O`Reilly Automotive Inc (ORLY) — Q3 2017 Earnings Call Transcript

Thank you, Allie. Good morning, everyone, and thanks for joining us. During today's conference call, we'll discuss our third quarter 2017 results and our outlook for the fourth quarter of 2017. After our prepared comments, we will 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 31st, 2016, 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 Henslee.

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 our Co-Presidents Greg Johnson and Jeff Shaw, as well as Tom McFall, our Chief Financial Officer. David O'Reilly, our Executive Chairman, is also present. I'd like to begin our call today by thanking Team O'Reilly for their continued dedication to providing consistently excellent service to our customers. This unwavering commitment to going above and beyond to meet our customers' needs was on full display during the third quarter and our team's response to Hurricane Harvey and Hurricane Irma. Jeff will touch on our team's efforts in more detail in a few minutes. But I want to thank each member of Team O'Reilly for their hard work and commitment they showed in providing great service to our customers during the recovery from these storms. We did see some headwinds during the quarter as a result of store closures caused by the storms. However, thanks to our team's amazing commitment to getting their stores back open as soon as possible, we estimate we were able to make up most of the lost volume prior to the end of the quarter, and more importantly, we were able to generate incredible goodwill with our customers that will benefit us for years to come. Our comparable store sales results for the third quarter were in line with the guidance expectations we established on last quarter's call as we saw a continuation of the business trends we experienced in the first half of the year. Clearly, our results this year have been below our robust long-term track record as a result of challenging market conditions in our industry driven by several factors I discussed in detail on our last conference call. These include the impact of two consecutive mild winters coupled with a mild summer in 2017, the impact to the addressable vehicle population from depressed new vehicle sales totals during the period from 2008 to 2011, and the significant economic pressure and uncertainty faced by many of our customers. None of these factors reflect a structural shift in the dynamics of our industry and we remain very confident in the long-term outlook for the automotive aftermarket. We operate in a very stable industry and expect to continue to see steady increases in total miles driven along with growth in the total vehicle population in the U.S. and will continue to benefit as the high-quality vehicle engineering and manufacturing support demand for parts laid into vehicles lifecycle. As we look forward to the fourth quarter in 2018, we remain diligently focused on executing our proven business model and consistently providing excellent service to our valued customers and fully expect to continue to lead our industry and generate robust profitable growth. Our confidence in our business is reflected in our continued reinvestment in new store growth. Jeff will provide his normal updates in a few minutes, but I'll steal some of his thunder to report to you that we are extremely proud to open our 5,000th store last week in Norwich, Connecticut. Our outstanding track record of extremely successful organic growth is the result of an amazing amount of hard work by so many of our team members throughout our history, and we continue to be very excited about our future growth prospects. I'll now turn the call over to Greg Johnson for some more detailed comments.

