O’Reilly Automotive Annual Report 2007

Plain-text annual report

Making Connections for 50 Years The O’Reilly Fundamental Difference 2007 Annual Report Financial Highlights In thousands, except earnings per share data and operating data (a) years ended december 31 Sales Operating Income Net Income(a) Working Capital Total Assets Total Debt Shareholders’ Equity 2007 $2,522,319 305,151 193,988 573,328 2,279,737 100,469 1,592,477 2006 2005 2004 2003 $2,283,222 $2,045,318 $1,721,241 $1,511,816 282,315 178,085 566,892 252,524 164,266 424,974 190,458 117,674 479,662 165,275 100,087 441,617 1,977,496 1,718,896 1,432,357 1,157,033 110,479 100,774 1,364,096 1,145,769 100,914 947,817 121,902 784,285 Net Income Per Common Share (assuming dilution) Weighted-Average Common Shares (assuming dilution) Stores At Year-End Same-Store Sales Gain 1.67 116,080 1,830 3.7% 1.55 1.45 1.05 0.92 115,119 113,385 111,423 109,060 1,640 3.3% 1,470 7.5% 1,249 6.8% 1,109 7.8% O’Reilly generated another solid year of sales and earnings in 2007. Our commitment to providing the right part at the right price while maintaining industry-leading customer service levels continues to be the fuel for our growth. 2007 marked the 15th consecutive year of record revenue and earnings and positive comparable store sales increases since we became a public company in 1993. E A R N I N G S P E R S H A R E (a) (assuming dilution) 7 6 . 5 1 5 . 1 5 4 . 1 5 0 . 2 1 9 . 0 N E T I N C O M E (a) (in thousands) 8 8 9 , 3 9 1 5 8 0 , 8 7 1 6 6 2 , 4 6 1 4 7 6 , 7 1 1 7 8 0 , 0 0 1 O P E R AT I N G I N C O M E (a) (in thousands) 1 5 1 , 5 0 3 5 1 3 , 2 8 2 4 2 5 , 2 5 2 8 5 4 , 0 9 1 5 7 2 , 5 6 1 ‘03 ‘04 ‘05 ‘06 ‘07 ‘03 ‘04 ‘05 ‘06 ‘07 ‘03 ‘04 ‘05 ‘06 ‘07 Our focus remains on profitable growth which resulted in a 7.7% increase in Earning Per Share to $1.67 in 2007. We continue to grow market share while maintaining our commitment to providing unparalleled customer service which resulted in an increase in Net Income of 8.9% to $194 million in 2007. Operating income increased 8.1% to $305 million in 2007 as a result of our continued improvements in vendor relationships and distribution system efficiencies. (a) 2004 f igures are based on income before cumulative effect of accounting change. C O M PA R I S O N O F F I V E -Y E A R C U M U L AT I V E R E T U R N o’reilly auto parts nasdaq retail trade stocks nasdaq us market $ 300 200 100 dec. ,  dec. ,  dec. ,  dec. ,  dec. ,  dec. ,  Letter to Shareholders the professional expertise that they expect and the parts availability that they need. At the core of our customer service culture is the partnership that we form with our customers. Our experience over the past 50 years has provided ample evidence that the auto parts business is a relationship business. We work diligently to build these relationships with our professional installer customers who count on us to consistently provide them with industry-leading parts availability and technical expertise. We understand that our success is contingent on their success, so we focus on the key factors that make their businesses profitable. We maintain the best in-stock parts availability in the automotive aftermarket business, so that our professional installers can get the parts they need quickly and can maximize the efficiency and profitability of their shops. We recruit and train the best parts people because our customers expect a very high level of expertise … the wrong part delivered to one of our professional installers means a repair job gets delayed and their customer is disappointed. So we focus on training through our e-learning system and hands-on mentoring of our store operations management. Our focus on training and mentoring the best parts people in the business allows us to establish and maintain a strong In 1957, Charles F. “C.F.” O’Reilly and his son, Charles H. “Chub” O’Reilly, along with 11 team members, opened the first O’Reilly Auto Parts store in Springfield, Missouri, and established the blueprint that has powered the growth of our company through 50 years and 1,830 new stores. The key elements of that blueprint haven’t really changed over the past 50 years since the opening of that first store. Team O’Reilly continues to be unwavering in its commitment by providing the best possible service to our customers and by working hard each and every day. At the center of our success are our people. Our financial success in 2007 reflect the thousands of daily interactions between our professional parts people and our customers. Our commitment to service means that we strive on a daily basis to make a connection with our customers by providing Wisdom comes with age – a glance at our 50-year journey. 1957 Chub O'Reilly and his father, C.F. O'Reilly, made the decision to open O'Reilly Automotive, Inc. They began with a single store and 11 team members at 403 Sherman in Springﬁeld, Mo. 1958 After our ﬁrst full year in business, sales totaled $700,000. 1961 Ozark Automotive Distributors was formed to specialize in wholesale distribution to independent auto parts stores. 1964 O’Reilly Automotive added its ﬁrst branch store at Glenstone and Bennett in Springﬁeld, Mo. 1 S A L E S (in billions) 5 . 2 3 . 2 0 . 2 7 . 1 5 . 1 2.5 2.0 1.5 1.0 .5 0 ‘03 ‘04 ‘05 ‘06 ‘07 Our dual market strategy and 50 years of experience in providing industry-leading customer service resulted in a 10.5% increase in sales to $2.52 billion in 2007. connection with our do-it-yourself customers. Do-it-yourself customers require more from their shopping experience than a cashier at a register. They seek out our professional parts people and rely on their professional expertise. If you spend any time in one of our stores, you quickly realize that the majority of our DIY sales are the culmination of a conversation at the counter where an O’Reilly team member works with the customer to get the right part to solve their problem. We know that our success in these individual encounters is the key to capturing our customer’s repeat business and word-of-mouth business, which leads to increased share in our markets. We constantly focus on meeting the highest service standards to ensure customer satisfaction. 2007 was a year of challenges for O’Reilly Auto Parts and our customers. After a strong start to the year, the demand in our markets softened as our customers encountered significant financial pressures due to higher energy costs and the generally difficult economic conditions. In this challenging environment, Team O’Reilly remained dedicated to providing the best service and value to our customers and achieved comparable store sales growth of 3.7%, which led our industry. In 2007, our team extended O’Reilly Auto Part’s track record of significant profitable growth through continued focus on exceptional customer service and expense control. We also added 190 new stores while delivering an operating margin of 12.1% and 7.7% earnings per share growth. We are pleased to have achieved total sales growth of 10.5% while increasing inventory only 8.5%. We were able to grow sales at a rate greater than inventory due to continued leverage of our core competency in inventory management. Our focus on deploying the right inventory assortment in our stores has allowed us to reduce average inventory per store even as sales volume has grown. We view the recent challenges in the macroeconomic environment to be temporary and continue to be very optimistic about the long-term prospects for growth and profitability in our industry. Even during the difficult economic conditions faced by consumers in 2007, the total number of miles driven in the United States remained stable. The total number of miles driven is one of the key factors that drives demand in the 1974 With nine stores operating in southwest Missouri, we broke ground on a new 48,000 square-foot distribution center. 1978 Our “Dual Market Strategy” was born to maximize sales in the professional installer and DIY businesses. 1979 O’Reilly began enhanced advertising campaigns with the addition of our animated little red van, which helped make O’Reilly a household brand. 1980 O’Reilly held ﬁrst Managers’ Conference at Kentwood Arms Hotel, Springﬁeld, Mo. 2 automotive aftermarket business. We are confident that the American consumer will adjust to economic pressures and that miles driven will be a positive contributor to demand over the long term. Over the past several years, the average age of the vehicle population in the United States, for both cars and light trucks, has seen significant increases. We expect that these increasing vehicle age trends will continue due to the higher quality level of the drive trains and key interior and exterior components in newer vehicles. These higher- mileage vehicles go through more routine maintenance and repair cycles and represent a significant driver of demand for our products. We are uniquely positioned to capitalize on the growth of the automotive aftermarket industry because of our time-tested, dual-market strategy that is unmatched by Our 14 distribution centers are staffed by over 3,300 dedicated team members who fill over 400,000 orders each day. When a customer requests a hard-to-find part, it is immediately picked and delivered to the store within 24 hours. any of our competitors. This core competency enables us to take advantage of growth in demand in both the DIY and the DIFM sides of our business and contributes to our consistent financial performance, particularly during these difficult economic conditions. Our ability to execute our dual-market strategy is the result of over 50 years of experience and a sustained commitment to building relationships, by providing our customers with the best parts availability in the business through an expansive network of 14 distribution centers supported by over 100 master inventory stores. Our competitive advantage in distribution is amplified by our sophisticated inventory management systems that customize the product assortment stocked at each store based upon market demand and vehicle registration data. Our ability to equip our highly-trained professional parts people with timely access to the parts our customers need translates into consistent customer satisfaction and loyalty. Building upon our proven dual-market strategy, we are planning to continue our aggressive growth in 2008 and have established a goal of opening 205 new stores. Store growth in 2008 will follow our strategy of concentrating new store openings in contiguous geographic markets, enabling us to quickly leverage our distribution, operating and advertising investment. In 2008, we will open our 15th distribution center in Lubbock, Texas, providing capacity for further growth 1983 O’Reilly Automotive reaches its 25 anniversary with 37 stores in Missouri and the Ozarks. 1993 O’Reilly went public and began oﬀering stock on the NASDAQ market under the symbol ORLY at $17.50 per share. 1993 O’Reilly opened our second distribution center in Kansas City, Mo. 1996 O’Reilly opened our 200th store in St. Joseph, Mo. 3 From the 11 team members who joined our founders to open the first O’Reilly Auto Parts store in 1957 to the 23,576 team members who staff our 1,830 stores, 14 distribution centers and corporate offices today, the culture at Team O’Reilly has truly been the foundation that has always set our company apart and allowed us to become the dominant auto parts supplier in the markets we serve. We understand that “culture” or “core values” is a popular and even overused conversation point for many companies. Our culture goes beyond a catchy corporate slogan … it is reflected in the daily activities of each of our team members. We understand the importance of our culture and the impact it has had on our 50 years as a company, and our top priority is perpetuating our culture values which have been such a meaningful contributor to our success. On behalf of Team O’Reilly, we want to express appreciation to our valued customers and shareholders. We are extremely excited about the outlook for O’Reilly Auto Parts and pledge to be the dominant auto parts supplier in our markets. Our co-founder, C.F. O’Reilly once said, “People do business with people they like”. Highly trained Parts Specialists offer industry leading customer service to each and every one of our customers. in one of our stronghold markets. Acquisitions have historically been a key component of our growth, and we continue to view our company as a consolidator in the automotive aftermarket industry. We will not waver from our commitment to profitable growth in our expansion strategy and will continue to exercise discipline in our selection of acquisition targets that fit our culture and return value to our shareholders. As each member of Team O’Reilly helps drive us on to achieving our sales goals, our customers and shareholders will reap the rewards of our continued success. DAVID O’REILLY Chairman of the Board GREG HENSLEE TED WISE TOM MCFALL Chief Executive Officer and Co-President Chief Operating Officer and Co-President Chief Financial Officer and Executive Vice President 1998 O’Reilly merged with Hi/LO Auto Supply, adding 182 stores in Texas and Louisiana, as well as a distribution center in Houston, Texas. This merger increased our total store count to 491 stores. 2001 O’Reilly acquired Mid-State Automotive Distributors, ending 2001 with 875 stores, 12,676 team members and over $1 billion in sales. 2005 O’Reilly reached $2 billion in sales and purchased Midwest Automotive Distributors, Inc., adding 71 stores in Minnesota, Montana, North Dakota, South Dakota, Wisconsin and Wyoming, and DCs in St. Paul, Minn. and Billings, Mont. 2007 Team O’Reilly celebrated 50 years in the auto parts industry with 1,830 stores, 23,576 team members and over $2.5 billion in sales. 4 Making Connections for 50 Years The O’Reilly Fundamental Difference At O’Reilly, our focus continues to be on making customer connections by building on the basic fundamentals. We do this by hiring the right people, training them to provide the highest levels of customer service and creating a culture in which our team members can thrive. We have always stayed true to the fundamentals that have set us apart and made us successful, and we continue to look for ways to grow as individuals, as a team and as a company. Making connections with our team members, our customers and our communities will always be a key to our growth and success. 5 Making Connections with our customers From the ﬁrst printed announcement of the opening of O’Reilly Auto Parts to many of the business relationships we enjoy today, friendship and loyalty have always been at the core of our partnerships with our customers. We have been oﬀering our customers the proven hand of friendship, courtesy and consideration, backed by extensive stocks of quality merchandise, and prompt, eﬃcient service since the day our doors opened 50 years ago. In today’s competitive market, it takes more than good prices and quality products to gain and retain customers. We must make their shopping experience memorable by providing service far above the realm of what our customers expect. After all, customer loyalty is not something we get, but something that comes as a result of what we give. We receive countless letters from our customers recounting the great service provided by our team members. They think they’ve received special treatment, but to Team O’Reilly, it’s a way of life. 6 “Since our humble beginning in 1957, we’ve been in the business of making lasting impressions on our customers.” “Bleeding Green” is a term often used by O’Reilly team members to describe our dedication. Since O’Reilly Automotive began in 1957 as a family-owned business, the philosophy has always been to treat team members like family. Our founders understood the importance of investing business trust in our team members and sharing the fruits of the venture as well as the burden. Today, nearly 24,000 dedicated team members work to keep this tradition alive. Making Connections with dedicated team members 7 We have a soft spot in our hearts for our professional installer customers as they were our ﬁrst customers, and we’ve enjoyed serving them since our very beginning. It wasn’t until the recession of the late 1970s that a new breed of automotive customer began to emerge and became known as the do-it-yourselfer. Our ability to successfully serve our traditional installer customers and the do-it-yourselfers led to our dual market strategy and set us apart from our competition. Our store inventories are designed to provide brands that professional installers prefer as well as quality private brands that are competitively priced. We also provide daily deliveries to all stores from our distribution centers and supplement customer needs at many of our stores with multiple deliveries throughout the day. We have extensive marketing programs for our installer customers and a dedicated sales force that delivers a wide array of support and services to our installer customers. We never lose sight of the fact that the better we serve our installer customers, the stronger our relationships become. “We have the systems and the fleet to connect our extensive distribution network to our parts people so we can be responsive to the needs of our installer customers.” Making Connections with installer customers 8 Making Connections with advanced technology Our voice-directed picking systems, e-learning technology, graphical point-of-sale systems, web-based sales and global inventory management systems are just a few of the advanced technologies that help us grow sales, control expenses and maximize proﬁts. These technological advances increase eﬃciencies in our distribution processes, enhance our team members technical knowledge and make a greater assortment of parts available to our customers at competitive prices … every day! 9 Making Connections with new markets In keeping with the “family” connection that is always present for Team O’Reilly, we are eager to be actively involved in our business communities. We make connections with customers as soon as we enter a new market. We let communities know that we are in town, not only to be their ﬁrst choice for auto parts, but also to show our active support for the community by beginning each grand opening ribbon-cutting ceremony with a donation to a local charity. 