O'Reilly Automotive, Inc.

Welcome to the O'Reilly Automotive Inc. Second Quarter 2020 Earnings Conference Call. My name is Bridget 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 30-minute question and answer session. During the question and answer session, if you have a question, please press star, then one on your touchtone telephone. I will now turn the call over to Tom McFaul. Mr. McFaul, you may begin.

Thank you, Bridget. Good morning, everyone, and thank you for joining us. During today's conference call, we'll discuss our Second Quarter 2020 results. 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 reclaim the protection under the St. 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 AIM report on Form 10-K for the year ending December 31, 2019, 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 Second 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 on the call. The five of us on the conference call today have a combined over 170 years' experience in the automotive aftermarket, and we have collectively experienced many, many ups and downs in our industry. But in the 63-year history of our company, I can safely say we've never seen a quarter like this year's second quarter. As we begin our prepared comments today, I'd like to start with the most important comment first, which is to thank Team O'Reilly for your amazing dedication and performance during one of the most difficult and challenging periods in our company's history. The communities we serve continue to face significant ongoing challenges from the COVID-19 pandemic, but our team has remained steadfast in executing our protocols to protect the health and safety of our team and our customers while providing outstanding customer service. It has never been more evident just how essential our role is in providing our customers with the critical parts they need and the service they expect to keep their vehicles on the road. This quarter, we experienced the most dramatic swing in demand our business we have ever seen, and we're extremely proud of how our team stepped up to the challenge and delivered a record-breaking quarter highlighted by a comparable store sales increase of .2% and a 57% increase in earnings per share, combined with a -to-date increase in operating cash flows of over $700 million. The numbers are a reflection of the tireless dedication and hard work of our team, and I want to congratulate all of Team O'Reilly on your incredible performance in the second quarter. Before we dig further into the results for the quarter, I would like to provide a brief update on how our teams are responding to COVID-19 to ensure the continued health and safety of our team members and our customers. As we discussed on last quarter's call, with the onset of COVID-19, we very quickly implemented numerous safety protocols across our companies based on recommendations by the CDC, WHO, and state and local governmental agencies. These measures include significantly increasing cleaning and sanitation efforts, the implementation of social distancing practices, and the utilization of appropriate personal protective equipment. Our teams did a great job working through the initial period of rapidly evolving recommendations and have remained diligent in their execution as the pace of change in requirements has slowed and best practices have emerged. We remain committed to constantly evaluating and revising our safety protocols, and currently all team members company-wide are wearing face coverings. Throughout the course of the crisis, our dedicated team members in our stores, distribution centers, and corporate offices have demonstrated extraordinary flexibility and resilience in the face of extremely difficult circumstances. Now I'd like to provide some details on our robust performance in the second quarter. We're extremely pleased with our top-line sales results in the quarter and even more pleased with the incredible execution of Team O'Reilly in delivering these results. As we announced in our first quarter press release, the beginning of our second quarter was marked by a significant COVID-19 headwind, which was a continuation of the pressure we saw in our business starting in the middle of March coinciding with the implementation of -at-home recommendations and orders. As we discussed on last quarter's conference call, this trend continued through the middle of April, but sales in the third week of April improved as our customers began to receive economic impact payments under the CARES Act. At that time, we had no way of forecasting the magnitude and the duration of the benefits from these stimulus payments, nor could we anticipate what other factors would impact our customers and our business moving forward. As a result, we took a cautious stance on how we planned for our business and maintained ample flexibility to respond to further headwinds. Simply put, our sales performance from the third week in April through the remainder of the quarter exceeded all expectations. During this time frame, our DIY business was the stronger contributor, coming on quickly in the middle of April, improving in May and staying very strong in June. We were also very pleased with the performance of our professional business. Sales on that side of the business also began to see improvement in the middle of April, but at a more gradual pace than the immediate turnaround in DIY. However, as we progressed through the quarter, professional sales continued to strengthen, generating robust comps above our expectations in May and June as -at-home orders began lifting and the broader economy began reopening. As a result of this cadence on both sides of our business, total comparable store sales were similar from May and June and have remained strong thus far in July. Next, I would like to provide a little color on the drivers of our record-setting sales results. For us to be able to produce a .2% comp increase in the second quarter, we obviously had a very favorable industry environment. However, just as it would have been tough to predict the sales results we've