O’Reilly Automotive, Inc. — FY2017 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2017. The filing is an annual Form 10-K, not a standalone quarterly filing; fourth-quarter information is presented in the annual quarterly-results disclosures.
Business context
O’Reilly is a U.S. specialty retailer and supplier of automotive aftermarket parts, tools, supplies, equipment and accessories serving do-it-yourself and professional service-provider customers. At year-end, the Company operated 5,019 stores in 47 states, supported by 27 regional distribution centers and 331 Hub stores. Approximately 58% of 2017 sales came from DIY customers and 42% from professional service providers.
Financial performance and key metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Sales | $8.978 billion | $8.593 billion | +4% |
| Gross profit | $4.721 billion | $4.509 billion | +5% |
| Gross margin | 52.6% | 52.5% | +10 bps |
| SG&A | $2.995 billion | $2.810 billion | +7% |
| SG&A as a percentage of sales | 33.4% | 32.7% | +70 bps |
| Operating income | $1.725 billion | $1.699 billion | +2% |
| Operating margin | 19.2% | 19.8% | -60 bps |
| Net income | $1.134 billion | $1.038 billion | +9% |
| Net margin | 12.6% | 12.1% | +50 bps |
| Diluted EPS | $12.67 | $10.73 | +18% |
| Comparable-store sales | +1.4% | +4.8% | Decelerated |
Net income and EPS benefited from a lower effective tax rate of 30.8%, compared with 36.6% in 2016. The reduction included a $53.2 million one-time benefit from revaluing deferred tax liabilities after enactment of the U.S. Tax Cuts and Jobs Act and a $48.7 million benefit from adopting ASU 2016-09 on share-based compensation.
Cash flow, liquidity and debt
- Cash provided by operating activities was $1.404 billion, down from $1.511 billion in 2016.
- Capital expenditures were $465.9 million, producing reported free cash flow of $889.1 million.
- Cash and cash equivalents were $46.3 million at year-end, compared with $146.6 million in 2016.
- Working capital was negative $249.7 million, compared with negative $142.7 million in 2016.
- Total debt was $2.978 billion, up 58% from $1.887 billion. Debt consisted primarily of $2.65 billion of unsecured senior notes and $346 million drawn under the revolving credit facility.
- The Company issued $750 million of 3.600% senior notes due 2027 and entered into a new $1.2 billion unsecured revolving credit facility maturing in April 2022.
- The fixed-charge coverage ratio was 5.72 times and the consolidated leverage ratio was 1.98 times, compared with covenant limits of 2.50 times and 3.50 times, respectively. The Company reported compliance with its debt covenants.
- The Company repurchased 9.3 million shares for $2.172 billion during 2017. Remaining authorization was approximately $715 million at December 31, 2017; subsequent repurchases through February 28, 2018 increased remaining authorization to approximately $1.43 billion.
Material changes versus the prior comparable period
- Sales growth slowed to 4% from 8% in 2016, while comparable-store sales growth declined to 1.4% from 4.8%.
- Management attributed weaker transaction counts to softer industry demand, an unseasonably mild winter and a cool, wet summer. Higher average ticket values partially offset lower transaction counts.
- Gross margin improved modestly because the non-cash LIFO impact was smaller, but merchandise margin declined and inventory shrinkage increased.
- SG&A deleveraged because of soft comparable-store sales, causing operating margin to decline despite higher operating income.
- Interest expense increased to $91.3 million from $70.9 million because of higher average borrowings and debt issuance costs.
- The Company opened 190 net new stores, ending the year with 5,019 stores, versus 210 net new stores plus the 48-store Bond acquisition in 2016.
- Shareholders’ equity declined to $653.0 million from $1.627 billion, principally because of substantial share repurchases.
Outlook, commentary, risks and unusual items
- Management planned approximately 200 net new store openings in 2018 and expected existing operating cash flow and revolving-credit availability to fund near-term capital and liquidity requirements.
- Estimated average cost to open a new store was approximately $1.6 million to $1.8 million, although leasing locations may reduce the cost.
- Management remained confident in gaining market share through the dual-market strategy, customer service, inventory availability, store expansion and distribution capabilities.
- Key risks include competition from national chains, independent operators and online retailers; adverse economic or weather conditions; pressure on customer transaction counts; execution of store expansion and acquisitions; supplier disruptions or trade-policy changes; labor and regulatory costs; cybersecurity and systems failures; litigation; and elevated debt and interest-rate exposure.
- The Company had $2.367 billion of future minimum operating lease payments, $3.749 billion of estimated long-term debt principal and interest payments, $147.7 million of self-insurance reserves and $54.4 million of construction commitments.
- A contract dispute, Meridian Creative Alliance v. O’Reilly, was scheduled for a new trial in May 2018. The Company had accrued $18.6 million at December 31, 2017.
- Adoption of the new revenue-recognition standard was scheduled for the first quarter of 2018 and was not expected to materially affect results. Adoption of the new lease standard was scheduled for the first quarter of 2019 and was expected to materially increase reported assets and liabilities.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective.
Important facts for investors to verify
- Reconcile reported EPS and net-income growth after removing the $53.2 million Tax Act benefit and $48.7 million ASU 2016-09 tax benefit.
- Assess whether comparable-store sales and customer transaction counts recover after the 2017 weather-related weakness.
- Monitor operating-margin pressure from SG&A growth, merchandise margin, inventory shrinkage and new-store deleverage.
- Review debt maturities, variable-rate borrowings, covenant headroom and the effect of lease capitalization on leverage after adoption of the lease standard.
- Evaluate whether planned 2018 store openings generate adequate returns relative to estimated opening costs and required inventory investment.
- Review the sustainability of cash flow after capital expenditures and the scale of share repurchases.
- Follow the Meridian litigation, uncertain tax positions, self-insurance reserves and other contingencies.