Welcome to the O'Reilly Automotive, Inc. Fourth Quarter and Full-Year 2020 Earnings Conference Call. My name is GeeGee, and I will be your operator for today's call. [Operator Instructions] I will now turn the call over to Mr. Tom McFall. Mr. McFall, you may begin.

Thank you, GeeGee. Good morning, everyone, and thank you for joining us. During today's conference call, we will discuss our fourth quarter 2020 results and our outlook for 2021. 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, 2019, and other recent SEC filings. The company assumes no obligation to update any forward-looking statements made during this call. At this time, I'd like to introduce Greg Johnson.

Thanks, Tom. Good morning, everyone, and welcome to the O'Reilly Auto Parts fourth quarter conference call. Participating on the call with me this morning, are 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. To begin today's call, I would like to congratulate team O'Reilly on delivering a truly remarkable year in 2020. At this time last year, when we first provided our outlook for 2020, we could never have anticipated the challenges we would face during the year. The COVID-19 pandemic has disrupted every facet of daily life in the United States, and has required our teams to show tremendous flexibility and executing our business model and taking care of our customers. There simply aren't words to describe the selfless dedication, hard work and sacrifices our team members in our stores, distribution centers and offices demonstrated during 2020. From the onset of the pandemic, we have closely monitored and quickly adapted to evolving information, recommendations and requirements issued by public health agencies and state and local governments, as we continually update our protocols and procedures to ensure best practices are followed. Our top priority continues to be the protection of health and safety of our team members and customers, while meeting the critical needs of our customers as an essential service provider. Before I move on to the rest of our prepared comments today, I want to thank team O'Reilly for your amazing dedication and performance during an incredibly challenging and successful 2020. The bedrock of our company's success since our founding 63 years ago, has been providing excellent customer service and never has the value we provide to our customer has been more evident…

Thanks, Greg. And good morning, everyone. I want to start by adding my congratulations and expressing my sincere appreciation to team O'Reilly for another incredible quarter and an amazing full year performance in 2020. 2020 has presented wave after wave of changes. And our teams have consistently stepped up to the challenge to run our business and take care of our customers. Challenges remain in 2021. And our teams remain committed as ever to deliver an exceptional service and value to our customers. At this time of year, we would normally be returning from our leadership conference, which is a huge in-person gathering of all of our store, field and DC leadership, where we enhance our product knowledge and technical proficiency, showcase new tools and strategies to improve our customer service and take market share and to recognize outstanding achievement throughout our company. Even though this year's event had to take on a new format as our first ever virtual conference, we had an extremely successful event and no slogan could be more on target than our conference theme of O'Reilly strong. That O'Reilly strength was on full display throughout 2020, and we're especially proud of the daily sacrifices our team made to go the extra mile to take care of our customers' critical needs while also ensuring that the health and safety of our team members and customers remain the top priority. Now I'd like to spend some time covering our SG&A and operating profit performance in 2020 and our outlook for 2021. For the fourth quarter, we generated an impressive increase in operating margin of 111 basis points and an operating profit dollar growth of 21%. For the full year, the improvements were 193 basis points and 26% of operating profit dollar growth yielding a record 20.9% operating…

