O'Reilly Automotive Inc (ORLY) 2006 Q2 法說會逐字稿

Good morning. My name is Matthew and I will be your conference operator today. At this time, I would like to welcome everyone to the O'Reilly Auto Parts 2006 quarter earnings release 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. Mr. Batten, may begin your conference.

Good morning everyone, thank you Matthew. Before we began the call, I'd like read our Safe Harbor disclaimer. 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 other similar words. In addition, statements contained within this conference call that are not historical facts are forward-looking statements, such as statements made 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, risk 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 in these forward-looking statements. Please refer to the risk factor sections of the Company's Form 10-K for the year ended December 31, 2005 for more details. With that, I'm going to turn it over to Greg Henslee, our CEO and co-President. Greg?

Thanks, Jim. Good morning, everyone, and welcome to our second-quarter 2006 conference call. Participating on the call with me this morning is Ted Wise, our Chief Operating Officer and Jim Batten, who just spoke, our Vice President and Treasurer. David O'Reilly, our Board Chairman, is also attending but won't be participating in the prepared comments.

We also want to introduce Tom McFall, our newly appointed Chief Financial Officer, who is present but is not planning to participate in the prepared comments as he's still acclimating himself to the Company and to his position. As most of you know, on May 24, we announced that Jim Batten had made the decision to step down from the CFO position in order to allow more time for some personal priorities and is currently spending most of his time helping familiarize Tom to our company and our accounting and finance operations.

I would like to start off by once again thanking and congratulating Team O'Reilly for another great job in the second quarter. Our team continues to focus on the basic fundamentals of providing the best customer service in our business to both our professional installer customers and our do-it-yourself customers, resulting in another strong quarter for Team O'Reilly.

As mentioned on the first-quarter investor call, comparable store sales in April started off stronger than we had been seeing at the end of the first quarter. April was our 80th comparison of the quarter and comps toward the end of May and June slowed somewhat as the comparisons became more challenging. We ended the quarter with comparable store sales of 3.5% compared to a very strong second quarter in '05 of 9.6%. Considering the very strong performance last year, we're reasonably satisfied with our comp performance for the second quarter.

As I've said many times before, we view the majority of our sales to be nondiscretionary in nature with half our business being to the professional installer who is performing necessary repair and maintenance for our do-it-for-me customers and the other half to our do-it-yourself customers, which we view as medium to hard-core do-it-yourselfers who are capable in many cases of doing much of the same types of repairs and maintenance as our installer customers. Most of this business is nondiscretionary; however, some of it can be deferred to some degree. For instance, when the air-conditioning doesn't blow as cold as it should, does it require immediate attention? Possibly not, but ultimately, it will fail as the system protects itself from running on low-pressure conditions and will completely shut down before additional component damage occurs.

In talking to some of our installer customers, they're seeing some consumers who are putting off servicing their air-conditioning systems and stretching oil changes and other periodic maintenance beyond normal intervals contributing to the somewhat softer sales we've experienced so far this year. We feel that over time, our customers will better adjust higher energy costs into their budgets and there will be an incremental catch-up on some of the deferred repairs and maintenance.

We also continue to believe there will be a longer-term positive for the automotive aftermarket as to some degree stretched household budgets aren't going to allow for new cars as often and consumers will continue to make the decision to keep their cars longer and maintain them better at higher mileages to ensure safe, efficient and dependable transportation.

In addition, the vehicle population fundamentals that drive demand in our business remain very much intact and I believe will continue to increase aftermarket demand as the number of vehicles on the road continues to rise, the vehicle population continues to age and the number of miles driven continues to grow.

Our gross margin for the quarter came in the 44.1%, compared to 43.9% second quarter last year, a 20 basis point improvement. We continue to see benefits from our ongoing growth, resulting in incremental improvements in our buying power as well as positive results from our category management efforts.

In addition, we continue to focus on minimizing our distribution costs without sacrificing the service levels that allow our stores the quick access to inventory coverage which we consider to be a significant competitive advantage. As most of you know, we replenish our store inventories five times per week and our stores in the areas surrounding our distribution centers get multiple drops per day, giving them quick access to hard-to-find parts. These costs are included in our cost of goods sold and due to the efforts we have underway to operate a more sufficient supply chain which include the implementation of voice-activated picking, merchandise slotting optimization, truck route optimization, as well as many other initiatives, we've been able to keep our distribution costs as a percentage of sales equal to what we experienced the first half of last year, despite the significantly higher energy costs we are experiencing and the start-up costs of the Indianapolis distribution center, which reopened on June 12.

Considering these factors as well as the fact that pricing in the marketplace has remained relatively stable, we're comfortable with projecting gross margin in the upper 43% to 44% for the third quarter and for the remainder of the year.

Operating expenses for the quarter came in at 30.9% of sales, equal to last year’s second quarter. Considering the comparable store sales leverage we had last year, we're very proud of our team's efforts this quarter to adapt to the decrease in comparable store sales leverage while still maintaining the high levels of service our customers have come to expect. Generally, we attribute our SG&A performance this quarter to our team's ongoing efforts to closely manage expenses on all fronts.

