O’Reilly Automotive, Inc. — 2018 Q3 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; filed November 7, 2018. O’Reilly operates automotive aftermarket parts and service stores serving do-it-yourself and professional customers. The company operated 5,190 stores in 47 states at quarter-end.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Change |
|---|
| Sales | $2.483 billion | $2.340 billion | +6% |
| Gross profit | $1.316 billion; 53.0% margin | $1.230 billion; 52.6% margin | +7%; margin +40 bps |
| Operating income | $485.1 million; 19.5% margin | $462.0 million; 19.7% margin | +5%; margin -20 bps |
| Net income | $366.2 million; 14.7% margin | $283.7 million; 12.1% margin | +29% |
| Diluted EPS | $4.50 | $3.22 | +40% |
| Comparable-store sales | +3.9% | +1.8% | +210 bps |
| Metric | Nine months 2018 | Nine months 2017 | Change |
|---|
| Sales | $7.221 billion | $6.787 billion | +6% |
| Gross profit | $3.806 billion; 52.7% margin | $3.562 billion; 52.5% margin | +7%; margin +20 bps |
| Operating income | $1.387 billion; 19.2% margin | $1.323 billion; 19.5% margin | +5%; margin -30 bps |
| Net income | $1.024 billion; 14.2% margin | $831.5 million; 12.3% margin | +23% |
| Diluted EPS | $12.36 | $9.15 | +35% |
- Sales growth reflected comparable-store sales, new stores, and higher average ticket values. Professional-customer transaction counts were positive, while DIY transaction counts were negative.
- Gross-margin expansion was driven by higher merchandise margins and the absence of the prior-year LIFO charge, partly offset by higher transportation costs. The company recorded no LIFO charge in 2018 versus approximately $3 million in Q3 2017 and $20 million in the first nine months of 2017.
- SG&A increased 8% in both comparable periods and reached 33.5% of sales for the quarter and nine months, reflecting store growth, additional personnel and facilities, and reinvestment of Tax Act savings.
- The effective tax rate declined to 19.6% in Q3 and 21.3% for the nine months, from 35.4% and 34.1%, respectively, primarily because of the lower federal corporate tax rate under the Tax Cuts and Jobs Act.
- Cash provided by operating activities was $1.342 billion for the first nine months, versus $1.087 billion in the prior year. Capital expenditures were $350.5 million, and reported free cash flow was $958.6 million versus $704.4 million.
- Cash and cash equivalents were $40.0 million at September 30, 2018, compared with $46.3 million at December 31, 2017. Inventory was $3.140 billion and accounts payable were $3.384 billion.
Debt, liquidity, and capital allocation
- Long-term debt was $3.174 billion at September 30, 2018, versus $2.978 billion at December 31, 2017. The increase primarily reflects the issuance of $500 million of 4.350% senior notes due 2028 in May 2018.
- The company had $45.0 million outstanding under its $1.2 billion unsecured revolving credit facility, which matures in April 2022, and $37.0 million of outstanding letters of credit. The facility’s weighted-average variable interest rate was 4.044%.
- All applicable senior-note and revolving-credit covenants were satisfied. The consolidated fixed-charge coverage ratio was 5.43x against a 2.50x minimum, and the consolidated leverage ratio was 2.01x against a 3.50x maximum.
- The company repurchased 4.695 million shares for $1.251 billion during the first nine months, reducing outstanding shares from 84.3 million at year-end 2017 to 80.3 million at September 30, 2018. Approximately $464.4 million remained available under the authorization.
- Through November 7, 2018, the company repurchased an additional 0.4 million shares for $143.7 million.
Material changes, outlook, and risks
- Management planned approximately 200 net new stores in 2018 and 200 to 210 net new stores in 2019. The company opened 43 net new stores in Q3 and 171 net new stores during the first nine months.
- Management expected Tax Act savings reinvestment to create approximately a 70-basis-point operating-profit headwind for full-year 2018.
- The company expected operating cash flow and revolving-credit availability to fund store growth, capital expenditures, strategic acquisitions, infrastructure, and share repurchases for the foreseeable future, while noting that lower demand could reduce cash generation and pressure debt-covenant compliance.
- Management identified industry risks including economic conditions, inflation, fuel prices, vehicle miles driven, consumer spending, competition, weather, labor retention, product demand, higher debt levels, credit ratings, regulation, and geopolitical events.
- Litigation was described as incidental to ordinary operations, with no current expectation of a material adverse effect after considering insurance and accruals.
- The company adopted revenue-recognition Topic 606 in 2018 without a material impact. It expected adoption of the lease standard in the first quarter of 2019, with estimated right-of-use assets and lease liabilities of $1.8 billion to $2.0 billion; management did not expect a material effect on earnings, cash flow, liquidity, or covenant compliance.
- The company early adopted ASU 2018-15 for cloud-computing implementation costs using prospective adoption; no costs were capitalized and there was no reported material impact.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting.
Investor verification points
- Verify the sustainability of comparable-store sales growth, particularly the divergence between higher average tickets and negative DIY transaction counts.
- Assess the effect of Tax Act reinvestment, transportation costs, wage and operating-cost inflation, and the absence of prior-year LIFO charges on future margins.
- Reconcile store-opening disclosures: the filing states 45 openings and two closures in one discussion, while the results section reports 43 net new stores for Q3.
- Monitor leverage, interest expense, refinancing requirements, and compliance headroom under the revolving-credit covenants.
- Evaluate the capital-allocation tradeoff between store expansion, debt issuance, and continued share repurchases.
- Confirm the eventual balance-sheet impact and implementation results of Topic 842 lease accounting.
- Review the complete Form 10-K risk factors and any subsequent filings for developments in litigation, demand, competition, labor, and macroeconomic conditions.
