Welcome to the O'Reilly Automotive Incorporated Fourth Quarter and Full Year 2018 Earnings Conference Call. My name is Vanessa, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we'll conduct a 30-minute question-and-answer session. [Operator Instructions] Please note, that this conference is being recorded. And I will now turn the call over to your host, Tom McFall. Mr. McFall, you may begin.

Thank you, Vanessa. Good morning, everyone, and thank you for joining us. During today's conference call, we'll discuss our fourth quarter 2018 results and our outlook for the first 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 estimates, 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, 2017, 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 O'Reilly Auto Parts fourth quarter conference call. Participating on the call with me this morning are Jeff Shaw, our Chief Operating Officer and Co-President; and Tom McFall, our Chief Financial Officer. David O'Reilly, our Executive Chairman; and Greg Henslee, our Executive Vice Chairman are also present. To begin today's call, I would like to recognize the hard work and commitment of all of our team members throughout 2018. Your commitment to our dual market strategy and the O'Reilly culture values drove a 3.8% comparable store sales growth which was at the top end of our annual guidance range of 2% to 4% which we set at the beginning of the year. Your dedication to exceptional customer service and the expense control yielded a total sales increase of 6.2% over the prior year, and an operating profit of 19% which was also at the top end of our annual guidance range. For the year we generated our 26th consecutive year of comparable sales growth, record revenue and operating income every year since becoming a public company in 1993; and I would like to thank Team O'Reilly for many contributions to support our growth and success in 2018. Now we'll cover our fourth quarter results and key expectations supporting our 2019 guidance. Our comparable sales for the fourth quarter grew 3.3% which is in line with our expectations. From a comp store sales progression standpoint October and November were strong with December being weaker and slightly negative. The December results fell short of our expectations due in part to seasonal business that was put forward into November as we experienced cold weather earlier in the quarter in 2018 than the prior year coupled with a lack of harsh weather in December which we were…

Thanks Greg, and good morning, everyone. I'd also like to thank team O'Reilly for delivering another record breaking year. Your commitment to consistent, excellent customer service has always been the strength of our company and will continue to be our strength in the future. At the beginning of the year, we plan to reinvest a portion of our savings from the Tax Cuts and Jobs Act back into the business with a target of 70 basis points of additional SG&A spend. We successfully executed on that plan and through solid expense control and better leverage from a solid 6.2% increase in sales, our SG&A only delevered 46 basis points coming in at 33.8% of sales for the year. For the full year, SG&A per store increased 3.4%, which was near the top end of our beginning of the year guidance of 3% to 3.5% of sales and is consistent with what we would expect with comparable sales at the higher end of our guidance range. The increase is primarily attributable to variable expenses and variable compensation at virtually every level of the company, as we structure our pay plans for our team members to run it like they own it. For 2019, we're expecting SG&A to continue to grow at a rate higher than our historical norms of 1.5% to 2%. Looking at our 2019 SG&A spend, we expect to continue to aggressively pursue our in-store in omnichannel goals and anticipate continued pressure to variable costs, especially payroll from the current inflationary environment and record low unemployment rates, which we expect to partially offset by better leverage on our fixed cost. As a result, we are establishing our initial SG&A guidance at a 2.5% to 3% increase per store. For the year, we successfully achieve our goal of opening 200…

