Welcome to the O’Reilly Automotive, Inc. Fourth Quarter and Full Year 2021 Earnings Conference Call. My name is James, 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 question-and-answer session. [Operator Instructions] And I’d now like to turn the call over to Tom McFall. Mr. McFall, you may begin.

Thank you, James. Good morning, everyone, and thank you for joining us. During today’s conference call, we’ll discuss our fourth quarter 2021 results and our full year outlook for 2022. 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 Greg Johnson.

Thanks, Tom. Good morning, everyone, and welcome to the O’Reilly Auto Parts fourth quarter conference call. Participating on the call with me this morning are Brad Beckham, our Chief Operating Officer; and Tom McFall, our Chief Financial Officer. Greg Henslee, our Executive Chairman; David O’Reilly, our Executive Vice Chairman; and Brent Kirby, our Chief Supply Chain Officer, are also present on the call. I’d like to begin our call today by congratulating Team O’Reilly on the tremendous results in the fourth quarter, which capped off another record-setting year. This year marked our company’s 65th year since our founding and our 29th year as a publicly traded company, and I feel very comfortable saying it was our best year yet driven by the truly remarkable contributions of our team of over 83,000 hard-working professional parts people. Our team’s performance in 2021 was highlighted by our comparable store sales growth of 13.3% and diluted earnings per share growth of 32%. This outstanding performance is even more impressive when you consider that our team delivered these results on top of a record-setting year in 2020, when we achieved comparable sales increase of 10.9% and growth in earnings per share of 32%. There are a number of different metrics I could provide to highlight the strength of our business, and we’ll talk through many of those details in our customary updates during the call today. However, there are two specific numbers that I’d like to provide an incredible picture of just how much growth Team O’Reilly has generated for our shareholders over the past two years. For 2021, our average store generated sales of $2.3 million, which represents an increase of over 23% from the average store sales volume just two years ago in 2019. During this same time – period of time, our…

Thanks, Greg, and good morning, everyone. I want to begin my comments today by echoing Greg and congratulating Team O’Reilly on another amazing year. After our record-breaking year in 2020, we came into 2021 knowing just how difficult it was going to be to sustain that same level of performance. However, our team once again proved they were up to the challenge and generated even more impressive growth in 2021. The core driver of our success is our team’s relentless focus on providing excellent customer service, and we are very excited about the opportunities we have in front of us in 2022. Greg previously discussed our strategic professional pricing initiative, but I want to add one more point before we move on to the rest of my prepared comments. Anyone who has participated in our earnings calls or attended our Analyst Days for any length of time has heard us say on multiple occasions that price is not the most important factor on the professional side of the business and that you cannot win sustainable business solely on price. We want to be very clear that this rule still holds true for our business and our industry. We strongly believe that the lion’s share of the professional business in the marketplace is, one, day in and day out through exceptional customer service and rapid inventory availability. However, we believe we can generate solid long-term returns by further investing in professional pricing. As an important part of our professional pricing initiative, we are intentionally not positioned as the lowest-price competitor in each market, and our store and sales teams remain as committed as ever to earning our customers’ business by outhustling and outservicing our competitors. Our team fully realizes that business won with price alone is easily lost to a lower…

Thanks, Brad. I’d also like to congratulate Team O’Reilly on another outstanding year. Now we’ll take a closer look at our fourth quarter results and provide some additional guidance for 2022. For the quarter, sales increased $463 million, comprised of a $398 million increase in comp store sales, a $56 million increase in non-comp store sales and a $9 million increase in non-comp non-store sales. For 2022, we expect our total revenues to be between $14.2 billion and $14.5 billion. Greg covered our gross margin performance earlier, but I want to provide additional details on our positive LIFO impact. For the full year 2021, the LIFO impact was $80 million compared to $11 million 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 costs, and we elected the conservative approach to not write up inventory value beyond the replacement cost. As a result of this accounting, we’ve seen a benefit from rising costs 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 replacement cost. As a result, we anticipate a limited benefit of less than $10 million in 2022 for the final sell-through of the remaining lower-cost inventory, which creates a headwind to our gross margin rate. Our fourth quarter effective tax rate was 19.4% of pretax income, comprised of a base rate of 20.4%,…

Thank you. [Operator Instructions] Our first question is from Scot Ciccarelli of Truist Securities.

