O REILLY AUTOMOTIVE INC
Item 1. Business
GENERAL INFORMATION
O’Reilly Automotive, Inc. and its subsidiaries, collectively “we,” “us,” “our,” the “Company,” or “O’Reilly,” is one of the largest specialty retailers of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States, selling our products to both do-it-yourself (“DIY”) and professional service provider customers, our “dual market strategy.” The business was founded in 1957 by Charles F. O’Reilly and his son, Charles H. “Chub’’ O’Reilly, Sr., and initially operated from a single store in Springfield, Missouri. Our common stock has traded on The NASDAQ Global Select Market under the symbol “ORLY” since April 22, 1993.
At December 31, 2016, we operated 4,829 stores in 47 states. Our stores carry an extensive product line, including
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new and remanufactured automotive hard parts, such as alternators, starters, fuel pumps, water pumps, brake system components, batteries, belts, hoses, temperature control, chassis parts, driveline parts and engine parts;
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maintenance items, such as oil, antifreeze, fluids, filters, wiper blades, lighting, engine additives and appearance products; and
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accessories, such as floor mats, seat covers and truck accessories.
Our stores offer many enhanced services and programs to our customers, such as
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used oil, oil filter and battery recycling;
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battery, wiper and bulb replacement;
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battery diagnostic testing;
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electrical and module testing;
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check engine light code extraction;
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loaner tool program;
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drum and rotor resurfacing;
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custom hydraulic hoses;
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professional paint shop mixing and related materials; and
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machine shops.
See the “Risk Factors” section of
Item 1A. Risk Factors
Unless otherwise indicated, “we,” “us,” “our” and similar terms, as well as references to the “Company,” refer to O’Reilly Automotive, Inc. and its subsidiaries.
Our future performance is subject to a variety of risks and uncertainties. Although the risks described below are the risks that we believe are material, there may also be risks of which we are currently unaware, or that we currently regard as immaterial based upon the information available to us that later may prove to be material. Interested parties should be aware that the occurrence of the events described in these risk factors, elsewhere in this Form 10-K and in our other filings with the Securities and Exchange Commission could
have a material adverse effect on our business, operating results and financial condition. Actual results, therefore, may materially differ from anticipated results described in our forward-looking statements.
Deteriorating economic conditions may adversely impact demand for our products, reduce access to credit and cause our customers and others, with which we do business, to suffer financial hardship, all of which could adversely impact our business, results of operations, financial condition and cash flows.
Although demand for many of our products is primarily non-discretionary in nature and tend to be purchased by consumers out of necessity, rather than on an impulse basis, our sales are impacted by constraints on the economic health of our customers. The economic health of our customers is affected by many factors, including, among others, general business conditions, interest rates, inflation, consumer debt levels, the availability of consumer credit, currency exchange rates, taxation, fuel prices, unemployment levels and other matters that influence consumer confidence and spending. Many of these factors are outside of our control. Our customers’ purchases, including purchases of our products, could decline during periods when income is lower, when prices increase in response to rising costs, or in periods of actual or perceived unfavorable economic conditions. In addition, restrictions on access to telematics, diagnostic tools and repair information imposed by the original vehicle manufacturers or by governmental regulations may force vehicle owners to rely on dealers to perform maintenance and repairs. If any of these events occur, or if unfavorable economic conditions challenge the consumer environment, our business, results of operations, financial condition and cash flows could be adversely affected.
Overall demand for products sold in the automotive aftermarket is dependent upon many factors including the total number of vehicle miles driven in the U.S., the total number of registered vehicles in the U.S., the age and quality of these registered vehicles and the level of unemployment in the U.S. Adverse changes in these factors could lead to a decreased level of demand for our products, which could negatively impact our business, results of operations, financial condition and cash flows.
In addition, economic conditions, including decreased access to credit, may result in financial difficulties leading to restructurings, bankruptcies, liquidations and other unfavorable events for our customers, suppliers, logistics and other service providers and financial institutions that are counterparties to our credit facilities. Furthermore, the ability of these third parties to overcome these difficulties may increase. If third parties, on whom we rely for merchandise, are unable to overcome difficulties resulting from the deterioration in economic conditions and provide us with the merchandise we need, or if counterparties to our credit facilities do not perform their obligations, our business, results of operations, financial condition and cash flows could be adversely affected.
The automotive aftermarket business is highly competitive, and we may have to risk our capital to remain competitive.
Both the do-it-yourself (“DIY”) and professional service provider portions of our business are highly competitive, particularly in the more densely populated areas that we serve. Some of our competitors are larger than we are and have greater financial resources. In addition, some of our competitors are smaller than we are, but have a greater presence than we do in a particular market. We may have to expend more resources and risk additional capital to remain competitive. For a list of our principal competitors, see the “Competition” section of Item 1 of this annual report on Form 10-K.
We are sensitive to regional economic and weather conditions that could impact our costs and sales.
Our business is sensitive to national and regional economic and weather conditions, and natural disasters. Unusually inclement weather, such as significant rain, snow, sleet, freezing rain, flooding, seismic activity and hurricanes, has historically discouraged our customers from visiting our stores during the affected period and reduced our sales, particularly to DIY customers. Extreme weather conditions, such as extreme heat and extreme cold temperatures, may enhance demand for our products due to increased failure rates of our customers’ automotive parts, while temperate weather conditions may have a lesser impact on failure rates of automotive parts. In addition, our stores and distribution centers (“DCs”) located in coastal regions may be subject to increased insurance claims resulting from regional weather conditions and our results of operations, financial condition and cash flows could be adversely affected.
We cannot assure future growth will be achieved.
We believe that our ability to open additional, profitable stores at a high growth rate will be a significant factor in achieving our growth objectives for the future. Our ability to accomplish our growth objectives is dependent, in part, on matters beyond our control, such as weather conditions, zoning, and other issues related to new store site development, the availability of qualified management personnel and general business and economic conditions. We cannot be sure that our growth plans for 2017 and beyond will be achieved. Failure to achieve our growth objectives may negatively impact the trading price of our common stock. For a discussion of our growth strategies, see the “Growth Strategy” section of Item 1 of this annual report on Form 10-K.
In order to be successful, we will need to retain and motivate key employees.
Our success has been largely dependent on the efforts of certain key personnel. In order to be successful, we will need to retain and motivate executives and other key employees. Experienced management and technical personnel are in high demand and competition for their talents is intense. We must also continue to motivate employees and keep them focused on our strategies and goals. Our business, results of operations and cash flows could be materially adversely affected by the unexpected loss of the services of one or more of our key employees. We cannot be sure that we will be able to continue to attract qualified personnel, which could cause us to be less efficient
and, as a result, may adversely impact our sales and profitability. For a discussion of our management, see the “Business” section of Item 1 of this annual report on Form 10-K.
A change in the relationship with any of our key suppliers, the unavailability of our key products at competitive prices or changes in trade policies could affect our financial health.
Our business depends on developing and maintaining close relationships with our suppliers and on our suppliers’ ability or willingness to sell quality products to us at favorable prices and terms. Many factors outside of our control may harm these relationships and the ability or willingness of these suppliers to sell us products on favorable terms. For example, financial or operational difficulties that our suppliers may face could increase the cost of the products we purchase from them or our ability to source product from them. In addition, the trend toward consolidation among automotive parts suppliers, as well as the off-shoring of manufacturing capacity to foreign countries, may disrupt or end our relationship with some suppliers and could lead to less competition and result in higher prices. We could also be negatively impacted by suppliers who might experience work stoppages, labor strikes or other interruptions to, or difficulties in the, manufacture or supply of the products we purchase from them. Changes in U.S. trade policies, practices, tariffs or taxes could affect our ability and our suppliers’ ability to source product at current volumes and/or prices.
Risks associated with future acquisitions may not lead to expected growth and could result in increased costs and inefficiencies.
We expect to continue to make acquisitions as an element of our growth strategy. Acquisitions involve certain risks that could cause our actual growth and profitability to differ from our expectations, examples of such risks include the following:
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We may not be able to continue to identify suitable acquisition targets or to acquire additional companies at favorable prices or on other favorable terms.
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Our management’s attention may be distracted.
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We may fail to retain key personnel from acquired businesses.
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We may assume unanticipated legal liabilities and other problems.
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We may not be able to successfully integrate the operations (accounting and billing functions, for example) of businesses we acquire to realize economic, operational and other benefits.
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We may fail, or be unable to, discover liabilities of businesses that we acquire for which we or the subsequent owner or operator may be liable.
Business interruptions in our distribution centers or other facilities may affect our store hours, operability of our computer systems, and/or availability and distribution of merchandise, which may affect our business.
Weather, terrorist activities, war or other disasters, or the threat of them, may result in the closure of one or more of our DCs or other facilities, or may adversely affect our ability to deliver inventory to our stores on a nightly basis. This may affect our ability to timely provide products to our customers, resulting in lost sales or a potential loss of customer loyalty. Some of our merchandise is imported from other countries and these goods could become difficult or impossible to bring into the United States, and we may not be able to obtain such merchandise from other sources at similar prices. Such a disruption in revenue could potentially have a negative impact on our results of operations, financial condition and cash flows.
We rely extensively on our computer systems to manage inventory, process transactions and timely provide products to our customers. Our systems are subject to damage or interruption from power outages, telecommunications failures, computer viruses, security breaches or other catastrophic events. If our systems are damaged or fail to function properly, we may experience loss of critical data and interruptions or delays in our ability to manage inventories or process customer transactions. Such a disruption of our systems could negatively impact revenue and potentially have a negative impact on our results of operations, financial condition and cash flows.
Failure to achieve and maintain a high level of product and service quality may reduce our brand value and negatively impact our business.
We believe our Company has built an excellent reputation as a leading retailer in the automotive aftermarket industry. We believe our continued success depends, in part, on our ability to preserve, grow and leverage the value of our brand. Brand value is based, in large part, on perceptions of subjective qualities and even isolated incidents can erode trust and confidence, particularly if they result in adverse publicity, governmental investigations or litigation, which can negatively impact these perceptions and lead to adverse effects on our business or Team Members.
Risks related to us and unanticipated fluctuations in our quarterly operating results could affect our stock price.
We believe that quarter-to-quarter comparisons of our financial results are not necessarily meaningful indicators of our future operating results and should not be relied on as an indication of future performance. If our quarterly operating results fail to meet the expectations of analysts, the trading price of our common stock could be negatively affected. We cannot be certain that our growth plans and business strategies will be successful or that they will successfully meet the expectations of these analysts. If we fail to adequately address any of these risks or difficulties, our stock price would likely suffer.
The market price of our common stock may be volatile and could expose us to securities class action litigation.
The stock market and the price of our common stock may be subject to wide fluctuations based upon general economic and market conditions. The market price of our common stock may also be affected by our ability to meet analysts’ expectations and failure to meet such expectations, even slightly, could have an adverse effect on the market price of our common stock.
In addition, stock market volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies. Downturns in the stock market may cause the price of our common stock to decline. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against such companies. If similar litigation were instituted against us, it could result in substantial costs and a diversion of our management’s attention and resources, which could have an adverse effect on our business.
Our increased debt levels could adversely affect our cash flow and prevent us from fulfilling our obligations.
We have an unsecured revolving credit facility and unsecured senior notes, which could have important consequences to our financial health. For example, our level of indebtedness could, among other things,
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make it more difficult to satisfy our financial obligations, including those relating to the senior unsecured notes and our credit facility;
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increase our vulnerability to adverse economic and industry conditions;
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limit our flexibility in planning for, or reacting to, changes and opportunities in our industry, which may place us at a competitive disadvantage;
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require us to dedicate a substantial portion of our cash flows to service the principal and interest on the debt, reducing the funds available for other business purposes, such as working capital, capital expenditures or other cash requirements;
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limit our ability to incur additional debt with acceptable terms, if at all; and
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expose us to fluctuations in interest rates.
In addition, the terms of our financing obligations include restrictions, such as affirmative, negative and financial covenants, conditions on borrowing and subsidiary guarantees. A failure to comply with these restrictions could result in a default under our financing obligations or could require us to obtain waivers from our lenders for failure to comply with these restrictions. The occurrence of a default that remains uncured or the inability to secure a necessary consent or waiver could have a material adverse effect on our business, financial condition, results of operations and cash flows.
A downgrade in our credit rating would impact our cost of capital and could impact the market value of our unsecured senior notes, as well as limit our access to attractive supplier financing programs.
Credit ratings are an important component of our cost of capital. These ratings are based upon, among other factors, our financial strength. Our current credit ratings provide us with the ability to borrow funds at favorable rates. A downgrade in our current credit rating from either rating agency could adversely affect our cost of capital by causing us to pay a higher interest rate on borrowed funds under our unsecured revolving credit facility and a higher facility fee on commitments under our unsecured revolving credit facility. A downgrade in our current credit rating could also adversely affect the market price and/or liquidity of our unsecured senior notes, preventing a holder from selling the unsecured senior notes at a favorable price, as well as adversely affect our ability to issue new notes in the future. In addition, a downgrade in our current credit rating could limit the financial institutions willing to commit funds to our supplier financing programs at attractive rates. Decreased participation in our supplier financing programs would lead to an increase in working capital needed to operate the business, adversely affecting our cash flows.
A breach of customer, Team Member or Company information could damage our reputation or result in substantial additional costs or possible litigation.
Our business involves the storage of personal information about our customers and Team Members. We have taken reasonable and appropriate steps to protect this information; however, if we experience a significant data security breach, we could be exposed to damage to our reputation, additional costs, lost sales or possible regulatory action. The regulatory environment related to information security and privacy is constantly evolving, and compliance with those requirements could result in additional costs. There is no guarantee that the procedures that we have implemented to protect against unauthorized access to secured data are adequate to safeguard against all data security breaches, and such a breach could potentially have a negative impact on our results of operations, financial condition and cash flows.
Litigation, governmental proceedings, environmental legislation and regulations, employment legislation and regulations and healthcare reform legislation may affect our business, financial condition, results of operations and cash flows.
We are, and in the future may become, involved in lawsuits, regulatory inquiries, and governmental and other legal proceedings, arising out of the ordinary course of our business. The damages sought against us in some of these litigation proceedings may be material and may adversely affect our business, results of operations, financial condition and cash flows.
Environmental legislation and regulations, like the initiatives to limit greenhouse gas emissions and bills related to climate change, could adversely impact all industries. While it is uncertain whether these initiatives will become law, additional climate change related mandates could potentially be forthcoming and these matters, if enacted, could adversely impact our costs, by, among other things, increasing fuel prices.
Our business is subject to employment legislation and regulations, including requirements related to minimum wage. Our success depends, in part, on our ability to manage operating costs and identify opportunities to reduce costs. Our ability to meet labor needs, while controlling costs is subject to external factors, such as minimum wage legislation. A violation of, or change in, employment legislation and/or regulations could hinder our ability to control costs, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.
The enacted Patient Protection and Affordable Care Act, as well as other healthcare reform legislation considered by Congress and state legislatures, significantly impacts our healthcare cost structure and increases our healthcare-related expenses. We continue to evaluate potential additional impacts the healthcare reform legislation will have on our business and the steps necessary to mitigate such impacts. If we cannot effectively mitigate the potential additional impacts of the healthcare reform legislation, our results of operations, financial condition and cash flows may be adversely impacted.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Unless otherwise indicated, “we,” “us,” “our” and similar terms, as well as references to the “Company,” refer to O’Reilly Automotive, Inc. and its subsidiaries.
Distribution centers, stores, and other properties
As of December 31, 2016, we operated 27 regional distribution centers (“DC”s), of which eight were leased (2.8 million operating square footage) and 19 were owned (7.8 million operating square footage) for total DC operating square footage of 10.6 million square feet. The following table provides information regarding our DCs, returns facility and corporate offices as of December 31, 2016:
(1)
Includes floor and mezzanine operating square footage, excludes subleased square footage.
The leased distribution facilities typically require a fixed base rent, payment of certain tax, insurance and maintenance expenses and have an original term of, at a minimum, 20 years, subject to one five-year renewal at our option.
