O'Reilly Automotive Inc (ORLY) 2006 Q3 法說會逐字稿

Good morning, my name is Rebecca, and I will your conference operator today. At this time I would like to welcome everyone to the O'Reilly Auto Parts 2006 Third Quarter Earnings Release Conference Call. [OPERATOR INSTRUCTIONS] I will now turn the conference over to Mr. Jim Batten.

Thanks Rebecca. Good morning everyone and welcome to our conference call. Before we start with our comments I would just like to 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 similar words.

In addition, statements contained within this conference 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 threat of war.

Actual results may materially differ from anticipated results described or implied in these forward-looking statements . Please refer to the risk factors sections of the company's Form 10-K for the year ended December 31, 2005, for more details. At this time, I would like to turn the call over to Greg Henslee, our CEO and Co-president. Greg.

Good morning everyone and welcome to our third quarter 2006 conference call. Participating in the prepared comments with me this morning will be tell Ted Wise, our Chief Operating Officer, and Tom McFall, our Chief Financial Officer, David O'Reilly, our Board Chairman, and Jim Batten, our Treasurer will also be present but not participating in the prepared comments. I would like to start off by thanking and congratulating Team O'Reilly for another great job in the third quarter.

Our team continues to focus on exceeding our customers expectations and 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. Considering the challenging economic environment we've been through this past summer, with consumers feeling the effects of higher interest rates and energy prices, we're pleased with the 3.6% comparables for sales growth we were able to achieve for the quarter. Sales remain relatively steady throughout the quarter with only slight, normal, weekly iterations that we would expect to see.

With average fuel prices having fallen during the past two weeks from around $3 a gallon average to $2.20 average, consumers are obviously feeling some relief at the pump, and I think we all predicted $2 a gallon gas, which seemed extremely high a year ago, seems more reasonable now considering the prices we've seen and we feel very strongly that our business will get back to what we consider more normal levels of comparable-store sales growth in 2007.

As I've mentioned before, we view the majority of our business as non-discretionary in nature. However, as we talked about in our second quarter call, some repairs can be deferred, such as air conditioning repair, emissions system maintenance, and even to some degree, periodic oil and filter changes. With the lower fuel prices we're seeing, we feel confident that over time, we'll see the positive effects on our business from some of the pent up demand for repair and maintenance that has been deferred due to economic necessity.

We also continue to believe that consumers will continue to keep their cars longer as proven by the average age of cars and light trucks on the road, which continues to incrementally increase year after year. These factors coupled with the growing population in the U.S. resulting in more vehicles on the road now being driven well over 3 trillion miles annually bodes well for the future of the automotive aftermarket.

Our gross margin for the quarter came in at 44.1%, equal with our second quarter this year, and a record high third quarter gross margin for our company compared to 43.5% third quarter last year, a 60 basis point improvement. I think our gross margin performance speaks very favorably to the quality of our comparables for sales growth as we continue to benefit from our ongoing square footage growth, resulting in incremental improvements in our buying power as well as positive results from our category management efforts.

As I have mentioned many times before, we continue to work diligently to operate a more efficient distribution network, focusing on minimizing our distribution costs, without sacrificing the service levels that allow our stores the competitive advantage the quick access to our distribution center inventories allow. We're very proud of the fact we been able to operate our distribution network at costs as percentage of sales equal to last year, despite the significantly higher energy prices. We are accomplished this in part by continued investments in technology that are allowing our distribution team members to operate more efficiently. Many of these investments are not uncommon in the distribution business but technologies that we've not used before that are paying dividends.

One relatively simple initiative we have underway is onboard computers for our over-the-road freight trucks. These computers allow us to not only keep track of where our trucks are, but allow us to measure how they're being driven relative to shift patterns, engine RPMs, driving speed, idle time, and other data points that help us measure the performance of our drivers relative to fuel conservation, safety, and care of the equipment.

In early tests, these systems have improved fuel mileage in some of our over-the-road trucks by as much as a full mile per gallon which is very significant considering each of our stores gets a delivery via one of these trucks five nights a week. We are just starting the roll out of these devices and expect they will contribute to our continued efforts to improve efficiency and productivity in our distribution network, without sacrificing the high levels of the service our customers have come to expect on hard-to-find parts.

Considering all the factors that effect our gross margin, as well as the fact that point-of-sale pricing has seemed to remain very stable among our competitors over the recent past, we continue to be comfortable projecting gross margin in the upper 43 to 44% range for the remainder of the year. Operating expenses for the quarter came in at 31.5% of sales, a 50 basis point increase over last year's third quarter.

The increase is primarily due simply to some loss of leverage with the lower comps as compared to last year, however higher energy prices were also a contributor. With consideration to the softer sales this year is, compared to last year, as well as somewhat higher cost of doing business, mainly due to energy prices, we are very proud of our team's efforts this quarter to manage every expense detail and adapt to the more challenging environment, while maintaining excellent customer service levels.

