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ORLY > SEC Filings for ORLY > Form 10-Q on 8-Nov-2013All 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-2013

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 three and nine months ended September 30, 2013 and 2012;

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, forward-looking statements and other risk factors 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 public debt, our ability to hire and retain qualified employees, risks associated with the performance of acquired businesses, 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, 2012, for additional factors that could materially affect our financial performance. Forward-looking statements speak only as of the date they were made and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

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 also offer enhanced services and programs to our customers: used oil, oil filter and battery recycling; battery, wiper and bulb replacement; battery diagnostic testing; electrical and module testing; check engine light code extraction; loaner tool program; drum and rotor resurfacing; custom hydraulic hoses; professional paint shop mixing and related materials; and 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 190 net, new stores in 2013, and 200 net, new stores in 2014. 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, 2013, we opened 50 stores and closed two stores. During the nine months ended September 30, 2013, we opened 163 stores, and closed four stores, and as of that date, operated 4,135 stores in 42 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 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. We believe that as the U.S. economy recovers and the level of unemployment declines, annual miles driven will return to historical growth rates and continue to drive demand for the 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 8% over the past decade, from 229 million light vehicles in 2002 to 247 million light vehicles in 2012. Annual new light vehicle registrations have declined 14% over the past decade, from 17 million registrations in 2002 to 14 million registrations in 2012; 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, 2013, 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 16% from 9.6 years in 2002 to 11.1 years in 2012, while vehicle scrappage rates have remained relatively stable over the same period. 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, 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. 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, 2013, the U.S. unemployment rate decreased to 7.2%, its lowest rate in nearly five years. 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 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, 2013, increased $126 million to $1.73 billion from $1.60 billion for the same period one year ago, representing an increase of 8%. Sales for the nine months ended September 30, 2013, increased $334 million to $5.03 billion from $4.69 billion for the same period one year ago, representing an increase of 7%. Comparable store sales for stores open at least one year increased 4.6% and 1.3% for the three months ended September 30, 2013 and 2012, respectively. Comparable store sales for stores open at least one year increased 3.9% and 3.7% for the nine months ended September 30, 2013 and 2012, 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, sales to Team Members and sales from the acquired VIP stores, due to the significant change in the business model and lack of historical data.

The following table presents the components of the increase in sales for the three and nine months ended September 30, 2013 (in millions):

                                                     Increase in       Increase in
                                                    Sales for the     Sales for the
                                                    Three Months       Nine Months
                                                   Ended September   Ended September
                                                      30, 2013,         30, 2013,
                                                   Compared to the   Compared to the
                                                   Same Period in    Same Period in
                                                        2012              2012
Store sales:
Comparable store sales                             $           72    $          180
Non-comparable store sales:
Sales for stores opened throughout 2012, excluding
stores open at least one year that are included in
comparable store sales                                         12                71
Sales in 2012 for stores that have closed                      (1)               (2)
Sales for stores opened throughout 2013, including
the acquired VIP stores                                        40                84
Non-store sales:
Includes sales of machinery and sales to
independent parts stores and Team Members                       3                 1
Total increase in sales                            $          126    $          334

We believe the increased sales achieved by our stores are the result of high levels of customer service provided by our well-trained and technically proficient Team Members, superior inventory availability, enhanced services and programs offered in most stores, a broader selection of product offerings 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, 2013, were driven by an increase in average ticket values for both DIY and commercial business, and an increase in customer transaction counts for commercial business, slightly offset by a decrease in customer transaction counts for DIY business. The improvements in average ticket values were the result of the continued growth of the more costly, hard part categories as a percentage of our total sales. The growth in the hard part categories was driven by the increase of professional service provider 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 existing vehicles. The increases in our professional service provider customer transaction counts were driven by the chainwide growth of our professional business, while macroeconomic pressures on disposable income continue to negatively impact DIY customer transaction counts. Both DIY and professional service provider customer 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 and the component parts are more durable and last for longer periods of time; however, when repairs are required, the cost of the repair is, on average, greater.

We opened 48 and 159 net, new stores during the three and nine months ended September 30, 2013, respectively, compared to 37 and 156 net, new stores during the three and nine months ended September 30, 2012, respectively. As of September 30, 2013, we operated 4,135 stores in 42 states compared to 3,896 stores in 39 states at September 30, 2012. We anticipate total new store growth to be 190 net, new store openings in 2013, and 200 net, new store openings in 2014.

