O'Reilly Automotive Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 27, 2021

There are 11 speakers on the call.

Operator

Welcome to the O'Reilly Automotive Incorporated Third Quarter 2021 Earnings Conference Call. My name is Adrienne, and I'll be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer I'll now turn the call over to Tom McFall. Tom McFall, you may begin.

Speaker 1

Thank you, Adrianne. Good morning, everyone, and thank you for joining us. During today's conference call, Before we begin this morning, I'd like to remind everyone that our comments today contain forward looking statements, and we intend to be covered by and we claim the protection under the Safe Harbor provisions for forward looking statements contained in 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, The company's actual results could differ materially from any forward looking statements due to several important factors described in the company's latest annual report on Form 10 ks for the year ended December 31, 2020, and other recent SEC filings. The company assumes no obligation to update any forward looking statements made during this call.

Speaker 1

At this time, I'd like to introduce Craig Johnson? Thanks, Tom.

Speaker 2

Good morning, everyone, and welcome to the O'Reilly Auto Parts Third Quarter Conference Call. Participating on the call with me this morning are Brad Beckham, our Executive Vice President of Store Operations and Sales and Tom McFall, our Chief Financial Officer. Greg Hensley, our Executive Chairman David O'Reilly, our Executive Vice Chairman and Jeff Schall, our Chief Operating Officer and Co President are also present on the call. As we announced on last quarter's call, Brad will be providing prepared comments today On today's call in Jeff's normal spot, as we anticipate and prepare for Jeff's upcoming retirement in early 2022 I'd like to congratulate team O'Reilly on yet another incredible performance in the 3rd quarter and to thank every member of our team for their unwavering commitment to our company and to our customers. The highlights of our 3rd quarter results include a 6.7% increase in comparable store sales On top of an impressive 16.9% increase in the Q3 of last year and a 14% increase in diluted earnings per share, which is all the more impressive considering we grew EPS 39% in the Q3 last year.

Speaker 2

We'll walk through the details of our performance in Our prepared comments today, but I don't want to miss an opportunity at the beginning of the call to express my sincere gratitude to our team For their relentless hard work and dedication as we continue to weather the pandemic. Our team has been incredibly resilient to the challenges we faced over the last year and a half, And it would be very easy to take this for granted their ability to respond so well to this difficult environment. It has been anything but easy and our track record of consistency doesn't diminish the massive undertaking by team O'Reilly to protect our customers and fellow team members while driving the highest sales and transaction volumes in the history of our company. So thank you, team O'Reilly for your outstanding performance in the 3rd quarter. I'd now like to take a few minutes and provide some color around our sales performance for the quarter.

Speaker 2

Our comparable store sales performance has continued to Well ahead of our expectations and we've been very pleased with both the consistency and broad based nature of the strength of our top line. From a cadence perspective, our sales results were fairly consistent throughout the quarter with solid positive comparable store sales growth each month. September was the strongest month of the quarter, but the variability from month to month throughout the quarter was not significant on a 2 or 3 year stack basis. These very steady elevated sales levels continued the trend we drove in the 2nd quarter despite not having a tailwind from government stimulus This top line sales strength has continued thus far in October and we continue to be pleased with the durable nature of the strong sales volumes we've been able to achieve. The components of our comparable store sales growth in the 3rd quarter are consistent with our 2nd quarter results with strong growth on the professional side of our business paired with solid growth from DIY.

Speaker 2

While our professional business faced easier comparisons from the prior year than the DIY business, we were still up against a challenging comparison We're very pleased with our team's ability to drive historically strong comparable store sales on a 1 2 year stack basis. We also continue to be very happy with the performance of our DIY business as this side drove the greater outperformance as compared to our expectations against extremely difficult compares in the prior year. Total ticket count comp for the Q3 were better than our expectations, but slightly negative as a result of pressure to DIY transaction counts due to the difficult comparisons and rising prices, which were partially offset by the growth in professional ticket counts. On last quarter's call, we commented that we expected to see incremental I'm sorry, we expected to see increased inflation in the back half of the year. However, 3rd quarter inflation was even higher than our expectations.

Speaker 2

Our 3rd quarter average ticket increase was aided by an increase in same SKU selling prices of approximately 5.5% as acquisition cost increases were passed along in selling price. As price levels have risen in the broader economy, Demand in our industry has been resilient and we continue to see strength in average ticket on a 1 2 year stack basis beyond the impact of same SKU inflation. However, we remain cautious and on guard to our inflation outlook as we would expect some partial offsets Same SKU benefit as continued rising prices may cause more economically challenged customers to defer non critical maintenance or trade down the product value spectrum. Finally, we drove solid sales volumes across all of our product categories With especially strong performance in undercar hard part categories, offsetting some of the pressure in appearance and accessory categories, which are up against extremely strong comparisons after growing at historically high levels in 2020.

