O'Reilly Automotive, Inc.

Welcome to the O'Reilly Automotive Incorporated third quarter 2021 earnings conference call. My name is Adrienne and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question and answer session. During the question and answer session, if you have a question, please press star then one on your touchtone phone. I'll now turn the call over to Tom McFall. Tom McFall, you may begin.

Thank you, Adrienne. Good morning, everyone, and thank you for joining us. During today's conference call, we'll discuss our third quarter 2021 results and our updated outlook for the full year. 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 10-K for the year ended December 31, 2020, and other recent SEC filings. The company assumes no obligation to update any forward-looking statements made during this call. At this time, I'd like to introduce Craig 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 Brad Beckham, our Executive Vice President of Store Operations and Sales, and Tom McFall, our Chief Financial Officer. Greg Hensley, our Executive Chairman. David O'Reilly, our executive vice chairman, and Jeff Schall, our chief operating officer and co-president, are also present on the call. As we announced on last quarter's call, Brad will be providing prepared comments today on today's call and Jeff's normal spot as we anticipate and prepare for Jeff's upcoming retirement in early 2022 after more than 33 years of distinguished and dedicated service to the company. It's my pleasure to congratulate Team O'Reilly on yet another incredible performance in the third quarter and to thank every member of our team for their unwavering commitment to our company and to our customers. The highlights of our third quarter results include a 6.7% increase in comparable store sales on top of an impressive 16.9% increase in the third quarter of last year and a 14% increase in diluted earnings per share which is all the more impressive considering we grew EPS 39% in the third quarter last year. We'll walk through the details of our performance and our prepared comments today, but I don't want to miss an opportunity at the beginning of the call to express my sincere gratitude to our team for their relentless hard work and dedication as we continue to weather the pandemic. Our team has been incredibly resilient to the challenges we've faced over the last year and a half, and it would be very easy to take this for granted, their ability to respond so well to this difficult environment. This is especially true since our team has been able to deliver quarter after quarter of record-breaking results. I can assure you it has been anything but easy, and our track record of consistency doesn't diminish the massive undertaking by Team O'Reilly to protect our customers and fellow team members while driving the highest sales and transaction volumes in the history of our company. So thank you, Team O'Reilly, for your outstanding performance in the third quarter. I'd now like to take a few minutes and provide some color around our sales performance for the quarter. Our comparable store sales performance has continued to track well ahead of our expectations, and we've been very pleased with both the consistency and broad-based nature of the strength of our top line. From a cadence perspective, our sales results were fairly consistent throughout the quarter with solid positive comparable store sales growth each month. September was the strongest month of the quarter, but the variability from month to month throughout the quarter was not significant on a two or three year stack basis. These very steady elevated sales levels continued the trend we drove in the second quarter despite not having a tailwind from government stimulus payments we saw in previous quarters. This top line sales strength has continued thus far in October, and we continue to be pleased with the durable nature of the strong sales volumes we've been able to achieve. The components of our comparable store sales growth in the third quarter are consistent with our second quarter results, with strong growth on the professional side of our business paired with solid growth from DIY. While our professional business faced easier comparisons from the prior year than the DIY business, we were still up against a challenging comparison and are very pleased with our team's ability to drive historically strong comparable store sales on a one and two year stack basis. We also continue to be very happy with the performance of our DIY business as this side drove the greater outperformance as compared to our expectations against extremely difficult compares in the prior year. Total ticket count comp for the third quarter were better than our expectations but slightly negative as a result of pressure to DIY transaction counts due to the difficult comparisons and rising prices, which were partially offset by the growth in professional ticket counts. On last quarter's call, we commented that we expected to see incremental, I'm sorry, we expected to see increased inflation in the back half of the year. However, third quarter inflation was even higher than our expectations. Our third quarter average ticket increase was aided by an increase in same skew selling prices of approximately five and a half percent as acquisition cost increases were passed along in selling price. As price levels have risen in the broader economy, demand in our industry has been resilient and we continue to see strength in average ticket on a one and two year stack basis beyond the impact of same skew inflation. However, We remain cautious in regard to our inflation outlook as we would expect some partial offsets to the same skew benefit as continued rising prices may cause more economically challenged customers to defer non-critical maintenance or trade down the product value spectrum. Finally, we drove solid sales volumes across all of our product categories with especially strong performance in undercar hard part categories, offsetting some of the pressure in appearance and accessory categories which are up against extremely strong comparisons after growing at historically high levels in 2020. On a year-to-date basis for the first nine months of 2021, our comparable store sales growth of 12.9% and our two-year