O’Reilly Automotive
Annual Report 2003

Plain-text annual report

2 0 0 3 O ’ R e i l l y A u t o m o t i v e A n n u a l R e p o r t S e e i n g G re e n . Th e co lo r o f re s u lts . An in-depth look at the performance of our company and the culture that brands it – O’Reilly Automotive. 233 South Patterson Springfield, Missouri 65802 417-862-3333 www.oreillyauto.com 2 0 0 3 O ’ R e i l l y A u t o m o t i v e A n n u a l R e p o r t p i c t u re d a b ov e a re t h e o r i g i n a l t e a m m e m b e r s a n d f o u n d e r s o f O ’ R e i l ly Au to m ot i ve . L to R: Red Hale, Wayne Schuler, Paul Ankrom, Jewel Sechler, C.F. O’Reilly, Chub O’Reilly, Ann Drennan, Bob Bach, Hubert Cox, Tony O’Reilly and Paul Branson. Not pictured are Vic Semmelbeck and Chris Bridwell. M i s s i o n S tat 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.” Certain statements contained in this annual report are forward-looking statements. These statements discuss, 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 in these forward-looking statements. Please refer to the Risk Factors sections of the company’s Form 10-K for the year ended December 31, 2003, for more details. m o c . n o s i r r a h k l a f . w w w i r u o s s i M , s i u o L . t S , e v i t a e r C n o s i r r a H k l a F : n g i s e D We s e e t h e b e g i n n i n g s o f a l e g ac y. The year was 1957. Chevrolet launched their classic 1957 Bel Air, the Russians launched the Sputnik and a father-and-son duo launched O’Reilly Automotive, a family owned auto parts store that would become one of the nation’s largest auto parts retailers. C.F. and C.H. “Chub” O’Reilly, along with 11 other team members, approached their job with commitment and dedication to a common cause, a full day’s work for a day’s pay, honesty and integrity, and working together to provide the best customer service in town. While all of those initial team members were not related, they did take care of business as a “family.” Each one realized that every person on the team was relying on them to successfully perform their duties and responsibilities. Without exception, these team members put their nose to the grindstone and together worked hard to accomplish their goals. They treated each other and their customers with respect, and committed themselves to the common goal of “winning for the team” by being honest and professional in their daily activities. pag e 1 We s e e t h at o ri g i n a l l e g ac y a l i ve i n a c u lt u re o f t e a m s p i ri t, i m pe cc a b l e c u s to m e r s e rv i c e a n d g ri t t y d e t e r m i n at i o n . The year is 2003 and the mission of our business remains the same … be the dominant supplier of auto parts in our market areas. The standards set by the original team members in 1957 created the culture that our team members take pride in today. It’s about doing whatever it takes to get the job done by offering our retail customers, professional installers and jobbers the best combination of inventory availability, price, quality and service. We continue to build our business around a culture created by our founders that believes in honest and fair dealings with our customers, suppliers and team members, and treating people with respect. We believe our culture will continue to drive results. pag e 2 pag e 3 Letter to Our Shareholders We s e e co n t i n u e d pe r f o r m a n c e a n d re s u lts . This year has been another outstanding year for Team O’Reilly. As a result of our team members’ dedication and hard work, we have had many successes in 2003. In January, we opened our 1,000th store in Chattanooga, Tennessee. We opened 128 new stores, expanding our footprint to 18 contiguous states including North Carolina and Virginia. We opened our 10th distribution center (DC) just outside of Mobile, Alabama, which allows us to further capitalize on the 2001 acquisition of Mid-State Automotive Distributors, Inc. We completed the remodel of our Knoxville, Tennessee DC and expect to complete the remodel of our Nashville, Tennessee DC in the spring of 2004. Both remodeling efforts will result in increased capacity and improved efficiency. In 10 years as a public company, O’Reilly has been one of Wall Street’s most consistent performers. This year was no exception. Our financial results for 2003 remained strong, with product sales increasing 15.2% to $1.51 billion, net income up 22.1% to $100.1 million, an operating margin of 10.9% and comparable store product sales up 7.8%. Our efforts to better manage our inventory and negotiate better terms with our vendors resulted in a 32% accounts payable to inventory ratio. Our net cash provided from operating activities significantly outpaced our purchases of property and equipment by $36.3 million. Our performance did not go unnoticed as the stock market once again rewarded our performance with an increase of 53% in our stock price. An investment of $100 in O’Reilly stock in April 1993 would be worth approximately $981 today, an increase of 881%! We continue to be extremely proud of the “Team O’Reilly Culture” that is the cornerstone of our customer service driven approach to business. Greater than 15,000 team members are working toward the common goal of being the dominant auto parts supplier in all of our markets. We are very confident in our ability to continue our growth and progress in all of our markets. We are pleased to have John Murphy and Ronald Rashkow join Team O’Reilly as independent directors. Our board is now comprised of nine total directors, five of which are independent, giving us an independent majority as required by the listing standards of NASDAQ. O’Reilly is well-positioned to capitalize on strong industry trends. Undone or underperformed maintenance is estimated at $60 billion. The average age of automobiles continues to increase as consumers choose to maintain vehicles. The American passion for driving remains strong as the number of registered vehicles and the total miles driven continue to rise. All of these factors point to continued opportunity for our company. We are looking forward to the opportunities that lie ahead in 2004 and beyond, and will continue to make decisions with a focus on the long-term health of our company, not just quarterly results. We remain confident in our business model, the demand for our products and our team’s ability to sustain our growth. Thank you to our valued customers and team members for making 2003 another successful year. We also want to thank our loyal shareholders for your confidence and for partnering with us to take advantage of the opportunities that lie ahead. David O’Reilly Chief Executive Officer & Co-Chairman of the Board Ted Wise Co-President Greg Henslee Co-President Jim Batten Executive Vice President of Finance & Chief Financial Officer pag e 4 2 0 0 3 f i n a n c i a l h i g h l i g h ts In thousands, except earnings per share data and operating data Year ended December 31 Product Sales Operating Income Net Income Working Capital Total Assets Long-Term Debt Shareholders’ Equity Net Income Per Common Share 2003 2002 2001 2000 1999 $ 1,511,816 $ 1,312,490 $ 1,092,112 $ 890,421 $ 754,122 165,275 100,087 441,617 138,301 81,992 483,623 1,187,592 1,009,419 120,977 784,285 190,470 650,524 113,831 66,352 429,527 856,859 165,618 556,291 90,029 51,708 296,272 715,995 90,463 463,731 76,920 45,639 249,351 610,442 90,704 403,044 (assuming dilution) 1.84 1.53 1.26 1.00 0.92 Weight-Average Common Share (assuming dilution) Stores At Year-End Same-Store Sales Gain 54,530 1,109 7.8% 53,692 52,786 51,728 49,715 981 3.7% 875 8.8% 672 5.0% 571 9.6% Team O'Reilly is committed to capitalizing on the demand for auto parts and accessories. Our 2-4-Your Future initiative, representing our goal to reach $2 billion in sales per year by December 31, 2005, demonstrates this commitment. pag e 5 e a r n i n g s pe r s h a re (assuming dilution) $1.84 $1.53 $1.26 $1.00 $0.92 1999 2000 2001 2002 2003 5-year compound annual growth rate: 21.0% Earnings per share (EPS) refers to net after-tax income of our company applicable to each share of common stock. Our goal is to increase EPS by 18-20% each year, reflecting our goals of growth in sales and expense control. Our team accepts the challenge of driving EPS growth and benefits from such growth as most of them are also shareholders. co m pa r a b l e s to re s a l e s 9.6% 8.8% 7.8% 5.0% 3.7% 1999 2000 2001 2002 2003 5-year average: 7.0% Comparable store sales percentage measures the sales increases or decreases of existing stores. We calculate comparable store sales data based on the change in product sales of stores open at least one year. pag e 6 o pe r at i n g i n co m e (dollars in millions) $165.3 $138.3 $113.8 $90.0 $76.9 1999 2000 2001 2002 2003 5-year compound annual growth rate: 23.8% Operating income refers to product sales, less cost of goods sold and operating expenses. Our goal is for operating income, as a percentage of sales, to be 11% or greater. Our team is committed to achieving this goal by offering excellent customer service to drive sales, coupled with relentless expense control. n e t i n co m e (dollars in millions) $100.1 $82.0 $66.4 $51.7 $45.6 1999 2000 2001 2002 2003 5-year compound annual growth rate: 26.6% Net income represents more than sales less all expenses and adjustments. It’s a critical metric of performance that is near and dear to all O’Reilly Team Members and the reward for a job well-done. Our team knows that taking care of our customers each day and watching our pennies drives net income. pag e 7 pag e 8 The Team O’Reilly C u lt u re We s e e a c u lt u re g e a re d f o r pe r f o r m a n c e . Th at’s w h at s e ts u s a pa rt f ro m t h e re s t. Since 1957, we have adapted to many changes and have enjoyed many successes in the auto parts business. We have completed various acquisitions from single stores to large chains