Q3 2020 O'Reilly Automotive Inc Earnings Call
Good day, ladies and gentleman.
Yeah, we are.
Right. Its third quarter 2020 earnings Conference call. My name is <unk> and I will be your operator for today's call. At this time all participants are in listen only mode. Later, we will conduct a 30 minute question answer session. During the question and answer session. If you have a question. Please press Star then one on your telephone touched just don't.
Telephone I would now turn the call over to Mr., Tom Mcfall Mr. <unk> you may begin.
Thank you Howard good morning, everyone and thank you for joining us.
During today's conference call, we will discuss our third quarter 2020 result.
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 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 Companys lease.
<unk> annual report on form 10-K for the year ended December 31st 2018, and other recent SEC filings.
And he assumes no obligation to update any forward looking statements made during this call.
At this time I'd like to introduce Greg Johnson.
Thanks, Tom Good morning, everyone and welcome to our work near Raleigh Auto parts third quarter conference call participating on the call with 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 and Greg Henslee, our executive Vice Chairman are also present on the call.
We're pleased to announce record breaking performance for our third quarter.
Again amazed to see ability of team O'reilly to produce such excellent results in the midst of one of the most challenging periods in the history of our company.
Our team remains dedicated to our customers and drove an outstanding 16.9% increase in comparable store sales in the third quarter, but.
39% increase in diluted earnings per share to $7.07. While also consistently executing on our protocols to protect the health and safety of our team members and customers in the midst of the COVID-19 crisis.
Well the challenges we faced during 2020 are far from routine art.
Our teams have done an exceptional job adjusting to the current environment. Some modifying the ways, we conduct business during this pandemic.
They've done so without sacrificing our focus on providing excellent customer service or any of the value our customers have come to expect.
We continue to be diligent in our efforts to constantly evaluate and revise our safety protocols as recommended by public health and governmental agencies and are extremely focused on executing best practices across our company.
Before we continue with our prepared comments I'd like to express our deep gratitude to our team for their hard work and commitment to our customers.
There is absolutely no question about how important our businesses and meeting our customers' critical needs and I couldn't be prouder of team O'reilly for their contributions during this once in a lifetime challenge.
Now I'd like to provide some details on our robust performance in the third quarter.
As we discussed on the second quarter Conference call. We started off the third quarter with a continuation of the strong trends in top line sales volume we generated from mid April through June.
As we progressed through the quarter, we continued to see resilient robust sales performance on both sides of our business.
From a cadence perspective comps run a strong mid to high teens throughout the quarter with the best performance at the beginning of a quarter in July.
We had steady consistent performance in the balance of the quarter in August and September after adjusting for Sunday comparison differences between these two months.
As we indicated in our press release yesterday, our comparable store sales thus far in the fourth quarter remained strong and are trending slightly below our third quarter exit rate in the low double digit rate range.
As we discussed on both our last two quarters earnings calls.
We've been very cautious on how we thought about ourselves outlook as we progress through the unprecedented uncertainty in our markets and the broader economy.
This includes a comment on last quarters conference call that we expected sales would moderate from the record setting pace, we were seeing at that time as we move through the back half of 2020.
We've been somewhat surprised that definitely pleased at how steady our strong sales comps trends have been and to the extent volumes did moderate in the third quarter and into the fourth quarter that moderation has been much more gradual than the immediate acceleration we experienced when demand swung heavily in our direction in April.
Our sales trends are even more encouraging in light of the fading tailwinds to our business from the expiration of government stimulus payments and enhanced unemployment benefits under the Cures Act as we moved further past when those dollars are being injected into the economy.
Moving to the composition of our strong sales performance in the third quarter, our DIY business was the stronger contributor during the quarter, but our professional business also performed very well and the relative trends on both sides of our business tracked along what the cadence for total sales in the quarter I just discussed.
From a ticket perspective, we continue to see robust increases in both ticket count comps and average ticket comps on both sides of our business, even though we saw a muted impact in average ticket from same skew inflation, which is in line with our expectations.
As we saw in the second quarter, our category performance reflected strong performance across all of our product lines with some of the best performance in upfront categories in our DIY business as well as another extremely saw strong sales quarter for batteries.
We believe these results indicate a continued ability and willingness of our DIY customers to work on larger projects.
I want to be clear that even though these more discretionary categories have been our better performers for the last two quarters, we have still been very pleased with ourselves volume across our business.
While demand in Undercar hard part categories is more failure related and did not perform quite as strong as the company average in the third quarter sales for these traditional categories were still robust and significantly better than historical trends.
At this point I'm sure. The question everyone listening in on todays call I would like to have answered is what are the discrete factors that are driving this incredible surge in our sales and how long will they persist.
Well, it's impossible to defy to provide a definitive answer that question, but we do expect demand to remain solid and there are several potential tailwinds and headwinds we're watching as we look forward.
We certainly saw for at least the last portion of our quarter continued tailwinds from government stimulus under the cares act and likely saw some residual benefit as unemployment benefits were partially extended for a short period of time later in our quarter.
