O'Reilly Automotive Inc (ORLY) 2007 Q3 法說會逐字稿

Ladies and gentlemen thank you for standing by, and welcome to the CSK Auto third quarter 2007 results conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session, with instructions being given at that time. (OPERATOR INSTRUCTIONS) As a reminder, this call is being recorded.

I would now like to turn the conference to your host, Mr. Larry Mondry. Please go ahead.

Thanks Chris. Hello everyone, and thank you for taking time this afternoon to be with us. Joining me today is Mr. Jim Constantine, our new Executive Vice President of Finance and Chief Financial Officer. Jim joined the team about a month ago, with over 25 years of experience in a variety of senior accounting, treasury, and corporate finance positions, including the last seven years as Chief Financial Officer, most recently with ShopKo stores. Also joining us today is our Chairman of the Board, Mr. Charlie Marquis, and Ms. Randi Morrison, our Senior Vice President, General Counsel, and Secretary .

At this time, I would like Randi to address the forward-looking statements disclosure, as well as provide an outline of the call.

Thank you Larry. Good afternoon ladies and gentlemen, and welcome to our third quarter 2007 conference call.

Before we begin, let me take a moment to remind you that some of the things we will discuss today concern future Company performance, and include forward-looking statements within the meaning of the Securities Laws, that we intend to be covered by the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995.

Actual results may materially differ from those discussed in these forward-looking statements, you should refer to the additional information contained in our 2006 Form 10-K, and our other SEC filings, concerning factors that could cause these results to be different than contemplated in today's discussion. Except as required by applicable law, we do not intend to update and undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.

Unless otherwise noted, the following financial information is presented on a GAAP basis. Larry and Jim may include in their remarks for purposes of assessing the comparability of financial performance for prior periods, a discussion of non-GAAP measures, as defined by SEC Regulation G. Corresponding GAAP measures and reconciliations with the non-GAAP numbers are available on our website, at www.CSKAuto.com under Investors.

I would like to define a few key terms that we will use during the call. Third quarter and the quarter, refer to the 13 weeks for the third quarter ending November 4, 2007. Last year refers to the 13 comparable weeks for the third quarter of fiscal 2006 ending October 29, 2006.

Year-to-date and first three quarters refers to the 39 weeks of fiscal 2007 ending November 4, 2007. Year-to-date last year and first three quarters last year, refer to the 39 weeks of fiscal 2006 ending October 29, 2006. Per share refers to a fully diluted share of our common stock.

I would now like to provide you with an outline for today's call. First Larry will provide a discussion on the state of the business. Next Jim will discuss key third quarter and year-to-date financial results. Finally Larry will speak about our key initiatives and the Company's future strategies. We will then open the call up for your questions.

I will now turn the call over to Larry Mondry, our President and Chief Executive Officer.

Thanks, Randi. As a result of the Company's focus on addressing and resolving it's historical accounting issues over the past couple of years, CSK has not been been in the position to regularly and freely communicate with it's stockholders. With the restated financials behind us, we look forward to more frequent communications with all of you.

Both Jim and I, as well as the full Board, firmly believe that regular and consistent communication with investors is an important part of our roles, and something we take very seriously. We realize that we had a bumpy few days in that regard. For a variety of reasons, unique to the circumstances.

But going forward, you will see a consistent and proactive approach. Since taking over the CEO position four months ago, I have been intensely focused on developing potential strategies, to improve profitability and restore top line growth. This is obviously not going to happen overnight, but I believe the opportunity does exist for us to address the challenges at CSK, and fix what is broken.

As I expressed three months ago, I believe that CSK is fundamentally sound company. And I didn't come here to oversee it's further decline. We are a market leader in most of our markets, and where we don't lead, we have a solid secondary position. This leadership position, coupled with the strength of a great new management team, and associates as well, makes me optimistic about our future. Three months ago, the Board and I commenced a comprehensive strategic business review that is ongoing.

We are in the process of evaluating all aspects of our business. The goal of this strategic review is to identify opportunities to improve our competitive position, enhance our operational and financial performance, and increase our ability to deliver value to you, our stockholders. You will hear more detail from me on some of the preliminary initiatives coming out of that review in a few minutes. As you may have seen in our 10-Q filing yesterday, we are exploring initiatives aimed at changing our cost structure to reduce cost and to raise capital, so that we can invest in operational improvements, aimed at driving sales growth and increasing profitability. These operational initiatives will require incremental investments in CSK.

Having said that, while we know that we need to invest in the business to improve our sales and profitability, we are critically aware that the Company is highly leveraged, and that we must reduce the Company's debt, if we are to achieve the flexibility necessary to improve the business. To assist us in developing strategies to raise capital to invest in the business and to reduce debt, we have retained the services of JPMorgan as our financial advisor.

Strategies under consideration could include the issuance of new securities, the sale of assets, and other approaches to debt reduction. Our engagement of JPMorgan also encompasses acting as our advisor in connection with any possible business combinations, recapitalization, or other potential transactions.

Concurrently, we have also retained Alvarez & Marsal to help us assess and modify our cost structure. Additionally as we announced yesterday in our 10-Q filing, we were successful in obtaining the fourth amendment to our term loan facility. We believe that with liquidity no longer a near term concern, we can remain focused on the business, and developing strategies to improve profitability.

