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

Thank you, Adrian. Good morning, everyone, and thank you for joining us. During today's conference call, we will discuss our third quarter 2021 results and our updated outlook for the full-year. After our prepared comments, we will host a question-and-answer period. Before we begin this morning, I would 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 would like to introduce Greg Johnson.

Thanks, Tom. Good morning, everyone, and welcome to the O'Reilly Auto Parts Third Quarter conference call. Participating on the call with me this morning are Brad Beckham, our Executive Vice President of Store Operations and Sales; and Tom McFall, our Chief Financial Officer. Greg Henslee, our Executive Chairman; David O'Reilly, our Executive Vice Chairman; and Jeff Shaw, 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 on today's call in 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 is 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 will 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 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…

Thanks, Greg, and good morning, everyone. I would like to begin today by echoing Greg's comments and congratulating Team O'Reilly on another outstanding quarter. As I stepped into Jeff's role on this call and provide commentary on our operating performance, I consider it a huge privilege to represent our team of over 80,000 dedicated professionals in our stores field operations, distribution centers and offices. Team O'Reilly has established a tremendous history of consistently excellent performance, building on the foundation established by the O'Reilly family beginning in 1957, but the last year plus of record-breaking results has been truly amazing. The single biggest driving factor of these results is the quality of our team and our unrelenting commitment to excellent customer service. As Greg previously discussed, our sales growth was very consistent throughout the quarter and solid on both sides of our business. Our team's commitment to our dual market strategy and our culture of excellent customer service has us well positioned to capitalize on the strong industry backdrop. We have been able to leverage our competitive advantages to meet the challenges of operating in an extremely difficult environment and deliver an attractive value proposition to our customers, including many customers who are new to O'Reilly. As strong as our results have been, we know we still have significant opportunities to enhance the great service we provide to customers and gain additional market share, and our teams are dedicated to improving our business every day. I would now like to provide some color on our SG&A expenses and operating profit for the quarter. Operating profit dollars in the third quarter grew by 4% compared to the third quarter of 2020 and are up an incredible 41% above our operating profits we generated two years ago in 2019. Our SG&A dollar spend…

Thanks Brad. I would also like to thank all of Team O'Reilly for their continued hard work and commitment to excellent customer service, which drove our tremendous third quarter and year-to-date performance. Now we will take a closer look at our third quarter results and add some additional color to our updated 2021 guidance. For the quarter, sales increased $272 million comprised of a $210 million increase in comp store sales, a $58 million increase in non-comp store sales, a $4 million increase in non-comp non-store sales. For the full-year of 2021, we now expect our total revenue to be between $12.9 billion and $13.2 billion, up from our previous guidance of $12.3 billion to $12.6 billion based on our strong year-to-date top line performance and our continued confidence in our team. Greg covered our gross margin performance earlier, but I want to provide additional details on our positive LIFO impact. For the third quarter, the LIFO impact was $43 million compared to no material benefit in the prior year. As a reminder, the positive LIFO impact is a byproduct of the reversal of our historic LIFO debit. Since 2013, due to negotiated acquisition price decreases, our calculated LIFO inventory balances exceeded the value of our inventory at replacement cost. And we elected the conservative approach to not write up inventory value beyond our replacement cost. As a result of this accounting, we have seen a benefit from rising cost and price levels via the sell-through of lower-cost inventory purchased prior to the recent cost increases. However, during the third quarter of 2021, our LIFO reserve flipped back to a credit balance as a result of inflation and acquisition costs. And moving forward, we expect to be back to typical LIFO accounting and no longer valuing inventory at a lower…

Thank you. We will now being the question-and-answer session. [Operator Instructions] And our first question comes from Brian Nagel from Oppenheimer.

Hi good morning. Another nice quarter. So the first question I want to ask. It was commented in the prepared remarks about pricing and the impact upon demand. And I'm recognizing that there is some conservatism as you look forward. But I guess the question I have is, are you seeing indications now that as prices have risen, the consumers are either shifting away from products or there is some hesitation to buy certain items in your stores?

