O'Reilly Automotive Inc (ORLY) 2009 Q3 法說會逐字稿

Good morning. I will be your conference operator today. At this time I would like to welcome everyone to the 2009 O'Reilly automotive third-quarter earnings release. 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).

I would now like to turn the call over to Mr. Tom McFall. Sir, you may begin.

Thank you, Teri. Good morning, everyone, and welcome to conference call. Before I introduce Greg Henslee, our CEO, I'd like to read a brief statement. The Company claims the protections of the Safe Harbor for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by forward-looking words, such as expect, believe, anticipate, should, plan, intend, estimate, project, will or similar words. In addition, statements contained within this press release that are not historical facts are forward-looking statements, such as the statements discussing, among other things, expected growth, store development, integration and expansion strategy, business strategies, future avenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions that are not guarantees of future events and results.

Such statements are subject to risks, uncertainties and assumptions including, but not limited to, competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our ability to hire and retain qualified employees, risks associated with the integration of acquired businesses, weather, terrorist activities, war and the threat of war. Actual results may materially differ from anticipated results described or applied in these forward-looking statements. Please refer to the risk factor section of the Company's Form 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 third-quarter conference call. Participating 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 present. Its now been a little over 15 months since we closed on our acquisition of CSK Auto and went about the task of integrating the two companies. Clearly this has been a huge undertaking considering the pure scope of the work that has been done and is yet to be done to complete this integration. I'm extremely proud of the spirit in which our management team has approached this large task and I'm very pleased with our results so far. All the way from consolidating corporate headquarters functions to showing our new customers in the western half of the country what O'Reilly Auto Parts is all about, I think our team has done a great job getting combined Company off to a great start.

At the same time, we're very fortunate to have such a solid team driving our business in the core O'Reilly markets. We've not missed a beat in our core markets as we've gone about the process of combining the two companies, and I think that speaks volumes to the quality of our core team and to the commitment our team members make to our culture values and to ensuring our Company's success, and I want to congratulate all 44,000 members of Team O'Reilly for the great job they've done in the third quarter.

We continue to try and disclose as much information as we think is reasonable, considering the competitive environment, with regard to the components of our comparable-store sales. Similar to the disclosure of our second-quarter performance, we again want to speak to each of the components that contributed to our 5.3% consolidated comp-store sales growth during the third quarter. We plan to disclose each of these components again when we report our fourth-quarter and year-end performance in February of next year. However, we plan to go back to reporting our Company's total comparable-store sales performance as a single consolidated comparison with our 2010 reporting.

Business during the third quarter generally remained very steady throughout the period, continuing the trend we've experienced throughout the year, and that steady trend has continued to this point in the fourth quarter. The stores that are on the O'Reilly point-of-sale system generated a 5.3% increase in comparable-store sales. I'll break the O'Reilly system-generated comp down into the following three components: Core O'Reilly, the 123 Checker store conversions, located in Texas, New Mexico, Montana and the upper midwest, and the 141 Murray stores, located in the Detroit and Chicago areas.

The core O'Reilly stores performed very well and we're very pleased with the strong continued sales performance and the 6.8% comp-store sales growth we achieved for the quarter. As I mentioned, we have an extremely strong team in our core O'Reilly markets and it's always encouraging to see such strong performance in our mature markets. We continually work to adapt to competitor strategies and ensure we're doing all we can reasonably do to take market share in existing markets. We're very pleased that our core stores continue to perform so well and have been able to take advantage of some of tailwinds currently provided our industry, with fuel prices having stayed reasonably low and miles driven on the increase as people defer replacing their older cars and instead maintain and drive them.

The next component of the O'Reilly system-generated comp is the 123 Checker stores located in the center of the country that have been completely converted. By that I mean the old inventory was lifted, the store reset, point-of-sale system replaced, new inventory installed, and the store reopened as an O'Reilly store. As we've reported previously, these complete conversions are disruptive and there's a significant training curve post conversion due to all of merchandise being relocated in the store, the different brands and new lines of products we carry, along with the new point-of-sales systems. We felt it was best to do these conversions in this way in order for us to begin the lengthy conversion process as soon as possible and to shut down the CSK distribution in St. Paul which duplicated the service we were able to provide out of the O'Reilly distribution center in St. Paul. In order for us to supply those stores out of our distribution center we needed to go ahead and abruptly change the merchandise the stores carried to match those carried by our distribution center.

While the conversion have been a little painful, we're very happy to report that we've improved our comp-store sales performance in these stores from a 3.4% decrease in the second quarter to a 5.2% increase in the third quarter. The really good news behind this increase is the quality of the sales that are being made. These stores have transitioned away from the ancillary non-automotive products and their dependence on weekly promotions to drive sales on commodities to performing well in the core automotive hard parts categories. These products generate significantly better margins and the sales are more sustainable based upon the demand for repair parts that exists in each market. A noteworthy point relative it our comp performance in these stores is that, as we stated before, the CSK stores were not priced to be market competitive. That was corrected in the first quarter of this year but we, of course, created a comparable headwind by adjusting our prices down.

We're also incrementally improving our penetration on the commercial side of the business out of these stores as our programs gain traction and our team members improve their skills in partnering with local shops to provide them the high levels of service that has driven the success of the core O'Reilly stores over the past 52 years. We expect this side of the business to grow significantly over the next couple of years in all the CSK stores, as we continue to incrementally put our business model in place.