Even as those payments have lapsed positive the positive impact they have had to support the health of the consumer has mitigated the negative impact from economic pressure on the consumer than we would normally expect in a period of such rapid increase in unemployment and significant economic stress.
We also have a long track record of experience from economic cycles in this industry seeing consumers respond to economic uncertainty about deferring new vehicle purchases and investing more in maintaining their existing vehicles.
The combination of this incentive to take care of it existing vehicle coupled with the government stimulus is likely driven a reduction and underperformed vehicle maintenance and we expect our business will continue to benefit as economic conditions recover.
Aside from the macro benefits that have helped the automotive aftermarket. It's also clear to us that our strong sales performance is the result of significant share gains our team has delivered over the course of the past several months.
We execute a high touch capital intensive business model that requires a well equipped technically proficient team of professional parts people providing outstanding service.
We have simply been blown away by the amazing commitment and resilience of our team.
In the face of extremely difficult circumstances, they havent wavered and delivering the value propositions, we promise to our customers.
Our teams consistency and providing excellent customer service differentiates us and help us drive market, leading results and a stable economic conditions and these advantages are even more pronounced.
In every one of the automotive aftermarket is facing enormous external challenges.
As pleased as we are with our teams great performance in the third quarter. We know the goodwill we've created for meeting customers essential needs. During this crisis will drive customer loyalty and even further business in the long term.
We remain optimistic about the health of the automotive aftermarket and believe we will continue to see strong demand in our industry, but remain cautious in our immediate sales outlook given the uncertainties that still exist.
As miles driven has remained under pressure at the same time. The government stimulus has seized we've been encouraged to see continued strong demand, particularly on our professional business, where the demographics of the ultimate consumer is more likely to work jobs that have instituted work from home arrangements.
We can't anticipate what risk, we could face if macroeconomic conditions worsen and miles driven stays depressed nor do we make any assumption as to whether there will be additional government stimulus or to the degree of which our demand would benefit.
In the immediate short term, we remind everyone on the call that our fourth quarter can be quite volatile given the variable impact of weather and consumer demand dynamics during the holiday season, which could be more pronounced this year as some consumer space economic challenges as a result of the pandemic.
We can also see some volatility as a result of the election next week as we did in 2016.
Ultimately, we will have to wait and see where our sales level. We have been very encouraged by the stability of sales trends during the six month period of record sitting comps and feel very confident of our company continued to deliver solid sales growth, even if the broader economic conditions deteriorate.
Moving on to gross margin for the quarter. Our gross margin of 52.4% was a 96 four basis point reduction from the third quarter 2019 gross margin.
The decrease from last year was driven by reduced LIFO benefit from the impact of merchants merchandise purchased in 2019 before tariff related cost increases, which Tom will discuss more fully in his comments as well as the plan expected dilution from layoffs.
For the third quarter, our team delivered an operating profit margin of 22.6% an increase of 250 basis points over the third quarter 2019 and for the first nine months of 2020, we have generated a $1.8 billion of free cash flow.
Jeff will discuss our outstanding operating performance in more details in his prepared comments.
Again, I want to offer my congratulations to team O'reilly for another quarter of record breaking sales and profitability.
Your willingness to go the extra mile to ensure everybody who enters our stores Dcs or corporate offices, while also providing unwavering customer service is truly outstanding.
I'll now turn the call over to Jeff Shaw Jeff.
Thanks, Craig and good morning, everyone.
I want to start today by echoing Greg's comments and expressing my sincere thanks to team O'reilly for another incredible quarter.
Our teams ability to diligently follow all of our pandemic protocols protect the health and safety of our team members and customers while generating the best topline results we've ever seen is simply remarkable.
We operate a very stable business model that has been fine tuned over many years to deliver an exceptional value to our customers, while maximizing the productivity of our human capital and shareholder investment.
However.
We would have never expected are modeled to be tested in the way it has in 2020.
We've never imagined a scenario where store volume skyrocketed overnight and sustain such a high rate of productivity for six months.
Simply put delivering the results, we announced yesterday requires a tremendous amount of hard work and ingenuity by the teams in our stores and Dcs.
As Greg previously discussed we generated an increase in operating margin of 250 basis points to 22.6% and operating profit dollar growth of 35%.
Both of which represent record third quarter operating profit results for our company.
We drove this increase profitability by generating 16.9% comparable store sales capitalizing both on the strong macroeconomic environment and taking market share while limiting our SGN eight restore growth to 3.6% for the quarter.
As we discussed last quarter the timing in unique circumstances of the changes weve seen in our business in 2020, starting with the significant headwinds at the onset of the COVID-19 crisis, followed by the dramatic immediate surge in business have created a perfect opportunity for us to execute our.
Model and drive record breaking operating profits.
As a result, we indicated on last quarter's call that we expected our SGN a expense would gravitate back towards historical levels as we refocused on important details in our business that can get deferred we're focused solely on doing everything in our power to provide excellent customer service.
