Business Context and Reporting Period
O’Reilly Automotive, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The company operates automotive aftermarket stores serving do-it-yourself and professional customers in the United States.
- Operated 4,984 stores in 47 states at September 30, 2017.
- Opened 162 stores and closed seven during the first nine months; management reported 155 net new stores.
- Plans 190 net new stores in 2017, including conversion of 48 Bond Auto Parts stores, and 200 net new stores in 2018.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Sales | $2.340 billion | $2.221 billion | $6.787 billion | $6.494 billion |
| Gross profit | $1.230 billion | $1.170 billion | $3.562 billion | $3.395 billion |
| Gross margin | 52.6% | 52.7% | 52.5% | 52.3% |
| Operating income | $462.0 million | $447.8 million | $1.323 billion | $1.291 billion |
| Operating margin | 19.7% | 20.2% | 19.5% | 19.9% |
| Net income | $283.7 million | $278.5 million | $831.5 million | $791.7 million |
| Diluted EPS | $3.22 | $2.90 | $9.15 | $8.14 |
- Comparable-store sales increased 1.8% in the quarter and 1.5% year to date.
- SG&A increased 6% year over year to $768.3 million in the quarter and $2.239 billion year to date; SG&A was 32.8% and 33.0% of sales, respectively.
- Interest expense increased to $24.3 million in the quarter and $64.6 million year to date, primarily because of higher borrowings.
- Cash provided by operating activities was $1.087 billion for the first nine months, compared with $1.214 billion in the prior-year period.
- Capital expenditures were $347.8 million, producing reported free cash flow of $704.4 million versus $812.0 million in the prior-year period.
- Cash and cash equivalents declined to $37.3 million from $146.6 million at December 31, 2016.
- Long-term debt increased to $2.901 billion from $1.887 billion at December 31, 2016. Debt included $269.0 million drawn under the revolving facility and approximately $2.632 billion of senior notes.
- The company issued $750 million of 3.600% senior notes due 2027 in August 2017.
- The $1.2 billion unsecured revolving facility matures in April 2022; $41.3 million of letters of credit reduced availability. The company remained in compliance with debt covenants, including a 3.50 maximum leverage ratio and a 2.50 minimum fixed-charge coverage ratio.
- The company repurchased 8.047 million shares for $1.893 billion during the first nine months. Approximately $994.8 million remained authorized at September 30, 2017.
Material Changes Versus the Prior Comparable Period
- Sales increased 5% in both the quarter and first nine months, supported by store growth, the Bond stores and comparable-store sales.
- Diluted EPS increased 11% in the quarter and 12% year to date, aided by lower share count from repurchases and the adoption of ASU 2016-09.
- Gross margin declined modestly in the quarter because of lower merchandise margin, higher inventory shrinkage and fixed-cost deleverage; year-to-date gross margin improved due primarily to a smaller LIFO impact.
- Operating margin declined in both periods as SG&A grew faster than sales and comparable-store sales softened.
- Operating cash flow and free cash flow decreased, while financing cash outflows increased substantially because of share repurchases.
- Debt increased materially following the 2027 senior-notes issuance and revolving-facility borrowing.
Guidance, Outlook, Risks and Unusual Items
- Management expects continued store expansion and stated that operating cash flow and available revolver capacity should fund foreseeable capital and liquidity needs; no specific earnings or sales guidance was provided in the filing.
- Management attributed weaker transaction counts to a second consecutive mild winter and a cool, wet summer, while higher average ticket values benefited from more complex and expensive vehicle repairs.
- Demand is sensitive to miles driven, vehicle age, unemployment, consumer spending, competition, fuel costs and weather. The business is seasonally stronger in the second and third quarters.
- The company expects adoption of the revenue-recognition standard in the first quarter of 2018; the impact and method of adoption had not been finalized.
- Adoption of the lease standard is planned for the first quarter of 2019 and is expected to have a material impact on reported assets and liabilities, although the amount was not yet determined.
- ASU 2016-09 reduced income-tax expense by approximately $3 million for the quarter and $35 million for the first nine months, increasing diluted EPS by $0.02 and $0.35, respectively.
- The company accrued $18.6 million for the Meridian Creative Alliance litigation, which was scheduled for a new trial beginning May 7, 2018. Management did not expect aggregate litigation matters to have a material adverse effect.
- Higher debt and variable-rate borrowings increase interest-rate risk. A 0.25 percentage-point rate increase on revolver borrowings outstanding at quarter-end would have reduced annual pretax earnings and cash flow by approximately $0.7 million.
Important Facts for Investors to Verify
- Reconcile the effect of share repurchases and ASU 2016-09 on diluted EPS and year-over-year earnings growth.
- Assess liquidity after $1.893 billion of year-to-date repurchases, $347.8 million of capital expenditures and the increase in debt.
- Monitor comparable-store sales, transaction counts, merchandise margin, shrinkage and SG&A leverage following weather-related demand weakness.
- Review debt maturities, covenant headroom and exposure to variable interest rates.
- Evaluate the expected balance-sheet effect of the pending lease standard and the unresolved impact of the revenue-recognition standard.
- Track the Meridian litigation and the $18.6 million recorded accrual.
- Confirm the pace and returns of planned 2017 and 2018 store openings, including Bond store conversions.