O’Reilly Automotive, Inc. — 2014 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2014, compared with the three months ended March 31, 2013. The company operates automotive aftermarket parts, tools, supplies, equipment and accessories stores serving do-it-yourself and professional customers in the United States.
Business Context and Operating Footprint
- Operated 4,216 stores in 42 states at March 31, 2014, compared with 4,041 stores a year earlier.
- Opened 51 stores and closed one store during the quarter, for 50 net new stores.
- Management planned approximately 200 net new stores for full-year 2014.
- Comparable-store sales increased 6.3%, versus 0.6% in the prior-year quarter.
Financial Performance and Key Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Sales | $1.728 billion | $1.585 billion | +9% |
| Gross profit | $877.7 million | $798.7 million | +10% |
| Gross margin | 50.8% | 50.4% | +40 bps |
| SG&A expense | $590.6 million | $547.6 million | +8% |
| SG&A as a percentage of sales | 34.2% | 34.5% | −30 bps |
| Operating income | $287.1 million | $251.1 million | +14% |
| Operating margin | 16.6% | 15.8% | +80 bps |
| Net income | $173.9 million | $154.3 million | +13% |
| Net margin | 10.1% | 9.7% | +40 bps |
| Diluted EPS | $1.61 | $1.36 | +18% |
- Sales growth reflected comparable-store gains, new-store sales and favorable repair demand. Management cited strong average ticket values and transaction counts, particularly in hard-part categories, and harsh winter weather that increased vehicle repairs.
- Gross-margin expansion reflected acquisition-cost improvements and favorable product mix, partly offset by an approximately $23 million non-cash LIFO charge related to inventory cost reductions.
- The effective income-tax rate increased to 36.8% from 35.9%, primarily because of reduced employment tax credits and adjustments to tax reserves related to prior-year tax audits.
Cash Flow, Liquidity and Capital Structure
- Cash provided by operating activities was $345.5 million, up from $226.3 million. The increase was primarily attributable to higher net income and accounts payable.
- Capital expenditures were $83.1 million, compared with $73.5 million, primarily for distribution facilities and store growth.
- Management-defined free cash flow was $262.5 million, compared with $152.9 million.
- Cash and cash equivalents increased to $511.8 million from $231.3 million at December 31, 2013.
- Total debt and capital lease obligations were $1.396 billion, consisting primarily of unsecured senior notes due from 2021 through 2023. There were no borrowings under the $600 million unsecured revolving credit facility.
- Outstanding letters of credit were approximately $54.7 million, reducing revolver availability; the facility matures in July 2018.
- The company reported a 5.04x fixed-charge coverage ratio and a 1.86x consolidated leverage ratio, compared with covenant requirements of at least 2.25x and no more than 3.00x, respectively, through December 31, 2014. The company remained in compliance with its debt covenants.
- The company repurchased 149,000 shares for $22.1 million during the quarter. The remaining authorization was approximately $623.7 million at March 31, 2014. Through May 9, 2014, it repurchased an additional 0.3 million shares for approximately $48.5 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated substantially, with comparable-store sales increasing 6.3% versus 0.6% in Q1 2013.
- Operating and net margins expanded despite higher operating expenses and interest expense.
- Interest expense increased to $13.4 million from $11.4 million, primarily due to higher average borrowings.
- Repurchases declined materially to $22.1 million from $227.9 million, contributing to positive financing cash flow in 2014 versus a financing cash outflow in 2013.
- Weighted-average diluted shares declined to 108.1 million from 113.4 million, supporting diluted EPS growth.
- Cash flow from operations and free cash flow increased, while capital expenditures rose to support distribution infrastructure and store expansion.
Guidance, Outlook, Risks and Unusual Items
- Management expected to open 200 net new stores in 2014 and believed operating cash flow and revolver availability would fund foreseeable capital and liquidity needs.
- Management expressed confidence in continued market-share gains through the dual-market strategy, customer service, inventory availability and store expansion.
- Key risks include competition, product demand, economic conditions, consumer spending, unemployment, fuel costs, weather, inflation, employee retention, acquisition performance, increased debt and credit ratings.
- The business is seasonal, with historically higher sales and profits in the second and third quarters. Management stated that inflation had not materially adversely affected operations.
- The company recorded an approximately $23 million LIFO inventory write-down to replacement cost and did not anticipate material additional charges from product-acquisition cost reductions for the remainder of 2014, although unforeseen cost declines could create further margin pressure.
- Ongoing litigation was considered immaterial in the aggregate based on available reserves and insurance. A remaining $13.4 million reserve related to CSK indemnification obligations covered legal fees and costs already incurred; insurance coverage and the ultimate outcome remained uncertain.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting.
Investor Verification Checklist
- Verify whether the planned 200 net new stores and related distribution investments were achieved without weakening returns or liquidity.
- Monitor comparable-store sales, transaction counts, average ticket values and the contribution from hard-part categories and weather-related demand.
- Assess sustainability of the 50.8% gross margin after the Q1 LIFO charge and any future vendor acquisition-cost changes.
- Reconcile free cash flow with capital expenditures, inventory growth and accounts-payable timing.
- Track debt covenant headroom, leverage, interest expense and available revolver capacity, including outstanding letters of credit.
- Evaluate the pace and pricing of share repurchases and their effect on diluted share count and EPS.
- Review developments in the CSK indemnification matter, including insurance coverage and potential additional cash costs.
- Consider seasonality and the filing’s warning that first-quarter results are not necessarily indicative of full-year performance.