O'Reilly Automotive Inc (ORLY) 2010 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 2010 third quarter earnings release conference call. All lines will remain on mute to prevent any background noise. After the speakers' remarks will be a question-and-answer session. (Operators Instructions). Thank you. Mr. McFall you may begin your conference.

Thank you, Operator. Good good morning, everyone, and welcome to the O'Reilly 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 within this conference call that are not historical facts are forward-looking statements, such as statements discusseing among other things, expected growth, store development, integration and expansion strategy, business strategies, future revenues and future performance.

These forward-looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions, including, but not limited to, competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our ability to hire or retain qualified employees, risk asscoiated with integration of acquired businesse,s 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 Risk Factors section of the Company's Form 10-K for the year ended September 31, 2009, for more details. At this time, I'd like to introduce Greg Henslee.

Thanks, Tom. Good morning, everyone, and welcome to our third quarter conference call. Participating on the call this morning this morning is, of course, Tom McFall, our Chief Financial Officer, and Ted Wise, our Chief Operating Officer. Davis O'Reilly, our Executive Chairman, is also present.

I would like to start off by once again congratulating Team O'Reilly on the outstanding results. Our performance across all markets in the third quarter was very strong, and we should all be proud of our performance so far this year. Especially impressive is the continued outstanding performance of the core O'Reilly stores. We have asked many of our more-tenured team members to take on the task of attending the CSK conversions and spend the first couple of weeks after conversion training the converted store team members. Even with these distractions, our core stores have continued to gain market share and post very impressive comparable store sales gains.

At the same time, the work that we put into these conversions is clearly bearing fruit. as we continue to gain market share in the converted stores. The strong comparable store sales that we have been able to achieve in the converted stores have been a team effort and every team O'Reilly member should be very proud of the success we are having with these conversions. Our outstanding sales performance is the direct result of the incredible customer service levels we provide at each of our locations, and I want to thank you for your commitment to providing the best customer service in our industry and to the continued success of our Company.

Before moving onto discussion of our operational performance during the quarter, I want to comment on the $5.9 million reserve we accrued in the third quarter to fund settlement of the legacy CSK Department of Justice issue. As discussed during our second quarter earnings release, this investigation is related to the alleged wrongdoings at CSK Auto in 2006 and prior. As most of you know, we did not 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 reached the conclusion that the actions of the Department of Justice and the Securities and 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, SOX compliance, along with many other factors. As expected, in March of 2009, the SEC determined to close the matter with respect to CSK without fine or penalty. With respect to the DOJ investigation, O'Reilly has continued to cooperate with and engage in discussions with the DOJ to resolve CSK's legacy accounting issues and we have now reached an agreement in principle with the DOJ.

Subject to final documentation, the DOJ, CSK, and O'Reilly will enter into a non-prosecution agreement and the Company will pay one-time monetary penalty in the amount of $20.9 million. As you may recall, we reserved $15 million for this matter during our second quarter this year and the additional $5.9 million reserve that we made this past quarter will resolve the matter.

Now onto our quarterly performance. We are very pleased with our performance during the third quarter. Business remained strong coming out of the second quarter and was steady at a solid rate throughout the quarter. These solid trends exist in pretty much all our markets across the US and yielded a strong comparable store sales increase of 11.1% for the quarter on top of the 5.3% increase we had last year. Our continued strong comp performance can be attributed to several factors, but the key contributor is very solid execution across all our markets. Our store operations and distribution teams are very simply doing an outstanding job providing incredibly high levels of customer service. This coupled with the ongoing effort we make in all stores to carry the right product assortment at competitive prices, as well as the investments we have made in our western distribution capability has put us in a good position.

At the same time, our industry clearly continues to benefit from the tailwinds that have been present for some time now. The average age of vehicles driven in the US continues to increase as new vehicle sales have stalled, fuel prices have been relatively steady for some time now and miles driven are back to solid incremental increases, and to a lesser degree, the dealership closures have redirected some of the service work that was being performed at the dealers to after-market shops. In the third quarter, all other factors I mentioned, both internal and external, coupled with favorable summer weather conditions culminated into a very good sales environment of our Company. We are very pleased with our comparable store sales performance on both sides of our business, DIY and Commercial. Yet, as has been the case for sometime now, our commercial sales continue to grow faster than our DIY sales as we have any enhanced our capabilities in the historic CSK markets.

To this point in the fourth quarter, we are very pleased with our sales performance, however, fourth quarter is always a difficult quarter to forecast comparable store sales. As winter rolls in, sales can be lumpy from week to week and with unemployment still over 9% I think it's reasonable to anticipate some slowdown in our business over the holiday season as consumers used their limited discretionary income for holiday activities. With this in mind, we're going to leave our comparable store sales forecast at 4% to 6% for the quarter, which would lead us to completing the full year with comps in the range of 7% to 8%.

Adjusting for the non-recurring $5.9 million expense item I mentioned, we generated a 14.4% operating margin for the quarter. This is an all-time high quarterly operating margin for our Company since going public in 1993, beating the record we set in second quarter this year by 20 basis points. The increased level of profitability is a direct result of the commitment all our team members have made to the profitability of our Company through diligent management of our gross margin and relentless expense control, while continuing to robustly grow market share.