Of the 4,829 stores that we operated at December 31, 2016, 1,912 stores were owned, 2,842 stores were leased from unaffiliated parties and 75 stores were leased from entities, in which certain of our affiliated directors, or members of our affiliated director’s immediate family, and an executive officer of the Company are affiliated. Leases with unaffiliated parties generally provide for payment of a fixed base rent, payment of certain tax, insurance and maintenance expenses and an original term of, at a minimum, 10 years, subject to one or more renewals at our option. We have entered into separate master lease agreements with each of the affiliated entities for the occupancy of the stores covered thereby. Such master lease agreements with six of the seven affiliated entities have been modified to extend the term of the lease agreement for specific stores. The master lease agreements or modifications thereto expire on dates ranging from March 31, 2018, to September 30, 2031. We believe that the lease agreements with the affiliated entities are on terms comparable to those obtainable from third parties.
We believe that our present facilities are in good condition, are adequately insured and are adequate for the conduct of our current operations. The store servicing capability of our 27 existing DCs is approximately 5,500 stores, providing a growth capacity of more than 650 stores. We believe the growth capacity in our 27 existing DCs will provide us with the DC infrastructure needed for near-term expansion. However, as we expand our geographic footprint, we will continue to evaluate our existing distribution system infrastructure and will adjust our distribution system capacity as needed to support our future growth.
Item 3. Legal Proceedings
O’Reilly Automotive, Inc. and its subsidiaries (the “Company” or “O’Reilly”) is currently involved in litigation incidental to the ordinary conduct of the Company’s business. The Company records reserves for litigation losses in instances where a material adverse outcome is probable and the Company is able to reasonably estimate the probable loss. The Company reserves for an estimate of material legal costs to be incurred in pending litigation matters. Although the Company cannot ascertain the amount of liability that it may incur from any of these matters, it does not currently believe that, in the aggregate, these matters, taking into account applicable insurance and reserves, will have a material adverse effect on its consolidated financial position, results of operations or cash flows in a particular quarter or annual period.
As previously reported, the Company received a subpoena from the District Attorney of the County of Alameda, along with other environmental prosecutorial offices in the state of California, seeking documents and information related to the handling, storage and disposal of hazardous waste. On November 30, 2016, the Company through its affiliates, entered into a Stipulation for Entry of Final Judgment and Permanent Injunction, including certain injunctive and monetary relief within the previously established accruals.
As previously reported, on June 18, 2015, a jury in Greene County, Missouri returned an unfavorable verdict in a litigated contract dispute in the matter Meridian Creative Alliance vs. O’Reilly Automotive Stores, Inc. et. al. in the amount of $12.5 million. The Company has vigorously challenged the verdict in the Court of Appeals. Following the matter being fully briefed by the parties, oral argument was held in the Court of Appeals on January 12, 2017. The Court currently has the matter under consideration. As of December 31, 2016, the Company had reserved $18.6 million with respect to this matter.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common stock:
Shares of O’Reilly Automotive, Inc. (the “Company”) common stock are traded on The NASDAQ Global Select Market (“Nasdaq”) under the symbol “ORLY.” The Company’s common stock began trading on April 22, 1993; no cash dividends have been declared since that time, and the Company does not anticipate paying any cash dividends in the foreseeable future.
As of February 21, 2017, the Company had approximately 238,000 shareholders of common stock based on the number of holders of record and an estimate of individual participants represented by security position listings.
The prices in the following table represent the high and low sales price for the Company’s common stock as reported by Nasdaq:
Sales of unregistered securities:
There were no sales of unregistered securities during the year ended December 31, 2016.
Issuer purchases of equity securities:
The following table identifies all repurchases during the fourth quarter ended December 31, 2016, of any of the Company’s securities registered under Section 12 of the Securities Exchange Act of 1934, as amended, by or on behalf of the Company or any affiliated purchaser (in thousands, except per share data):
(1)
Under the Company’s share repurchase program, as approved by its Board of Directors on January 11, 2011, the Company may, from time to time, repurchase shares of its 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 not to exceed a dollar limit authorized by the Board of Directors. The Company’s 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, 2016, May 27, 2016, and November 16, 2016, the Company’s Board of Directors each time approved a resolution to increase the authorization amount under the share repurchase program by an additional $750 million, resulting in a cumulative authorization amount of $7.8 billion. Each additional authorization is effective for a three-year period, beginning on its respective announcement date. The authorization under the share repurchase program that currently has capacity is scheduled to expire on November 16, 2019. No other share repurchase programs existed during the twelve months ended December 31, 2016.
The Company repurchased a total of 5.7 million shares of its common stock under its publicly announced share repurchase program during the year ended December 31, 2016, at an average price per share of $264.21, for a total investment of $1.5 billion. Subsequent to the end of the year and through February 28, 2017, the Company repurchased an additional 1.4 million shares of its common stock, at an average price per share of $267.32, for a total investment of $387.5 million. The Company has repurchased a total of 58.4 million shares of its common stock under its share repurchase program since the inception of the program in January of 2011 and through February 28, 2017, at an average price of $124.14, for a total aggregate investment of $7.2 billion.
Stock performance graph:
The graph below shows the cumulative total shareholder return assuming the investment of $100, on December 31, 2011, and the reinvestment of dividends thereafter, if any, in the Company’s common stock versus the Standard and Poor’s S&P 500 Retail Index (“S&P 500 Retail Index”) and the Standard and Poor’s S&P 500 Index (“S&P 500”).
Item 6. Selected Financial Data
The table below compares O’Reilly Automotive, Inc.’s (the “Company”) selected financial data over a ten-year period.
(a)
In 2008, 2012, and 2016, the Company acquired CSK Auto Corporation (“CSK”), VIP Parts, Tires & Service (“VIP”), and Bond Auto Parts (“Bond”), respectively. The 2008 CSK acquisition added 1,342 stores, the 2012 VIP acquisition added 56 stores, and the 2016 Bond acquisition added 48 stores to the O’Reilly store count. Financial results for these acquired companies have been included in the Company’s consolidated financial statements from the dates of the acquisitions forward.
(b)
Total square footage includes normal selling, office, stockroom and receiving space.
(c)
Sales per weighted-average store are weighted to consider the approximate dates of store openings, acquisitions or closures.
(d)
Sales per weighted-average square foot are weighted to consider the approximate dates of store openings, acquisitions, expansions or closures.
(e)
Comparable store sales are calculated based on the change in sales of stores open at least one year and excludes sales of specialty machinery, sales to independent parts stores, sales to Team Members, sales from Leap Day during the years ended December 31, 2016, 2012 and 2008, and sales during the one to two week period certain CSK branded stores were closed for conversion.
(f)
Comparable store sales for 2008 include sales for stores acquired in the CSK acquisition. Comparable store sales for stores operating on O’Reilly systems open at least one year increased 2.4% for the year ended December 31, 2008. Comparable store sales for stores operating on the legacy CSK system open at least one year decreased 1.7% for the portion of CSK’s sales in 2008 since the July 11, 2008, acquisition.
(g)
Certain prior period amounts have been reclassified to conform to current period presentation, due to the Company’s adoption of new accounting standards during the fourth quarter ended December 31, 2015. See Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements of the annual report on Form 10-K for the year ended December 31, 2015.
(h)
Inventory turnover is calculated as cost of goods sold for the last 12 months divided by average inventory. Average inventory is calculated as the average of inventory for the trailing four quarters used in determining the denominator.
(i)
Accounts payable to inventory is calculated as accounts payable divided by inventory.
(j)
Free cash flow is calculated as net cash provided by operating activities less capital expenditures for the period.
Item 7. 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
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an overview of the key drivers of the automotive aftermarket industry;
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key events and recent developments within our company;
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our results of operations for the years ended December 31, 2016, 2015 and 2014;
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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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any off-balance sheet arrangements we utilize;
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our critical accounting estimates;
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the inflation and seasonality of our business;
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our quarterly results for the years ended December 31, 2016, and 2015; and
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recent accounting pronouncements that may affect our Company.
The review of Management’s Discussion and Analysis should be made in conjunction with our consolidated financial statements, related notes and other financial information, forward-looking statements and other risk factors included elsewhere in this annual 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 annual 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 economy in general, inflation, product demand, the market for auto parts, competition, weather, risks associated with the performance of acquired businesses, our ability to hire and retain qualified employees, consumer debt levels, our increased debt levels, credit ratings on public debt, governmental regulations, terrorist activities, war and the threat of war. Actual results may materially differ from anticipated results described or implied in these forward-looking statements. Please refer to the “Risk Factors” section of this annual report on Form 10-K for the year ended December 31, 2016, 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.
OVERVIEW
We are a specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States. We are one of the largest U.S. automotive aftermarket specialty retailers, selling our products to both do-it-yourself (“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 margin dollars are 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. 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 December 31, 2016, we operated 4,829 stores in 47 states.
Operating within the retail industry, we are influenced by a number of general macroeconomic factors including, but not limited to, fuel costs, unemployment rates, consumer preferences and spending habits, and competition. We have ongoing initiatives aimed at tailoring our product offering to adjust to customers’ changing preferences, and we also have 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.
We believe the key drivers of current and future demand of 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, average vehicle age and unemployment.
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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 3 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 Department of Transportation, the number of total miles driven in the U.S. increased 2.8%, 3.5% and 1.7% in 2016, 2015 and 2014, respectively, and we expect to continue to see modest improvements in total miles driven in the U.S., supported by an increasing number of registered vehicles on the road, resulting in continued demand for automotive aftermarket products.
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Number of U.S. Registered Vehicles, New Light Vehicle Registrations and Average Vehicle Age - 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 6% from 2005 to 2015, bringing the number of light vehicles on the road to 258 million by the end of 2015. For the year ended December 31, 2016, the seasonally adjusted annual rate of light vehicles sales in the U.S. (“SAAR”) was approximately 18.3 million, contributing to the continued growth in the total number of registered vehicles on the road. In the past decade, vehicle scrappage rates have remained relatively stable, ranging from 4.4% to 5.7% annually. As a result, over the past decade, the average age of the U.S. vehicle population has increased, growing 22%, from 9.4 years in 2005 to 11.5 years in 2015. We believe this increase in average age can be attributed to better engineered and manufactured vehicles, which can be reliably driven at higher mileages due to better quality power trains and interiors and exteriors, and the consumer’s willingness to invest in maintaining these higher-mileage, better built vehicles. As the average age of the vehicle 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.
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Unemployment - Unemployment, underemployment, the threat of future joblessness and the uncertainty surrounding the overall economic health of the U.S. have a negative impact on consumer confidence and the level of consumer discretionary spending. Long-term trends of high unemployment have historically impeded the growth of annual miles driven, as well as decrease consumer discretionary spending, both of which negatively impact demand for products sold in the automotive aftermarket industry. As of December 31, 2015, the U.S. unemployment rate was 5.0%, and as of December 31, 2016, the U.S. unemployment rate decreased to 4.7%. We believe, total employment should remain at healthy levels with marginal improvements, and we would expect to see an increase in commuter traffic with a growing work force, further aiding the positive trend of growth of total miles driven in the U.S. and 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.
KEY EVENTS AND RECENT DEVELOPMENTS
Several key events have had or may have a significant impact on our operations and are identified below:
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Under the Company’s share repurchase program, as approved by our Board of Directors in January of 2011, 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, 2016, May 27, 2016, and November 16, 2016, our Board of Directors each time approved a resolution to increase the authorization amount under our share repurchase program by an additional $750 million, resulting in a cumulative authorization amount of $7.75 billion. Each additional authorization is effective for a three-year period, beginning on its respective announcement date. As of February 28, 2017, we had repurchased approximately 58.4 million shares of our common stock at an aggregate cost of $7.25 billion under this program.
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On March 8, 2016, we issued $500 million aggregate principal amount of unsecured 3.550% Senior Notes due 2026 (“3.550% Senior Notes due 2026”) at a price to the public of 99.832% of their face value with United Missouri Bank, N.A. as trustee. Interest on the 3.550% Senior Notes due 2026 is payable on March 15 and September 15 of each year, which began with the first interest payment on September 15, 2016, and is computed on the basis of a 360-day year.
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At the close of business on December 1, 2016, we completed an asset purchase of Bond Auto Parts (“Bond”), a large, privately held automotive parts supplier operating 48 stores throughout Vermont, New Hampshire, Massachusetts and New York.
RESULTS OF OPERATIONS
The following table includes income statement data as a percentage of sales for the years ended December 31, 2016, 2015 and 2014:
(1)
Each percentage of sales amount is computed independently and may not compute to presented totals.
2016 Compared to 2015
Sales:
Sales for the year ended December 31, 2016, increased $626 million to $8.59 billion from $7.97 billion for the same period one year ago, representing an increase of 8%. Comparable store sales for stores open at least one year increased 4.8% and 7.5% for the years ended December 31, 2016 and 2015, respectively. Comparable store sales are calculated based on the change in sales of stores open at least one year and exclude sales of specialty machinery, sales to independent parts stores, sales to Team Members and sales from Leap Day during the year ended December 31, 2016.
The following table presents the components of the increase in sales for the year ended December 31, 2016 (in millions):
We believe the increased sales achieved by our stores were the result of store growth, sales from one additional day due to Leap Day for the year ended December 31, 2016, sales from the acquired 48 Bond stores, 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 in our regional distribution centers, 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.
Our comparable store sales increase for the year ended December 31, 2016, was driven by increases in average ticket values and customer transaction counts from both our DIY and professional service provider customers. The improvement in average ticket values was the result of 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. This 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. Customer transaction counts for both DIY and professional service provider customers increased for the year ended December 31, 2016, despite the added pressure from the better engineered, more technically advance vehicles requiring less frequent repairs. The increase in customer transaction counts was supported by an increase in miles driven, and the corresponding increase in vehicle maintenance, lower year-over-year gas prices and decreasing unemployment levels, creating an overall positive macroeconomic environment. The increase in our DIY customer transaction counts benefited from our continued focus on ensuring our stores are staffed with knowledgeable parts professionals to assist our DIY customers during high DIY traffic periods, such as nights and weekends. The increase in our professional service provider customer transaction counts benefited from the continued growth of our less mature markets and our better parts and service availability.
We opened 210 net, new stores and acquired 48 Bond stores during the year ended December 31, 2016, compared to opening 205 net, new stores for the year ended December 31, 2015. As of December 31, 2016, we operated 4,829 stores in 47 states compared to 4,571 stores in 44 states at December 31, 2015. We anticipate new store growth will be 190 net, new store openings in 2017, slightly below the 2016 net, new store openings, due to the resources necessary to convert the acquired 48 Bond stores to our systems, inventory selection and décor packages during 2017.
Gross profit:
Gross profit for the year ended December 31, 2016, increased to $4.51 billion (or 52.5% of sales) from $4.16 billion (or 52.3% of sales) for the same period one year ago, representing an increase of 8%. The increase in gross profit dollars for the year ended December 31, 2016, was primarily a result of the increase in comparable store sales at existing stores, sales from new stores and one additional day due to Leap Day. The increase in gross profit as a percentage of sales for the year ended December 31, 2016, was primarily due to product acquisition cost improvements, partially offset by a larger non-cash last-in, first-out (“LIFO”) impact. Product acquisition cost improvements are the result of our ongoing negotiations with our suppliers to improve our inventory purchase costs based on our increasing scale. The non-cash LIFO impact is the result of these continued product acquisition cost reductions, and due to these reductions, we fully depleted our LIFO reserve in 2013. Our policy is to not write up inventory in excess of replacement cost, and accordingly, we are effectively valuing our inventory at replacement cost. During the years ended December 31, 2016 and 2015, our LIFO costs were written down by approximately $49 million and $28 million, respectively, to reflect replacement cost.
Selling, general and administrative expenses:
Selling, general and administrative expenses (“SG&A”) for the year ended December 31, 2016, increased to $2.81 billion (or 32.7% of sales) from $2.65 billion (or 33.2% of sales) for the same period one year ago, representing an increase of 6%. The increase in total SG&A dollars for the year ended December 31, 2016, was primarily the result of additional Team Members, facilities and vehicles to support our increased sales and store count and one additional day due to Leap Day. The decrease in SG&A as a percentage of sales for the year ended December 31, 2016, was primarily the result of increased leverage of store occupancy costs on comparable store sales growth and a $19 million litigation loss charge in the prior year, resulting from an adverse verdict in a contract dispute with a former service provider.
Operating income:
As a result of the impacts discussed above, operating income for the year ended December 31, 2016, increased to $1.70 billion (or 19.8% of sales) from $1.51 billion (or 19.0% of sales) for the same period one year ago, representing an increase of 12%.
