O’Reilly Automotive, Inc. — Q3 2012 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 customers. This unaudited Form 10-Q covers the three and nine months ended September 30, 2012, compared with the corresponding 2011 periods.
During the nine months, the company opened 161 stores and closed five, ending the period with 3,896 stores in 39 states. Management planned approximately 180 net new stores in 2012 and 190 in 2013.
Financial performance and key metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Sales | $1.602 billion | $1.535 billion | $4.694 billion | $4.398 billion |
| Gross profit | $805.5 million | $754.2 million | $2.347 billion | $2.143 billion |
| Gross margin | 50.3% | 49.1% | 50.0% | 48.7% |
| Operating income | $263.3 million | $241.1 million | $754.4 million | $659.9 million |
| Operating margin | 16.4% | 15.7% | 16.1% | 15.0% |
| Net income | $159.3 million | $148.4 million | $452.9 million | $384.7 million |
| Diluted EPS | $1.32 | $1.10 | $3.60 | $2.76 |
| Comparable-store sales growth | 1.3% | 4.8% | 3.7% | 4.9% |
Q3 sales increased 4%, net income increased 7% and diluted EPS increased 20%. Nine-month sales increased 7%, net income increased 18% and diluted EPS increased 30%. The EPS improvement benefited from substantial share repurchases, which increased Q3 diluted EPS by approximately $0.10 and nine-month diluted EPS by approximately $0.12.
Q3 SG&A increased to $542.2 million, or 33.9% of sales, from 33.4% in the prior-year quarter. Nine-month SG&A was $1.593 billion, or 33.9% of sales, versus 33.7%. The effective tax rate was 37.3% in Q3 and 37.9% for the nine-month period.
Cash flow, balance sheet, debt and liquidity
- Operating cash flow for the nine months was $1.033 billion, compared with $840.1 million in 2011.
- Capital expenditures were $217.3 million, compared with $243.3 million in 2011; investing cash outflow was $211.6 million.
- Financing cash outflow was $760.3 million, driven primarily by $1.134 billion of share repurchases, partly offset by $298.9 million of new long-term debt issuance.
- Cash and cash equivalents were $422.7 million at September 30, 2012, versus $361.6 million at December 31, 2011.
- Total debt and capital lease obligations were $1.096 billion, including approximately $1.095 billion of long-term debt. The company issued $300 million of 3.800% senior notes due 2022 in August 2012.
- The $660 million unsecured revolving credit facility had no outstanding borrowings; $57.6 million of letters of credit reduced availability. The facility matures in September 2016.
- The company reported a fixed-charge coverage ratio of 4.97 times and an adjusted consolidated leverage ratio of 1.85 times, remaining in compliance with all debt covenants.
Material changes versus the prior comparable period
- Gross margin improved 120 basis points in Q3 and 130 basis points for the nine months, reflecting distribution-center efficiencies, acquisition-cost improvements, pricing strategy, lower inventory shrinkage and a favorable product mix. A one-time capitalization of distribution costs benefited Q3 gross margin by approximately 25 basis points.
- Comparable-store sales growth slowed to 1.3% in Q3 from 4.8% in Q3 2011 and to 3.7% for the nine months from 4.9%. Average ticket values increased, while DIY transaction counts declined; professional-customer growth partly offset the DIY weakness.
- Interest expense increased because of higher average borrowings. Prior-year nine-month results included $21.6 million of debt issuance-cost write-offs and $4.2 million of interest-rate-swap termination costs. Excluding these items, 2012 nine-month adjusted net income was $452.9 million versus $400.8 million in 2011, and adjusted diluted EPS was $3.60 versus $2.88.
- Inventory increased to $2.207 billion from $1.986 billion at December 31, 2011, while accounts payable increased to $1.863 billion from $1.279 billion, supported by expanded vendor financing and extended payment terms.
- Shareholders’ equity declined to $2.259 billion from $2.845 billion, principally reflecting $1.134 billion of share repurchases and the related reduction in outstanding shares.
Guidance, outlook, risks and unusual items
- Management expected 180 net new stores in 2012 and 190 in 2013 and stated that operating cash flow and revolver availability should fund foreseeable capital and liquidity needs.
- Management identified miles driven, vehicle population and age, new vehicle registrations, unemployment, fuel prices, consumer spending and competition as key demand drivers.
- Risks include weaker demand, adverse macroeconomic conditions, sustained unemployment, product demand changes, inflation, competition, employee retention, weather, regulation, credit ratings, increased debt and integration or performance risks associated with CSK.
- The company recognized no goodwill impairment and held no derivative instruments qualifying as cash-flow hedges at September 30, 2012.
- Closed-store and facility reserves totaled approximately $10.8 million at September 30, 2012. Lease obligations related to closed properties extend through April 2023.
- The company maintained a $13.9 million reserve for legal fees and costs related to potential CSK indemnification obligations. Management did not expect a material adverse outcome after considering reserves and insurance, but noted that resolution could materially affect a particular period.
- The company repurchased 12.647 million shares for $1.133 billion during the first nine months and had $390.4 million remaining under its authorization at September 30. It repurchased an additional 1.6 million shares for $136.6 million through November 8, 2012.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the temporary 25-basis-point distribution-cost benefit and other gross-margin improvements persist.
- Trends in comparable-store sales, DIY transaction counts and the professional-customer mix.
- The pace and capital requirements of planned store openings.
- Debt covenant headroom, revolver availability, interest expense and the effect of the 2022 notes.
- Whether continued share repurchases remain financially prudent relative to debt, inventory investment and store expansion.
- Developments in the CSK-related indemnification matter and the adequacy of the $13.9 million reserve.
- Actual full-year results, since interim operating results are not necessarily indicative of the full fiscal year.