O'Reilly Automotive Inc (ORLY) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CSK Auto second-quarter financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Chairman and CEO of CSK Auto, Mr. Maynard Jenkins. Mr. Jenkins, you may begin.

Good afternoon. Welcome and thank you for joining us on our second-quarter 2005 conference call. With me on the call today are Martin Fraser, our President and Chief Operating Officer; Don Watson, our Chief Financial Officer; and Randi Morrison, our Vice President, General Counsel and Secretary. At this time, I would like Randy to address the forward-looking disclosure concerning this call, as well as a guide or outline for the call.

Thank you, Maynard. Good afternoon, ladies and gentlemen, and welcome to our second-quarter 2005 conference call. Certain statements within this call are forward-looking statements. These statements discuss among other things expected growth, store 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, the overall condition of the national and regional economy, factors affecting the import of products, factors impacting consumer spending and driving habits such as high gas prices, war and terrorism and natural disasters, consumer debt levels and inflation, demand for our products, conditions affecting new store development, weather and regional 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 non-GAAP measures, including free cash flow and net debt. Corresponding GAAP measures and reconciliation 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 and then Press Releases.

I would like to define a few key terms that we will use during the call. Second quarter refers to the 13 weeks for the second quarter ending July 31, 2005. Last year refers to the 13 comparable weeks for the second quarter of fiscal 2004, ending August 1, 2004. Year to date refers to the 26 weeks of fiscal 2005 ending July 31, 2005. Year to date last year refers to the 26 weeks of fiscal 2004 ending August 1, 2004. Per share refers to a fully-diluted share of our common stock.

I would now like to provide you with outline for today's call. First, Maynard will provide an overview of the second quarter. Next, Martin will discuss key operating results. Then, Don will review our second-quarter and year-to-date financial results. Maynard will conclude with a discussion on key developments and 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, Randi. We continue to make progress on our key goals and initiatives. Over the long term, this will drive both top and bottom-line growth. Total sales for the second quarter increased 2.4%, while our same-store sales increased 1.1%. The same-store sales trends have continued to improve since the end of the third quarter of 2004. Sales at the beginning of the second quarter started slower than expected. However, same-store sales are currently running 3% higher than last year. Historically, improvements in our retail business have followed improvements in our commercial sales trends. Our commercial same-store sales increased 10.2% compared to last year. Net income for the second quarter was 13.1 million or $0.29 a share, which included a 1.6 million write-off of the deferred financing fees associated with our recent financing and approximately 700,000 in severance charges. Excluding these charges, net income would have been 14.4 million or $0.32 per share.

We continue to be optimistic about the future strength of our business. For example, we recently completed a refinancing consisting of a $325 million asset-based credit facility and $125 million in senior exchangeable notes. This refinancing is consistent with one of our primary objectives, to obtain the lowest cost of capital available and add flexibility to further reduce our long-term debt and provide the needed liquidity to grow our company. Our cash position remains strong, and we have continued to reduce our net debt year over year.

Our sales trends are trending higher, and if that trend continues we anticipate further improvement in our sales during the second half of the year. The increased sale of core products to our commercial customer reinforces our belief in the strength and growth potential of our business. The Company continues to focus on productivity of our merchandise inventory. On a per-store basis, our inventory is down compared to last year. We believe there are further opportunities to reduce our inventory on a per-store basis, resulting in increased inventory turns.

Although we will continue to pursue additional expense control efficiencies, I'm pleased with our ability to improve expense leverage of approximately 80 basis points during the second quarter compared to last year. At the same time, we increased our store count. Acceleration of our new store growth remains on track. We plan to open, relocate or expand approximately 50 Checker, Schuck's and Kragen stores in 2005. We are currently operating 1,142 stores and will continue to add to that base.

We are optimistic about the enthusiasm of and demand by our do-it-yourself and commercial customers for our products, given the solid industry fundamentals. Although sales trends ramped up later than anticipated, same-store sales for the last ten weeks have been approximately 3%. We are optimistic in regard to the industry and the company-specific fundamentals outlined above. The damage to the energy industry in the Gulf Coast caused by Hurricane Katrina is not fully determined, and the length of time it will impact the gasoline supply chain is unknown. With the expectation that gasoline will exceed $3 per gallon at the pump, we're uncertain as to the near-term impact this will have upon our customer base and our current sales trends.

