filings.toolsItem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
46K characters. Original on sec.gov ·
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Unless otherwise indicated, “we,” “us,” “our” and similar terms, as well as references to the “Company” or “O’Reilly,” refer to O’Reilly Automotive, Inc. and its subsidiaries.
In Management’s Discussion and Analysis, we provide a historical and prospective narrative of our general financial condition, results of operations, liquidity and certain other factors that may affect our future results, including
| ● | recent developments within our Company; |
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| ● | an overview of the key drivers of the automotive aftermarket industry; |
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| ● | our results of operations for the three and nine months ended September 30, 2021 and 2020; |
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| ● | our liquidity and capital resources; |
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| ● | any contractual obligations, to which we are committed; |
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| ● | our critical accounting estimates; |
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| ● | the inflation and seasonality of our business; and |
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| ● | recent accounting pronouncements that may affect our Company. |
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The review of Management’s Discussion and Analysis should be made in conjunction with our condensed consolidated financial statements, related notes and other financial information, forward-looking statements and other risk factors included elsewhere in this quarterly report.
FORWARD-LOOKING STATEMENTS
We claim the protection of the safe-harbor for forward-looking statements within the meaning of 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. In addition, statements contained within this quarterly report that are not historical facts are forward-looking statements, such as statements discussing, among other things, expected growth, store development, integration and expansion strategy, business strategies, future revenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions, including, but not limited to, the COVID-19 pandemic or other public health crises; the economy in general; inflation; consumer debt levels; product demand; the market for auto parts; competition; weather; tariffs; availability of key products; business interruptions, including terrorist activities, war and the threat of war; failure to protect our brand and reputation; challenges in international markets; volatility of the market price of our common stock; our increased debt levels; credit ratings on public debt; historical growth rate sustainability; our ability to hire and retain qualified employees; risks associated with the performance of acquired businesses; information security and cyber-attacks; and governmental regulations. Actual results may materially differ from anticipated results described or implied in these forward-looking statements. Please refer to the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2020, and subsequent Securities and Exchange Commission filings, for additional factors that could materially affect our financial performance. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.
RECENT DEVELOPMENTS
As we naviate the ongoing challenges resulting from the COVID-19 pandemic, we continue to place additional emphasis on the safety and wellness of our Team Members and our customers. During the nine months ended September 30, 2021, the increased level of vaccinations, the ongoing reopening processes across markets we operate in, government stimulus payments and enhanced unemployment benefits have positively impacted demand for the products we sell. We continue to keep our stores open and operating to meet our customers’ critical needs, while also ensuring the safety of our Team Members and customers through strict adherence to safety protocols. However, we cannot predict how long the current crisis will last or the extent of its future impacts on our customers, our Team Members, our supply chain and overall industry demand.
For additional risks related to the COVID-19 pandemic, please refer to the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2020.
OVERVIEW
We are a specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States and Mexico. We are one of the largest U.S. automotive aftermarket specialty retailers, selling our products to both DIY customers and professional service providers – our “dual market strategy.” Our stores carry an extensive product line consisting of new and remanufactured automotive hard parts, maintenance items, accessories, a complete line of auto body paint and related materials, automotive tools and professional service provider service equipment.
Our extensive product line includes an assortment of products that are differentiated by quality and price for most of the product lines we offer. For many of our product offerings, this quality differentiation reflects “good,” “better,” and “best” alternatives. Our sales and total gross profit dollars are, generally, highest for the “best” quality category of products. Consumers’ willingness to select products at a higher point on the value spectrum is a driver of sales and profitability in our industry. We have ongoing initiatives focused on marketing and training to educate customers on the advantages of ongoing vehicle maintenance, as well as “purchasing up” on the value spectrum.
Our stores also offer enhanced services and programs to our customers, including used oil, oil filter and battery recycling; battery, wiper and bulb replacement; battery diagnostic testing; electrical and module testing; check engine light code extraction; loaner tool program; drum and rotor resurfacing; custom hydraulic hoses; professional paint shop mixing and related materials; and machine shops. As of September 30, 2021, we operated 5,740 stores in 47 U.S. states and 22 stores in Mexico.