stock comp of 23.6% were well above our expectations coming into this year. As the pandemic recovery has progressed, we've remained cautious as to the lasting effect of demand tailwinds our industry has experienced and candidly had anticipated more moderation off the historically high growth rates we generated in 2020. Each month as we move further past the significant government stimulus and enhanced unemployment benefits, the stability of demand in our business is very encouraging and reflects the continued willingness for consumers to invest in repairing and maintaining their vehicles in the face of an overall shortage of new and used vehicles and continued economic uncertainty. Similarly, we believe our strength of our professional business reflects the return to more daily commutes for many of the vehicle owners who professional customers serve. And we expect the gradual improvement in miles driven trends to continue and provide a benefit to the aftermarket as the recovery moves forward. Beyond the macroeconomic tailwinds in our industry, It is also clear to us that we are taking share and capitalizing on the opportunities to meet our customer needs in a very challenging environment. As we discussed in our earnings release yesterday, we are increasing our full-year comparable store sales guidance to a range of 10 to 12% from our previous range of 5 to 7%. This increase reflects our year-to-date performance through our press release and also anticipates solid business trends through the end of the year. As I've already indicated, we've seen a high degree of consistency in our top line sales volume for several months now, and we feel it appropriate to revise our expectations as we near the completion of the fiscal year. However, the fourth quarter can be a volatile period, especially in light of possible further impacts from the pandemic, rising price levels, variability in winter weather and the holiday shopping season, and potential economic shock from the higher gas prices. Now I'd like to move on to the gross margin performance for the quarter. Our third quarter gross margin of 52.3 was a 13 basis point decrease from our third quarter 2020 gross margin and was in line with our expectations we discussed on the second quarter call. While the stronger performance of our professional business put mixed pressure on the gross margin percentage, I want to spend a little time walking through two other dynamics that drove our gross margin results. First, we have seen higher than normal broad-based increases in acquisition and input costs in our industry. One of the defining features of the automotive aftermarket throughout our history is the ability of the industry to leverage pricing power to pass through cost increases to end-user consumers with minimal impact to demand due to the essential nondiscretionary nature of the products we sell. The cost increases we've seen during the current inflationary environment represent broader-based inflation than we've seen for some time. However, we did see significant inflation during 2018 and 2019 on certain product lines caused by tariffs. Consistent with the 2018-2019 time period, we've continued to see rational pricing in our industry and are very confident this will continue moving forward. Our pricing philosophy over time is to attempt to achieve consistent gross margin rates as a percentage of sales and higher gross profit dollars in line with the sales growth, which serves to offset similar cost pressures and SG&A expenses. However, as we've discussed in the past, similar to the 2018-2019 period of rising acquisition costs, we are currently benefiting from an enhanced gross margins as a result of increased prices on the sell-through of products purchased prior to the cost increases. The second gross margin dynamic I want to discuss today is the continued pressure we're seeing on distribution costs. As we discussed on last quarter's call, our distribution infrastructure is facing inefficiencies due to the massive sales spikes over the past six quarters, the difficult labor environment, and global logistics challenges. We operate a high service, high touch distribution model, and we are fully committed to protecting and enhancing our competitive advantage in industry leading parts availability. Our dedicated supplier partners, corporate supply chain team, and extraordinarily hardworking distribution team members continue to do an amazing job navigating one of the most challenging supply chain environments we've seen in our careers. And we have taken specific targeted steps and incurred incremental expense to respond to the hurdles we're facing. Ultimately, we do believe these pressures will abate and conditions will normalize and be more conducive to driving appropriate leverage of our distribution cost. But we'll continue to prioritize inventory availability and take necessary steps to ensure excellent customer service, which is a fundamental driver of our long-term success. As the result of these puts and takes, we are maintaining our gross margin guidance of 52.2% to 52.7% for the full year, but would now anticipate finishing the year in the bottom half of that range. Before handing the call off to Brad, I'd like to highlight our third quarter earnings per share increase of 14% to $8.07 with a year-to-date increase of 29% to $23.45. Our third quarter EPS growth comes on top of our growth of 39% in the third quarter of 2020 resulting in a two-year compounded quarterly growth rate of 26%. We're raising our full year earnings per share guidance to $29.25 to $29.45, which at the midpoint now represents an increase of 25% compared to 2020 and a two year compounded annual growth rate of 28%. This increase in full year guidance is driven by our strong year to date results, updated sales expectations for the remainder of 2021, an excellent operating profit flow-through, which Brad will provide more detail on shortly. As a reminder, our EPS guidance includes the impact of shares repurchased through this call, but does not include any additional share repurchases. To conclude my comments, I want to again thank Team O'Reilly for their tremendous hard work and dedication to living our culture and taking care of our customers every day. I'll now turn the call over to Brad Beckham. Brad?