Thanks, Jeff. Now, we'll take a closer look at our quarterly results and our guidance for 2019. For the quarter, sales increased to $124 million, comprised $71 million increase in comp store sales, a $50 million increase in non-comp store sales, a $6 million increase in non-comp non-store sales and a $3 million decrease from closed stores. For 2019, we expect our total revenues to be between $10 billion and $10.3 billion. Our gross margin was up 41 basis points for the quarter, as we experienced stable merchandise margins and benefited from the LIFO comparison to the prior year. We did not see a LIFO charge during the quarter versus a $3 million charge last year. For the full year, we did not experience a LIFO charge versus a $22 million charge in the prior year. For 2019, we do not anticipate a LIFO charge, as we expect inflation will continue to put upward pressure on aggregate acquisition costs. On a year-over-year basis, we expect gross margins for the first two quarters of the year to see the largest improvement, as we receive a benefit from selling through the on-hand inventory that was purchased prior to the recent tariffs -- tariff-driven acquisition price increases and corresponding retail and wholesale price increases. Our fourth quarter effective tax rate was 23.6% of pre-tax income and was comprised of a base rate of 24%, reduced by a 0.4% benefit from share-based compensation. This compares to the fourth quarter of 2017 rate of 19.8% of pre-tax income, which was comprised of the base tax rate of 37.4%, reduced by a 3.5% benefit for share-based compensation, and a benefit of 14.1% or $53 million related to the initial measurement --remeasurement of our federal deferred tax liability, from a tax rate of 35%, down to the…

And thank you. We will now open the question-and-answer session. [Operator Instructions] Our first question from Christopher Horvers with JPMorgan.

Can you talk a little bit about the regional performance that you saw during the quarter. How does that compare to earlier than -- earlier in the year? And related to that, can you expand upon your quarter-to-date comments? Obviously, a lot of variability around the winter some tough compares, but overall, what are you seeing quarter-to-date, and how would you assess the winter so far compared to sort of history in last year?

Yes, this is Jeff, and I'll take the first half of that and then flip it over to Tom and Greg. As far as regional performance, really our regional performance was in line with our expectations and pretty solid across the majority of the country that the central part of the country was a little bit softer than the rest, really due to just lack of winter weather in a lot of those markets. And also we had a little bit of headwind down south from the post hurricane numbers we compare against.

So Chris, from a from a cadence standpoint, although we don't disclose what our actual comp numbers or trends are on a month-by-month basis, what I would tell you is, we feel good about our three to five guide. We've talked about December being the softest month of the quarter and as we moved into 2019, we've seen a more typical weather pattern. We would view this winter as a more normal winter. We've had ups and downs. We've had spikes along the way in different areas of the country and as normal, where we have those spikes, we have improved sales related to the winter weather spikes. But, overall we feel, we continue to feel good about our three to five guide for the quarter.

And then as my follow-up, can you -- Tom, can you remind us of what the inflation was for in totality for 2018? I think you mentioned 2% in the fourth quarter, what was that over the year and how are you thinking about the overall inflationary environment in 2019? Thanks very much.

It ramped up through 2018. No significant numbers in the first and second quarter. So, we ramped up to 1% and 1.5% in the third quarter and 2%. So, I'd say a little above 1% in total. When we look at 2019 and Greg's prepared comments, our expectation is, we're going to see a similar number that we saw in the fourth quarter, which was 2%.

We have our next question from Seth Sigman with Credit Suisse.

I wanted to follow-up on that inflation point. So, the 200 basis points of same SKU inflation that you're expecting in '19. Just to clarify, is that, that's the net impact on comps, or so in other words, are you considering the volume offsets within that as well?

So, that would be our expectation for what's going to drive our total inflation number that goes into our average ticket, as we've seen over the last 10 or 15 years of the new model years roll on. They have more expensive parts primarily based on technology that's in those parts and that's been a tailwind to average ticket over the last decade. We think that's going to be augmented by 2% in totality in 2019.

And then on the DIY trends, you've talked about that for a couple of quarters now, some level of caution around the DIY business, suggesting that maybe the consumers have been deferring maintenance. Any signs that, that may be starting to normalize? If you give us some more color on what you think is driving that deferral, and what needs to happen for that to change? That would be helpful. Thank you.