Speaker 3

On a

Speaker 2

year to date basis for the 1st 9 months of 2021, our comparable store sales growth of 12.9% And our 2 year stack comp of 23.6 percent were well above our expectations coming into this year. As the pandemic recovery has progressed, we remain cautious as to the lasting effect of demand tailwinds of our industry has experienced and candidly had anticipated more moderation off the historically high growth rates we generated in 2020. Each month as we move further past the significant government stimulus and enhanced unemployment benefits, the stability of demand in our business is very encouraging and reflects the continued willingness for consumers to invest in repairing and maintaining their vehicles in the face of an overall shortage of new and used vehicles and continued economic uncertainty. Similarly, we believe our strength of our professional business reflects the return to more daily commutes for many of the vehicle owners who professional customers serve. And we expect the gradual improvement in miles driven trends to continue and provide a benefit to the aftermarket as the recovery moves forward.

Speaker 2

Beyond the macroeconomic tailwinds in our industry, it is also clear to us that we are taking share and capitalizing on the opportunities to meet our customer needs in a very challenging environment. As we discussed in our earnings release yesterday, we are increasing our full year comparable store sales guidance to a range of 10% to 12% from our previous range of 5% to 7%. This increase reflects our year to date performance through our consistency in our top line sales volume for several months now, and we feel it appropriate to revise our expectations as we near the completion of the fiscal year. However, the Q4 can be a volatile period, especially in light of possible further impacts from the pandemic, Rising price levels, variability in winter weather and the holiday shopping season and potential economic shock from the higher gas prices. Now I'd like to move on to the gross margin performance for the quarter.

Speaker 2

Our 3rd quarter gross margin of 52.3 was a 13 basis point decrease from our Q3 2020 gross margin and was in line with our expectations we discussed on the 2nd quarter call. One of the defining features of the automotive aftermarket throughout our history is the ability of the industry to leverage pricing power to pass through cost increases to end user consumers with minimal impact to demand due to the essential nondiscretionary nature of the products we sell. The cost increases we've seen during the current inflationary environment represent broader based inflation than we've seen for some time. However, we did see significant inflation during 2018 2019 on certain product lines caused by tariffs. Consistent with the 2018 2019 time period, we've continued to see rational pricing in our industry and are very confident this will continue moving forward.

Speaker 2

Our pricing philosophy over time is to attempt to achieve consistent gross margin rates As a percentage of sales and higher gross profit dollars in line with the sales growth, which serves to offset similar cost pressures and SG and A expenses. However, as we've discussed in the past, similar to the 20 eighteen-twenty 19 period of rising acquisition cost, We are currently benefiting from an enhanced gross margins as a result of increased pricing increased prices on the sell through of products purchased prior to the cost increases. The second gross margin dynamic I want to discuss today is the continued pressure we're seeing on distribution costs. As we discussed on last quarter's call, our distribution infrastructure is facing inefficiencies due to the massive sales spikes over the past 6 quarters, The difficult labor environment and global logistics challenges. We operate a high service, high touch distribution model and we are fully committed to Our dedicated supplier partners, corporate supply chain team An extraordinarily hardworking distribution team members continue to do an amazing job navigating one of the most challenging supply chain environments we've seen in our careers and we have taken specific targeted steps and incurred incremental expense to respond to the hurdles we're facing.

Speaker 2

Ultimately, we do believe these pressures will abate and conditions will normalize and be more Conducive to driving appropriate leverage of our distribution cost, but we'll continue to prioritize inventory availability and take necessary steps to ensure excellent customer service, which is a fundamental driver of our long term success. As a result of these puts and takes, we are maintaining our gross margin guidance of 52.2% to 52.7% for the full year, We would now anticipate finishing the year in the bottom half of that range. Before handing the call off to Brad, I'd like to highlight our 3rd increase of 29% to $23.45 Our 3rd quarter EPS growth comes on top of our growth of 39% in the Q3 of 2020 resulting in a 2 year compounded quarterly growth rate of 26%. Which at the midpoint now represents an increase of 25% compared to 2020 and a 2 year compounded annual growth rate of 28%. This increase in full year guidance is driven by our strong year to date results, updated sales expectations for the remainder of 2021 and excellent operating profit flow through, which Brad will provide more detail on shortly.

Speaker 2

As a reminder, our EPS guidance

Speaker 4

Thanks, Greg, and good morning, everyone. I'd like to begin today by echoing Greg's comments and congratulating Tim O'Reilly on another outstanding quarter. As I step into Jeff's role on this call and provide commentary on our operating performance, I consider it a huge privilege to represent our team of over 80,000 Dedicated professionals in our stores, field operations, distribution centers and offices. Team O'Reilly has established a tremendous history of consistently excellent performance, building on the foundation established by the O'Reilly family beginning in 1957, But the last year plus of record breaking results has been truly amazing. The single biggest driving factor of these results It's the quality of our team and our unrelenting commitment to excellent customer service.

