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ORLY > SEC Filings for ORLY > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for O REILLY AUTOMOTIVE INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for O REILLY AUTOMOTIVE INC


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Unless otherwise indicated, "we," "us," "our" and similar terms, as well as references to the "Company" or "O'Reilly" refer to O'Reilly Automotive, Inc. and its subsidiaries.

In Management's Discussion and Analysis, we provide a historical and prospective narrative of our general financial condition, results of operations, liquidity and certain other factors that may affect our future results, including:

an overview of the key drivers of the automotive aftermarket industry;

our results of operations for the quarters and nine month periods ended September 30, 2012 and 2011;

our liquidity and capital resources;

any contractual obligations to which we are committed;

our critical accounting estimates;

the inflation and seasonality of our business; and

recent accounting pronouncements that may affect our company.

The review of Management's Discussion and Analysis should be made in conjunction with our condensed consolidated financial statements, related notes and other financial information included elsewhere in this quarterly report.

FORWARD-LOOKING STATEMENTS

We claim the protection of the safe-harbor for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these statements by forward-looking words such as "expect," "believe," "anticipate," "should," "plan," "intend," "estimate," "project," "will" or similar words. In addition, statements contained within this quarterly report that are not historical facts are forward-looking statements, such as statements discussing among other things, expected growth, store development, integration and expansion strategy, business strategies, future revenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions, including, but not limited to, competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental regulations, our increased debt levels, credit ratings on our public debt, our ability to hire and retain qualified employees, risks associated with the performance of acquired businesses such as CSK Auto Corporation ("CSK"), weather, terrorist activities, war and the threat of war. Actual results may materially differ from anticipated results described or implied in these forward-looking statements. Please refer to the "Risk Factors" section of our annual report on Form 10-K for the year ended December 31, 2011, for additional factors that could materially affect our financial performance. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

OVERVIEW

We are a specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States. We are one of the largest automotive aftermarket specialty retailers, selling our products to both do-it-yourself ("DIY") customers and professional service providers - our "dual market strategy". Our stores carry an extensive product line consisting of new and remanufactured automotive hard parts, maintenance items, accessories, a complete line of auto body paint and related materials, automotive tools and professional service provider service equipment. Our extensive product line includes an assortment of products that are differentiated by quality and price for most of the product lines we offer. For many of our product offerings, this quality differentiation reflects "good", "better", and "best" alternatives. Our sales and total gross margin dollars are highest for the "best" quality category of products. Consumers' willingness to select products at a higher point on the value spectrum is a driver of sales and profitability in our industry.

Our stores offer enhanced services and programs to our customers, including those identified below:

used oil and battery recycling

battery diagnostic testing

electrical and module testing

loaner tool program

drum and rotor resurfacing

custom hydraulic hoses


professional paint shop mixing and related materials

machine shops

Our strategy is to open new stores to achieve greater penetration into existing markets and expansion into new, contiguous markets. We plan to open 180 net, new stores in 2012. We typically open new stores either by (i) constructing a new facility or renovating an existing one on property we purchase or lease and stocking the new store with fixtures and inventory; (ii) acquiring an independently owned auto parts store, typically by the purchase of substantially all of the inventory and other assets (other than realty) of such store; or
(iii) purchasing multi-store chains. We believe our investment in store growth will be funded with the cash flows expected to be generated by our existing operations and through available borrowings under our existing credit facility. During the three months ended September 30, 2012, we opened 38 stores and closed one store. During the nine months ended September 30, 2012, we opened 161 stores and closed 5 stores, and as of that date, operated 3,896 stores in 39 states.

Operating within the retail industry, we are influenced by a number of general macroeconomic factors including, but not limited to, fuel costs, unemployment rates, consumer preferences and spending habits, and competition. The difficult conditions that affected the overall macroeconomic environment in recent years continue to impact O'Reilly and the retail sector in general. We believe that the average consumer's tendency has been to "trade down" to lower quality products during the recent challenging macroeconomic conditions. We have ongoing initiatives aimed at tailoring our product offering to adjust to customers' changing preferences; however, we also continue to have initiatives focused on marketing and training to educate customers on the advantages of "purchasing up" on the value spectrum. We believe these ongoing initiatives targeted at marketing higher quality products will result in our customers' willingness to return to "purchasing up" on the value spectrum in the future as the U.S. economy recovers; however, we cannot predict whether, when, or the manner in which, these economic conditions will change.