Other income and expense:
Total other expense for the year ended December 31, 2016, increased to $62 million (or 0.7% of sales), from $54 million (or 0.7% of sales) for the same period one year ago, representing an increase of 16%. The increase in total other expense for the year ended December 31, 2016, was primarily the result of increased interest expense on higher average outstanding borrowings and increased amortization of debt issuance costs, partially offset by an increase in the value of our trading securities. For additional information concerning our trading securities, see Notes to Consolidated Financial Statements in this annual report on Form 10-K.
Income taxes:
Our provision for income taxes for the year ended December 31, 2016, increased to $600 million (36.6% effective tax rate) from $529 million (36.2% effective tax rate) for the same period one year ago, representing an increase of 13%. The increase in our provision for income taxes for the year ended December 31, 2016, was the result of higher taxable income in 2016, primarily driven by our strong operating results, and higher effective tax rates. The increase in our effective tax rate for the year ended December 31, 2016, was primarily
due to a larger amount of favorable resolutions of historical tax matters in 2015, compared to 2016, and a smaller benefit in 2016 from the realization of employment tax credits.
Net income:
As a result of the impacts discussed above, net income for the year ended December 31, 2016, increased to $1.04 billion (or 12.1% of sales), from $931 million (or 11.7% of sales) for the same period one year ago, representing an increase of 11%.
Earnings per share:
Our diluted earnings per common share for the year ended December 31, 2016, increased 17% to $10.73 on 97 million shares from $9.17 on 102 million shares for the same period one year ago.
2015 Compared to 2014
Sales:
Sales for the year ended December 31, 2015, increased $751 million to $7.97 billion from $7.22 billion for the same period one year prior, representing an increase of 10%. Comparable store sales for stores open at least one year increased 7.5% and 6.0% for the years ended December 31, 2015 and 2014, respectively. Comparable store sales were calculated based on the change in sales of stores open at least one year and exclude sales of specialty machinery, sales to independent parts stores and sales to Team Members.
The following table presents the components of the increase in sales for the year ended December 31, 2015 (in millions):
We believe the increased sales achieved by our stores were the result of store growth, and 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 in our regional distribution centers, 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 focus on serving both DIY and professional service provider customers.
Our comparable store sales increase for the year ended December 31, 2015, was driven by increases in average ticket values and customer transaction counts for both our DIY and professional service provider customers. The improvement in average ticket values was the result of the increasing complexity and cost of replacement parts necessary to maintain the current population of better engineered and more technically advanced vehicles, and this improvement was without the benefit of an increase in the selling price of like kind items. These better engineered vehicles require less frequent repairs, as the component parts are more durable and last for longer periods of time, which does create pressure on customer transaction counts; however, when repairs are required, the cost of replacement parts is, on average, greater. Despite pressure from these better engineered vehicles requiring less frequent repairs, customer transaction counts increased for both our DIY and professional service provider customers for the year ended December 31, 2015. These increases in transaction counts were driven by an increase in miles driven and a corresponding increase in vehicle maintenance, which was led by lower gas prices and decreasing unemployment levels. These factors created a positive macroeconomic environment, which was beneficial to both DIY and professional service provider customer transaction counts. In addition, the increase in our DIY transaction counts benefited from our continued focus on staffing our stores with knowledgeable parts professionals to assist our DIY customers during high DIY traffic periods, including nights and weekends, and the increase in our professional service provider customer transaction counts benefited from the continued growth of our less mature stores.
We opened 205 net, new stores during the year ended December 31, 2015, compared to 200 net, new stores for the year ended December 31, 2014. As of December 31, 2015, we operated 4,571 stores in 44 states compared to 4,366 stores in 43 states at December 31, 2014.
Gross profit:
Gross profit for the year ended December 31, 2015, increased to $4.16 billion (or 52.3% of sales) from $3.71 billion (or 51.4% of sales) for the same period one year prior, representing an increase of 12%. The increase in gross profit dollars for the year ended December 31, 2015, was primarily a result of the increase in comparable store sales at existing stores and sales from new stores. The increase in gross profit as a percentage of sales for the year ended December 31, 2015, was primarily due to product acquisition cost improvements, a smaller non-cash negative LIFO impact and distribution system efficiencies. Acquisition cost improvements are the result of our ongoing negotiations with our suppliers to improve our inventory purchase costs based on our increasing scale. The non-cash negative LIFO impact is the result of our continued product acquisition cost reductions, and due to these acquisition cost reductions, we fully depleted our LIFO reserve in 2013. Our policy is to not write up inventory in excess of replacement cost, and accordingly, we were effectively valuing our inventory at replacement cost. During the years ended December 31, 2015 and 2014, our LIFO costs were written down by approximately $28 million and $41 million, respectively, to reflect replacement cost. Distribution system efficiencies are the result of leverage on our increased sales volumes and lower fuel costs.
Selling, general and administrative expenses:
SG&A for the year ended December 31, 2015, increased to $2.65 billion (or 33.2% of sales) from $2.44 billion (or 33.8% of sales) for the same period one year prior, representing an increase of 9%. The increase in total SG&A dollars for the year ended December 31, 2015, was primarily the result of additional Team Members, facilities and vehicles to support our increased sales and store count and a $19 million litigation loss charge from an adverse verdict in a contract dispute with a former service provider. The decrease in SG&A as a percentage of sales for the year ended December 31, 2015, was primarily the result of increased leverage of store occupancy costs on strong comparable store sales results.
Operating income:
As a result of the impacts discussed above, operating income for the year ended December 31, 2015, increased to $1.51 billion (or 19.0% of sales) from $1.27 billion (or 17.6% of sales) for the same period one year prior, representing an increase of 19%.
Other income and expense:
Total other expense for the year ended December 31, 2015, increased to $54 million (or 0.7% of sales), from $48 million (or 0.7% of sales) for the same period one year prior, representing an increase of 11%. The increase in total other expense for the year ended December 31, 2015, was primarily the result of a decrease in the amount of capitalized interest in 2015, as compared to the same period in 2014.
Income taxes:
Our provision for income taxes for the year ended December 31, 2015, increased to $529 million (36.2% effective tax rate) from $444 million (36.3% effective tax rate) for the same period one year prior, representing an increase of 19%. The increase in our provision for income taxes for the year ended December 31, 2015, was the result of higher taxable income in 2015, driven by our strong operating results. The decrease in our effective tax rate for the year ended December 31, 2015, was primarily due to the non-typical favorable tax reserve adjustment, which was related to historical tax positions due to a previous acquisition, partially offset by a decreased benefit in 2015 from the realization of employment tax credits.
Net income:
As a result of the impacts discussed above, net income for the year ended December 31, 2015, increased to $931 million (or 11.7% of sales), from $778 million (or 10.8% of sales) for the same period one year prior, representing an increase of 20%.
Earnings per share:
Our diluted earnings per common share for the year ended December 31, 2015, increased 25% to $9.17 on 102 million shares from $7.34 on 106 million shares for the same period one year prior.
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 customer 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.
Liquidity and related ratios:
The following table highlights our liquidity and related ratios as of December 31, 2016 and 2015 (dollars in millions):
(1)
Working capital is calculated as current assets less current liabilities.
(2)
Debt to equity is calculated as total debt divided by total equity.
Current assets increased 8%, current liabilities increased 12%, total debt increased 36% and total equity decreased 17% from 2015 to 2016. The increase in current assets was primarily due to the increase in inventory, resulting from the opening of 210 net, new stores and acquiring 48 Bond stores in 2016. The increase in current liabilities was primarily due to the increase in accounts payable, resulting from inventory growth related to new store openings supported in part by our suppliers and additional supplier participation in our supplier financing program during the year. Our accounts payable to inventory ratio was 105.7% as of December 31, 2016, as compared to 99.1% in the prior year. The increase in total debt was attributable to the issuance of $500 million of 3.550% Senior Notes due 2026. The decrease in total equity resulted from the impact of share repurchase activity, under our share repurchase program, on additional paid-in-capital and retained earnings, partially offset by an increase in retained earnings from strong net income for the year.
The following table identifies cash provided by/(used in) our operating, investing and financing activities for the years ended December 31, 2016, 2015 and 2014 (in thousands):
(1)
Calculated as net cash provided by operating activities, less capital expenditures for the period.
Operating activities:
The increase in net cash provided by operating activities in 2016 compared to 2015 was primarily due to an increase in net income and a greater decrease in net inventory investment, partially offset by a decrease in income taxes payable. Net inventory investment reflects our investment in inventory, net of the amount of accounts payable to suppliers. Our accounts payable to inventory ratio was 105.7%, 99.1% and 94.6% as of December 31, 2016, 2015 and 2014, respectively. The larger increase in our accounts payable to inventory ratio in 2016 was primarily attributable to incrementally better terms from our suppliers and additional suppliers participating in our supplier financing programs. The decrease from income taxes payable in 2016, compared to the increase in income taxes payable in 2015, was primarily the result of a prepaid income taxes position at the end of 2016, versus an income taxes payable position at the end of 2015.
The increase in net cash provided by operating activities in 2015 compared to 2014 was primarily due to an increase in net income and a greater increase in income taxes payable, partially offset by a smaller decrease in net inventory investment and a decrease in accrued payroll-related liabilities. The larger increase in income taxes payable was primarily the result of higher accrued income taxes payable at the end of 2015, as compared to the end of 2014. Our net inventory investment continues to decrease as a result of the impact of our enhanced supplier financing programs. The smaller decrease in net inventory investment in 2015 was the result of fewer new suppliers entering our supplier financing programs in 2015, as compared to 2014. Our accounts payable to inventory ratio was 99.1% and 94.6%
as of December 31, 2015 and 2014, respectively. The decrease in accrued payroll-related liabilities during 2015, as compared to the increase in 2014, was due to the timing of pay period end dates versus check dates.
Investing activities:
The increase in net cash used in investing activities in 2016 compared to 2015 was primarily the result of an increase in capital expenditures and other investing activities in 2016. Total capital expenditures were $476 million and $414 million in 2016 and 2015, respectively, and the increase was primarily related to the timing of property acquisitions, closings and construction costs for new stores and our distribution expansion projects during 2016, as compared to 2015. The increase in other investing activities was primarily due to small acquisitions during 2016.
The increase in net cash used in investing activities in 2015 compared to 2014 was primarily the result of a decrease in capital expenditures. Total capital expenditures were $414 million and $430 million in 2015 and 2014, respectively, and the decrease was primarily related to the construction of additional distribution facilities in 2014 to support our ongoing store growth, partially offset by an increase in the number of new store openings in 2015.
We opened 210, 205, and 200 net, new stores in 2016, 2015 and 2014, respectively, and acquired 48 Bond stores in 2016. We plan to open 190 net, new stores in 2017. The current costs associated with the opening of a new store, including the cost of land acquisition, building improvements, fixtures, vehicles, net inventory investment and computer equipment, are estimated to average approximately $1.5 million to $1.8 million; however, such costs may be significantly reduced where we lease, rather than purchase, the store site.
Financing activities:
The decrease in net cash used in financing activities during 2016 compared to 2015 was primarily attributable to net proceeds from the issuance of long-term debt during 2016, partially offset by a greater impact from the repurchases of our common stock under our share repurchase program during 2016.
The increase in net cash used in financing activities during 2015 compared to 2014 was primarily attributable to a greater impact from the repurchases of our common stock under our share repurchase program during 2015.
Unsecured revolving credit facility:
On January 14, 2011, we entered into a credit agreement, as amended by Amendment No. 1 dated as of September 9, 2011, as further amended by Amendment No. 2 dated as of July 2, 2013, and as further amended by Amendment No. 3 dated as of June 18, 2015 (the “Credit Agreement”). The Credit Agreement provides for a $600 million unsecured revolving credit facility (the “Revolving Credit Facility”) arranged by Bank of America, N.A., which is scheduled to mature in July 2018. 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, we may, from time to time subject to certain conditions, increase the aggregate commitments under the Revolving Credit Facility by up to $200 million.
As of December 31, 2016 and 2015, we had outstanding letters of credit, primarily to support obligations related to workers’ compensation, general liability and other insurance policies, in the amounts of $39 million and $38 million, respectively, reducing the aggregate availability under the Revolving Credit Facility by those amounts. As of December 31, 2016 and 2015, we had no outstanding borrowings under the Revolving Credit Facility.
Senior Notes:
On March 8, 2016, we issued $500 million aggregate principal amount of unsecured 3.550% Senior Notes due 2026 (“3.550% Senior Notes due 2026”) at a price to the public of 99.832% of their face value with United Missouri Bank, N.A. (“UMB”) as trustee. Interest on the 3.550% Senior Notes due 2026 is payable on March 15 and September 15 of each year, which began with the first interest payment on September 15, 2016, and is computed on the basis of a 360-day year.
We have issued a cumulative $1.90 billion aggregate principal amount of unsecured senior notes, which are due between January 2021 and March 2026 with UMB as trustee. Interest on the senior notes, ranging from 3.550% to 4.875%, is payable semi-annually and is computed on the basis of a 360-day year.
The senior notes are guaranteed on a senior unsecured basis by each of our subsidiaries (“Subsidiary Guarantors”) that incurs or guarantees obligations under our Credit Agreement or under other credit facility or capital markets debt of ours or any of our Subsidiary Guarantors. The guarantees are joint and several and full and unconditional, subject to certain customary automatic release provisions, including release of the Subsidiary Guarantor’s guarantee under our Credit Agreement and certain other debt, or, in certain circumstances, the sale or other disposition of a majority of the voting power of the capital interest in, or of all or substantially all the property of, the Subsidiary Guarantor. Each of the Subsidiary Guarantors is 100% owned, directly or indirectly, by us, and we have no independent assets or operations other than those of our subsidiaries. Our only direct or indirect subsidiaries that would not be Subsidiary Guarantors would be minor
subsidiaries. Neither we, nor any of our Subsidiary Guarantors, are subject to any material or significant restrictions on our ability to obtain funds from our subsidiaries by dividend or loan or to transfer assets from such subsidiaries, except as provided by applicable law.
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: (i) create certain liens on assets to secure certain debt; (ii) enter into certain sale and leaseback transactions; and (iii) merge or consolidate with another company or transfer all or substantially all of our or its 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 December 31, 2016, 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 times and a maximum consolidated leverage ratio of 3.00 times. The consolidated fixed charge coverage ratio includes a calculation of earnings before interest, taxes, depreciation, amortization, rent and non-cash share-based compensation expense (“EBITDAR”). Fixed charges include interest expense, capitalized interest and rent expense. The consolidated leverage ratio includes a calculation of adjusted debt to EBITDAR. Adjusted debt includes outstanding debt, outstanding stand-by letters of credit and similar instruments, six-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 6.15 times and 5.99 times as of December 31, 2016 and 2015, respectively, and a consolidated leverage ratio of 1.63 times and 1.52 times as of December 31, 2016 and 2015, respectively, remaining in compliance with all covenants related to the borrowing arrangements. Under our current financing plan, we have targeted an adjusted debt to EBITDAR ratio range of 2.00 times to 2.25 times.
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 years ended December 31, 2016 and 2015 (dollars in thousands):
Free cash flow, the consolidated fixed charge coverage ratio and 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 our 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, 2016, May 27, 2016, and November 16, 2016, our Board of Directors each time approved a resolution to increase the authorization amount under our share repurchase program by an additional $750 million, resulting in a cumulative authorization amount of $7.75 billion. Each additional authorization is effective for a three-year period, beginning on its respective announcement date.
The following table identifies shares of our common stock that have been repurchased as part of our publicly announced share repurchase program (in thousands, except per share data):
As of December 31, 2016, we had $888 million remaining under our share repurchase program. Subsequent to the end of the year and through February 28, 2017, we repurchased an additional 1.4 million shares of our common stock under our share repurchase program, at an average price of $267.32, for a total investment of $388 million. We have repurchased a total of 58 million shares of our common stock under our share repurchase program since the inception of the program in January of 2011 and through February 28, 2017, at an average price of $124.14 for a total aggregate investment of $7.25 billion. As of February 28, 2017, we had approximately $500 million remaining under our share repurchase program.