Yes, I think a big part of -- we talked last year about fuel prices maybe impacting discretionary spending. This year, we're cautious that inflation may again have an impact on discretionary spending for that lower income DIY customer. That customer would have to make necessary repairs to keep their car running, to get them into work, to the grocery store and what have you. But from a discretionary standpoint, when you get to items like routine maintenance, deferring oil changes, longer extended oil change periods, those things you can push out a little longer, filters things like that and your car still runs fine. You're just not following the manufacturer's recommended schedules for doing that. So, I think the DIY customers that are on the lower end of the wage scale and are more economically challenged, as we said, they're going to have to make those breakage related repairs. But some of those repairs and maintenance things that are somewhat discretionary, they're going to be likely to push those off.

Our next question comes from Elizabeth Suzuki with Bank of America.

Throughout 2018, you guys have guided to comps 2% to 4%, now you're looking for '19 at 3% to 5%. Given that we still have a fair amount of winter left, which could either end up being favorable or unfavorable versus last year's normal winter, and you mentioned that you think this year is looking fairly normal as well. And what are the other factors that are really driving the outlook for an acceleration and comps?

Yes, a lot of the things we talked about Liz, it's you know, we fuel cost has come down over the past several weeks. And I think the expectation is that fuel prices will continue to be lower this year than prior year and that will be supportive of increasing miles driven. Just we look at the whole industry backdrop, the fact that employment rates are higher, the economies more stable. Those things it just these created an industry backdrop that's more favorable and you add that to Tom's point about average ticket growing because of a combination of parts complexity, the cost of the more technology related parts on newer cars and the inflation tailwind we had. We felt good about three to five guide. One of the things, I would add to that, and it's not really related to the guide, but it sure makes us feel a lot better about, where we are. We had our annual Leadership Conference in Dallas back in mid-January and in that conference, we had about 6900 O'Reilly team members, all of our store managers, district managers, regional managers were there. And we do that every year, but it sure felt different, going into conference this year than it has the past year or two because there was just a lot of excitement, a lot of positive attitudes coming from our store managers when they got there and we really focused that week on, on things like ownership, running the business like you own it. We talked about commitment of running and driving a profitable business. We talked about customer service. And our team is left that conference really motivated and we feel like that they're out there on the streets, driving sales and providing even a higher level of customer service than they may have done last year.

So, in an environment that where the industry is potentially growing kind of mid-single digits, as it usually does like 2% to 3%, or maybe a little bit better. Do you feel like you can continue to gain market share in 2019?

Yes, we do. I mean that again to Greg's point, I mean, our philosophy, our business model, our strategic distribution network, I mean, our programs, I mean, we are our teams with a lot of tools, what happens one customer and one store at a time and we're focused on fundamental execution on both the do-it-for-me and the DIY side each and every day in each one of our markets.

Our next question is from Simeon Gutman with Morgan Stanley.

Tom, I wanted to ask you first about the flow through. And so in the past, when you guided you typically allowed sales to what drives the upside, or downside to your forecast. And I want to ask you about 2019, if there's any greater likelihood that margins could surprise, or it's really dictated by where you end up with net sales guidance?

As a multi-unit retailer relatively high fixed cost because of the service component of our business, sales will be the key to leveraging operating profit performance to the extent that those sales don't come in as high as we'd like. We have levers to pull. Although we won't do anything in the short term that will impact long-term relationships. And on the upside, we'll continue to -- we'll see leverage, but we want to make sure that if the demand is there, we're providing the level of customer service that builds those long-term relationships.

And then secondly for Greg; I wanted to ask about map or whatever they call eMRP pricing that's out there. We're hearing from more brands that or some even distributors that more brands are going toward this direction, basically controlling price. Curious if you've seen that to sort of what's changing, and I guess did that price discipline being shown across different channels, where we're just not seeing is, I don't know bigger as problematic pricing differences as there could be?

Yes, I mean, one of our -- one of our suppliers half bunch of suppliers for couple of years now has been for them to protect their brand and control their pricing online. And there were a couple of suppliers, a couple of years ago in 2017, that they really pioneered this for the industry and we really had a slow start to get other suppliers to come onboard. So, late 2018, we had two or three major suppliers come onboard and so far in 2019, we've had several additional suppliers to commit. So, whether it's an eMRP pricing program, or a Matt pricing program, or unilateral pricing program, different suppliers have taken different approaches based on recommendations from their legal department or counsel. We are gaining some traction in that respect and I think, we'll see more tighter controls across the industry for online sales going forward.

