O’Reilly Automotive, Inc. — 2017 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2017; comparable period ended March 31, 2016. The company operates automotive aftermarket parts, tools, supplies, equipment and accessories stores serving do-it-yourself and professional customers. It operated 4,888 stores in 47 states at quarter-end.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $2.156 billion | $2.096 billion | +3% |
| Comparable-store sales | +0.8% | +6.1% | Down 5.3 percentage points |
| Gross profit | $1.131 billion | $1.098 billion | +3% |
| Gross margin | 52.5% | 52.4% | +10 basis points |
| SG&A | $728.0 million | $679.0 million | +7% |
| Operating income | $403.2 million | $418.6 million | -4% |
| Operating margin | 18.7% | 20.0% | Down 130 basis points |
| Net income | $264.9 million | $255.4 million | +4% |
| Diluted EPS | $2.83 | $2.59 | +9% |
| Diluted weighted-average shares | 93.5 million | 98.5 million | Down 5% |
| Operating cash flow | $376.7 million | $503.1 million | Down 25% |
| Free cash flow | $242.8 million | $384.4 million | Down 37% |
Net income margin was 12.3% versus 12.2% in the prior-year quarter. The effective tax rate declined to 31.2% from 37.0%, principally because adoption of ASU 2016-09 produced a $23.3 million tax benefit and increased diluted EPS by $0.23.
At March 31, 2017, cash and cash equivalents were $27.5 million, inventory was $2.873 billion, total assets were $7.204 billion, and shareholders’ equity was $1.423 billion. Long-term debt was $1.978 billion, including approximately $1.9 billion of senior notes and $90 million reported as revolving-facility borrowings. The filing contains an inconsistency: the balance sheet and debt note report $90 million of revolving borrowings, while the MD&A states that no revolving-facility borrowings were outstanding at quarter-end.
Material changes versus the prior comparable period
- Sales increased $60 million, driven by new stores, the 48 acquired Bond stores and comparable-store growth. The company opened 60 stores and closed one during the quarter, for 59 net additions.
- Comparable-store growth slowed materially, reflecting negative DIY transaction counts, flat professional-customer transactions, delayed tax refunds, mild winter weather and unfavorable spring weather.
- Gross margin improved modestly because of a smaller non-cash LIFO impact, partly offset by lower merchandise margins and distribution-cost deleverage.
- SG&A grew faster than sales, increasing to 33.8% of sales from 32.4%, primarily because of additional personnel, facilities and vehicles and deleveraged store operating costs.
- Operating income and operating margin declined despite higher sales. Higher interest expense, associated with greater average borrowings, increased total other expense to $17.9 million from $13.1 million.
- Operating cash flow declined because of greater inventory investment and lower income taxes payable. Capital expenditures increased to $110.6 million from $104.0 million.
- The company repurchased 1.829 million shares for $490.3 million, versus 1.231 million shares for $312.6 million in the prior-year quarter. Shares outstanding declined to 91.3 million at March 31 from 92.9 million at December 31, 2016.
Guidance, outlook, risks and unusual items
- Management planned approximately 190 net new stores in 2017, in addition to converting 48 Bond stores. Store growth was expected to be funded through operating cash flow and available revolver capacity.
- Management cited continued demand support from miles driven, an aging U.S. vehicle fleet and employment, but cautioned that demand is affected by fuel costs, consumer spending, weather, competition, unemployment and vehicle repair patterns.
- On April 5, 2017, the company replaced its prior facility with a new $1.2 billion unsecured revolving credit facility maturing in April 2022. The new agreement permits up to an additional $600 million of commitments and uses a maximum consolidated leverage covenant of 3.50:1.00.
- The company reported compliance with its debt covenants at March 31, 2017. Reported covenant ratios were 5.98 times for fixed-charge coverage versus a 2.50-times minimum and 1.69 times for leverage versus a 3.00-times maximum under the prior facility.
- The company reserved $18.6 million for the Meridian Creative Alliance litigation. The Missouri Court of Appeals reversed and affirmed portions of the matter and remanded the claim associated with a $12.5 million verdict; Meridian subsequently sought Missouri Supreme Court review.
- Adoption of the new share-based compensation standard resulted in a $0.3 million opening retained-earnings adjustment and materially reduced the reported tax rate and increased EPS.
- The company expected future adoption of revenue-recognition and lease-accounting standards. Management stated that lease adoption is expected to materially increase reported assets and liabilities, while the revenue-standard assessment was incomplete.
- Management stated that no material changes had occurred in previously disclosed risk factors, contractual obligations or critical accounting estimates. The business is seasonal, with historically higher sales and profits in the second and third quarters.
Important facts for investors to verify
- Reconcile the $90 million revolving-facility borrowing reported in the balance sheet and debt note with the MD&A statement that no borrowings were outstanding at March 31, 2017.
- Assess whether weak 0.8% comparable-store sales were temporary weather and tax-refund timing effects or evidence of broader demand and transaction-count pressure.
- Evaluate the sustainability of EPS growth given the $0.23 benefit from ASU 2016-09 and the substantial share repurchases.
- Monitor liquidity after $490.3 million of quarterly repurchases, $110.6 million of capital expenditures and the quarter-end cash balance of only $27.5 million.
- Review execution and funding requirements for the 190 planned net store openings and conversion of the 48 Bond stores.
- Track the Meridian litigation, the $18.6 million reserve and the pending Supreme Court transfer application.
- Review the eventual effects and adoption methods for the revenue and lease accounting standards, particularly the expected balance-sheet impact of lease capitalization.