seen, it's also very difficult to quantify the magnitude of each of the positive macro factors. But I'll discuss in general terms what we've seen as the positive supporting demand in our markets. To begin, it's evident from the sharp turn in DIY business that the receipt of governmental stimulus payments under the CARES Act was the first catalyst supporting our sales growth in the quarter. However, given the degree of which robust sales trends have persisted, it's clear to us that enhanced unemployment benefits have also been a tailwind to the business and were likely more prominent in driving demand as we move through the quarter. We also believe that reopening of the economy and the partial recovery of miles driven was a positive factor, especially in our professional business as our customers serve a demographic that is more likely to have been a positive impact for the industry than it has been for the world from home during March and April. Although the impact of weather gets a little lost in the world of double digit comps, in any other year we'll be talking about the hot weather we've had and it's likely has been another positive for our industry. There are other beneficial industry dynamics we believe could have contributed to the strong demand in the quarter, but are also difficult to measure over a short period of time. We have long held that times of economic uncertainty motivate consumers to make more cautious financial, have a more cautious financial outlook, often leading them to postpone the purchase of a new vehicle and invest in maintaining their existing vehicle. Consumers with safety concerns about other modes of transportation, either for a daily commute or vacation travel, could also be focusing more on maintaining and repairing an existing vehicle. It's difficult to have a clear picture, yet of the magnitude of benefit we could be seeing from an increased vehicle age or catch up of underperformed maintenance, but we're seeing some benefit. Finally, we could be seeing shifts in customer demand benefiting our business, either in share gains from smaller competitors or big box stores, or a more general shift of demand dollars into the automotive aftermarket and away from discretionary expenditures for activities not possible in a COVID environment. From a ticket perspective, we saw robust ticket count increases during the second quarter, but average ticket size also increased significantly. With average tickets, same-ski inflation was in line with our expectations, so the increase in ticket size is being driven primarily by larger jobs or more items on the ticket. On a category performance basis, we saw strong performance throughout our product offerings, including especially good results in appearance and accessory categories. These ticket and category dynamics suggest some of the strong demand we realized in the second quarter as a result of our customers having the ability and desire to work on larger projects as they have more time to spend repairing and maintaining their vehicles. As you look forward to the balance of the year, we remain very cautious in our sales outlook and recognize the significant uncertainty that still exists concerning the duration of the current positive market backdrop. In particular, we can't project the potential impact an expiration of the enhanced unemployment benefits would have and can't speculate as to whether there will be additional government stimulus or the degree to which our demand would benefit. We also remain concerned that continued pressure to miles driven from difficult economic conditions and increased work from home arrangements could be a headwind if other positive catalysts proved to be temporary. Ultimately, we expect to see a moderation of the record-setting sales pace at some point in the back half of 2020, but feel very confident our company can continue to deliver solid sales growth even if the broader economic conditions deteriorate. As important as general market factors were the catalysts for our growth in the second quarter, we could not have delivered such outstanding top-line results without the incredible execution by our team. It's one thing to have strong demand. It's another to live up to the challenge of having the right part at the right time to take care of customers while the business is on fire and we're allocating additional time to safety precautions. It takes a tremendous amount of hard work to handle the extra volume we saw this quarter, and the outstanding contributions of our team were reflected in the strongest profit margins in the history of our company. For the quarter, our gross margin of 53% was a 12 basis point improvement over the second quarter of 2019 margin and above our expectations. Our gross margin benefited from the heavier DIY mix in our business, which carries a higher gross margin than our professional business, as well as strong leverage on DC expenses on the robust sales volumes and incremental cost improvements. Partially offsetting these positive gross margin factors was a small lifeboat headwind driven by acquisition cost decreases during the quarter, which Tom will discuss in more detail in his prepared comments. For the second quarter, our team generated an operating profit margin of 23.8%, which exceeds our previous best single quarter performance by well over 300 basis points. As we reported in our press release yesterday, we don't view these levels of SG&A leverage to be sustainable over the long term, and Jeff will more fully cover these dynamics when I turn the call over to him in a moment. Before I do that, however, I just want to congratulate Timo Riley on these great results and your ability to provide excellent customer service even while tightly controlling expenses. Your extraordinary contributions to our company's success have never been more apparent, and I feel comfortable speaking for all of our shareholders and saying thank you for an incredible performance in the second quarter and your unwavering commitment to serve our customers. I'll now turn the call over to Jeff Shaw.