Our next question comes from Bret Jordan with Jefferies.

On pricing, I guess as you get other brick and mortar shops, are you seeing any increased competition, I guess, anybody rather than passing through some of the inflation holding it, and trying to reduce pricing to get more commercial volume?

Well, I mean that's ongoing. I mean that's happened forever. I mean there's always been suppliers out there, when times get tough, they cut their prices a little, offer rebates, try to buy the business. That's normally a short-term strategy. I mean it's really, probably I've been in the business, it's been a service and relationship business. And you really build the business and keep the business through solid service, availability and then solid relationships, partnering with that shop to help them grow their business. But pricing comes and goes depending on how tough business is.

And then I guess within your omnichannel initiatives, you have any sort of data as far as maybe increase of buy online, pickup in store, where the trajectory is there, I mean, obviously you ramp it up?

Overall, it has increased significantly. I will tell you that from a breakout standpoint, ship-to-home, buy online, pickup in store, it fluctuates slightly, Bret. But we're staying right around that two-thirds of our online sales or pickup in store, which is where we want. We want to end up that customer inside our store, we can make sure that we provide the highest level of service and make sure they -- we have everything they knew to complete the job.

We have our next question from Michael Lasser with UBS.

So, as we think about modeling the course of your year, you're guiding 3 to 5, it sounds like the start of the year it has been good, in part because of inflation, progressively over the course of the year. The inflation repairs are getting it more difficult and you're going to no longer likely see the benefit of some of the tariff related price increases and probably have less visibility into the second half of the year. So, as we model the year should we take a more cautious view on the second half of the year, and along those lines, what happens if it -- how our models be affected if 25% tariff goes through?

Okay, Michael, this is Tom. What we would tell you that our comps will be relatively consistent on a quarter-by-quarter basis. On a year-over-year basis, as you pointed out, the first quarter will have the most inflationary benefit. We also have an extra Sunday here in the first quarter, which is a 50 bp headwind. When we look at the rest of the year, it should be relatively consistent, we pickup a Sunday in the third quarter and it was the fourth quarter, the ease going from a weekend to Monday, really were a big headwind for our business and that from a calendar standpoint, will help the fourth quarter. So, we look a pretty consistent comps throughout the quarter.

And on the 25% tariff?

I'm sorry. And your second question, Michael was --

On the 25% tariffs?

On the 25% tariffs. Yes, as Greg pointed out, our expectations are, we're going to be in the same state we are now for the year and obviously things have changed a lot. To the extent that we saw those additional tariffs go in March, we'll have to see how the market reacts. But our expectation is that we'll see a larger increase in average ticket, driven by those cost increases. And then offsetting pressure because of those rising prices on ticket count.

And if I could ask a follow-up on the SG&A in the investment side, this will be second in a year -- another year where SG&A per store growth is above what it's been historically. Is this a function of maybe the cost of doing business within the auto part retail sector becoming more expensive for whatever reason, more competition becoming more complicated, or is this just a catch-up from maybe some different investment philosophies in the past?

Well, I would point you back to our call this year -- last year this time and we talked about a rise in SG&A cost, as people reinvested, part of their savings from the new tax laws and that we would see those costs go up, but we wouldn't see a proportional increase in average ticket from inflation, on the top line. And at that time, we said when we look at next year, if we continue to see cost inflation and the expenses to run the business, we'd expect to feel that tailwind in our top line same SKU inflation and that's what we're seeing this year. Given that unemployment is very low, wages are growing up very quickly, costs are going up, interest rates are going up, we're seeing that inflation run through all our expenses and getting the top-line tailwinds. So, we don't think the business itself has changed, we think that we're just more in an inflationary environment than we've seen in the last five to eight years.