We believe the key drivers of current and future demand of the products sold within the automotive aftermarket include the number of U.S. miles driven, number of U.S. registered vehicles, new light vehicle registrations, average vehicle age and unemployment.

Number of U.S. Miles Driven - The number of total miles driven in the U.S. heavily influences the demand for the repair and maintenance products sold within the automotive aftermarket. Historically, the long-term trend in the total miles driven in the U.S. has steadily increased; however, according to the Department of Transportation, total miles driven in the U.S. have remained relatively flat since 2007 as the U.S. has experienced difficult macroeconomic conditions. Historically, rapid increases in gasoline prices have negatively impacted U.S. total miles driven as consumers react to the increased expense by reducing travel. We believe that as the U.S. economy recovers and gasoline prices remain stable, annual miles driven will return to historical growth rates and continue to drive demand for our industry.

Number of U.S. Registered Vehicles, New Light Vehicle Registrations and Average Vehicle Age - The total number of vehicles on the road and the average age of the U.S. vehicle population also heavily influence the demand for products sold within the automotive aftermarket industry. As reported by the Automotive Aftermarket Industry Association ("AAIA"), the total number of registered vehicles has increased 15% over the past decade, from 209 million light vehicles in 2001 to 241 million light vehicles in 2011. Annual new light vehicle registrations have declined 24% over the past decade, from 17 million registrations in 2001 to 13 million registrations in 2011; however, the seasonally adjusted annual rate (the "SAAR") of sales of light vehicles in the U.S. increased to 15 million as of September 30, 2012, indicating that the trend of declining new light vehicle registrations has reversed. As reported by the AAIA, the average age of the U.S. vehicle population has increased 21% over the past decade, from 8.9 years in 2001 to 10.8 years in 2011. We believe this increase in average age can be attributed to better engineered and manufactured vehicles, which can be reliably driven at higher miles due to better quality power trains and interiors and exteriors; new car sales over the past three years, which have been below historical levels; and the consumer's willingness to invest in maintaining their higher-mileage, better built vehicles. As the average age of the vehicle on the road increases, a larger percentage of miles are being driven by vehicles which are outside of a manufacturer warranty. These out-of-warranty, older vehicles, generate strong demand for automotive aftermarket products as they go through more routine maintenance cycles, have more frequent mechanical failures and generally require more maintenance than newer vehicles. Based on this change in consumer sentiment surrounding the length of time older vehicles can be reliably driven at higher mileages, we believe consumers will continue to keep their vehicles even longer as the economy recovers, maintaining the trend of an aging vehicle population.

Unemployment - Unemployment rates and continued uncertainty surrounding the overall economic health of the U.S. have had a negative impact on consumer confidence and the level of consumer discretionary spending. The annual U.S. unemployment rate over the past two years has remained at 30-year highs. We believe macroeconomic uncertainties and the potential for future joblessness can motivate consumers to find ways to save money, which can be an important factor in the consumer's decision to defer the purchase of a new vehicle and maintain their existing vehicle. While the deferral of vehicle purchases has led to an increase in vehicle maintenance, long-term trends of high unemployment could continue to impede the growth of annual miles driven, as well as decrease consumer discretionary spending, both of which negatively impact demand for products sold in the automotive aftermarket industry. As of September 30, 2012, the U.S. unemployment rate decreased slightly to 7.8% from 8.5% as of December 31, 2011, and 9.0% as of September 30, 2011. We believe that as the economy recovers, unemployment will return to more historic levels and we will see a corresponding increase in commuter


traffic as unemployed individuals return to work. Aided by these increased commuter miles, overall annual U.S. miles driven should begin to grow resulting in continued demand for automotive aftermarket products.