CONTRACTUAL OBLIGATIONS
Our contractual obligations as of December 31, 2016, included commitments for short and long-term debt arrangements, interest payments related to long-term debt, future payments under non-cancelable lease arrangements, self-insurance reserves, purchase obligations for construction contract commitments and other long-term liabilities, which are identified in the table below and are fully disclosed in Note 6 “Leasing,” Note 9 “Share-Based Compensation and Benefit Plans” and Note 10 “Commitments” to the Consolidated Financial Statements. We expect to fund these commitments primarily with operating cash flows expected to be generated in the normal course of business or through borrowings under our Revolving Credit Facility.
Deferred income taxes, as well as commitments with various suppliers for the purchase of inventory, are not reflected in the table below due to the absence of scheduled maturities, the nature of the account or the commitment’s cancellation terms. Due to the absence of scheduled maturities, the timing of certain of these payments cannot be determined, except for amounts estimated to be payable in 2017, which are included in “Current liabilities” on our Consolidated Balance Sheets.
We record a reserve for potential liabilities related to uncertain tax positions, including estimated interest and penalties, which are fully disclosed in Note 12 “Income Taxes” to the Consolidated Financial Statements. These estimates are not included in the table below because the timing related to the ultimate resolution or settlement of these positions cannot be determined. As of December 31, 2016, we recorded a net liability of $41 million related to these uncertain tax positions on our Consolidated Balance Sheets, all of which was included as a component of “Other liabilities.”
We record a reserve for the projected obligation related to future payments under the Company’s nonqualified deferred compensation plan, which is fully disclosed in Note 9 “Share-Based Compensation and Benefit Plans” to the Consolidated Financial Statements. This
estimate is not included in the table below because the timing related to the ultimate payment cannot be determined. As of December 31, 2016, we recorded a liability of $20 million related to this uncertain liability on our Consolidated Balance Sheets, all of which was included as a component of “Other liabilities.”
The following table identifies the estimated payments of the Company’s contractual obligations as of December 31, 2016 (in thousands):
(1)
Our Revolving Credit Facility, which has a maximum aggregate commitment of $600 million and matures in July 2018, bears interest (other than swing line loans), at our option, at either the Base Rate or Eurodollar Rate (both as defined in the agreement) plus a margin, that will vary from 0.875% to 1.250% in the case of loans bearing interest at the Eurodollar Rate and 0.000% to 0.250% in the case of loans bearing interest at the Base Rate, in each case based upon the better of the ratings assigned to our debt by Moody’s Investor Service, Inc. and Standard & Poor’s Rating Services, subject to limited exceptions. Swing line loans made under the Revolving Credit Facility bear interest at the Base Rate plus the applicable margin described above. In addition, we pay a facility fee on the aggregate amount of the commitments in an amount equal to a percentage of such commitments, varying from 0.125% to 0.250% per annum based upon the better of the ratings assigned to our debt by Moody’s Investor Service, Inc. and Standard & Poor’s Rating Services, subject to limited exceptions. Based on our current credit ratings, our margin for Base Rate loans was 0.000%, our margin for Eurodollar Rate loans was 0.875% and our facility fee was 0.125%. As of December 31, 2016, we had no outstanding borrowings under our Revolving Credit Facility.
(2)
The minimum lease payments above do not include certain tax, insurance and maintenance costs, which are also required contractual obligations under our operating leases but are generally not fixed and can fluctuate from year to year. These expenses historically average approximately 20% of the corresponding lease payments. See Note 6 “Leasing” to the Consolidated Financial Statements for further information on our operating leases.
(3)
We use various self-insurance mechanisms to provide for potential liabilities from workers’ compensation, vehicle and general liability, and employee health care benefits. The self-insurance reserves above are at the undiscounted obligation amount. The self-insurance reserves liabilities are recorded on our Consolidated Balance Sheets at our estimate of their net present value and do not have scheduled maturities; however, we can estimate the timing of future payments based upon historical patterns. See Note 10 “Commitments” to the Consolidated Financial Statements for further information on our self-insurance reserves.
OFF-BALANCE SHEET ARRANGEMENTS
Off-balance sheet arrangements are transactions, agreements, or other contractual arrangements with an unconsolidated entity, for which we have an obligation to the entity that is not recorded in our consolidated financial statements. We historically utilized various off-balance sheet financial instruments, including sale-leaseback and synthetic lease transactions, but we have not entered into any such transactions for over five years and do not plan to utilize off-balance sheet arrangements in the future to fund our working capital requirements, operations or growth plans.
We issue stand-by letters of credit provided by a $200 million sub limit under the Revolving Credit Facility that reduce our available borrowings under the Revolving Credit Facility. Those letters of credit are issued primarily to satisfy the requirements of workers’ compensation, general liability and other insurance policies. Substantially all of the outstanding letters of credit have a one-year term from the date of issuance. Letters of credit totaling $39 million and $38 million were outstanding at December 31, 2016 and 2015, respectively.
Other than in connection with executing operating leases, we do not have any off-balance sheet financing that has, or is reasonably likely to have, a material, current or future effect on our financial condition, cash flows, results of operations, liquidity, capital expenditures or capital resources. See “Contractual Obligations” section of Item 7 of this annual report on Form 10-K and Note 6 “Leasing” to the Consolidated Financial Statements for further information on our operating leases.
CRITICAL ACCOUNTING POLICIES AND 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 consolidated financial statements are prepared. Management believes that the following policies are critical due to the inherent uncertainty of these matters and the complex and subjective judgments required in establishing these
estimates. Management continues to review these critical accounting policies and estimates to ensure that the consolidated financial statements are presented fairly in accordance with GAAP. However, actual results could differ from our assumptions and estimates and such differences could be material.
Inventory Obsolescence and Shrink:
Inventory, which consists of automotive hard parts, maintenance items, accessories and tools, is stated at the lower of cost or market. The extended nature of the life cycle of our products is such that the risk of obsolescence of our inventory is minimal. The products that we sell generally have applications in our markets for a relatively long period of time in conjunction with the corresponding vehicle population. We have developed sophisticated systems for monitoring the life cycle of a given product and, accordingly, have historically been very successful in adjusting the volume of our inventory in conjunction with a decrease in demand. We do record a reserve to reduce the carrying value of our inventory through a charge to cost of sales in the isolated instances where we believe that the market value of a product line is lower than our recorded cost. This reserve is based on our assumptions about the marketability of our existing inventory and is subject to uncertainty to the extent that we must estimate, at a given point in time, the market value of inventory that will be sold in future periods. Ultimately, our projections could differ from actual results and could result in a material impact to our stated inventory balances. We have historically not had to materially adjust our obsolescence reserves due to the factors discussed above and do not anticipate that we will experience material changes in our estimates in the future.
We also record a reserve to reduce the carrying value of our perpetual inventory to account for quantities in our perpetual records above the actual existing quantities on hand caused by unrecorded shrink. We estimate this reserve based on the results of our extensive and frequent cycle counting programs and periodic, full physical inventories. To the extent that our estimates do not accurately reflect the actual unrecorded inventory shrinkage, we could potentially experience a material impact to our inventory balances. We have historically been able to provide a timely and accurate measurement of shrink and have not experienced material adjustments to our estimates. If the shrink reserve changed 10% from the estimate that we recorded based on our historical experience at December 31, 2016, the financial impact would have been approximately $1 million or 0.1% of pretax income for the year ended December 31, 2016.
Valuation of Long-Lived Assets and Goodwill:
We evaluate the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of these assets might exceed their current fair values. As part of the evaluation, we review performance at the store level to identify any stores with current period operating losses that should be considered for impairment. A potential impairment has occurred if the projected future undiscounted cash flows realized from the best possible use of the asset are less than the carrying value of the asset. The estimate of cash flows includes management’s assumptions of cash inflows and outflows directly resulting from the use of that asset in operations. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the assets. Our impairment analyses contain estimates due to the inherently judgmental nature of forecasting long-term estimated cash flows and determining the ultimate useful lives and fair values of the assets. Actual results could differ from these estimates, which could materially impact our impairment assessment.
We review goodwill for impairment annually during the fourth quarter, or when events or changes in circumstances indicate the carrying value of these assets might exceed their current fair values. We have never recorded an impairment to goodwill. The process of evaluating goodwill for impairment involves the determination of the fair value of our Company using the market approach. Inherent in such fair value determinations are certain judgments and estimates, including estimates that incorporate assumptions marketplace participants would use in making their estimates of fair value. In the future, if events or market conditions affect the estimated fair value to the extent that an asset is impaired, we will adjust the carrying value of these assets in the period in which the impairment occurs; however, we do not believe there has been any change of events or circumstances that would indicate that a reevaluation of goodwill is required as of December 31, 2016, nor do we believe goodwill is at risk of failing impairment testing. If the price of O’Reilly’s stock, which was a primary input used to determine our market capitalization during step one of goodwill impairment testing, changed by 10% from the value used during testing, the results and our conclusions would not have changed and no further steps would have been required.
Supplier Concessions:
We receive concessions from our suppliers through a variety of programs and arrangements, including co-operative advertising, allowances for warranties, merchandise allowances and volume purchase rebates. Co-operative advertising allowances that are incremental to our advertising program, specific to a product or event and identifiable for accounting purposes are reported as a reduction of advertising expense in the period in which the advertising occurred. All other material supplier concessions are recognized as a reduction to the cost of sales. Amounts receivable from suppliers also include amounts due to us relating to supplier purchases and product returns. Management regularly reviews amounts receivable from suppliers and assesses the need for a reserve for uncollectible amounts based on our evaluation of our suppliers’ financial position and corresponding ability to meet their financial obligations. Based on our historical results and current assessment, we have not recorded a reserve for uncollectible amounts in our consolidated financial statements, and we do not believe there is a reasonable likelihood that our ability to collect these amounts will differ from our expectations. The eventual ability of our suppliers to pay us the obliged amounts could differ from our assumptions and estimates, and we may be exposed to losses or gains that could be material.
Warranty Reserves:
We offer warranties on certain merchandise we sell with warranty periods ranging from 30 days to limited lifetime warranties. The risk of loss arising from warranty claims is typically the obligation of our suppliers. Certain suppliers provide upfront allowances to us in lieu of accepting the obligation for warranty claims. For this merchandise, when sold, we bear the risk of loss associated with the cost of warranty claims. Differences between supplier allowances received in lieu of warranty obligations and estimated warranty expense are recorded as an adjustment to the cost of sales. Estimated warranty costs, which are recorded as obligations at the time of sale, are based on the historical failure rate of each individual product line. Our historical experience has been that failure rates are relatively consistent over time and that the ultimate cost of warranty claims has been driven by volume of units sold as opposed to fluctuations in failure rates or the variation of the cost of individual claims. If warranty reserves were changed 10% from our estimated reserves at December 31, 2016, the financial impact would have been approximately $4 million or 0.2% of pretax income for the year ended December 31, 2016.
Self-Insurance Reserves:
We use a combination of insurance and self-insurance mechanisms to provide for potential liabilities from workers’ compensation, general liability, vehicle liability, property loss, and Team Member health care benefits. With the exception of certain Team Member health care benefit liabilities, employment related claims and litigation, certain commercial litigation and certain regulatory matters, we obtain third-party insurance coverage to limit our exposure for any individual workers’ compensation, general liability, vehicle liability or property loss claim. When estimating our self-insurance liabilities, we consider a number of factors, including historical claims experience and trend-lines, projected medical and legal inflation, growth patterns and exposure forecasts. The assumptions made by management as they relate to each of these factors represent our judgment as to the most probable cumulative impact of each factor to our future obligations. Our calculation of self-insurance liabilities requires management to apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not yet reported as of the balance sheet date, and the application of alternative assumptions could result in a different estimate of these liabilities. Actual claim activity or development may vary from our assumptions and estimates, which may result in material losses or gains. As we obtain additional information that affects the assumptions and estimates we used to recognize liabilities for claims incurred in prior accounting periods, we adjust our self-insurance liabilities to reflect the revised estimates based on this additional information. These liabilities are recorded at our estimate of their net present value, using a credit-adjusted discount rate. These liabilities do not have scheduled maturities, but we can estimate the timing of future payments based upon historical patterns. We could apply alternative assumptions regarding the timing of payments or the applicable discount rate that could result in materially different estimates of the net present value of the liabilities. If self-insurance reserves were changed 10% from our estimated reserves at December 31, 2016, the financial impact would have been approximately $13 million or 0.8% of pretax income for the year ended December 31, 2016.
Legal Reserves:
We maintain reserves for expenses associated with litigation, for which O’Reilly is currently involved. We are currently involved in litigation incidental to the ordinary conduct of our business. Management, with the assistance of outside legal counsel, must make estimates of potential legal obligations and possible liabilities arising from such litigation and records reserves for these expenditures. If legal reserves were changed 10% from our estimated reserves at December 31, 2016, the financial impact would have been approximately $4 million or 0.2% of pretax income for the year ended December 31, 2016.
Taxes:
We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. We regularly review our potential tax liabilities for tax years subject to audit. The amount of such liabilities is based on various factors, such as differing interpretations of tax regulations by the responsible tax authority, experience with previous tax audits and applicable tax law rulings. Changes in our tax liability may occur in the future as our assessments change based on the progress of tax examinations in various jurisdictions and/or changes in tax regulations. In management’s opinion, adequate provisions for income taxes have been made for all years presented. The estimates of our potential tax liabilities contain uncertainties because management must use judgment to estimate the exposures associated with our various tax positions and actual results could differ from our estimates. Alternatively, we could have applied assumptions regarding the eventual outcome of the resolution of open tax positions that could differ from our current estimates but would still be reasonable given the nature of a particular position. While our estimates are subject to the uncertainty noted in the preceding discussion, our initial estimates of our potential tax liabilities have historically not been materially different from actual results, except in instances where we have reversed liabilities that were recorded for periods that were subsequently closed with the applicable taxing authority.
INFLATION AND SEASONALITY
For the last three fiscal years, we have generally been successful 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 cost increased due to base commodity price increases industry-wide, 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.
QUARTERLY RESULTS
The following tables set forth certain quarterly unaudited operating data for fiscal years ended December 31, 2016 and 2015. The unaudited quarterly information includes all adjustments, which management considers necessary for a fair presentation of the information shown (in thousands, except per share and comparable store sales data):
(1)
Earnings per share amounts are computed independently for each quarter and annual period. The quarterly earnings per share amounts may not sum to equal the full-year earnings per share amount.
The unaudited operating data presented above should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report, and the other financial information included therein.
RECENT ACCOUNTING PRONOUNCEMENTS
In May of 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standard Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). Under ASU 2014-09, an entity is required to follow a five-step process to determine the amount of revenue to recognize when promised goods or services are transferred to customers. ASU 2014-09 offers specific accounting guidance for costs to obtain or fulfill a contract with a customer. In addition, an entity is required to disclose sufficient information to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In August of 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date” (“ASU 2015-14”), to defer the effective date of ASU 2014-09 by one year. For public companies, ASU 2015-14 changes ASU 2014-09 to be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. These ASUs can be adopted retrospectively or as a cumulative-effective adjustment at the date of adoption, with early adoption allowed, but not before December 15, 2016. We will adopt this guidance beginning with our first quarter ending March 31, 2018. We have established a task force, composed of multiple functional groups inside of the Company, that is currently in the process of evaluating critical components of this new guidance and the potential impact of the guidance on our financial position, results of operations and cash flows. Based on the preliminary work completed, we are considering the potential implications of the new standard on our recognition of customer related accounts receivable, warranty costs
that are not the responsibility of our suppliers, the application of the Company’s retail O’Rewards loyalty program and all applicable financial statement disclosures required by the new guidance. At this time, the task force has not completed its evaluation of the impact or means of adoption.
In February of 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). Under ASU 2016-02, an entity will be required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. For public companies, ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We will adopt this guidance beginning with our first quarter ending March 31, 2019. We have established a task force, composed of multiple functional groups inside of the Company, that is currently in the process of evaluating critical components this new guidance and the potential impact of the guidance on our financial position, results of operations and cash flows. Based on the preliminary work completed, we are considering the potential implications of the new standard on determining the discount rate to be used in valuing new and existing leases, the treatment of existing favorable and unfavorable lease agreements acquired in connection with previous acquisitions, procedural and operational changes that may be necessary to comply with the provisions of the guidance and all applicable financial statement disclosures required by the guidance, all of which are areas that could potentially be impacted by adoption of the guidance. At this time, the task force has not completed its full evaluation; however, we believe the adoption of the new guidance will have a material impact on the total assets and total liabilities reported on our consolidated balance sheets.
