O'Reilly Automotive Inc (ORLY) 2010 Q2 法說會逐字稿

Good morning, my name Shanteller and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2010 O'Reilly 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) Now I'd like to turn the call over to Mr. Tom McFall, Chief Financial Officer. Sir, you may begin.

Thank you, Shanteller. Good morning, everyone, and welcome to our conference call. Before I introduce Greg Henslee, our CEO, we have a brief statement. The Company claims the protection of the Safe Harbor, for forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by forward-looking words such as -- expect, believe, anticipate, should, plan, intend, estimate, project, will, or similar words. In addition, statements contained with this conference call that are not historical facts, are forward-looking statements. Such as statements discussing, among other things -- expected growth, store development integration and business strategy, business strategies, expansion strategies, future revenues, 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, 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, including the acquisition of CSK Auto Corporation, weather, terrorist activities, war and the threat of war. Actual results may materially differ from anticipated results, described or implied in these forward-looking statements. Please refer to the risks factors sections of the Company's Form 10-K for the year ended December 31, 2009, for more details. At this time I'd like to introduce Greg Henslee.

Thanks, Tom. 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. I'd like to start off by congratulating Team O'Reilly on the outstanding second quarter results. Our solid performance and continued success, across the 38 states in which we do business, is the result of the commitment each of you has made to our culture values. Embracing these values have been the bedrock of our Company's phenomenal growth over the years. And it's so encouraging to see that the way we do business, continues to be so successfully engrained in our stores and distribution centers, across all markets. I strongly believe that we offer the very best service levels in our business. And, want to thank all of you for your hard work and dedication to the Company's continued success.

Before moving on to the discussion of our operational performance during the quarter. I want to comment on the $15 million reserve we accrued in the second quarter, to potentially fund settlement and related costs of the investigation of CSK Auto, being performed by the United States Department of Justice. This information is related to the alleged wrongdoings at CSK Auto in 2006 and prior. We didn't purchase the company until July of 2008. Part of our due diligence process prior to this purchase was of course, evaluating the exposure the Company could have, related to the alleged issues. After extensive work, we reach the conclusion that the actions of the Department of Justice and the Securities Exchange Commission, would most likely stop short of penalizing or charging CSK, based on the level of cooperation with the SEC and the DOJ, the merits of our acquisition, prior actions by the SEC and DOJ, our track record of solid management, Sarbanes-Oxley Compliance, along with many other factors. As expected, in March 2009, the SEC determined to close the matter with respect to CSK, without fines or penalties.

In recent discussions with the DOJ, it's become clear that they feel a penalty against CSK is in order. And we've been working with them to reach an agreement, as to the amount of that penalty. I know all of our shareholders, many of which were previously CSK shareholders, will have difficulty understanding how penalizing our Company, at this point, could be fair and justified. All I can tell you, is that I completely understand your sentiments. We're doing our best to communicate our position to the DOJ, as we continue to cooperate with their investigation of these legacy issues related to the individuals that were involved. We hope our good faith efforts will bring closure to these matters in the near future.

Now on to our quarterly performance. I think it probably goes without saying, that we're very pleased with our second quarter results. The strong business trend that began for us during the middle of the first quarter, continued through the second quarter. And we continue to see solid sales results to this point in the current quarter. These solid trends exist pretty much in all markets across the US and yielded a very solid comparable stores sales increase of 7.9% for the quarter, on top of the 4.8% increase we had last year.

We attribute the continued strong comp performance to a combination of solid execution, in both the core O'Reilly stores and the CSK stores, along with the help from the tailwinds that are present for the automotive aftermarket, as we benefit from the reduction in new vehicle sales in the US. This reduction in sales has contributed to increasing the average age of vehicles on the road in the US to 10.2 years, up from 8.8 years, just ten years ago. This average age increase, along with the stabilization of fuel costs, and increases in miles driven, has been helpful to our business, as motorists focus on better maintaining these older vehicles in order to keep them on the road. These factors are, of course, mitigated to some degree, by the overhang of high unemployment. But, the net effect seems to bode well for the automotive aftermarket.

Comparable store sales are always difficult to forecast. And we clearly exceeded our second quarter estimate of 4% to 6%. As I've already mentioned, sales to this point in the third quarter, have continued on a solid trend. But, we feel like it would be imprudent on our part, to forecast same store sales, beyond the 4% to 6% range for the third quarter, on top of the 5.3% comps we generated last year. So, our comp store sales estimate for the third quarter, is to generate comparable store sales in the range of 4% to 6%. And, considering our performance in the first half of the year, we're increasing our full year 2010 guidance to 5% to 7%.

Adjusting for the nonrecurring $15 million expense item I mentioned, we generated a 14.2% operating margin for the quarter. This is a quarterly record for our Company. And is the result of our continued efforts on all fronts, to drive the profitability of the Company, through diligent management of our gross margin and relentless expense control, while continuing to robustly grow sales. We're very pleased with our efforts on all fronts, to grow our profits, as we incrementally work to complete the integration of the CSK stores.

This month marks the second anniversary of the acquisition of CSK. While there's been a lot of effort put into this integration to get us to this point, I think I speak for all of Team O'Reilly, when I say, it's been very satisfying work. It's been a pleasure for all of us, to see these stores pull out of the negative comparable store sales trend that have been present at CSK for several consecutive quarters, prior to the acquisition to generating positive comps for the first full quarter we own them and every subsequent quarter. It's been satisfying to see our newest team members tell our customers that we have the part they need in stock, or that we can get a hard to find part out of one our hub stores or local distribution centers, that same day. It's also been pleasing to see the store's gain momentum as they gain confidence and realize they have all the tools they need to go out and develop strong relationships with the best commercial customers in their markets.