We are very pleased with our efforts on all fronts to grow our profits as we incrementally work to complete the integration of CSK. We are now in our 28th month of the CSK integration work that began with the acquisition in July of 2008. I am very pleased to announce that we are right on schedule with the plan we put in place directly following the acquisition. We have now completed the distribution expension and in the Western half of the country, with O'Reilly distribution centers now operating in Seattle, Moreno Valley, California, Denver, Salt Lake City, and Stockton, California.

Stockton was our most recent opening and our team has simply done an excellent job at moving our operations from Dixon, California, to a larger facility in Stockton, and in completing the system conversions of the 274 stores that are supplied by the new distribution center. We are now in the process of closing down the facility in Dixon but still have some duplicate inventory to work through and will do so over the next few months. This duplicate inventory is one of the contributors to the inventory growth we had in the third quarter.

The final leg of the distribution and system conversions will be completed on November 7 with the system conversion of the Phoenix distribution center and simultaneous conversion of the 151 stores that are supplied by that distribution center. On that date, all our stores and DCs will be operating on the same systems and we'll be able to retire the legacy CSK systems that are being used in the unconverted stores. We'll also be able to focus more of our efforts on execution of our business strategy in all the converted stores, which will lead to continued success in gaining back the DIY auto parts marketshare these stores have sacrificed over the years in the growth of our commercial programs.

With respect to the Phoenix DC conversion, I want to reassure everyone that we are very confident in our ability to perform a single-weekend conversion of this size. We have done it before and have been doing conversions most weekends at a rate of 20 to 40 stores for some time now. In 1998 we converted all of the 180 Hi/LO stores we purchased in Texas and Louisiana in one night, and in April 2009 we converted the CSK Detroit DC and 79 supported stores in one night. Both of these conversions were a accomplished without service disruptiuon to the stores, as we have a lot of experience with these types of system conversions.

Following completion of the system conversions we will finish the last leg of the integration by completing the remaining store resets, renovation work and rebranding. Ted will be reviewing this in detail in a moment, but I just want to re-emphasize that we are on schedule with our plan and are very satisfied with the performance of our converted stores and new distrubution centers.

A lot has changed in a relative short period of time for our team members in the acquired stores and we are very proud of the jobs our teams in both converted and unconverted stores have done in adapting our culture values and our dual marketing strategies. Generally speaking, and as I have expressed through the integration, we are very enthused about what the future holds for our Company. We very simply have a huge opportunity to expand our ability to execute our dual-market strategiy in many new markets and we now have ourselves in a position to do that. At the same time, we have several initiatives underway to improve our operations, profitability and market penetration in all markets. Things like the implementation of retail price optimization software, enhanced e-commerce capabilities, incremental improvements to our inventory management systems and enhancements to our point-of-sale system content, just to name a few of the initiatives that we currently have underway.

We also feel that the industry tailwind we have had for sometime now could be long-lasting as consumers permanently change their behavior and gain comfort with driving well-maintained vehicles at higher mileages.

Again, congratulations to all Team O'Reilly on the outstanding third quarter results for I will now turn the call over tto Ted Wise. Thanks, Greg. Good morning, everyone. To start, I would like to also thank our nearly 49,000 O'Reilly team members for the absolutely outstanding results in our third quarter. Without question, the general conditions for the auto parts business have been good. However, for our team to produce 11% comps defines the superior level of service we are giving our customers and the market share gains we are experiencing across the core O'Reilly stores, as well as our new conversion stores out West. Also our 14.4% operating margin last quarter demonstrates our team's ability to effectively manage both our expenses and gross profits.

Most amazing, these results parallel the work in various projects involving the CSK/O'Reilly store conversions and installations of our new distribution centers. We are proud of our team's above and beyond commitment to take care of our normal business while managing the integration of CSK into our Company. We are anxiously looking forward to next year when we have the many tasks of the conversion behind us, all the support in place on the West Coast and our entire team can be 100% focused on growing our sales.

Before commenting on our progress in the conversion work on the West Coast, I will quickly summarize our new store expansion for the third quarter. We ended the quarter were 3511 stores, a net gain of 44 new stores. This brings us up to 115 stores year-to-date and on schedule to end the year at 150 new stores. Again, an incredible accomplishment for our store expansion and installation team members, considering the additional workload involving in the West Coast conversion and reset work that I'll outline in a minute. Also we performed 11 major store renovations and relocated four stores into new locations. In regard to our area of expansion, the stores were in 15 different states. Wisconsin and Ohio had seven stores each, Texas and Indiana received six stores and Michigan and North Carolina had four stores each. The remaining stores were spread out primarily in the south and southeast states.

