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 customers. This unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.
- Operated 4,934 stores in 47 states at June 30, 2017, versus 4,660 stores in 44 states a year earlier.
- Opened 50 stores and closed four during the second quarter; opened 110 and closed five during the first six months.
- Management planned approximately 190 net new stores in 2017, plus conversion of 48 Bond Auto Parts stores acquired in December 2016.
Financial Performance and Key Metrics
| Metric | Q2 2017 | Q2 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Sales | $2.291 billion | $2.177 billion | $4.447 billion | $4.273 billion |
| Gross profit | $1.200 billion | $1.127 billion | $2.331 billion | $2.225 billion |
| Gross margin | 52.4% | 51.8% | 52.4% | 52.1% |
| Operating income | $457.4 million | $425.1 million | $860.6 million | $843.7 million |
| Operating margin | 20.0% | 19.5% | 19.4% | 19.7% |
| Net income | $282.8 million | $257.8 million | $547.8 million | $513.2 million |
| Diluted EPS | $3.10 | $2.65 | $5.93 | $5.24 |
- Q2 sales increased 5%; six-month sales increased 4%.
- Comparable-store sales increased 1.7% in Q2 and 1.3% for the six-month period. Growth reflected higher average ticket values, partly offset by lower customer transaction counts.
- Q2 net income increased 10% and six-month net income increased 7%. Diluted EPS increased 17% and 13%, respectively, helped by lower share count from repurchases and a favorable tax-accounting adoption effect.
- SG&A increased 6% in both comparison periods. SG&A was 32.4% of sales in Q2 and 33.1% for the six months, versus 32.3% and 32.3%, respectively, in the prior-year periods.
- Gross margin benefited primarily from a smaller non-cash LIFO write-down: approximately $10 million in Q2 2017 versus $23 million in Q2 2016, and $17 million for the six months versus $36 million.
Cash Flow, Balance Sheet, Debt and Liquidity
- Six-month operating cash flow was $710.5 million, down from $828.7 million, primarily because of a larger inventory investment.
- Capital expenditures were $227.5 million versus $220.4 million, primarily for new stores, property acquisitions, construction and distribution expansion.
- Management-defined free cash flow was $450.5 million versus $578.2 million. This measure excludes capital expenditures and excess tax benefits from share-based compensation.
- Financing activities used $601.9 million, including $1.343 billion of share repurchases, partially offset by net borrowings.
- Cash and cash equivalents declined to $26.5 million from $146.6 million at December 31, 2016.
- Long-term debt was $2.604 billion at June 30, 2017, up from $1.887 billion, including $716.0 million outstanding under the revolving credit facility and approximately $1.9 billion of senior notes.
- On April 5, 2017, the company entered into a new $1.2 billion unsecured revolving credit facility maturing in April 2022, with potential commitments expandable to $1.8 billion. Outstanding letters of credit were approximately $41.2 million.
- The company stated that it was in compliance with its debt covenants. The filing reports a fixed-charge coverage ratio of 6.00 times and a consolidated leverage ratio of 1.82 times at June 30, 2017.
Material Changes, Outlook and Unusual Items
- The company increased its share-repurchase authorization by $1.0 billion in May 2017. It repurchased 5.3 million shares for $1.343 billion during the first six months and had approximately $545 million remaining under the program at June 30.
- Subsequent to quarter-end through August 7, 2017, the company repurchased an additional 0.2 million shares for $35.0 million.
- Management attributed softer transaction counts to a second consecutive unusually mild winter and a cool, wet start to summer, which reduced weather-related vehicle repairs.
- Management remained confident in continued market-share gains and store expansion, supported by expected operating cash flow and available revolver capacity.
- ASU 2016-09 reduced the effective tax rate and increased diluted EPS by approximately $0.09 in Q2 and $0.32 for the six-month period. The company recognized tax benefits of $9.2 million and $32.5 million, respectively.
- The company expects future adoption of the lease standard to have a material impact on reported total assets and liabilities, although the full effect had not been determined. Revenue recognition and other accounting implementations were also still under evaluation.
- A legacy legal dispute was remanded to a Missouri trial court after the Missouri Supreme Court declined transfer. The company had accrued $18.6 million at June 30, 2017.
- Key risks include softer aftermarket demand, weather, competition, consumer spending, execution of store growth and acquisitions, employee retention, increased debt, interest rates and compliance with debt covenants.
Investor Verification Checklist
- Verify the final 2017 store-opening pace, Bond store conversions and comparable-store sales trends as weather-related pressures normalize.
- Assess inventory growth, working-capital needs and whether operating cash flow and free cash flow recover from the year-over-year decline.
- Review leverage, interest expense and revolver utilization following the increase in debt.
- Confirm the applicable consolidated leverage covenant: the filing describes a 3.50:1.00 maximum in Note 3 but a 3.00:1.00 maximum in the MD&A section.
- Evaluate the sustainability of EPS growth excluding the $0.09 Q2 and $0.32 six-month benefit from ASU 2016-09 and the impact of share repurchases.
- Monitor the Meridian litigation, the $18.6 million accrued liability and any subsequent developments.
- Review the eventual effects and adoption methods for the revenue-recognition and lease-accounting standards.