Thanks Greg. Good morning everyone. I'd like to begin my comments today by thanking our team for their continued commitment to outstanding customer service and their hard work in the third quarter which allowed us to generate respectable results in a tough environment. Team O'Reilly has consistently demonstrated that we will respond to market challenges by working even harder to take care of our customers. And that commitment to our customers has us well-positioned to profitably gain market share moving forward. I would now like to provide some additional color on the third quarter comparable store sales result and the fourth quarter guidance. Our results were within expectations as we began the quarter on a similar trend line to the results we posted in the second quarter. Greg previously mentioned our month-to-month cadence for the third quarter was impacted by some headwind in the middle of the quarter as a result of store closures caused by the hurricanes. But we estimate we were able to make up for the lost volume in the affected regions, as we saw demand increase for recovery-related activities. Excluding the timing impact of the hurricanes, our results for the quarter were relatively steady, with September finishing as the strongest month of the quarter. On a category basis, our results in the third quarter were very similar to what we saw in the second quarter. We experienced continued softness in hot weather categories such as cooling, HVAC, and refrigerants, particularly in the Central and Southern U.S. where mild summer conditions persisted throughout the quarter. In addition to the pressure in hot weather categories, we saw continued headwinds in other weather-related categories such as ride control and driveline which did not experience the typical wear and tear this past winter in the absence of harsh weather, which drives damage for these categories. While it is difficult to quantify the specific impact of any particular market factor has on our business over short periods of time, it is very clear to us that weather has created a short-term headwind to our business. Our comparable store sales increase was driven by increases in average ticket size offset by pressures on ticket count for both DIY and professional customers. Our comparable store sales growth was evenly balanced between DIY and professional customers for the third quarter and our comp results for the first nine months were similarly balanced. We believe that parity on both sides of the business speaks to the impact of overall demand for auto parts being soft rather than isolated pressure resulting from a channel shift in the industry. As we discussed last quarter, our tight connection to our professional customers gives us deep insight into the drivers of our comparable store sales results since we can identify changes in demand from prior periods on a customer-by-customer basis. We continue to receive feedback that the sluggish demand we've seen in the first nine months of 2017 is being felt across the industry as our professional customers report similar sluggishness in their business. I would now like to spend a few minutes discussing the comparable store sales guidance we provided in yesterday's press release. As noted, we have established our fourth quarter guidance range at flat to 2%. While this range is lower than the guidance we provided for the third quarter, it does not reflect an expectation of a negative shift in the trend of our business. We finished the third quarter on a good pace with September being the best month of the quarter and that better pace has continued into October. One has to consider that we have our toughest fourth quarter comparisons in December, and that coupled with the impact of the calendar shift in the fourth quarter led us to step up our comp sales guidance down to flat to 2%. This calendar headwind resulted from an additional Sunday in 2017 versus the fourth quarter of 2016, as well as the timing of the Christmas holiday, which falls on a Monday this year versus Sunday last year. Both of these calendar shifts create a headwind for us since most professional shops are closed on Sunday and it represents our lightest volume day of the week. Based on historical experience, we expect the calendar shifts to represent a combined headwind of 50 to 100 basis points of comparable store sales growth in the quarter. As I mentioned, we have been reasonably pleased with the business thus far in the quarter, but remain cautious given the volatility we face in the fourth quarter due to the variability of the holiday shopping season and the timing of when or whether. This is especially true this year since we've faced difficult comparisons at the end of the quarter as we compare a strong business in December of 2016. We benefited from the harsh weather we saw last winter. Taking these factors into account, our guidance range for the fourth quarter is consistent with our actual results in the first nine months of the year on a two and three-year stack basis. Just to reiterate, the midpoint of our fourth quarter comp guidance of 1% is below our year-to-date results of 1.5% because of the calendar shift headwinds, and we continue to expect to see a continuation of the underlying business trends. We're leaving our full-year guidance unchanged at 1% to 2% based on our actual performance for the first nine months of 2017 and our expectations for the fourth quarter. Looking at the broader automotive aftermarket, we have benefited from solid macroeconomic trends and the core underlying drivers of business in our industry. Total miles driven in the U.S. is up 1.5% year-to-date through July and gas prices continue to remain stable at low historical levels. Overall employment levels in the economy continue to be solid, and the corresponding stable commuter model underpins support for demand in our industry. We feel our industry is facing normal cyclical short-term pressures, but it is in very stable and healthy condition and will return to the long-term growth rates in the industry as the industry has historically experienced. More importantly, we remain very confident our team will continue to take share and generate results which outperform the overall market. I would now like to discuss our gross margin results for the third quarter and our updated guidance for the full year. Our third quarter gross margin of 52.6% came in at the bottom end of our guidance expectation, as we saw continued pressure to our gross margins from deleverage of fixed costs on low sales volumes as well as other factors Tom will discuss in more detail. We expect sequential margins will improve in the fourth quarter as compared to the third quarter as we benefit from a more favorable product mix. However, we expect continued pressure for the fourth quarter from deleverage on fixed costs to result in a full year gross margin at the bottom end of our previously issued guidance. As a result, we're adjusting our full-year gross margin to lower the top end of the range and now expect our full-year gross margin to be within a range of 52.5% to 52.7% versus our previous range of 52.5% to 52.9%. We continue to see an absence of broad-based pressure on pricing in our industry, and we see no significant inflation and we assume those significant inflation on both our comparable store sales and gross margin guidance. For the third quarter, we generated earnings per share of $3.22, which includes a $0.02 benefit from a change in accounting related to the tax benefits from stock option gains, and is at the top of our previously guided EPS range for the third quarter. While our third quarter EPS performance is below the historical growth rates we had generated over the past several years, as a result of the tough sales environment and corresponding leverage pressures on our business, it still represents a 10% increase over the prior year after adjusting for the accounting change. Our team's ability to provide excellent customer service which drives long-term value for the company while still producing solid financial results is a testament to their hard work and dedication. Moving on to the fourth quarter, we're establishing a guidance range of $2.65 to $2.75, an increase in the full-year guidance to a range of $11.82 to $11.92. Our full-year guidance includes the previously discussed positive benefits realized in the first nine months of the year for a change in accounting for taxes as well as the shares repurchased through today's call. But neither the fourth quarter nor the full-year guidance includes any additional benefit related to the accounting change for taxes or additional share repurchases. Before I turn the call over to Jeff, I'd like to echo Greg's comments and reiterate our confidence in the strength and fundamental drivers of our industry and our team's ability to successfully execute our business plan, drive profitable growth, and generate exceptional returns for our shareholders. Our past successes and opportunities for the future are driven by the excellent experience we provide to our customers, which is the direct result of the quality of our professional parts people. This exceptional service provides a tremendous value for our customers and is extremely difficult to replicate. I'll now turn the call over to Jeff Shaw.