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

Thank you, Maynard, and good afternoon, everyone. Same-store sales continued to improve during the second quarter and through the third quarter to date. Our commercial business continues to post strong same-store sales increases. We are also pleased with the sales of core items such as brakes, batteries, suspensions and fluids. Our new product offerings such as off-road dirt bikes, arc welders, generators and instant garages continue to generate enthusiasm and strong demand by our customers.

We continue to refine our core auto parts offering, improving our selection and inventory performance. Our category management process has resulted in improved planograms, higher related transaction sales and lower inventories. Our market basket analyzer continues to provide us with information on what add-on items our customers purchase. This has improved our product adjacencies and made our stores easier for our customers to shop.

As previously announced, we implemented a new individual store incentive program called Great Rewards. Great Rewards was developed to give our customers and our store associates the advantages that come with selling complementary and accessory products. Our customers experience better service by receiving the full package of products in one trip to the store. In turn, our associates receive extra dollars for any sales they make from the Great Rewards program. For example, when an associate sells and alternator, the associate receives a bonus if they also sell a fan belt to the customer as part of the same transaction. The customer gets the complete package of products, and our associates gets an incentive to ensure that the customer is satisfied. It is truly a win-win situation. In addition, the program allows the Company to promote the sale of premium, higher-ticket type products that result in additional gross margin dollars. Great Rewards for the second quarter showed improved sales and margin dollars for premium and related categories that were included in the program.

We continue to increase the reach of our media marketing programs. Television advertising and NASCAR and NHRA motor sports events has been introduced into our media mix in addition to cable television program targeting DIYers and the automotive enthusiast. CSK's extensive Major League Baseball sponsorships build our brand recognition. Our strong print media advertising program focuses on driving traffic through weekly sales promotion.

We have also implemented additional initiatives in our Hispanic marketing program. This important and growing consumer segment is currently estimated to account for 25% of all auto parts shopping in our markets. It is estimated that Hispanic consumer spending will grow by more than 40% by 2010. To better serve the Hispanic market and to ensure we are meeting the needs and expectations of this important customer group, we have joined forces with an advertising agency that specializes in Hispanic marketing to handle strategic and media planning and create a grass-roots effort for CSK.

This enhanced marketing campaign launched in the spring of this year. Examples of this program initiated under this campaign include our primary sponsorship of the Copa Univision soccer tournament, in which participating neighborhood teams throughout San Diego registered in our Kragen Auto Parts stores. This type of program builds on affinity with the Hispanic community and traffic in our stores.

We have continued to identify and implement operational efficiencies such a shrink controls, utilizing payroll dollars to maximize sales, store expense control and making the most of every customer dollar through our great customer service program. We continue to invest in our most valuable asset, our store associates. We will train, support and encourage all store associates to join our more than 2,000 ASE-certified associates.

Commercial sales represent approximately 18% of our total sales compared with 17% last year. Commercial margins have also increased through improved product offerings and a broad assortment of brand-name products. Tailored customer loyalty programs targeting specific product categories and assortments help our installer customers improve their business. Our focus on reducing our commercial delivery times has enhanced customer satisfaction and provides greater customer loyalty.

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

Thank you, Martin, and good afternoon, everyone. Net sales for the second quarter were 419 million compared to 409.1 million for the same period last year. This represents a second-quarter sales increase of 2.4%, a same-store sales increase of 1.1%, consisting of an increase of 10.2% in commercial same-store sales and a decline of 0.8% in the retail same-store sales.

Gross profit for the second quarter was 193 million or 46.1% of sales, compared to 194.1 million or 47.4% of sales for last year. Although the Company increased its gross profit rate from the first quarter to the second quarter, the increased commercial balance of sales, which carries a lower gross profit rate, has caused the rates to be lower. The higher transportation costs and lower recognition of vendor allowances also resulted in lower gross profit rates compared to last year.

The lower recognition of vendor allowances will flow through the inventory as we sell through the product in the future months, which will improve our gross margin rate going forward. Operating and administrative expenses for the quarter were 160.9 million or 38.4% of sales, compared to 160.5 million or 39.2% of sales.

The decline in operating expenses as a percent of sales year over year is attributable to our management of our store and corporate expenses. Operating profits for the second quarter were 31.4 million or 7.5% of sales, compared to 33 million or 8% of sales last year.

Interest expense for the second quarter was 8.3 million, compared to 8 million last year. The increase is primarily due to the higher interest rates.

