O'Reilly Automotive Inc (ORLY) 2011 Q2 法說會逐字稿

Good morning, my name is Latasha, and I will be your conference operator today. At this time, I would like to welcome everyone to the O'Reilly Automotive 2011 second quarter earnings 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). I will now turn the call over to Mr. Tom McFall, Chief Financial Officer. Sir, you may begin.

Thank you, Latasha. 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 within 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 expansion strategy, business strategies, future revenue, future performance.

These forward-looking statements are based on estimates, projections, beliefs and assumptions that are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions, including but not limited to competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our increased debt levels, credit ratings on our public debt, our ability to hire and retain qualified employees, risks associated with the integration of acquired businesses including 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-Q for the year ended December 31, 2010, for more details.

At this time, I would like to introduce Greg Henslee.

Thanks, Tom. Good morning, everyone, and welcome to the O'Reilly Auto Parts second quarter conference call. Participating on the call with me this morning is, of course, Tom McFall, our CFO; and Ted Wise, our Chief Operating Officer; and David O'Reilly, our executive Chairman, is also present.

To start off, I would like to again congratulate Team O'Reilly on the excellent performance. Our second-quarter operating margin of 15% is a significant milestone and sets a new high water mark for our Company. This performance, as always, is a direct result of the effort each one of us puts into abiding by our culture values every day, ensuring our customers receive the best customer service in our business, that we are all as productive as we can possibly be and that we manage our expenses with an eye toward making sure we create the best value in the automotive aftermarket for our loyal customers. Great job, Team O'Reilly.

Now on to some details of our second-quarter performance. As we discussed on our first quarter conference call, we projected second-quarter comparable store sales in the range of 3% to 5%, and we ended the quarter in that range of 4.4%. We have been on a reasonably steady sales trend for some time now, generating first- and second-quarter comparable store sales on a two-year stacked basis of 12.5% and 12.3%, respectively.

With consideration to the variation and comparisons we had by market, we saw solid sales performance across most of the country. As has been the case for some time now, the markets in which we have converted CSK stores continue to be our best comparable store sales contributors, as the seeds we have sown during the integration of CSK continue to bear fruit.

July 11 marked the third anniversary of acquisition of CSK, and I'm very pleased to announce that the vast majority of the integration work is now behind us. Ted will review this in more detail in a moment, but generally speaking we are now able to focus all our efforts in these markets towards growing market share by establishing ourselves as an incredibly capable business partner for the commercial customers in each market as well as an outstanding resource and supplier for the DIY customers.

We've still got a long way to go to reach our potential in the CSK markets, but we are well down the road and are in a good position to incrementally gain market share on both the commercial and retail sides of our business. To this point in July, the steady sales trend we have been on has continued, and with the extremely high temperatures we have seen the past few weeks across much of the country, we have seen very good seasonal demand.

However, with fuel prices approximately 35% higher than they were this time last year, miles driven down 1 percentage point for the year through May and unemployment hovering around 9%, we are inclined to be somewhat conservative in our comparable store sales forecast for the third quarter, especially when considering that we are comparing to the 11.1% comp store sales gain we generated last year.

With this in mind, we are forecasting comp store sales for the third quarter in the 2% to 4% range, which at the midpoint would put us around a 14% increase on a two-year stacked basis.

Gross margin for the quarter came in at 48.6% of sales, a 12-basis-point decrease compared to last year. This decrease is primarily related to the timing of some advertised commodity items on which we receive cost increases along with the faster rate at which we are growing our commercial sales versus our DIY sales, which yields a slightly lower gross margin rate. This is primarily related to the CSK integration and the execution of our dual-market strategy in those markets.

As I've mentioned before, we have several initiatives underway to enhance our gross margin over time. These include refinements to the way we price products, both commercial and DIY, more direct sourcing of products coming from overseas, growth of some of our private-label product offerings and continued distribution efficiencies. To this point, we have been pleased with our ability to maintain our gross margin rate as we execute our dual-market strategy plan in the CSK conversion stores.

SG&A expenses for the quarter came in at 33.5% of sales, a 95-basis-point improvement compared to last year. This is primarily the result of our ongoing focus on productivity and expense control. However, winding down the CSK integration was also a contributor. I am extremely proud of the job our team is doing managing expenses. It's part of our culture, and I feel like we're doing as good a job as we have ever done focusing on spending money where it's necessary to provide better service to our customers and eliminating unnecessary expenses.

Also, it's clear that the rollout of our commission-based compensation plan in the CSK stores has been a contributor. We are very focused on team member productivity, and our incentive programs align our store teams' interests in making our sales and productivity goals.

That said, we are very pleased with the operational expense improvements we've seen in the converted stores as well as our execution in the core O'Reilly stores. The result was an all-time high quarterly operating margin of 15% of sales, an 83-basis-point improvement compared to last year's adjusted operating margin.

