O`Reilly Automotive Inc (ORLY) — Q1 2019 Earnings Call Transcript

Thank you, Michelle. Good morning, everyone, and thank you for joining us. During today's conference call, we'll discuss our first quarter 2019 results and our outlook for the second quarter and full year of 2019. After our prepared comments, we'll host a question-and-answer period. Before we begin this morning, I'd like to remind everyone that our comments today contain forward-looking statements. And we intend to be covered by, and we claim the protection under, the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You can identify these statements by forward-looking words, such as 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, 2018, and other recent SEC filings. The company assumes no obligation to update any forward-looking statements made during this call. Greg Johnson, our CEO and Co-President, is unable to be with us today due to a very serious health issue involving a close family member. For today's call, Greg Henslee, our Executive Vice Chairman and Former CEO, will be participating in Greg Johnson's absence. At this time, I'll turn the call over to Greg Henslee.

Thanks, everyone, and welcome to the O'Reilly Auto Parts first quarter conference call. Joining me this morning are Jeff Shaw, our Chief Operating Officer and Co-President, and Tom McFall, our Chief Financial Officer. David O'Reilly, our Executive Chairman, is also here. I want to start by expressing my gratitude to Team O'Reilly for their steadfast commitment to delivering excellent service to our valued customers. This dedication is crucial for our long-term success, and I take great pride in how we care for both our professional and DIY customers. As noted before, the timing of weather patterns in our first quarter can lead to significant volatility throughout the year. This quarter was particularly affected, as we experienced prolonged harsh winter weather that positively impacts our business and should support strong demand for the rest of 2019. However, we also faced considerable rain during the quarter, which adversely affected our DIY business. Additionally, delays in tax refunds and a decrease in overall refund amounts contributed to the sales fluctuations we observed. It’s also important to point out that our first quarter had an additional Sunday compared to 2018, which negatively impacted our comparable store sales by roughly 50 basis points since Sundays are typically our lowest sales days. Consequently, our comparable store sales increase of 3.2% was at the lower end of our guidance range due to the transient challenges experienced during the quarter. Despite reviewing our results on a day-by-day and region-by-region basis, we remain confident in our business and the overall health of the automotive aftermarket along with the robust trends in our industry. Given the sales fluctuations this quarter, I commend our team's efforts in managing expenses and achieving profitable sales growth, which resulted in a 5.2% increase in operating profit dollars compared to the first quarter of 2018 and an operating margin rate of 18.5%. Besides the solid sales and operating profit growth, we also experienced a significantly lower tax rate than anticipated, which Tom will elaborate on in his comments. This combination of operating performance along with our ongoing share buyback program drove an increase in first quarter earnings per share of 12.2% to $4.05 per share, which exceeded the top end of our guidance range of $4.02 per share and reflects our team's ability to consistently execute our business model and drive solid profitable results. Now I'd like to provide some additional color on our first quarter comparable store sales results. The composition of our sales results was consistent with our recent trends, with both the professional and DIY sides of our business being positive contributors to our comp store sales increase in the first quarter with professional continuing to exceed DIY. The typical growth in our professional business outpaced DIY and continued to drive comparable store sales even with the headwind of the additional Sunday in the first quarter. The impact of weather volatility during the quarter was most evident in DIY ticket counts. However, the demand on this side of the business was otherwise consistent with recent trends even as these customers feel the pinch of rising prices across the economy. Average ticket was a strong contributor to comparable store sales on both sides of the business driven by the increasing complexity of vehicle repairs and a favorable overall business mix. The impact to average ticket from same SKU inflation was in line with our expectations for the first quarter, and we still believe the full year impact will be approximately 2%. Moving on to the cadence of our comparable store sales growth. As Greg Johnson mentioned during our 2018 Year-End Analyst Call in February, we were pleased with our start to 2019. However, we met softness from a comparable standpoint in the back half of February due to the timing of tax refunds compared to last year and generally unfavorable weather in most of our markets. This was somewhat offset by the harsh winter weather from the polar vortex in many markets. However, business was good in March, and we finished the quarter strong as March was easily our strongest month of the quarter even with the extra Sunday headwind. And I'm pleased to report that this strong trend has continued to this point in April. Given the delay in timing of tax refunds and refund dollars down approximately 3%, it's difficult to fully estimate the impact to our first quarter results, but we are confident in the core underlying fundamentals that drive demand in our business moving forward. On a category basis, our performance matched the trends I've already discussed with strong performance in key categories driven by cold, harsh weather such as batteries and wipers along with good performance in maintenance and repair categories, such as brakes, lighting and drive line. As we look ahead to the second quarter and the remainder of 2019, our outlook on the strength of our industry and our opportunity to continue to gain market share by executing our business model and providing the best customer service in our industry has remained unchanged since we provided guidance at the beginning of the year. As a result, we are reiterating our full year comparable store sales guidance of 3% to 5% and establishing our second quarter guidance at the same 3% to 5% rate. For the quarter, our gross margin of 53.1% was a 44 basis point improvement over first quarter 2018 margin and, as expected, was towards the top end of our expectations built into our full year margin guidance. During the quarter, we benefited from continued incremental improvements in acquisition cost, a favorable mix of hard part sales and a rational inflationary pricing environment. Tom will discuss LIFO and the impact of tariffs to our acquisition cost in more details in his comments, but I will add that we've been pleased to see that tariff cost increases in general have been passed along in market prices, and we continue to expect pricing in our industry to be rational moving forward. We are leaving our full year gross margin guidance unchanged at 52.7% to 53.2% of sales and also continue to expect our full year operating profit to be within our previously guided range of 18.7% to 19.2% of sales. For earnings per share, we're establishing our second quarter guidance at $4.55 to $4.65 and are reiterating our full year EPS guidance of $17.37 to $17.47. Our full year guidance includes the impact of shares repurchased through this call which does not differ significantly from the impact we included in our fourth quarter call but does not include any additional share repurchases. Before I turn the call over to Jeff, I would like to again thank Team O'Reilly for their hard work and dedication to our company's continued success. Due to our continued commitment to our customers, we are off to a solid start in 2019, and I'm confident in both the long-term drivers of demand in our industry and our team's ability to capitalize on this demand by providing excellent service to our customers every day. I'll now turn the call over to Jeff Shaw. Jeff?

