O'Reilly Automotive Inc (ORLY) 2009 Q2 法說會逐字稿

I will be your conference operator today. At this time I would like to welcome everyone to the 2009 second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) If you would like to withdraw your question, press the pound key.

I will now turn the conference over to Mr. Tom McFall, Chief Financial Officer. You may begin your conference.

Thank you. Good morning, everyone, and welcome to the O'Reilly conference call. Before I introduce Greg Henslee, our CEO, I would like to read a brief statement. The Company claims the protections of the Safe Harbor 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, estimate, project, will, or similar words. In addition, statements contained within this press release that are not historical facts are forward-looking statements. Such as statements discussion, among other things, expected growth, development, integration and expansion strategy, business strategy, 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 and our ability to hire and retain qualified employees, risks associated with the integration of our businesses, weather, (inaudible) activities, war and the threat of war. Actual results may materially differ from anticipated results described in our filings with these forward-looking statements. Please refer to the risk factors section of the Company's 10-K for the year ended December 31, 2008, for more details. At this time, I'd like to introduce Greg Henslee.

Good morning, everyone, and welcome to our second quarter conference call. Participating on the call with me this morning is, of course, Tom McFall, our Chief Financial Officer and Ted Wise our Chief Operating Officer. David O'Reilly, our Executive Chairman is also presently. It's now been a little over a year since we closed on the acquisition of CSK Auto and embarked on the task of integrating CSK's operations into O'Reilly. This has been a very significant task, and we've still got a long way to go to be fully integrated and able to execute our go to market strategy in the western half of the country.

At the same time, however, we've come a long way in a relatively short time. We've integrated many of the headquarters' functions, converted or merged the stores in the middle of the country, where we have distribution reach from an O'Reilly distribution center, converted the Detroit distribution center to O'Reilly Systems and material handling equipment, implemented delivery service to commercial customers in most stores, improved inventory availability, adjusted our pricing to be market-competitive, and many other projects that will lay the groundwork for the incremental improvements in the CSK performance over time. On top of all this, the core O'Reilly stores continue to perform very well, generating sales gains in both the commercial and do it yourself sides of the business.

Clearly, the first-year following the inquisition has been a challenging yet outstanding year for team O'Reilly, and it's one that will be reflected on in the future as one of the greatest years in our country's rich history, and I want to thank all of team O'Reilly for your commitment to our continued success and for the great job you're doing in taking care of our customers and ensuring that they continue to make our stores your first choice in fulfilling their automotive needs or supplying their auto repair business.

Business during the second quarter generally remains steady throughout the period, continuing the trend we experienced earlier in the year, and that steady trend has continued to this point in the third quarter. We're very pleased with the core O'Reilly sales performance, and feel the 7.8% comparable store sales growth that we achieved clearly exhibits the ability and commitment of the core O'Reilly team, as we simultaneously work to integrate the CSK operations.

As shown in our press release last night, we continue to work to clearly express the components of our comparable store sales. There are a lot of moving parts with the integration of CSK, and we believe dividing our comparable store sales up as we did in the press release is the clearest way to represent each of the different components of the 4.8% consolidated comparable store sales growth we achieved in the second quarter.

I'll take just a moment to expand on each of those components, and I'll start off with the stores that are operating on the O'Reilly point of sales systems. These stores include the core O'Reilly stores, the fully converted Checker stores, which are located in West Texas, New Mexico, Montana and the upper Midwest, and both converted, partially converted as well as non-converted Murray stores, which are running on the O'Reilly point of sale system. 79 of the Murray stores placed on the O'Reilly sell system in order to facilitate the conversion of the Detroit distribution center to the O'Reilly operating system, although we did not fully convert the merchandise at the stores, and are doing the back-door conversions one line at a time at the same pace as the CSK stores in the western half of the country.

During the second quarter, 26 of these stores have had their display area reset while the store teams did their best to keep the stores open for business. The merchandise mix in the display area of these stores was refreshed, but the back-room inventories will not be fully converted at one time, as we've done in the Chicago conversion stores and the Checker conversion stores. Again, their back-room inventories will be changed and updated at the same pace as those in the CSK store in the western half of the country. The display areas in the remainder of the conversion stores will be reset in the third quarter.

These stores, in total, which represent 2,351 of the 3,387 stores we had open at the end of the quarter, generated 6.1% comparable store sales growth in the second quarter. As I mentioned, the core O'Reilly stores, which represent 2,087 stores generated 7.8% comparable store sales for the second quarter. Business in our key locations has remained relatively steady throughout the cold, continuing a strong trend that has been present for the past several month. We have an outstanding EO management team running our key locations and we're pleased to continue the strong performance in these stores. Our business has been performing nicely in both the commercial and do it yourself sides of the businesses with the commercial business outpacing the DIY business by a small amount.

The second component of the 6.1% comp generated on O'Reilly systems is the Checker stores that we've been working to convert over the past several months. This group represents 123 stores. These stores, some of which were converted during the second quarter, generated a comparable stores sales decrease of 3.4%. Many of these stores have performed extremely well after the conversion, as we've discussed, and the longer they've been converted, the better they perform. However, several of these stores, on an accrual performance trend coming into the conversion, and it takes time to turn that trend.

At the end of the first quarter, we reported on 51 of these conversion stores that were completed through the end of 2008, and I'm pleased to report that these 51 stores continue to comp positive, as do many of the conversion stores. Please keep in mind the CSK stores are not price-competitive, and we have headwinds from a comparison standpoint, to the lower market competitive prices that we've implemented. CSK was also very promotionally driven, and we've reduced the promotional activity to what we consider to be appropriate to build traffic in the stores in order to give ourselves the opportunity to create repeat business, not drive sales dependent upon promotional activity. Additionally, it probably goes without saying that the conversion in general is somewhat disruptive to business, and there's a pretty significant training following the conversion.