Our average inventory value for the quarter was up 5.2% over last year that generated a sales increase of 7.1%. As we've discussed before, we are working to dial in the converted store inventories and are gaining ground. Currently, our converted store inventories are higher on average than the core O'Reilly stores, and over the remainder of next year we will work to bring them much closer to the core O'Reilly store per average inventory.

Our goal continues to be -- to incrementally, over time, return to our pre-CSK inventory turnover rate of approximately 1.7 times as we dial in inventory levels and work to increase our per-unit average volume in the converted stores. With the majority of the conversion work behind us, we continue to focus on some strategic priorities that we feel will drive long-term value. These initiatives, for the most part, are simply improvements that we want to make to our business. We are now able to focus.

I've mentioned some of these before, but I'll touch on them again. They are things like more detailed work with our vendors on a wide array of projects to assure appropriate inventory coverage in our DCs and stores, best use of capital in deploying inventory, logistics cost management, improved demand forecasting, along with several other merchandise-related priorities. We are very pleased to see that our efforts to improve use of capital yielded a 10.6% improvement in our AP to inventory ratio, taking it from 44.2% last June to 54.8% this year.

Another initiative is enhancing the content we have available in our point of sale systems. Having the best information easily available to our parts specialists is one of the keys to success in our business. We have been an industry leader in this area for a long time. However, we see more opportunity to not only improve the way we look up application parts but to provide more information for our parts specialists in order to help them quickly help our customers solve their problems.

This includes more information about problem diagnosis, product specification and installation along with other pieces of content detail we are working to add. We're also continuing our efforts to improve our e-commerce and now m-commerce capabilities. As I have mentioned before, we have done a good job on this for a long time with our professional customers but feel we have continuing opportunity to improve not only those systems but also the electronic interaction we have with our DIY customers, especially on mobile devices.

We have deployed some improvements and are working on several additional improvements as time moves along. There's a long list of additional internal priorities, but I wanted to just mention a few of the things we continue to work on to improve our customer service, our profitability and our market penetration. We continue to see a lot of opportunity to grow our business through market share gains and through the continued growth of our store count. The opportunity that we saw three years ago when we bought CSK is now coming to fruition and we expect solid sales results from these stores over the next several years as we gain credibility with both the commercial and the DIY customers.

Our industry continues to benefit from the average age of vehicles on the road reaching record highs. I continue to believe that many of our customers have learned that with proper maintenance cars and light trucks can be driven at higher mileages than ever before, due to the quality of the drivetrain and other key componentry. I don't believe the positive effect this aging of the vehicle population could have on our industry has yet been fully realized. With unemployment as high as it has been the last couple years, there's no question that there has been a lot of maintenance deferred. We hear this not only from our commercial customers, but see it in our stores as DIY customers look for low-cost alternatives and weigh the risks of deferring repairs that can be deferred.

In closing, I'd just like to again say thanks to all of Team O'Reilly for their hard work and for the great service we provide our loyal customers. Our team has done an excellent job over the past three years incorporating what used to be CSK into Team O'Reilly. We have a bright future ahead of us as we continue to improve our customer service capabilities and we expand the O'Reilly culture in new markets. I will now turn the call over to Ted Wise.

Good morning, everyone. Like Greg, I would like to start by saying thank you to over 49,000 O'Reilly team members. Our team, working together, whether it be in the corporate office, distribution centers or in store operations and sales teams, was responsible for producing our first-ever 15% operating margin.

Following the excellent comps from a year ago, we knew we had to focus on great customer service levels to grow our business. Under these challenging market conditions, we produced a very respectable same-store sales last quarter. We realize the Company's sales and profit performance are the result of the commitment and hard work of our talented group of professional auto parts people, and we sincerely appreciate everyone's contribution.

Before I give a brief update on the last stage of the CSK store conversions, I want to overview our new store growth during the second quarter. We installed 44 new stores, which, on top of the 55 new stores in the first quarter, brings us to 99 new installations for the year. During the first part of the year we closed 12 CSK non-performing and overlapping stores that we had previously announced in our plans last year.

For the year we have grown a net 87 new stores, bringing us up to 3657 stores operating in 39 states.

Our third quarter installation schedule is shaping up nicely and looks to be in the range of an additional 60 new stores, well on track to finish the year on plan with 170 net new stores. The new store growth was spread out in 17 different states, with North Carolina at nine stores and Texas at six stores leading the pack. Our real estate teams, working closely with field operations, continue to identify and find good expansion opportunities that can be adequately serviced within the current capacity of our network of 23 distribution centers.

On the West Coast we are very focused on expanding into new markets, but store relocations will be very critical to our overall growth as we work to relocate stores out of shopping centers into more freestanding prototype buildings. West Coast real estate is challenging, but we are confident that over time we can find good options in many markets that will improve our location and our occupancy costs.

Now for an update on the final stage of our store conversions out West -- as outlined on our last call, we have implemented our O'Reilly dual-market infrastructure and installed distribution centers so that all stores are serviced on a nightly basis. We completed the changeover and update of all the hard parts inventory line and all out-front plan Planograms in the stores. We've installed all store computers and have our teams fully trained on the point-of-sale and store operational procedures.