Operating margin for the quarter came in 12.6%, a 10 basis point improvement over last year, and the highest third quarter operating margin we've had as a publicly traded company. This was fueled by our continued focus on all front to operate more efficiently and to manage our gross margin through point of sale pricing reviews, supplier line reviews, and our category management efforts. We are also very pleased with the 8% net income percentage which again is a third quarter record for us.

During the quarter, we added 41 new stores, and are well on track to hit our year end target of at least 170 new new stores. Ted will be reviewing in more detail our continued expansion efforts this year as well as our plans for next year in a moment. Our expansion this quarter resulted in a $16 million increase in our inventory value compared to second quarter and $101 million, 14.2% increase over third quarter last year. A portion of this increase can be attributed to inventory we deployed in our Indianapolis distribution center which has the capability of servicing at least 250 stores, and is currently servicing just 70 stores as we continue our expansion in that part of the country.

Another somewhat out of the ordinary contributor to our inventory growth are the Midwest stores which we've now fully converted to our merchandise mix and have adjusted their inventories to fit what we see as a market potential in those markets. Which has resulted in us beefing up those inventories. This inventory expansion is not fully leveraged as we continue to work to grow market share in that region. If we subtract 70% of the Indy DC inventory investment from our quarter-end inventory to represent the unused capacity, our inventory grew at 12.9%, in line with our 12.7% year-to-date sales growth.

Another way of looking at this, is to compare sales for the trailing 12 months, sales in the trailing 13 to 24 months range. Comparing those two periods, our sales increased 14.4%, on an two periods, our sales increased 14.4%, on an all end inventory value increase of 14.2%.

We remain very confident in the proprietary inventory management systems that we use to deploy inventory in both our stores and distribution centers. These systems are very sophisticated and use many different types of data and factors to determine the optimum inventory for each location. As you know, in our business, if you don't have a part and a competitor does, we can in many cases lose a sale and possibly a customer so we put a lot internal focus on continued enhancement of these systems, which we consider to be the best in our business. Our inventory turnover run rate decreased from 1.7 times third quarter last year to 1.6 times this past quarter on a gross basis due to some things I've mentioned.

However, the inventory turnover net of payables increased 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 payable to inventory ratio improved 160 basis points from 40.2% last year, to 41.8% this year. We continue to focus on getting to a sustainable 45% accounts payable to inventory ratio, and work with each vendor during each line review to maximize our payment terms.

In closing, we remain very confident in the vehicle population dynamics that drive our industry. Record miles driven, record number of vehicles on the road, and average age of vehicles in operation continues to increase. We also know that while a majority of our business is not discretionary, I think we all agree that with the higher interest rates and energy prices, our customers pocketbooks have been very stretched this year, and any repair work and maintenance that can be deferred has been. With that in mind, we're very encouraged by the recent decrease in fuel prices and know that sustained prices at these levels will relieve consumers to some degree and we'll start seeing the benefits of some of the pent-up demand that we feel is out there.

Comparables for sales, which were relatively steady throughout the third quarter remain on that approximate pace for this quarter. We have to keep in mind that for the fourth quarter this year, we are comparing to very strong comparables for sales we had fourth quarter last year partly due to hurricanes Katrina and Rita, which both created some demand spikes for flood-repair parts and other miscellaneous emergency type merchandise like generators, fuel containers, flashlights, batteries and so forth.

We also have to keep in mind that due to the fact that we report on calendar quarters, this fourth quarter will be comparing to a quarter last year which had one less Sunday, which will have an approximate 50 basis point negative effect on our reported comp performance this fourth quarter. We do that much less volume on a Sunday compared to the other days of the week due to the vast majority of our installers being closed, so I just wanted everybody to be aware of that.

For these reasons, we continue to project comparables for sales in the 3 to 5% range, in line with projections we've given for both the second and third quarters this year, but a little below our normal guidance of 4 to 6%. Tom will be outlining our EPS guidance in a moment.

As I've said, we very proud of the job Team O'Reilly has done this year adapting to the tougher sales environment, and keeping our expenses in check while ensuring the best customer service in our business. We remain excited about improving our customers' experience in our stores even more with the rollout of our new point-of-sale system which is currently in the final stages of development and testing and is slated to begin rollout early next year.

I'll now turn it over to Ted Wise, our Chief Operating Officer, who will provide some additional operational details as well as more detailed comments on our continued expansion efforts.

Thanks ,Greg. As previously mentioned, last quarter we installed 41 new stores. Which brings us to 126 stores for the year. At the end of the quarter, we had 1596 locations and over 22,000 O'Reilly Team Members. The majority of this expansion continued to be out of the Atlanta and the new Indianapolis distribution center. We are on schedule to reach our goal of 170 stores for the year, with 44 new stores opening in this quarter.

Our real estate team is also working closely with field operations evaluating opportunities for new locations throughout many of our existing markets. For example, we installed 6 new stores in Texas last quarter, and 24 new Texas stores so far this year. These stores open up with strong sales due to the O'Reilly brand being well established, and with proper positioning within the market or adjacent markets have very little if any impact on surrounding store sales.