Good morning, guys. Hope, you’re well. I think we can appreciate that price isn’t the most important factor in driving a customer’s decision. But I guess my questions are, number one, why are we making these price investments now, as in what has changed? And then number two, why couldn’t we see this round of price cuts become another set of price cuts at some point in the future, potentially threatening one of the key investment pillars of this vertical? Thanks.

Yes, Scot, this is Greg. I’ll take that one and then see if Tom and Brad may have something to add to it. As to – first of all, I want to reiterate what you said. Our philosophy hasn’t changed. We always lead with service. Service is most important followed by inventory availability and then price. As far as why now, when you look at the past couple of years, we’ve been through two years of inflation, price increases. We’ve seen rising prices. We’ve seen supply chain disruption. And I think we’ve performed better than a lot of our competitors over the past couple of years, especially our smaller competitors. When you look at the professional side of our business as a whole, as you know, it’s very, very fragmented. There’s a lot of players out there on that side of our business, some of which are the large national players, some of which are the smaller WDs and two-steppers. We compete against each of those every day in every market that we operate in. So we felt like coming off of a couple of years of inflation and supply chain disruption, again, where we’ve performed well, and the anticipation that some of the supply chain disruption may moderate in the back half of the year, timing was right to implement this change. We – what we did here is really no different than what we do day in and day out with our pricing team. Our pricing team constantly monitors pricing on both sides of our business and makes tweaks to pricing at both the professional and the DIY level across our customers. And this initiative specifically targets our DIFM customers and – just we feel like this will enable us to take additional market share on that side of the business. So that’s why now. Brad, did you want to add anything to that or take the second part of the question?

Yes. Hi, good morning, Scot. I would just really echo what Greg said, Scot, in terms of you as well as anybody on the call knows how fragmented the DIFM side of the business is. And you know how really little share when you add up us and our public competitors on the – really the addressable DIFM share in the United States is still very small. And so I would just reiterate really what you said and what Greg said that it’s so important for us to convey that this is not a change in terms of our focus. We have built our company on service. We have built our company on relationships. And as you know, we built our company on the professional customer, and retail came later. And so this is not abandoning all the things that got us where we are and the things that are going to get us into the future. To your point on the timing of it, Greg had some great comments there. And the other thing I would say, Scot, is with everything that our industry and really everybody in the world has been through the last couple of years, especially our professional customers. Whether it be a shade tree mechanic to an independent garage to the national and regional accounts, we have not backed off of being out there, calling on them, meaning actually visiting their shops day in, day out, week in, week out. And an opportunity that we saw the last couple of years is our shops are telling us, I mean, our service is where it needs to be. Our teams in the stores, everything that you know we’ve done with inventory availability. And when it comes to the independents out there and the two-step-type model competitors as well as some of the specialty-type competitors that maybe just focused on a couple of categories, we just simply see an opportunity from our sales team and in the field to go out and with a rifle approach, target those areas; and with existing customers that may be buying a certain amount from us, maybe buying a certain amount from an independent in another amount from a true specialty company, consolidating that customer and truly getting a first and only call, and we feel very good about that.

And Scot, just on your second part of your question, I want to reiterate that this is a targeted approach. This is a very scientific approach we’re taking. This is not across the board. This price enhancement was done by category, by SKU. And we still feel like that based on our performance, our supply chain strength, that we can still charge a premium to our professional customers. So we do not feel like this is a race to the bottom. We do not feel like we are low-balling cost. We’re just getting competitive with some of our competitors out there in the market to take additional market share.

Got it. Thanks a lot for the time guys.

Thanks, Scot.

Our next question is from Christopher Horvers of JPMorgan.

