a week and our customers 2005 was a very exciting year for us in the area of depend on our ability to deliver hard-to-find parts the distribution and 2006 promises to be the same. We saw same-day or overnight. This industry-leading parts significant expansion in our geographic footprint in 2005 availability has proven to be one of our core competencies with the Midwest acquisition and growth in the Southeast and has been a key factor in developing customer loyalty. markets supported by a new distribution center opened in Our industry-leading best practices in distribution and Atlanta, Georgia in March 2005. The 350,000 square foot inventory management drive our exceptional customer distribution center in Atlanta and the Midwest distribution service. Each of our stores is linked to our global inventory centers in St. Paul, Minnesota and Billings, Montana were management system, allowing them access to order from added to our existing network to support our retail stores the inventory of other stores or any of our 13 distribution in 25 states. We will continue our expansion in 2006 with centers. We also customize the merchandise assortment we the addition of a 405,000 square foot distribution facility stock at each store and distribution center based upon in Indianapolis, Indiana that will have the capability of product demand and vehicle registration in their market serving up to 250 stores. We anticipate the opening of 170 area. We are continuing to implement new initiatives to to 175 new stores in 2006, primarily in the geographic areas reduce costs and improve efficiency in our supply chain, supported by the recent distribution center additions. We including the use of slotting software that allows us to have never been more confident in our ability to support 1 4 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T 1 5 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T e x p a n d i n g f o o t p r i n t O’Reilly Auto Parts Stores and Distribution Centers (D.C.’s) 2004 footprint 2005 expanded footprint 2004 d.c.’s 2005 d.c.’s With the acquisition of Midwest in 2005, we entered into six new states, expanding our footprint to 25 contiguous states reaching from the Southeast United States to the upper Midwest. o ’ r e i l ly y au t o p o í r e i l l s t o r e s u t o p a ra r t s t s s t o r e s 81 stores louisiana 81 stores minnesota 11 stores mississippi 64 stores missouri 49 stores montana 13 stores nebraska 64 stores south carolina 40 stores south dakota 52 stores tennessee 149 stores texas 16 stores virginia 26 stores wisconsin 65 stores north carolina 27 stores wyoming 12 stores 2 stores 99 stores 404 stores 3 stores 7 stores 4 stores alabama arkansas florida georgia illinois indiana iowa kansas kentucky 39 stores oklahoma 59 stores north dakota 3 stores 100 stores t ot o t a l a l n u m b e r n u m b e r o f o f s t o r e s : s t o r e s : 1,470 1,470 store growth in new, contiguous markets while maintaining disruptions just as it allows us the responsiveness to overnight delivery to every store and the product availability continually provide our customers with the parts they that our customers need. need on a daily basis. However, none of our advanced It should be no surprise that our stores were among distribution systems would be effective without the hard the last to close in most markets before the Gulf Coast work and dedication of each and every one of our team hurricanes and among the first to reopen following the members. It is truly their commitment to providing storms. The flexibility and extensive reach of our “better parts at better prices … everyday” that distribution network enabled us to adjust to these drives our success. 1 6 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T 1 7 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T 1 8 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T team members growth 25,000 22,500 20,000 17,500 15,000 12,500 10,000 7,500 5,000 2,500 0 01 02 03 04 05 We continue to grow our team of Professional Parts People, targeting those people who will accept our values and be true to our culture by Living Green. C o m p e t i t i v e A d v a n t a g e Outstanding Customer Service The driving principle behind every aspect of the O’Reilly loyalty of each customer who enters one of our stores. In Culture is the mandate to provide the absolute best 2006, we will roll out our revamped point of sale and parts customer service possible. We continually strive to provide lookup systems which will reduce the amount of training a positive experience for our customers. We understand time necessary for new team members and enhance our that in order to be successful we must partner with our ability to make product recommendations to our customers. customers to meet their needs. To support our professional We have also improved our scheduling system and given installers, we have implemented the Certified Auto Repair our store managers better tools to ensure that we maintain Center, a new marketing program that assists them in the appropriate staffing levels necessary to provide the growing and marketing their shops while providing them consistent service our customers have come to expect. with business tools that drive profitability. Over 1,000 shops We will continue to follow the same time-tested are now enrolled in this program and we are realizing business practices for delivering service to our customers increased sales as these customers prosper. that have been the key to our success. We constantly review As we expand into new markets, we will leverage our market prices for our products so that we can continue to existing systems and promote new initiatives to earn the provide the best prices for our customers. The appearance of our stores is a high priority for our team members who diligently maintain a neat and organized environment for our customers. Since our team member training and incentive programs emphasize the development of product knowledge, our stores are always staffed with the most Professional Parts People in the business. However, we are proudest of our track record of being able to locate and deliver the “hard to find” part when no other store in town can help, even if it requires using a flashlight to pull parts from a shelf after a hurricane has knocked out the electricity. 1 9 O ’ R E I L L Y A U T O M O T I V E O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 2 0 0 5 A N N U A L R E P O R T A N N U A L R E P O R T m e m o r y y o fo f C h a r l e s H . H . “ C h u b ” C h a r l e s InIn m e m o r C h u b ” O ’ r e i l l ’ r e i l ly 2 0 0 5 1 9 1 3 - - 2 0 0 5 1 9 1 3 “ I“ It’t’s s i m p o r t a n t i m p o r t a n t t o t o t rt re a te a t o t h e r s o t h e r s w i t h i t h h o n e s t y h o n e s t y.”.” 2 0 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T Results of Living Green Our introduction to this annual report outlined the maxim that “Culture can’t be selected or scripted, it must be consistently practiced.” Another maxim is equally true: “Culture cannot be created overnight.” The O’Reilly Culture reflects the core values inherent in our company from its very beginnings. We owe this legacy to the personal and business values embraced by Charles F. (C.F.) O’Reilly and his son, Charles H. “Chub” O’Reilly when they opened their first auto parts store in Springfield, Missouri in 1957. The culture handed down from C.F. and Chub O’Reilly and nurtured over nearly 50 years lives on today in over 19,000 enthusiastic, hardworking, professional O’Reilly team members. This culture is the driving force behind our profitable growth and financial success and will continue to be our greatest asset in the future. 2 1 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T s e l e c t e d c o n s o l i d a t e d f i n a n c i a l d a t a (In thousands, except per share data) years ended december 31, income statement data: Product sales Cost of goods sold, including warehouse and distribution expenses Gross profit Operating, selling, general and administrative expenses Operating income Other income (expense), net Income before income taxes and cumulative effect of accounting change Provision for income taxes Income before cumulative effect of accounting change Cumulative effect of accounting change, net of tax (a) 2005 2004 2003 $2,045,318 1,152,815 892,503 639,979 252,524 (1,455) 251,069 86,803 164,266 - $1,721,241 $1,511,816 978,076 743,165 552,707 190,458 (2,721) 187,737 70,063 117,674 21,892 873,481 638,335 473,060 165,275 (5,233) 160,042 59,955 100,087 - Net income $ 164,266 $ 139,566 $ 100,087 basic earnings per common share: Income before cumulative effect of accounting change Cumulative effect of accounting change (a) Net income per share Weighted-average common shares outstanding earnings per common share-assuming dilution: Income before cumulative effect of accounting change Cumulative effect of accounting change (a) Net income per share Weighted-average common shares outstanding - adjusted pro forma income statement data (b): Product sales Cost of goods sold, including warehouse and distribution expenses Gross profit Operating, selling, general and administrative expenses Operating income Other income (expense), net Income before income taxes Provision for income taxes Net income Net income per share Net income per share – assuming dilution $ 1.47 - $ 1.47 111,613 $ 1.45 - $ 1.45 113,385 N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A $ 1.07 0.20 $ 1.27 110,020 $ 1.05 0.20 $ 1.25 111,423 N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A $ 0.93 - $ 0.93 107,816 $ 0.92 - $ 0.92 109,060 $1,511,816 872,658 639,158 473,060 166,098 (5,233) 160,865 60,266 $ 100,599 $ 0.93 $ 0.92 (a) See Management’s Discussion and Analysis of Financial Condition and Results of Operations, 2004 Compared to 2003. (b) The pro forma income statement reflects the retroactive application of the cumulative effect of the accounting change to historical periods. 2 2 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T s e l e c t e d c o n s o l i d a t e d f i n a n c i a l d a t a (continued) 2002 2001 2000 1999 1998 1997 1996 $1,312,490 $1,092,112 $ 890,421 $ 754,122 $ 616,302 $ 316,399 $ 259,243 759,090 553,400 415,099 138,301 (7,319) 130,982 48,990 81,992 - 624,294 467,818 353,987 113,831 (7,104) 106,727 40,375 66,352 - 507,720 382,701 292,672 90,029 (6,870) 83,159 31,451 51,708 - 428,832 325,290 248,370 76,920 (3,896) 73,024 27,385 45,639 - 358,439 257,863 200,962 56,901 (6,958) 49,943 19,171 30,772 - 181,789 134,610 97,526 37,084 472 37,556 14,413 23,143 - 150,772 108,471 79,620 28,851 1,182 30,033 11,062 18,971 - $ 81,992 $ 66,352 $ 51,708 $ 45,639 $ 30,772 $ 23,143 $ 18,971 $ 0.77 $ 0.64 $ 0.51 $ 0.47 $ 0.36 $ 0.27 $ 0.23 - $ 0.77 106,228 - $ 0.64 104,242 - $ 0.51 102,336 - $ 0.47 97,348 - - - $ 0.36 $ 0.27 $ 0.23 84,952 84,172 83,456 $ 0.76 $ 0.63 $ 0.50 $ 0.46 $ 0.36 $ 0.27 $ 0.23 - $ 0.76 107,384 - $ 0.63 105,572 - $ 0.50 103,456 - $ 0.46 99,430 - - - $ 0.36 $ 0.27 $ 0.23 86,408 85,108 84,128 $1,312,490 $1,092,112 $ 890,421 $ 754,122 $ 616,302 $ 316,399 $ 259,243 754,844 557,646 415,099 142,547 (7,319) 135,228 50,595 $ 84,633 $ 0.80 $ 0.79 618,217 473,895 353,987 119,908 (7,104) 112,804 42,672 $ 70,132 $ 0.67 $ 0.66 501,567 388,854 292,672 96,182 (6,870) 89,312 33,776 $ 55,536 $ 0.54 $ 0.54 425,229 328,893 248,370 80,523 (3,896) 76,627 28,747 $ 47,880 $ 0.49 $ 0.48 350,581 265,721 200,962 64,759 (6,958) 57,801 22,141 $ 35,660 $ 0.42 $ 0.41 180,170 136,229 97,526 38,703 472 39,175 15,025 $ 24,150 $ 0.29 $ 0.28 149,248 109,995 79,620 30,375 1,182 31,557 11,638 $ 19,919 $ 0.24 $ 0.24 2 3 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T s e l e c t e d c o n s o l i d a t e d f i n a n c i a l d a t a (continued) (In thousands, except selected operating data) years ended december 31, selected operating data: Number of stores at year-end (a) Total store square footage at year-end (in 000’s) (a) (b) Weighted-average product sales per store (in 000’s) (a) (b) Weighted-average product sales per square foot (b) (d) Percentage increase in same store product sales (c) balance sheet data: Working capital 2005 1,470 9,801 2004 1,249 8,318 2003 1,109 7,348 $ 1,478 $ 220 $ 1,443 $ 217 $ 1,413 $ 215 7.5% 6.8% 7.8% $ 424,974 $ 479,662 $ 441,617 Total assets 1,713,899 1,432,357 1,157,033 Current portion of long-term debt and short-term debt Long-term debt, less current portion 75,313 25,461 592 925 100,322 120,977 Shareholders' equity 1,145,769 947,817 784,285 (a) Store count for 2002 does not include 27 stores acquired from Dick Smith Enterprises and Davie Automotive, Inc. in December 2002. (b) Total square footage includes normal selling, office, stockroom and receiving space. Weighted-average product sales per store and per square foot are weighted to consider the approximate dates of store openings or expansions. (c) Same-store product sales are calculated based on the change in product sales of stores open at least one year. Prior to 2000, same-store product sales data were calculated based on the change in product sales of only those stores open during both full periods being compared. Percentage increase in same-store product sales is calculated based on store sales results, which exclude sales of specialty machinery, sales by outside salesmen and sales to employees. (d) 1998 does not include stores acquired from Hi/LO. Consolidated weighted-average product sales per square foot were $207. 