In March of 2016, the FASB issued ASU No. 2016-06, “Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments” (“ASU 2016-06”). ASU 2016-06 clarifies the requirements for assessing whether contingent call or put options that can accelerate the payment of principal on debt instruments are clearly and closely related to the economic characteristics and risks of the debt hosts and requires entities to solely use the four-step decision sequence, which is already in existence, when assessing the embedded call or put options. For public companies, ASU 2016-06 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and can be adopted on a modified retrospective basis, with early adoption permitted. We will adopt this guidance beginning with our first quarter ending March 31, 2017. The application of this new guidance is not expected to have a material impact on our consolidated financial condition, results of operations or cash flows.
In March of 2016, the FASB issued ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). Under ASU 2016-09, several aspects of the accounting for share-based payment transactions, including tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows, were simplified. For public companies, ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, with early adoption permitted. ASU 2016-09 includes various adoption methods, depending on the guidance being adopted; amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements and forfeitures should be applied using a modified retrospective transition method, while the amendments related to the presentation of employee taxes paid on the statement of cash flows should be applied retrospectively, the amendments requiring recognition of excess tax benefits and deficiencies in the income statement should be applied prospectively, and amendments related to the presentation of excess tax benefits on the statement of cash flows should be applied either prospectively or retrospectively. We will adopt this guidance beginning with our first quarter ending March 31, 2017. We are in the process of evaluating the future impact this new guidance will have on our consolidated financial position, results of operations and cash flows, as well as which method of adoption is most appropriate. At this time, we anticipate the adoption of the new guidance will prospectively impact our reported provision for income taxes, net income, weighted-average common shares outstanding - assuming dilution and earnings per share - assuming dilution, as well as retrospectively and prospectively impact our reported net cash provided by/used in operating activities and net cash provided by/used in financing activities.
In June of 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). Under ASU 2016-13, businesses and other organizations are required to present financial assets, measured at amortized costs basis, at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis, such as trade receivables. The measurement of expected credit loss will be based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. For public companies, ASU 2016-13 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We will adopt this guidance beginning with our first quarter ending March 31, 2020. The application of this new guidance is not expected to have a material impact on our consolidated financial condition, results of operations or cash flows.
In August of 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force)” (“ASU 2016-15”). ASU 2016-15 reduces the existing diversity in practice for eight specific parts on cash flow statement presentation and classification: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance (COLI) policies; distributions received from equity method investments; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. For public companies, ASU 2016-15 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and requires retrospective adoption, with early adoption permitted. We will adopt this guidance beginning with our first quarter ending March 31, 2018. The application of this new guidance is not expected to have a material impact on our consolidated financial condition, results of operations or cash flows.
In January of 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business” (“ASU 2017-01”). ASU 2017-01 revises the definition of a business in the Accounting Standards Codification and clarifies the guidance for determining whether the purchase or disposal of an asset or group of assets qualifies as the purchase or disposal of a business. For public companies, ASU 2017-01 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and requires prospective adoption, with early adoption permitted with certain conditions. We will adopt this guidance beginning with our first quarter ending March 31, 2018. The application of this new guidance is not expected to have a material impact on our consolidated financial condition, results of operations or cash flows.
In January of 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 eliminates the second step in the previous process for goodwill impairment testing; instead the test is now a one-step process that calls for goodwill impairment loss to be measured as the excess of the reporting unit’s carrying amount over its fair value. For public companies, ASU 2017-04 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period, and requires prospective adoption, with early adoption after January 1, 2017. We will adopt this guidance beginning with our first quarter ending March 31, 2019. The application of this new guidance is not expected to have a material impact on our consolidated financial condition, results of operations or cash flows.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
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.
We are subject to interest rate risk to the extent we borrow against our unsecured revolving credit facility (the “Revolving Credit Facility”) with variable interest rates based on either a Base Rate or Eurodollar Rate, as defined in the credit agreement governing the Revolving Credit Facility. As of December 31, 2016, we had no outstanding borrowings under our Revolving Credit Facility.
We had outstanding fixed rate debt of $1.90 billion and $1.40 billion as of December 31, 2016 and 2015, respectively. The fair value of our fixed rate debt was estimated at $1.98 billion and $1.47 billion as of December 31, 2016 and 2015, respectively, which was determined by reference to quoted market prices.
We invest certain of our excess cash balances in short-term, highly-liquid instruments with maturities of 90 days or less. We do not expect any material losses from our invested cash balances and we believe that our interest rate exposure is minimal. As of December 31, 2016, our cash and cash equivalents totaled $147 million.
Item 8. Financial Statements and Supplementary Data
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of O’Reilly Automotive, Inc. and Subsidiaries (the “Company”), under the supervision and with the participation of the Company’s principal executive officer and principal financial officer and effected by the Company’s Board of Directors, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13(a)-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
Internal control over financial reporting includes all policies and procedures that
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management recognizes that all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to risk. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework (2013 framework). Based on this assessment, management believes that as of December 31, 2016, the Company’s internal control over financial reporting is effective based on those criteria.
Ernst & Young LLP, Independent Registered Public Accounting Firm, has audited the Company’s consolidated financial statements and has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting, as stated in their report, which is included herein.
/s/
Greg L. Henslee
/s/
Thomas McFall
Greg L. Henslee
Thomas McFall
Chief Executive Officer
Executive Vice President of Finance &
February 28, 2017
Chief Financial Officer
February 28, 2017
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of O’Reilly Automotive, Inc. and Subsidiaries
We have audited O’Reilly Automotive, Inc. and Subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). O’Reilly Automotive, Inc. and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, O’Reilly Automotive, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of O’Reilly Automotive, Inc. and Subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016, of O’Reilly Automotive, Inc. and Subsidiaries and our report dated February 28, 2017, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Kansas City, Missouri
February 28, 2017
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of O’Reilly Automotive, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of O’Reilly Automotive, Inc. and Subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of O’Reilly Automotive, Inc. and Subsidiaries at December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), O’Reilly Automotive, Inc. and Subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 28, 2017, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Kansas City, Missouri
February 28, 2017
Consolidated Balance Sheets
(In thousands, except share data)
See accompanying Notes to consolidated financial statements.
Consolidated Statements of Income
(In thousands, except per share data)
See accompanying Notes to consolidated financial statements.
Consolidated Statements of Shareholders’ Equity
(In thousands)
See accompanying Notes to consolidated financial statements.
Consolidated Statements of Cash Flows
(In thousands)
See accompanying Notes to consolidated financial statements.
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of business:
O’Reilly Automotive, Inc. and its subsidiaries, collectively, “O’Reilly” or the “Company,” is a specialty retailer and supplier of automotive aftermarket parts. The Company’s stores carry an extensive product line, including new and remanufactured automotive hard parts, maintenance items and various automotive accessories. As of December 31, 2016, the Company owned and operated 4,829 stores in 47 states, servicing both do-it-yourself (“DIY”) and the professional service provider customers. The Company’s robust distribution system provides stores with same-day or overnight access to an extensive inventory of hard-to-find items not typically stocked in the stores of other auto parts retailers.
Segment reporting:
The Company is managed and operated by a single management team reporting to the chief operating decision maker. O’Reilly stores have similar characteristics, including the nature of the products and services, the type and class of customers and the methods used to distribute products and provide service to its customers and, as a whole, make up a single operating segment. The Company does not prepare discrete financial information with respect to product lines, types of customers or geographic locations and as such has one reportable segment.
Principles of consolidation:
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company balances and transactions have been eliminated in consolidation.
Use of estimates:
The preparation of the consolidated financial statements, in conformity with United States generally accepted accounting principles (“GAAP”), requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could materially differ from those estimates.
Cash equivalents:
Cash equivalents include investments with maturities of 90 days or less on the date of purchase.
Accounts receivable:
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. The Company considers the following factors when determining if collection is reasonably assured: customer creditworthiness, past transaction history with the customer, current economic and industry trends and changes in customer payment terms. Allowances for doubtful accounts are determined based on historical experience and an evaluation of the current composition of accounts receivable. Amounts due to the Company from its Team Members are included as a component of accounts receivable. These amounts consist primarily of purchases of merchandise on Team Member accounts. Accounts receivable due from Team Members was approximately $1.2 million and $1.1 million as of December 31, 2016 and 2015, respectively.
The Company grants credit to certain customers who meet the Company’s pre-established credit requirements. Concentrations of credit risk with respect to these receivables are limited because the Company’s customer base consists of a large number of small customers, spreading the credit risk across a broad base. The Company also controls this credit risk through credit approvals, credit limits and accounts receivable and credit monitoring procedures. Generally, the Company does not require security when credit is granted to customers. Credit losses are provided for in the Company’s consolidated financial statements and have consistently been within management’s expectations.
Amounts receivable from suppliers:
The Company receives concessions from its suppliers through a variety of programs and arrangements, including allowances for new stores and warranties, volume purchase rebates and co-operative advertising. Co-operative advertising allowances that are incremental to the Company’s advertising program, specific to a product or event and identifiable for accounting purposes are reported as a reduction of advertising expense in the period, in which the advertising occurred. All other supplier concessions are recognized as a reduction to the cost of sales. Amounts receivable from suppliers also includes amounts due to the Company for changeover merchandise and product returns. The Company regularly reviews supplier receivables for collectability and assesses the need for a reserve for uncollectable amounts based on an evaluation of the Company’s suppliers’ financial positions and corresponding abilities to meet financial obligations. Management does not believe there is a reasonable likelihood that the Company will be unable to collect the amounts receivable from suppliers and the Company did not record a reserve for uncollectable amounts from suppliers in the consolidated financial statements as of December 31, 2016 or 2015.
Inventory:
Inventory, which consists of automotive hard parts, maintenance items, accessories and tools, is stated at the lower of cost or market. Inventory also includes capitalized costs related to procurement, warehousing and distribution centers (“DC”s). Cost has been determined using the last-in, first-out (“LIFO”) method, which more accurately matches costs with related revenues. Over time, as the Company’s merchandise inventory purchases have increased, the Company negotiated improved acquisition costs from its suppliers and the corresponding price deflation exhausted the Company’s LIFO reserve balance. The Company’s policy is to not write up the value of its inventory in excess of its replacement cost, and accordingly, the Company’s merchandise inventory has been effectively recorded at replacement cost since December 31, 2013. The replacement cost of inventory was $2.78 billion and $2.63 billion as of December 31, 2016 and 2015, respectively. LIFO costs exceeded replacement costs by $132.0 million and $85.9 million at December 31, 2016 and 2015, respectively.
Fair value of financial instruments:
The Company uses the fair value hierarchy, which prioritizes the inputs used to measure the fair value of certain of its financial instruments. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The Company uses the income and market approaches to determine the fair value of its assets and liabilities. The three levels of the fair value hierarchy are set forth below:
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Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
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Level 2 - Inputs other than quoted prices in active markets included within Level 1 that are observable for the asset or liability, either directly or indirectly.
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Level 3 - Unobservable inputs for the asset or liability.
See Note 2 for further information concerning the Company’s financial and non-financial assets and liabilities measured at fair value on a recurring and non-recurring basis.
Property and equipment:
Property and equipment are carried at cost. Depreciation is calculated using the straight-line method, generally over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the lease term or the estimated economic life of the assets. The lease term includes renewal options determined by management at lease inception, for which failure to execute renewal options would result in a substantial economic penalty to the Company. Maintenance and repairs are charged to expense as incurred. Upon retirement or sale, the cost and accumulated depreciation are eliminated and the gain or loss, if any, is recognized in the Company’s Consolidated Statements of Income. The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.
Notes receivable:
The Company had notes receivable from suppliers and other third parties in the amount of $17.3 million at December 31, 2015. The Company regularly reviews its notes receivable for collectability and assesses the need for a reserve for uncollectable amounts based on an evaluation of the Company’s borrowers’ financial positions and corresponding abilities to meet financial obligations. Management did not believe there was a reasonable likelihood that the Company would be unable to collect the notes receivable and the Company did not record a reserve for uncollectable notes receivable in the consolidated financial statements as of December 31, 2015. During the year ended December 31, 2016, the notes receivable from suppliers and other third parties were dissolved, in connection with new supplier contracts, and during the year ended December 31, 2016, no new notes receivable arrangements have been entered into.
Goodwill and other intangibles:
The accompanying Consolidated Balance Sheets at December 31, 2016 and 2015, include goodwill and other intangible assets recorded as the result of acquisitions. The Company reviews goodwill for impairment annually during the fourth quarter, or when events or changes in circumstances indicate the carrying value of these assets might exceed their current fair values, rather than systematically amortizing goodwill against earnings. During 2016 and 2015, the goodwill impairment test included a quantitative assessment, which compared the fair value of the reporting unit to its carrying amount, including goodwill. The Company operates as a single reporting unit, and the Company determined that its fair value exceeded its carrying value, including goodwill, as of December 31, 2016 and 2015; as such, no goodwill impairment adjustment was required as of December 31, 2016 and 2015. Finite-lived intangibles are carried at cost and amortization is calculated using the straight-line method, generally over the estimated useful lives of the intangibles.
Impairment of long-lived assets:
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. When such an event occurs, the Company compares the sum of the undiscounted expected future cash flows of the asset (asset group) with the carrying amounts of the asset. If the undiscounted expected future cash flows are less than the carrying value of the assets, the Company measures the amount of impairment loss as the amount, by which the carrying amount of the assets exceeds the fair value of the assets. The Company has not historically recorded any material impairment charges to its long-
lived assets and the Company did not record a material impairment charge to its long-lived assets during the year ended December 31, 2016 or 2015.
Valuation of investments:
The Company has an unsecured obligation to pay, in the future, the value of deferred compensation and a Company match relating to employee participation in the Company’s nonqualified deferred compensation plan (the “Deferred Compensation Plan”). See Note 9 for further information concerning the Company’s benefit plans. The future obligation is adjusted to reflect the performance, whether positive or negative, of selected investment measurement options, chosen by each participant. The Company invests in various marketable securities with the intention of selling these securities to fulfill its future obligations under the Deferred Compensation Plan. The investments in this plan were stated at fair value based on quoted market prices, were accounted for as trading securities and were included as a component of “Other assets, net” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015. See Note 2 for further information concerning the fair value measurements of the Company’s marketable securities.
Self-insurance reserves:
The Company uses a combination of insurance and self-insurance mechanisms to provide for potential liabilities for Team Member health care benefits, workers’ compensation, vehicle liability, general liability and property loss. With the exception of certain Team Member health care benefit liabilities, employment related claims and litigation, certain commercial litigation and certain regulatory matters, the Company obtains third-party insurance coverage to limit its exposure. The Company estimates its self-insurance liabilities by considering a number of factors, including historical claims experience and trend-lines, projected medical and legal inflation, growth patterns and exposure forecasts. Certain of these liabilities were recorded at an estimate of their net present value, using a credit-adjusted discount rate.
The following table identifies the components of the Company’s self-insurance reserves as of December 31, 2016 and 2015 (in thousands):
The current portion of the Company’s discounted self-insurance reserves totaled $67.9 million and $72.7 million as of December 31, 2016 and 2015, respectively, which was included in “Self-insurance reserves” on the accompanying Consolidate Balance Sheets as of December 31, 2016 and 2015. The remainder was included was included as a component of “Other liabilities” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015.
Warranties:
The Company offers warranties on certain merchandise it sells with warranty periods ranging from 30 days to limited lifetime warranties. The risk of loss arising from warranty claims is typically the obligation of the Company’s suppliers. Certain suppliers provide upfront allowances to the Company in lieu of accepting the obligation for warranty claims. For this merchandise, when sold, the Company bears the risk of loss associated with the cost of warranty claims. Differences between supplier allowances received by the Company, in lieu of warranty obligations and estimated warranty expense, are recorded as an adjustment to cost of sales. Estimated warranty costs, which are recorded as obligations at the time of sale, are based on the historical failure rate of each individual product line. The Company’s historical experience has been that failure rates are relatively consistent over time and that the ultimate cost of warranty claims to the Company has been driven by volume of units sold as opposed to fluctuations in failure rates or the variation of the cost of individual claims. See Note 7 for further information concerning the Company’s aggregate product warranty liabilities.
