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

Thank you, GeeGee. Good morning, everyone, and thank you for joining us. During today's conference call, we will discuss our fourth quarter 2020 results and our outlook for 2021. After our prepared comments, we'll host a question-and-answer period. Before we begin this morning, I'd like to remind everyone that our comments today contain forward-looking statements, and we intend to be covered by and we claim the protection under the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You can identify these statements by forward-looking words such as estimate, may, could, will, believe, expect, would, consider, should, anticipate, project, plan, intend or similar words. The company's actual results could differ materially from any forward-looking statements due to several important factors described in the company's latest annual report on Form 10-K for the year ended December 31, 2019, and other recent SEC filings. The company assumes no obligation to update any forward-looking statements made during this call. At this time, I'd like to introduce Greg Johnson.

Thanks, Tom. Good morning, everyone, and welcome to the O'Reilly Auto Parts fourth quarter conference call. Participating on the call with me this morning are Jeff Shaw, our Chief Operating Officer and Co-President; Tom McFall, our Chief Financial Officer; David O'Reilly, our Executive Chairman; and Greg Henslee, our Executive Vice Chairman are also present on the call. To begin today's call, I would like to congratulate team O'Reilly on delivering a truly remarkable year in 2020. At this time last year, when we first provided our outlook for 2020, we could never have anticipated the challenges we would face during the year. The COVID-19 pandemic has disrupted every facet of daily life in the United States and has required our teams to show tremendous flexibility in executing our business model and taking care of our customers. There simply aren't words to describe the selfless dedication, hard work and sacrifices our team members in our stores, distribution centers, and offices demonstrated during 2020. From the onset of the pandemic, we have closely monitored and quickly adapted to the evolving information, recommendations, and requirements issued by public health agencies and state and local governments, as we continually update our protocols and procedures to ensure best practices are followed. Our top priority continues to be the protection of the health and safety of our team members and customers while meeting the critical needs of our customers as an essential service provider. Before I move on to the rest of our prepared comments today, I want to thank team O'Reilly for your amazing dedication and performance during an incredibly challenging and successful 2020. The bedrock of our company's success since our founding 63 years ago has been providing excellent customer service, and never has the value we provide to our customer been more evident than during the past year. Our team consistently stepped up to the plate to meet our customers’ critical needs in the midst of extremely challenging circumstances and delivered record-breaking results in 2020, highlighted by full-year comparable store sales growth of 10.9% and an annual operating profit of 26%. 2020 represents our 28th consecutive year of comparable store sales growth, record revenue and operating income of none of the 27 preceding years was anything like 2020. Now we will cover our fourth quarter results and the full-year expectations supporting our 2021 guidance. Our comparable store sales for the fourth quarter grew at 11.2%. As we discussed on the last two quarter calls, we anticipated that sales were to return to a level which was closer to our expectations from the record-setting pace we saw in the middle of the year. However, we remain pleased with how steady and elevated our sales have been. From a cadence perspective, after starting the quarter on a strong trend, as noted on our last conference call, we saw sales moderate somewhat in November but finished December with the strongest performance of the quarter, as we saw our robust underlying sales trends supplemented by a benefit from cold weather categories. The composition of our strong sales performance in the fourth quarter continued the trends we’ve experienced in the past two quarters with our DIY business being a stronger contributor during the quarter, driven by robust increases in both ticket count comps and average ticket comps. However, our professional business also performed well and strengthened as we progressed through the quarter. Our average ticket growth in the quarter and full year 2020 exceeded our expectations, despite a limited benefit from inflation, indicating a continued ability and willingness of our customers to work on larger projects. From a category standpoint, we continue to see broad-based, robust sales trends across all categories with very strong performance in our DIY outfront categories and batteries. Even in an environment of pressure on total miles driven as a result of the pandemic, we saw continued brisk sales in our undercar hard part categories. As we look forward to 2021, we remain very confident about the health of the automotive aftermarket. And we're monitoring several potential tailwinds and headwinds that affect our outlook for the coming year. While it is impossible to quantify the exact impact of the various factors that drove the surge in volume we experienced in 2020, we believe our industry benefited from several positive tailwinds that contributed to our extremely strong performance. In the early stages of the pandemic, government stimulus payments and enhanced unemployment benefits under the CARES Act provided immediate demand in our markets and have helped shore up the U.S. consumer, even in the face of increased unemployment. However, the strength of demand in our industry has stayed very strong throughout 2020. And it is also clear that we've benefited from an increased willingness by DIY consumers to invest in repairing and maintaining their vehicles for a number of reasons. As we've seen repeatedly in previous economic cycles, the current economic uncertainty drives consumers to defer new car purchases and invest in keeping their existing vehicles on the road. The trend in 2020 for DIYers to take on larger jobs reflects this renewed focus on addressing underperformed maintenance. We also believe the strength we've seen in what have typically been more discretionary appearance and accessory categories reflects a shift in consumers allocating more of their time and spend to their vehicles and away from spending on other activities not possible during the pandemic. As we evaluate the staying power of increased demand and we've seen on the DIY side of our business in 2020, we remain cautious knowing that some of those tailwinds to automotive