2 4 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T s e l e c t e d c o n s o l i d a t e d f i n a n c i a l d a t a (continued) 2002 2001 2000 1999 1998 1997 1996 981 6,408 1,372 211 3.7% $ $ 875 5,882 $ 1,426 $ 219 672 4,491 $ 1,412 $ 218 571 3,777 $ 1,422 $ 223 491 3,172 $ 1,368 $ 238 259 1,417 1,300 244 $ $ 219 1,151 $ 1,240 $ 251 8.8% 5.0% 9.6% 6.8% 6.8% 14.4% $ 483,623 $429,527 $296,272 $249,351 $208,363 $ 93,763 $ 74,403 1,009,419 856,859 715,995 610,442 493,288 247,617 183,623 682 16,843 49,121 19,358 13,691 130 190,470 165,618 90,463 90,704 170,166 22,641 3,154 237 650,524 556,291 463,731 403,044 218,394 182,039 155,782 2 5 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T m a n a g e m e n t ’ s d i s c u s s i o n a n d a n a l y s i s o f f i n a n c i a l c o n d i t i o n a n d r e s u l t s o f o p e r a t i o n s The following discussion of our financial condition, results of operations and liquidity and capital resources should be read in conjunction with our consolidated financial statements, related notes and other financial information included elsewhere in this annual report. We are one of the largest specialty retailers of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States, selling our products to both do-it-yourself (DIY) customers and professional installers. Our stores carry an extensive product line consisting of new and remanufactured automotive hard parts, maintenance items and accessories, and a complete line of auto body paint and related materials, automotive tools and professional service equipment. We calculate same-store product sales based on the change in product sales for stores open at least one year. Prior to January 2000, we calculated same-store product sales based on the change in product sales of only those stores open during both full periods being compared. We calculate the percentage increase in same-store product sales based on store sales results, which exclude sales of specialty machinery, sales by outside salesmen and sales to team members. Cost of goods sold consists primarily of product costs and warehouse and distribution expenses. Cost of goods sold as a percentage of product sales may be affected by variations in our product mix, price changes in response to competitive factors and fluctuations in merchandise costs and vendor programs. Operating, selling, general and administrative expenses consist primarily of salaries and benefits for store and corporate team members, occupancy, advertising expenses, general and administrative expenses, data processing, professional expenses and other related expenses. c r i t i c a l a c c o u n t i n g p o l i c i e s a n d e s t i m a t e s The preparation of our financial statements in accordance with accounting policies generally accepted in the United States (GAAP) requires the application of certain estimates and judgements by management. Management bases its assumptions, estimates, and adjustments on historical experience, current trends and other factors believed to be relevant at the time the consolidated financial statements are prepared. Management believes that the following policies are critical due the inherent uncertainty of these matters and the complex and subjective judgments required to establish these estimates. Management continues to review these critical accounting policies and estimates to ensure that the consolidated financial statements are presented fairly in accordance with GAAP. However, actual results could differ from our assumptions and estimates and such differences could be material. ■ Vendor concessions – We receive concessions from our vendors through a variety of programs and arrangements, including co-operative advertising, allowances for warranties, merchandise allowances and volume purchase rebates. Co-operative advertising allowances that are incremental to our advertising program, specific to a product or event and identifiable for accounting purposes are reported as a reduction of advertising expense in the period in which the advertising occurred. All other vendor concessions are recognized as a reduction of cost of sales when recognized in the consolidated statement of income. Amounts receivable from vendors also includes amounts due to the Company for changeover merchandise and product returns. Amounts receivable from vendors are regularly reviewed by management and reserves for uncollectible amounts are provided for in our consolidated financial statements. We do not believe there is a reasonable likelihood that uncollectible amounts will exceed management’s expectations. However, actual results could differ from our assumptions and estimates and we may be exposed to losses or gains that could be material. ■ Self-Insurance reserves – We use a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation, general liability, vehicle liability, property loss, and employee health care benefits. With the exception of employee health care benefit liabilities, which are limited by the design of these plans, we obtain third-party insurance coverage to limit our exposure. When estimating our self-insurance liabilities, we consider a number of factors, including historical claims experience and trend-lines, projected medical and legal inflation, and growth patterns and exposure forecasts. Our calculation of these liabilities requires management to apply judgement to estimate the ultimate cost to settle reported claims and claims incurred but not yet reported as of the balance sheet date. Actual claim activity or development may vary from our assumptions and estimates, which may result in material losses or gains. ■ Accounts receivable – Management estimates the allowance for doubtful accounts based on historical loss ratios and other relevant factors. Actual results have consistently been within management’s expectations and we do not believe that there is a reasonable likelihood that there will be a material change in future assumptions or estimates we use to calculate our allowance for doubtful accounts. However, if actual results differ from our estimates, we may be exposed to losses or gains that could be material. ■ Taxes – We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions These audits can involve complex issues, which may require an extended period of time to resolve. We regularly review our potential tax liabilities for tax years subject to audit. Changes in our tax liability occurred in 2005 and may occur in the future as our assessments change based on the progress of tax examinations in various jurisdictions and/or changes in tax regulations. In management’s opinion, adequate provisions for income taxes have been made for all years presented. However, the estimates of our potential tax liabilities contain uncertainties because management must use judgement to estimate the exposures associated with our various tax positions. Actual results could differ from our estimates and such differences could be material. 2 6 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T m a n a g e m e n t ’ s d i s c u s s i o n a n d a n a l y s i s o f f i n a n c i a l c o n d i t i o n a n d r e s u l t s o f o p e r a t i o n s (continued) r e s u l t s o f o p e r a t i o n s The following table sets forth, certain income statement data as a percentage of product sales for the years indicated: years ended december 31, Product sales Cost of goods sold, including warehouse and distribution expenses Gross profit Operating, selling, general and administrative expenses Operating income Other expense, net Income before income taxes and cumulative effect of accounting change Provision for income taxes Income before cumulative effect of accounting change Cumulative effect of accounting change, net of tax Net income 2005 100.0% 56.4 43.6 31.3 12.3 (0.1) 12.2 4.2 8.0 - 8.0% 2004 100.0% 56.8 43.2 32.1 11.1 (0.2) 10.9 4.1 6.8 1.3 8.1% 2003 100.0% 57.8 42.2 31.3 10.9 (0.3) 10.6 4.0 6.6 - 6.6% See Management’s Discussion and Analysis of Financial Condition and Results of Operations, 2005 Compared to 2004, for detailed information on cumulative effect of accounting change. 2 0 0 5 c o m p a r e d t o 2 0 0 4 Product sales increased $324.1 million, or 18.8% from $1.72 billion in 2004 to $2.05 billion in 2005, primarily due to 221 net additional stores opened during 2005, and a 7.5% increase in same-store product sales for stores open at least one year. We believe that the increased product sales achieved by the existing stores are the result of our offering of a broader selection of products in most stores, an increased promotional and advertising effort through a variety of media and localized promotional events, continued improvement in the merchandising and store layouts of most stores, and compensation programs for all store team members that provide incentives for performance. Also, our continued focus on serving professional installers contributed to increased product sales. Gross profit increased $149.3 million, or 20.1% from $743.2 million (43.2% of product sales) in 2004 to $892.5 million (43.6% of product sales) in 2005, due to the increase in product sales. The increase in gross profit as a percent of product sales is related to improvements in our distribution cost and improved product margin related to product acquisition cost. OSG&A increased $87.3 million, or 15.8%, from $552.7 million (32.1% of product sales) in 2004 to $640.0 million (31.3% of product sales) in 2005. The increase in these expenses was primarily attributable to increased salaries and benefits, rent and other costs associated with the addition of employees and facilities to support the increased level of our operations. The decrease in OSG&A as a percentage of sales was the result of ongoing expense management efforts and benefits from increased economies of scale resulting from our sales growth. Other expense, net, decreased by $1.3 million from $2.7 million in 2004 to $1.5 million in 2005. The decrease was primarily due to increased interest income as a result of higher average interest rates earned on comparable average cash and cash equivalent balances. Provision for income taxes increased from $70.1 million in 2004 (37.3% effective tax rate) to $86.8 million in 2005 (34.6% effective tax rate). The increase in the dollar amount was primarily due to the increase of income before income taxes. The decrease in the effective tax rate in 2005 is primarily attributable to a non-cash adjustment of $6.1 million in the third quarter resulting from the favorable resolution of prior year tax uncertainties. This tax benefit is nonrecurring and reflects the reversal of previously recorded income tax reserves related to a prior acquisition. The cumulative change in accounting method, effective January 1, 2004, changed the method of applying our LIFO accounting policy for certain inventory costs. Under the new method, we inventory certain procurement, warehousing and distribution center costs. The previous method was to recognize those costs as incurred, reported as a component of costs of goods sold. We believe the new method is preferable, since it better matches revenues and expenses and is the prevalent method used by other entities within the automotive aftermarket industry. As a result of the impacts discussed above, income before the cumulative effect of the accounting change increased $46.6 million from $117.7 million in 2004 (6.8% of product sales) to $164.3 million in 2005 (8.0% of product sales). Net income in 2004, after the cumulative effect of the accounting change, was $139.6 million (8.1% of product sales). 