In line with those expectations, we've seen incremental increases in our operating cost that our sales have simply just continue to out run the growth of Orest DNA.
Looking forward, we've been encouraged by the steady sales trends, we've seen and as each week goes by and our team continues to adjust to the current environment, we've been better able to plan and manage our SG and expenses, especially our store payroll.
However, there is still a significant amount of uncertainty in how long and at what level. The extremely strong sales will last and we're remaining cautious in how we planned expenses, especially as we enter a more volatile sales season in the fourth quarter.
Since our biggest challenge remains providing excellent customer service in the heavy sales environment. We acknowledge that there are certain important task such as refocusing on the imaging appearance of our stores and catching up on our team member training and development, which are still being deferred in some cases.
As always we will be extremely focused on controlling our expenses to match our service levels to customer demand and we will leverage the lessons learned so far in 2020, as we respond to market conditions moving forward.
Next I'd like to touch briefly on our capital expenditure and expansion plans.
On last quarters conference call I discussed our reset in expectations for new store lease.
The capital project development in a lot of the challenges we faced as a result of the pandemic.
And my update today as it we've tracked along with those revise plans.
Through the first nine months of 2020, we've opened 153 net new stores, which was within our expected range of 150 to 165, new stores revised down from 180, new stores. After we encountered delays for design and permitting approvals.
We still have new stores on the schedule to open in the fourth quarter and expect our total count will ultimately fall towards the top end of that updated range.
Now even in the best conditions opening a new store takes a tremendous amount of hard work.
So we've been especially pleased with our ability to open great new store locations with solid teams. This year in our 2020 cohort of new stores are off to a very strong start.
We typically announce our new store target for next year on today's third quarter conference call. However.
However, we're still fine tuning our 2021 target based on our evaluation how many stores. We think we can get through the lengthy process of planning and permitting given continued expectations that the pandemic will sell these timelines.
After successfully opening our newest DC in Lebanon, Tennessee in the first quarter. We had originally planned to open a second facility in one like Mississippi, just south of Memphis, This year as well, but if shifted opening that DC to the first half of 2021 due to team member health concerns associated with the travel network.
This area to train new team members in preparation for opening the facility.
Our distribution teams have a great track record of identifying strong DC leadership and running a smooth opening process and this project is no exception.
Finally, we've also made good progress on our other planned 2020 capex projects in the third quarter, including work, we've discussed before to update our store hardware modernize our distribution vehicle fleet and other initiatives to enhance the service we provide to our customers and drive strong returns.
We remain extremely excited about the opportunities presented by these projects and we will continue to move forward aggressively even though a significant amount of the Capex plan for 2020 will fall into next year.
Before I turn the call over to Tom I want to once again, thank team O'reilly for their dedication and hard work in the third quarter.
Hopefully, we will never see another year with the difficulties 2020 as post but I'm amazed at how our team has stepped up to meet the challenges, although I'm not surprised since team O'reilly has consistently proven to be the best in our industry.
Well, we've never had a crisis that's affected all of our company in such a profound ways COVID-19.
Our teams have encountered many difficult environments over the years, including the full spectrum of national disasters, and they always proved their ability to weather the storm.
To close I will repeat the same comment I made on our second quarter call.
I am, especially proud of the commitment of our team has shown to our customers their diligence in executing best practices to protect the health and safety of everyone in our stores Dcs and offices, while keeping our business running efficiently to provide our customers with the essential parts. They need is truly.
World Class now I'll turn the call lease up.
Thanks, Jeff I'd also like to thank all of team O'reilly for their continued commitment to our customers, which drove our incredible performance in the third quarter.
Now, we'll take a closer look at our quarterly results.
For the quarter sales increased $541 million comprised of a $441 million increase in comp store sales.
$71 million increase in non comp store sales, a $32 million increase in non comp non store sales and a $3 million decrease from closed stores.
As a reminder, we previously with through our 2020 guidance.
Given the ongoing uncertainty related to COVID-19, we're not resuming guidance at this time.
As Greg previously mentioned gross margin for the third quarter decreased 96 basis points to 52.4%.
Which was driven by year over year comparisons to the significant gross margin benefits, we captured in the third quarter of 2019 related to the sell through of pre Tara on hand inventory.
As well as dilution from the acquisition of Massa.
As a reminder throughout 2019, we received the gross margin benefit from the sell through of on hand inventories that was purchased prior to tariff driven acquisition price increases in 2018, and 2019 and anticipated we would see a continued benefit that would taper off each quarter in 2020.
We did not receive a third quarter benefit in 2020.
Since we had received the full benefit of pre tariff inventory in the first half of 2020 due to acquisition cost decreases in the second quarter.
Which create a short term headwind, but benefits future Pos.
Looking at the third quarter Standalone, we did not have a materially positive impact from LIFO.
We expect to see year over year headwind again in the fourth quarter as we compare against the prior year pre tariff inventories benefit.
We received a more muted benefit from same SKU inflation in line with our expectations as we began annualizing last year's terror driven price increases in the third quarter.