Net income for the second quarter was 13.1 million or $0.29 per share, compared to net income of 15.3 million or $0.33 per share last year. Excluding the after-tax impact of the debt retirement and severance charges, net income for the second quarter of fiscal 2005 would have been 14.4 million or $0.32 per share.

Net sales for the 26 weeks ended July 31, 2005 increased 1.3% to 816.2 million from the 806.1 million for the 26 weeks ended August 1, 2004. Same-store sales for the first half of fiscal 2005 were flat, compared to the first half of fiscal 2004. That consists of an increase of 8% in commercial same-store sales and a decline of 1.7% in retail same-store sales.

Gross profit for the first half of 2005 decreased 9.9 million to 372.9 million or 45.7% of net sales, compared to 382.8 million or 47.5% of net sales for the first half of 2004.

Operating and administrative expenses for the first half of 2005 were 318.8 million or 39.1% of net sales, compared to 319.2 million or 39.6% of net sales for the first half of 2004. Our operating expenses in dollars and as a percent of sales decreased despite the addition of 22 net stores year over year.

Net income for the first half of fiscal 2005 was 21.1 million or $0.46 per share, compared to net income of 28.1 million or $0.60 per share for the first half of 2004. Excluding the after-tax impact of the loss on debt retirement and the severance charges, net income for the first half of fiscal 2005 would have been 22.5 million or $0.49 per share.

Some of the key financial performances measured in the second quarter and year-to-date are as follows. Net debt, which includes any cash on hand at the end of the second quarter, decreased by 51.9 million or 11% to 412.2 million, compared to the second quarter of last year. Free cash flow for the first half of 2005 was 65.4 million, up 26.4 million or 68% year over year. The full-year free cash flow was expected to still be in a range between 80 to 90 million full year. Accounts payable to inventory leverage continues to increase. It was to 39% in the second quarter, compared to 37% in the second quarter of last year. The recent completion of our refinancing has now given us the flexibility to profitably grow our top line through additional new stores. At the same time, we've increased our fixed-rate debt from 30% of our total debt to 60% of our total debt.

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

Thanks, Don. Our long-term strategic initiatives remain as follows.

First, we are focused on increasing our cash flow from operations, reducing our debt and utilizing our capital to maximize our return on investments.

Second, we have accelerated our new store growth program. We are targeting approximately 50 new, relocated or expanded stores for 2005. This will result in 40 net new stores, an increase of eight stores over our original projection. We will continue to focus on maximizing the productivity of our existing stores.

Third, we will continue to scrutinize all expense lines in our business for opportunities to reduce our SG&A costs without adversely impacting our long-term key initiatives and objectives.

Finally, we will continue to focus on our customers' needs through our ongoing improvements and our great customer service programs.

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

(OPERATOR INSTRUCTIONS). Matthew Nemer, Thomas Weisel.

The first question is just on the environment on gas prices. Can you give us any color on how customers are reacting, and maybe if there has been a change in the mix, if there is a segment of products where you've seen increased sales like gas locks, gas cap locks, et cetera?

During the second quarter, there is no question there was impact on gas prices. There was an increase in locking gas caps in that segment. But gladly, because we had somewhat of a weak heat performance issue a year ago, a lot of that was offset with the heat we had, especially in the Southwest, and rebounding the current levels in those categories of merchandise.

Now, how this thing continues looking forward, nobody really knows. And you know, the impact of the current devastation is a big question mark for everyone. I think it's really too soon to see what will actually happen as far as supplies. You know, there is a national call to quit driving as much and conserve fuel, and we'll just have to wait and see what impact it has on our business. If our current trends continue, we will have comp increases for the second half of the year.

My next question is on margins. It looks like the comparisons look a little better than in the first quarter. Some of that may be the restatement, but I'm wondering if you can give us some guidance for the back half on gross margins and expenses?

The year-over-year margin is obviously not where it needs to be yet. But remember, we did go through a LIFO to FIFO change, which hangs up a lot of inventory or vendor rebates and inventory. And it's really tough to exactly, precisely pick what items are going to sell, so you can estimate how it comes out of there. We think that just looking to the second half of the year, we'd say from the second quarter to the third quarter, 50 basis points improvement, which will basically make it flat to last year. Then, when you get to the fourth quarter, we will probably have up another 20 basis points on top of that, which, when you start comparing them year over year, it's about a 250 basis points increase in the fourth quarter year over year.

