O'Reilly Automotive Inc (ORLY) 2005 Q4 法說會逐字稿

Good morning and welcome to O'Reilly Auto Part's 2005 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. [OPERATOR INSTRUCTIONS]

Thank you, I will now turn the call over to Mr. Jim Batten, CFO. Please go ahead, sir.

Thanks, Matthew. Welcome, everybody, to our call. Before we get started, I'd like to read our normal disclaimer. We started a couple of minutes late just to give some of you on the AutoZone call time to get over. So, thank you for your understanding.

The Company claims the protection of the Safe Harbor for forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by forward-looking words, such as expect, believe, anticipate, should, plan, intend, estimate, project, will, or similar words.

In addition, certain statements contained within this call that are not historical facts are forward-looking statements, such as statements discussing among other things, expected growth, store development, and expansion strategy, business strategies, future revenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions, and are not guarantees of future events and results.

Such statements are subject to risks, uncertainties and assumptions, including but not limited to competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our ability to hire and retain qualified employees, risks associated with the integration of acquired businesses, weather, terrorist activities, war, and the threat of war. Actual results may materially differ from anticipated results described or implied by these forward-looking statements. Please refer to the risk factors section of our Form 10-K for the year ended December 31, 2004, for more details.

With that, I will turn it over to our Chairman, David O'Reilly.

Thanks, Jim. Good morning, everyone. Thanks for being with us this morning. Our call agenda this morning will be brief opening remarks by myself, and then Greg Henslee, our CEO, Ted Wise, our COO, and Jim Batten, our CFO, will all have remarks, as well.

It's a real pleasure for me to make this opening brief comment before turning the call over to Greg. 2005 represented the very best year that O'Reilly has ever had in almost every aspect of the business. Whether you look at our EBITDA performance of over 15%, or the return on invested capital of over 14%, or even our operating income, which is this year for the first time over 12%, or any other of a number of other measures, it's reflective of really two I think critical dynamics in the business today.

First, we have a leadership team in place that is just awesome, both in the corporate and the regional offices, as well as out in the field. And that leadership team gets up every morning with one objective, and that's to do their part to improve our customer service, and our overall business operations. And I think our performance in 2005 is clearly a result of that mindset, and of their hard work and their dedication. And represents that of every Team O'Reilly member throughout the Company.

Secondly, we are operating in an industry that continues to experience unmistakably strong fundamentals, that lend themselves to continued strength and growth in the entire automotive after market parts business. One must look really no further than the, consistent vehicle population growth in conjunction with the fact, that according to a very recent government study, 50% of the passenger cars today survive until they are 13 years old.

Only 30 years ago that survival age was around 10 years. In that same period, the expected miles driven for a vehicle during its lifetime, went from 107,000 miles to 152,000 miles. Simply put, people are keeping their vehicles longer, they're driving them further, and there's more of them on the road than ever before. Again, that bodes well for our business, no matter how you view it.

Our executive management team is committed to continue the great work of this past year, and years past, and we are gratified to know that we continue to have significant opportunities for growth and improved customer service. That's our focus and it's our culture. In the knowledgeable hands-on approach of growing our business, it's a true pleasure to be a part of. 2006 will be another exciting year for Team O'Reilly, and we're indeed fortunate to have a leadership team with the experience, the confidence, and the dedication to continue the Team O'Reilly tradition.

With that, I'd like to turn the call over to Greg Henslee, our CEO.

Thanks, David. Good morning, everyone and again, welcome to our fourth quarter 2005 conference call. Let me begin by thanking all of Team O'Reilly for the outstanding results in the fourth quarter and for all of 2005. Our team again focused on the key drivers of our dual market strategy, which revolve around providing the best customer service in our industry, to both wholesale and retail customers, and have continued to grow sales on both sides of our business.

As David mentioned, 2005 was just an outstanding year for us. I'd like to briefly review some of the more significant events and accomplishments in 2005, before I move on to our fourth quarter and year-end performance. In March of '05, we opened our 11th distribution center in Atlanta, Georgia. This DC is capable of serving up to 250 stores, supporting our continued growth in to the southeast. In May, we acquired Midwest Auto Parts, which included 72 stores and two distribution centers, adding our footprint to a total of 25 states, and positioning us for growth in the years to come in these northern states.

In September, our team was challenged to recover from Hurricane Katrina, which affected approximately 160 of our stores in one way or another. We were the first stores to open following the hurricane, and of the stores that sustained substantial damage, all but one is now open. The one store that remains closed is in New Orleans, and we continue to evaluate whether or not it will re-open, depending on future development in that market. Team O'Reilly also achieved record operating margins of 12.3%, which is our highest annual operating margin ever.

And lastly, after finishing 2001 at just over $1 billion in annual sales, we set an aggressive goal to double our revenue, and grow to $2 billion in just four years. We called this our two for your future goal, and we achieved that goal as planned in 2005, finishing the year at $2,045,000,000.

We asked ourselves, after accomplishing a four-year goal to do $2 billion annually, what's next? That was decided in Dallas, Texas at our Annual Store Manager's conference earlier this month, and we're very pleased to announce our new sales goal called 4 and 10, we all win. Which means our goal is to be a $4 billion company by the end of the year 2010.