Speaker 4

As Greg previously discussed, Our sales growth was very consistent throughout the quarter and solid on both sides of our business. Our team's commitment to our dual market strategy And our culture of excellent customer service has us well positioned to capitalize on the strong industry backdrop. We have been able to leverage our competitive advantages to meet the challenges of our operating of operating in an extremely difficult environment and deliver an attractive value proposition to our customers, including many customers who are new to O'Reilly. As strong as our results have been, we know we still have significant opportunities to enhance the great service we provide to customers and gain additional market share, And our teams are dedicated to improving our business every day. I'd now like to provide some color on our SG and A expenses and operating profit for the quarter.

Speaker 4

Operating profit dollars in the 3rd quarter grew by 4% compared to the Q3 of 2020 and are up an incredible 41% Above our operating profits, we generated 2 years ago in 2019. Our SG and A dollar spend per store for the Q3 was up 8% Over 2020, which is significantly higher than our typical growth in operating expenses. This is a result of the cost reduction measures we executed last year in response to the uncertainty around the pandemic as well as expenses incurred in 2021 in store payroll, incentive compensation and variable operating expenses to drive our sales growth. While our Q3 2021 SG and A expense 30.6 percent of sales represented a 78 basis point increase over 2020, it significantly outperformed our expectations as a result of our robust sales performance and solid expense control. As a reminder, last year's Q3 SG and A expense levered 344 basis points and generated a level of profitability that was unique to the specific circumstances that we're facing We were facing at the point in the pandemic and was not sustainable nor appropriate for our long term business.

Speaker 4

While this unusually difficult comparison created pressure on our year over year SG and A expense rate, we are very pleased with the improvement in our profitability on a 2 year stack. On this basis, our SG and A percentage is 2 66 basis points lower than our Q3 2019 SG Our team was able to drive significantly higher top line sales growth than the rate of our SG and A increases. Based upon our results year to date and our expectations for the Q4, we are now estimating our full year increase in SG and A per store to be approximately 8%, which is below our comparable store sales guidance despite the extremely difficult comparisons. We are also increasing our operating profit guidance by 50 basis points to a range of 21% to 21.4%. Expense control is a core value of our culture and we manage operating expenses on a store by store month to month basis.

Speaker 4

Our top priority is to ensure we are providing excellent customer service and ensuring we lead the industry in the value we provide our customers. We have a very high standard for service and we are relentless in developing long term and loyal customer relationships through consistent daily execution of our business model. These relationships are the foundation of our business and the key to future growth. We also prudently manage our expenses to capitalize on opportunities to grow market share and operating profit dollars through enhancements to the customer service tools we provide our teams. Next, I'd like to provide an update on our store growth during the quarter.

Speaker 4

During the Q3, we opened 30 new stores bringing our year to date total to 146 net new store openings across 40 states. This pace sets us up well to achieve our plan of 165 to 175 net new stores for 2021. Logistical supply and governmental challenges continue to make new store development difficult, but our teams are diligently grinding away to open great new store locations with outstanding teams and we continue to be pleased with our new store performance and our opportunities for future growth. For 2022, we expect to open between 175185 net new stores in the U. S.

Speaker 4

And Mexico, And these store openings will again be in both new and existing markets as we have capacity to support profitable growth across our distribution footprint. In addition to investments we're making to grow our business with expansion into new markets, we continue to reinvest in our existing

Speaker 5

stores and distribution infrastructure with

Speaker 4

a particular focus on and distribution infrastructure with a particular focus on supporting and enhancing our industry leading inventory availability. Our ability to provide our customers all the parts they need to complete their repair faster than our competitors is critical to earning repeat business and gaining new market share. The vast number of different parts needed to service the U. S. Light vehicle fleet means no store could ever stock enough parts to service any given trade area.

Speaker 4

Every store in our chain has a unique inventory tailored to that store specific trade area that we deploy to provide immediate access to those products with the highest demand. To further enhance our availability, we are pursuing ongoing initiatives to aggressively add incremental dollars to our store level inventories above the typical annual investment for new stores and product updates. During the strong sales environment this year, Rolling out the full scope of these initiatives had to take a back seat to the replenishment needs of our stores, but we still see significant opportunities to increase our market share by beefing up the inventory that sits closest to our customers and will execute on a larger investment in 2022. To support the demand for less requested parts, our stores receive overnight deliveries from 1 of our 28 regional distribution centers supplemented by multiple deliveries per day, 7 days a week if the store is located in the market area of 1 of our DCs. For stores that aren't located in close proximity to a DC, including stores in a very large metro area with a longer drive time to the DC, We utilize a hub and spoke network with hub store stocking additional parts depth to support surrounding stores through multiple daily deliveries.

Speaker 4

Hub Stores carry between 2 and 4 times the SKU count of a normal store depending on the market area. We continue to aggressively enhance our hub network with not only upgrades, but the addition of new hubs, which are typically of the larger variety. These large investments are critical to support our store team's ability to provide exceptional customer service. Before I turn it over to Tom, I want to thank team O'Reilly for their continued dedication to our company's success. With 1 quarter left in 2021, We've had an amazing year so far, but we will continue to stay focused on finishing the year strong.