But a lot of it, as we talked about, is we have got a lot of vendor rebates caught up in inventory capitalization. You have to flow it through the system. It will get through there. One of the things, when we talked about our May started out slow, June and July have come along very well. So if you're running a little bit behind on sales, you're obviously going to run behind turning those vendor allowances through the cost cap.

And then, on the operating expenses, is there any reason why you can't continue to put up some improvement there?

If you look at it year over year, I think one of the things -- and you and I have talked about this before -- is the way we had to finance our company is with short-term debt, things like short-term leases. Those are now coming off the books, and bought our way out of a lot of these leases, which are helping our store expenses and our SG&A, and we would expect a slight increase year over year in SG&A, last year's third quarter to this year's third quarter, like maybe 1.5 million. But I think in the fourth quarter, we could still be flat on 20 million more in sales. I think that part has gone very well for us.

And then, lastly, just some housekeeping. Can you explain what the severance charge was in the quarter?

Matt, that's a personnel matter that does not involve a principal officer or require a Form 8-K disclosure, so we don't view it as material, and we are not going to really discuss that any further.

And then, another housekeeping item. In the EBITDA section of your release, can you explain what the noncomparable items are? Maybe it's one and the same, the severance.

In the noncomparable, it's the cost associated with the write-off of the old bank deal in addition to the severance that Martin just talked about. That's the whole number. But the majority of that number is the write-off of the bank debt.

Michael Baker, Deutsche Bank.

Just a couple of questions. On the gross margins, the three impacts you talked about -- being the vendor financing, the transportation costs and the mix shift to commercial -- can you give us sort of an order of magnitude?

When you look at that, you guys have modeled the commercial sales; they do come with substantially lower gross profit rates. But it allows you to leverage your SG&A. So on the bottom line, we end up doing better in those type of transactions. And then, if you take the vendor rebates, we believe that's a timing issue. And when you look at the cost of fuel, most of that is when you are delivering to 1,150 stores every week, and the diesel fuel is $0.40 a gallon higher than gasoline, that kind of hurt us. So I would say, in priority, vendor rebates is probably the highest, but not much difference in commercial and not much more than just the cost of fuel.

And the transportation costs are up, even though I think -- didn't you guys renegotiate some transportation contracts, to try to offset that?

Yes, well, we did. Our distribution guys did an awesome job. They have taken -- in theory, you take a bunch of money out of the fixed costs there. But, as any distribution contract is, it's a pass-through for gas. So, when we save it on the trucking, you save it on handling, you save it on depreciation. But when diesel fuel, like I said, is $0.40 to $0.50 a gallon higher, that over time -- you know, we have to react to that and we have to pay it.

Obviously, what's going on with the gas prices now -- that's the sort of included in that gross margin outlook that you just gave on the previous question?

We did look at it, and that's why we are a little skeptical about this. Driving to work this morning, when you see lines at the gas station, it makes me a little nervous. I think people may -- maybe some of these people are overreacting, but what we need to do is get that area of the country fixed. And as we go forward, I think we can continue to bring the gas prices down. We may have to look at delivering some of the smaller stores every other week. There are certain things that we will look at.

Two more quick ones, if I could. The number of commercial stores this year versus this quarter a year ago? Is that something you can disclose?

Well, we have 625 commercial stores this year. The same time last year, we had 587.

And then, last real quick -- the 3% costs that you discussed, can you discuss how the -- that's, I guess, how the quarter ended and how this quarter is beginning. Are the retail comps positive within that mix?

Yes. One thing -- and we really don't give out stuff on a monthly basis, but May, I think, for most retailers started out slow. June and July, with the heat, have been good. And we are trending that, what Maynard said, that 3%. We would expect that to continue going forward. But what I'm happy about in that 3% is that the retail has turned positive. Now, it's not at the 3% level, but it's slightly positive. And I think, if you look over the last five quarters now, retail has got better and so has commercial. So I think those are good trends, but like I said, we want to remain a little cautious, because we don't know what happens over the next several days.

The big caveat to this whole thing is how the consumer is going to react to fuel prices and supply, and whether it's going to have any impact on the do-it-yourself business, the retail business and/or the commercial business.

And I think all retailers are facing that same question.

David Siino, Gabelli & Company.

Don, can you just verify -- that 3%, you said, is over the last ten weeks?

