O'Reilly Automotive Inc (ORLY) 2004 Q3 法說會逐字稿

Good afternoon, and welcome to the CSK Auto Inc. third-quarter 2004 financial results conference call. At this time, all lines have been placed on a listen-only mode, and the floor will be open for questions following today's presentation.

It is now my pleasure to turn the call over to your host, Mr. Maynard Jenkins. Sir, you may begin.

Good afternoon. Thank you all for joining us for our third-quarter conference call. Joining me today on the call is Martin Fraser, our President and Chief Operating Officer; Don Watson, our Chief Financial Officer; and Lon Novatt, our Chief Administrative Officer.

At this time, I'll turn it over to Lon, and he will address the forward-looking disclosure concerning this call, as well as provide an outline for the call. Lon?

Thank you, Maynard. Good afternoon, ladies and gentlemen, and welcome to our third-quarter call. Certain statements within this call are forward-looking statements. These statements discuss, among other things, expected growth, core development and expansion strategy, business strategy, future revenues and future performance. The forward-looking statements are subject to risks, uncertainties and assumptions, including but not limited to competitive pressures, demand for our products, the overall condition of the economy, timing and number of equity awards issued, factors affecting the import of products, inflation, consumer debt levels, factors impacting consumer spending and driving habits, conditions affecting new store development, weather conditions, risks related to compliance with Section 404 of the Sarbanes-Oxley Act and litigation and regulatory matters. Actual results may differ from anticipated results described in these forward-looking statements. Additional information regarding these and other risks is contained in the Company's periodic filings with the SEC.

Unless otherwise noted, the following financial information is presented on a GAAP basis. Maynard and Don will include in their remarks, for purposes of assessing the comparability of our financial performance with prior periods, a discussion of free cash-flow and net debt, which are non-GAAP measures. To the extent applicable, corresponding GAAP measures and reconciliations with the non-GAAP numbers are available in the Company's earnings press release issued earlier today, which is posted on our website at www.CSKAuto.com, under investors then press releases.

I would like to define a few key terms we will use during the call. "Third quarter" refers to the 13 weeks of fiscal 2004 ending October 31, 2004. "Last year" refers to the 13 comparable weeks for the third quarter of fiscal 2003. "Year to date" refers to the 39 weeks of fiscal 2004 ending October 31, 2004. "Year to date last year" refers to the 39 weeks of fiscal 2003 ending November 2, 2003. "2004" refers to the 52 weeks of the current fiscal year. "2003" refers to the 52 comparable weeks of the prior fiscal year. "Per share" refers to a fully-diluted share of our common stock.

I would now like to provide you with an outline for today's call. First, Maynard will provide an overview of the third quarter and touch on some of our accomplishments. Next, Martin will discuss key operating results. Third, Don will review our third-quarter financial results and address our financial outlook. Maynard will conclude with an update of our 2004 goals and key initiatives. We will then open the call up for your questions.

I will now turn the call over to Maynard Jenkins, our Chairman and Chief Executive Officer.

Thank you, Lon. Although we continue to make progress on our key initiatives, a difficult sales environment continued to adversely impact our financial performance. Our same-store sales results, while consistent with our prior guidance, continue to be our most significant challenge. However, we also recognize that the strength of last year's sales performance has created extremely tough comparisons for 2004, especially in light of the sales peak of our wheel goods category in 2003. We've achieved a two-year blended same-store sales increase of 3 percent and a three-year blended same-store sales increase of 4 percent.

Despite the challenging sales environment, we remain optimistic about the long-term prospects for our business. For example, our sales to commercial customers have improved and trended positively since the beginning of October. The increased volume reinforces our belief that the core business remains strong. Our cash position continues to improve. At the end of the quarter, we had 55 million of cash on hand, and no borrowings against our $145 million revolving credit facility. We have generated almost 57 million of free cash flow for the first three quarters of the year. This month, we will utilize cash on hand to redeem the 15 million remaining balance of our 12 percent senior notes, further reducing our debt. Since early 2002, we have reduced our net debt by almost 31 percent.

We continue to increase our gross margin rates year over year. This is a result of our continued ability to reduce the acquisition costs on selected products, our improved balance of sales through the enhanced category management system, and favorable shrink results.

Despite our recent sales challenges, we've continued to effectively manage our inventory. We are comfortable with our inventory position going into the balance of the year. To avoid any cost increases, we made a forward buy purchase of approximately $12 million during the quarter on certain commodities, as compared to the same time last year.

Our expenses are in line with our previous guidance, even with our increased advertising expenditures and benefit-related expenses. We will continue to assess additional opportunities for expense reductions without impacting our long-term objectives.