We are influenced by a number of general macroeconomic factors that impact both our industry and our consumers, including, but not limited to, fuel costs, unemployment trends, interest rates and other economic factors. Due to the nature of these macroeconomic factors, we are unable to determine how long current conditions will persist and the degree of impact future changes may have on our business. Macroeconomic factors, such as total U.S. unemployment, and demand drivers specific to the automotive aftermarket, such as U.S. miles driven, have been pressured as a result of responses to the COVID-19 pandemic, including stay at home orders, work from home arrangements and reduced travel. However, government stimulus and additional unemployment benefits, the ongoing reopening processes across markets we operate in and increased miles driven have positively impacted our performance. We are unable to predict the ongoing and future impact of the pandemic on broader economic conditions or our industry.
We believe the key drivers of current and future long-term demand for the products sold within the automotive aftermarket include the number of U.S. miles driven, number of U.S. registered vehicles, new light vehicle registrations and average vehicle age.
Number of Miles Driven
The number of total miles driven in the U.S. influences the demand for repair and maintenance products sold within the automotive aftermarket. In total, vehicles in the U.S. are driven approximately three trillion miles per year, resulting in ongoing wear and tear and a corresponding continued demand for the repair and maintenance products necessary to keep these vehicles in operation. According to the U.S. Department of Transportation, the number of total miles driven in the U.S. decreased 13.2% in 2020, as a result of responses to the COIVD-19 pandemic, but through August of 2021, year-to-date miles driven has improved, increasing 12.2%. Government measures or consumer and business behavior in response to the COVID-19 pandemic could again have a negative impact on miles driven, but we are unable to predict the duration and severity of the impact to our business.
Size and Age of the Vehicle Fleet
The total number of vehicles on the road and the average age of the vehicle population heavily influence the demand for products sold within the automotive aftermarket industry. As reported by The Auto Care Association, the total number of registered vehicles increased 12.7% from 2010 to 2020, bringing the number of light vehicles on the road to 281 million by the end of 2020. For the year ended December 31, 2020, the seasonally adjusted annual rate of light vehicle sales in the U.S. (“SAAR”) was approximately 16.3 million. For 2021, the outlook for the SAAR is uncertain and estimated to be approximately 12.2 million, as the duration of the COVID-19 pandemic and supply chain constraints have limited new vehicle production capacity and made it difficult to determine the ultimate forecast of new vehicle sales. The annual changes to the vehicle population resulting from new vehicle sales and the fluctuation in vehicle scrappage rates in any given year represent a small percentage of the total light vehicle population and have a muted impact on the total number and average age of vehicles on the road over the short term. From 2010 to 2020, vehicle scrappage rates have remained relatively stable, ranging from 4.1% to 5.7% annually. As a result, over the past decade, the average age of the U.S. vehicle population has increased, growing 12.3%, from 10.6 years in 2010 to 11.9 years in 2020.
We believe the increase in average vehicle age can be attributed to better engineered and manufactured vehicles, which can be reliably driven at higher mileages due to better quality power trains, interiors and exteriors, and the consumer’s willingness to invest in maintaining these higher-mileage, better built vehicles. As the average age of vehicles on the road increases, a larger percentage of miles are being driven by vehicles that are outside of a manufacturer warranty. These out-of-warranty, older vehicles generate strong demand for automotive aftermarket products as they go through more routine maintenance cycles, have more frequent mechanical
failures and generally require more maintenance than newer vehicles. We believe consumers will continue to invest in these reliable, higher-quality, higher-mileage vehicles and these investments, along with an increasing total light vehicle fleet, will support continued demand for automotive aftermarket products.
We remain confident in our ability to gain market share in our existing markets and grow our business in new markets by focusing on our dual market strategy and the core O’Reilly values of hard work and excellent customer service.
RESULTS OF OPERATIONS
Sales:
Sales for the three months ended September 30, 2021, increased $272 million or 8% to $3.48 billion from $3.21 billion for the same period one year ago. Sales for the nine months ended September 30, 2021, increased $1.26 billion or 14% to $10.04 billion from $8.78 billion for the same period one year ago. Comparable store sales for stores open at least one year increased 6.7% and 16.9% for the three months ended September 30, 2021 and 2020, respectively. Comparable store sales for stores open at least one year increased 12.9% and 10.7% for the nine months ended September 30, 2021 and 2020, respectively. Comparable store sales are calculated based on the change in sales for U.S. stores open at least one year and exclude sales of specialty machinery, sales to independent parts stores and sales to Team Members, as well as sales from Leap Day in the nine months ended September 30, 2020. Online sales for ship-to-home orders and pickup in-store orders for U.S. stores open at least one year are included in the comparable store sales calculation.