There's no question, that this integration has been a lot of work. And that it's tested the strength of many areas of our Company. We've come a long way, in two short years we've owned CSK. And are proud of the success we've had to date. And feel we're laying the groundwork for a very successful future, as we complete the integration work, and our dual market strategy gains traction in these expansion markets. We continue to be pleased with the performance results of all the CSK converted stores. The Checker stores, in the center portion of the country, that are completely converted, are performing extremely well. And the Murray conversions have clearly turned the corner, and continue to make great progress.

In the western US, the converted stores are incrementally benefiting from the new distribution service and inventory availability they have. And we're clearly establishing our Company, as a very capable supplier and partner to the commercial customers in each market. As we discussed previously, we see a lot of opportunity in the western half of the country. We feel we're just scratching the surface on the amount of business we can incrementally do, as a commercial supplier in many major markets in the west. We're on track with our integration plan and are looking forward to completing our distribution and computer system conversions, before the end of this year, as previously announced.

We also continue to make good progress with our store layout resets and sign changes. We still have a lot of work ahead of us in this area and permitting in some of the western states can be challenging, but we're making good progress. We're nearing the completion of the product changes we'll be making in the CSK stores. We completed the backroom merchandise changes, quite some time ago. And we've now completed a good majority of the display area changes. The remaining display area product changes are still on track to be finished this Fall, as previously announced. Ted will be reviewing more details of our integration progress and timing in a moment.

Generally speaking, we remain very enthused about the future prospects of our business. We feel our dual market strategy, has proven, over time, to be the most effective business model in aftermarket retail. That said, we continue to work to refine and improve our operational execution. And our ability to manage our inventory coverage, pricing, operating expenses and all other key aspects of our business. We also continue to feel that many of the changes we've seen in the vehicle population, and consumer behavior, with regard to better maintaining their vehicles, will be long lasting. Like cars and trucks are being driven to mileages beyond what these vehicles have been driven in the past. And we feel consumers will over time, gain confidence in the reliability and safety of well maintained vehicles being driven at even higher mileages. Again, congratulations to all of Team O'Reilly on the outstanding second quarter results. I'll now turn the call over to Ted Wise.

Thanks, Greg. And good morning, everyone. Let me also start by saying thanks to our team, for the sales and profit growth that O'Reilly accomplished in the second quarter. While much of our attention in the corporate office has and continues to be on the CSK to O'Reilly transition, the core O'Reilly store operations, sales teams and distribution group are totally focused on our customers, and managing our profitability. The results are very evident in last quarter's 7.9% comp sales growth. And the increase in our operating margin to 14.2%.

During the last couple of years, leading up to the purchase of CSK, several new tools and systems had been implemented in the stores and DCs. Our new store scheduling system, our store based computer training, electronic sales call tracking, regional installer pricing, and voice pick in the DCs, are some of the key initiatives that have enabled our stores and DCs to better, and more efficiently service the customer. Of course, we know the key to our growth and success is a culture and the dedication of our team members.

It's important that we also acknowledge all of the team members from the core O'Reilly stores, who have been involved in the training for the CSK to O'Reilly store computer conversions and store resets. We have had thousands of team members volunteer and spend weeks at a time away from their family to help in these conversions. Needless to say we couldn't have physically done it without them. And it's been an important part of replicating the O'Reilly culture out west to our new team members.

Prior to discussing the CSK conversions, I would like to quickly update everyone on our second quarter expansion results. Our total store count increased to 3,492 with the addition of 24 new store locations. We closed two stores. One originally identified as a closure in our initial CSK review, and the second that we chose not to renew our lease. This gives us a net 71 new stores for the year. Which puts us on track to reach our goal of 150 net new stores, for the year.

Due to a late spring and late construction start dates on stores in the northern states about ten stores that was originally scheduled in the second quarter, was moved to the third quarter. Which will result in approximately 50 stores in the third quarter. This will put us well ahead of our schedule, going into the fourth quarter. Our 24 new stores were spread out in seven states. The top expansion areas were -- North Carolina with seven stores, Texas with six stores, and Georgia with five stores. We continue to concentrate much of our growth in the south and the southeast states, around and out of our new Greensboro, North Carolina distribution center. As well as the Atlanta, Georgia distribution center. We're seeing great improvement in store performance in both comp sales and new store sales, as our store count increases and O'Reilly brand continues to grow in the southeast.

Now, in addition to the new stores, we relocated three stores to new prototype buildings and performed 14 renovations in the core markets. For the year, this puts us at seven relocations and 26 renovations for the total Company. We continue to evaluate and make improvements, as needed, in our older core markets.

Now, to move on to an update on our CSK conversion progress. As reported last quarter, our new Seattle DC and computer and point of sale conversion of 193 shut stores, started in December. The new distribution center in the Moreno Valley, and the surrounding 238 Kragen stores, followed with their computer conversion in January. Then in March, we opened a new distribution center in Denver, Colorado and converted the 85 area stores. We've concentrated on providing good training ahead of the actual computer conversions as well as having experienced core O'Reilly Team members in all stores, following the conversion. This helped provide a smooth transition. But, still understanding that the learning and total transition in each store, would take time to be fully comprehended and become efficient on the systems.