2000 1500 1000 500 0 0 3 8 , 1 2 7 3 , 1 0 6 7 2 2 1 6 8 ‘87 ‘92 ‘97 ‘02 ‘07 T O TA L N U M B E R O F S T O R E S We successfully opened 190 stores in 2007, bringing our total number of stores to 1,830, and we have plans to open 205 new stores in 2008. 10 O’Reilly distribution centers make an average of 4,000 connections to our stores each day, this high service level is a strong competitive advantage. Virtually every O’Reilly store has access to over 116,000 stock keeping units (SKUs) by same-day or overnight delivery service. We have real-time connectivity to our stores, which allows every store to see not only their servicing DC inventory, but also the entire O’Reilly inventory network. The O’Reilly distribution process connects to our stores in metro markets several times a day. Hub stores act as mini distribution centers and deliver to spoke stores in their area, allowing them to provide an enhanced inventory selection. Our highly automated systems allow for more eﬃcient handling, which means increased service to our stores at reduced costs. We will continue to take advantage of new technologies that will boost our productivity, accuracy and, ultimately, our bottom line, and are committed to strengthening this competitive advantage in 2008 and beyond. 2 0 0 7 O ’ R E I L L Y A U T O P A R T S S T O R E S A N D D I S T R I B U T I O N C E N T E R S DISTRIBU TION CENTERS OPERATING FOOTPRINT ALABAMA ARKANSAS FLORIDA GEORGIA ILLINOIS INDIANA IOWA KANSAS KENTUCKY LOUISIANA 100 90 20 115 61 55 65 63 50 73 stores stores stores stores stores stores stores stores stores stores MINNESOTA MISSISSIPPI MISSOURI MONTANA NEBRASKA NORTH CAROLINA NORTH DAKOTA OHIO OKLAHOMA SOUTH CAROLINA stores 58 stores 63 stores 169 stores 20 27 stores 38 stores stores 7 stores 14 stores 103 stores 32 SOUTH DAKOTA TENNESSEE TEXAS VIRGINIA WISCONSIN WYOMING stores 3 stores 117 stores 467 4 stores 11 stores stores 5 TOTAL NUMBER OF STORES 1,830 Making Connections with distribution efficiency 11 Making Connections with the O’Reilly culture Team O’Reilly is connected through our culture – the grass roots of our early beginnings. Our culture is the glue that holds us all together. We stick together by oﬀering great customer service, watching our expenses, working hard to share the load and having fun. We care for each other, respect each other and help each other to be the best that we can become. When you hear a team member talk about “LIVING GREEN,” they are talking about living all aspects of our culture values. It’s the tool we use to help us accomplish our personal and professional goals and to help lead and inﬂuence our fellow team members. As we continue to strive toward our goal of being the dominant supplier of auto parts in all of our market areas, our key advantage will be the culture that was established by our founders 50 years ago. This culture has been fostered ever since our inception and is at the heart of everything we do as we “LIVE GREEN!” 12 “We depend on our team members to make our company a success and, in the process, our team members succeed.” Making Connections for 50 Years The O’Reilly Fundamental Difference “We’re focused, connected and committed to keeping our minds on the MAIN THING . . . People, Service and Performance! We are ENTHUSIASTIC, HARD-WORKING PROFESSIONALS who are DEDICATED to TEAMWORK, SAFETY and EXCELLENT CUSTOMER SERVICE. We will practice EXPENSE CONTROL, while setting an example of RESPECT, HONESTY and a WIN-WIN ATTITUDE in everything we do!” 13 Selected Consolidated Financial Data (In thousands, except per share data) Years ended December 31, I NCOME STAT EMENT DATA: Sales Cost of goods sold, including warehouse and distribution expenses Gross profit Operating, selling, general and administrative expenses Operating income Other income (expense), net Income before income taxes and cumulative effect of accounting change Provision for income taxes Income before cumulative effect of accounting change Cumulative effect of accounting change, net of tax (a) 2007 2006 2005 $ 2,522,319 $ 2,283,222 $ 2,045,318 1,401,859 1,120,460 815,309 305,151 2,337 307,488 113,500 193,988 -- 1,276,511 1,006,711 724,396 282,315 (50) 282,265 104,180 178,085 -- 1,152,815 892,503 639,979 252,524 (1,455) 251,069 86,803 164,266 -- Net income $ 193,988 $ 178,085 $ 164,266 BASIC EARNI NGS P ER COMMON SHARE: Income before cumulative effect of accounting change Cumulative effect of accounting change (a) Net income per share Weighted-average common shares outstanding EARNI NGS P ER COMMON SHARE-ASSUMI NG DI LU T ION: Income before cumulative effect of accounting change Cumulative effect of accounting change (a) Net income per share $ $ $ $ 1.69 -- 1.69 114,667 1.67 -- 1.67 $ $ $ $ 1.57 -- 1.57 113,253 1.55 -- 1.55 $ $ $ $ 1.47 -- 1.47 111,613 1.45 -- 1.45 Weighted-average common shares outstanding – adjusted 116,080 115,119 113,385 P RO FORMA I NCOME STAT EMENT DATA: (b) Sales Cost of goods sold, including warehouse and distribution expenses Gross profit Operating, selling, general and administrative expenses Operating income Other income (expense), net Income before income taxes Provision for income taxes Net income Net income per share Net income per share – assuming dilution (a) The cumulative change in accounting method, effective January 1, 2004, changed the method of applying LIFO accounting policy for certain inventory costs. Under the new method, included in the value of inventory are certain procurement, warehousing and distribution center costs. The previous method was to recognize those costs as incurred, reported as a component of costs of goods sold. (b) The pro forma income statement reflects the retroactive application of the cumulative effect of the accounting change to historical periods. 14 Selected Consolidated Financial Data (continued) 2004 2003 2002 2001 2000 1999 1998 $ 1,721,241 $ 1,511,816 $ 1,312,490 $ 1,092,112 $ 890,421 $ 754,122 $ 616,302 978,076 743,165 552,707 190,458 (2,721) 187,737 70,063 117,674 21,892 873,481 638,335 473,060 165,275 (5,233) 160,042 59,955 100,087 -- 759,090 553,400 415,099 138,301 (7,319) 130,982 48,990 81,992 -- 624,294 467,818 353,987 113,831 (7,104) 106,727 40,375 66,352 -- 507,720 382,701 292,672 90,029 (6,870) 83,159 31,451 51,708 -- 428,832 325,290 248,370 76,920 (3,896) 73,024 27,385 45,639 -- 358,439 257,863 200,962 56,901 (6,958) 49,943 19,171 30,772 -- $ 139,566 $ 100,087 $ 81,992 $ 66,352 $ 51,708 $ 45,639 $ 30,772 $ $ $ $ 1.07 0.20 1.27 110,020 1.05 0.20 1.25 $ $ $ $ 0.93 -- 0.93 107,816 0.92 -- 0.92 $ $ $ $ 0.77 -- 0.77 106,228 0.76 -- 0.76 $ $ $ $ 0.64 -- 0.64 104,242 0.63 -- 0.63 $ $ $ $ 0.51 -- 0.51 102,336 0.50 -- 0.50 $ $ $ $ 0.47 -- 0.47 97,348 0.46 -- 0.46 $ $ $ $ 0.36 -- 0.36 84,952 0.36 -- 0.36 111,423 109,060 107,384 105,572 103,456 99,430 86,408 $ 1,511,816 $ 1,312,490 $ 1,092,112 $ 890,421 $ 754,122 $ 616,302 872,658 639,158 473,060 166,098 (5,233) 160,865 60,266 100,599 0.93 0.92 $ $ $ 754,844 557,646 415,099 142,547 (7,319) 135,228 50,595 84,633 0.80 0.79 $ $ $ 618,217 473,895 353,987 119,908 (7,104) 112,804 42,672 70,132 0.67 0.66 $ $ $ 501,567 388,854 292,672 96,182 (6,870) 89,312 33,776 425,229 328,893 248,370 80,523 (3,896) 76,627 28,747 350,581 265,721 200,962 64,759 (6,958) 57,801 22,141 $ 55,536 $ 47,880 $ 35,660 $ $ 0.54 0.54 $ $ 0.49 0.48 $ $ 0.42 0.41 15 Selected Consolidated Financial Data (continued) (In thousands, except per share data) Years ended December 31, SELECT ED OP ERAT I NG DATA: Number of stores at year-end (a) Total store square footage at year-end (in 000’s)(a)(b) Sales per weighted-average store (in 000’s)(a)(b) Sales per weighted-average square foot (b)(d) Percentage increase in same store sales (c) BALANCE SH EET DATA: Working capital Total assets Current portion of long-term debt and short-term debt Long-term debt, less current portion Shareholders’ equity 2007 2006 2005 1,830 12,439 1,430 212 $ $ 1,640 11,004 1,439 215 $ $ 1,470 9,801 1,478 220 $ $ 3.7% 3.3% 7.5% $ 573,328 $ 566,892 $ 424,974 2,279,737 1,977,496 1,718,896 25,320 75,149 1,592,477 309 110,170 1,364,096 75,313 25,461 1,145,769 (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. Sales per weighted-average store and square foot are weighted to consider the approximate dates of store openings or expansions. (c) Same-store sales are calculated based on the change in sales of stores open at least one year. Prior to 2000, same-store sales data was calculated based on the change in sales of only those stores open during both full periods being compared. Percentage increase in same-store sales is calculated based on store sales results, which exclude sales of specialty machinery, sales by outside salesmen and sales to team members. (d) 1998 does not include stores acquired from Hi/LO. Consolidated sales per weighted-average square foot were $207. 16 Selected Consolidated Financial Data (continued) 2004 2003 2002 2001 2000 1999 1998 1,249 8,318 1,443 217 $ $ 1,109 7,348 1,413 215 $ $ 981 6,408 1,372 211 $ $ 875 5,882 1,426 219 $ $ 672 4,491 1,412 218 $ $ 571 3,777 1,422 223 $ $ 491 3,172 1,368 238 $ $ 6.8% 7.8% 3.7% 8.8% 5.0% 9.6% 6.8% $ 479,662 $ 441,617 $ 483,623 $ 429,527 $ 296,272 $ 249,351 $ 208,363 1,432,357 1,157,033 1,009,419 592 100,322 947,817 925 120,977 784,285 682 190,470 650,524 856,859 16,843 165,618 556,291 715,995 49,121 90,463 463,731 610,442 19,358 90,704 403,044 493,288 13,691 170,166 218,394 17 Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 installer service equipment. We calculate same-store sales based on the change in sales for stores open at least one year. We calculate the percentage increase in same-store sales based on store sales results, which exclude sales of specialty machinery, sales by outside salesmen and sales to team members. Cost of goods sold consists primarily of product costs and warehouse and distribution expenses. Cost of goods sold as a percentage of 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 costs, advertising expenses, depreciation, general and administrative expenses, information technology expenses, professional expenses and other related expenses. C R I T I C A L A C C O U N T I N G P O L I C I E S A N D E S T I M AT E S The preparation of our financial statements in accordance with accounting policies generally accepted in the United States (“GAAP”) requires the application of certain estimates and judgments by management. Management bases its assumptions, estimates, and adjustments on historical experience, current trends and other factors believed to be relevant at the time the consolidated financial statements are prepared. Management believes that the following policies are critical due to the inherent uncertainty of these matters and the complex and subjective judgments required to establish these estimates. Management continues to review these critical accounting policies and estimates to ensure that the consolidated financial statements are presented fairly in accordance with GAAP. However, actual results could differ from our assumptions and estimates and such differences could be material. • Vendor concessions – We receive concessions from our vendors through a variety of programs and arrangements, including co-operative advertising, allowances for warranties, merchandise allowances and volume purchase rebates. Co-operative advertising allowances that are incremental to our advertising program, specific to a product or event and identifiable for accounting purposes, are reported as a reduction of advertising expense in the period in which the advertising occurred. All other material vendor concessions are recognized as a reduction to the cost of inventory. Amounts receivable from vendors also include amounts due to us relating to vendor purchases and product returns. Management regularly reviews amounts receivable from vendors and assesses the need for a reserve for uncollectible amounts based on our evaluation of our vendors’ financial position and corresponding ability to meet their financial obligations. Based on our historical results and current assessment, we have not recorded a reserve for uncollectible amounts in our consolidated financial statements, and we do not believe there is a reasonable likelihood that our ability to collect these amounts will differ from our expectations. The eventual ability of our vendors to pay us the obliged amounts could differ from our assumptions and estimates, and we may be exposed to losses or gains that could be material. • Self-Insurance Reserves – We use a combination of insurance and self-insurance mechanisms to provide for potential liabilities from workers’ compensation, general liability, vehicle liability, property loss, and employee health care benefits. With the exception of employee health care benefit liabilities, which are limited by the design of these plans, we obtain third-party insurance coverage to limit our exposure for any individual claim. When estimating our self-insurance liabilities, we consider a number of factors, including historical claims experience and trend-lines, projected medical and legal inflation, and growth patterns and exposure forecasts. The assumptions made by management as they relate to each of these factors represents our judgment as to the most probable cumulative impact of each factor to our future obligations. Our calculation of our self-insurance liabilities requires management to apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not yet reported as of the balance sheet date and the application of alternative assumptions would result in a different estimate of these liabilities. Actual claim activity or development may vary from our assumptions and estimates, which may result in material losses or gains. As we obtain additional information that affects the assumptions and estimates we used to recognize liabilities for claims incurred in prior accounting periods, we adjust our self-insurance liabilities to reflect the revised estimates based on this additional information. If self-insurance reserves were changed 10% from our estimated reserves at December 31, 2007, the financial impact would have been approximately $4.7 million or 1.5% of pretax income. • Accounts receivable – Management estimates the allowance for doubtful accounts based on historical loss ratios and other relevant factors. Actual results have consistently been within management’s expectations, and we do not believe that there is a reasonable likelihood that there will be a material change in the future that will require a significant change in the assumptions or estimates we use to calculate our allowance for doubtful accounts. However, if actual results differ from our estimates, we may be exposed to losses or gains. If the allowance for doubtful accounts were changed 10% from our estimated allowance at December 31, 2007, the financial impact would have been approximately $0.3 million or 0.1% of pretax income. 