The following table presents the components of the increase in sales for the three and nine months ended September 30, 2021 (in millions):
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| | | Increase in Sales for the | Increase in Sales for the | |||
| | | Three Months Ended | | Nine Months Ended | ||
| | | September 30, 2021 | | September 30, 2021 | ||
| | | Compared to the Same | | Compared to the Same | ||
| | | Period in 2020 | | Period in 2020 | ||
| Store sales: | | | | |||
| Comparable store sales | | $ | 210 | | $ | 1,097 |
| Non-comparable store sales: | | | ||||
| Sales for stores opened throughout 2020, excluding stores open at least one year that are included in comparable store sales, and Mayasa store sales | | 11 | | 79 | ||
| Sales for stores opened throughout 2021 | | 46 | | 88 | ||
| Sales from Leap Day in 2020 | | | — | | | (35) |
| Sales for stores that have closed, including temporarily closed stores | | 1 | | (2) | ||
| Non-store sales: | | | ||||
| Includes sales of machinery and sales to independent parts stores and Team Members | | 4 | | 33 | ||
| Total increase in sales | | $ | 272 | | $ | 1,260 |
We believe our increased sales are the result of store growth, the high levels of customer service provided by our well-trained and technically proficient Team Members, superior inventory availability, including same day and over-night access to inventory from our regional distribution centers and hub store network, enhanced services and programs offered in our stores, a broader selection of product offerings in most stores with a dynamic catalog system to identify and source parts, a targeted promotional and advertising effort through a variety of media and localized promotional events, continued improvement in the merchandising and store layouts of our stores, compensation programs for all store Team Members that provide incentives for performance and our continued focus on serving both DIY and professional service provider customers. The government stimulus payments, enhanced unemployment benefits, lifting of stay at home orders and associated ongoing market reopenings, when combined with positive industry dynamics, such as consumers investing in existing vehicles and favorable weather, contributed to strong demand in the nine months ended September 30, 2021.
Our comparable store sales increase for the three months ended September 30, 2021, was driven by increases in average ticket values for both professional service provider and DIY customers, partially offset by negative transaction counts. Our comparable store sales increase for the nine months ended September 30, 2021, was driven by increases in average ticket values and transaction counts for both professional service provider and DIY customers. Average ticket values continue to be positively impacted by the increasing complexity and cost of replacement parts necessary to maintain the current population of better-engineered and more technically advanced vehicles. These better-engineered, more technically advanced vehicles require less frequent repairs, as the component parts are more durable and last for longer periods of time. The resulting decrease in repair frequency creates pressure on customer transaction counts; however, when repairs are needed, the cost of replacement parts is, on average, greater, which is a benefit to average ticket values. Average ticket
values continue to benefit from consumers spending additional time and money repairing and maintaining their vehicles in response to the COVID-19 pandemic, economic environment and new and used vehicle scarcity. Average ticket values also benefited from increases in average selling prices, on a same-SKU basis, as compared to the same period in 2020, driven by increases in acquisition costs of inventory, which were passed on in market prices. The decrease in transaction counts for the three months ended September 30, 2021, was driven by a challenging comparison to the strong DIY customer transaction counts in the prior year, partially offset by positive transaction counts from professional service provider customers in the current period. Improvements in transaction counts for the nine months ended September 30, 2021, were primarily due to prior year headwinds to traffic from the initial COVID-19 stay at home orders in 2020 and business restrictions, which resulted in immediate pressure to transaction counts for both DIY and professional service provider customers. Continued market reopening and recovery plans, ongoing government stimulus, favorable winter and spring weather conditions and the new and used vehicle scarcity positively impacted our customers’ willingness to perform or invest in maintenance on their vehciles, which benefited transaction counts in the nine months ended September 30, 2021.
We opened 30 and 146 net, new U.S. stores during the three and nine months ended September 30, 2021, compared to opening 30 and 153 net, new U.S. stores during the three and nine months ended September 30, 2020. As of September 30, 2021, we operated 5,740 stores in 47 U.S. states and 22 stores in Mexico compared to 5,592 stores in 47 U.S. states and 21 stores in Mexico at September 30, 2020. We anticipate total new store growth to be 165 to 175 net, new store openings in 2021, and 175 to 185 net, new store openings in 2022.