The new O'Reilly system included point of sale and electronic cataloging, store operational procedures, inventory management and daily stock replenishment, which were all much different than what the stores had been accustomed to. We have been very pleased with the ability of the store teams to learn and adjust to the new systems and procedures. And most importantly, we were able to keep a high level of customer service. Our service levels will continue to improve with time and as our team members become better and more trained to do business the O'Reilly way. Now that the conversions are finished in these markets, we're moving forward with changing exterior signs and doing interior layout and remodels.

In May, and on schedule, we opened our new Salt Lake City 209,000 square foot distribution center, that serviced the 85 surrounding stores. It was a smooth opening and all stores are up and running on O'Reilly's systems. Just September, we will be opening our 519,000 square foot distribution center in Stockton, California. As you may recall, this is actually a relocation of the smaller CSK distribution center, located 60 miles away in Dixon, California. This also involves the largest number of store conversions. -- 276 Kragen stores, that are primarily located in central and northern California. We are currently installing store training system and the distribution center is on schedule to open. Immediately following the opening of Stockton, the closing of Dixon, and the sell down of inventory, we will distribute the leftover inventory to other DCs.

The last of the conversions will take place the first part of November and includes the existing CSK Phoenix distribution center and the last 151 Checker stores. The remodel of the Phoenix DC, is well underway allowing us to reset and make it ready to stock more parts and convert to our nightly distribution model. Store systems will soon be installed and training started at the store level. This conversion will differ somewhat in that the stores will all convert on one night. And the distribution of these stores will change to a nightly replenishment, over the following five weeks. This plan will allow us to finish all stores and all distribution center conversions by the holidays and enable us to be off the CSK computer systems by year-end. Based on our past experience, and proper planning and preparation, we are very confident that this conversion will be successful.

Now, to recap the store changeover progress. To start, in regard to the product, all the hard parts lines that we saw as our biggest priority, are now finished We do continue to finetune the inventory coverage in the individual markets, as we open new distribution centers and reconfigure our hub and spoke store models. Also, as the stores convert over to a nightly replenishment, store stocking models are being adjusted down.

Now, with regard to the out front merchandise. As Greg mentioned, we are well past the halfway point of changing product lines and getting the new O'Reilly planograms out to the stores. We anticipate we will be finished in the first part of the fourth quarter. Our plan was to hold off on the out front changeovers and balance the workload at both the distribution centers and at the stores. And again, knowing that our highest priority and biggest opportunity to grow the installer business, was in the hard parts lines. Our goal now, is to have all stores changed to the new and updated O'Reilly merchandise mix and new planograms set in the stores by this late Fall.

The planning and execution of the resets of the store interiors and image upgrade, is well underway. And we're making good progress. To redesign the various store layouts, water fixtures, draw plans and obtain proper city permits, and then coordinate the projects around the distribution center and store computer conversions, is a large task. We also have to factor in the terms of the lease and the possible relocations of certain stores. At this time all store computer conversions -- at the time the store computer conversions are finished, we will set a final schedule that will finish the interior remodels, during the first part of next year. This is a little behind our original schedule, due to permitting issues, that we have found to be so challenging and take longer in the California and west coast markets. It is important, and I want to point out again, that all the CSK store planograms will be updated and refreshed by this late fall, which is definitely the most important part of the remerchandising of the stores.

Now, in regard to the sign conversions, we have reached the point now, that with our co-branding advertising, that we are very comfortable with moving forward with rebranding the store's exterior and signage. We are on schedule and plan to have new O'Reilly signage on most stores by the end of this year. Based on timing and permitting, and acquiring landlord approvals, there will be a small group of stores that will fall into the first quarter of next year.

Our advertising will transition from the co-branding format we're using now, to the O'Reilly Auto Parts only, during the first half of next year. We are using much more radio, as well as an aggressive print schedule, to educate our customers on the brand transition. Our advertising theme and messages are designed to reinforce a competitive out front accessory and chemical selection. But, most important, create a new imagine of having good hard parts inventory coverage at competitive prices. We see a lot of opportunity to grow our sales with the retail customer in hard parts, going forward. But, it will take time to reinforce and establish this new store image.

Now on the installer side of the business, we continue to work at building customer relationships, with very aggressive sales work in the field. We are using every tool we have in our first call program to build these relations. And most important, working very hard to improve the quality of service that we provide at the stores to our installer customers. We are experienced good results, as our experience level grow in the stores, and our sales team builds stronger ties to the customer. While we have great progress this year, we are definitely looking forward to the time when the stores are totally and fully converted, distribution in place and our teams are trained and ready to do business the O'Reilly way.

There's been a tremendous amount of work and changes put on our west coast team members. And it's such a short period of time. We appreciate their great attitude, long hours, and hard work. And most important, the willingness to accept and execute the O'Reilly program. It is an exciting time for everyone involved to see and experience the success. And mostly importantly, realize the future opportunities we have to look forward to. I will now turn this over to Tom McFall. Thanks.

Thanks, Ted. Now we'll move on to the numbers. For the quarter, sales increased $130 million, 10% over the prior year, to $1.38 billion. The increase was attributable to a $97 million increase in comp store sales, a $32 million increase in noncomp new store sales, and a $1 million increase in noncomp non-store sales For the quarter ticket average and ticket count contributed equally to a comparable store sales increase. The increase in the ticket average was driven mainly by mix. The sales of hard parts, which typically carry a higher ticket, accounted for a larger portion of the overall sales volume. For 2010, our total revenue guidance remains at $5.2 billion to $5.3 billion.