Thanks Greg, and good morning everyone. I'd like to begin my comments today by thanking our team for their relentless commitment to excellent customer service and their continued hard work every day to serve our customers and outperform our competition. Team O'Reilly's dedication was especially evident in those regions of our company impacted by Hurricanes Harvey and Irma, and I want to provide a little color on the impact of these storms and more importantly, on the tremendous efforts of our team to overcome significant challenges and provide outstanding customer service. In total, we had approximately 450 stores impacted by the storms, with the closures concentrated over the three to four-day time period when the storms made landfall, though the majority of the impacted stores were closed for less than two full days. In addition, our distribution centers in Houston, Texas, and Lakeland, Florida, were also impacted for a short period during the storms. While we sustained some damage as a result of the storms and we'll continue to evaluate the total cost of the storms, we did not see material headwind from storm-related losses in the third quarter, and we don't expect for these costs to be material going forward. As both Greg and Greg previously discussed, the headwind from store closures during the worst of the storms, we estimate was offset in the quarter by the incremental sales volumes we captured upon reopening the stores in the affected markets. Our ability to recover quickly from disasters such as these hurricanes isn't a new phenomenon for our company, and our teams have long prided themselves in being among the first businesses to reopen and be there for our customers after a disaster. Getting an auto parts store up and running after events like the ones we faced in the third quarter requires a tremendous amount of hard work and dedication from our team, including everything from removing water and damaged product from the affected stores, to working with limited lighting and no air conditioning, writing manual tickets in the absence of electricity or communication, unloading trailer loads of generators, gas cans, and other post-hurricane supplies, and the list goes on and on. While this certainly provides a benefit as we begin to make up for the lost days of sales, the real benefit we generate is the goodwill we create with our customers by being there to provide the supplies and repair parts necessary to help them recover from the storms. This goodwill is the direct result of the hard work and sacrifice shown by our store and distribution center teams to overcome these challenges and take care of our customers, despite many of them also facing personal impacts from these storms. We remain committed to contributing our resources in helping those affected by the hurricanes, and we're extremely grateful for the amazing contributions of Team O'Reilly during the storms. Now, I'd like to spend a little time talking about our SG&A expense for the third quarter. Our SG&A was 32.8% of sales, which represents a 32 basis point increase over the third quarter of 2016. As we saw in the second quarter, the deleverage of our SG&A spending was the direct result of the top-line pressure to our comparable store sales results. On a dollar growth basis, we're pleased with the strong expense control management demonstrated by our teams as average per store SG&A expense in the third quarter increased by 50 basis points as compared to the same period last year. This disciplined focus on expense control by our store and distribution center teams is a result of active daily management in each store, distribution center, and office to ensure that every dollar we spend is directed toward improving the service levels we provide to our customers. Our SG&A spending is deliberate, and the adjustments we've made to respond to the current sales environment during the course of 2017 have been measured and gradual. We execute our business model with the expectation that our high level of customer service will drive robust sales growth over the long term, and we will not overreact to make dramatic adjustments that would negatively impact our customer service levels. As a result, we will continue to see some deleverage pressure as low single-digit comparable store sales growth, but the strong expense control focus of our team has significantly limited this pressure and enabled us to generate a third-quarter operating profit percentage of 19.7%, which continues to be one of the best results in all of retail. Based on our strong expense control in the third quarter and our expected spending for the remainder of the year, we now expect that our average per store SG&A increase for the full year 2017 will be in the range of 1% to 1.5% over our previously stated range of 1.5% to 2%. Before I turn the call over to Tom, I'd like to spend a few minutes discussing our store growth in the first nine months of the year and our plans moving forward. In the third quarter, we successfully opened 50 net new stores, bringing our year-to-date total to 155 net new stores spread across the country in 34 different states. During the fourth quarter, we'll achieve our 2017 new store growth target of 190 stores, which includes, as Greg discussed earlier, the opening of our 5,000th store last week. This is an incredible achievement for our company, and we remain as confident as ever in our ability to execute our growth strategy. Our excitement about our future new store growth opportunities is the result of the strong performance of our new stores which continue to exceed both our historical averages and our internal expectations even against a more challenging backdrop for the industry. As we look forward to 2018, we expect another strong year of new store expansion and our established store growth target of 200 net new stores. I've got to conclude my comments today by, again, thanking our team for their continued dedication to providing the best customer service in our industry. Our teams have responded to the market conditions we face throughout 2017 by working that much harder to take care of our customers, and that relentless commitment is the key ingredient as we move forward and continue to take market share. Now, I'll turn the call over to Tom.