The third component of the O'Reilly system-generated comp is the 141 Murray stores located in Michigan, Illinois and Ohio, primarily in Detroit and Chicago. During the quarter we completed the remaining display area conversions of the 79 Murray stores located in Michigan and Ohio, and at this time all the Murray store conversion work is complete with the exception of some backroom product line additions and changes that are still to come in the Michigan and Ohio stores, as well as some exterior signage work. The 62 Chicago-area stores were converted in the second quarter in much the same way we converted the Checker stores in the middle of country. As we've expressed before, these stores were not the typical CSK stores. Murrays was a much different operation and their product mix differentiated greatly from that from a typical O'Reilly store, more so than the other CSK stores. They were completely retail oriented. They carried a significant amount of non-automotive merchandise and were very promotionally dependent.

While it would be very difficult to say that we're pleased with the 13% decline in comparable-store sales we had during the quarter in these stores, I would say that this performance is not at all reflective of what's going on in the stores. The relatively high volume these stores were doing in the past shouldn't be confused with the solid auto parts business that is very sustainable and much more profitable than the lower-margin commodities and non-automotive products, many of which were completely promotion driven and was the driven of a significant portion of the above-average sales performance in these stores. These stores are still performing above the average volume of the other CSK stores, and business is performing nicely in the core auto parts categories. This is a huge transition for these stores that will ultimately result in a greatly-improved profitability based on a hard parts oriented product mix and our ability to sustain the business without being overly dependent on promotions to drive traffic as we work to establish ourselves as not only a destination for the DIY customers needing automotive maintenance and repair products, but as an excellent supplier and partner to the commercial customers in the area.

Considering the economic conditions in the Detroit area, with unemployment near 30%, the comparable-store sales headwind related to the merchandise mix and the selling price reductions we've put in place, along with the disruption we created with the conversion that we completed in the third quarter, we fully understand the comp-store sales decline in these stores and feel confident that this is a transition that will lead to greatly-improved profitability in these stores.

I want to make sure I'm clear on one point here: The transition that we've taken the Checker and Murray stores through in the center of the country is much different and much more disruptive than the transition being conducted in the 1,032 stores in the western half of country. The western CSK stores, which make up the remainder of our comparable-store sales base, have already changed and updated 90% of their hard parts offering and have adjusted to the new product lines and product mix improvements that we've made. We still have much of the display area work ahead of us in these stores but it will be done incrementally with line changeovers and planogram updates, although the stores will have minor resets of display fixtures, parts counters, interior signage following the replacement of the point-of-sale system as we open our new distribution centers. Ted will be updating you on the conversion plans in a moment, so I won't go that any more detail on that at this time. But I'm very pleased to announce our comparable-store sales growth in the western CSK stores of 5.2% for the third quarter.

We've done a lot of work out west to improve our inventory coverage and set our prices to be competitive and are very pleased with our performance out there. We've gained a lot of ground in the commercial business and in many markets, and beginning next month, with the opening of our Seattle distribution center, we'll be in position to begin the execution of our duel-market strategy in the Pacific Northwest. Generally speaking, we're very encouraged with our comp-store sales performance in the third quarter and are very pleased with the progress we're making in the CSK integration. The execution of the CSK integration plan is right on schedule, and we're now starting the most important phase of the conversion plan as we begin opening our new distribution centers in the western half of the country. These openings are key to our ability to execute our duel-market strategy, and we're looking forward to building on the momentum we currently have going in these western markets.

Now on to our gross margin performance. For the third quarter we achieved a 290-basis point improvement in our gross margin, taking it from 45.6% of sales last year third quarter to 48.5% this year. This improvement continues to be driven by three primary factors. First, the higher mix of retail sales in the CSK stores; second improved cost of goods as a result of our negotiations with vendors related to the acquisition of CSK; and third, we continue to make better margins on commodities like oil and antifreeze due to cost-of-goods reductions related to raw material cost decreases. To this point, we've generally been able to maintain our selling prices, which continues to generate higher than usual gross margin in these commodity categories. We continue to be very pleased with the support our vendor partners have shown for this acquisition. As the automakers' production has slowed, our integration of CSK has allowed our vendors, many of which supply both OE manufacturers and the aftermarket, the opportunity to yes along with us in a period that might have otherwise been very difficult for them. We're very pleased to have such loyal and supportive business partners.

Our merchandise and pricing teams put a lot of effort into growing our gross margin while maintaining a competitive price position in each market and we would estimate our guess margin for the year to end up at approximately 47.9%. Our SG&A for the quarter came in at 36.7% of sales compared to 37.3% last year, a 60-basis point decrease. We're working diligently to incrementally decrease our operating expenses as we grow sales in the converted stores. Contributing pretty significantly to operating costs this past quarter were the costs of store conversions, the product line updates and changeovers and other conversion-type work. With much of that behind us, we feel we have a very significant opportunity to improve productivity in the CSK stores as we proceed through the conversion of our point-of-sale systems and enhance the way we measure individual sales productivity.

We're encouraged by the 11.9% operating income we were able to generate in the third quarter. We've still got a long way to go to complete the CSgay -- CSK integration process, and feel we have an outstanding opportunity to further leverage our fixed costs in the western half of the country as we grow our sales with the implementation of our duel-market strategy, while at the same time benefiting greatly in the core O'Reilly stores with the improved gross margin performance. We're well ahead of the plan we put in place early in the year and feel we're in a good position to build on this performance as we finish out 2009 and begin the new year. Tom will be covering more details of our quarterly financial performance, as well as providing more guidance for the remainder of year in a moment.

To summarize, its clear that the lower fuel prices we've experienced in recent months, the decrease in new car sales and increases we've seen in miles driven continues to create a tailwind for our industry. Team O'Reilly in all 38 states we currently serve works very hard to make sure we take full advantage of this opportunity, as we work to adapt our merchandise mix to an ever-changing vehicle population, leverage our extensive distribution capabilities and most importantly, provide outstanding levels of service to our loyal customers across all markets. Starting next month with the opening of our Seattle distribution center we begin the process of rolling out our full-blown commercial sales capability on the West Coast and we're extremely excited about the prospects that that will bring as we continue to focus on gaining market share in our more established markets.