As Greg mentioned, the O'Reilly store incentive plan has been rolled out, and we have restructured and added the management required for our store operations and sales teams to properly cover the current store count and future growth. We are in the final stage of completing the store interior resets and remodels as well as wrapping up the exterior store sign conversions to the O'Reilly brand.

During the past quarter we completed another 108 store resets, leaving us approximately 50 stores to complete this quarter. We are also at the end of the sign conversions with around 100 stores pending release of permits, delivery of signs and scheduled to install as soon as possible. While we still have some fine tuning and miscellaneous projects to finish, the store interiors with O'Reilly Planograms, layout and decor is a huge improvement in our retail image. Many of the CSK exterior signs were in very poor shape, and now our stores present a new, bright, sharp exterior image with the O'Reilly signage and, in many situations, new exterior paint jobs. We are ready for business as O'Reilly, as we discontinue the co-branding advertising and now convert over to using only O'Reilly advertising in market throughout all of our markets.

The development and growth of our West Coast stores and sales teams is progressing well, and we continue to focus on several key areas. The store sales teams have become very efficient as they understand and implement the O'Reilly point-of-sale and other operational procedures. Now, with the distraction of the store resets and the inventory work behind us, our teams are focused entirely on sales, product training and providing a higher level of customer service on the retail counter and to our first call customers.

Second, we continue to expand our outside sales efforts to build solid relationships with our more professional customer. It takes repetition and time to build these relationships and earn the professional customer's business, and we are starting to see good progress made in this area. Our team member training is resulting in higher productivity at the store level. We have also improved our store productivity by better scheduling for the business using our scheduling tool, which provides higher service levels. The obvious result has been increased sales and better leverage of our store payroll.

We have to be very careful in our staffing plans and ensure that stores continue to have the level of staffing that will provide the great customer service needed to compete for each individual market sales entitlement. Staffing for great service levels is a store-by-store, market-by-market evaluation, and is considered the top priority for our entire field management team.

We feel we have trained and developed a great leadership team in the West Coast stores and also feel confident that we will continue to see the growth and success that mirrors our core O'Reilly store group. I will now turn the call over to Tom.

Thanks, Ted. Now I will cover second-quarter financial results and our guidance for the remainder of the year.

For the quarter, comparable store sales increased 4.4%, which was within our 3% to 5% guidance for the quarter. Sales increased 7.1% to $1.48 billion. The sales increase of $98 million was comprised of a $60 million increase in comp store sales, a $39 million increase in non-comp store sales, a $3 million increase in non-comp, non-store sales and a $4 million decrease from closed stores.

For the quarter ticket average drove our comparable store sales gains. The ticket average trends for the quarter were consistent with previous quarters, driven by the continued shift in our product mix towards hard part categories, which typically carry a higher average ticket. During the quarter, comparable DIY ticket count came under pressure as consumers faced increased fuel costs. However, this pressure was offset by continued strong growth in the DIFM comp ticket count.

Year-to-date, our comparable store sales increased 5% on top of last year's 7.4% first-half gain. Our third quarter comp guidance is 2% to 4% on top of the 11.1% comp for the third quarter of 2010, which was our highest comp quarter for that year. Our full-year sales guidance remains at $5.7 billion to $5.8 billion, and our 2011 comparable store sales guidance is also unchanged at 3% to 6%.

While we do expect continued headwinds from fuel prices and the high level of unemployment, we expect sales to remain relatively solid, based on the continuing economic pressure that requires consumers to maintain their existing vehicles and on the solid growth potential we have in the acquired in CSK markets.

Gross profit for the quarter was 48.6% of sales and was down slightly from the prior year, but within our expectations. Looking at the quarter, we definitely saw inflationary pressures with our LIFO reserve increasing $23 million. While we still feel confident in our long-term ability to pass along raw material price increases to our customers, the second quarter margin was compressed in part by price increases on highly promotional merchandise. The tight timing of the price increases and our seasonal promotional activities did not allow us to adjust advertising pricing. This compression, in addition to the ongoing pressure on gross margin percentage caused by a higher mix of commercial business, resulted in a 12-basis-point decrease in gross margin percentage for the quarter.

We are maintaining our annual guidance of gross margin of 48.4% to 48.8% of sales versus 48.6% in 2010. While we do anticipate further inflationary pressures, we expect the pricing environment in the industry will remain rational and inflationary pressures will be effectively passed on to the consumer.

SG&A results for the quarter were very strong at 33.5% of sales versus 34.5% in the prior year. The improvement was driven by improved leverage on store occupancy costs, improving store payroll efficiency and improved leverage on headquarters expenses. These efficiencies were partially offset by increasing fuel costs related to store delivery vehicles, and we would expect that headwind to continue throughout the year.