At the end of the third quarter, we operated 1,129 stores compared to 1,108 stores at the end of the same quarter last year, an increase of 21 stores. During the third quarter, we opened six new stores and relocated one store. We expect to open approximately 40 to 45 new or relocated stores for 2004, consisting of approximately 30 to 35 new and 10 relocated stores. The Company expects to close approximately eight stores, at or close to their lease expirations in 2004. This will result in a net store increase of approximately 25 stores, or just over a 2 percent increase in square footage for 2004. Our long-term objective is to continue to accelerate our new store growth in our existing markets.

Despite what we believe to be short-term economic and business-related challenges over the past several months, our long-term sales outlook remains positive. This is a result of favorable long-term industry growth drivers such as the increasing number of total registered vehicles in the marketplace, increasing population of licensed drivers, increasing the age of the average vehicle, increasing number of miles driven per vehicle and the growing number of light trucks and SUVs. Over the long term, these growth drivers will continue to result in enhanced customer loyalty, increasing average tickets and ultimately more dollars spent on automotive maintenance, repair, and accessory type items. We are optimistic about the enthusiasm of and demand by our do-it-yourself customer as well as our commercial customers for our products, given these solid industry fundamentals.

Although we are not satisfied with our current sales performance, we continue to manage our business toward achievement of our longer-term goals and key initiatives. We expect this result will result in strong earnings over the long term, as our sales momentum returns.

Now, I will turn over the call to Martin Fraser, our President and Chief Operating Officer.

Thank you, Maynard, and good afternoon everyone. The Company has undertaken several initiatives in response to the softness in sales, while maintaining our focus on our long-term objectives. We remain committed to our current merchandising strategies. We have continued to refine our core auto parts offering, improving our selection and inventory performance. Our noncore promotional items continue to be successful. We will continue to introduce items that maximize store productivity and bring value to our customers. These new items, along with our broader selection of core automotive products, enhance the customer experience inside the store, giving our customers additional reasons to shop.

We enter the fourth quarter with an aggressive promotional program in place. Our ongoing color newspaper insert program is being supplemented with strategically-placed weekend ad events focused on exceptional value for our customers. The quick turnaround nature of these events allows us to tailor our advertising to current market conditions. Print advertising will be reinforced with season-specific holiday broadcast advertising. At point-of-sale, merchandise display and signage will assure that every CSK customer is aware of our great holiday gift offerings.

We continue to use motor sports as a way to reach our customers. We are utilizing our major NHRA and NASCAR event sponsorships to generate store-specific traffic and excitement. Our NASCAR Nextel Cup Checker Auto Parts 500 Race at Phoenix International Raceway broke all attendance records, with more than 105,000 fans watching the event live and more than 5.4 million U.S. households turned to the event on NBC television, making it the largest motor sports event in Arizona's history. We have recently announced the extension of our NASCAR event sponsorship for five additional seasons through 2009.

We continue to tailor our marketing programs to be more customer and community specific through our advertising media and sports sponsorship. During the third quarter, we continued with our "We Got It" ad campaign, which speaks to our broad assortment of replacement parts and accessories. Our extensive print ad program is supported this year with additional broadcast and outdoor advertising, reinforcing our "We Got It" message. We've increased the flexibility of our ad plan to take better advantage of local market sales opportunities and seasonal trends, which are important to a chain with our geographic range. In addition, we continue to implement new advertising initiatives such as the recent introduction of our weekly newspaper advertising available on our Internet site CSKAuto.com. Now just over 1 million visitors to our website each month can locate their nearest CSK store and browse our weekly advertising circular any day of the week.

Our commitment to oil recycling is an important part of our support of the DIY segment of the industry. Since 1992, Checkers, Schucks and Kragen stores have recycled more than 35 million gallons of used motor oil processed by DIY customers. We're now the largest DIY oil recycler in the State of California. We work with dozens of state and local agencies in the development of oil recycling promotions to motivate and reward DIY recycling through our distribution area. Marketing programs are focused on enlightening all DIYers in regard to the benefit, means and convenience of our oil recycling by visiting their neighborhood CSK store. We continue to support and encourage the synergies between the retail and commercial areas of our business to improve our efficiency, productivity and overall operating effectiveness, as well as enhance our sales approach for both our retail and commercial customers. Commercial sales continue to represent approximately 17 percent of our total sales. We believe strongly that our offering a broad assortment of brand-name products represents quality to our commercial installers. We remain committed to enhancing all aspects of our commercial sales program with new and innovative merchandising and marketing programs. We have developed additional marketing and merchandising strategies which recognize the unique needs and expectations of our commercial customers. These strategies include a tailored customer loyalty program and specific targeting of certain product categories designed to improve the commercial customers business. We understand that the key to meeting our commercial customers' needs and expectations is to provide them with the products they want in a timely manner. We aggressively review and tailor our inventory mix to insure that are meeting the needs of our commercial customers. As we continue to focus on reducing our delivery times, we obtain greater customer loyalty and enhance our customer satisfaction.

