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ORLY > SEC Filings for ORLY > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for O REILLY AUTOMOTIVE INC

Form 10-Q for O REILLY AUTOMOTIVE INC


9-May-2014

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 months ended March 31, 2014 and 2013;
• 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, 2013, 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 U.S. 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 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 March 31, 2014, we opened 51 stores and closed one store and, as of that date, operated 4,216 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 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 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. influences the demand for repair and maintenance products sold within the automotive aftermarket. According to the Department of Transportation, prior to 2007, the annual number of total miles driven in the U.S. had steadily increased; however, since that time, as the U.S. experienced difficult macroeconomic conditions and historically high levels of unemployment, the number of total miles driven in the U.S. have remained relatively flat. Although total miles driven have not significantly increased since 2007, vehicles in the U.S. continue to be driven approximately three trillion miles per year, resulting in ongoing wear and tear and continued demand for the repair and maintenance products sold within the automotive aftermarket. In addition, we believe that as the U.S. economy continues to recover and the level of unemployment declines, total miles driven in the U.S. will return to a period of annual growth, supporting continued demand for automotive aftermarket products.

• 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 vehicle population 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 declined 14% over the past decade, from 16.7 million registrations in 2002 to 14.3 million registrations in 2012; however, the seasonally adjusted annual rate (the "SAAR") of sales of light vehicles in the U.S. increased to 16 million as of March 31, 2014, indicating that the trend of declining new light vehicle registrations has reversed. In addition, during the past decade, vehicle scrappage rates remained relatively stable, ranging from just 4.6% to 5.7% annually. The stable scrappage rates over the past decade have contributed to an increase in the average age of the U.S. vehicle population over that period, growing 16%, from 9.6 years in 2002 to 11.1 years in 2012. We believe this increase in average age can be attributed to better engineered and manufactured vehicles, which can be reliably driven at higher mileages due to better quality power trains and interiors and exteriors, and the consumer's willingness to invest in maintaining these 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. As the U.S. economy recovers, we believe consumers will continue to invest in these reliable, higher-quality, higher-mileage vehicles and these investments, along with an increasing total light vehicle fleet, will support continued demand for automotive aftermarket products.

• Unemployment - Unemployment, underemployment, the threat of future joblessness and the 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. 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. However, as of March 31, 2014, the U.S. unemployment rate decreased to 6.7%, its lowest rate in over five years. We believe that as the economy continues to recover, unemployment rates should decline and we would expect to see a corresponding increase in commuter traffic as unemployed individuals return to work. Aided by the anticipated increase in commuter miles, we believe overall annual U.S. miles driven should return to a period of annual growth, 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 hard work and excellent customer service.

RESULTS OF OPERATIONS

Sales:
Sales for the three months ended March 31, 2014, increased $143 million to $1.73 billion from $1.59 billion for the same period one year ago, representing an increase of 9%. Comparable store sales for stores open at least one year increased 6.3% and 0.6% for the three months ended March 31, 2014 and 2013, respectively. Comparable store sales for the first quarter ended March 31, 2013, adjusted for the impact of one additional day during the first quarter ended March 31, 2012, as a result of Leap Day, would have been 1.9%. 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 months ended March 31, 2014 (in millions):

                                                    Increase in Sales for the Three
                                                              Months Ended
                                                  March 31, 2014, Compared to the Same
                                                             Period in 2013
Store sales:
Comparable store sales                            $                               99
Non-comparable store sales:
Sales for stores opened throughout 2013,
excluding stores open at least one year that are
included in comparable store sales                                                39
Sales in 2013 for stores that have closed                                         (1 )
Sales for stores opened throughout 2014                                            7
Non-store sales:
Includes sales of machinery and sales to
independent parts stores and Team Members                                         (1 )
Total increase in sales                           $                              143

We believe our increased sales are the result of store growth and the 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 with a dynamic catalog system to identify and source parts, 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 increase for the three months ended March 31, 2014, was driven by solid increases in average ticket values and customer transaction counts for both DIY and professional service provider customers. The improvement in average ticket values was the result of the continued growth of the more costly, hard part categories as a percentage of our total sales. The overall growth in the hard part categories continues to be driven by the increasing cost of replacement parts necessary to maintain the current population of better engineered and more technically advanced vehicles. The increase in professional service provider customer transaction counts was primarily driven by our acquired markets and maturation of less mature stores. Harsh winter weather conditions during the period, across many of our markets, led to an increase in vehicle repairs. The increase in DIY transaction counts was driven by these increased vehicle repair levels as our DIY customers were forced to perform necessary repairs in order to keep their vehicles on the road. Both DIY and professional service provider customer transaction counts 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 replacement parts is, on average, greater.

