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Nov. 8, 2021, 4:34 p.m. EST

10-Q: O REILLY AUTOMOTIVE INC

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(EDGAR Online via COMTEX) -- 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

? recent developments within our Company;

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

? our results of operations for the three and nine months ended September 30, 2021 and 2020;

? 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 "estimate," "may," "could," "will," "believe," "expect," "would," "consider," "should," "anticipate," "project," "plan," "intend" 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, the COVID-19 pandemic or other public health crises; the economy in general; inflation; consumer debt levels; product demand; the market for auto parts; competition; weather; tariffs; availability of key products; business interruptions, including terrorist activities, war and the threat of war; failure to protect our brand and reputation; challenges in international markets; volatility of the market price of our common stock; our increased debt levels; credit ratings on public debt; historical growth rate sustainability; our ability to hire and retain qualified employees; risks associated with the performance of acquired businesses; information security and cyber-attacks; and governmental regulations. 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, 2020, and subsequent Securities and Exchange Commission filings, 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.

RECENT DEVELOPMENTS

As we naviate the ongoing challenges resulting from the COVID-19 pandemic, we continue to place additional emphasis on the safety and wellness of our Team Members and our customers. During the nine months ended September 30, 2021, the increased level of vaccinations, the ongoing reopening processes across markets we operate in, government stimulus payments and enhanced unemployment benefits have positively impacted demand for the products we sell. We continue to keep our stores open and operating to meet our customers' critical needs, while also ensuring the safety of our Team Members and customers through strict adherence to safety protocols. However, we cannot predict how long the current crisis will last or the extent of its future impacts on our customers, our Team Members, our supply chain and overall industry demand.

For additional risks related to the COVID-19 pandemic, please refer to the "Risk Factors" section of our Annual Report on Form 10-K for the year ended December 31, 2020.

OVERVIEW

We are a specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States and Mexico. We are one of the largest U.S. automotive aftermarket specialty retailers, selling our products to both 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 profit dollars are, generally, 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. We have ongoing initiatives focused on marketing and training to educate customers on the advantages of ongoing vehicle maintenance, as well as "purchasing up" on the value spectrum.

Our stores also offer enhanced services and programs to our customers, including 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. As of September 30, 2021, we operated 5,740 stores in 47 U.S. states and 22 stores in Mexico.

We are influenced by a number of general macroeconomic factors that impact both our industry and our consumers, including, but not limited to, fuel costs, unemployment trends, interest rates and other economic factors. Due to the nature of these macroeconomic factors, we are unable to determine how long current conditions will persist and the degree of impact future changes may have on our business. Macroeconomic factors, such as total U.S. unemployment, and demand drivers specific to the automotive aftermarket, such as U.S. miles driven, have been pressured as a result of responses to the COVID-19 pandemic, including stay at home orders, work from home arrangements and reduced travel.

We believe the key drivers of current and future long-term demand for 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 and average vehicle age.

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. In total, vehicles in the U.S. are driven approximately three trillion miles per year, resulting in ongoing wear and tear and a corresponding continued demand for the repair and maintenance products necessary to keep these vehicles in operation.

Size and Age of the Vehicle Fleet

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 Auto Care Association, the total number of registered vehicles increased 12.7% from 2010 to 2020, bringing the number of light vehicles on the road to 281 million by the end of 2020. For the year ended December 31, 2020, the seasonally adjusted annual rate of light vehicle sales in the U.S. ("SAAR") was approximately 16.3 million. For 2021, the outlook for the SAAR is uncertain and estimated to be approximately 12.2 million, as the duration of the COVID-19 pandemic and supply chain constraints have limited new vehicle production capacity and made it difficult to determine the ultimate forecast of new vehicle sales. The annual changes to the vehicle population resulting from new vehicle sales and the fluctuation in vehicle scrappage rates in any given year represent a small percentage of the total light vehicle population and have a muted impact on the total number and average age of vehicles on the road over the short term. From 2010 to 2020, vehicle scrappage rates have remained relatively stable, ranging from 4.1% to 5.7% annually. As a result, over the past decade, the average age of the U.S. vehicle population has increased, growing 12.3%, from 10.6 years in 2010 to 11.9 years in 2020.

We believe the increase in average vehicle age can be attributed to better engineered and manufactured vehicles, which can be reliably driven at higher mileages due to better quality power trains, interiors and exteriors, and the consumer's willingness to invest in maintaining these higher-mileage, better built vehicles. As the average age of vehicles on the road increases, a larger percentage of miles are being driven by vehicles that 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. 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.

