Welcome to the O'Reilly Automotive Inc. Third Quarter 2022 Earnings 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 will conduct our question-and-answer session. [Operator Instructions] I will now turn the call over to Jeremy Fletcher. You may begin.

Thank you, Vanessa. Good morning everyone and thank you for joining us. During today's call, we will discuss our third quarter 2022 results and our outlook for the remainder of the 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 31st, 2021 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 Jeremy. Good morning everyone and welcome to the O'Reilly Auto [ph] Parts third quarter conference call. Participating on the call with me this morning are Brad Beckham, our Chief Operating Officer; and Jeremy Fletcher, our Chief Financial Officer. Brent Kirby, our Chief Supply Chain Officer; Greg Hensley, our Executive Chairman; and David O'Reilly, our Executive Vice Chairman are also present on the call. I'd like to begin our call today by thanking Team O'Reilly for your hard work and commitment to providing excellent customer service, which drove our strong results in the third quarter. Our quarterly results were highlighted by a 7.6% increase in comparable store sales resulting in an impressive two and three-year comp sales stack of 14.3% and 31.2% respectively. Before we walk through the details of our performance and our prepared comments I want to begin the call today by acknowledging all of those affected by Hurricane Ian. On behalf of all of Team O'Reilly, I wanted to express our greatest sympathies for the devastation and loss being felt by so many families in the regions impacted by the hurricane. As a company, we were very fortunate to have incurred only limited damage and our teams were simply incredible in their rapid response to the recovery from the storm. I am always extremely proud of the way Team O'Reilly shines during these challenging times and we are all incredibly appreciative of how our team members once again stepped up in the aftermath of Hurricane Ian to serve their communities with critical supplies necessary in the recovery efforts. Thank you to each of our over 84,000 team members for living our culture of excellent customer service so well, for truly being the friendliest parts store in town, and producing the outstanding results we will discuss today. Now,…

Thanks, Greg and good morning, everyone. I would also like to personally thank Team O'Reilly for their commitment to our continued success and dedication to delivering excellent customer service by out-hustling and out-servicing our competition. Our top line results for the quarter are a testament to our team's ability to compete and I am proud of the way our team members in our stores and distribution centers go to market each and every day to win. Our team has repeatedly proven they are up to any challenge and I want to join Greg in showing my appreciation for the way our supply chain teams as well as our store operations and DC leadership in the Southeast took care of our teams and our customers in the aftermath of Hurricane Ian. Since safety has always been a critical culture value for Team O'Reilly, our primary focus during the weather event like Ian is ensuring our team members and their families are safe. Then as soon as we can safely make our way back to our store locations our leaders and teams waste no time getting their stores back up and running often on generator power with no communication systems. This incredible hard work and sacrifice creates tremendous goodwill with our customers who often have limited options to source the critical parts and supplies they need to meet the basic needs not only with their vehicles, but at home with their families to start recovering from the storm. Now I'd like to give some additional color on our professional sales performance for the quarter. As Greg previously discussed, strength in our professional business underpinned our comparable store sales growth for the quarter and we are extremely pleased to continue to see robust growth in both ticket and traffic on this side of…

Thanks, Brad. I would also like to add my thanks to all of Team O'Reilly, for your performance in the third quarter and continued dedication to our company's long-term success. Now we will cover some additional details on our quarterly results, and updated guidance for the remainder of 2022. For the quarter, sales increased $319 million comprised of a $257 million increase in comp store sales, a $60 million increase in non-comp store sales, a $4 million increase in noncomp nonstore sales and a $2 million decrease from closed stores. For 2022, we now expect our total revenues to be $14.1 billion to $14.3 billion, which is an increase from our previous range of $14.0 billion to $14.3 billion and is in line with the updated comparable store sales guidance range Greg discussed earlier. Greg covered our gross profit performance earlier, noting that gross margin for the third quarter was in line with our expectations with anticipated year-over-year pressure from the rollout of the Pro pricing initiative, LIFO comparisons and accelerated professional sales mix headwind. Since I'm sure you're all anxiously awaiting a detailed accounting discussion, I want to provide some additional details on the LIFO comparison, and how we view the flow-through of acquisition cost inflation in our gross margin results. We think it is helpful to contrast the impact of our earlier LIFO reporting prior to 2022, when we were still in a debit LIFO position versus the current situation where we have returned to a traditional LIFO credit balance. As we discussed throughout 2021, the application of LIFO accounting meant that as acquisition costs and selling prices went up, we realized the benefit from the sell-through of existing on-hand inventory that we carried at a lower historical cost due to our debit LIFO position. This nonrecurring benefit…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] We have our first question from Greg Melich with Evercore ISI.