Speaker 4

As always, the key to our success is providing unwavering customer service that surpasses expectations and continues to earn our customers' business, And I am confident in our team's ability to continue our tremendous success. Now I'll turn the call over to Tom.

Speaker 1

Thanks, Brad. I'd also like to thank all of T. O'Reilly for their continued hard work and commitment to excellent customer service, which drove our tremendous third quarter and year to date performance. Now we'll take a closer look at our Q3 results and add some additional color to our updated 2021 guidance. For the quarter, sales increased $272,000,000 comprised of $210,000,000 increase in comp store sales, A $58,000,000 increase in non comp store sales, a $4,000,000 increase in non comp non store sales.

Speaker 1

For the full year of 2021, we now expect our total revenue to be between $12,900,000,000 $13,200,000,000 up from our previous guidance of $12,300,000,000 to $12,600,000,000 based on our strong year to date top line performance and our continued confidence in our team. Greg covered our gross margin performance earlier, but I want to provide Additional details on our positive LIFO impact. For the Q3, the LIFO impact was $43,000,000 compared to no material benefit in the prior year. As a reminder, the positive LIFO impact is a byproduct of the reversal of our historic LIFO debit. Since 2013, due to negotiated acquisition price decreases, our calculated LIFO inventory balances exceeded the value of our inventory at replacement cost, and we elected the conservative approach to not write up inventory value beyond our replacement cost.

Speaker 1

As a result of this accounting, we've seen a benefit from rising cost and price levels via the sell through of lower cost inventory purchased prior to the recent cost increases. However, during the Q3 of 2021, our LIFO reserve flipped back to a credit balance as a result of inflation and acquisition costs. And moving forward, we expect to be back to typical LIFO accounting and no longer valuing inventory at a lower replacement cost. As a result, we anticipate a benefit from the final sell through of the remaining Lower cost inventory will hit primarily in the Q4 of 2021 and will no longer be a tailwind beyond that. We will provide gross margin guidance for 2022 on our Q4 earnings call, but wanted to outline this switch back to a LIFO credit since it will have the impact of being a declining benefit moving forward, which we anticipate will in part be offset by expected Our 3rd quarter effective tax rate was 22.5 percent of pretax income, comprised of base rate of 24.2 percent reduced by 1.7% benefit for share based compensation.

Speaker 1

This compares to the Q3 of 2020 rate of 23.2 percent of pretax income,

Speaker 5

which was comprised of

Speaker 1

a base tax rate of 24 point 4% reduced by 1.2% benefit for share based compensation. The Q3 of 2021 Base rate was in line with our expectations. And for 2021 full year, we continue to expect to see For the full year of 2021, we continue to expect an effective tax rate of approximately 23%. These expectations assume no significant changes to existing tax codes. Also variations in the tax benefit from share based compensation can create fluctuations in our tax rate.

Speaker 1

Now we'll move on to free cash flow and the components that drove our results as well as our updated expectations for 2021. Free cash flow for the 1st 9 months of 2021 was $2,200,000,000 up from $1,900,000,000 for the 1st 9 months of 2020, with the improvement driven by an increase in net income, A larger benefit from our net inventory investment and a larger prior investment in solar projects, partially offset by reduced benefit from accrued tax withholdings, resulting from the ability to defer certain payroll tax payments in 2020 under the provisions of the CARES Act. We do anticipate additional investments in solar projects in the Q4 of 2021. For the full year of 2021, we now expect free cash flow to be in the range of $2,000,000,000 to 2,300,000,000 up $500,000,000 at the midpoint from our previous guidance based on our strong year to date operating profit and cash flow performance and our net inventory performance. Inventory per store at the end of the 3rd quarter was 633,000 which was down 3% from the beginning of the year, but up 1% from this time last year, driven by the extremely strong sales volumes and supply chain constraints.

Speaker 1

Our AP inventory ratio at the end of the 3rd quarter was 126%, which matched the all time high our company set at the end of the second quarter and was heavily influenced by the extremely strong sales volumes and inventory turns over the last year. We now anticipate our year end AP to inventory ratio to finish near a similar level. However, over time as we increase inventory levels, we expect to see moderation in this ratio. Capital expenditures for the 1st 9 months of 2021 were $341,000,000 which was down $23,000,000 from the same period of 2020, primarily driven by the timing of expenditures for new store and DC development activities and strategic initiatives. As we look to the remainder of the year, we still see tremendous opportunity to deploy capital to enhance our service offerings and capitalize on growth opportunities.

Speaker 1

But we would now expect for some of those investments to be pushed into 2022. As a result, we're revising our CapEx forecast to come in between 4 $550,000,000 $550,000,000 for the year. Moving on to debt. We finished the 3rd quarter with an adjusted debt to EBITDA ratio of 1.7 5 times as compared to our end of 2020 ratio of 20.3 times, with the reduction driven by a decrease in adjusted debt, including the redemption of $300,000,000 of senior notes in the 2nd quarter as well as substantial growth in our trailing 12 month EBITDAR. We continue to be below our leverage target of 2.5x, and we will approach that number when appropriate.