18 Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) • Taxes – We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. We regularly review our potential tax liabilities for tax years subject to audit. The amount of such liabilities is based on various factors, such as differing interpretations of tax regulations by the responsible tax authority, experience with previous tax audits and applicable tax law rulings. Changes in our tax liability may occur in the future as our assessments change based on the progress of tax examinations in various jurisdictions and/or changes in tax regulations. In management’s opinion, adequate provisions for income taxes have been made for all years presented. The estimates of our potential tax liabilities contain uncertainties because management must use judgment to estimate the exposures associated with our various tax positions and actual results could differ from our estimates. Alternatively, we could have applied assumptions regarding the eventual outcome of the resolution of open tax positions that would differ from our current estimates but that would still be reasonable given the nature of a particular position. Our judgment regarding the most likely outcome of uncertain tax positions has historically resulted in an estimate of our tax liability that is greater than actual results. While our estimates are subject to the uncertainty noted in the preceding discussion, our initial estimates of our potential tax liabilities have historically not been materially different from actual results except in instances where we have reversed liabilities that were recorded for periods that were subsequently closed with the applicable taxing authority. The accounting for our tax reserves changed with the adoption of Financial Accounting Standards Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48") on January 1, 2007. Refer to Note 1 for further discussion of the impact of adopting FIN 48 and change in reserves during Fiscal 2007. • Share-based compensation – Prior to January 1, 2006, we accounted for share-based compensation plans under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), as permitted under Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123. Effective January 1, 2006, we adopted SFAS No. 123R, “Share Based Payment,” under the modified prospective method. Accordingly, prior period amounts have not been restated. Under this application, we record share-based compensation expense for all awards granted on or after the date of adoption and for the portion of previously granted awards that remain unvested at the date of adoption. Currently, our share-based compensation relates to stock option awards, employee share purchase plan discounts, restricted stock awards and shares contributed directly to other employee benefit plans. Under SFAS No. 123R, we use a Black-Scholes option-pricing model to determine the fair value of stock options. The Black-Scholes model includes various assumptions, including the expected life of stock options, the expected volatility and the expected risk-free interest rate. These assumptions reflect our best estimates, but they involve inherent uncertainties based on market conditions generally outside our control. Since our adoption of SFAS No. 123R, share-based compensation cost would not have been materially impacted by the variability in the range of reasonable assumptions we could have applied to value option award grants, but we anticipate that share-based compensation cost could be materially impacted by the application of alternate assumptions in future periods. Also, under SFAS No. 123R, we are required to record share-based compensation expense net of estimated forfeitures. Our forfeiture rate assumption used in determining share-based compensation expense is estimated based on historical data. The actual forfeiture rate and corresponding share-based compensation expense could differ from those estimates. • Inventory Obsolescence and Shrink – Inventory, which consists of automotive hard parts, maintenance items, accessories and tools is stated at the lower of cost or market. The extended nature of the life cycle of our products is such that the risk of obsolescence of our inventory is minimal. The products that we sell generally have application in our markets for a relatively long period of time in conjunction with the corresponding vehicle population. We have developed sophisticated systems for monitoring the life cycle of a given product and, accordingly, have historically been very successful in adjusting the volume of our inventory in conjunction with a decrease in demand. We do record a reserve to reduce the carrying value of our inventory through a charge to cost of sales in the isolated instances where we believe that the market value of a product line is lower than our recorded cost. This reserve is based on our assumptions about the marketability of our existing inventory and is subject to uncertainty to the extent that we must estimate, at a given point in time, the market value of inventory that will be sold in future periods. Ultimately, our projections could differ from actual results and could result in a material impact to our stated inventory balances. We have historically not had to materially adjust our obsolescence reserves due to the factors discussed above and do not anticipate that we will experience material changes in our estimates in the future. We also record a reserve to reduce the carrying value of our perpetual inventory to account for quantities in our perpetual records above the actual existing quantities on hand caused by unrecorded shrink. We estimate this reserve based on the results of our extensive and frequent cycle counting programs and periodic, full physical inventories at our stores and distribution centers. To the extent that our estimates do not accurately reflect the actual inventory shrinkage, we could potentially experience a material impact to our inventory balances. We have historically been able to provide a timely and accurate measurement of shrink and have not experienced material adjustments to our estimates. If unrecorded shrink at December 31, 2007 were double the estimate that we recorded based on our historical experience, the financial impact would have been less than $3 million or less than 1.0% of pretax income. 19 Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) R E S U LT S O F O P E R AT I O N S The following table sets forth, certain income statement data as a percentage of sales for the years indicated: Years ended December 31, Sales Cost of goods sold, including warehouse and distribution expenses Gross profit Operating, selling, general and administrative expenses Operating income Other income/(expense), net Income before income taxes and cumulative effect of accounting change Provision for income taxes Net income 2007 100.0% 55.6 44.4 32.3 12.1 0.1 12.2 4.5 7.7% 2006 100.0% 55.9 44.1 31.7 12.4 -- 12.4 4.6 7.8% 2005 100.0% 56.4 43.6 31.3 12.3 (0.1) 12.2 4.2 8.0% 2 0 0 7 C O M PA R E D T O 2 0 0 6 Sales increased $239 million, or 10.5%, from $2.28 billion in 2006 to $2.52 billion in 2007, due to 190 net additional stores opened during 2007 which contributed $72.5 million to the sales increase, a full year of sales for stores opened throughout 2006 adding $83.5 million and a 3.7% increase in same-store sales for stores open at least one year providing $82.6 million of the sales increase. We believe that the increased sales achieved by our existing stores are the result of superior inventory availability, offering a broader selection of products in most stores, an increased promotional and advertising effort through a variety of media and localized promotional events, continued improvement in the merchandising and store layouts of most stores, compensation programs for all store team members that provide incentives for performance and our continued focus on serving professional installers. The same store sales increase in 2007 of 3.7% was greater than the prior year’s increase of 3.3%, but below our historical results. The decrease from historical trends is the result of challenging external macroeconomic factors in 2006 and 2007. The external macroeconomic factors, which we believe negatively impacted our sales, were constraints on our customers’ discretionary income as a result of increased interest rates and higher energy costs. Consumers also encountered higher gas prices which resulted in annual miles driven, a key driver of demand for our products, remaining flat in comparison to the long term trend of annual increases. We anticipate that continued store unit and sales growth consistent with our historical rates will continue in the future. Gross profit increased $113.7 million, or 11.3%, from $1.01 billion (44.1% of sales) in 2006 to $1.12 billion (44.4% of sales) in 2007, primarily due to the increase in sales resulting from a larger number of stores and increased sales levels at existing stores. The increase in gross profit as a percent of sales is the result of improvements in product mix, lower product acquisition cost and distribution system efficiencies. Improvements in product mix were the result of strategies which differentiated our merchandise selections at each store based on customer demand and vehicle demographics in the store’s market and through ongoing Team Member training initiatives focused on selling products with greater gross margin contribution. Product acquisition cost improved due to increased imports from lower cost providers in foreign countries as well as improved negotiating leverage with our vendors resulting from our increased purchasing power. Improvements in our distribution system were the result of capital projects designed to create operating expense efficiencies. We anticipate these trends to continue at a moderate rate throughout 2008. SG&A increased $90.9 million, or 12.6%, from $724.4 million (31.7% of sales) in 2006 to $815.3 million (32.3% of sales) in 2007. The increase in these expenses was primarily attributable to increased salaries and benefits, rent and other costs associated with the addition of employees and facilities to support the increased level of our operations. The increase in SG&A as a percentage of sales was the result of increased store salaries primarily driven by the timing of new store openings, higher advertising costs, increased depreciation expense primarily driven by investment in new store technology and increased stock compensation expense. Other income, net, increased by $2.4 million from ($0.1) million in 2006 to $2.3 million in 2007. The increase was primarily due to decreased interest expense on long-term debt resulting from a reduction in the interest rate on long-term debt as well as increased interest income derived from a higher than average cash balance. Provision for income taxes increased from $104.2 million in 2006 (36.9% effective tax rate) to $113.5 million in 2007 (36.9% effective tax rate). The increase in the dollar amount was due to the increase of income before income taxes. As a result of the impacts discussed above, net income increased $15.9 million from $178.1 million in 2006 (7.8% of sales) to $194.0 million in 2007 (7.7% of sales). 20 Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) 2 0 0 6 C O M PA R E D T O 2 0 0 5 Sales increased $238 million, or 11.6%, from $2.05 billion in 2005 to $2.28 billion in 2006, primarily due to 170 net additional stores opened during 2006 which contributed $67.4 million to the sales increase, a full year of sales for stores opened throughout 2005 adding $76.1 million and a 3.3% increase in same-store sales for stores open at least one year providing $93.5 million of the sales increase. We believe that the increased sales achieved by our existing stores are the result of our offering of a broader selection of products in most stores, an increased promo- tional and advertising effort through a variety of media and localized promotional events, continued improvement in the merchandising and store layouts of most stores and compensation programs for all store team members that provide incentives for performance. Also, our continued focus on serving professional installers contributed to increased sales. The same store sales increase in 2006 of 3.3% was below the prior year increase of 7.5% and our historical results. The decrease from the prior year is the result of extremely strong same store sales in 2005 (higher than historical rates) and external macroeconomic factors in 2006. The external macroeconomic factors which we believe negatively impacted our sales were constraints on our customer's discretionary income as a result of increased interest rates and higher energy costs combined with a reduction in the miles driven due to higher gas prices during the key summer selling season. Gross profit increased $114.2 million, or 12.8%, from $892.5 million (43.6% of sales) in 2005 to $1.01 billion (44.1% of sales) in 2006, due to the increase in sales. The increase in gross profit as a percent of sales is the result of improvements in product mix and product acquisition cost. Improvements in product mix were the result of strategies which differentiated our merchandise selections at each store based on customer demand and vehicle demographics in the store’s market and through ongoing Team Member training initiatives focused on selling products with greater gross margin contribution. Product acquisition cost improved due to increased imports from lower cost providers in foreign countries as well as improved negotiating leverage with our vendors resulting from our increased purchasing power. SG&A increased $84.4 million, or 13.2%, from $640.0 million (31.3% of sales) in 2005 to $724.4 million (31.7% of sales) in 2006. The increase in these expenses was primarily attributable to increased salaries and benefits, rent and other costs associated with the addition of employees and facilities to support the increased level of our operations. The increase in SG&A as a percentage of sales was the result of increased advertising and energy costs. Other expense, net, decreased by $1.4 million from $1.5 million in 2005 to $0.1 million in 2006. The decrease was primarily due to decreased interest expense on long-term debt resulting from a reduction in the interest rate on long-term debt. Provision for income taxes increased from $86.8 million in 2005 (34.6% effective tax rate) to $104.2 million in 2006 (36.9% effective tax rate). The increase in the dollar amount was primarily due to the increase of income before income taxes. The increase in the effective tax rate in 2006 is primarily attributable to a non-cash adjustment of $6.1 million in the third quarter of 2005 resulting from the favorable resolution of prior year tax uncertainties. This tax benefit was nonrecurring and reflected the reversal of previously recorded income tax reserves related to a prior acquisition. As a result of the impacts discussed above, net income increased $13.8 million from $164.3 million in 2005 (8.0% of sales) to $178.1 million in 2006 (7.8% of sales). L I Q U I D I T Y A N D C A P I TA L R E S O U R C E S Net cash provided by operating activities was $299.4 million in 2007, $185.9 million in 2006 and $206.7 million in 2005. The increase in net cash provided by operating activities in 2007 was principally due to increased net income and a reduction in net inventory investment. Net inventory investment reflects our investment in inventory net of the amount of accounts payable to vendors. The reduction in net inventory investment is the result of reductions in our per store inventory levels and our ongoing effort to extend terms with our vendors. Reductions in our per store inventory levels are driven by our continued optimization of inventory selection at our stores and our ability to efficiently deploy inventory throughout our distribution network. The decrease in net cash provided by operating activities in 2006 compared to 2005 was primarily due to increases in inventory related to new store growth and a decrease in the percentage of inventory funded by accounts payable, partially offset by the effect of increased net income in 2006. The decrease in net cash provided by operating activities in 2006 was also due to the reclassification of the tax benefit derived from the exercise of stock options. In accordance with our prior year adoption of SFAS No. 123R, the excess tax benefit from the exercise of stock options of $8.5 million is reflected as cash provided by financing activities in our consolidated statement of cash flows for the year ended December 31, 2006. For the year ended December 31, 2005, the excess tax benefit totaled $7.1 million and was included with net cash provided by operating activities in our 2005 consolidated statement of cash flows. Net