As I mentioned, our installation schedule calls for another 35 stores in the fourth quarter for a net 150 new stores in 2010. Our new store expansion plans for 2011 will be 170 new stores. Considering the amount of conversion and reset work on the West Coast that will spill over into the first part of next year, we will have a very busy and productive year ahead of us. Our real estate team continues to evaluate the conversion store leases and develop the stay and relocation strategy for our store group out West. We'll also starting a more aggressive new store growth plan in the West now that the new distribution centers are open and the stores are operating under the O'Reilly system and brand.

Now to overview our conversion progress for last quarter. In the second week of September we officially opened our new 520,000-square-foot distribution center in Stockton, California. As Greg mentioned, it was actually a move from a smaller CSK distribution center in Dixon, California. This allowed us to start the computer conversions for the 274 Kragen stores, primarily in the surrounding markets, at a rate of approximately 40 stores per week. In addition to receiving new store computers and POS system, the stores began nightly stock replenishment and daily access to the additional DC inventory coverage. To date, this was not the only the largest distribution center we opened, but also the largest group of stores to convert.

We are now finished with the project and in process of shutting down the old Dixon DC and redistributing their inventory to our surrounding distribution centers. The last phase of the distribution and store conversions will take place on November 7, when we convert the existing CSK Pheonix DC over to O'Reilly warehouse system and convert the 151 surrounding stores to O'Reilly systems. Unlike the other conversions, as Greg mentioned, all 151 stores will convert over the same week and time. This allows us to be totally off the CSK computer systems by the end of the year and start all distribution centers and stores under one reporting system in 2011. The installation of five new distribution centers, conversion of two CSK distribution centers to O'Reilly systems, the conversions to nightly replenishment and installation of new store systems in all 1299 CSK stores will have been completed in approximately two-and-a-half years. This is an outstanding accomplishment that has involved a great deal of planning and execution across all areas of our Company.

We are also making good progress on the store resets and now that the stores are finished with the computer conversions, more stores will be available to fit on the reset schedule. We have completed almost all of the individual store layout plans and have the new plans into the city for permits. We completed resets for over 130 stores last quarter and we will do an additional 190 stores in the fourth quarter. Our goal is to finish the store resets by the end of first quarter of next year. The exception being a small group of resolution stores and some that may still be pending permitting issues. Immediately following the store resets to the O'Reilly floorplans, the interior decor package and necessary remodel work follows. Our plan calls for all interior decor and related work to be refinished following the resets in the first half of next year.

In regard to the actual backroom merchandise changeovers and the new retail planograms, this work has been ongoing independently of the physical reset. The backroom hard parts changeovers were completed by mid-year and we are 80% completed without frontline changeovers with a balance to be scheduled in November, December, and January. At that time the stores will have the O'Reilly product mix, is both hard parts and new retail planograms, even though a small group of stores will still have the old CSK store layout.

Our co-branding advertising plan for CSK and O'Reilly brand has been going on for almost two years and has paved the way for changing the exterior signs. This task is well underway and so far we have completed sign conversions to the O'Reilly brand at approximately half of our stores. An additional 180 stores will be installed as soon as the signs are received by the installing sign company, and the balance of the sign surveys for the stores will have been completed, bids sent out to sign companies and plans into the city. We expect to have the rebranding completed by the end of first quarter. Again, there may be a small number of resolution stores and perhaps a group of stores that still has permitting issues that will go into the second quarter. Following the sign conversions, we are evaluating the rest of our exterior store in regard to paint and other image upgrades that may be needed and the appropriate work will be scheduled as soon as possible.

To summarize the store conversion tasks and projected completion schedule, all computer systems and nightly replenishment will be finished by the end of this year. All inventory hard parts upgrades were finished this year, all outfront planograms finished by this coming January. Store resets finished in the first quarter. O'Reilly sign changeouts finished in the first quarter, and the interior decor and exterior work completed in the second quarter of next year. Our store operations and sales teams are developing well as they become more familiar with the O'Reilly product lines, computer system and all aspects of our dual-marking plan.

Our team members have been very receptive to the conversion task, introduction of the new POS system, the new store operational procedures and the physical resets going on in the stores. Most importantly, we are seeing a good sales improvment as we transition stores' traffic from a more pure oil and accesory sales mix to include more hard parts to both the retail and professionals installer customers. Improved store inventories and the access to additional inventory coverage at the hub and distribution center has and is playing a key role in growing our retail and installer business.

Market-driven pricing is also helping us gain new customers as the customers realize that we are competitive now. An important goal of our print and radio advertising has been to build the O'Reilly image of having better parts coverage at everyday low prices. They better inventory and better pricing has gained momentum as the stores are reset to the O'Reilly format and O'Reilly exterior signs go up.

On the professional sales side, we are very focused on building strong and experienced teams at the stores that will result in higher service levels. As stores convert to O'Reilly systems we are opening up more stores to delivery and implementing first-call installer service counters to better service the professional customer. We are expanding our territory sales management team, making more sales calls, and developing stronger customer relationships with a wider group of both large and small customers. As we now transition from the CSK to O'Reilly brand, and along with the improved inventory, market-driven pricing and higher service levels in the stores, we feel our relationship and business with the professional customer will continue to grow for years to come.