Thanks, Greg, and good morning, everyone. I'd like to begin my remarks today by echoing Greg's comments and thanking our team members for their hard work and dedication to providing top-notch customer service. Our team weathered the significant sales volatility during the quarter by remaining dedicated to taking care of our customers while closely managing expenses to drive profitable growth. Now I'd like to spend a few minutes discussing our SG&A results for the quarter. SG&A as a percent of sales was 34.6%, a deleverage of 52 basis points from 2018. On an average per store basis, our SG&A grew 3%, which is at the top end of our full year guidance but in line with our expectations for the quarter. During the quarter, our SG&A included a 12 basis point challenge related to deferred compensation, which was offset by a benefit in other income. We are actively working towards our customer service and omni-channel objectives while facing pressure from wages and other variable costs due to low unemployment and inflation. Our emphasis on expense control is a fundamental part of the O'Reilly culture, and each manager is responsible for the profitability of their respective store, distribution center, or corporate department. We take a long-term approach to managing our SG&A spending by fostering strong relationships with our customers and rigorously examining all expenses to ensure that every dollar spent contributes to excellent customer service. We are confident in our ability to continue driving profitable growth by diligently executing our business model and anticipate a full-year increase in SG&A per store between 2.5% and 3%. I would now like to provide an update on our ongoing distribution center projects and share some additional news regarding our DC expansion. If our decades of experience in executing our dual market business model have taught us anything, it's that we must continue to innovate and invest to lead the industry in parts availability. It's crucial to the economic livelihood of our professional customers and equally critical to our DIY customers who depend on us to get all the parts they need to get their car back on the road. Our ability to provide outstanding customer service in our stores is dependent on the work our 27 distribution center and 342 hub store teams do to get hard-to-find parts in our customers' hands faster than our competitors. As we previously announced, we have 2 significant DC expansion projects under way with the addition of a new location in Twinsburg, Ohio just South of Cleveland and an upgrade to a new larger facility in the Nashville market in Lebanon, Tennessee. Both of these projects are on track, with the Cleveland DC targeted to open in the fourth quarter and the new Nashville DC set to open in the first half of 2020. On our last call, we also discussed that our 2019 CapEx plan included an additional DC project starting in 2019, and we're pleased to announce the purchase of an existing facility in Horn Lake, Mississippi, just south of Memphis. The new DC will be approximately 580,000 square feet, and our initial plan is to build our capacity to service 250 stores. We plan to complete the infill work for this new DC in the back half of 2020, and at that time, we'll consolidate the operations and convert our existing DC in Little Rock, Arkansas into a super hub store. The new DC will provide us with additional capacity for store growth in this region of the country and provide flexibility for the surrounding DCs while also accommodating a broader SKU capacity, increasing our breadth of hard-to-find parts and allowing us to provide an even higher level of service to the Memphis metropolitan area markets. This plan is similar to our strategy for the relocation to the larger Nashville DC, which will allow us to consolidate Nashville and convert the Knoxville DC to a super hub. Now managing 3 major DC projects at one time is a significant undertaking, but it isn't a first for our experienced distribution operations teams. And I'm extremely confident in the ability of this team to successfully build, plan and open each of these facilities. Finally, before turning the call over to Tom, I'd like to provide a brief update on our store expansion during the quarter and our plans for the remainder of the year. In the first quarter, we opened 62 net new stores, and we continue to be on track to open at least 200 net new stores for the year. We continue to spread our store growth across the country, with new store openings in 27 different states during the quarter as we continue to identify great opportunities to open stores across all of our market areas. We also have successfully begun the work of converting the Bennett Auto Supply stores, which we acquired at the end of 2018. The acquisition of the 33 Bennett stores will net a total of 20 new O'Reilly locations, with the remaining 13 stores merging into existing O'Reilly stores. We will complete the conversion of the Bennett stores by the end of the second quarter. The Bennett team has been a great addition, and we look forward to continuing to grow our market share in Florida. Before I finish up today, I'd like to once again thank our store and distribution teams for their continued dedication to providing the best customer service in our industry. We're off to a solid start in 2019, but we're never satisfied and remain highly focused on driving industry-leading results by outhustling our competition to win our customers' business each and every day. I'm confident we have the right team in place to deliver an outstanding year in 2019, and I want to thank Team O'Reilly for their continued commitment to our company's success. Now I'll turn the call over to Tom.