Gross profit was 48.7% of sales for the quarter, versus 48.2% in the prior year. The 45 basis point improvement, was driven by improved acquisition costs, more favorable product mix, and decreased shrink at the stores converted to the O'Reilly POS system, which provide more robust tools for managers to control shrink. These improvements were in part offset, by deleverage on distribution costs, which is the result of the new distribution centers coming on line, and consistent with our expectations. Year to date, gross profits stands at 48.5% of sales. For the full fiscal year, we continue to estimate, gross profit as a percent of sales, will be 48.1% to 48.4% of sales. While we've been successful in growing the commercial business, which typically carry a lower gross margin percent, the shift in mix of sales to more hard parts, has helped us maintain our margins. And we now expect to be in the upper end of our guidance range.

SG&A for the quarter was 34.5% of sales, versus 36.3% in the prior year. The leverage on SG&A was a result of strong comparable store sales. On a per store basis, SG&A per store was up 1.4%, which allowed for strong leverage on the 7.9% increase, in comparable store sales. Year-to-date SG&A has improved 177 basis points, as a result of the strong sales and expense control. For the full year, we expect SG&A dollars per store, to be slightly up from 2009, as we continue to see opportunities to be more aggressive in investing in store SG&A to drive strong sales results. We anticipate the SG&A for 2010, in total, will increase approximately 4.5% over the prior year.

Adjusted operating margin for the quarter, which excludes the impact of the legacy CSK/DOJ matter, discussed by Greg earlier, was extremely strong, at 14.2% of sales, an improvement of 224 basis points over the prior year. This large improvement, was a result of strong comp sales and tight of expense control and represents the highest quarterly operating margin in Company history. For the full year, we expected our adjusted operating margin to approach 13%, with variability being driven, primarily by sales volumes.

Net interest expense for the quarter, was $11 million, which was flat with the prior year. The reduced expense, from less outstanding debt during the quarter, was offset by a reduction in capitalized interest, based on fewer major capital projects under construction this year. For 2010, we expect net interest expense to be approximately $41 million.

The tax provision for the quarter, and year-to-date, was 41.9% and 40.3% of pretax income, respectively. The tax rate was negatively impacted by the charge related to the legacy CSK/DOJ matter, which we currently do not anticipate to be tax deductible. Excluding this one time charge, the quarterly and year-to-date rate was 38.5% of pretax income, which was slightly lower than the prior year. For 2010, we expect our tax rate, as a percent of pretax income to be 39.1% to 39.4%. Included in this estimate, is a 90 basis point one time increase, related to the reserve to settle the DOJ matter. Adjusted diluted earnings per share for the second quarter, was $0.81 per share, which represents a increase of 31% over the second quarter of 2009. For the year, adjusted EPS of $1.51 increased 40% over the prior year.

Now, we'll move on to the balance sheet. The average inventory per store, at the end of the quarter, was $553,000, which represents an 8% increase over the prior year average of $513,000. This increase is the result of significantly increasing the hard parts SKUs stocked in the acquired stores and the addition of the western DCs to our dual market strategy.

Since the beginning of the year, we've added 71 net new stores and three new DCs. And our total inventory has only increased $19 million. For the remainder of the year, we will remain focused on refining the inventory mix at the [update] stores and leveraging the DCs to reduce the [sagging depth] at the western stores. Based on these 2010 initiatives, we continue to expect to only increase our year-over-year investment, slightly, despite opening 150 new stores and three new DCs.

Our reserve for LIPO, at the end of the quarter, was $23 million, which was an increase of $10 million from the previous quarter. This change in our last buy to LIPO reserve, did not have a material impact on gross margin for the quarter. Accounts payable of $855 million, was 44.2% of inventory, as compared to 47.2% in the prior year. In 2010, we expect our AP to inventory ratio will continue to be under pressure until year-end, as we work excess inventory through and out of the system.

Now for capital expenditures, they were $92 million for the quarter, bringing our year-to-date CapEx up to $182 million. For all of 2010, we are reducing our expected capital expenditures from $400 million to $440 million, down to $370 million to $410 million. This reduction in CapEx spend, relates to the adjustment in timing of a portion of the front end conversions at the CSK stores, which Ted discussed earlier. We now expect this CapEx spend to occur in the first half of 2011.

Depreciation and amortization for the quarter was $40 million. For 2010, we continue to expect appreciation and amortization to be $156 million to $160 million. Total borrowings at the end of the quarter were $584 million compared to $797 million at the end of Q2 2009. At the end of the quarter, we also had $647 million of availability, under our existing ABL facility. For 2010, we expect to reduce our total outstanding borrowings by $200 million to $250 million. As noted in our press release on July 1, the legacy CSK convertible notes became exchangeable, and will remain so until the end of the third quarter. Based on our stock price at the end of the third quarter, the notes could potentially be exchanged for the fourth quarter also. To date, no notes had been surrendered for exchange. To the extent remain outstanding, we continue to intend to call the notes in December. Our plan is to fund this with our existing ABL, which will still allow us significant financial flexibility.