We remain confident in our ability to continue to gain market share in our existing markets and grow our business in new markets by focusing on our dual market strategy and the core O'Reilly values of customer service and expense control.

RESULTS OF OPERATIONS

Sales:

Sales for the three months ended September 30, 2012, increased $66 million to $1.60 billion from $1.54 billion for the same period one year ago, representing an increase of 4%. Sales for the nine months ended September 30, 2012, increased $296 million to $4.69 billion from $4.40 billion for the same period one year ago, representing an increase of 7%. Comparable store sales for stores open at least one year increased 1.3% and 4.8% for the three months ended September 30, 2012 and 2011, respectively. Comparable store sales for stores open at least one year increased 3.7% and 4.9% for the nine months ended September 30, 2012 and 2011, respectively. Comparable store sales are calculated based on the change in sales of stores open at least one year and exclude sales of specialty machinery, sales to independent parts stores and sales to Team Members.

The following table presents the components of the increase in sales for the three and nine months ended September 30, 2012 (in millions):

                                                                         Increase
                                                                         in Sales
                                                  Increase in            for the
                                                   Sales for               Nine
                                                   the Three              Months
                                                    Months                Ended
                                                     Ended              September
                                                   September            30, 2012,
                                                   30, 2012,             Compared
                                                  Compared to             to the
                                                   the Same                Same
                                                   Period in            Period in
                                                     2011                  2011
Store sales:
Comparable store sales                          $         20        $         157
Non-comparable store sales:
Sales for stores opened throughout 2011,
excluding stores open at least one year that
are included in comparable store sales                    16                   76
Sales in 2011 for stores that have closed                 (1)                  (2)
Sales for stores opened throughout 2012                   31                   59
Non-store sales:
Includes sales of machinery and sales to
independent parts stores and Team Members                   -                   6
Total increase in sales                         $         66        $         296

We believe the increased sales achieved by our stores are the result of high levels of customer service, superior inventory availability, a broader selection of products offered in most stores, a targeted promotional and advertising effort through a variety of media and localized promotional events, continued improvement in the merchandising and store layouts of our stores, compensation programs for all store Team Members that provide incentives for performance and our continued focus on serving both DIY and professional service provider customers.

Our comparable store sales increases for the three and nine months ended September 30, 2012, were driven by an increase in average ticket values, partially offset by a decrease in DIY customer transaction counts. The improvement in average ticket values was a result of the continued growth of the higher priced, hard part categories, as a percentage of our total sales. The growth in the hard part categories is driven by the increase of professional service provider customer sales as a percentage of our total sales mix and the continued growth in DIY hard part sales, as consumers continue to maintain and repair their vehicles. Transaction counts also continue to be negatively impacted by better-engineered and more technically advanced vehicles, which have been manufactured in recent years. These vehicles require less frequent repairs as the component parts are more durable and last for longer periods of time; however, when repairs are required, the cost of the repair is typically greater. In addition, DIY customer transaction counts continue to be negatively impacted by macroeconomic pressures on disposable income, including sustained unemployment levels above historical averages. The strong increases in our professional service provider customer transaction counts, driven by our acquired markets, have been offset by the pressured DIY transaction counts.

We opened 37 and 156 net, new stores during the three and nine months ended September 30, 2012, respectively, compared to 50 and 137 net, new stores for the three and nine months ended September 30, 2011, respectively. As of September 30, 2012, we operated


3,896 stores in 39 states compared to 3,707 stores in 39 states at September 30, 2011. We anticipate total new store growth to be 180 net, new store openings in 2012 and 190 net, new store openings in 2013.