The O'Reilly culture is growing stronger every day in our new stores on the West Coast. Our team members are very happy to have the conversions and theh inventory changes beyond them, and moving forward so rapidly with the interior resets and exterior sign changes. They are excited to be fully integrated in the O'Reilly systems and procedures and looking forward to continue building our business. The core O'Reilly managers and team members that have spent time helping with the conversions and training at these stores, have done a great job in expanding our O'Reilly culture as well as training in the O'Reilly procedures. We are now operating as one team moving forward. With this I'll turn the call back over to Tom.

Thanks, Ted. Now we will move on to the numbers. For the quarter, sales increase $168 million, 13% over the prior year to $1.43 billion. The increase was attributable to a $136 million increase in comp store sales, a $30 million increase in non-comp store sales and a to $2 million increase in non-comp, non-store sales. For the quarter ticket, average and ticket count contributed equally to our comparable store sales increase. The increase in ticket average continues to be driven mainly by mix as sales of hard parts, which typically carry a higher ticket, accounted for a larger portion of the overall sales volume. For 2010, we are increasing our total revenue guidance to a range of $5.3 billion to $5.4 billion.

Gross profit was 48.6% of sales for the quarter versus 48.5% in the prior year. The 10-basis point improvement was driven by improved acquisition costs and improved shrink of the converted stores. These improvements were in part offset by deleverage on the distribution costs, which is a result of the new DC coming online and consistent with our expectations. Year-to-date gross profit stands at 48.6% of sales, and for the full fiscal year we expect gross profit to be approximately 48.5% of sales.

SG&A for the quarter was 34.3% of sales versus 36.7% in the prior year. The leverage on SG&A was a direct result of strong comparable store sales. On a per-store basis, SG&A-per-store is up 2.6%, which allowed for strong leverage on 11.1% increase in comp store sales. Year-to-date SG&A improved 200 basis points as a result of strong sales and expense control. For the full year, we expect SG&A dollars per store to be up slightly from 2009 as we continue to see opportunities to more aggressively invest in store SG&A to drive strong sales results. We anticipate the total SG&A for 2010 will increase approximately 5% to 5.5% 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 14.4% of sales, an improvemnt of 250 basis points over the prior year. This large improvement was a large result of strong comp sales and tight expense control and represents a record quarterly operating margin. For the full year we expect our adjusted operating margin to come in at 13% to 13.5% of sales.

Net interest expense for the quarter was $10 million, which was better than the prior year by $1 million due to lower borrowings, offset in part by higher rates as a result of our outstanding interest rates swaps. For 2010, we expect net interest expense to be approximately $40 million. The tax provision for the quarter and year-to-date was 38.7% and 39.7% of pre-tax income, respectively. The tax rate was negatively impacted by the charge related to the legacy CSK/DOJ matter, which we currently do not anticipate being tax-deductible.

Excluding this one-time charge, the quarterly rate was 37.6% and the year-to-date rate was 38.2% of the pre-tax income, which were both flat with the prior year. For 2010, we expect our tax rate as a percent of pre-tax income to be approximately 39.5%. Included in this estimate is the 120-basis-point one-time increase related to the non-tax deductible reserve to settle the legacy CSK/ DOJ issue. Adjusted diluted earnings per share for the third quarter was $0.86 per share, which represents an increase of 37% over the third quarter of 2009. For the year, adjusted EPS of $2.37 increased 39% over the prior year.

Moving on to the balance sheet, the average inventory-per-store at the end of the quarter was $565,000, which represents a 4% increase over the prior-year average of $543,000. This increase is a result of our continuing effort to add hard parts coverage to the stores and duplicitive inventory as new DCs come online.

Since the beginning of the year, we have added 115 net new stores, four new DCs with one to close when we relocate in the Stockton DC. As a result, our total inventory has increased $85 million. We remain focused on refining inventory mix at the CSK stores and leveraging the new DCs to reduce the stocking depth at the Western stores. We expect our total inventory levels will not increase significantly through the end of the year despite impacts of 35 new stores in the fourth quarter. Our reserve for LIFO at the end of the quarter was $24 million, which was an increase of $1 million over the previous quarter. This change in our last buy to LIFO reserve did not have a material impact on gross margin for the quarter.

Accounts payable of $943 million was 47.2% of inventory, as compared to 47.9% in the prior year.. We continue to work hard at increasing our APed inventory ratio by improving our inventory productivity and improving terms of vendors. The capital expenditures were $94 million for the quarter, bringing our year-to-date CapEx up to $276 million, versus $317 million in the comparable period 2009. For 2010 we expect our CapEx to range from $375 million to $400 million. As discussed in our last conference call, approximately $40 million of CapEx we plan to spend this year will be deferred into the first half of 2010 based on adjustment and timing to a portion of the front-end CSK conversions.

Depreciation and amortization for the quarter was $41 million. For 2010 we expect depreciation and amortization to be $160 million to $165 million versus $148 million in 2009. Total borrowings at the end of the quarter were $431 million compared to $704 million at the end of Q3 2009. During the quarter we elected to permanently retire the FILO traunche ABL facility, which lowered our maximum borrowings to $1.075 billion. The $125 million traunche carried an interest rate premium of 125 bps.