2 7 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T m a n a g e m e n t ’ s d i s c u s s i o n a n d a n a l y s i s o f f i n a n c i a l c o n d i t i o n a n d r e s u l t s o f o p e r a t i o n s (continued) 2 0 0 4 c o m p a r e d t o 2 0 0 3 Product sales increased $209.4 million, or 13.9% from $1.51 billion in 2003 to $1.72 billion in 2004, primarily due to 140 net additional stores opened during 2004, and a 6.8% increase in same-store product sales for stores open at least one year. We believe that the increased product sales achieved by the existing stores are the result of our offering of a broader selection of products in most stores, an increased promotional and advertising effort through a variety of media and localized promotional events, continued improvement in the merchandising and store layouts of most stores, and compensation programs in place for all store team members that provide incentives for performance. Also, our continued focus on serving professional installers contributed to increased product sales. Gross profit increased 16.4% from $638.3 million (42.2% of product sales) in 2003 to $743.2 million (43.2% of product sales) in 2004. Gross profit dollars rose $100.4 million due to the increase in product sales and $4.4 million due to the change in inventory accounting method. The increase in gross profit as a percent of product sales is related to improvements in our distribution cost and improved product margin related to product acquisition cost as well as the change in inventory accounting method. OSG&A increased $79.6 million, or 16.8%, from $473.1 million (31.3% of product sales) in 2003 to $552.7 million (32.1% of product sales) in 2004. The increase in these expenses was due to increased salaries and benefits, rent and other costs associated with the addition of employees and facilities to support the increased level of our operations as well as corrections of errors related to lease accounting totaling $10.4 million (see Note 1 to the Company’s consolidated financial statements.) The increase in OSG&A as a percentage of sales was primarily attributable to increased costs for team member health insurance coverage and the lease accounting correction discussed above. Other expense, net, decreased by $2.5 million from $5.2 million in 2003 to $2.7 million in 2004. The decrease was primarily due to a reduction in interest expense as a result of lower average borrowings under our credit facility. Provision for income taxes increased from $60.0 million in 2003 (37.5% effective tax rate) to $70.1 million in 2004 (37.3% effective tax rate). The increase in the dollar amount was primarily due to the increase of income before income taxes. As a result of the impacts discussed above, income before the cumulative effect of the inventory accounting change increased $17.6 million or 17.6% from $100.1 million (6.6% of product sales) in 2003 to $117.7 million (6.8% of product sales) in 2004. Net income in 2004, after the cumulative affect of the accounting change, was $139.6 million (8.1% of product sales.) l i q u i d i t y a n d c a p i t a l r e s o u r c e s Net cash provided by operating activities was $213.3 million in 2005, $226.5 million in 2004 and $168.8 million in 2003. The decrease in cash provided by operating activities in 2005 compared to 2004 was primarily due to a smaller increase in accounts payable of $43.2 million in 2005 compared to the significant increase in 2004 of $94.6 million. The increase in accounts payable in 2005 and 2004 was primarily due to management’s continued efforts with vendors to extend the terms of payments. The effect on operating cash flows of the 2005 decrease in accounts payable growth was partially offset by the effect of the 2005 increase in net income. The increase in cash provided by operating activities in 2004 compared to 2003 was primarily due to increases in net income and accounts payable, partially offset by increases in receivables and inventory. The increases in accounts receivable and inventory primarily relate to the increased level of our operations. Net cash used in investing activities was $269.1 million in 2005, $172.0 million in 2004 and $130.6 million in 2003. The increase in cash used in investing activities in 2005 and 2004 was primarily due to increased purchases of property and equipment and the acquisition in 2005 of Midwest Auto Parts Distributors, Inc. (“Midwest”), which included 72 stores and distribution centers in St. Paul, Minnesota and Billings, Montana. Capital expenditures were $205.2 million in 2005, $173.5 million in 2004 and $136.5 million in 2003. These expenditures were primarily related to the opening of new stores, as well as the relocation or remodeling of existing stores. We either opened or acquired 221, 140 and 128 net stores in 2005, 2004 and 2003, respectively, including the 72 stores acquired with the acquisition of Midwest in 2005. We remodeled or relocated 37 stores in 2005, remodeled or relocated 30 stores and remodeled one distribution center in 2004 and remodeled or relocated 46 stores and two distribution centers in 2003. In 2004, we acquired one new distribution center near Atlanta, Georgia. We acquired an additional facility near Indianapolis, Indiana in 2005 for the opening of a distribution center in 2006. One new distribution center was acquired in 2003, located near Mobile, Alabama. Our continuing store expansion program requires significant capital expenditures and working capital principally for inventory requirements. Our 2006 growth plans call for approximately 170-175 new stores and capital expenditures of $210 million to $220 million. The costs associated with the opening of a new store (including the cost of land acquisition, improvements, fixtures, inventory and computer equipment) are estimated to average approximately $900,000 to $1.1 million; however, such costs may be significantly reduced where we lease, rather than purchase, the store site. 2 8 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T m a n a g e m e n t ’ s d i s c u s s i o n a n d a n a l y s i s o f f i n a n c i a l c o n d i t i o n a n d r e s u l t s o f o p e r a t i o n s (continued) Although the cost to acquire the business of an independently owned parts store varies, depending primarily upon the amount of inventory and the amount, if any, of real estate being acquired, we estimate that the average cost to acquire such a business and convert it to one of our stores is approximately $400,000. We plan to finance our expansion program through cash expected to be provided from operating activities and available borrowings under our existing credit facilities. On July 29, 2005, we amended the unsecured, five-year syndicated credit facility (“Credit Facility”) in the amount of $100 million led by Wells Fargo Bank as the Administrative Agent, replacing a three-year $150 million syndicated credit facility. The Credit Facility is guaranteed by all of our subsidiaries and may be increased to a total of $200 million, subject to the availability of such additional credit from either existing banks within the Credit Facility or other banks. The Credit Facility bears interest at LIBOR plus a spread ranging from 0.50% to 1.0% (4.86% at December 31, 2005) and expires in July 2010. At December 31, 2005 and 2004, we had no outstanding borrowings under the Credit Facility. The available borrowings under the Credit Facility are reduced by stand-by letters of credit issued by us primarily to satisfy the requirements of workers compensation, general liability and other insurance policies. Our aggregate availability for additional borrowings under the Credit Facility was $70.7 million and $128.7 million at December 31, 2005 and 2004, respectively. In May 2006, $75 million of our private placement notes will become due. We anticipate repaying these notes with cash expected to be provided by operating activities or a combination of such cash, available borrowing capacity under our revolving credit facility and the issuance of new private placement notes. o f f b a l a n c e s h e e t a r r a n g e m e n t s We have utilized various financial instruments from time to time as sources of cash when such instruments provided a cost effective alternative to our existing sources of cash. We do not believe, however, that we are dependent on the availability of these instruments to fund our working capital requirements or our growth plans. On December 29, 2000, we completed a sale-leaseback transaction. Under the terms of the transaction, we sold 90 properties, including land, buildings and improvements, which generated $52.3 million of additional cash. The lease, which is being accounted for as an operating lease, provides for an initial lease term of 21 years and may be extended for one initial ten-year period and two additional successive periods of five years each. The resulting gain of $4.5 million has been deferred and is being amortized over the initial lease term. Net rent expense during the initial term will be approximately $5.5 million annually. In August 2001, we completed a sale-leaseback with O’Reilly-Wooten 2000 LLC (an entity owned by certain shareholders of the Company). The transaction involved the sale and leaseback of nine O’Reilly Auto Parts stores and resulted in approximately $5.6 million of additional cash to us. The transaction did not result in a material gain or loss. The lease, which has been accounted for as an operating lease, calls for an initial term of 15 years with three five-year renewal options. On June 26, 2003, we completed an amended and restated master agreement to our $50 million Synthetic Operating Lease Facility, relating to our properties leased from SunTrust Equity Funding, LLC (the “Synthetic Lease”), with a group of financial institutions. The terms of the Synthetic Lease provide for an initial lease period of five years, a residual value guarantee of approximately $42.2 million at December 31, 2005, and purchase options on the properties. The Synthetic Lease also contains a provision for an event of default whereby the lessor, among other things, may require us to purchase any or all of the properties. One additional renewal period of five years may be requested from the lessor, although the lessor is not obligated to grant such renewal. The Synthetic Lease has been accounted for as an operating lease under the provisions of Financial Accounting Standards Board (“FASB”) SFAS No. 13 and related interpretations, including FASB Interpretation No. 46. We issue stand-by letters of credit provided by a $50 million sublimit under the Credit Facility that reduce our available borrowings. These letters of credit are issued primarily to satisfy the requirements of workers compensation, general liability and other insurance policies. Substantially all of the outstanding letters of credit have a one-year term from the date of issuance and have been issued to replace surety bonds that were previously issued. Letters of credit totaling $29.3 million and $21.3 million were outstanding at December 31, 2005 and 2004, respectively. 2 9 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T m a n a g e m e n t ’ s d i s c u s s i o n a n d a n a l y s i s o f f i n a n c i a l c o n d i t i o n a n d r e s u l t s o f o p e r a t i o n s (continued) c o n t r a c t u a l o b l i g a t i o n s We have other liabilities reflected in our balance sheet, including deferred income taxes and self-insurance accruals. The payment obligations associated with these liabilities are not reflected in the financial commitments table due to the absence of scheduled maturities. Therefore, the timing of these payments cannot be determined, except for amounts estimated to be payable in 2006 that are included in current liabilities. In addition, we have commitments with various vendors for the purchase of inventory as of December 31, 2005. The financial commitments table excludes these commitments because they are cancelable by their terms. Our contractual obligations, including commitments for future payments under non-cancelable lease arrangements and short and long-term debt arrangements, are summarized below and are fully disclosed in Notes 6 and 7 to the consolidated financial statements payments due by period (In thousands) contractual obligations: Long-term debt Operating leases Total contractual cash obligations total before 1 year 1-3 years 4-5 years over 5 years $100,774 339,685 $440,459 $ 75,313 42,251 $117,564 $25,050 73,555 $98,605 $ 33 55,237 $55,270 $ 378 168,642 $169,020 We believe that our existing cash and cash equivalents, cash expected to be provided by operating activities, available bank credit facilities and trade credit will be sufficient to fund both our short-term and long-term capital needs for the foreseeable future. i n f l a t i o n a n d s e a s o n a l i t y We attempt to mitigate the effects of merchandise cost increases principally by taking advantage of vendor incentive programs, economies of scale resulting from increased volume of purchases and selective forward buying. As a result, we do not believe that our operations have been materially affected by inflation. Our business is somewhat seasonal, primarily as a result of the impact of weather conditions on store sales. Store sales and profits have historically been higher in the second and third quarters (April through September) of each year than in the first and fourth quarters. q u a r t e r l y r e s u l t s The following table sets forth certain quarterly unaudited operating data for fiscal 2005 and 2004. The unaudited quarterly information includes all adjustments which management considers necessary for a fair presentation of the information shown. In the prior year, we restated our quarterly financial information for each of the first three quarters of 2004. Effective January 1, 2004, we changed our method of applying our LIFO accounting policy for inventory costs. Under the new method, we have inventoried certain warehousing and distribution center costs. Our previous method recorded these expenses directly into cost of goods sold. We believe the change in application of accounting method is preferable as it more accurately matches revenues and expenses and is the prevelant method used by other entities within our industry. The cumulative effect of this change in application of accounting method is $21,892,000 as of January 1, 2004, net of the related deferred tax effect of $13,303,000. The unaudited operating data presented below should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report, and the other financial information included therein. (In thousands, except per share data) fiscal 2005 Product sales Gross profit Operating income Net income Basic net income per common share Net income per common share-assuming dilution first quarter $466,239 196,169 53,581 33,213 0.30 0.30 second quarter $521,209 228,970 68,127 42,923 0.39 0.38 third quarter $542,906 235,916 67,585 48,623 0.43 0.42 fourth quarter $514,964 231,448 63,231 39,507 0.35 0.35 3 0 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T m a n a g e m e n t ’ s d i s c u s s i o n a n d a n a l y s i s o f f i n a n c i a l c o n d i t i o n a n d r e s u l t s o f o p e r a t i o n s (continued) (In thousands, except per share data) first quarter second quarter fiscal 2004 third quarter Product sales Gross profit Operating income Income before cumulative effect of accounting change Cumulative effect of accounting change, net of tax Net income Basic net income per common share before cumulative effect of accounting change Cumulative effect of accounting change, net of tax Basic net income per common share Diluted net income per common share before cumulative effect of accounting change Cumulative effect of accounting change, net of tax Net income per common share-assuming dilution previously reported $403,294 169,338 43,772 restated $403,294 169,593 44,027 previously reported $435,167 187,758 52,565 restated 435,167 189,435 54,242 previously reported $455,162 195,848 53,809 fourth restated $455,162 198,169 56,130 quarter (a) $427,618 185,968 36,059 27,126 27,285 32,652 33,695 33,243 34,687 22,007 - 27,126 21,892 49,177 - 32,652 - 33,695 - 33,243 - 34,687 - 22,007 0.25 - 0.25 0.24 - 0.24 0.25 0.20 0.45 0.24 0.20 0.44 0.30 - 0.30 0.29 - 0.29 0.31 - 0.31 0.30 - 0.30 0.30 - 0.30 0.30 - 0.30 0.31 - 0.31 0.31 - 0.31 0.20 - 0.20 0.20 - 0.20 (a) During the fourth quarter 2004, the Company recorded a correction of an error of $10.4 million ($3.5 million related to 2004) $6.5 million, net of tax. See Note 1 to our consolidated financial statements. n e w a c c o u n t i n g s t a n d a r d s In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. The provision is effective for fiscal periods beginning after June 15, 2005. We do not expect the adoption of this standard to have a material effect on our financial position, results of operations or cash flows. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. SFAS 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not expect the adoption of this standard to have a material effect on our financial position, results of operations or cash flows. In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R is a revision of SFAS No. 123, Accounting for Stock Based Compensation, and supersedes APB No. 25, Accounting for Stock Issued to Employees. Among other items, SFAS No. 123R eliminates the use of APB No. 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. SFAS No. 123R also requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date. These future amounts cannot be estimated, because they depend on, among other things, when employees exercise stock options. However, the amount of operating cash flows recognized in prior periods for such tax deductions, as shown in our Consolidated Statements of Cash Flows were $7.1 million, $4.5 million, and $5.5 million, for the years ended December 31, 2005, 2004, and 2003, respectively. The effective date of SFAS No. 123R is the first reporting period of the first fiscal year beginning on or after June 15, 2005, which is first quarter 2006 for calendar year companies, such as ourselves, although early adoption is allowed. We intend to adopt SFAS No. 123R beginning with the first quarter of 2006 using the “modified prospective” method under which compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS No. 123R for all share-based 3 1 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T m a n a g e m e n t ’ s d i s c u s s i o n a n d a n a l y s i s o f f i n a n c i a l c o n d i t i o n a n d r e s u l t s o f o p e r a t i o n s (continued) payments granted after that date, and based on the requirements of SFAS No. 123 for all unvested awards granted prior to the effective date of SFAS No. 123R. In the fourth quarter of 2005, the Board of Directors approved the accelerated vesting of all unvested stock options previously awarded to employees and executive officers. As a result, the pro forma impact to net income and net income per share under SFAS No. 123’s fair value method of accounting as reflected in Note 1 to the consolidated financial statements is not indicative of future annual expense to be recognized under SFAS No. 123R. To the extent that we grant stock options in the future, the associated expense for these awards under the provisions of SFAS No. 123R may have a material impact on our consolidated financial statements. Based upon anticipated levels of share-based awards, we estimate this impact to be approximately $2 million or $0.02 per diluted share for 2006. See Notes 1 and 10 to the consolidated financial statements for further information on our stock-based compensation plans. f o r w a r d - l o o k i n g s t a t e m e n t s We claim the protection of the safe-harbor for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these statements by forward-looking words such as “expect,” “believe,” “anticipate,” “should,” “plan,” “intend,” “estimate,” “project,” “will” or similar words. In addition, statements contained within this annual report that are not historical facts are forward-looking statements, such as statements discussing among other things, expected growth, store development and expansion strategy, business strategies, future revenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions, including, but not limited to, competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our ability to hire and retain qualified employees, risks associated with the integration of acquired businesses, weather, terrorist activities, war and the threat of war. Actual results may materially differ from anticipated results described or implied in these forward-looking statements. Please refer to the Risk Factors sections of the annual report on Form 10-K for the year ended December 31, 2005, for additional factors that could materially affect our financial performance. m a n a g e m e n t ’ s r e p o r t o n i n t e r n a l c o n t r o l o v e r f i n a n c i a l r e p o r t i n g The management of O’Reilly Automotive, Inc. and Subsidiaries (the Company), under the supervision and with the participation of our principal executive officer and principal financial officer, is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes all policies and procedures that: ■ pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; ■ provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and ■ provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to risk. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, we assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on our assessment, we believe that as of December 31, 2005, the Company’s internal control over financial reporting is effective based on those criteria. Ernst & Young LLP, Independent Registered Public Accounting Firm, has audited the Company’s consolidated financial statements has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting, as stated in their report which is included herein. Greg Henslee Chief Executive Officer & Co-President Jim Batten Executive Vice President of Finance & Chief Financial Officer 3 2 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T r e p o r t o f i n d e p e n d e n t r e g i s t e r e d p u b l i c a c c o u n t i n g f i r m t h e b o a r d o f d i r e c t o r s a n d s h a r e h o l d e r s o f o ’ r e i l l y a u t o m o t i v e , i n c . a n d s u b s i d i a r i e s We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that O’Reilly Automotive, Inc. and Subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). O’Reilly Automotive, Inc. and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that O’Reilly Automotive, Inc. and Subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, O’Reilly Automotive, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of O’Reilly Automotive, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005 of O’Reilly Automotive, Inc. and Subsidiaries and our report dated March 3, 2006 expressed an unqualified opinion thereon. Kansas City, Missouri March 3, 2006 3 3 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T c o n s o l i d a t e d b a l a n c e s h e e t s (In thousands, except per share data) december 31, assets Current assets: Cash and cash equivalents Accounts receivable, less allowance for doubtful Accounts of $2,778 in 2005 and $3,417 in 2004 Amounts receivable from vendors, net Inventory Other current assets Total current assets Property and equipment, at cost: Land Buildings Leasehold improvements Furniture, fixtures and equipment Vehicles Accumulated depreciation and amortization Net property and equipment Notes receivable, less current portion Other assets, net Total assets liabilities and shareholders’ equity Current liabilities: Income taxes payable Accounts payable Self insurance reserve Accrued payroll Accrued benefits and withholdings Deferred income taxes Other current liabilities Current portion of long-term debt Total current liabilities Long-term debt, less current portion Deferred income taxes Other liabilities Shareholders’ equity: Preferred stock, $0.01 par value: Authorized shares – 5,000,000 Issued and outstanding shares – none Common stock, $0.01 par value: Authorized shares – 245,000,000 Issued and outstanding shares – 112,389,002 in 2005 and 55,377,130 in 2004 Additional paid-in capital Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying notes. 3 4 2005 2004 $ 31,384 $ 69,028 73,849 57,224 726,390 21,808 910,655 109,327 368,996 127,685 310,570 76,321 992,899 274,533 718,366 24,051 60,827 60,928 52,976 625,320 5,225 813,477 82,781 278,752 108,144 257,890 64,227 791,794 224,301 567,493 21,690 29,697 $1,713,899 $ 1,432,357 $ - 292,667 34,797 19,356 14,997 2,451 46,100 75,313 485,681 25,461 42,516 14,472 $ 9,736 240,548 25,174 15,130 10,620 7,198 24,817 592 333,815 100,322 38,440 11,963 - - 1,124 360,325 784,320 1,145,769 $1,713,899 554 326,650 620,613 947,817 $ 1,432,357 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T c o n s o l i d a t e d s t a t e m e n t s o f i n c o m e (In thousands, except per share data) years ended december 31, Product sales Cost of goods sold, including warehouse and distribution expenses Gross profit Operating, selling, general and administrative expenses Operating income Other income (expense): Interest expense Interest income Other, net Total other income (expense) Income before income taxes and cumulative effect of accounting change Provision for income taxes Income before cumulative effect of accounting change Cumulative effect of accounting change, net of tax 2005 $2,045,318 1,152,815 892,503 639,979 252,524 (5,062) 1,582 2,025 (1,455) 251,069 86,803 164,266 - 2004 $1,721,241 2003 $1,511,816 978,076 743,165 552,707 190,458 (4,700) 901 1,078 (2,721) 187,737 70,063 117,674 21,892 873,481 638,335 473,060 165,275 (6,864) 298 1,333 (5,233) 160,042 59,955 100,087 - Net Income $ 164,266 $ 139,566 $ 100,087 Basic income per common share: Income before cumulative effect of accounting change Cumulative effect of accounting change Net income per common share Weighted-average common shares outstanding Income per common share—assuming dilution: Income before cumulative effect of accounting change Cumulative effect of accounting change Net income per common share-assuming dilution Adjusted weighted-average common shares outstanding See accompanying notes. $ 1.47 - $ 1.47 111,613 $ 1.45 - $ 1.45 113,385 $ 1.07 0.20 $ 1.27 110,020 $ 1.05 0.20 $1.25 111,423 $ $ $ $ 0.93 - 0.93 107,816 0.92 - 0.92 109,060 3 5 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T c o n s o l i d a t e d s t a t e m e n t s o f s h a r e h o l d e r s ’ e q u i t y (In thousands) balance at december 31, 2002 Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Net income balance at december 31, 2003 Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Net income balance at december 31, 2004 2-for-1 stock split Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Share based compensation Net income common stock shares par value additional paid-in capital retained earnings total 53,371 $ 534 $269,030 $380,960 $ 650,524 242 1,052 - - 2 11 - - 6,746 21,429 5,486 - - - - 100,087 6,748 21,440 5,486 100,087 54,665 $ 547 $302,691 $481,047 $ 784,285 221 491 - - 2 5 - - 8,358 11,075 4,526 - - - - 139,566 8,360 11,080 4,526 139,566 55,377 55,861 $ 554 559 $326,650 - $620,613 (559) $ 947,817 - 268 883 - - - 2 9 - - - 9,477 14,906 7,137 2,155 - - - - - 164,266 9,479 14,915 7,137 2,155 164,266 balance at december 31, 2005 112,389 $1,124 $360,325 $784,320 $1,145,769 See accompanying notes. 3 6 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T c o n s o l i d a t e d s t a t e m e n t s o f c a s h f l o w s 2005 2004 2003 $164,266 $139,566 $100,087 - 57,228 (671) 7,840 7,137 1,978 (8,974) (62,157) 43,158 3,517 213,322 (205,159) 1,935 4,558 (7,261) (63,145) (1) (269,073) - (602) 18,709 18,107 (37,644) 69,028 $ 31,384 (21,892) 54,325 7,640 5,067 4,526 2,988 (11,636) (66,375) 94,594 17,733 226,536 (173,486) 1,653 2,634 - - (2,787) (171,986) - (20,989) 14,373 (6,616) 47,934 21,094 $ 69,028 $ 55,140 4,960 - 42,374 13,796 4,026 5,486 2,197 (9,108) (19,652) 29,760 (130) 168,836 (136,497) 1,273 871 - - 3,793 (130,560) 27,900 (98,577) 24,162 (46,515) (8,239) 29,333 $ 21,094 $ 43,007 6,864 (In thousands) years ended december 31, operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of accounting change Depreciation and amortization Deferred income taxes Share based compensation programs Tax benefit of stock options exercised Other Changes in operating assets and liabilities: Accounts receivable Inventory Accounts payable Other Net cash provided by operating activities investing activities Purchases of property and equipment Proceeds from sale of property and equipment Payments received on notes receivable Advances made on notes receivable Acquisition, net of cash acquired (Investment in) reduction of other assets Net cash used in investing activities financing activities Proceeds from issuance of long-term debt Principal payments on long-term debt Net proceeds from issuance of common stock Net cash provided by (used in) financing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year supplemental disclosures of cash flow information: Income taxes paid Interest paid, net of capitalized interest $ 98,440 5,062 See accompanying notes. 