Thanks, Jeff. I would also like to thank all the team of O'Reilly for their continued commitment to our customers, which drove our record setting performance in the fourth quarter and full year of 2020. Now, we'll take a closer look at our quarterly results and our guidance for 2021. For the quarter, sales increased $346 million comprised of the $273 million increase in comp store sales, a $51 million increase in non-comp store sales, a $25 million increase in non-comp non-store sales and a $3 million decrease from permanently closed stores. For 2021, we expect our total revenues to be between $11.5 billion and $11.8 billion. As Greg previously mentioned, gross margin for the fourth quarter decreased 131 basis points to 52%, which was driven by the year-over-year comparison to significant gross margin benefits we captured in the fourth quarter of 2019 related to sell through a pre-tariff on hand inventory and tariff exclusions on certain product lines, as well as dilution from the acquisition of Mayasa. Looking at the fourth quarter of standalone, we had a positive impact from LIFO of $6 million, down from $23 million in 2019. Included within our guidance for 2021 is a larger anticipated positive impact from LIFO, which will offset pressure to our POS margins from the expiration of tariff exclusions we've benefited from in the first half of 2020. We received a very minor benefit from same skew inflation in the fourth quarter of 2020 in line with our expectations. And our outlook for 2021 for sales and gross margin includes a muted expectation for same skew inflation of 1%. The pricing environment remains rational, and we expect that to continue. Our fourth quarter effective tax rate was 21.4% of pre-tax income comprised to the base rate of 21.8% reduced by…

Thank you. [Operator Instructions] Your first question comes from the line of Simeon Gutman from Morgan Stanley. Your line is now open.

Hey, good morning, everyone. My first question is on the sales line. Can you talk about in the outlook, the minus 20 comp? Can you talk about your assumption for industry growth versus market share? And if there's any commentary you can provide looking backwards on the 11% comp that you did in 2020. And I know, I think Greg Johnson mentioned in his prepared remarks that under car was doing well in despite miles driven being down. Can – does that – should that make us more tempered about how the industry should recover as miles driven resumed to starts to grow again? Thanks.

Tom, do you want to take that one off?

Okay. So on the guidance for the comps of negative two to flat, we break that into two pieces. We didn't see the incredible upside on the professional side of the business that we saw on the DIY side of the business and consumers have more time on their hands. They had government money in their pocket book. And as we talked about, took on larger projects, some of which are very atypical for economic downturns, where they were working on projects and making sure their vehicles were maintained. So when we look at the professional side of the business, we continue to see growth on that side of the business. On the DIY side of the business much more cyclical. And after the huge gains in 2020, we'd expect them to be pressured in 2021. On the miles driven, it kind of feeds off of that same comment. We would expect as miles driven to increase that our business will see a positive impact from that, with the caveat that we sell a lot of DIY projects during the year, ultimately for our business to be up that much. Consumers were being more proactive in maintaining their vehicles and the amount of underperformed or unperformed maintenance decreased.

Yes. I add to add to that. Simeon, on the category question, we were pleased with our performance across the board. I did call out under car, really the only categories that underperformed were weather and miles driven related things like lighting and wipers were softer than what we would have liked to seen. But one of the shifts that we saw during the quarter, and I also called this out is the willingness and ability of the DIY customer to take on larger jobs than perhaps they would have historically. And for example, some are under car lines, like brakes really performed well and better than expected on the DIY side of the business that were typically, that would be a stronger category for the DIFM side.

Okay. Thanks for that. My follow-up is on incremental margins, and I guess maybe more for Tom. If you look back pre-COVID and you mentioned some 2019 stats, your incremental were closer to 20%, I don't know when, we'll get to a new normal, and I appreciate we're not going to give 2022 guidance at this time, but is there any reason why we can't get back to that level when the business can grow again, is the leverage point of the business higher, or can we look at the 2019 and 2018 levels of incremental margin and use that as a normal level going forward?

I don't think that the incremental leverage points for our business have changed, 2020 was such a dramatic year with sales being softer at the beginning of the year, and then down significantly at the onset of the pandemic. And that protects the health of the business. We made dramatic cuts in our expenses and then mid April sales turn directly north. So it was a very unusual circumstance. We weren't sure how long that was going to last. And we're very prudent on adding back SG&A. Obviously sales continue to be exceptionally strong. So comparison to the 2020 metrics is very difficult. That said, I don't think that the core underlying economics of our business have changed. And I think that we will go back to continuing to execute that very similar business model.

Okay. Thanks. Good luck.

Thank you. Our next question comes from the line of Michael Lasser from UBS. Your line is now open.