Hi. Thanks. Just to kick it off on the current trends into the quarter -- when you say that it's as strong as it was in the third quarter is that on a three-year view or year-over-year, or how are you measuring that?

Yeah, Greg thanks for the question. I think really when we think about that it's versus our expectations as we kind of move through the year, and those factor and the comparisons were up against. So, we've just been in this unique environment where you really do have to look at kind of two-year, three-year performance. So what we'd say is its up kind of on that basis the nominal comps do move around just based upon the comparisons.

Got it. And then, second, could you give us a little more color on inflation and average ticket size between, Pro and DIY. It seems like, they would be a little higher in DIY and a little less than Pro because of PPI, but any color there would be great.

Yeah, Greg, I think you're thinking about it the right way. We're seeing similar inflation benefits when we think about SKU level, year-over-year when you exclude the specific strategic moves that we've made on the professional side of our business. That's the largest driver of the strength that we've seen in average ticket. Average ticket always has other components to it as well. And we think on the professional side just because of the success of what we've seen in the Pro pricing initiative, we've we benefited from growing our average ticket beyond just price that we've seen. But -- so that's probably a little bit of a helper. But we continue to view both sides very favorably, given the ability to pass through cost increases really very effectively all year long.

And then last is trade down. Have you seen anything through the box on either side of the business?

Greg, we really haven't seen anything material that stands out. We look at this very closely, both on a consolidated basis and category by category. And where we have seen movement, either up or down, it's really been more a result of supplier performance and inventory availability. Trading across brands of oil for example or up and down the value perspective for both our proprietary brands and national brands.

That’s great. Thanks guys and good luck.

Thanks, Greg.

We have our next question from Christopher Hoevers with JPMorgan.

Thanks. Good morning, guys. So maybe following up on the question about cadence. So, it was the best month on a three-year basis. So basically, September is sort of an eight handle comp. And then as we look in the fourth quarter, we degrade that by a few hundred basis points for the inflation comparison and then you're basically some plus or minus around the consumer and the holidays and weather uncertainty versus accelerated pro pricing gains?

Yes. Yes, Chris. I think, you're thinking about this right. As we called out, we were pleased with our third quarter performance. We're pleased with quarter-to-date through October without a doubt. The challenge we have is the unknowns and the volatility. And frankly, the challenges that we may very well experienced in the back half of the quarter. When you look at fourth quarter, we always worry about weather, volatility you layer on the volatility in fuel prices, you layer beyond the weather just the uncertainty of the consumer and what they're going to do. And frankly, Chris, we just haven't seen an inflationary environment around the holidays in many, many years. And the holidays are always a wildcard in the fourth quarter as well. You layer on the inflation component. Those are all the reasons we're cautious in our outlook for the fourth quarter.

Got it. And then maybe, gross margin and open up LIFO a little bit which everybody loves. So basically, as you go forward, your expectation is product acquisition costs, go lower, so there should be really no -- and you've lapped through all the LIFO headwind from last year or substantially. Maybe there's a little bit left in the fourth quarter. And so, then as you go forward, if you expect lower product acquisition costs getting into '23, does that mean that you could start to see actually some gross margin tailwinds on the product acquisition side?

Yes, Chris, I don't know that we really would view it that optimistically. We're always going to work with our supplier base to ensure that we're walking a lockstep with any relief from pressure that they've seen from an input cost perspective. A lot of what we've seen so far over the course of the last year plus, has been driven by several factors, including raw materials costs, wage rates, pressures, obviously from freight that our suppliers have seen in. And we're always going to work to be sure that we're realizing appropriate reductions in rolling back cost increases where we can. But we're pretty cautious in building any expectation that that's going to be a significant helper for us as we move forward. Obviously we'll see and we'll see that play out. We do feel very confident that to whatever degree that we do see any relief on the cost side that the industry will be able to maintain those selling prices. That's certainly our intent. We'll, obviously, see how that plays out as well, but some of these cost increases are probably around the stay.

Got it. And then just one quick one Jeremy on the LIFO side, I mean, can you maybe give us some numbers in terms of how many basis points that was in the third quarter? I mean, we're around 120. And does that go down to really a de minimis amount in the fourth quarter?