Litigation reserves:
O’Reilly is currently involved in litigation incidental to the ordinary conduct of the Company’s business. The Company records reserves for litigation losses in instances where a material adverse outcome is probable and the Company is able to reasonably estimate the probable loss. The Company reserves for an estimate of material legal costs to be incurred in pending litigation matters. Although the Company cannot ascertain the amount of liability that it may incur from any of these matters, it does not currently believe that, in the aggregate, these matters, taking into account applicable insurance and reserves, will have a material adverse effect on its consolidated financial position, results of operations or cash flows in a particular quarter or annual period. See Note 14 for further information concerning the Company’s litigation reserves.
Share repurchases:
In January of 2011, the Company’s Board of Directors approved a share repurchase program. Under the program, the Company may, from time to time, repurchase shares of its 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.
All shares repurchased under the share repurchase program are retired and recorded under the par value method on the accompanying Consolidated Balance Sheets. See Note 8 for further information concerning the Company’s share repurchase program.
Revenue recognition:
Over-the-counter retail sales are recorded when the customer takes possession of the merchandise. Sales to professional service provider customers, also referred to as “commercial sales,” are recorded upon same-day delivery of the merchandise to the customer, generally at the customer’s place of business. Wholesale sales to other retailers, also referred to as “jobber sales,” are recorded upon shipment of the merchandise from a regional DC with same-day delivery to the jobber customer’s location. Internet retail sales are recorded when the merchandise is shipped or when the merchandise is picked up in a store. All sales are recorded net of estimated returns allowances, discounts and taxes.
The Company maintains a retail loyalty program named O’Reilly O’Rewards, designed to build brand recognition. The program allows a retail customer to enroll at no charge, does not impose a membership fee and provides members with the ability to earn loyalty points by making qualifying purchases at the Company’s stores. Upon reaching established thresholds, the members are automatically issued coupons, which expire 90 days after issuance, have no cash value and may be redeemed for most items in the Company’s stores with a total purchase price equal to or greater than the value of the coupon. Points accrued in a member’s account, which have not been awarded to the member with a coupon, expire 12 months after the date that they were earned. The Company records a deferred revenue liability, based on a breakage adjusted estimated redemption rate, and a corresponding reduction in revenue in periods when loyalty points are earned by members. The Company recognizes revenue and a corresponding reduction to the deferred revenue liability in periods when loyalty program issued coupons are redeemed by members.
As of December 31, 2016 and 2015, the Company had recorded a deferred revenue liability of $4.8 million and $7.2 million, respectively, related to its loyalty program, which were included as a component of “Other liabilities” in the accompanying Consolidated Balance Sheets. During the year ended December 31, 2016 and 2015, the Company recognized $12.7 million and $11.2 million, respectively, of deferred revenue related to its loyalty program.
Cost of goods sold and selling, general and administrative expenses:
The following table illustrates the primary costs classified in each major expense category:
Operating leases:
The Company recognizes rent expense on a straight-line basis over the lease terms of its stores, DCs and corporate offices. Generally, the lease term for stores and corporate offices is the base lease term and the lease term for DCs includes the base lease term plus certain renewal option periods, for which renewal is reasonably assured and failure to exercise the renewal option would result in a significant economic penalty. The Company’s policy is to amortize leasehold improvements associated with the Company’s operating leases over the lesser of the lease term or the estimated economic life of those assets. See Note 6 for further information concerning the Company’s operating leases.
Advertising expenses:
Advertising expense consists primarily of expenses related to the Company’s integrated marketing program, which includes television, radio, direct mail and newspaper distribution, in-store and online promotions, and sports and event sponsorships. The Company expenses advertising costs as incurred. The Company also participates in cooperative advertising arrangements with certain of its suppliers. Advertising expense, net of cooperative advertising allowances from suppliers that were incremental to the advertising program, specific to the product or event and identifiable for accounting purposes, total $83.0 million, $79.3 million and $79.0 million for the years ended December 31, 2016, 2015 and 2014, respectively, which were included as a component of “Selling, general and administrative expenses” on the accompanying Consolidated Statements of Income.
Share-based compensation and benefit plans:
The Company sponsors employee share-based benefit plans and employee and director share-based compensation plans. The Company recognizes compensation expense over the requisite service period for its share-based plans based on the fair value of the awards on the date of the grant, award or issuance. Share-based plans include stock option awards issued under the Company’s employee incentive plans and director stock plan, stock issued through the Company’s employee stock purchase plan and restricted stock awarded to employees and directors through other compensation plans. See Note 9 for further information concerning the Company’s share-based compensation and plans.
Pre-opening expenses:
Costs associated with the opening of new stores, which consist primarily of payroll and occupancy costs, are charged to “Selling, general and administrative expenses” on the accompanying Consolidated Statements of Income as incurred. Costs associated with the opening of new distribution centers, which consist primarily of payroll and occupancy costs, are included as a component of “Cost of goods sold, including warehouse and distribution expenses” on the accompanying Consolidated Statements of Income as incurred.
Interest expense:
The Company capitalizes interest costs as a component of construction in progress, based on the weighted-average interest rates incurred on its long-term borrowings. Total interest costs capitalized for the years ended December 31, 2016, 2015 and 2014, were $7.9 million, $7.4 million and $11.5 million, respectively, which were included in “Interest expense” on the accompanying Consolidated Statements of Income.
In conjunction with the issuance or amendment of long-term debt instruments, the Company incurs various costs, including debt registration fees, accounting and legal fees and underwriter and book runner fees. Debt issuance costs related to the Company’s long-term unsecured senior notes are recorded as a reduction of the principal amount of the corresponding unsecured senior notes. Debt issuance costs related to the Company’s unsecured revolving credit facility are recorded as an asset. These debt issuance costs have been deferred and are being amortized over the term of the corresponding debt instrument and the amortization expense is included as a component of “Interest expense” on the accompanying Consolidated Statements of Income. Deferred debt issuance costs totaled $10.6 million and $8.3 million, net of accumulated amortization, as of December 31, 2016 and 2015, respectively, of which $0.7 million and $1.2 million were included as a component of “Other assets, net” as of December 31, 2016 and 2015, respectively, with the remainder included in “Long-term debt” on the accompanying Consolidated Balance Sheets.
The Company issued its long-term unsecured senior notes at a discount. The original issuance discount on the senior notes is recorded as a reduction of the principal amount due for the corresponding senior notes and is accreted over the term of the applicable senior note, with the accretion expense included as a component of “Interest expense” on the accompanying Consolidated Statements of Income. Original issuance discounts, net of accretion, totaled $3.1 million and $2.9 million as of December 31, 2016 and 2015, respectively.
See Note 5 for further information concerning debt issuance costs and original issuance discounts associated with the Company’s issuances of long-term debt instruments.
Income taxes:
The Company accounts for income taxes using the liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on differences between the GAAP basis and tax basis of assets and liabilities using enacted tax rules and rates currently scheduled to be in effect for the year, in which the differences are expected to reverse. Tax carry forwards are also recognized in deferred tax assets and liabilities under this method. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period of the enactment date. The Company would record a valuation allowance against deferred tax assets to the extent it is more likely than not the amount will not be realized, based upon evidence available at the time of the determination and any change in the valuation allowance is recorded in the period of a change in such determination.
The Company did not establish a valuation allowance for deferred tax assets as of December 31, 2016 and 2015, as it was considered more likely than not that deferred tax assets were realizable through a combination of future taxable income, the realization of deferred tax liabilities and tax planning strategies. The Company regularly reviews its potential tax liabilities for tax years subject to audit. The
amount of such liabilities is based on various factors, such as differing interpretations of tax regulations by the responsible tax authority, experience with previous tax audits and applicable tax law rulings. Changes in the Company’s tax liability may occur in the future as its assessments change based on the progress of tax examinations in various jurisdictions and/or changes in tax regulations. In management’s opinion, adequate provisions for income taxes have been made for all years presented. The estimates of the Company’s potential tax liabilities contain uncertainties because management must use judgment to estimate the exposures associated with the Company’s various tax positions and actual results could differ from estimates. See Note 12 for further information concerning the Company’s income taxes.
Earnings per share:
Basic earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the fiscal period. Diluted earnings per share is calculated by dividing the weighted-average number of common shares outstanding plus the common stock equivalents associated with the potential impact of dilutive stock options. Certain common stock equivalents that could potentially dilute basic earnings per share in the future were not included in the fully diluted computation because they would have been antidilutive. Generally, stock options are antidilutive and excluded from the earnings per share calculation when the exercise price exceeds the market price of the common shares. See Note 13 for further information concerning the Company’s common stock equivalents.
New accounting pronouncements:
In May of 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standard Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). Under ASU 2014-09, an entity is required to follow a five-step process to determine the amount of revenue to recognize when promised goods or services are transferred to customers. ASU 2014-09 offers specific accounting guidance for costs to obtain or fulfill a contract with a customer. In addition, an entity is required to disclose sufficient information to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In August of 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date” (“ASU 2015-14”), to defer the effective date of ASU 2014-09 by one year. For public companies, ASU 2015-14 changes ASU 2014-09 to be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. These ASUs can be adopted retrospectively or as a cumulative-effective adjustment at the date of adoption, with early adoption allowed, but not before December 15, 2016. The Company will adopt this guidance beginning with its first quarter ending March 31, 2018. The Company has established a task force, composed of multiple functional groups inside of the Company, that is currently in the process of evaluating critical components of this new guidance and the potential impact of the guidance on the Company’s financial position, results of operations and cash flows. Based on the preliminary work completed, the Company is considering the potential implications of the new standard on the Company’s recognition of customer related accounts receivable, warranty costs that are not the responsibility of the Company’s suppliers, the application of the Company’s retail O’Rewards loyalty program and all applicable financial statement disclosures required by the new guidance. At this time, the task force has not completed its evaluation of the impact or means of adoption.
In February of 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). Under ASU 2016-02, an entity will be required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. For public companies, ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. The Company will adopt this guidance beginning with its first quarter ending March 31, 2019. The Company has established a task force, composed of multiple functional groups inside of the Company, that is currently in the process of evaluating critical components of this new guidance and the potential impact of the guidance on the Company’s financial position, results of operations and cash flows. Based on the preliminary work completed, the Company is considering the potential implications of the new standard on determining the discount rate to be used in valuing new and existing leases, the treatment of existing favorable and unfavorable lease agreements acquired in connection with previous acquisitions, procedural and operational changes that may be necessary to comply with the provisions of the guidance and all applicable financial statement disclosures required by the new guidance, all of which are areas that could potentially be impacted by adoption of the guidance. At this time, the task force has not completed its full evaluation; however, the Company believes the adoption of the new guidance will have a material impact on the total assets and total liabilities reported on the Company’s consolidated balance sheets.
In March of 2016, the FASB issued ASU No. 2016-06, “Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments” (“ASU 2016-06”). ASU 2016-06 clarifies the requirements for assessing whether contingent call or put options that can accelerate the payment of principal on debt instruments are clearly and closely related to the economic characteristics and risks of the debt hosts and requires entities to solely use the four-step decision sequence, which is already in existence, when assessing the embedded call or put options. For public companies, ASU 2016-06 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and can be adopted on a modified retrospective basis, with early adoption permitted. The Company will adopt this guidance beginning with its first quarter ending March 31, 2017. The application of this new guidance is not expected to have a material impact on the Company’s consolidated financial condition, results of operations or cash flows.
In March of 2016, the FASB issued ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). Under ASU 2016-09, several aspects of the accounting for share-based payment transactions, including tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows, were simplified. For public companies, ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, with early adoption permitted. ASU 2016-09 includes various adoption methods, depending on the guidance being adopted; amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements and forfeitures should be applied using a modified retrospective transition method, while the amendments related to the presentation of employee taxes paid on the statement of cash flows should be applied retrospectively, the amendments requiring recognition of excess tax benefits and deficiencies in the income statement should be applied prospectively, and amendments related to the presentation of excess tax benefits on the statement of cash flows should be applied either prospectively or retrospectively. The Company will adopt this guidance beginning with its first quarter ending March 31, 2017. The Company is in the process of evaluating the future impact this new guidance will have on its consolidated financial position, results of operations and cash flows, as well as which method of adoption is most appropriate. At this time, the Company anticipates the adoption of the new guidance will prospectively impact its reported provision for income taxes, net income, weighted-average common shares outstanding - assuming dilution and earnings per share - assuming dilution, as well as retrospectively and prospectively impact the Company’s reported net cash provided by/used in operating activities and net cash provided by/used in financing activities.
In June of 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). Under ASU 2016-13, businesses and other organizations are required to present financial assets, measured at amortized costs basis, at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis, such as trade receivables. The measurement of expected credit loss will be based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. For public companies, ASU 2016-13 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. The Company will adopt this guidance beginning with its first quarter ending March 31, 2020. The application of this new guidance is not expected to have a material impact on the Company’s consolidated financial condition, results of operations or cash flows.
In August of 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force)” (“ASU 2016-15”). ASU 2016-15 reduces the existing diversity in practice for eight specific parts on cash flow statement presentation and classification: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance (COLI) policies; distributions received from equity method investments; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. For public companies, ASU 2016-15 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and requires retrospective adoption, with early adoption permitted. The Company will adopt this guidance beginning with its first quarter ending March 31, 2018. The application of this new guidance is not expected to have a material impact on the Company’s consolidated financial condition, results of operations or cash flows.
In January of 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business” (“ASU 2017-01”). ASU 2017-01 revises the definition of a business in the Accounting Standards Codification and clarifies the guidance for determining whether the purchase or disposal of an asset or group of assets qualifies as the purchase or disposal of a business. For public companies, ASU 2017-01 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and requires prospective adoption, with early adoption permitted with certain conditions. The Company will adopt this guidance beginning with its first quarter ending March 31, 2018. The application of this new guidance is not expected to have a material impact on the Company’s consolidated financial condition, results of operations or cash flows.
In January of 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 eliminates the second step in the previous process for goodwill impairment testing; instead the test is now a one-step process that calls for goodwill impairment loss to be measured as the excess of the reporting unit’s carrying amount over its fair value. For public companies, ASU 2017-04 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period, and requires prospective adoption, with early adoption after January 1, 2017. The Company will adopt this guidance beginning with its first quarter ending March 31, 2019. The application of this new guidance is not expected to have a material impact on the Company’s consolidated financial condition, results of operations or cash flows.
NOTE 2 - FAIR VALUE MEASUREMENTS
Financial assets and liabilities measured at fair value on a recurring basis:
The Company’s marketable securities were accounted for as trading securities and the carrying amount of the Company’s marketable securities were included as a component of “Other assets, net” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015. The Company recorded an increase in fair value related to its marketable securities in the amount of $1.9 million for the
year ended December 31, 2016, and a decrease in the amount of $0.2 million for the year ended December 31, 2015, which were included in “Other income (expense)” on the accompanying Consolidated Statements of Income.
The tables below identify the estimated fair value of the Company’s marketable securities, determined by reference to quoted market prices (Level 1), as of December 31, 2016 and 2015 (in thousands):
Non-financial assets and liabilities measured at fair value on a nonrecurring basis:
Certain long-lived non-financial assets and liabilities may be required to be measured at fair value on a nonrecurring basis in certain circumstances, including when there is evidence of impairment. These non-financial assets and liabilities may include assets acquired in a business combination or property and equipment that are determined to be impaired. As of December 31, 2016 and 2015, the Company did not have any non-financial assets or liabilities that had been measured at fair value subsequent to initial recognition.
Fair value of financial instruments:
The carrying amounts of the Company’s senior notes are included in “Long-term debt” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015. See Note 5 for further information concerning the Company’s senior notes.
The table below identifies the estimated fair value of the Company’s senior notes, using the market approach. The fair values as of December 31, 2016 and 2015, were determined by reference to quoted market prices of the same or similar instruments (Level 2) (in thousands):
The accompanying Consolidated Balance Sheets include other financial instruments, including cash and cash equivalents, accounts receivable, amounts receivable from suppliers and accounts payable. Due to the short-term nature of these financial instruments, the Company believes that the carrying values of these instruments approximate their fair values.
NOTE 3 - PROPERTY AND EQUIPMENT
The following table identifies the types and balances of property and equipment included in “Property and equipment, at cost” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015, and includes the estimated useful lives for its types of property and equipment (in thousands, except original useful lives):
The Company recorded depreciation and amortization expense related to property and equipment in the amounts of $217.0 million, $203.4 million and $193.4 million for the years ended December 31, 2016, 2015 and 2014, respectively, which were primarily included as a component of “Selling, general and administrative expenses” on the accompanying Consolidated Statements of Income.