Now, on to a closer look at our fourth quarter and year-end results. We're very pleased with our comparable store sales performance in the fourth quarter of 7.4%, up against a strong 8.5% comp from fourth quarter '04. We finished the year with 7.5% comparable store sales.

We believe our comps are fueled by our continued efforts to outservice our competitors, both wholesale and retail, with our high level of professional service, access to inventory coverage and selection second to none. Our assortment of quality brands, and as David mentioned, the vehicle population data that continues to show, that cars and trucks stay on the road longer, and are driven more miles today than ever in history.

The average age of a vehicle on the road today is over 9.5 years. Additionally, as has been proven in the past, trucks typically stay on the roads longer than cars, and all the SUVs and trucks that were sold in the '90s, are now well into their heaviest repair cycle, and will be for some time to come. And as we mentioned before, the drive trains, bodies and interiors of the newer vehicles, are so much better than in the past, these vehicles are capable of staying on the road, and are worthy of significant maintenance and repair investments at very high mileages.

I know some of you are wondering about the impact, the recovery from Hurricane Katrina had on our fourth quarter comps. To answer that, we ran our comparable store sales, excluding the stores that were affected by Katrina. For the quarter, our comp, excluding those stores, was 7%. Keep in mind that the stores in that area were comping very well prior to the Hurricane, so, obviously not all of their comp growth can be contributed to Katrina, but we felt it might help clarify the impact if we ran the number excluding them from the comp base.

For 2006, we continue to target comps in the mid-single digit range of 4 to 6%. First quarter of last year, we reported comparable store sales of 7.1%, of which January and February were absolutely outstanding months, and March significantly slower. Which is not unusual at all to have some pretty meaningful swings from month-to-month in any given quarter.

So far this quarter, our comp store sales pace has slowed somewhat from the end of last year, due to the comparisons, and the unseasonably mild weather. We hate to talk about weather, but everyone knows our business benefits in the short-term from extreme temperatures, either hot or cold. We've had an extremely mild winter in most of our markets, as has most of the U.S. Considering that as a contributing factor, our estimating first quarter comps is at the lower end of our range. However, we are almost through the winter season, and are confident in our mid-single digit comp goal for 2006. Jim will be reviewing detailed first quarter and 2006 guidance in a few moments.

Our gross margin for the fourth quarter and year-end came in at 44.9% and 43.6%, compared to 43.5 and 43.2% last year respectively. We attribute most of the increase in the fourth quarter to nonrecurring vendor rebates and volume incentives, some attributable to the acquisition of Midwest Auto. We have several efforts under way to maintain and grow our gross margin, and are projecting gross margin for 2006 in the mid-43% range.

Considering the substantial increase in energy prices in '05, we're extremely proud of our team's effort to keep operating expenses in check. If we exclude the nonrecurring adjustments for the lease accounting corrections in fourth quarter '04, and the stock option vesting expense in '05, we decreased operating expenses 60 basis points for the quarter, from 32.8% to 32.2%, and 50 basis points for the year from 31.7 to 31.2%.

This is the result of our team's relentless efforts on all fronts to manage operating expenses, while at the same time ensure the highest level of professional service for our customers. As I stated earlier, this resulted in the highest annual operating margin our Company has ever achieved at 12.3%, and earnings per share of $1.45. Excluding the third quarter benefit from the income tax resolution, and the fourth quarter charge for stock option acceleration, our annual EPS was $1.41. A 29.4% increase over 2004 earnings per share adjusted for lease accounting corrections.

Additionally, we continue to focus on our inventory performance, and consider the customization of our Distribution Center and store inventories as strategic advantage. Most of our businesses in the application parts, or hard parts business, so, if a customer needs a part and we don't have it in and a competitor does, we could miss a sale, and possibly lose a customer. So, we're very focused on leveraging our systems, to deploy the correct depth and coverage of inventory in our stores, while ensuring we continue to improve inventory turnover.

We've had customized inventories for a number of years. Dating back to before we used computer systems, but today we have what we feel are the best systems in our business, to combine use of by market, vehicles, and operation data, combined with demand and failure rate data, to arrive at what we consider ideal inventories for each location.

We ended the year with 1470 stores, an addition of 221 stores for the year, including the Midwest acquisition. This was $726 million of inventory, compared to $625 million in the prior year, a 16.2% increase leveraged by an 18.8% increase in sales. We also increased our accounts payable as a percent of inventory, from 38.5% to 40.3%, taking our own inventory turnover from 2.57 times to 2.83 times. Inventory performance and AP leverage will continue to be a point of focus in 2006.

Again, we're very pleased with our fourth quarter and year-end performance, and are excited about our continued growth in 2006, as we start down the road to our $4 billion sales goal in 2010.

I will now turn it over to Ted Wise for some additional comments.

Thanks, Greg. I would like to begin in also congratulating our team members, for just an outstanding sales performance last year. Our team in the stores and the Distribution Centers, and in the corporate support offices, did an outstanding job in meeting our customers expectation, growing market share, and in reaching our $2 billion milestone.