Now, for some other financial information. Cash flow from operating activities for the quarter was $185 million, an increase of $119 million over the second quarter of 2009. For the year, cash flow from operating activities has increased 133% to $356 million. The improvement was driven by a significant decrease in net inventory investment, higher net income and timing of payments of other liabilities. For the quarter, free cash flow was $94 million, versus the use of $14 million in the second quarter of 2009. Year-to-date, free cash flow was $173 million, versus a use of $78 million in the first half of 2009. The improvement was driven by the previously mentioned increase in cash flow from operations, and a $50 million decrease in capital expenditures. We now expect free cash flow to be $150 million to $200 million in 2010. And we will use these funds to reduce our outstanding debt. Stock option expense for the quarter was $3.8 million, compared to $3.6 million in the prior year. The increase was primarily driven by the year-over-year increase in our stock price. For 2010, we continue to expect stock option expense to be approximately $15 million, versus $13 million in the 2009.

To recap, our overall guidance, for the second quarter, our comparable store guidance is 4% to 6%. For the year, we are raising our comparable store sales guidance, from an increase to of 4% to 6%, to an increase of 5% to 7%. Our GAAP diluted earnings per share guidance for the third quarter, is from $0.69 to $0.73 on 142.3 million shares. For the year, our EPS guidance is $2.64 to $2.74 per share, on 141.1 million shares. On an adjusted basis, excluding the DOJ matter, our guidance for the full year adjusted diluted earnings per share is a range of $2.75 to $2.85. At this time, I'd like to ask Shanteller, the operator, to come back and we'll be happy to answer your questions. Shanteller?

Thank you.

(Operator Instructions)

And your first question will come from the line of Gary Balter, with Credit Suisse.

Another nice quarter, first of all, so congratulations.

Thanks, Gary.

Question is, you know your stock is in this position now, where people are saying, "hey, you've had really strong results to date, but now it's time for compares." And we look at it and say, "you're just starting on some of these conversions and there's so much opportunity to go forward, as you convert." I'm not asking you to detail out Seattle, but could you kind of walk us through how, if you went back, because that's your oldest one, kind of how the process works? You make the change --- How long does it take until you really start having a penetration with the customers? And then, in your mind, is this a multi-year process? Is this like, one big year of catch up, and then it's back to regular comps?

Gary, my opinion is, that it takes time and it happens incrementally. You know, the commercial customers in every market -- or at least we've not found any, that were really under served. You know, most commercial customers have a supplier that's doing a reasonably good job. You know, our effort once we convert, is to go out and convince those customers that we can do a better job. And you don't get that opportunity first try. And sometimes that opportunity happens incrementally and over time. And that's probably the case most of the time. And in this case, where we're converting stores to new systems, new product lines, new methods of inventory availability, the need to look up parts in paper catalogs for heavy duty application. And a variety of things that have been the nature of the more traditional aftermarket for years, my comment would be that this is a multi-year process. But, we immediately give pretty good results following the conversion, once everyone gets used to the systems and so forth. Just by virtue of the inventory availability. But, for us to fully maximize this opportunity, it's a multi-year process.

Hello, Gary, this is Ted. You also remember that stores are really doing a nice retail volume to start with, too. So, you know, it's going to be a growing process in that store, to build the right team to go after the wholesale business. And as Greg mentioned, you know they're being taken care of by someone now. And since it is a relationship basis, you know, sometimes the best business takes a little longer to earn, because you want to make sure you can keep it.

Yes. And then something else I want to add, Gary. Is that once we start having success in the commercial business, it gains momentum. You know, a lot of these commercial customers watch their competitors. And they see who they're buying from and they see good results or they talk to them. They have little associations in towns where they talk some. And you'll probably, some of the -- well, the first stores that we converted, these Checker stores in the center part of the country. I can tell you they have really established themselves now, as solid commercial providers and we're doing really well in the commercial business. You know, Seattle follows behind that. And I think that we're pleased with all of the conversions that we've done, considering the time that's elapsed from the point of conversion. And, I think they'll all kind of, fall into similar patterns, as these original conversions, over some period of time.

Have they followed, pretty much, the way you expected it? In terms of your ability to capture those customers? Has it been faster, slower, more expensive?

It's certainly not more expensive. I think that it's hard to know. And it varies by market. And a lot of it depends on just the guys you have running the operation in a particular store and district and region. But, I would say that it's met our expectations. I think that we would have expected that we would have had solid results, as a result of the conversions. And we've had solid results. Would we like it to be, just crazy-better? Yes. Yes, we want to do as much business as we can. But, I think that we're directly on task with what we would have expected, as we converted these stores.

Thank you, very much.

You bet. Thank you Gary.

Next question will come from the line of Kate McShane, with Citi Investment.

Hello. Good morning.

Good morning.

Can you give a little bit more insight into what is driving the stronger than expected growth, in your hard part sales? I know you guided that gross profit margins are going to be at the higher end of your guidance range, as a result of this. But, was wondering if you expect a similar level of hard parts sales, going forward for the back half of the year? Or if its really from just the strength you saw this quarter?

Well, I think the things that we're fundamentally doing, are going to drive more hard parts sales in the Western stores. In the core O'Reilly stores in our more established markets, we are trying to grow both our retail and wholesale business. Both in hard parts and in display area merchandise. In the Western stores, we feel like we have more upside and more opportunity to grow in the hard parts business. Simply, because CSK really was not a very good hard parts provider. You know, they of course win the auto parts business. But, they were not nearly the robust hard parts provider that we are. So, we think that we'll continue, or at least we hope, that we'll continue to perform well in these hard parts lines. As we grow it both in retail and we grow in commercial, which the commercial comes at a little bit less gross margin than does the retail. But, we're hopeful that we'll be successful in establishing ourselves as a destination for the retail customers for hard parts. As Ted mentioned, that's what our advertising efforts are doing. And to the extent we're successful doing that, we mitigate, to some degree, the effect that the roll-in of more commercial business has on our gross margin rate.