Our commercial sales organization continues to take the business to our commercial customers, increasingly satisfying their needs for product selection and mix at reasonable prices with maximum convenience. For example, we continue to broaden the scope and functionality of our website, CSKProShop.com, allowing our commercial customers quick, convenient online shopping with no-hassle prompt delivery.

Finally, consistent with our long-term strategy, we continue to grow our national accounts business, which we believe has benefited and enhanced our commercial marketing and merchandising strategies and initiatives. We will continue to focus on maximizing the shopping experience for all of our current customers, broadening our commercial customer base and accelerating the growth of commercial operations.

Now, I would like to turn the call over to Don Watson, the Company's Chief Financial Officer.

Thank you, Martin, and good afternoon everyone. Net sales for the third quarter were 401.5 million, compared to 409.8 million last year. This represents a third-quarter same-store sales decline of 3.2 percent, which is comprised of a 3.8 percent decline in retail and flat in the commercial area.

Although we are not satisfied with our current retail sales, we are pleased with our gross profit rate increase. Our gross profit for the third quarter was 190.9 million or 47.5 percent of sales, compared to 192.2 million or 46.9 percent of sales for the last year.

Gross profit rate for the third quarter increased 78 basis points compared to the prior quarter, and 65 basis points over the third quarter of last year. This increase was achieved through our ongoing ability to negotiate lower acquisition cost of select inventory, the improvements in our balance of sales through our enhanced category management system, and reduced store inventory shrinkage through the new procedures and enhanced inventory control system.

Operating and administrative expenses for the quarter were 158.7 million or 39.5 percent of sales, compared to 155.1 million or 37.8 percent of sales last year. The dollar increase in expenses is primarily attributable to the higher advertising expenses, as a result of our certain marketing initiatives and increased benefit-related expenses. Expense control remains a key objective of ours, as reflected by only a 2 percent dollar increase in expenses year over year, while adding 21 new stores. The ongoing execution of our advertising and merchandising programs, despite the current difficult sales and economic climate, reflect our commitment to our long-term goals and objectives.

Operating profits for the third quarter were 31.5 million or 7.8 percent of sales, compared to 36.9 million or 9 percent last year. Interest expense for the third quarter decreased by 4.6 million to $7.8 million, compared to 12.4 million for the same period last year, as a result of our lowering outstanding debt and the lower interest rates due to our refinancing late last year.

Net income for the third quarter was 14.4 million compared to 15 million last year, and earnings per share for the third quarter were 32 cents per share on a base of 45.3 million shares, as compared to 33 cents last year on a base of 46.2 million shares. Year to date, total sales increased by 0.2 percent to 1,208,000,000. Same-store sales on a year-to-date basis are flat to last year. The year-to-date gross profit was 570.8 million or 47.3 percent of sales, compared to 560.9 million or 46.5 percent of sales for the same period last year, an increase of approximately 80 basis points. As stated earlier, we are pleased with our ability to lower our acquisition cost of select inventory and obtain increased margin through our balance of sales.

Year-to-date operating and administrative expenses were 47.9 million or 39.6 percent of sales, compared to 462.3 million or 38.3 percent of sales last year. The increase year over year is attributable to the higher advertising expenditures and payroll and related benefit costs. Year-to-date operating profits were 91.3 million or 7.6 percent of sales, compared to 98.3 million or 8.2 percent of sales last year.

Year-to-date interest decreased by 15.9 million to 23.7 million, compared to 39.6 million for the same period of last year, as a result of our lower outstanding debt and the lower interest rate due to the refinancing. Year-to-date net income was 41.2 million or 89 cents per share, compared to 33.4 million or 73 cents per share last year. This is an increase of 7.8 million or 23 percent increase year over year. Net income last year was negatively impacted by 4.3 million of costs related to the debt retirement and 0.2 million of costs related to our secondary offering.

Some key financial measures for the third quarter and year to date are as follows. Net debt, which includes cash on hand, decreased to 449 million, a reduction of 11.1 million. Free cash flow was 17.1 million for the quarter and 56.7 million year to date. At the end of the quarter, we had no borrowings on our revolving credit facility. Cash on hand increased by 7.8 million to 54.7 million compared to last year.