aftermarket demand may soften as we move further past the economic disruption brought on by the pandemic. However, we have been encouraged by how resilient the strong sales trends have been as we've moved past the injection of additional dollars into the economy and remain confident that consumers will continue to see value in repairing and maintaining their vehicles in a difficult economic environment, as we've seen during similar periods in our history. We've also been pleased with our performance even in the face of declines in miles driven in the U.S., driven by decreased employment and increased work-from-home arrangements, as well as a slower pace of economic activity. The performance of our professional business took longer to stabilize after the initial pandemic shutdowns due to the consumers' initial reluctance to take their vehicle to a professional installer shop for repairs, and the demographics of the consumers on this side of the business, making them more likely to work-from-home and drive less. The professional business began to turn around in May and delivered solid above-plan results for the third and fourth quarters. However, for the full year, our professional business was below our expectations. While sustained pressure to miles driven is a long-term negative for the business, we're encouraged that we've performed well in the current environment and believe we will benefit as miles driven returns to historical norms post-pandemic. While it is evident that these positive tailwinds have also benefited the entire automotive aftermarket, our extremely strong results in 2020 were also driven by significant share gains. We offer a compelling value proposition to our customers, providing excellent customer service through a well-equipped, technically proficient team of professional parts personnel, leveraging industry-leading parts availability. The strength of this business model and our team who work tirelessly to keep our stores open, stocked, and supplied was and continues to be a huge advantage in an incredibly difficult environment, and differentiates us from the experience offered by some of our competitors and big box stores. Each new customer is hard-won and our team remains committed to delivering on the promise of outstanding customer service in each store every day. We're confident the goodwill we've created for meeting our customers essential needs during this crisis will drive customer loyalty and earn their repeat business. As we have thought through the dynamics of demand in our industry and our performance over the last several quarters with a focus on looking forward to 2021, we remain confident in the strength of our industry and the ability for our team to continue to produce strong top-line sales. However, we have experienced a tremendous surge in our business after the initial onset of the pandemic, and we remain cautious as we plan for the coming year in anticipation of continued significant uncertainty and the potential for volatility in our results. On the professional side of our business, we expect solid performance throughout the year as we anticipate our current momentum to continue as miles driven continues to rebound. However, on the DIY side of the business, we face extremely difficult comparisons beginning in April, as we left the biggest surge in demand in a short period of time in our company's history. As a result, we are guiding to a comparable store sales range of down 2% to flat versus comparable store sales growth of 10.9% in 2020, with the most significant pressure in that outlook expected for the second and third quarters as we left the record volumes. Thus far in 2021, we have been pleased with our results, as our strong sales trends have continued, and we've benefited from additional government stimulus and favorable winter weather. For 2021, we are reinstating our practice of providing selected annual guidance. As we move through 2021, we anticipate we’ll face significant quarter-to-quarter uncertainty, as the broader impact of recovery from the pandemic is difficult to predict. The potential volatility, coupled with dramatic different comparisons to the unique business trends we saw play out in 2020, makes it extremely difficult to project the timing and cadence of our business with a high degree of certainty. As a result, we're limiting our guidance to expectations for the full year of 2021 and not providing guidance for individual quarters. As a final note on our outlook, our guidance doesn't incorporate any further benefits from additional government stimulus or unemployment benefits since the timing and ultimate impact of these measures is difficult to project. As we move through 2021, we will update our annual guidance as appropriate, as we could see more significant volatility than we have historically as our industry and the U.S. economy charts a course out of this pandemic. Moving on to gross margin. For the fourth quarter our gross margin of 52% was a 131-basis point decrease from the fourth quarter of 2019 gross margin. The reduction from last year was driven by a reduced LIFO benefit from the impact of merchandise purchased in 2019 before tariff-related cost increases, as well as the planned, expected dilution from Mayasa. Both impacts are consistent with the pressure experienced in the third quarter and in-line with our expectations. As a reminder, on the tariff cost impact through 2019, we received a gross margin benefit from the sell-through of pre-tariff, on-hand inventory that was purchased prior to the tariff-driven acquisition price increases in 2018 and 2019, and we have experienced headwinds in the back half of 2020 as we compare it against this 2019 benefit. We also experienced headwinds to gross margin in the fourth quarter related to the expiration of certain tariff exclusions we had received in the back half of 2019 that expired in 2020. For the full year, gross margin came in at 52.4%. And for 2021, we expect our gross margin to be in the range of 52.2% to 52.7%. For the quarter, earnings per share of $5.40 represents an increase of 27% over $4.25 in the fourth quarter of 2019. For the full year earnings per share were $23.53, which represents a 32% increase over 2019. For 2021, our guidance is $22.70 to $22.90, representing a decrease of 3% versus 2020 at the midpoint. However, on a two-year compounded annual growth rate basis compared to 2019, our expected 2021 diluted earnings per share represents a forecasted annual increase of 12.9%. Our EPS guidance includes the impact of shares repurchased through this call, but does not include any additional share repurchases. To finish my comments, I want to again offer my appreciation to team O'Reilly for an outstanding year. We truly have the best team in the country and we couldn't be prouder of your hard work and dedication to our customers in 2020. I'll now turn the call over to Jeff Shaw. Jeff?