Thanks, Jeff. I would also like to thank all of Team O'Reilly for their continued commitment to our customers, which drove our solid performance in the first quarter. Now we'll take a closer look at our quarterly results and update our guidance for the full year. For the quarter, sales increased $128 million, comprised of $72 million increase in comp store sales, a $60 million increase in non-comp store sales, which includes the contribution from the acquired Bennett stores, and a $1 million decrease in non-comp, non-store sales and a $3 million decrease from closed stores. For 2019, we still anticipate our total revenues will reach between $10 billion and $10.3 billion. As Greg noted earlier, our gross margin improved by 44 basis points for the quarter due to favorable acquisition costs, product mix, and pricing. Year-over-year, the first quarter gross margins benefited from the sale of existing inventory that was purchased before the recent increases in acquisition prices driven by tariffs, along with corresponding retail and wholesale price hikes. We expect this will continue to positively impact gross margin year-over-year in the second quarter as well. Due to inflation-related pressures on acquisition costs, there was no LIFO charge during the quarter, and we do not foresee any charges for the rest of 2019. Our first quarter effective tax rate was 22.5% of pretax income and was comprised of a base rate of 24.5% reduced by a 2% benefit from share-based compensation. This compares to the first quarter of 2018 rate of 22.9% of pretax income, which was comprised of a base tax rate of 24.5% reduced by a 1.6% benefit for share-based compensation. For the full year of 2019, we continue to expect an effective tax rate of approximately 23.5% comprised of a base rate of 24.1% reduced by a benefit of 0.6% for share-based compensation. While the benefit from share-based compensation will fluctuate from quarter to quarter and exceeded our expectations for the first quarter, we expect these variations to even out over the course of the year, and we are leaving our full year tax rate expectations unchanged. We expect our base tax rate to be relatively consistent with the exception of the third quarter, which may be lower due to the tolling of certain open tax periods. Now we move on to free cash flow and the components that drove our results for the quarter and our guidance expectations for the full year of 2019. Free cash flow for the first quarter was $279 million versus $311 million in the first quarter of 2018 with the reduction driven by increased CapEx and higher credit card receivable balances, offset in part by higher pretax income and a reduction in our net inventory investment. For the full year, we are maintaining our free cash flow guidance in a range of $1 billion to $1.1 billion. Inventory per store at the end of the quarter was $609,000, which was down slightly from the beginning of the year and up 1.6% from this time last year. We continue to expect per store inventory to grow in the range of 2% to 2.5% this year as a result of the acquisition cost increases and the fourth quarter opening of the Cleveland DC putting pressure on the growth percentage. Our AP-to-inventory ratio at the end of the first quarter was 106%, in line with where we ended 2018 and where we expect to finish 2019. Finally, capital expenditures for the first quarter were $153 million, which was up $38 million from the same period of 2018 driven by our ongoing investments in new distribution projects Jeff discussed in his prepared comments as well as CapEx to convert Bennett stores, drive new store growth and accelerate technology investments. We continue to forecast CapEx to come in between $625 million and $675 million for the year. Moving on to debt. We finished the first quarter with an adjusted debt-to-EBITDA ratio of 2.24x, in line with our ratio at the end of 2018. We are below our stated leverage target of 2.5x, and we will approach that number when appropriate. We continue to execute our share repurchase program. And during the first quarter, we repurchased 0.9 million shares at an average share price of $347.09 for a total investment of $322 million. We remain very confident the average purchase price is supported by the expected discounted future cash flows of our business, and we continue to view our buyback program as an effective means of returning available cash for our shareholders. Before I open up our call to your questions, I'd like to thank the O'Reilly team for their dedication to our company and our customers. This concludes our prepared comments. And at this time, I'd like to ask Michelle, the operator, to return to the line, and we'll be happy to answer your questions.