Before I turn the call to Jim for a review of the third quarter, let me just say that this management team is wholly focused on, and dedicated to doing whatever is necessary to restore value at CSK.

Now I am going to ask Jim to provide you with financial results of the quarter, and then I will come back to talk with you about some of the operational initiatives we have recently put in place. Jim?

Thank you, Larry. Good afternoon everyone. I will now review the results for the third quarter of fiscal 2007. Net sales for the third quarter were $471 million, compared with $483 million for the same period last year. This represents a third quarter net sales decrease of 2.4%. Same store sales for the third quarter declined 3%, consisting of an increase of 5.4% in commercial same store sales, and a decline of 4.8% in retail same store sales.

Our sales decline was more than was anticipated in the third quarter, primarily due to a decline in transaction count, which was partially offset by an increase in the average transaction size. Gross profit for the third quarter was $214 million, or 45.5% of sales, compared to $226.9 million, or 47% of sales for last year.

The decrease in gross profit dollars was the result of the decline in sales, as well as the decline in the gross profit percentage. The decrease in the gross profit percentage was caused by a number of factors, including sales mix, and higher levels of clearance activities for the third quarter of fiscal 2007, as compared to the third quarter of 2006, as well as an increase in commercial sales, which carries a lower gross profit percentage and due retail sales. As a reminder, 17% of our total business is commercial.

Operating and administrative expenses for the quarter were $207 million, or 44% of net sales, compared with $201 million, or 41.6% of net sales last year. Of the $6.3 million increase in operating and administrative expenses for the quarter, $3.8 million was attributable to severance pay associated with personnel reductions, and fixed asset impairment costs incurred relative to the planned closure of 40 stores in fiscal 2008, as well as reserves for various regulatory and compliance matters.

A nearly equal amount of the increase in operating and administrative expense for the quarter was the result of expenses associated with the 30 net new stores, added from the third quarter 2006 to the third quarter of 2007. These increases in operating and administrative expenses exceeded certain cost decreases we experienced in the personnel reductions, and other initiatives discussed above.

Operating profits for the third quarter were $4.3 million, or 0.9% of sales, compared to $18.7 million, or 3.9% of sales last year. Operating profits were negatively impacted by the net sales decrease, resulting in a decline in gross profit. An increase in operating and administrative expenses, and increased to our closing costs.

Interest expense for the quarter was $13.2 million, compared to $13.3 million last year. Our interest expense was essentially flat, despite an increase in the weighted average interest rate during the third quarter of fiscal 2007, due to the pay down of $36.5 million of our senior credit facility during the quarter. The income tax benefit for the quarter was $3.1 million, compared to an income tax expense of $2.2 million last year.

Our effective tax rate was 34.7% in the quarter, compared to 40.8 for last year. We has a net loss during the quarter of $5.8 million, or $0.13 per diluted common share, compared to net income of $3.2 million, or $0.07 per diluted common share last year. Now I would like to discuss our year-to-date results.

The first three quarters of fiscal 2007, net sales were $1.424 billion, compared with $1.435 billion in the first three quarters of fiscal 2006, representing a 0.8% decrease in net sales year-over-year. Total same-store sales for the first three quarters of fiscal 2007 declined by 2.4% compared to the first three quarters of fiscal 2006, consisting of an increase of 6.6% in commercial same-store sales, and a decline of 4.3% in retail same-store sales.

Gross profit for the first three quarters of fiscal 2007 decreased by $9.1 million to $665 million, or 46.7% of net sales, compared to $674 million, or 47% of net sales, for the first three quarters of fiscal 2006. Operating and administrative expenses for the first three quarters of fiscal 2007 were $610 million, or 42.9% of net sales, compared to $582 million, or 40.6% of net sales, for the first three quarters of fiscal 2006.

Interest expense for the first three quarters of fiscal 2007 was $39.7 million, compared to $34.6 million for the first three quarters of fiscal 2006. The $5.1 million increase in interest expense was primarily the result of the refinancing that was completed in the second quarter of fiscal 2006, which resulted in increased rates on most of our debt. Net income for the first three quarters of fiscal 2007 decreased to $1.1 million, or $0.03 per share, compared to net income of $7.5 million, or $0.17 per share for the first three quarters of fiscal 2006.

Some key performance measures for the third quarter and year-to-date are as follows. Inventory has increased $27 million since last year-end. When looked at on a per store basis, inventory levels in the third quarter of 2007 are comparable with the third quarter of 2006. The trade portion of accounts payable is running at about 51% of inventory. Total debt has been reduced by $32 million since the first of the year. Approximately half of our cash flow from operating activity has been used to repay debt.

Now I will turn the call back to Larry.

Thanks, Jim. As I took the reins in August of last year, I did so with an open mind about our prospects as we move forward. As we announced, with the assistance of Kurt Salmon & Associates, we commenced a comprehensive strategic review of our business, aimed at improving profitability, and restoring top line growth. Among our chief objectives in this regard, are targeted investments in the business, that will improve operations, cut our costs, and reduce our debt levels.