Again I want to thank all of our Team O'Reilly members for the great job they did in the third quarter and for the hard work that each of you put in to establishing O'Reilly Auto Parts as friendliest auto parts store in town in each of our markets, as we work to earn the business of each and every customer that gives us a chance to do so. I'll now turn the call over to Ted for some additional comments the.

Thanks, Greg. Good morning, everyone, again, thanks for joining this morning's conference call. Well, at the end of third quarter we increased our store count to 3,415 stores. This was an increase of 32 new stores, giving us a total of 140 new stores so far for this year. This excludes four store closures announced as part of a group of 18 overlapping core CSK stores that we identified to be closed and consolidated. The remaining 14 stores will be consolidated in the near future. As you can see, we are well ahead of our expansion goal for 150 new stores in '09, which allows us to redirect more of our store installation teams to work on the store resets in the western CSK stores.

Now to give you a brief overview of our new store expansion activity by state, North Carolina led the growth with five stores last quarter, Tennessee and Wisconsin followed with four new stores each and Ohio had three new stores. The remaining 16 stores were opened in 12 different states. As far as leading expansion state year to date, North Carolina again opened 26 stores, Ohio 17 stores, Texas 16 stores, Georgia 12 stores and Wisconsin nine stores. Now in addition to the 32 new stores last quarter, we also relocated three stores to new prototype buildings and completed 13 major store renovations in the core O'Reilly group. Of course we also finished the remaining 54 Murray store conversions in the quarter. As a reminder, this completes the Phase I of the CSK changeover involving the 123 Checker stores in the upper midwest states, New Mexico and south Texas, as well as the 141 Murray stores in the Chicago and Detroit markets.

As we enter into the second phase of the conversion, our installation teams are moving to the western states to address the resets of the remaining CSK stores. I want to take this opportunity to, again, thank our store operation teams for the outstanding jobs in accomplishing these Phase I changeovers during this past year, as well as installing the 140 new stores, 40store renovations and 13 store relocations in the existing core O'Reilly markets.

Now on the distribution side, in August we moved our Kansas City distribution center into a new 2009 -- 2,000 square- foot building along with upgrading the warehouse management system, which will improve productivity and allow us to grow more stores out of Kansas City market. Our most recent new distribution center installed in Greensboro, North Carolina in May continues to ramp up in sales and productivity as we add new stores in the surrounding market area. After the addition of our four new distribution centers in the western states next year, we will operate from 23 locations, providing nightly service to our stores in 38 states. Based on our distribution capacity, we are in good shape to continue expanding into new markets throughout the states we currently operate in.

The West Coast store conversions begin with the opening of the new Seattle distribution center on November the 9th. This includes the changeover of 194 Shuck's stores that will be changing out computer systems, and we will be converting at a rate of approximately 30 stores each week to our nightly stock replenishment system. The Marino Valley distribution center in Southern California is scheduled to open on January the 18th and will support the transition of the 100 -- or the 239 Kragen stores. Denver distribution will open on March the 15th, and support 85 Checker stores and the Salt Lake City DC will open May the 17th to support 87 Checker stores. That leaves the two existing CSK distribution systems -- centers located in Dixon, California and Phoenix, Arizona.

After additional evaluation of the Dixon DC it became apparent that we needed a larger facility for the current 276 stores and future growth, and since the property didn't allow for expansion, the decision was made to move to a new 520,000 square-foot distribution center located in Stockton, California and this move will take place next September. Stockton will then be able to handle the conversion of the 276 Kragen stores in the center and northern part of California. And then to finish, the Phoenix DC conversion and the last 151 Checker stores will convert systems in November of next year. The opening of our new western distribution capacity is an exciting time for our Company, and we are looking forward to providing our customers greatly-increased levels of service as we roll out our POS system to coincide with the new distribution centers.

The final stage of the store conversions, which include the out-front resets and remodels and then the final exterior sign change, will start following each distribution opening and the store conversion of systems. These are underway now and will continue throughout next year. Our conversion goal is to be completely finished and operating under the O'Reilly brand for the first quarter of 2011. These stores will continue to grow stronger as we move forward with each of the changeover phase, including our store system conversions, nightly distribution, front room resets, interior decor work and then finally replacing the exterior signage. In the core CSK stores, most of the heavy lifting and the huge task of changing over the hard parts lines and additions is almost finished, and now with improved inventory levels, increased hub store support and the new market-driven pricing, we are helping our stores service new customers, both retail and installer. The co-branding and our print advertising and our radio advertising is sending out the message of more parts and lower prices to our customers.

We are very pleased with the level of enthusiasm and commitment from our new team members as they perform the changeover projects and learn all aspects of the O'Reilly sales plan. The task of performing installer sales entitlement as been finished in all CSK markets and we are very focused on training and improving the level of parts knowledge of the store team members. In addition, our district managers are recruiting and staffing our stores with additional parts professionals that are needed to continue the effective roll-out of our first call installer program to the additional stores. We continue the evaluation and expansion of our sales teams and our store leadership teams to mirror the O'Reilly model, which provides the time needed to focus on integration task, develop installer/customer relationships and build store teams that will grow sales and profits. Also as the stores go to the O'Reilly systems, we will begin the transition in our stores to our team incentive pay plan and our store manager's sales and profit commission plan. Our compensation plans have been very successful and a key ingredient in growing our sales and profits by rewarding our store teams and our managers providing -- for providing outstanding customer service.