In accordance with our stock repurchase program announced in June, we have repurchased approximately $24 million or 1.6 million shares of our common stock. Consistent with our long-term initiative to reduce debt, we plan to redeem the remaining 15 million outstanding balance of our 12 percent senior notes with our existing cash on hand.

CSK's outlook is as follows. Based on our current sales trend and the 7 percent same-store sales increase in the fourth quarter of last year, we would now expect same-store sales to decline between 1.5 and 3.5 percent during the fourth quarter. Assuming these sales result (ph), we expect fourth-quarter net income to be in the range of 9.5 million to 12.5 million, or 21 cents to 26 cents a share, and full-year net income of between 50.7 million and 53.2 million, which is $1.11 to $1.16 per share, excluding any costs that would be associated with the redemption of the 12 percent senior notes that will be done during this period. And it also assumes that there will be about 46 million shares outstanding at year end. We expect the year to end with about 545 to 560 million of FIFO inventory, which will be about flat to $10 million increase last year with an additional 25 stores. We would also expect free cash flow for the year of approximately 70 million.

Now, I will turn the call back over to Maynard.

Thanks, Don. Prior to taking any of your questions, I would like to update you on the status of our primary goals and key objectives.

First, we remain focused on reducing our debt, while at the same time utilizing our capital to maximize our return on investment and increase our cash flow from operations. Consistent with this objective, as Don indicated, this month we will redeem 15 million remaining balance of our 12 percent senior notes.

Second, we are accelerating our new store growth program. We are tracking to open or relocate approximately 40 to 45 stores in 2004, as compared to 25 in 2003. Our preliminary estimate for 2005 is 50 to 55 new or relocated stores. At the same time, as we are accelerating our new store growth program, we will continue to focus on maximizing productivity in our existing stores.

Third, we will continue to strengthen our vendor partnerships to reduce the cost of the supply chain.

Fourth, we will continue to scrutinize all expense line in our business for opportunities to reduce our expenses and further reduce our SG&A costs, without adversely impacting our key longer-term initiatives and objectives. Finally, we will continue to focus on our customers' needs through ongoing improvements in our great customer service program.

In closing, I would like once again to stress our commitment to our long-term business strategies and the growth potential of our business. Now, I would like to open it up for any questions you may have.

(OPERATOR INSTRUCTIONS). Kevin Flaherty, CSFB.

I have two quick questions -- one for Maynard, one for Don. Just with regards to the comp trends, you mentioned the sales peak in wheel goods in 2003. I wanted to see if it was possible to quantify at all how much of the DIY complex (ph) line was just related to sort of the non-core merchandise versus some of the other items, and also in terms of comp trends, if there was any change sequentially at the end of the quarter. You mentioned that commercial had improved since the beginning of October. Has DIY worsened or improved or been the same in November? And then I had a follow-up for Don.

Currently, the DIY business hasn't changed since the end of the third quarter. Commercial business has improved. When it comes to the wheel goods category and/or the promotional goods that we were talking about, previously, the impact on the quarter was just about equal. Equal impacted negatively on the incremental goods, as compared to the core goods.

And then, just -- Don, with regards to the fourth-quarter EPS guidance, I think Martin had referred to increased advertising expenditures. What are you looking at, ballpark, for SG&A for the fourth quarter? Would that entirely be moving up due to the advertising, or is there anything else in there?

Well, if you look at the fourth quarter, we actually have been pretty successful on taking out some expenses. When we had our last conference call, I said the fourth-quarter SG&A was probably going to be slightly down year over year. If you take the fourth-quarter SG&A last year and the fourth-quarter SG&A this year, even with the incremental advertising, we're expecting it to be down about $3 million. So I think we've done a pretty good job of reducing expenses.

Matthew Fassler, Goldman Sachs.

I've got three quick ones. First of all, I want to follow up on the sales trend, as well. Can you talk about any variability that you saw on the DIY line through the quarter? Was there kind of a ray of sunshine at one point? And as we've seen the low-end consumer evidently slow down a bit in other sectors, did you see that fade at all, kind of parallel to what we saw from Wal-Mart, for example?

I think the answer is yes. We're seeing the same parallel with a lot of people. I think one of the key things that we look at, when you take a look at the total retail business, is when you take a look at the closeout stores and the impact on the lower-income people, you can say there have been some economic issues out there, whether it's gas prices or uncertainty. What percentage focus in each camp is a question mark, but there has been an effect, and when you're dealing with an auto parts customer, $40,000-a-year household income or less, an extra $20 to $40 a week going into a fuel tank, if it is all fuel prices, is an issue. And we believe strongly that we have seen that impact on our DIY business.