Next year, our expansion schedule and plans will increase to 190 to 195 new O'Reilly stores. The Atlanta DC in the southeast, the Indianapolis DC in the Ohio valley states and the St. Paul DC in the upper Midwest will support much of this new growth. As I mentioned, we will continue to look for expansion opportunities in all markets that will give us a good growth balance with cost of company operations. I want to also mention that we relocated five stores to new buildings last quarter, bringing us to 15 store relocations for the year.

We also (inaudible) in the last quarter and 52 renovations for the year. In addition, we install our new interior image package at 250 stores this last quarter. The majority of our major renovations are taking place in the Midwest corridor. These renovations along with a number of relocations will continue on in the Midwest store group throughout next year. (inaudible)We'll finish the Midwest sign conversions to O'Reilly auto parts and we'll be ready to change all of our advertising and marketing to the O'Reilly brand.

With a full (inaudible) of O'Reilly point-of-sale system to Midwest stores, line changeovers completed and the inventory and remerchandising work finished, we are starting to see positive sales trends. Our real estate (inaudible) good sites for additional stores in these Midwest market areas, and relocation of the St. Paul DC next year, we will have the needed capacity to support our growth in these states for the next several years.

Now, in the store ops area, we have finished a roll out of our new scheduling system in stores. We are starting to get some good comments as managers and DMs gain more experience using it. (inaudible) Benefit will be better customer service level and improved salary management.

The new POS and the enhanced electronic parts look up catalog is in the final stage of development and, as Greg mentioned, will be rolled out and in test phase by the end of the year. And last, our O'Reilly Online which is our new learning management system is scheduled to be in the stores this quarter. With these three store operational enhancements, we will see a significant role in improving the professionalism and productivity of our store teams, and result in even a higher level of customer service in our stores.

We are just finishing (inaudible) our field management, and much of our successes (inaudible) and the critical role they play in staffing our new stores and ramping up sales. Great customer service and executing our dual market strategy continues to be the foundation of our growth and success as we enter into new markets. Increased emphasis will be placed on both the retail grand opening activities and our installer sales work as we go forward.

To briefly comment on our marketing and sales work for the quarter, using direct mail we reached 25 million customers with our Fourth of July summer sales flyer, supported by aggressive radio campaign. Our motor sports marketing sponsorship included three NASCAR truck and IRL events, four NASCAR, Busch, and cup events, four NHRA races, and our ongoing involvement and support at the many local race tracks in our markets.

We also have put a new level of emphasis on marketing to our Hispanic customers in both print and radio, and also our involvement and sponsorship of the many local festivals and events throughout our markets. And at the installer level, we continue to focus on developing our customer relationships, using a combination of store Sales Specialists and our full-time Territory Sales Managers to sell, communicate, the many advantages of O'Reilly First Call sales program. I will now turn the call over to Tom McFall for our financial review.

Thanks,Ted. First I would like to say how excited I am to be part of Team O'Reilly. Also I would like to thank Jim for being so supportive and helpful during my transition. Jim's team-first attitude and integrity are great examples of the O'Reilly culture. Jim has developed an outstanding finance team and we look forward to continuing the level of excellence Jim has established.

Moving on to the numbers, for the quarter, sales of $597 million were up 10% from the prior year on comp sales of 3.6%. Year-to-date, sales are up 12.7% to $1.72 billion, and comps are 3.6%. Gross profit for the quarter was 44.1% versus 43.5% in the prior year. Year-to-date gross margin is 43.9% versus 43.2% in the prior year. As discussed previously, gross margin improvements were due to a more favorable sales mix and improved product margins.

SG&A expense was 31.5%, versus 31.0% the prior year, year to date SG&A is 31.3%, versus 30.8% the prior year. SG&A leverage pressures came from increased vehicle costs, utilities, and additional advertising expense. Operating income for the quarter was 12.6% versus 12.5% the prior year, which is a 11.1% increase in dollars.

Year-to-date operating income was 12.7%, versus 12.4% the prior year, a 15.3% increase in dollars. The tax provision for the quarter was 36.5% of pretax income, and 36.9% for the 9 months. Net income for the quarter was $47.9 million, 8% of sales, on an adjusted basis excluding the favoring tax resolution in the prior year, net income increased 12.4% for the quarter. Year to date net income, $137.7 million, is 8% of sales also. Again, on adjusted basis excluding last year's favorable tax resolution, net income increased 16%.

Diluted earnings per share for the quarter were $0.42 on 115 million shares, which was flat with last year. Excluding last year's favorable tax resolution, which was $0.05, EPS for the quarter increased 13.5%. Year to date diluted EPS was $1.20 versus last year, $1.10, on 114.9 million shares. And again, excluding last year's favorable tax resolution, we had an increase of 14.3% year to date.