The pricing environment remains rational in the industry and we expect that to continue.
Our third quarter effective tax rate was 23.2% of pre tax income comprised of a base rate of 24.4%.
Which was in line with our expectations reduced by 1.2% benefit for share based compensation.
This compares to the third quarter of 2019 rate of 22% pre tax income, which was comprised of a tax rate of 22.5% reduced by 1.5% benefit for share based compensation.
Changes in the tax benefit from share based compensation can create fluctuations in our quarterly tax rate.
And we continue to expect our rate for the fourth quarter to be lower as a result of the tolling of certain tax periods.
Now, we'll move on to free cash flow in the components that drove our results for the quarter.
Year to date.
Free cash flow for the first nine months of 2020 was $1.9 billion versus $977 million in the first nine months of 2018 with.
With the increase driven by an increase in net income a reduction in that inventory an increase in taxes payable as a result, the deferral of tax payments under the cares Act and a reduction in Capex.
Actually offset by the investment in solar projects.
Inventory per store at the end of the quarter was 628000.
Which was down 8.7% from the beginning of the year.
But up 1.7% from this time last year.
The inventory per store balances below our expectations and reflects the strong sales volumes in the second and third quarter of 2020.
Our PD inventories issue at the end of the second quarter was 116%, which is the highest ratio in our history and heavily influenced by the extremely strong sales volumes inventory turns in the last six months.
We still anticipate growth in per store inventory in the remainder of 2020 as we improve in stock positions and resume our inventory enhancement initiatives.
And this will also moderate the increase in EAP percentage over time.
Finally capital expenditures for the first nine months of the year were $363 million, which was down $118 million from the same period of 2019.
Driven by lower New store project development spending and the prior level of investment in new distribution projects, which exceeded distribution development in the first nine months of 2020.
As Jess excuse me as Jeff previously discussed we have resumed certain deferred capex projects, which were on pause due to the impact of COVID-19, and we'll continue to adjust our capex plans as appropriate given the current environment.
Moving on to liquidity and capital structure.
We're very pleased to execute our second successful bond issuance in 2020 with the issuance of $500 million of 10 year senior notes at a rate of 1.8% on September 20 Threerd.
By far our best rate since we moved to an unsecured capital structure and began issuing public debt 10 years ago.
These notes replaced our first bond issuance from January 2011, which carried an interest rate of 4.9%.
We paid out the senior notes when they reach their attempts and call date in October so the proceeds from the September issuance, we're still sitting in excess cash in our balance sheet at September Thirtyth.
We finished the third quarter with an adjusted debt to EBITDA ratio of 2.26 times as compared to the second quarter ratio of 2.24 times and our end of 2019 ratio of 2.34 times.
This calculation excludes the $1.6 billion of cash we held as of the end of the quarter, but does include both the September bonds as well as the 2011 notes retired in October.
We continue to be below our leverage target of five times and will approach that number when appropriate.
As we discussed on last quarter's call. We resumed our share repurchase program on May 29, 2020 after temporarily suspending buybacks in March to preserve liquidity at the onset of Cove at 19.
We continue to judiciously execute our program in the third quarter and year to date, we have repurchased 2.6 million shares at an average share price of $415.28 for a total investment of $1.09 billion.
Subsequent to the end of the third quarter and through the date of our press release, we repurchased 7 million shares at an average share price of $450.97.
As a result of our continued strong performance in the third quarter. We finished the quarter with $2.2 billion of total liquidity and cash and available borrowings under our $1.2 billion revolving credit facility net of the cash held to retire the 2011 notes in October and we feel we have.
Ample liquidity under the existing facility.
As we evaluate our liquidity leverage use of capital and share repurchase program moving forward, we will continue to prioritize maintaining our strong financial position, including the investment grade ratings and our public debt.
We have a long history of conservatively managing our balance sheet and we'll continue to take prudent steps to ensure the long term health and stability of our company.
Before I open up our calls to your questions I'd like to thank the O'reilly team for their hard work and continued dedication to our company and our customers.
This concludes our prepared comments.
And at this time I'd like to ask the operator Howard to return to the line and we will be happy to answer your questions.
Thank you we will now begin the question and answer session. If you have a question. Please press Star then one on your Touchtone phone if you wish to be removed from the queue. Please press the pound sign or to hash key if you are using a speaker phone you need to pick up the handset before pressing the numbers.
We ask that you. Please limit your questions to one question and to one follow up question. Once again, if you have a question at this time. Please press Star then one on your Touchtone phone.
Our first question or comment comes from the line of Greg Melich from Evercore. Your line is open.
Hi, Thanks, I wanted to follow up.
A bit more on the traffic and the share gains.
The tickets. So if you think about it is that gap now between DIY and do it for me.
Both are healthy, but it sounds like into this quarter. There there's still narrowing a bit is that was that fair to interpret that and then second.
When you say that you have been gaining share do you think thats been bigger on the DIY side or the do it for me side. Thanks.