3 7 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s n o t e 1 – s u m m a r y o f s i g n i f i c a n t a c c o u n t i n g p o l i c i e s Nature of Business O'Reilly Automotive, Inc. (the Company) is a specialty retailer and supplier of automotive aftermarket parts, tools, supplies and accessories to both the do-it-yourself (DIY) customer and the professional installer throughout Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Minnesota, Mississippi, Missouri, Montana, Nebraska, North Carolina, North Dakota, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Virginia, Wisconsin and Wyoming. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Revenue Recognition Over-the-counter retail sales are recorded when the customer takes possession of merchandise. Sales to professional installers, also referred to as “commercial sales,” are recorded upon delivery of merchandise to the customer, generally at the customer’s place of business. Wholesale sales to other retailers, also referred to as “jobber sales,” are recorded upon shipment of merchandise. All sales are recorded net of estimated allowances and discounts. Use of Estimates The preparation of the consolidated financial statements, in conformity with accounting principles generally accepted in the United States (GAAP), requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Cash Equivalents Cash equivalents consist of investments with maturities of 90 days or less at the day of purchase. Inventory Inventory, which consists of automotive hard parts, maintenance items, accessories and tools, is stated at the lower of cost or market. Inventory also includes related procurement, warehousing and distribution center costs. Cost has been determined using the last-in, first-out (LIFO) method. If the first-in, first-out (FIFO) method of costing inventory had been used by the Company, inventory would have been $738,877,000 and $628,309,000 as of December 31, 2005 and 2004, respectively. Please refer to Note 2 for cumulative effect of accounting change. Amounts Receivable from Vendors The Company receives concessions from its vendors through a variety of programs and arrangements, including co-operative advertising, devaluation programs, allowances for warranties and volume purchase rebates. Co-operative advertising allowances that are incremental to our advertising program, specific to a product or event and identifiable for accounting purposes are reported as a reduction of advertising expense in the period in which the advertising occurred. All other vendor concessions are recognized as a reduction of cost of sales when recognized in the consolidated income statement. Amounts receivable from vendors also includes amounts due to the Company for changeover merchandise and product returns. Reserves for uncollectible amounts receivable from vendors are provided for in the Company’s consolidated financial statements and consistently have been within management’s expectations. Property and Equipment Property and equipment are carried at cost. Depreciation is provided on a straight-line method over the estimated useful lives of the assets. Service lives for property and equipment generally range from three to thirty-nine years. Leasehold improvements are amortized over the lesser of the lease term or the estimated economic life of the assets. The lease term includes renewal options determined by management at lease inception for which failure to renew options would result in a substantial economic penalty to the Company. Maintenance and repairs are charged to expense as incurred. Upon retirement or sale, the cost and accumulated depreciation are eliminated and the gain or loss, if any, is included in the determination of net income as a component of other income (expense). The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. The Company capitalizes interest costs as a component of construction in progress, based on the weighted-average rates paid for long-term borrowings. Total interest costs capitalized for the years ended December 31, 2005, 2004 and 2003 were $2,885,000, $2,579,000 and $1,808,000, respectively. Leases The Company’s policy is to amortize leasehold improvements over the lesser of the lease term or the estimated economic life of those assets. Generally, for stores the lease term is the base lease term and for distribution centers the lease term includes the base lease term plus certain renewal option periods for which renewal is reasonably assured and failure to exercise the renewal option would result in an economic penalty. The calculation for 3 8 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) straight-line rent expense is based on the same lease term. Prior to 2003, leasehold improvements were amortized over a period of time which includ- ed both the base lease term and the first renewal option period of the lease and rent expense was recorded as paid. As a result, the Company’s 2004 statement of income includes an adjustment to correct its lease accounting of $10.4 million ($3.5 million related to 2004), $6.5 million, net of tax. Prior years’ financial statements were not restated due to the immateriality of the amount to the results of operations and statement of financial position for 2004 or any prior individual year. As the correction relates solely to accounting treatment, it did not affect the Company’s historical or future cash flows. The effect from these corrections, which is reflected in the financial statements, is an increase in depreciation expense in 2004 of $6.0 million ($2.6 million related to 2004), an increase in rent expense in 2004 of $4.4 million ($0.9 million related to 2004), and a decrease in income tax expense in 2004 of $3.9 million. Notes Receivable The Company had notes receivable from vendors and other third parties amounting to $28,950,000 and $25,108,000 at December 31, 2005 and 2004, respectively. The notes receivable, which bear interest at rates ranging from 0% to 10%, are due in varying amounts through August 2017. Goodwill The “Other assets, net” caption in the Consolidated Balance Sheets at December 31, 2005 and 2004 includes goodwill recorded as the result of previous acquisitions. Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets requires the Company to assess goodwill for impairment rather than systematically amortize goodwill against earnings. The goodwill impairment test compares the fair value of a reporting unit to its carrying amount, including goodwill. The Company operates as one reporting unit and its fair value exceeds its carrying value, including goodwill. Therefore, the Company has determined that no impairment of goodwill existed at December 31, 2005 and 2004. Self-Insurance Reserves The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation, general liability, vehicle liability, property loss, and employee health care benefits. With the exception of employee health care benefit liabilities, which are limited by the design of these plans, the Company obtains third-party insurance coverage to limit its exposure. The Company estimates our self-insurance liabilities by considering a number of factors, including historical claims experience and trend-lines, projected medical and legal inflation, and growth patterns and exposure forecasts. Income Taxes The Company accounts for income taxes using the liability method in accordance with Statement of Financial Accounting Standards (SFAS) No. 109. The liability method provides that deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using tax rates based on currently enacted rules and legislation and anticipated rates that will be in effect when the differences are expected to reverse. Advertising Costs The Company expenses advertising costs as incurred. Advertising expense charged to operations amounted to $28,715,000, $22,999,000 and $19,533,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Pre-opening Costs Costs associated with the opening of new stores, which consist primarily of payroll and occupancy costs, are charged to operations as incurred. Stock Option Plans The Company currently sponsors share-based employee benefit plans and stock option plans. Please see Notes 9 and 10 for further information concerning these plans. The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations in accounting for its employee stock options. Under the intrinsic value method in accordance with APB 25, because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, further established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. In the fourth quarter of 2005, the Board of Directors approved the accelerated vesting of all unvested stock options previously awarded to employees and executive officers. Option awards granted subsequent to the Board’s action are not included in the acceleration and will vest equally over the service period established in the award, typically four years. The primary purpose of the accelerated vesting was to enable the Company to avoid recognizing future compensation expense associated with these options upon the planned adoption of SFAS No. 123R, Share-Based Payment (SFAS 123R) by O’Reilly in 2006. As a result of the vesting acceleration, options to purchase approximately 4.2 million shares of O’Reilly Common Stock 3 9 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) became exercisable immediately. O’Reilly’s Board of Directors took this action with the belief that it is in the best interest of shareholders as it will reduce the Company’s reported non-cash compensation expense in future periods. In order to limit unintended personal benefits to employees and officers, the Board of Directors imposed restrictions on any shares received through the exercise of accelerated options held by those individuals. These restrictions prevent the sale of any stock obtained through exercise of an accelerated option prior to the earlier of the original vesting date or the individual’s termination of employment. The Company recorded pre-tax stock-based compensation expense of $2.2 million in 2005 based on the intrinsic value of in-the-money options subject to acceleration and the Company’s estimate of awards that would have expired unexercisable absent the acceleration. The pro forma table below includes the compensation expense related to the acceleration of the unamortized portion of unvested stock options. The significant increase in stock based compensation expense under the fair value method is primarily due to the compensation expense related to the acceleration. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. During the fourth quarter of 2004, the Company changed its method of applying its LIFO accounting policy for inventory costs (see Note 2 – Accounting Changes). Our stock compensation pro forma information for the years ended December 31, is as follows, both excluding and including the effects of the inventory accounting change: (In thousands, except per share data) Excluding inventory accounting change Net income, as reported Add stock-based compensation expense, net of tax, as reported Deduct stock-based compensation expense, net of tax, under fair value method Pro forma net income Pro forma basic net income per share Pro forma net income per share–assuming dilution Net income per share, as reported Basic Assuming dilution Including inventory accounting change Net income Add stock-based compensation expense, net of tax, as reported Deduct stock-based compensation expense, net of tax, under fair value method Pro forma net income Pro forma basic net income per share Pro forma net income per share– assuming dilution 2005 $164,266 1,355 (22,178) $143,443 $ 1.29 $ 1.27 $ 1.47 $ 1.45 N/A N/A N/A N/A N/A N/A 2004 2003 $139,566 $100,087 - - (7,468) $132,098 $ 1.20 $ 1.19 $ 1.27 $ 1.25 N/A N/A N/A N/A N/A N/A (9,204) $ 90,883 $ 0.84 $ 0.83 $ 0.93 $ 0.92 $100,599 - (9,204) $ 91,395 $0.85 $ 0.84 The fair values for options were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2005, 2004, and 2003, respectively: risk-free interest rates of 4.25%, 3.01% and 3.61%; volatility factors of the expected market price of the Company's common stock of .358, .404, and .458; and expected life of the options of 4.0, 4.0 and 9.4 years. The Company assumed a 0% dividend yield over the expected life of the options. The weighted-average fair values of options granted during the years ended December 31, 2005, 2004, and 2003 were $8.82, $14.47 and $20.56, respectively. Earnings per Share Basic earnings per share is based on the weighted-average outstanding common shares. Diluted earnings per share is based on the weighted-average outstanding shares adjusted for the effect of common stock equivalents. Common stock equivalents that could potentially dilute basic earnings per share in the future that were not included in the fully diluted computation because they would have been antidilutive were 226,750, 544,000 and 133,500 for the years ended December 31, 2005, 2004 and 2003, respectively. 