As you might expect, we're proud of this past quarter's results and, like Greg, I would also like to recognize and give credit to our hard-working and dedicated team members, as well as all of our customers that support us with their business. This level of sales and profit growth is a result of a very coordinated effort from an entire team, including corporate support, distribution, and sales and store operations, all focused on giving great customer service. The continued balance of our DIY and our installer sales growth reflects the ongoing effectiveness of our duel-market and sales strategy. While the core O'Reilly 6.8% comps is outstanding, the CSK store comps of 5.2% in the last quarter is most encouraging, and a very strong and positive indicator of the growth we can expect to experience as we continue to execate -- execute our business plan in the stores.

I will now turn the call back over to Tom McFall. Thanks.

Thanks, Ted. Now we'll take a more in-depth look at the numbers. Sales increased $147 million, 13% over prior year to $1.26 billion for the quarter. The increase was attributable to a $51 million increase in comp-store sales, a $37 million increase in non-comp new store sales, a $3 million increase in non-comp non-store sales and $56 million in CSK sales for the period we did not own CSK in Q3 of 2008, which was July 1st through the 11th. At the time we purchased CSK their operating margin was very low and as a result, including July 1st to July 11, 2008 then the first quarter of 2008 would not have had a significant impact on the EPS for that quarter. For the year we estimate our total revenue will be approximately $4.85 billion.

Gross profit was 48.5% of sales for the quarter versus 45.6% in the third quarter of 2008. The improvement was driven by product acquisition costs negotiated with vendors based on our increased post-acquisition purchasing levels. For the third quarter, gross profit increased 28-basis points over the second quarter of 2009. This increased was driven by our continued alignment of product offerings across the chain and improved distribution efficiency resulting from the completion of the clean sweep store product lifts. On our last call we estimated the buying-related synergies we had realized in 2009 would be between $60 million and and $65 million. We now feel we will achieve the jumper end of that ranging, primarily based on the rapid rate of product alignment. We continue to be confident with our total annual estimate of $90 million merchandise acquisition cost savings starting in 2010 and ongoing thereafter. For the year, we estimate our gross margin as a percent of sales will be approximately 47.9%.

SG&A for the quarter was 36.7% of sales versus 37.3% in the prior year. The decrease from the prior year was due to our efforts to reduce duplicitous and non-needed expenses from the CSK SG&A infrastructure and lower fuel costs, offset in part by higher investments in store payroll to accomplish the ongoing line conversions and build the commercial business. The 38-basis point increase in SG&A as percent of sales from the second quarter of 2009 to the third quarter was a result of some increase in energy costs, which increased our vehicle and utility expenses, as well as further investment in store payroll at CSK implemented to grow the commercial business. We continue to very closely monitor our investment in the expansion of the CSK commercial business and given the acceleration of comps at the CSKs and converted Checker's stores curing during the quarter we are beginning to see solid results.

Operating margin for the quarter was 11.9%, an improvement of 350-basis points over the prior year. The LTM operating margin as of the end of the third quarter was 10.3% of sales and is quickly closing in on our pre-acquisition LTM operating margin of 11.8% for the period ended June 2008. As we previously stated, we expect our operating margin post acquisition to exceed the pre-acquisition operating margins once the integration is complete. Net interest expense for the quarter was $11 million, which was flat with the prior year on slightly higher debt levels, lower LIBOR and fact that the debt was outstanding for the full third quarter in 2009. We expect 2009 net interest expense to be $44 million to $46 millions. The tax provision for the quarter was 37.4% of pretax income as compared to 41.8% in the prior year. The prior-year rate included an one-time charge related to the change in tax liabilities related to the acquisition. Excluding that one-time charge last year's third quarter tax rate was also 37.4% of pretax income. We expect the full-year tax rate to be 38.2% to 38.4% of pretax income.

Adjusted EPS for the third quarter was $0.63 per share, which represents a 58% increase over the adjusted EPS in the third quarter of 2008. For the year adjusted EPS was was $1.74, a 37% increase over the prior year. The only remaining acquisition charge we expect to record is the amortization of trade names and trademarks recorded as part of the purchase price allocation. We'll amortize the remaining value over the next year as we convert all the stores to O'Reilly brand. For the year the impact of this non-cash charge will be reduction to gap EPS of $0.03.

Now we'll move on to the balance sheet. The average inventory per store at the end of the quarter was four -- excuse me -- $543,000, which was a 17% increase from the average first store inventory of $463,000 as of last September. The increase was the result of the acquired CSK store inventories being below historical O'Reilly inventory levels as of September of 2008, combined with the additional inventory currently in the system related to store conversions, product changeovers and inventory being to be stocked in the Seattle DC. We anticipate at the end of the line conversion process, store conversions and DC ramp up the chain-wide inventory per store will be similar to pre-acquisition O'Reilly levels.

Our reserve for LIFO at the end of the quarter was $12.8 million, which was a decrease of $15.6 million from the previous quarter. This significant decrease in our reserve to adjust last-buy inventory to LIFO over the last two quarters is consistent with the significant product acquisition price decreases negotiated with our vendors. Accounts payable of $889 million was 47.9% of inventory, as compared to 49.9% in the prior year. Our AP to inventory ratio was negatively impacted by the additional inventory in the system related to the extensive line changeover process and the elimination of a major consignment program with one of our vendors.

Moving on to capital expenditures, CapEx was $86 million for the quarter, bringing the year-to-date total to $317 million, and we are maintaining our estimate for the '09 CapEx spend to be $400 million to $420 million. Depreciation amortization for the quarter was $37 million, and we anticipate full-year depreciation and amortization to be approximately $150 million. For some debt numbers, total borrowings were $704 million at the end of September this year compared to $665 million at the end of the third quarter of 2008. The increased debt of $38 million was used to fund new store growth at core O'Reilly and a conversion investment, including both CapEx and net inventory, at the acquired CSK stores. However, the majority of these investments have been covered by internally-generated cash flow. For the year, we have decreased our debt outstanding by $29 million and currently have $538 million of available borrowing capacity under our ABL facility. As we enter our season of higher working capital needs and we continue to invest in CapEx for the CSK conversion, we anticipate our debt levels will increase during the fourth quarter. We currently estimate our new debt balances will be between $730 million and $750 millions at the end of year, which means our borrowings will be essentially flat with the end of 2008.