NOTE 4 - GOODWILL AND OTHER INTANGIBLES
Goodwill:
Goodwill is reviewed for impairment annually during the fourth quarter, or more frequently if events or changes in business conditions indicate that impairment may exist. Goodwill is not amortizable for financial statement purposes. The Company did not record any goodwill impairment during the years ended December 31, 2016 or 2015.
The carrying amount of the Company’s goodwill was included in “Goodwill” on the accompanying Consolidate Balance Sheets as of December 31, 2016 and 2015. During the year ended December 31, 2016 and 2015, the Company recorded an increase in goodwill of $28.3 million and $0.8 million, respectively, resulting from small acquisitions.
The following table identifies the changes in goodwill for the years ended December 31, 2016 and 2015 (in thousands):
As of December 31, 2016 and 2015, other than goodwill, the Company did not have any other indefinite-lived intangible assets.
Intangibles other than goodwill:
The following table identifies the components of the Company’s amortizable intangibles as of December 31, 2016 and 2015 (in thousands):
During the years ended December 31, 2016 and 2015, the Company recorded non-compete agreement assets in conjunction with small acquisitions in the amounts of $1.1 million and $0.2 million, respectively.
The Company recorded favorable lease assets in conjunction with the acquisition of CSK Auto Corporation (“CSK”); these favorable lease assets represent the values of operating leases acquired with favorable terms. These favorable leases had an estimated weighted-average remaining useful life of approximately 9.0 years as of December 31, 2016. For the years ended December 31, 2016, 2015 and 2014, the Company recorded amortization expense of $2.1 million, $2.7 million and $3.9 million, respectively, related to its amortizable intangible assets, which were included as a component of “Other assets, net” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015.
The Company recorded unfavorable lease liabilities in conjunction with the acquisition of CSK; these unfavorable lease liabilities represent the values of operating leases acquired with unfavorable terms. These unfavorable leases had an estimated weighted-average remaining useful life of approximately 3.7 years as of December 31, 2016. For the years ended December 31, 2016, 2015 and 2014, the Company recognized an amortized benefit of $2.1 million, $2.8 million and $3.7 million, respectively, related to these unfavorable operating leases, which were included as a component of “Other liabilities” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015.
The following table identifies the estimated amortization expense and benefit of the Company’s intangibles for each of the next five years as of December 31, 2016 (in thousands):
NOTE 5 - FINANCING
The following table identifies the amounts of the Company’s financing facilities, which were included in “Long-term debt” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015 (in thousands):
(1)
Net of unamortized discount of $1.4 million and $1.8 million as of December 31, 2016 and 2015, respectively, and debt issuance costs of $1.8 million and $2.3 million as of December 31, 2016 and 2015, respectively.
(2)
Net of unamortized discount of $0.2 million and $0.3 million as of December 31, 2016 and 2015, respectively, and debt issuance costs of $1.1 million and $1.3 million as of December 31, 2016 and 2015, respectively.
(3)
Net of unamortized discount of $0.7 million and $0.8 million as of December 31, 2016 and 2015, respectively, and debt issuance costs of $1.5 million and $1.7 million as of December 31, 2016 and 2015, respectively.
(4)
Net of unamortized discount of less than $0.1 million as of December 31, 2016 and 2015, and debt issuance costs of $1.6 million and $1.8 million as of December 31, 2016 and 2015, respectively.
(5)
Net of unamortized discount of $0.8 million as of December 31, 2016, and debt issuance costs of $3.9 million as of December 31, 2016.
The following table identifies the principal maturities of the Company’s financing facilities as of December 31, 2016 (in thousands):
Unsecured revolving credit facility:
On January 14, 2011, the Company entered into a credit agreement, as amended by Amendment No. 1 dated as of September 9, 2011, as further amended by Amendment No. 2 dated as of July 2, 2013, and as further amended by Amendment No. 3 dated as of June 18, 2015 (the “Credit Agreement”). The Credit Agreement provides for a $600 million unsecured revolving credit facility (the “Revolving Credit Facility”) arranged by Bank of America, N.A., which is scheduled to mature in July 2018. 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 under the Revolving Credit Facility. 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 $200 million.
As of December 31, 2016 and 2015, the Company had outstanding letters of credit, primarily to support obligations related to workers’ compensation, general liability and other insurance policies, in the amounts of $38.7 million and $37.5 million, respectively, reducing the aggregate availability under the Revolving Credit Facility by those amounts. As of December 31, 2016 and 2015, the Company had no outstanding borrowings under the Revolving Credit Facility.
Borrowings under the Revolving Credit Facility (other than swing line loans) bear interest, at the Company’s option, at the Base Rate or Eurodollar Rate (both as defined in the Credit Agreement) plus an applicable margin. Swing line loans made under the Revolving Credit Facility bear interest at the Base Rate plus the applicable margin for Base Rate loans. In addition, the Company pays a facility fee on the aggregate amount of the commitments in an amount equal to a percentage of such commitments. The interest rate margins and facility fee are based upon the better of the ratings assigned to the Company’s debt by Moody’s Investor Service, Inc. and Standard & Poor’s Ratings Services, subject to limited exceptions. As of December 31, 2016, based upon the Company’s credit ratings, its margin for Base Rate loans was 0.000%, its margin for Eurodollar Rate loans was 0.875% and its facility fee was 0.125%.
The Credit Agreement contains certain covenants, including limitations on indebtedness, a minimum consolidated fixed charge coverage ratio of 2.50 times and a maximum consolidated leverage ratio of 3.00 times. 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, six-times rent expense and excludes any premium or discount recorded in conjunction with the issuance of long-term debt. The consolidated fixed charge coverage ratio includes a calculation of earnings before interest, taxes, depreciation, amortization, rent and non-cash share-based compensation expense. Fixed charges include interest expense, capitalized interest and rent expense. In the event that the Company 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 lenders. As of December 31, 2016, the Company remained in compliance with all covenants under the Credit Agreement.
Senior notes:
On March 8, 2016, the Company issued $500 million aggregate principal amount of unsecured 3.550% Senior Notes due 2026 (“3.550% Senior Notes due 2026”) at a price to the public of 99.832% of their face value under its shelf registration statement with United Missouri Bank, N.A. (“UMB”) as trustee. Interest on the 3.550% Senior Notes due 2026 is payable on March 15 and September 15 of each year, which began with the first interest payment on September 15, 2016, and is computed on the basis of a 360-day year.
The Company has issued a cumulative $1.9 billion aggregate principal amount of unsecured senior notes, which are due between January 2021 and March 2026 with UMB as trustee. Interest on the senior notes, ranging from 3.550% to 4.875%, is payable semi-annually and is computed on the basis of a 360-day year.
The senior notes are guaranteed on a senior unsecured basis by each of the Company’s subsidiaries (“Subsidiary Guarantors”) that incurs or guarantees obligations under the Company’s Credit Agreement or under other credit facility or capital markets debt of the Company’s or any of the Company’s Subsidiary Guarantors. The guarantees are joint and several and full and unconditional, subject to certain customary automatic release provisions, including release of the Subsidiary Guarantor’s guarantee under the Company’s Credit Agreement
and certain other debt, or, in certain circumstances, the sale or other disposition of a majority of the voting power of the capital interest in, or of all or substantially all of the property of, the Subsidiary Guarantor. Each of the Subsidiary Guarantors is 100% owned, directly or indirectly, by the Company, and the Company has no independent assets or operations other than those of its subsidiaries. The only direct or indirect subsidiaries of the Company that would not be Subsidiary Guarantors would be minor subsidiaries. Neither the Company, nor any of its Subsidiary Guarantors, is subject to any material or significant restrictions on the Company’s ability to obtain funds from its subsidiaries by dividend or loan or to transfer assets from such subsidiaries, except as provided by applicable law. Each of the senior notes is subject to certain customary covenants, with which the Company complied as of December 31, 2016.
NOTE 6 - LEASING
The following table identifies the future minimum lease payments under all of the Company’s operating leases for each of the next five years and in the aggregate as of December 31, 2016 (in thousands):
See Note 11 for further information concerning the Company’s related party operating leases.
Operating lease commitments:
The Company leases certain office space, retail stores, property and equipment under long-term, non-cancelable operating leases. Most of these leases include renewal options and some include options to purchase, provisions for percentage rent based on sales and/or incremental step increase provisions.
The future minimum lease payments under the Company’s operating leases, in the table above, do not include potential amounts for percentage rent or other operating lease related costs and have not been reduced by expected future minimum sublease income. Expected future minimum sublease income under non-cancelable subleases is approximately $20.5 million at December 31, 2016.
The following table summarizes the net rent expense amounts for the years ended December 31, 2016, 2015 and 2014, which were included as a component of “Selling, general and administrative expenses” on the accompanying Consolidated Statements of Income (in thousands):
NOTE 7 - WARRANTIES
The Company’s product warranty liabilities are included in “Other current liabilities” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015. The following table identifies the changes in the Company’s aggregate product warranty liabilities for the years ended December 31, 2016 and 2015 (in thousands):
NOTE 8 - SHARE REPURCHASE PROGRAM
In January of 2011, the Company’s Board of Directors approved a share repurchase program. Under the program, the Company may, from time to time, repurchase shares of its 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. The Company’s 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, 2016, May 27, 2016, and November 16, 2016, the Company’s Board of Directors each time approved a resolution to increase the authorization amount under the share repurchase program by an additional $750 million, resulting in a cumulative authorization amount of $7.8 billion. Each additional authorization is effective for a three-year period, beginning on its respective announcement date.
The following table identifies shares of the Company’s common stock that have been repurchased as part of the Company’s publicly announced share repurchase program (in thousands, except per share data):
As of December 31, 2016, the Company had $887.8 million remaining under its share repurchase program. Subsequent to the end of the year and through February 28, 2017, the Company repurchased an additional 1.4 million shares of its common stock under its share repurchase program, at an average price of $267.32, for a total investment of $387.5 million. The Company has repurchased a total of 58.4 million shares of its common stock under its share repurchase program since the inception of the program in January of 2011 and through February 28, 2017, at an average price of $124.14, for a total aggregate investment of $7.2 billion.
NOTE 9 - SHARE-BASED COMPENSATION AND BENEFIT PLANS
The Company recognizes share-based compensation expense based on the fair value of the grants, awards or shares at the time of the grant, award or issuance. Share-based compensation includes stock option awards issued under the Company’s employee incentive plans and director stock plan, restricted stock awarded under the Company’s employee incentive plans, performance incentive plan and director stock plan, stock issued through the Company’s employee stock purchase plan and stock awarded to employees through other benefit programs.
The table below identifies the shares that have been authorized for issuance and the shares available for future issuance under the Company plans, as of December 31, 2016 (in thousands):
Stock options:
The Company’s employee incentive plans provide for the granting of stock options for the purchase of common stock of the Company to certain key employees of the Company. Employee stock options are granted at an exercise price that is equal to the closing market price of the Company’s common stock on the date of the grant. Employee stock options granted under the plans expire after ten years and typically vest 25% per year, over four years. The Company records compensation expense for the grant date fair value of the option awards, adjusted for estimated forfeitures, evenly over the minimum required service period.
The table below identifies the employee stock option activity under these plans during the year ended December 31, 2016:
The Company’s director stock plan provides for the granting of stock options for the purchase of common stock of the Company to directors of the Company. Director stock options are granted at an exercise price that is equal to the closing market price of the Company’s common stock on the date of the grant. Director stock options granted under the plans expire after seven years and vest fully after six months. The Company records compensation expense for the grant date fair value of the option awards evenly over the vesting period.
The table below identifies the director stock option activity under this plan during the year ended December 31, 2016:
The fair value of each stock option award is estimated on the date of the grant using the Black-Scholes option pricing model. The Black-Scholes model requires the use of assumptions, including the risk free rate, expected life, expected volatility and expected dividend yield.
•
Risk-free interest rate - The United States Treasury rates in effect at the time the options are granted for the options’ expected life.
•
•
Expected life - Represents the period of time that options granted are expected to be outstanding. The Company uses historical experience to estimate the expected life of options granted.
•
Expected volatility - Measure of the amount, by which the Company’s stock price is expected to fluctuate, based on a historical trend.
•
Expected dividend yield - The Company has not paid, nor does it have plans in the foreseeable future to pay, any dividends.
The table below identifies the weighted-average assumptions used for grants awarded during the years ended December 31, 2016, 2015 and 2014:
The Company’s forfeiture rate is the estimated percentage of options awarded that are expected to be forfeited or canceled prior to becoming fully vested. The Company’s estimate is evaluated periodically and is based upon historical experience at the time of evaluation and reduces expense ratably over the vesting period or the minimum required service period.
The following table summarizes activity related to stock options awarded by the Company for the years ended December 31, 2016, 2015 and 2014:
At December 31, 2016, the remaining unrecognized compensation expense related to unvested stock option awards was $26.4 million, and the weighted-average period of time, over which this cost will be recognized, is 2.6 years.
Restricted stock:
The Company’s performance incentive plans provide for the award of shares of restricted stock to its corporate and senior management that vest evenly over a three-year period and are held in escrow until such vesting has occurred. Generally, unvested shares are forfeited when an employee ceases employment. The fair value of shares awarded under these plans is based on the closing market price of the Company’s common stock on the date of award and compensation expense is recorded over the minimum required service period.
The table below identifies the employee restricted stock activity under these plans during the year ended December 31, 2016 (in thousands, except per share data):
(1)
Includes two thousand shares withheld to cover employees’ taxes upon vesting.
The Company’s director stock plan provides for the award of shares of restricted stock to the directors of the Company that vest evenly over a three-year period and are held in escrow until such vesting has occurred. Unvested shares are forfeited when a director ceases their service on the Company’s Board of Directors for reasons other than death or retirement. The fair value of shares awarded under this plan is based on the closing market price of the Company’s common stock on the date of award, and compensation expense is recorded evenly over the vesting period.
The table below identifies the director restricted stock activity under this plan during the year ended December 31, 2016 (in thousands, except per share data):
The following table summarizes activity related to restricted stock awarded by the Company for the years ended December 31, 2016, 2015 and 2014 (in thousands, except per share data):
At December 31, 2016, the remaining unrecognized compensation expense related to unvested restricted share awards was $0.9 million, and the weighted-average period of time, over which this cost will be recognized, is 0.1 years.
Employee stock purchase plan:
The Company’s employee stock purchase plan (the “ESPP”) permits eligible employees to purchase shares of the Company’s common stock at 85% of the fair market value. Employees may authorize the Company to withhold up to 5% of their annual salary to participate in the plan. The fair value of shares issued under the ESPP is based on the average of the high and low market prices of the Company’s common stock during the offering periods. Compensation expense is recognized based on the discount between the grant-date fair value and the employee purchase price for the shares sold to employees.
The following table summarizes activity related to the Company’s ESPP for the years ended December 31, 2016, 2015 and 2014 (in thousands, except per share data):
Profit sharing and savings plan:
The Company sponsors a contributory profit sharing and savings plan (the “401(k) Plan”) that covers substantially all employees who are at least 21 years of age and have completed one year of service. The Company makes matching contributions equal to 100% of the first 2% of each employee’s wages that are contributed and 25% of the next 4% of each employee’s wages that are contributed. An employee generally must be employed on December 31 to receive that year’s Company matching contribution, with the matching contribution funded annually at the beginning of the subsequent year following the year in which the matching contribution was earned.
The Company may also make additional discretionary profit sharing contributions to the plan on an annual basis as determined by the Board of Directors. The Company did not make any discretionary contributions to the 401(k) Plan during the years ended December 31, 2016, 2015 or 2014. The Company expensed matching contributions under the 401(k) Plan in the amounts of $20.6 million, $18.5 million and $16.8 million for the years ended December 31, 2016, 2015 and 2014, respectively, which were included as a component of “Selling, general and administrative expenses” on the accompanying Consolidated Statements of Income.