cash used in investing activities was $300.3 million in 2007, $225.2 million in 2006 and $262.4 million in 2005. The increase in cash used in investing activities in 2007 was due to increases in capital expenditures resulting from our ongoing store expansion program, store relocations, enhancements in existing store technology and the purchase of $21.7 million in short-term investments. The changes in cash used in investing activities during 2006 were the result of changes in capital expenditures and the $63 million acquisition in 2005 of Midwest Auto Parts Distributors, Inc. (“Midwest”), which included 72 stores and distribution centers in St. Paul, Minnesota and Billings, Montana. Capital expenditures were $282.7 million in 2007, $228.9 million in 2006 and $205.2 million in 2005. These expenditures were primarily related to 21 Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) the opening of new stores and distribution centers, as well as the relocation or remodeling of existing stores. We opened 190, 170, and 149 (excluding the 72 stores acquired with Midwest) net stores in 2007, 2006 and 2005, respectively. We remodeled or relocated 55, 31 and 37 stores in 2007, 2006 and 2005, respectively. Enhancements in existing store technology include the roll out of our new point of sale system as well as hardware upgrades, new in-store starter and alternator testers and the installation of energy management systems. We acquired a location and began construction in 2007 on a new distribution center that will be located in Lubbock, TX. The new distribution center is scheduled to be completed and to begin operations in 2008. We acquired a new facility near Minneapolis, Minnesota in 2006 for the relocation of the St. Paul, Minnesota distribution center that was completed and began operations in 2007. We acquired a new distribution center near Indianapolis, Indiana in 2005 that was subsequently equipped and opened in 2006. Our continuing store expansion program requires significant capital expenditures and working capital principally for inventory requirements. Our 2008 growth plans call for approximately 205 new stores and the addition of one distribution center with total capital expenditures of $275 million to $285 million. The costs associated with the opening of a new store (including the cost of land acquisition, improvements, fixtures, net inventory investment and computer equipment) are estimated to average approximately $1.2 million to $1.4 million; however, such costs may be significantly reduced where we lease, rather than purchase, the store site. We plan to finance our expansion program through cash expected to be provided from operating activities and available borrowings under our existing credit facility. On May 15, 2006, we entered into a private placement agreement that allows for the issuance of an aggregate of $300 million in unsecured senior notes, issuable in series. On May 15, 2006, the Company completed the private placement of $75 million of the first series of Senior Notes (the “Series 2006-A Senior Notes”) under the Private Placement Agreement. The $75 million of Series 2006-A Senior Notes are due May 15, 2016 and bear interest at 5.39% per year. Proceeds from the Series 2006-A Senior Notes private placement transaction were used to repay certain existing debt of the Company, including $75 million of 7.72% Series 2001-A Senior Notes due May 15, 2006. On July 29, 2005, we entered into an unsecured, five-year syndicated credit facility (“Credit Facility”) in the amount of $100 million led by Wells Fargo Bank as the Administrative Agent, replacing a three-year $150 million syndicated credit facility. The Credit Facility is guaranteed by all of our subsidiaries and may be increased to a total of $200 million, subject to the availability of such additional credit from either existing banks within the Credit Facility or other banks. The Credit Facility bears interest at LIBOR plus a spread ranging from 0.375% to 0.750% (5.25% at December 31, 2007) and expires in July 2010. There were no outstanding borrowings under the Credit Facility at December 31, 2007. Outstanding borrowings totaled $9.7 million at December 31, 2006. The available borrowings under the Credit Facility are reduced by stand-by letters of credit issued by us primarily to satisfy the requirements of workers compensation, general liability and other insurance policies. Our aggregate availability for additional borrowings under the Credit Facility was $71.4 million and $57.4 million at December 31, 2007 and 2006, respectively. O F F B A L A N C E S H E E T A R R A N G E M E N T S We have utilized various financial instruments from time to time as sources of cash when such instruments provided a cost effective alternative to our existing sources of cash. We do not believe, however, that we are dependent on the availability of these instruments to fund our working capital requirements or our growth plans. On December 29, 2000, we completed a sale-leaseback transaction with an unrelated party. Under the terms of the transaction, we sold 90 properties, including land, buildings and improvements, which generated $52.3 million of additional cash. The lease, which is being accounted for as an operating lease, provides for an initial lease term of 21 years and may be extended for one initial ten-year period and two additional successive periods of five years each. The resulting gain of $4.5 million has been deferred and is being amortized over the initial lease term. Net rent expense during the initial term will be approximately $5.5 million annually. In August 2001, we completed a sale-leaseback with O’Reilly-Wooten 2000 LLC (an entity owned by certain shareholders of the Company). The transaction involved the sale and leaseback of nine O’Reilly Auto Parts stores and resulted in approximately $5.6 million of additional cash to us. The transaction did not result in a material gain or loss. The lease, which has been accounted for as an operating lease, calls for an initial term of 15 years with three five-year renewal options. On September 28, 2007, the Company completed a second amended and restated master agreement to its $49 million Synthetic Operating Lease Facility with a group of financial institutions. The terms of such lease facility provide for an initial lease period of seven years, a residual value guarantee of approximately $39.7 million at December 31, 2007 and purchase options on the properties. The lease facility also contains a provision for an event of default whereby the lessor, among other things, may require the Company to purchase any or all of the properties. Management believes it is reasonable to assume that such an event of default will not occur. One additional renewal period of seven years may be requested from the lessor, although the lessor is not obligated to grant such renewal. The second amended and restated Facility has been accounted for as an operating lease under SFAS No. 13 and related interpretations, including FASB Interpretation No. 46R. 22 Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) We issue stand-by letters of credit provided by a $50 million sub limit 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 $28.6 million and $32.9 million were outstanding at December 31, 2007 and 2006, respectively. C O N T R A C T UA L O B L I G AT I O N S We have other liabilities reflected in our balance sheet, including deferred income taxes and self-insurance accruals. The payment obligations associated with these liabilities are not reflected in the financial commitments table due to the absence of scheduled maturities. Therefore, the timing of these payments cannot be determined, except for amounts estimated to be payable in 2008 that are included in current liabilities. In addition, we have commitments with various vendors for the purchase of inventory as of December 31, 2007. The financial commitments table excludes these commitments because they are cancelable by their terms. Our contractual obligations, including commitments for future payments under non-cancelable lease arrangements, short and long-term debt arrangements, interest payments related to long-term debt and purchase obligations for construction contract commitments, are summarized below and are fully disclosed in Notes 6 and 7 to the consolidated financial statements. Payments Due By Period (In thousands) CONT RACT UAL OBLIGAT IONS: Long-term debt Interest payments related to long-term debt Operating leases Purchase obligations Total contractual cash obligations Total Before 1 Year 1-3 Years 3-5 Years Over 5 Years $ 100,469 35,165 502,583 96,251 $ 734,468 $ 25,320 4,845 51,765 96,251 $ 178,181 $ 149 8,086 90,619 -- $ 98,854 $ -- 8,085 74,896 -- $ 82,981 $ 75,000 14,149 285,303 -- $ 374,452 We believe that our existing cash and cash equivalents, cash expected to be provided by operating activities, available bank credit facilities and trade credit will be sufficient to fund both our short-term and long-term capital needs for the foreseeable future. I N F L AT I O N A N D S E A S O N A L I T Y We attempt to mitigate the effects of merchandise cost increases principally by taking advantage of vendor incentive programs, economies of scale resulting from increased volume of purchases and selective forward buying. As a result, we do not believe that our operations have been materially affected by inflation. Our business is somewhat seasonal, primarily as a result of the impact of weather conditions on customer buying patterns. Store sales and profits have historically been higher in the second and third quarters (April through September) of each year than in the first and fourth quarters. Q UA R T E R LY R E S U LT S The following table sets forth certain quarterly unaudited operating data for fiscal 2007 and 2006. 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. (In thousands, except per share data) Sales Gross profit Operating income Net income Basic net income per common share Net income per common share – assuming dilution First Quarter $ 613,145 269,281 77,192 48,407 0.42 0.42 Fiscal 2007 Second Quarter $ 643,108 287,185 81,558 51,899 0.45 0.45 Third Quarter $ 661,778 293,701 82,716 53,087 0.46 0.46 Fourth Quarter $ 604,288 270,293 63,685 40,595 0.35 0.35 23 Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) (In thousands, except per share data) Sales Gross profit Operating income Net income Basic net income per common share Net income per common share – assuming dilution First Quarter $ 536,547 233,428 64,966 40,564 0.36 0.35 Fiscal 2006 Second Quarter $ 591,199 260,928 78,236 49,313 0.44 0.43 Third Quarter $ 597,144 263,326 75,084 47,856 0.42 0.42 Fourth Quarter $ 558,332 249,029 64,029 40,352 0.35 0.35 N E W A C C O U N T I N G S TA N D A R D S In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, a revision of SFAS No. 123, Accounting for Stock Based Compensation, that supersedes APB No. 25, Accounting for Stock Issued to Employees. In April 2005, the SEC adopted a rule permitting implementation of SFAS No. 123R at the beginning of the first fiscal year commencing after June 15, 2005. Among other items, SFAS No. 123R eliminated the use of APB No. 25 and the intrinsic value method of accounting, and requires companies to recognize in the financial statements the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards. SFAS No. 123R also requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under APB No. 25. The Company was required to adopt SFAS No. 123R beginning in its quarter ended March 31, 2006. Under the provisions of SFAS No. 123R, the Company had the choice of adopting the fair-value-based method of expensing of stock options using (a) the “modified prospective method”, whereby the Company recognizes the expense only for periods beginning after December 31, 2005, or (b) the “modified retrospective method”, whereby the Company recognizes the expense for all years and interim periods since the effective date of SFAS No. 123. The Company adopted SFAS No. 123R using the modified prospective method. See Note 9, “Share-Based Employee Compensation Plans”, for information regarding expensing of stock options in 2006 and 2007 and for pro forma information regarding the Company’s accounting for stock options in 2005. In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 prescribes a recognition threshold and a measurement process for recording in the financial statements the tax benefit of uncertain tax positions taken or expected to be taken in a tax return. For a benefit to be recognized, a tax position must be more-likely-than-not to be sustainable upon examination by the applicable taxing authority. Additionally, FIN 48 provides guidance on derecognition, measurement, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The Company adopted the provisions of FIN 48 on January 1, 2007. No adjustment was required in the liability for unrecognized income tax benefits as a result of the implementation of FIN 48. As of January 1, 2007 and December 31, 2007, the Company had a gross exposure for unrecognized tax benefits (including interest and penalties) of $14.9 million and $19.7 million, respectively, all of which would affect the Company’s effective tax rate if recognized, generally net of federal tax effect. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of January 1, 2007 and December 31, 2007, the Company had accrued approximately $1.7 million and $2.8 million, respectively, of interest and penalties related to uncertain tax positions before the benefit of the deduction for interest on state and federal returns. During the year ended December 31, 2007, the Company recorded tax expense related to an increase in its liability for interest and penalties of $1.3 million. Although unrecognized tax benefits for individual tax positions may increase or decrease during 2008, the Company expects a reduction of $0.8 million of unrecognized tax benefits during the one-year period subsequent to December 31, 2007 resulting from settlement or expiration of the statute of limitations. The Company’s U.S. federal income tax returns for tax years 2005 and beyond remain subject to examination by the Internal Revenue Service (“IRS”). The IRS concluded an examination of the Company’s consolidated 2002, 2003 and 2004 federal income tax returns in the first quarter of 2007. The statute of limitations for the Company’s federal income tax returns for tax years 2003 and prior have expired. The statute of limitations for the Company’s U.S. federal income tax return for 2004 will expire on September 15, 2008, unless otherwise extended. The Company’s state income tax returns remain subject to examination by various state authorities for tax years ranging from 2001 through 2006. F O R WA R D - L O O K I N G S TAT E M E N T S We claim the protection of the safe-harbor for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these statements by forward-looking words such as “expect,” “believe,” “anticipate,” “should,” “plan,” “intend,” “estimate,” “project,” “will” or similar words. In addition, statements contained within this annual report that are not historical facts are forward-looking statements, such as statements discussing among other things, expected growth, store development and expansion strategy, business strategies, future revenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions, including, but not limited to, competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our ability to hire and retain qualified employees, risks associated with the integration of acquired businesses, weather, terrorist activities, war and the threat of war. Actual results may materially differ from anticipated results described or implied in these forward-looking statements. Please refer to the Risk Factors sections of the annual report on Form 10-K for the year ended December 31, 2007, for additional factors that could materially affect our financial performance. 24 Management’s Report On Internal Control Over Financial Reporting The management of O’Reilly Automotive, Inc. and Subsidiaries (the “Company”), under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes all policies and procedures that: • pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; • provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Management recognizes that all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to risk. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework. Based on this assessment, management believes that as of December 31, 2007, the Company’s internal control over financial reporting is effective based on those criteria. Ernst & Young LLP, Independent Registered Public Accounting Firm, has audited the Company’s consolidated financial statements and has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting, as stated in their report which is included herein. Greg Henslee Chief Executive Officer and Co-President Thomas McFall Chief Financial Officer and Executive Vice President 25 Report Of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of 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, 2007 and 2006, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of O’Reilly Automotive, Inc. and Subsidiaries at December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), O’Reilly Automotive, Inc. and Subsidiaries’ internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2008 expressed an unqualified opinion thereon. Kansas City, Missouri February 27, 2008 26 Report Of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of O’Reilly Automotive, Inc. and Subsidiaries We have audited O’Reilly Automotive, Inc. and Subsidiaries’ internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). O’Reilly Automotive, Inc. and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, O’Reilly Automotive, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2007 of O’Reilly Automotive, Inc. and Subsidiaries and our report dated February 27, 2008 expressed an unqualified opinion thereon. Kansas City, Missouri February 27, 2008 27 Consolidated Balance Sheets (In thousands, except share data) December 31, ASSETS Current assets: Cash and cash equivalents Accounts receivable, less allowance for doubtful accounts of $3,179 in 2007 and $2,861 in 2006 Amounts receivable from vendors Inventory Other current assets Total current assets Property and equipment, at cost Less: accumulated depreciation and amortization Net property and equipment Notes receivable, less current portion Goodwill Other assets Total assets LIABI LI T I ES AND SHAREHOLDERS’ EQ UI T Y: Current liabilities: Accounts payable Self insurance reserve Accrued payroll Accrued benefits and withholdings Deferred income taxes Other current liabilities Current portion of long-term debt Total current liabilities Long-term debt, less current portion Deferred income taxes Other liabilities Shareholders’ equity: Preferred stock, $0.01 par value: Authorized shares – 5,000,000 Issued and outstanding shares – none Common stock, $0.01 par value: Authorized shares – 245,000,000 Issued and outstanding shares – 115,260,564 in 2007 and 113,929,327 in 2006 Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying Notes to Consolidated Financial Statements 2007 2006 $ 47,555 $ 29,903 84,242 48,263 881,761 40,483 1,102,304 1,479,779 389,619 1,090,160 25,437 50,447 11,389 81,048 47,790 812,938 28,997 1,000,676 1,214,854 331,759 883,095 30,288 49,065 14,372 $ 2,279,737 $ 1,977,496 $ 380,683 29,967 23,739 13,496 6,235 49,536 25,320 528,976 75,149 27,241 55,894 $ 318,404 31,084 21,171 12,948 5,779 44,089 309 433,784 110,170 38,171 31,275 -- -- 1,153 441,731 1,156,393 (6,800) 1,592,477 $ 2,279,737 1,139 400,552 962,405 -- 1,364,096 $ 1,977,496 28 Consolidated Statements Of Income (In thousands, except per share data) December 31, Sales Cost of goods sold, including warehouse and distribution expenses Gross profit Operating, selling, general and administrative expenses Operating income Other income (expense), net: Interest expense Interest income Other, net Total other income (expense), 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 to Consolidated Financial Statements. 2007 $ 2,522,319 1,401,859 1,120,460 815,309 305,151 (3,723) 4,077 1,983 2,337 307,488 113,500 2006 $ 2,283,222 1,276,511 1,006,711 724,396 282,315 (4,322) 1,573 2,699 (50) 282,265 104,180 2005 $ 2,045,318 1,152,815 892,503 639,979 252,524 (5,062) 1,582 2,025 (1,455) 251,069 86,803 $ 193,988 $ 178,085 $ 164,266 $ $ 1.69 114,667 1.67 116,080 $ 1.57 113,253 $ 1.47 111,613 $ 1.55 115,119 $ 1.45 113,385 29 Consolidated Statements Of Shareholders' Equity Common Stock Accumulated Other Retained Comprehensive Loss Earnings Comprehensive Income Total (In thousands) Balance at December 31, 2004 Net income Other comprehensive income Comprehensive income 2-for-1 stock split Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Share based compensation Balance at December 31, 2005 Net income Other comprehensive income Comprehensive income Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Share based compensation Balance at December 31, 2006 Net income Other comprehensive loss Comprehensive income Issuance of common stock under employee benefit plans Issuance of common stock under stock option plans Tax benefit of stock options exercised Share based compensation Shares 55,377 -- -- -- 55,861 268 883 -- -- 112,389 -- -- -- 387 1,153 -- -- 113,929 -- -- -- 367 965 -- -- Additional Paid-In Capital $ 326,650 -- -- -- -- 9,477 14,906 7,137 2,155 Par Value $ 554 -- -- -- 559 2 9 -- -- $ 620,613 164,266 -- -- (559) -- -- -- -- $ 1,124 -- -- -- $ 360,325 -- -- -- $ 784,320 178,085 -- -- 4 11 -- -- 12,169 15,959 8,538 3,561 -- -- -- -- $ 164,266 -- $ 164,266 $ 178,085 -- $ 178,085 $ -- -- -- -- -- -- -- -- -- $ 947,817 164,266 -- -- -- 9,479 14,915 7,137 2,155 -- $ 1,145,769 178,085 -- -- -- -- -- -- -- -- -- 12,173 15,970 8,538 3,561 $ 1,139 -- -- -- $ 400,552 -- -- -- $ 962,405 193,988 -- -- -- $ 1,364,096 193,988 -- (6,800) (6,800) -- -- $ 193,988 (6,800) $ 187,188 4 10 -- -- 11,543 17,114 6,835 5,687 -- -- -- -- -- -- -- -- 11,547 17,124 6,835 5,687 Balance at December 31, 2007 115,261 $ 1,153 $ 441,731 $ 1,156,393 $ (6,800) $ 1,592,477 See accompanying Notes to Consolidated Financial Statements. 30 Consolidated Statements Of Cash Flows 2007 2006 2005 $ 193,988 $ 178,085 $ 164,266 (In thousands) Years ended December 31, OP ERAT I NG ACT IVI T I ES Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Deferred income taxes Share based compensation programs Tax benefit of stock options exercised Other Changes in operating assets and liabilities: Accounts receivable Inventory Accounts payable Other Net cash provided by operating activities I NVEST I NG ACT IVI T I ES Purchases of property and equipment Proceeds from sale of property and equipment Payments received on notes receivable Purchase of short-term investments Advances made on notes receivable Acquisition of Midwest Auto Parts Distributors net of cash acquired Other Net cash used in investing activities FI NANCI NG ACT IVI T I ES Proceeds from issuance of long-term debt Principal payments on long-term debt Tax benefit of stock options exercised Net proceeds from issuance of common stock Net cash provided by financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year 78,943 (6,341) 12,777 -- 5,007 (8,555) (68,823) 62,279 30,143 299,418 (282,655) 2,327 5,202 (21,724) -- -- (3,468) (300,318) 16,450 (26,460) 6,835 21,727 18,552 17,652 29,903 $ 47,555 SUP P LEMENTAL DISCLOSURES OF CASH FLOW I NFORMAT ION: Income taxes paid Interest paid, net of capitalized interest $ 93,040 3,727 See accompanying Notes to Consolidated Financial Statements. 31 64,938 (1,017) 11,029 -- 1,812 (9,426) (91,427) 25,737 6,197 185,928 (228,871) 875 5,174 -- -- -- (2,379) (225,201) 88,950 (80,189) 8,538 20,493 37,792 (1,481) 31,384 $ 29,903 $ 98,650 4,536 57,228 (671) 7,840 7,137 1,978 (8,974) (68,794) 43,158 3,517 206,685 (205,159) 1,935 4,558 -- (624) (63,145) (1) (262,436) -- (602) -- 18,709 18,107 (37,644) 69,028 $ 31,384 $ 98,440 5,062 Notes to Consolidated Financial Statements N O T E 1 — S U M M A R Y O F S I G N I F I C A N T A C C O U N T I N G P O L I C I E S Nature of Business O'Reilly Automotive, Inc. (the “Company”) is a specialty retailer and supplier of automotive aftermarket parts, tools, supplies and accessories to both the do-it-yourself (“DIY”) customer and the professional installer throughout Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Minnesota, Mississippi, Missouri, Montana, Nebraska, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Virginia, Wisconsin and Wyoming. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation. Revenue Recognition Over-the-counter retail sales are recorded when the customer takes possession of the merchandise. Sales to professional installers, also referred to as “commercial sales,” are recorded upon same-day delivery of the 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 the merchandise from a regional distribution center with same-day delivery to the jobber customer's location. All sales are recorded net of estimated allowances, discounts and taxes. Use of Estimates The preparation of the consolidated financial statements, in conformity with accounting principles generally accepted in the United States (“GAAP”), requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Cash Equivalents Cash equivalents consist of investments with maturities of 90 days or less at the day of purchase. Accounts Receivable The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. The Company considers the following factors when determining if collection is reasonably assured: customer credit-worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment terms. Inventory Inventory, which consists of automotive hard parts, maintenance items, accessories and tools, is stated at the lower of cost or market. Inventory also includes related procurement, warehousing and distribution center costs. Cost has been determined using the last-in, first-out (“LIFO”) method. The replacement cost of inventory was $888,299,000 and $833,626,000 as of December 31, 2007 and 2006, respectively. 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 the Company’s 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 material vendor concessions are recognized as a reduction to the cost of inventory. Amounts receivable from vendors also includes amounts due to the Company for changeover merchandise and product returns. The Company regularly reviews vendor receivables for collectibility and assesses the need for a reserve for uncollectible amounts based on an evaluation of the Company’s vendors’ financial position and corresponding ability to meet its financial obligations. Management does not believe there is a reasonable likelihood that the Company will be unable to collect the amounts receivable from vendors and the Company did not record a reserve for uncollectible amounts in the consolidated financial statements at December 31, 2007 and 2006. Investments The Company determines the appropriate classification of marketable equity securities at the time of purchase and reevaluates such designation as of each balance sheet date. Available-for-sale securities are stated at fair value, with the unrecognized gains and losses, net of tax, reported in accumulated other comprehensive income (loss). Available-for-sale securities in the amount of $10.8 million, stated at fair value, are included in Other Current Assets on the Company’s balance sheet at December 31, 2007. The Company did not own any material available-for-sale securities on December 31, 2006. See Note 2, “Investments”, for information regarding available-for-sale securities acquired during 2007. 32 Notes to Consolidated Financial Statements (continued) Property and Equipment Property and equipment are carried at cost. Depreciation is provided on a straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the lease term or the estimated economic life of the assets. The lease term includes renewal options determined by management at lease inception for which failure to renew options would result in a substantial economic penalty to the Company. Maintenance and repairs are charged to expense as incurred. Upon retirement or sale, the cost and accumulated depreciation are eliminated and the gain or loss, if any, is included in the determination of net income as a component of other income (expense). The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. (In thousands) Land Buildings and building improvements Leasehold improvements Furniture, fixtures and equipment Vehicles Construction in progress Less: accumulated depreciation and amortization Net property and equipment Original Useful Lives December 31, 2007 December 31, 2006 15 – 39 years 3 – 25 years 3 – 20 years 5 – 10 years $ 220,950 501,598 189,097 429,217 102,665 36,252 1,479,779 389,619 $ 1,090,160 $ 171,048 394,810 147,357 351,889 90,240 59,510 1,214,854 331,759 $ 883,095 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, 2007, 2006 and 2005 were $2,554,000, $2,639,000 and $2,885,000, respectively. Leases The Company’s policy is to amortize leasehold improvements over the lesser of the lease term or the estimated economic life of those assets. Generally, for stores the lease term is the base lease term and for distribution centers the lease term includes the base lease term plus certain renewal option periods for which renewal is reasonably assured and failure to exercise the renewal option would result in a significant economic penalty. The calculation for straight-line rent expense is based on the same lease term. Notes Receivable The Company had notes receivable from vendors and other third parties amounting to $32,119,000 and $36,955,000 at December 31, 2007 and 2006, respectively. The notes receivable, which bear interest at rates ranging from 0% to 10%, are due in varying amounts through August 2017. Goodwill The accompanying consolidated balance sheets at December 31, 2007 and 2006 include goodwill recorded as the result of previous acquisitions. Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, requires the Company to assess goodwill for impairment rather than systematically amortize goodwill against earnings. The goodwill impairment test compares the fair value of a reporting unit to its carrying amount, including goodwill. The Company operates as one reporting unit, and its fair value exceeds its carrying value, including goodwill. Therefore, the Company has determined that no impairment of goodwill existed at December 31, 2007 and 2006. At December 31, 2007 and 2006, the carrying value of the Company’s goodwill was as follows: (In thousands) Beginning balance Acquisitions Ending balance Self-Insurance Reserves December 31, 2007 December 31, 2006 $ 49,065 1,382 $ 50,447 $ 48,069 996 $ 49,065 The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation, general liability, vehicle liability, property loss, and employee health care benefits. With the exception of employee health care benefit liabilities, which are limited by the design of these plans, the Company obtains third-party insurance coverage to limit its exposure. The Company estimates its self-insurance liabilities by considering a number of factors, including historical claims experience and trend-lines, projected medical and legal inflation, and growth patterns and exposure forecasts. 