O'Reilly Automotive, Inc.

Duct a 30-minute question and answer session. During the question and answer session, if you do have a question, press star then one on your touchtone phone. Now I'll turn the call over to Tom McFaul.

Thank you, John. Good morning, everyone, and thank you for joining us. During today's conference call, we'll discuss our third quarter 2019 results and our outlook for the fourth quarter and full year of 2019. After our prepared comments, we'll host a question and answer period. 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, plan, intend, or similar words. 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 10K for the end of December 31st, 2018, and other recent SEC filings. The company assumes no obligation to update any forward-looking statements made during this call. At this time, I'd like to introduce Greg Johnson.

Thanks, Tom. Good morning, everyone, and welcome to the O'Reilly Auto Parts Third Quarter Conference Call. Participating on the call with me this morning are Jeff Shaw, our Chief Operating Officer and Co-President, and Tom McFaul, our Chief Financial Officer. David O'Reilly, our Executive Chairman, and Greg Hensley, our Executive Vice Chairman, are also present. It's my pleasure to congratulate Team O'Reilly on our excellent performance in the third quarter, and to thank every member of the team for their unwavering commitment to our company's culture of providing excellent customer service to each and every one of our valued customers. After seeing some weather-driven volatility in the first half of 2019, demand in our industry evened out in the third quarter, and our team did an excellent job of taking advantage of the solid industry backdrop to deliver a strong 5% comparable store sales growth in the quarter, which was at the top end of our guidance range. I'm pleased that our team was able to translate this top-line performance into an 11% increase in operating profit dollars, and a 13% increase in earnings per share to $5.08 per share, which exceeded the top end of our guidance range by 25 cents. Our third quarter performance is the result of our team's relentless focus on excellent customer service and expense control. -to-date, our comparable store sales growth stands at 3.9%, which is consistent with prior year and in line with our full-year guidance we have maintained throughout the year at 3 to 5%. Now I'd like to provide some additional color on the composition of our third quarter comparable store sales results. Both the DIY and professional sides of our business contributed positively to our comp growth in the third quarter, with professional, again, being the stronger contributor. Part of the performance of the professional side of our business is the result of a calendar benefit from one less Sunday during the third quarter this year as compared to 2018. Sunday is our lowest volume day of the week on the professional side, and the impact of one less Sunday was a benefit of roughly 50 basis points to our total comp sales for the quarter. During the first quarter of 2019, we had one additional Sunday versus 2018, so through the first nine months, we're even on Sunday, and there's no impact to our -to-date comps. Even adjusting for this benefit, we saw robust comparable ticket growth in our professional business during the quarter driven by strong performance in key undercar hard parts categories, including brakes, ride control, and chassis, as well as more typical performance in hot weather-related categories. Ticket counts in our DIY business continue to see pressure consistent with our recent trends as customers on this side of our business remain more susceptible to the rising price environment. However, in total, our comparable ticket counts were positive for the quarter. The long-term driver of increased parts complexity coupled with the current inflationary environment continues to drive increases in average ticket, which accounted for the majority of our comp increase in our third quarter. On a -over-year basis, we have experienced product acquisition cost inflation driven by tariffs and other input cost increases passed on from our suppliers. As has been the historical experience in our industry, the non-discretionary nature and immediacy of need in the product sold in the aftermarket has allowed our industry to rationally pass through these acquisition cost increases. The impact of those top-line increases accelerated in the third quarter as the most recent round of tariffs went into effect and our industry began passing through these costs at the beginning of the quarter. We would expect to see a continued tailwind from the benefit of these price increases in the fourth quarter, though to a lesser extent as we begin to calendar price increases that occurred in the fourth quarter of 2018, driven by the first round of tariffs. Including the additional price changes, we began to see the beginning of the third quarter this year. We now expect to see a larger benefit from increasing average ticket with same-skew pricing of .5% to 3% for the full year. As we have discussed on our last two calls, we continue to believe the pressure of rising prices to be a short-term constraint to DIY ticket count growth as much as our more strapped consumers react to deferred maintenance when possible, trading down to the good, better, best value spectrum when necessary repairs can't be deferred. However, we believe that consumers will adjust to price pressures and that ticket count growth in our business will return to historical trends over time. As I previously mentioned, we saw more normal weather patterns in the third quarter than we saw in the first half of the year. We would describe sales of seasonal products as being as expected and did not significantly benefit from catch-up of pin-up demand on seasonal products. Adjusted for the Sunday shift, the cadence of the third quarter sales were also very steady as we saw very consistent results, especially in core hard parts categories throughout the quarter, and have seen a similar start to the fourth quarter thus far in October. Looking forward to the remainder of the year, we continue to have confidence in the strength of the broader aftermarket, characterized by stable employment and general macroeconomic conditions, low gas prices, modest increases in miles driven, and increasing age and complexity of vehicles. In line with these market conditions and based on our performance so far in 2019, we're establishing our fourth quarter comparable store sales guidance at three to five percent and reiterating our full year comparable store sales guidance of three to five percent. As always, our team remains focused on providing the best possible service to our customers, and we remain very confident in our ability to gain share and generate results which outperform the market. For the quarter, our gross margin of .3% was a 35 basis point improvement over the third quarter of 2018 margin, and was at the high end of our expectations for the quarter. We continue to see stability in gross margin, even in light of pressure from tariffs and other input cost increases, as pricing remains rational in our industry. We're leaving our gross margin guidance for the full year unchanged at .7% to .2% of sales, though as Tom will discuss in his prepared comments, we would now expect to come in near the top end of that range. Our operating profit dollar growth was 11% for the third quarter, which represents our strongest quarter growth since 2016. We also expect our operating profit as a percentage of sales to come in at the top end of our previously guided range of 18.7 to 19.2%. Moving on to earnings per share, our third quarter EPS of $5.08 was an increase of 13% over last year, and on a -to-date basis for the first three quarters, our EPS of $13.63 was an increase of 10% over 2018. We're establishing our fourth quarter guidance at $4.12 to $4.22 based on our strong sales and profit results for the quarter. Our expectations for the fourth quarter profit and EPS tailwinds from shares repurchased, we're raising our full year EPS guidance to $17.75 to $17.85.