We and our advisors are focused on developing specific strategies to accomplish these goals. I have been asked many times why I joined CSK Auto. Simply CSK has a basic business model that works. I believe CSK's performance gap relative to it's peers, relates to the execution of clearly defined and well-communicated strategies, rather than a flawed business in itself. Among other things, we are making cultural changes here at CSK, that for the first time engender a sales mentality for all of our team members, both store support and front line sales associates.

Another cultural change relates to empowering our team, giving them authority with clear accountability. I believe that accountability is critical to our success. Simply a retail adage,that stated what gets measured gets done. These changes in culture prompt changes in how we do our everyday jobs, and that supports improved sales, and provides our customers with a better shopping experience. I would like to now talk about our future.

We believe that we can improve profitability, by changing how we manage three key drivers. Number one goes without saying, that we need to improve our overall sales. Number two, we need to improve gross margin, and number three, we must reduce our expense ratios.

What I have learned in the last four months, reminds me of an old retail adage. Retailers have A problems and they have B problems. By the way, the A problems are sales, and the B problems are everything else. CSK has A problems and B problems. However, I do believe that if we fix the A problems, the B problems as well need to be fixed certainly, but in large part, fixing the A problems makes the B problems easier, and in fact ultimately makes them go away.

What you are going to find out about me as we get to know one another better, is that I will never commit the Company to an action, without testing the idea first in a controlled and measurable environment. Having said that, we may well conduct 50 tests to find one that is truly successful. Let me give you an idea of some of the things we're working on.

I am very big on looking at metrics, and some of the metrics that you would see when you compare us to our competitors, are things such as the following. In fact, one of them in particular stands out, sales per square foot. Our sales per square foot are roughly $190. The lowest level any of our other competitors are at is roughly $200 per square foot. That is a 5% delta.

So one of the things that we strive for, while we have an ultimate goal to have the highest sales per square foot among all of our competitors, is to at least be up to the next guy in line, so that we don't have to be the worst in class all by ourselves. It doesn't seem to me that is an unreasonable goal. You all can do the math, a 5% increase in our sales would be pretty significant, and make a heck of a lot of difference to those expense ratios, and ultimately to the bottom line.

The average inventory per store is another metric that we look at. Most of our competitors have an average inventory per store of about $500,000 all-in per store. We average about $400,000.

Now I am certain that that additional $100,000 of inventory in our competitors, translates to some level of additional sales, as a result, we went and conducted some tests, where we improved the mix in a variety of our stores by adding more and more hard parts particularly, with a goal towards achieving greater sales through an enhanced inventory mix, and I am happy to say in the test stores we have improved sales, and we intend to go and roll that out into more and more stores, and verify the concept, and we think ultimately the ROI, and those additional inventory dollars will be significant.

As we continue to test our improved merchandising mix with greater emphasis on hard parts, we are simultaneously testing across docking models to achieve greater efficiencies in our distribution network, that not only moves product more efficiently, but takes cost out of the process.

Let me talk about commercial sales. We have all seen the industry information out there, stating that the commercial segment of the aftermarket business is growing faster than the retail segment. At CSK we are committed and we are resolved to growing our commercial business.

As we have analyzed the business, it is apparent to me, that the devil is always in the details, but it is really about two basic concepts. One is having the right assortment for the customers, and the second one is getting the part that the customer needs to their bay in 30 minutes.

That speaks to again assortments and distribution network efficiency. We are working on these things diligently. And I can assure you that they are at the forefront of mine, and the management team's minds, as keys to our future success.

Next we are working on changes in our approach to marketing and advertising. Clearly we need to improve our top of mind awareness with our customer base, where particularly a commercial customer thinks of as being their first call, it has to be a CSK store. That is something that we are working on diligently to improve, and we will improve.

I think in the past our advertising approach, when I have analyzed it, is that we try to be all things to all people. We advertise in parts on radio, in print, in circulars, on billboards, a little bit of TV, in sports sponsorships, in all sorts of ways.

I really believe, and the strategy for this Company going forward, is that we have to be more professional. We have to be targeted, and we have to be much more refined. We don't have an absolute number of dollars to use. So we have to be much more targeted in the way in which we go after our customer base, and as part of being more professional, for the first time in 10 years the Company has hired an outside ad agency, to help us with these metrics, as well as the creative side of advertising.

I believe that this can make a significant change in our business as we go forward. But I will tell you, typically marketing changes are not the type that you see great results from overnight. We do believe that it is about building our brands and about building awareness. Ultimately we must of course improve profitability.

I would like to speak now about our near-term action plans to reach that goal. It is no secret that when you walk into one of our stores, you see very little Private Label merchandise. Also we currently direct source only about 4% of our inventory. We are not ready yet to say what percent of our inventory ought to be direct sourced, but we can say that we are exploring expansion of direct sourcing, and our Private Label line of merchandising, to help improve our gross profit percentages.

This fall we undertook and completed an initial cost reduction initiative that identified an approximate $7 million of net pre-tax expense reduction for 2007, and approximately $34 million of net pre-tax in expense reductions in 2008. The net difference for 2008, we would expect to be roughly $25 million. As we will have achieved some of those savings in 2007, the difference being approximately $25 million, from the 34 minus the 7 and then associated severance costs.