Thanks, good morning. I’ll be the second to ask about the pricing. I thought that was a great answer. I just want to focus on a couple of things. So first, going back to the introductory comment that you intentionally try not to be the lowest price in the market because you have the leading service model. Do you still expect that to be true going forward? And if some of this is just you’re not passing along the inflation that you’re experiencing, what’s the risk that you actually lower the market – lower the low range of the market price range? Do you know what I mean?

Yes, Chris. On the first, we absolutely feel like that this makes us competitive in the marketplace. And as far as lowering, again, we are not doing this to be the lowest price in the marketplace. We feel like that there is tremendous value in the services that we provide and the relationships. You have to remember the professional customer, while price is important, we’re not seeing price is not important, what’s more important to that professional customer is the relationship we have with them, the inventory availability that we have and our consistent performance and ability to get that part to them timely so they can complete the jobs they’re working on. Our professional customers will always prioritize that over price, again, assuming that we’re competitive on price. So we feel like this move will enable us to take additional market share both from existing customers and gain market share from customers we may not be getting business from today.

Chris, to address your second part of your question, you’re absolutely right. In many cases, due to the significant inflation – same-SKU inflation, it varies across product line. In many cases, this isn’t reducing The Street price. It’s just not taking that acquisition increase to The Street in price.

Got it. And then as a follow-up, you talked about sort of targeting sort of product lines and categories where you see some specialty players having share. So can you maybe expand on that? Is this targeted at share with like national accounts? Is it up and down The Street mechanics? And to what extent it is something like, I don’t know, like fuel injection lines that maybe have a certain degree of specificity where that specialty player provides differentiated sort of product?

Well, Chris, this is Tom. I’m going to start with the answer. So you know that the answer is going to be we’re not going to give that. But I really want to make sure that – we’re talking about a broad pricing strategy. We don’t communicate the details of our pricing strategy. A lot of science, a lot of work goes into it, a lot of history. So we’re not going to get down into the details of what the program is. But in general, I’ll turn it over to Brad for his comments.

Yes, Chris, I think what’s important to talk about here is this isn’t a, again, new strategy or initiative that’s focused on one customer group. Again, this is going to – this is our commitment to everybody from the Shade Tree to the independent garages to the regional players to the national accounts. And Chris, as you know, we still have a gap in footprint in a part of the – Northeast part of the country that keeps us from really being the first call for some of the national guys from a matchup standpoint. But what I would say, again, to remember is that while we have new opportunity for new customers always, one of the things that we really like about this is our existing customers that are buying a piece from us, maybe a piece from our public competitors, a really big piece from the independents and then another piece of their monthly purchases from a specialty company. And we’re already delivering to these shops. In some cases, we’re delivering part of the job that maybe they had to get another item from somewhere else. And so we just see tremendous opportunity. And our customers are telling us that with our inventory availability, our service, our people, if we can make some adjustments there, we really have a huge opportunity to turn into the first and only call for those garages.

Makes sense. Thanks very much.

Thanks, Chris.

Our next question is from Bret Jordan of Jefferies.

Hey, good morning, guys. I’ll jump from pricing to supply chain. Could you talk about maybe the cadence of supply chain disruption? Or I think in prior quarters, we talked about some categories specifically being really hard from an import or production standpoint. Could you talk about how you saw your availability of inventory in the fourth quarter?

Yes, Bret, I’ll start that, and then I’ll see if Brent has anything to add because he lives that day in and day out. We have seen improvement. And when you talk about supply chain constraints over the past several months, it’s bigger than just supply and demand. There’s been a lot of facets to that. I would say that it has improved from overseas. Container availability has improved. We still have some port challenges. We still have some targeted suppliers, primarily suppliers that are operating in smaller markets domestically that are having – still having some labor issues. We got some raw material challenges that some of our suppliers are having. Overall, I would tell you that our fill rate from our DCs to our stores has improved. I would tell you that our in-stock position at our stores has and continues to improve, and most of our suppliers overall fill rate has improved. Now that said, we still have some suppliers that are challenged, and we still work with those. I know Brent and his team, some of our suppliers there meeting with weekly or even multiple times a week to work through those constraints. Brent, did you want to add anything to that?