33 Notes to Consolidated Financial Statements (continued) Income Taxes The Company accounts for income taxes using the liability method in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rules currently scheduled to be in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period of the enactment date. The Company adopted the provisions of FIN 48 on January 1, 2007. This interpretation provides guidance on measurement, derecognition of benefits, classification, interest and penalties, accounting in interim periods, disclosure and transition and requires that income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized. Advertising Costs The Company expenses advertising costs as incurred. Advertising expense charged to operations amounted to $40,472,000, $34,929,000 and $28,715,000 for the years ended December 31, 2007, 2006 and 2005, 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. Share-Based Compensation Plans The Company currently sponsors share-based employee benefit plans and stock option plans. Please see Note 9 for further information concerning these plans. In the first quarter of 2006, the Company adopted Statement of Financial Accounting Standards No. 123R, Share Based Payment (“SFAS No. 123R”), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”) and supersedes the Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), using the modified prospective transition method and began recognizing compensation expense for its share-based payments based on the fair value of the awards. Under this transition method, compensation cost recognized in 2006 includes the compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Results for prior periods have not been restated. Share-based payments include stock option awards issued under the Company’s employee stock option plan, director stock option plan, stock issued through the Company’s employee stock purchase plan and stock awarded to employees through other benefit programs. Prior to January 1, 2006, the Company accounted for share- based payments using the intrinsic value based recognition method in accordance with APB No. 25. Under APB No. 25, no compensation expense for stock option awards was recognized since the exercise price of the Company’s stock options equaled the market price of the underlying stock on the date of grant. As a result of adopting SFAS No. 123R on January 1, 2006, the Company’s income before income taxes and net income for the year ended December 31, 2006, are approximately $2.8 million and $1.7 million lower, respectively, than if it had continued to account for share-based compensation under APB No. 25. Basic and diluted earnings per share for the year ended December 31, 2006 are $0.02 lower than if the Company had continued to account for share-based compensation under APB No. 25. In the fourth quarter of 2005, the Board of Directors approved the accelerated vesting of all unvested stock options previously awarded to employees and executive officers. Option awards granted subsequent to the Board’s action are not included in the acceleration and will vest equally over the service period established in the award, typically four years. The primary purpose of the accelerated vesting was to enable the Company to avoid recognizing future compensation expense associated with these options upon the planned adoption of SFAS No. 123R in 2006. As a result of the vesting acceleration, options to purchase approximately 4.2 million shares of O’Reilly Common Stock became exercisable immediately. O’Reilly’s Board of Directors took this action with the belief that it is in the best interest of shareholders as it will reduce the Company’s reported non-cash compensation expense in future periods. In order to limit unintended personal benefits to employees and officers, the Board of Directors imposed restrictions on any shares received through the exercise of accelerated options held by those individuals. These restrictions prevent the sale of any stock obtained through exercise of an accelerated option prior to the earlier of the original vesting date or the individual’s termination of employment. The Company recorded pre-tax share-based compensation expense of $2.2 million in 2005 based on the intrinsic value of in-the-money options subject to acceleration and the Company’s estimate of awards that would have expired unexercisable absent the acceleration. For purposes of pro forma disclosures required under SFAS No. 123 for the year ended December 31, 2005, the estimated fair value of the stock options was assumed to be amortized to expense over the stock options’ vesting periods. For unvested stock option awards that were included in the acceleration in the fourth quarter of 2005, any unamortized estimated fair value is assumed to be fully recognized as compensation expense 34 Notes to Consolidated Financial Statements (continued) in the year ended December 31, 2005 for purposes of pro forma disclosure. The pro forma effects of recognizing estimated compensation expense under the fair value method on net income and earnings per common share were as follows: (In thousands, except per share data) Year Ended December 31, 2005 Net income, as reported Add stock-based compensation expense, net of tax, as reported Deduct stock-based compensation expense, net of tax, under fair value method Pro forma net income Pro forma basic net income per share Pro forma net income per share – assuming dilution Net income per share, as reported Basic Assuming dilution $ 164,266 5,699 (26,522) $ 143,443 $ $ $ $ 1.29 1.27 1.47 1.45 Prior to the adoption of SFAS No. 123R in 2006, the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the accompanying consolidated statement of cash flows. SFAS No. 123R requires excess tax benefits, the cash flow resulting from the tax deductions in excess of the compensation cost recognized for those options, to be classified as financing cash flows. The excess tax benefit was $6.8 million and $8.5 million for the years ended December 31, 2007 and 2006, respectively. Earnings per Share Basic earnings per share is based on the weighted-average outstanding common shares. Diluted earnings per share is based on the weighted- average outstanding shares adjusted for the effect of common stock equivalents. Common stock equivalents that could potentially dilute basic earnings per share in the future that were not included in the fully diluted computation because they would have been antidilutive were 1,613,000, 448,000 and 226,750 for the years ended December 31, 2007, 2006 and 2005, respectively. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, accounts receivable and notes receivable. The Company grants credit to certain customers who meet the Company's pre-established credit requirements. Concentrations of credit risk with respect to these receivables are limited because the Company’s customer base consists of a large number of smaller customers, thus spreading the credit risk. The Company controls credit risk through credit approvals, credit limits and monitoring procedures. Generally, the Company does not require security when credit is granted to customers. Credit losses are provided for in the Company's consolidated financial statements and consistently have been within management's expectations. The carrying value of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and long-term debt, as reported in the accompanying consolidated balance sheets, approximates fair value. Reclassifications The accompanying consolidated financial statements for prior years contain certain reclassifications to conform to the presentation used in 2007. New Accounting Pronouncements In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, a revision of SFAS No. 123 that supersedes APB No. 25. In April 2005, the SEC adopted a rule permitting implementation of SFAS No. 123R at the beginning of the first fiscal year commencing after June 15, 2005. Among other items, SFAS No. 123R eliminated the use of APB No. 25 and the intrinsic value method of accounting, and requires companies to recognize in the financial statements the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards. SFAS No. 123R also requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under APB No. 25. The Company was required to adopt SFAS No. 123R beginning in its quarter ended March 31, 2006. Under the provisions of SFAS No. 123R, the Company had the choice of adopting the fair-value-based method of expensing of stock options using (a) the “modified prospective method”, whereby the Company recognizes the expense only for periods beginning after December 31, 2005, or (b) the “modified retrospective method”, whereby the Company recognizes the expense for all years and interim periods since the effective date of SFAS No. 123. The Company adopted SFAS No. 123R using the modified prospective method. See Note 9, “Share-Based Employee Compensation Plans”, for information regarding expensing of stock options in 2006 and 2007 and for pro forma information regarding the Company’s accounting for stock options in 2005. 35 Notes to Consolidated Financial Statements (continued) In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 prescribes a recognition threshold and a measurement process for recording in the financial statements the tax benefit of uncertain tax positions taken or expected to be taken in a tax return. For a benefit to be recognized, a tax position must be more-likely-than-not to be sustainable upon examination by the applicable taxing authority. Additionally, FIN 48 provides guidance on derecognition, measurement, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The Company adopted the provisions of FIN 48 on January 1, 2007. No adjustment was required in the liability for unrecognized income tax benefits as a result of the implementation of FIN 48. As of January 1, 2007 and December 31, 2007, the Company had a gross exposure for unrecognized tax benefits (including interest and penalties) of $14.9 million and $19.7 million, respectively, all of which would affect the Company’s effective tax rate if recognized, generally net of federal tax affect. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of January 1, 2007 and December 31, 2007, the Company had accrued approximately $1.7 million and $2.8 million, respectively, of interest and penalties related to uncertain tax positions before the benefit of the deduction for interest on state and federal returns. During the year ended December 31, 2007, the Company recorded tax expense related to an increase in its liability for interest and penalties of $1.3 million. Although unrecognized tax benefits for individual tax positions may increase or decrease during 2008, the Company expects a reduction of $0.8 million of unrecognized tax benefits during the one-year period subsequent to December 31, 2007 resulting from settlement or expiration of the statute of limitations. The Company’s U.S. federal income tax returns for tax years 2005 and beyond remain subject to examination by the Internal Revenue Service (“IRS”). The IRS concluded an examination of the Company’s consolidated 2002, 2003 and 2004 federal income tax returns in the first quarter of 2007. The statute of limitations for the Company’s federal income tax returns for tax years 2003 and prior have expired. The statute of limitations for the Company’s U.S. federal income tax return for 2004 will expire on September 15, 2008, unless otherwise extended. The Company’s state income tax returns remain subject to examination by various state authorities for tax years ranging from 2001 through 2006. A summary of the changes in the gross amount of unrecognized tax benefits, excluding interest and penalties, for the year ended December 31, 2007, is shown below: (In thousands) Balance as of January 1, 2007 Addition based on tax postions related to the current year Addition based on tax positions related to prior years Reduction due to lapse of statute of limitations Balance as of December 31, 2007 $ 13,245 3,484 827 (604) $ 16,952 N O T E 2 – I N V E S T M E N T S The following is a summary of available-for-sale securities included in Other Current Assets on the Company’s balance sheet at December 31,2007: Available-for-Sale-Securities Equity securities (In thousands) Amortized Cost $ 21,724 $ 21,724 Gross Unrealized Gains $ $ -- -- Estimated Fair Value (Net Carrying Amount) Gross Unrealized Losses $ (10,933) $ (10,933) $ 10,791 $ 10,791 Available-for-sale securities held by the Company are securities that are publicly traded in active markets and are valued based on quoted closing prices as of December 31, 2007. N O T E 3 - A C Q U I S I T I O N On May 31, 2005, the Company purchased all of the outstanding stock of W.E. Lahr Company and its subsidiary, Midwest Auto Parts Distributors, Inc. and combined affiliates (“Midwest”) for approximately $63 million cash, net of cash acquired, including acquisition costs. Midwest was a specialty retailer, which supplied automotive aftermarket parts in Minnesota, Montana, North Dakota, South Dakota, Wisconsin and Wyoming. The acquisition was accounted for using the purchase method of accounting, and accordingly, the results of operations of 36 Notes to Consolidated Financial Statements (continued) Midwest 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 with the excess allocated to goodwill. The acquisition of Midwest was not material for pro forma presentation requirements. N O T E 4 – S T O C K S P L I T On May 20, 2005, the Company’s Board of Directors declared a two-for-one stock split that was effected in the form of a 100% stock dividend payable to all shareholders of record as of May 31, 2005. The stock dividend was paid on June 15, 2005. Accordingly, this stock split has been recognized by reclassifying $559,000, the par value of the additional shares resulting from the split, from retained earnings to common stock. All share and per share information included in the accompanying consolidated financial statements has been restated to reflect the retroactive effect of the stock split for all periods presented. N O T E 5 — R E L AT E D PA R T I E S The Company leases certain land and buildings related to 48 of its O'Reilly Auto Parts stores under six-year operating lease agreements with O'Reilly Investment Company and O'Reilly Real Estate Company, partnerships in which certain shareholders and directors of the Company are partners. Generally, these lease agreements provide for renewal options for an additional six years at the option of the Company and the lease agreements are periodically modified to further extend the lease term for specific stores under the agreement. Additionally, the Company leases certain land and buildings related to 21 of its O’Reilly Auto Parts stores under fifteen-year operating lease agreements with O’Reilly-Wooten 2000 LLC, which is owned by certain shareholders and directors of the Company. Generally, these lease agreements provide for renewal options for two additional five-year terms at the option of the Company (see Note 7). Rent payments under these operating leases totaled $3,446,000, $3,413,000 and $3,380,000 in 2007, 2006 and 2005, respectively. N O T E 6 — L O N G -T E R M D E B T On July 29, 2005, the Company entered into an unsecured, five-year syndicated credit facility (Credit Facility) in the amount of $100 million led by Wells Fargo Bank as the Administrative Agent, replacing a three-year $150 million syndicated credit facility. The Credit Facility is guaranteed by all of the Company’s subsidiaries and may be increased to a total of $200 million, subject to the availability of such additional credit from either existing banks within the Credit Facility or other banks. The Credit Facility bears interest at LIBOR plus a spread ranging from 0.375% to 0.750% (5.25% at December 31, 2007) and expires in July 2010. There were no outstanding borrowings under the Credit Facility at December 31, 2007. Outstanding borrowings under the Credit Facility at December 31, 2006 totaled $9.7 million. The Company issues stand-by letters of credit provided by a $50 million sub limit 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 $28.6 million and $32.9 million were outstanding at December 31, 2007 and 2006, respectively. Accordingly, the Company’s aggregate availability for additional borrowings under the Credit Facility was $71.4 million and $57.4 million at December 31, 2007 and 2006, respectively. The Company is subject to a commitment fee ranging from 0.075% to 0.175% (.075% at December 31, 2007) for unused borrowings under the Credit Facility. On May 15, 2006, the Company entered into a private placement agreement that allows for the issuance of an aggregate of $300 million in unsecured senior notes, issuable in series. On May 15, 2006, the Company completed the private placement of $75 million of the first series of Senior Notes (the “Series 2006-A Senior Notes”) under the Private Placement Agreement. The $75 million of Series 2006-A Senior Notes are due May 15, 2016 and bear interest at 5.39% per year. Proceeds from the Series 2006-A Senior Notes private placement transaction were used to repay certain existing debt of the Company, including $75 million of 7.72% Series 2001-A Senior Notes due May 15, 2006. 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 and were repaid on May 15, 2006 from the proceeds from the issuance of the Series 2006-A Senior Notes discussed above. 