Jeff? Thanks, Greg, and good morning, everyone. I'd like to begin my comments today by joining Greg and expressing my extreme gratitude to Timo Riley for their amazing performance in the second quarter. The results you were able to generate validate both the strength of our model and the deep quality of our team and culture. Your ability to capitalize on a positive market-wide catalyst and generate comparable store sales growth of .2% and operating profit dollar growth of 48% is truly incredible, and I continue to be extremely proud at what our team, working together, can accomplish. Now I'd like to provide some color on our SG&A expenses for the quarter and further describe the remarkable performance of our team. As we discussed at length on our first quarter conference call, we undertook several steps in March and April in response to the impact COVID-19 was having on our business. Throughout our company's history, we've been active and detailed managers of the variable expenses of our business with our store payroll spend representing the largest driver. As we analyzed the trends we were seeing in our business beginning in the middle of March, we made adjustments we felt were appropriate to right-size our model for the existing and expected environment caused by the pandemic. As we progressed through the month of April and began to see the stark sales improvement as Greg discussed in his prepared comments, we remained very cautious in our forward-looking sales outlook. At the time, we didn't know how long the positive sales trends would persist, especially since the initial sales tailwinds were so closely aligned with the initial wave of the $1,200 stimulus payments under the CARES Act. We've had a lot of experience with similar spikes in demand during tax refund season, and since we know these surges tend to be short-term in nature, we were prepared for the positive trends to revert to the pressured sales environment we encountered from mid-March to mid-April. The positive trends didn't reverse, but instead strengthened in May and June, and we began to slowly increase our SG&A spend as we progressed through the quarter to more closely match our service levels to the demand that we were seeing. As a result, we exited June at a higher rate of SG&A spend than we saw in April and May. The net result of this cadence in SG&A spend during the quarter resulted in a decrease in average SG&A per store of approximately 1% compared to the second quarter of 2019. This exceptional expense control discipline, combined with the immediate drastic sales rebound, drove that truly remarkable profitability in the second quarter, highlighted by a reduction in SG&A expense as a percentage of sales of 447 basis points. While our team deserves all the credit for the great performance in the second quarter, we also recognize that the impressive numbers were driven in part by the timing and unique circumstances of how our quarter played out. As Greg previously mentioned, we know to provide the consistent level of customer service required to build our business over the long term, this level of SG&A productivity is not sustainable. Our priority for the past three months has been to do everything in our power just to take care of the next customer, but we have enough experience throughout all levels of our company to understand that we can't neglect the other fundamentals of our business. As we move through the back half of the year, we will refocus on the important details of our business that get deferred when we're running double-digit comps, such as the image and appearance of our stores, and store team member training and development. However, we will leverage the lessons learned through this process. While we expect to see our SG&A dollar spend navigate back towards historical levels, we will be diligently focused on driving strong leverage and robust top-line growth. Next, I'd like to touch briefly on our capital expenditure and expansion plans. Through the first six months of 2020, we opened 123 net new stores in line with our original plan to open 180 new stores in 2020, and we successfully opened our newest distribution facility in Lebanon, Tennessee. These new properties were well underway prior to the onset of COVID-19 and the disruption from the -at-home orders, so we were able to complete development pretty much on schedule. However, we've seen delays in the development schedules for our planned new store openings in the back half of the year, especially as the required approvals for design and permitting have slowed as local cities implemented health and safety measures. At the same time, we were very judicious in how we moved forward with both our store expansion plans as well as our other capital project priorities in light of the significant economic uncertainty we were facing. As market conditions improved, we began to see our local communities open up in May and June. We were able to resume the pace of our new store development. However, given the delays we experienced in the first half of the year, it was prudent to withdraw our original 2020 new store guidance, and we would now expect to open between 150 and 165 new stores this year. We've been pleased with our ability to open great new store locations in 2020, but where we ultimately fall within that range will be somewhat out of our control as we anticipate seeing further localized delays in final permitting approvals. Outside of our new store and distribution growth, we have restarted the exciting projects and initiatives that we identified coming into 2020 to enhance the service we provide to our customers and to drive strong returns. While we haven't spent the plan level of CAPEX for these initiatives in the first six months of the year, we will begin to close that gap as these projects gain steam in the remainder of 2020. We continue to make great progress converting the hardware that runs our stores, and we're continuing to invest in projects that modernize our distribution vehicle fleet, improve the image and appearance of our stores, implement enhanced safety measures in our store vehicle fleet, and to enhance our omni-channel capabilities. None of our high expectations on the opportunities presented by these projects has diminished based on our experience so far in 2020, and we're excited to reap the benefits from these initiatives moving forward. Finally, before I turn the call to Tom, I want to once again thank Team O'Reilly for their tremendous efforts in the second quarter. For a number of different reasons, 2020 has been a very challenging year, but our team has stepped up and met every challenge and really proved they're the cream of the crop in our industry. I'm especially proud of the commitment that our team has shown to our customers. Their diligence in executing best practices to protect the health and safety of everyone in our stores, DCs and offices while keeping our business running efficiently to provide our customers with the essential parts they need is truly world class. Now I'll turn the call to Tom. Thanks, Jeff. I would also like to thank all of Team O'Reilly for their hard work and dedication taking care of our customers and driving the phenomenal performance in the second quarter. Now we'll take a closer look at our quarterly results. For the quarter, sales increased $502 million, comprised of a $412 million increase in comp store sales, a $70 million increase in non-comp store sales, a $21 million increase in non-comp non-store sales, and a $1 million decrease from stores permanently closed in line with our 2020 plan. For clarification, these store closures were planned and are broken up consistent with our past reporting practices. As a reminder, we previously withdrew our 2020 guidance, and given the ongoing uncertainty related to COVID-19, we are not resuming guidance at this time. As Greg previously mentioned, gross margin for the second quarter increased 12 basis points to 53.0%, which includes the benefit from mixed VC leverage and acquisition cost benefits, partially offset by a life-throw charge headwind of $4 million. As a reminder, coming into 2020, we anticipated we would continue to see a gross margin benefit from the sell-through of on-hand inventory that was purchased prior to the tariff-driven price increases during 2019. However, this benefit was reduced as we saw acquisition cost decreases in the second quarter, which although they represent a short-term headwind to gross margin, will benefit us throughout the remainder of the year in higher POS margins. At this point, we have realized the full benefit of the pre-tariff inventory, and any further net acquisition cost reductions moving forward will result in a life-throw charge, but again will benefit our future POS margins. This is similar to our life-throw situation prior to the cost increases in 2018 and 2019. The pricing environment remains rational, and we expect that to continue. Our second quarter effective tax rate was .1% of pre-tax income, comprised of a base rate of 24.5%, reduced by a .4% benefit from share-based compensation, both of which were in line with our expectations. This compares to the second quarter of 2019 rate of .9% of pre-tax income, which was comprised of a base tax rate of 24.4%, reduced by a .5% benefit from share-based compensation. Changes in the tax benefit from share-based compensation can fluctuate quarter to quarter, and we continue to expect our rate for the remainder of 2020 to be lower in the fourth quarter as a result of the tolling of certain tax periods. Now we'll move on to pre-cash flow and the components that drove our results for the quarter. Pre-cash flow for the first six months of 2020 was $1.2 billion, versus $539 billion in the first six months of 2019, with the increase driven by an increase in net income, a reduction in net inventory, an increase in taxes payable as a result of the deferral of Tax Payment Center and Care Act, and a reduction in capex, partially offset by investments in solar projects. These investments in solar projects generate investment tax credits, which will benefit cash taxes paid in the remainder of 2020, but the timing of these investments can create unevenness in our quarterly cash flows. Inventory per store at the end of the quarter was $632,000, which was even with the beginning of the year and up .5% from this time last year. The increase reflects additional inventory investments made in the first quarter of 2020, partially offset by a reduction in inventory balances in the second quarter as a result of the strong sales volume. Our APD inventory ratio at the end of the second quarter was 112%, which is the highest ratio in our history and heavily influenced by the extremely strong sales volume in inventory terms in the second quarter. We still anticipate growth in per store inventory in the remainder of 2020 as we resume our inventory enhancement initiatives, and this will moderate the increase in our AP percentage over time. Finally, capital expenditures for the first six months of the year were $244 million, which was a $51 million decrease from the same period of 2019, driven by the prior level of investment in these distribution projects versus the first six months of 2020. As Jeff previously discussed,