We look at the performance of these stores very closely on a by category basis, and we're very pleased with the performance we're seeing in the key hard parts categories, yet this performance is muted by the transition away from the non-automotive categories that CSK focused on along with other factors I mentioned. We feel confident that our model is more sustainable based on netting demand from both commercial and do it yourself customers, through application hard parts, and are confident in our ability to perform with this model as we demonstrated in the O'Reilly stores.

Our experience has been that converted stores incrementally gain momentum following the conversion, as many of the stores included in this group don't have much time to accomplish the conversion, and we're confident in our ability to generate positive results in the conversions as we continue through this transition into the pure auto parts business. Through this point in the third quarter, these stores, as a group have been positive, and we expect incremental improvement in these stores as they continue to gain traction.

The third and last implement of the 6.1% of the O'Reilly system generated is 141 Murray stores. 62 of these stores were fully converted during the second quarter. 26 had the layout reset and the display merchandise computed, and the remainder have not had any conversion work at the end of the period, other than back-room product line changes as well as the POS system change. The reason we decided to report the Murray comp separately is that Murray's really is a much different operation. For years, Murray's operated as some of the very best retail automotive stores in the country, with very large display areas, relatively small hard parts inventories, with very high retail service levels. These stores were built to serve the light do it yourselfers. We looked at them several years ago before CSK bought them as a potential acquisition target and realized just how finely tuned the retail presence was.

Their performance has incrementally waned under the management of CSK, and the trends we've seen since we've owned them have certainly left room for improvement. Some of this is related to the general economic conditions in Detroit and the surrounding areas, and some of it is simply the continuation of a trend that has been present at some of the Murray stores for some time, coupled with the main factors that I mentioned that are creating some headwind at the Checker conversion. The Murray stores as a unit generated a comparable store sales decrease of 11.9%.

As is the case with the Checker store conversions, we're taking the converted Murray stores through a very significant transition. On a by category basis, corporate is doing very well in many, many of the key categories, but on balance, not offsetting the sale of promotional products, non-automotive merchandise that was present at CSK. We see a lot of potential for the stores in the pure auto parts business, as we put them in the business. Both retail and commercial, and we're confident in our ability to generate positive results as we complete conversion in these stores and start executing our dual market strategy, supported by much improved inventory coverage and competitive pricing.

As I mentioned earlier our consolidated comparable store sales growth for the second quarter was 4.8%. The last improvement of this is the CSK stores, operated in the western half of the country. This represents 1,037 stores; and as I mentioned, these stores are being converted one product line at a time, and are benefiting from the improved inventory coverage, as we change or update product lines and pricing. At this point, approximately 80% of the hard parts volumes in the CSK stores that are going to be changed have been changed. These stores generated 2.1% comparable stores sales growth in the second quarter, representing their third consecutive quarter of positive comparable store sales gains since we've owned the Company.

We continue to be very encouraged by our prospects in the western half of the country, as we work to establish distribution capability that will allow us to execute our business model. This expansion is coming along as planned; and Ted will review in detail the progress we're making as well as our plans to reset and refresh the display area of these stores in a moment. On balance, we're very pleased with our comparable stores sales performance in the second quarter and look forward to the continuation of the solid trend we've been on in the past several months, as we work to take advantage of the opportunities we have in the markets that are new to us as part of the acquisition of CSK.

Now onto our gross margin performance. The second quarter, we achieved a 320 basis point improvement in our gross margin, taking it from 45% of sales, last year second quarter to 48.2% this year. This improvement was driven by three primary factors. First, the higher mix of retail sales in the CSK locations; second, the improved cost of goods as a result of our negotiations with vendors as a much larger Company; and third, better margins on commodities, like oil and antifreeze, due to cost bid reductions related to raw material cost decreases. To this point, we've been able to maintain our selling price with just taking several of these products to higher than usual gross margins.

We're very pleased with the support our vendors have shown for this acquisition. It's clear that many of them see as much opportunity as we do to grow our business in these stores using a dual strategy, and we're working to deploy better inventory coverage across all CSK markets with the product line changing and the updates we have, as well as the expansion of our distribution capability in the west. We work hard to maintain and grow our gross margin, but we want to be caution with regard to future expectations of our gross margin performance. The contribution grew much better than expected commodity gross margin, would be hard to maintain, since the prices can be relatively volatile, and those product lines are currently contributing at significantly higher than historical levels. We'll certainly work to maintain the higher levels, but would expect our gross margin for the full year to be in the 47.4 to 48.8% range.

Our SG&A for the quarter came in at 36.3% of sales, compared to 32.5% last year a 380 point -- basis-point increase, due partly to the payroll cost related to the integration effort, primarily due to the higher occupancy and payroll we experienced in the CSK stores. As outlined when we acquired CSK, our intent is to improve productivity and leverage fixed costs in the CSK stores by executing our dual market strategy, and we're making good progress and expect continued improvements in our productivity and fixed cost leverage as we work to complete the integration.

We're very pleased with the 12% operating income we were able to generate in the second quarter. We're still very early in the CSK integration process and are very pleased with the performance of the core O'Reilly stores as we work to improve the profitability of the CSK operations and position ourselves to execute our proven business model in these new markets. Tom will be covering more details of our quarterly financial performance as well as our guidance for the third quarter and the remainder of the year in a moment.

In summary, it's clear that the lower fuel prices, the decrease in new car sales and the increases we've seen in miles driven in the most recently reported months is creating a tail wind for our industry. Team O'Reilly is working hard to make sure we take full advantage of this opportunity as we focus on optimizing our merchandise mix, take advantage of our extensive distribution capabilities, and, most importantly, provide unprecedented levels of service to both our loyal customers and our first-time customers.

Again, I want to thank all of our team O'Reilly members, for the great job you're doing and for all the hard work that's being put into the integration of CSK. O'Reilly Auto Parts will soon be a brand that is recognized across the United States, and our continued success is attributable to the great job each of you are doing taking care of each of our customers, one customer at a time. I'll now turn the call to Ted Wise for some additional comments.