Now I'd like to briefly review our store expansion efforts for last quarter and the year-to-date. We finished with 39 stores in the fourth quarter, giving us a total of 150 new stores for the year. There were three acquisition stores in the fourth quarter, which brings us to the total of 10 acquisitions, or approximately 7% of our 150 store growth. Somewhat a live year for acquisitions, until you factor in the purchase of Midwest Auto, and the 72 acquisition stores from the Midwest buy. Overall, an extremely successful and busy year for our store expansion teams. In addition to our new store growth and the Midwest acquisition, we relocated 25 stores to new buildings, and completed 29 fairly major renovations last year.

We worked to improve the planning and balancing out the flow of new store installations this year. And it's giving us installs of 25% in the first quarter, 27 in the second, 22% in the third, and 26% in the fourth. This has obviously resulted in a much smoother and higher quality installation, and helped us in improving the staffing of these new stores as they come online. As planned, and following the opening of our new Atlanta D.C. in the spring, we concentrated much of our growth in the southeast states, with 44 new stores in Georgia, 11 new stores in South Carolina, 8 new stores in Alabama, and 6 new stores in North Carolina.

Once again, Texas continued to be a top producer with 17 new stores last year. In preparing for the opening of our 14th DC this summer in Indianapolis, we also concentrated growth in Illinois, resulting in 17 new stores last year. The remainder of our new stores were fairly well spread out, with the expansion reaching 18 different states. To help support the opening of the Indy DC this summer, we will continue to focus much of our growth in Indiana and the surrounding states, as well as continuing to grow in the southeast states.

Our store plans for the northern states out of Minneapolis and Billings DCs, continues to develop and we will have several new stores come on this year in these markets. We have an established plan for 2006 of 170 to 175 new store installations. Now in regard to the new Midwest stores, by the end of March, we will be finished with the first round of remerchandising their front display areas to our product lineup. And for the most part, all of the hard part line changeovers will be completed too.

We continue the planning process and scheduling more extensive remodels or relocations for all these stores, and expect to make significant progress by the end of this year. Our goal is to have all the stores changed over to O'Reilly identification by our summer sale this year. Of course we are evaluating new expansion markets, and several new properties are in the planning phase today for the northern states.

Now in regard to the area of store design, we have finalized our new interior graphic package for the perimeters of the display floor/wall, and we plan to have these installed in the majority of the stores by year-end. This is sort of the last step in an interior reimaging program that has been implemented to the stores, in a number of steps within the last year. It included new aisle markers, end cap signage, extensions of display fixtures, and several smaller design components. It has definitely resulted with our stores having a much brighter and more appealing shopping atmosphere for our customers.

A couple of comments on our Sales and Manager's Conference last year in Dallas. It was very successful. We had over 2,000 O'Reilly Team members from sales, store management, and corporate support in attendance. In addition, we had approximately 400 vendor partners that were involved in product and sales training of our team. And obviously, we celebrated our $2 billion a year accomplishment and the entire O'Reilly team left Dallas, charged up to have another great year.

At the Conference, we also announced several new store programs that were extremely well received. First in the second quarter, we will be rolling out our new store productivity and scheduling system that will help us improve flow and customer service at the counter. Shortly falling, we will install a new graphical Point Of Sale interface in the store, which will be more user-friendly, and easier to learn for new team members.

And last but not least, during this year, we will be implementing a new LMS, or learning management system, that will convert our paper-based training over to an in-store computer-based system. The new system will add a new level of effectiveness to our team member training programs, and help ensure that we continue to have the most professional parts specialists in the business. Without question, the entire O'Reilly team left the Conference, with a lot of excitement and enthusiasm for the upcoming year.

With that, I will turn the call back to Jim Batten for his comments.

Okay, thanks, Ted. I'd just like to run through the financial results and then talk about guidance. Then we will give it back to the operator for questions.

First of all, our sales performance, we were up 18.8% to $2.05 billion for the year, with 7.5% comps. And we calculate comps for stores open greater than 12 months. In the quarter, our sales were up 20.4%, to $515 million, and the comps were 7.4%. Sales to independent jobbers were $48.2 million for the year, compared to $33.3 million for the prior year. And in the quarter, $14.5 million compared to $7.8 million in the prior year. And both of those increases are due to the Midwest acquisition and the independent jobber business we gained there.

On a gross margin, just to reiterate briefly, 43.6 in the quarter, excuse me, for the year, versus 43.2, a 40 basis point improvement. And then or the quarter, 44.9% compared to 43.5, a 140 basis point improvement. Our gross margin trends continue to be very consistent and strong. This increase was due to improvements in our distribution cost, and then as Greg mentioned, vendor rebates and then just ongoing product margin improvements through negotiations with our vendors, and adjusting our pricing where we can.

SG&A, I'm going to refer to SG&A as adjusted numbers. And just to clarify again, that excludes the charge for stock option acceleration in the fourth quarter of '05, and will also exclude the lease corrections made in the fourth quarter of '04. That's what I will be referring to from now on as adjusted numbers. SG&A adjusted was 31.2% for the year, compared to 31.7. That's a 50 basis point improvement. For the quarter, 33.2% compared to 32.8%, a 60 basis point improvement.