Our

full year guidance includes the impact of shares repurchased through this call, but does not include any additional share repurchases. Again, I would like to thank our team of over 82,000 dedicated team members for the outstanding third quarter performance. I'll now turn the call over to Jeff Schall. Jeff.

Thanks, Greg, and good morning, everyone. I'd like to begin today by echoing Greg's comments on the dedication of Team O'Reilly. As a result of the hard work and commitment of each of our store and DC team members, we were able to produce strong results in the third quarter at the top end of our expectations. In my comments today, I'll provide some color on our performance in the third quarter and discuss our organic store and DC expansion plans, and also touch on the exciting plans we have to expand our company's footprint into Mexico with our upcoming acquisition of Myoseth Auto Parts. Our success has been built on the foundation of the O'Reilly culture of excellent customer service, and we remain very confident in our team's ability to seize on growth opportunities as we expand into new markets. I'll begin my comments today by discussing our SG&A results for the third quarter. We were pleased to be able to leverage SG&A expenses 22 basis points during the quarter as a result of the strong comp performance and effective expense management by our teams. On an average for store basis, SG&A grew 2.5%, which was in line with our expectations for the quarter. As we discussed on last quarter's conference call, we've experienced continued pressure in SG&A this year from rising wages and other variable costs in the current tight labor market, and those pressures continued in the third quarter. However, the year over year comparisons ease as we counter against the increased payroll spend in 2018 from our reallocation of the savings from the tax reform, which had ramped fully by the third quarter of 2018. We're maintaining our guidance range for full year growth in SG&A per store of 2.5 to 3%, and we expect to come in towards the higher end of that range based on the ongoing inflationary environment, which is consistent from our second quarter call. Our strategy for managing our operating expense pin for 2019 continues to be focused on ensuring we are equipping our store teams with the resources they need to provide excellent customer service, while also driving omni-channel and technology initiatives to capitalize on opportunities to drive increased sales and improve efficiency and operating profit.