Thanks Jeff. Now, we'll take a closer look at our quarterly results and updated guidance for the remainder of 2017. For the quarter, sales increased to $119 million prior to the $57 million increase in comparable store sales, a $64 million increase in non-comparable store sales, a $1 million decrease in non-comparable non-store sales, and a $1 million decrease from closed stores. For 2017, we expect our total revenues to be $8.9 billion to $9 billion. For the quarter, gross margin was 52.6% of sales which was a 10 basis point deleverage versus the last year. The reduced gross margin percentage was the result of product mix, the loss of leverage on fixed costs, and higher strength offset in part by lower LIFO charge. The LIFO impact resulting from continued incremental acquisition cost reductions was a headwind of $3 million in the third quarter of 2017 versus $10 million in that same period of 2016. We're anticipating the headwind from LIFO in the fourth quarter will be similar to the third quarter. For the quarter, our tax rate was 35.5% of pretax income, which was better than the 36.4% we anticipated. One-third of the positive variance was due to better than anticipated results on the tolling of certain tax periods. As a reminder, the third quarter rate is typically lower than the remainder of the year due to the tolling of open tax periods. The remaining two-thirds was due to the required accounting change for the tax benefit relating to share-based compensation. For the fourth quarter, our tax rate will be approximately 37.3% of pretax income before any benefit we may receive relating to the accounting change for share-based compensation. Now, we'll move on to free cash flow and the components that drove our results in the quarter and our guidance expectations for the full year of 2017. Free cash flow for the first nine months of 2017 was $704 million, which was a $108 million decrease from the prior year driven by a smaller decrease in our net inventory investment than in the prior year, partially offset by higher income. For the full year, we're maintaining our free cash flow guidance of $830 million to $880 million. Inventory per store at the end of the quarter was $600,000, which is a 4% increase from the end of 2016, in line with our expectations for normal seasonal fluctuations. For the full year, we continue to expect the inventory per store to grow approximately 1.5% to 2%. Our ongoing goal is to ensure we grow per store inventory at a lower rate than the comparable store sales growth we generate. And we now project these growth rates will be similar for 2017. We remain confident in our effective deployment of inventory. Our accounts payable to inventory ratio finished the third quarter at 106%, which is where we ended 2016, and we anticipate the end of 2017 will be at a similar rate of 106%. Finally, capital expenditures for the first nine months of the year were $340 million, which was down slightly from the same period of 2016 and in line with our expectations. We continue to forecast CapEx of $470 to $500 million for the full year of 2017. Moving on to debt, we finished the third quarter with an adjusted debt to EBITDA ratio of 2.08 times as compared to our ratio of 1.63 times at the end of 2016. The increase in our leverage ratio reflects the $750 million 10-year bonds we issued in August and incremental borrowings on our $1.2 billion unsecured revolving credit facility. Our increased borrowings moved into our targeted ratio of 2 to 2.25 times. We continue to execute our share repurchase program, and year-to-date through this call, we've repurchased 8.3 million shares at an average share price of $234.51 for a total investment of $1.95 billion. During the third quarter, we repurchased 2.7 million shares at an average price of $200.70. We remain very confident that the average repurchase price is supported by expected discounted future cash flows of our business, and we continue to view our buyback program as an effective means of returning available cash to our shareholders. Finally, before I open up our call for questions, I'd like to thank the entire O'Reilly team for their continued dedication to the company's long-term success. This concludes our prepared comments, and at this time I'd like to ask Allie, the operator, to return to the line; we'll be happy to answer your questions.

Good morning. Big thanks for taking my question Greg. Are you seeing any signs or any evidence that the industry is becoming more promotional or that pricing pressure is becoming an issue in light of your gross margin performance for the quarter? I think that's becoming a question mark for the industry at this point.