We continue to get good leverage in our salaries and benefit lines, and some other, you know, fixed costs, which was somewhat offset by higher utilities and fuel costs, and a very good performance overall. Operating income on an adjusted basis is 12.5% for the year. That's adding the stock options back, compared to 11.5 in the prior year, or a 29% increase in dollars. For the quarter, 12.7% versus 10.7%, a 43.4% increase in dollars on an adjusted basis.

Our tax provision for the year was 34.6%, including the tax benefit in the third quarter. Excluding that, it would be 37.1%, and that is also the same tax rate for the quarter. Our net income on an adjusted basis, this would be the items I talked to before, plus adding back the tax benefit will be $159.6 million, or 7.8% of sales, a 30.8% increase for the year. Then without those adjustments, $164.3 million, or 8% of sales for a 39.6% increase.

Then for the quarter, of an adjusted basis, $40.9 million, or 7.9% of sales, a 46.2% increase for the quarter, and then without the adjustments, $39.5 million, 7.7% of sales, or a 79.5% increase for the quarter. And then diluted earnings per share adjusted, $1.41 compared to $1.09, a 29.4% increase on 113.4 million shares, a Consensus estimate for the year was $1.35. For the quarter, adjusted basis, $0.36 compared to $0.25, a 44% increase on 114 million shares. The Consensus estimate was $0.30.

Moving to the balance sheet, again as Greg mentioned, our inventory was $726 million, the growth there is due to the new stores, the Midwest acquisition, and then the Atlanta D.C. but again less than our sales growth. Total assets, 1.7 billion, a $281.5 million increase from last year-end. On accounts payable, $292.7 million, an increase of $52.1 million, and AP inventory is now 40.3% compared to 38.5 at 12/31/04. Our total debt is 100.8 million consistent with the prior year balance, our debt to total cap is 8.1%. Our debt-to-EBITDA is 0.32.

We have $75 million of our private placement notes that are due in May of this year. And we are starting the process of issuing new private placement notes to repay those. That deal is under way, but will close in the early part of May. That's concurrent with the maturity of the existing private placement notes. Our EBITDA for the quarter and year, $315.5 million for the year. This is adjusted, 15.4% of sales and our EBITDA to interest coverage is still very, very strong on our debt at 62 times.

Our other return metrics, return on equity, again on an adjusted basis, 15.2%. The highest we've had in a number of years, return on assets 10.1%. Return on invested capital 14.3%. All of these are highs. Other information, our LIFO for the quarter, we had a LIFO charge of $6.8 million. For the year, we had a LIFO charge of $9.5 million. That's just reflective of increases in prices on petroleum-based items and other products.

Depreciation, $15 million for the quarter, $57.2 million for the year. CapEx, $55.6 million for the quarter, $205.2 million for the year. Interest expense, 1.5 million for the quarter, 5.1 for the year, again, that's gross interest expense. Cash flow from operating activities, $213.3 million for the year. We ended up the year at 8.2 million of free cash flow, that's a little lower than what we anticipated, but that's due to some large tax payments in the fourth quarter. And the seasonality of the fourth quarter and also our new stores this year. We had more stores that were owned than lease. Which is the driving cause of our CapEx being higher than the original estimate we had given.

Now to move to the guidance. We are giving guidance on CapEx of 215 to $225 million for 2006. Revenue guidance of $2,310,000,000 to $2,375,000,000. Interest, 4 to $5 million. Depreciation, 60 to $63 million.

Continuing our tax rate at 37.1%, then on earnings per share for the year, $1.59 to $1.65, excluding stock option expense of $0.02 for the year. Or $1.57 to $1.63, including the $0.02 of option expense. And then for the first quarter, $0.34 to $0.36, and option expense in the first quarter will be probably around $0.005, or something like that, so we'll just have to see how that turns out exactly.

Free cash flow for the year of 2006, we're targeting 25 to $35 million, and I wanted to also report that our Sarbanes-Oxley project for 2005 is virtually wrapped up, and we're anticipating receiving a clean bill of health on that again for the year. Just want to remind everyone, that we always try with our guidance to be reasonable on that and we'll fine tune it as we go through the year.

And with that, Matthew if you'll come back on, we'll take questions.

[OPERATOR INSTRUCTIONS] Our first question comes from Alan Rifkin with Lehman Brothers.

Yes, congratulations on a terrific quarter and a terrific year!

Thank you, Alan.

A couple of questions if I may. Any sort of long-term operating margin goal that would go hand in hand with the $4 billion revenue target in 2010? And I also wanted to ask you, with respect to the new store productivity and scheduling systems that you're looking to implement in Q2, can you maybe just talk about any expenses that may be one-time in nature, that will be associated with that?

Sure. From an operating margin goal perspective, Alan, this is Greg, you know, we like to continue to incrementally grow it, as we continue to grow, you know, continue to operate somewhere in the 12.5% range. That's our goal, you know, at some point we get a little bit uncomfortable with being able to service our customers the way we like to service them, but we look for opportunities all over the place to continue to grow it. We don't have a specific goal, but look to continue to improve operating margins and will continue to do that as we move toward $4 billion.

On the scheduling system and the POS system, the scheduling system is something that we're developing in-house with our own IT staff. So, we really will have no meaningful expense along with that.

And our POS system, a lot of that expense has already been, is being depreciated currently as the hardware to facilitate the system, is for the most part, already deployed. So, for it also there will be no meaningful expense that will be noticed.