Thanks, Greg, and good morning, everyone. Well, in the second quarter, we increased our story count to 3,287 locations with net gains at 50 new stores in the last quarter, and 108 new locations so far this year. This number is actually nesting out to 102 stores when you subtract the store closures in the first quarter due to the consolidation with the Checkers (inaudible). Our Company new site expansion over the year remains 150, which at this point, we're well ahead of the schedule.

In addition 50 new store installations, we relocated 3 new stores to new prototype locations and completed 11 store renovations and core O'Reilly's (inaudible). This is a tremendous accomplishment by our field installation group, considering the task of the ongoing CSK store conversions during the same time.

To give a brief overview of our expansion activity by state. North Carolina (inaudible) in 11 new stores last year. This gives us 21 new North Carolina stores so far this year, which was the growth plan to support our new 325,000 square foot North Carolina distribution center that had a very successful opening in May. North Carolina and the surrounding states will continue to be a key part of future expansion. Ohio was next, with 10 new stores in the quarter, and 15 year to date. Texas followed with 5 new locations, and a total of 14 new stores so far this year, which gives us 519 stores in Texas. Served by our Houston, Dallas and our new Lubbock distribution centers, we continue to find great expansion opportunities in the state. South Carolina added two new stores, for a total of eight stores this year. The additional 20 new stores net out in 12 different states.

We've had store growth in 22 states so far this year, which is made possible by the distribution coverage of our current guidance in DC. By the end of next year and with the addition of four new distribution centers in Washington, California, Colorado and Utah, we will provide nightly service in all of our markets. With this level of distribution coverage and capacity, store expansion growth throughout our 38 stores becomes more manageable with the real estate and operational level, resulting in better new store productivity.

Now, in regard to the CSK problems, we continue to evaluate the locations and leases from the CSK stores. Based on the timing of these leases, we are establishing plans to stay at the present location or search for a new and better location. Our objective is also to renegotiate the leases that are mature and may not be in line with the (inaudible) lease market. During this process, we've identified a group of 18 stores that will be scheduled to close by the end of this year. These are extremely low-volume non-performing stores that fall into the category of overlapping other CSK locations, higher (inaudible) demographics not suitable for do it yourselfer business growth, and limited or no installer business in the immediate area. These 18 stores are spread throughout the (inaudible), and all are in (inaudible) which gives us the opportunity to transfer the (inaudible) to another CSK and (inaudible). And These 18 stores are spread, and all are in multimarkets, givers us the opportunity to transfer companies to other CSK or O'Reilly school nearby. And from a team member standpoint with a number of surrounding schools, the staff can easily be transferred to another location (inaudible).

I will briefly discuss the stores infusions. As Greg mentioned, 79 new stores in the Detroit market, with the last to arrive with computer systems. We now have over 300 CSK Murray stores operating in O'Reilly systems in service and O'Reilly distribution center O'Reilly (inaudible). 26 Murray stores have plans to re-staff to the O'Reilly (inaudible) plant by the end of the second quarter, with an additional 32 having been completed since (inaudible). During the next three weeks, the last new Murray store have their planograms reset, with interior decorating and remodels to follow in the out front reset.

After co-branding and advertising in all markets during this past year, the exterior signage in these 300 plus stores is now in the process of being changed out to the O'Reilly brand. We had hoped to have this group of stores rebranded by the end of this year. We are seeing positive sales trends in our converted stores. As a team, we've become more comfortable with the systems and product lines. This group of stores experienced inventory (inaudible), systems conversions, interior remodel, all of which obviously created temporary disruption in business. The additional hard parts inventory, HUD system, nightly distribution, and market competitive pricing now is in place and we're beginning to improve our hard parts sales mix for both the retail and the installer customer. These changes in the stores have been (inaudible) by co-branding advertising designed to educate the customer on the everyday low pricing and expanding levels available at O'Reilly's store. Our training continues at the store level with all team members and especially with district management, store management and installer service specialists o ensure that we provide O'Reilly service levels to all of our customers. We are confident that the current trends will continue to grow business to O'Reilly over comps.

Now, in regard to our work in the thousand-plus CSK stores out west, we have made good progress in changing product lines and increasing coverage to all stores. This process has been accomplished one product line at a time, using the CSK distribution system and a store computer system. We have also evaluated each market and established a (inaudible) hub and spoke system to provide same-day delivery service to almost all stores. The additional inventory is helping us promote a hard parts business to both retail and wholesale customers. Pricing has also been adjusted to be competitive in the markets and our co-branded advertising is continuing to educate the customer as to the increased parts coverage with the new low everyday competitive process, as we convert away from rebate and promotional prices CSK can provide to help build traffic.

The store conversion systems to the O'Reilly computer and nightly replenishment will follow a schedule tied to the opening of the four new distribution centers. These conversions will follow a schedule of approximately 30 computer installations per week. We will start with the Seattle DC opening and the 109 full system conversions in November. The Southern California DC will open and the 240 store conversions, which start in January. The Denver DC opens and a 92 store conversions start in March. And last, the Salt Lake City DC opens in the following (inaudible) will start in May. That will leave us with the two existing ESK distribution centers located in (inaudible) California.

We're following a very comprehensive evaluation in basic capacity in the current Northern California DC located in Dickson. We have decided to relocate it to a new 520,000 square foot facility in (inaudible) California that will give us the ability to efficiently service up to 350 stores in this area. The exact date has not been determined, but we expect it will take place in August of 2010, by which time the Northern California group of 278 stores will be changed to remodeled systems, and then last CSK Phoenix DC will be converted along with the 151 stores in the Phoenix area immediately following the Northern California conversion.