Can you discuss the performance throughout the quarter? You noted that March was the strongest month, even considering a 150 basis point headwind. Was February a negative month? How did January compare to those two?

March was our strongest quarter, while February wasn't negative and January was solid. However, it's clear that March performed the best, boosted by the arrival of spring and tax refunds. In February, we faced some challenges due to comparisons related to tax refunds and the size of those refunds, which we believe contributed to the shortfall compared to our plans for that month. However, as tax refunds started coming in during March, we noticed an uptick in business. I can also report that we've been experiencing positive trends in business up to this point in April.

Understood. Do you think there was any deferral between the first and second quarter? Or is it all going to sort of wash out within the quarters?

I believe there was a shift into April likely due to delays in tax refunds and the weather we experienced in February. DIY customers tend to hold off on working on their cars during prolonged rainy days, which led to this push. Additionally, regarding weather, I've been reviewing reports over the past couple of months about the polar vortex and other weather events. It's important to note that both extreme cold and hot weather are beneficial for our business as they drive demand. For instance, cold weather can lead to the deterioration of rubber parts and freeze-thaw cycles that damage roads, causing potholes and affecting chassis and steering parts. However, snow alone isn't advantageous for us unless it's accompanied by severe cold that creates these freeze-thaw effects. When it snows heavily, schools may close and people tend to stay indoors, which negatively impacts our DIY sales on those days. We experienced some of this alongside the rainfall in February, and I wanted to clarify this point.

Understood. Regarding the snow question, how would you evaluate this winter? Was the snowfall linked to the extreme weather variations? Are you anticipating a similar impact from damaged roads in the second quarter?

I would say that it was a good winter for the auto parts business. While we may not see immediate results, I believe that the winter we experienced will lead to strong business in the spring and summer as we transition into those months.

And sorry, just any particular regions that you're thinking about had a better winter versus others?

The regional performance largely depended on the weather we experienced during the quarter. The distribution across regions was about what you would expect. As Greg mentioned, certain areas in the central and southern parts of the country faced heavy rains, which delayed the arrival of early spring weather. Additionally, there was significant flooding in the northern regions, while the eastern and northeastern markets likely benefited more from a relatively normal winter than others.

So first, to follow up on Chris' weather question. But in the past, you've discussed in these type of quarters variance in performance between weather affected and non-weather affected markets. Is there some type of number like that you can give us here for Q1 just to help understand better what maybe the core business was tracking at excluding the impact of weather?

Yes. Just the difference between our best-performing markets and our worst-performing markets, is that what you're asking?

Yes.

You got any numbers on it, Tom?

What we would tell you, Brian, is that there was some beneficial weather in all of our markets and some headwind weather in all of our market. I think as Jeff talked about, the overriding driver for the little softer sales than we anticipated was how much rain and cool temperatures we received in the center part of the country. We're not disclosing that comp variance at this point. Obviously, when you look at where we are versus our midpoint, it's relatively close performance and to call that out probably wouldn't be appropriate as we expect that to normalize throughout the year and haven't changed our comp expectation or total revenue expectation for the full year.