Speaker 1

We continue to execute our share repurchase program. And during the Q3, we repurchased 1,600,000 shares at an average share price of $595.96 for a total investment of $943,000,000 Year to date, through our press release yesterday, we repurchased 4 point 1,000,000 shares at an average price of $534.60 for a total investment of $2,200,000,000 We remain very confident that the average repurchase price is supported by the expected future discounted cash flows of our business, and we continue to view our buyback program as an Effective means returning excess capital to our shareholders. Before I open up our call to your questions, I'd like to thank the O'Reilly team This concludes our prepared comments. At this time, I'd like to ask Adrian to ask I'm sorry, I'd like to ask Adrian, the operator,

Operator

And our first question comes from Brian Nagel from Oppenheimer. Your line is open.

Speaker 6

Hi, good morning. Congratulations on a nice quarter. Another nice quarter.

Speaker 1

Thanks, Brad.

Speaker 6

So the first question I want to ask, just you commented it was commented in the prepared Remarks about pricing and the impact upon demand. And recognizing that there's some conservatism as you look forward. But The question I have is, are you seeing indications now that as prices have risen that the consumers are either shifting away from products or there's some hesitation to buy certain items in your stores?

Speaker 2

Yes, Brian. What I would tell you is we have not seen any significant movement thus far. We called that out as A possibility going forward if fuel prices continue to rise and continue to be Challenges within the general economy, but so far we haven't. What might happen or what has happened historically during times where consumer spending drops off to a degree is Consumers may defer things like oil changes out beyond their normal oil change intervals or trade down the value We really haven't seen that. We have over the last several quarters, we have really done a nice job of And we've seen a shift to some of those proprietary brands Like, for example, Syntech Motor Oil.

Speaker 2

And what we've seen is those shifts are more related to us promoting those products Then a shift downward in buying habits. Those are really planned shifts, but I would say, unpredicted shifts or Prizes, we have not seen those thus far.

Speaker 6

That's really helpful. And the second or the follow-up question I have, a separate different topic, but With and maybe kind of bigger picture in nature, but with regard to sales, I mean, clearly the business is performing extraordinarily well here and it continuing to perform well from a sales perspective As we move past, like you said, past the benefits of stimulus past while COVID is still a factor, maybe past some of the disruptions or even benefits of COVID. So as you look at your business and compare it now to say pre pandemic levels, what's really what do you think is really driving? I mean, is there are certain factors you can point to that are kind of underpinning this continued better than pre pandemic sales levels?

Speaker 2

Yes. I'll start that and then I'll see if Brad might have something to add. Brian, there are several things that are Right now in the economy that short term are probably impacting that. And a couple of those things I called out is the availability of new cars And the availability and extended pricing on used cars today. It's just it's not cost effective.

Speaker 2

People are paying as much for A 2 year old used car is what sticker price is on a new car because new cars are not available. And I think That's driving more people to maintain their existing vehicles, more so than perhaps they did pre pandemic. Also, I think during the pandemic, we saw a trend of more traditional white collar Employees and employers and people in general doing some of the things themselves that historically They may not have done. So that trend may be extending as well, which would support the DIY side of our business. So I think those things in combination are drivers that are positively impacting Our sales volume as of recent and throughout the pandemic.

Speaker 2

Brad, did you want to add anything to that?

Speaker 4

Yes. Hey, good morning, Brian. The only other thing I'd add to what Greg said is just What I mentioned earlier just about new customers, when I'm out in the field and I have been quite a bit here lately seeing our teams and Pat, I'm on the back and talking to customers on both sides of the business. We're seeing a lot of new customers, Brian, and Again, on both sides of the business. And back to your original question, what we're seeing is a huge need.

Speaker 4

While Prices are higher. We're seeing a huge need for value. And as you well know, with the nondiscretionary nature of our business, like Greg mentioned, With us totally focused on our supply chain, executing better than anybody else out there, our delivery times and turning those For the customers and all the value that we know we can create on that front counter with our professional parts people, highly focused on retention right now. And We just see our teams doing a great job winning those new customers. And then when we win them over, we impress them with our service levels.

Speaker 2

And Brian, one more additional thing. I think part of the growth we're seeing is we're taking some market share. I said that in our prepared comments. And when you look at industry reporting on our performance across the board against remainder of market, we continue to outperform In most categories, and I think that we are taking market share. And I think as challenged as our supply chain has Ben, as large of a company as we are and the buying power that we represent, I have to think that some of these smaller companies are having more supply chain Our challenges perhaps than we are, which is supporting our market share gains.

Speaker 6

That's all very helpful. Congrats again. Thank you.

Speaker 2

Thanks, Brian. Thanks.