Now for some other financial information. Cash flow from operating activities for the quarter was $136 million versus $74 million in the prior year. The increase in the quarter was driven by higher net income after deferred income taxes. Year-to-date cash flow from operating activities was $289 million, which was flat with the prior year. Higher net income after deferred taxes and depreciation wer fully offset by a higher level of net inventory investment required for the CSK line conversion process. Stock-option expense for quarter was $3.3 million, compared to $2.6 million in the prior year, and year-to-date stock-option expense was $10.2 million compared to $5.5 million in the prior year. Both increases were driven by the options issued in connection with the CSK acquisition.

To recap our guidance, for the fourth quarter our comparable-store sales guidance for O'Reilly and converted stores is 2% to 4%, as we face tougher compares and incur some drag from the stores that will convert in the fourth quarter, as the conversion process initially creates some headwinds related to POS training issues. The CSK comp guidance is 3% to 5%, as we continue to see solid results from our enhanced hard parts selection, and the consolidated comp guidance is 2% to 4%. Our GAAP EPS guidance for the third quarter is from $0.47 to $0.51 on the 139.6 million shares. Our GAAP EPS guidance for the full year is $2.18 to $2.22 on 138 million shares. At this time, I'd like to ask Teri, the operator, to come back and we'll be happy to answer your questions. Teri?

(Operator Instructions). Your first question comes from the line of Gary Balter with Credit Suisse.

Good morning, Gary. Gary ?

Hi. Yes, sorry, it was on mute.

Good morning.

First of all, a very strong quarter. Could you walk us through -- you talked about Murrays and the problems at Murrays and how you are dealing with it, so essentially are we looking at two more quarters of pretty strong negative comps and then you think you get back to positives, or you turn it to positives, or is this an ongoing problem?

Well, we're doing everything we can to roll out the way we do business in the Murray stores, and we've seen significant improvement in the Chicago market and not as much improvement in Detroit, partly related to the economy and partly related to the fact that the Detroit stores were more established under the Murrays business model. But, yes, I think what we'll see. Gary. and it's an estimation on our part at this point, and I know that's what you're asking for but we would say that we'll see incremental improvement. I don't know really at what point we would get into positive territory, but we are actively pursuing establishing ourselves as a commercial provider there as we transition the retail business to more of an auto parts business as opposed to some of the other things that Murrays and CSK sold, and and items are less reliant on promotions to drive the sales dollars. So, yes, I would say over the next couple of quarters we'll move into positive territory but it's yet to be seen exactly when we'll accomplish that.

On the other stores, just to explain the difference between the CSK's not converted and CSK's converted, both did 5.2% because 5.2% at the Checkers, as you start putting in the DC's in Seattle in November and then as you roll them out, as Ted described, for the rest of the year and next year, when do we -- when do you think that we start seeing the big pickup in commercial, like, as you start calling on clients, because that's a process, I assume, that you're not really doing until you've got the distribution centers in place to a big degree?

Well, we're doing it to some degree now. A good portion of the increase that we've reflected in the western stores and in the Checker-converted stores in the center of the country is commercial business, because even without the full support of our distribution center we wanted to go out and start incrementally building relationships with customers. It's a relatively long road to become the first call with a commercial customer. It takes a lot of proving yourself and developing relationships, establishing credibility, and as we enable ourselves to provide the breadth of not only parts but service equipment and things that we're able to provide out of our distribution centers, that will enable us to better do that. I would say that beginning immediately with the opening of our Seattle distribution center, we'll start doing better in the commercial business that week and then incrementally from that point forward. And so by mid next year we should be in good stride in Seattle and then in Southern California, as we convert -- or open that DC and those stores start having service from the distribution center.

And, Ted, you may have some comments.

Gary, this is Ted. I think we've got roughly two-thirds of the -- those CSK stores now have delivery service and a commercial program. Now we've been conservative as far as our efforts, because it's very difficult to develop a relationship with installer customers and you don't want to go out and promise what you can't deliver. So based on the market and the store, where we have a good hub support system, we've been aggressive. Other markets we've been a little conservative and we've started building the team in the store that can grow the business and keep the business. And so to Greg's point, as we open up the distribution centers, we'll become more aggressive and we've been working hard this last year to put the people in place, the sales team, the regional sales managers and territory sales managers and start developing those relationships to where we can really hit the ground running when we have the distribution every night.

And then one last question and I'll let somebody else ask. There's a competitor that's not a direct competitor a couple of hundred miles south of you in the discount store business who have raised a little bit of a splash last week by talking about DIY auto and pricing 30% below, have you seen any impact or do you expect to see any impact given your focus and their focus in this business?

Well, that's yet to be seen and obviously we're clearly aware of that. And I would obviously question the accuracy of some of the comments on the ads relative to our Company, although we're not mentioned specifically, but we've not seen any impact yet. Our position relative to Wal-Mart, we've never taken the position that we're going to beat Wal-Mart on price, as I wouldn't think that many retailers would. To this point, it's early, we've not seen any impact, but it's yet to be seen if we will and we've not yet determined if we -- if and how we will react to that advertising strategy.

Your next question comes from the line of Colin McGranahan with Bernstein.