Yes, that's fair. I want to ask a second question that is somewhat longer term. In your comments, you discussed the number of stores opened this quarter as well as the integration of the acquisition in Florida. As we consider this, how do you currently assess the productivity of the new stores as you continue to open them at a good pace? Additionally, given that there are still several smaller chains that could be potential acquisition targets, how do you weigh the decision between opening new stores and making strategic acquisitions? What is your thought process on this?

Tom, you want to talk about it?

So our new store performance has been right where we would expect. Obviously, we're putting the Bennett stores, and I talked about that in my prepared comments, goes into the non-comp store sales, which throws out the calculation for a new store performance. But we continue to be very pleased with the performance of our new stores. When we talk about the number of chains that are out there and how we enter new markets, our business philosophy has always been when we're going to enter a new market, what we want to do is find out who's selling parts in the market and see if there's an opportunity to team up with those parts sellers, whether it's 1 store and with CSK, it was 1,300 stores. So that's always our first lead. But what we have to do is be able to find a win-win where they're looking to exit, we're opportunistic in our acquisitions. We continue to do a large number of 1 and 2 store acquisitions. When we look at the Bennett stores, not a huge store count but really a very solid team in the market that we're growing in and an opportunity to leverage those teams and those relationships in the market to really add those stores but also make our new stores that much better.

I know you guys talked about expecting about 200 basis points of part inflation for the year, but two questions related to that. First of all, what was the impact on Q1? I don't know if you had said that. And then number two, how do you guys measure that? Like is that against kind of year-end or is that a year-over-year figure, et cetera?

Tom?

It's slightly above two. And what we would tell you is we do a detailed calculation on a SKU-by-SKU basis outflowed for the volume that was sold this year versus last year and prices this year versus last year. So as we talked about on our call in the fourth quarter and really we talked about last year's is last year we saw SG&A inflation without as much same SKU inflation as people reinvested in our industry and in retail in general the reduced tax amount, and we talked about it, this year we'd expect our SG&A growth to be similar unless we saw increases in inflation on the top line, and that's what we're seeing as we talked about in the fourth quarter that we're pressured on our SG&A from inflationary standpoint, but we're seeing those price increases flow through really started primarily with the tariffs.

And if the tariffs did go away based on what's happening on the political front, does your view on that change, Tom?

I think we would expect to see some opportunities to reduce prices. But tariffs are only one portion of what's driving inflation. I'd tell you that wage inflation is a bigger driver in aggregate of our price increases. So that's to be determined on how the market prices that through, how fast they come through. Obviously, we're planning our business from a go-forward basis that the tariffs that are in place will stay in place and that we won't see additional tariffs or reductions of existing tariffs to the extent that, that happens, we'll manage the business on a day-by-day basis to make sure that we are being competitive in the marketplace.

This is Josh on for Simeon. Was the gap between your DIY and DIFM growth in the quarter consistent with how it's been over the past few quarters?

We tell you, it was a little bit more, which is not unexpected given the weather volatility and some of the headwinds we have seen from weather, which, obviously, when you talk about precipitation, impacts our DIY customers as our professional shops are primarily inside and also the delay in tax returns, which is a bigger impact on our lower-end consumer.

That makes sense. And then just a quick follow-up. Aside from maybe the weather and the tax for this quarter, if you can sort of push that to the side, are you seeing any change in the sort of number of really old, call it, 11-, 12-, 13-year-old vehicles coming into your stores?

What we would tell you is that the vehicle population in the United States moves very slowly. We haven't seen a dramatic change in the reported scrap rates and sales have maintained about the same amount. So we haven't seen a big change. And we continue to see the age of the vehicles get older as they're better manufactured and able to go through more routine maintenance cycles and be driven safely on the road at higher mileages. So that's change as the vehicle population we see happens very slowly over time, and we tell you it's pretty consistent.

I wanted to follow up on the inflation. It sounds like the same SKU inflation is tracking as you would expect. What are you guys seeing from a competitive perspective? Are there others basically doing what you're doing as well? And then any signs of elasticity?

Yes. So we do a lot of work on making sure that our prices are competitive both on the professional and DIY side of the business. And we would tell you that we continue to be very competitive in the market and adjust our prices appropriately. When we talk about elasticity of products, it really depends on the product itself. For example, batteries have a high lead content and the change in lead prices leads to quarterly changes in the prices of batteries, but it's a very inelastic product. If you go out and your battery doesn't work, your car doesn't start, and people need to replace them. On the flip side of that, our routine maintenance items, for example, oil changes to the extent that you see oil prices go up, people can extend those miles that they drive between oil changes. So it really depends on a maintenance and a failure standpoint.