Next,

I'd like to provide an update on our store expansion during the quarter and our plans for the remainder of the year and for 2020. In the third quarter, we opened 76 new stores, bringing our total -to-date 2019 store openings to 181 net new stores, and significantly closing the shortfall to our quarterly plan for new store openings, which was caused by weather-related construction delays in the first half of the year. We remain very confident we will achieve our goal of opening 200 net new stores in 2019. We're very pleased with the performance of our new stores and continue to be excited about our opportunities to identify great locations and great store teams to profitably grow our business in markets across the country. A key factor in our successful expansion is the consistent, industry-leading support of our distribution teams. Our ability to provide the best parts availability in the aftermarket is the result of the excellent job our distribution teams do on a daily basis to support our stores, coupled with our ongoing commitment to enhance our distribution advantages through continued investments in distribution infrastructure and technology. We continue to progress on schedule with our 3DC projects and will open our new facility in Twinsburg, Ohio, just south of Cleveland during the fourth quarter. Our ability to deploy the right inventory at the right location within our supply chain and get parts in the hands of our customers faster than our competitors is one of the keys to our success. We're very confident in our team's ability to successfully manage the distribution expansion projects currently underway and to continue to capitalize on our advantage in parts availability. As Greg announced in our press release yesterday, we've set a new store growth target of 180 net new stores in 2020. Our 2020 new store growth target is slightly below our growth number from the past several years, which reflects the significant effort and resources that we will direct towards our international expansion into Mexico. As we announced in August, we've entered into a definitive agreement to purchase MyASA Auto Parts, headquartered in Guadalajara, Mexico. First, to update on the progress of the transaction. We're working diligently through the customary closing conditions and regulatory approvals and still expect to close before the end of the year. As we've discussed for the past few years, we view expansion outside of the US as a natural next step in our long-term growth strategy. And we focused on evaluating opportunities closer to home in North America in both Mexico and Canada, which have similar vehicle populations. Our process has involved both evaluating the potential opportunities present in the automotive aftermarket in these countries, as well as understanding the competitive landscape and potential acquisition targets to partner with for our expansion strategy. Throughout our history at O'Reilly, we've taken pride in sticking to the fundamentals and making sure we grind out the -to-day blocking and tackling of executing our business. And we've taken the same detailed approach to working through our evaluation of international expansion. The results of this process have only served to reaffirm to us that we have a great opportunity in Mexico to enhance value for our shareholders as we meld our proven business strategies in partnership with an outstanding company in Miasa. From their beginnings over 65 years ago, Miasa's history has mirrored our own history at O'Reilly as a family-owned company that has grown into a very successful supplier in the aftermarket by focusing on the same fundamental culture values of hard work and excellent customer service. The Orndine family has built a strong, highly respected business through its five distribution centers which support 20 company-owned stores and an expansive independent job or customer base across Mexico. At this time, Miasa's company-owned stores represent the smaller portion of the business and the overall magnitude of this transaction is not material in comparison to our existing US business. However, this partnership represents a tremendous foundation for us to grow upon from the platform that Miasa has established to expand the base of company-owned stores over time and become a major competitor at a national level in Mexico. As we look forward to executing this strategy, we're excited to partner with Miasa's season management team who will continue to operate the business in conjunction with O'Reilly's experienced leadership team. While we're anxious to close the transaction and get started, we will be cautious at the pace at which we move forward in Mexico. Just as it was during our evaluation process, we will be very focused on ensuring we take the time to learn the Mexican market, work with the Miasa team to develop the growth strategy, and invest in developing solid leadership and infrastructure that will move us forward in Mexico. We're very happy to welcome the over 1,100 hardworking and dedicated Miasa team members to the O'Reilly family, and we look forward to the closing of the transaction in the fourth quarter. To close my comments, I would like to once again thank team O'Reilly for their outstanding performance in the third quarter and continued dedication to our customers. Our team's execution has driven solid results in the first three quarters of 2019, and we're in a great position to finish the year strong. Now I'll turn the call over to Tom.