Operating margin for the quarter came in at 13.2%, a 10-basis-point improvement over last year and the highest second-quarter operating margin we've had as a publicly-traded company. This was of course fueled by our continued focus on growing our gross margin, as well as our relentless focus on expense control. We're also very pleased with the 8.3% net income, again a second quarter record for us.

During the quarter, we added 49 new stores, and as I mentioned, opened our newest distribution center in Indianapolis. This expansion resulted in a $45 million growth in inventory from the end of first quarter and a $105 million, or 15% increase, compared to last year's second quarter. On the surface, this looks uncharacteristic for us considering revenue grew 13.4% for the quarter. However, a significant contributor to our inventory investment in the second quarter was our recently opened Indianapolis distribution center, which is one of our largest with a $14.5 million inventory which we have not yet leveraged as it was only open for 18 days of the quarter. When the Indianapolis distribution center inventory investment is excluded from our quarter end inventory value, our inventory grew 13.5% during the last 12 months, in line with our 13.4% increase in sales.

Our distribution center inventory investment will level out as we decrease inventory at three of our other distribution centers that were previously servicing the stores now serviced by Indy and we began leveraging the investment we have made in the new distribution center.

Our inventory turnover remained equal with last year’s second quarter at 1.6 times on a gross basis. However, the inventory turnover net of payables increase to 2.8 times from 2.7 times last year as a result of our ongoing efforts to negotiate the best possible payment terms with our vendors while retaining the important national brand offerings which are so critical to the success of our commercial business. Our payables to inventory ratio improved 560 basis points from 39.1% last year to 44.7% this year, getting us very close to our year-end goal of at least 45%.

In closing, we remain very confident in the vehicle population dynamics that fuel our industry, as well as the adaptability of our dual-market strategy and our ability to execute this strategy which allows us to capitalize on growth of both the do-it-yourself as well as the do-it-for-me sides of the aftermarket. July comparable store sales started out in line with second quarter performance and have improved over the past couple of weeks as summer has really heated up in most of our markets and we're hopeful this trend continues. However, we have relatively strong comparisons for the remainder of the year and with consideration given to the difficult comparisons, our year-to-date comp performance, as well as the continued effect of higher energy costs and interest rates are having on our customers' pocketbooks, which again, we still feel will dissipate over time as deferred maintenance and repairs create some pent-up demand, we're projecting comparable store sales for the third quarter and for the remainder of the year in the 3% to 5% range and are slightly modifying or EPS guidance for the year to a range of $1.54 to $1.60. Jim will be providing more detailed third quarter and year-end guidance in a moment.

We remain very excited about our continued expansion and are comfortably on plan to open 170 to 175 new stores this year and are looking forward to leveraging the investment that we've made in Indianapolis to make O'Reilly Auto Parts the dominant parts supplier for those markets. We're also on plan to complete our new graphical point-of-sale system by the end of the year and begin the rollout which we feel will significantly improve our ability to quickly train new parts specialists on selling parts the O'Reilly way as we continue our aggressive expansion, ensuring our newer stores are quickly able to provide the high service levels our customers have come to expect and on which we've built our business.

I will now turn it over to Ted Wise, or Chief Operating Officer, who will make some additional operational detailed comments, as well as some detailed comments concerning our continued expansion.

Thanks, Greg. Good morning everyone. Regarding store expansion, as Greg mentioned, we opened 49 new O'Reilly locations in the second quarter. That gives us 85 new stores for the first half of the year and a total of 1555 stores. This puts us on schedule to reach our stated goal of 170 to 175 stores for the year.

Now to briefly comment on the expansion markets, we continue to focus much of our growth in the Southeast states that are serviced out of our Atlanta distribution center. For example, we added 22 new stores in the second quarter in Georgia and Alabama markets. We are finding great markets and good opportunities in these states and are very optimistic about our future success in the Southeast.

We also installed six new stores serviced from the new Indianapolis distribution center that put us up to 70 stores being serviced from this facility. As you recall, this is a state-of-the-art 400,000 square foot DC with a capacity to service over 250 stores in the surrounding states. New markets serviced from the Atlanta and the Indy DC will continue to be our primary expansion area, although we continue to find new growth opportunities throughout our existing markets. For example, this year, we have installed 18 new locations in Texas, nine in the first and nine in the second quarter, giving us a total of 422 stores in the state.

We also have lots of expansion work going on in our new northern states that we entered last year with the Midwest purchase. Last quarter, we installed three new stores for a total of seven stores year-to-date out of the Minneapolis distribution center. The renovation and relocation plans for the existing Midwest stores are coming along nicely. Except for a handful of stores that are scheduled to be moved in the near future, we will finish re-signing all stores to O'Reilly Auto Parts within the next 60 days. All product lines have been changed over to our brand and the inventory adjustments have been made to allow us to aggressively grow the business in these markets.

