O’Reilly Automotive, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2016; unaudited interim financial statements prepared under U.S. GAAP. O’Reilly is a U.S. specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories serving DIY and professional customers.
Business Context and Operations
- The company operated 4,660 stores in 44 states at June 30, 2016, compared with 4,465 stores in 43 states a year earlier.
- During the quarter, O’Reilly opened 38 stores and closed one; for the first six months, it opened 90 and closed one, for 89 net additions.
- Management planned 210 net new store openings for 2016 and expected store growth to be funded through operating cash flow and available revolving-credit capacity.
- Management cited increased miles driven, lower fuel costs, declining unemployment, vehicle age, customer transaction growth and higher average ticket values as demand drivers.
Financial Performance
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Sales | $2.177 billion | $2.036 billion | $4.273 billion | $3.937 billion |
| Gross profit | $1.127 billion | $1.059 billion | $2.225 billion | $2.046 billion |
| Gross margin | 51.8% | 52.0% | 52.1% | 52.0% |
| Operating income | $425.1 million | $385.8 million | $843.7 million | $736.1 million |
| Operating margin | 19.5% | 19.0% | 19.7% | 18.7% |
| Net income | $257.8 million | $233.5 million | $513.2 million | $446.4 million |
| Net margin | 11.8% | 11.5% | 12.0% | 11.3% |
| Diluted EPS | $2.65 | $2.29 | $5.24 | $4.35 |
- Quarterly sales increased 7%; six-month sales increased 9%.
- Comparable-store sales increased 4.3% in the quarter and 5.1% for the first six months.
- Quarterly operating income increased 10% and six-month operating income increased 15%. Net income increased 10% and 15%, respectively.
- Diluted EPS increased 16% in the quarter and 20% year to date, benefiting from earnings growth and share repurchases.
- SG&A increased 4% for the quarter and 5% year to date, while SG&A as a percentage of sales declined to 32.3% from 33.1% and 33.3%, respectively.
- The effective tax rate was 36.9% for the quarter and 37.0% for the six-month period, compared with 37.3% and 37.1%, respectively.
Cash Flow, Liquidity and Capital Structure
- Six-month operating cash flow was $798.4 million, compared with $698.5 million in the prior-year period.
- Capital expenditures were $220.4 million, up from $186.5 million. Reported free cash flow was $578.0 million, compared with $511.9 million.
- Cash and cash equivalents were $398.3 million at June 30, 2016, compared with $116.3 million at December 31, 2015.
- Long-term debt was $1.886 billion, up from $1.390 billion at year-end 2015, primarily due to the March 2016 issuance of $500 million of 3.550% senior notes due 2026.
- The company had no borrowings under its $600 million unsecured revolving credit facility; $39.0 million of letters of credit reduced availability. The facility matures in July 2018.
- The company remained in compliance with debt covenants. The fixed-charge coverage ratio was 6.15 times versus a 2.50-times minimum, and the consolidated leverage ratio was 1.69 times versus a 3.00-times maximum.
- Share repurchases totaled $856.8 million for the first six months, covering 3.306 million shares at an average price of $259.14. Remaining authorization was $786.4 million at June 30, 2016.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected comparable-store gains, new-store contributions, one additional Leap Day in the six-month period and non-store sales.
- Gross margin was broadly stable year to date but declined modestly in the quarter because of a larger non-cash LIFO inventory adjustment. LIFO inventory costs were written down by approximately $23 million in the quarter and $36 million year to date, versus $11 million and $19 million, respectively, in 2015.
- Operating margins improved because of comparable-store sales leverage and the absence of the approximately $19 million litigation-loss charge recorded in the prior-year quarter.
- Interest expense increased because of higher average borrowings and additional debt-issuance-cost amortization.
- Debt increased by approximately $496 million net of discounts and issuance costs, while cash also increased substantially because operating cash flow and debt proceeds exceeded capital spending and repurchases.
- Weighted-average diluted shares declined to approximately 97.3 million in the quarter and 97.9 million year to date, from 102.1 million and 102.7 million, respectively.
Guidance, Outlook, Risks and Unusual Items
- Management maintained its stated plan for 210 net new stores in 2016 and expressed confidence in market-share gains and expansion into new markets. The filing does not provide a full-year sales or earnings-per-share forecast.
- Key risks identified include general economic conditions, product demand, competition, weather, fuel costs, consumer spending and debt levels, employee hiring and retention, acquisition performance, government regulation, credit ratings and increased debt.
- The company’s business is seasonal, with historically higher sales and profits in the second and third quarters.
- O’Reilly is responding to an Alameda County, California, subpoena concerning hazardous-waste handling, storage and disposal. The potential outcome cannot currently be predicted; management has accrued amounts considered probable and estimable and does not expect a material adverse effect.
- The company reserved $18.7 million at June 30, 2016, for the Meridian Creative Alliance contract dispute and is appealing an unfavorable $12.5 million jury verdict.
- Routine litigation is not expected to have a material aggregate effect after considering insurance and reserves.
- Management stated that recent accounting changes concerning revenue recognition, leases, share-based compensation and credit losses were being evaluated; no material impact was expected for certain standards, while the impact of others remained under evaluation.
Important Facts for Investors to Verify
- Whether the planned 210 net store openings and related capital spending remain achievable without materially weakening free cash flow.
- The sustainability of comparable-store sales growth and the effect of vehicle repair frequency, fuel prices, miles driven and consumer spending.
- The effect of increased debt and interest expense on future earnings, leverage and share-repurchase capacity.
- The size and timing of any cash impact from the California hazardous-waste investigation and the Meridian litigation appeal.
- The extent to which non-cash LIFO adjustments and supplier-cost improvements affect reported gross margins.
- The company’s future adoption effects from the new revenue, lease, stock-compensation and credit-loss accounting standards.