Good morning. Thanks a lot for taking my question. How have you thought about using this period of remarkable [indiscernible] to take a look at your pricing and make any investments in your pricing that might be necessary to ensure your competitiveness with both your traditional and online competitors, and because you did not call out pricing as an impact here, gross margin during the period. And one might think that that given some of the competitive factors out there, especially with one of your large competitors talking about price investments that that would have been the case.

Yes, Michael. This is Greg. Really, 2020 was no different than, than any other year. We have competitors out there, both on the professional side of the business and the retail side of the business that there's price movement based on cost inputs, there's price input based on commodities that go into the product there's price inputs based on trying to grow sales, changing suppliers, it's an ongoing battle. And it's something that we face year-over-year and really, we work hard both on the professional side of the business and the retail side of the business to make sure we're priced competitively. And frankly, I don't see 2020 as being any different than any other year in that respect. We did the same things. We passed along cost increases where we could as we always do, and we closely monitored our competitor pricing trends. So, so really, I don't think we did anything any different in 2020 than we would do any other year.

And just to confirm, there were no price investments that were a significant contributor to your gross margin being down more in the fourth quarter than it was in the third quarter?

When we look at our fourth quarter of gross margin versus our third quarter, it was pretty consistent except for on the distribution side. We have lower volumes, so we have less leverage on our distribution costs. And quite frankly, our distribution centers have worked tirelessly all year and some of the normal maintenance and inventory maintenance had to be put aside as we worked to fulfill record volumes, and we had some catching up to do on our distribution side and had to spend additional payroll there.

Okay. My follow up question is, as you look out to 2021, it feels are weaker than you expect because there's more demand that was pulled forward than what you anticipated. How would you manage your SG&A and response to that? Will it still be up 2.5%, otherwise, might you have under-invested in operating expenses in 2021 and need to catch up this year, which might limit some of your flexibility?

Jeff, you want to start that off and maybe Tom will add to it.

Yes, I just say that we always have managed our SG&A in HR business and we manage our payroll store by store and really adjust to the sales demand in the market. And if sales are a little softer, we adjust accordingly. Maybe it's less hours, it's less overtime, maybe less head count and vice versa like we've seen last year. It's the most dramatic swing we'd ever seen in having a ramp down when it ended up period, we would normally ramp up going into season and it had to immediately try to ramp back up the best we could to meet the incredible sales demand. So it's a – it's always fluid. Last year was incredibly volatile though. We adjust accordingly for the long-term health of our business, and what's best for our customer service.

Like what I'd add to that is as a multiunit retailer, we have a relatively high fixed cost to operate the stores. I think you saw in 2020 is that if we have the expectation, we're going to have a significant downturn in volumes that we can and will take very active steps to address our SG&A.

Awesome. Thank you so much.

Thanks, Michael.

Thank you. Our next question comes from the line of Chris Horvers from JPMorgan. Your line is now open.

Thank you. My peers leaving me the opportunity to ask about LIFO, Tom, can we talk about that that the LIFO benefit of 6 million here in the fourth quarter on an absolute basis? Is that a fair assumption as you look into 2021 and on a quarterly basis, or are you expecting that to rise as there's some parts inflation – price inflation coming through, and then more broadly, can you provide some color on sort of gross margin cadence over the year.

So from a LIFO standpoint $6 million in the fourth quarter. We'd expect to be around that number, maybe just a little bit higher looking at the price increases. We're aware of currently in our expectation from moderate inflation rate of 1% throughout the year. So hopefully that covers our LIFO number obviously was significantly different and lower in 2020 than it was 2019 after the 2018 and 2019 tariff price increases that could change based on the tariffs. But as you know, we plan to continue to exist in the current tariff tax world. And as those change, we make the appropriate changes within our business. When we look at gross margin for next year, I'd tell you that absent any of those significant shifts, we would expect to be relatively flat throughout the year.