we resumed

the per capex projects, which were on pause due to the impact of COVID-19, and will continue to adjust our capex plan as appropriate given the current environment. Moving on to liquidity and capital structure. We continue to have ample liquidity as a result of the measures we took earlier in the year to preserve capital and liquidity, coupled with the extremely strong cash flow performance in the second quarter. As a result, we finished the second quarter with an adjusted debt-debit ratio of 2.24 times as compared to the first quarter, ratio of 2.59 times, and our end of 2019 ratio of 2.34 times. This calculation excludes the $872 million of cash we held as of the end of the quarter. As one of the measures to preserve liquidity at the onset of COVID-19, we temporarily suspended our share buyback program in the middle of March. We continue to evaluate business conditions and liquidity, and as a result of this evaluation, resumed our share repurchase program on May 29, 2020. Year to date, we've repurchased 1.7 million shares, and the average share price is $390.14, for a total investment of $651 million. Subsequently, at the end of the second quarter and through the date of our press release, we repurchased 0.1 million shares at an average price of $423.09. As a result of the strong performance in our second quarter, we finished the quarter with $2 billion of total liquidity in cash and available borrowings under our $1.2 billion revolving credit facility, and we feel we have ample liquidity under this existing facility. As we evaluate our liquidity, leverage, use of capital, and share repurchase program moving forward, we will continue to prioritize maintaining our strong financial position, including the investor grade rating on our public debt. We have a long history of conservatively managing our balance sheet, and will continue to take prudent steps to ensure the long-term health and stability of the company. Before I open up the call to your questions, I'd like to thank the O'Reilly team for the resilience they've shown for the last several months and for their continued dedication to our company and our customers. This concludes our prepared comments. At this time, I'd like to ask Brigitte, the operator, to turn to the line, and we'll be happy to answer your questions.