Looking at average SG&A per store for the second quarter, we were able to keep the expense flat through tight expense control. Year-to-date, SG&A per store has increased less than 1%, and for the full year we now expect to see an average per-store SG&A increase below 1% as we leverage store [activity] cost in the acquired CSK stores, leveraged headquarter expenses and benefit from the reduced store project costs related to conversions and training in 2010.

Operating margin for the quarter was 15% of sales, representing an 83-basis-point improvement over the prior year on an adjusted basis as we were able to tightly control expenses. Based on an operating margin of 14.6% of sales for the first half of this year versus 13.7% in the prior year on an adjusted basis, we are updating our full-year operating margin guidance to 14.2% to 14.6% of sales as compared to an adjusted operating margin of 13.6% in 2010. As a reminder, our fourth-quarter operating margin is typically the lowest operating quarter based on sales volume and mix.

Diluted earnings per share for the second quarter was $0.96 per share, which represents an increase of 19% over an $0.81 per share adjusted diluted earnings per share in the prior year, which excludes the impact of the CSK DOJ settlement charge. Year-to-date adjusted EPS, which excludes charges related to the Company's new financing plan in 2011 and the aforementioned CSK DOJ settlement in 2010, was $1.78 per share versus $1.51 in the prior year, which is an 18% increase.

At the end of the second quarter, our adjusted debt to adjusted EBITDAR was 1.6 times, which is consistent with the beginning of the year but remains well below our long-term targeted leverage range of 2 to 2.25 times. While we will incrementally increase our leverage over time, we remain very committed to maintaining our investment-grade ratings.

Looking at our balance sheet at the end of June, two things stand out. First, we are sitting on an unusual amount of cash, which we will discuss in a moment. And second, we are making significant progress towards improving our net inventory investment. Reducing our per-store inventory as well as improving our vendor terms both represent great opportunities for us to improve our net inventory investment position.

Year-to-date, we have opened 87 new stores with an increase of inventory of only $12 million. On a per-store basis, inventory at the end of the quarter was $557,000 versus $567,000 per store at the end of 2010. We expect to see continued reduction in our per-store inventory over the next few years as we continue to work hard to refine the mix and depth of inventories at converted CSK stores and new DCs.

For the year we continue to believe we can add 170 new stores with only a small increase in gross inventory.

At the end of the quarter, our AP to inventory ratio was 54.8%, which was a tremendous improvement over the second quarter of the prior year in December of 2010, which were 44.2% and 44.3%, respectively. A portion of the improvement is the result of some timing issues related to product changeovers. However, the biggest improvement is a result of permanent improvement in payable terms which we have been able to negotiate with vendors as a result of our improved vendor financing program. We have been able to enhance our program to reduce supply chain costs based on our new unsecured debt structure. We expect to continue to increase our AP to inventory ratio over time.

Cash flow from operations improved $206 million over last year, which represents a 58% increase. This strong improvement was driven by increased adjusted net income and the improvement in net inventory investment.

Looking at capital expenditures for the first six months, our spend of $151 million was $32 million less than last year. This decrease relates to the 2010 CapEx on new DCs to support the CSK conversions. For the full year we're reducing our forecast from between $310 million and $340 million down to $290 million to $320 million, based in part on timing and in part on below-plan expenditures.

The strong improvement in our cash flow from operations, coupled with CapEx spend below last year, drove a significant improvement in our free cash flow. The first six months free cash flow of $411 million was a $237 million improvement over the prior year. For the full year, expected free cash flow guidance, we are increasing our estimate from $360 million to $400 million, up to $425 million to $475 million. We have increased our guidance based on expected lower net inventory investment at the end of the year, lower CapEx and lower than planned cash taxes based on changes to the tax law.

During the quarter, we continued to aggressively repurchase shares. Prior to June 4 when we entered our restricted trading window, we executed a 10b5-1 plan which allowed us to continue to be purchase shares during the closed window. At the time, our stock had been trading in a relatively tight range between $58 and $60 and we developed our 10b5-1 plan with that range in mind. During the closed window, our share price saw significant appreciation, and as a result, we have not repurchased as many shares to date as we had anticipated. The result of this lower-than-expected level of repurchase was the quarter-end cash balance of $269 million. Our 10b5-1 plan remains in effect until our trading window reopens on August 2; and, when it does, we anticipate continuing to execute our repurchase program.

Our guidance for both the third quarter and full year takes into account the shares repurchased through yesterday but does not reflected the impact of any potential future share repurchases. For the third quarter our diluted earnings per share guidance is $0.98 to $1.02 per share. For the full year our adjusted diluted earnings per share guidance, which excludes the non-recurring charge related to the refinancing plan mentioned previously, is $3.53 to $3.63 per share.

The second quarter represents another solid operating performance on many fronts, and we remain confident in our ability to execute on our plan through the remainder of the year.

At this time, I would like to ask Latasha, the operator, to come back, and we will be happy to answer your questions. Latasha?

(Operator instructions) Alan Rifkin, Barclays.