To support our store grows out of Minneapolis, we will be relocating the distribution center in the second quarter of next year. To speed up the relocation, we are fortunate to locate a great existing warehouse for a reasonable price. The new facility will give us the ability to double our store count to service over 200 stores in the surrounding states. Along with the 49 new stores last quarter, we also relocated eight stores to new buildings and did 10 fairly major renovations; all in all, a busy quarter for our store installation team.

To briefly update everyone on our three new store initiatives for this year operationally, first, our labor scheduling system is installed in over a third of our stores and will be fully implemented by the end of this quarter. As we've previously discussed, this tool will assist our managers in forecasting sales and team member staffing, ensuring that we provide consistent service levels and effectively and efficiently manage our payroll expense. Our new computer-based learning management system is scheduled to be finished and out to the stores this quarter and fully implemented by the end of the year. As Greg mentioned, the rollout of the graphical point-of-sale and enhanced catalog is in the final phase of development and will also be out into the stores by the end of the year. Our store labor scheduling program, learning management system and new point-of-sale system combined will be a great set of new tools for our store operations, giving them the ability to better service our customers.

Now in the marketing and promotion area for the last quarter, we were the title NHRA Drag Race sponsor for three major events -- the Houston Spring Nationals, the Bristol Spring Nationals and the Midwest Nationals in St. Louis. Each of these races draw a local attendance of over 100,000 fans, as well as supporting television on EPSN and the [Speedway] Channel. In addition, we entered into an agreement with NHRA that gives us the naming rights to the historical Indianapolis Raceway Park. Now known as O'Reilly Raceway Park at Indianapolis, this is one of the busiest multipurpose auto racing venues in the United States, hosting both NASCAR and NHRA events. This is a great branding opportunity for O'Reilly in Motorsports that applies to both our DIY customers and our installer customers, and perfect timing concerning considering our expansion into the Indianapolis area.

Last quarter, we also sponsored Back To The 50's Car Show in Minneapolis, which is one of the largest car shows in the nation with over 130,000 attending. And last, we were the title sponsor of the O'Reilly 300 Busch race in Texas last quarter. All in all, a very productive schedule for Motorsports marketing. And of course, O'Reilly stores continued our involvement at the numerous racing and community events at the local grass roots level through our company.

Now in regard to sales activities at the store level, our sales team was very focused on the challenge of last year's sales numbers. And while we were never totally satisfied, considering what we feel are temporary market issues and sales trends of our peer group, we acknowledge and think our team members for the hard work and success of obtaining a 3.5% comp growth. Our team worked hard to grow our sales, and while having competitive prices in the market is important, we're most focused on building relationships by giving great service levels and having good inventory availability, which we know results in sustainable, profitable growth. At this point, I'll turn it back to Jim Batten.

Thanks, Ted. Just to go through some of the details and the numbers, before I do that, I just want to say thanks to all of you investors and analysts for all your friendship and support over the years. It has been fun working with you and I will continue to be involved with the investor relations efforts of the Company here in my new role, along with Tom McFall.

Moving onto the numbers -- on sales, we were up 13.4% to $591.2 million for the quarter, our comps were 3.5% for stores opened greater than 12 months. After the year-to-date period, sales are up 14.2% to 1.13 billion for six months, comps were 3.6% for stores opened greater than 12 months. Our independent jobber sales were $13.5 million for the quarter. Gross margin as Greg mentioned was 44.1% compared to 43.9 in the prior year quarter and year-to-date, 43.8 compared to 43.1. These improvements are due to reductions in our distribution costs, more favorable sales mix and improved product margins.

Moving on to SG&A expenses, again, we're at 30.9% for the quarter compared to the prior year 30.9, and year-to-date, 31.1 compared to 30.7. Good management of our salaries and benefit cost have helped us offset the increases in vehicle costs, utilities and advertising that we've experienced this year. Operating income, margin percentage was 13.2% compared to 13.1 for the quarter. That's a 14.8% dollar increase. And then for the year-to-date period, we're at 12.7% compared to 12.3, and that is a 17.7% increase in dollars.

Our tax provision continued at 37.1% for the quarter and the year-to-date period. Net income of 49.3 million, or 8.3% of sales, and that's a nearly 15% increase for the quarter; $89.9 million year-to-date, or 8% of sales, and that's an 18.1% increase. Diluted earnings per share, $0.43 compared to $0.38 in the prior year; that's a 13.2% increase on 115.2 million shares outstanding and in line with our guidance, which was 43 to 44 for the quarter. Year-to-date, we were at $0.78 compared to $0.67 and that's a 16.4% increase on 114.9 million shares.