Okay. Well, thanks Michael. What I would say is that anytime our industry has a year where demand isn't quite as great as the prior year or the prior period or whatever, we have primarily regional independents I call them undercard warehouses that do literally everything they can to hang on to and grow their professional business. So we have those kinds of things happening regionally, but there's nothing new that happens. You see it more during times of lower industry sales growth than you do in times of higher industry sales growth. But it's nothing new. But I would add to that that we've seen nothing across the industry that's changed the way that we compete on price. And I would speculate that there really has been no material change among our competitors. There's a method by which they go to market relative to price other than what we've read about one of our competitors who is considering going to a zone pricing strategy which all of us, except for them, evidently currently deploy. And we'll just have to see what effect that has. But I guess my comment would be is there's nothing new on the pricing front for us.

That's helpful. And then my follow-up question is how do you reconcile your comments about weather influencing the industry sales and the fact that your trends improved in September? And it sounds like that continued into October despite the fact that it's been abnormally warm in areas of the country like the Northeast? And then if we see another abnormally warm and dry winter, is this 1% to 2% growth rate kind of a new norm for the business?

We've experienced two consecutive mild winters and a mild summer. As winter approaches in some areas, we've noticed a positive response to winter preparation items. Many people likely recognize that they neglected some car maintenance during the previous mild winters and are now planning to address those issues. This anticipation might be contributing to early-season demand before the colder weather arrives. While we hope for a harsh winter across much of the country, we understand that demand in the Northeast has been softer, although we're still seeing growth there due to our newer stores. In terms of whether a 1% to 2% growth rate could become the new normal, it's uncertain. It would be surprising to have three consecutive mild winters. Certain products may fail regardless of weather conditions, with extreme weather simply accelerating that failure. If we experience a cooler winter, we expect strong demand, but if the winter remains mild, we may still see items fail due to age and usage rather than weather. Therefore, we anticipate this winter to be better for us and do not expect 1% to 2% to become the new standard.

Thanks much. And good luck with the fourth quarter.

Okay. Thank you, Michael.

Hi good morning. Thanks for taking my question.

Sure.

So, I too just want to begin with a question on gross margins. And Tom, I know you addressed this somewhat in your prepared comments, but can you help us understand better what really changed from, say, Q2 to Q3, where gross margins went up from being up solidly to down slightly? What were the key factors that changed there? And then recognizing you don't give guidance beyond 2017, but how should we think about gross margins if we look out into 2018 and beyond?

So, your question is, to make sure I have this right, is the year-over-year difference from the second quarter to the third quarter?

That's correct.

Okay. So, when we look at the second quarter of 2016, we had a significant LIFO charge, and that created a lot of the difference. When we look at our gross margin, we tend to look on a quarter-to-quarter basis, not year-over-year. The best indicator is how we did the quarter before. And there is some seasonality within that based on the product mix that we sell during that quarter. So, the comparison of how much we're over in the second quarter versus that of the third quarter really has to do with that LIFO number. If we look at the sequential margin from the second to the third quarter, we actually improved, and a lot of that is based on seasonality, and we'd expect it to continue to improve per our guidance in the fourth quarter based on the products. As far as next year, we see a pretty stable pricing environment out there. We see a non-inflationary environment continuing, and we'd anticipate that we'll continue to work hard at improving our gross margins to the extent that we are better able to leverage our fixed costs we’ll see an improvement. And our merchants are always working on getting better deals. So, we wouldn't expect to have the pressure that we've seen this year excluding LIFO.

It's helpful. My follow-up question is about hurricanes. It seems like your stores recover quickly after the storms. Should we anticipate any recovery demand in your business for the rest of 2017 or even further out?

Well, I think there's always some. Cars that were flooded that weren't totaled or cars that maybe were in really bad shape that people decided to salvage, there are fluid changes and other things. We've been through this before. And Jeff, I might ask you to, kind of, speak to some of the things that we see in the stores relative to items that people worked on and repaired following hurricanes and how long that lasts.

Certainly. The main items will be filters, fluids, and other products needed to service flooded cars that were not totaled. Additionally, we expect to see an increase in demand for rotating electrical parts in the affected markets. It’s difficult to predict the timing, but based on our experience with similar situations in the past, we anticipate some post-hurricane demand in those areas will last for a while.