In September we announced that we are opening only 14 stores for fiscal 2008, versus an average of 54 stores opened between 2004 and 2006. This is being done to enable us to focus on stabilizing our business. The reduction in planned store openings will allow us to reduce capital expenditures in 2008. We plan to use any free cash flow to pay down our debt.

Although our CFO has been in place for just about four weeks, our EVP in Merchandising has only been on board a short time, and I am still less than two quarters into it, we recognize that this has been a long road for many of you. We appreciate your patience and support, as we get our arms around the business, and set the right course going forward.

Now we would like to open it up to your questions, Operator, if you please?

Ladies and gentlemen, (OPERATOR INSTRUCTIONS) And our first question comes from the line of Jeff Sonnek with FBR.

Thank you. Thanks for taking our call. You know, you talked about some of these expense initiatives, you know, regarding the distribution and supply chain, which really enabled you to move that inventory closer to the customer, you know, something I think you in your prepared remarks, you mentioned the you know, cross docking initiative. Are there other things that are just kind of obvious, no brainers in the supply chain you see, as you take a fresh look at this business?

Yes, I appreciate the question. I think there are some. One is an example, you know, in this business you look at, you look at the warehouse distributors, or two-steppers, or jobbers as they are called, and they seem to have a model for the commercial business, that employs having in a given market, a lot of merchandise, a breadth of assortment, but not in every location, and having a lot of trucks moving those goods around, so they can get to the customers faster.

One of the tests we are doing in one of our markets, is that we are enabling our stores, and ultimately have an infrastructure set up, so that we can go and do that, and see if we can employ that WD type of system throughout our Company. I believe it to be much more efficient. I believe that actually you can improve in-stocks, you can get goods to customers much faster, and can do it certainly with no more inventory, and perhaps with less.

Thanks and then just as a follow-up, you talked about the strategic review, both with JPMorgan, as well as Kurt Salmon, is there a timeline you can share with us, just to give everyone a sense what the next milestone is for you as a new management team here?

I don't know that I want to go and put a given date out there in the marketplace, to say at this date we know we will do this or we'll do that, I appreciate the fact that people would want that, but I think it is probably more prudent for us to just say, that as we now have a completed senior management team in place, and we have people who are particularly in the financial end of the business very, very focused, have been there before, who are devoting a lot of energies, to analyzing our business, understanding costs and the like, that we start now. We don't, you know, there is not a goal towards working at a given date. We start right now.

All right, great, best of luck.

Thank you.

We will go to the line of Matt Fassler with Goldman Sachs. Please go ahead.

Thanks a lot. Good afternoon, it is Matt Fassler. How are you?

Good Matt, how are you?

Very well. Couple of questions for you. First of all, can you give us a little more color on the gross margin decline? You talked about seasonality, you talked about lower sales, the hit that you took was pretty significant year-to-year, much more so than we had seen in the first half of the year, do you view that as an aberration, as you think about clearance, as you think about mix, and what can you do to stabilize that really important line item in your margin structure?

Okay. Thanks for the question. I am going to start off sort of at a high level, and then move it over to Jim to give a little bit more detail. Obviously we spend a lot of time trying to learn more and more about the specifics of this. So that two things, one, we can at least know what is going on, and then two, we can prevent this from occurring in the future.

The difference that I assume you are referring to, is roughly I think 145 to 150 basis points of gross margin differential. Q3 '06 to Q3 '07. I think we have spoken about some of them.

Some of them have to do with items that relate to clearance, some of them relate to distribution costs, because we deleveraged a little bit, and obviously there is no news out there that some of those things, the price of oil and the like do have some effect, but some of these things probably are, you would like to think one-time, somewhat self-inflicted wounds. I would like to give it to Jim for a little bit more specific color on some of those.

As Larry mentioned, a portion of the decline was related to clearance-related activities, I would say, kind of posture that. That was the biggest single item that hit our gross margin this quarter.

The second item that, and Larry has already mentioned it, is the deleveraging of our warehousing distribution costs, as you can appreciate a fair amount of fixed costs in a lower sales base. It hits the margin percent a little bit higher.

The other area that certainly we saw some increased costs on, certainly in some of our [inaudible-background noise] due to in part some fuel costs. There is a mix of, I think it is well-known that our commercial business margin is less than the retail business. [inaudible-background noise]

Understood. Second question, if I could, as I listen to your discussing some of your initiatives, you know, you talk about putting a little more inventory into the store, you talk about some direct sourcing exploration, all of these cost some money, and at the moment, you have relatively little cushion for discretionary investments, even if this would be helpful to the business, so how are you managing around those capital constraints, as you think about some of these ideas?

Operator, I will answer in just one second. Operator can you make sure that everyone is on, that you have everything set up so everyone is on mute except for the person asking the question? There is a lot going on in the background.

That noise was coming from--

That actually is my line, I am at the airport, I apologize Larry.