Moving to the balance sheet, inventory as Greg mentioned was $800.5 million. Our total assets were $1.9 billion. That's a nearly $200 million increase from December of '05 due to the new store growth. Ted mentioned our Indy distribution center and seasonality. Accounts payable, $358.1 million, a $65 million increase from year end due to our efforts to extend terms with vendors, and our Accounts Payable inventory is 44.7% compared to 39.1 at June of last year. Long-term debt continues to $100 million, debt to total capital of 7.4% and our debt to EBITDA is 29.6%. Our EBITDA for the quarter was 16.1% of sales and for the six months was 15.6% of sales.

Other performance measures are -- return on equity for the quarter was 15%, return on assets 9.8% and our return on invested capital 14.3%. These are increases and continue our strong performance in these measures. LIFO or the quarter was an $8.9 million charge. We're at a $14.3 million charge for the six months. Our depreciation expense was $15.7 million, and for the year-to-date period, $30.8 million. CapEx was 72 million in the quarter and 119 million for six months. Interest expense was 1.1 million for the quarter and is 2.4 million for the year-to-date period.

Cash flow from operating activities was 68 million for the quarter and 124 million for the year-to-date period and we had negative $5.1 million of free cash flow in the quarter. Year-to-date, we're at a $4.4 million free cash flow. This was due to our fluctuations in inventory related to Indy DC and other measures.

Now moving onto guidance, our CapEx guidance remains in the $215 to $225 million range for the year; revenue guidance 2.27 to 2.33 billion for the year; interest expense on a gross basis 4 to 5 million; depreciation $60 to $63 million; our tax rate should be in the 37.1 to 37.2% range as we finish the year; earnings per share for the full year $1.56 to $1.62 without option expense and $1.54 to $1.60 including option expense. And then for the quarter guidance, it's $0.42 to $0.44; and then our free cash flow guidance for the year is $20 to $30 million.

At this time, I'd like to ask Matthew the operator to come back and we will be happy to answer questions for you. Matthew?

(OPERATOR INSTRUCTIONS). Scott Stember.

Good morning guys. Can you maybe quantify, I believe I heard you say that it sounded as if July comps appeared to be improving somewhat. Can you talk about maybe which side of the business -- is it on the commercial side, the retail side, or is it just general across the board?

It's pretty well balanced between both sides of the business. For the quarter, our commercial comps grew just slightly better than our DIY comps. Both were obviously positive, but July has shown a similar balance to what we experienced during the second quarter.

And just maybe quantify a little bit more on the weakness in the quarter the last couple of months and some of these products that were being delayed. You mentioned air conditioning. Anything else like brakes or anything like that along those lines?

Again, we get these -- my comments were based on our installer customers' comments, we were talking to consumers everyday selling the jobs that they sell. We have not noticed a meaningful reduction in anything by product line. Our air conditioning sales are actually very good, although when we talk to our installer customers about what's going on with their business, there have just been several comments that they have had a tougher time selling A/C jobs because the thing was not completely down; it was just blowing mediocre air as opposed to cold air. They've seen consumers putting off the repair as opposed to having it serviced right away. They've seen customers that are waiting a little bit longer between oil change intervals, things like that. So we don't see a deferment of the critical repair jobs like brakes and chassis, steering parts, stuff like that. But when consumers get squeezed as they are now, you would naturally expect them to defer some of the things that they can and air conditioning jobs might be one of those things, sometimes stretching an oil change a little longer might be another.

How about by region? Anything you guys are seeing across the country?

No. All of our regions performed pretty -- there's always swings by region or by division, but nothing meaningful. All of our regions were comping fine, and then of course our growth areas comped a little better than some of the other areas, but we didn't see anything regionally that raised any flags.

That's all I have for now. Thanks.

David Cumberland.

Can you comment on the impact of high gas prices on your expenses relative to your budget when you initially gave '06 guidance, is that impact big enough to be part of the $0.03 reduction in your EPS range?

We did budget in some good increases on fuel cost. It's slightly higher than that. Really, our guidance stems from the fact that we are halfway through the year and we're at the lower end of our guidance and with the comp guidance that Greg mentioned for the rest of the year. And you know us -- we would rather be conservative and beat expectations or meet them than set guidance as too high.

And on another subject, can you comment on new store productivity versus your plan, and also what impact the Midwest conversions might have had lately on the total sales growth rate?

Sure. New store productivity is continuing well. We've had new stores opening up nicely. The Midwest conversion, as Ted mentioned, is virtually complete now in terms of product and so we're seeing some improvements there. Kind of the thing that maybe you're looking at in total sales, our independent jobber sales have come down somewhat as we have either acquired some of those or some have maybe moved to a different program group or maybe closed in some of those markets. So that's probably the missing piece in some of our total sales increase you're looking at.

Thank you.

Gary Balter.

Hi, good morning, it's actually Seth Basham for Gary. Could you comment a little further on the mix shift in gross margin? You mentioned it was [sterile] for the quarter. What products are selling well that helped there and which weren't?