Needless to say this is an extremely aggressive schedule and both the store and distribution management teams are doing a tremendous job in planning and executing these transitions in the O'Reilly service model. The addition of nightly service and complete inventory availability helps us to take business to the next level as well as compete an aggressive store expansion program in the west. This September, we'll start the out-front recess in the western stores following the O'Reilly core installations. We will continue to co-brand our advertising, during this time and make the necessary plans to rebrand the stores to O'Reilly following the computer system conversions. This schedule and changeover process will allow the West Coast to be well prepared and ready ahead of the time of the actual computer installations. We will have most of the product lines keep moving, store inventory levels updated, prices adjusted to be competitive, and stores profitably staffed to move retail and installer business.

The current comp trend in the West Coast is a sign of effectiveness of the changes we are and will continue to make in these stores. We continue to evaluate, train and expand store sales distribution teams to ensure we have the best leadership in the field to execute the O'Reilly business model as these stores become fully converted. To finish, I would like to thank the 44,000 O'Reilly team members for their contribution to achieving outstanding sales profit in the second quarter. In addition to the massive amount of work and involvement from all areas of the Company in executing the CSK store and DC transitions coming up, we have kept a strong focus on customer service and growing our sales in both the retail and consolidated business, which has resulted in a strong 7.8% comp sales increase in our core O'Reilly (inaudible). Now I'd like to turn the call over to McFall.

Thanks, Ted. Now we'll take a more in-depth look at the numbers. Sales increased $547 million a 78% increase over the prior year, and $1.25 billion for the quarter. The increase was attributable to a $54 million increase in O'Reilly comp store sales, 39 million in non -- new store sales, flat non-comp non floor sales and $454 million from the acquired CSK stores. For the year, we are raising our total revenue guidance to [4.8 billion to $4.9 billion]. Gross profit was 48.2% of sales for the quarter versus 46.6 in the first quarter of 2009. The improvement was driven by an increase in synergies and an advantageous pricing environment as it relates to products comprised primarily of these commodities, although we do not expect this environment to continue.

We've been very successful in completing the acquisition-related negotiations with our vendors, and we are raising our estimate of the merchandise acquisition cost savings in 2009 to 60 million to $65 million from our previous guidance of $50 million. We are also raising our annual total estimate of the merchandise acquisition cost savings, starting in 2010, from $75 million to approximately $90 million. For the year, we are raising our gross profit guidance to 47.4 to 47.8% of sales. SG&A for the quarter was 36.3% of sales versus 32.5% in the prior year. The 3.8% increase was due to the higher cost structure of required CSK stores. Taking a look at SG&A we continue to benefit from lower than expected fuel cost and we continue to incur additional store labor costs at the CSK stores to accomplish the expensive product line resets that are under way. We continue to work hard to eliminate (inaudible) and continue to expect 2009 SG&A synergies to be 7.5 million to $12.5 million on top of the $7.5 million realized in 2008.

Net interest expense for the quarter was $11 million, with $2.1 million of that representing amortization of debt issuance costs. To the extent our debt is not swapped at fixed rates, continued historically low LIBOR rates during the quarter had a positive impact on our interest expense. We expect 2009 interest expense to be 47 million to $50 million with $9 million being non-cash amortization and debt issuance costs. The tax provision for the quarter was 38.7% of pre-tax income. We expect full-year tax provision to be 34 to 37%, with increases in the fiscal 2008 contributable, including a full year for the CSK stores, which predominantly operate at higher tax rates.

Excluding the non-cash acquisition related charge for EPS -- I'm sorry -- acquisition related charge, EPS in the first quarter on an adjusted basis was $0.63 per share which represents an increase of 31% over the prior year. For the year, adjusted EPS was $1.10 a share, a 25% increase over the prior year. The only remaining acquisition charge is amortization of trade names and trademarks incurred as part of the purchase price allocation in accordance with generally accepted accounting standard 141. We will amortize our remaining value over the next year and half as we convert all of the stores to the O'Reilly brand. For the year, the impact of this non-cash charge would be a reduction of GAAP EPS of $0.03.

Moving on to the balance sheet, the O'Reilly average store inventory at the end of the quarter was $505,000, which was a 7% increase from $472,000 as of last June. The increase was driven by the excess inventory in the system related to store conversions and the end of a major vendor consignment program. For the CSK stores, the average per-store inventory increased from $511,000 at the end of March to $530,000 at the end of June. This increase is a result of our ongoing line conversion process. The average CSK store inventory in excess of the average O'Reilly store is the result of duplicative inventory in the CSK system as a result of these extensive line change orders. When the integration process is complete, we continue to expect average CSK inventory to be similar to the O'Reilly levels.

Accounts payable of 118 -- $819 million was 47.2% of inventory as compared to 49.3% in the prior year. Our AP to inventory ratio was negatively impacted by the excess inventory in the system related to the extensive line changing processes, the elimination of a major consignment program with one of our vendors, and continued pressure on one of our vendors caused by the distress in the credit markets.

Moving on to capital expenditures, CapEx was $80 million for the quarter, bringing the year to date total to $231 million. We are lowering our estimated 2009 CapEx from 400 million to $420 million. This reduction is a combination of savings from the northern CAL DC relocation, which Ted spoke about earlier. Again, the original plan, we were expected to buy this facility, but we were able to obtain a favorable lease which reduced our CapEx by approximately $30 million. The remaining reduction in our expected '09 CapEx is a result of timing with these deferred expenditures moving into 2010. Depreciation and amortization grew $38 million, and we anticipate full-year depreciation and amortization to be approximately $150 million.

Total borrowings at the end of the quarter were $797 million, which brings our year to date net increase to $64 million. The increased borrowings we expected, based on our plan to invest additional dollars in the CSK store's inventory, develop DC properties and convert stores. As of June 30, $447 million of availability under our ABM, primarily based on our reduced CapEx spend, we now estimate we will incur 60 million to $90 million of additional debt for the full year. Cash flow from operating activities was $66 million versus $97 million in the prior year quarter. Year to date cash flow from operating activities was $152 million, versus $215 million in the prior year.