Gross profit:
Gross profit for the three months ended September 30, 2021, increased 8% to $1.82 billion (or 52.3% of sales) from $1.68 billion (or 52.4% of sales) for the same period one year ago. Gross profit for the nine months ended September 30, 2021, increased 15% to $5.29 billion (or 52.7% of sales) from $4.61 billion (or 52.6% of sales) for the same period one year ago. The increase in gross profit dollars for the three months ended September 30, 2021, was primarily the result of new store sales and the increase in comparable store sales at existing stores. The increase in gross profit dollars for the nine months ended September 30, 2021, was primarily the result of new store sales and the increase in comparable store sales at existing stores, partially offset by prior year gross profit dollars generated from one additional day due to Leap Day. The decrease in gross profit as a percentage of sales for the three months ended September 30, 2021, was due to increased distribution system costs and a greater percentage of total sales mix generated from professional service provider customers, which carry a lower gross margin than DIY sales. Increased distribution system costs were driven by the significant increase in volumes over the past year, challenging labor markets and ongoing global logistical supply chain pressures. These headwinds were partially offset by a benefit from selling through inventory purchased prior to recent acquisition cost increases and corresponding selling price increases. We determine inventory cost using the last-in, first-out (“LIFO”) method but have, over time, seen our LIFO reserve balance exhausted, resulting in a LIFO inventory value above replacement cost prior to September 30, 2021. Our policy is to not write up inventory in excess of replacement cost, and accordingly, we had effectively valued our inventory at replacement cost, resulting in a benefit when selling prices increase as we sell through this lower cost inventory. During the three months ended September 30, 2021, our LIFO reserve reverted back to a more typical credit balance due to recent, significant inflation in acquisition costs; as a result, we anticipate a diminishing benefit moving forward from the final sell through of inventory valued at older, lower replacement cost. The increase in gross profit as a percentage of sales for the nine months ended September 30, 2021, was due to the benefit from the sell through of inventory purchased before acquisition cost and selling price increases.
Selling, general and administrative expenses:
Selling, general and administrative expenses (“SG&A”) for the three months ended September 30, 2021, increased 11% to $1.06 billion (or 30.6% of sales) from $955 million (or 29.8% of sales) for the same period one year ago. SG&A for the nine months ended September 30, 2021, increased 12% to $3.04 billion (or 30.3% of sales) from $2.73 billion (or 31.1% of sales) for the same period one year ago. The increase in total SG&A dollars for the three months ended September 30, 2021, was the result of additional Team Members, facilities and vehicles to support our increased sales and store count, combined with the unsustainably low level of prior year operating expenses resulting from our cautionary approach and stringent expense control measures taken in response to the onset of the COVID-19 pandemic. The increase in total SG&A dollars for the nine months ended September 30, 2021, was the result of additional Team Members, facilities and vehicles to support our increased sales and store count, increased incentive compensation for Team Members resulting from our increased sales and the unsustainably low level of prior year second and third quarter operating expenses, partially offset by prior year incremental SG&A expenses incurred from one additional day due to Leap Day. The increase in SG&A as a percentage of sales for the three months ended September 30, 2021, was due to deleverage of store operating costs, resulting from the unsustainably low level of prior year operating expenses. The decrease in SG&A as a percentage of sales for the nine months ended September 30, 2021, was due to better leverage of first quarter store operating costs on strong comparable store sales growth, partially offset by an increase from the unsustainably low level of prior year second and third quarter store operating costs.
Operating income:
As a result of the impacts discussed above, operating income for the three months ended September 30, 2021, increased 4% to $755 million (or 21.7% of sales) from $725 million (or 22.6% of sales) for the same period one year ago. As a result of the impacts discussed
above, operating income for the nine months ended September 30, 2021, increased 19% to $2.24 billion (or 22.3% of sales) from $1.89 billion (or 21.5% of sales) for the same period one year ago.
Other income and expense:
Total other expense for the three months ended September 30, 2021, decreased 12% to $34 million (or 1.0% of sales) from $39 million (or 1.2% of sales) for the same period one year ago. Total other expense for the nine months ended September 30, 2021, decreased 13% to $104 million (or 1.0% of sales) from $119 million (or 1.4% of sales) for the same period one year ago. The decrease in total other expense for the three months ended September 30, 2021, was the result of decreased interest expense on lower average outstanding borrowings and lower average cost of borrowings, partially offset by a decrease in the value of our trading securities. The decrease in total other expense for the nine months ended September 30, 2021, was the result of decreased interest expense on lower average outstanding borrowings and lower average cost of borrowings.