Thank you. We will now begin the question and answer session. If you have a question, please press star, then 1 on your touchtone phone. If you wish to remove from the queue, please press the pound sign or the hash key. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Please limit your questions to one question and one follow-up question. Once again, if you have a question, please press star, then 1 on your touchtone phone. Our first question comes from the line of Matt McClintock with Raymond James. Your line is open.

Hi, yes. Good morning, everyone. And I have to say outstanding results. Congrats on the execution. Regarding that, I'm trying to conceptualize, or at least trying to figure out how such strength could occur with miles driven still being a little bit pressured. And clearly over history, that's been the main driver of this industry. So when you talked about strength and appearance and accessories, was that a large factor in the outperformance? And can you kind of help us try to think through or parse through what might be one time versus sustainable growth in the industry? Thank you.

Sure. So I'll start that and let's see if Jeff or Tom wanted to add on. So first on appearance and accessories, that was, you know, that's not typically a real strong category for us. When you think about car care, cleanup, waxes, you know, the accessories and trinkets that you can buy in our stores, all frankly online, those are typically not real strong sellers for us. And what we found this quarter is those type items as well as, you know, performance related items, hobby related items, items, you know, people are tuning up, you know, there are hot rods, there are street rods, the cars that may have been covered up in the backyard or in the garage for a number of years. And we've seen, you know, a spike in sales in some of those categories that are typical, typically maybe average performing categories. And we, you know, we think part of the reason for that is just, you know, consumers, they have more time and in a lot of cases they have more discretionary money to spend because they're not doing a lot of the peripheral family activities that they might have done in prior years because of closures, you know, sporting events not taking place, things like that. Tom, did you want to

add? Matt, what I'd add to that is we saw strength across all our categories. We spoke to that particular set of categories because it acted unusually for what we usually see in downturns as Craig talked about. When we look at downturns, we look at people deferring new vehicle purchases, and when we look historically what we see is people catching up on unperformed or underperformed maintenance. And that was the biggest driver, we feel like, in the health performance for the quarter.

Thanks for that commentary. But try to take this to a step further, and I don't want to take away from the outstanding performance you did this quarter. But as we look to next year, and not trying to get ahead of ourselves, but how do you think about growth on top of the growth that you've seen this year just because we've never seen anything really like this in history. So just anything you can say to people who are trying to think about next year and what the growth, the compare this year means for next year. Thanks.

You know, Matt, I think you hit the nail on the head there. This is an unprecedented time, and the results are quite dramatic how they've turned around. We've got a lot of water to go under the bridge, and we're still in the middle of this pandemic. So for us to speculate on next year I think would not be appropriate at this time.

Thanks. I really appreciate the color. Congrats, guys. Great job.

Thanks, Matt. Our next question is from the line of Liz Suzuki with Bank of America. Your line is open.

Great. Thank you. Could you just go through some of the puts and takes on where you expect SG&A dollar growth to run year over year in the next two quarters, and just whether any of the reductions that were made in March and April can be maintained as you kind of get back to the normal run rate of SG&A as a percent of sales?

We know that we ran a very skinny SG&A and deferred some of the work we need to do in the stores in the second quarter just to take care of customers. So we anticipate that we'll ramp up our staffing to meet the demand. Obviously we've pared back our staffing significantly based on a negative 13% comp that thankfully didn't persist. So we know we're going to have a higher SG&A spend. We're going to continue to detail, manage that on a -to-day basis. And the biggest discretionary item for us is store payroll, and I'll let Jeff speak to that. Well, there again, we've always managed our payroll one store at a time. And we always really try to do our best to tie our staffing levels to what our business is doing. And when the pandemic hit and we had the drastic drop in volume in mid-March that persisted for a few weeks, we obviously had to react to that and adjust our payroll accordingly, as we always would in seasonal downturns or things like that. I mean, this was more dramatic than we normally see. So we obviously implemented the procedures that we have in place to manage our payroll, starting with hiring freeze and just not hiring. And then adjusting hours based on the demand in the store, adjusting part-time hours, reducing overtime, transferring people between stores, all the things that we would normally do to manage our payroll appropriately for the volume of the business.

Liz, to add a little bit more color to what Jeff's saying, I think we've run our stores just on a very, very tight budget, you know, the last several weeks. And we have got to get back, as Jeff said in his prepared comments, to some of the fundamentals on store appearance and some of the things that frankly have suffered over the past few weeks. So we're going to have to put some more SG&A dollars back into the stores. We've already started that, you know, to make sure that our stores' appearance and the customer experience is as high as it ever has been.