Thanks, Greg. And good morning, everyone. I want to start by adding my congratulations and expressing my sincere appreciation to team O'Reilly for another incredible quarter and an amazing full year performance in 2020. 2020 has presented wave after wave of changes, and our teams have consistently stepped up to the challenge to run our business and take care of our customers. Challenges remain in 2021. And our teams remain committed as ever to deliver exceptional service and value to our customers. At this time of year, we would normally be returning from our leadership conference, which is a huge in-person gathering of all of our store, field, and DC leadership, where we enhance our product knowledge and technical proficiency, showcase new tools and strategies to improve our customer service and take market share, and to recognize outstanding achievement throughout our company. Even though this year's event had to take on a new format as our first-ever virtual conference, we had an extremely successful event and no slogan could be more on target than our conference theme of O'Reilly strong. That O'Reilly strength was on full display throughout 2020, and we're especially proud of the daily sacrifices our team made to go the extra mile to take care of our customers' critical needs while also ensuring that the health and safety of our team members and customers remain the top priority. Now I'd like to spend some time covering our SG&A and operating profit performance in 2020 and our outlook for 2021. For the fourth quarter, we generated an impressive increase in operating margin of 111 basis points, and an operating profit dollar growth of 21%. For the full year, the improvements were 193 basis points and 26% of operating profit dollar growth, yielding a record 20.9% operating margin. This increase in operating profit results for 2020 was driven by the combination of a robust 10.9% comparable store sales growth, and very limited per store SG&A growth of 1.2% after adjusting for leap day resulting in leverage of SG&A of 263 basis points. As we've discussed since our second quarter 2020, it was a very unique year in our industry as the onset and progression of the pandemic created extreme short-term sales volatility in our business. Our corresponding actions to execute significant cost control measures to protect the company at the onset of the pandemic and our caution in adding back SG&A dollars created a situation where very strong sales generated levels of profitability that far exceeded historical performance and are not sustainable nor healthy for the long-term success of our business. As we move through 2020, we've redeployed more SG&A dollars back in our stores to adjust to the current sales environment. We have continued to see sales outrun the growth of our SG&A and drive significant leverage. In establishing our operating margin guidance for 2021, we're projecting an increase in SG&A per store of approximately 2.5% after adjusting for leap day in 2020. This outlook reflects our plans to continue to actively manage our cost structure to provide excellent customer service to match the sales environment and ensure we're allocating sufficient resources to the image and appearance of our stores and the training and development of our team members. Even with the continued prudent outlook on managing SG&A, we will face very challenging comparisons in the middle of 2021 to the deliberate significant cost reductions we executed in 2020. As we've evaluated our forecast for 2021, we've looked in the rearview mirror to not only last year but 2019 as well. As compared to 2019, our current expectations for per store SG&A growth drive solid incremental leverage reflecting lessons learned as we've navigated through the high levels of sales and productivity gains in 2020, especially as we capitalize on the quality and experience of our team. As always, we don't manage our business for short-term results, but we'll invest the dollars necessary to provide excellent customer service that drives our long-term success. Our assumptions for operating costs include anticipated wage pressures in line with existing minimum wage statutes currently scheduled, but does not include potential further