Thanks, Jeff. I would also like to thank all of team O'Reilly for their continued commitment to our customers, which drove our strong results in the third quarter. Now we'll take a closer look at our quarterly results. For the quarter, sales increased to $184 million, comprised of a $122 million increase in comp store sales, a $57 million increase in non-comp store sales, which includes the contribution from the acquired Bennett stores, a $7 million increase in non-comp, non-store sales, and a $2 million decrease from closed stores. For 2019, we continue to expect our total revenue to be 10 to $10.3 billion. As Greg previously mentioned, our gross margin was up 35 basis points for the third quarter. On a year over year basis, third quarter gross margin benefited from the sell through of on hand inventory that was purchased prior to tariff driven acquisition price increases, which have gone into effect in stages, starting in the second half of 2018 and continuing throughout 2019, and the corresponding retail and wholesale price increases. When we established guidance for 2019 at the beginning of the year, we expected this gross margin benefit from the sell through of lower cost inventory to be bigger in the first half of the year, based on the then current tariffs and pricing environment. However, with the most recent round of acquisition cost increases, driven significantly by the last round of tariffs, but also by other inflation being passed on by our suppliers, we are seeing an additional benefit to our gross margin. This benefit will continue in the fourth quarter of 2019, which is the driver of our expectation that gross margins will be at the top end of our full year guidance range, as Greg mentioned earlier. While we are not yet prepared to provide gross margin guidance for 2020, we would expect this tailwind to gross margin to carry forward in the next year, but decrease quarter by quarter as we turn the low cost inventory and anniversary tariff price increases. Our expectations are based on the current tariff and inflation landscape, but the impact of our gross margin will ultimately be determined by the timing of inflation, tariffs, and any corresponding market price changes. Most importantly, we continue to be pleased with our industry's ability to retain rational pricing and pass through cost increases and are confident based on the non-discretionary nature of demand for the products we sell, we will be able to sustain this strategy moving forward. Our third quarter effective tax rate was 22% of pre-tax income, which was below our expectation and comprised of a base rate of 22.5%, reduced by .5% benefit for share-based compensation, both of which were better than our expectations. This compares to the third quarter of 2018 rate of .6% of pre-tax income, which was comprised of a base tax rate of 22.6%, reduced by 3% benefit for share-based compensation. As a reminder, the third quarter is typically lower than the remainder of the year due to the tolling of certain open tax periods, and the better than expected base tax rate this quarter is the result of positive resolution of certain tax matters in the quarter. For the full year of 2019, we now expect an effective tax rate of 23%, comprised of a base rate of 23.8%, reduced by a benefit of .8% for share-based compensation. However, changes in tax benefit from share-based compensation could create fluctuations in our quarterly tax rate. Now we'll move on to free cash flow and the components that drove our results for the quarter and our guidance expectations for the full year of 2019. Free cash flow for the first nine months of 2019 was $995 million versus $959 million in the first nine months of 2018. As Greg noted in yesterday's press release, a big driver of the -over-year increase in free cash flow relates to our investment in solar projects that generate investment tax credits, and the timing of these investments can create unevenness in our cash flows. Based on when these solar projects come online, we expect this timing difference in free cash flow to normalize during the fourth quarter. Absent this timing effect, free cash flow is lower year to date, with the reduction driven by increased capex, offset in part by higher pre-tax income. For the full year, we're maintaining our free cash flow guidance in the range of one to $1.1 billion. Inventory per store at the end of the quarter was $618,000, which is up 1% from the beginning of the year and up .1% from this time last year. We continue to expect to grow per store inventory in the range of two to .5% this year. As a result, acquisition cost increases, and the fourth quarter opening of the Twinsburg, D.C., putting pressure on the growth percentage. Our APD inventory ratio at the end of this quarter was 108%, which is up from 106% from the end of 2018. We now expect to finish 2019 around 107%. Finally, capital expenditures for the first nine months of the year were $481 million, which is up $131 million from the same period of 2018, driven by our ongoing investment in new D.C. projects, the conversion of the Bennett stores, new store growth, and technology investments. We continue to forecast capbacks to come in between 625 and 675 million for the full year. Moving on to debt, we finished the third quarter with an adjusted debt to EBITR ratio of 2.28 times, as compared to our ratio of 2.23 times at the end of 2018. The increase in our leverage reflects our May bond issuance and the borrowings on our unsecured revolving credit facility. We're below our stated leverage target of 2.5 times, and we'll approach that number when appropriate. We continue to execute our share repurchase program. In year to date, we repurchased 3.6 million shares at an average share price of $364.84 for a total investment of $1.3 billion. Subsequent to the end of the third quarter and through the date of our press release, we repurchased 0.1 million shares at an average price of $393.33. We remain very confident that the average repurchase price is supported by expected discounted future cash flows to our business, and we continue to view our buyback program as an effective means of returning available cash to our shareholders. Before I open up our call to your questions, I'd like to thank the O'Reilly team for their outstanding performance in the third quarter and for their continued dedication to our company and our customers. This concludes our prepared comments and at this time I'd like to ask John, the operator, to return to the line and we'll be happy to answer your questions.

Thank you and I'll begin the question and answer session. If you have a question, please press star then one on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. And please limit your questions to one question and one follow-up question. Once again, if you have a question, press star then one on your touchtone phone. And our first question is from Chris Horvitz from JPMorgan.

Thanks, good morning guys. I just wanted to ask a little bit about the DIY business and sort of what you're seeing on the sequential trends in the -it-yourself business. As you pass along more price increases, what have you seen from an elasticity deferral perspective, you know, one hand prices are higher, but on the other hand, miles driven have generally picked up since bottoming in the back half of last year and we think that's a nice driver of that business and the overall business. So how is this balanced out in terms of deferred spending?

Sure, Chris. Third quarter, we were up slightly on the cash, the DIY side of our business. You know, if the tariffs and inflation persist, you know, we feel like the more cash strapped consumer will have to make some decisions, not much different than what we would face with rising fuel prices and ordinary inflation. And while we haven't seen a lot of evidence of deferred maintenance, it would be somewhat likely that that would be a decision that that consumer might make if they were having financial difficulties to defer, not complete those maintenance cycles, defer those and extend those maintenance cycles out a little bit longer. So, you know, we haven't seen a lot of evidence, you know, those more elastic categories are more of the maintenance categories like oil and things like that. And we haven't seen any evidence that there's been a big shift there, but that could happen, could these tariffs and inflationary, should this inflationary environment continue?