that nearly doubled our company’s size. We have grown from operating one store in Springfield, Missouri to over 1,100 stores in 18 contiguous states. Through it all one thing remains the same, the O’Reilly Culture. The 10 values that make up our culture include respect, honesty, teamwork, expense control, hard work, professionalism, enthusiasm, excellent customer service, dedication and a win-win attitude. When considering a prospective team member, we seek individuals who will embrace our core values and dedicate themselves to the O’Reilly Culture. For new team members, a significant amount of their training focuses on our culture, to carry forward those values that have been critical to the success of the company. Our monthly publication, Team Spirit, and weekly team memo remind our veteran team members that our culture plays a significant role in the success of our company. It is both our goal and our challenge to continue promoting the values that make up our culture throughout our entire team, now more than 15,000 strong. As we look to 2004 and the challenges we will face, we are confident that the time we have invested to develop the O’Reilly Culture will pay dividends for years to come and continue to guide our team members. Team O’Reilly takes pride in what we do, the values we have and the customers we serve. pag e 9 We s e e s at i s f i e d c u s to m e r s f u e l i n g o u r b ot to m l i n e ev e ry d ay. pag e 1 0 p ro d u c t s a l e s (dollars in millions) $1,511.8 $1,312.5 $1,092.1 $890.4 $754.1 1999 2000 2001 2002 2003 5-year compound annual growth rate: 19.7% Our goal of 15-20% annual sales growth supports our “2-4-Your Future” initiative, obtaining $2 billion in sales by December 31, 2005. n u m b e r o f s to re s 1,109 981 875 672 571 number 5 of the top 100 auto parts chains Source: January 2004 Aftermarket Business Magazine 1999 2000 2001 2002 2003 5-year compound annual growth rate: 17.7% Our growth plans for 2004 include the addition of approximately 140 new stores, an increase of 12.6%. pag e 1 1 t e a m m e m b e r s (in thousands) 15.5 14.3 12.7 10.8 9.5 1999 2000 2001 2002 2003 The addition of team members is to support the expanded level of our operations. They are truly our best “part.” c a p i ta l s t ru c t u re (dollars in millions) $784.3 $650.5 $556.3 $463.7 $403.0 $182.5 $191.2 $139.6 $110.1 $121.9 1999 2000 2001 2002 2003 total shareholders’ equity total debt Our capital structure consists of debt and shareholders’ equity. Our strong balance sheet supports our expansion plans and gives us the flexibility to capitalize on potential acquisitions. pag e 1 2 pag e 1 3 We s e e o p p o rt u n i t i e s t h at m a k e a d i f f e re n c e . Our customers have become accustomed to the many advantages of shopping at O’Reilly Auto Parts. A friendly greeting within their first five steps in the store, unparalleled availability of parts and our knowledgeable parts professionals helping them find the right part for the job are just a few of the reasons our customers keep coming back. Our professional installer customers rely on the frequent clinics we host, to educate them on the latest in automotive technology. We also have a dedicated sales force that caters to their special needs. This commitment coupled with an excellent track record of service has earned us a reputation of being the “First Call” for professional installers. pag e 1 4 pag e 1 5 O’Reilly Automotive S t r at e g i c D i s t r i bu t i o n Sy s t e m s We s e e o u r d e l i ve ry m o d e l s e t t i n g t h e s ta n d a rd f o r t h e f u t u re o f t h e au to m ot i ve a f t e r m a rk e t i n d u s t ry. On average, we stock over 100,000 individual stock keeping units (SKUs) in our distribution centers. Customers have unparalleled access to hard-to-find parts, creating a competitive advantage for our company. They have become accustomed to our same-day or overnight delivery of any part in our distribution center, making any substitute unacceptable. We believe they deserve this level of service and will continue to reward our company with their loyalty. We continue to evaluate the efficiencies and capacity of our distribution network. We have successfully completed expansions of our distribution centers in Little Rock, Arkansas and Houston, Texas. We completed the remodel of our distribution centers in Knoxville, Tennessee and Springfield, Missouri and expect to complete the remodel of our distribution center in Nashville, Tennessee in spring of 2004. It’s our commitment to extraordinary customer service that determines the number and location of our distribution centers. Our distribution centers are strategically located to pursue new, contiguous markets, allowing for growth, while sustaining overnight delivery to every store. In June 2003, we successfully opened our 10th distribution center near Mobile, Alabama, which will enable further penetration into the Southeast and further capitalize on the acquisition of Mid-State Automotive Distributors, Inc., completed in 2001. pag e 1 6 pag e 1 7 2 0 0 3 o’re i l ly au to pa rts s to re s a n d d i s t ri bu t i o n c e n t e r s o’reilly auto parts states alabama arkansas florida georgia illinois indiana iowa kansas kentucky 43 Stores 72 Stores 7 Stores 8 Stores 19 Stores 6 Stores 64 Stores 57 Stores 21 Stores louisiana mississippi missouri nebraska north carolina oklahoma tennessee texas virginia 50 Stores 32 Stores 132 Stores 24 Stores 15 Stores 99 Stores 78 Stores 381 Stores 1 Store total number of stores: 1,109 distribution centers dallas, texas des moines, iowa houston, texas kansas city, missouri knoxville, tennessee little rock, arkansas mobile, alabama nashville, tennessee oklahoma city, oklahoma springfield, missouri Customer service is the No. 1 priority in every aspect of our business. We will continue the successful O’Reilly strategy of expanding to new, contiguous markets, keeping all stores within a 150-mile to 200-mile radius of an O’Reilly distribution center ensuring overnight delivery to every store. pag e 1 8 pag e 1 9 O’Reilly Automotive D ua l M a r k e t S t r at e g y We s e e a co m pe t i t i ve a dva n tag e i n s e rv i n g t wo m a rk e ts . Maintaining an approximate 50/50 balance between serving professional installer and do-it-yourself (DIY) customers is a challenging, but rewarding task. This blend of customers is very unique in our industry. Through 46 years of perseverance and dedication to our customers, we have successfully served these two, very different markets. This approach has enabled us to reach markets otherwise too small for traditional retail auto parts stores. Both our professional installer and our DIY customers value the outstanding customer service provided by our professional parts people. Our DIY customers appreciate our attractive, conveniently located stores that are easy to shop with clearly labeled aisles and products. Our competitive prices and low-price guarantee compels our customers to continue rewarding us with their business. They rely on our professional parts people to ensure they have the right part and the right tool for the job. Many programs and services are made available to our professional installer customers to further strengthen the relationship we share. Our customer support programs keep them up to date with new developments and changes in automotive technologies. Hot-shot delivery service allows them access to parts on demand. Our unmatched parts availability assures they can get hard-to-find parts and our knowledgeable parts professionals are an excellent resource for their business. All of our professional parts people receive ongoing training to provide this level of service, and many achieve ASE certification. These programs and services deliver an unbeatable combination for our professional installers. pag e 2 0 pag e 2 1 pag e 2 2 au to m ot i ve a f t e r m a rk e t i n d u s t ry u n d e r pe r f o r m e d m a i n t e n a n c e $60 Billion Underperformed Maintenance $36 Billion Existing DIY Market* $71 Billion Existing DIFM Market** Experts estimate automotive underperformed maintenance to be approximately $60 billion. We continue to promote routine maintenance through our advertising efforts raising awareness to customers and driving additional sales. The “Be Car Care Aware™” campaign educates drivers in our markets about automotive underperformed maintenance and the benefits performing maintenance can have on their second largest investment, their automobile. o’re i l ly re ta i l v s . co m m e rc i a l s a l e s 53% DIY Market* 47% DIFM Market** Our dual market strategy provides us a competitive advantage allowing penetration into smaller rural markets otherwise not suitable for traditional retail outlets. *diy – do-it-yourself or retail market **difm – do-it-for-me or commercial market, also known as professional installer market pag e 2 3 We s e e a s t ro n g c u lt u re co u p l e d w i t h u n m atc h e d pe r f o r m a n c e t h at l e a d s to a b ri g h t f u t u re . pag e 2 4 2 0 0 3 F i n a n c i a l R e s u lts pag e 2 5 s e l e c t e d co n s o l i d at e d f i n a n c i a l d ata (In thousands, except per share data) years ended december 31, i n co m e s tat e m e n t d ata : 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 Provision for income taxes Net income b a s i c e a r n i n g s pe r co m m o n s h a re : Net income per share Weighted-average common shares outstanding 2003 2002 2001 $1,511,816 $1,312,490 $1,092,112 873,481 638,335 473,060 165,275 (5,233) 59,955 759,090 553,400 415,099 138,301 (7,319) 48,990 624,294 467,818 353,987 113,831 (7,104) 40,375 $ 100,087 $ 81,992 $ 66,352 $ 1.86 $ 1.54 $ 1.27 53,908 53,114 52,121 e a r n i n g s pe r co m m o n s h a re - a s s u m i n g d i lu t i o n : Net income per share $ 1.84 $ 1.53 $ 1.26 Weighted-average common shares outstanding – adjusted 54,530 53,692 