Okay. Got it. Okay. Understood. And then I guess, more broadly on the balance sheet and share repurchases either seem to be sticking to this very consistent buyback, which is always been the hallmark of O'Reilly, but at the same time, you are below your long-term leverage target and your valuation is, has dislocated relative to history. As you think about that and think about the opportunity to maybe add some debt to the balance sheet to fuel some extra buyback. Do you want to see what happens in the middle part of the year as you lap through these tremendous stimulus fuel DIY comps, is there some prudence there that you're just trying to play out given that uncertainty?

So when we look at our leverage and we look at our plan in 2021 with the lower EBITDA rate. We will have some fluctuations and our rate will go up as some of those quarters roll off. In relation to the buyback, we evaluate where we think the stock is trading in relation to our discounted cash flows, and we're going to continually buy back shares. And when we feel that there's that dislocation, you talked about, we're going to buyback more shares. When we look at 2020, we had suspended our buyback at the onset of the pandemic for an abundance of caution, and to make sure that liquidity is king in those situations. And I think our results show that in good times and bad, our model generates significant cash. And to the extent that we can't deploy that in that way within the business that creates the right ROI, we'll consistently buyback shares and try to buy back more when we think about the market isn't perceiving the value of the stock right?

Understood. Very helpful. Best of luck guys.

Thanks.

Thanks.

Thank you. Our next question comes from the line of Scot Ciccarelli from RBC Capital.

Hi guys, Scot Ciccarelli. Okay. I think we all recognize that e-commerce historically hasn't been a very big part of your business, but just given the broader acceleration that we've seen in e-com penetration this year, even across sectors, where it's never really been prevalent. Can you update us on the size of your e-commerce business today and how much of that is focused versus shipped-to-home?

Scot, here is what I would tell you, our sales overall grew incredible pace this year. And our e-comm sales grew at an incredible pace this year. But the end result is that e-commerce is still a very, very small percentage of our overall sales number. When you break it down by buy online, pick-up in store, or ship-to-store versus, ship, purchase in store, our growth was substantially higher, pick-up in store, ship-to-store, just demonstrating that the consumer again sees tremendous value in coming to our brick-and-mortar business, whether it's curbside pickup, or they actually come into our stores, in lieu of buy online, ship-to-home where they actually get additional discounts. So, we're very pleased with our e-com results. Although again, it's a very, very small percentage of our total overall sales.

Got it. Very helpful. And then just a second quick question here. We are still hearing about product shortages, in the category, can you help us understand how you guys are thinking about product availability and whether you think that your ability to obtain product has potentially played a role in some of share gains you referenced today?

Yes, I mean, Scott, the strength of our supply chain, I think, really, has been one of our competitive strengths forever. And I think it really shined through in 2020 and just demonstrated that true strength. One of the things that we elected to do years ago was to require our international suppliers to keep products stateside here in the U.S. And that helped us early in the pandemic, and we were very aggressive with our ordering on the onset, because we could see, as sales began to trend upward. That said, our supply chain was definitely pressured in 2020. And we did have some suppliers that underperformed, we still have a handful of suppliers that are not performing at the level that we would like for them to and we're working very aggressively to ensure that they get back up to speed. Some of that, much of that is related to the pandemic, whether domestic or international, we have one domestic supplier that has challenges with COVID right now in the market that they are doing their manufacturing and distribution is really being hit hard right now. But that's a short-term pain. And then there's a couple of suppliers that we're having issues with, it's more of an industry-wide event where we lost a supplier in the category early on this year. But what I would tell you generally is things have improved from a supply standpoint. And we feel good about the very few suppliers that we have that are not performing well.

Super helpful. Thanks a lot, guys.

Yes, thanks.

Thank you. Our next question comes in the line of Chris Bottiglieri from Exane BNP Paribas. Your line is now open.