Really compared to last year, there were not any meaningful swings. Our product mix remains pretty consistent, even air conditioning parts, despite the comments that were made by some of our installer customers, air conditioning parts continue to grow well. So by product, we did not see any meaningful swings. Jim, do you have any comments on that?

I was just going to say, I mentioned favorable sales mix there for the year. In the first quarter, we referenced that some of the lower margin parts didn't sell as much and we had a good continued favorable mix in general there Seth. There wasn't like one or two things really driving it, just some of the -- like oil, Greg mentioned oil changes being deferred a little bit. Oil is a lower margin item.

As you forecast gross margin for the rest of the year, do you expect any favorable or negative impact from mix from gross margin?

No. Last call, we projected gross margin somewhere in the 43.5% range, and our experience over the past three or four quarters has shown us that we can maintain gross margin at a little bit higher level, and not necessarily dependent on product mix, but just the consistency of the product mix that we sell. And that's what gave us the comfort to say that we're more comfortable projecting gross margin community up near the 44% range.

And Seth, one thing that just kind of slipped my mind. I said that independent jobber sales were slightly down. Those are lower gross margin sales. So that helps our sales mix overall.

Gotcha. Lastly on [AP] inventory, looked like you made a lot of progress this quarter. Are there any particular contracts that you can talk about, and where do you expect the year to end from an AP to inventory standpoint?

We obviously cannot talk about our particular deals with our vendors. We work on this everyday. Our merchandise team with every conversation they have with a vendor, this is a topic. And some vendors are capable of doing more than others. And because of our branded orientation with our commercial customers, we are -- we refrain from moving to the best term vendor simply to improve our payment terms, which if we were willing to go offshore for more of our hard parts and maybe use some maybe lower quality suppliers that aren't as brand recognized, we good obviously could increase it substantially. But it's important for our commercial business success and the future growth of our company that we continue with the branded products that we carry. So we're happy with where we've guided to over second quarter of last year and our goal early in the year was to get it to 45% by the end of the year. We will do something north of that, I feel like. We really don't have a number yet, but we're working on it everyday and I guess our shorter-term goal now would be to get it up to 50%, and then over time, continue to go from there.

Gotcha. Thanks guys.

Matthew Fassler.

Thanks a lot and good morning. A couple of questions. First of all, on the expense front, just sort of curious how you managed that line item through the quarter, because obviously you showed decelerating growth in SG&A and good discipline. Was that something that you had started at the outset, or if that an adjustment that you kind of made on the fly as the business ultimately softened a bit midway through?

Sure Matt, a couple of things. We made some planned designed changes earlier in the year on medical and continued management on work comps, safety initiatives, and those things continue to bear fruit. And then obviously, managing things like travel costs, managing payroll, which Ted and the store team, they work aggressively on that all of the time, but it's kind of a combination of those type of things.

And at the store level, we're very careful not to try to bring payroll down and sacrifice customer service, which we know is what keeps our sales growing. So when we focus on store payroll, what we really focus on is the management of the schedule, the elimination of unnecessary overtime and things like that. We've continued to fund our stores with plenty of help to provide the service levels that it takes for us to continue to grow the business.

Second question, just to get a more granular in the drivers of your guidance, I guess it's pretty straightforward, a comp lower on the year for EPS and then $0.03 or lower two guidance. You did raise kind of the implied gross margin guidance you'd be talking in terms of 43.5, and it sounds like you think you can do a bit better than that. So am I on top of the arithmetic there, basically sales off a little bit, gross margin compensates for some of it, it kind of nets out to the couple of cents down?

Yes, that's it exactly. Really, our -- we had said our gross margin was 43.5, but most of you guys had us to 44 or better anyway, so anyway, what you said is exactly right.

Gotcha. And then, finally, as you kind of compare this to other slowdowns that you have seen, there's been a lot of sort of head fakes or air pockets if you will that have been very brief over the past three or four years, nothing terribly severe. As you look at how this one has sort of developed, the depths (indiscernible) for you have not been that bad, how does it feel compared to others in terms of the way it has evolve, and once again in severity?

To some degree, it's a little hard to measure, Matt. The one thing that makes this one even harder to measure is coming off such a great year we came off of last year, and we are comparing against such tough comp comparisons. What I have to lean on I think is just the general knowledge that most consumers have to use their cars. And while they can make some modifications as to how they get from point A to point B, I'm of the opinion that most of them in the markets that we do business in are going to continue to want to use their cars the same way they have in the past, and that while they can defer some maintenance for a period of time, over time as I said earlier, they will build those higher fuel prices and build in the maintenance costs that were maybe deferred into household budgets and make it work as consumers and America always have. So we expect it to be a relatively short adjustment. Again, the unknown is where are gas prices going to end up. We certainly don't not see them going down. If they increase significantly, maybe doubled or something like that, it obviously would have an impact on -- a significant impact on consumer spending and probably us to some degree, although we continue to feel like that we're insulated more than most retailers and that the majority of our sales are nondiscretionary and if people want to drive their cars, they have to the thing running. And there's also the effect of just fuel efficiency. People paying that kind of money for gas want them to run as efficient as they can. So there's a little bit of upside there too. Ted, did you have a comment?