No, it is okay, I certainly understand the question, and clearly it is going to force us to have to be much smarter operators. There are things we are going to have to do. If we do a test that shows us that it is very clear, the greater inventory investment in hard parts, translates to more sales and more ultimate profitability, we have to figure out how to do that.

And we understand that we effectively can't do it by spending more dollars. So it means that many of the initiatives that we have here, are oriented to reducing inventory in some areas, maybe by geography, maybe by product category, and the like, so that we can spend money more effectively in other areas.

That is helpful.

And that is the kind of thing we are looking to do.

And then finally, from a restructuring perspective, you have JPMorgan, you talked about a whole variety of initiatives, if there were assets to sell, you know, how would you think about it, in terms of pieces of the Company? What are the logical pieces to contemplate, and have you had interest interest from anyone for that kind of transaction? Thanks a lot.

That is kind of a tough question to answer. Clearly the Company has a lot of very valuable assets. I don't think it is probably appropriate at this point in time, for us to have a conversation or discussion about which of those assets may have certain value to certain people. Suffice it to say that I think the Company has a lot of terrific assets, and has a lot of value to it, and we think there are opportunities to do things in that arena.

Having said that though, we would only entertain going in and looking at asset divestiture that you are referring to, if it was a very appropriate thing to do, and it is just one of many different possibilities that we look at, as to how we can shore up our balance sheet, reduce our debt, and leave ourselves operating capital, to do some of the smart things we think need to be done.

That is great, makes a lot of sense. Thanks so much.

Thanks Matt. Safe trip.

(OPERATOR INSTRUCTIONS) We will next go to the line of Mike Baker with Deutsche Bank. Please go ahead.

Thanks guys. Couple of questions. One, just in general, your EBITDA was, if my memory serves me, in the $160 million range for a couple of years, it is certainly going to be less than that this year, and it sounds like because of what you did with your debt covenants, you expect it to be substantially worse than that in '08 as well, can you comment? Has anything there changed structurally since you were north of 150, or is that do you think, a reasonable benchmark to think about getting back to over time?

I will try and answer your question as best I can. I think some, I mean some things have changed. I don't know if they are structural per se, but I think some things have changed. One is, clearly, we have had compounded decreasing comp sales over the last little while now, and you know, you just do the math and obviously it doesn't spell as good a picture. That is a part of it.

Another part of it is that we have added a good number of stores over the last three years. Frankly those stores have not produced at a level the Company had anticipated, nor that we had ultimately hoped for. So you end up having, to some degree a greater fixed expense, and that is true. So that is, I guess you could call that structural.

In terms of expectations on a go-forward basis, I think there is a lot of expectations for some of the things that we are doing for improvement. I think that it is very real, and I think it is accomplishable. But I wouldn't want to quantify it.

Okay well, then just a follow-up to that. As part of your strategic review, you came out and you closed a number of stores, but based on your last comment, I would suspect that, you know, there might be a lot more that potentially could be closed. So if you could comment on that. You say your review is ongoing. Is that a potential possibility, and then maybe a separate but real quick, can you comment on Murray's? I think when you bought Murray's, the EBITDA was somewhere in the mid-$20 million range a year and a half or so later, but I imagine that has fallen off. If you could talk about what you are seeing in Murray's that would be great, thanks.

The first part, in terms of different assets, whether they be a given store in a given market, or whatever the case might be, I am just going to say it to you this way, you have this new senior management here, there is no legacy that everyone is tied to, okay? There are no sacred cows.

If there are stores that need to be closed, we will close them. If there are assets that are not performing in the way in which they need to perform, we are going to deal with them. That is where we are today, and that is what I think management needs to do. I am not trying to telegraph anything, we are just going to do whatever is prudent and appropriate to make sure that we give ourselves the opportunities to do smarter things in the business.

As regard to Murray's I think there is no question on a macro economic basis, the Midwest, particularly the Detroit area is in really tough shape. A lot of our stores are in that area, the Murray stores, and clearly we suffer along with the rest of the economy. In addition, I think there has been a lot of competition that has come to our Midwest stores, and as a result we suffer some there.

Okay, thanks. That is helpful.

You are welcome.

And next we will go to the line of Rick Weinhart with Bank of Montreal. Please go ahead.

Hi, good evening and thank you. Couple of questions. First just a clarification on the forecasted savings for next year, I believe you talked about a net number now of $25 million, now does that include the expenses of the 40 stores that you will be closing next year as well, in that number?

You mean the net of that? I just want to, yes, it would. I mean, part of the savings is related to store closures, yes.

Okay, and the store closures themselves, we could talk a little about the 40 store closures, first of all, are these stores, the revenues from these stores, are they dramatically different than just your average store? How should we think about the impact on revenue from that?

Unfortunately I can't just say to you that they fall into a given category. I can't just say to you they all are stores that were dramatically underperforming stores at a given percentage of average, or something like that. I would have to tell you the stores are in some part those that are underperformers, that are underperformers. At the same time, there are some stores that may be reasonable performers, that are coming up to a lease expiration, and we may not have an option, or the options that we have are market options, and the market has gone up a lot, as an example.

There are different reasons, but you can assume that we would work really hard to keep those stores open, if it made financial sense to do so. So I think you should assume that those 40 stores in one manner or another, are drags on the Company. They are not, they are what I call leaners, they are not lifters, that is for sure.