Great. And just one follow-up on investments in labor and in the stores. I mean, it's still early in election season, but there are some policies getting more airtime than others, one of which is a potential increase in the corporate tax rate. So back in 2017-18 when the Tax Cuts and Jobs Act went into effect, O'Reilly invested a lot of those tax savings into wages and technology. But if the tax rate goes up, do you think there are areas where the company can make some reductions or cuts to mitigate those effects?

Liz, what we would tell you is on a -over-year basis, we do our best to create an environment that's a model in a company that can increase operating profit dollars year after year, which is what we've done. To the extent that the tax system changes, that's out of our control. And we need to be focused on how we continue to generate increasing operating profit dollars.

Thanks very much. Thank you. Our next question comes from the line of Brett Jordan with Jeffery. Your line is open.

Hey, good morning, guys. Morning. On the share gain, I guess you've talked about potentially having taken some share from big box retailers or other smaller competitors. Could you maybe bucket what you think, who you think the bigger donors were, and obviously a lot of stress for smaller parts distributors during the quarter. Do you think we've seen any real change in the population of some of those smaller players?

You know, I don't think we've seen a lot of change yet on the parts store side or the professional installer side of our business. We've seen a little bit, but nothing material. As far as market share gain, you know, Brett, it's really hard to say until the next few weeks when we see what all of our competitors report. It's hard to tell what their sales look like. We know our sales were strong. We're very, very pleased with the performance of our store and DC teams to drive the results that we drove this quarter. We feel like we've taken some market share, but we won't know for sure until we see the earnings releases. You know, when you look at big box specifically, you know, that comment is centered around, you know, myself and others have seen, you know, a lot of product outages, not necessarily only in the auto parts sector, but just the big box and the pure e-commerce players have struggled somewhat over the past several weeks due to the pandemic. And they've had challenges staying in an in-stock position. And we're very, very proud of, you know, our supply chain because we've been able to maintain an in-stock position both for our brick and mortar and our online customers. And we've seen some shift. You know, it's no secret that our e-commerce business, our online business has improved through this pandemic as it has for most retailers. But the trend has continued that the majority of that volume continues to end up in our store, either in a pickup in store, shift to store, or curbside pickup that we've implemented. So I think that a lot of consumers have regained confidence in some of the brick and mortar players, especially those that have strength in their supply chain and have performed really well through the pandemic.

Okay. Well, my second question was online, so you already answered it. So my second question is going to be regional performance. I guess, you know, could you give us a feeling for the spread between the weakest markets and the strongest markets and where they were?

Yeah,

Jeff, do you want to take that one? Yeah. I mean, really, you know, the COVID pandemic has impacted us in every market across the country. And, you know, as we talked about in the prepared comments, I mean, we saw pressure across the entire chain starting in mid-March and it persisted for several weeks. But then when the stimulus check started in there in the third week of April, I mean, we've seen that dramatic uptick in our business, really, all across the country and in all markets. And, you know, it really exceeded our expectations on both sides of the business. And as we've mentioned several times in our prepared comments, I mean, demand's one thing, but we're extremely proud of the way our team members have really stepped up to the plate and taking care of our customers, satisfying their needs, you know, through these challenging times.

Great. Thank you very much.

Thanks,

bro.

Thank you. And our next question comes from the line of Chris Horvitz with JPMorgan. Your line is open.

Thanks. Good morning, guys. So my question has to do with commercial versus DIY. You talk about robust trends in May and June in the commercial side of the business. Can you maybe define what exactly robust is and can you also talk about, you know, have a gap between DIY and Do It For Me evolved over the months of the quarter and if you could into July? Thank you.

Yeah, we're not going to break out, you know, the numbers between DIY and DIFM. What I would tell you is, as we said in our prepared comments and on our prior call, I think everyone realizes that April started out really slow and as the government subsidies kicked in, I would say that the DIY side of our business ramped up much more quickly than the DIFM side of our business. I would tell you that for April, May and June, overall, we cop positive in all three months with May and June being stronger of the three months and those trends have continued into July.

But presumably, did the gap between commercial and DIY narrow into June? It doesn't sound like DIY, commercial ever exceeded DIY over the quarter.

So, yeah, the DIY side of the business was the bigger contributor to our comps. The DIY business really took off as soon as the stimulus checks started. The professional business really didn't start to turn around in a dramatic fashion until the stay at home orders started to lift. So inherently, there was a narrowing of those two throughout the quarter, but both remain very strong.

Understood. And then a follow up on the gross margin. You mentioned some comments around the benefits of the tariff price increases being fully baked in through 2Q and potential headwinds ahead on LIFO. So, extra potential leverage from very strong comp trends in the cost of goods line. How are you thinking about those other components? Do you expect them to be a net headwind in the back half of the year?