Income taxes:
Our provision for income taxes for the three months ended September 30, 2021, increased 2% to $162 million (22.5% effective tax rate) from $159 million (23.2% effective tax rate) for the same period one year ago. Our provision for income taxes for the nine months ended September 30, 2021, increased 21% to $492 million (23.0% effective tax rate) from $407 million (23.0% effective tax rate) for the same period one year ago. The increase in our provision for income taxes for the three months ended September 30, 2021, was the result of higher taxable income, partially offset by higher excess tax benefits from share-based compensation. The increase in our provision for income taxes from the nine months ended September 30, 2021, was the result of higher taxable income and a benefit in the prior year from renewable energy investment tax credits, partially offset by higher excess tax benefits from share-based compensation in the current period. The decrease in our effective tax rate for the three months ended September 30, 2021, was the result of higher excess tax benefits from share-based compensation.
Net income:
As a result of the impacts discussed above, net income for the three months ended September 30, 2021, increased 6% to $559 million (or 16.1% of sales) from $527 million (or 16.4% of sales) for the same period one year ago. As a result of the impacts discussed above, net income for the nine months ended September 30, 2021, increased 21% to $1.65 billion (or 16.4% of sales) from $1.36 billion (or 15.5% of sales) for the same period one year ago.
Earnings per share:
Our diluted earnings per common share for the three months ended September 30, 2021, increased 14% to $8.07 on 69 million shares from $7.07 on 75 million shares for the same period one year ago. Our diluted earnings per common share for the nine months ended September 30, 2021, increased 29% to $23.45 on 70 million shares from $18.12 on 75 million shares for the same period one year ago.
LIQUIDITY AND CAPITAL RESOURCES
Our long-term business strategy requires capital to open new stores, fund strategic acquisitions, expand distribution infrastructure, operate and maintain existing stores and may include the opportunistic repurchase of shares of our common stock through our Board-approved share repurchase program. The primary sources of our liquidity are funds generated from operations and borrowed under our unsecured revolving credit facility. Decreased demand for our products or changes in customer buying patterns could negatively impact our ability to generate funds from operations. Additionally, decreased demand or changes in buying patterns could impact our ability to meet the debt covenants of our credit agreement and, therefore, negatively impact the funds available under our unsecured revolving credit facility. We believe that cash expected to be provided by operating activities and availability under our unsecured revolving credit facility will be sufficient to fund both our short-term and long-term capital and liquidity needs for the foreseeable future. However, there can be no assurance that we will continue to generate cash flows at or above recent levels, and we are unable to predict the impact of the uncertainty and disruption caused by the COVID-19 pandemic on our ability to generate funds or maintain liquidity.
The following table identifies cash provided by/(used in) our operating, investing and financing activities for the nine months ended September 30, 2021 and 2020 (in thousands):
| | | | | | | |
|---|---|---|---|---|---|---|
| | | For the Nine Months Ended | ||||
| | | September 30, | ||||
| Liquidity: | 2021 | 2020 | ||||
| Total cash provided by/(used in): | | | ||||
| Operating activities | | $ | 2,565,327 | | $ | 2,349,129 |
| Investing activities | | (337,736) | | (447,339) | ||
| Financing activities | | (2,243,517) | | (314,343) | ||
| Effect of exchange rate changes on cash | | | (412) | | | (755) |
| Net (decrease) increase in cash and cash equivalents | | $ | (16,338) | | $ | 1,586,692 |
| | | | | | | |
| Capital expenditures | | $ | 340,687 | | $ | 363,425 |
| Free cash flow (1) | | | 2,193,889 | | | 1,875,626 |
| (1) | Calculated as net cash provided by operating activities, less capital expenditures and excess tax benefit from share-based compensation payments, and investment in tax credit equity investments for the period. |
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Operating activities:
The increase in net cash provided by operating activities during the nine months ended September 30, 2021, compared to the same period in 2020, was primarily due to an increase in net income, partially offset by a smaller increase in accrued benefits and withholdings. The smaller increase in accrued benefits and withholdings in the current period, as compared the same period in the prior year, was due to the ability to defer certain payroll tax payments in the prior year under the provisions of the Coronavirus Aid, Relief, and Economic Security Act.