4 0 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) Concentration of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, accounts receivable and notes receivable. The Company grants credit to certain customers who meet the Company's pre-established credit requirements. Concentrations of credit risk with respect to these receivables are limited because the Company’s customer base consists of a large number of smaller customers, thus spreading the credit risk. The Company controls credit risk through credit approvals, credit limits and monitoring procedures. Generally, the Company does not require security when credit is granted to customers. Credit losses are provided for in the Company's consolidated financial statements and consistently have been within management's expectations. The carrying value of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and long-term debt, as reported in the accompanying consolidated balance sheets, approximates fair value. New Accounting Pronouncements In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. The standard is effective for fiscal years beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on it’s financial position, results of operations or cash flows. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. SFAS No. 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows. In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R is a revision of SFAS No. 123, Accounting for Stock Based Compensation, and supersedes APB No. 25, Accounting for Stock Issued to Employees. Among other items, SFAS No. 123R eliminates the use of APB No. 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. SFAS No. 123R also requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date. These future amounts cannot be estimated, because they depend on, among other things, when employees exercise stock options. However, the amount of operating cash flows recognized in prior periods for such tax deductions, as shown in the accompanying Consolidated Statements of Cash Flows were $7.1 million, $4.5 million, and $5.5 million, for the years ended December 31, 2005, 2004, and 2003, respectively. The effective date of SFAS 123R is the first reporting period of the first fiscal year beginning on or after June 15, 2005, which is first quarter 2006 for calendar year companies, such as the Company, although early adoption is allowed. The Company intends to adopt SFAS No. 123R beginning with the first quarter of 2006 using the “modified prospective” method under which compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS No. 123R for all share-based payments granted after that date, and based on the requirements of SFAS No. 123 for all unvested awards granted prior to the effective date of SFAS No. 123R. In the fourth quarter of 2005, the Board of Directors approved the accelerated vesting of all unvested stock options previously awarded to employees and executive officers. As a result, the pro forma impact to net income and net income per share under SFAS No. 123’s fair value method of accounting as reflected above is not indicative of future annual expense to be recognized under SFAS No. 123R. To the extent that the Company grants stock options in the future, the associated expense for these awards under the provisions of SFAS No. 123R may have a material impact on the Company’s consolidated financial statements. Based upon anticipated levels of share-based awards, the Company estimates this impact to be approximately $2 million or $0.02 per diluted share for 2006. See Note 10 for further information on our stock-based compensation plans. n o t e 2 – a c c o u n t i n g c h a n g e s The Company’s inventory consists of automotive hard parts, maintenance items, accessories and tools. During the fourth quarter of 2004, the Company changed its method of applying its LIFO accounting policy for inventory costs. Under the new method, the Company has inventoried certain procurement, warehousing and distribution center costs. The Company’s previous method was to recognize those costs as incurred, reported as a component of costs of goods sold. The Company believes the change in application of the LIFO accounting method is preferable as it better matches revenues and expenses and is the prevalent method used by other entities within the Company’s industry. The cumulative effect of this change in application of accounting method was $21,892,000 as of January 1, 2004, net of the related deferred tax effect of $13,303,000. The change increased 2004 net income by $2,722,000 or $0.02 per share. Pro forma changes to results of operations as if the new method had been applied for the year ended December 31, 2003 are presented as follows. 4 1 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) year ended december 31, (in thousands) Product sales Cost of goods sold, including warehouse and distribution expense Operating, selling, general and administrative expenses Operating income Other expense, net Income before income taxes Provision for income taxes Net income Basic income per share Net income per share – assuming dilution Weighted-average common shares outstanding Weighted-average common shares outstanding–assuming dilution as originally reported 2003 $1,511,816 pro forma adjustment $ - 873,481 473,060 165,275 (5,233) 160,042 59,955 $ 100,087 $ $ 0.93 0.92 107,816 109,060 (823) - 823 - 823 311 $ 512 $ 0.00 $ 0.00 107,816 109,060 2003 $1,511,816 872,658 473,060 166,098 (5,233) 160,865 60,266 $ 100,599 $ 0.93 $ 0.92 107,816 109,060 n o t e 3 – a c q u i s i t i o n On May 31, 2005, the Company purchased all of the outstanding stock of W.E. Lahr Company and its subsidiary, Midwest Auto Parts Distributors, Inc. and combined affiliates (“Midwest”) for approximately $63 million cash, net of cash acquired, including acquisition costs. Midwest was a specialty retailer, which supplied automotive aftermarket parts in Minnesota, Montana, North Dakota, South Dakota, Wisconsin and Wyoming. The acquisition was accounted for using the purchase method of accounting, and accordingly, the results of operations of Midwest are included in the consolidated statements of income from the date of acquisition. The purchase price was allocated preliminarily to assets acquired and liabilities assumed based on their estimated fair values on the date of acquisition with the excess allocated to goodwill. The acquisition of Midwest was not material for pro forma presentation requirements. n o t e 4 – s t o c k s p l i t On May 20, 2005, the Company’s Board of Directors declared a two-for-one stock split that was effected in the form of a 100% stock dividend payable to all shareholders of record as of May 31, 2005. The stock dividend was paid on June 15, 2005. Accordingly, this stock split has been recognized by reclassifying $559,000, the par value of the additional shares resulting from the split, from retained earnings to common stock. All share and per share information included in the accompanying consolidated financial statements has been restated to reflect the retroactive effect of the stock split for all periods presented. n o t e 5 – r e l a t e d p a r t i e s The Company leases certain land and buildings related to forty-nine of its O'Reilly Auto Parts stores under six-year operating lease agreements with O'Reilly Investment Company and O'Reilly Real Estate Company, partnerships in which certain shareholders and directors of the Company are partners. Generally, these lease agreements provide for renewal options for an additional six years at the option of the Company and the lease agreements are periodically modified to further extend the lease term for specific stores under the agreement. Additionally, the Company leases certain land and buildings related to twenty-one of its O’Reilly Auto Parts stores under 15-year operating lease agreements with O’Reilly-Wooten 2000 LLC, which is owned by certain shareholders and directors of the Company. Generally, these lease agreements provide for renewal options for two additional five-year terms at the option of the Company (see Note 7). Rent payments under these operating leases totaled $3,380,000, $3,374,000 and $3,238,000 in 2005, 2004 and 2003, respectively. n o t e 6 – l o n g - t e r m d e b t On July 29, 2005, the Company amended the unsecured, five-year syndicated credit facility (Credit Facility) in the amount of $100 million led by Wells Fargo Bank as the Administrative Agent, replacing a three-year $150 million syndicated credit facility. The Credit Facility is guaranteed by all of the Company’s subsidiaries and may be increased to a total of $200 million, subject to the availability of such additional credit from either existing banks within the Credit Facility or other banks. The Credit Facility bears interest at LIBOR plus a spread ranging from 0.50% to 1.0% (4.86% at December 31, 2005) and expires in July 2010. At December 31, 2005 and 2004, the Company had no outstanding balance with the Credit Facility. The Company’s aggregate availability for additional borrowings under the Credit Facility was $70.7 million and $128.7 million at December 31, 2005 and 2004, respectively. 4 2 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) The Company issues stand-by letters of credit provided by a $50 million sublimit under the Credit Facility that reduce available borrowings. These letters of credit are issued primarily to satisfy the requirements of workers compensation, general liability and other insurance policies. Substantially all of the outstanding letters of credit have a one-year term from the date of issuance and have been issued to replace surety bonds that were previously issued. Letters of credit totaling $29.3 million and $21.3 million were outstanding at December 31, 2005 and 2004, respectively. On May 16, 2001, the Company completed a $100 million private placement of two series of unsecured senior notes (Senior Notes). The Series 2001-A Senior Notes were issued for $75 million, are due May 16, 2006 and bear interest at 7.72% per year. The Series 2001-B Senior Notes were issued for $25 million, are due May 16, 2008 and bear interest at 7.92% per year. The private placement agreement allows for a total of $200 million of Senior Notes issuable in series. Proceeds from the transaction were used to reduce outstanding borrowings under the Company’s former revolving credit facility. The Company leases certain computer equipment under a capitalized lease. The lease agreement has a term of 30 months, expiring in 2006. At December 31, 2005, the monthly installment under this agreement was approximately $48,500. The present value of the future minimum lease payments under these agreements totaled $285,000 and $858,000 at December 31, 2005 and 2004, respectively, which has been classified as current portion of long-term debt in the accompanying consolidated financial statements. During 2005 and 2004, the Company did not purchase any assets under a capitalized lease. Principal maturities of long-term debt are as follows: (amounts in thousands) 2006 2007 2008 2009 2010 Thereafter principal maturities of long-term debt $ 75,313 31 25,019 16 17 378 $100,774 n o t e 7 – c o m m i t m e n t s Lease Commitments On June 26, 2003, we completed an amended and restated master agreement to our $50 million Synthetic Operating Lease Facility (the Facility or the Synthetic Lease) with a group of financial institutions. The terms of the Facility provide for an initial lease period of five years, a residual value guarantee of approximately $42.2 million at December 31, 2005, and purchase options on the properties. The Facility also contains a provision for an event of default whereby the lessor, among other things, may require us to purchase any or all of the properties. One additional renewal period of five years may be requested from the lessor, although the lessor is not obligated to grant such renewal. The amended and restated Facility has been accounted for as an operating lease under SFAS No. 13 and related interpretations, including FASB Interpretation No. 46. Future minimum rental commitments under the Facility have been included in the table of future minimum annual rental commitments below. The Company also leases certain office space, retail stores, property and equipment under long-term, non-cancelable operating leases. Most of these leases include renewal options and some include options to purchase and provisions for percentage rent based on sales. At December 31, 2005, future minimum rental payments under all of the Company’s operating leases for each of the next five years and in the aggregate are as follows: (amounts in thousands) 2006 2007 2008 2009 2010 Thereafter related parties $ 3,349 3,351 3,277 2,480 1,678 6,462 $20,597 non-related parties $ 38,902 35,359 31,568 27,564 23,515 162,180 $319,088 total $ 42,251 38,710 34,845 30,044 25,193 168,642 $339,685 Rental expense amounted to $43,047,000, $39,145,000 and $31,865,000 for the years ended December 31, 2005, 2004, and 2003, respectively. 2004 rental expense includes an adjustment to correct lease accounting in the amount of $4,367,000 ($900,000 related to 2004.) See Note 1 – Leases for further details. Other Commitments The Company had construction commitments, which totaled approximately $57.5 million, at December 31, 2005. 