Thanks, Craig lot of questions there.
First on the.
The traffic and ticket question I would tell you that if you if you divide that into.
To four quadrants.
Cash and charge for each all four of those qualities are positive and we were pleased with both our ticket candle and our high average ticket.
The gap looking at the gap between our DIY and DIFM side of the business. It did narrow slightly this timing our overall comp was less.
So our DIFM side of the business performed well to our expectation and our DIY traffic was off slightly.
From where we were last quarter.
What I would add to that is if we reflect back to the beginning of the second quarter.
Where we saw a significant drop in business and then a spike and continued strong sales from the middle of April.
That was primarily on the DIY side of the business the professional side of the business.
Was impacted longer.
Due to the customer service nature and dropping off your car.
Worked on so it took longer for the professional business to come back so the gear the narrowing of the gap to the third quarter. I think is more of a reflection of the more significant challenges that the professional side of the business had in the second quarter.
And do you think you gain more share in DIY or do it for me.
That's a hard one to determine we will see overtime as others report and we look at industry.
Industry data, what we would tell you is that we think we gained significant share of both sides of the business.
All right. Thanks, a good luck great job guys.
Thanks, Greg.
Thank you. Our next question or comment comes from the line of Brian Nagel from Oppenheimer. Your line is open.
Hi, good morning.
For taking my question congratulations on a blend as performance.
So first I just wanted to ask this with regard to sales trends recognizing that the strength. We've seen up lots of of course has persisted during the fourth quarter, but this was particularly look now maybe that they thought Q4 transition are you seeing significant different skews.
Brent women, a little problem with your connection yes.
Let me move here, sorry can you hear clearly.
Now I'll try again, if that's any better I apologize modest on a cell phone so that the.
Question I have is is whether it's particularly with regard to sales from Q3 to Q4 has there been any significant change in the categories are performing are you seeing a different different where the customers are shopping the stores as these corporate headwinds persist.
Brian I would tell you that the trend we saw in the second quarter has carried over into the third quarter.
A lot of our traditional categories that performed well have continued to perform well in the fourth quarter, we called out batteries, especially.
Performing well I'm, sorry, fourth quarter third quarter I'm getting ahead of myself there.
But you know we did see we did see strong performance and a lot of DIY categories.
As we did in the second quarter.
Lot of categories that historically have not performed as well.
Meaning whether it's.
Hi, Rod parts performance parts.
Current detailing.
Components things like that that we just think that a lot of the DIFM consumers have more time on their hands to perform some of those repairs and frankly feel like some of the shift.
From DIFM to de why for some of those easier repairs has been a result of that DIFM customer.
Leading some of those repairs themselves as opposed to taking into the shop repair.
Try and what I would add to that is as our professional business.
Strengthens.
[music].
Away from Covidien, the the restrictions on their business that that drove that business is much more focused on the hard part repairs. So to the extent that those have done better it's narrowed the gap, but more about raising more of the traditional categories.
And.
Then weakness and others.
Got it that's very helpful. I appreciate it thank you.
Thank you. Our next question or comment comes from the line of Kate Mcshane from Goldman Sachs. Your line is open.
Hi, good morning, Thanks for taking my question.
My first question was just with regards to the US dollar growth. Tom I know you went through that a little bit in your prepared comments, but can you remind us.
The areas, where you are still being able to limit that spend.
Okay.
Jeff covered those those comments, but I'll go through it sounds like an accounting question. When we look at our SGN a the biggest driver of our SGN a expenses store payroll and you win cobot hit and we had four weeks of affordable sales, we were planning for the worst and reduced our staff.
Jeff can speak to the specifics of how we went through staff evaluations and what that means for our long term business.
But we continue to be very conservative in our sales outlook in and make sure that we're staffing to run the business and provide good.
Good great customer service, but still be cognizant that sales trends could change when we look up and down are you now.
A lot of items some items have been deferred when you look at maintenance.
When we look at.
Anything fuel related whether its utilities or gas to run the delivery vehicles those have been significantly less than we would have thought some of our capex projects, where we deferred the capex.
They have a great return over time, but have some drag in the initial implementation so.
Some of those deferrals of had caused a positive short term pop.
Impact, but the main item in the main driver for prior question a is store payroll I'll turn it over to Jeff to comment on that I, just add that as we talked about in the.
The second quarter of the tail end of the second quarter.
As we made headway ramped up our staffing levels to try to meet the demand and that trend continued again continued into the third quarter, but we still remain very cautious in our staffing just not knowing how long. This this sales demand will last the other.
The thing I'd mentioned is we've had a.
Ongoing focus of our company about increasing our full time team member mix and we've made we've made headway with that this year.
There are several benefits that obviously, the higher levels of service, especially on nights and weekends weekends from a more tenured full time team member, but really just as important as it continues to build our bands for our future promotions from within.
And obviously there is a cost associated with that besides the wages the additional health benefits and paid time off but we believe it's the right thing to do to drive even higher levels of service and over the long term that will make for a more productive workforce.