Yes.

And free cash flow, second half versus first half, slows down. Is there more CapEx in the second half?

(Multiple speakers) we will open 60% of our stores in the second half of the year. So that's why the 80 to 90 makes more sense. But I've got to tell you we have been very successful with the vendors getting AP up, getting better dating. And now, with our credit facility in place, that instead of keeping the cash because you didn't want to lose your long-term debt, now we have the ability to pay that down. Now we're working much better with our vendors. We have just negotiated some more longer dating with them. So if payables continue where they are, we could have some upside in that number.

But just one clarification. He meant you didn't want to lose your long-term availability.

That's right.

Not your long-term debt.

And Don, the status on the share buyback right now? Where did you end the quarter at?

Well, as part of the bank refinancing, we did buy back $25 million worth of stock, which was 1,409,000 shares, approximately. But we also are going to be opportunistic. Our new bank deal gives us the opportunity. We have no covenants, unless your availability gets down under 60 million. We're up to the 185 to 190 million of availability. So we're going to look at that. I think the best thing for us is to look at opening new and profitable stores in our existing market areas, because they really help us leverage our expenses. I think we've got, like I said -- with the gross profit sequentially going up each quarter and we manage just operating expenses, over time, short-term hits of gas prices may be tough. But over the long-term this is still a strong business. Cars are not going away.

So as we sit here on September 1st, that 185 to 190 -- that's maximum amount available for a stock buyback?

Well, there's a couple of things that are in there. Obviously, you have some restricted payments baskets that are associated with our high yield 7% deal out there. But when you look at -- you know, we just put another -- we went from $250 to $325 million. We do have the ability to buy back probably 10 to 15 million a quarter.

Jerry Marks, Raymond James.

Don, I didn't catch what your payables number was. How was your payables inventory this quarter?

It went from 37% last year to 39% this year. And we expect that obviously the first quarter -- because, as you ramp up inventory, you get a free ride in payables. But we believe we are slightly better; we expect it to be about 36 at this time. And we would certainly like to get to 40 by year end. And 40 to year end will generate some extra free cash flow for us.

And on free cash flow, I noticed you're accelerating areas, square footage plans, but your CapEx seemed to come down on a year-to-date, year-over-year basis. How come? Is it just timing of --?

Yes, I mean, a lot of it is the timing of when you open the stores. But as many presentations we've done, CSK is not an owner of real estate at this time; it's something we may look at in the future. But to open up a new store, when you talk about all the costs, you're talking $200,000 to open up a new store, excluding any inventory costs that are not in AP. So then, you've got to go and say 60% of your stores are going to grow in the second half, so that's part of that.

So you are not giving EPS guidance or anything, anymore?

As you know, we previously gave guidance at the end of May. We don't give quarterly guidance. Excluding our refinancing and severance charges, we're comfortable with our prior guidance, but with our sales, we think we're at the lower end of that range. However, as Maynard said, there's a lot of uncertainty out there in the environment relative to factors such as gas prices, the gasoline supply and the recent hurricane. So those things could -- they haven't, obviously; it's only been a short period of time. But that's some pretty bad devastation down there, and we wish those people well. And whatever we can do to help, we will. But I think we can't predict the future right now, because we just don't know.

So, in terms of your EPS guidance, I forget what it used to be. But that still stands right now, your annual guidance?

Yes. There's a Street number out there that's there. We don't talk about that, and I think annual guidance will be probably the only guidance you have, because we feel good about the full year. And when you try and pinpoint it into quarters, there's a lot of things that happened in individual quarters that may be misleading -- the timing of vendor allowances and things like that. We have to look at our business over a course of a year.

On an annual basis, both last year and maybe this year, you seem to be running kind of 6 to 7% operating margins. And I'm sorry -- this is my last question. A lot of your competitors kind of seem to be running 10 to 18%, but there's been a lot of these charges and FIFO to LIFO. Is it more accounting differences, or is there just something else that you feel operationally you can improve on?

I think, when you start looking at our company, you really need to do an analysis of EBITDAR versus EBITDA, because if you look at the AutoZones of the world and the Advance and the O'Reillys, they own a good portion of their real estate. And the last analysis that I did with AutoZone of what they own in real estate -- it gives them an advantage of about 690 basis points in operating margins, and it gives Advance Auto and O'Reilly about 300 basis points on a comparable basis. So I think you really need to go look at EBITDAR and do that analysis. But as we said, we still feel comfortable that there's 30 to 50 basis points year over year for the next several years in our operating margins.