Gross profit:

Gross profit for the three months ended September 30, 2013, increased to $879 million (or 50.9% of sales) from $805 million (or 50.3% of sales) for the same period one year ago, representing an increase of 9%. Gross profit for the nine months ended September 30, 2013, increased to $2.55 billion (or 50.7% of sales) from $2.35 billion (or 50.0% of sales) for the same period one year ago, representing an increase of 9%. The increases in gross profit dollars for the three and nine months ended September 30, 2013, were primarily a result of the increase in comparable store sales at existing stores and sales from new stores. The increases in gross profit as a percentage of sales for the three and nine months ended September 30, 2013, were primarily due to acquisition cost improvements, pricing management and distribution center ("DC") operating efficiencies, partially offset by the impact of increased commercial sales as a percentage of our total sales mix and a smaller amount of capitalized distribution costs. Acquisition cost improvements are the result of our ongoing negotiations with our vendors to improve our inventory purchase costs. DC operating efficiencies are the result of continued leverage on our increased sales volumes and more tenured and experienced DC Team Members in our maturing DCs. 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. The decrease in capitalized distribution costs in the current period compared the same period in the prior year is the result of the larger than typical benefit from capitalized distribution


costs associated with our initiative to increase our store-level inventories in the prior year. The costs to move this additional inventory into the stores were more efficient than routine restocking activity; as a result, we realized a benefit from capitalized distribution costs.

Selling, general and administrative expenses:

Selling, general and administrative expenses ("SG&A") for the three months ended September 30, 2013, increased to $579 million (or 33.5% of sales) from $542 million (or 33.9% of sales) for the same period one year ago, representing an increase of 7%. SG&A for the nine months ended September 30, 2013, increased to $1.70 billion (or 33.8% of sales) from $1.59 billion (33.9% of sales) for the same period one year ago, representing an increase of 7%. The increases in total SG&A dollars for the three and nine months ended September 30, 2013, were primarily the result of additional Team Members, facilities and vehicles to support our increased store count. The decreases in SG&A as percentages of sales for the three and nine months ended September 30, 2013, were primarily the result of increased leverage of store occupancy and headquarter costs on solid comparable store sales increases.

Operating income:

As a result of the impacts discussed above, operating income for the three months ended September 30, 2013, increased to $300 million (or 17.4% of sales) from $263 million (or 16.4% of sales) for the same period one year ago, representing an increase of 14%. Operating income for the nine months ended September 30, 2013, increased to $848 million (or 16.9% of sales) from $754 million (or 16.1% of sales) for the same period one year ago, representing an increase of 12%.

Other income and expense:

Total other expense for the three months ended September 30, 2013, increased to $12 million (or 0.7% of sales) from $9 million (or 0.6% of sales) for the same period one year ago, representing an increase of 30%. Total other expense for the nine months ended September 30, 2013, increased to $33 million (or 0.6% of sales) from $26 million (or 0.5% of sales) for the same period one year ago, representing an increase of 28%. The increases in total other expense for the three and nine months ended September 30, 2013, were primarily due to increased interest expense on higher average outstanding borrowings and increased amortization of debt issuance costs.

Income taxes:

Our provision for income taxes for the three months ended September 30, 2013, increased to $102 million (or 5.9% of sales) from $95 million (or 5.9% of sales) for the same period one year ago, representing an increase of 8%. Our provision for income taxes for the nine months ended September 30, 2013, increased to $297 million (or 5.9% of sales) from $276 million (or 5.9% of sales) for the same period one year ago, representing an increase of 8%. The increase in our provision for income taxes for the three and nine months ended September 30, 2013, was due to the increases in our taxable income. Our effective tax rate for the three months ended September 30, 2013, was 35.3% of income before income taxes compared to 37.3% for the same period one year ago. Our effective tax rate for the nine months ended September 30, 2013, was 36.5% of income before income taxes compared to 37.9% of income before income taxes for the same period one year ago. The decreases in our tax rates for the three and nine months ended September 30, 2013, were primarily due to the benefits of employment tax credits and adjustments to tax reserves related to the favorable resolution of certain income tax audits during the current year and unfavorable adjustments relating to certain income tax audits in the prior year.

Net income:

As a result of the impacts discussed above, net income for the three months ended September 30, 2013, increased to $186 million (or 10.8% of sales) from $159 million (or 9.9% of sales) for the same period one year ago, representing an increase of 17%. As a result of the impacts discussed above, net income for the nine months ended September 30, 2013, increased to $518 million (or 10.3% of sales) from $453 million (or 9.6% of sales) for the same period one year ago, representing an increase of 14%.