One additional benefit, Brian, is that many of the cars that were totaled resulted in people not purchasing new cars. I would speculate that many of our customers who had cars that were totaled and received insurance checks may have never bought a new car in the past and likely won’t this time either. As a result, they are now opting for used cars. In fact, the used car market in Houston is thriving, with a shortage of used cars available, and auctions across the U.S. are helping to meet the demand for vehicles in those flooded areas. As these customers buy used cars, many times, someone acquiring a vehicle that is new to them will take it through a maintenance cycle, which is generally beneficial for us. Therefore, I believe that late 2017 and 2018 may provide us with some advantages from those used cars that are becoming new family vehicles and going through a maintenance cycle.

Got it. Helpful. Thank you.

Okay. Thanks, Brian.

Hi, thank you for taking my question. I think you'd mentioned in the prepared comments to some of the better results that you're seeing at your new stores. Can you walk through how close some of these newer stores are to existing stores and what is exactly driving some of these better results and how they can maybe be leveraged into the rest of the fleet?

Okay. We put in some fantastic new stores, and I think you may be surprised to know that one of our largest growth markets is Texas where we have a number of stores and operate in virtually every market. So they are backfill stores and they are even in Houston, Dallas, Austin, San Antonio, markets like that. We're constantly evaluating where we might put additional stores. So some of the new stores we open are stores that are reasonably close to existing stores. But we know by the work we do demographically that we're not getting as much business as we could potentially get if we had another store and we justify opening an additional store. On the other hand, many of our new stores are in Florida and the Northeast where we don't have existing stores and those stores where we don't have overlap, we establish our brand and do very well. I just attended our new store up in Norwich, Connecticut, which was our 5,000th store. I attended that opening. And it's just incredible the number of customers that come in who are thankful we're there, happy we’re there, enthused about the new store, and impressed with the way the store looks. So we do a lot around promotions and putting a great team in the store to get a store off to a good start. And frankly, over the years, we've just got better at it than we were in the past. Today our new store openings outpace what they had a few years ago, and we're pleased with the new stores we opened both in backfilled markets and in new store growth markets.

Okay. Thank you.

Thank you.

Hey guys good morning. First question is on sales. I wanted to ask how do you know if some of the strength that you saw in September/October wasn't just this hurricane rebound that you mentioned and that you don't see that that trends won't soften from there? I guess maybe you can talk to some geographic markets or categories or parts?

Yes, we have an understanding of the impact those affected regions can have, based on the overall performance of the company. While there has been some recovery in those markets, it is not significant enough to be the main reason for the improvement.

Got it. Okay. And then I want to ask about the sweet spot. We've talked a lot about it and there's a lot of ways to slice it. I mean, clearly, 2017 wasn't the year it happened, or at least it was clouded by weather. But it would seem like 2018 should be a year where mathematically the number of cars in that sweet spot do increase. Do you agree with that? And is there any rhyme or reason for it to occur earlier or later in next year?

I agree with you that we should begin seeing an increase in 2018. The 2008 to 2011 cars will be on the tail end of the demand curve and their presence in the population and the number of those cars won't be as impactful on the overall demand in the industry.

Got it. Okay. Thanks Greg.

Thanks, Simeon.

Thanks. Greg, I want to follow up on that same topic. Back in 2008 the company had an unexpected weakening in same-store sales along with the economy, and had a nice rebound of 4.6% in 2009. A little bit of a similar pullback in 2012 results, followed by a recovery to 4.3% comps in 2013. When you think about next year, do you think that we're set up for a snapback in comp sales, maybe to at least the midpoint of 3%? Sounds like you're a little bit more bullish on the demographics as well for next year.

Dan, I would say that I was somewhat surprised by the softness we experienced this year. You can’t predict how a year will unfold when you’re planning. Tom and his team excel in budgeting and forecasting. However, I believe we have easier comparisons to make next year, especially after facing challenging comparisons for several years. Therefore, considering the air bubble in the population and the easier comparisons, we do expect to see better comparable store sales next year compared to this year. Although we haven't finalized our forecast or set our plan to provide guidance yet, I am optimistic that based on our performance in the fourth quarter, we will feel confident in establishing a more aggressive plan for comparable store sales for next year.

Also, you commented on the feedback from your commercial customers, and they indicated they think the weakness is impacting them as well. What are they saying about the dealer's service business? You know the public companies have been showing that their service business has been strengthening. Is there a risk that they're having some impact on that down-the-street mechanic, and that could be having some influence on their softer results?