What I

would add

to that, Chris, is ticket counts were up slightly on the DIY side, total comps were relatively strong, although as Greg mentioned in his prepared comments, the professional business continues to lead the way in total comps. When we look at our category performance, items that can be deferred, especially on the DIY side are a little bit lagging, whereas our hard parts business, things that you need to run your car continue to be good on both sides of the business.

And then as you think about, have you tried to desegregate, to strengthen the hard parts business between price and unit to try to tease out, you know, how the car park improving, you know, this year and even more so next year, if that's, how much of that is driving this commercial comp acceleration, which is, you know, accelerating on a stack basis?

So not to break down the individual numbers, but when we look over the last few years with the lighter, sour years coming into the professional side of the business, really entering our market, which tend to be the newer the car, sooner it's off warranty, the higher propensity is to be serviced by a professional. You know, that put pressure on us over the last couple of years when we were seeing that abate. When we look at our category type performance, you know, especially items like brakes, which are routinely repaired or changed out after they come out of warranty, we continue to do well on that side. So we think that bubble, you know, moving into our years and then higher, sour years coming into our market off warranty bodes well has been a positive this year or not a negative. And we'd expect that to continue into next year.

Thanks, best of luck guys.

Our next question is from Matt McClintock from Raymond James.

Hi, yes, good morning everyone. I was wondering, just given the magnitude of this being your first time going into a different country, if you could just remind us how you think about the Mexican market overall, the opportunities there, you know, how it's different than the United States market. Just give us a little bit more context just so we can frame it, you know, in general.

Thanks. Sure, great question, Matt. You know, I think that the question that we're asking one of the things kind of going back, we've been talking about entering markets outside of the US for a few years now. And we've been looking obviously in Mexico as well as in other North American countries for that right opportunity. What I would tell you is that the Mexico opportunity seemed to come about more quickly than other areas of North America. And as we moved into Mexico, we really were looking for acquisition candidates that checked several boxes that we needed to have checked. And some of those include, they need to have a solid store base, they need to have a leadership team that was grounded and understood the marketplace very well. They needed to be a good culture fit for our company. And they needed to have scalable systems. And while we looked at some companies along the way that were larger than the Mayasa organization, the Mayasa organization seemed to check all of those boxes. So very solid leadership team, as Jeff said in his prepared comments, they've been in business for well over 60 years. The leadership team in Mexico will remain in place and will work very closely with our company's leadership to direct our future opportunities down there. Now, what I would tell you is, we haven't closed on the deal yet and there's much work to be done, which as Jeff said, was one of the reasons that we reduced our store count outlook for 2020 is because of the level of effort that goes into preparing for growth in Mexico. And again, the Mayasa organization gives us the ability to do that. They've got distribution, they've got the knowledge of the marketplace, but our real estate team and operations teams have a great deal of work to do to really understand, to fully understand that marketplace and learn from the Orndyne family and the leadership to drive our future growth in Mexico. Jeff, did you wanna add anything to that? I mean, you covered

it

pretty well.

I mean, it's obviously a new market for it. We've got a lot to learn, but when you go down there and visit the markets, I mean, it's like the US 40 years ago. I mean, it's a highly fragmented market. There's really not that many chains of any size, AutoZone being the biggest, but there's just a ton of small, independent job or business. So, it's obviously a much smaller market than US, but we're very excited about entering the market and growing our business down there.

Well, it sounds pretty exciting. I wish you all the best of luck. Thanks for the color.

Thank

you.

Our next question is from Greg Mullick from Evercore ISI.

Hi, thanks. I'd love to follow up a little bit more on the pass-through of inflation and the response from both DIY and Do It For Me. Specifically, you mentioned already some of the potential deferral. What have you guys been able to do to help offset or mitigate that by maybe growing private label or offering a different sort of assortment, both in hard parts and maybe more traditional maintenance stuff?

Okay, thanks, Greg. This is Tom. Just to clarify one item on Chris's question earlier when he asked about DIY trip ticket trends, what I meant to say was the trend was slightly positive, but continues to be under pressure. To answer your question, Michael, we continue to look for ways to entice our DIY customers to repair their vehicles. We do a lot of work online with how to repair vehicles. We're promotional in our industry, but really what we think our best opportunity is to continue to grow that base is to provide great customer service, know-how, tooled owners, testing, so that as these consumers feel the pinch of higher prices, they feel more confident in their ability to repair their vehicles and save money that way.

Do you see indirectly any of that happening on the hard part side, where you're getting the unit demand, but people are maybe changing the mix on older cars?

Not any more than what we've normally seen. When you look at the life cycle of our good, better, best product levels, as the vehicle gets older in that life cycle, the consumer tends to buy more towards the good or better into the spectrum. There's exceptions to that, but overall, leading into the higher-end vehicles would tend, and the professional side of our business would lean more towards the higher end of that good, better, best spectrum, and then the older the vehicle gets, the more likely they are to trade down to the lower end of that spectrum.