We have our next question from Chris Bottiglieri with Wolfe Research.

One quick follow-up and I got one bigger picture question. So, is there a way to walk us on the 10 point tariff to a 2 price increase. What percentage of SKUs were impacted, product costs, percentage of COGS or were the offsets are, maybe I just want to bridge there?

So, all of our products are produced overseas. It's a portion of them and even for some lines, some are here in the States and some are not. We're not going to get into breaking down the individual numbers. We push back on all the price increases we get, whether they're tariff related, interest rate related, healthcare related, raw commodity related, but that ends up being the blended number. And we didn't take full 10% increases on most of our products.

And then a bigger picture question was just from your distribution strategy. You talked about the super hub that you referenced after you consolidated the TDCs. The nomenclature though of our super hub, I think is different, not to be confused with your peers are doing to replace DCs with larger hubs stores. So, it's just like more equivalent to your master DCs or you just walk us through kind of what you're doing there would be helpful.

I mean, we basically have -- our spoke store, and then we have a hub store, that would be in the 45,000 SKU range and then we have super hubs, but we don't have DCs in a large metro market that would be in that 80,000, 90,000 SKU range and then our DCs would obviously have in that 160,000, 170,000 SKU range.

Yes, Chris, if I could, could add to that a little bit about why we're making that change. We are facing some pretty significant capacity issues in both Middle Tennessee or Nashville DCs located and our East Tennessee market in Knoxville. And we had to make a move and we decided to consolidate those two facilities into a much larger facility. That will allow DC to have a larger breadth of SKUs for the some of that customer base, but because that market in Knoxville is a market that's had a DC inventory presence for a number of years now, we wanted to supplement that markets for same-day service by converting that DC into a super hub and making sure that we maintain that same day parts availability in the Knoxville market.

Lastly, this is a one-off just specific to that market? Or do you foresee or envision creating more these super hubs throughout the country? Thank you.

We've always used to super hub strategy, but in the case of Knoxville, I mean Knoxville was just, it was no mid-stage DC and it just didn't -- it wasn't big enough to have the capacity that we needed to truly service that market.

Jeff, we got 340-ish hub stores and how many super hubs of those super hubs?

40 give or take.

We've got several on the markets right now.

Our next question is from Seth Basham with Wedbush Securities.

Thanks a lot, and good morning. My questions around the gap between DIY and pro-comps. Could you provide some color as to how that trended for each quarter through 2018 and how you're looking at that through 2019?

We've spoken to it on each quarter you can find that information. We don't give the actual number. What we would tell you is that, when we look at 2018, we've been pressured on the DIY customer count. Pro has grown each year -- each quarter. Average ticket is up on both and we'd expect that trend to continue in 2019.

But you don't expect that sales gap to widen between DIY and commercial in 2019?

We're anticipating a similar difference with professional business continuing to grow faster based on our ability to consolidate the market, based on that consumer being less impacted by general rising prices and based on other macro factors our business slightly aging population and more expensive repairs that are more technical in nature on late model vehicles being expensive.

And then secondly, looking at your CapEx budget for 2019, you provide some color on some of the things are driving the increase. Could you give a little bit more granularity, which are the factors DCs, new stores, IT projects, maintenance, are changing the most from 2018 to 2019?

Biggest changes are, number one is DCs and DC projects. Number two is in-store technology.

Our next question is from Matt McClintock with Barclays.

Yes, good morning everyone. In 26 years, it's just amazing. Congrats. I'd like to follow up on Michael's question a little bit maybe parse it out in a different way. Just the in-store and omnichannel investments in 2018 that you're continuing to do in 2019. I know you invest for long-term sustainable growth, but can you give us some sense of when the payback is on those investments are? When we should expect the payback on those investments, whether that be through increased sales, accelerating sales or margin or whatever the payback is? Thanks.