Good morning, wanted to focus first on gross margin. Just in the near term, looking at the guidance for the fourth quarter, it seems to imply a 48.0-type gross margin in 4Q, was wondering in looking historically, looked like the fourth quarter gross margins were -- have been 30, 40, 50-basis point higher than 3Q and given how some of these synergies are building, is there anything that we should be aware of that you wouldn't maybe do a little bit better than that and how you are thinking about the commodity pricing and cost at this point in time, because I know certainly this the contract third quarter you didn't think it would stick and obviously it did?

Hi, Colin, ,this is Tom. When we look at our historic margins, we've had some fluctuations in the fourth quarter, primarily related to vendor support that's based on an annual program, and we've talked about this probably the last three or four third-quarter calls. Our industry has moved away from a lot of those annual programs so it takes the estimation out. Our goal is to get all of our support from our vendors as an off-invoice discount to help our cash flow so we have less waves there. As far as the change between the third quarter and the fourth quarter guidance, your math is pretty good. So the decrease we're looking at is driven by a couple things. One is we're going to start to have distribution centers come online and initially there's a little bit of drag there. And also, as Greg mentioned in his comments, we continue to see some above historic pricing on commodities and as Gary pointed out on the last call, the entity that sets really what the competitive price is for oil, which is a large category for us, has come out aggressive so our expectation will be that we will see some change in that market.

Okay, that's fair. And then just a little bit longer term on the same topic on gross margin, clearly some incremental purchasing synergies hit the P&L next year, but how should we think about this rate that we're seeing today at, let's call it 48.5%, as the CSK business successfully starts to mix towards more commercial activity?

Well, next year we will see in the first half of the year some additional synergy dollars drive the percentage up. Over the long haul we would expect margin -- there to be some pressure on our gross margin percentage as we add the commercial business to the CSK and they become more balanced in their mix. The delivery business has a lower gross margin percentage and so we will see some pressure over time. Obviously we're focus the on generating as many gross margin dollars as we can.

Okay. And then just final follow up on that, but if I look historically your gross margins were more in the 44% range, give or take. Obviously you've got the benefit of the purchasing synergies and probably some incremental scale, but that's a long way from 48.5% and you say "some pressure," are we talking halfway between the two? Where do you think you end up?

Over time we'll have pressure. I wouldn't expect next year to see a lower gross margin percentage than this year.

Your next question comes from Scott Stember with Sidoti.

Did you guys talk about any difference in the commercial versus retail in the quarter.

Both businesses continue to perform well. The commercial performed a little better than retail business. We don't disclose our comp on commercial/retail separately, but both performed well and commercial continues to perform just a little better.

And to that point about commercial doing a little better, have you heard any anecdotal from your customers that the declining dealership base in the country is actually starting to have an impact, -- a positive impact on the business?

Yes, we've had commercial customers talk about that and then our sales force has made that observation. It's certainly hard to measure because for a commercial customer it happens one customer at a time at a very slow pace, but clearly, as some of the dealerships close that had successful service departments, that business gets pushed out, some -- to other dealerships in maybe larger metro markets where the dealerships may still be open, but hopefully much of it into the aftermarket and to the contract customers that would be buying parts from us.

That's all I have. Thanks.

Your next question comes from the line of Dan Wewer with Raymond James.

Tom, you'd noted that the $15.6 million reduction in the LIFO reserve was in step with the buying synergies that you're getting from CSK, I believe. When you were highlighting the the $65 million in benefits to gross profits for the year for the buying synergies, was that including this reduction in LIFO reserve?

The reduction in LIFO reserve -- we had this discussion and at some point our LIFO reserve may become zero so we can stop answering this question -- but the LIFO reserve is the different between our last buy inventory and our LIFO inventory, so the impact in the reserve is directionally the same as the impact in margin, but the impact on margin is much less significant. The $60 million to -- or the $65 million synergies is straight. This is was we used to buy for, this is what we buy for now and here's how much product we sold that sold at this lower rate.

So it is correct that the reduction in the LIFO reserve benefited the GAAP gross margin rate by 130 BIPS approximately during the quarter?

No, that's not correct.

No? What would that number be?

It's a tenth of that.

Okay, my bad. And then a second question. On the pickup in sales at Checker, is that primarily coming on the commercial side of their business? I know it's very small to begin with.

Yes, currently the commercial side is growing better there than retail, as we transition the stores to more of a hard-parts oriented retail base and implement our commercial programs. Oe other comment I might make real quick with regard it our gross margin, this ties back to your comment about the LIFO contribution, but more so to Gary Balters and Colin McGranahan's comments, with the advertising promotion at one of our competitors -- or I guess the largest competitor of any retailer has in place right now, the ad basically compares the everyday price to what some of the retail specialty stores everyday price would be, of course without recognizing that all of the specialty stores, us included, are consistently running oil change specials and things like that. So I think that there's a significant factor from a customer's perspective that if they can drive to the door of an auto parts store and get a very competitive price on the components that it takes to do an oil change, the oil and the filter and the tools, if they need them, the air filter, belts and hoses, all of those things, I think that there is a lot of factors that go into a customer's decision as to where they buy motor oil and all of these related things other than just the pure price of the product. So that is something that we consider as we plan a reaction or just stay with the plan that we currently have relative to the advertising campaign that they currently have underway.

Okay, great. Thank you.

Okay, thank you.

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

Thank you, good morning.

Morning, Tony.

Wanted to talk a little bit more about the commercial side of the business. When you look at the mix of business at CSK, Murrays aside, and I think in the 18% of revenue, were there pockets of -- or regions that you saw significant utilization of commercial and others where you saw very little, or was that fairly spread out evenly across geography?