Congratulations, gentlemen. Greg, if we go back and look at the stores supported by, let's say, either Stockton or Phoenix, which were converted later in the process, and compare them to, let's say, the upper Midwest or Western Texas or even Seattle, which were converted earlier in the process, can you maybe just shed a little bit of color on the difference in the operating performance of those two groups of stores?

Yes, I can, to some degree. The stores that -- of the converted stores, the ones that took off the quickest and perform the best out of the gate have been the stores that we converted in the upper Midwest and Texas. That's partly due to the fact that the O'Reilly brand was recognized there. We had team members that existed in markets close that we were able to use for training and, in some cases, move them into some of those stores to help teach our strategy. And we had the distribution capability to those stores that allowed us to very quickly execute the dual-market strategy that we executed.

And then, of course, with the Seattle stores and the other markets that we've converted, we've had similar results, but they didn't come on quite as quick, mainly because of just the fact that there's a training curve and that the team members had to get over that training curve before they were really capable of executing our business model.

If you compared those to Stockton and Phoenix, those two markets probably haven't done as good as the two that you mentioned, the upper Midwest, Texas and Seattle, putting the upper Midwest and Texas into one group and Seattle in another. Those two would fall a little bit behind those. Some of the other markets, like Southern California, for instance, which is a very big market supplied out of Moreno Valley -- they've done incredibly well, and they would be more comparable to what we saw in the upper Midwest and Seattle.

So, on balance, they all tend to kind of migrate towards the same spot and the same rate of comp or at least a similar rate of comp, but the time it takes to get there has varied some, depending on, probably, people more than anything.

I might add there, the first stores we converted over all in one big project. And we had the flying conversions, the out-front converted, everything was short and a lot of pain for a little amount of time. These other markets, we've had these store remodel/resets been going on all through this transition, too. So that combined with the computer conversion and the learning curve has kind of made a little difference in their speed on picking up our whole strategy and implementing it.

In general, what we've seen is the longer the stores have been converted, the better they have performed as we've gotten over those training issues, as we've had time to start developing commercial relationships and bolstering our DIFM business. So the stores that have been converted the longest continue to perform the best, but we see a similar trajectory, given the time after conversion between the different convergent classes.

Okay, so stores converted the longest are performing the best. Okay. And if I could just follow up with a question, if you don't mind -- Greg, with the significant increase in free cash flow together with you guys pretty aggressively buying back stock since you first announced the program at the beginning of the year, can we expect, going forward, a greater emphasis on share buybacks and possibly even a dividend implementation in the future?

Well, I think what I would say is that our first priority with use of free cash flow is to grow our Company and be opportunistic when it comes to expansion. And that has been the case for a long time, and it's clearly the best return to our investors. To the extent that we have excess cash that we can't use to grow, our first priority will be share buybacks. And I would expect that in the future, as we use up the authorized capability that we have, that we will be looking to expand our share buyback authorization.

Today, we have no plans to implement a dividend program, but that could change in the future. Our Board has not yet seriously considered approving that, in light of the fact that we have the expansion opportunities that we have and the fact that we have implemented the share buyback program we have. But that could happen in the future, but we have no current plans to pay a dividend right now.

Okay, thank you all very much.

Kate McShane, Citi Investment.

I wondered if you could get a little bit more specific on which categories you're seeing the most inflationary pressure. And what gives you the confidence that prices will be able to be passed through in the back half of the year, when there seems to have been a little bit more promotional activity during the quarter?

Well, the primary product that we see the most inflationary pressure on is lubricants. With oil prices going up, motor oil, transmission fluids, all the lubricants that are used in automobiles are increasing. Those are highly promotional products, especially during the peak of our selling season in the summertime when we are working to try and drive traffic into our stores.

So that's where we are seeing the majority of it. Although that does carry over into some other products, that we are -- oils and various products like that are used in the manufacturing process, are used in transportation. So we've seen some inflationary pressure in other products, including friction materials were heavy resins are used and things like that.

We feel confident in our ability to pass these increases along to the consumer, although what Tom and I mentioned in our prepared comments is that some of the promotional activity that we plan sometimes eight weeks out or really even further than that, but by -- within six to eight weeks out, we are pretty well locked into the promotional activity that we would have plan for a specific period. Because costs have escalated as fast as they have, we have had little bit of problem keeping our costs in parity with those promotional plans. And for that reason, we had some drag on gross margin during the quarter related to some of the promotional, mainly motor oil type products.

Okay, that's very helpful, thank you.

Michael Lasser, UBS.

Tom, can you expand on your comments about most of the comp increase being driven by a rise in average ticket? Does that suggest that any transaction gains that you are seeing from the commercial business are more than being offset by softness in transactions on the DIY side?

Well, what we would say about that is that, when we look at our average ticket going up, it's also a mix shift, as we have a higher percentage of do-it-for-me business as a mix of the total, and that relates to the CSK conversion stores. When we look at the DIY side of the business, we continue to sell more and more hard parts.