52,786 s e l e c t e d o pe r at i n g d ata : 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) b a l a n c e d ata s h e e t: Working capital Total assets Short-term debt Long-term debt, less current portion Shareholders’ equity 1,109 7,348 $ 1,413 $ 215 981 6,408 $ 1,372 $ 211 875 5,882 $ 1,426 $ 219 7.8% 3.7% 8.8% $ 441,617 1,187,592 925 120,977 784,285 $ 483,623 1,009,419 682 190,470 650,524 $ 429,527 856,859 16,843 165,618 556,291 (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 data 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. pag e 2 6 2000 1999 1998 1997 1996 1995 1994 $ 890,421 $ 754,122 $ 616,302 $ 316,399 $ 259,243 $ 201,492 $ 167,057 507,720 382,701 292,672 90,029 (6,870) 31,451 428,832 325,290 248,370 76,920 (3,896) 27,385 358,439 257,863 200,962 56,901 (6,958) 19,171 181,789 134,610 97,526 37,084 472 14,413 150,772 108,471 79,620 28,851 1,182 11,062 116,768 84,724 62,687 22,037 236 8,182 97,758 69,299 52,142 17,157 376 6,461 $ 51,708 $ 45,639 $ 30,772 $ 23,143 $ 18,971 $ 14,091 $ 11,072 $ 1.01 $ 0.94 $ 0.72 $ 0.55 $ 0.45 $ 0.40 $ 0.32 51,168 48,674 42,476 42,086 41,728 35,640 34,620 $ 1.00 $ 0.92 $ 0.71 $ 0.54 $ 0.45 $ 0.39 $ 0.32 51,728 49,715 43,204 42,554 42,064 35,804 34,778 672 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 $ 251 188 923 165 785 $ 1,101 $ 227 $ 1,007 $ 215 5.0% 9.6% 6.8% 6.8% 14.4% 8.9% 8.9% $ 296,272 $ 249,351 $ 208,363 $ 93,763 $ 74,403 $ 80,471 $ 41,416 715,995 49,121 90,463 463,731 610,442 19,358 90,704 403,044 493,288 13,691 170,166 218,394 247,617 130 22,641 182,039 183,623 3,154 237 155,782 153,604 231 358 133,870 87,327 311 461 70,224 pag e 2 7 m a n ag e m e n t’s d i s c u s s i o n a n d a n a ly s i s o f f i n a n c i a l co n d i t i o n a n d re s u lts o f o pe r at 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 employees. 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. critical accounting policies and estimates The fundamental objective of financial reporting is to provide useful information that allows a reader to comprehend the business activities of our company. To aid in that understanding, management has identified our “critical accounting policies.” These policies have the potential to have a more significant impact on our financial statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events which are continuous in nature. Cost of goods sold – Cost of goods sold includes warehouse and distribution expenses and estimates of amounts due from vendors for certain merchandise allowances and rebates. These estimates are consistent with historical experience. Operating, selling, general and administrative expense (OSG&A) – Operating, selling, general and administrative expense includes estimates for medical, worker’s compensation and other general liability obligations, which are partially based on estimates of certain claim costs and historical experience. Accounts receivable – Allowance for doubtful accounts is estimated based on historical loss ratios and consistently has been within management’s expectations. Revenue – 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. Vendor concessions – 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 statement of income. pag e 2 8 m a n ag e m e n t’s d i s c u s s i o n a n d a n a ly s i s o f f i n a n c i a l co n d i t i o n a n d re s u lts o f o pe r at i o n s (continued) Stock-based compensation – We have elected to use the intrinsic value method of accounting for stock options issued under our stock option plans and accordingly do not record an expense for such stock options. For purposes of pro forma disclosures under the fair value method, the estimated fair value of the options is amortized to expense over the options’ vesting period. Our pro forma information for the years ended December 31, is as follows: (In thousands, except per share data) Net income as reported Stock-based compensation expense as reported Stock-based compensation expense under fair value method Pro forma net income Pro forma basic net income per share Pro forma net income per share - assuming dilution 2003 $100,087 – 9,204 $ 90,883 $1.69 $1.67 2002 $81,992 – 7,217 $74,775 $1.41 $1.39 results of operations 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 Provision for income taxes Net income 2003 100.0% 57.8 42.2 31.3 10.9 (0.3) 10.6 4.0 6.6% 2002 100.0% 57.8 42.2 31.6 10.6 (0.6) 10.0 3.7 6.3% 2001 $66,352 – 5,406 $60,946 $1.17 $1.15 2001 100.0% 57.2 42.8 32.4 10.4 (0.6) 9.8 3.7 6.1% 2003 compared to 2002 Product sales increased $199.3 million, or 15.2% from $1.31 billion in 2002 to $1.51 billion in 2003, primarily due to 128 net additional stores opened during 2003, and a 7.8% 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, and continued improvement in the merchandising and store layouts of most stores. Also, our continued focus on serving professional installers contributed to increased product sales. pag e 2 9 m a n ag e m e n t’s d i s c u s s i o n a n d a n a ly s i s o f f i n a n c i a l co n d i t i o n a n d re s u lts o f o pe r at i o n s (continued) Gross profit increased 15.4% from $553.4 million (42.2% of product sales) in 2002 to $638.3 million (42.2% of product sales) in 2003. The increase in gross profit dollars is due to the increase in product sales. Operating, selling, general and administrative expenses (OSG&A) increased $58.0 million from $415.1 million (31.6% of product sales) in 2002 to $473.1 million (31.3% of product sales) in 2003. The increase in these expenses in dollar amount 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 expenses as a percent of product sales was primarily due to achieving greater economies of scale resulting from increased product sales and through management’s expense control initiatives. Other expense, net, decreased by $2.1 million from $7.3 million in 2002 to $5.2 million in 2003. The decrease was primarily due to a reduction in interest expense as a result of lower average borrowings under the Company’s credit facility and to a lesser extent lower average interest rates. Provision for income taxes increased from $49.0 million in 2002 (37.4% effective tax rate) to $60.0 million in 2003 (37.5% effective tax rate). The increase in the dollar amount was primarily due to the increase of income before income taxes. Principally as a result of the foregoing, net income in 2003 was $100.1 million (6.6% of product sales), an increase of $18.1 million or 22.1%, from net income in 2002 of $82.0 million (6.3% of product sales). 2002 compared to 2001 Product sales increased $220.4 million, or 20.2% from $1.09 billion in 2001 to $1.31 billion in 2002, due to 106 net additional stores opened during 2002, and a 3.7% 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, and continued improvement in the merchandising and store layouts of most stores. Also, our continued focus on serving professional installers contributed to increased product sales. Gross profit increased 18.3% from $467.8 million (42.8% of product sales) in 2001 to $553.4 million (42.2% of product sales) in 2002. The increase in gross profit dollars is primarily due to increases in sales. The decrease in gross profit as a percent of product sales is primarily due to increased product sales to independent jobbers, which are at a lower gross margin, and increased distribution costs at the distribution centers acquired from Mid-State Automotive Distributors, Inc. Operating, selling, general and administrative expenses increased $61.1 million from $354.0 million (32.4% of product sales) in 2001 to $415.1 million (31.6% of product sales) in 2002. The increase in these expenses in dollar amount 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 expenses as a percent of product sales was primarily due to reductions in payroll, benefits and other OSG&A expenses through management’s expense control initiatives. Other expense, net, increased by $215,000 from $7.1 million in 2001 to $7.3 million in 2002. The increase was primarily due to interest expense on increased borrowings under our credit facility and a decrease in interest income. Provision for income taxes increased from $40.4 million in 2001 (37.8% effective tax rate) to $49.0 million in 2002 (37.4% 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 rate was primarily due to changes in the mix of business between the states in which we operate. pag e 3 0 m a n ag e m e n t’s d i s c u s s i o n a n d a n a ly s i s o f f i n a n c i a l co n d i t i o n a n d re s u lts o f o pe r at i o n s (continued) Principally as a result of the foregoing, net income in 2002 was $82.0 million (6.3% of product sales), an increase of $15.6 million or 23.6%, from net income in 2001 of $66.4 million (6.1% of product sales). liquidity and capital resources Net cash provided by operating activities was $172.8 million in 2003, $104.5 million in 2002 and $50.0 million in 2001. The increase in cash provided by operating activities in 2003 compared to 2002 was primarily due to increases in net income, accounts payable, accrued payroll, accrued benefits and withholdings, partially offset by increases in receivables and inventory. The increase in accounts payable was primarily due to management’s efforts with vendors to extend the terms of payment. The increases in accrued payroll, benefits and withholdings, accounts receivable and inventory primarily relate to the increased level of our operations. The increase in cash provided by operating activities in 2002 compared to 2001 was primarily due to increases in net income, accounts payable, income taxes payable, accrued payroll and accrued benefits and withholdings, partially offset by increases in receivables and inventory. These increases relate primarily to the increased level of our operations. Net cash used in investing activities was $134.6 million in 2003, $105.4 million in 2002 and $77.8 million in 2001. The increase in cash used in investing activities in 2003 and 2002 was primarily due to increased purchases of property and equipment. 