Well, that will depend on what happens with pricing. We're always trying to reduce our acquisition costs through scale and sourcing and to some extent private label. So that will be pending. When we look at the second quarter itself, when we looked at our plan, we were anticipating continuing

to

get a LIFO benefit in the second quarter. But because of negotiated price decreases, we actually offset that and had a headwind. So that was a headwind to margin for the quarter, but with an annuity attached to it as we have lower acquisition costs. Otherwise, we would have had a higher year over year improvement in gross margin driven by the higher DIY mix and the leverage on the distribution costs. When we look forward, we would anticipate pricing acquisition prices to be relatively stable through the end of the year. And our expected plan benefit was less as we theoretically sold through the pre-tariff goods. So we'd expect to be relatively neutral for the remainder of the year.

Thanks, guys. Best of luck.

Thank you.

Thank you. Our next question is from the line of Sidney and Guttman with Morgan Stain. Your line is open.

Hey, good morning, everyone. I wanted to ask on the DIFM side, it sounds like, and I'm going to put words out there, it sounds like you're running double digit. Do you have a sense, you know, where the market's running and how much market share you're taking in that channel?

That's difficult to say, as Greg mentioned earlier, you know, our competitors haven't reported, although I guess one's reporting now. We're out on the street calling on customers, trying to take care of our customers, you know, when the market is difficult. And as Greg talked about, the strength of our supply chain, and we're able to provide parts that then shops normal. Supplier can't come up with that benefit for us and ability to get our foot in the door and build long term strength. We're happy with our business is trending. We continue to call in our shots in a very safe way with the safety protocols and then try to help them through this, which has been a difficult environment for them also. I would just add to Tom's comments on really the strength of the supply chain availability. As you know, availability is key to, you know, to grow in a professional business. And, you know, we've always prided ourselves, you know, in our service levels, a big part of that being availability. And, you know, when you have the part on the shelf and maybe somebody else doesn't that maybe was a primary supplier, you could move up in the call list in that shop.

Yep. Nope, that makes sense. I think it's important in that, right, miles driven is down a lot and understanding, let's say, where you're running versus the industry. Maybe could tell you how sustainable things may be. And that leads into my next question, which is, you mentioned you're cautious for the rest of the year. And it does seem like you exited about the same level. It seems like double digits in both sides of your business. And so I'm curious if the cautiousness is, look, we just don't know what we're going to get in terms of stimulus. Because in theory, if we do that, that should continue some of the momentum and maybe it depends up the man side, which is harder to understand how that flows through. So I just want to connect the dots on the cautious comments despite exiting on your strength.

Yes. I mean, you know, one thing that is for sure is the trends we're seeing won't last forever. We know this is not typical. It's a unique time for the world right now. And it's not going to last forever. You know, if you look at this on, you talk about miles driven and will it persist. If you break that down to short term and long term, my opinion on that is long term, I think miles driven will come back. I think people will drive their cars more miles again as they've done in the past. I think there's a lot of consumers that are still concerned about mass transit systems from a health and safety perspective. You read about more and more people moving to the suburbs and out of the major cities, which is better for miles driven, you know, more automobile traffic, less mass transit. So I think all those things long term will support growth in miles driven. The caveat to that is from a short term perspective, none of us know what's going to happen with stimulus. None of us know if there will be another round of shelter at home orders in some of these markets. All of those things would potentially negatively impact miles driven for the short term. So because of the degree of uncertainty with all that, that's the reason for our cautiousness in calling that out in our prepared comments.

Okay. Thanks, Greg. Good luck.

Our next question is from Seth Sigmund with CreativeSwift. Your line is open.

Hey, guys. Good morning. I wanted to follow up on commercial and wondering if you'd talk about what you're seeing across your commercial customer base. So I think many of them were essential, but I'm sure there was some disruption over the last few months as well. In some cases, furloughs and in some cases now labor shortages. So I'm just curious, what are you seeing? Is that a limiting factor at all on the commercial side? I'd just love to get your thoughts on that.

Yeah, that's Jeff. I'll speak to that one. You know, no doubt it was early on when the pandemic broke out and all the shelter in place, orders were in place. I mean, there were shops that reduced hours, there were some shops and some of the markets that actually closed during that period. And obviously there's been a shortage of techs in some shops. But it seems like, you know, I guess this is kind of a broad statement that that has rebounded coming into May and June. Now, you know, with these new outbreaks, COVID outbreaks in several states, we are hearing some comments about maybe some shops have slowed back down just a little bit from where they were when it kind of opened back up.

And on essential, you know, we worked with a lot of industry organizations early on to ensure that most, if not all markets would make sure that auto parts supply and repair remained essential.