Okay. and one more question, if I may, Greg, with respect to the Midwest acquisition, I believe on the last call you stated your comfort level with potentially increasing the EBIT margins at that chain alone, by about 500 basis points, within 12 months. Can you maybe just give us an update on where you stand there?

We're still comfortable with that. We've done a lot of work up there. We have changed over all the merchandise, and we continue to do the things we do when we acquire a company. We're just now getting to the point where we feel like we can hit the road, and start gaining business up there. We're still comfortable with increasing EBIT margins by 500 basis points over what they were previously.

Alan, this is Jim, maybe to follow on a little bit, we've initiated the product changeovers, and that helps us get part of the margin, and getting our buying power, obviously. And as Greg mentioned, as we grow the sales volume, we can leverage the fixed cost, which right now, that isn't happening as yet, because of all the changeovers we're doing. We have the stores messed up a little bit. We will see that continue to improve later in '06.

Okay. Terrific. Thank you very much.

Thanks, Alan.

Our next question comes from Scott Stember with Sidoti.

Good morning, guys.

Good morning, Scott.

Could you maybe talk about the vendor rebates in the quarter, maybe quantify from a basis point standpoint, how much it accounted for in the quarter? And also maybe talk about how really one-time in nature are these?

Scott, we don't really want to give a specific number, but we kind of add three or four things in the quarter. We had improvements our distribution costs, which we continue to work on that, and then we had a vendor rebates and the reason, you know, we're saying some of those are what we'd classify as nonrecurring, when you have strong comps, things like that, it can rachet up those type of things. So, those factors kind of evenly contributed, along with continued efforts to buy better, and drive our margin at the point of sale.

So, really those three things are what you can look at with the margin. If you look back over our history, we've had fourth quarters with a 46% gross margin, because you have year-end trueups, physical inventories, those things. We're targeting the mid-43 range going forward on margin.

Okay. And you touched on some of the softness in the sales, given the fact we haven't had extreme weather either way recently. Can you just talk about some of the products that you're talking about, which are being impacted?

Well, it's, of course, the winter type products, you know, the heater cores and radiators and, you know, batteries to some degree. Things that would typically be cold weather-related, which goes beyond the items I just mentioned. But to some degree, just traffic in general. A lot of you know, weather, as we've talked about, extreme weather conditions drive traffic into our stores for various reasons. So, we're looking forward to spring. We feel like the spring selling season will kick in here and business will, you know, pick up to where it's been here pretty soon.

And Jim, I missed it, did you give the free cash flow number for 2005?

Yes. $8.2 million for '05. And our guidance for '06 is 25 to $35 million.

Okay, that's all I have. Thank you.

Thanks, Scott.

Your next question is from Scot Ciccarelli with RBC Capital Markets.

Hey, guys, how are you?

Hi, Scot.

How you doing, Scot?

All right. A couple of questions. You know, one follow-up on the rebates. Is there any way to quantify or give us color on what you would think of as more one-timish in nature, and what is on a more recurring basis?

Scot, let me make a comment, and see if Jim or David want to add to that.

Okay.

The reason the rebates came into play this year, maybe more than they had in previous years is, you know, some of our product, or our vendor relationships, they're a hurdle set -- at the beginning of the year for the end of the year. Then you would get a certain amount of rebate. With the Midwest acquisition, and business maybe being better than we anticipated earlier in the year. We exceeded some of those hurdles.

And that really is what caused the rebates to be the issue they were in the fourth quarter. Where they may not have been in previous years, but in some years they have been.

As far as quantifying them, you know, it's pretty hard to quantify. I think the best guidance we could give you would be to target mid-43% range gross margin for the year.

So, it's one of those where if you think you're on track for "X," you will wind up accruing to that rate, but since things turned out better, you will wind up getting the overage. Is that correct?

That's exactly right.

All right. That's fine. Another question, regarding, you know, any color on, you know, average ticket versus traffic, number one and number two in terms of retail versus commercial? I know you guys have been tracking pretty consistently between those two segments of the business. Is that still remain true, or has there been divergence there?

As far as average ticket versus traffic, you know, both grew pretty evenly. We measure both, of course, as any retailer would, and both grew comfortably. Both were contributors to our comp. As you know, we don't report comps, the commercial versus retail separately, but I can tell you that both grew very healthfully and very comparable with commercial comps being just slightly higher than the retail comps.

And Scot, our mix of business in it, almost identical at 48/52, 48 commercial, 52 retail, as it was in '04.

That's perfect. That's what I was looking for. Thanks, guys.

Thanks.

Our next question comes from Michael Baker with Deutsche Bank.

Hi. Thanks. Just wanted to maybe focus real quick on, are you seeing any product inflation work its way through the system? Is that helping your comp at all? Is it being offset? Are you seeing anything competitively? Is anyone getting sharper with their prices, et cetera?

On inflation, there's nothing unusual that's happened, you know, the oil prices over the past couple of years have contributed, you know, to some degree to our comp. I don't have a measurement of that. We don't do as much business in oil as some of our retail competitors do. Half of our business is retail, and half wholesale. But oil would have been the primary product that would have had inflation, other than a few steel products, which the steel component is relatively minimal. What was the other question?