increases at a federal, state, or local level, nor does it include any incremental top-line inflation assumptions that we believe would result from the legislation. Based on relatively flat gross margin and increasing operating expenses, we expect operating profit to decline between 150 basis points and 200 basis points from 2020's phenomenal results. However, our operating profit guidance range of 19% to 19.5% of sales represents solid growth from the 18.9% operating profit that we achieved in 2019. Our capital expenditures for 2020 are $466 million, which was lower than our typical capital spend, and was below our original plan coming into 2020. At the onset of the pandemic in the second quarter, we prioritized financial stability and flexibility. As we move forward in a COVID-19 world, we reset our expectations for new store DC and capital project development. Our number one priority is to drive strong returns on our investments by ensuring our new stores start with a great store team to provide excellent customer service from day one, and our projects are completed successfully to enhance our service and drive efficiencies. We resumed our capital deployment plan in the back half of 2020, and in line with our revised plans, we were successful in opening 156 net new stores in 2020, including our first greenfield new store opening in Mexico during the fourth quarter. We've been very pleased with our team's ability to successfully open great new store locations in a very difficult year, and our 2020 stores are off to a great start. For 2021, we're setting our capital expenditure guidance at $550 million to $650 million. We've also established a target of 165 to 175 new store openings. Our new store target is higher than our new store openings in 2020, but it is still restrained by expected delays in regard to design and permitting approvals. We feel confident that we can achieve our target and open another strong class of new stores, but we'll be dependent on local market conditions and municipal agencies for us to stay on our development schedule. After the successful opening of our newest distribution facility in 2020 in Lebanon, Tennessee, we have another major distribution project on the horizon for 2021. With the completion and opening of our new DC in Horn Lake, Mississippi, which is just south of Memphis in the second quarter of this year, this new DC will be approximately 580,000 square feet. Our initial plan is to build out capacity to service 250 stores servicing over 220 stores at startup. The new DC will provide us with additional capacity for store growth in this region of the country and provide flexibility for the surrounding DC while also accommodating a broader SKU capacity increase in our breadth of hard-to-find parts and allowing us to provide an even higher level of service through the Memphis metropolitan area markets. Our distribution teams are very experienced at planning, designing, building, and opening our new DCs, and we're looking forward to another successful project in 2021. Outside of our new store and distribution growth, we've also identified several exciting projects and initiatives in 2021 to enhance the service we provide our customers and drive strong returns. Several of these projects were included in our 2020 plan, but were delayed as we monitored our business to ensure a successful rollout while prioritizing the immediate needs of our customers during the pandemic. Finally, we continue to invest heavily in enhancing our omni-channel capabilities to meet our customers on their terms with solutions that meet their specific needs, whether they visit a store, call us, or click. As it relates to our Mexico operations, our new store growth target includes five new stores that we have slated to open towards the end of 2021, but we're still in the early stages of our expansion plans and don't expect a meaningful capital spend in Mexico this year. Our collaboration with our Mayasa team members was excellent in 2020, and we continue to learn these new markets and lay a strong foundation for future growth. Before I turn the call over to Tom, I want to once again thank team O'Reilly for their dedication and hard work in 2020. Now I'll turn the call to Tom.