On other performance measures, inventory was at $817 million, as Greg discussed in detail, total assets are $1.9 billion, which is a $226 million increase from 12/31/05. Primarily driven by new store growth and the additional Indy DC. Accounts payable are $341 million, an increase of $49 million from 12/31/05 [sic - see press release], due to continued efforts to extend terms with vendors. The A/P to inventory percentage of 41.8%, is a 1.6% increase from the prior year at 9/30/05.

Long term debt continues to be $100 million, with total debt to capital of 7.1%, and debt to EBITDA of .3 times. EBITDA was 15.5% of sales, 15.6% of sales for the 9 months. Other ratios. Return on equity was 14.8%, return on assets 9.9%, and return on investment capital was 14%. We continue to perform well in these measures .

Now on to our guidance for the remainder of the year. Cap Ex for the year, we anticipate being $230 to $240 million. Revenue $2.285 million, to $2.3 million. Interest guidance is $4 to $5 million. Depreciation, $64 to $66 million, and the tax rate should be 37 to 37.1% for the year. Now on to our EPS guidance. Without stock option expense, the guidance for the year EPS is $1.56 to $1.58. With stock option expense, $1.54 to $1.56. Fourth quarter EPS guidance with stock options is $0.34 to $0.36. Pre-cash flows for the year should be a use of $30 to $40 million, primarily due to new stores and the DC costs, plus our energy management initiative costs.

At this time, I would like to ask Rebecca, the operator, to come back and we would be happy to answer your questions.

[OPERATOR INSTRUCTIONS] First question comes from Tony Cristello from BB&T Capital Markets.

Thanks, good morning guys.

Good morning.

I guess one question, can you talk a little bit more about the productivity of your new stores now that you are opening versus more mature stores from a sales standpoint? I know you've lowered sort of your run rate for same store sales from 3 to 5%, I'm wondering, are you seeing a decline in productivity there as well that matches the decline in your core same-store sales?

Each new store brings a different opportunity and a different challenge, but if we look at our new store openings for any period of time, and you measure for instance how the stores open a year ago have done first year, and how the ones opened two years ago have done the first two years, even the more recent stores, we are on track on what we've historically done, which leads to about a $900,000 first year sales environment from around 1.2 second year, and then right at our average sales 1.4, 1.5 during the third year.

Okay. When you look at the environment right now, it sounded like you basically saw your comps consistent throughout as the quarter progressed. And I'm just wondering have you seen October any better with gas prices coming down in the second quarter did you see the mix of business shift around at all? With respect to that?

We do see weekly iterations like I said in the weekly comps. We've not seen anything that would indicate a pattern that comps were accelerating beyond what we've done this past quarter, although you know there are weeks in there where you have comps that will be double what we had a for the quarter, but there also are weeks are a little lower. You know, we're comfortable projecting comps as I said in the 3% to 5% range for the quarter, considering the factors that I've talked about, and we've not really seen a significant change in product mix.

You know, consumers are obviously conservative right now because their pocketbooks are stretched, so we do see, you know, the normal sell-up, not happening as often as it might otherwise, a consumer might decide to take a private label product as opposed to a branded product or something like that just because their pocketbooks are stretched, but nothing that would alarm us.

Okay. And one last question. With respect to seeing some leverage on the cost side, is there a certain comp you would like to get to to maybe start to show those costs going a little bit in the more favorable direction?

Well, we were really happy with our comps last year, so we would like to see that again, but comps more in the 4% to 6% range, the upper end of that, we start feeling good leverage, so obviously we feel more comfortable there. I would say that we start gaining leverage somewhere around 4%, something like that.

Okay. Great, thanks, guys.

Next question comes from Sharon Zackfia with William Blair.

Hi, good morning. If I'm correct, I think your previous implied earnings going into the fourth quarter was 36 to 38, and since you didn't really change comp guidance, I'm curious as to what the other variables are that would cause fourth quarter guidance now to be a bit below what you were expecting previously.

I think we are looking at what our leverage on expenses are and what the run rate of expenses are. Where the gross margins going to be at. I think that the changes in the fourth quarter are probably only a penny so it's a minor change.

And Sharon, it could be something with the share number, too, you know, things of that nature.

Okay, and then can you remind us, you mentioned that in October so far trends are pretty similar with what you saw in the September quarter. Was October last year in line with the 7.4 that you did for the full quarter or was October weaker or stronger than the full quarter?

If I remember right, October was stronger, I think because of the hurricanes, October and November were the strongest and then December, we're looking at it right now, yes, December decelerated a little bit, October was strongest, November was slightly stronger than December, it decelerated a little. December decelerated a little.

And then, I might have missed this Tom, did you get the LIFO charge or credit this quarter?

the LIFO charge was $2 million dollars for the quarter, $16.3 million for the 9 months.

Thank you.

Thanks, Sharon.

Next question comes from Scott Stember with Sidoti.

Good afternoon, guys.

Good morning.

Can you maybe touch on fuel costs? You indicated that obviously it's had an impact on your business, with your delivery trucks and aside from some of the initiatives that you have going forward, where would you see any benefits in the timing of it, at least, hitting your numbers?

You mean relative to operating expenses?

Yes.