I believe there is some truth to that. The shops that focus on diagnostic and drivability work, which is quite technical, have seen dealers improving their efforts over the past few years to retain some of that business. This isn't just about the revenue generated from repairs, although that's helpful. It's largely because dealers aim to attract new car buyers. Those who purchase new cars and go through the warranty process at a dealer are seen as potential future customers for new car sales. Dealers believe that if they provide good service, they stand a better chance of securing the next new car sale. Some of our competitors and customers perceive dealers as significant rivals, especially if they operate technical shops. However, shops that primarily handle under-car work like brake services, alignments, tires, and chassis are not as affected by dealers since I don't think dealers engage much in that type of work.

Okay, great. Thank you.

Okay. Thanks.

Hey good morning guys.

Good morning.

Could you discuss the extent of the improvement in same-store sales? Some suppliers are mentioning that they have seen positive point-of-sale data from their perspective in September. Can you elaborate on how much improvement we experienced as the quarter progressed? Additionally, you mentioned that the central states were the weakest; could you provide some insights into the spread between the lowest and highest performing regions?

Yes. Well, yes, we don't want to get into a lot of detail about our comps, specifically by month. But we said that September was the best month of the third quarter and that better trend has continued into the end of the fourth quarter. Although we don't want to sound overly aggressive, because we know we have this tough compare coming in December, we have the headwind from the holiday and the extra Sunday and so forth. But yes, I think that what you're hearing from suppliers would be reasonably accurate about the improvement that's been seen in September and October. And I'm sorry, I forgot the second half of your question.

The regional spread, how much did the central states underperform in your strong markets?

Yes, the Central and East would be softer than our West. The West Coast and the western half of the country have been our best performing this past quarter.

Okay. And then the follow-up question, on M&A, obviously the GPC guys bought Monroe in Rochester, or buying and you've done the Bond deal a year ago. Are you seeing more of the smaller independents, the undercar warehouses you talk about, that maybe are challenged in a soft environment looking to sell now?

There's always a few out there that are ready to sell. Some overlap with us, causing valuation to be a problem. But yes, I think the softness in the business causes more of them to be interested in selling than they are in times of robust business.

Okay, great. Thank you.

Yes, thank you.

Thank you very much. My first question relates to inflation, both with respect to commodity prices as well as wages. Greg, one of your chief competitors talked about that they were seeing some inflation in commodity pricing. I was wondering why at this point you're not really seeing that. And then the second half to that first question, what are you seeing, if any, with respect to wage pressure inside your stores?

Regarding commodity pricing, we continuously monitor our competitors and have noticed some inflation in commodities over time. While this does provide some benefits, it is not significant across our entire inventory since most of our business involves hard parts and batteries. We remain vigilant about our competitors' pricing practices and seek opportunities to adjust our prices accordingly. As for wages, we experience similar pressures as our competitors. It's widely recognized that many municipalities have set their minimum wage significantly higher than the federal level, and we strive to ensure that our stores operate as efficiently as possible. Jeff Shaw and his team excel in managing this situation. Jeff, if you would like to discuss productivity initiatives and routing improvements for our drivers that enhance store productivity, please feel free to share.

Yes. I mean, anytime there's low unemployment, there's going to be wage pressure, and these municipalities don't really help things. But when payroll goes up, you’ve got to manage productivity team member by team member, and we do that with various things and we're using more and more technology all the time to try to leverage our team member productivity to keep our SG&A in line. So, it's just the same thing we've always fought. I mean, we'll work through it and manage it quarter-to-quarter and year-to-year.

Hey Alan, this is Greg Johnson. I'd like to just add to the commodity pricing question. I don't think we've seen anything out of the norm this year from a commodity pricing perspective. A lot of the commodity pricing is based on pricing of various metals, fuel-based pricing, things like that. We see fluctuations every year and we've been able to pass along most of those price increases.

Okay. Thank you very much. And just a follow-up, if I may. Greg Henslee, you said one of the factors, although further down on the list, that you thought was responsible for the weakness, not only in your business but for the industry, was the addressable vehicles from 2008 to 2011 time period. That's a pretty long period of time, right, both during the recession as well as the year before and the year after. Does that length of time and the fact that you believe that it is influencing your business, does that maybe give you some pause in terms of changing just the near-term strategy since it looks like it's somewhat of a prolonged period of time possibly taking down the new store growth just a little bit till we get to the other end of that?

No, it doesn't, Alan. Just to clarify, what we're discussing is the decline in new car sales during those years, which resulted in fewer cars that fall into the ideal market for selling auto parts. When that population decreases, it can impact demand for parts. However, I wouldn't view it from the perspective you mentioned regarding anticipating this change and adjusting our growth plans. I believe the impact is significantly countered by the fact that cars are lasting longer on the road. Some of the older cars that customers typically wouldn’t invest in are no longer reaching the end of their life cycle as quickly. So, while this situation is a factor, its effect is somewhat diminished because there are more older cars on the road that are still worth investing in, as they continue to perform well.