Even with the elimination of the FILO traunche, we have $674 million of availability at the end of the quarter. For 2010 we expect to reduce our total outstanding borrowings by $325 million to $350 million. As noted in our press release in October 1, the legacy CSK convertible notes remain exchangeable and will remain so until the end of the fourth quarter. To date $11 million in the notes have been surrendered for exchange. To the extent any notes remain outstanding we continue to intend the 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 $237 million, an increase of $101 million over the third quarter of 2009. For the year, cash flow from operating activities has increased 105% to $593 million. The improvement was driven by a significant decrease in net inventory investment, higher net income and the timing of payments of other liabilities. For the quarter, free cash flow was $143 million versus $50 million in the third quarter of 2009. Year-to-date free cash flow was $316 million versus a use of $28 million in the first nine months of 2009. The improvement was driven by the previously mentioned increase in cash flow from operations and a $41 million decrease in capital expenditures. We now expect free cash flow to be $250 million to $275 million in 2010, and we'll use any additional free cash flow to further reduce our outstanding debt.

Stock option expense for the quarter was $3.8 million compared to $3.3 million in the prior year. The increase was driven by the year-over-year increase in our stock price. For 2010, we continue to expect stock option expense to be approximately $50 million versus $13 million in 2009.

Now to recap our overall guidance. For the third quarter, our comparable store sales guidance was 4% to 6%. For the year we are raising our comparable store sales guidance of an increase of 7% to 8%. Our GAAP diluted share earnings per share guidance for the fourth quarter is from $0.56 to $0.60 on a 142.3 million shares. For the year our EPS guidance is $2.79 to $2.83 per share on 141.4 million shares. On an adjusted basis, excluding the second and third quarter charges, our guidance for the full-year EPS on a diluted basis is a range from $2.94 to $2.98. At this time, I'd like to ask the Operator to come back and we'll be happy to answer your questions.

(Operator Instructions). Your first question comes from the Scot Ciccarelli with RBC Capital Markets.

Hey, guys, Scot Ciccarelli.

Hey, Scot.

Listen, I know you guys don't break out CSK specifically anymore, but is there any color you can provide or a way to think about the impact that the commercial sales growth at the CSK stores has had on the overall Company?

Well, as I have talked about for sometime now, Scot, we are not going to break out our sales in a secular way like we had been. It was confusing to many and it was just one of those things that, for competitive reasons and other reasons, we decided not to do. But I will tell you that the CSK commercial program is contributing significantly to our performance and the converted stores, in general our oldest converted stores are best-performing comp stores. So I think from there, what I'm implying is that the conversions are working and that the commercial business is the majority of the gain we are seeing in comps in the converted stores. And the longer the stores have been converted the more traction that they get.

And given the growth in we have seen in the commercial side, have we kind of reached a gross margin peak given the margin delta between commercial and DIY.

Yes, I think so. I think the more -- as we continue to grow the commercial business we will continue to put some pressure on our gross margin, but we have a lot of mitigating factors in our Company that we work on to maintain our gross margin.

Okay. Great. Thanks a lot guys.

Okay, thank you.

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

Hi, good morning.

Good morning.

Congratulations on another very nice quarter.

Thank you very much.

The first question I have, if you just look at the sales line, and you guys -- particularly in your prepared comments, a lot of the drivers of sales, but there was a -- if I look at your sales and I characterize it went from good -- and actually great in the second quarter, to really great in the third quarter. There was an acceleration if you look on a two-year basis on your comps. Is there anything you saw that could explain that acceleration we have seen over the last few months in your business?

Well, there's a lot of positive factors. All of the macro factors that we talk about. But then also, for the past -- at least in the third quarter, we had what I consider to be almost ideal weather conditions to drive some demand on summer products like temperature control products and batteries and things like that. And then just those other macro factors are meaningful. Those factors have --with the cars having a more miles on them, the cars been a little older on average than what they were and people having made the decision to drive those cars for even longer than maybe they originally planned when the recession started. I think those factors are continuing to build, but I do think we had some benefit in the third quarter of just usually warm and dry summer in most markets which was good for us.

Okay. Very good. Then the follow-up question, longer-term in nature, you commented in your prepared remarks that -- and you have said this before, but you commented that you look at trends and you believe they may be longer lasting. We talked a lot about the macro environment in August, a lot of the very significant changes you made in your model with the integration of model with the integration of CSK, but is there something you're seeing specifically, maybe with the customer data, et cetera, that gives you the confidence that this is more than a cyclical-type phenomenal, it is more of a structural type shift in the business?

Well, no, I do not think we have any data that would not be available to you just from a pure macro level. What we see that you don't see, obviously, is just the types of products that are being bought for the cars. We do really well on the repair parts, maintenance parts, in many cases the types of parts that higher-mileage vehicles take.