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 and is included in the table of contractual obligations under non-cancelable operating leases. On May 16, 2001, we 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 and is guaranteed by all of our subsidiaries. Proceeds from the transaction were used to reduce outstanding borrowings under our former revolving credit facility. 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 the Company. 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 (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 $44.2 million at December 31, 2003, 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 Facility has been accounted for as an operating lease under the provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 13 and related interpretations, including Financial Interpretation No. 46. Future minimum rental commitments under the Facility have been included in the table of contractual obligations below. pag e 3 1 m a n ag e m e n t’s d i s c u s s i o n a n d a n a ly s i s o f f i n a n c i a l co n d i t i o n a n d re s u lts o f o pe r at i o n s (continued) Capital expenditures were $136.5 million in 2003, $102.3 million in 2002 and $68.5 million in 2001. 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 128, 106 and 203 net stores in 2003, 2002 and 2001, respectively. We remodeled or relocated 46 stores and two distribution centers in 2003, 27 stores in 2002 and 16 stores in 2001. Three new distribution centers were acquired; one in 2003, located near Mobile, Alabama and two in October 2001, located in Nashville, Tennessee and Knoxville, Tennessee. Our continuing store expansion program requires significant capital expenditures and working capital principally for inventory requirements. Our 2004 growth plans call for approximately 140 new stores and capital expenditures of $125 million to $135 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. 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, 2002, the Company completed an unsecured, three-year syndicated credit facility (Credit Facility) in the amount of $150 million led by Wells Fargo Bank as the Administrative Agent, replacing a five-year 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 0.875% to 1.375% (2.06% at December 31, 2003 and 2.26% at December 31, 2002) and expires in July 2005. At December 31, 2003 and 2002, $20.0 million and $90.0 million, respectively, of the Credit Facility was outstanding. Additionally, letters of credit totaling $11.0 million and $6.0 million were outstanding at December 31, 2003 and 2002, respectively. Accordingly, our aggregate availability for additional borrowings under the Credit Facility was $119.0 million and $54.0 million at December 31, 2003 and 2002, respectively. Prior to July 29, 2002, the Company had available an unsecured credit facility providing for maximum borrowings of $140 million. The facility was comprised of a revolving credit facility of $125 million, and a term loan of $15 million. The credit facility, which bore interest at LIBOR plus 0.50%, expired in January 2003. All borrowings outstanding under the old credit facility were fully repaid in July 2002. off balance sheet arrangements 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. We completed two sale-leaseback transactions in 2000 and 2001 and the Synthetic Lease in 2000, the terms of all which are described above under Liquidity and Capital Resources. The purpose of the sale-leaseback transactions was to reduce outstanding borrowings under our former revolving credit facility. The purpose of the Synthetic Lease was to fund a portion of our store growth, primarily in 2001 and 2002. We issue stand-by letters of credit provided by a $20 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 $11.0 million and $6.0 million were outstanding at December 31, 2003 and 2002, respectively. pag e 3 2 m a n ag e m e n t’s d i s c u s s i o n a n d a n a ly s i s o f f i n a n c i a l co n d i t i o n a n d re s u lts o f o pe r at i o n s (continued) contractual obligations 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 5 and 6 to the consolidated financial statements. (In thousands) co n t r ac t ua l o b l i g at i o n s : Notes payable Long-term debt Capital lease obligations Operating leases Total contractual cash obligations payments due by period total less than 1 year 2-3 years 4-5 years after 5 years $ 17 120,064 1,821 321,282 $443,184 $ 12 13 900 32,671 $33,596 $ 5 95,029 921 58,200 $154,155 $ – 25,022 – 48,191 $73,213 $ – – – 182,220 $182,220 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- and long-term capital needs for the foreseeable future. inflation and seasonality We succeeded, in many cases, in reducing 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. quarterly results The following table sets forth certain quarterly unaudited operating data for fiscal 2003 and 2002. The unaudited quarterly information includes all adjustments which management considers necessary for a fair presentation of the information shown. 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. pag e 3 3 m a n ag e m e n t’s d i s c u s s i o n a n d a n a ly s i s o f f i n a n c i a l co n d i t i o n a n d re s u lts o f o pe r at i o n s (continued) (In thousands, except per share data) Product sales Gross profit Operating income Net income Basic net income per common share Net income per common share – assuming dilution (In thousands, except per share data) Product sales Gross profit Operating income Net income Basic net income per common share Net income per common share – assuming dilution first quarter $339,475 140,946 33,341 19,728 0.37 0.37 first quarter $295,489 126,028 28,638 16,642 0.31 0.31 second quarter $393,112 165,713 44,726 26,924 0.50 0.50 second quarter $343,181 144,186 37,769 22,547 0.42 0.42 third quarter $412,182 175,653 48,362 29,533 0.55 0.54 third quarter $359,579 152,196 40,723 24,096 0.45 0.45 fiscal 2003 fourth quarter $367,047 156,023 38,846 23,902 0.44 0.43 fiscal 2002 fourth quarter $314,241 130,990 31,171 18,707 0.35 0.35 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 shareholders of record as of the close of business on May 31, 2002. Each right initially entitles shareholders to buy a unit representing one one-hundredth of a share of a new series of preferred stock of the Company for $160 and expires 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 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. new accounting standards In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Under the new rules, a liability for the costs associated with an exit or disposal activity will be recognized when the liability is incurred as opposed to the date of an entity’s commitment to an exit plan. The new rules were effective for exit or disposal activities initiated after December 31, 2002. The adoption of the new rules did not have a significant impact on our consolidated financial position or results of operations. In November 2002, the FASB issued Financial Interpretation 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees. The interpretation elaborates on the disclosures to be made in interim and annual financial statements of a guarantor about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing such guarantee. Initial recognition and measurement provisions of the interpretation were applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements were effective for financial statements of interim or annual periods ending after December 15, 2002. As of December 31, 2003 and 2002, we did not have any outstanding guarantees other than subsidiary guarantees of parent debt and a residual value guarantee as disclosed in Notes 5 and 6, respectively, to the consolidated financial statements. pag e 3 4 m a n ag e m e n t’s d i s c u s s i o n a n d a n a ly s i s o f f i n a n c i a l co n d i t i o n a n d re s u lts o f o pe r at i o n s (continued) In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, amending SFAS No. 123, Accounting for Stock-Based Compensation. SFAS 148 gives companies electing to expense employee stock options three methods to do so. In addition, the statement amends the disclosure requirements to require more prominent disclosure about the method of accounting for stock-based employee compensation and the effect of the method used on reported results in both annual and interim financial statements. We have elected to continue using the intrinsic value method of accounting for stock-based compensation, therefore, SFAS No. 148 did not have any effect on our consolidated financial position or results of operations. See Note 9 to the consolidated financial statements for additional information regarding stock-based compensation. In January 2003, the FASB issued Financial Interpretation 46, Consolidation of Variable Interest Entities. The interpretation expands upon and strengthens existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. The interpretation requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of the interpretation applied immediately to variable interest entities created after January 31, 2003. The consolidation requirements applied to older entities in the first fiscal year or interim period beginning after December 15, 2003. On June 26, 2003, we signed an Amended and Restated Agreement relating to our properties leased from SunTrust Equity Funding, LLC. The agreement with SunTrust Equity Funding, LLC has been recorded and disclosed as an operating lease in the consolidated financial statements in accordance with SFAS No. 13 and Financial Interpretation 46. In March 2003, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 02-16, Accounting by a Customer (including a Reseller) for Certain Consideration Received from