Anything competitively? Maybe sort of weighing against the inflation?

Just from a pricing standpoint? No, there's nothing unusual. Prices, you know, we shop our competitors every day and we set our prices to match them, and there's been no abrupt change, no reduction in price with any of our competitors, or nothing that should raise any concern.

Okay. And I hate to focus on it one more time, but on the vendor rebates. So, presumably you were under accruing that in the first few quarters of the year. So, now as you cycle up against that, you know, I'd imagine because of the strength in sales, you will accrue a higher amount, or so is that set on what you did this year? Would you be accruing a higher amount? Or because sort of sales are starting off a little bit slow, do you sort of anticipate, you know, a lower volume of sales for the year.

Right. Well, we don't want to make the vendor rebate thing be this big huge thing. That's just one piece of the gross margin improvement, but we look at those estimates every quarter, and true them up through the year, based on how we're performing, and if we think if there are fluctuations, either good or bad, we try to think where we're going to end up for the year. And the volume piece of the rebate is the smaller piece of our rebates in total.

So, we normally we are within 1 to 2%, you know, of our estimates and how we accrue. So, it's not like we sandbag early in the year, or anything like that, but the one thing we don't want to do is accrue too high, and then have a negative surprise in the fourth quarter. So, we watch that very closely. So, I would just again, target the gross margin line, as we said, mid-43 range and we hope to continue to eek that up, as we go forward, to buy better, get more efficient.

Okay, thank you. Appreciate the color.

Thanks.

Our next question is from Tony Cristello with BB&T Capital Markets.

Thanks, good morning, gentlemen.

Good morning, Tony.

I don't have a rebate question.

Thank you! [laughter]

What I was wondering is another component that's sort of helping you out is distribution, and are there any changes you've made with how you approach distribution now that, you know, fuel costs have been higher, and in what ways has that benefited you?

Well, the result of our distribution model hasn't changed at all. We still deliver to our stores with the same frequency that we always have, and the stores that are in towns where we have Distribution Centers, we continue to have daily drops of them, to keep our installer customers with parts that may not move as fast. We have done a lot of things inside our Distribution Centers, however, to make them operate more efficient.

You know, we've done things in some of our DCs like Voice Picking, that allowed us to operate more efficiently. We've done a lot of, we've had a company help us with rerouting our trucks. You know, we run more miles than a lot of companies our size would because of the frequency of delivery. So, we'd put a lot of focus on the route that our trucks take overnight to make our deliveries, and have done a lot of modeling and improvements in the routes that we take.

Just in general, doing time and motion studies in our DCs, and looking for ways to operate more efficiently. So, and we continue to do that. We have opportunities this year, we think, to continue the trend we've had over the past couple of years, of incrementally decreasing our distribution costs.

And does it benefit you with respect to inventory management, as well?

Well, yes, you know, the DCs, they get cramped for space with parts that aren't moving, and certainly don't operate as efficiently. We're very diligent on making sure we keep our inventories turning, and that we move inventory that is on the downward cycle, that we pick the right point to move it either back to the vendor, or decide what we're going to do with it.

Okay. When you look at your expansion into the southeast, have you noticed any changes or competitive responses, whether with respect to either the commercial side, or the DIY side, to your entry?

Do you want to --

No. It's stayed about the same. I think, you know, pricing is pretty rational in all of those markets. So, no, we haven't noticed anything differently this year than we have.

All right. Is the installer base or the commercial customer in the southeast, any different than what you've experienced more in your more established Midwest markets?

No. No. The retail might be a little stronger as you go into the southeast, you know, the warmer, you know, there's probably a larger base of retail, but, no, the installers are, you know, the same type of installer.

Okay.

They're interested in service. Delivery times.

In many of the markets down there, the installer base has really kind of welcomed us because of the way we commit to them. The electronic connections that we have with them. The product offerings that we give them, which includes the products they need to keep their shop running. If they have problems with their lift or their compressor, diagnostic equipment, we can help them get those things fixed. So, in many, almost always when we expand into new markets, we're kind of a welcomed entity among the installer base.

Okay. Okay. And one last question, with respect to labor, I know you focus a lot on the commercial side in finding capable employees to manage the desk for you. Has that become more difficult? Is it about the same? I know you're instituting more and more training to maintain a level of consistency throughout your store base.

Well, obviously it's always a challenge to find good people and, of course, we work very hard on growing our own people internally, as well. And as I mentioned, our new management system we're going to roll out this year, it is going to be a real advantage in that regard, just from being more efficient, electronically being able to train people in remote areas, versus the paper system is really challenging.

So, again, that's probably our bigger challenge, as always, is to find the right team members to run our businesses. So, we work harder on that and our district managers, our regional managers, you know, that's their #1 focus, is recruiting and training and promoting and, you know, growing the team. And with the expansion goals we have, you know, we have to stay right on top of that game, for sure.

Yes, I mean you will notice, too, we have more full-time people than part-timers as a ratio, than a lot of our competitors do. We feel like that helps us attract people, too, because they have a little more stability and know kind of what they're up against.

Great, thank you, good quarter.

Thanks, Tony.

Our next question is from Matthew Fassler with Goldman Sachs.