Yes, Brian. What I would tell you is we have not seen any significant movement thus far. We called that out as a possibility going forward if fuel prices continue to rise and continue to be challenges within the general economy. But so far, we haven't. What might happen or what has happened historically during times where consumer spending drops off to a degree as consumers may defer things like oil changes out beyond their normal oil change intervals or trade down the value spectrum. We really haven't seen that. Over the last several quarters, we have really done a nice job of promoting some of our proprietary branded products. And we have seen a shift to some of those proprietary brands like, for example, SYNTEC motor oil. And what we have seen is those shifts are more related to us promoting those products than a shift downward in buying habits. Those are really planned shifts. But I would say unpredicted shifts or surprises, we have not seen those thus far.

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

Yes. I will start that, and I will see if Brad might have something to add. Brian, there are several things that are going on right now in the economy that short term are probably impacting that. And a couple of those things I called out is the availability of new cars and the availability and extended pricing on used cars today. It is not cost-effective. People are paying as much for a two year-old used car as what sticker prices on a new car because new cars are not available. And I think that is driving more people to maintain their existing vehicles more so than perhaps they did pre-pandemic. Also, I think during the pandemic, we saw a trend of more traditional white collar employees and employers and people in general doing some of the things themselves that historically they may not have done. So that trend may be extending as well, which would support the DIY side of our business. So I think those things in combination are drivers that are positively impacting our sales volume as of recent and throughout the pandemic. Brad, did you want to add anything to that?

Yes hi, good morning Brian. The only other thing I would add to what Greg said, it is just what I mentioned earlier, just about new customers. When I'm out in the field and I have been quite a bit here lately seeing our teams and had them on the back and talking to customers on both sides of the business. We are seeing a lot of new customers, Brian. And again, on both sides of the business and back to your original question, what we are seeing is a huge need. While prices are higher, we are seeing a huge need for value. And as you well know, with the nondiscretionary nature of our business, like Greg mentioned, with us totally focused on our supply chain, executing better than anybody else out there. Our delivery times and turning those base for the customers and all the value that we know we can create on that front counter with our professional parts people highly focused on retention right now. And we just see our teams doing a great job winning those new customers. And then when we win them over, we impress them with our service levels.

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

That is all very helpful. Congrats again. Thank you.

Thanks Brian.

Thanks.

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

So first one for Tom. Your ex-LIFO gross margin was about 51% in Q3, which is about 100 basis point step down versus Q2, if I'm calculating that right. So first question is, how much would you view the step down as transitory due to the supply chain factors today and then as we look to 2022, is it fair to expect the core ex-LIFO gross margin to hover around this 51% level? Or is a return to the 52% level the right way to think about it?

Well, Zach, there is a lot of moving pieces in margin right now as prices have gone up dramatically in a short period of time. To answer your first question, ex-LIFO would that have been the margin. I think that because we have product that we purchased at a lower cost, it allows us to maybe be a little more prudent in the timing of raising prices and doing that in a smart way with our customers to make sure that we don't have a shock value. So I'm not sure that I would say that, that is how - absent that ability to leverage that benefit that we may have run prices through a little bit different, not saying we are not going to eventually run all the prices through. The second I might tell you is that when we look at our gross margin, we had a big LIFO benefit, but we also had a similar headwind from distribution. So over time, we will balance those. We feel like we have been pretty consistent in the gross margin percentage we have run over time. Obviously, since over the last 10-years since we purchased CSK and worked on a lot of outsourcing - I'm sorry, sourcing to the most economical countries in private label, we have increased our gross margin substantially over that period. But over the last couple of years, it is been pretty consistent. And although we are not going to guidance on this call for next year, we wouldn't anticipate dramatic changes in our overall gross margin.