We opened 50 net, new stores during the three months ended March 31, 2014, compared to 65 net, new stores for the three months ended March 31, 2013. At March 31, 2014, we operated 4,216 stores in 42 states compared to 4,041 stores in 42 states at March 31, 2013. We anticipate total new store growth to be 200 net, new stores in 2014.

Gross profit:
Gross profit for the three months ended March 31, 2014, increased to $878 million (or 50.8% of sales) from $799 million (or 50.4% of sales) for the same period one year ago, representing an increase of 10%. The increase in gross profit dollars was primarily a result of the increase in comparable store sales at existing stores and sales from new stores. The increase in gross profit as a percentage of sales was primarily due to acquisition cost improvements and favorable product mix, partially offset by the non-cash LIFO charge resulting from continued product acquisition cost reductions. Acquisition cost improvements are the result of our ongoing negotiations with our vendors to improve our inventory purchase costs. Harsh winter weather conditions during the period across many of our markets led to an increase in vehicle repairs. Many of these vehicle repairs resulted in sales in our hard part categories, which carry above average gross margins, and resulted in an overall favorable product mix. During the third quarter of 2013, we depleted our LIFO reserve due to acquisition cost improvements we realized over time. Our policy is to not write up inventory in excess of replacement cost and, accordingly, we are effectively valuing our inventory at replacement cost. During the three months ended March 31, 2014, our LIFO cost was written down by approximately $23 million to reflect replacement cost. We do not anticipate material charges from product acquisition cost reductions for the remainder of 2014; however, unforeseen, significant acquisition cost decreases could occur and may create additional LIFO gross margin headwinds.


Selling, general and administrative expenses:
Selling, general and administrative expenses ("SG&A") for the three months ended March 31, 2014, increased to $591 million (or 34.2% of sales) from $548 million (or 34.5% of sales) for the same period one year ago, representing an increase of 8%. The increase in total SG&A dollars was primarily the result of additional Team Members, facilities and vehicles to support our increased store count. The decrease in SG&A as a percentage of sales was primarily the result of increased leverage of store occupancy costs on strong comparable store sales results.

Operating income:
As a result of the impacts discussed above, operating income for the three months ended March 31, 2014, increased to $287 million (or 16.6% of sales) from $251 million (or 15.8% 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 March 31, 2014, increased to $12 million (or 0.7% of sales), from $10 million (or 0.7% of sales) for the same period one year ago, representing an increase of 16%. The increase in total other expense was primarily the result of increased interest expense on higher average outstanding borrowings.

Income taxes:
Our provision for income taxes for the three months ended March 31, 2014, increased to $101 million (or 5.9% of sales) from $86 million (or 5.4% of sales) for the same period one year ago, representing an increase of 17%. Our effective tax rate for the three months ended March 31, 2014, was 36.8% of income before income taxes compared to 35.9% for the same period one year ago. The increase in our provision for income taxes was primarily the result of higher taxable income in the current period driven by our strong operating results. The increase in our tax rate was primarily due to reduced benefit from employment tax credits in the current period and adjustments to tax reserves related to the favorable resolution of certain prior year income tax audits.

Net income:
As a result of the impacts discussed above, net income for the three months ended March 31, 2014, increased to $174 million (or 10.1% of sales), from $154 million (or 9.7% of sales) for the same period one year ago, representing an increase of 13%.

Earnings per share:
Our diluted earnings per common share for the three months ended March 31, 2014, increased 18% to $1.61 on 108 million shares from $1.36 on 113 million shares for the same period one year ago.

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 three months ended March 31, 2014 and 2013 (in thousands):

                                                    For the Three Months Ended
                                                            March 31,
Liquidity                                              2014              2013
Total cash provided by (used in):
Operating activities                             $     345,549       $  226,344
Investing activities                                   (81,898 )        (72,100 )
Financing activities                                    16,862         (196,962 )
Increase (decrease) in cash and cash equivalents $     280,513       $  (42,718 )

Capital expenditures                                    83,085           73,484
Free cash flow (1)                                     262,464          152,860

(1) Calculated as net cash provided by operating activities, less capital expenditures for the period.

