O REILLY AUTOMOTIVE INC quarterly report, Q3 FY2016

O’Reilly Automotive, Inc. — Form 10-Q Summary

Business Context and Reporting Period

O’Reilly Automotive is a U.S. specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories serving do-it-yourself and professional service provider customers. This unaudited Form 10-Q covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.

Operated 4,712 stores in 45 states at September 30, 2016, versus 4,523 stores in 43 states a year earlier.
Opened 52 stores during the third quarter and 141 net new stores during the first nine months.
Management expected 210 net new stores in 2016 and 190 in 2017.

Financial Performance and Key Metrics

Metric	Q3 2016	Q3 2015	9M 2016	9M 2015
Sales	$2.221 billion	$2.080 billion	$6.494 billion	$6.018 billion
Gross profit	$1.170 billion	$1.089 billion	$3.395 billion	$3.135 billion
Gross margin	52.7%	52.4%	52.3%	52.1%
Operating income	$447.8 million	$415.3 million	$1.291 billion	$1.151 billion
Operating margin	20.2%	20.0%	19.9%	19.1%
Net income	$278.5 million	$266.3 million	$791.7 million	$712.6 million
Diluted EPS	$2.90	$2.64	$8.14	$6.98

Sales increased 7% in the quarter and 8% year to date. Comparable-store sales increased 4.2% and 4.8%, respectively.
Net income increased 5% in the quarter and 11% year to date. Diluted EPS increased 10% and 17%, aided by lower share count from repurchases.
Gross-margin expansion reflected product acquisition cost improvements and, for the nine-month period, distribution-cost leverage. These benefits were partly offset by larger non-cash LIFO inventory write-downs of approximately $10 million in the quarter and $47 million year to date.
SG&A was $722.2 million, or 32.5% of sales, in the quarter, and $2.103 billion, or 32.4% of sales, year to date. Costs increased primarily to support store growth and related personnel, facilities and vehicles.
Effective tax rates increased to 35.5% in the quarter and 36.5% year to date, compared with 33.6% and 35.8%, respectively, primarily because the prior year benefited from more favorable resolutions of historical tax matters.

Cash Flow, Debt and Liquidity

Net cash provided by operating activities was $1.168 billion for the first nine months, compared with $1.063 billion in 2015.
Capital expenditures were $356.2 million, resulting in reported free cash flow of $811.8 million, compared with $766.2 million in 2015.
Cash and cash equivalents totaled $560.3 million at September 30, 2016, versus $116.3 million at December 31, 2015.
Capital expenditures supported new-store construction, property acquisitions, closings and distribution expansion.
Long-term debt increased to $1.887 billion from $1.390 billion at year-end, primarily following the issuance of $500 million of 3.550% senior notes due 2026.
The company had no borrowings under its $600 million unsecured revolving credit facility, with $38.6 million of letters of credit outstanding. The facility matures in July 2018.
The company remained in compliance with its debt covenants. The fixed-charge coverage ratio was 6.14 times against a 2.50-times minimum, and the consolidated leverage ratio was 1.66 times against a 3.00-times maximum.
Share repurchases totaled $959.7 million for the first nine months, covering 3.673 million shares. Remaining authorization was approximately $683.5 million at September 30.

Material Changes Versus the Prior Comparable Period

Revenue, operating income and net income increased, with operating-margin improvement despite higher store-support costs.
Comparable-store sales growth moderated from the unusually strong 2015 comparison, but remained positive and was supported by higher average ticket values and transaction counts across both customer channels.
Debt increased by approximately $496.5 million following the 2026 senior-notes issuance, while cash increased substantially.
Operating cash flow and free cash flow improved, partly reflecting stronger earnings and improved supplier payment terms.
Share count declined: nine-month diluted weighted-average shares fell to 97.3 million from 102.0 million.

Guidance, Outlook, Risks and Unusual Items

Management remained confident in market-share gains and continued store expansion, citing miles driven, the growing vehicle fleet, increasing average vehicle age and improving employment as demand drivers.
The company expected 210 net new stores in 2016 and 190 in 2017. It also announced an agreement to acquire substantially all assets of Bond Auto Parts, including 48 stores in New England, expected to close before year-end 2016.
Key risks include economic conditions, fuel prices, consumer spending, competition, product demand, weather, employee retention, acquisition and integration execution, increased debt, credit ratings and regulatory matters.
The company disclosed an environmental hazardous-waste subpoena in California. The ultimate outcome was not determinable, although management had accrued amounts considered probable and estimable and did not expect a material adverse effect.
The company reserved $18.6 million for the Meridian Creative Alliance contract dispute and was appealing an unfavorable $12.5 million jury verdict.
Subsequent to quarter-end through November 8, 2016, the company repurchased approximately 0.6 million additional shares for $169.9 million.
Future adoption of revenue-recognition, lease, share-based compensation and cash-flow accounting standards was disclosed; the company was evaluating potential impacts, with certain standards not expected to have a material effect.
Management stated that controls and procedures were effective and that there were no material changes in internal control over financial reporting.

Investor Verification Priorities

Verify the sustainability of comparable-store sales growth as 2015 comparisons become less favorable.
Assess the effect of continued store expansion and the Bond Auto Parts acquisition on sales, margins, capital expenditures and integration costs.
Monitor leverage, interest expense, debt maturities and compliance with the revolving-credit covenants.
Evaluate inventory growth, supplier financing terms and the potential effect of LIFO replacement-cost adjustments on gross margin.
Review the environmental matter and Meridian litigation for changes in reserves, outcomes or cash exposure.
Reconcile free cash flow and covenant ratios to GAAP measures and confirm the pace and economic effect of ongoing share repurchases.