a Vendor. Under the new guidance, cash consideration received from a vendor should be classified as a reduction of cost of sales. If the consideration received represents a payment for assets delivered to the vendor, it should be classified as revenue. If the consideration is a reimbursement of a specific, incremental, identifiable cost incurred in selling the vendor’s product, the cost should be characterized as a reduction of that cost incurred. The guidance was adopted by the Company on January 1, 2003. The Company’s policies and practices for recording such vendor concessions as co-operative advertising and vendor allowances and discounts were aligned with the EITF’s guidance both prior to and after the application date, therefore, the release did not have any effect on our consolidated financial position or results of operations. forward-looking statements We claim the protection of the safe-harbor for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Certain statements contained within this annual report discuss, 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 in these forward-looking statements. Please refer to the Risk Factors sections of the Company’s annual report on Form 10-K for the year ended December 31, 2003, for more details. pag e 3 5 co n s o l i d at e d b a l a n c e s h e e ts (In thousands, except per share data) december 31, a s s e ts Current assets: 2003 2002 Cash and cash equivalents Accounts receivable, less allowance for doubtful accounts $ 21,094 $ 29,333 of $986 in 2003 and $865 in 2002 Amounts receivable from vendors, net Inventory Deferred income taxes 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 l i a b i l i t i e s a n d s h a re h o l d e r s’ e qu i t y Current liabilities: Income taxes payable Accounts payable Accrued payroll Accrued benefits and withholdings Other current liabilities Current portion of long-term debt Total current liabilities Long-term debt, less current portion Deferred income taxes Other liabilities Commitments and contingencies 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 – 90,000,000 Issued and outstanding shares – 54,664,976 in 2003 and 53,371,242 in 2002 Additional paid-in capital Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying notes. pag e 3 6 52,235 50,695 554,309 4,753 4,399 687,485 58,571 212,937 79,994 220,123 54,517 626,142 177,084 449,058 24,313 26,736 45,421 42,918 504,098 5,040 4,235 631,045 52,362 160,425 57,376 177,293 44,067 491,523 137,922 353,601 1,880 22,893 $1,187,592 $1,009,419 $ 6,872 176,513 17,307 27,368 16,883 925 245,868 120,977 29,448 7,014 – – 547 302,691 481,047 784,285 $ 9,798 85,370 15,257 19,165 17,150 682 147,422 190,470 15,939 5,064 – – 534 269,030 380,960 650,524 $1,187,592 $1,009,419 co n s o l i d at e d s tat e m e n ts o f i n co m e (In thousands, except per share data) december 31, Product sales Cost of goods sold, including warehouse and distribution expenses Operating, selling, general and administrative expenses Operating income Other income (expense): Interest expense Interest income Other, net Income before income taxes Provision for income taxes Net income Basic income per common share: Net income per common share Weighted-average common shares outstanding Income per common share – assuming dilution: Net income per common share – assuming dilution Adjusted weighted-average common shares outstanding See accompanying notes. 2003 2002 2001 $1,511,816 $1,312,490 $1,092,112 873,481 473,060 1,346,541 165,275 (6,864) 298 1,333 (5,233) 160,042 59,955 759,090 415,099 1,174,189 138,301 (9,248) 989 940 (7,319) 130,982 48,990 624,294 353,987 978,281 113,831 (9,092) 1,362 626 (7,104) 106,727 40,375 $ 100,087 $ 81,992 $ 66,352 $ 1.86 53,908 $ 1.84 54,530 $ $ 1.54 53,114 1.53 53,692 $ 1.27 52,121 $ 1.26 52,786 pag e 3 7 co n s o l i d at e d s tat e m e n ts o f s h a re h o l d e r s’ e qu i t y (In thousands) b a l a n c e at d e c e m b e r 3 1 , 2 0 0 0 Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Net income b a l a n c e at d e c e m b e r 3 1 , 2 0 0 1 Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Net income b a l a n c e at d e c e m b e r 3 1 , 2 0 0 2 Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Net income b a l a n c e at d e c e m b e r 3 1 , 2 0 0 3 See accompanying notes. common stock shares par value additional paid-in capital retained earnings total 51,545 $515 $230,600 $232,616 $463,731 223 1,083 – – 52,851 223 297 – – 2 11 – – 4,856 14,924 6,415 – – 4,858 – – 66,352 14,935 6,415 66,352 528 256,795 298,968 556,291 3 3 – – 6,094 4,677 1,464 – – 6,097 – – 81,992 4,680 1,464 81,992 53,371 534 269,030 380,960 650,524 242 1,052 – – 54,665 2 11 – – 6,746 21,429 5,486 – – 6,748 – – 100,087 21,440 5,486 100,087 $547 $302,691 $481,047 $784,285 pag e 3 8 co n s o l i d at e d s tat e m e n ts o f c a s h f low s (In thousands) december 31, o pe r at i n g ac t i v i t i e s Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Amortization Provision for doubtful accounts and notes Gain on sale of property and equipment Deferred income taxes Common stock contributed to employee benefit plans Tax benefit of stock options exercised Changes in operating assets and liabilities, net of the effects of the acquisition: Accounts receivable Amounts receivable from vendors Inventory Refundable income taxes Other current assets Accounts payable Income taxes payable Accrued payroll Accrued benefits and withholdings Other current liabilities Other liabilities Net cash provided by operating activities i n v e s t i n g ac t i v i t i e s Purchases of property and equipment Proceeds from sale of property and equipment Acquisition, net of cash acquired Payments received on notes receivable (Investment in) reduction of other assets Net cash used in investing activities f i n a n c i n g ac t i v i t i e s Borrowings on notes payable to bank Payments on notes payable to bank 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 increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year 2003 2002 2001 $ 100,087 $ 81,992 $ 66,352 41,216 1,158 2,461 (264) 13,796 4,026 5,486 (9,108) (4,824) (50,211) – (540) 60,319 (2,926) 2,050 8,203 (267) 2,179 172,841 (136,497) 1,273 – 871 (212) (134,565) – – 27,900 (98,577) 24,162 (46,515) (8,239) 29,333 35,923 984 1,873 (58) 5,666 3,512 1,464 (5,701) (4,478) (56,305) 168 (788) 23,495 9,798 2,391 5,127 (1,148) 618 104,533 (102,257) 2,278 – 862 (6,268) (105,385) – (5,000) 179,640 (166,761) 7,265 15,144 14,292 15,041 28,963 1,581 2,635 (158) 6,371 2,690 6,415 (3,432) (7,908) (35,115) (76) 1,244 (16,891) (1,011) 3,557 4,678 (9,756) (110) 50,029 (68,521) 8,534 (20,536) 721 1,956 (77,846) 5,000 (35,000) 289,974 (243,422) 17,102 33,654 5,837 9,204 Cash and cash equivalents at end of year $ 21,094 $ 29,333 $ 15,041 See accompanying notes. pag e 3 9 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts note 1—summary of significant accounting policies 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, Mississippi, Missouri, Nebraska, North Carolina, Oklahoma, Tennessee, Texas and Virginia. 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. Inventory Inventory, which consists of automotive hard parts, maintenance items, accessories and tools, is stated at the lower of cost or market. 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 $543,924,000 and $499,501,000 as of December 31, 2003, and 2002, respectively. During 2003, the Company entered into various programs and arrangements with certain of its vendors that provide for extended dating and payment terms for inventory purchases, including pay-on-scan arrangements. 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 include amounts due the Company for changeover merchandise and product returns. Reserves for uncollectable 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 straight-line and accelerated methods over the estimated useful lives of the assets. Service lives for property and equipment generally range from three to forty years. Leasehold improvements are amortized over the lesser of the useful lives or the term of the respective underlying lease. 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 pag e 4 0 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) 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, 2003, 2002 and 2001, were $1,808,000, $369,000 and $1,358,000, respectively. 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 the enacted tax rates and laws 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 $19,533,000, $14,442,000 and $12,796,000 for the years ended December 31, 2003, 2002 and 2001, 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 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 because, as discussed in Note 10, the alternative fair value accounting provided for under SFAS No. 123, Accounting for Stock-Based Compensation, requires the use of option valuation models that were not developed for use in valuing employee stock options. 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. 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. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information for the year ended December 31, is as follows: (In thousands, except per share data) Net income as reported Stock-based compensation expense as reported Stock-based compensation expense under fair value method Pro forma net income Pro forma basic net income per share Pro forma net income per share-assuming dilution 2003 $100,087 – 9,204 $ 90,883 $ 1.69 $ 1.67 2002 $ 81,992 – 7,217 $ 74,775 $ 1.41 $ 1.39 2001 $ 66,352 – 5,406 $ 60,946 $ $ 1.17 1.15 pag e 4 1 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) 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 66,750, 816,250 and 28,000 for the years ended December 31, 2003, 2002 and 2001, respectively. cash equivalents Cash equivalents consist of investments with maturities of 90 days or less at the day of purchase. concentration of credit risk Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and trade 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 trade receivables are limited because the Company’s customer base consists of a large number of smaller customers, thus spreading the trade credit risk. The Company controls credit risk through credit approvals, credit limits and monitoring procedures and generally does not require security when trade 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. notes receivable The Company had notes receivable from vendors and other third parties amounting to $27,636,000 and $2,362,000 at December 31, 2003 and 2002, respectively. The notes receivable, which bear interest at rates ranging from 0% to 6%, are due in varying amounts through August 2017. new accounting pronouncements In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Under the new rules, a liability for the costs associated with an exit or disposal activity will be recognized when the liability is incurred as opposed to the date of an entity’s commitment to an exit plan. The new rules are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of the new rules did not have a significant impact on our consolidated financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, amending SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 gives companies electing to expense employee stock options three methods to do so. In addition, the statement amends the disclosure requirements to require more prominent disclosure about the method of accounting for stock-based employee compensation and the effect of the method used on reported results in both annual and interim financial statements. The Company has elected to continue using the intrinsic value method of accounting for stock-based compensation, therefore, SFAS No. 148 did not have any effect on the Company’s consolidated financial position or results of operations. See Note 9 to the consolidated financial statements for additional information regarding stock-based compensation. pag e 4 2 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) In November 2002, the FASB issued Financial Interpretation 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees. The interpretation elaborates on the disclosures to be made in interim and annual financial statements of a guarantor about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing such guarantee. Initial recognition and measurement provisions of the interpretation were applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements were effective for financial statements of interim or annual periods ending after December 15, 2002. As of December 31, 2003 and 2002, the Company did not have any outstanding guarantees other than subsidiary guarantees of parent debt and a residual value guarantee as disclosed in Notes 5 and 6, respectively, to the consolidated financial statements. In January 2003, the FASB issued Financial Interpretation 46, Consolidation of Variable Interest Entities. The interpretation expands upon and strengthens existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. The interpretation requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of the interpretation applied immediately to variable interest entities created after January 31, 2003. The consolidation requirements applied to older entities in the first fiscal year and interim period beginning after December 15, 2003. On June 26, 2003, the Company signed an Amended and Restated Agreement relating to our properties leased from SunTrust Equity Funding, LLC. As a result, the agreement with SunTrust Equity Funding, LLC has been properly recorded and disclosed as an operating lease in the consolidated financial statements. In March 2003, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 02-16, Accounting by a Customer (including a Reseller) for Certain Consideration Received from a Vendor. Under the new guidance, cash consideration received from a vendor should be classified as a reduction of cost of sales. If the consideration received represents a payment for assets delivered to the vendor, it should be classified as revenue. If the consideration is a reimbursement of a specific, incremental and identifiable cost incurred in selling the vendor’s product, the cost should be characterized as a reduction of that cost incurred. The guidance was adopted by the Company on January 1, 2003. The Company’s policies and practices for recording such vendor concessions as co-operative advertising and vendor allowances and discounts were aligned with the EITF’s guidance both prior to and after the application date, therefore, the release did not have any effect on our consolidated financial position or results of operations. note 2 – acquisition On October 1, 2001, the Company purchased all of the outstanding stock of Mid-State Automotive Distributors, Inc. (Mid-State) for approximately $20.5 million including acquisition costs. Mid-State was a specialty retailer which supplied automotive aftermarket parts throughout certain states in the southeastern part of the United States. The acquisition was accounted for using the purchase method of accounting, and accordingly, the results of operations of Mid-State are included in the consolidated statements of income from the date of acquisition. The purchase price was allocated to assets acquired and liabilities assumed based on their estimated fair values on the date of acquisition. The pro forma effect on earnings of the acquisition of Mid-State was not material. pag e 4 3 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) note 3 – related parties The Company leases certain land and buildings related to 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. Additionally, the Company leases certain land and buildings related to nine 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 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 6). Rent expense under these operating leases totaled $3,238,000, $3,222,000 and $2,894,000 in 2003, 2002 and 2001, respectively. note 4 – note payable to bank At December 31, 2001, the Company had available short-term unsecured bank lines of credit providing for maximum borrowings of $5 million, all of which was outstanding at December 31, 2001. The lines of credit were fully repaid in 2002. note 5 – long-term debt On July 29, 2002, the Company completed an unsecured, three-year syndicated credit facility (Credit Facility) in the amount of $150 million led by Wells Fargo Bank as the Administrative Agent, replacing a five-year 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 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 0.875% to 1.375% (2.06% at December 31, 2003 and 2.26% at December 31, 2002) and expires in July 2005. At December 31, 2003 and 2002, $20.0 million and $90.0 million, respectively, of the Credit Facility was outstanding. Additionally, letters of credit totaling $11.0 million and $6.0 million were outstanding at December 31, 2003 and 2002, respectively. Accordingly, our aggregate availability for additional borrowings under the Credit Facility was $119.0 million and $54.0 million at December 31, 2003 and 2002, respectively. Prior to July 29, 2002, the Company had available an unsecured credit facility providing for maximum borrowings of $140 million. The former credit facility was comprised of a revolving credit facility of $125 million, and a term loan of $15 million. The credit facility, which bore interest at LIBOR plus 0.50%, expired in January 2003. All borrowings outstanding under the former credit facility were fully repaid in July 2002. The Company issues stand-by letters of credit provided by a $20 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 $11.0 million and $6.0 million were outstanding at December 31, 2003 and 2002, 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 out- standing borrowings under the Company’s former revolving credit facility. The Company leases certain computer equipment under capitalized leases. The lease agreements have terms ranging from 30 months to 36 months, expiring from 2004 to 2006. At December 31, 2003, the monthly installments under these agreements were approxi- mately $85,000. The present value of the future minimum lease payments under these agreements totaled $882,000 and $549,000 at December 31, 2003, and 2002, respectively, which has been classified as long-term debt in the accompanying consolidated financial statements. During 2003, 2002 and 2001, the Company purchased $1,426,000, $812,000 and $467,000, respectively, of assets under capitalized leases. pag e 4 4 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) Additionally, the Company has various unsecured notes payable to individuals and banks, amounting to $81,000 and $172,000, at December 31, 2003, and 2002, respectively. The weighted-average interest rate on these notes is 7.2% with monthly installments of approximately $2,000 including interest. Principal maturities of long-term debt for each of the next five years ending December 31, are as follows: (amounts in thousands) 2004 2005 2006 2007 2008 Thereafter $ 925 20,650 75,305 17 25,005 – $121,902 Cash paid by the Company for interest during the years ended December 31, 2003, 2002, and 2001, amounted to $6,864,000, $9,248,000, and $9,092,000, respectively. note 6 – commitments 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 $44.2 million at December 31, 2003, 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 Financial Interpretation No. 46. Future minimum rental commitments under the Facility have been included in the table of future minimum annual rental commitments below. On December 29, 2000, the Company completed a sale-leaseback transaction. Under the terms of the transaction, the Company 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 is approximately $5.5 million annually and is included in the table of future minimum annual rental commitments below. In August 2001, the Company 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 the Company. 