Yeah, Chris, I think the best way to look at that is just really what we called out positive good guys last year. We still have a headwind in the fourth quarter. It softens up a little bit. For us now, it's really more a function of as the cost environment moves around, how quickly and seem can you be sure to adjust prices. Sometimes we're out ahead. Other times we're just in line. But the more significant comparison headwinds for how we would have looked prior to when our LIFO credit foot back will largely be behind us after fourth quarter, a little bit less than fourth quarter and then first quarter and next year a little bit less than that.

Great. Thanks so much. Best of luck.

Thanks, Chris.

We have our next question from Bret Jordan with Jefferies.

Hey, good morning guys.

Good morning Bret.

Question around fill rates, I guess my usual. Are you guys back to where you'd like to be from an inventory standpoint versus pre-COVID? And I guess, how do you see your fill rates versus the broader market? Are the WDs and some of the other competitors in the space relatively in stock as well, or is that still helping your market share?

Brent, do you want to start that and then maybe Brad can talk about the competitive situation?

Yeah. Sure Bret, great question. Yeah, fill rates have improved sequentially from suppliers. We've got some suppliers that are really back to healthy fill rates. We've got a few that still are making sequential improvements but aren't fully back to where they were pre-COVID. I give our supply chain team a lot of credit for the work with our suppliers to make sure we've got the parts available that our customers need both DIY and professional. So we feel good with our availability position given the market backdrop that we're operating in. But yeah sequentially we're continuing to get better, but still a little work to do in some areas.

The another question on -- go ahead please.

Sorry, Bret. Just real quick I'll just back up what Brent said maybe from the Street and from the sales and store operations standpoint. Brent hit it pretty good. But we're basically -- we're pleased especially in some categories that we needed to get better we got better. We have a few that we still have some work to do, but really just from a competitive landscape Bret, we feel like our large competitors, they're great competitors that we always say we have tremendous respect for. They've done a good job. We hope we've done as good or better, but we are feeling like there's some share gains maybe against some of the smaller players for sure.

Okay, great. Thank you. And then a question on the supplier cost or pricing side. I mean, obviously, the rates are hitting factoring expenses. Do you see a step-up in pricing again to offset that or some of the other expenses like shipping that have come down that offset that?

Yeah. I think Bret, maybe to add a little to Jeremy's color around that on the previous question, while we've seen costs certainly can't go up forever and we are seeing some of that begin to normalize with suppliers and in the market. But if you think about wage inflation is pretty much baked into some of the cost of goods now. Yeah, we've seen ocean rates go down some, but we've seen rail rates come up. We've seen some domestic lanes come up. So trend is still high elevated versus historicals and probably is going to remain that way. So to Jeremy's point earlier, we remain cautious there and we remain confident in our ability to be able to pass those increases on in the event we see any more of those.

I guess specifically around rates though, since most of the suppliers are saying they're going to ask for pricing to offset the factoring expense? Is that a near-term incremental inflation, or do you not see that necessarily the case?

Bret, there's a potential that it could work out that way. It's I think going to be determined a little bit by -- more broadly in the market where it hits. Those rates have more of a relative impact supplier to supplier than maybe some of the other things that go into the cost of providing the products that we buy in some won't have the same pressure that others may have. And so I think competitively you'll see some ability to push back on some of those. And in other instances they will flow through. We we're obviously active in those conversations and will work. There'll probably be some equilibrium that gets stuck at some point. But in the greener scheme of things, I think it is a part of how we think about acquisition costs. Some of the other things that Brent identified are obviously the bigger drivers. And we -- our views on that is that we do expect it to continue to stay around for a while.

Great. Thank you.

Thanks, Bret.

Our next question is from Simeon Gutman with Morgan Stanley.

Good morning, everyone. First topic is on pricing and inflation and maybe the outlook, trying to think about how you're thinking about the cadence, we're about to lap some heavier price increases or inflation from a year ago. Does it -- and I think based on the prior answer, it seems like we're not going to have any material step down in the rate of inflation. It feels like it's structural. And if it subsides it doesn't feel like there will be a shock where we lose five points. Is that a fair way to think about it? And then I have a follow-up.

Yes, Simeon I think that's fair. As we came into this year, just from a purely comparison standpoint, we had expected moderation really in the third quarter and fourth quarter from that year-over-year benefit. As we move through the year, we've had continued incremental cost increases we've passed them through. As you know, it's benefited our top line. I think that's been pretty rational. And because of that we end up with more of a positive for that than we would have expected. And we'll see where the rest of the year plays out I think versus where we would have thought at the beginning of the year that year-over-year pressure won't be as significant in the fourth quarter there's still some extent to where it's there. Moving forward, we'll see -- I think our caution is on an expectation that we're going to see dramatic rollbacks that match some level of the volume or magnitude that we've seen since really the middle of 2021. We don't anticipate that. Hopefully we'll work to get some of the cost improvements moved down. But from a pricing to the Street perspective, we would continue to expect that to be resilient to market to be rational and for that not to change.