Hey everyone thanks for taking the question. So, I guess the first one wanted to do is just kind of clerically go through gross margin. So, I heard you right, it sounds like relative to Q3 the gross margin happing in Q4 the LIFO compare with similar, the DC pressure was in totality worse than Q3, tariff was something new, [indiscernible] something similar. I guess is there anything else in that gross margin headwind like ocean freight was that impact? And then how about tariffs, is that just a one-time event, or is this something we'll see in they are out in 2021 as well until you anniversaried? The tariff exclusion I’m referring to.

The tariff items are ongoing and have more to do with them being consistent with last year as comparing to 2019 when they were new items. The tariff exclusions, I think, we talked to occurred end of 2019 and 2020 and produced premium margins when those prices went – when the acquisition price went down, but the selling prices didn't go down. So hopefully that addresses that laundry list of questions. On the ocean freight, I don't think that we have seen – we've all read that that is an area of pinch point right now and prices are going up. I don't think that we've seen at this point, a meaningful impact of that. But obviously, we're keeping a close eye on that. To the extent that that rises within our industry, we tend to all acquire the similar parts from similar areas. And we view that as a input cost that should hit all of the retailers and wholesalers.

Got you. That makes sense. Okay, then just to kind of one bigger picture question, obviously this is a tremendous year, if the industry, in terms of a behavioral shift from your customer base, in terms of the projects they are tackling, in terms of the channels of their shopping at, do you see this being kind of – once the economy reopens, did you think any of this can stick? Are people going to continue to tackle some of these hobbies? Do you think there is a bit chance they want to continue staying at auto parts stores rather than the big box? And I guess anything that that O'Reilly specifically is doing proactively to kind of retain those sales will be helpful?

Yes, Chris, as we talked about there are several levers, several tail winds that benefited us in 2020. And we certainly hope some of those dynamics carry over into 2021 obviously, not the pandemic itself, but some of the other trends. When you look at where we feel like we made the most progress from a share gain perspective in 2020, we feel like it was some of the smaller WD [ph] players out there that maybe don't have the supply chain strength we did and had the product availability that we had. I think that shift, assuming that our stores did a good job servicing those customers, which we all know they did, we hope that some of that is sticky business. And we're in a relationship business. And hopefully some of those customers on both sides, both the professional on the retail side, continue to come into our stores. The other area where we feel like we took some shares is the big box retailers. And when you think about what you experience when you walk into a big box store today, there's a little more apprehension with a lot of consumers about going into that environment for fear of contracting disease, you're masked and obviously all of those things. But I think some of the consumers rather than walk to the back of the store to pick up a battery or wiper blades, or what have you, fight that crowd, take that risk, and then go home and install those products themselves, they came to O'Reilly. And what they saw is, hey, we've got quality products, we've got competitive pricing. And guess what, we'll install those products for you there in the parking lot. So those customers that experience that shift in 2020, we certainly hope a lot of that carries over 2021 and beyond.

That's really helpful. Thank you.

Thank you. Our next question comes from the line of Daniel Imbro from Stephens Inc. Your line is now open.

Yes, good morning, guys. Thanks for taking a question. Greg, I want to start on a longer-term question. Obviously, another outcome of the pandemic been a bit of de-urbanization, maybe increase used vehicle ownership, we've seen a lot of headlines around that from the dealers and other auto names. Should that become a tailwind to your business, as we think through 2021 and longer term with the 2022 and 2023, as there is more older vehicles on the road, or how did that impact your business in the coming years?

Yes, it should definitely be favorable to our business. For every consumer that buys a used vehicle, as opposed to a new vehicle, which would be under warranty, and the first few years of repairs may go back to the dealer. When those consumers elect to buy a used vehicle rather than a new vehicle, typically, those are out of the warranty cycle, which brings more of that volume into our stores sooner.

To add to Greg's comments, we'll have to see how it plays out long-term obviously. The vehicle sales were down due to the economic concerns and production concerns and then have bounced back. To the extent that consumers move more to the suburbs and rural and drive more miles, that's good for our business long-term. To the extent that people decide they want to control more of their own transportation, and the vehicle count per household goes up, that's another good item for us from a long-term perspective. Early in that cycle, we'll see how it turns out.