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

Yes. Zach, this is Greg. I will take this one. I don't think we are near the end of this, unfortunately. Obviously, the backlog, you watch the news, the backlog of ships in China, at port in the U.S., various ports in the U.S. and on the water continues to be pressured and challenged. When you talk about our supply chain, you have to think about it sequentially. And really, the pressure started in the DC just based on the sheer volumes that they've experienced over the past several quarters. And to compound that, those volumes came at a time where the supply and demand of human capital was way out of balance. And it is very, very difficult, as everyone knows, to hire in the environment that we have been in the last several months or past few quarters. Now we have seen some improvement since some of the government stimulus and unemployment benefits have subsided but we are still having some challenges staffing up in some of our DCs. The good news is, from a DC perspective, we are showing continued improvement, and our DCs are getting caught up and we are working hard to make sure we are positioned to be prepared for future growth in 2022 and make sure that our staffing levels are adequate and we are working on continued productivity gains and get our distribution costs more in line with where they were. So that was really the initial component of the supply chain crisis, but then you compound that with increased freight charges, I think most everyone has heard the variation in container shipping cost from as low as $3,000 in 2021 up to recently as high as $18,000 to $20,000 per container equivalent and that has been a challenge. And then just everything that we face seems to compound. Now there is rationing of electricity in China. So all these things have compounded the issues and the timing has been a challenge the way these things have layered on. What I will tell you is that we, from a distribution perspective, we are in much better shape than we were this time last quarter as recently as then. From a supply chain perspective, we continue to work on - our strategy is to have multiple suppliers for most of our major product categories to mitigate any risk, and we are leveraging current suppliers and additional suppliers in order to try to get product. And we are seeing improvement on product flow, but it is still a lot longer tail from order to delivery than what it typically is.

Thanks for the color. I appreciate the time.

You bet.

And we have a question coming from Greg Melich from Evercore. Your line is open.

Hi, thanks. Really two questions. One, first on the pricing. You mentioned that you came in stronger than you thought for all the cost reasons. And Tom, it would be fair to say that, that 5.5, if that is what was realized in the third quarter, it should actually be more than that year-over-year as we look into the fourth quarter and beyond, just given the way pricing flows through?

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

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

Greg, just for clarification. The prepared comments on were related to the third quarter of 2021, where we let 344 basis points. That is not the right SG&A leverage - level for the company long term. We said that then, and we are back more in SG&A spend that is appropriate for the sales we are generating.

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

Given the comp levels that we are at, yes. We are a multi-unit specialty retailer with a high fixed cost base, and we are able to generate exceptionally high sales volumes and increases, we see great leverage.

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

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

Got it. Thank you.

Thanks Greg.

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

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

Simeon, would you repeat your first question again?

It is basically, can you help us quantify the impact on gross margin from higher distribution or supply chain costs or inefficiency?

Got you. In the previous question, I commented that the LIFO benefit and the distribution headwinds were similar. And on the second question, when we look at our distribution centers. They are primarily a variable cost item. There is some leverage from having higher volumes to a point, and I think Greg talked about that on the last call in this call, if we get too much volume within our system, we end up with inefficiencies. So and the other part I would add to that is we are already one of the major suppliers of auto parts. So increased volumes don't necessarily mean a lower cost in the products we purchase at this point in our Company’s life cycle.

Okay. And maybe just a follow-up, maybe to Greg Johnson. Should market share gains continue at this outsized rate or now that there is so much that has happened, it is just going to be hard to maintain the level of outsized market share gains.

Yes, Simeon, that is a great question. I wish I had a great crystal ball answer for you. I mean, I think that first of all, this year, when we started the year, we projected flat to negative comps. We certainly didn't expect for our comp growth to continue to be as strong as they have been in 2022. Considering that a lot of the stimulus and benefits have subsided and our sales have remained strong. Our expectation would be for the aftermarket as a whole to continue to perform well going forward. And we will certainly continue to be a consolidator and continue to try to grow our market share going forward as well.

Thank you.