My observation has been, and I think it's the observation of several in our industry, is that the cars that have been built over the past 10 or 15 years are generally higher quality cars than what had been built in the years prior. Because of that, the enhancements that were made by the OEs during that time to make the interiors last longer, make the bodies last longer, just make it more comfortable and presentable to drive at higher mileages, I think, as people have spent some money on maintaining these cars they will continue to invest in maintaining them, because they are not a car that they do not want to drive. These cars, many of them can be driven over 200,000 miles without having major drive train issues, engine, transmission, differential transaxle, and because of that people are willing to maintain the brakes and suspensions and ignition and the drivability components. So, I think that what we will see is that the consumer behavior with regard to trading cars every three or four years or less than 100,000 miles, that may be long-lasting.

Thank you very much and congratulations again.

Thank you.

Your next question comes from the line of Michael Lasser with Barclays. Michael, your line is open.

Good morning, thanks a lot for taking my question. On the leverage you have been seeing, so SG&A per store was up 1.4% in the second quarter on a 7% comp increase -- almost 8% comp increase. It was up 2.6% in the third quarter on an 11% comp increase. So this 300-basis-point delta, should we continue to think about the ratio of SG&A per store increases to comp increases as kind of a 1 per 3?

Tom, do you want to take that?

Yes. Some of is going to be a sliding scale on high or low comps are, As we have talked about previously, especially on the acquired stores which have a high occupancy cost, which is fixed, we have a tremendous amount of opportunity to leverage those sales with existing expenses. When we started the year we discussed that we thought that per-store SG&A would be relatively flat, not down a little bit. Obviously that was on a lower comp assumption, we have quite a few variable costs that drive our business as we see more customers. But we still have a tremendous amount of fixed-cost to leverage.

So for the remainder of this year, I would say, Michael, that statistic holds true. As we start to anniversary high amounts of leverage on sales increases, I think that is going to be a lower number. But we still have opportunity next year to be well above our historical rate.

This isn't my follow-up, but next year, will the flat SG&A per store, if it's in the mid-single-digit range, does that hold true?

We will give you guidance on the next call for 2011.

Okay. And then just a broader question. It seems that part of the message you were articulating earlier this morning, in your recent analyst days, that you are nearing the end of some of the heavy lifting on the CSK acquisition and now the focus turns to organic growth and various improvement initiatives such as price optimization, et cetera. How much opportunity do you think there is to -- both on the margin and the sales side from some of these initiatives that you are now going to turn to given the renewed focus you will have?

Well, Michael, we do not really know the full untapped availability of some of the things that we have not done yet, although we have done some early tests of things like price optimization and other things. I think it would be premature to apply a perspective number to a we could do in gross margin due to price optimization or what we can do sales-wise to enhance the very solid program we have already with some additional things that we can do with our point-of-sale systems and e-commerce content and the transaction products and stuff like that. But they will be positive.

There are things over the last two-and-a-half years we probably would have already implemented some of these things had we not been so focused in resources tied up on the integration of CSK, because there are things that are tested and work well and they have been used by many retailers, and they are just opportunities for us now that we are going to have a little bit more time to focus on things we can do to improve our business outside the integration of CSK. So we will continue to report on these things, but we would expect positive results from them based on our early analysis of tests.

All right, cool. Thanks a lot and good luck with the rest of the year.

Okay, thanks, Michael.

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

This is actually Steven Gregory with Mandalay Research. A couple of thing, you guys mentioned early in the call that enhanced e-commerce capabilities is a big initiative of your organization. Can you provide some color as to what you guys are doing regarding that initiative?

Well, there are several things going on with e-commerce. We have been managing transactions with our installer customers for years, before the internet was prevalent and mainstream, we did transactions with our installers via green screen terminals that we would set up, and over time we have enhanced that to internet-based and now we have systems integrated into the systems that they used that allow internet-based transactions. Our efforts both on that front and on the retail front are to improve the content that is available to customers so they can see more about our products, see more about the availability of products, maybe schedule better the amount of time it's going to take for them to get our products on the commercial side, really just some of the things you see some of the best e-commerce retailers doing.

Like I said earlier, some of the work we have been doing on CSK has probably had as a little bit distracted from focusing on some of those things over the past two-and-a-half, three years, and we've gotten back to focusing on some of these fundamental things that we feel are opportunities for us. But most of them revolve around content and integration into systems that we want to improve.

And just a follow-up to that. Are you going to be steering people to buy products on your site or are you just more using it as informational source to get people to stores? And second to that, are you guys building a mobile commerce or social commerce solution to gain more (inaudible) out there in the marketplace, allow people to go on via an iPhone, et cetera?

Yes, we will at some point implement a mobile app for access to our website, yes, we want to do as much e-commerce business as we can. So yes, we would steer our customers to buy online -- which we've been selling online for quite some time now, both commercial and retailer, as I said.

Yes, we would steer customers to do that but we also do very well with our existing buy online/pickup in store, or just the inquiries that can take place on the internet to go to one of our local stores. We have enough stores in many markets so that using the internet to do an inquiry as to whether we have a product, what the price is, what it looks like is an enhancement to retail transactions. But sure, we want to do as much as we can online. We are a little bit hand-tied, when it comes to pricing on the internet, because we certainly do not want to price lower on the internet than what we price in our stores for local customers. But we are working on some things that might improve that situation, too.