Matt, this is Ted. And as always, when there is a temporary slowdown like this, it forces some consolidation. It kind of weeds out the market and we're in a position and that's what we empowered and charged and our team out in the field, they're taking advantage of this as far as just building their customer base, just going out there and hustling for the business in normally what is a -- create some opportunity when business slows down.

Gotcha. Thank you very much.

Bills Sims.

Thank you and good morning. My questions are follow-ups from Matt's regarding SG&A. From a labor perspective, was it just timing, better labor scheduling, or were there any headcount cuts, whether at corporate or at the store level?

No, headcounts continue to grow as we've grown the business. There have been no cutbacks at all. We manage overtime better than we do during high comp growth times. Sometimes you will keep your headcount maybe lower and pay some overtime when business is real strong to avoid going into the fall season with two large of a headcount. And this year with new business like it has been, we just managed overtime better, but there's been absolutely no headcount reduction.

And then the second question is -- was there any onetime expense savings during the quarter that can not carry through the remainder of the year, or if we (indiscernible) that similar labor management scheduling will support the expense leverage that you saw offsetting some of the rental expense deleverage that you saw throughout the remainder of the year?

Well Bill, you know like you, we don't have a crystal ball to know what's coming, but there weren't onetime events here. Obviously, claim history, accident rates, things like that, we hope they will continue at these good levels. We can manage the scheduling and things like that. So we are hopeful that that will continue.

Has there been a point in your recent history where you've had to cut on labor at all?

I don't think we ever have in our whole history. We have always -- when we focus on -- really focus down on managing payroll at the store level, it is always an effort to manage overtime and make sure that [teamwork] and productivity is there. We one time had an event in a distribution center where we had opened a new one and had some extra help in our distribution center that we were not able to relocate to the new one, so we had to decrease headcount a little bit. That's the only time I can remember in our history that we have decreased headcount in that way.

Very good, thank you.

Sharon Zackfia.

Understanding been a lot of your business is nondiscretionary, I'm kind of curious as to what you might be seeing with average tickets and whether not you're seeing customers kind of trade from maybe best product to better to good within categories?

No, we have not seen that. In fact, some of our better brands continue to grow partly because we market them to our wholesale customers so intently. But that ticket average has continued to incrementally grow this past quarter as they did the previous quarter and they have for the past several quarters.

The average ticket is now versus the year ago quarter?

It's probably higher than it was a year ago.

Are we talking like low-single digits higher?

Yes.

Thank you.

Rick Weinhart.

I had a couple of questions on the gross margin. One, your LIFO charge in the quarter and actually the last couple of quarters have been a little bit higher than some of your competitors. I'm wondering if there's something in your mix or in your business or what's driving that and you might be able to explain maybe what the difference is there for you?

Obviously our mix, if you're comparing us to the other retailers, we have more hard parts as a percentage of our sales than maybe some of the chemicals and things like that. I don't know if that would specifically do it, but we -- as Greg will tell you, the first answer we have when we get a price increase proposal from a vendor is no, and then we work from there. So we aggressively manage that, but there have been some increases as well. And then you know what I think the other thing is with our store growth, when you have a price increase, it extrapolates -- I don't if you're talking percentage or relative dollars, but with our inventory growth, that magnifies the effect of those price increases.

It was more percentage. So it sounds like you're seeing some price increases in steel and hard parts that you're seeing inflation?

Some. We pressure our manufacturers of course to not give us price increases and figure how to produce more efficiently, and many of them have opened their own plants outside of the United States to keep their costs down in spite the rising cost of raw materials, but everyone has to deal with the transportation cost increases that are a result of energy crisis. So, yes, we have seen price increases in hard parts that use steel and copper and things like that, you know, electrical items, and then we have also seen price increases in the petroleum-based products -- chemicals and motor oils and things like that.

Okay. And I don't believe you're doing any direct importing yet, although you do have some private labels -- is it running still around 22% nation [wise]?

Yes, that's pretty close on private level, and then Greg can answer the direct importing.

We actually do do a little bit of direct importing. We typically do it through one of our vendors or someone that has people in China for the most part that are able to manage the production and the quality. But we do direct import certain items. We don't direct import hard parts, we generally do those through an existing vendor in the U.S. But some of the items like jacks and jack stands and ramps and hand tools and things like that, we do direct importing.

Is there an opportunity to expand that at all?

Yes, we look at that all the time, and we do more today than we have ever done in our past, and that's a little bit of a contributor to our continued gross margin growth, because those items typically we can sell at a little better gross margin than what we have experienced in the past. But we stop short of buying hard parts directly from plants in China without having someone involved here from a manufacturing standpoint to help manage quality just because of the perception that we have built over the years of being a high-quality provider and we're just not comfortable with buying hard parts direct, although we will continue to expand some of the other offerings, the equipment and tools and things like that as we see opportunities to do so.