Gross profit:

Gross profit for the three months ended September 30, 2012, increased to $805 million (or 50.3% of sales) from $754 million (or 49.1% of sales) for the same period one year ago, representing an increase of 7%. Gross profit for the nine months ended September 30, 2012, increased to $2.35 billion (or 50.0% of sales) from $2.14 billion (or 48.7% of sales) for the same period one year ago, representing an increase of 10%. The increases in gross profit dollars were primarily a result of the increases in sales from new stores and the increases in comparable store sales at existing stores. The increases in gross profit as percentages of sales were primarily due to distribution center ("DC") efficiencies, acquisition cost improvements, a more focused advertised price strategy and improved inventory shrinkage, partially offset by the impact of increased commercial sales as a percentage of the total sales mix. DC efficiencies are the result of continued leverage on our increased sales volumes and more tenured and experienced DC Team Members in our maturing DCs. In addition, during the current period, we increased our store-level inventories as a component of our focus on providing higher service levels. The costs to move this additional inventory into the stores were more efficient than routine restocking activity; as a result, we realized a one-time benefit from capitalized distribution costs. This one-time capitalization of costs benefited gross margin for the three months ended September 30, 2012, by approximately 25 basis points, and we do not anticipate realizing this benefit in future periods. Acquisition cost improvements are the result of our ongoing negotiations with our vendors to improve our inventory purchase costs. The benefit to gross margin from a more focused advertised price strategy is the result of short duration, low margin promotions in the current period, which are designed to drive customer loyalty, build brand awareness and generate future business, but run for a shorter duration as compared to the same period one year ago. The improved inventory shrinkage is driven by our continued focus on inventory control and accountability through our distribution and store networks. Commercial sales typically carry a lower gross profit as a percentage of sales than DIY sales, as volume discounts are granted on wholesale transactions to professional service provider customers, therefore, creating pressure on our gross profit as a percentage of sales.

Selling, general and administrative expenses:

Selling, general and administrative expenses ("SG&A") for the three months ended September 30, 2012, increased to $542 million (or 33.9% of sales) from $513 million (or 33.4% of sales) for the same period one year ago, representing an increase of 6%. SG&A for the nine months ended September 30, 2012, increased to $1.59 billion (or 33.9% of sales) from $1.48 billion (or 33.7% of sales) for the same period one year ago, representing an increase of 7%. The increases in total SG&A dollars were primarily the result of additional employees, facilities and vehicles to support our increased store count. The increases in SG&A as percentages of sales were primarily the result of deleverage on soft comparable store sales.

Operating income:

As a result of the impacts discussed above, operating income for the three months ended September 30, 2012, increased to $263 million (or 16.4% of sales) from $241 million (or 15.7% of sales) for the same period one year ago, representing an increase of 9%. Operating income for the nine months ended September 30, 2012, increased to $754 million (or 16.1% of sales) from $660 million (or 15.0% of sales) for the same period one year ago, representing an increase of 14%.

Other income and expense:

Total other expense for the three months ended September 30, 2012, increased to $9 million (or 0.6% of sales) from $6 million (or 0.4% of sales) for the same period one year ago, representing an increase of 55%. Total other expense for the nine months ended September 30, 2012, decreased to $26 million (or 0.5% of sales) from $42 million (or 0.9% of sales) for the same period one year ago, representing a decrease of 39%. The increase in total other expense for the three months ended September 30, 2012, is the result of increased interest expense on higher average outstanding borrowings and increased amortization of debt issuance costs in the current period as compared to the same period one year ago. The decrease in total other expense for the nine months ended September 30, 2012, was primarily due to one-time charges related to our financing transactions that were completed in January of 2011 (discussed in detail below), partially offset by increased interest expense on higher average outstanding borrowings and increased amortization of debt issuance costs in the current period as compared to the same period one year ago.

Income taxes:

Our provision for income taxes for the three months ended September 30, 2012, increased to $95 million (or 5.9% of sales) from $87 million (or 5.6% of sales) for the same period one year ago, representing an increase of 9%. Our provision for income taxes for the nine months ended September 30, 2012, increased to $276 million (or 5.9% of sales) from $234 million (or 5.3% of sales) for the same period one year ago, representing an increase of 18%. The increase in our provision for income taxes was due to the increase in our taxable income. Our effective tax rate for the three months ended September 30, 2012, was 37.3% of income before income taxes compared to 36.8% for the same period one year ago. Our effective tax rate for the nine months ended September 30, 2012, was 37.9% of income before income taxes compared to 37.8% for the same period one year ago. The increase in our effective tax rate for the three months ended September 30, 2012, was primarily due to benefits of employment tax credits taken during the three months ended September 30, 2011, certain of which were not available during the same period in the current year.