Now, the question has come up many times, in dealing with the street -- what happens to the long-term effect on maintenance repair vehicle? It can be deferred, but essentially it has to be done at some time, and we believe when the conditions get right again, our sales trends are going to start moving back in the right direction.

And as you think about that, Maynard, and you consider the sources of the weakness, does it seem like it was the more discretionary piece of your business that slowed down, or was it also --?

It was across the board. And one of the things -- you know we don't break out sales by operating area, but I can just tell you, one of the strongest areas of comp during the quarter we had was in Southern California, and Southern California is the area where you've got a broad cross-cut of customer base, huge amount of vehicles, but the least weather effect. And we're not pointing to anything at all in the results to weather, across our company. But you know, when you take a look at the areas of the country that had little or no weather effect, and then you take a look at the effect on the economy question, there's no question we had weakness in our business across the board, but stronger areas in areas like Southern California, where we have the most competition. So it's a question mark.

Two quick follow-ups, if I could. You spoke about commodity costs increasing, and some forward buys. If you look generally across your merchandise categories, are you seeing pricing pressure, and beyond things like motor oil, but in some of the core hard parts?

There is very little pricing pressure behind the counter, or in the hard parts. Now, there are some commodities out there that there has been chemical pricing pressure on, and without carrying too much inventory, we do what we can to offset some of those price increases to help ourselves out in the long run.

And then finally, Don, as you look out into the fourth quarter, I know that from time to time, your volumes will have an impact on your gross margin rate. And I am curious how you see that playing out here in Q4.

You know, if you look in the forecast that we gave you, the fourth quarter, we would expect fourth-quarter gross profit to be on the original plan we told you, which would really be flat to where we achieved third quarter of this year. So we're at 47.6, we'll probably be at 47.6. We do have a very rebate-intense business, and it is volume, but we think when you look at it in total, over the course of a full year, we've continually been able -- even with the slow-down in sales -- to get better costs and increase gross profit rates.

So you're looking at 47.6 for the quarter?

Yes.

Now, that's up against 50 or better for two prior years, and is most of that rebates?

The majority of it is vendor allowances. But you also have to take into consideration, if you look -- we've said this many times, at least seven quarters in a row -- as the Company continued to get healthier, you didn't get a lot of the -- we'd get a lot of step-ups from the first quarter to the fourth quarter in '02. Then, when we got to '03, it was going to be less. And then, in '04, we thought we'd get them all the way through the year, and we have done that. So there's no real negative impact in the fourth quarter on rebates. You have to go back to the first quarter to understand that the first quarter we beat last year by 130 basis points in gross profit, when you start looking year over year. You get the second quarter, we beat them by 80 points. You get to the third quarter, we continued to beat them by 80 basis points. And, you know, as a company, when you smooth those step-ups up during the year, you can't continually -- you know, in that fourth quarter, where you got some heavy rebates last year, to expect that trend to continue. We look at it, you know, a full-year basis.

Just quickly eyeballing it, if your grosses are going to be 47.6 again, it looks like your expense dollars would have to be down to get to your guidance. Is that (multiple speakers)?

I'd just -- when I was talking to Kevin -- we think year over year, we can take in excess of $3 million on a comparable basis out of our SG&A.

Matt Nemer, Thomas Weisel.

First question is regarding some of the gross margin initiatives that helped you out last quarter and this quarter. I think the category management and the shrink initiatives -- when do we anniversary that? I mean, should we still expect you get some benefit from that in the fourth quarter and first quarter of next year?

When we talk about it, we talk over a two- or three- year comp basis, when you look at sales -- we've consistently said that we believe, on a normalized comp -- and I've got to say that the second half of the year has not been normal, but if you look at our blended comps over two years, it was 3 percent. If you look over three years, it was 4 percent. Assuming those trends, we still believe there's 30 to 40 basis points a year initiative in our gross profit rate. So we think over the long term, although we've had a tough go here in the last couple quarters, we believe long term, that our business can continually grow 40 to 60 basis points and a combination gross profit, lower SG&A, so the net income -- the operating income should grow that 40 to 60 basis points. And we believe that over time, the EBIT percents (ph) will get back up to that 9.8 to 10 percent.

So there aren't specific initiatives that we're going to anniversary at some point?

No, absolutely. I mean, we think there's a lot of opportunity. And you have also got to understand that oil costs are not going to stay up there. I mean, just look in the market. The cost of a barrel of oil has dropped $10 in the last month. So there's maybe opportunities in oil costs over the next year, and they typically go every other year. So I think there's a lot of initiatives we have. We're certainly not going to get specific on the phone call, but there's a lot, and none of them that are going to be tough to go against.