What we would tell you is that, most of these changes are just consumer expectations. Consumers shop outside of auto parts that many retailers and their expectation of what great services changes over time. And our job is to continue to make sure that our customer service levels are up there, to maintain our business. It's hard to parse out what that is from a sustaining standpoint versus additional business. It's part of the factors that go into customer service that drive our comps to be higher than the industry growth rates.

Yes, Matt, to add on to that, I'm not going to go into any details about what the initiatives are for competitive reasons. But from an omnichannel perspective, we're primarily focused on improving content, improving online search, improving -- customers buying decisions, whether they buy online, ship to home, buy online pickup in store or research online buy in store, a lot of those transactions and buying decisions are made based on research online. So, we're just focused on making sure that we are providing the highest level of searchability so to speak, for our products, for our customers and we think that's going to pay dividends long-term from a sales perspective. How we quantify that, it's very difficult to do.

All right, I understand that. And thanks for the color. And just on my follow-up, just the seasonal pull forward in November, were there any margin implications for the quarter from that?

No, there wouldn't be.

We have our next question from Scot Ciccarelli with RBC Capital Markets.

So, I'm curious, in your business plan for 2019, are you expecting any industry trend change based on the car park and tell me how are you thinking about the car park? It's obviously an investor topic, but as company operating in that industry, I'm curious, you know, how you guys thinking about it?

As the bubble year go through from the Great Recession, that's part of the reason that two years ago was kind of the biggest headwind for those year vehicles entering our sweet spot and kick that professional business more in 2018. That's part of the reason that it was more of a gap between the DIY and professional. We'd expect that, that will continue to, as that moves through to the older vehicle years that are much higher DIY to continue to, one be a positive on the professional side, because there is not the headwind and it will start to be more of a headwind on the DIY side.

And so, are you expecting those trends to become exaggerated in 2019? In other words, aren't there just more vehicles kind of coming into that repairs stage, and have you factored that into your expectations your 3 to 5 comp count?

We wouldn't expect it to accelerate because if the pressure is the DIY side of the business that's also the side of the business, it's growing from a longer tail of vehicles and vehicle staying on the road longer. Those 10, 12, 14, 15 year vehicles are primarily DIY side business and that's helping to offset the pressure from those bubble years.

Our next question is from Daniel [ph] with Stephens.

On the gross margin guidance, you guys mentioned as far as cadence, the expansion to be front-half weighted. And I think you identified freight pressures, as a potential headwind to gross margins? Can you talk about, when you really saw freight pressure step up in 2018? And, is there anything different about those cost pressures that would inhibit you from passing them through in the form of price, like you would any other form of inflation?

Well, it seems like we've been on the three year run for freight costs us continue to go up, and that's a population of jobs that is a very, very tight market and that type market is driving increases. When we look at our distribution costs obviously, we deliver nightly at all the stores. So, there is quite a bit of pressure there and we built that into our costs. But we've got to be market competitive. So, to the extent that we're a higher distribution intensive company that's more exposed to this. We're going to have little pressure that we're not able to pass on.

Got it. And then just within that expectation, are you expecting a similar price increase that we saw in 2018 and 2019?

2018 was pretty, pretty high for rate. The incremental year-over-year increase is less, but the number still a higher rate than we experienced in 2018.

And then from a follow-up, when I think about December, you guys mentioned a few negative impact, the holiday calendar shift, weather a tougher compare. Can you maybe quantify some of those headwinds, as we think about the deceleration from November and December?

We can't -- we are not going to quantify them. But in that order of magnitude, number one item in December it's very weather driven, people fix their vehicles, if they have to, otherwise into holiday shopping. So, that's number one. And then number two would be the calendar shifts of the eves.

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

Thank you, Vanessa. We'd like to conclude our call today by thanking the entire O'Reilly team for our solid fourth quarter and full year 2018 results. We look forward to a strong year in 2019. I would like to thank everyone for joining our call today and we look forward to reporting our 2019 first quarter results in April. Thank you.

And thank you ladies and gentlemen, this concludes our conference. We thank you for participating. You may now disconnect.