Thank you very much.

You bet, thank you.

Your next question comes from the line of Kate McShane with Citi Investments.

Hi, good morning.

Good morning.

On the last call you said that in the core O'Reilly stores and more established markets you were trying to grow retail and wholesale, in hard parts. Can you tell us where you are with this initiative in the O'Reilly stores and how this falls into the sequence of events you outlined today for the converted CSK stores?

Well, I will make a couple comments and then Ted can may have some comments that he wants to make to this, too. One of the things we talked about early on when we acquired CSK is that it appeared to as us they had given up some of the core auto parts, hard parts business that had been -- is the foundation for all of our operations. They had given it up and exchanged it for some of the import, non-automotive, accessory-type products that we really have not dabbled in. One because we just have always done well in auto parts and put our focus on auto parts, and two, we don't feel as confident in the ability to have demand for those products without the support of ongoing large advertising spends and promotional support.

So yes, our advertising effort in the CSK markets are focused around exemplifying our ability to be a great hard parts supplier at competitive prices, and we have seen much improvement in our hard parts sales in those markets and we'll continue to do that. And then, of course, to add to that typically what repair shops and commercial customers buy are these hard parts, so yes, we are doing very well there. But that is our focus, is to continue taking these stores through a transition of this large portion of non-automotive products over to hard parts. I feel that we have been successful to this point but we will continue to have more success with that as we continue to gain traction and the reputation as being a company that can supply auto parts and hard-to-find parts.

Yes. And it obviously started by putting inventories in the stores. We purchased CSK, generally speaking, their backroom inventory was very, very poor on the majority of the stores. I mean, they had some larger stores that did installer business that had good hard parts inventory, but over time they had just swapped accessory and oil business for their parts business. And then also the hard parts they did have, they were not competitive and they did not have a very good selection of house brand, entry-level product, a good, better or best concept.

So it all starts with educating the customer because for many, many years their ads, all of their print, everything that the retail customer saw would indicate that they were more of an accessory house, tool, promotional house. Now we have to more or less rebrand the Company in the eyes of the hard-core DIY customers, the ones that really by the hard parts, that we are the place to go for parts now and that we are competitive, because, again, not only did they have very inventories, what they had, their mindset was they could be 10%, 15% higher than the competition. So it's all coming along well. Again, it will not happen overnight. They have taken years to build a reputation and it will take us a while to rebuild the reputation to be a hard parts store.

Okay, great. Thank you, and this is a follow-up to that than, in terms of the inventory than for hard parts at the CSK stores, you're where you want to be at this point?

No, well we have plenty of inventory, up to the extent I think we have to much inventory. We are working to adjust those inventories incrementally, but we do not want to get too far ahead of ourselves on the adjustments because we still have a lot of untapped potential in those markets. But we put these hard parts inventories out there awful quickly. And we used good systems and information to decide what inventory to put out. But in some markets that maybe has a population of customers that maybe would not be as inclined to buy some of the higher-price branded products, we'll be making some adjustments over time in just our assortment of hard parts products to better fit the market and reduce some of the duplication we may have now.

And the reason we may be to some degree put too many hard parts to begin with was because we did not have our distribution centers in place and they were not getting nightly delivery service. And now that all of the stores are being serviced nightly, we have our hubs in place, to Greg's point, we can selectively go back and fine-tune the inventories.

Thank you.

Thank you.

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

Yes, thank you very much and congratulations, gentlemen, on the outstanding quarter.

Thank you, Alan.

Just a couple of questions, if I may. Greg, I certainly recognize that the oldest Checker stores that were converted earliest are still performing the best, but of the various steps in the conversion process, between implementing the computer systems and putting the hard parts in the stores and the planograms and the resets, what -- all of which are at various stages, of course, together with the exterior signage, what, in your opinion, drives the greatest incremental benefits once each of those conversion processes are added to the stores?

Well clearly it's having the hard parts. That is the business we are in. While our systems facilitate making transactions the way we want to make them, making connections -- electronic connections with the commercial customers and sourcing parts. We feel like our planograms are optimized to do business the way we want to do business retail, and the resets or just something you have to do in retail to keep your store looking fresh, because some of these stores were getting pretty weathered. Clearly having the parts on the shelf is what makes the most difference.

To Ted's point earlier, from a retail perspective, once you have the reputation and customers form buying habits like going to on of your competitors to get hard parts, that it's an easy thing to break. And we've incrementally improved that as we've owned the Company and had better inventories and will continue to put our marketing advertising efforts into exposing that fact to consumers. And I think that is something that gains momentum as customers realize that we are in the hard parts business. But clearly that is the most impacting factor.

Alan, this is Ted. Another thing you did not mention there, particularly on the wholesale side of the business, as we address the staffing levels of each of the stores and make sure that we have professional parts people in the store that can handle the installer business, that is a huge plus. You can have the parts but if you don't have the people that can sell the parts, if you don't have enough people or the right people, you do not maximize your sales. So that is an ongoing process that we are working on. We had a lot of good people to start, and we just need to add more people as our business continues to grow.