Okay, thanks, that is helpful.

Sure.

And on looking at your store base, I think we've got about 50% of the stores in California, Arizona, and Michigan, and from a state perspective anyway, I know locally it is different, but those are parts of the country that have had very high foreclosure rates, and so forth. I am just wondering, are you seeing an impact that you could quantify at all in those states, or perhaps like, is there a dramatic difference between that kind of group of stores versus the rest of the chain?

We certainly do have regional differences in the performance of our stores today. I am not going to get completely specific, but clearly I think that our stores in large part, the performance of our stores in large part, does follow the macro economic conditions that you see in various parts of the country.

It would be fair to say that in California the marketplace is tough. I mentioned Michigan already as another place, and yet, we have some markets that are performing really well. So it is different by market, if that is the ultimate kind of question beneath the question, it is definitely different by marketplace, yes.

Okay, thanks, my last question, just some follow-ups on the gross margin. One, you talked about some clearance activity, that is not something you generally hear from an auto parts store, I am assuming this is non-core kind of business, or if you could talk about, what is this clearance and is this a shift at all in strategy, or is this just something different?

Yes, first of all, I don't think it is a shift in strategy. I don't think we are trying to do anything remarkably different. I think that, I think that ultimately any time you get a new set of eyes, on inventory being an example, you do tend to have, a deeper and harder look as to the quality of your inventory in some cases.

I think in some of the cases that we are referring to clearance, there has been some opportunity to get ourselves out of some older parts, and to frankly turn that into cash. I think that is just the prudent thing to do, but if the question sort of beneath that, is there an oh-my-gosh kind of inventory clearance problem waiting around the corner? There is not. I have always believed, I am an old-time merchant, I have always believed that your best markdown is your first markdown. I don't know if that is the way in which we have always operated, but it is the way in which we operate now.

Generally these types of activities take more than a quarter to play out. Is that a fair assumption here?

Not necessarily, no.

Thanks. And last thing, gross margin, you have also talked about capitalizing costs in the first quarter and second quarter, you mentioned that in the Q, just wondering if you could clarify what that is? Is that a trend, or just a change in accounting?

The capitalizing of costs would just be the normal, oftentimes reply to Unicap, where you are capitalizing warehousing costs, consistent with your inventory levels, that is basically an accounting concept that most retailers use. Really nothing out of the ordinary there, other than perhaps we had a higher level of inventory slightly, in terms of dollars.

Okay, thank you. Thanks.

Sure.

(OPERATOR INSTRUCTIONS) We will go to the line of Cid Wilson with Kevin Dann and Partners. Please go ahead.

Hi. Good evening. Could you give us any comments on your conversations with employees and vendors, in terms of trying to give them the direction towards where you see the Company going? Any thoughts there?

Sure, one of the things that I have undertaken as I have come into the Company is to really have a much stronger flow of communication, certainly to our team members. Senior management, we spent a lot of time not only here in the corporate offices, just making sure that people know what is going on, but as well, throughout all of our regions and districts, and I think that the message is consistent, and that is that everybody has to be very sales focused, that that is what we're all about.

And I think that is the way in which people are looking at their jobs day-to-day. Clearly people are disappointed in recent results. That goes without saying, but at the same time, I think there is a general sense around here that we are going down the right path, and that people feel good about the future. I am actually pretty comfortable with that.

With regards to the vendor community, I recently was able to get in front of our vendor community, and talk to most all of our vendors in a given setting, and was able to lay out for them, our basic strategy and go forward plans. You could ask them, but I think they welcomed it.

I think they liked the idea that there was a sharing of information, and it was an open sharing of information, that no one was telling them that everything is perfect, but that we are very willing to roll up our sleeves, work hard, and get things done together. Our vendor community, I am so please because they stand with this Company. They have been a partner to this Company, they understand the value of the Company, and the value the Company has in its strategic markets. I think they understand we are shoulder to shoulder together.

Okay, and my last question is, you mentioned that you know, that you have seen weakness in California and the Midwest, if you look at the comp that was reported for the third quarter, any guidance or thoughts which areas were, like the best performing area, and the area that was the most challenging?

Well, I think we outlined pretty much the most challenging. The most challenging, it would be fair to say, is generally California and the Midwest generically. Okay? I think that a couple particular high spots for us would be the Pacific Northwest and the Rocky Mountain areas.

Okay, thank you very much.

You are very welcome.

And thank you. Next we will go to the line of Matt Fassler. Please go ahead.

Thanks, and sorry about the background noise again, but I just have a couple of quick follow-up questions. One of them, you spoke about some of the stores that you are closing reflecting some leases that are ready to expire, that were coming, they were below market rents that were going to be rolling over to market. Can you talk about the average lease lift that you have, and whether you have leases coming due, and being exposed to market rents, is this an issue for you?

I don't think that we have any more significant exposure to change in our rents than any other retailer typically would. That is the way in which I would characterize it.

Okay, and second question, can you give us any color on business trends in the fourth quarter to date?

I think in general, I mean, business remains tough. I am not going to quantify it. I think that it is fair to say that the markets that we have been seeing tough business in remain the markets that are tough.