But, to answer your question directly, we were pretty neutral on ticket in total, with pressure on the DIY side, so a below zero number and above zero number on to do-it-for-me side of the business.

And is that, as things have -- as trends have improved a little bit in July because you're facing a more difficult comparison, so it sounds like (inaudible) a little bit and has gotten a little bit better as the comparisons become more difficult -- is that because the commercial business has gotten better, or the DIY business has gotten better with the weather?

We have seen improvements in the trends on both sides of the business here in July.

Okay, great, keep up the good work.

Chris Horvers, JPMorgan.

Recognizing that you don't disclose the comp delta or the different comp by CSK versus core O'Reilly, can you perhaps talk about how the comps have ebbed and flowed over the past year and a half? Do you see a relative acceleration similar in CSK and O'Reilly as you went into the back half of last year? And then, as you reach these tougher comparisons, are they both similarly decelerating on the comp side, at a similar pace?

When we look at the -- it's kind of a tale of two things. Core O'Reilly ramped pretty consistent on do-it-for-me/do-it-yourself last year. And then, of course, on the CSK side, we put a lot of effort into growing the do-it-for-me business and there was a lot more opportunity, so that comp has run faster.

As the stores have been converted longer, they comp better and better. So we're kind of at the point where all of them have quite a bit of time that they have been out there from a training perspective from a -- penetrating the do-it-for-me side of the business, and they're actually -- they are definitely leading the comps for the Company.

Okay, so basically, actually, so that -- is it fair to say, then, yes, core O'Reilly has seen the accel/decel, but CSK has actually had -- has decelerated, didn't decelerate at the same pace because as it aged, it improved. Is that what you're saying?

Yes. Our expectation, when we look at the beginning of the year at 2011, was that core O'Reilly was going to have a tough comparisons, especially in the third and fourth quarter. And so did CSK, but our expectation was that we were going to see an acceleration on a two-year stacked basis as the stores have been converted longer, as they had better penetration to the do-it-for-me business, as they became more familiar with our business model. And we continue to expect that.

Okay --

We continue to expect that.

I got you. And then, as you -- granted, I know the comparison went up 300 basis points 2Q to 3Q '10, But was there -- was that more back-half weighted to the quarter? Maybe some insight on how the monthlies stacked up in the third quarter of last year?

Yes. The third quarter that we are in right now, our performance, what we are comparing to our performance last year was better in the back half of the quarter than it was in the front half of the quarter. All three periods that we look at monthly, of course, all three periods were strong periods, but July is our easiest compare.

And then one final question, just sneak in here. On the expense side, very impressive in the second quarter in winding down some of those expenses. As you look at the comparisons to the back half, it looks like SG&A per store -- you did like a -- I have about a 1.8% in 2Q '10, and you go up to a 2.6%-ish. So is it fair to think that, since those expenses are winding down, that you should see an equivalent -- why wouldn't you see an equivalent drop in SG&A per store into the back half?

Well, two things. We have a lot of new stores to continue to open. We have a higher store count this year and new stores that are not as efficient. The second item will be -- Ted talked about it -- staffing is a very delicate item. We need to make sure that, especially -- really, in all our stores, that we are appropriately staffed for the business and have hours to go out and build the business.

Yes; especially at CSK, the low-hanging fruit this year came off pretty quick, as our sales did well and we got all the projects behind us and we were able to better focus on staffing and using our scheduling program. Today, we want to make sure that -- to feed the sales, that we make sure the CSK stores have the right amount of help. And we think we have opportunity there, but not as much as maybe we had this year. We will want to leverage our payroll with better comps and not try to over-cut the payroll before it's time, reduce the payroll.

Thanks very much.

Gregory Melich, ISI.

A question on the SG&A, the leverage performance, which is impressive -- I'm just curious how much of it had to do with the -- you mentioned the change in the commission structure at CSK. And sort of where are we in that process of getting them more on an O'Reilly-type pay system?

There would have been no -- the positive effect I referred to as a result of the commission structure is more just getting everyone focused on accomplishing sales goals and measuring productivity, making sure that a parts specialist who is well-compensated is generating the amount of sales that would justify that compensation and just having measurements in the store and having some competitiveness in the store to create the environment that we want to create in each store.

If there's a positive SG&A effect because of that, it would be a result of just better sales productivity because there would not have been a pure salary or pay decrease as a result of the commission structure. It would simply be an incentive that's put in place to reward those that are highly productive and reward those that are not as highly productive less.

Great. And then on the gross margin side, you mentioned the LIFO reserve. Is it fair to say, given the timing of the promotions and that that LIFO reserve is behind you and easier compares, that that's why we expect gross margin to get better in the back half, or is there something else we should be watching, given you are trying to take down inventory, etc., that could hurt the margin?

Well, when we look at our gross margin from last year, the second quarter was our best gross margin percentage. If we look at where we are year to date, we're comfortably within our guidance range and very similar to where we were last year at this time.

That's what you are reflecting in the guidance with -- how you think -- this feels like the biggest pain that you have come from where you sit today?