Okay. So, the main difference then between your comments on the gross profit margin rates from last quarter, to this quarter, where you had emphasized that it might come in at the lower end of the range, but now you're saying it could come in at the higher end of the range, is because of the success in the hard parts -- that is contributing to your business faster, I guess, than you had originally expected?

Yes. I think that's correct. And our plan would be, like I said, that this wouldn't be a single quarter issue. That this would be something that we could sustain long term, as we establish ourselves as a good hard parts provider to retail customers.

Okay, great, thank you, very much.

Okay. Thank you, Kate.

Your question will come from the line of Matt Fassler, with Goldman Sachs.

Good morning. Goldman Sachs. How are you?

Good. How are you doing, Matt?

Great. Congratulations on a good quarter. One quick question and a follow up. You pointed out, obviously, that your second quarter margin was the strongest margin in the firm's history. And that was the case by, you know ballpark, 100 basis points. And if you look at your guidance for the remainder of the year, you still have very good quarters, relative to your long term track record, but by a much lesser degree. Would there be any particular reason why the profit level relative to history, would recede? Or would you just attribute that to conservativism about the environment?

Matt, the operating margin for the second half of the year, obviously, is projected lower than the first half. And that's directly related to lower expected comps. So, it's more a leverage issue. We're pretty comfortable with our gross margin estimates for the second half of the year. As you know, we are diligent in controlling expenses, and will focus on that. To the extent that our comp store sales are above our guidance, we're going to see better operating margin results.

As to follow up, Tom, you mentioned gross margins. Just a couple of the moving pieces within that. I guess, where are we in terms of incremental buying synergies? And what do you expect the cadence of distribution leverage, or deleverage, to be, as you work your way through the introduction of new distribution capacity?

I would say that we are -- have all of our buying synergies included. We'll continue to try to work on lowering our acquisition cost and becoming more efficient. That's just part of the business. On the second part of your question, on distribution. I would say we're at the most inefficient, right now, that we will be. Over the next year, we'll continue to get more efficient. We still have two DCs to convert, although they're not additional incremental DCs. So, really over the next year, as we train our team members we're going to become more and more efficient.

How would you quantify the opportunity, as those distribution costs decline, as a percent of sales? Is that 100 BIPS over time, or something less than that?

Something less than that.

Got it. Thank you so much.

Thank you, Matt.

And your next question will come from the line of William Truelove, with UBS.

Hello, guys. Really, a question for Tom and Ted. Do you anticipate into next year, also probably having a higher advertisements on the West Coast, related to the converted stores? And just to educate the consumers? If so, could that result in maybe slightly -- or less leveraging on the SG&A line for maybe the next four or five quarters?

When we look at our advertising, we have some additional advertising that's being done out West, to augment what the standard O'Reilly program is. We're in the process of converting over a customer on the West Coast, that was used to seeing a lot of hot prices and circulars. And that's how CSK drove traffic. To more of an every day low price, we are priced right every day and we have the parts in stock system. So we don't anticipate seeing tremendously more advertising expense. There still exist a few contracts, that CSK was a big baseball sponsor, they did some races, and as those contracts come up, we'll look at rationalizing those with our other national media exposure.

Okay. Thanks. That answered my question. And great quarter by the way, thanks.

Thank you.

And your next question will come from the line of Tony Cristello, with BB&T Capital Markets.

Good morning, gentlemen.

Good morning, Tony.

Question I have and then a follow up, has to do with just sort of the conversion and some of the benefits you're seeing. Tom, on the call you actually discussed, in your prepared remarks, shrink and some of the benefits you're receiving as a result of the systems conversions. Can you maybe differentiate or quantify some of the benefits you're seeing? And then, how different CSK was from a shrink standpoint, versus a core O'Reilly store?

In general, the O'Reilly system works very hard at managing inventory. We have a very high level of accountability for the store manager, with his inventory, both from a shrink dollar instance standpoint to a replenishment standpoint. If the perpetual isn't right, they're not going to get replenished right, and they can't optimize their sales. So, our system is built with a lot of tools to manage the perpetual inventory and make sure it's right. And identify opportunities to reduce shrink. So, there was a pretty marked difference in the shrink amount between O'Reilly and CSK. As Ted talked about, it's a training issue. And we've seen great improvement in the stores that have converted. But, there's still opportunity out there.

Okay. And then just on the follow up. I notice that the rent expense was actually down year-over-year, even though it seems like you're growing and expanding. Is there something that you're benefiting from as well, from a conversion standpoint. Or are you owning more properties? Can you just, maybe, help us-- help me understand a little bit why that would be actually down?

Well, first of all, we're going through all the CSK leases. And doing everything we can to -- A, renegotiate leases, as we get close to the end of the term. Or, look for relocation sites and move to better sites, at less rent. And that's working pretty good. I mean, its the right timing, I think, even on the West Coast. The real estate is not quite as high. And then in our core market expansion. In the new stores we are putting in now. We're finding some pretty reasonable property acquisitions out there, to buy and build. As well as some fair priced lease spaces. So, I think those conditions are good for expansion right now.