Both the quarterly and year to date increases are the result of investment and inventory related to the product changing in the CSK stores offset in part by higher net income and depreciation. Stock option expense for the quarter was $3.6 million compared to $1.6 million in the prior year, and the year to date stock option expense was $6.9 million compared to $2.9 million in the prior year. The increases driven by the options issued in conjunction with the CSK acquisition.

For the quarter, the reserve for LIFO decreased by $29 million as we finalized product acquisition related notes, negotiations with our vendors, and prices decreased especially for those products priced primarily for these commodities.

To recap our guidance, same-store sales guidance for the quarter, core O'Reilly and converted stores is 4 to 6%, the CSK comp guidance was to 3%, and the consolidated comp guidance was 3 to 5%. Our GAAP EPS guidance for the third quarter is $0.53 to $0.57 a share and 138.2 million shares. For the full-year 2009, our comparable store sales guidance for O'Reilly and converted stores was 4 to 6%. The CSK comp guidance was 1 to 3%, and the consolidated GAAP guidance was 3 to 5%. We are raising our GAAP EPS guidance for the year to $2.06 to $2.10 on 137.7 million shares. Excluding the non-cash charge for Names and Marks, which is the only acquisition charge related charge we expect to take in 2009, we expect adjusted EPS to be $2.09 to $2.13. At this time, I'd like to ask the operator to come back, and we'll be happy to answer your questions.

(Operator Instructions) And your first question comes from the line of Scot Ciccarelli with RBC Capital Markets.

Good morning, Scott.

Can we talk a little bit about the comp depression of the converted stores? I know there's major timing issues depending on when stores get converted, et cetera; but can you just help us reconcile the plus double digit comps we're seeing after call it, 15, 16 weeks and the negative 3.4% that we saw posted in the quarter?

Well, Scot -- and if you're talking about what we -- the first stores we converted on the year end call, I believe, and several of those Checker stores did really well out of the gate. In that, we explained that we were excluding the first four weeks of the -- of those stores converging with us, because the negative trend continued, and that was their performance at that point. What we gave you for the whole comp or at least the Checkers store camp, the decrease of 3.4% includes those stores that were converted in the second quarter and includes the performance of those stores as they continue to try to climb out of the negative trend that they were in. The 51 stores that we reported on at the end of the first quarter that were converted before the end of the year, as I mentioned in my prepared comments, continue to comp positive. This time of year what we are up against is comparing against CSK numbers, which has some effect, is that they were extremely heavy promoters of all products, both non-automotive and automotive, and we don't have nearly the promotional activity they're going on, as compared to them. And for that reason, the double digit comps that we were saying aren't happening, but we continue to gain traction on the wholesale side, and over time, we'll continue to build the retail business. So we feel pretty good about how we're doing with the converted stores, and obviously, they're not comping double digit, as some of the others did out of the gate in the middle of the winter.

And, Greg, just a clarification. When you guys do the full conversion, we know the stores have to kind of fall in the hole, as you mentioned, but are those stores kind of comping down? Is it double digits? Is it down 18? Can you just give us an idea of how much of a hole they have to dig themselves out of?

Well, it varies by store obviously, and there are some of the stores that were comping double digit coming into the conversion and the double digit negative -- I mean, comping negative double digit coming into the conversion, and it takes a little while to dig out of that. So yes, we had some that were comping like that, and some that were doing okay into the conversion, and they obviously comped much better continuing the trend that they were on. But, yes, there were some of those Checker stores, even some of them (inaudible) stores for that matter, as exhibited by our other stores, that were coming into the conversion, that were certainly struggling prior to the conversion, and are doing better, but it takes a while, as I said, to dig out of the -- that they were on.

Okay. Thanks a lot, guys.

Okay. Thanks, Scot.

Your next question comes from the line of Christopher Horvers with JPMorgan.

Thanks and good morning, guys.

Good morning.

Can you talk about the synergies? It seems like they're running ahead of plan. You provided a number with the cost of goods synergies at the end of the fourth quarter last year. Can you talk about where you are through the end of the second quarter, on cost of goods synergies; and from an accounting perspective, don't they get hung up in cost of goods until you sell that product, so shouldn't the synergies accelerate into the back half of the year?

Good question To address the first part of the question, the synergies are tied to when the products replace them at CSK stores. To the extent that we sign new deals and the O'Reilly product line exists and is already in the stores as we said, selling them, but at a lower coast. So we're going to see the synergies build as we get the product all aligned at the CSK stores. I think we made that comment on the last two calls. From your question of does this get hung up in inventory, you got to remember that we're LIFO based accounting. So the last product that we bought -- and in this case, the last product we brought which is at a lower cost is the first one that we sell.

And any quantification of where you are from the cost of goods side? You talked about the SG&A side.

We expect to see 60 million to $65 million for the total year. Obviously the first quarter being by far the lowest as the product line deducts - changeovers, haven't started at the CSK stores. So we would expect it to continue to mount through the year. When you look at 2010, the $90 million that we're estimating should be spread relatively flat across the year based on the amount of product that we move within each quarter.

Okay. So you don't want to tell us the exact number, is what you're saying. And then, as a follow-up on a separate topic, can you talk about, the disruption -- you have a thousand stores that you're going to convert in the West Coast starting in the fourth quarter. Is there something that you can do to change the process that will -- or is there something different about those stores that will make it less disruptive so the hole won't be so deep?

Well, let me kind of define a little bit about what these conversions entail, and maybe the difference between the conversions that we've done here in the center part of the country, as compared to those that we'll do out west. The Checker stores in the central part of the country and the Murray stores that we've done these full conversions on, basically what we're doing to those stores is we are pulling all of the merchandise out of those stores, pulling the fixtures out of the stores in many cases, and replacing those fixtures. If we decide to reuse the fixtures -- and they're relocated and the store is reset. The display area is redefined to countermove in the POS system, basically we kind of lift. clean and place the new store, and it's extremely disruptive.