Thanks a lot. Just one kind of leftover question, if you will, related to the impact of LIFO, and kind of what your apples to apples FIFO margin would have been on a year-over-year basis. I know you gave us the LIFO charge, but if you could spell it out for us, that would be ever helpful.

Sure, Matt, just one second here. This year in total, we had a LIFO charge of $9.5 million. Last year we had $13.4 million, but that was increased because of our inventory accounting change we made in the fourth quarter. So, really this year if you took that out, we've probably had a bigger LIFO charge this year, so our FIFO margin would be a little bit stronger. And I don't have that right here at my fingertips, but I will get that and I can follow up with you.

And for the fourth quarter, Jim, is it the same, or are the fourth quarter numbers a little bit different?

Fourth quarter is within $800,000. Last year was $6 million. This year, 6.8.

So, in other words, the FIFO increase would look a lot like the LIFO increase?

Correct.

Thank you very much.

Thanks, Matt.

Our next question is from Cid Wilson with Kevin Dann & Partners.

Hi and congratulations on an outstanding quarter.

Thanks.

I'm not going to ask some of the other questions that I will save you from those, but my question is that I wasn't sure if you could give this, but can you give us an idea in terms of average ticket versus store traffic?

It's about split down the middle, Cid. And we don't give the specifics on that, but we watch it close because we, of course, want to understand where our comps are coming from. We have efforts under way, of course, to increase average ticket, with related selling and selling up to better products, and also our traffic is up. We would consider our comp to be driven maybe slightly more by traffic, but average ticket is certainly a contributor.

And you mentioned that the reason why your cash flow wasn't to your expectations was because you were actually opening more owned stores. Is that a function of the fact that maybe you're finding more opportunities from a real estate standpoint, to pick up owned stores, and how should we interpret that going forward in 2006?

We always look for the best location and in most markets, the lease locations, you know, they may be in a strip center and our philosophy is we need a free-standing location, if at all possible, not that we won't go in the end cap of the strip. So, that pretty well dictates it from just a development standpoint that we need to go in and buy, acquire, and do the development on our own. We also find it's much easier to keep on-schedule, too, when we're kind of in control of our own destiny in that regard.

So, bottom line, we just give the real estate folks the freedom to do either one based on the best site for the store in that market.

Okay. And I know you don't quantify your DIY versus commercial, but is it reasonable to assume that you're seeing similar trends than what we're seeing from the industry, that commercial is doing better than DIY?

Ours is actually very, very close. But commercial was just very slightly, our comps on commercial grew very slightly better than what our retail did.

Okay. And also, can you give us an update on your advertising initiatives, in terms of any changes there, if any, in terms of advertising, I know that sporting events and et cetera, et cetera. And what's your plans for 2006?

Yes, we really haven't made any major change, if you noticed, if you watch college basketball, we've certainly become more involved with that sport. You know, Motor sports continues to be a key driver of our marketing. We get a lot of return on that. As I mentioned in the past, not only are we involved in quite a few major, you know, events across, you know, our market areas, but particularly in the grassroots, you know, local track, drag strip, and that spills over into fairs, and you know, other type of community events.

And then we will continue on kind of a push on print and media. We will do three major flyers per year to all of our market areas. And about that same amount of expenditure in radio.

TV, we spent a little bit more last year. We will probably hold on that. That's still pretty expensive for us, and we don't feel like we get the same return as we do on radio and our print, and such.

Okay, my last question is you mentioned that you had a larger tax cash payment. Can you talk more about that and what we can expect going into 2006?

Sure. Sure. Our tax rate will continue to be the same, about 37.1. Really we had a couple of things related to the Midwest acquisition that we weren't 100% sure how they'd be treated for tax. So, we paid in a little extra to just make sure, and it turns out we probably wouldn't have had to pay in quite as much. So, we've got a tax receivable amount of about $12 million on our books here at year-end versus normally we would have, you know, a slight income tax payable. So, it was playing it safe on some of those things that were uncertain when we had to make the tax payment.

Okay, thank you very much.

Our next question is from David Cumberland with Robert Baird.

Thanks, good morning.

Hi, David.

On Q4, can you comment on the impact of whether on your business, both in terms of sales and margin.

Really in Q4, weather was pretty normal. You know, maybe a little bit on the mild side compared to what it normally is, but really the extremely mild temperatures came in in January. The winter came in late November/December. I would consider it probably normalized.

Thanks. And also you discussed relocations and renovations in the quarter, aside from Midwest, what is the remaining opportunity for relocations and store renovations?

That's just an ongoing evaluation, as our leases come due or, you know, markets change. We outgrow a building, just volume-wise. So, I would expect we continue about that same pace of, you know, about 20, 25 store relocations a year. And an equal amount of renovations.

Thank you.

Thanks.

Our next question is from Rick Weinhart with Harris Nesbitt.

Hi, guys, Rick Weinhart. Good morning.

Good morning.

I had a couple of follow-ups. First of all, on the store opening plan for this year, are we still looking at about, not including large acquisitions, about 25% smaller acquisitions, tuck-ins?

Probably something slightly less than that. You know, we are opportunists when it comes to acquisitions and historically we've run somewhere in the 20% range. I would think that we may be under that this year.