Okay. My second question is, whether it was a headwind for you guys this summer, really the whole industry -- is there anything -- in terms of the winter weather, could that be a tailwind for you? What are you seeing so far? What shall we be looking for? Is it a lot of snow? Is it extreme cold? How does that impact you guys this winter?

Well, we haven't had a normal weather program from the beginning of the second quarter at -- most recently, up until last week or the last 10 days, the whole Northern Plains was extreme temperatures that were above normal. In the California marketplace, we got some early snow in October, and then didn't get hardly anything in November, and we're not looking at any big increase yet in the amount of snowfall or rainfall that's going to come into the State of California. I think it's still a wait-and-see. We're starting to get some cold temperatures now in the Northern Plains and the Minneapolis marketplace. And we got some weather in Denver in the last week, as everybody saw on Monday Night Football. So hopefully, that will spur some winter goods category sales.

And about -- can you tell us what about what percent of your product is -- would be sort of winter weather related?

In a given quarter, it has less than a 10 percent effect on the seasonal categories, so a lot of commodity goods. It all depends upon how much is done maintenance-wise, preseason by the customers, and then if you have any overriding issue like a snowstorm that closes a bunch of highways down in California, where you need chains to get through and everything else, that will spur (ph) our sales in a given point. But it's never more than a double double-digit effect in any two-week period.

And then on the CapEx, it looked like it was down pretty significantly on a per-store basis, year over year. I was just wondering if that is timing, or if there's some change in store maintenance costs that we should be thinking about?

No. But if you go into the third quarter, it was down year over year. But if you go to the first two quarters of this year, it was substantially up. We've spent $16.4 million of capital expenditures year to date. We think there's probably another 5 to 6 million, based on the number of stores we're able to get open. So we will be slightly lower by about 3.5 million, based on our prior guidance, and one of the reasons that is, we've been able to -- with the softer sales, we've deferred some of our -- I wouldn't say maintenance CapEx, because you just aren't going to sacrifice what your stores look like. But when you're getting ready to upgrade some POS equipment and some things like that, with printers and computer screens, you are able to move some of that into next year, when sales pick up a little (ph). So, we have done that.

And lastly, can you update us on what you're thinking, Don, in terms of debt paydown for '05?

We believe, right now, our net debt has come from almost 680 million down to about 450 million. We think that there's some opportunity to get more than the 75 million of free cash flow to be used all for that we told you (ph), and we would assume that that 75 million of free cash flow is going to be used mainly to pay down debt. So, we think -- so somewhere next year, we should be sitting at somewhere by year end, 360 to 375 million in net debt.

Gary Balter, UBS.

Just two follow-up questions on everything that's been asked. Competitively, it doesn't sound like anybody is really using price as a weapon to try to drive more traffic and obviously, based on your margin the last few quarters, it seems like you are in that same ballpark. Are you seeing anything from either Zone or Pep Boys or other people in your markets that imply that maybe that's changing at all?

No, Gary, as you know in this business, our basic core customer shops our stores two to three times a year. And generally, when they do, they are not having a positive experience, or they are having a bad day, because something has broken.

Now, one of our strategies in offering some incremental things in our stores is to try and create a customer that will shop the store more than three times a year. With a three-time-a-year customer, essentially you're not talking about a price customer. It's a customer of need. You're making model specific (ph).

Now, the competition out there, I think, realizes that and I don't think anybody has gone to the mat or tried to gain any market share through lower prices on core hard parts. Now, what has been done with us and other people is when you start taking a look at a category that might be incremental to your business, you are trying to show a customer value to shop your store, in an additional shopping trip over and above their normal three times a year.

When you break down where the sales -- I know you talked about this a little bit, but just to give me a clear understanding -- is the weakness in the front part of store, or the back part of the store, or pretty much across the board?

We had equal weakness between the front part of store and behind the counter. Now, in saying that, you do have some year-, make- and model-specific items that are merchandised in the front of the store, like batteries, like windshield wipers, like gas caps and things like that that wouldn't be deemed just accessory items. When you take a look at the effective sales in the third quarter, our incremental promotional items were about equal to the core category in the decrease. There wasn't 20 basis points difference either way.

Scot Ciccarelli, RBC Capital Markets.

Another follow-up question regarding weather. I know it's something you guys certainly pointed to in the second quarter that created some weakness, and it's not exactly clear to me what the message is -- whether it did or did not have an impact. Because I think you actually tried to quantify it for people previously.