And then, Alan, the other factor there is just distribution capability. We put inventory out in the stores initially to help the CSK stores that did not have good access to distribution, and that helped some, but now having overnight access and same-day access to many stores to larger inventories is a big help. The average stores has a little over 20,000 SKUs and our DCs would have more like 120,000, and that access makes a big difference in our ability to allow -- one, to hire good people and get good people in a position that they could be successful, but then also deliver to commercial customers.

Okay. Thank you. And one follow-up, if I could. Certainly it's understandable that DC costs in the quarter were deleveraged, and that's a direct result of opening up five new DCs in a very short period of time. First of all would you be able to quantify how much DC costs were deleveraged, and would it be fair to assume, with Phoenix now opening in just a couple of week, is the (inaudible -- technical difficulties) point in time we you're seeing maximum deleverage on the DC costs?

Tom, do you want to take that?

First, when we look at the amount of deleverage, it was less than we would have expected or planned based on the DCs coming online. When we look at where the maximum is, really the issue for us at this time is team member training and efficiency of team members. We are confident in our ability to get back to where we have been historically from a percent of sales standpoint. We just have a lot of new team members out there and as we ramp up these converted stores, our emphasis is on making sure that if anything, we're over-servicing the stores and over time will be able to reduce that. I would say this quarter was probably our maximum deleverage, as the DCs that converted during at the beginning of the year become more and more efficient.

Thank you all, very much.

Thank you, Alan.

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

Thanks a lot, good morning. Congratulations on a strong quarter. A lot of my questions have been answered, but there is one I want to focus on, and that is the seasonality of the fourth quarter. I guess some strange things happened the past two years in terms of your sales in Q4 relative to Q3. As you think about the reality that we're in a somewhat more stable economic environment, do you feel like what transpired last year -- and the year before was symptomatic of the economic chaos that we had, more or less. Do you feel like in a more stable environment you can return to more typical seasonality? And, I guess, are you making any special plans with regards to cost structure inventory as you think about your financial planning for Q4?

Well, Matt, we hope that the factors you stated our right. We have experienced erratic sales in the fourth quarter for a longer period time than just the recession due to holiday spending and the effect that the onset of winter can have and so forth. So we are doing everything that we can to make sure that our fourth quarter is strong and that the trend that we are on and that we have had coming out of the third quarter continues. But as we have seen, we have been surprised before following Thanksgiving when heavy holiday shopping starts and limited discretionary cash that consumers have starts going elsewhere. So we'll just have to see. So it's always easier for me, as it is for you, to look back at comps and make comments on how they went as opposed to look forward, but we're hoping for the best but we're trying to plan as reasonable as we can.

And to your question about our resources for the fourth quarter, from an inventory standpoint we really do not make much of a change there. Our inventories are pretty well set to service the vehicle needs in the areas that they service, and we just don't have that many promotional products that we push out seasonally that make a material impact. Now, labor or payroll we certainly do make adjustments to that based on -- and those adjustments are made weekly based on our staffing system productions that we have out in the stores. And they adjust for the business cycles that we have season after season. So we are in good shape there.

Got it, thank you so much.

Thank you, Matt.

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

Good morning. Just a quick question. Do you have a sense of what you think your market share looked like in the quarter? I would assume commercial was up nicely, but any sense DIY versus commercial, what kind of share gains you see?

Well I think we grew share in both. It's hard to measure the total market to know how much share we gained but I think we gained share on both sides. Both were good contributors to our growth. The do-it-for-me side, we have clearly taken a lot more share there than we have on the retail side just because we've put so much effort into capital into getting ourselves in the commercial business out in the west stores and the converted Checker stores here in the center part of the country, and the Murray's stores, so that's growing. So, yes, we are taking a lot of market share on the commercial side and I'd say some market share retail. Both are performing well but I do not have a specific market share number for you.

Okay. And then just a quick follow-up, it is not that important, but I would be curious as to what the justification was from the Justice Department to fine O'Reilly shareholders $20 million from actions of previous management?

That is the question I was asking. They're really -- their justification is -- their perception is that crimes were committed, and that there should be a penalty applied for that. And while our perspective was that there probably would not be a penalty and our advisors felt like there would not be a penalty at the time of the acquisition, it turns out that there was.

So we have now put that behind us and it is history now. But I can -- of course, the fines apply to CSK. But I can tell you, I defended our shareholders' position as aggressively as I felt it could be defended. And this is where we ended up after long negotiations. So we are glad to have it behind us.

Okay. Good luck going forward.

Thank you.

There are no further questions at this time. I would now like to turn the conference back over for closing remarks.

Well, thanks, everyone, for your attention this morning. We are certainly part of our performance in the third quarter and you can bet we will be trying to accomplish great results in the fourth quarter. We will look forward to reporting those results to you after the first of the year. Thank you very much.

This does conclude today's conference call. Thank you for participating. You may now disconnect.