Yes. Bret, Greg gave a good summary. I mean, I think we are seeing general trends of improvement, as he alluded to. We still have some spotty suppliers that we’re working more closely with than others. But generally, we’re encouraged by what we’re seeing, and we anticipate that improvement to continue, hopefully, as we work through the first half of the year and into the back half of the year.

Okay. Great. And my follow-up question is going to be on price. But you said you’re going to be competitive in the markets. And I guess, given your higher service levels and historically higher in-stocks than peers, can you be priced still above those peers just given the other values you offer in the transaction? Or are you thinking by competitive, do you mean you’ll be priced on a dollar basis in line?

No. Bret, we still feel like we can be priced at a higher price point than our competitors based on the services we provide, which has been our historic stance on this. Tom, did you…

The thing that I’d point to, Bret, is we have a wide range of competitors, and Brad touched on them earlier. Some compete solely on price. A lot of specialty one-line suppliers, they get business by being absolutely the lowest price, and that’s not our business model. So when we say we’re going to be more, we’re going to be within a competitive range. Obviously, it depends on how expensive the part is. If it’s $1 part, you’re $1 over, that’s a heck of a lot. If you’re $1 over and it’s a $100 part, that’s a different thing. And what we got to remember is the biggest cost for professional installers is they’re lat. And that ability to turn those bays is what turns their profit. So we want to make sure that we’re pricing holistically for the quality of the product, the availability of the product, the team that we offer, services that we offer. So we look at it in aggregate. But there is always going to be someone, and we talked about it in our prepared comments, who’ll be the lowest price. And if that’s how you sustain your business, if somebody comes along, decides to drop the price, you’re going to be in trouble. And we want to have a relationship and a partnership with our professional shops that help them make money over the long-term.

Great. Thank you. Appreciate it.

Thanks, Bret.

And our next question from Greg Melich of Evercore ISI.

Thanks. I guess I’d love to go to the guidance on the top line, the five to seven comp guide. I think you said it was mid-single-digit inflation in that. And assuming that mix is still positive. Is it fair to say units will be flat or even slightly down this year?

So five to seven – that mid-single digit within the five to seven was specifically for the DIY side of the business, and we would expect it to be sure on the ticket count there. Because of the price – the professional price initiative, we won’t see as robust an increase in same-SKU inflation on the professional side. So we need to generate a meaningful increase in average ticket on the professional side, so that – your numbers are right, but that was just for the DIY side.

Got it. Thanks. And then I guess the follow-up linked to that is, if we look at the gross margin rate in your guidance this year versus last year, I guess, LIFO is maybe 50 bps. Could you give us how much of it is the pro pricing initiative versus just the normal mix change you would expect to pro outperformance?

So Greg, you’ve picked up on a good point. Part of it is going to be just a mix shift. As professional grows faster than DIY because they’re buying on volume, the gross margin is lower. We also have the benefit of the supply chain. I would tell you that the professional pricing is larger than LIFO, but we’re not going to get into parsing out because the next we’ll be talking about our distribution costs, and that’s something we just don’t do.

Got it. That’s helpful. Thanks and good luck.

Thanks, Greg.

Thanks, Greg.

And our next question from Michael Baker of D.A. Davidson.

Hi, thanks a lot. I wish I could add something not about pricing, but this is the topic. So – what do you expect the competitive response to be? Do you have any precedent for doing something like this? And what have you seen competitors do? And I guess, related to that, just to be clear, who is – who do you think you’re taking share from, from this initiative? It sounds like it’s more about taking share from smaller players rather than your big public competitors, but I just wanted to confirm that.