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

Hey guys thanks. I suspect I know the answer to this question, but when you do the implied sort of fourth quarter comp in your full-year guidance, you get somewhere - I get somewhere at the midpoint around 2% or 3%, which would be a pretty big slowdown on both a two and a three year basis relative to the first few quarters, which saw a remarkably consistent trends on a two and three year basis. And your commentary is suggesting that things are continuing. So why the lower guidance. Is it just conservatism. Is it just the unknown of not having the government stimulus, even though that doesn't seem to be impacting your business or is it something else that I'm not thinking about?

Well, I guess I would better answer that one because it sounds like a math question. We kept the 2% full-year guidance range because that is what we had given all year and at 10% to 12%. So the math for what the variability for the fourth quarter needs to be to reach those is pretty extensive. So we will have to look at whether we want to do that next year, tighten the range. I would say the math for us works out a little different that it works out 1% to 9%. Obviously, we don't anticipate that side of a range of outcomes.

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

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

Okay, understood. I appreciate that. Thank you.

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

Hey good morning guys. On the topic of share gain, I mean, it sounded as if you guys were picking up some share in undercar hard parts last quarter, which I think you guys called out as a strong category. Could you talk maybe about the cadence? Are you seeing the smaller or larger competitors seeing increasing difficulties or are things getting better in the supply chain that is allowing that than to hold share better as the quarter progressed?

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

Yes. As you well know, we have a tremendous respect for all our competitors. I have been here 25-years this year, and I grew up competing against some very strong independents and the independents that are still alive and well in the United States are pretty tough competitors and very tough on the professional side, as you know, better than anybody, and we have equal amount of respect for our larger retail competitors that have gotten better in some areas of professional. But when I think of share gains, I definitely think there is something to what Greg mentioned in terms of some of maybe the struggling independents and maybe some of the mediocre or weaker independent competitors. But again, as you know, the big strong independence in the United States are very tough. But Bret, me and my team, what we spend our time on is a little bit less of where the share gains are coming from and more about what we know works and what we are doing right now that is equaling share gains. And those things are just around some of the things we mentioned earlier. We talked about supply chain struggles. But as you well know, the supply chain struggles are a level playing field for everybody, us and our competitors in the United States, and it is about who is going to step up and execute better under the conditions. And I'm just extremely proud of our supply chain team from distribution to merchandise inventory control that gives my team in the stores not many excuses. They have done a tremendous job backing stuff when it comes to what Greg said earlier. They are getting better every month, even though we still do have challenges in there ensuring we have the right part at the right place at the right time. And we feel like that is a big part of the gains. We also feel like that as you have always heard us talk, our professional parts people, what we are doing with our shops, creating value, better delivery times, helping them get a car off the rack and just really our professional parts people. And everything we focus on in our stores is really what is equaling those gains.

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

Yes, Bret. I mean some of the categories we talked about last quarter, we are still having challenges with. Maybe some of those challenges have changed or evolved. Some of those challenges may have been labor-related for domestic suppliers last quarter and it is transitioned more to raw material or component challenges now coming from China. But our suppliers, as a whole, are doing a good job. We have got some suppliers, especially those with products coming out of China that continue to struggle. Another challenge, and I keep sounding like a broken record here of all the woes and challenges we are facing. But it has been the most challenging supply chain year in my 40-year career in the industry is on top of everything else, some of the things we haven't talked about was simple things that you might not consider like the freeze in Houston earlier this year that is impacted the production of plastic bottles and additives for oil. And some of those things still linger within the industry. So some of the issues have subsided or lessened. Some of them have become more material. So I think on a category-by-category basis, supplier-by-supplier, as a whole. We are starting to see the light at the end of the tunnel. It is just how much further is the track to get us to that light what we are trying to determine now.

Great, thank you.

And our next question is from Katie McShane from Goldman Sachs.

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

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

Okay. Great. And if we could just go back to the question on what the comp guidance implies for Q4. I wondered if you could tell us what you are thinking with regards to how much price would influence that comp range in Q4?

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

Thank you.

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

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