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 September 30, 2021, increased $272 million or 8% to $3.48 billion from $3.21 billion for the same period one year ago. Sales for the nine months ended September 30, 2021, increased $1.26 billion or 14% to $10.04 billion from $8.78 billion for the same period one year ago. Comparable store sales for stores open at least one year increased 6.7% and 16.9% for the three months ended September 30, 2021 and 2020, respectively. Comparable store sales for stores open at least one year increased 12.9% and 10.7% for the nine months ended September 30, 2021 and 2020, respectively. Comparable store sales are calculated based on the change in sales for U.S. stores open at least one year and exclude sales of specialty machinery, sales to independent parts stores and sales to Team Members, as well as sales from Leap Day in the nine months ended September 30, 2020. Online sales for ship-to-home orders and pickup in-store orders for U.S. stores open at least one year are included in the comparable store sales calculation.

The following table presents the components of the increase in sales for the three and nine months ended September 30, 2021 (in millions):







                                                       Increase in Sales for the       Increase in Sales for the
                                                           Three Months Ended              Nine Months Ended
                                                           September 30, 2021             September 30, 2021
                                                         Compared to the Same            Compared to the Same
                                                             Period in 2020                 Period in 2020
        Store sales:
        Comparable store sales                        $                        210    $                     1,097
        Non-comparable store sales:
        Sales for stores opened throughout 2020,
        excluding stores open at least one year
        that are included in comparable store
        sales, and Mayasa store sales                                           11                             79
        Sales for stores opened throughout 2021                                 46                             88
        Sales from Leap Day in 2020                                              -                           (35)
        Sales for stores that have closed,
        including temporarily closed stores                                      1                            (2)
        Non-store sales:
        Includes sales of machinery and sales to
        independent parts stores and Team Members                                4                             33
        Total increase in sales                       $                        272    $                     1,260
        


We believe our increased sales are the result of store growth, the high levels of customer service provided by our well-trained and technically proficient Team Members, superior inventory availability, including same day and over-night access to inventory from our regional distribution centers and hub store network, enhanced services and programs offered in our 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. The government stimulus payments, enhanced unemployment benefits, lifting of stay at home orders and associated ongoing market reopenings, when combined with positive industry dynamics, such as consumers investing in existing vehicles and favorable weather, contributed to strong demand in the nine months ended September 30, 2021.

Our comparable store sales increase for the three months ended September 30, 2021, was driven by increases in average ticket values for both professional service provider and DIY customers, partially offset by negative transaction counts. Our comparable store sales increase for the nine months ended September 30, 2021, was driven by increases in average ticket values and transaction counts for both professional service provider and DIY customers.

values continue to benefit from consumers spending additional time and money repairing and maintaining their vehicles in response to the COVID-19 pandemic, economic environment and new and used vehicle scarcity. Average ticket values also benefited from increases in average selling prices, on a same-SKU basis, as compared to the same period in 2020, driven by increases in acquisition costs of inventory, which were passed on in market prices. The decrease in transaction counts for the three months ended September 30, 2021, was driven by a challenging comparison to the strong DIY customer transaction counts in the prior year, partially offset by positive transaction counts from professional service provider customers in the current period. Improvements in transaction counts for the nine months ended September 30, 2021, were primarily due to prior year headwinds to traffic from the initial COVID-19 stay at home orders in 2020 and business restrictions, which resulted in immediate pressure to transaction counts for both DIY and professional service provider customers. Continued market reopening and recovery plans, ongoing government stimulus, favorable winter and spring weather conditions and the new and used vehicle scarcity positively impacted our customers' willingness to perform or invest in maintenance on their vehciles, which benefited transaction counts in the nine months ended September 30, 2021.

We opened 30 and 146 net, new U.S. stores during the three and nine months ended September 30, 2021, compared to opening 30 and 153 net, new U.S. stores during the three and nine months ended September 30, 2020. As of September 30, 2021, we operated 5,740 stores in 47 U.S. states and 22 stores in Mexico compared to 5,592 stores in 47 U.S. states and 21 stores in Mexico at September 30, 2020.

Gross profit:

Gross profit for the three months ended September 30, 2021, increased 8% to $1.82 billion (or 52.3% of sales) from $1.68 billion (or 52.4% of sales) for the same period one year ago. Gross profit for the nine months ended September 30, 2021, increased 15% to $5.29 billion (or 52.7% of sales) from $4.61 billion (or 52.6% of sales) for the same period one year ago. The increase in gross profit dollars for the three months ended September 30, 2021, was primarily the result of new store sales and the increase in comparable store sales at existing stores. The increase in gross profit dollars for the nine months ended September 30, 2021, was primarily the result of new store sales and the increase in comparable store sales at existing stores, partially offset by prior year gross profit dollars generated from one additional day due to Leap Day. The decrease in gross profit as a percentage of sales for the three months ended September 30, 2021, was due to increased distribution system costs and a greater percentage of total sales mix generated from professional service provider customers, which carry a lower gross margin than DIY sales. Increased distribution system costs were driven by the significant increase in volumes over the past year, challenging labor markets and ongoing global logistical supply chain pressures. These headwinds were partially offset by a benefit from selling through inventory purchased prior to recent acquisition cost increases and corresponding selling price increases. We determine inventory cost using the last-in, first-out ("LIFO") method but have, over time, seen our LIFO reserve balance exhausted, resulting in a LIFO inventory value above replacement cost prior to September 30, 2021. Our policy is to not write up inventory in excess of replacement cost, and accordingly, we had effectively valued our inventory at replacement cost, resulting in a benefit when selling prices increase as we sell through this lower cost inventory. During the three months ended September 30, 2021, our LIFO reserve reverted back to a more typical credit balance due to recent, significant inflation in acquisition costs; as a result, we anticipate a diminishing benefit moving forward from the final sell through of inventory valued at older, lower replacement cost. The increase in gross profit as a percentage of sales for the nine months ended September 30, 2021, was due to the benefit from the sell through of inventory purchased before acquisition cost and selling price increases.