It's really driven, Tony, by where we have put our programs in place via hub store access and things like that. There are markets in the new markets provided us with CSK that will not be great retail markets for us right out of the gate, because of the locations that the -- that they have -- wholesale markets for us right out of the gate because of the locations that CSK has, and then others right now performing very well where we have hub stores and good access to inventory and things like that. So, yes, there is iteration from one market to the other, but we're confident that the majority of stores that we'll be able to execute a wholesale commercial plan similar to what we've done with the O'Reilly stores over some period of time.

Tony, this is Tom. Might I add, that when CSK reported their mix of commercial and DIY business, they had stated 18%. The way that we look at charge business when we took over CSK, and recalculated the number, their commercial business was only about 10% of the total mix.

Okay. Okay, so much lower. Well, when you look at the typical maturity or ramp, and I think you talked about this a little bit earlier in your -- one of the questions, Greg, but usually if you were to go into a new market and open up stores, it's probably about a four to 4.5 year ramp to get a commercial business mature or move up to where you represent much higher on the call list. If -- are you had a little bit of a head start with what CSK brought to the table, such that you're not looking at the typical maturity ramp so maybe you can get there in a couple of years?

Well, I think we're ahead of what we would -- where we would be with a brand new store for reasons of the work that CSK had previously done but then also the work that we've done as combined companies since we've owned CSK because -- well, we haven't -- as Ted said we haven't went out and aggressively pursued the commercial business in some markets where we don't have good access to hub store inventories and things like. We have introduced our programs and informed installers that we are planning to be a commercial provider in the area and we'll be staying in contact with them and things like that. Those relationships take a while to build, as you've said, and you want to start the conversations as early as you can, even though you don't really start asking for their business until you're really ready to do business with them.

Okay. And one last follow up on that, Tom, you talked about building inventory and working capital, should we continue to expect a further working capital need as more and more of the DC's are brought online, and then you -- so it could be another two, three, maybe even four quarters as -- through next September when you move that final facility in until we see a drop-off in that? Is that a fair way to look at it?

I look at it in a few pieces. The big piece right now is the line changeovers, and as we complete those and we cycle them through the system, we would expect the total inventory per store to reduce over the next couple of quarters. The DC's will be a situation where, when we bring a DC online we have to add all new inventory. Once that takes over the service of those stores, we're able to sell down in the DC that used to service those, so it'll be a process that will gradually reduce -- we'll reduce inventory over the next year, five quarters.

Your next question comes from the line of Mark Mandel with FNT Equity Capital.

Thanks, good morning. Last year you had two major hurricanes which imposed some significant disruption on many of your operations, if you filter that out, what can you tell us about the underlying tone of your business? Is it as consistent as you implied in your opening remarks, or is there some fluctuations on a month-to-month basis?

No, it was very consistent. The -- really business this year has been very consistent for pretty much all of the year. The one observation I would have relative to hurricanes is, while the hurricanes can be disruptive for a short period of time as people evacuate areas, usually the bounce back from a hurricane is really a positive impact. So really we had tougher compares in those hurricane markets this year. And in those regions -- those Gulf regions where they had hurricanes we had some comp-store sales pressure as we compared to those hurricane periods because last year post hurricanes, we had very robust comp-store sales in those markets.

Okay. And related to that, what are you seeing in terms of deferred maintenance, I don't know if you guys measure this or not, but are you seeing that metric being worked down, or is that also a steady flow of business for you?

Well, it's -- that's a very difficult thing to measure and really the only measurement that we really have is that -- well, two things. One is just the Automotive Aftermarket Industry Association, their estimation of -- at any given time what the unperformed maintenance is in the vehicle population in the US and that has declined a little bit over the last 12, 24 months as people have tended to keep their cars and the feeling has been that people have worked to maintain their cars more since they plan to keep them for longer. The other source would be just comments that come from our installers, and it's clear that consumers continue to be very pressured with unemployment where it's at and all of things that are going on with the economy. But people at that are planning to keep their cars longer are doing major repairs and doing maintenance on them to prevent catastrophic repairs in the future. So most of our installers feel pretty good about their ability to sell jobs when customers need work based on on the idea that consumers are typically going to keep their cars longer in the current environment.

(Operator Instructions). Your next question comes from the line of Alan Rifkin with Banc of America.

A couple of weeks that coincide with the first DC opening you're going to significantly increase the number of stores that you convert per week from what was six to eight to now 30. As you look at other DC's that you've opened up recently, whether it's Kansas City, Minneapolis, Indianapolis, what kind of comp progression can we expect on the stores supported by a DC as a result of the DC opening in and of itself?

Well, I -- that's a tough one to answer, Alan. It varies by store and a lot of it depends on the hub store situation that the store was in, if they are a hub store, or they were a spoke off of a hub prior to the DC opening, the impact is much less. If they were a standalone store that did not have access to a hub or an expanded inventory, then it's much greater. We definitely will see a positive effect over time of -- from having access to the inventory, but it's really hard for us to quantify. It'll be positive also, Ted, I don't know if you have any comments on that?

Yes, Alan it's really not -- you're not comparing apples to apples there, because typically when we open up a new DC, we're transferring stores in, or close to that DC that has already been on a nightly distribution service model, or they're brand new stores. Whereas when we open up the western DC's, we're going to be transferring existing stores that have got a high volume of business already, so it's -- I don't think that you can compare the two, for sure.

Okay. And one follow up, if I may. You folks through the year have consistently been raising your earning guidance and if you look even at your guidance now compared to where it was 90-days ago you're still talking about $115 million in synergies. Where is the incremental upside in your earnings guidance coming from? Is it greater revenue gains at CSK? Is it greater store productivity and comp sales at your core business? Could you maybe just shed a little bit of color there?

When you -- hi, Alan. When you look at the change in guidance from our last call to this call, specifically related to the fourth quarter, the increase in EPS estimate is primarily driven by a higher assumption on comp-store sales?