That's helpful. Could you provide more insight into the strength of March and the improvements observed during that month? Specifically regarding the DIY business, you've expressed some caution about it in recent quarters. What is your perspective on the current macro environment for your DIY customers?

Tom, do you want to take that?

So we saw a benefit in March partially from easing weather and partially from tax returns getting out there. We continue to view our low-end DIY customers as somewhat exposed to price increases. And to the extent that fuel goes up, they're a little more exposed to that. We continue to see it as a great business and a great opportunity for us to grow our market share.

Just I was thinking higher level. You talked a little bit about continued investments in part availability and you discussed the new DCs that you're opening and the new super hub, mega hub, et cetera, that you're going to do. And there's a lot of discussion about investments that some of your competitors and others in the marketplace are making to improve their part availability. And it just seems like it's overlooked sometimes that maybe you're not just sitting down doing nothing while that's occurring. So I was wondering if you can maybe just give us an overview of over the last couple of years some of the things that you've done to increase and continue to build upon your marketing-leading position in part availability?

Jeff, do you want to take that?

Sure, I'll start with it and maybe you guys can chime in. Obviously, it starts with our distribution centers. And you heard us talk on the call here that we've got 3 new distribution centers under way. And putting in that number of SKUs out in the market to provide that availability is just huge for the stores that benefit from that. A couple of those DCs, the Little Rock DC and the Knoxville DC that we mentioned, they were legacy DCs from the Midwest acquisition and through the CarPro acquisition back in 2000. And they just didn't have the footprint to hold the necessary number of SKUs that we needed to hold to support a market and the capacity as well. So that's the reasoning for the new Lebanon DC as well as the new Memphis DC. Obviously, the Akron DC is an expansion these to support greenfield growth. Beyond that, the next level would be the super hubs, as well as the hub stores in semi-metro freestanding markets where we lack distribution centers. We need to ensure we have the right amount of SKUs to support the market based on local competition. Typically, this is influenced by the number of traditional competitors present. There are numerous strong regional and two-step competitors in many of these markets that often go unmentioned. They perform exceptionally well and still dominate the majority of the do-it-for-me business nationwide, which we compete against daily. Therefore, we are consistently assessing our market position from an inventory perspective and responding accordingly, which has been our practice for many years.

And what I would add to that is we commented that the Little Rock DC and the DC in Tennessee are going to become super hubs. We have stores in those locations. The DCs are relatively small. So what we're trying to communicate is those are important markets for us that we aren't going to step away from and we'll continue to have a high level of parts availability at.

I want to add, Matt, this is Greg. This has been a longstanding discussion at O'Reilly. If we look back 20 or 30 years, we were considering how to make more parts available to each store. The reason this topic has gained more attention in public forums is that our larger publicly traded competitors have increasingly adopted the do-it-for-me model and recognized that availability is crucial for success in that sector. Consequently, we have made efforts to enhance availability through hub stores and better SKU deployment tools in our standalone stores, which we refer to as Spoke stores, that aren't supported by a hub or distribution center on a same-day basis. A significant aspect of success in our business, whether it involves us or our competitors, is having the part on the shelf or making it available within an hour or two when a customer needs it.

One near term and then one long term one. So inflation, given that 2% inflation isn't entirely driven by tariffs, like given the methodologies to calculate it, was there any inflation in Q1 '18 last year? Because I think wages were still up pretty considerably last year?

We saw a little bit of inflation. We talked about it in 2018 was the first year in the past five years that the saw some same SKU inflation, and we've talked extensively about that. A lot of it was commodity-driven and the first quarter was less than 1%.

Got you. Yes, that's helpful. Bigger, longer-term question. In your 10-K, you've suggested that as of 12/31, you had the capacity your DC networks support additional 900 stores with Twinsburgh, now you're adding the DC in Mississippi. Historically, at Analyst Days, you've targeted store potential of 6,000 but seems like you're capacitating your business to do a bit more than that, especially if you open any more DCs on the East Coast or whatnot. So I guess, just the question is like have you really thought at all your 6,000 store potential?

The additions we are seeing are being offset by the closures in Little Rock and Knoxville. As expected, there are more vehicles on the road, more model years, and more parts specific to each model, leading to an increase in the number of SKUs. Consequently, we require more square footage per store to accommodate this SKU diversity. However, we continue to seek all available opportunities to add stores, and we expect to have over 6,000 stores at this point.