Thank you and then.
My follow up question was just on the very strong used car sales that we've been seeing I wondered in the history of the company.
If you've seen probably not a similar level, but when there are higher used car sales how it.
Work through your business and what kind of sales lift and timing could we expect that over the long term.
Historically, when we've seen used car sales go up and the prices go up that's a benefit to our business.
Two standpoints one the price increase is being driven by people are sought seeking used cars as opposed to as many new cars. So more miles driven or are on cars outside of warranty. So thats a positive for us the other big positive for US is it's a used car sale, but it's new to somebody else. So both on the seller side.
People are making repairs to sell their vehicles and as people acquire new vehicles, they're making repairs to those vehicles, both of which benefit us.
Yes.
Thank you. Our next question or comment comes from the line of Zach Fadem from Wells Fargo. Your line is open.
Hey, good morning, guys. Thanks for taking my question.
Could you talk about the impact of the discretionary or product project categories, and how that lifts compared versus Q2, and then when thinking about that that hobby customer any indication that you are seeing a step up in new customers relative to your typical run rate.
Well, it's hard to really determine some categories. It's obvious that it's quote unquote the hobby customer other categories. It's really hard to tell when you sell spark plugs is that is that a hobby customer is that a maintenance needs are they working on a a.
Project car that that's had dust on it with a cover on it for four or five years. They just have time to work on.
You know all of a sudden because they've got more time from from working from home. They don't have the daily can be things like that so I would say those categories that we called out performance car care things like that.
Perform similarly to second quarter.
But again I don't want to send the impression to any to anybody that that that was the meat of our sales improvement because it's not we did see that as an unusual trends for our industry to see sales in those categories, but.
But really the meat and potatoes of RPL, where the traditional categories that we sell that continued to sell throughout the quarter.
Got it that makes sense and for Tom on the gross margin line can you talk about how the LIFO dynamic that compared to your expectations at the beginning of the year and when you think about the initial 52.5% to 53% gross margin guide I know thats no longer on the table, but is the low end.
That range the right way to think about the gross margin run rate going forward are there any other one off items around mix or that supply chain that we should keep in mind.
Well I appreciate that you acknowledge that weve suspended guidance and therefore, I cant make any comments in relation to past guidance because it's been suspended but why we'll talk about the gross margin for the quarter. So as we talked about on our third quarter 2019.
Conference call and were very pointed in calling out is we were seeing a benefit in gross margin from items were tariffs have been imposed.
Hi prices on the street selling prices had increased but we are able to sell through the merchandise that we had on hand, and we were seeing a benefit from that we expected that benefit to continue although declining three.
During the first and second quarter of this year.
In the second quarter. This year, we actually saw more price decreases primarily as suppliers work to adjust their supply chains to.
Limit the impacts of tariffs.
So when we get to the third quarter, we've really annualize those items and.
It's reflected in our LIFO charge for our LIFO benefit as the case may be in this case its benefit so you'll you'll.
You'll see it in our Q last year, we had a LIFO benefit in the third quarter of $22 million. This year it was $1 million.
Got it appreciate the time guidance.
Thank you.
Thank you. Our next question or comment comes from the line of David Bellinger from Wolfe Research. Your line is open.
Hey, guys. Good morning, Thanks for taking the question.
Talk a bit more about some of the better performing categories, particularly the battery category, where sales have been incredibly strong with past few quarters. So how is quite shaping up at this point and are you working through any constraints now and what does that mean subsequently to gross margins.
Yeah, I'll take the category question and see if Tom wants to comment on the margin component.
As we said all of our categories were very pleased with how all of our categories have performed.
The only surprises again will be the call out, but I've talked about the last question about performance, although not nearly as material as the traditional lines. So I'm very well for us if you talk specifically about batteries, yes, we've seen we've.
We've seen a significant battery sales for the quarter actually the past two quarters.
Why others, there's probably several reasons why I think some of it.
Is related to you know maybe car sitting at home because people are working from home we had a mild winter last year. So there may be some some pull forward, we'll have to see how that plays out in the in the fourth quarter, but as far as supply you know we've had some supply issues through.
Throughout the third quarter from from some of our suppliers, it's probably a handful of suppliers that that had significant supply issues there.
Theres only a couple of major battery suppliers in the industry and both of those suppliers have performed well one of them better than the other but both have have performed well.
Like other categories, our suppliers have faced challenges.
With co bid related to the number of shifts they can work related to social distancing requirements in one case related to wildfires out west.
So it's been tough for our suppliers just like it's been tough for us and our competitors.
To maintain staffing levels to keep up with demand, but overall battery cells are great.
As we called out and our suppliers are doing a good job I think that if you look at the chart fill rate from our suppliers over the past.
Six months since the pandemic began you see the hockey stick effect and those few that are still not filling as well as we would like we're starting to see an upturn in their fill rate Tom do you want to talk about the margin impact sure.