And then my follow-up was on Mexico and the grander scheme of the growth algorithm. I think you mentioned stores now being about 180. Is that the number you guys said in the beginning?

A company owned stores is 20 in Mexico.

Got it, but for the company, now we're gonna do 180 net new stores next year.

And

so, is that because next year you're doing Mexico, and should we think about the 180 as a step down that could step up again, or is it more of like, look for the US business to do .5% footage growth, and now the additional point of footage growth might come out of Mexico? Like longer than

that? What I would tell you is we still feel like we can operate somewhere in the neighborhood of 6,500 stores in the US, and our US growth over time will continue as we approach that number, but what we're gonna do is we're gonna kind of blend that growth between the US and countries outside the US, the first being Mexico.

To add to Greg's comment, we felt like it was prudent, having gone through a number of acquisitions, knowing how important it is to get the foundation of that acquisition right before we move forward, that we as a company are gonna allocate a lot of time to understanding the Mexican market, developing our plan, and to make sure that we can put the appropriate amount of focus on developing and starting that plan, we're gonna back off new stores just for this year. I don't think it indicates anything about future years of what we're gonna do. We're gonna run our business with a mind of continuing to grow our store base profitably and set that going forward, but we wouldn't say that this is an indication. We think the total number of stores we can open in the US for our ability to open stores has changed.

Right, that's clear. Thanks a lot, guys, and good luck.

Thank you.

Our next question is from Scott Ciccarelli from

RBC Capital. Good morning, guys, Scott Ciccarelli. I guess I have a bigger picture question for you guys. So historically, this industry kind of viewed a sweet spot for cars entering their initial repair stage at maybe six, eight years old for the pro side of business, but a recurring theme for a long time is we keep hearing about, let's call it, sluggish ticket counts being offset by higher average tickets. So my question is this. With parts continuing to be made better and lasting longer, should we start to think about that initial repair stage maybe starting later in the vehicle's life? In other words, could we have seen, or are we seeing, I should say, the sweet spot maybe shift to seven to nine years or eight to 10 years, where they really come into that kind of initial repair stage for your pro customers?

Yes, Scott, what I would tell you is that, I don't know that the starting point of that sweet spot hasn't moved that much, but I think the sweet spot itself has expanded because vehicles are just lasting longer. Whether it's five to seven, six to eight, six to 10, I think that that initial inflection point of the sweet spot is driven by the vehicles coming off warranty. As soon as those vehicles come off warranty, a lot of those maintenance and repair items go to the professional installer. And then over time, as those vehicles get older, we benefit on the DIY side as well. But vehicles are just lasting longer. Vehicles lasting between 11 and 12 years now, and a lot of times, vehicles that are on their second and third ownership pattern are being maintained as well as they were when they came off the assembly line.

Well, Greg, just conceptually, yes, I understand that. It comes off the warranty, and then you start taking it somewhere other than the dealer, and you're gonna start using aftermarket parts, but I don't know, let's call it the brakes or the starter. Maybe it doesn't need to be changed right at six years. You really can last till seven or eight or nine years. I guess that was the thought process.

So what I would add to that, Scott, is a lot of the routine maintenance items, when you look at oil change intervals, fluid change intervals, when you look at tune-up type items, those have definitely expanded with different technologies that cost more to do but don't happen as often. When you look at a lot of our core items, brakes, belts, hoses, rotating electrical batteries, that hasn't changed dramatically, but some of those categories that have changed and have been spread out, example, oil changes where it used to be 3,000 miles, and now your car tells you when you should change your oil with synthetic or semi-synthetic. Those have a lot of ticket count, but don't have the per transaction value that hard part repairs have.

Got it, okay, thanks, guys.

Our next question is from Simeon Gutman from Morgan Stanley.

Thanks, everyone. So you're on track to hit, looks like you're midpoint of your comp guidance of about four. You mentioned there's a little bit of help from price, I think 2% to 3% now for the full year, if I heard that right. So if you look at it that way, the underlying growth is more like 2%, maybe 1% to 2% arguably. And if you look past, in the past, your business seems to have averaged something a little bit higher than that with no inflation, 2% to 3%, or even better than that with no inflation. Do you diagnose it in that same way, or how do you diagnose it? Is underlying demand softer? And then when we start to lap some of these pricing, will we see units go back up? I don't know if that's how it should work, but curious your thoughts on that.