And additionally, we would expect that some of our smaller regional competitors will continue to be consolidating, increasing the number of stores that we would be able to have in the U.S. by replacing those stores with our stores.

That was a great segue into my question about further industry consolidations. How do you assess the ability of some of your competitors to capture market share or the trends we have seen in recent years regarding share movement among large chains, smaller independent businesses, auto dealerships, and online-only retailers?

I will begin, and then Tom and Jeff might have some thoughts. The large chains clearly hold an advantage due to the immediate need for parts in our business, and we are in the best position to supply any market. We are all looking to grow through acquisitions when it's appropriate. This is undeniably an advantage. From an online standpoint, we are positioned to lead in that area over time, particularly if there is a shift on the DIY front towards online purchases. This is largely because of our distribution networks and the availability we offer for online orders, many of which will involve in-store pickups. Tom, do you want to add anything?

No. Sounds good.

Great. And what percentage of the market at this point do you think is still not contained in the large chains that could potentially be up for potential acquisition?

When you look at the number of stores that are selling auto parts over the last 15 years, it's been relatively consistent at 32,000 to 34,000 outlets. So when you look at the top chains, we continue to consolidate the market, but we're a little less than 50% of the overall market at this point.

This is Atul Maheshwari filling in for Michael Lasser. Can you provide some insight on the comparison to the second quarter? I believe April has an easier comparison compared to May and June. Is that correct? And if the comparisons are actually becoming more challenging as the quarter progresses, what gives you confidence in the 2% to 5% comparable store sales target for the second quarter?

April is indeed our easier comparison for the quarter. The current state of our industry, with lower gas prices and increased miles driven, along with the positive trend we've experienced in recent weeks, gives us confidence in our ability to perform well throughout the quarter. While we don't disclose our monthly comparisons, April provides a favorable comparison when looking at May and June.

What I would add to that is when we look at our guidance for each quarter and for the year, we're looking at a daily sales plan and obviously, April is the easiest compare. So our expectations are at the highest and we continue to do well versus our daily expectations for our 3% to 5% guidance for the second quarter.

Understood. And as my follow-up, if we look at your result versus a competitor who recently reported, it does appear that the spread narrowed somewhat this quarter. So do you think you're not gaining as much share as you were in the past? Or can the narrowing of the spread this quarter be explained by other factors such as calendar mix or maybe just recent variance?

I believe we are still gaining market share. However, some competitors do not report their results in the same time frames we do, which means our internal comparisons might show a different picture. Additionally, some of our competitors face simpler comparisons than we do. It's also important to consider the composition of their comparable store sales, especially those with a significant amount of job or business, and how those sales are measured. Overall, I remain confident in our market share growth, and in time, this will be reflected in our annual comparisons.

On that market share question, I guess you got a couple of competitors that seem to be doing relatively better than they were, and you guys are gaining share. Does it seem like that independent network that's just over 50% of the store base is losing share at an accelerating pace?

I don't know if it's an accelerating pace. I know as we look at some of the companies that we've talked about buying and not bought and some of the companies that we have bought, there's definitely some pressure on some of the independent guys as we grow into their markets as some of our primary competitors have improved their ability to be successful on the do-it-for-me side of the business, which is the primary business that most of these independently owned shops. So yes, I think that many of them are under pressure as those of us that have larger have continued to grow and improve the go-to-market strategy.

Great. I have a question about the tax impact, particularly regarding DIY. Do you notice any indication that the DIFM business has experienced a slowdown due to tax refunds, or is that consumer segment with higher socio-economic status still able to afford the service?

It was more noticeable on the DIY side. I think that as you said from just a socio-economic standpoint, the do-it-for-me customer typically is not under the same pressure as the DIY customer. Many of which who choose to work on their own cars out of economic necessity as opposed to hobbyists and things like that. So yes, we see more pressure on the DIY side than we do on the do-it-for-me.

Just following up on that question. If you think about the impact on DIY customer for the delayed tax refunds in February, how do you come to the conclusion that you don't do all of that delayed spending back in March?

Well, I don't think we'd come to that conclusion. We just look at our daily sales and kind of how we compare to the plan that we had for the year. And the trend that we started on in March has continued to this point in April. But it's hard for us to know exactly what the drivers of our comp store sales results are. We just simply look back at what's happened and say, well, this could have been a factor, that could have been a factor. What I can tell you is that March we finished strong and April has been strong to this point. And based on the daily plan that we have, we feel reasonably confident that we'll be able to beat or exceed our plan for the remainder of the quarter, which is what we're trying to do every day.