To reiterate what Greg said, we're happy with the performance of all our categories. We cant post is 16.9% comparable store increases unless all the categories are doing well the items where we.
Pulling out some of the discretionary items that DIY consumers are buying which is really for two reasons. One when we get into economic constrained conditions are those typically go the other direction. So thats abnormal.
The other item is just that consumers are looking at their vehicles wanting to invest in their vehicles wanting in the reduction of repaired.
Underperformed or and perform maintenance is going down and that is helping our sales value. So all the categories are doing well so.
The difference in gross margin between those categories in other categories is not significant enough in that performance differences not significant enough to create a mix difference in our gross margin.
Understood.
Maybe just another follow up on a previous margin question. So you walked us through the mechanics, Paris and the flow through there, but in the Q3 period, but was there anything else any ordinary that you saw in terms of the year over year margin decline in anything from a promotional perspective to keep some of the like customers either because.
System or higher freight transportation cost and just anything out of the ordinary that further explains that the year over year 96 basis point decline.
Up so I'd put it in three buckets, one is LIFO, we covered that and then.
Two is we have some dilution as we talked about on our first quarter call from the massive business in Mexico, where they run more independent chopper much more independent jobber business and it's got a lower gross margin you're not operating the stores machining or the gross margin with the independent job is operating the sources we have.
Normally you would think in the distribution centers with high volume we'd have the leverage.
But in this case the volume is so high that.
We are having to do extraordinary things to get products shipped out so we actually have some headwind there.
Yes.
What Tom's referring to is the incredible volume swings and she has created really inefficiencies in our really receiving and shipping areas in our DC and we.
With that volume and trying to staff that volume we've had to use overtime until we can catch up with with head count as well as temps to help us keep our shipping percentages, where they where they need to be.
Got it congrats on a nice quarter and thanks for taking my question I appreciate it.
Thanks, David.
Thank you.
Our next question or comment comes from a line of Bret Jordan from Jefferies. Your line is open.
Hey, good morning, guys.
Good morning.
Hi, I'm a supply chain question.
It sounds like a couple of suppliers, maybe one of the Big battery guys has had some recent challenges.
Could you give us color sort of the cadence of supply chain stresses we'd heard back a quarter ago about some of the specialty performance parts being in short supply do you see your suppliers sort of having adjusted to the disruption and improving their inbox or.
I guess as we had the sustained period of above average demand is the supply chain, having a harder time keeping up.
Yes, good question, Brad what I would tell you is.
We've seen improvements like I said, there's really only a handful of suppliers that are well, let me break that out there theres a handful of suppliers that are having fill rate issues that they control there.
There's also a handful of smaller chemical suppliers that are having some issues just simply to get product for their product in other words. There's so many containers that are going to head towards hand sanitizers. Some of these specialty vendors are still having trouble getting containers to ship their products, but that too has started to shift.
Back into a favorable position so what I would tell you from a supplier component of the supply chain, we're seeing continued improvement.
There's only really a handful of suppliers that are really continuing to to not fill at a rate that we desire looking at the entire supply chain as Jeff called out as strong as our supply chain isn't as strong as our Dcs perform.
They're just not equipped for the comparable store sales volume, we've seen so to Jeff's earlier point, we've seen some pressures there in our Dcs keeping up.
With the demand we've done a good job of getting product out to our stores on a daily basis, but we've had some backlog on incoming freight and we're working really hard to get that called so overall, we feel good suppliers are doing a good job. We're doing a good job of getting caught up and I would say within the next 30 to 45 days.
We felt like our supply chain will be back to normal.
Okay, and then could you give us a quick update on regional performance, maybe the highs and the lows and what kind of spread you're seeing between those those comps.
Yes, Jeff do you want take that for sure.
Sure you know as we mentioned on our second quarter call. We were extremely pleased with the performance on both sides of the business across all of our markets really exceeding our expectations and really that trend continued into the third quarter.
As you'd expect our newer markets continue to out comp are more mature markets, but overall the outperformance in the third quarter was really across all of our divisions all of our divisions performed very well exceeding our expectations.
Okay, great. Thank you.
Thank you.
Thank you. Our next question or comment comes from the line of Mike Baker from Davidson. Your line is open.
Thank you guys.
A couple of let's see I guess I'll ask.
I guess on the gross margin so I.
The.
If the remaining you talked about gross margins down 95 basis points I think if we do the math on the LIFO you talked talked about maybe that looks like a 65 basis point headwind. So can we assume the remainder is Mexico and more importantly, how do we think about it in the fourth quarter, you said the dynamic will play out similarly or.
Play out the same factors will play out, but what about the magnitude of the words.
Should we expect the same impact from that LIFO dynamic of roughly 65 basis points as we saw this quarter.
Now what we would expect first item is there were some other factors in there so I wouldnt necessarily assume that masses, all those and we're not.
But we're not commenting specifically on therapy and now what I would tell you is that.
When we look at the fourth quarter, we would expect not to have a significant LIFO impact on our gross margin.
Not significant or not as significant.
Sorry, I just didn't hear.