Got it. And then just to follow up on that point around the shops and what's happening now, are there signs of moderating growth in markets where COVID is picking up now?

It seems like it's spotty. I mean, we're here from a few places where it seems like maybe the shops have slowed down just a little bit.

And again, it goes back to the comment I said before. I've heard this multiple times from our sales teams. As some of these shops are saying in those markets, I think there's still some degree of concern for safety with taking your car to a shop, perhaps for some of the tasks that you might want to tackle at home. Oil changes, breaks, things like that, where you may have traditionally taken that car to a shop for those jobs. Now you've got more time to perform those tasks and you're just not totally comfortable yet dropping that car off and having someone you don't know inside your car from a safety perspective. I think there's still some degree of concern there.

Got it. All right. Thanks, guys. Good luck.

Thank you.

Thank you. And our next question is from Michael Laster with UBS. Good morning.

Thanks a lot for taking my question. So based on those comments, has your DIFM business in July slowed relative to where it was running in June?

We're not going to comment on three weeks within the quarter, Michael. Okay.

And Tom, if you were to take what you've seen from a category perspective and overlay it with 2008, 2009, does it look identical, suggesting that that period is a good parallel for how to think about demand for the aftermarket from here? Or are there any major differences?

Well, Greg commented in the prepared comments in the reason we brought out appearance and appearance type products is that's very unusual compared to 2008, 2009. Appearance and performance and all of those

more

discretionary categories in 2008 took a big hit and maintenance and failure parts went up quite a bit. So that's different this time. I think it has to do with the stimulus and the people staying at home.

Right. I mean, if you look back at eight and nine, we saw consumers extending service intervals, delaying some of these repairs that they could. You know, we haven't seen the same thing this time around.

So based on those comments, would you consider this to be more temporary whereas 2008, 2009 was a longer lasting tailwind at the sector experience?

That's a great question. And I wish we had a great answer for that. You know, with the uncertainty of where this pandemic goes from here, it's really difficult to answer that,

Michael. Michael, what we would point you to, though, is the magnitude of the pickup in this particular economic downturn is significantly more and more immediate than 2008, 2009.

Understood. Thank you very much and good luck. Thank you. Thank you.

Our next question comes from the line of Scott Ciccarelli with RBC Capital Markets. Your line is open.

Good morning, guys. So you talked about adding SG&A back into the stores and obviously headcount is down quite a bit. So first, do you guys have a target you're thinking about from an SG&A per store growth perspective? And then kind of related to that, do you plan on bringing back some of those same employees? Were any of them furloughed or do you kind of have to start fresh and go out and hire and train people? And obviously that takes a while to kind of ramp them up on a productivity basis.

Yeah, Scott, I'll start with that. Tom might want to chime in. But, you know, obviously on the average SG&A per store, I would think that as we talk about prepared comments, we would move back toward what we stated as our goal early in the year. We've already – I mean, there again, we're talking about something that happened 90 days ago. And when the pandemic hit and the business took a dramatic downturn, we had to react to that. And we had to adjust our staffing by store to what the sales demand was. And we've been cautious. You know, as businesses ran back up, we had no idea how long this would last. And it's really uncertain times. And as we've seen, you know, week by week, as we've seen the business, the demand continue to stay in place, we've ramped back up our staffing accordingly. No doubt, you know, maybe not as much headcount as we normally put in, knowing that this is unsustainable, as Greg mentioned. And we've leveraged over time things like that to maybe compensate for headcount. But, you know, we'll always – we've always managed our business for the long run and staffed, you know, to provide the customer service that's going to grow our business and build those relationships. And we'll continue to do that.

You know, Scott, the other thing, this is Greg. You know, I think sometimes we tend to underestimate the task at hand here. When you look at our stores that are operating shorthanded and delivering the sales volumes they are, it just speaks to the professionalism in our stores. And that's what we've built our success on. And so we've got the same situation in our distribution centers. Our distribution centers are operating shorthanded. They're working long hours. They're working weekends in a lot of cases to keep up with demand in our stores. And, you know, that's just not sustainable long term. We've got to put some more labor dollars back into our stores and DCs.

And Scott, I think to address the other part of your question, you know, our intent is to focus on professional parts people that are full time and bring back the right people. If we look at the employment environment pre-COVID, unemployment was extremely low, much higher now. And we're going to be very selective in who we bring back or who we hire to make sure that we're building the core full time professional parts people we need to win business.

Got it. Very helpful. Thanks, guys.

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, Bridget. We'd like to conclude our call today by thanking the entire O'Reilly team for their continued selfless dedication to our customers. I'd like to thank everyone for joining the call today, and we look forward to reporting our third quarter results in October. Thank you.

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