Net income:

As a result of the impacts discussed above, net income for the three months ended September 30, 2012, increased to $159 million (or 9.9% of sales) from $148 million (or 9.7% of sales) for the same period one year ago, representing an increase of 7%. As a result of the impacts discussed above, net income for the nine months ended September 30, 2012, increased to $453 million (or 9.6% of sales) from $385 million (or 8.7% of sales) for the same period one year ago, representing an increase of 18%.

Earnings per share:

Our diluted earnings per common share for the three months ended September 30, 2012, increased 20% to $1.32 on 121 million shares versus $1.10 for the same period one year ago on 135 million shares. The impact of year-to-date share repurchases on diluted earnings per share for the three months ended September 30, 2012, was an increase of approximately $0.10. Our diluted earnings per common share for the nine months ended September 30, 2012, increased 30% to $3.60 on 126 million shares versus $2.76 for the same period one year ago on 139 million shares. The impact of year-to-date share repurchases on diluted earnings per share for the nine months ended September 30, 2012, was an increase of approximately $0.12.

Adjustments for nonrecurring and non-operating events:

Our results for the nine months ended September 30, 2011, included one-time charges associated with the financing transactions we completed in January of 2011, as discussed in Note 4 "Long-Term Debt". The one-time charges included a non-cash charge to write off the balance of debt issuance costs related to our previous asset-based revolving credit facility in the amount of $22 million ($13 million, net of tax) and a charge related to the termination of our interest rate swap agreements in the amount of $4 million ($3 million, net of tax). The charges related to these financing transactions were included in "Other income (expense)" on our Condensed Consolidated Statements of Income for the nine months ended September 30, 2011. The results discussed in the paragraph below are adjusted for these nonrecurring items for the nine months ended September 30, 2012 and 2011, and are reconciled in the table below.

Adjusted net income for the nine months ended September 30, 2012, increased 13% to $453 million (or 9.6% of sales) from $401 million (or 9.1% of sales), for the same period one year ago. Adjusted diluted earnings per common share for the nine months ended September 30, 2012, increased 25% to $3.60 from $2.88, for the same period one year ago.

The table below outlines the impact of the charges related to the financing transactions for the nine months ended September 30, 2012 and 2011 (amounts in thousands, except per share data):

                                                For the Nine Months Ended September 30,
                                                2012                               2011
                                         Amount     % of Sales              Amount      % of Sales
GAAP net income                      $     452,944      9.6  %          $      384,685      8.7  %
Write-off of asset-based revolving
credit facility debt issuance costs,
net of tax                                        -        - %                  13,458      0.3  %
Termination of interest rate swap
agreements, net of tax                            -        - %                   2,637      0.1  %
Non-GAAP adjusted net income         $     452,944      9.6  %          $      400,780      9.1  %

GAAP diluted earnings per common
share                                $        3.60                      $         2.76
Write-off of asset-based revolving
credit facility debt issuance costs,
net of tax                                        -                               0.10
Termination of interest rate swap
agreements, net of tax                            -                               0.02
Non-GAAP adjusted diluted earnings
per common share                     $        3.60                      $         2.88
Weighted-average common shares
outstanding - assuming dilution            125,670                             139,183

The financial information presented in the paragraph and table above is not derived in accordance with United States generally accepted accounting principles ("GAAP"). We do not, nor do we suggest investors should, consider such non-GAAP financial measures in isolation from, or as a substitute for, GAAP financial information. We believe that the presentation of financial results and estimates excluding the impact of the non-cash charge to write off the balance of debt issuance costs and the charge related to the termination of interest rate swap contracts, provide meaningful supplemental information to both management and investors, which is indicative of our core operations. We exclude these items in judging our performance and believe this non-GAAP information is useful to investors as well. Material limitations of these non-GAAP measures are that such measures do not reflect actual GAAP amounts. We compensate for such limitations by presenting, in the table above, a reconciliation to the most directly comparable GAAP measures.

. . .

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