4 3 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) n o t e 8 – l e g a l p r o c e e d i n g s The Company is involved in various legal proceedings incidental to the ordinary conduct of its business. Although the Company cannot ascertain the amount of liability that it may incur from any of these matters, it does not currently believe that, in the aggregate, these matters will have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company. n o t e 9 – e m p l o y e e b e n e f i t p l a n s The Company sponsors a contributory profit sharing and savings plan that covers substantially all employees who are 21 years of age with at least six months of service. A total of 3,200,000 shares of common stock were reserved for issuance under the plan. Employees may contribute up to 100% of their annual compensation subject to Internal Revenue Code maximum limitations. The Company has agreed to make matching contributions equal to 50% of the first 2% of each employee's contribution and 25% of the next 4% of each employee's contribution. Additional contributions to the plan may be made as determined annually by the Board of Directors. After two years of service, Company contributions and earnings thereon vest at the rate of 20% per year. Company contributions charged to operations amounted to $6,606,000 in 2005, $5,278,000 in 2004 and $4,353,000 in 2003. Company contributions, in the form of common stock, to the profit sharing and savings plan to match employee contributions during the years ended December 31 were as follows: year contributed 2005 2004 2003 value shares 71,125 81,368 84,366 market $1,928,000 1,766,000 1,478,000 Profit sharing contributions accrued at December 31, and funded in the next year through the issuance of shares of the Company's common stock were as follows: year funded 2005 2004 2003 value shares 139,336 157,460 170,368 market $3,500,000 3,000,000 2,300,000 Additionally, the Company has adopted a stock purchase plan under which 2,600,000 shares of common stock were reserved for issuance. Under the plan, substantially all employees and non-employee directors have the right to purchase shares of the Company's common stock monthly at a price equal to 85% of the fair market value of the stock, not to exceed 5% of the participants annual salary. Purchases of common stock under the plan during the years ended December 31 were as follows: year 2005 2004 2003 shares 161,903 187,754 206,914 weighted average fair value $27.57 20.85 16.19 market value $4,464,000 3,915,000 3,350,000 The Company has in effect a performance incentive plan for the Company's senior management under which 800,000 shares of stock were reserved for issuance. Shares awarded under the plan vest equally over a three-year period and are held in escrow until such vesting has occurred. Shares are forfeited when an employee ceases employment. Shares, net of forfeitures, issued under the plan during the years ended December 31 were as follows: year funded 2005 2004 2003 value shares 14,986 15,834 21,060 market $381,000 302,000 248,000 n o t e 1 0 – s h a r e h o l d e r s ’ e q u i t y Shareholder Rights Plan On May 17, 2002, the Board of Directors adopted a Shareholder Rights Plan. One Right was distributed for each share of common stock, par value $.01 per share, of the Company held by stockholders of record as of the close of business on May 31, 2002. The Rights initially entitle stockholders to buy a unit representing one one-hundredth of a share of a new series of preferred stock of the Company for $160 and expire on May 30, 2012. The Rights generally will be exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's common stock or commences 4 4 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) a tender or exchange offer upon consummation of which such person or group would beneficially own 15% or more of the Company's common stock. If a person or group acquires beneficial ownership of 15% or more of the Company's common stock, each Right (other than Rights held by the acquiror) will, unless the Rights are redeemed by the Company, become exercisable upon payment of the exercise price of $160 for common stock of the Company having a market value of twice the exercise price of the Right. A copy of the Stockholder Rights Plan was filed on May 28, 2002, with the Securities and Exchange Commission, as Exhibit 99.1 to our report on Form 8-K. Stock Option Plans The Company has a stock option plan under which incentive stock options or non-qualified stock options may be granted to officers and key employees. An aggregate of 24,000,000 shares of common stock were reserved for issuance under this plan. The exercise price of options granted shall not be less than the fair market value of the stock on the date of grant and the options will expire no later than 10 years from the date of grant. Generally, options granted pursuant to the plan become exercisable no sooner than six months from the date of grant. See Note 1 for a discussion of the 2005 acceleration of vesting related to our stock option plans. All grants under the plan since its inception have been non-qualified stock option grants. A summary of outstanding stock options under this plan is as follows: Outstanding at December 31, 2002 Granted Exercised Canceled Outstanding at December 31, 2003 Granted Exercised Canceled Outstanding at December 31, 2004 Granted Exercised Canceled Outstanding at December 31, 2005 of shares price per share $ 4.47 - 18.81 11.51 - 22.41 4.47 - 18.81 4.47 - 19.49 $ 5.28 - 22.41 $18.53 - 23.38 5.28 - 20.20 5.47 - 23.15 $ 5.47 - 23.38 22.18 - 32.08 5.47 - 23.38 6.97 - 32.08 $ 6.03 - 32.08 number 6,981,404 2,071,500 (2,103,880) (444,826) 6,504,198 1,716,250 (941,954) (478,228) 6,800,266 1,933,500 (1,202,012) (648,712) 6,883,042 Options to purchase 6,770,042, 3,225,200 and 2,446,818 shares of common stock were exercisable at December 31, 2005, 2004 and 2003, respectively. The Company also maintains a stock option plan for non-employee directors of the Company under which 1,000,000 shares of common stock were reserved for issuance. All director stock options are granted at fair market value on the date of grant and expire on the earlier of termination of service to the Company as a director or seven years. Options granted under this plan become exercisable six months from the date of grant. A summary of outstanding stock options under this plan is as follows: Outstanding at December 31, 2002 Granted Outstanding at December 31, 2003 Granted Exercised Outstanding at December 31, 2004 Granted Exercised Outstanding at December 31, 2005 of shares price per share $ 6.22 - 14.51 14.60 $ 6.22 - 14.60 20.84 6.22 - 10.33 $10.33 - 20.84 23.50 14.51 $10.33 - 23.50 number 160,000 60,000 220,000 25,000 (40,000) 205,000 25,000 (40,000) 190,000 All options under this plan were exercisable at December 31, 2005, 2004 and 2003. The weighted-average remaining contractual life at December 31, 2005, for all outstanding options under the Company's stock option plans is 7.1 years. The weighted-average exercise price for all outstanding options under the Company's stock option plans was $17.67, $14.94 and $13.06 at December 31, 2005, 2004 and 2003, respectively. 4 5 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) n o t e 1 1 – i n c o m e p e r c o m m o n s h a r e The following table sets forth the computation of basic and diluted income per common share: (In thousands, except per share data) years ended december 31, Numerator (basic and diluted): Net income Denominator: Denominator for basic income per common share- weighted-average shares Effect of stock options (Note 10) Denominator for diluted income per common share- adjusted weighted-average shares and assumed conversion Basic net income per common share Net income per common share-assuming dilution 2005 $164,266 111,613 1,772 113,385 $ 1.47 $ 1.45 2004 $139,566 110,020 1,403 111,423 $ 1.27 $ 1.25 2003 $100,087 107,816 1,244 109,060 $ 0.93 $ 0.92 n o t e 1 2 – i n c o m e t a x e s Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows at December 31: (In thousands) Deferred tax assets: Current: Allowance for doubtful accounts Other accruals Noncurrent: Other accruals Total deferred tax assets Deferred tax liabilities: Current: Inventory carrying value Noncurrent: Property and equipment Other Total deferred tax liabilities Net deferred tax liabilities The provision for income taxes consists of the following: (In thousands) 2005: Federal State 2004: Federal State 2003: Federal State 2004 2005 $ 1,050 17,601 10,038 2,404 21,055 21,102 42,255 2,665 66,022 $ 1,292 1,980 13,310 18,528 39,203 1,217 58,948 $(44,967) $(45,638) current deferred $ (616) (55) $ (671) $ 6,942 698 $ 7,640 $12,362 1,434 $13,796 $79,720 7,754 $87,474 $56,385 6,038 $62,423 $41,465 4,694 $46,159 4 6 total $79,104 7,699 $86,803 $63,327 6,736 $70,063 $53,827 6,128 $59,955 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s (continued) A reconciliation of the provision for income taxes to the amounts computed at the federal statutory rate is as follows: (In thousands) Federal income taxes at statutory rate State income taxes, net of federal tax benefit Other items, net 2005 $87,874 4,986 (6,057) $86,803 2004 $65,708 4,355 - $70,063 2003 $56,015 3,935 5 $59,955 The Company's provision for income taxes for the third quarter of 2005 included a non-cash tax adjustment of $6.1 million in the quarter resulting from the favorable resolution of prior tax uncertainties. The tax benefit realized in the third quarter is nonrecurring and reflects the reversal of previously recorded income tax reserves related to a prior acquisition. In determining the quarterly provision for income taxes, the Company uses an estimated annual effective tax rate based on expected annual income by jurisdiction and statutory tax rates. The impact of significant discrete items, including the tax benefit realized in the third quarter of 2005, is separately recognized in the quarter in which they occur. The tax benefit associated with the exercise of non-qualified stock options has been reflected as additional paid-in capital in the accompanying consolidated financial statements. 4 7 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T r e p o r t o f i n d e p e n d e n t r e g i s t e r e d p u b l i c a c c o u n t i n g f i r m t h e b o a r d o f d i r e c t o r s a n d s h a r e h o l d e r s o f o ’ r e i l l y a u t o m o t i v e , i n c . a n d s u b s i d i a r i e s We have audited the accompanying consolidated balance sheets of O’Reilly Automotive, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of O’Reilly Automotive, Inc. and Subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, in 2004 the Company changed its method of accounting for inventory. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of O’Reilly Automotive, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2006 expressed an unqualified opinion thereon. Kansas City, Missouri March 3, 2006 4 8 Chub O'Reilly Chairman of the Board of Emeritus David O'Reilly Chairman of the Board of Directors Paul Lederer Director Audit Committee Compensation Committee O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T d i r e c t o r s a n d e x e c u t i v e c o m m i t t e e Jeff Shaw Senior Vice President of Store Operations and Sales Mike Swearengin Senior Vice President of Merchandise John Murphy Director Audit Committee Chairman Corporate Governance and Tricia Headley Vice President and Corporate Secretary Nomination Committee Ronald Rashkow Director Audit Committee Compensation Committee Greg Henslee Chief Executive Officer and Co-President Ted Wise Chief Operating Officer and Co-President Jim Batten Executive Vice President of Finance and Chief Financial Officer David McCready Senior Vice President of Distribution Tony Bartholomew Vice President of Sales Greg Beck Vice President of Purchasing Ron Byerly Vice President of Marketing, Advertising and Training Ken Cope Vice President of Eastern Division Charlie Downs Vice President of Real Estate Alan Fears Vice President of Store Expansion and Acquisitions o p e r a t i o n s m a n a g e m e n t Keith Childers Director of Little Rock Region Doug Hopkins Director of Distribution Systems Tom Connor Regional DC Director Jack House Director of Customer Services Joe Edwards Director of Store Installations Brad Knight Director of Pricing Phyllis Evans Director of Store Operations Jason Frizzell Director of Knoxville Region David Glore Director of Ozark Sales John Krebs Director of Gulf States Region Terry Lee Director of Midwest Region Dave Leonhart Regional DC Director John Grassham Director of St. Louis Region Herb Lohse General Manager Midwest Jobber Julie Gray Director of Corporate Services Kenny Martin Director of Indianoplis Region Jaime Hinojosa Vice President of Southern Division Steve Jasinski Vice President of Information Systems Greg Johnson Vice President of Distribution Randy Johnson Vice President of Store Inventories Michelle Kimrey Vice President of Finance Steve Pope Vice President of Human Resources Wayne Price Vice President of Risk Management Barry Sabor Vice President of Loss Prevention Phillip Thompson Vice President of Human Resources Mike Williams Vice President of Advanced Technology Shari Reaves Director of Compensation and Benefits Steve Rice Director of Credit and Collections Art Rodriguez Director of Southern Division Sales Rick Samsel Director of Inventory Control Tom Seboldt Director of Merchandise Denny Smith Director of