Hey Mike, this is Brad. I’ll jump in there and see what Greg and Tom have to say about it. But on – I’ll answer the share question. And on the share, it’s hard a little bit to always tell exactly where it’s coming from. But I would say that what we’re seeing, it’s more from the – more of the mid-tier, maybe the mediocre or maybe the weaker, independent competitors that have struggled the last couple of years with supply and things like that. Mike, as you know, as good as anybody, I mean, we have tremendous public competitors that we have the utmost respect for and then we have these regional competitors that are the strong, strong independent two-step-type competitors that not too long ago, we were in the Ozarks and kind of our old part of the company. But I would just say on the share that we’re seeing a lot of different things, but the majority of the opportunity we see is with the smaller independents and the ones that have struggled the last couple of years.

Yes. Mike, on what the reaction would be, I can tell you based on the test that we were in, in multiple markets before rolling this out, the reaction was obviously favorable or we wouldn’t have rolled it out company-wide.

When you say the reaction, so I mean the competitive reaction, not the customer reaction. So when you say the competitive reaction was favorable, I presume that means you didn’t necessarily see them drop price as well?

Yes.

That’s correct, Michael. We can – obviously, our competitors are going to do what they do with their price. I think we just want to stress that we are not setting the low market price here. So it’s not as if competitors that are winning business on price alone are not going to still be the lowest.

Understood. Makes sense. And I think all these answers clarify the strategy quite a bit. So I appreciate that.

Thank you

Our next question from Chris Bottiglieri of BNP Paribas.

Hey guys, thanks for taking the question. So my question is going to be, I guess, on inventory/inflation. So the inventory investment you spoke of plus 8%. It sounds like your guidance assumes kind of like flattish inflation, maybe even deflation for Q4 2022, I would think, with the price investments. So are you effectively just raising in-store inventory units or by year-end? And then do I have that right first? And then how do you think of the cadence of that inventory? Is it going to be pretty smooth as you throughout the year? Is it front-half loaded? I mean any context there would be helpful.

This is Tom. Let me take a shot at that one. So when we talk about 8% increase, we don’t have – and we talked about it for the last seven quarters, we’re not sitting on as much inventory as we would normally sit on because of supply constraints and because of the high volume. So part of it is to get back to where we normally would be. And part of it – these initiatives go back to our 2020 guidance. And I guess it would be the end of 2019 fourth quarter call where we had a plan to add to the hub-and-spoke network. So it’s a combination of those two items. When we look at how fast we can roll this inventory in, everybody in this room and everybody on our team would like to have it tomorrow. The question is, how fast can suppliers supply it? How fast can we push it through the distribution network? So this is, as Brent said earlier today, and he can add to this, this is going to be an all-year project. We’re going to move a lot of units.

Yes. Again, Chris, this is not a new strategy. It’s something we’ve had planned for a couple of years, but supply chain constraints and the volumes we pushed through our DCs in the last couple of years have just prohibited us from getting this inventory rolled out.

Got you. That makes sense. And then a related question, on the LIFO, the $10 million, is that more like kind of a Q1-ish event? Or is it – are these slow-turning SKUs that would cause you to take that throughout the year? And then like – yes, that’s it for me.

A great question. That should all roll in, in the first quarter.

Got you. Okay. Thanks, guys. Appreciate it.

Thank you, Chris.

Thanks, Chris.

Next question from Michael Lasser of UBS.

Good morning. Thanks a lot for taking my question. What – as you were laying out your plan for 2022, what did you assume that the overall industry is going to grow at in the year ahead?

That’s an interesting question, Michael. I think what we look at is when we look at inflation, what we’re going to anniversary in same-SKU inflation, I think that’s a pretty reasonable number for the industry. I think we’ll be pressured more on the DIY side. Professional will continue to grow faster, more resilience to those price increases. Of course, we build our plan from product line and store up, and it’s really independent of what the market is going to do. But our expectation is – as you know, has always been that we are going to grow faster than the market.

Yes. Obviously, the intent of the question was to try and size how much market share you expect to get for the price investments that you’re going to be making. So is there another way to frame that out? And then I’ll let you answer that, and then I have one quick follow-up.

Okay. So there are a lot of puts and takes within what we think is going to happen with the business, both on the DIY and the professional side of the business. And we are confident that when we look at our gross margin dollars that this is going to be a winner for us. And we’ve rolled it out here in February, and we are very optimistic it’s going to exceed our expectations.