And then last question, just on the actual guidance talking about high 43% to 44%. I believe last year in the fourth quarter, you had almost a 45%, so 44.9. Is it possible -- was there something unusual last year, or is it possible we will actually see roughly 100 basis points decline in the fourth quarter?

Last year, Rick, if you'll recall, we had some, due to our strong sales, we hit some levels and incentives in some of our vendor programs. And so if you look back over our history since being public, you will see the fourth quarter is a little more variable than the other quarters because you have all of those year-end adjustments that come through. So we just had a very strong fourth quarter margin. And so I wouldn't anticipate it to be that strong this year. So it's not really a deceleration. For the year, we'd see an increase, but last year was exceptionally strong.

Thank you so much.

Michael Cox.

Good morning, thanks a lot for taking my call. My first question is on the new store productivity question from earlier. I was wondering if you could more specifically on the new stores you're opening in the Southeast, if you're seeing any difference there relative to new store openings in other markets?

The Southeast, yes. I would say generally speaking, the markets down there are a little bit larger than what we're doing in the Midwest right now. We have traction down there now, we have been long enough to where O'Reilly is becoming known from market to market more often. So out of the gate, I think we're opening stores stronger. We're also doing a much better job recruiting down there than maybe in the past. Again, we have critical mass in enough stores to where we transfer people around and plan people to get the stores off to a better start. So yes, I'd say generally speaking, the Southeast is coming on fairly strong now.

My second question is, in a challenging macro environment like we're in right now for a lower income consumer, I was wondering if you could comment on the sales trends between hard parts say versus accessories. Do we see accessories slow at a more -- at a faster rate in this type of environment?

You know, we have never been maybe as robust in accessories and stuff as some of our competitors, although we have a good offering of truck accessories and things like that. We have not seen a noticeable slowdown in that kind of thing. I think the consumers that are buying those in many cases are buying them for new vehicles, so they're consumers who can afford to buy a new vehicle, and therefore can afford to put the accessories on. And, again, it may just be the demographic of our typical customer compared to some of the other retailers. But we have not seen a meaningful decrease in any of our accessory sales as compared to our hard part sales.

Great. My last question is on the Indianapolis DC, and I apologize if you mentioned this earlier. But if you could remind us how many stores do you need in operation being served by that DC to be breakeven from a cost perspective?

Probably somewhere in the -- about halfway to capacity, it will get to the point that we're offering pretty efficiently, so somewhere around 120 stores, something like that, we would the operating pretty efficient.

Great. Thanks a lot.

Alan Rifkin.

Most of my questions have been answered, but I just had a couple. Can you maybe give some commentary on where the Midwest stores collectively stand today versus the corporate average, both with respect to revenues per store and a productivity number?

As you may recall, the majority of the Midwest stores are in fairly small markets, so they are going to be somewhat on the lower end of our store productivity range. Now, the Midwest renovations were more or less a Phase I, Phase II, and Phase I was to get the line changeovers finished and remerchandised. Phase II, which will go one for the next year or so, is more of a major renovation or a relocation to a better facility that will really I think enhance the sales to the next level. Most importantly, we're going back to the better markets because Midwest we're in more of the smaller rural markets, we're going back and backfill around those markets to even better markets and larger potential stores.

Alan, if you remember, when we bought that Company, their stores were averaging somewhere around 900,000 per store and we average 1.4 to 1.5. And those stores have comped pretty well as we've done the changeovers and so forth. So I would expect them today to be averaging closer to $1 million, something like that, and we'll continue to grow that as Ted said. And as you may have noticed, that has had an effect on our sales per square foot as we've brought those stores into our measurement. In many cases, they are in small towns and maybe a good-sized store, yet they are not creating the volume that we would typically expect.

One follow-up if I may. Certainly I think it's safe to say that high gas prices are here to say and it's more a question of to what degree. And assuming that you're not going to really back off on your commitment to service those stores hardly to a greater degree than anyone else in the industry, what measures with respect to the transportation site can you maybe take a look at in order to mitigate some of the incremental costs that are coming as a result of higher gas prices?

We're doing a lot of things, Alan. Just to name a few here, we're in the process now of testing these global positioning sensors that we put on the tractors that also are tied to an onboard computer on the truck that measures idle time, it measures shift patterns, it measures really everything that goes on with the truck and then we're going to incentivized our drivers to improve gas mileage because we've proven through some tests that the efficiency of a tractor-trailer rig, which you can get as bad as seven or better miles -- I mean you can get as seven miles per gallon or better, or you can get as bad as 5.5 depending on how it's driven. So we're incentivizing our guys to drive the trucks better.