I don't know that it's -- we talked about in the past that we will continue to have gross margin pressure as we increase the mix of do-it-for-me business, which carries a 400 basis points lower gross margin percentage. But we also feel like we have a lot of initiatives out there and opportunities to grow it to offset that pressure. For this quarter we just happened to get caught in a position where we had a lot of items coming up on add, prices hit us right before those promotions occurred and you are, as Greg said, locked in.

So we don't look at -- we don't look at it as a permanent challenge to gross margin above the normal retail issue of always trying to maintain our good, solid gross margin.

And then, Greg, something else I might add is that there are some other things, you know, just mitigating factors with regard to things we can do to grow gross margin as we bring in a higher mix of do-it-for-me business, and some of those things we are in the process of implementing; others we're in the process of exploring.

Our Company is one that has typically used brokers and distributors here in the US to bring in products from overseas. Over the past -- well, year, two years and more aggressively in the past several months, we've made the decision to pursue some of those products more direct from some of the overseas manufacturers. Those things will create positive effects on our gross margin over time. And there has just been some other things that we can do relative to revenue management on a by-customer bases, where we can just apply more science to the way that we manage gross margin by commercial customer and just being more in tune with what our competitors are doing on the retail side and making sure that we do everything we can to optimize our margin on the retail side.

So we have some factors that should play positive for our gross margin in the quarters to come that have not yet been fully implemented.

Thanks.

Matthew Fassler, Goldman Sachs.

Two questions on the numbers -- first, on LIFO, you gave us the LIFO charge. I know it's not always perfectly straightforward how LIFO flows through gross margin. So can you talk about the impact that the LIFO number had on your gross margin rate year on year?

Based on our LIFO index, the change is -- between 5% and 10% of the gross change rolls through gross margin, as a (multiple speakers) pressure in this particular case.

So it's a couple of million bucks?

That's fair to say.

Okay, so pretty insignificant. And is there a kind of a tail to that, or is this all we are going to see in terms of the impact it has on your reported gross?

That would be the only -- because we had price increase in the second quarter, it won't impact. It had a LIFO charge in the second quarter; it won't impact our third quarter, to the extent we don't have additional price increases.

Got it, okay, thanks. And then the second question, just a bit more on payables to inventory -- I think, on the first quarter call you indicated that the improvement would be somewhat back-end loaded. It sounds like, even with some one-offs and some timing issues, the underlying rate of improvement is pretty good. So how should we think about the payables ratio progressing now versus typical seasonality? Will we give a little more back, or is this a pretty good base to build off of here?

Well, we experienced a quicker ramp than we thought because we were able to get vendors to sign up not just for their payables going forward but for all their payables outstanding. And that's what has jump-started the program and got us results faster. We continue to have tail wind to add more vendors and have those vendors that didn't convert their whole balance, to fill up their bucket, so to speak.

But we also face -- at this point in the year, we are at our highest inventory churn. So we have our best AP to inventory ratio from a seasonality standpoint, as you spoke. We have a lot of work to do between now and the end of the year. We would expect to be somewhere in the range we are now with those two being offsetting forces.

And I ask in part because, when you look at the free cash flow guidance relative to the earnings guidance, it seems like you might be implying some give-back of the progress that you made, and that if you were to actually hold current levels towards year end, free cash flow could be substantially higher. Is that a fair statement?

It will depend on a number of factors. Typically, for us, the third quarter is a positive free cash flow quarter and the fourth quarter is a negative free cash flow quarter. Based on sales volumes, reductions of AP to inventory ratios are seasonally driven, and then cash taxes.

Okay, thank you so much.

Colin McGranahan, Bernstein.

First question, on expenses -- not thinking about leverage but thinking about actual dollars and looking at it on of per-foot basis by our math, it fell -- SG&A fell like about 0.7% per foot. So there was actual reduction of SG&A dollars on a per-foot basis. How much of that was CSK kind of reduced integration labor and cost? How much of it was productivity, labor productivity, specifically and -- across the store base? And was there anything unusual or that wouldn't be persistent in terms of costs falling, not just leveraging?

Well, we had a number of conversions in the second quarter of last year with Denver and Salt Lake City converting, and had a lot of activity. From a being negative standpoint, I would say that that is what is generating that negative. We also continue to look for ways to reduce our expenses. Looking at the model, at CSK, when we look at the negative it's mostly coming out of CSK because we really feel like, and what we have seen historically is we run tight expenses at the core O'Reilly stores.

But we've also had a lot of traction with reducing rent in the current environment. So those are kind of the two drivers that allow this to become negative from a square footage standpoint.

So, Tom, no plans to bunk three to a room instead of two?

Don't give anybody around here any ideas.

Second quick follow-up -- just, again, by our math it looks like there was maybe around 2 percentage points of benefit or just under that from growth of CSK, if we kind of assume some left over time. Is that reasonable? And if so, the core, then, was kind of running on a 2.5 comp base?