Okay. Thank you, Greg. I appreciate the explanation.

You bet. Thanks Alan.

Thanks. Good morning. Could you remind us about the extent of the decline in the business during December? I understand that you benefited from the cold weather, but there were also some emerging headwinds with the Hispanic customer base. I'm curious if you could discuss the current situation there. Is that customer segment more stable now? Do you believe this was a factor affecting your business around the time of the election?

We don't provide monthly comparable numbers, but December's performance was roughly double that of the previous two months in the quarter. This represents a significant increase. A substantial portion of our December business was linked to extremely cold weather, which drove sales of batteries and other winter-related items. We may see similar conditions again in December. If we experience severe cold weather, it could lead to many batteries failing, resulting in increased sales. December marked a notable improvement in comparable store sales compared to October and November. Regarding the Hispanic customer base, we believe the situation is improving. Jeff, you had mentioned earlier some insights from the RMs and DMs, so we see positive trends there. Perhaps you would like to add something on this topic.

Yes. I mean, what we're hearing from some of the heaviest Hispanic markets is the operators feel that it's taking back up. Foot traffic is picking up and some of the professional business is picking back up. So, at this point, it's isolated, but we are hearing some positive comments more than we've heard all year.

Could you share your thoughts on how much that customer has been a challenge, either in the fourth quarter last year or in the first quarter? Is the impact around 20 or 30 basis points, or is it something more significant?

It would just be an absolute guess, and I'd rather not put a number on it. It's been a factor. There's been enough discussion about it, and the information we get from a company called NPD, who you're probably familiar with, outlines just the general retail demand among the Hispanic customer base and where the Hispanic population is most prevalent in driving retail demand across the country has indicated that it's a factor. But it would be very difficult, if not impossible, for us to put a number on the impact.

Understood. And then just as a quick follow-up. Tom, did the shrink headwind continue as you look into the next few quarters? Is that sort of a new rate of accrual? Or was this just more of a one-time adjustment here in the third quarter? Thank you.

We have invested considerable effort in managing shrink. Our field team and distribution center teams are doing an excellent job, as is our loss prevention team. This situation is somewhat unusual for us and is likely related to the timing at the end of the quarter and the adjustments we had to make regarding inventory movement based on events that occurred during the quarter.

Understood. Thanks.

Thanks.

Thanks for taking the question. First one is clerical, does your SG&A guidance, is that GAAP? Like do you adjust that for the legal reserve and for the M&A? How are you looking at that?

I'm sorry. Our SG&A guidance would be GAAP.

Okay. You have performed impressively year-to-date, essentially flat versus 3%. This is without considering depreciation and rent in your SG&A compared to running 3% in previous years. Can you clarify how much of the incentive compensation is included in the SG&A base? Is there a chance that some of these expenses could be deferred into 2018? I would like to hear your thoughts on this.

I would say it's primarily due to tight expense management. As we've discussed previously, every team member at O'Reilly, from drivers to executives, has variable compensation. This percentage is facing some pressure this year, resulting in savings that won't materialize. However, we are managing expenses effectively, particularly payroll, which is our largest cost at both distribution centers and stores. We will also effectively manage the volume-based expenses that increase with higher sales and activity.

Okay. Then just one brief one on LIFO. Those tailwinds have kind of slowed down a little bit or I guess initial headwinds, I call them lag tailwinds. How do you think about kind of your ability to extract better procurement from your vendors? Are you seeing anything change on the discussion points? Is there a certain percentage of your portfolio turnover in the last couple of years that makes those slower? Or how do you think about those?

As Greg mentioned earlier, we have experienced some inflation in commodity prices, which impacts our ability to secure better deals, partially countered by inflation on certain commodities. We are still focused on obtaining great deals, but if we continue to see commodity prices rise, that could provide a boost to our top line. Our industry has been quite successful in implementing price increases to address cost increases we face.

Okay, cool. Thank you for the help. Appreciate it.

Thank you.

Okay. Thank you, Allie. We just like to conclude our call today by thanking the entire O'Reilly team for our continued dedication to customer service in the third quarter and for the year. We look forward to finishing 2017 on a solid note and getting off to a strong start in 2018. I'd like to thank everyone on the call today for attending our call, and we look forward to reporting our fourth quarter 2017 results in February. Thank you very much.