Whether it be California and the Midwest, and those that look good, remain the ones that look good. I think it is fair to say that we have some weeks that we get disappointed in, and some weeks that we go, Wow, things are really turning and we feel really good. I would love to see more consistency in the latter. That would be great.

Would you characterize the third quarter as having been a tough quarter just to try to quantify that a bit?

Yes. It would be fair that we looked at the third quarter as a tough quarter, yes.

Thank you so much.

Okay, Matt.

Okay and then we will go to the line of [Mark Levin] with Oppenheimer. Please go ahead.

I know you have got a little breathing room from the banks. It sounds like you are optimistic about the business. I can understand selling it at the right price, just wanted to get your thoughts on raising capital at current levels?

I guess the way I would say it is this, the Company, there are lots of options open to the Company, amongst them we have to go and work on creating, now that the banks have agreed via the most recent amendment to work with us, we have got to make sure that we put together a capital structure that allows us, not only to survive, but to thrive. And to do that, we are going to have to be very creative in the way in which we get access to capital. Obviously this is a difficult environment in the macro marketplace to go and get capital today.

Having said that though, we do believe that there are many different avenues we can go down. Someone mentioned asset sales of some nature earlier relating to our Q. That is one.

There are certainly others. There are lots of different, there are lots of different approaches as to how it is that we can delever our balance sheet, and all I am going to say to you is that we are willing to look at each and every one of them. I am very interested by the way, if it is you or anyone else, who has a smart idea on how to do it. Certainly we have brought in JPMorgan to help us, but I don't think anybody has a monopoly on good ideas, and we are all ears, particularly from our large shareholders.

Okay, thanks.

Okay, Mike.

Okay and next we will go to the line of Michael Bruynesteyn with Lehman Brothers. Please go ahead.

Good afternoon. Thanks for taking my call. Could you talk about at the store and regional level, any changes that you might be contemplating, or testing on compensation and incentive levels?

I think, first of all we are doing a number of different tests, and there are a few different things that we are putting in place, but mostly, and it is going to sound pretty simple, it is the time, the fortunes of our people, at both store and district and regional levels, to the performance of their areas. I don't think in the past the Company had done a very good job of that.

We have different things in place today, and things that have, some have been announced in the field, frankly some have not at this point. That we believe do more closely align, what is best for the individual at store level, and ultimately all the way up through the Company, to the shareholders of the Company.

Is there any kind of, what kind of frequency are those metrics sort of gauged and paid out on? Is that something that is done annually, like for senior executives, or more frequently?

It is really different by positions. You know, I think the typical is, without getting too specific, the higher up in the organization you go, the less frequent, the lower in the organization you are, the more frequent.

Thank you very much.

We have a follow-up question from Rick Weinhart. Please go ahead.

Thanks, just a couple of quick follow-ups. One, you had some encouraging things to say about marketing and the savings there, I am wondering, one of the things that comes to mind, it is probably expensive to build four brands. Any thought on consolidating those at some point? Have you done any cost/benefit analysis on that?

I have lots of thoughts about what it is we should be doing in the way of brands. In a perfect world, I would think four brands is not the way in which you want to go to market. Having said that, a change to go from four brands to less than four brands is very, very expensive, at a time when frankly it is just not going to give us, in my opinion, the bang for the buck that we would need.

I think we talked about on the call, and questions on the call, about how we need to be very disciplined in the use of our capital. To me at this point in time, it is just as much as, in some ways it is appealing, it just wouldn't be the best use of capital today.

Understood, and one quick one. Can you provide us with an update on the number of commercial programs you have right now in your stores, or a percentage, if you have that, either way?

I am not sure that I understand what you mean when you say commercial programs, I want to make sure I understand before I answer the question.

I am referring to the number of stores where you actually have a commercial set-up with a desk and delivery out of the store.

I understand, roughly half of our stores.

Okay, thanks very much.

You are welcome.

Our last question will come from the line of Mike Baker with Deutsche Bank. Please go ahead.

Thanks for taking the second question. One quick follow-up on the inventories, it sounds like, Larry, you are a merchandising guy, and correct me if I am wrong, that is where you see a huge opportunity to get the inventories to look right. So you cleared out a lot of bad stuff, but can you sort of characterize in your mind's eye, you know, how far away are you from the inventories in the CSK stores being where you want them to be, in the complexion or the amount of inventory.

And then if you could, sort of clarify again, how do you, it sounds like, you think you have too little inventory, yet you don't have the capital to go out and increase the inventory. I wasn't exactly sure how you planned on pulling that off again, thanks.

Well, first of all it is a little bit of kind of all the above. In answering the second part of the question, yes, I wish we had a lot more capital to be able to go and increase our inventories, but one of the things, you know in kind of a strange way I like, is that necessity is the mother of invention.

Although we have less dollars to use, one of the things we found out for instance, one of our recent tests is we took five stores, and in those five stores we went and allowed people locally to put in what they believed to be the right additional $100,000 worth of inventory, to see in their marketplace, what they could do by having a broader parts mix, and in every single one of those stores, we had a reasonably, we have a significant amount of increase in sales. Significant can be whatever number you want it to be, okay?