So, does it sound like then both the benefit of the gross margin from shrink and the benefit to the SG&A from leasing and rent expense. Are those, I guess, sustainable, at least for the next several quarters?

We certainly hope so.

Okay, great. Thank you, guys.

Okay. Thanks, Tony.

And your next question will come from the line of Mike Baker, with Deutsche Bank.

Hello. Thank you, guys. I have one question and a follow up. I'm just wondering if you can talk publicly, about what you think the average sales volumes can ultimately be in the acquired stores? Relative to the core O'Reilly stores, that do about $1.5 million or $1.6 million. And the follow up, I guess, would be if you can provide that number. How does that break down between commercial and DIY? And would that be indicative of what you're seeing in the Checker stores in the center of the country? Thanks.

Well, Mike, we -- the core O'Reilly stores, are the stores that we had prior to the CSK acquisition. Many of those stores are stores that were put in as part of our incremental growth from a very young, small Company. Are put in rural areas, at very low rent rates, or occupancy expense, many of them we own. Those -- many of those stores operate below our $1.5 million O'Reilly average. If you look at the stores that are in the metro areas-- Houston, Dallas, Fort Worth, some other big metro areas. Our average is much higher than that. The way we view the CSK stores, which most of them are in more metro-type areas, is that those stores could eventually do the volume that we do in our metro stores, which is at minimum $1.8 million. And really that's what we're targeting, with an average on these stores at about $1.8 million, over time. So, yes, we think that over some period of time we can get them to $1.8 million. The business mix out West, will be a little bit more slated toward the DIY sides. And some of the locations, approximately I'd say 10% to 15%, are in locations that are much more conducive to doing retail business, than they are doing a combination of business. Although, we'll do some commercial business out of pretty much all locations. There will be some that will be much more conducive to the retail business. So, I think the business mix will continue to be, dominated out West, by the retail side. But, we'll add -- most of the growth will come on the wholesale side or the commercial side.

And any time frame on that type of $1.8 million?

Well, we're working as hard as we can, to get there as quick as we can, I will say. Tom, what would you guess? 2013, something like that?

We look at probably four years, after converting to our systems and getting five night a week delivery, to build the commercial business.

Great. Thanks, very helpful.

You bet, thank you.

And your next question will come from the line of Alan Rifkin, with Bank of America.

Good morning this is Vincent Sinisi in for Alan. And let me add my congratulations, as well, on a nice quarter.

Thank you.

My question is, if you can give us an update, in terms of the number of addition to the commercial sales force? And then, it sounds clearly, and certainly in some of the earlier converted markets, that the commercial business has been beginning to ramp up for the CSK stores. Any updates, at this point, to your forecast synergies for the overall integration? I know originally it was 100 up to 125, any updates there?

Let me answer the commercial sales force, you know, we really haven't increased a sales force head count, that much, out on the West Coast. I checked with the sales department the other day, and we're up probably about 10% on TSM, territory sales managers. Where we really put more investment in, is the management of how they perform the job. And we basically doubled the number of regional sales managers, to manage -- I think it's right at 200 TSMs right now. And, like they had four sales managers covering those 200. We've gone to like, eight to nine. And there our goal was to more closely manage the productivity of the type of customers they call on and the more accountable sales call schedule. Plus, our TSM commission schedule is quite a bit different than what CSK had, which really makes them much more focused on growing the business. So, you know, from the manpower out in the field, I don't think we've increased the dollars of salary out there, but we've definitely increased the productivity and the accountability of the type of customer they call on and how they interact with the store based on building good service levels. And not necessarily going out there and selling price, but selling service and being competitive, at the same time.

On the second part of your question, on synergies. We're comfortable with the last number we gave as the ultimate synergy number. As we get further and further away from the acquisition. And businesses integrate and normal activities occur with SG&A and with gross margin, as we continually always try to improve that. It's hard to track down a specific synergy number. We're comfortable we achieved the last number that we gave out.

Okay, and one quick follow up, if I may. As you're looking towards advertising for next year, taking into account slightly higher for the West Coast markets. Do you have a target, in terms of percentage of sales? As well as the break down between the radio and the print?

We go through an extensive process in the next couple months, of every year. And we look at how we want to spend our advertising dollars. Where we think we can get a bang for the buck. What we think the appropriate amount to spend is, given the current business trends. So, that's still in the planning stage. We're going to be somewhere, give or take, around 1.5% of sales. This is typically what we spend on advertising. With half of our business being in the commercial side, our sales forces is really our advertising and marketing tool there. So, that's a little different than if we were full retailer.

And in regard to the radio and the print, I think Tom mentioned earlier, CSK was primarily print in newspaper, a very expensive way to advertise. We've transitioned to print in flyers, which covers a lot more households. And we moved a majority of what they were spending in print over to radio, which we think is very effective. CSK did limited amount of radio and we're doing quite a bit. Comparable to what we do in our core markets .

Thank you, very much.

Thank you.

And your next question will come from the line of Dan Wewer, with Raymond James.

Tom, I wanted to follow up on the guidance, particularly for the third quarter. Looking historically, quarterly earnings, going back to 2003. And typically your third quarter and second quarter earnings are almost identical. The only one exception was the year that you bought CSK. Therefore, in the third quarter guidance, $0.69 to $0.73 looks a bit off, compared to the $0.81 achieved in the second quarter. You know, I heard your answer earlier that, the margin is going to be under pressure if same store sales were to weaken. But it sounds like your sales are off to a great start and your margins actually at the high end of plan?