Selling, general and administrative expenses:

Selling, general and administrative expenses ("SG&A") for the three months ended September 30, 2021, increased 11% to $1.06 billion (or 30.6% of sales) from $955 million (or 29.8% of sales) for the same period one year ago. SG&A for the nine months ended September 30, 2021, increased 12% to $3.04 billion (or 30.3% of sales) from $2.73 billion (or 31.1% of sales) for the same period one year ago.

Operating income:

As a result of the impacts discussed above, operating income for the three months ended September 30, 2021, increased 4% to $755 million (or 21.7% of sales) from $725 million (or 22.6% of sales) for the same period one year ago.

above, operating income for the nine months ended September 30, 2021, increased 19% to $2.24 billion (or 22.3% of sales) from $1.89 billion (or 21.5% of sales) for the same period one year ago.

Other income and expense:

Total other expense for the three months ended September 30, 2021, decreased 12% to $34 million (or 1.0% of sales) from $39 million (or 1.2% of sales) for the same period one year ago. Total other expense for the nine months ended September 30, 2021, decreased 13% to $104 million (or 1.0% of sales) from $119 million (or 1.4% of sales) for the same period one year ago. The decrease in total other expense for the three months ended September 30, 2021, was the result of decreased interest expense on lower average outstanding borrowings and lower average cost of borrowings, partially offset by a decrease in the value of our trading securities. The decrease in total other expense for the nine months ended September 30, 2021, was the result of decreased interest expense on lower average outstanding borrowings and lower average cost of borrowings.

Income taxes:

Our provision for income taxes for the three months ended September 30, 2021, increased 2% to $162 million (22.5% effective tax rate) from $159 million (23.2% effective tax rate) for the same period one year ago. Our provision for income taxes for the nine months ended September 30, 2021, increased 21% to $492 million (23.0% effective tax rate) from $407 million (23.0% effective tax rate) for the same period one year ago. The increase in our provision for income taxes for the three months ended September 30, 2021, was the result of higher taxable income, partially offset by higher excess tax benefits from share-based compensation. The increase in our provision for income taxes from the nine months ended September 30, 2021, was the result of higher taxable income and a benefit in the prior year from renewable energy investment tax credits, partially offset by higher excess tax benefits from share-based compensation in the current period. The decrease in our effective tax rate for the three months ended September 30, 2021, was the result of higher excess tax benefits from share-based compensation.

Net income:

As a result of the impacts discussed above, net income for the three months ended September 30, 2021, increased 6% to $559 million (or 16.1% of sales) from $527 million (or 16.4% of sales) for the same period one year ago. As a result of the impacts discussed above, net income for the nine months ended September 30, 2021, increased 21% to $1.65 billion (or 16.4% of sales) from $1.36 billion (or 15.5% of sales) for the same period one year ago.

Earnings per share:

Our diluted earnings per common share for the three months ended September 30, 2021, increased 14% to $8.07 on 69 million shares from $7.07 on 75 million shares for the same period one year ago. Our diluted earnings per common share for the nine months ended September 30, 2021, increased 29% to $23.45 on 70 million shares from $18.12 on 75 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, and we are unable to predict the impact of the uncertainty and disruption caused by the COVID-19 pandemic on our ability to generate funds or maintain liquidity.

The following table identifies cash provided by/(used in) our operating, investing and financing activities for the nine months ended September 30, 2021 and 2020 (in thousands):







                                                                  For the Nine Months Ended
                                                                       September 30,
        Liquidity:                                                   2021            2020
        Total cash provided by/(used in):
        Operating activities                                    $    2,565,327    $ 2,349,129
        Investing activities                                         (337,736)      (447,339)
        Financing activities                                       (2,243,517)      (314,343)
        Effect of exchange rate changes on cash                          (412)          (755)
        Net (decrease) increase in cash and cash equivalents    $     (16,338)    $ 1,586,692
        Capital expenditures                                    $      340,687    $   363,425
        Free cash flow (1)                                           2,193,889      1,875,626
        


(1) Calculated as net cash provided by operating activities, less capital . . .

Nov 08, 2021

COMTEX_396529317/2041/2021-11-08T16:34:23

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