Alan Rifkin, Lehman Brothers.

A couple of questions, if I may. What contribution, if any, did new products have to the same-store sales number? And can you maybe break down, Don, if you would, the performance of the core items versus the new products, from a comp perspective?

Well, if you look at it, obviously we had a big benefit a couple years ago on the wheels category into last year. We have kind of cycled that now, but if you look at our business and you look where the strength was in the second quarter, it came out of areas such as brakes, batteries, air conditioning, starters, alternators, fuel pumps. So the core business is trending really well, and I think the strength of our commercial business says that this is a good industry. And we had some tough comps to go against for a couple years, but for us to continue to grow those comps, we've got to continue to grow the top line with new stores and new products. But, all that being said, we don't have anything out there that's generating sales like we got out of the wheel category.

Alan, it's also difficult because those new items you referred to cycle into the mix as they become good movers. So a lot of our categories we introduced last year and the year before -- generators, some of the power tool categories, power washer categories -- those are all comped now, and they continue to be good SKUs in the Company. And then we also have new items that we're rolling in all of the time as part of our promotional schedule.

But Martin, like on an annual basis, how many new SKUs would you say you're introducing into the mix?

I don't even know if I can give you an exact answer on that. On a year-over-year basis, there's literally -- there's over 1,000 new items that go into the Company and another 1,000 that gets deleted out, when you count all the parts and everything.

When you start talking about a net basis, just a guesstimate, it's in the low 100's, probably.

Martin, one more question for you, if you don't mind. With respect to the Great Rewards program, can you maybe just shed a little color on like what types of attachment rates you are seeing today, and maybe compare that to, let's say, six months ago? And where, ideally, would you like to be from an attachment rate perspective, let's say, at year end?

There are two parts to the program. One is the premium part; one is the related part to that program. The attachment rates vary by category. In some category, attachment rates have gone from 7% to close to 30%. In other categories, attachment rates have gone from 15% to 19%. It really depends a lot on the category and how many additional add-on sales we're doing ahead of time.

But the key to the program is -- and the example I gave on alternators and fan belts, the fact of the matter is that customers are buying new alternators. If they don't buy a fan belt with it, they are going to be, probably, back to the store in a short period of time with a broken fan belt, just because of the difference in the grooves.

But we are doing very well on that. The premium part of the program is also doing very well, upselling. That rate also varies by category. Some categories of premium goods are up as much as 20%. Other categories are up as much as 5 to 10.

Michael Cox, Piper Jaffray.

Just a couple of questions. I was wondering if you could give us an update on the Pay N Save program and the number of stores in the 40 net new that will be the Pay N Saves?

We are currently operating three, soon to be four, soon to be five. And still too early to tell exactly where we are going to be with the Pay N Save program. But having said that, so far we are very encouraged by what we think we can do with that operation.

And turning to the balance sheet, I was wondering, as you look at the year end, where do you expect your debt balance will be, approximately? And looking at interest expense, following the debt refinancing that you have done here, what should we be thinking about for back-half run rate for interest expense?

First of all, Mike, the 50 new or relocated stores, which was the 40 net new stores, do not count any of the Pay N Save stores. So that would actually take that number up four or five more -- one issue.

The second issue is we think that we are at 412 million right now of debt. We think that we can get that number down another $40 million by year end. And if you assume that, with the current interest rates and the convert we did, you should be somewhere about 7 million of interest expense a quarter, down from 8.5 in the first quarter.

That's very helpful.

Did that (multiple speakers) your questions?

Yes, it does, thank you.

(OPERATOR INSTRUCTIONS). Matthew Fassler, Goldman Sachs.

Matthew Fassler: I've got two follow-up questions. The first relates to gross margin. Don, as you talk about the gross margin you expect to capture from rebates as you work through your inventory, are those essentially rebates that you have already earned? In other words, they are not at risk based on sales?

No. What happens is with our change -- what happens is you get vendor rebates. You get the money, you get the rebate, but you capitalize the rebate until the quarter. So there's no estimations on this stuff. We don't look and forecast any step-ups. So until you receive the product and sell through the product, you really don't get those.

Matthew Fassler: The issue is merely one of timing, then, rather than of any risk getting that money, to booking that money on the P&L?