Operating activities:
The increase in net cash provided by operating activities during the three months ended March 31, 2014, compared to the same period in 2013, was primarily due to increases in accounts payable and net income for the period. The increase in accounts payable during the period, as compared to the same period in the prior year, was driven by an increased level of inventory purchases during the three months ended March 31, 2014, resulting from our strong sales performance and the timing of payments.

Investing activities:
The increase in net cash used in investing activities during the three months ended March 31, 2014, compared to the same period in 2013, was primarily the result of an increase in capital expenditures during the current period related to the construction of distribution facilities to support our ongoing store growth.

Financing activities:
The cash provided by financing activities during the three months ended March 31, 2014, versus cash used in financing activities during the three months ended March 31, 2013, was primarily attributable to a lower level of repurchases of our common stock during the current period, under 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 March 31, 2014, we had outstanding letters of credit, primarily to support obligations related to workers' compensation, general liability and other insurance policies, in the amount of $55 million, reducing the aggregate availability under the Revolving Credit Facility by that amount. As of March 31, 2014, we had no outstanding borrowings under the Revolving Credit Facility.

Senior Notes:
We have issued $1.4 billion aggregate principal amount of unsecured senior notes due between 2021 and 2023 with United Missouri Bank, N.A. ("UMB") as trustee. Interest on the unsecured senior notes of 3.800% to 4.875% is payable biannually and is computed on the basis of a 360-day year.

The senior notes are guaranteed on a senior unsecured basis by each of our subsidiaries ("Subsidiary Guarantors") that incurs or guarantees our obligations under our Revolving Credit Facility or certain of our other debt or any of our Subsidiary Guarantors. The guarantees are joint and several and full and unconditional, subject to certain customary automatic release provisions, including release of the subsidiary guarantor's guarantee under our Credit Agreement and certain other debt, or, in certain circumstances, the sale or other disposition of a majority of the voting power of the capital interest in, or of all or substantially all the property of, the subsidiary guarantor. Each of the Subsidiary Guarantors is 100% owned, directly or indirectly, by us and we have no independent assets or operations other than those of our subsidiaries. Our only direct or indirect subsidiaries that would not be Subsidiary Guarantors would be minor subsidiaries. Neither we, nor any of our Subsidiary Guarantors, are subject to any material or significant restrictions on our ability to obtain funds from our subsidiaries by dividend or loan or to transfer assets from such subsidiaries, except as provided by applicable law. Each of our senior notes is subject to certain customary covenants, with which we complied as of March 31, 2014.


Debt covenants:
The indentures governing our senior notes contain covenants that limit our ability and the ability of certain of our subsidiaries to, among other things:
(i) create certain liens on assets to secure certain debt; (ii) enter into certain sale and leaseback transactions; and (iii) merge or consolidate with another company or transfer all or substantially all of our or its property, in each case as set forth in the indentures. These covenants are, however, subject to a number of important limitations and exceptions.

The Credit Agreement contains certain covenants, including limitations on indebtedness, a minimum consolidated fixed charge coverage ratio of 2.25 times through December 31, 2014, and 2.50 times thereafter through maturity, and a maximum consolidated leverage ratio of 3.00 times through maturity. The consolidated leverage ratio includes a calculation of adjusted debt to earnings before interest, taxes, depreciation, amortization, rent and stock-based compensation expense ("EBITDAR"). Adjusted debt includes outstanding debt, outstanding stand-by letters of credit and similar instruments, six-times rent expense and excludes any premium or discount recorded in conjunction with the issuance of long-term debt. In the event that we should default on any covenant contained within the Credit Agreement, certain actions may be taken, including, but not limited to, possible termination of credit extensions, immediate payment of outstanding principal amounts plus accrued interest and other amounts payable under the Credit Agreement and litigation from our lenders. We had a consolidated fixed charge coverage ratio of 5.04 times and 4.86 times as of March 31, 2014 and 2013, respectively, and a consolidated leverage ratio of 1.86 times and 1.84 times as of March 31, 2014 and 2013, respectively, remaining in . . .

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