Where, Tom, at the CSK stores, or the core, or both?

Both. I would say primarily at the CSK stores with their comps accelerating from 2% to 5% and where we see those sales coming from and the sustainability that we see in those sales primarily being hard parts we take a lot of confidence in that.

Okay, thank you very much.

Thanks, Alan.

Your next question comes from the line of Matthew Fassler of Goldman Sachs.

Thanks a lot and good morning to you. My question focuses on conversions, if you look at the Checker business how many actual conversions did you have this past quarter?

Well, the Checker's were all completed prior to the beginning of the third quarter.

And I guess my question then is, if you think about the change and the 3% comp decline that you had in the second quarter and the increase that you had in the current quarter, how much of that do you think relates to the disruption associated with conversions? And where I'm going with this is just it try to understand what you see in the quarter when you actually make the conversion versus what happens when that work is done and you start to see the ramp up.

Yes. Well, I -- we relate a lot of the comp pressure that these stores were under initially to what we would call conversion, really it's just training, it's learning the products that we carry, the line, our point-of-sale system, how to source parts, all of those things, and so if we wrap all of that stuff into -- and call it the conversion, then, yes, I would say that much of the comp performance in the second quarter for these stores was related to the conversion. But the thing you have to remember is that these stores were coming out of a huge hole, they had a lot of improvement to make. So while the 3.4%, I believe, decline in comp-store sales in these stores in the second quarter obviously wasn't desirable, they were improving from where they had come from because they had underperformed for quite some time.

And just to make sure that I -- we don't imply something that be misunderstood, again, again, these types of conversions are now behind us. We're not doing any more of these types of conversions. The 1,032 stores that are in the west are a completely different type of conversion. The hard parts that we deploy in the stores are, for most part, already in those stores, the team members are used to the products, they're used to the lanes that we carry and the types of products we have available, and the conversions that we'll do there are simply repointing their distribution to a distribution center that's going to replenish them nightly and have more inventory than they've had and they're going to do that via a new point-of-sale system that we've been told, and our observation is, that it's very much robust than the distri -- the POS system that CSK has been using. And then the other piece of their conversion is just the display area enhancements that we'll do, which is not very disruptive to the stores.

And those display conversions, they won't happen at the exact time of the system conversions. They'll follow that, they'll be on a different schedule, so it won't be an issue of the store just being bombarded with changes. To Greg's point, the only real change they'll have will be the POS system and we're doing an excellent job, I think, of pre-training. We have systems in those stores, we have classrooms set up, so the time they go live it'll be a much easier conversion. And we've been doing this now for, I think, about two weeks, we've been training in the stores, and all indications are -- is that our system is a -- is a huge improvement just from the usability and so it'll be a positive.

Your next question comes from the line of Michael Lasser with Barclays Capital.

Good morning, thank you, Tom, for taking my question. On the stores -- CSK stores that have yet to be converted if there is a head start on the commercial side at those locations, are you capitalizing on some of growth a little earlier than you thought, or is there an opportunity to -- that the growth may be more significant over the long term? I'm just trying to understand whether -- I mean, some of the growth now is coming at perhaps some of the expense of the growth later.

No, it's really what we expected, and while we're pleased with the 5.2% western comp-store sales -- and we watch it a day at a time, a week at a time and it's progressed as we've worked to establish our commercial program -- early on in the conversion some of you may remember we talked about deploying inventory in strategic locations, so early on we enhanced the product offering that we had in these strategic locations to make that inventory available to many stores, I think that there was 120-some-odd stores that we did that with. Those stores, many served as hub stores to other stores and that really laid the foundation for us to start executing a sized-down version of our commercial plan. So our plan all along has been to walk into this, start establishing relationships, you have to have decent inventories to do that and that's why we deployed inventory in these 120 stores. And now as the DC's open we're able to really show these customers what we're all about and what has made O'Reilly such a successful commercial provider in the eastern half of the country and we're excited about the opportunity to do that.

One quick follow up, Ted made the earlier comment that by virtue of being ahead of schedule with the store openings and the Company's allocating some more of that labor towards the conversions, did that change the timing, or perhaps the cost of the process at all?.

And Ted, I'll let you speak for yourself, but let me make a comment. What we're talking about there are the -- we have teams that travel and go out and set up our new stores and have helped with these center of the part -- center part of the country conversion, when he's talking about the conversions we're not talking about the POS conversions, or pointing them to the distribution centers out west as we open them, what we're talking about is the reset of the display fixtures, the interior signage, the resets of the parts counters, things like that. These teams -- really that does not -- that part of this process does not tie to the opening of the distribution centers, we really could do that at any time. His point was is that with us being a little ahead of schedule, we can get a little head start on that, moreso than we'd originally planned, but the cost will be exactly the same. We're estimating that we'll be completely done with that process, of these out-front resets and the things that we'll do to make the stores look like O'Reilly stores inside and fit our display planograms by the end of the first quarter of '11.

Which unlike the Murray stores and a lot of the Checker stores we converted there last year, the majority of the CSK stores on the West Coast will not take near as much work as far as interior reset. Their prototype store was basically very similar to our prototype stores so there won't be a lot of moving of fixtures and walls and stuff like that. So my point a while ago was the additional manpower we've had, we've redirected that out to the West Coast and we're working on some of the critical stores and some that will be more difficult to changeover and getting a head start on those stores.

We have reached the allotted time for the Q&A portion of today's call, Mr. Henslee, do you have any closing remarks?

Well, I would just like to thank everyone for their time and their attention this morning . We're excited with the progress that we're making with the CSK integration and look forward to reporting our fourth-quarter and year-end-results in February.

And that does conclude today's call. You may now disconnect.