No, that money is booked in capitalized purchase discounts. And it's, at the end of the quarter, $58.2 million, and there's no risk on us coming back saying, "Hey, look, that 58.2 should really be 58," or something. Because that's money that the vendors have already given us.

Matthew Fassler: Got you. Secondly, on the gas issue, Maynard, given that you are younger than the rest of us and have seen these things, I would imagine, before, in the mid-70s, late 70s or early 80s, do you have some firsthand experience with energy shocks? If you could just kind of talk about your recollections of how those played out, where in the business you saw challenges and kind of what the triggers were, in terms of gas prices, and where you felt it during prior cycles? I would find it really helpful.

Even though we have been through it in the past, there's still big question marks, because times and circumstances have changed. When you back to the 70s, it was an issue of supply and long lines and all the rest of things. When you take a look at -- and it wasn't necessarily the price.

Now, today, we are talking about price and the possibility of availability. So far, we haven't seen the availability pop up everywhere, but just in a few sporadic areas. As an example, in Phoenix yesterday, the Circle K stores, a lot of them ran out of fuel, both in unleaded regular and the step-up to it.

But when you take a look at some of the things that I have been reading, even with the gas prices in the high $2, on a relative basis, when you take a look at inflationary forces, the numbers that I have been reading said that the gas prices were the same in the high $2 or lower than they were comparatively back in the 70s. Now, obviously, the consumer that is now having to pay $60 or $70 to fill up a tank may not look at it that way. So we'll just have to wait and see what the impact is.

The thing that concerns me is when you'd hear people like Wal-Mart and some of these big-box retailers saying that they are seeing an impact of gas prices on retailing in general. We believe industry fundamentals -- vehicles are still going to be the mode of transportation, and they are going to have to be maintained at some point in time. And it may end up, at the end of the day, being a choice between doing other things and keeping people's vehicles on the road. And if it comes down to the economic issue, it could be a boon for the DIY business.

Matthew Fassler: I guess the only other question I would ask -- if you look at the trends from June to July to August, clearly there's a bit of a step-up in fuel prices in July. But then in August itself, from the beginning to the end of the month, you had something like a $0.40 per gallon increase. And I'm curious -- other than the gas tank locks, et cetera -- whether you saw changes in tone or in any other way that would reflect what really was a pretty big move in August prior to Katrina hitting New Orleans.

The only changes in tone is what we saw electronically with the newscasters and that type of thing. Our business, as stated in the last 10, 11 weeks, has been as strong as it's been for nine months in both segments -- the do-it-yourself retail segment and the commercial business. And I think it's too early to tell whether we are really going to have a change in attitudes which will impact the business.

Another thing clouding the issue right now is the lead-up to Labor Day. I think most people had already made their travel plans. So as we look at the sales on the lead-up to Labor Day, we haven't seen anything yet, because I think people had already made their plans. So it's going to be a while before we see.

We got a return to normal towards the end of the second quarter in our heat-related products. We had some real hot weather in some of our operating areas, and it helped put back the sales on the board that a year ago we were struggling to get.

We feel strong that over time the sales will be normalized. We think that 3% is a normalized rate. That's why we went to more annual guidance, so you don't have to say, "Hey, gas prices were up for six weeks. What do people do?" So that's why we've had it that way. But sales --

Matthew Fassler: You don't have to, but we have to.

Well, we kind of have to, too.

Matthew Fassler: Fair enough.

(OPERATOR INSTRUCTIONS). David Siino, Gabelli & Co.

Don, the sequential gross margin improvement, given the quarterly improvement you laid out for the remainder of the year -- can we assume that the incremental 70 BPS, second quarter versus first quarter, was from basically the vendor rebate recognition?

No. I think there's a lot of things that are in there. We have done a better job in shrink. We have also done a better job in balance of sales. When you get into certain categories like batteries, air conditioning, they come with a much higher gross profit rate than some of your existing. But if you looked at just vendor rebates, they were just slightly higher in the second quarter than they were in the first. So in a company whose inventory turns 1.7 times a year, it's a question whether it takes you 7 to 12 months to get those funds to flow through the vendor rebates. That's just the timing issues we deal with.

(OPERATOR INSTRUCTIONS). I am showing no further questions.

If there no further --

Thanks, everyone, and have a nice holiday weekend.

We'll see you all at the end of next quarter.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Thank you and have a nice day.