Well, you know, diesel has come down, also, the majority of what we use for a fuel standpoint of diesel. And you know, it started hitting us as soon as it comes down as a positive, and it will throughout the fourth quarter. I really don't have a number on what a 20% decrease in fuel costs does to us, but yes, it would just be a guess, actually, Scott.

Okay. If you can maybe give some discussion on retail versus commercial in the quarter, and any trends carrying over on that front to October.

Well, comps on both sides of the business were pretty close, wholesaler and commercial business was slightly stronger than what the retail business was.

Given the soft environment, have you seen any pricing pressure from any of your local competitors?

You know, we do see pricing pressure from, we call them two-step operations, they're independently owned commercial types suppliers, that typically operate out of a non-retail location, and they have basically a warehouse type inventory buy direct from vendors and they cost-shop deliveries just like we would. And those guys have, as market share has gotten harder to obtain, they of course become competitive.

And we compete with those guys our whole lives, so it's nothing new, and they have always been very competitive, but we hear a lot about that, this year. We heard about that last year even though we had, 7.5% comp last year, so it's not anything new, but there is a lot of competition in the wholesale business.

And last year, you guys in the fourth quarter benefited from significant vendor credits which I believe were due to yearly sales levels that you guys hit. Where do you see that, do you expect to see some kind of benefit in the fourth quarter and can you quantify how it would compare to last year?

Last year, the sales for the year were outstanding, and we got into an area where we were looking at vendor credits and deals that we hadn't hit those goals before, and we counted conservatively throughout the year, and when we closed the books for the year, and looked at these annual programs, we had done substantially better than we thought that we would.

And that resulted in the fourth quarter increase in gross margin. This year, having been down that path before, and having seen what the discounts looked like, based on our new volume including Midwest, we were able to, I think, pick those up in the appropriate quarter and come up with better estimates, so we should see a gross margin in the fourth quarter this year that trends similar to what we've seen throughout the year.

Last question just to make sure that $0.34 to $0.36 for the fourth quarter, that includes options?

Yes, sir.

Okay. Thank you.

Thank you, Scott.

Your next question comes from Gary Balter with Credit Suisse.

Thank you. I have Seth with me on the phone as well. Just a couple little things. One is, receivables went up a lot, I think 13% from customers and 26% from vendors, can you discuss what's behind that?

On the front customers, that also includes or credit card receivables, and that's about as near to cash as you can get, and it's a two or three day delay, and depending on when the quarter closes and how many credit cards receipts are out there it can change that quite a bit. Excluding that, it's 8%, so in line with our sales.

Uh-huh.

On the vendor receivables, we are going to be flexible with our vendors when we negotiate our deals, and we are going to try to negotiate the best deal that we can, and one of the areas we have the benefit of being flexible is the timing of payments because our cash and debt position, so we look at that in total of what's going to get us the best deal, and you can see that we've increased our gross margin pretty substantially over the last couple of years, and that directly relates to being flexible in negotiating with our vendors.

You are comfortable those are going to be -- you know sometimes we see these battles go on with vendors where you don't get that. You are comfortable this is what you are going to see?

We're very comfortable that we are going to collect the amounts that are shown.

Okay, and stepping back, I sat through Wal-Mart's meeting for the last couple days and they talked about a 1% comp they're running in October, and now you are mentioning, and I suspect that this carries through to the other players, that you haven't seen a pickup yet, is it possible that that lower end customer is just kind of spent out and, whether they get lower gas prices or they don't, they just don't have the money right now and we have got a problem that could carry into next year? What are your thoughts?

Gary, I don't know how far it will carry forward, but when I started seeing all the information when gas prices came down, that a lot of the automotive retailers would have an instant benefit, we knew better than that. One, because we see the numbers every week, but, two, just the feeling as you mentioned that the low income consumers had been strapped for 12 months now with gas prices, and natural gas, and electricity, and interest rates, credit card debt, and it's going to take some time for that to come back.

Now, in our business, because most of the stuff that we do is not discretionary, we think that we will be close to the top of the list of things that they do, as they do have more cash flow in the household, but I would suspect that if gas prices stay down we will start to see the benefits of that, hopefully, in the upcoming quarter, if not early in 2007.

Thank you very much.

Thanks, Gary.

Our next question comes from Scot Ciccarelli from RBC Capital Markets.

Hey guys, Scot Ciccarelli.

Hey Scott, Good morning.

How are you? A couple questions. When I kind of look at the comp trends, even looking at a two and three year basis, it looks like fourth quarter is significantly more difficult than the third quarter, and if you are still running in the 3.5% range on a comp basis, is it fair to assume the actual run rate of business is actually improved, or is that the wrong way to look at it?

Well, we're comparing to October, November, our toughest comp months, so, yes, I think that that is a fair assumption. We had strong fourth quarters both last year and in '04, and as I said earlier, we are hoping gas prices being down will bring us some cash flow, when the lower income consumer is played in our favor, which we think it will. The question is timing to that, and hopefully, we see some benefit in the fourth quarter.