Investing activities:
The decrease in net cash used in investing activities during the nine months ended September 30, 2021, compared to the same period in 2020, was the result of a decrease in investments in renewable energy tax credit investment funds and a decrease in capital expenditures. The decrease in investments in renewable energy tax credit funds was the result of the timing of tax credit equity investments in the current period, as compared to the same period in the prior year. The Company has entered into an agreement to make additional tax credit equity investments in the current year; however, the timing of such investments is variable and outside of the Company’s control. The decrease in capital expenditures was primarily due to a lower level of distribution expansion projects, vehicle fleet upgrade and store technology projects in the current period, as compared to the same period in the prior year.
Financing activities:
The increase in net cash used in financing activities during the nine months ended September 30, 2021, compared to the same period in 2020, was attributable to the prior year benefit provided by the issuance of $1.0 billion aggregate principle amount of senior notes and the current year redemption of $300 million aggregate principal amount of senior notes, partially offset by net repayments on our revolving credit facility in the prior year, and higher repurchases of our common stock during the current period, as compared to the same period in the prior year.
Unsecured revolving credit facility:
On June 15, 2021, the Company entered into a new credit agreement (the “Credit Agreement”). The Credit Agreement provides for a five-year $1.8 billion unsecured revolving credit facility (the “Revolving Credit Facility”) arranged by JPMorgan Chase Bank, N.A., which is scheduled to mature in June of 2026. The Credit Agreement includes a $200 million sub-limit for the issuance of letters of credit and a $75 million sub-limit for swing line borrowings. As described in the Credit Agreement governing the Revolving Credit Facility, the Company may, from time to time, subject to certain conditions, increase the aggregate commitments under the Revolving Credit Facility by up to $900 million, provided that the aggregate amount of the commitments does not exceed $2.7 billion at any time.
In conjunction with the closing of the Credit Agreement, the Company’s previous credit agreement, which was originally entered into on April 5, 2017, was terminated (the “Terminated Credit Agreement”), and all outstanding loans and commitments under the Terminated Credit Agreement were terminated and replaced by the loans and commitments under the Credit Agreement.
As of September 30, 2021, we had outstanding letters of credit, primarily to support obligations related to workers’ compensation, general liability and other insurance policies, in the amount of $84.0 million, reducing the aggregate availability under the Credit Agreement by that amount. As of September 30, 2021, we did not have any outstanding borrowings under our Revolving Credit Facility.
Senior Notes:
On June 15, 2021, we redeemed our $300 million aggregate principal amount of unsecured 4.625% Senior Notes due 2021 at a redemption price of $300 million, plus accrued and unpaid interest up to, but not including, the date of redemption.
As of September 30, 2021, we have issued and outstanding a cumulative $3.9 billion aggregate principal amount of unsecured senior notes, which are due between 2022 and 2031, with UMB Bank, N.A. and U.S. Bank as trustees. Interest on the senior notes, ranging from 1.750% to 4.350%, is payable semi-annually and is computed on the basis of a 360-day year. None of our subsidiaries is a guarantor under our senior notes.
Debt covenants:
The indentures governing our senior notes contain covenants that limit our ability and the ability of certain of our subsidiaries to, among other things, create certain liens on assets to secure certain debt and enter into certain sale and leaseback transactions, and limit our ability to merge or consolidate with another company or transfer all or substantially all of our property, in each case as set forth in the indentures. These covenants are, however, subject to a number of important limitations and exceptions. As of September 30, 2021, we were in compliance with the covenants applicable to our senior notes.
The Credit Agreement contains certain covenants, including limitations on indebtedness, a minimum consolidated fixed charge coverage ratio of 2.50:1.00 and a maximum consolidated leverage ratio of 3.50:1.00. The consolidated fixed charge coverage ratio includes a calculation of earnings before interest, taxes, depreciation, amortization, rent and non-cash share-based compensation expense to fixed charges. Fixed charges include interest expense, capitalized interest and rent expense. The consolidated leverage ratio includes a calculation of adjusted debt to earnings before interest, taxes, depreciation, amortization, rent and non-cash share-based compensation expense. Adjusted debt includes outstanding debt, outstanding stand-by letters of credit and similar instruments, five-times rent expense and excludes any premium or discount recorded in conjunction with the issuance of long-term debt. In the event that we should default on any covenant contained within the Credit Agreement, certain actions may be taken, including, but not limited to, possible termination of commitments, immediate payment of outstanding principal amounts plus accrued interest and other amounts payable under the Credit Agreement and litigation from our lenders.