Now we try our best to continue and do some business, and facilitate customers that need emergency parts and stuff like that, while we're going through this, but it -- it's a disruptive process, but it's short. It's painful, but it doesn't move very long. In the CSK stores out west, their back-room merchandise will have already been changed prior to us doing any display-area conversion, and the majority of those stores really don't have to have these huge resets of the display areas. The Murray stores had much larger display areas from what we would typically have, and that required a huge layout reset, whereas the CSK stores in the central part of the country, but also the ones out west don't have a big disparity between the sizes they were using as compared to what we would typically use. So the layout doesn't have to be changed as much.

So the CSK conversions in general would be much less disruptive, because not only will the back-room merchandise have been changed, the majority of the front-room merchandise will have been changed, and the only conversion of the activity that will happen is we l want to modify the layout a little bit. But there won't be the lifting of inventory and the replacement of inventory we've had with these stores, which creates most of the disruption, because it makes the inventory unavailable for sale as it will continue to be available for sale with the western CSK convergence.

I might also cede that just from a parts specialist standpoint, the familiarity with what they're selling, the part numbers, where it's at in the store, all of that will be behind us at the time of the conversion, system conversion. I mean, they will be selling the brands, for months and actually even years at that point, so from a product-knowledge standpoint, it won't be a challenge. Also, just categorically, I think the 300 stores that we finished converting, they were running in a negative comp prior to the conversions, prior to time we wanted, so we had a little deeper hole already established to dig out of.

Thank you.

Thanks.

Your next question comes from the line of Steve Chick with FBR Capital Markets.

Oh, hi, thanks.

Hey, Steve.

Hey. How are you?

Good.

A good quarter. Two questions, I guess. Maybe Tom, to clarify, did you say the -- the comment at the end there, about the LIFO reserve, is that -- was there a $29 million credit in the quarter? Is that how we look at that? And I think that's against an $8 million expense of a year ago; and if I got that number right, I don't know if that means the FIFO group margins actually -- were they down for the quarter ?

The answer is that it was a reduction of the reserve. So it was theoretically a helper, but you can't take the change in LIFO and add it to gross margin and get FIFO.

You can't be that simple about it? I know the LIFO account can get pretty complex, but, I guess the question -- well, if you can't -- so were FIFO gross margins actually up in the quarter?

Yes.

You mentioned the commodity pricing fees.

Yes.

--and margins as a third contributor so--?

We cannot change this call into an accounting call, the answer is yes, the FIFO gross margin were up in the quarter.

Okay. All right. Well, we can try, probably going through the nuances offline, too. Okay. And second, if I could. So it sounds likes sales trends so far this quarter have held up very nicely. Can you just clarify -- I mean, last year, you know, we had in the southeast, a pretty big (inaudible) shortage of convert trends. So can you talk about as we look into the quarter upcoming, as I remember it, you started the quarter off at 3 to 4% rate of growth in comps a year ago and actually ended the quarter at 1.5. So how are you thinking about that with your guidance? I think once again looking maybe on the conservative side, and can you clarify does the comps pricing get a lot easier from here?

Yes. I think -- if I remember right, third quarter last year, the easier part of it, comparison for this year, the tougher part last year was the earlier part of the quarter. So yes, it (inaudible) get a little easier. And we're just trying to be realistic in our comp guidance as we can, without being too aggressive. We've been on a good run here with core O'Reilly from a comparable store sales perspective, and we don't see anything in front of us within the next few months that will either change the trend -- the projection being that gas prices will stay fairly reasonable -- that there's not going to be a significant spike in new car sales, which I didn't know there would be that much of a difference very quickly anyway. I wouldn't say we're being conservative with our guidance of 4 to 6% with core O'Reilly, but we're certainly going to work to continue to generate comparable store sales, keeping what we're generating right now and hopefully continue that through the quarter.

Okay. Great. Thanks, Greg.

Thanks, Steve.

Your next question comes from the line of Craig Kennison.

On the commercial side of the business, the repair shops we talked to are telling us that repair part availability has become a serious problem across the industry. Is that dynamic, I guess, providing you with an opportunity to build new relationships and maybe take some share on the commercial side?

Well, we work awfully hard to make a wide array of parts available; and, one of the things that our industry has gone through over the past 10, 20 years is a huge proliferation of -- necessary to service the vehicle fleet on the road; and, I feel like we're positioned much better than most companies to provide parts; and be hard to find and for that reason, as we make these -- that inventory available for the expanded distribution network out west, we would expect some improvement -- or hopefully significant improvement in our commercial business in the western stores, and we continue every day to dial in the method by which we determine what parts we keep in our distribution centers and our stores based on the (inaudible) population, failure rates we see, and the vehicles that exist in each market and then just demand in general. So I'm not sure what part of the country you guys talk to or what repair shops you talk to. Acquiring parts for the repair shop is always a challenge. They hope to have the parts in 30 minutes no matter what kind of car they're working on or what the part is, and we work hard to do that. Sometimes that's not possible, but we feel like we're well positioned to provide the parts as compared to (inaudible) others.

That is helpful. Thank you.

Thank you .

Your next question comes from the line of Brian Nagel with Oppenheimer.

Thank you. Good morning.

Good morning, Brian.

Just a couple of questions. First off, on gross margins, I appreciate all the comments you gave us in your prepared remarks, but as we look at the improvement -- the 320 basis points, which was better than the 200 basis points you showed in Q1, so that incremental say 120 basis points, is that largely commodities then if I go along the three parameters that you gave us?

The larger part of that would be acquisition synergies, as we completed deals with our vendors, some of the major vendors we've highlighted took longer to deals done. Combined, as we change over the parts at CSK, especially the hard part. We buy a lot more effectively than they have in the past. And those are -- that's the biggest, by far, piece of the gross margin improvement.