Springfield Region Dick Smith Director of Construction Mark Smith Director of Dallas Region Charlie Stallcup Director of Training Ron Greenway Director of Tax Jeff Groves Director of Legal and Claims Servies Joe Hankins Director of Store Design Billy Harris Director of Iowa and Nebraska Region 4 9 Jim Maynard Director of Employment and Team Member Relations Brad Oplotnik Director of Systems Management David Strom Sr Director of Houston Region Kevin Overmon Director of Nashville Region Bert Tamez Director of Valley Region Greg Pelkey Director of Store Development David Turney Director of Internal Audit Mike Chapman Director of West Texas Region Brett Heintz Director of Retail Systems Ed Randall Director of Property Management Charlie O'Reilly Vice Chairman of the Board of Directors Larry O'Reilly Vice Chairman of the Board of Directors Rosalie O'Reilly-Wooten Director Jay Burchfield Director Compensation Committee Chairman Corporate Governance and Nominating Committee Joe Greene Director Corporate Governance and Nominating Committee Chairman senior management Jeanene Asher Director of Telecommunications Buddy Ball Director of Kansas City Region Mike Ballard Director of Internet Development and Networking Emmitt Barina Director of Safety and Environmental Regulations Brad Beckham Director of Atlanta East Region Steve Beil Director of Atlanta West Region Bert Bentley Director of Houston Region David Bock Director of Bumper to Bumper Marketing Rob Bodenhamer Director of Technology Development Larry Boevers Regional DC Director Doug Bragg Director of Oklahoma Region O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T o p e r a t i o n s m a n a g e m e n t (continued) Tamra Waitman Director of Accounting Sean Dando Regional Field Sales Manager David Hawker Regional Field Sales Manager Jeff McKinney Customer Satisfaction Manager Jeff Watts Director of Eastern Division Sales Cecil Davis DC Inbound Operations Manager Troy Hellerud Central Support Manager Mindy Morgan Team Member Relations Manager Saundra Wilkinson Director of Store Administration Mark Decker Distribution Center Manager Doy Hensley Computer Help Support Manager Asa Nelson Distribution Center Manager Wes Wise Director of Marketing Randy Decoito Regional Field Sales Manager Rubin Herrera Regional Field Sales Manager Chapman Norman Inventory Maintenance Manager corporate management Ray Aguirre Regional Field Sales Manager Curt Allen Real Estate Site Acquisition Manager Tom Allen Computer Operations Manager Dan Altis Distribution Center Manager Mark Alwardt Division Loss Prevention Manager Keith Asby Sales Manager of Special Markets Gary Baker Technical Assistance Manager Carl Barina Regional Field Sales Manager Doug Bennett O'Reilly Sales Department Manager Ron Biegay Southern Division Training and Recruiting Manager Larry Blundell Regional Field Sales Manager Tom Bollinger Regional Field Sales Manager Marcus Boyer Distribution Center Manager Kent Brewer DC Transportation Manager Brian Callis Regional Field Sales Manager Yvonne Cannon Payroll Manager Stephen Carlson Jobber Systems Sales Manager Mark Chambers Regional Field Sales Manager Tim Cordell Regional Field Sales Manager Bruce Creason DC Safety Manager Garry Curbow Replenishment Manager William Dempster Distribution Center Manager Jay Enloe Risk and Insurance Manager Nancy Evans DC Administrative Services Manager Paula Eyman Special Projects Manager Carl Falke Regional Field Sales Manager Becky Fincher Advertising Manager Jeremy Fletcher Financial Reporting and Budgeting Manager Kevin Ford DC Projects and Procedures Manager Randy Freund Regional Field Sales Manager David Furr Service Equipment Sales Manager Lori Fuzzell Customer Service Manager Jaydee Garrison Regional Field Sales Manager Bob Gillespie Store Safety Manager Art Glidewell Distribution Center Manager Garry Glossip Payroll Manager Michael Granberg PBE Field Sales Manager Larry Gray Distribution Center Manager Robert Greene Real Estate Contract Administrator Manager Kevin Greven Motorsports Manager Bridget Harmon PC Support Manager Mike Hauk Division Training Manager Diana Hicks Internal Communications Manager James Owens Regional Field Sales Manager Jim Hoover Regional Field Sales Manager David Hunsucker Catalog Department Manager Doug Hutchison Inventory Project Manager Karen James Marketing Production Manager Curtis Johnson Jobber Regional Field Sales Manager Dave Jordan Distribution Center Manager Les Keeth Accounts Payable Manager Jennifer Kent Store Design Manager Bryan Packer Jobber Computer Sales and Services Manager Wendi Page Real Estate Property Manager Steve Peterie Construction Design Manager Tony Phelps Distribution Center Manager Steve Phillips Division Loss Prevention Manager Paul Pike Regional Field Sales Manager Lyn Robertson Accounts Receivable Manager Corey Robinson Inventory Accounting Manager Duane Keys Application Development Manager Chuck Rogers Installer Systems Manager Marcus Kilmer Installer Marketing Manager James Samson Distribution Center Manager Gus Krafve Investor Relations Manager Tim Scholl DC Field Projects Manager Scott Kraus Regional Field Sales Manager Joyce Schultz Houston Office Manager Steve Lines Sales Training Manager Jim Litchford Jobber Regional Field Sales Manager Robert Long Retail Marketing Manager James Lovelace Regional Field Sales Manager Jeff Main Jobber Systems Sales Manager Richard Mann Distribution Center Manager Harry Marcley Distribution Center Manager Ed Martinez Distribution Center Manager William Seiber Distribution Center Manager Darren Shaw Product Manager II Garry Shelby Regional Field Sales Manager Craig Smith Real Estate Contract Manager Phil Smith Eastern Division Loss Prevention Manager Tim Smith Credit Manager Tom Smith Training Manager Dave Steinle Application Development Manager Carla McElveen New Store Inventory Manager Mary Stratton Human Resources Records Manager 5 0 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T o p e r a t i o n s m a n a g e m e n t (continued) Camille Strickland Real Estate Contract Manager Darin Venosdel Application Development Manager Matt Weldon PBE Field Sales Manager Terry Yates Regional Field Sales Manager Robert Suter Product Manager II Dallas Thompson Real Estate Site Acquisition Manager Arnulfo Vega Regional Field Sales Manager Rob Verch Product Manager II Patton Walden Midstate Division Training Manager Scotty Weidman Product Manager II Larry Wiles Audio/Video Communications Manager Karla Williams Application Development Manager Joe Winteberg Product Manager II Mike Young Retail Facilities Manager district corporate management Abel Abila Doug Adams David Adams Jr Eddie Allen Conrad Alvidrez Henry Armington Brince Beasley Aaron Biggs Kirk Bilski Mic Bowers Eric Bowman Randy Brewer Lester Brown Patrick Brown Mark Cannon Donnie Carden Fred Carrington Jimmy Carter Jody Carter David Chavis Dirk Chester Jim Dickens Robert Doss Bruce Dowell Dan Dowell Skip Dull Robert Dumas Tommy Dunn Mike Eckelkamp Judy Ellington Paul Engaldo Ron England Tony Fagan Bill Fellows Kirk Frazier Mark Frazier Chad Gagnelius Butch Galloway Samuel Garza Dennis Gonzales John Gouette Daniel Grandquest Dan Griffin Tony Haag Chris Harrelson James Harris Jon Haught Rick Hedges Gerry Hendrix Ed Hernandez Perry Hess Matt Hill Mike Hollis Terry Horrisberger Craig Hudgens Clint Hunter Johnny Jarvis Jeff Jennings Chuck Kaiser Justin Kale Chad Keel Butch Kelton Todd Kemper Troy King Rick Koehn Greg Lair Mark Langrehr Scott Leonhart Chris Lewis Greg Locker Kirk Locklin Oliverio Lopez Mark Mach John Martinez Tommy Mason Rodger McClary Clint McFadden Marc McGehee Chris Meade Curt Miles Jack Miller Andy Moore Don Morgan Trey Morgan Randy Morris Ciro Moya Jr Ramon Odems Ken Omland Ron Papay Jude Patterson Gilbert Perez Pernell Peters David Pilat Randy Pilcher Brent Pizzolato Mike Platt Jeffrey Swanson Alan Sweeton Jeff Tagert Randy Tanner Rick Tearney Justin Tracy Jim Turvey Mark Van Hoecke Andy Velez Fred Wadle Bo Waldrop Terry Walker Brett Warstler John Weatherly Rob Weiskirch John Wells Terry White John Winburn Allen Wise Dexter Woods Cody Zimmerman Troy Polston Robert Poynor James Ramsey Will Reger Christopher Reynolds Tommy Rhoads Alan Riddle Edward Robles Larry Roof Juan Salinas Matt Schlueter Mike Schroeder Jim Scott Steven Severe Kevin Shockey Frank Silvas Eric Sims Bob Snodgrass Robert Spencer Wayne Spratlin Thomas Stack Dennis Streitenberger Marvin Swaim Randy Swaim 5 1 O ’ R E I L L Y A U T O M O T I V E 2 0 0 5 A N N U A L R E P O R T s h a r e h o l d e r i n f o r m a t i o n c o r p o r a t e a d d r e s s 233 South Patterson Springfield, Missouri 65802 417/862-3333 Web site – www.oreillyauto.com r e g i s t r a r a n d t r a n s f e r a g e n t UMB Bank 928 Grand Boulevard Kansas City, Missouri 64141-0064 Inquiries regarding stock transfers, lost certificates or address changes should be directed to UMB Bank at the above address. i n d e p e n d e n t a u d i t o r s Ernst & Young LLP One Kansas City Place Kansas City, Missouri 64105-2143 l e g a l c o u n s e l Gallop Johnson & Neuman, L.C. 101 South Hanley Road, Suite 1600 St. Louis, Missouri 63105 Greensfelder, Hemker & Gale, P.C. 10 South Broadway, Suite 2000 St. Louis, Missouri 63102 a n n u a l m e e t i n g The annual meeting of shareholders of O’Reilly Automotive, Inc. will be held at 10:00 a.m. local time on May 9, 2006, at the Clarion Hotel, Ballrooms 1 and 2, 3333 South Glenstone Ave in Springfield, Missouri. Shareholders of record as of February 28, 2006, will be entitled to vote at this meeting. f o r m 1 0 - k r e p o r t The Form 10-K Report of O’Reilly Automotive, Inc. filed with the Securities and Exchange Commission and our quarterly press releases are available without charge to shareholders upon written request. These requests and other investor contacts should be directed to James R. Batten, Executive Vice President of Finance/Chief Financial Officer, at the corporate address. t r a d i n g s y m b o l The Company’s common stock is traded on The Nasdaq Stock Market (National Market) under the symbol ORLY. n u m b e r o f s h a r e h o l d e r s As of February 28, 2006, O’Reilly Automotive, Inc. had approximately 35,589 shareholders based on the number of holders of record and an estimate of the number of individual participants represented by security position listings. a n a l y s t c o v e r a g e The following analysts provide research coverage of O’Reilly Automotive, Inc.: AG Edwards & Sons – Brian Postol BB&T - Anthony Cristello Citigroup – Bill Sims Credit Suisse First Boston – Gary Balter Deutsche Bank Securities Inc. – Michael Baker Friedman, Billings, Ramsey & Co – Jeff Sonnek Goldman Sachs Research – Matthew Fassler Harris Nesbitt Corp – Richard Weinhart Kevin Dann & Partners – Cid Wilson Lehman Brothers Equities Research – Alan Rifkin Piper Jaffray – Michael Cox RBC Capital Markets – Scot Ciccarelli Robert W. Baird & Co – David Cumberland Sidoti & Company – Scott Stember Stifel Nicolaus/Hanifen Imhoff, Inc. – David Schick William Blair & Company – Sharon Zackfia m a r k e t p r i c e s a n d d i v i d e n d i n f o r m a t i o n The prices in the table below represent the high and low sales price for O’Reilly Automotive, Inc. common stock as reported by the Nasdaq Stock Market. The common stock began trading on April 22, 1993. No cash dividends have been declared since 1992, and the Company does not anticipate paying any cash dividends in the foreseeable future. 2005 2004 high $26.22 30.50 32.53 32.52 32.53 low $21.98 23.21 26.54 25.75 21.98 high $20.85 23.54 22.68 22.82 23.54 low $18.23 19.59 18.03 18.50 18.03 First Quarter Second Quarter Third Quarter Fourth Quarter For the Year o ’ r e i l l y a u t o m o t i v e , i n c . a n d s u b s i d i a r i e s e x h i b i t 2 1 . 1 - s u b s i d i a r i e s o f t h e c o m p a n y subsidiary state of incorporation Ozark Automotive Distributors, Inc. Greene County Realty Co. O’Reilly II Aviation, Inc. Ozark Services, Inc. Hi-LO Investment Company Hi-LO Management Company Missouri Missouri Missouri Missouri Delaware Delaware One hundred percent of the capital stock of each of the above listed subsidiaries is directly owned by O’Reilly Automotive, Inc. 5 2 Board of Directors Chub O’Reilly (1913-2005) Chairman of the Board Emeritus David O’Reilly Chairman of the Board Charlie O’Reilly Vice Chairman of the Board Larry O’Reilly Vice Chairman of the Board Rosalie O'Reilly-Wooten Director Jay Burchfield Director Since 1997 Compensation Committee - Chairman Corporate Governance/Nominating Committee Joe Greene Director Since 1993 Corporate Governance/ Nominating Committee - Chairman Paul Lederer Director 1993-July 1997; February 2001 Audit Committee Compensation Committee John Murphy Director Since 2003 Audit Committee - Chairman Corporate Governance/Nominating Committee Ronald Rashkow Director Since 2003 Audit Committee Compensation Committee M i s s i o n S t a t e m e n t “O’Reilly Automotive will be the dominant supplier of auto parts in our market areas by offering our retail customers, professional installers and jobbers the best combination of inventory, price, quality and service; providing our team members with competitive wages and benefits, and working conditions which promote high achievement and ensure fair and equitable treatment; and, providing our stockholders with an excellent return on their investment.” 233 South Patterson Spring field, Missouri 65802 417-862-3333 www.oreillyauto.com