So when we look at our business, I think we've been pretty clear that the professional side of the business where the average consumer or end consumer is less price sensitive, continue to see good unit growth and average ticket growth, and that's why that side of the business continues to lead. On the DIY side of the business, we have pressure on our ticket count from rising prices, so that is limiting what the comp is on that side, so we still feel very good about a 5% comp in the third quarter. When we look at annualizing these price increases, I think our direction is similar to where we've seen shocks in gas prices. We would expect that the DIY side will, that average consumer will become adjusted to what the current prices are and that we will see as we annualize these increases, less pressure on count.

Okay, so I think just if I could paraphrase, it seems like there's really no impact that a do it for me demand side or unit count, it's really the do it yourself sort of would explain maybe some of that, some of the underlying softness, I guess.

Well, I don't know that we would characterize it as soft when we deliver 5% comps, we're very, very happy with that result.

Fair enough. Can I ask this one follow-up? If, have you thought about a scenario in which tariffs get revoked? I don't know if you planned for that or thinking through that, but what percentage of the price increases could the industry, do you think the industry could keep?

Well, we'll have to see what happens with tariffs. As we've talked about on our quarterly calls, starting with the first quarter, our guidance anticipates that the current inflationary slash tariff environment will remain and we will adjust our business accordingly when those changes occur, but to speak about something that hasn't occurred or may not occur is probably not the appropriate thing to do.

Thank you. Our next question is from Michael Lanser from UBS.

Got it. Good morning, thanks a lot for taking my question. There was a little bit of confusion in terms of some of the commentary about the consumer response to the price increases and on the one hand it seemed as though there was a comment that you're anticipating some unit demand destruction from the price increases, on the other hand, there was indication that some categories that were deferrable, like motor oil in some other areas were actually seeing some unit demand destruction from price increases. So could you clarify what category, if there's actually seeing some elastic response in what categories right now?

Yeah, Michael, we're not seeing any, again, our professional side of our business was very strong, so what we'd be talking about here is the DIY side of our business and we haven't seen any of the elastic categories take a big hit because of this. What we would say in summary is if inflation persists, again, no different than ordinary inflation or gas prices or what have you, that that consumer may have to make some decisions and what those decisions may be would be deferring or extending maintenance cycles on those categories, some of which are more elastic, or perhaps trading down from a good, better, best spectrum on required repairs.

Okay, and so is a way to characterize what happened this quarter is everything remained largely stable, you didn't see as much of a negative impact from the weather, plus you had a slightly higher benefit from pricing this quarter and that's all adjusting out for the extra funding. Is that a fair way to think about it?

I think it is, yes.

Okay, and then my last question's for Tom. Is there a scenario in 2020 where S&A per store doesn't grow .5% or above and what's the likelihood of that?

Well, we're not giving guidance for 2020, but I'll reiterate what we've said on previous conference calls is to the extent that the labor market remains tight, we would expect to continue to have pressure on our SG&A growth, that's the biggest expense that we have in that line, and really that pressure of higher wages impacts everything that we do and a business does, but we would expect to see if that were the case continued to be the case. So, we're not giving guidance to inflation and selling price to help offset that.

Okay, thank you very much and good luck with the fourth quarter. Thanks,

Michael.

Our next question is from Seth Sigmund from Credit Suisse.

Hey guys, good morning, thank you for taking the question. I wanted to follow up on CapEx. So obviously this year there was a big increase related to some of the DC work and store conversions. I'd assume some natural step down next year, particularly with less US store growth, but can you just discuss some of the capital requirements related to MIASA and whether there's gonna be a need for any sort of meaningful investment within that chain at some point?

So, this is Tom. We would expect to have a lower CapEx level next year just based on not having three ongoing DC projects, so it'll continue to be elevated because two of the projects will still be ongoing. To speculate on MIASA right now and what we'll do next year is premature. We haven't even closed down the business, but our expectation over time is that we have a great opportunity to grow a large store base in Mexico and we'll deploy capital successfully in Mexico, but to Jeff's earlier comments, we really wanna make sure we understand the market, have the team in place, have the infrastructure in place before we commit additional capital to start growing that store base robustly.

Got it, understood, okay, thank you. And then I just wanted to follow up on pricing. How would you guys categorize the competitive landscape today from a pricing perspective? Do you feel like it's rational? Have competitors followed some of your moves on pricing? And then, sort of related, when you analyze your price gaps versus some of the emerging competitors in the space, whether that's pure play online companies or whoever that is, have you seen any major change in those price gaps as you guys have taken pricing up, thanks?