We might have seen a pick up in the run rate of business but from an optics point of view it's still about the same because of the comparison.

That's exactly right.

Okay. Regarding September, some of your competitors and some other people in this industry did talk about a bit of a pickup in September. I'm just curious why that didn't necessarily translate to you? I know that the gas price drop doesn't automatically flow through, it takes a while, as Gary was just asking about, but any reason why somebody like Genuine Parts or Monroe, some of the other people who talked about some better numbers in September wouldn't necessarily translate to you guys? Anything going on specifically in your areas or at your business level that might have kept that from translating?

Well, actually September was a little better for us. And you know, we look at this on a weekly basis more than anything, to look at it daily gets a little confusing. But there were some weeks in September that were very strong, but unfortunately there were some weeks also that weren't nearly as strong, so you know, I, to speak to how our trend would differ from some of the other companies, I really couldn't do that, but we feel confident that fourth quarter and next year that with fuel prices coming down that we will start seeing stronger weeks once we get past the tougher comparisons especially.

Okay. So September was relatively flat but maybe a little bit better than what we saw in what's called the July, August doldrums?

We had some weeks in September that were twice as good as what we reported our comp as being, which was very encouraging, but then you just have a week that falls off and it's hard to understand why sometimes. And weather of course has short term impacts when you start looking at small pieces of time like that, but we ended up with 3.6% for the quarter.

Now, and does it always fluctuate evenly between DIY and DIF when something like that happens?

Weather seems to have more of an effect on DIY, you have a weekend where it rains on a lot of our markets, DIY business can be down quite a bit, so for that reason, on those weeks, you can have higher commercial comps than you would retail comps. Which would be a little bit unusual.

And then the last question, just regarding, how many mom and pops did you buy during the quarter? I know that tends to be part of your store expansion strategy if you will. Has it still been at the same rate and have we seen any change in that? Thanks, guys.

For the year we are about ten percent of our expansions that come from small store buy outs.

How many did we have in the quarter?

I think there was two.

Isn't that below historical run rates?

Yes, It is. We typically have had more small acquisitions than we've had this year. It's just a matter of as we expand, we are opportunists and each market we look at, and we've just not had the opportunity to buy as many small businesses as we have in the past.

It's not a change in philosophy at all, we still plan to look at those opportunities as they come about and make a decision as to whether we would rather acquire someone or build a store. This year, there just haven't been as many opportunities as what there had been in the past.

Great. Thanks, guys.

You bet, thanks.

Your next question comes from David Cumberland with Robert Baird.

Good morning. Tom mentioned increased advertising expenses in the quarter. How much did that impact the expense ratio and what was the reason for the increase?

I don't think we commented specifically on our advertising spend. What we are seeing though is, for example, when we went into Indianapolis, we renamed the speedway, bought the naming rights for the Indianapolis speedway, and that creates some loss of leverage as we grow the name, we don't have the stores to support it yet.

But we need to get the name out there, so as we enter these new markets, we have some quantum type expense in our advertising expense which requires us to spend more money. Now, every additional store we add into the Indianapolis market we aren't going to have to spend as many incremental dollars on.

Thanks. And on the topic of weather, following up on the prior questions, how would you describe the overall impact of weather on your sales in the third quarter?

Neutral. I don't think we had a necessarily a negative or a positive effect. I think third quarter was a pretty normalized weather pattern.

Exception would be the lack of hurricane sales we had down--

Yes.

Pretty much, just from a comparison standpoint. You know, following Katrina and Rita last year, we had stores in the south that comped huge, just because of all the cars that had been under water, fluid changes that have to take place as a result, electrical damage that's done to starter motors and various things from being under water, so we had a huge shot in the arm last year that we are comparing to, so while this year's weather was normal, we are comparing against a season that was very unusual last year.

Some of that comp benefits post hurricane come in the third quarter?

Yes. These did. Tail end of the third quarter then more so in the fourth quarter

Thank you.

Thank you.

Your next question comes from Dan Wewer with Raymond James.

Greg, I appreciate your comments about the new store productivity remaining fairly steady at $900,000 a store, yet if we look at the algebra, 12.5% square footage growth, and 3%, 3.6% same store sales gain, one would expect more than 10% revenue growth. Was there anything in the pace of the store openings during the quarter, in other words, were a lot of stores opening at the very end of the period that may have slowed rate of total revenue growth?

--has the calendar here, so I'll let him answer that. .

As far as the month --

Yes, just the pace of openings -- I actually don't have the dates of the openings with me. I think we were fairly steady throughout the quarter, there may have been the last few weeks of the quarter - or last couple weeks of the quarter, there may have been a little ramp up,

One thing we don't talk about a lot relative to just total revenue is the fact that part of our business is to independent jobber customers, they are parts stores we sell that are independently owned, and in many cases our trucks will be driving right past these stores going to one or our stores, and if there's a store there that wants to buy a brand that we offer, which would be either Auto Value, or Bumper to Bumper, we would sell those customers as independent parts stores. And as we've expanded and bought some of those stores as part of our expansion, and then some of the overlap we have with O'Reilly stores and those guys, we've lost a little bit of that business, and that's probably, and I don't have the number on what we are down in independent jobber sales year over year, but that would have some effect on how you would view our new stores.