Operator

And our next question comes from Zack Fadem from Wells Fargo. Your line is open.

Speaker 7

Hey, good morning guys. So first one for Tom. Your ex LIFO gross margin was about 51% in Q3, which is about 100 basis points step down versus Q2, if I'm calculating that right. So first question is, how much would you view the step down as transitory due to the supply chain factors today? And then as we look to 2022, is it fair to expect the core ex LIFO gross margin to hover around this 51% level?

Speaker 7

Or is a return to the 52% level the right way to think about it.

Speaker 1

Well, Zach, there's a lot of moving pieces in margin right now as prices have gone up Dramatically in a short period of time. To answer your first question, ex LIFO, would that have been the margin? I think that Because we have product that we purchased at a lower cost, it allows us to maybe be a little more prudent in The timing of raising prices and doing that in a smart way with our customers to make sure that we don't have a shock value. So I'm not sure that I would say that that's how absent that ability to leverage that benefit that we may have Run prices through a little bit different, not saying we're not going to eventually run all the prices through. The second item I'd tell you is that When we look at our gross margin, we had a big LIFO benefit, but we also had a similar headwind from distribution.

Speaker 1

So over time, we will balance those. We feel like we've been pretty consistent in the gross margin Percentage we've run over time, obviously, since over the last 10 years since we purchased CSK and worked on a lot of outsourcing I'm sorry, Sourcing to the most economical countries and private label, we've increased our gross margin substantially over that period, But over the last couple of years, it's been pretty consistent. And although we're not going to give guidance on this call for next year, We wouldn't anticipate dramatic changes in our overall gross margin.

Speaker 7

Got it. So in terms Of the broader laundry list of supply chain and inflationary pressures across all of retail, you've called out Product and DC costs, we're also dealing with higher freight and port delays and labor and product availability issues. So when You think about all these pinch points impacting your business today, could you talk about which ones are most Front and center for you, which aspects have been more manageable? And would you say we've reached peak pressure? Or do you Still think there's incremental headwinds from here in the upcoming months?

Speaker 2

Yes, Zach, this is Greg. I'll take this one. I don't think we're near the end of this, unfortunately. Obviously, the backlog you watch the news, the backlog of ships in China That port in the U. S, various ports in the U.

Speaker 2

S. And on the water continues to be pressured and challenged. When you talk about our supply chain, you have to think about it sequentially. And really, it started The pressure started in the DC just based on the sheer volumes that they've experienced over the past several quarters. And to compound that, those volumes came at a time where the supply and demand of human capital was way out of balance.

Speaker 2

And it's very, very difficult, as everyone knows, to hire in the environment that we've been in the last Several months or past few quarters. Now we have seen some improvements since some of the government stimulus and Unemployment benefits have subsided, but we're still having some challenges staffing up in some of our DCs. The good news is from a DC perspective, we are showing continued improvement and our DCs are getting caught up And we're working hard to make sure we're positioned to be prepared for future growth in 2022 And make sure that our staffing levels are adequate and we're working on continued productivity gains and get our distribution costs more in line with So that was really the initial component of the supply chain crisis, but then you compound that With increased freight charges, I think most everyone's heard the variation in container shipping costs As low as $3,000 in 2021 up to recently as high as $18,000 to $20,000 per container equivalent. And that has been a challenge. And then it just everything that we face seems to compound.

Speaker 2

Now there's rationing of electricity in China. All these things have compounded the issues and the timing has been a challenge the way these things have layered on. What I will tell you is that we from a distribution perspective, we're in much better shape than we were this time last quarter as recently as then. From a supply chain perspective, we continue to work on our strategy is to have multiple suppliers for most of our major Product categories to mitigate any risk and we're leveraging current suppliers and additional suppliers in order to try to Product and we're seeing improvement on product flow, but it's still a lot longer tail from order to delivery than what it typically is.

Speaker 7

Thanks for the color. Appreciate the time.

Speaker 1

You bet.

Operator

And our next question comes from Greg Melich from Evercore, your line is open.

Speaker 3

Hi, thanks. Really two questions. One first on the pricing. You mentioned that you came in Stronger than you thought for all the cost reasons. And Tom, it would be fair to say that, that 5.5%, if that's what was realized in the 3rd quarter, It should actually be more than that year over year as we look into the Q4 and beyond just given the way pricing flows through.

Speaker 1

Well, we would expect it to be a strong number again in the 4th quarter, Optimistic that some of these supply chain items will write themselves, but we will have more view on that on our Q4 call for next year.

Speaker 3

Got it. And then I think you mentioned that your 2nd quarter EBIT margin was Yes, unsustainable and really not good for the long term health of the company or something like that. So if this year ends up at 21%, 21.5%, I guess that's a new range. Is that a good healthy level to grow from?

Speaker 1

Greg, just for clarification, The prepared comments on were related to the Q3 of 2021, where we were at 3 44 basis points. That's not the right SG and A leverage level for the company long term. We said that then, and we're back more in an SG and A Spend that's appropriate for the sales we're generating.