Thanks, Jeff. I would also like to thank all the team of O'Reilly for their continued commitment to our customers, which drove our record-setting performance in the fourth quarter and full year of 2020. Now, we'll take a closer look at our quarterly results and our guidance for 2021. For the quarter, sales increased $346 million comprised of the $273 million increase in comp store sales, a $51 million increase in non-comp store sales, a $25 million increase in non-comp non-store sales, and a $3 million decrease from permanently closed stores. For 2021, we expect our total revenues to be between $11.5 billion and $11.8 billion. As Greg previously mentioned, gross margin for the fourth quarter decreased 131 basis points to 52%, which was driven by the year-over-year comparison to significant gross margin benefits we captured in the fourth quarter of 2019 related to sell-through of pre-tariff on-hand inventory and tariff exclusions on certain product lines, as well as dilution from the acquisition of Mayasa. Looking at the fourth quarter standalone, we had a positive impact from LIFO of $6 million, down from $23 million in 2019. Included within our guidance for 2021 is a larger anticipated positive impact from LIFO, which will offset pressure to our POS margins from the expiration of tariff exclusions we've benefited from in the first half of 2020. We received a very minor benefit from same skew inflation in the fourth quarter of 2020 in line with our expectations. And our outlook for 2021 for sales and gross margin includes a muted expectation for same skew inflation of 1%. The pricing environment remains rational, and we expect that to continue. Our fourth quarter effective tax rate was 21.4% of pre-tax income comprised of the base rate of 21.8% reduced by a 0.4% benefit from share-based compensation. This compares to the fourth quarter of 2019 rate of 20.6% of pre-tax income, which was comprised of a base rate of 23.8% reduced by a 3.2% benefit for share-based compensation. The fourth quarter of 2020 base rates as compared to 2019 benefited from renewable energy tax credits in line with our expectations. For the full year, our effective tax rate was 22.7% of pre-tax income comprised of the base rate of 23.4% reduced by a 0.7% benefit for share-based compensation. For the full year of 2021, we expect an effective tax rate of 23% comprised of the base rate of 23.4% reduced by a benefit of 0.4% for share-based compensation. We expect the fourth quarter rate to be lower than the other three quarters due to the expected timing of benefits from renewable energy tax credits and tolling of certain tax periods in the fourth quarter. These expectations assume no significant changes to existing tax codes. Also, variations in the tax benefit for share-based compensation can create fluctuations in our quarterly tax rate. Now, we'll move on to free cash flow and the components that drove our results and our expectations for 2021. Free cash flow for 2020 was $2.2 billion versus $1 billion in 2019, the significant increase of $1.2 billion or 115% was driven by an increase in operating income, a reduction in net inventory and deferral of tax payments under the CARES Act, and a reduction in CapEx. In 2021, we expect free cash flow to be in the range of $1 billion to $1.3 billion with the year-over-year decrease due to increased net inventory investment, lower operating profit on slower sales growth, a more normal SG&A spend, increased CapEx as Jeff previously outlined, and an increase in cash payroll taxes paid as half of the taxes deferred in the 2020 CARES Act will be paid at the end of 2021. Inventory per store at the end of the quarter was 650,000, which was up 2.8% from the end of last year. I want to touch briefly on our per store inventory growth in 2020 and our plans for 2021. We came into 2020 and have developed a plan to further enhance our store-level inventory position and build on our industry-leading parts availability and targeted per store inventory growth of 5%. This increase was driven by just over a $100 million of additional inventory in our store and hub network above and beyond our normal new store and typical product additions. As we move through 2020, we needed to refocus our priorities to support the extremely solid sales volumes and replenishment needs of our stores, and had to delay some of the inventory initiatives we planned and finished the year below our original plan at an inventory increase of 2.8%. For 2021, we plan to complete our 2020 inventory expansion plan and expect per store inventory to increase approximately 4%. Our AP to inventory ratio at the end of the quarter was 114.5%, which was significantly higher than our normal ratio, heavily influenced by the extremely strong sales volumes and inventory turns in the last nine months of the year. We anticipate our AP to inventory ratio to come back off of these historic highs as we complete our inventory initiatives and our sales growth moderates. Our current expectation is to finish 2021 at a ratio of approximately 109%. Moving on to debt. We finished the fourth quarter with an adjusted debt to EBITDA ratio of 2.03 times as compared to the end of 2019 of 2.34 times, with the reduction driven by the significant growth in our EBITDA during 2020. We continue to be below our leverage target of 2.5 times and will approach that number when appropriate. After a brief pause at the onset of the pandemic, we've continued to execute our share repurchase program. For 2020, based on the strength of our business, we were able to repurchase 4.8 million shares at an average share price of $431.93 for a total investment of $2.1 billion. Subsequent to the end of the year and through the date of our press release, we repurchased 0.7 million shares at an average share price of $447.40. We remain very confident that the average repurchase price is supported by the expected future discounted cash flows for our business. And we continue to view our buyback program as an effective means of returning excess capital to shareholders. As we evaluate our liquidity leverage, use of capital and share repurchase program moving forward, we'll continue to prioritize maintaining our strong financial position, including the investment-grade rating on our public debt. We have a long history of conservatively managing our balance sheet, and we'll continue to take prudent steps to ensure the long-term health and stability of our company. Before I open up our call to your questions, I'd like to congratulate the O'Reilly team on a great 2020 and thank them for their continued dedication to our company and our customers. This concludes our prepared comments. And at this time, I'd like to ask GeeGee, the operator to return to the line, and we'll be happy to answer your questions.

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

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

Tom, do you want to take that one off?

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

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

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

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

Okay. Thanks. Good luck.

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

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

Yes, Michael. This is Greg. Really, 2020 was no different than any other year. We have competitors out there, both on the professional side of the business and the retail side of the business that there's price movement based on cost inputs, there's price input based on commodities that go into the product, there's price inputs based on trying to grow sales, changing suppliers, it's an ongoing battle.

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

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

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

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

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

Awesome. Thank you so much.

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

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

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

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

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

Understood. Very helpful. Best of luck guys.

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

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

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

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

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

Super helpful. Thanks a lot, guys.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Okay, that's great. Thanks very much.

Thank you.

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

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

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