Nonqualified deferred compensation plan:
The Company sponsors a nonqualified deferred compensation plan (the “Deferred Compensation Plan”) for highly compensated employees whose contributions to the 401(k) Plan are limited due to the application of the annual limitations under the Internal Revenue Code. The Deferred Compensation Plan provides these employees with the opportunity to defer the full 6% of matched compensation, including salary and incentive based compensation, that was precluded under the Company’s 401(k) Plan, which is then matched by the Company using the same formula as the 401(k) Plan. An employee generally must be employed on December 31 to receive that year’s Company matching contribution, with the matching contribution funded annually at the beginning of the subsequent year following the year in which the matching contribution was earned. In the event of bankruptcy, the assets of this plan are available to satisfy the claims of general creditors. The Company has an unsecured obligation to pay, in the future, the value of the deferred compensation and Company match, adjusted to reflect the performance, whether positive or negative, of selected investment measurement options chosen by each participant during the deferral period. The liability for compensation deferred under the Deferred Compensation Plan was $20.5 million and $16.9 million as of December 31, 2016 and 2015, respectively, which were included as a component of “Other liabilities” on the Consolidated Balance Sheets. The Company expensed matching contributions under the Deferred Compensation Plan in the amounts of $0.1 million, $0.1 million and $0.2 million for the years ended December 31, 2016, 2015 and 2014, respectively, which were included as a component of “Selling, general and administrative expenses” on the accompanying Consolidated Statements of Income.
NOTE 10 - COMMITMENTS
Construction commitments:
As of December 31, 2016, the Company had construction commitments in the amount of $79.6 million.
Letters of credit commitments:
As of December 31, 2016, the Company had outstanding letters of credit, primarily to satisfy workers’ compensation, general liability and other insurance policies, in the amount of $38.7 million. See Note 5 for further information concerning the Company’s letters of credit commitments.
Debt financing commitments:
The Company’s senior notes are redeemable in whole, at any time, or in part, from time to time, at the Company’s option upon not less than 30 nor more than 60 days notice at a redemption price, plus any accrued and unpaid interest to, but not including the redemption date, equal to the greater of (i) 100% of the principal amount thereof or (ii) the sum of the present value of the remaining scheduled payments of principal and interest thereon discounted to the redemption date on a semiannual basis at the applicable Treasury Yield plus basis points identified in the indentures governing the notes. In addition, if at any time the Company undergoes a Change of Control Triggering Event, as defined in the indentures governing the notes, the holders may require the Company to repurchase all or a portion of their senior notes at a price equal to 101% of the principal amount of the notes being repurchased, plus accrued and unpaid interest, if any, but not including the repurchase date. See Note 5 for further information concerning the Company’s debt financing commitments.
Self-insurance reserves:
The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for Team Member health care benefits, workers’ compensation, vehicle liability, general liability and property loss. With the exception of certain Team Member health care benefit liabilities, employment related claims and litigation, certain commercial litigation and certain regulatory matters, the Company obtains third-party insurance coverage to limit its exposure to this obligation.
NOTE 11 - RELATED PARTIES
The Company leases certain land and buildings related to 75 of its O’Reilly Auto Parts stores under fifteen- or twenty-year operating lease agreements with entities, in which certain of the Company’s affiliated directors, or members of an affiliated director’s immediate family, and an executive officer of the Company are affiliated. Generally, these lease agreements provide for renewal options for an additional five years at the option of the Company and the lease agreements are periodically modified to further extend the lease term for specific stores under the agreements. Lease payments under these operating leases totaled $4.5 million, $4.5 million and $4.6 million during the years ended December 31, 2016, 2015 and 2014, respectively. The Company believes that the lease agreements with the affiliated entities are on terms comparable to those obtainable from third parties. See Note 6 for further information concerning the Company’s operating leases.
NOTE 12 - INCOME TAXES
Deferred income tax assets and liabilities:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and also include the tax effect of carryforwards.
The following table identifies significant components of the Company’s net deferred tax liabilities included in “Deferred income taxes” on the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015 (in thousands):
Provision for income taxes:
The following tables reconcile the amounts included in “Provision for income taxes” on the accompanying Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014 (in thousands):
The following table outlines the reconciliation of the “Provision for income taxes” amounts included on the accompanying Consolidated Statements of Income to the amounts computed at the federal statutory rate for the years ended December 31, 2016, 2015 and 2014 (in thousands):
The excess tax benefit associated with the exercise of non-qualified stock options has been included within “Additional paid-in capital” on the accompanying Consolidated Balance Sheets.
As of December 31, 2016, the Company had tax credit carryforwards available for state tax purposes, net of federal impact, in the amount of $9.4 million. As of December 31, 2016, the Company had net operating loss carryforwards available for state purposes in the amount of $9.8 million. The Company’s state net operating loss carryforwards generally expire in years ranging from 2022 to 2028, and the Company’s tax credits generally expire in 2024.
Unrecognized tax benefits:
The following table summarizes the changes in the gross amount of unrecognized tax benefits, excluding interest and penalties, for the years ended December 31, 2016, 2015 and 2014 (in thousands):
For the years ended December 31, 2016, 2015 and 2014, the Company recorded a reserve for unrecognized tax benefits, including interest and penalties, in the amounts of $40.6 million, $43.6 million and $58.4 million, respectively. All of the unrecognized tax benefits recorded as of December 31, 2016, 2015 and 2014, respectively, would affect the Company’s effective tax rate if recognized, generally net of the federal tax effect of approximately $13.8 million. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2016, 2015 and 2014, the Company had accrued approximately $5.8 million, $6.7 million and $8.8 million, respectively, of interest and penalties related to uncertain tax positions before the benefit of the deduction for interest on state and federal returns. During the years ended December 31, 2016, 2015 and 2014, the Company recorded tax expense related to an increase in its liability for interest and penalties in the amounts of $2.4 million, $2.8 million and $2.8 million, respectively. Although unrecognized tax benefits for individual tax positions may increase or decrease during 2017, the Company expects a reduction of $7.4 million of unrecognized tax benefits during the one-year period subsequent to December 31, 2016, resulting from settlement or expiration of the statute of limitations.
The Company’s United States federal income tax returns for tax years 2015 and beyond remain subject to examination by the Internal Revenue Service (“IRS”). The IRS concluded an examination of the O’Reilly consolidated 2012 and 2013 federal income tax returns in the second quarter of 2015. The statute of limitations for the Company’s federal income tax returns for tax years 2012 and prior expired on September 15, 2016. The statute of limitations for the Company’s U.S. federal income tax return for 2013 will expire on September 15, 2017, unless otherwise extended. The IRS is currently conducting an examination of the Company’s consolidated returns for tax years 2014 and 2015. The Company’s state income tax returns remain subject to examination by various state authorities for tax years ranging from 2005 through 2015.
NOTE 13 - EARNINGS PER SHARE
The following table illustrates the computation of basic and diluted earnings per share for the years ended December 31, 2016, 2015 and 2014 (in thousands, except per share data):
(1)
See Note 9 for further information concerning the terms of the Company’s share-based compensation plans.
Subsequent to the end of the year and through February 28, 2017, the Company repurchased 1.4 million shares of its common stock, at an average price of $267.32, for a total investment of $387.5 million.
NOTE 14 - LEGAL MATTERS
As previously reported, the Company received a subpoena from the District Attorney of the County of Alameda, along with other environmental prosecutorial offices in the state of California, seeking documents and information related to the handling, storage and disposal of hazardous waste. On November 30, 2016, the Company through its affiliates, entered into a Stipulation for Entry of Final Judgment and Permanent Injunction, including certain injunctive and monetary relief within the previously established accruals.
As previously reported, on June 18, 2015, a jury in Greene County, Missouri returned an unfavorable verdict in a litigated contract dispute in the matter Meridian Creative Alliance vs. O’Reilly Automotive Stores, Inc. et. al. in the amount of $12.5 million. The Company strongly believes that the verdict was unjust and unsupported by the law and the underlying facts and, further, that there are several potential bases for reversal on appeal. The Company has vigorously challenged the verdict in the Court of Appeals. Following the matter being fully briefed by the parties, oral argument was held in the Court of Appeals on January 12, 2017. The Court currently has the matter under consideration. As of December 31, 2016, the Company had reserved $18.6 million with respect to this matter.
NOTE 15 - QUARTERLY RESULTS (Unaudited)
The following tables set forth certain quarterly unaudited operating data for the fiscal years ended December 31, 2016 and 2015. The unaudited quarterly information includes all adjustments, which the Company considers necessary for a fair presentation of the information shown (in thousands, except per share data):
(1)
Earnings per share amounts are computed independently for each quarter and annual period. The quarterly earnings per share amounts may not sum to equal the full-year earnings per share amount.
The unaudited operating data presented above should be read in conjunction with the Company’s consolidated financial statements and related notes, and the other financial information included therein.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the management of O’Reilly Automotive, Inc. and Subsidiaries (the “Company”), under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) and as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company, including its consolidated subsidiaries, in reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
CHANGES IN INTERNAL CONTROLS
There were no changes in the Company’s internal control over financial reporting during the fiscal quarter ended December 31, 2016, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer and effected by the Company’s Board of Directors, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13(a)-15(f) or 15(d)-15(f) under the Exchange Act. The Company’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
Internal control over financial reporting includes all policies and procedures that
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management recognizes that all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to risk. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013 framework). Based on this assessment, management believes that as of December 31, 2016, the Company’s internal control over financial reporting was effective based on those criteria.
Ernst & Young LLP, Independent Registered Public Accounting Firm, has audited the Company’s consolidated financial statements and has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting, which is included in Item 8.
Item 9B. Other Information
Not Applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Certain information required by Part III is incorporated by reference from O’Reilly Automotive, Inc. and Subsidiaries’ (the “Company”) Proxy Statement on Schedule 14A for the 2017 Annual Meeting of Shareholders (“Proxy Statement”), which will be filed with the Securities and Exchange Commission (the “SEC”) within 120 days of the end of the Company’s most recent fiscal year. Except for those portions specifically incorporated in this Annual Report on Form 10-K by reference to the Company’s Proxy Statement, no other portions of the Proxy Statement are deemed to be filed as part of this Annual Report on Form 10-K.
Directors and Officers:
The information regarding the directors of the Company will be included in the Company’s Proxy Statement under the caption “Proposal 1 - Election of Directors” and “Information Concerning the Board of Directors” and is incorporated herein by reference. The Proxy Statement will be filed with the SEC within 120 days of the end of the Company’s most recent fiscal year. The information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I, in accordance with General Instruction G(3) to Form 10-K, for the Company’s executive officers who are not also directors.
Section 16(a) of the Securities Exchange Act of 1934, as amended:
The information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), required by Item 405 of Regulation S-K, will be included in the Company’s Proxy Statement under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference.
Code of Ethics:
The Company’s Board of Directors has adopted a code of ethics that applies to all of its directors, officers (including its chief executive officer, chief operating officer, chief financial officer, chief accounting officer, controller and any person performing similar functions), and Team Members. The Company’s Code of Ethics is available on its website at www.oreillyauto.com, under the “Corporate Home” caption. The information on the Company’s website is not a part of this Annual Report on Form 10-K and is not incorporated by reference in this report or any of the Company’s other filings with the SEC.
Corporate Governance:
The Corporate Governance/Nominating Committee of the Board of Directors does not have a written policy on the consideration of Director candidates recommended by shareholders. It is the view of the Board of Directors that all candidates, whether recommended by a shareholder or the Corporate Governance/Nominating Committee, shall be evaluated based on the same established criteria for persons to be nominated for election to the Board of Directors and its committees.
The Board of Directors has established an Audit Committee pursuant to Section 3(a)(58)(A) of the Exchange Act. The Audit Committee currently consists of Jay D. Burchfield, Thomas T. Hendrickson, Paul R. Lederer, John R. Murphy and Ronald Rashkow, each an independent director in accordance with The Nasdaq Stock Market Marketplace Rule 5605(a)(2), the standards of Rule 10A-3 of the Exchange Act and the requirements of The Nasdaq Stock Market Marketplace Rule 5605(c)(2). In addition, our Board of Directors has determined that Mr. Murphy, Chairman of the Audit Committee, qualifies as an audit committee financial expert under Item 407(d)(5) of Regulation S-K.
Item 11. Executive Compensation
Director and Officer Compensation:
The information required by Item 402 of Regulation S-K will be included in O’Reilly Automotive, Inc. and Subsidiaries’ (the “Company”) Proxy Statement on Schedule 14A for the 2017 Annual Meeting of Shareholders (“Proxy Statement”) under the captions “Compensation of Executive Officers” and “Compensation of Directors” and is incorporated herein by reference.
Compensation Committee:
The information required by Item 407(e)(4) and (e)(5) of Regulation S-K will be included in the Company’s Proxy Statement under the captions “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 201(d) of Regulation S-K will be included in O’Reilly Automotive, Inc. and Subsidiaries’ (the “Company”) Proxy Statement on Schedule 14A for the 2017 Annual Meeting of Shareholders (“Proxy Statement”) under the caption “Equity Compensation Plans” and is incorporated herein by reference.
The information required by Item 403 of Regulation S-K will be included in the Company’s Proxy Statement under the captions “Security Ownership of Certain Beneficial Owners” and “Security Ownership of Directors and Management” and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 404 of Regulation S-K will be included in the O’Reilly Automotive, Inc. and Subsidiaries’ (the “Company”) Proxy Statement on Schedule 14A for the 2017 Annual Meeting of Shareholders (“Proxy Statement”) under the caption “Certain Relationships and Related Transactions” and is incorporated herein by reference.
The information required by Item 407(a) of Regulation S-K will be included in the Company’s Proxy Statement under the caption “Director Independence” and is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
The information required by Item 9(e) of Schedule 14A will be included in O’Reilly Automotive, Inc. and Subsidiaries’ Proxy Statement on Schedule 14A for the 2017 Annual Meeting of Shareholders under the caption “Fees Paid to Independent Registered Public Accounting Firm” and is incorporated herein by reference.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a)
The following documents are filed as part of this Annual Report on Form 10-K:
1.
Financial Statements - O’Reilly Automotive, Inc. and Subsidiaries
The following consolidated financial statements of O’Reilly Automotive, Inc. and Subsidiaries included in the Annual Shareholders’ Report of the registrant for the year ended December 31, 2016, are filed with this Annual Report in Part II, Item 8:
Management’s Report on Internal Control over Financial Reporting
Report of Independent Registered Public Accounting Firm - Internal Control over Financial Reporting
Report of Independent Registered Public Accounting Firm - Financial Statements
Consolidated Balance Sheets as of December 31, 2016 and 2015
Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014
Notes to Consolidated Financial Statements for the years ended December 31, 2016, 2015 and 2014
2.
Financial Statement Schedules - O’Reilly Automotive, Inc. and Subsidiaries
The following consolidated financial statement schedule of O’Reilly Automotive, Inc. and Subsidiaries is included in Item 15(a):
Schedule II - Valuation and qualifying accounts
All other schedules, for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission, are not required under the related instructions or are inapplicable, and therefore have been omitted.
3.
Exhibits
See Exhibit Index beginning on page E-1.
Item 16. Form 10-K Summary
Not applicable.
O’REILLY AUTOMOTIVE, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
(1)
Uncollectable accounts written off.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
O’REILLY AUTOMOTIVE, INC.
(Registrant)
Date:
February 28, 2017
By:
/s/
Greg L. Henslee
Greg L. Henslee
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Date:
February 28, 2017
/s/
David O’Reilly
/s/
Charles H. O’Reilly Jr.
David O’Reilly
Charles H. O’Reilly Jr.
Director and Chairman of the Board
Director and Vice Chairman of the Board
/s/
Larry O’Reilly
/s/
Rosalie O’Reilly Wooten
Larry O’Reilly
Rosalie O’Reilly Wooten
Director and Vice Chairman of the Board
Director
/s/
Jay D. Burchfield
/s/
Thomas T. Hendrickson
Jay D. Burchfield
Thomas T. Hendrickson
Director
Director
/s/
Paul R. Lederer
/s/
John R. Murphy
Paul R. Lederer
John R. Murphy
Director
Director
/s/
Ronald Rashkow
/s/
Greg L. Henslee
Ronald Rashkow
Greg L. Henslee
Director
Chief Executive Officer
(Principal Executive Officer)
/s/
Thomas McFall
Thomas McFall
Executive Vice President of Finance and
Chief Financial Officer
(Principal Financial and Accounting Officer)
EXHIBIT INDEX
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EXHIBIT INDEX (continued)
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EXHIBIT INDEX (continued)
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