And maybe the follow-up thinking about gross margin this is directionally, obviously, not in magnitude. It does feel like and maybe some headwinds go away. I wouldn't jump to say there are tailwinds and I wanted to hear the reaction to it. Greg Johnson mentioned some of the pricing may hold industry has been rational. So, that in theory should be a good guide to the margin if pricing holds and there are some cost pullbacks. You're lapping PPI, it doesn't become an incremental headwind. And then to whatever extent freight and even some raw material costs moderate, that could be favorable for you. So, is it fair to say that some of the headwinds maybe go away they may not flip to tailwinds per se. I think you're being hesitant to acknowledge that but at least the removal of headwinds.

Yes. The one thing maybe I would caution on that Simeon is as you think about those being headwinds, we've worked I think appropriately and aggressively to stay out in front of those pressures as we passed along in pricing really since the middle of last year. Our approach has always been from a pricing perspective to highly scrutinize anything we see from our suppliers to make sure that we're making them provide the right justification for taking -- for sending a cost increase through to us. And then often we've got some ability to hold off the impact of that through the course of the negotiations that we've had and not see it for a month or two. And then you couple that with really during the tail end of last year we also had some supply chain delays that push those costs back further. So, that's given us ample opportunity. We feel like to be sure that by the time we really see the impact of that we've already started to float those prices to the Street. So, I think for us they maybe have not created the same level of headwinds that because of just our approach in doing that that you might otherwise expect.

And Simeon one other thing maybe to add on that topic. As you think about growth in our proprietary brands and our offering across good better best in those brands we're able to further diversify that supplier base than we are a national supplier base. So that kind of speaks to some of the point Jeremy just made as well if you think about it that way.

Yes, thanks guys. Good luck.

Thanks Simeon

Our next question is from Michael Lasser with UBS.

Good morning. Thanks a lot for taking my question. One of the key debates on O'Reilly and the auto part retail sector more broadly is whether or not it can generate growth in 2023 in the absence of passing along all these price increases that have been the principal driver of growth up until now. So, A, do you think that there is elasticity within the category whereas the pricing pressure abates there will be elasticity of demand so volumes will improve? And B, even if the industry doesn't pick up and see elasticity next year can O'Reilly's share continue to grow at what seemed like an accelerating rate in the third quarter likely in response to a delayed reaction to the Pro pricing initiative that you implemented earlier this year?

Michael, it's Jeremy. Thanks. There are a lot of questions within that question. So just maybe you want to take a little bit of a step back. We haven't – obviously, haven't guided to 2023 yet in – we're in a unique situation where there continue to be cost impact – cost inflation impacts, pricing inflation that are being passed through. I think what we would tell you is we'll see where that where that flattens out or what it does. I think for us, our expectation is if we see modest inflation or we see more elevated inflation that we will continue to be able to effectively pass that through to our customers. And that becomes very rational and relatively inelastic. So to whatever degree that we see that, any relief from that type of pressure. I don't know that we would say that we think it bounces back. For us from a broader perspective, we think that the automotive aftermarket is in just from an industry perspective in pretty good shape and have an expectation that the prospects for our industry in general grow and for all the things that Greg talked about within his prepared comments the vehicle fleet dynamics that miles driven I think continue to recover and be positive the incredible value proposition for consumers to invest in their existing vehicles. Those things we all feel like will be a positive and where that shakes out for the pieces of what drives the comp. We think that that's helpful. And then we continue to think that we have the ability to grow our share. That's always been our approach and we will aggressively pursue that.

Yes Michael, just to add to that, we remain very bullish on both the industry as a whole, as I said in my prepared comments and our ability to continue to take market share. I don't want anyone to think that our growth this year has been purely the result of inflation or price inflation. We feel very confident that we're taking market share on both sides of the business and we'll continue to do so into 2023.

And just a follow-up on that one, Greg. You're not going to quantify what you think the impact has been from the return on investment in the Pro pricing initiative. But could you qualify it to say that you think the impact was greater in the third quarter than it was in the second quarter? And is it reasonable, just given the lag that it might take for your commercial customers to recognize some of these pricing changes that the impact could grow in the fourth quarter and into the beginning of next year?

