O’Reilly Automotive, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless stated otherwise. The filing is unaudited and prepared under U.S. GAAP. O’Reilly operates automotive aftermarket parts, tools, supplies, equipment and accessories stores serving do-it-yourself and professional customers.
Business Context and Operating Footprint
- O’Reilly operated 5,147 stores in 47 states at June 30, 2018, compared with 4,934 stores at June 30, 2017.
- The company opened 54 stores and closed four during the quarter, for 50 net new stores; it opened 128 net new stores during the first six months.
- Management planned approximately 200 net new store openings for 2018.
- Demand is influenced by miles driven, vehicle population and age, unemployment, weather, fuel costs, consumer spending and competition. The filing notes that delayed spring weather negatively affected DIY transaction counts in some markets.
Financial Performance and Key Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|
| Sales | $2.456 billion, up 7% | $4.739 billion, up 7% |
| Gross profit | $1.289 billion; 52.5% margin | $2.490 billion; 52.5% margin |
| Operating income | $479.2 million; 19.5% margin | $902.0 million; 19.0% margin |
| Net income | $353.1 million; 14.4% margin | $658.0 million; 13.9% margin |
| Diluted EPS | $4.28, up 38% | $7.89, up 33% |
| Comparable-store sales | Up 4.6% | Up 4.0% |
- Professional customer sales increased to $1.042 billion in the quarter and $2.017 billion year to date. DIY sales were $1.373 billion and $2.645 billion, respectively.
- SG&A increased 9% in the quarter to $809.5 million and 8% year to date to $1.588 billion. SG&A represented 33.0% of quarterly sales and 33.5% year to date.
- Interest expense increased to $30.9 million in the quarter and $59.1 million year to date, primarily because of higher average borrowings.
- The effective tax rate declined to 21.5% in the quarter and 22.2% year to date, from 35.2% and 33.3%, respectively, primarily reflecting the Tax Cuts and Jobs Act and share-based compensation tax benefits.
Cash Flow, Liquidity and Capital Structure
| Six Months Ended June 30 | 2018 | 2017 |
|---|
| Cash provided by operating activities | $875.2 million | $710.5 million |
| Capital expenditures | $224.1 million | $227.5 million |
| Free cash flow | $631.5 million | $450.5 million |
| Net cash used in financing activities | $663.1 million | $601.9 million |
| Ending cash and cash equivalents | $36.9 million | $26.5 million |
- Total assets were $7.767 billion at June 30, 2018, compared with $7.572 billion at December 31, 2017. Inventory was $3.092 billion.
- Long-term debt was $3.254 billion, up from $2.978 billion at year-end 2017. The increase primarily reflects the issuance of $500 million of 4.350% senior notes due 2028 on May 17, 2018.
- The company had $125.0 million outstanding under its $1.2 billion unsecured revolving credit facility and $36.9 million of outstanding letters of credit at June 30, 2018. The facility matures in April 2022.
- Management reported compliance with the debt covenants. The fixed-charge coverage ratio was 5.50x versus a 2.50x minimum, and the consolidated leverage ratio was 2.07x versus a 3.50x maximum.
- The company repurchased 3.763 million shares for $965.8 million during the first six months. Approximately $749.6 million remained available under the repurchase authorization at June 30, 2018.
Material Changes and Unusual Items
- Gross margin improved from 52.4% to 52.5%, partly because the prior-year periods included approximately $10 million of quarterly and $17 million of year-to-date LIFO charges. The improvement was partly offset by lower merchandise margins and higher transportation costs.
- Operating margin declined from 20.0% to 19.5% for the quarter and from 19.4% to 19.0% year to date. SG&A included planned reinvestment of a portion of Tax Act savings; management estimated this would create approximately 70 basis points of operating-profit headwind for full-year 2018. Prior-year results also benefited from a $9.1 million reduction in legal accruals.
- Revenue recognition under ASC Topic 606 was adopted using the modified retrospective method beginning in the first quarter of 2018. Management reported no material impact on financial condition, results, cash flows or opening retained earnings.
- The company issued $500 million of 4.350% senior notes due 2028, expanding its senior-note maturity profile through 2028.
- Subsequent to quarter-end through August 8, 2018, the company repurchased 0.5 million additional shares for $149.4 million.
Outlook, Risks and Contingencies
- Management remained confident in gaining market share through its dual-market strategy, store expansion, customer service and inventory availability.
- Management expected operating cash flow and available revolver capacity to fund foreseeable capital and liquidity needs, while cautioning that weaker demand or changed buying patterns could reduce cash generation and affect covenant compliance.
- Key risks include economic conditions, inflation, product demand, competition, weather, employee hiring and retention, consumer debt, increased debt levels, credit ratings, regulation, acquisitions and geopolitical events.
- The company expects to adopt the lease standard, Topic 842, in the first quarter of 2019. Although its evaluation was incomplete, management expected adoption to materially increase reported assets and liabilities.
- Litigation is ordinary-course in nature. Management did not believe existing matters, after insurance and accruals, would have a material adverse effect, although potential liability could not be determined with certainty.
- The business is seasonal, with historically higher sales and profits in the second and third quarters. The filing states that inflation had not materially adversely affected operations.
Investor Verification Checklist
- Verify the sustainability of comparable-store sales growth, particularly the balance between higher average ticket values and negative DIY transaction counts.
- Monitor gross-margin trends for merchandise mix, transportation costs, fuel prices and the absence of prior-year LIFO effects.
- Assess leverage, interest expense and refinancing requirements following the 2028 senior-note issuance and continued share repurchases.
- Reconcile the stated share-repurchase authorization: different filing sections refer to cumulative authorization amounts of approximately $10.75 billion and $10.8 billion.
- Evaluate the effect of planned 2018 store growth and Tax Act reinvestment on operating margins and free cash flow.
- Review the expected balance-sheet impact and implementation status of Topic 842 lease accounting.
- Confirm subsequent share repurchases and remaining authorization after August 8, 2018.