We had a consolidated fixed charge coverage ratio of 6.68 times and 5.80 times as of September 30, 2021 and 2020, respectively, and a consolidated leverage ratio of 1.65 times and 2.15 times as of September 30, 2021 and 2020, respectively, remaining in compliance with all covenants related to the borrowing arrangements.
The table below outlines the calculations of the consolidated fixed charge coverage ratio and consolidated leverage ratio covenants, as defined in the Credit Agreement governing the Revolving Credit Facility, for the twelve months ended September 30, 2021 and 2020 (dollars in thousands):
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|---|---|---|---|---|---|---|---|
| | | | For the Twelve Months Ended | ||||
| | | | September 30, | ||||
| | | 2021 | 2020 | ||||
| GAAP net income | | $ | 2,038,657 | | $ | 1,684,273 | |
| Add: | Interest expense | | 148,385 | | 158,065 | ||
| | Rent expense (1) | | 367,676 | | 348,926 | ||
| | Provision for income taxes | | 598,962 | | 491,516 | ||
| | Depreciation expense | | 311,594 | | 297,512 | ||
| | Amortization expense | | 9,185 | | 4,491 | ||
| | Non-cash share-based compensation | | 24,229 | | 22,405 | ||
| Non-GAAP EBITDAR | | $ | 3,498,688 | | $ | 3,007,188 | |
| | | | | | | | |
| | Interest expense | | $ | 148,385 | | $ | 158,065 |
| | Capitalized interest | | 7,671 | | 11,348 | ||
| | Rent expense (1) | | 367,676 | | 348,926 | ||
| Total fixed charges | | $ | 523,732 | | $ | 518,339 | |
| | | | | | | | |
| Consolidated fixed charge coverage ratio | | 6.68 | | 5.80 | |||
| | | | | | | | |
| GAAP debt | | $ | 3,826,073 | | $ | 4,622,207 | |
| Add: | Stand-by letters of credit | | 83,985 | | 66,527 | ||
| | Discount on senior notes | | 4,531 | | 5,352 | ||
| | Debt issuance costs | | 19,396 | | 22,441 | ||
| | Five-times rent expense | | 1,838,380 | | 1,744,630 | ||
| Non-GAAP adjusted debt | | $ | 5,772,365 | | $ | 6,461,157 | |
| | | | | | | | |
| Consolidated leverage ratio | | 1.65 | | 2.15 |
| (1) | The table below outlines the calculation of Rent expense and reconciles Rent expense to Total lease cost, per Accounting Standard Codification 842 (“ASC 842”) the most directly comparable GAAP financial measure, for the twelve months ended September 30, 2021 and 2020 (in thousands): |
|---|
| | | | | |
|---|---|---|---|---|
| Total lease cost, per ASC 842, for the twelve months ended September 30, 2021 | $ | 438,205 | ||
| Less: | Variable non-contract operating lease components, related to property taxes and insurance, for the twelve months ended September 30, 2021 | | 70,529 | |
| Rent expense for the twelve months ended September 30, 2021 | | $ | 367,676 | |
| | | | | |
| Total lease cost, per ASC 842, for the twelve months ended September 30, 2020 | | $ | 413,314 | |
| Less: | Variable non-contract operating lease components, related to property taxes and insurance, for the twelve months ended September 30, 2020 | | | 64,388 |
| Rent expense for the twelve months ended September 30, 2020 | | $ | 348,926 |
The table below outlines the calculation of Free cash flow and reconciles Free cash flow to Net cash provided by operating activities, the most directly comparable GAAP financial measure, for the nine months ended September 30, 2021 and 2020 (in thousands):
| | | | | | | | |
|---|---|---|---|---|---|---|---|
| | | | For the Nine Months Ended | ||||
| | | | September 30, | ||||
| | | 2021 | 2020 | ||||
| Cash provided by operating activities | | $ | 2,565,327 | | $ | 2,349,129 | |
| Less: | Capital expenditures | | 340,687 | | 363,425 | ||
| | Excess tax benefit from share-based compensation payments | | 28,956 | | 14,786 | ||
| | Investment in tax credit equity investments | | 1,795 | | 95,292 | ||
| Free cash flow | | $ | 2,193,889 | | $ | 1,875,626 |
Free cash flow, the consolidated fixed charge coverage ratio and the consolidated leverage ratio discussed and presented in the tables above are not derived in accordance with United States generally accepted accounting principles (“GAAP”). We do not, nor do we suggest investors should, consider such non-GAAP financial measures in isolation from, or as a substitute for, GAAP financial information. We believe that the presentation of our free cash flow, consolidated fixed charge coverage ratio and consolidated leverage
ratio provides meaningful supplemental information to both management and investors and reflects the required covenants under the Credit Agreement. We include these items in judging our performance and believe this non-GAAP information is useful to investors as well. Material limitations of these non-GAAP measures are that such measures do not reflect actual GAAP amounts. We compensate for such limitations by presenting, in the tables above, a reconciliation to the most directly comparable GAAP measures.