Speaker 3

Okay. So I would say given that, that was unusual, would you say now we're at a right base, This year's margin at 21%, 21.5%

Speaker 1

Given the comp levels that we are at, yes. We're a multiunit specialty retailer with a high fixed cost base, and we're able to generate Exceptionally high sales volumes and increases, we see great leverage.

Speaker 3

Got it. And I guess my Last on this is just to make sure I got the math right. If the comp was 6.7% in the quarter And price was 5.5 and traffic was slightly down our ticket counts. Is the difference just mix and units in the basket?

Speaker 1

Well, we have a long term trend of increasing average ticket as the technology and Complexity of parts on newer vehicles become more expensive and that trend has continued.

Speaker 3

Got it. Thank you.

Speaker 2

Thanks, Greg.

Operator

And the next question comes from Simeon Gutman from Morgan Stanley. Your line is open.

Speaker 8

Thanks, everyone. Good morning. Tom, is there a way to think about or how we should think about the impact of higher distribution costs, the weight of it on the gross margin? And then, I guess the second question on that is the gross came in at, I think, 53.1% pre COVID, and I'm sure there was a LIFO impact in there. Now that your volumes are much higher, once supply chain things get back to normal, and I don't know when that is, why shouldn't your gross margin end up being higher than where we were pre pandemic since there's just more volume in the system.

Speaker 1

Simeon, would you repeat your first question again?

Speaker 8

It's basically can you help us quantify the impact on gross margin from higher Distribution or supply chain costs or inefficiency?

Speaker 1

Got you. In the previous question, I commented that The LIFO benefit and the distribution headwinds were similar. And then the second question, When we look at our distribution centers, they're primarily a variable cost item. There is some leverage From having higher volumes to a point, and I think Craig talked about that on the last call, in this call, if we get too much volume within Our system, we end up with inefficiencies. So and the other part I would add to that is we are Already one of the major suppliers of auto parts, so increased volumes don't necessarily mean a lower cost in the products we purchase

Speaker 8

Thanks. And maybe just a follow-up, maybe to Greg Johnson. Should market share gains continue at this outsized rate? Or now that is so much that has happened, it's just going to be hard to maintain the level of outsized market share gains. Thank you.

Speaker 2

Yes. Simeon, that's a great question. I wish I had a great crystal ball answer for you. I think that, First of all, this year, when we started the year, we projected flat to negative comps. We certainly didn't expect For our comp growth to continue to be as strong as they have been in 2022, considering that a lot of the stimulus and benefits have subsided And our sales have remained strong.

Speaker 2

Our expectation would be for the aftermarket as a whole to continue To perform well going forward and we'll certainly continue to be a consolidator and continue to try to grow our market share going forward as well.

Speaker 8

Thank you.

Operator

And the next question comes from Mike Baker from D. A. Davidson. Your line is open.

Speaker 5

Hey, guys. Thanks. I suspect I know the answer to this question, but when you do the implied sort of 4th quarter comp In your full year guidance, you get somewhere at least I get somewhere in the midpoint around 2% or 3%, which would be a pretty big slowdown on both a 2 and a 3 year basis relative to the 1st few quarters, which saw remarkably consistent trends on the 2 year and 3 year basis. And all your commentary is suggesting that things are continuing. So Why lower guidance?

Speaker 5

Is it just conservatism? Is it just the unknown of not having the government stimulus even though that doesn't seem to be impacting your business?

Speaker 1

Well, I guess I better answer that one because it sounds like a math question. We kept the 2% full year guidance range because that's what we had given all year and It's 10 to 12. So the math for what the variability for the Q4 needs to be to reach those is pretty extensive. So we'll have to look at whether we're going to do that next year, tighten the range. I'd say the math for us works out a little different than it works out 1 to 9.

Speaker 1

Obviously, we don't anticipate that wide of a range of outcomes.

Speaker 5

Okay. So you're saying you're just to clarify, I got an implied range of somewhere around down 1% to plus 6% and 2% to 3% at the midpoint. You're saying that the better math would be somewhere around 1% to 9%, Or about what is that about 5 at the midpoint? A, is that what you're saying just so we're all clear? And then B, again, that does imply a pretty big slowdown on a 2 year basis.

Speaker 5

Just conservatism in that?

Speaker 1

The implied range is 1% to 9%. The width of the range was unintended. It was more based on continuing giving annual guidance in the same fashion we gave it in the 1st 3 quarters.

Speaker 5

Okay. Okay. Understood. I appreciate that. Thank you.

Operator

And your next question from Bret Jordan from Jefferies. Your line is open.

Speaker 1

Hey, good morning guys.

Speaker 2

Good morning, Bret.

Speaker 9

On the topic of share gain, I mean it If you guys were picking up some share in under car hard parts last quarter, which I think you guys called out as a strong category. Could you talk maybe about That's allowing that them to hold share better as the quarter progressed?