It was a little light last year. This year, I think it will be stronger than last year. We just had a light year for some reason. First of all, we got preoccupied in the middle of the year with Midwest.

Sure.

So, the team that handles acquisitions, they were, you know, pretty well loaded up in handling that process. It went on for several months.

Okay. But obviously still an ample opportunity out there for you?

Absolutely.

I think we'd be safe projecting somewhere in the 20% range, something like that.

Okay. Okay. And then on acquisitions, you guys have been very disciplined, I think in the past on what you would pay for a company. I wondered if you could share any target metrics you may have, whether it's book value or what you kind of look at in terms of what you're going to pay for an acquisitions?

Well, if we're talking about just a single store acquisition, more or less our benchmark, or our max is just an asset-based purchase. You know, whatever the cost of the inventory is. And look at any usable furniture and fixtures that might have worked for us, and we will give them market value for those.

You know, unfortunately, normally there's not much market value because when we go in and buy a store, we move it, or reset it and refixture it. Typically those type of acquisitions, all the furniture and fixtures is depreciated out, and there's really not much value to it. So, we get into those single and small acquisitions at a very low cost from a blue sky standpoint.

And this is Jim. On the bigger acquisitions, obviously we look at it a couple of different ways, and we do kind of a really hard scrub of all the assets, you know, inventory being the largest, also customer receivables, we will then look at the earnings stream, cash flow analysis, and obviously if you're looking a multiple of EBITDA, we try to pay as small as we can on that. So, the different big acquisitions we've done, all have different factors that drive them.

Typically, before Midwest, most of them didn't really have much EBITDA. They were break-even companies. So, we relied more on the asset values. With Midwest that was more profitable, you know, we relied more on the EBITDA analysis there some , but we've walked away from deals where the multiples have been higher than what we like.

And for the Midwest, can you remind us of the multiple roughly?

It ended up being around 5, 6 times.

Okay.

6 of adjusted EBITDA.

Okay. And related to that, your new DC in the Indiana area, you talked about opening stores in states, in the surrounding states. Would that include stores in Chicago proper?

Indiana will reach to southern Chicago. It stretches a little bit. But we, of course, would grow in Chicago, out of Indianapolis first, just to create some critical mass before we consider putting a Distribution Center there.

That would definitely allow us to stretch into Chicago, if we so choose to in the future.

Okay. Yes, so my question was really pointed towards will you be competing in more markets with the Murray's chain that's there.

If we end up extending into Chicago, we would. They don't have any stores anywhere that we would grow out of Indianapolis, I don't think, except for Chicago. So, that would be our only overlap.

Okay. And Jim, you mentioned on the interest expense, 4 to $5 million. Is that taking into account, assuming a lower interest rate when you're rolling over the debt this year?

Correct. We look to save probably about 1.7 million on gross interest. Some of our interest gets capitalized into new stores. But that's just on the coupon, what we anticipate saving on that.

$1.7 million you said, I'm sorry?

Yes, for the year. For the year. That's a gross number.

And my last question, are the gross margins --

Sure.

You know, I'm just trying to understand exactly the guidance in particular for mid 43s, 43.5 mid point there. What I'm looking at your margins this year, I understand you had some unusual rebate activity, but you know, for the year, anyway, that would be washed out, and you're at about a 43.6, I think.

You're going to be cycling up against the higher gas rates which were impacting in the second quarter, about 15 points from higher fuel, and you know, you're going to have the better distribution you will be cycling through next year. I assume you'd have better buying opportunities with Midwest. There seems to be so many positives here. I am just wondering at your guidance. Is there something I'm missing on the negative side to keep it relatively flat at the mid-43 range?

Well, you know, there's really nothing that would keep us there. And obviously we will do everything we can to grow our gross margin wherever we can. We're comfortable somewhere in the mid-43 range. There are a lot of factors that play into our gross margin, including product mix and several different things. We had the rebate thing this year that we already talked about.

This is David, you know, it's expensive to grow. When you open a new Distribution Center, darn near every year and a half or so, we can do as great a job as we can, and it's been a super job, but you don't open at full steam ahead.

You open it with a relatively small number of stores. You have fixed costs there. So, the leverage distribution that we're gaining everywhere else, is somewhat offset to a point, by the extent that it takes to grow. Of course, we've got that dialed in, we've been doing that for a number of years. As we continue to, you know, continue to grow, it's going to continue to be a factor.

And of course, the other thing I would mention is the competitiveness of the market out there and the pricing. You know, we're going to be competitive, as Greg has eluded to. So, the margin that we're able to realize is somewhat controlled by the competitive marketplace out there, and we don't see it getting a lot stronger.

Okay. Okay. That's very helpful. Just one clarifying point, though, the competitive issue, that may restrain your margins from growing, but you're not seeing that as a downward pressure on margins at this point?

No, we're not.

Thanks very much.

Thanks.

Ladies and gentlemen, we've reached the end of the allotted time for questions and answers. Gentlemen, are there any closing remarks?

Just thanks, everyone, we will look forward to talking to you after the first quarter. Thanks.

Ladies and gentlemen, this concludes the O'Reilly Auto Parts 2005 earnings conference call. We thank you for your participation. You may now disconnect.