In the third quarter, we don't think that weather was an overriding issue in our comps. Now, into the last quarter, we stated that in the second quarter, the heat-related category cost us on a comp basis over $20 million of comp during that given quarter. And we also stated at the time there is visibility in the marketplace that the gas prices might be affecting things. There might be an issue of the economy. There might be an issue that people brought up before -- the amount of money that was pumped into the economy in 2003, through child credits and the refunds on taxes and all the rest of the thing. Now, what we said was at the end of September, when we started to get into the October timeframe, if our sales remain weak, it's not going to be just because of heat-related category, because that issue goes away and we're going to have something else out there that is affecting our business.

I would say the belief today is it's primarily economic-related, for one reason or another.

We believe the answer to that is yes, there are issues out there -- gas prices, the effect on lower-household-income customer and maybe some uncertainty. Now, can I quantify it says (ph) 60 percent of our decrease was because of gas prices? I can't do that today. But we are suspecting that the issue is real, and that is what has affected our business across the board, both in the promotional side of the business as well as the core category.

And I know there had been a question about kind of trends during the quarter, and without getting into too many details, I think you had mentioned that you saw some parallel with the others. Does that suggest that later in the quarter, it was softer than earlier in the quarter or was it fairly similar throughout?

I think it's just the opposite of that. I think -- I think when you've talked to our competitors, obviously, we listen to their conference calls like they listen to ours. October was stronger for us, and it was consistent. I think if you follow the largest retailer out there, Wal-Mart, which is a very similar type customer to us, parallel ours to them and it's following them almost exactly.

Fair enough. And then the last question -- you guys brought up the issue of shrink. What kind of impact has that had, and is that something that has been a material issue for you to date?

No. If you look at it -- when you start looking at year over year, you know, it can make a difference of a couple of million quarter over quarter, but you know, when sales are soft, we have very good systems, and we're very control-oriented. We look at every single dollar. We were, year over year, better by a couple of million dollars just in the shrink category -- when you look at it, 15 or 20 basis points. So, it's not a huge issue.

And then the last quick question is you guys obviously bought back a nice chunk of stock in the quarter. Is that a trend that is going to continue? Because it sounds like from your other comments, it sounds like most of the free cash flow is going to go towards debt repayment. How should we be thinking about that balance?

As we stated before, we had a basket of some $25 million that we could buy back under our current covenants. And as we got to different ratios, that could increase by another $20 or $25 million. Don't hold me to the actual 5 million on the thing. We're going to take a look at every scenario as it arises. We thought we were making a great buy at $17, when we bought a lot of the stock back, and obviously we're not looking so great today, but we still have enormous amount of confidence in this company. As we go forward and the ratios are right, and we have the ability to buy $40 or $45 million worth of stock in a given year, we will put all of the financial issues on the table and determine whether a stock buyback and accelerated store growth program and/or accelerated debt repayment is the right way to do it. It could be a combination of all of those things. So, we will look at each of them.

Susan Janson (ph), Lehman Brothers.

It's Scott Litman (ph) calling in for Susan. We were wondering if you could just provide an update on some of your new product introductions? Anything that's been particularly successful recently?

We have continued to add a lot of successful categories, in the wheel category as well as in the tool category. Continued to improve our offerings, value items we can put in our ads that our customers want to buy, as opposed to items they need to buy. And we're continuing to do that -- to add many new brands and many new types of items. Nothing in particular that would -- no particular item that has outshined anything else.

Okay, and one more question. I don't know if you guys are prepared to give any outlook for next year, as far as comps are concerned, if not for the full year. Do you guys expect comps to return to positive territory? In the first quarter, you're still facing ia mid-single-digit comp, but after that you know the comps return to negative (ph). So, any thoughts around comps for next year would be great.

We expect our comps to get better. However, as early as we are in the fourth quarter, we are a bit reticent to tell you that we're going to return to a 1 to 3 percent positive comp for the first quarter of next year, because there's still a big question mark out on the fourth quarter of this year.

Understood. Thank you.

David Siino, Gabelli & Co.

Don, just a couple of housekeeping items. Any LIFO benefit in the quarter?

David, yes, there was about $2 million of LIFO benefit, which kind of further supports the Company's ability to continue to get lower costs from our vendors, even with the offset of oil prices going up.

What is that compared to a year ago? Do you have that?

I've got to think -- it's about flat to last year.

And on the shares, the 46 million share number at year end, was that the average share count for the full year?

That's the actual shares -- obviously assuming share price, we think it's about 45,200,000 shares at year end. The 46 million one that we refer to is the average share count that you have to use to calculate earnings.