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. pag e 4 5 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) 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, 2003, 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) 2004 2005 2006 2007 2008 Thereafter related parties $ 3,255 3,062 2,882 2,865 2,790 52,732 $ 67,586 non-related parties $ 29,416 27,016 25,240 22,909 19,627 129,488 $ 253,696 total $ 32,671 30,078 28,122 25,774 22,417 182,220 $ 321,282 Rental expense amounted to $31,865,000, $29,652,000 and $25,122,000 for the years ended December 31, 2003, 2002, and 2001, respectively. Other Commitments The Company had construction commitments, which totaled approximately $52.8 million, at December 31, 2003. note 7 – legal proceedings The Company is involved in various legal proceedings incidental to the 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, they will have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company. note 8 – employee benefit plans 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 1,600,000 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 $4,353,000 in 2003, $3,438,000 in 2002 and $3,207,000 in 2001. 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 2003 2002 2001 shares 42,183 38,354 37,567 market value $1,478,000 1,136,000 969,000 pag e 4 6 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) 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 2003 2002 2001 market shares 85,184 77,876 88,118 value $2,300,000 2,200,000 1,729,000 The Company also sponsors a non-funded non-contributory defined benefit health care plan, which provides certain health benefits to qualified retired employees. According to the terms of this plan, retirees’ annual benefits are limited to $1,000 per employee starting at age 66 for employees with 20 or more years of service. Post-retirement benefit costs for each of the years ended December 31, 2003, 2002, and 2001 amounted to $12,000. Additionally, the Company has adopted a stock purchase plan under which 1,300,000 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 2003 2002 2001 shares 103,457 102,662 97,991 weighted average price $27.52 25.18 22.13 market value $2,723,000 2,585,000 2,168,000 The Company has in effect a performance incentive plan for the Company’s senior management under which 400,000 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 2003 2002 2001 shares 10,530 4,779 (536) market value $ 248,000 175,000 (9,000) pag e 4 7 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) note 9 – shareholders’ equity 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 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 12,000,000 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. Options granted pursuant to the plan become exercisable no sooner than six months from the date of grant. 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, 2000 Granted Exercised Canceled Outstanding at December 31, 2001 Granted Exercised Canceled Outstanding at December 31, 2002 Granted Exercised Canceled Outstanding at December 31, 2003 price per share $ 8.00 - 26.75 18.25 - 37.62 8.15 - 26.37 8.00 - 37.38 $ 8.69 - 37.62 24.96 - 35.48 8.69 - 30.23 8.75 - 38.00 $ 8.94 - 37.62 23.01 - 44.81 8.94 - 37.62 8.94 - 38.98 $10.56 - 44.81 number of shares 3,295,830 1,214,750 (1,012,695) (220,750) 3,277,135 712,500 (296,858) (202,075) 3,490,702 1,035,750 (1,051,940) (222,413) 3,252,099 Options to purchase 1,223,409, 1,566,104 and 1,250,261 shares of common stock were exercisable at December 31, 2003, 2002, and 2001, respectively. pag e 4 8 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) The Company also maintains a stock option plan for non-employee directors of the Company under which 500,000 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, 2000 Granted Exercised Outstanding at December 31, 2001 Granted Outstanding at December 31, 2002 Granted Outstanding at December 31, 2003 price per share $ 9.09-23.91 20.65 9.09-23.91 $12.44-23.91 29.02 $12.44-29.02 29.20 $12.44-29.20 number of shares 90,000 30,000 (70,000) 50,000 30,000 80,000 30,000 110,000 All options under this plan were exercisable at December 31, 2003, 2002, and 2001. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee and non-employee director stock options under the fair value method. The fair values for these options were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2003, 2002, and 2001, respectively: risk-free interest rates of 3.61%, 4.01% and 5.16%; volatility factors of the expected market price of the Company’s common stock of .458, .481, and .475; and weighted-average expected life of the options of 9.4, 9.0 and 9.0 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, 2003, 2002, and 2001 were $20.56, $17.75 and $16.52, respectively. The weighted-average remaining contractual life at December 31, 2003, for all outstanding options under the Company’s stock option plans is 7.5 years. The weighted-average exercise price for all outstanding options under the Company’s stock option plans was $26.11, $22.78 and $20.63 at December 31, 2003, 2002 and 2001, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing model does not necessarily provide a reliable single measure of the fair value of its employee stock options. pag e 4 9 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) note 10 – income per common share 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: 2003 2002 2001 $100,087 $ 81,992 $ 66,352 Denominator for basic income per common share- weighted-average shares Effect of stock options (Note 9) 53,908 622 Denominator for diluted income per common share- adjusted weighted-average shares and assumed conversion 54,530 Basic net income per common share Net income per common share-assuming dilution $ 1.86 $ 1.84 53,114 578 53,692 $ 1.54 $ 1.53 52,121 665 52,786 $ 1.27 $ 1.26 note 11 – income taxes 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 Inventory carrying value 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 2003 2002 $ 373 – 6,973 7,346 2,593 29,171 277 32,041 $ 327 967 3,746 5,040 – 15,685 254 15,939 $ (24,695) $ (10,899) pag e 5 0 n ot e s to co n s o l i d at e d f i n a n c i a l s tat e m e n ts (continued) The provision for income taxes consists of the following: current deferred total (In thousands) 2003: Federal State 2002: Federal State 2001: Federal State $ 41,465 4,694 $ 46,159 $ 39,038 4,286 $ 43,324 $ 30,429 3,575 $ 34,004 $ 12,362 1,434 $ 13,796 $ $ 5,113 553 5,666 $ 5,702 669 $ 6,371 $ 53,827 6,128 $ 59,955 $ 44,151 4,839 $ 48,990 $ 36,131 4,244 $ 40,375 2001 37,354 2,775 246 40,375 $ $ 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 2003 $ 56,015 3,935 5 $ 59,955 2002 45,844 3,140 6 48,990 $ $ 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. During the years ended December 31, 2003, 2002, and 2001, cash paid by the Company for income taxes amounted to $43,007,000, $31,119,000 and $28,676,000, respectively. pag e 5 1 re p o rt o f i n d e pe n d e n t au d i to r s the board of directors and shareholders o’reilly automotive, inc. and subsidiaries We have audited the accompanying consolidated balance sheets of O’Reilly Automotive, Inc. and Subsidiaries as of December 31, 2003, and 2002, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. 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 auditing standards generally accepted in the 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, 2003, and 2002, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Kansas City, Missouri February 19, 2004 pag e 5 2 d i re c to r s a n d e xe c u t i v e co m m i t t e e Chub O’Reilly Chairman of the Board Emeritus Charlie O’Reilly Vice Chairman of the Board and Director David O’Reilly Co-Chairman of the Board and Chief Executive Officer and Director Larry O’Reilly Co-Chairman of the Board and Director Rosalie O’Reilly-Wooten Director Jay Burchfield Director since 1997 Compensation Committee – Chairman Corporate Governance/ Paul Lederer Director 1993-July 1997; Feb. 2001 Audit Committee Compensation Committee John Murphy Director since December 2003 Audit Committee – Chairman Corporate Governance/ Nominating Committee Ronald Rashkow Director since December 2003 Audit Committee Compensation Committee Ted Wise Co-President Greg Henslee Co-President Jim Batten Executive Vice President Nominating Committee of Finance Joe C. Greene Director since 1993 Corporate Governance/ Nominating Committee – Chairman Chief Financial Officer Jeff Shaw Senior Vice President of Store Operations and Sales Mike Swearengin Senior Vice President of Merchandise Tricia Headley Vice President of Corporate Services and Corporate Secretary Tony Bartholomew Vice President of Sales Ron Byerly Vice President of Marketing, Advertising and Training Charlie Downs Vice President of Real Estate Alan Fears Vice President of Store Expansion and Acquisitions Jaime Hinojosa Vice President of Southern Division Steve Jasinski Vice President of Information Systems Randy Johnson Vice President of Store Inventories David McCready Vice President of Distribution Operations Steve Pope Vice President of Human Resources Wayne Price Vice President of Risk Management Barry Sabor Vice President of Loss Prevention Mike Williams Vice President of Advanced Technology s e n i o r m a n ag e m e n t Allen Alexander Director of Iowa/Nebraska Region Buddy Ball Director of Kansas City Region Mike Ballard Director of Internet Development and Networking Greg Beck Director of Purchasing o pe r at i o n s m a n ag e m e n t Bert Bentley Director of Houston Region Tom Connor Regional DC Director Brett Heintz Director of Retail Systems Rob Bodenhamer Director of Technology Development Larry Boevers Regional DC Director Doug Bragg Director of Oklahoma Region