Yes Michael, I'll generally answer your question and then kick it across to Brad. He's obviously, living these professional pricing programs day in and day out and dealing with our competitors and out in the marketplace. We said from the very beginning that it was going to take time to gain traction that this was not as easy as flipping a switch and everybody realizes our pricing is better and all of a sudden miraculously our sales grow. We knew it was going to take time and I think it did compound in the third quarter and will continue to grow over a reasonable period of time. At some point it will stabilize. But we do expect to see continued benefit from that. Brad do you want to talk to any specifics or anything you've seen?

Yes. Michael, Greg said it pretty well. Really what we saw in our testing as we mentioned I think both after we rolled it out in the last quarter is we saw some immediate impact but we also saw a delayed impact. And to answer your question directly as Greg did, yes we do feel like there's a building effect for sure. Kind of what we see Michael, just maybe at the street level is, if you have a really big repair shop in a particular market that has bought from an independent maybe on the traditional side of the business for a couple of decades. And maybe we're second or third or fourth call even. Just because we lower our price to be a lot more competitive with that two-step independent competitor, that doesn't mean that they just start buying from us the day after we call on them. It means that what may happen, if we combine our pricing with the best team in town, the best service, the best availability and sense of urgency and everything that goes along with the relationship then what happens is, we may just move up the call list. We may move from fourth to third and third to second. And then, it can be a month later, it could be six months later, it could be a year later, if one of our independent competitors, for example, drops the ball, that could be the time that we moved from second to first. So, there's some immediate impact, but there's also that building effect.

Awesome. Thank you so much.

Thanks Mike.

Thanks, Michael.

Our next question comes from Scot Ciccarelli with Truist Securities.

Thanks, guys. I guess I have a follow-up on Michael's question. Basically, it sounds like there's a -- let's call it almost a new store maturity curve that occurs with these pricing changes. Is that fair? I mean a typical store is going to kind of mature that Pro business over what a five, six kind of year time frame like -- are we talking about that kind of waterfall or is it something presumably much shorter than that?

Yes Scott, I think that's a hard comparison to try. The dynamics are just are just different. It's definitely a ramp. But I think the best way to guide you on that from our perspective, those are harder and gain. So they're incremental improvements that build over time, they're not huge level of stepped up. So to Brent's point, we think that that will continue to get a little bit better as we move through that. And then at some point, I think we'll have realized the benefit of it. But to try to make the same analogy, I think it's a little bit tough.

Yes Scot, I want to add to that. Let's keep in mind that pricing is only one component of market share growth and it's a smaller component than execution service level inventory availability and we continue to focus on those items as well to ensure market share growth. It's a lot more than just the pricing piece.

So as you guys have gained share with some of those customers that maybe you weren't doing business with or as much business with. Are there any other changes outside of the pricing initiatives that we're all familiar with that you guys started to make where, maybe there was a reluctance on Riley's kind of game plan for one piece or another?

No, Scot, I don't know that we pointed out any real fundamental differences to what we do. Brad talked about it earlier, the keys to success -- and it was in our prepared comments, the keys success on the professional side of our business, are helping our customer partners run a more profitable business. So the things that we do to be sure that we're the best partner with our customers are the same things we've talked about for a long time. I think for us, continuing to push inventory availability, the investments that Brad talked about in the script in terms of what we've added stores this year, continue improvements in supply chain. I think those have helped us reap some of the benefit too. But this is a blocking and tackling business.

Yes, Scot, the only thing I might add to that is, we've been able to get back to a lot of our in-person relationship type things with supplier customers. Our training programs are back fully in place. Some of the things that we haven't been able to do because of the pandemic, we're back to doing day-in and day-out. That's probably helped from a relationship and strengthening perspective.

Yes, Scott, this is Brad. I just want to real quick add nothing new, Jeremy said it best, blocking and tackling. We work in a simple business. It's not easy, but it's simple. And really, we had our regional managers from the field into Springfield last month. And our focus was on our fundamental execution. That didn't start in that meeting. But really all year, our battle cry from our EVP of Stores Doug Bragg has been, we're going to get out of the COVID funk and not accept where we may have high turnover in stores, high team member turnover, high store manager turnover, that's just not acceptable with the way we built our business, getting out seeing more customers, not having that excuse that unfortunately we made for ourselves the last couple of years, that we're just getting back to the execution that built our company and making sure that we don't have that hangover from COVID and everything we do.

Understood. Thanks, guys.

Thanks, Scot.

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

Thank you, Vanessa. We'd like to conclude our call today by thanking the entire O'Reilly team for your continued hard work in the third quarter. I'd like to thank everyone for joining our call today and we look forward to reporting our fourth quarter and full year results in February. Thank you.

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