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 Company leases certain computer equipment under a capital lease agreement. The lease agreement has a term of 36 months, expiring in 2009. At December 31, 2007, the monthly installment under this agreement was approximately $28,000. The present value of the future minimum lease payments under capital leases totaled approximately $469,000 and $779,000 at December 31, 2007 and 2006 respectively, which have been classified as long-term debt in the accompanying consolidated financial statements. The Company did not acquire any equipment under capital 37 Notes to Consolidated Financial Statements (continued) leases during the period ended December 31, 2007. The Company acquired $943,000 of assets under the capital lease during the periods ended December 31, 2006. Principal maturities of long-term debt are as follows (amounts in thousands): 2008 2009 2010 2011 2012 Thereafter $ 25,320 149 -- -- -- 75,000 $ 100,469 N O T E 7 — C O M M I T M E N T S Lease Commitments On September 28, 2007, the Company completed a second amended and restated master agreement to its $49 million Synthetic Operating Lease Facility with a group of financial institutions. The terms of such lease facility provide for an initial lease period of seven years, a residual value guarantee of approximately $39.7 million at December 31, 2007 and purchase options on the properties. The lease facility also contains a provision for an event of default whereby the lessor, among other things, may require the Company to purchase any or all of the properties. One additional renewal period of seven years may be requested from the lessor, although the lessor is not obligated to grant such renewal. The second amended and restated Facility has been accounted for as an operating lease under SFAS No. 13 and related interpretations, including FASB Interpretation No. 46R. Future minimum rental commitments under the Facility have been included in the table of future minimum annual rental commitments below. The Company also leases certain office space, retail stores, property and equipment under long-term, non-cancelable operating leases. Most of these leases include renewal options and some include options to purchase and provisions for percentage rent based on sales. At December 31, 2007, 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): 2008 2009 2010 2011 2012 Thereafter Related Parties $ 3,404 2,790 2,043 1,778 1,746 6,817 $ 18,578 Non-related Parties $ 48,361 45,131 40,655 37,452 33,920 278,486 $ 484,005 Total $ 51,765 47,921 42,698 39,230 35,666 285,303 $ 502,583 Rental expense amounted to $55,358,000, $49,245,000 and $43,047,000 for the years ended December 31, 2007, 2006, and 2005, respectively. Other Commitments The Company had construction commitments, which totaled approximately $96.3 million, at December 31, 2007. N O T E 8 — L E G A L P R O C E E D I N G S The Company is involved in various legal proceedings incidental to the ordinary conduct of its business. Although the Company cannot ascertain the amount of liability that it may incur from any of these matters, it does not currently believe that, in the aggregate, these matters will have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company. N O T E 9 — S H A R E - B A S E D E M P L O Y E E C O M P E N S AT I O N P L A N S Stock Options The Company’s employee stock based incentive plan provides for the granting of stock options to certain key employees of the Company for the purchase of common stock of the Company. A total of 24,000,000 shares have been authorized for issuance under this plan. Options are granted at an exercise price that is equal to the market value of the Company’s common stock on the date of the grant. Options granted under the plan expire after ten years and typically vest 25% a year, over four years. Since the adoption of SFAS No. 123R, the Company records compensation 38 Notes to Consolidated Financial Statements (continued) expense for the grant date fair value of option awards evenly over the vesting period under the straight-line method. A summary of the shares subject to currently issued and outstanding stock options under this plan is as follows: Outstanding at December 31, 2006 Granted Exercised Forfeited Outstanding at December 31, 2007 Vested or expected to vest at December 31, 2007 Exercisable at December 31, 2007 Shares 6,450,745 1,416,925 (1,045,292) (577,538) 6,244,840 5,846,832 4,404,403 Weighted-Average Exercise Price $ 20.38 33.67 16.38 27.86 $ 23.41 $ 22.76 $ 19.31 Weighted-Average Remaining Contractual Terms (in years) Aggregate Intrinsic Value 6.69 6.53 5.70 $ 58,549,000 $ 58,319,000 $ 57,879,000 The Company maintains a stock based incentive plan for non-employee directors of the Company pursuant to which the Company may grant stock options. Up to 1,000,000 shares of common stock have been authorized for issuance under this plan. Options are granted at an exercise price that is equal to the market value of the Company’s common stock on the date of the grant. Options granted under the plan expire after seven years and vest fully after six months. Since the adoption of SFAS No. 123R, the Company records compensation expense for the grant date fair value of option awards evenly over the vesting period under the straight-line method. A summary of the shares subject to currently issued and outstanding stock options under this plan is as follows: Outstanding at December 31, 2006 Granted Exercised Forfeited Outstanding at December 31, 2007 Vested or expected to vest at December 31, 2007 Exercisable at December 31, 2007 Shares 190,000 25,000 -- -- 215,000 215,000 215,000 Weighted-Average Exercise Price $ 18.09 34.84 -- -- $ 20.12 $ 20.12 $ 20.12 Weighted-Average Remaining Contractual Terms (in years) Aggregate Intrinsic Value 2.89 2.89 2.89 $ 2,769,000 $ 2,769,000 $ 2,769,000 At December 31, 2007, approximately 10,687,000 and 375,000 shares were reserved for future issuance under the employee stock option plan and director stock option plan, respectively. For the year ended December 31, 2007, the Company recognized stock option compensation expense related to these plans of $4,882,000 and a corresponding income tax benefit of $1,801,000. For the year ended December 31, 2006, the Company recognized stock option compensation expense related to these plans of $2,762,000 and a corresponding income tax benefit of $1,019,000. The fair value of each stock option grant is estimated on the date of the grant using the Black-Scholes option pricing model. The Black-Scholes model requires the use of assumptions, including expected volatility, expected life, the risk free rate and the expected dividend yield. Expected volatility is based upon the historical volatility of the Company’s stock. Expected life represents the period of time that options granted are expected to be outstanding. The Company uses historical data and experience to estimate the expected life of options granted. The risk free interest rate for periods within the contractual life of the options are based on the United States Treasury rates in effect for the expected life of the options. The following weighted-average assumptions were used for grants issued for the years ended December 31, 2007, 2006 and 2005: Risk free interest rate Expected life Expected volatility Expected dividend yield 2007 4.47% 4.4 years 33.7% 0% 2006 4.01% 4.7 years 35.1% 0% 2005 4.25% 4.0 years 35.8% 0% The weighted-average grant-date fair value of options granted during the years ended December 31, 2007, 2006 and 2005 were $11.81, $11.72 and $8.82, respectively. The total intrinsic value of options exercised during the years ended December 31, 2007, 2006 and 2005 were $19,511,000, $22,985,000 and $19,100,000, respectively. The Company recorded cash received from the exercise of stock options of $17,124,000, $15,970,000 and $14,915,000, in the years ended December 31, 2007, 2006 and 2005, respectively. The remaining unrecognized compensation cost related to unvested awards at December 31, 2007, was $18,107,000 and the weighted-average period of time over which this cost will be recognized is 2.9 years. 39 Notes to Consolidated Financial Statements (continued) Employee Stock Purchase Plan The Company’s employee stock purchase plan permits all eligible employees to purchase shares of the Company’s common stock at 85% of the fair market value. Participants may authorize the Company to withhold up to 5% of their annual salary to participate in the plan. The stock purchase plan authorizes up to 2,600,000 shares to be granted. During the year ended December 31, 2007, the Company issued 156,466 shares under the purchase plan at a weighted average price of $29.12 per share. During the year ended December 31, 2006, the Company issued 165,306 shares under the purchase plan at a weighted average price of $27.36 per share. During the year ended December 31, 2005, the Company issued 161,903 shares under the purchase plan at a weighted average price of $27.57 per share. SFAS No. 123R requires compensation expense to be recognized based on the discount between the grant date fair value and the employee purchase price for shares sold to employees. During the year ended December 31, 2007, the Company recorded $804,000 of compensation cost related to employee share purchases and a corresponding income tax benefit of $290,000. During the year ended December 31, 2006, the Company recorded $799,000 of compensation cost related to employee share purchases and a corresponding income tax benefit of $295,000. At December 31, 2007, approximately 243,000 shares were reserved for future issuance. Other Employee Benefit Plans The Company sponsors a contributory profit sharing and savings plan that covers substantially all employees who are at least 21 years of age and have at least six months of service. The Company has agreed to make matching contributions equal to 50% of the first 2% of each employee’s wages that are contributed and 25% of the next 4% of each employee’s wages that are contributed. The Company also makes additional discretionary profit sharing contributions to the plan on an annual basis as determined by the Board of Directors. The Company’s matching and profit sharing contributions under this plan are funded in the form of shares of the Company’s common stock. A total of 4,200,000 shares of common stock have been authorized for issuance under this plan. During the year ended December 31, 2007, the Company recorded $6,849,000 of compensation cost for contributions to this plan and a corresponding income tax benefit of $2,527,000. During the year ended December 31, 2006, the Company recorded $6,429,000 of compensation cost for contributions to this plan and a corresponding income tax benefit of $2,372,000. During the year ended December 31, 2005, the Company recorded $6,606,000 of compensation cost for contributions to this plan and a corresponding income tax benefit of $2,444,000. The compensation cost recorded in 2007 includes matching contributions made in 2007 and profit sharing contributions accrued in 2007 to be funded with issuance of shares of common stock in 2008. The Company issued 197,431 shares in 2007 to fund profit sharing and matching contributions at an average grant date fair value of $32.90. The Company issued 204,000 shares in 2006 to fund profit sharing and matching contributions at an average grant date fair value of $34.34. The Company issued 210,461 shares in 2005 to fund profit sharing and matching contributions at an average grant date fair value of $25.79. A portion of these shares related to profit sharing contributions accrued in prior periods. At December 31, 2007, approximately 863,000 shares were reserved for future issuance under this plan. The Company has in effect a performance incentive plan for the Company’s senior management under which the Company awards shares of restricted stock that 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. A total of 800,000 shares of common stock have been authorized for issuance under this plan. Shares awarded under this plan are valued based on the market price of the Company’s common stock on the date of grant and compensation cost is recorded over the vesting period. The Company recorded $459,000 of compensation cost for this plan for the year ended December 31, 2007 and recognized a corresponding income tax benefit of $169,000. The Company recorded $416,000 of compensation cost for this plan for the year ended December 31, 2006 and recognized a corresponding income tax benefit of $154,000. The Company recorded $289,000 of compensation cost for this plan for the year ended December 31, 2005 and recognized a corresponding income tax benefit of $107,000. The total fair value of shares vested (at vest date) for the years ended December 31, 2007, 2006 and 2005 were $478,000, $503,000 and $524,000, respectively. The remaining unrecognized compensation cost related to unvested awards at December 31, 2007 was $521,000. The Company awarded 16,189 shares under this plan in 2007 with an average grant date fair value of $34.02. The Company awarded 18,698 shares under this plan in 2006 with an average grant date fair value of $33.12. The Company awarded 14,896 shares under this plan in 2005 with an average grant date fair value of $25.41. Compensation cost for shares awarded is recognized over the three-year vesting period. Changes in the Company’s restricted stock for the year ended December 31, 2007 were as follows: Non-vested at December 31, 2006 Granted during the period Vested during the period Forfeited during the period Non-vested at December 31, 2007 Shares 16,291 16,189 (14,738) (2,619) 15,123 Weighted-Average Grant Date Fair Value $ 30.80 34.02 31.05 32.53 $ 33.70 At December 31, 2007, approximately 645,000 shares were reserved for future issuance under this plan. 40 Notes to Consolidated Financial Statements (continued) N O T E 1 0 — S H A R E H O L D E R R I G H T S P L A N On May 7, 2002, the Board of Directors adopted a shareholder rights plan whereby one right was distributed for each share of common stock, par value $.01 per share, of the Company held by stockholders of record (the “Rights”) 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 com- mon 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 an amount of common stock of the Company having a market value of twice the exercise price of the Right. A copy of the Rights Agreement was filed on June 3, 2002, with the Securities and Exchange Commission, as Exhibit 4.2 to the Company’s report on Form 8-K. N O T E 1 1 — I N C O M E P E R C O M M O N S H A R E The following table sets forth the computation of basic and diluted income per common share: (In thousands, except per share data) Years ended December 31, Numerator (basic and diluted): Net income 2007 2006 2005 $ 193,988 $ 178,085 $ 164,266 Denominator: Denominator for basic income per common share– weighted-average shares Effect of stock options (Note 9) Denominator for diluted income per common share- adjusted weighted-average shares and assumed conversion Basic net income per common share Net income per common share-assuming dilution 114,667 1,413 116,080 $ $ 1.69 1.67 113,253 1,866 115,119 $ $ 1.57 1.55 111,613 1,772 113,385 $ $ 1.47 1.45 N O T E 1 2 — I N C O M E TA X E S Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows at December 31: (In thousands) Deferred tax assets: Current: Allowance for doubtful accounts Unrecognized loss on short term investments Other accruals Noncurrent: Other accruals Total deferred tax assets Deferred tax liabilities: Current: Inventories Noncurrent: Property and equipment Other Total deferred tax liabilities Net deferred tax liabilities 41 2007 2006 $ 1,202 4,133 14,440 17,800 37,575 26,010 40,431 4,610 71,051 $ 958 -- 19,251 2,967 23,176 25,988 37,517 3,621 67,126 $ (33,476) $ (43,950) Notes to Consolidated Financial Statements (continued) The provision for income taxes consists of the following: (In thousands) Current Deferred Total 2007: Federal State 2006: Federal State 2005: Federal State $ 110,302 9,539 $ (5,847) (494) $ 104,455 9,045 $ 119,841 $ (6,341) $ 113,500 $ 96,824 8,373 $ (938) (79) $ 95,886 8,294 $ 105,197 $ (1,017) $ 104,180 $ 79,720 7,754 $ (616) (55) $ 79,104 7,699 $ 87,474 $ (671) $ 86,803 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 2007 $ 107,620 5,880 -- $ 113,500 2006 $ 98,793 5,387 -- $ 104,180 2005 $ 87,874 4,986 (6,057) $ 86,803 The Company's provision for income taxes for 2005 included a non-cash tax adjustment of $6.1 million in the third quarter of 2005 resulting from the favorable resolution of prior tax uncertainties. The tax benefit realized in 2005 was nonrecurring and reflected the reversal of previously recorded income tax reserves related to a prior acquisition. In determining the provision for income taxes, the Company uses an estimated annual effective tax rate based on expected annual income by jurisdiction and statutory tax rates. The impact of significant discrete items, including the tax benefit realized in the third quarter of 2005, is separately recognized in the quarter in which they occur. The tax benefit associated with the exercise of non-qualified stock options has been reflected as additional paid-in capital in the accompanying consolidated financial statements. 