Earnings per share:

Our diluted earnings per common share for the three months ended September 30, 2013, increased 28% to $1.69 on 110 million shares versus $1.32 for the same period one year ago on 121 million shares. Our diluted earnings per common share for the nine months ended September 30, 2013, increased 29% to $4.63 on 112 million shares versus $3.60 for the same period one year ago on 126 million shares.

LIQUIDITY AND CAPITAL RESOURCES

Our long-term business strategy requires capital to open new stores, fund strategic acquisitions, expand distribution infrastructure, operate and maintain existing stores and may include the opportunistic repurchase of shares of our common stock through our Board-approved share repurchase program. The primary sources of our liquidity are funds generated from operations and borrowed under our unsecured revolving credit facility. Decreased demand for our products or changes in customer buying patterns could negatively impact our ability to generate funds from operations. Additionally, decreased demand or changes in buying patterns could impact our ability to meet the debt covenants of our credit agreement and, therefore, negatively impact the funds available under our unsecured revolving credit facility. We believe that cash expected to be provided by operating activities and availability under our unsecured revolving credit facility will be sufficient to fund both our short-term and long-term capital and liquidity needs for the foreseeable future. However, there can be no assurance that we will continue to generate cash flows at or above recent levels.


The following table identifies cash provided by/(used in) our operating, investing and financing activities for the nine months ended September 30, 2013 and 2012 (in thousands):

                                        For the Nine Months Ended
                                              September 30,
Liquidity                                  2013            2012
Total cash provided by (used in):
Operating activities                  $     719,848    $ 1,033,126
Investing activities                       (294,505)      (211,626)
Financing activities                       (310,463)      (760,347)
Increase in cash and cash equivalents $     114,880    $    61,153

Operating activities:

The decrease in net cash provided by operating activities for the nine months ended September 30, 2013, compared to the same period in 2012, was primarily due to a smaller decrease in net inventory investment and a smaller increase in income taxes payable (adjusted for the effect of non-cash change in deferred income taxes and the excess tax benefit from stock options exercised), partially offset by an increase in net income in the current period. Net inventory investment reflects our investment in inventory, net of the amount of accounts payable to vendors. Our vendor financing programs enable us to reduce overall supply chain costs and negotiate extended payment terms with our vendors. Our accounts payable to inventory ratio was 87.8% and 84.7% at September 30, 2013, and December 31, 2012, respectively, versus 84.4% and 64.4% at September 30, 2012, and December 31, 2011, respectively. The smaller increase in our accounts payable to inventory ratio is the result of a smaller increase in the number of new vendors added to our financing programs in the current period, versus the same period in the prior year. We launched our enhanced vendor financing program in January of 2011, and were able to add a large number of vendors to the programs during 2011 and 2012. As we anniversary these vendor additions to the programs, we expect to see a slower rate of growth in our accounts payable to inventory ratio. The smaller increase in income taxes payable, adjusted for the non-cash impacts discussed above, was primarily the result of a prepaid tax position at the end of 2011 versus a payable position at the end of 2012.

Investing activities:

The increase in net cash used in investing activities during the nine months ended September 30, 2013, as compared to the same period in 2012, was primarily the result of an increase in capital expenditures during the current period related to the purchase and construction of new distribution facilities during 2013 to support our ongoing store growth.

Financing activities:

The decrease in net cash used in financing activities during the nine months ended September 30, 2013, as compared to the same period in 2012, was primarily attributable to the impact of fewer repurchases of our common stock during the current period, in accordance with our Board-approved share repurchase program.

Unsecured revolving credit facility:

In January of 2011, and as amended in September of 2011 and July of 2013, we entered into a credit agreement (the "Credit Agreement"), for a five-year $600 million unsecured revolving credit facility (the "Revolving Credit Facility"), arranged by Bank of America, N.A., which is scheduled to mature in July of 2018. The Credit Agreement includes a $200 million sub-limit for the issuance of letters of credit and a $75 million sub-limit for swing line borrowings under the Revolving Credit Facility. As described in the Credit Agreement governing the Revolving Credit Facility, we may, from time to time subject to certain conditions, increase the aggregate commitments under the Revolving Credit Facility by up to $200 million. As of September 30, 2013, we had outstanding . . .

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