Not significant.
Not significant I understood, Okay, and then I guess.
To be more likely to be more clear.
Never know until the quarter is done and what price changes happened during the quarter, but we were $1 million positive this year or this quarter, so pretty darn flat.
Right, but on a year over year basis, Thats, where the issue comes right. So so when you say not not a significant LIFO.
In the fourth quarter, so, let's say, it's around that same level of 1 million, but on a year over year impact year over year basis that impacts the gross margin change or the gross margin rate year over year is that the right way to think about it.
Our fourth quarter 2019 impact is within our SEC filings.
Okay, No I get that it's okay. Okay.
Okay.
By way, perhaps a follow up if it's still on the TNL if that counts as the same general area.
On the SGN a you know made my sense is after the second quarter, you were pretty insistent that you're going to ramp back up yesterday, because it was too low.
And now it sounds like a little bit more cautious from the third quarter going into the fourth quarter was up because you've got me yesterday back to the level that you think is appropriate or is it more commentary of where you think sales are going in the next three months.
Well clearly in the second quarter, the spike in volume caught us by surprise as we had reduced our workforce based on the four first onset of of Cove. It in the results. So.
There are many different grades of leverage the second quarter leverage was extreme and not something that is sustainable or good for our business in the long term and the third quarter as Jeff talked about we increased our staffing to match the expected sales are closer to the expected sales.
We continue to see significant SGN a leverage in the third quarter I think our comments around that or we're going to manage our SGN and our spend per store prudent. The so that we can react to changes in sales volume up to be the same and continue that is high.
Low double digit rate or to the extent that we see fluctuations that we can actively manage our expenses.
Okay that makes sense thanks for the time.
Thank you thank.
Thank you. Our next question or comment comes from the line of Seth Sigman from Credit Suisse. Your line is open.
Hey, guys. Thanks for taking the question nice quarter I wanted to follow up on market share at your results, obviously outperforming the industry seems like probably a wider margin than we've seen in the past and it does seem like a good portion of that is.
Actual share gains it perhaps from independence, how much of this is transitory benefits from perhaps being able to manage inventory more effectively than others.
Versus something that maybe is more structural how do you think about the drivers of what's driving that outperformance right now.
Yes, I think it's several things and if you look at if you look at market share gains one thing I would tell you is I think the pie itself is bigger this year I think theres more money being spent any after market as a whole because of the stimulus and some of the incentives that consumers have but if you look at where those market share.
Gains are coming from you mentioned the smaller independents I think that is a result of supply chain strings, and our leverage in our ability to have inventory within our supply chain and have that inventory positions in such a way in our supply chain that gives us a competitive benefit.
The other piece that I think to a much lesser degree.
Would be.
From.
The mass retail side I think we're taking some some.
Market share from the mass retail side, although to a much lesser degree because its a lot fewer categories. I think the consumer in that case is frequently concerned about walking into two big box store to buy.
You know a battery or set of wiper blades or some some product and theres been a shift to the smaller retail box like ours and I think there has been a surprise and delight function that goes along with that when that customer comes in to one of our stores. You know not only are they able to get that product with not having the degree of interaction.
They would have been a big box store, but we also installed that product for them as well and I think thats evident I get a lot of letters from customers over the years and lately a lot of those letters I'm talking about the service level, we provide have called out with a degree of surprise that we perform those functions we installed.
Those batteries and wipers, and our traditional customer knows we do that so I think we brought some new customers into our stores and I think one of the keys to that market share that we've taken from both sides of the business is just the service level, we provide them a sticky business and our focus on keeping those customers for the long term both from from both.
Panels that I described.
Okay. That's helpful, but our team just to expand on that I mean, it's been an incredible.
Incredibly disruptive in the last six months to our business and our corporate office has done a great job supporting our teams in the Dcs in stores and our DC teams have done a fantastic job with all the adverse they faced is shipping product to our stores and keeping them at an in stock position and in our stores.
Just in all the adversity and issues they face all their markets with Lockdowns and and the regulations has just done an incredible job in execution.
Here of our customers day in and day out.
Okay. All right. Thank you for that color and then just on one of the prior points around SGN a it sounds like you will continue to manage conservatively does that mean that if comps to remain at this low double digit rate that SGN a growth may remain constrained in Q4 like we saw this quarter is that.
The way to think about it.
If we can.
There is a lot of quarter left and we'll see what happens with the sales volumes.
We would tell you is that.
You're going to be conservative that means not staffing up to the current level of business because the current level of business has been heightened from historic norms to the extent that we can continue to drive those results. We will continue to see strong leverage.
Great. Thanks very much.
Thank you we have reached our allotted time for questions I will now turn the call over to Mr., Greg Johnson for closing remarks.
Thank you Howard.
We'd like to conclude our call today by thanking the entire O'reilly team for their continued selfless dedication to our customers and.
I'd also like to thank everyone for joining our call today, and we look forward to reporting our fourth quarter and full year 2020 results in February.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may now disconnect.
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