Got it. And as a follow-up on a different topic, can you provide an update on the progress you've made in improving the site experience, average home delivery times, in-store pickups, and so on?

Tom, do you want to take that?

That's an area we continue to focus on. We want to interact with customers in the way they choose to reach out to us. While we can't discuss specific initiatives, we can say that we are enhancing engagement and improving our website. We're also increasing the knowledge we're providing to customers regarding SKU availability and delivery times. These are our main focuses, especially since two-thirds of our business is pick-up-in-store. Customers want to know if we have the part they need, what part is required, when they can get it, and if they can pick it up in the store. These are the key areas we are working on.

Following up on that last question, on the omni-channel, it does seem like some of your peers definitely are also talking about investing more heavily into that channel. So can you talk about just the online competition. Has that changed at all from either the big chains getting more aggressive there or the online-only competitors? How are legacy online-only competitor responding to you guys' investments?

The legacy online competitors typically offer lower prices than traditional stores. The urgency of needing a part and receiving advice during the purchase process are significant factors. Our focus is on assisting customers with their car-related issues. We see a significant opportunity in how many people use their phones to research before buying. By providing detailed information and support for car parts, installation, and necessary tools, we aim to enhance the customer experience. This investment is a priority for us because of the strong relationships we have with our customers. We believe that the threat from online-only competitors is not very significant, especially given the abundance of parts stores in the U.S. and the necessity for many customers to purchase parts the same day for their vehicles. Therefore, we consider ourselves somewhat insulated from online competition, while still recognizing that both our business and our competitors strive to lead in content and provide essential information for car repairs.

Got it. That's extremely helpful. And then, Tom, on the gross margin outlook, I think in your prepared comments, you mentioned that you thought the tailwinds from selling through previously bought inventory would continue into the second quarter. But as we look at the back half and comparisons get more difficult, I understand transportation headwinds could get easier, but how should we think about the cadence of gross margin as we move through the remainder of 2019?

We would expect as we saw in the first quarter for our year-over-year growth to be more in the first and second quarters of the year and then to moderate in the third and fourth quarter. Based on that sell-through, we continue to work hard at making sure that we're optimizing our gross margin dollars on a daily basis. But year-over-year, we'd expect to be higher than the midpoint of our range in the second quarter and then moderating to come to our annual guidance.

On the cost side in the quarter, could you talk through the drivers of the SG&A per store up 3%? And how much of this would you categorize as business as usual versus investment spending or maybe the Bennett acquisition? And then given the 2.5% to 3% guide for the year, how much should we expect that level to moderate as we move into Q2 and the back half?

In the first quarter, our total SG&A spending is in line with our expectations. Last year, we chose to reinvest a significant portion of our tax savings into service-related areas, primarily technology and store payroll. In the first quarter, there was a notable adjustment related to some of the benefits we provide, which resulted in a substantial charge, although we have not annualized these figures. We anticipate that the growth in per-store SG&A will peak in the first quarter and then moderate in the second, third, and fourth quarters. This will depend heavily on fluctuations in unemployment and wage rates, which are the primary factors influencing the increase. Additionally, we continue to experience inflationary pressures in our SG&A, and we have seen some benefit from same SKU inflation.

Got it. That's helpful. And then just bigger picture, can we talk about the importance of national brands for your customers? Just given the competitive dynamics and rising price environment, are there any categories where your customers either Pro or DIY are shifting to your label brands versus national brands? Any thoughts there?

We have always considered national brands or branded products to be extremely significant, particularly when there is a product distinction. This has been evident with many national brands where the product offered is simply superior or provides benefits that a private-label brand may not. We manage several private label brands that we have positioned as national brands. Some of these brands were once independently owned national brands by suppliers, which we have had the opportunity to acquire and now exclusively represent at O'Reilly. Our strategy is to stock the best products in our stores that offer exceptional service to our customers and create profitable business opportunities. This can include national brands not owned by us, private-label brands that we present as national brands, or private-label brands that offer a considerable cost advantage for our customers—essentially entry-level products. We aim to provide customers the option to upgrade to a higher-quality product if they seek something better than what our lower-end private labels offer. Thanks, Michelle. We just want to conclude our call today by thanking the entire O'Reilly team for their continued hard work and delivering another solid quarter. And I'd like to thank everyone on the call for joining us today. We look forward to reporting our second quarter results in July. Thank you very much.