You'd be assuming that that increase would be all due to new stores when actually there is a portion of it that's coming out of our independent jobber sales.

Okay, That would be an interesting number to provide. Because I think a lot of investors who have nothing but the public statements are a little bit confused by the new store trends.

We are looking here. Give us --

Yes, about $2 million down over the quarter.

And that, those sales are not included in comp, so that's creating part of your math problem.

Second question, this economic cycle compared to 2001, I'm curious as to what's different today from that cycle when your same-store sales were holding up better.

Well, the primary difference is we have something concrete to view as the reason for the downturn, we view that as being just the economic pressure that's put on the average consumer. It's easy, I guess, to understand how consumers are pressured for cash, and we talk to installers every day, and understand the decisions they are making to not do repairs that they would have made a year or two ago, things like that.

If I remember right, in 2001, we were kind of scratching our heads, wondering why sales were down, and that happens sometimes when you have weeks or months when sales aren't as good as what they were the previous month or the previous quarter. You kind of look around and try to understand why that was, and sometimes it's hard to understand. In this case, it's pretty easy to understand with the economic environment like it is. And really, we're pleased with that from the perspective that as the economics turn around, we feel like we'll benefit from the pent up demand that has been created.

Greg, the last question I have for you, have you had a chance to look at Amazon's website for auto parts, and your thoughts on their offering and how it may impact the business.

I have had a chance to look at it, and we had talked to Amazon at different points as they were seeking suppliers, and we are not one of their suppliers today. Our parts sold online and have been for a long time. Our business is a business of convenience to a large degree, and most of our parts, most of the product we sell are repair parts, and with as many parts stores there are in the U.S., and with convenience to households being such a prominent factor in the success of our stores, we don't see it as a meaningful factor.

I can't see people waiting for two or three days or whatever the case may be to get a set of brake pads that they could drive a mile and get. Now, we talked about this long ago, and that is that people that live in very very rural areas that would be a long ways away from parts stores or 50 miles from a town or something like that, they obviously are candidates to order repair parts online, but there's very few, you take a road trip through the United States, you'll see very, very few towns, even small towns, that don't have some type of an auto parts store.

We agree with your views. Thanks, and good luck.

Next question comes from Jeff Sonnek with Friedman Billings Ramsey

Thank you. Ted, you in your prepared comments you talked a bit about some of these ongoing initiatives you have in place, such as payroll management, we had a bad connection on our end, is that fully rolled out and were there any early learnings you can kind of discuss, give some color on?

Well, the payroll management is out in stores today, and the stores are learning the system. It's implemented in all the stores and they are becoming more comfortable in using the projections and staffing the stores. With the wholesale business, we have to be careful because you just can't go buy a computer that will tell you how many hours you need for this time and date. You have to kind of intervene and factor in your sales calls and all the work that goes around supporting the actual sales per hour.

But so far, the comments are real favorable, and I think as they become more comfortable using it they will be able to be more efficient, and at the same time, put their hours to where the sales growth will support more sales growth, particularly the night and the weekends.

Jeff, just an additional comment, this is Greg. One thing that we probably have been guilty of as our company has grown is coming from the wholesale side of the business, we've been guilty of staffing our stores for the wholesale business, and not being as attentive to staffing for the retail business, so one of the things we hope to gain with this system as Ted mentioned is just more visual realization of the fact that we need to have better staffing on nights and weekends in some of our stores even though we have a very strong wholesale business, there's a lots of retail opportunity out there and we are kind of using this as a spring board to initiate better retail market share gains.

Great, and then a final question, a previous individual asked kind of about the acquisition environment. I thought last quarter you had some commentary kind of around qualitatively saying when the industry slows down, kind of like it is today, and you have a bunch of macroeconomic factors playing in the industry, that actually helps your cause or you gain leverage in the marketplace with some of these smaller mom and pop operators. Is that still the case?

Yes, that's absolutely true. But again, it's a matter of geography and our expansion efforts, and I feel like the pressure that is being put on the, some of the independent parts stores, just like the pressure is being put on all auto parts chains, they will be more apt to want to discuss sale as we expand, as opposed to they would be in times of great economic times.

Next question comes from Matthew Fassler with Goldman Sachs.

Thanks a lot, and good morning. Most of my questions have been asked, but I do want to follow up with a couple questions on sales trends in relation to gasoline. First of all, I think it was Scott who talked about whether you were seeing essentially a better underlying bid from your customers that's kind of masked by difficult comparisons. Do you look at your business sequentially kind of in a seasonally adjusted way, from week to week in a way that would get you clarity as to whether you are actually seeing some improvement in that trend, even if the year-to-year numbers are tougher?