Share repurchase program:
In January of 2011, our Board of Directors approved a share repurchase program. Under the program, we may, from time to time, repurchase shares of our common stock, solely through open market purchases effected through a broker dealer at prevailing market prices, based on a variety of factors such as price, corporate trading policy requirements and overall market conditions. Our Board of Directors may increase or otherwise modify, renew, suspend or terminate the share repurchase program at any time, without prior notice. As announced on February 10, 2021, and May 27, 2021, our Board of Directors each time approved a resolution to increase the authorization amount under our share repurchase program by an additional $1.0 billion and $1.5 billion, respectively, resulting in a cumulative authorization amount of $17.3 billion. The additional authorizations are effective for a three-year period, beginning on their respective announcement dates.
The following table identifies shares of our common stock that have been repurchased as part of our publicly announced share repurchase program for the three and nine months ended September 30, 2021 and 2020 (in thousands, except per share data):
| | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | For the Three Months Ended | | For the Nine Months Ended | ||||||||
| | | September 30, | | September 30, | ||||||||
| | 2021 | 2020 | 2021 | 2020 | ||||||||
| Shares repurchased | | 1,583 | | 965 | | 3,801 | | 2,634 | ||||
| Average price per share | | $ | 595.96 | | $ | 458.70 | | $ | 528.09 | | $ | 415.28 |
| Total investment | | $ | 942,955 | | $ | 442,962 | | $ | 2,007,122 | | $ | 1,093,973 |
As of September 30, 2021, we had $974.4 million remaining under our share repurchase authorization. Subsequent to the end of the third quarter and through November 8, 2021, we repurchased 0.4 million additional shares of our common stock under our share repurchase program, at an average price of $618.44, for a total investment of $246.9 million. We have repurchased a total of 85.2 million shares of our common stock under our share repurchase program since the inception of the program in January of 2011 and through November 8, 2021, at an average price of $193.88, for a total aggregate investment of $16.5 billion.
CONTRACTUAL OBLIGATIONS
There have been no material changes to the contractual obligations, to which we are committed, since those discussed in our Annual Report on Form 10-K for the year ended December 31, 2020.
CRITICAL ACCOUNTING ESTIMATES
The preparation of our financial statements in accordance with GAAP requires the application of certain estimates and judgments by management. Management bases its assumptions, estimates, and adjustments on historical experience, current trends and other factors believed to be relevant at the time the condensed consolidated financial statements are prepared. There have been no material changes in the critical accounting estimates since those discussed in our Annual Report on Form 10-K for the year ended December 31, 2020.
INFLATION AND SEASONALITY
We have been successful, in many cases, in reducing the effects of merchandise cost increases principally by taking advantage of supplier incentive programs, economies of scale resulting from increased volume of purchases and selective forward buying. To the extent our acquisition costs increased due to base commodity price increases or other input cost increases affecting the entire industry, we have typically been able to pass along these increased costs through higher retail prices for the affected products. As a result, we do not believe inflation has had a material adverse effect on our operations.
To some extent, our business is seasonal, primarily as a result of the impact of weather conditions on customer buying patterns. While we have historically realized operating profits in each quarter of the year, our store sales and profits have historically been higher in the second and third quarters (April through September) than in the first and fourth quarters (October through March) of the year.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 14 “Recent Accounting Pronouncements” to the Condensed Consolidated Financial Statements for information about recent accounting pronouncements.
INTERNET ADDRESS AND ACCESS TO SEC FILINGS
Our Internet address is www.OReillyAuto.com. Interested readers can access, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, through the Securities and Exchange Commission’s (“SEC”) website at www.sec.gov and searching with our ticker symbol “ORLY.” Such reports are generally available the day they are filed. Upon request, we will furnish interested readers a paper copy of such reports free of charge. The information on our website is not part of this report and is not incorporated by reference into this report or any of the Company’s other filings with the SEC.
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