Well, I guess what I'd tell you, Dan, is that we achieved 7.9% comps in the second quarter. Our guidance for the third quarters is 4% to 6%. If we exceed that guidance and put up another 7.9%, our operating margins would look similar and our EPS will be similar. So, it's really a sales volume question.

But, you're thinking that just a 2 percentage point change in comp sales could impact earnings per share by as much as $0.07 or $0.10?

It's a significant amount.

It wouldn't be quite that much. That would be the upper end of our range. But, it would be meaningful.

And then, just as a follow up on the strength in sales for O'Reilly and really, your entire sector. You know, one quarter ago there was speculation that the ramp up could be reflecting a favorable change in winter weather. It could be reflecting earlier receipt of income tax refunds. You know, we've cycled through that. Are we now thinking that we're at the tipping point? Where the aging of vehicles and fewer cars under manufacture's warranty, that's really beginning to kick in, in terms of the industry top line growth?

Like I said, in my prepared remarks, it seems as though our industry is undergoing a pretty sustained period of solid demand. For us, and I think this has been reflected in some of our competitor's comments. Around the first of February or middle of February, business picked up. And based on our experience, it has sustained that better pace to this point. In our first quarter comments, we reflected on the potential for pent up demand. Because of the softer fourth quarter and what generally happens in a period of recession, with consumer spending around Christmas, and trying to defer things that they can defer, in order to have money to spend on the holidays. It appears as though, we've weathered that. And the trend that we're on, is the result of some of the very clear dynamics that we can see in the vehicle population. With regard to the vehicles getting older, the new vehicle sales continuing to be at levels less than they had been in prior years, and then, of course, gas prices seeming to stabilize, and miles driven increasing. You know, all those things add up -- and based on our results, add up to solid demand for the aftermarket.

And I agree it doesn't make sense to publicly forecast comp sales growth of 8%. But it does sound like you're thinking this ramp up is more secular, not cyclical.

I do, but we've been surprised before with comp store sales changing abruptly. We've not experienced that this year. But, that can happen. We have to remember that unemployment is, I think, last time I looked it was 9.6%. That's a high rate. I just don't see anything on the horizon, that's going to change that, any time soon. So, there's a lot of people out there that are strapped for cash. And, that being the condition, it's hard to project or be real aggressive in our projection of comp store sales. And then, also the effect that fuel prices could have, if fuel prices were to spike. With maybe a hurricane or all the different things that could potentially happen, that can drive fuel prices-- a fuel price spike, clearly effects consumer spending on other items and can affect miles driven.

I understand that. Great. Thank you.

Okay. Thank you.

And your next question will come from the line of Jack Fowles, with Focus Research.

I was very impressed with the 1.4% SG&A increase per store. But, I was wondering how that was done, considering that you have sales commissions, I assume, that go up in line with the 7.9% comp in sales? And since sales commissions are a big part of your SG&A, I wonder if you can break out, I guess, the noncommission related SG&A? And how that's being so well controlled?

Hi Jack, we're hesitant to break out our store expense line. But, obviously, as mentioned earlier on the call, the real estate group has done a great job of controlling our rent. And we do see fluctuations in our payroll from the commission. But we're also seeing, is better utilization of payroll. And how we staff the stores out West, to make sure that we have a pyramid type weight scale. And we're appropriately leveraging people in the West Coast. And we continue to work hard at the CSK stores, to bring the same expense control discipline that we've had at the O'Reilly stores for a long time.

Jack, to kind of add to Tom's comment. You know, the most impacting factor probably, is just measuring the sales results of individual performance. You know, one of the things that I feel like we've always been good at, and we've been successful with, is creating a competitive environment in a store with regard to sales performance of individuals. CSK didn't do that. And that really ensures that each individual carries their weight, so to speak, from a store operating expense standpoint. And while we've not done everything we'd like to do in that regard, we'll complete that over time. But we have seen good results with what we've done so far.

When it comes to the expenses involved in the entire CSK conversion, you have a number of what that number amounts to? And how much of that would be saved going into 2011?

Well -- to kind of wind back to 2009 and to talk about 2009, 2010 together, Jack. The cost in our physical assets get capitalized. But we have incurred costs on the payroll line in 2009, a lot of store hours to reset the hard parts this year, hours to reset the front end, and hours for training on conversion. So, that's an opportunity going into next year to recycle that payroll to other tasks. And, ideally it's to drive more sales volume, so that we get the bang for the buck, otherwise we'll take those hours out. I can't quantify for you specifically, but it's a reasonable number that we spent in both years to restore payroll.

So you're saying that the hours you're going to spend on payroll on 2011, might be similar to the conversion hours you spent in 2010?

Well, how many hours we spend will depend on what the sales volumes are. But, I'm saying that there are tasks that we won't do in the second half of 2011, that we've done in the last two years, and have hit our payroll line. We'll benefit from this in the latter part of the first half and the second half of 2011.

Okay. Thank you very much.

You bet. Thank you, Jack.

There are no further questions at this time.

Okay. Well, I would just in closing comments, say thanks for everyone's time. We look forward to reporting our continued progress with the integration of CSK in October along with our third quarter results and thank you very much.

Thank you everyone. This does conclude today's conference call.