That's helpful. And then just as a quick follow-up to your last answer around the big box market share, is there anything you are seeing from those mass merchant or big box customers that different from your core customer? Are they more price sensitive, are they using loyalty rewards or discounts more frequently? And do you think you've done enough, during the pandemic to make that customer market share sticky as big box, maybe reopens some of their online or auto offering that they took offline during the pandemic? Thanks.

Yes, I don't know that we've looked at it from a loyalty perspective. I don't know that when a customer walks in our store if we really know if they were previously a big box shopper or not. So from a loyalty perspective, a lot of the demographic that shops in the big box stores you would think would be loyalty customers. They are definitely price sensitive customers. They came into our store. As far as sticky transactions, it was a challenging year for us, as Jeff said in his prepared comments. And our store team members just did a heck of a job working long hours to take care of customers, meeting them in the parking lot, doing curbside delivery. We upped our service level in 2020. And we certainly hope that that pays off from a relationship standpoint to maintain a lot of that volume 2021 and beyond.

Got it. Thanks so much. You all stay safe. And best of luck.

Thank you.

Thank you.

Thank you. Our next question comes from the Seth Sigman from Credit Suisse. Your line is now open.

Hi, guys. Thanks for taking the question. I wanted to follow-up on the quarter-to-date performance. You mentioned December was the strongest of Q4, and that January had remained strong. I assume the implication here is that Q1 is tracking ahead of that 11% in Q4. But you can give us a little bit more on that? And then, weather was talked about a little bit, you alluded to some favorability. Are you seeing extreme conditions that beyond just the short term can provide some sort of tailwind looking out over the next few quarters?

Seth the first part of your question, I think, you can infer what you said from our data points that we gave. On the second part of the question, cold weather is good for us, cold weather brakes cars. To the extent that we have very cold weather, especially on the electrical and battery system, it will weaken those faster, and should provide support in the middle of the year, when it gets really hot, those weaker batteries will fail at a higher rate.

Got it. Okay. And then just to follow on the gross margin, I have a few questions on this. It has come down modestly in recent years, they are basically saying it's stabilizing in 2021. Fully appreciating your focus on gross profit dollars. But just wondering, is this the right run rate to be thinking about long-term for gross margin rate, or are there incremental gross margin initiatives? And I'm talking about gross margin rate initiatives that should help long-term, like how should we be thinking about the long-term outlook?

I think if you look back to our comments, especially in 2019, we were pretty direct that we were making premium margin on many products because of the shifts in the tariffs and the LIFO impact of having bought product before the tariffs. But having raised prices when the tariffs kicked in, and then having premium pricing on items where the tariffs came off from an exclusion, but the selling prices didn't change. I think we are pretty clear that 2019 was an abnormally high year. So, if we take that year out, I think, if you look over time, our goal is to incrementally improve margins 10 to 20 basis points through better buying and through more efficient distribution. Obviously, as Greg talked about it earlier, pricing is very dynamic in our market. And to the extent that we have a lot of acquisition price changes, creates the opportunity for better or worse margin. But as we've been in the last 10 years outside of 2020, end of 2018 and 2019, pretty consistent acquisition cost, very low same skew inflation, gives you a more consistent margin. So, I guess in short, what I tell you is that end of 2018, 2019 presented some opportunities to charge a premium margin in our industry, those who have run their course, I think, were back to an appropriate margin with incremental increases at a small level over time.

Okay, that's great. Thanks very much.

Thank you.

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

Thank you, GeeGee. We would like to conclude our call today by thanking the entire O'Reilly team once again for their continued, selfless dedication to our customers and for their incredible performance in 2020. We look forward to another strong year in 2021. I'd like to thank everyone for joining our call today. And we look forward to reporting our 2021 first quarter results. Thank you.

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