Sure, so what I would say is we've seen very little change in the competitive landscape. Our industry still is very rational from a pricing perspective and there are categories that we lead and move up in and typically, our competitors will follow and I guess vice versa, that holds true as well. But our industry has always been very rational and continues to be very rational from a pricing perspective. As far as online, really haven't seen a lot of change there except for the method by which some of the brick and mortar retailers price online. I think it's become more typical that our price points are the same or very similar to what we have in the stores and we offer discounts across the ticket to be more competitive with pure online retailers. And again, a lot of times there's a perception out there that when you're looking at brand to brand, we might not be competitive from a pricing standpoint, but when you look at it from an application to application standpoint, we are consistently very competitive from a price point standpoint. That consumer that's buying products online for price will be able to go out and look for a part for his vehicle that maybe we have in a proprietary brand at equal to or sometimes less than what the pure online retailers are selling at.

Okay, thanks guys.

Next question is from Chris Bodeglieri from Wolf Research.

Hey guys, thanks for taking the question. I guess the first question is, kind of wanted to think through the impact of opening DCs. Great to see opening DCs again, it's been a while. Kind of what are the impact on comps that you've observed when you open a DC? Is there any kind of quantifiable uplift in that market? And then two, how do we think about the margin cadence? I would think maybe initial headway to some kind and then it becomes a tailwind, but just kind of curious how you think about the net of those. Thank you.

I might take the first part at this Jeff and then let Tom or Greg chime in. But, you know, anytime you open a DC in a given market, I mean, that market could be serviced by a hub store carrying somewhere from 45 to 65, 70,000 SKUs. And opening that DC, we have availability same day, several times a day availability to 160 to 170,000 SKUs. So when you have that inventory available, you're just able to say yes to the DIY customer or the professional customer or fulfill the B2B ticket more times than not where before it would have been available overnight. So I don't know if it's exactly quantifiable, but it's sure another tool in the toolbox for those stores in that given market service by that new DC.

And from a cost perspective, our history has been to continue to grow our store base and expand DCs really beyond the range that's ideal from efficiency standpoint for them to run and to overload their store count, which makes them internally inefficient before we open a new DC. So as we open these new DCs and unload the stores from overloaded DCs, that makes their labor more efficient, it makes the miles driven more efficient. So we don't see a real big impact in our gross margin on a comparative basis.

Okay, great, thanks. And then a quick follow up on the gross margin commentary from Tara if she said earlier, that's what I got to confirm and we talk a little bit more. So you expect the gross margins to be up year over year and accelerate the Q4 and then decelerate, but still positive year over year into 2020. Is that the way we look at it? Like, or how should we like maybe just clarify that wasn't quite sure what the answer was.

So we're seeing a benefit in our POS margin as prices have moved up with the tariffs. Obviously we have a slow turn industry. So we have an amount of inventory that we've purchased before the tariff increase. So we make a higher gross margin. So that was a benefit here in the third quarter will be a benefit in the fourth quarter as we sell through that merchandise and reduce that amount that was basically sitting in LIFO, we will see that tailwind diminish quarter by quarter next year.

Gotcha, okay, but still up though is the answer right now.

The answer for the fourth quarter is we expect to see strong gross margins which will drive us to the top end of our gross margin, full year gross margin guidance.

Gotcha, okay, good enough, thank you.

Our next question is from Seth Vashman from Red Bush Securities.

Thanks a lot and good morning. I have a question that relates to a number of employees. On a per store basis we saw a bit of a decline year over year this quarter. Is that because of a mixed shift towards full time or are you managing your employee base a little bit differently?

I think we fielded this question on a few different conference calls. We have obviously a large employee base and that number is a point in time number. So depending on the time of the week it ends, depending on how many jobs we have that are open and the fluctuation, especially on the part time, that number can fluctuate that's not an indication of any actual change in our business staffing philosophy. And for that I'll turn it over to Jeff.

Really, I mean, we run our business one store at a time and have the appropriate staffing to take care of the business in that market and that's easily ramps up and ramps down depending on the time of year. Obviously we're kind of in the ramp down mode a little bit coming out of summer or going into fall and winter. So nothing's changed structurally in how we run our business. We've always ran our business for the long haul to provide excellent customer service each and every day.

Got it, thank you. And just to follow up a clarifying question. Tom, did you say that DIY ticket counts, so traffic on a comparable store basis was up or down this quarter and how did that trend relative to the last two quarters?

Yeah, make sure I get it right this time. The number continues to be under pressure, so it was negative. It was slightly improved from the second quarter is what I was attempting to say.

Understood now, thank you.

Thank you.

And we have reached our allotted time for questions. I will now turn the call back over to Mr. Greg Johnson for closing remarks.

Thank you, John. We'd like to conclude our call today by thanking the entire Raleigh team for your continued hard work in delivering a strong third quarter. I'd like to thank everyone for joining our call today and we look forward to reporting our fourth quarter and full year results in February. Thank you.

Thank you, ladies and gentlemen. That concludes today's conference. Thank you for participating and you may now disconnect.