42 Notes to Consolidated Financial Statements (continued) N O T E 1 3 — A C C U M U L AT E D O T H E R C O M P R E H E N S I V E L O S S The adjustment to unrealized holding loss on available-for-sale securities included in accumulated other comprehensive loss for the period ended December 31, 2007 totaled $10,933,000 with a corresponding tax benefit of $4,133,000 resulting in a net of tax effect of $6,800,000. Changes in accumulated other comprehensive loss for the period ended December 31, 2007 consist of the following: (In thousands) Balance at December 31, 2006 Current-period change Balance at December 31, 2007 Unrealized Losses on Securities Accumulated Other Comprehensive Loss $ -- (6,800) $ (6,800) $ -- (6,800) $ (6,800) 43 Directors and Executive Committee David O'Reilly Chairman of the Board of Directors Charlie O'Reilly Vice Chairman of the Board of Directors Larry O'Reilly Vice Chairman of the Board of Directors Rosalie O'Reilly-Wooten Director Jay Burchfield Director Compensation Committee Chairman Corporate Governance and Nominating Committee Joe Greene Director Corporate Governance and Nominating Committee Chairman Paul Lederer Director Audit Committee Compensation Committee John Murphy Director Audit Committee Chairman Corporate Governance and Nomination Committee Ronald Rashkow Director Audit Committee Compensation Committee Greg Henslee Chief Executive Officer and Co-President Ted Wise Chief Operating Officer and Co-President Tom McFall Chief Financial Officer and Executive Vice President Greg Johnson Senior Vice President of Distribution Jeff Shaw Senior Vice President of Store Operations and Sales Mike Swearengin Senior Vice President of Merchandise Tricia Headley Vice President and Corporate Secretary Tony Bartholomew Vice President of Sales Greg Beck Vice President of Purchasing Brad Beckham Vice President of Eastern Region Ken Cope Vice President of Central Region Charlie Downs Vice President of Real Estate and Expansion Phyllis Evans Vice President of Store Administration Alan Fears Vice President of Jobber Sales and Acquisitions Brett Heintz Vice President of Retail Systems Jaime Hinojosa Vice President of Southern Region Steve Jasinski Vice President of Information Systems Randy Johnson Vice President of Store Inventories Kenny Martin Vice President of Northern Region Wayne Price Vice President of Risk Management Doug Ruble Vice President of Marketing and Advertising Barry Sabor Vice President of Loss Prevention Tom Seboldt Vice President of Merchandise Phillip Thompson Vice President of Human Resources Mike Williams Vice President of Advanced Technology Operations Management SENIOR MANAGEMENT Doug Adams Director of Atlanta East Region Tom Allen Director of Store Computer Operations Jeanene Asher Director of Telecommunications Mike Ballard Director of Internet Development and Networking Emmitt Barina Director of Safety and Environmental Regulations Steve Beil Director of Atlanta West Region Bert Bentley Director of Houston Region Rob Bodenhamer Director of Technology Development Larry Boevers Regional DC Director Doug Bragg Director of Oklahoma Region Julie Gray Director of Corporate Services Jack House Director of Customer Services Mike Chapman Director of Dallas Region Larry Gray Regional DC Director Chad Keel Director of St. Louis Region Keith Childers Director of Little Rock Region Tom Connor Regional DC Director Joe Edwards Director of Store Installations Jay Enloe Director of Workers’ Compensation and Risk Administration Robert Greene Director of Real Estate Legal Services Ron Greenway Director of Tax Jeff Groves Director of Legal and Claims Services Joe Hankins Director of Store Design Jeremy Fletcher Director of Finance/Controller Chris Harrelson Director of Nashville Region Jason Frizzell Director of Knoxville Region David Glore Director of Ozark Sales John Gouette Director of Minneapolis/St. Paul Northwest Region Billy Harris Director of Iowa and Nebraska Region Doy Hensley Director of Store Support Services Doug Hopkins Director of Distribution Systems Michelle Kimrey Director of Accounting Brad Knight Director of Pricing Scott Kraus Director of Minneapolis/St. Paul Northeast Region John Krebs Director of Gulf States Region Terry Lee Director of Mississippi Region Dave Leonhart Regional DC Director Scott Leonhart Director of Ohio Region John Martinez Director of Rio Grande Valley Region 44 Jim Maynard Director of Employment and Team Member Relations Rodger McClary Director of Kansas City Region Curt Miles Director of Indianapolis Region Brad Oplotnik Director of Systems Management Kevin Overmon Director of Site Acquisitions Steve Peterie Director of Construction/Design Ed Randall Director of Property Management Shari Reaves Director of Compensation and Benefits Steve Rice Director of Credit and Collections Art Rodriguez Director of Southern Division Sales Chuck Rogers Director of Sales Administration Rick Samsel Director of Store Inventory Denny Smith Director of Springfield Region Mark Smith Director of Dallas Region Charlie Stallcup Director of Training David Strom Sr Director of Houston Region Ron Todd Director of Northern Division Sales David Turney Director of Internal Audit Tamra Waitman Director of Financial Analysis and Planning Jeff Watts Director of Eastern Division Sales Saundra Wilkinson Director of Store Administration Wes Wise Director of Marketing Mike Young Director of Construction Operations Management (continued) CORPORATE MANAGEMENT Dale Agee Computer Help Support Manager Jeff Alexander Creative Services Manager Curt Allen Real Estate Site Acquisition Manager Mike Crawford Division Loss Prevention Manager Charlie Hill Regional Field Sales Manager Bruce Creason DC Safety Manager Garry Curbow Replenishment Manager Josh Dalrymple Distribution Center Manager Mike Hill Installer Systems Manager Brian Holdcraft Regional Field Sales Manager Jim Hoover Regional Field Sales Manager Dan Altis Distribution Center Manager Jack Darovich Regional Field Sales Manager David Hunsucker Catalog Department Manager Keith Asby Sales Manager of Special Markets Cecil Davis DC Inbound Operations Manager Doug Hutchison Inventory Project Manager Gary Baker Technical Assistance Manager Tim Evans National Accounts Manager Johnny Ivy Regional Field Sales Manager Carl Barina Regional Field Sales Manager Paula Eyman Special Projects Manager Karen James Retail Marketing Manager Jason Bayless Retail Facilities Manager Paul Fagan Distribution Center Manager John Jay Regional Field Sales Manager Randy Freund Regional Field Sales Manager Steve Lines Installer Programs Manager Doug Bennett Installer Pricing/Bid Manager Becky Fincher Advertising Manager Merle Bever Senior Product Manager Ron Biegay Southern Division Human Resources Manager Larry Blundell Regional Field Sales Manager Tom Bollinger Regional Field Sales Manager Marcus Boyer Distribution Center Manager Kevin Ford DC Projects and Procedures Manager Doug Fox Distribution Center Manager David Furr Service Equipment Sales Manager Lori Fuzzell Special Orders Manager Clint Brewer Regional Field Sales Manager Jaydee Garrison Regional Field Sales Manager Kent Brewer DC Transportation Manager Adam Buchanan Regional Field Sales Manager Eddie Buttler Regional Field Sales Manager Brian Callis Regional Field Sales Manager Scott Cannon Product Manager Yvonne Cannon Payroll Manager Stephen Carlson Jobber Systems Sales Manager Danny Clark Regional Field Sales Manager Dennis Cook Real Estate Site Acquisition Manager Rudy Cortez Regional Field Sales Manager Bob Gillespie Regulatory and Environmental Manager Art Glidewell Distribution Center Manager Bridget Harmon PC Support Manager Jim Harnisfager Product Manager Candy Haskin Treasury Manager Mike Hauk Division Training Manager David Hawker Regional Field Sales Manager Troy Hellerud Central Support Manager Diana Hicks Internal Communications Manager 45 Les Keeth Accounts Payable Manager Jennifer Kent Store Design Manager Duane Keys Application Development Manager Jim Litchford Jobber Regional Field Sales Manager T. J. Madrid Regional Field Sales Manager Jeff Main Jobber Systems Sales Manager Harry Marcley Distribution Center Manager Ed Martinez Distribution Center Manager John Massie Regional Field Sales Manager Shawn McCormick Division Loss Prevention Manager Becky McCurry Accounts Payable Expense Manager Carla McElveen New Store Inventory Manager Jeff McKinney Customer Satisfaction Manager Mindy Morgan Team Member Relations Manager Asa Nelson Distribution Center Manager Paul Southard IS Governance Manager Kim Stone Product Manager II Mary Stratton Human Resources Programs/Tech Support Manager Camille Strickland Real Estate Contract Manager Robert Suter Senior Product Manager Roger Taylor Regional Field Sales Manager Dallas Thompson Real Estate Site Acquisition Manager Arnulfo Vega Regional Field Sales Manager Darin Venosdel Application Development Manager Rob Verch Product Manager II Patton Walden Training Manager Eastern Division Lane Wallace Pricing Manager Susan Weaver Human Resources Records/Benefits Manager Sherry Webb Accounts Payable Merchandise Manager Les Weber Regional Field Sales Manager David Wehrenberg Distribution Center Manager Scotty Weidman Product Manager II Brian Welch Logistics Manager Matt Weldon PBE Sales Manager Jan Whitney Travel Manager Larry Wiles Audio/Video Communications Manager Karla Williams Application Development Manager Jimmy Wilmoth Division Training Manager Joe Winteberg Product Manager II Heather Woody Assistant Controller Christina Zahn HRIS and Compensation Manager Tom Nunley Regional Field Sales Manager James Owens Regional Field Sales Manager Bryan Packer Jobber Computer Sales and Support Manager Operations Management (continued) Jim Riggs Construction Manager Tim Smith Credit Manager Corey Robinson Inventory Accounting Manager Tom Smith Training Manager Mary Sabor DC Administrative Services Manager Wendi Page Real Estate Property Manager James Samson Distribution Center Manager Suzanne Parks Accounts Receivable Manager Rob Payne Product Manager Abby Pennell Real Estate Counsel Kolby Perusse Distribution Center Manager Tony Phelps Distribution Center Manager Steve Phillips Division Loss Prevention Manager Matt Pickering Inventory Maintenance Manager Paul Pike Regional Field Sales Manager Chris Pridgen Human Resources Employment Manager Brian Prock Division Training Manager Tim Rathbun Store Inventory Manager Hugo Sanchez Hispanic/Sports Marketing Manager Tim Scholl DC Field Projects Manager Ronald Scivicque Regional Field Sales Manager William Seiber Distribution Center Manager Darren Shaw Product Manager II Tim Shaw Eastern Division Human Resources Manager John Shelton Regional Field Sales Manager Leigh Sides Alarm Services Manager Craig Smith Real Estate Counsel Dave Smith Product Manager II Phil Smith Division Loss Prevention Manager 46 DISTRICT CORPORATE MANAGEMENT Abel Abila Eddie Allen Kurt Anderson Henry Armington Scott Baglo Chris Baker Tracy Banks Brince Beasley Jim Belschner Michael Bering Adam Berryman Aaron Biggs Kirk Bilski Richard Blackwell Tommy Boudwin Robert Boutwell Mic Bowers Eric Bowman Randy Brewer Lester Brown Patrick Brown Mark Cannon Donnie Carden Fred Carrington Jimmy Carter Jimmy Chadwick Carl Chaffin David Chavis Dirk Chester Aaron Clay Mark Cleary Justin Coker Tim Coleman Adam Cortez Dean Dassel Jim Dickens Robert Doss Bruce Dowell Ward Duffy Robert Dumas Tommy Dunn Mike Eckelkamp Judy Ellington Paul Engaldo Ron England Tony Fagan Chris Farrow Bill Fellows Jacky Floyd Donald Ford Rodney Ford Kirk Frazier Mark Frazier Curtis Fulkerson Butch Galloway Tim Gardner Brad Garrison Craig Garrison Ernie Golden Dennis Gonzales Daniel Grandquest Dan Griffin Tony Haag Jeffery Haire James Harris Jon Haught Paul Hayden Rick Hedges Mike Heiter Gerry Hendrix Shannon Henry Ed Hernandez Perry Hess Brady Hicks Matt Hill Mike Hollis Kenneth Hubbart Allen Hughes Clint Hunter Johnny Jarvis Jeff Jennings Wayne Johnson Natalie Johnson Chuck Kaiser Justin Kale Butch Kelton Todd Kemper Jimi Kent Troy King Rick Koehn Greg Lair Chris Lewis Oliverio Lopez Steve Luellen Billy Lynn Shelton Maben Mark Mach Chris Mancini Albert Martinez Tommy Mason Brian Matthews Clint McFadden Marc McGehee Chris Meade Tom Meyer Jack Miller Chuck Mitchell Andy Moore Don Morgan Trey Morgan Randy Morris Ciro Moya Jr Ramon Odems Lance O’Donnell Ron Papay Jude Patterson Gilbert Perez Pernell Peters Randy Peterson David Pilat Brent Pizzolato David Plaster Mike Platt Rob Pocklington Troy Polston Charles Ponder Robert Poynor James Ramsey Clint Reaux Lee Reese Will Reger Christopher Reynolds Tommy Rhoads Alan Riddle Larry Roof Randall Rowland Daniel Rozowski Juan Salinas Steve Sandman Diego Santillana Matt Schlueter Paul Schmidt Barry Scott Jim Scott Dusty Sermersheim Steven Severe Garry Shelby Frank Silvas Eric Sims Greg Sims Bobby Smith Bob Snodgrass Wayne Spratlin Robin Stivers Angela Stokes Beverli Sumrall Marvin Swaim Alan Sweeton Bert Tamez Randy Tanner Ricky Tanner Shawn Taylor Rick Tearney Justin Tracy Jim Turvey Mark Van Hoecke Andy Velez Robert Verver Fred Wadle Bo Waldrop Terry Walker Mark Warden Brent Warner Rob Weiskirch Chris Westfall John Winburn Allen Wise Dexter Woods Cody Zimmerman 47 Shareholder Information C O R P O R AT E A D D R E S S 233 South Patterson Springfield, Missouri 65802 417-862-3333 Web site – www.oreillyauto.com R E G I S T R A R A N D T R A N S F E R A G E N T Computershare Investor Services P.O. Box 43078 Providence, RI 02940-3078 Inquiries regarding stock transfers, lost certificates or address changes should be directed to Computershare Investor Services at the above address. I N D E P E N D E N T R E G I S T E R E D P U B L I C A C C O U N T I N G F I R M Ernst & Young LLP One Kansas City Place 1200 Main Street, Suite 2000 Kansas City, Missouri 64105-2143 A N N UA L M E E T I N G The annual meeting of shareholders of O’Reilly Automotive, Inc. will be held at 10:00 a.m. local time on May 6, 2008, at the Clarion Hotel, Ballrooms 1 and 2, 3333 South Glenstone Ave in Springfield, Missouri. Shareholders of record as of February 28, 2008, will be entitled to vote at this meeting. F O R M 1 0 - K R E P O R T The Form 10-K Report of O’Reilly Automotive, Inc. filed with the Securities and Exchange Commission and our quarterly press releases are available without charge to shareholders upon written request. These requests and other investor contacts should be directed to Thomas McFall, Chief Financial Officer and Executive Vice President, at the corporate address. T R A D I N G S Y M B O L The Company’s common stock is traded on The Nasdaq Global Select Market under the symbol ORLY. N U M B E R O F S H A R E H O L D E R S As of February 28, 2008, O’Reilly Automotive, Inc. had approximately 48,463 shareholders based on the number of holders of record and an estimate of the number of individual participants represented by security position listings. A N A LY S T C O V E R A G E The following analysts provide research coverage of O’Reilly Automotive, Inc.: BB&T Capital Markets – Anthony Cristello BMO Capital Markets U.S. – Richard Weinhart Credit Suisse – Gary Balter Deutsche Bank Research – Michael Baker FTN Midwest Research Securities Corp. – William Keller Goldman Sachs Research – Matthew J. Fassler Kevin Dann & Partners – Cid Wilson Merriman Curhan Ford & Co. – Robert Straus Morgan Stanley – Gregory Melich Raymond James & Associates – Dan Wewer RBC Capital Markets – Scot Ciccarelli Robert W. Baird & Co. – J. David Cumberland Sidoti & Company – Scott Stember Stifel Nicolaus & Company, Incorportated – David Schick Wachovia Securities – Peter Benedict William Blair & Company – Sharon Zackfia M A R K E T P R I C E S A N D D I V I D E N D I N F O R M AT I O N The prices in the table below represent the high and low sales price for O’Reilly Automotive, Inc. common stock as reported by The Nasdaq Global Select Market (see Note 4 in the Company’s consolidated financial statements for information concerning the Company’s stock split in 2005). 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. 2007 2006 High $ 35.20 38.84 38.20 34.72 38.84 Low $ 31.45 32.58 31.44 30.43 30.43 High Low $ 38.30 36.99 34.24 35.10 38.30 $ 30.87 29.30 27.49 30.92 27.49 First Quarter Second Quarter Third Quarter Fourth Quarter For the Year 48 Board of Directors DAV I D O’ R E I L LY Chairman of the Board C H A R L I E O’ R E I L LY Vice Chairman of the Board L A R R Y O’ R E I L LY Vice Chairman of the Board R O S A L I E O ’ R E I L LY -W O O T E N Director JAY B U R C H F I E L D Director Since 1997 Compensation Committee - Chairman Corporate Governance/Nominating Committee J O E G R E E N E Director Since 1993 Corporate Governance/ Nominating Committee - Chairman PA U L L E D E R E R Director 1993-July 1997; February 2001 Audit Committee Compensation Committee J O H N M U R P H Y Director Since 2003 Audit Committee - Chairman Corporate Governance/ Nominating Committee R O N A L D R A S H KO W Director Since 2003 Audit Committee Compensation Committee Mission Statement “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, benefits and working conditions which promote high achievement and ensure fair and equitable treatment; and providing our stockholders with an excellent return on their investment.” 233 South Paterson Springfield, Missouri 65802 417.862.3333 www.oreillyauto.com

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