Sure.

The question then was, via some analysis that we got from our IT folks, is how much of those $100,000 did we actually sell, that got us the increase in sales? The answer was maybe 30% of it.

So does that mean that we should just put in $30,000 worth of parts into every one of our stores? Maybe. Does it mean that you can't do it quite that way, that it is not quite that simple?

Probably. But you also have to look at it and say, how can we afford it? Let's assume we find a magic number, and the magic assortment. We recognize that it will be different by store, it is certainly different by geographic area, and let's take this fictitious $30,000, and let's go and say then that we typically have vendor financing, because I think Jim talked about our accounts payable ratio of 51%.

Roughly on average, if it was the average SKU, half of it we would have to pay for. I believe, one of the things going on with merchants today, they are going back to our vendors, and saying look, we have done this in a variety of our stores, this works. Don't you want to sell more? Help us out.

Figure a way to make terms something that is consistent, with us making more money and them making more money, and we can put more goods in the stores, and we can do it without it having to cost under us, really significant money out of our pockets. In addition to that, I think there is an opportunity there for us to go, and just as I talked about earlier, to be smarter with our inventory. As much as we need more, we need right, and I think that in some cases, we just don't have right. There is opportunities to pull inventory out of stores and reposition it. I think there is opportunity there.

The first part I think is how long is it going to take for us to get there as regards inventory? I think that is a never-ending process. I think that we are going to be forced to do it a little slower than we would like, because we are going to have to be prudent with our dollars, but I do think that the opportunity is there for us to get that done.

When you say just better, I forget exactly how you said it, but sounds like maybe it wasn't looked at as sharply, or you are coming with better metrics, or a sharper eye on the inventory, better analytics? Is that fair to say?

I think it is some of all of the above. There has just not been the proper level of focus to get us the results that we need, and you know, it is one of the reasons that we have brought people in who, I think can really help in that process.

Okay, well thanks. That is helpful. I will end it there.

Okay, thanks very much.

And we did get another question queued up from Justin Thomas with Citigroup. Please go ahead.

Thank you. I just wanted to follow up on a couple of the previous questions. On the raising of capital, maybe you could help us out with what are the important metrics you are going to be using when you decide which path to take? I know you can't say now, but whether it is selling assets, or raising equity at these very low levels. What were the metrics that you look at be to help decide that path?

I don't know that I want to hem myself in a corner too much on that one, I will give you some broad thoughts. One is, clearly having advisors such as JPMorgan, I think a big part of their charge is to help us with that analysis, but it would be fair to say we are going to look for things that give us the greatest ROI, with the least risk to the Company and to our investors. I think ultimately that is the way in which we have to decide.

Okay, thank you. I wanted to also follow-up on the gross margin. Are you largely done with the clearance items that brought down the gross margin in the third quarter, and is it fair to say that roughly of that 150 basis points, maybe half of that was the result of clearance?

I think you are pretty close on the half number. Let's leave it at that, and in terms of the future, you know, I don't want to tell you that we are not going to have any clearance in the future, that is retail. Having said that, I don't believe that we have any kind of pent up need to go and clear out of the ordinary. That is the way in which I think I would answer the question to you. Okay?

Would you consider the third quarter out of the ordinary?

I would like to think that we don't need to spend that much money on clearance on a go-forward business, yes.

And then on the real estate, you were talking about the new stores weren't exactly at the levels you would have liked, is that an execution problem, or is it a real estate problem, where they might never actually be at the levels where you would like them to be?

Well, I don't know that we can completely tell yet. I think there are some cases that you know, and this by the way, is the way it works when you have a lot of stores. There are some cases where we look and we wish we didn't open them. But every retailer in the real estate portfolio, that is how it works.

Having said that though, I do believe that there has not been enough emphasis, there was a lot of emphasis on opening new stores. I don't think there was enough emphasis on opening new stores that were highly productive, and then sheperding them through hard times, so that you can assure that they would be productive. Those are the kinds of things we are doing.

Okay, and one last one, in your response I think it was was to Matt's question, the fourth quarter business remaining, would you say it is actually getting tougher? I think where Matt was trying to go with that, is it actually getting worse, would you say the macro environment, or whatever the pressures might be are actually worse, or it is similar to the third quarter?

I kind of knew where Matt was going with that one, and I will just stick with tough.

All right, thank you.

Okay.

Thank you, and I have no more further questions in queue.

Thank you, Operator. In closing, I just want to mention a couple of things. Even though our team and I can't commit to a timeframe for ultimate success today, I can without a doubt commit the following to each of you. This is a team and this is a Company that will work very hard.

We are very dedicated to the process of success for everyone. We are dedicated to the best interests of our team members, our vendors, and ultimately our stockholders. We will make decisions based on facts. Bottom line in the future, you will see a difference in the way this Company is managed. We will be top line focused as regards sales, and bottom line focused as regards profitability. I want to thank you all for your time, I want to thank you for your questions.

I want to wish everybody Happy Holidays, and a very Happy and Healthy New Year. Thank you all.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation, and using AT&T Teleconference Service. You may now disconnect.