And my follow-up question is, do you expect this strategy, which will weigh on your gross margin and drive market share, to be unique to 2022? Your guidance implies that your gross margin rate this year is going to get back to levels that it was last at in 2013, 2014. So what are the chances that you will have to continue to execute this pricing and investment strategy beyond 2022 such that your gross margins are going to float lower even after this year?

Well, the thing, I guess, I would point out is that percents are nice and dollars pay the bills. So I did see a note where in 2014, the gross margin percent was the same. But I would say that we’re about 98% more gross margin dollars, which is $3.5 billion. At the end of the day, we’re trying to figure out how we build a sustainable business that generates increasing operating profit dollars year-over-year. And we think that this initiative continues to move us in that direction. And after the number exercises, I’ll turn it over to Greg.

Yes, Michael. We don’t have any planned initiatives like this beyond this year. That said, as I said earlier, our pricing team consistently day in and day out looks at pricing in the marketplace. And we tweak the SKU up, the SKU down just to optimize our margin. So there’s always changes in our pricing structure both – on both sides of our business, but we don’t anticipate future larger-scale price reductions like this.

Okay. So Greg, just to clarify that you expect this year, you’re going to make some price tweaks away in your gross margin. And then after this, it will be normal course of business to continue with what you’ve done in the past?

That is correct.

Okay. Thank you very much.

Thank you.

Thanks, Michael.

Our next question from Daniel Imbro of Stephens.

Yes. Hey, good morning, guys. Thanks for taking our question. I’ll ask one, not on pricing. Greg, I wanted to ask one just on the customer. I think you mentioned the potential for customer repair deferrals during periods of inflation or maybe economic uncertainty. Just as we head into this year, as the low-end consumer feels pressure from broader inflation, are you seeing any indication early on of repair deferrals or something that make you think that could happen this year? And is there anything like that baked into the comp guidance you’ve given?

Yes, Daniel, we call that out as we often do because historically, we’ve seen those changes to that lower-income consumer being one of the first things they do. We have not. We have not seen any signs of our DIY or our professional customers for that matter trading down or deferring maintenance at this point.

What I would add to that is we’ve seen pretty significant price increases. And to the extent when we look historically, when that’s happened, DIY, especially on the lower end, we faced headwinds on customer transaction counts. And we anticipate some of that this year and have built that into the forecast.

Got it. That’s helpful color. And then I can ask a follow-up on SG&A. I think SG&A per store, it looks like at the midpoint, call it, 3% to 4% increase. I guess, one, is that right? And then two, with wages being as inflationary – Tom, you mentioned efficiency benefits earlier in kind of fixed costs, but are there any other initiatives you guys are doing to keep that at such a muted pace? I think we expect there to be more SG&A growth given the wage backdrop we’re seeing. So trying to understand what’s driving that improvement. Thanks.

So I think in our prepared comments, our math is around 2.5% increase. Last year, we were significantly above that, and sales were significantly above that. As Brad talked about in his prepared comments, we manage our SG&A at a micro level, especially store payroll, which is our biggest variable expense, to make sure that we’re taking opportunities to gain share but not getting out over our skis. So this is based on the sales forecast. To the extent that we exceed the sales forecast, it will be higher than this. To the extent we are less than the sales forecast, you better believe it will be less than this. So more of a normal – actually, higher than our normal run rate because our comp guide’s higher than our run rate. On the SG&A efficiencies, eight, nine years ago, we used to talk a lot about our initiatives, then they seem to become other people’s initiatives. So we tend not to go into detail on those.

Fair enough. I appreciate the color and best of luck.

Thank you, Daniel.

Thanks, Daniel.

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

Thank you, James. We’d like to conclude our call today by thanking the entire O’Reilly team once again for their unwavering commitment to our customers and for their incredible performance in 2021. We look forward to another strong year in 2022. I’d like to thank everyone for joining our call today, and we look forward to reporting our 2022 first quarter results in April. Thank you.

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for your participation. You may now disconnect.