Those are, in general, the numbers. The core stores and new stores are a high -- are two-thirds of the business, so that might be a little bit light.

Okay, great, thank you very much.

Tony Cristello, BB&T Capital Markets.

Question on CSK -- I wonder if you could update us sort of on what the mix is today on the DIY versus the commercial, just so we can kind of get an idea of the initiatives, the replenishment, and sort of gauge the success that you've had there growing that commercial side of the business.

They have grown to where they are about a 70/30 mix, right; that would be real close.

And with the demographics and with the locations of the stores, is there still the belief that you can get that number closer to the 50-50? Are there some things you have seen operationally and competitively that may have changed that thought or, perhaps, the ramp time to get there?

No. We still think we can get close to that. We continue to believe that there's a portion of the stores -- I would say, just to use a round number, somewhere around 100 stores that would be in areas of markets that would not be as conducive to serving the commercial customer, is what we would ideally like. And that will cause the -- if we look at historical CSK as a whole, that will cause us to probably not get completely to the mix rate that we were at with core O'Reilly, but we will get close.

And again, our target is not necessarily to get to that 50-50 rate, to just have -- you know, our goal is to have as much penetration both on the DIY side and the do-it-for-me side as we possibly can. And in core O'Reilly, that has historically led us to about a 50-50 mix. And I would suspect that the CSK stores, over time, will get to approximately that mix.

Okay, but it's sort of the replenishment capability now that is really what was needed to sort of start to get you to that next level, at least (multiple speakers) --

Yes. It's the replenishment capability. It's having the systems, the pricing abilities, the teams in place that have the -- that can develop the relationships with the shops. It's having all the equipment that the shops need to run their shops and being able to partner with a supplier that can not only supply their parts but supply the products that keep the shop running. It's having the electronic connections with the shops. It's a long list of things that we now have in place that have those stores in a good position to become more of a dominant supplier on the commercial side of the business.

Okay, thank you.

Jack (inaudible) [Focus Research].

You have had very good expense control with 3.8% more average stores, only being up 4.2% in SG&A. I was wondering if you could tell us what particular productivity enhancements you are implementing and to what degree that can continue longer-term, let's say, through 2012 and what -- in other words, in 2012, what kind of a total sales gain do you need to have continued SG&A leverage?

Tom and Ted may have something to add to this, but I think the -- and this is a very general statement; but I think you will understand it well, Jack, is that if we look just at the CSK stores, because I feel like we've had good productivity controls in core O'Reilly forever. But at CSK, I don't think they did a very good job without us in managing their productivity by team member. They didn't align the productivity of team members in the stores, for instance, with what that team member was making from a compensation standpoint.

Part of our management structure is to make sure that our district managers and our regional managers do that ongoing. And what this does is, not necessarily from a pay standpoint, but from a sales productivity standpoint, it creates kind of a competitive environment in the stores so that everyone is seeing how much each team member is selling. And those team members want to do better and want to sell more.

And then, in addition, we make it -- we create an economic incentive for them to want to sell more. We pay them a commission for selling more. And then, to offset the factor that you can have where we've got to change of Planogram or we are changing over a product line, and you have team members that might say, well, I don't want to do that kind of work because I'd rather be selling products to compete better -- we have kind of a team commission plan so that the team members that are doing that kind of work also participate in the commission program by being part of a team that's, overall, more productive.

So I think that has been the biggest change that we've implemented with CSK that has improved the productivity.

I might add that there were just a lot of CSK stores that were medium volume or maybe even small volume. They had some great volume stores; but when you are more retail, you have to have X number of people to keep the store open seven days a week, the hours, whatever they may be. As we've added the wholesale business, we have been able to add that to the business mix without adding as much salary as maybe we would have if we didn't have that retail base with the X number of people in the store. It has more or less been kind of incremental to the store staffing, to a certain degree, sometimes. And that has helped us leverage the payroll there.

Jack, to answer the other part of your question -- this is Tom -- obviously we are growing sales without growing SG&A thus far this year, and it relates to this item that Ted and Greg just talked on, of getting team members that are productive and buy into our culture and are focused on what we want them to be focused on.

The other part is, we spent a lot of money on training and conversion projects last year, both at the CSK stores and then, when you look at core O'Reilly, all the store managers that went out and spent a week or two training, and many of them did multiple tours of that.

So that has helped this year, and that is driving that. When we look at next year, we would expect to continue to be slightly below our historical leverage point as we continue to have good productivity gains in the acquired stores, based on building staffs to understand the compensation structure are motivated by the compensation structure -- actually get paid more but grow sales faster.

So you're saying that you expect continued SG&A positive leverage next year compared to this year?

Somewhat, not to the extent of this year.

Okay, thank you.

We have reached the time allotted for questioning. Back to you, Greg, for any closing remarks.

Well, I would just like to thank everyone for their time this morning. We will be working hard in the third quarter to generate solid results, and we will look forward to reporting those results to you in October. Thanks.

This concludes today's conference call. You may now disconnect.