So you don't have a big slug of options coming back on in the fourth quarter?

Well, we did -- yes, you know, we did issue some options, but it isn't going to move that much.

And lastly, just Maynard, if you want to take this one on the commercial side -- do you get a sense that you're taking share from let's say AutoZone in particular?

No. I think when you take a look at that business in total, the AutoZone's of the world and Advance's of the world and the CSK's of the world -- if we're taking share, we're taking it from the smaller operator, as those units continue to dwindle. When you take a look at our 17 percent, and you realize that out of the 1,129 stores we're operating today, there's only 570 or 580 commercial centers in the operation. Some of our operations on the commercial side are doing in excess of 40 percent of their total business. For our company, it will never work to have a commercial center in every one of our stores, because we cluster a lot of stores in a given area, but we really think that the effect of our market share, wherever gained, is coming from the smaller operator, and really not the AutoZone's of the world or Pep Boys of the world where we compete right down the street.

And just kind of going forward, it's all (ph) sort of remained at that 50 percent as you open new stores, is it safe to say 50 percent of those will have (multiple speakers)?

I think that is a fair assumption. Now, having said that, if we continue to fill in stores in a given marketplace like Phoenix, where we've opened eight or nine new stores in the last 18 months, and have a lot of stores in this marketplace, I'm not sure that 50 percent of those locations would have commercial centers in them, because we already have a huge cluster in the marketplace.

David, on top of that, there is in our plan for next year to increase the number of commercial stores. We think -- as the number of people have tire repairs, we think we can increase 30 to 50 new commercial centers, which should help sales there.

Michael Cox, Piper Jaffray.

Thanks for taking my call. I can certainly attest to the cold weather here in Minneapolis. But a couple of questions -- first, on new store openings -- you mentioned in 2005 50 to 55 with relo's. Can you give us the net new that you are targeting for 2005?

On the breakdown for 2005, and realize this is a preliminary estimate, we're looking at about 40 to 45 new stores, about 10 relocations and about six to eight closures -- ordinary course closures. So the net number is going to be somewhere in the range of about 35 to 40.

Which, you know, Mike, is based on our store count. We could get close to a 3.5 -- you know, 3.5 to 4 percent square footage growth.

Sure. And then, on free cash flow for 2005, Don, I think you mentioned 75 million. Is that what you --?

Assuming just the earnings increase we expect to have, we expect net income year over year to grow about 15 percent. We also think keeping working capital neutral, there's 75 million. We think there's some opportunities to do some other things on leverage of payables, you start comparing last year to this year. We're still up year over year about 5 percent AP percent to inventory. We still think there's some opportunities to leverage our inventory dollars down. So it could get higher than that number.

And then lastly, on traffic versus ticket, it sounds like traffic was the drag on the DIY side. Could you give any color there?

We don't give that kind of detail, but knowing the type of product that we sold, the dollar increase has been positive and the traffic has been negative.

John Pate (ph), Raymond James.

Gerry is actually out of the office today, so I am filling in for him. But I had a couple of questions. One, your earnings guidance for '04 didn't change all that much from the last quarterly report and -- but the free cash flow number did decrease from your last guidance. I believe it went from 70 to 80 million last quarter to approximately 70 million this quarter. Can you help me understand what's going on there?

We think there's still an opportunity to get to 80, but as Manard talked about earlier, the Company has made a decision to do some significant forward buys of some oil and antifreeze to help us long-term -- you know, helps our profit long-term. So the adjustment quarter over quarter is nothing more than those forward buys that we have in there. And we hedged a little bit on that cash flow, based on if we can continue to save costs, we will do that.

And then, the year-over-year increase in operating expenses dollar-wise, can you give me an idea of how much of that is advertising versus benefits?

We're not going to give you details on that, but if you assume that of the increase they are half and half, you would be pretty close.

And of the 3 million that you expect to take out in the fourth quarter, would that still be -- I mean, where would that -- what would make up that 3 million? Would that be mostly advertising?

No. Actually, we will spend about 1 million 2 more in advertising in the fourth quarter than we did last year, just to help sales. Where we have made it up is in some of the store variable labor. We have a labor management system that allows us to manage payroll at the stores every week, so we've been able to take advantage of that. But if you look at just corporate G&A and the hiring freezes and some of the things that the management group has put in place, that has been a significant amount of the savings.

Thank you. I'll now turn the floor back over to Mr. Jenkins for any closing comments.

Thank you all for participating in today's conference call, and we will talk to you at the end of the next quarter. Thanks a lot.

Thank you. This concludes today's conference. Please disconnect all lines and have a great day.