Okay. So -- and in the comments with respect to gross margins going forward, you think now we're sort of past the peak point of that?

There is a positive environment out there on these used commodities, and I think that's when we look forward for the last half of the year, when you work through our numbers, the gross margin estimate for the second half of the year is slightly less than what was achieved in the second quarter, and that's really coming from the expectation that those abnormally high gross margins that we're seeing high commodity will revert to the norm.

Okay. That's helpful. And the second question I had was broad-based; but with respect to the converted stores, anything changing there with the competitive response as you convert these CSK stores?

Well, our business is a very competitive business, and there are several -- very solidly managed companies that we compete with; and, we've not noticed anything different happening in the markets that we're converting stores as compared to stores that -- where we were not converting stores, so although there were certainly plenty of competitors, and we work hard to adapt to everything that our competitors do, and really, our philosophy has been that -- we have a very solid strategy. We continue to tweak that strategy ongoing, but we've not had to adapt anything our competitors are doing on the conversions and we're pretty confident in just our ability to execute the business model as we have in the O'Reilly stores and that's what we're working to establish right now. I mean, we've not seen anything change in our competitors in those markets.

Okay. And then just one final question -- you gave us a lot of numbers with respect to the conversion stores in different stage of conversion. Just overall, is that -- the sort of hit to comps that you've seen in the early stages of these conversions, is that consistent with what you thought you would see before you exited into this process?

Well, the stores that we've converted in the center part of the country are stores in most cases that we overlap with, and when we were buying the Company, we of course evaluated the performance of the (inaudible) stores and district (inaudible) they were in. We could see that those stores that we overlapped with were struggling. (Inaudible). We've done things to try and mend that ongoing, the biggest step being to convert these stores. Most of these stores were on a negative trend to begin with and following the conversion that trend continues with the added disruption of the conversion itself, it will soon start pulling out; and as I said, the Checker store conversions, the stores that are in the center part of the country as a whole -- if we take all of them and they're open. There's a hundred and three of them I believe, those stores are comping positive so far this quarter. So I think we've pulled out of the negative territory with those as a whole. They're now comping positive, and hopefully we'll continue that trend as we establish these stores as stores that have better access to inventory, competitive pricing, and are serviced by a distribution center that's giving them at least five nights a week replenishment and in many cases need times a day access to at least 100,000 SKUs which allows them to be a very savvy competitor with stores that don't have that kind of (inaudible).

Thanks a lot.

Okay. Thank you.

Your next question comes from the line of Michael Baker with Deutsche Bank.

Just two questions. One a little bit bigger picture then one maybe accounting minutiae. On the bigger picture question, so you're viewed as a business a little bit incentive, does well in a poor economy. So how do you think of things, if auto parts sales get better, cash for clunkers, et cetera, if the general economy stabilizes, do you think that could pull some business away from you? And then the accounting question is your goodwill has been going up. I'm wondering if you could discuss what's been going on behind that? That thanks.

Well, obviously we've been doing this for over 50 years, and we've seen ups and downs in the business, with different economic trends. I've been here 25 years; and with different things that can happen in the economy, you see swings. Really, we've done well in many years in good economies, when cars weren't selling, and we wouldn't expect a instruction at all for cash for clunkers program. But, obviously it pays increase new car sales some. But you wouldn't think we would see a material change in the demand for auto parts. Some of the categories that are really suffering right now are truck accessories, accessories in general. Dress up parts for new cars and trucks. We just don't -- those things aren't selling, and so our performance is somewhat muted by the fact that those product categories are doing very poorly. And those categories do much better when new cars do sell well. So we don't see anything in the immediate future, at least on our radar that would abruptly change demand for auto parts. We'll obviously keep an eye on that and report if anything that we think could cause a disruption. I wouldn't foresee us needing to update our guidance or comparable store sales for some time to come unless there is a change in the economy.

On your question for goodwill, Michael. We had a year to adjust our opening balance sheet for this price allocation. This will be the last time it's adjusted. The primary reason that goodwill went up were additional liability reserves primarily related to legal issues revolving around former CSK arrangement.

Okay. Thanks for that clarification.

Your next question comes from the line of Alan Rifkin with the Bank of America.

Hi, good afternoon. Thanks very much for taking our question. This is Vincent (inaudible) in for Alan. Just to get into the accounts a little bit more, I know you folks had said in the past that generally, a good way to think about the converted stores were that they would comp negative potentially in the high singles to double digits, and then, within the four such six weeks period post-conversion, would turn flat then to positive. Just wondering if that's a good way to think about it going forward; and then, as a follow-up question, more of a point of clarification, regarding the Murray stores, now they represent roughly around 2% of the store base. Is it safe to assume that it's actually less of a percentage of revenues than that? And then your reported negative 11.9 comp was that relatively in line with your expectations? Thank you.

Okay. Well, on the converted stores -- and when I speak of this, I'll speak of the converted stores representing the Checker conversions and not the Murray's, but on the Checker, I think your comments are correct. It's somewhere in the 4 to 6 weeks following the conversion. Those stores would typically start to pull out of the negative range, depending on how far negative they were. Our experience has been that the Checker stores would pull out somewhere in that range. As I said, the different stores as a whole are comping positive so far this quarter. So I think your comment there relative to the comments we previously made is accurate.

On the Murray stores, those stores were, I guess, performing poorly to a greater degree than the Checker stores, and their business model is different enough that it may take a little lump on those stores. We've got a lot of effort right now going into the way we go to market, in Chicago, and in Detroit, and we're hoping to improve the performance of those stores. There's a whole lot of effort in our Company. As a matter of fact, Ted and I spent a lot of time this morning prior to the call. So we're doing a lot of things there to convert the stores to our business model. Continue to build on the retail business that they've done. Those stores pose a little bit bigger challenge than the rest of CSK in general, which is the reason that we reported Murray tests separately. Murray, as you said, it represents about 2% of the store base. I would say it represents a slightly more than that as a percentage of revenue--.