We also use some route optimization software. With us growing like we are, routes constantly need to change and there's a lot of different ways to get from store to store. And if you just map it out yourself, you may not come up with the most efficient route. We have guys in each DC who are responsible for that, but we use some software now that has greatly improved our ability to optimize our route costs and we really rely on it to help us do that. And we're also looking at in some of our in-town stores at decreasing the amount of times that we replenish them since in many cases, they will get eight or 12 drops a day out of the distribution center anyway. So really, we're looking at anything and everything that we think will save us on route costs without decreasing the service level that allows us to be so successful in the commercial side of our business.

As well as continuing aggressive negotiations with our fuel providers and those type of things, both on the distribution side and with our one that provides store-level fuel.

Great, thank you very much, good luck.

Jon Braatz.

Last year in the second half, obviously, we were hit by some hurricanes. And I am wondering if you could just remind us on net balance how you were impacted by the hurricanes favorably. unfavorably, and how might that be factored into your numbers for the second half of the year?

I think in the third quarter last year, we said that the hurricane was a negative impact of about 0.5 point on comps and about the same on total sales increase. So hopefully, that might help us. But then I know in the fourth quarter, it was a positive effect. And I don't remember -- I don't know that we quantified it exactly, but a lot of those markets, Ted may want to speak to this, are still are having a lot of activity with rebuilding.

The business has continued to be good. Obviously the fourth quarter was a banner quarter following the hurricanes down there, but they are rebuilding along the Gulf and we still have a kind of business due to the activity down there.

Okay. And secondly, somebody asked this earlier, regarding a tougher market and consolidation within the industry, obviously, your balance sheet remains very, very strong. Would there be an opportunity or a greater opportunity today as conditions have toughened a little bit for you to maybe make another acquisition or two or what have you? Would conditions be such that it might make that more possible?

I think so nothing, and I think Ted's point was, and I think he was referring more to the individual acquisitions that we make. When we go into an expansion market, one of the things we do is look around at who's selling parts there. And in many cases, there is some independent providers who have businesses that can be bought. In tougher conditions, they feel more pressure and two things. One, they're going to be more willing to sell, and two, they're going to be more willing to sell for the price that we would like to buy them. And I think that same rationale would apply to some of the chains that still excess in our expansion markets relative to just the strain the market conditions can put on some of the weaker parts chains.

Thank you.

Tony Cristello.

Thanks, good morning. I guess most of my questions have been answered, but one, could you just touch on the comps of July, August and September? And was July tougher -- are you [just a tougher] compare last year? And do they ease as we go into September or is it going to be pretty much flat through the three months?

We were real close to even last year. If you've looked, we had a 6.1% comp for the third quarter last year. July was just slightly stronger, then we were pretty well level throughout the remaining two months.

Okay. And just touching on then your last commentary about entering new markets and the independent jobbers. Is it a situation now where you are going into markets and there's just maybe not even books of business to pick up, there's just a void that is left? Is there that much pressure on the independents, or is it situation where you're going in and they're coming to you before you even get there and saying, hey, let's partner up, what can we do there?

Well, when we go into a market, the first thing we do a survey it and understand who the independents are and how much business they're doing and we go from there and contact possible acquisitions. Of course, the consolidation works both ways, whether we're doing the consolidating or somebody else in the marketplace, it ends up being fewer players and more business to be shared. A lots of independents quite honestly are just deciding to go out of business. We see stores every day, very small operators in small markets or larger markets where there is a lot of competition, they just call it quits and close the business down. Again, lot of times, they're not doing a lot of volume, but whatever they are is available for the market to divide up. And we're in a good position to realize additional sales from those.

Has that put more pressure on competitive pricing? Are you seeing -- the longer that this environment goes on, do you anticipate that becoming a bit more problematic?

We're not rally seeing a big move in prices. Normally if there's some competitive pricing going on, it's from someone that's about ready to go out of business, and that's just one more nail in the coffin.

But, in terms of what we're paying for these jobbers, I don't think we are seeing a big increase there either. A lot of times, they may not have a whole lot of alternatives to sell a business to.

As you expand though into some of the more densely populated areas, are you -- where there's a lot more competition, are they more price sensitive in those markets than some of the other markets that you have more of a competitive advantage in?

When you say price sensitive, Tony, are you talking sales price, or if we were buying their business?

No, sales price.

Okay. Again, the independent owned stores, they're limited on how price competitive they can be because they're buying through a [step of] subdivision that are stores and the company-owned NAPA and CarQuest and so forth are not. So those guys are strained from a margin standpoint anyway when they are competing with a company-owned store. So from an independent standpoint, you occasionally will have -- you'll run into one that they, they own the business, they don't have any debt, they're operating for cash and they can be relatively price competitive. But it varies by market and it depends more on the individual condition of the business that we're talking about as opposed to a market condition.

Alright, thank you.

Ladies and gentlemen, we have reached the allotted for questions and answers. Mr. Henslee, do you have any closing remarks?

No. I would just say thanks everyone for your attention and we're looking forward to a strong third quarter and we will talk to you at the end of the quarter. Thanks.

Ladies and gentlemen, this concludes today's conference call, you may now disconnect.