We look at comps year-to-year by product line, by customer ties, and so forth, and we've not really seen any trend other than just that sales are a little flatter this year than they were last year, like I said earlier, from a product lineup perspective, we see more private label products being bought and sellups to maybe a higher price, to maybe a lifetime guarantee or branded products being fewer, but other than that, it's pretty normal.

As you think about the kind of lag that you've been conditioned to see from moves in gas prices, I realize this has been a more central topic in the past year than probably in the prior several but you've been the business awhile and seen some of these trends, how would you -- what do you typically expect to see in terms of lag time?

As far as gas prices go up or down, how long does it take to have a material effect on our business?

Correct.

We really don't have a lot of experience in that. For a long time, I really didn't feel like that gas prices increasing at the levels they were increasing about a year and a half ago had much of an impact on our business, and we realized following Katrina, when gas prices got up over $2 a gallon and sustained there, that it truly does have an affect in our business, and that effect back then, hurricane Katrina was I think in September, and we didn't see it until the first quarter of '07.

So I would say it takes a little bit of time. I think what we are seeing right now is the fact that consumers have been pressured for quite some time now, and even though gas prices have come back down, they just don't have the, it didn't instantly put cash in their pocket. They had other things, household repairs, kids in school, things like that, that they had deferred spending money on so they have got a lot of needs they are trying to fill with the money they are saving at the pump. Which they really didn't have that money budgeted a year ago anyway. So it's just, I think it's a challenging time for the American consumer.

Got you. And then finally, just as we think about the hurricane impact a year ago, you obviously see not only your aggregate compares but kind of state by state, market by market, you talked about October-November being the toughest months a year ago. Do you feel like the hurricane impact abated once you got past October and November, or was it sustained through some of 2006?

I think -- you mean through 2007. I think it was slightly sustained in some of those markets there. I think the unusual spike in sales happened in October or November.

Got you. So after that, the hurricane compare is kind of normalized.

I think so.

Great. Thank you very much.

Thanks.

Your next question come from Jack Balous with Midwood Research.

Hi, I just wanted to ask you regarding expense control, and that is in the second quarter of this year, when you had a 3.5% comp gain, the SG&A ratio was unchanged so what is the difference between the third quarter of this year going up and second quarter of this year when you were able to maintain it flat?

Zach, as you know, there's a lot of moving parts when we look at SG&A, and the change is not a huge percentage. I think we pointed out that advertising -- I'm sorry, Jack --the advertising was a slight change, but when we look at the overall expense picture, we still look at it to be comparable with that 0.5%, obviously we would like to have had it been lower, but there aren't specific items that we can point to, the second and third quarter that say why it was flat and why it was marginally up.

And you know something that effects our business, Jack, because we're growing as fast as we are, is that we ramp up for new stores, and we have payroll that's kind of waiting in the wings for new stores to open, and depending on the amount of payroll we have at any given time, that can impact things and as Tom said, you don't always keep an accurate record of what those things might be, but they're always there.

We're as conservative as we can be with the way we build those benches for new stores, but there are times when you have opportunity to hire individuals that you want to put in a new store, and maybe geography doesn't allow it to happen very quick. So you may hold someone in a holding pattern on a bench for a while that really you wouldn't want to keep for as long as you do, but you do it because it's the right thing to do for the business.

Oh, I understand what you're saying. Let me just maybe clarify further, I don't know, do you keep track of how payroll ratio to sales are at the store level on a comp store basis?

Oh, yes, that's been, from back in 1957 when David's grandfather was managing the business, that's been a was a key metric in measuring our ability to run the business profitably. And is that primary focus of our whole store operations team, our Divisional Vice Presidents, Regional Managers, District Managers and Store Managers, one of their primary goals is management of that payroll percentage which is set every year and managed day by day, week by week, months by month.

On that metric, how does the third quarter of '06 look like relative to the second quarter of '06?

Our fluctuations in the SG&A expense relate to expenses that are not payroll related primarily.

Oh, okay. Last question, you were talking about your new payroll system and implementing perhaps more labor on nights and weekends to better service the retail customer. Can you describe how that would be implemented? Would you just first add people and then see what the response is? That there might be a delay in getting sales for a while? How would that work?

This is Ted. The first thing we do is reallocate hours if at all possible in a store. We look at that hours throughout the day, and obviously the first objective, depending on what their payroll was and the level of productivity would be to move people around their schedule when you can, and then the second option depending on the time of the year and what the business trends might be we would add staff at the right times, based on what the payroll system would project as far as sales.

So you have enough flexibility within the current payroll hours just to reschedule them more toward perhaps the weekends and nights without having to increase total payroll?

Depending on the store, yes we do.

Okay, thank you very much.

[OPERATOR INSTRUCTIONS] At this time, you have no further questions.

Okay. Well, I appreciate everybody's continued interest in O'Reilly Auto Parts. We are looking forward to a good fourth quarter and a great 2007, and we'll look forward to reporting fourth quarter results to you following the end of the year. Thanks.

This concludes today's conference call. [OPERATOR INSTRUCTIONS]