Slightly more. Okay.

A little bit more. Those stores had a higher average per unit than what our -- the remainder of the stores have been. So it's more as reflected from that store comp perspective.

Okay. Great. Thank you very much.

Okay. Thank you.

Your next question comes from the line of Tony Cristello with BB&T.

Good morning, Tony.

Hey, guys. I guess, as a point of clarification, Greg, you noted that -- and I guess you could look at it two ways. Either the 51 stores, I think, you said were actually comping positive. If you look at that group of 51 that you noted in Q1 that comped plus 4.3, how positive are those? I mean, are they 4.3 still? Are they better or worse than that level?

Yes. They're low single digits. We didn't put the number in the press release, and don't want to file an 8-K by providing the exact number, but it's low single digits on the 51 stores that we have put at the end of 2008.

Okay. And the other question, then, I have is, when you look at the West Coast stores, you've got 80% of the line changeover in the parts there. Is it simply replenishment now that gets you going from 2% to 6% to 8% to drive the commercial, or are there -- what are the sort of important pieces we need to look for to know that that business is going to start to turn or -- or what can contribute to getting those comps going at an even greater level.

Yes. Well, the reason is distribution capability -- like said, 80% of the lines have been changed. The reason the distribution capability so important is it gives the stores in the area around the distribution center time of the-day access. Those DCs out there will have it in excess of 100,000 SKUs and our average store will have 20,000, 22,000 SKUs, something like that. So that's the big thing that allows us to really start penetrating the commercial side of the business. And then the stores that don't have same day access to the distribution center, if they're in the Metro, we try to augment the fact that they're not posted DC with the hub store. There are many stores will be in areas that might not have access to a hub store, and by having our distribution capability out there, the stores would have overnight access. During the night, they can have any one of over 100,000 SKUs to their stores. So they can have it first thing next morning and (inaudible) customer in that market. And that's a big thing.

Those kinds of service levels are what has allowed O'Reilly Auto Parts to grow into the Company that we are today; and without that, we simply can't execute our commercial strategy out there. Getting the distribution centers in place is a very, very important thing from a replenishment standpoint, because it allows us to deploy more SKUs and get away from some of the depth you have to have with the weekly replenishment, that's more important just from an access to broader array of SKUs which we're working to establish.

Tony, this is Ted. I also want to add -- and as you know, the wholesale business is very relationship based, and CSK was a retailer in a little wholesale business, so there's a process we have to go through store by store, recruiting and building the ISS, installer service specialist, that can be a delivery service once we get the parts and prices in line. And that is an ongoing process, and we've made some great headway, and continue to hope that -- every district manager, every REM, that's one of their primary focuses right now is building the right key to address the wholesale business going forward.

And then, Tony, one more thing I'll add to that, is just from a systems standpoint, our systems, our point of sale and sourcing systems are really held to service the wholesale side of the business, and those stores will benefit significantly from using our system to look up (inaudible) out of our distribution center and other stores as opposed to what they're using now.

Great. Very helpful. Thanks, guys.

Thanks, Tony.

Our final question comes from the line of Gregory Melich with Morgan Stanley.

Thanks. I had really just one question with a couple parts, and it's about the core O'Reilly store's comp. Still a really impressive performance, and it sounds like the commercial got a little bit better sequentially, and maybe the DIY got a little bit of a deceleration sequentially. Could you describe that? Are we getting that right? And then second, within that, what was traffic and ticket on the retail side, and was your growth into it forming more business with existing customers or winning new accounts?

Yes. Well, you're right. The commercial business was stronger in the core O'Reilly stores than the DIY business. Not by a huge margin but it was better. From a traffic and -- Tom, you have the traffic numbers?

Both traffic and average ticket contributed to the positive comps.

Yes.

And on the do it for me side, did you find -- was that acceleration more about getting more items in the basket and getting more business with your existing accounts, or were you able to get out and get new accounts in this environment?

Well, that's a tough one to measure. We've grown our business with our existing customers ongoing; but usually, when we set up a store, we open an account for virtually everyone who can possibly buy a part for us just to make sure when they do make the first transaction, it's easy. So it's a little bit hard to measure who's who, and who's not, because generally customers around our store will do some business with us. But I would say that we've probably done a little better job penetrating our existing customers, doing more business with them, as their business has improved in the economy also, because there's typically not a lot of customers around the store that we just simply wouldn't be doing business with.

Got you. And finally, with a lot of the dealerships closing and that service business moving afternoon, do you think that's helped some of your commercial accounts get more business yet, or has it not--?

Well, I think it's helped some. I think that as these dealers close, there's an array of things that will happen. Sometimes that business that was going to the dealership will be disbursed out among the after-market shops around the dealership. Some of it could possibly go to to dealership in another area, and some of it goes to new shops that are open either in the existing dealership location, because some of the dealerships are continuing service operations and used car lots or maybe another brand or something like that, and some of these highly skilled technicians and shop managers are going out on their own and opening shops which will potentially be customers of ours. So I would say the net-net of it is it is a positive for the after market and for us, but there's a variety of things that happen as the dealerships close.

Great. Thanks.

Okay. Thank you.

We have reached the allotted amount of time for questions. Do you have any further remarks?

Yes. I would like to thank everyone for their continued interest in our Company. We worked hard to move through the CSK acquisition, and take advantage of the opportunities that we saw when we acquired CSK. I can tell you we feel even more encouraged today than we have, and it's been the case as we have worked through this with the prospects of the business that we do in the western half of the country as we get in position to execute our business model. We'll look forward to reporting our results in the third quarter this year. So thank you very much for your time.

This does conclude today's conference. You may disconnect at this time.