Phyllis Evans Director of Store Administration Ken Cope Director of Nashville Region Jack House Director of Customer Service Joe Edwards Director of Store Installations Greg Johnson Director of Distribution Michelle Kimrey Director of Internal Audit Brad Knight Director of Pricing Richard Mann Regional DC Director Mike Chapman Director of West Texas Region John Grassham Director of Dallas Region Keith Childers Director of Little Rock Region Joe Hankins Director of Store Design pag e 5 3 Jim Deshotel Regional Field Sales Manager Doy Hensley Help Support Manager o pe r at i o n s m a n ag e m e n t (continued) Kenny Martin Director of Gulf States Region Jim Maynard Director of Employment and Team Member Relations Kim Mesenbrink Director of Accounting Brad Oplotnik Director of Systems Management Shari Reaves Director of Compensation and Benefits Steve Rice Director of Credit and Collections Art Rodriguez Director of Southern Division Sales Tom Seboldt Director of Merchandise Denny Smith Director of Springfield Region Dick Smith Director of Construction and Maintenance Charlie Stallcup Director of Training David Strom Director of Houston Region Mark Van Hoecke Director of Knoxville Region Wes Wise Director of Marketing Danny Woods Director of Installer Marketing co r p o r at e m a n ag e m e n t Tom Allen Computer Operations Manager Dan Altis Distribution Center Manager Keith Asby Sales Manager of Special Markets Jay Enloe Property and Liability Risk Manager Paula Eyman Accounting Special Projects Manager Jeanene Asher Telecommunications Manager Carl Falke Regional Field Sales Manager Gary Baker Technical Assistance Manager Becky Fincher Advertising Manager Carl Barina Regional Field Sales Manager Doug Bennett O’Reilly Sales Department Manager Ron Biegay Southern Division Training and Recruiting Manager Kevin Ford Distribution Center Projects and Procedures Manager Randy Freund Regional Field Sales Manager David Furr Service Equipment Sales Manager Larry Blundell Regional Field Sales Manager Lori Fuzzell Customer Service Manager Tom Bollinger Regional Field Sales Manager Art Glidewell Distribution Center Manager Marcus Boyer Distribution Center Manager David Glore Jobber Sales Manager Kent Brewer Distribution Center Transportation Manager Yvonne Cannon Payroll Manager Garry Curbow Replenishment Manager Garry Glossip Store Accounting Manager Ron Greenway Tax Manager Larry Gregory Real Estate Store Maintenance Manager Cecil Davis Distribution Center Inbound Manager Kevin Greven Retail Marketing and Promotions Manager Mark Decker Distribution Center Manager Bridget Harmon PC Support Manager Ray Aguirre Regional Field Sales Manager Randy Decoito Regional Field Sales Manager Mike Hauk Division Training Manager pag e 5 4 Julie Hibler Corporate Services Manager Diana Hicks Internal Communications Manager Brad Hilker Safety Manager Mark Hoehne Regional Field Sales Manager Chris Holder Jobber Regional Field Sales Manager Joe Hook Regional Field Sales Manager Doug Hopkins Distribution Systems Manager Doug Hutchison Inventory Project Manager Karen James Marketing Production Manager Curtis Johnson Distribution Center Manager Dave Jordan Distribution Center Manager Al Kasishke Product Manager Les Keeth Supplier Credit Manager Jennifer Kent Store Design Manager Dave Leonhart Distribution Center Manager Steve Lines Sales Training Manager Jim Litchford Jobber Regional Field Sales Manager o pe r at i o n s m a n ag e m e n t (continued) Jeff Main Jobber Systems Sales Manager Ed Randall Property Manager Darren Shaw Product Manager Tamra Waitman Assistant Controller Ed Martinez Distribution Center Manager Lyn Robertson Accounts Receivable Manager Tim Smith Credit Manager Jeff McKinney Customer Satisfaction Manager Bryan Mescher Regional Field Sales Manager Chapman Norman Inventory Maintenance Manager Steve Peterie Construction Design Manager Tony Phelps Distribution Center Manager Jana Phillips Corporate Counsel Steve Phillips Southern Division Loss Prevention Manager Chuck Rogers Installer Systems Manager Tom Smith Training Manager Mary Sabor Distribution Center Administrative Services Manager Rick Samsel Inventory Control Manager Tim Scholl Distribution Center Field Projects Manager Joyce Schultz Houston Office Manager Bill Seiber Distribution Center Manager Dwayne Snow Regional Field Sales Manager Paul Stinson Regional Field Sales Manager Mary Stratton Human Resources Records Manager Bert Tamez Regional Manager in Training Tom Tunnell Financial Reporting and Budgeting Manager Rob Verch Product Manager Patton Walden MidState Division Training Manager Jeff Watts Regional Field Sales Manager Larry Wiles Audio Visual Communications Manager Saundra Wilkinson Store Support Manager Joe Winterberg Product Manager Terry Yates Regional Field Sales Manager d i s t ri c t co r p. m g m t. Abel Abila Gary Addison Eddie Allen Henry Armington Chuck Avis Emmitt Barina Brince Beasley Brad Beckham Steve Beil Aaron Biggs Kirk Bilski Tim Brakebill Patrick Brown David Byers Mark Cannon Fred Carrington Jimmy Carter David Chavis Dirk Chester Jim Dickens Robert Doss Bruce Dowell Dan Dowell Tommy Dunn Paul Engaldo Ron England Tony Fagan Bill Fellows Kirk Frazier Mark Frazier Jason Frizzell Scott Garrett Samuel Garza Dennis Gonzales Kyle Gorzik James Harris Jon Haught Rick Hedges Gerry Hendrix Perry Hess Mike Hollis Jeff Howard Jeff Jennings Chad Keel Butch Kelton Todd Kemper Scott Kraus John Krebs Scott Leonhart Chris Lewis Kirk Locklin Oliverio Lopez Mark Mach John Martinez Rodger McClary Marc McGehee Travis McPherson Chris Meade Curt Miles Randy Morris Ciro Moya Ramon Odems Kenny Omland Kevin Overmon Ron Papay Jude Patterson Mike Payne Pernell Peters David Pilat Mike Platt Will Reger Tommy Rhoads Alan Riddle Larry Roof Juan Salinas Jim Scott Brad Seaborn Cliff Sedtal Steve Severe Garry Shelby Kevin Shockey Eric Sims Mark Smith Bob Snodgrass Robert Spencer Scott Strayhorn Jeff Stutzman Marvin Swaim Randy Swaim Jeff Tagert Randy Tanner Mike Tatum Rick Tearney Dallas Thompson Justin Tracy Bo Waldrop Brett Warstler Steven Watkins John Weatherly Rob Weiskirch John Wells Allen Wise Dexter Woods Mike Yates Jason York Cody Zimmerman pag e 5 5 s h a re h o l d e r i n f o r m at i o n corporate address 233 South Patterson Springfield, Missouri 65802 417/862-3333 Web site – www.oreillyauto.com registrar and transfer agent 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. independent auditors Ernst & Young LLP One Kansas City Place Kansas City, Missouri 64105-2143 legal counsel Gallop Johnson & Neuman, L.C. 101 South Hanley Road, Suite 1600 St. Louis, Missouri 63105 Skadden, Arps, Slate, Meagher & Flom 333 West Wacker Drive, Suite 2100 Chicago, Illinois 60606 annual meeting The annual meeting of shareholders of O’Reilly Automotive, Inc. will be held at 10:00 a.m. local time on May 4, 2004, at the University Plaza Convention Center, 333 John Q. Hammons Parkway in Springfield, Missouri. Shareholders of record as of February 27, 2004, will be entitled to vote at this meeting. form 10-k report 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. trading symbol The Company’s common stock is traded on The Nasdaq Stock Market (National Market) under the symbol ORLY. number of shareholders As of February 27, 2004, O’Reilly Automotive, Inc. had approximately 26,299 shareholders based on the number of holders of record and an estimate of the number of individual participants represented by security position listings. analyst coverage The following analysts provide research coverage of O’Reilly Automotive, Inc.: Advest, Inc. – Derrick Irwin AG Edwards & Sons – Brian Postol Lehman Brothers Equities Research – Alan Rifkin Raymond James & Associates – Gerald Marks Sidoti & Company – Scott Stember Smith Barney – Bill Sims SunTrust Robinson Humphrey Capital Markets – Frank Brown Wells Fargo Securities, LLC – Christopher Svezia Whitaker Securities LLC – Cid Wilson William Blair & Company – Sharon Zackfia UBS Equities – Gary Balter Piper Jaffray – Reed Anderson market prices and dividend information 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. 2003 2002 First Quarter Second Quarter Third Quarter Fourth Quarter For the Year high $27.86 35.39 39.96 44.90 44.90 low $22.91 26.76 33.23 36.54 22.91 high $37.25 34.42 32.47 31.40 37.25 low $28.61 27.05 24.10 24.28 24.10 subsidiaries of the company subsidiary state of incorporation Ozark Automotive Distributors, Inc. Greene County Realty Co. O’Reilly II Aviation, Inc. Ozark Services, Inc. Hi-Lo Investment Co. Hi-Lo Management Co. 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. pag e 5 6 p i c t u re d a b ov e a re t h e o r i g i n a l t e a m m e m b e r s a n d f o u n d e r s o f O ’ R e i l ly Au to m ot i ve . L to R: Red Hale, Wayne Schuler, Paul Ankrom, Jewel Sechler, C.F. O’Reilly, Chub O’Reilly, Ann Drennan, Bob Bach, Hubert Cox, Tony O’Reilly and Paul Branson. Not pictured are Vic Semmelbeck and Chris Bridwell. M i s s i o n S tat 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.” Certain statements contained in this annual report are forward-looking statements. These statements discuss, 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 in these forward-looking statements. Please refer to the Risk Factors sections of the company’s Form 10-K for the year ended December 31, 2003, for more details. m o c . n o s i r r a h k l a f . w w w i r u o s s i M , s i u o L . t S , e v i t a e r C n o s i r r a H k l a F : n g i s e D 2 0 0 3 O ’ R e i l l y A u t o m o t i v e A n n u a l R e p o r t S e e i n g G re e n . Th e co lo r o f re s u lts . An in-depth look at the performance of our company and the culture that brands it – O’Reilly Automotive. 233 South Patterson Springfield, Missouri 65802 417-862-3333 www.oreillyauto.com 2 0 0 3 O ’ R e i l l y A u t o m o t i v e A n n u a l R e p o r t 

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