Speaker 2

Yes, Brett, I would I'll say a few things here and then let Brad comment on what he's hearing from the field. He's closer to The store operators than I am on a day to day basis. But generally, as I said, I While we really have no way of knowing other than the more macro view by category on industry reporting, The perception is, and we feel pretty strongly that this is the case that considering the supply chain pressures that we're facing, the Smaller players would have to be facing at least equal to if not much greater pressures, which would be impacting their in stock position and their ability to comp as strong as we have. Brad, want to add anything to that?

Speaker 4

Yes. Hey, good morning, Brett. As you well know, we have a tremendous respect for all our competitors. I've been here 25 years this year, and I grew up competing against some very strong independents. And the independents that are Still alive and well in the United States are pretty tough competitors and very tough on the professional side as you know better than anybody, and we have Equal amount of respect for our larger retail competitors that have gotten better in some areas of professional.

Speaker 4

But when I think of I definitely think there's something to what Greg mentioned in terms of some of maybe the struggling independents and maybe some of the mediocre Our weaker independent competitors, but again, as you know, the big strong independents in the United States are Very tough. But Brett, me and my team, what we spend our time on is a little bit less of where the share gains are coming from and more about what we know works And what we're doing right now that is equaling share gains and those things are just around some of the things we mentioned earlier. We talked about supply chain Struggles, but as you well know, the supply chain struggles are a level playing field for everybody, us and our competitors in the United States, and it's about Who's going to step up and execute better under the conditions? And I'm just extremely proud of our supply chain team from distribution to Merchandised inventory control that gives my team in the stores not many excuses. They've done a tremendous job backing us up.

Speaker 4

When it comes to what Greg said earlier, they're getting better every month even though we still do have challenges, and they're ensuring we have the right part at the right place at the right time. And We feel like that's a big part of the gains. We also feel like that, as you've always heard us talk, our professional parts people, What we're doing with our shops, creating value, better delivery times, helping them get a car off the rack and just really our professional parts people And everything we focus on in our stores is really what's equaling those gains.

Speaker 9

Appreciate that. And I guess last quarter you guys talked about some Standout suppliers that or issues with suppliers in certain categories that were material challenges. Are you seeing, I guess, the supply chain Issues moderating, I mean, are there big holes in in stocks? Or is it just sort of tough across the board, but no real Areas to call out.

Speaker 2

Yes, Brett. I mean, some of the categories we talked about last quarter, we're still having Challenges with maybe some of those challenges have changed or evolved. Some of those challenges may have been labor for domestic suppliers last quarter and it's transitioned more to raw material or component challenges now coming from China. But our suppliers as a whole are doing a good job. We've got some suppliers, Especially those with products coming out of China, they continue to struggle.

Speaker 2

Another challenge and I keep sounding like a broken record here of all The woes and challenges we're facing, but it has been the most challenging supply chain here in my 40 year career in the industry is On top of everything else, some of the things we haven't talked about was simple things that you might not consider like the freeze in Houston earlier this year that's impacted The production of plastic bottles and additives for oil and some of those things still linger within the industry. So some of the issues have subsided or lessened. Some of them have become more material. So I think on a category by category basis supplier by supplier as a whole. We're starting to see the light at the end of the tunnel.

Speaker 2

It's just how much farther is the track to get us to that light is what we're trying to determine now.

Speaker 9

Great. Thank you.

Speaker 1

Yes.

Operator

And our next question comes from Kate McFadgen from Goldman Sachs.

Speaker 10

Hi, good morning. Thanks for taking our question. Tom, you had mentioned towards the end of the prepared comments about reducing the CapEx and pushing some investments out. Is there a way to Quantify or not quantify, but list what some of those investments would be?

Speaker 1

Well, so when we look at our store DTE growth, just getting some of the work done has been a challenge. When we look at updating our over the road truck fleet and our store fleet to More fuel efficient vehicles with safety features, that was a big initiative this year. Obviously, getting new Small like cars and trucks have been tough this year. Some of our store development isn't quite As far ahead as we would like, there's supply chain issues within construction materials and There's a lot of construction going on. So those are the general items that have been pushed into next year.

Speaker 10

Okay, great. Thanks. And if we could just go back to the question on what the comp guidance implies for Q4, I wondered if you could Tell us what you're thinking with regards to how much price would influence that comp range in Q4?

Speaker 1

We would expect that it would be at least as much as this quarter.

Operator

Thank you. We have reached our allotted time for questions. I'll now turn the call back over to Mr. Greg Johnson for closing remarks.

Speaker 2

Thank you, Adrian. We'd like to conclude our call today by again thanking the 80,000 team members of Team O'Reilly for their hard And dedication to our ongoing success, you have proven time and time again that the relentless focus on providing consistent excellent customer service is the key to long term profitable growth. I'd like to thank everyone for joining our call today and we look forward to reporting our 4th quarter Earnings and full year results in February. Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today's conference call.

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Earnings Conference Call
O'Reilly Automotive Q3 2021
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