O’Reilly Automotive, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The filing was signed August 8, 2014. O’Reilly operates a U.S. automotive aftermarket parts, tools, supplies, equipment and accessories retail business serving DIY and professional customers. The company operated 4,257 stores in 42 states at quarter-end.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Sales | $1.847 billion, up 8% | $3.575 billion, up 8% |
| Gross profit | $950.9 million; 51.5% margin | $1.829 billion; 51.1% margin |
| Operating income | $336.5 million; 18.2% margin | $623.6 million; 17.4% margin |
| Net income | $205.6 million; 11.1% margin | $379.5 million; 10.6% margin |
| Diluted EPS | $1.91 | $3.52 |
| Comparable-store sales | Up 5.1% | Up 5.7% |
- Six-month operating cash flow was $655.5 million, compared with $439.4 million in the prior-year period.
- Capital expenditures were $194.9 million, producing reported free cash flow of $460.6 million.
- Cash and cash equivalents totaled $453.4 million at June 30, 2014, compared with $231.3 million at December 31, 2013.
- Inventory was $2.463 billion and total assets were $6.508 billion at quarter-end.
- Total debt and capital lease obligations were $1.396 billion, consisting primarily of unsecured senior notes due 2021 through 2023. No borrowings were outstanding under the $600 million revolving credit facility; letters of credit reduced availability by approximately $47.8 million.
Material changes versus the prior comparable period
- Second-quarter sales increased $132 million, or 8%; six-month sales increased $275 million, or 8%.
- Second-quarter gross margin expanded from 50.8% to 51.5%; six-month gross margin increased from 50.6% to 51.1%.
- SG&A increased 7% in both the quarter and six months, but declined as a percentage of sales to 33.3% and 33.7%, respectively, from 33.6% and 34.0%.
- Second-quarter operating income rose 14% and net income rose 16%; six-month operating income rose 14% and net income rose 14%.
- Diluted EPS increased 21% in the quarter and 20% year to date, aided by higher earnings and fewer weighted-average shares outstanding.
- Operating cash flow increased $216.1 million year over year, while capital expenditures increased $18.4 million.
- The company repurchased 2.022 million shares for $299.6 million during the first six months, versus 5.013 million shares for $501.8 million in the prior-year period.
Guidance, outlook, commentary and risks
- Management planned approximately 200 net new stores in 2014. The company opened 93 stores and closed two during the first six months, for 91 net additions.
- Management attributed sales growth to store expansion, comparable-store gains, customer service, inventory availability, enhanced services, merchandising and growth in professional-customer transactions.
- Comparable sales benefited from higher average ticket values and professional customer transactions, while DIY transaction counts were slightly negative in the second quarter. Newer vehicles require fewer repairs but generally have higher replacement-part costs.
- Gross-margin improvement reflected vendor acquisition-cost gains, partly offset by non-cash LIFO reductions of approximately $4 million in the quarter and $27 million year to date. Further vendor cost reductions could create additional LIFO margin headwinds.
- Management expected operating cash flow and revolving-credit availability to fund foreseeable capital and liquidity needs, but cautioned that weaker demand or changed customer buying patterns could reduce cash generation and affect debt-covenant compliance.
- The company remained compliant with its debt covenants. The June 30 fixed-charge coverage ratio was 5.13x versus a 2.25x minimum, and the leverage ratio was 1.81x versus a 3.00x maximum.
- The business is seasonal, with historically higher sales and profits in the second and third quarters. Key external risks include fuel costs, unemployment, consumer spending, competition, inflation, weather, regulation, employee retention, acquisition performance and higher debt levels.
- Routine litigation was not expected to have a material aggregate effect. A CSK-related indemnification matter had a remaining reserve of $13.4 million, with insurance coverage and ultimate resolution uncertain.
- The company announced adoption of the new revenue-recognition standard, ASU 2014-09, beginning with the quarter ending March 31, 2017; the potential impact was still under evaluation.
- The board had authorized $4.0 billion cumulatively for share repurchases, with $346.1 million remaining at June 30. Through August 8, the company repurchased an additional 1.2 million shares for $177.8 million.
Facts investors should verify
- Whether comparable-store sales and professional-customer growth remain strong as the store base expands.
- The effect of additional vendor cost reductions and LIFO accounting on future gross margins.
- The pace, capital requirements and returns of the planned 200 net new stores.
- Cash conversion, inventory growth and the sustainability of reported free cash flow.
- Debt maturities, interest expense, revolving-credit availability and continued covenant compliance.
- The amount and resolution of the CSK-related indemnification exposure and insurance recoveries.
- The impact of continued share repurchases on leverage, liquidity and per-share earnings.