O'Reilly Automotive, Inc.
Q3 2009 Earnings Call Transcript

Published: 29 Oct 2009

[Operator:]

Good morning. My name is Terry and I will be your conference operator today. At this time, I would like to welcome everyone to the 2009 O’Reilly Automotive third quarter earnings release. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) I would now like to turn the call over to Mr. Tom McFall. Sir, you may begin.

[Tom McFall:]

Thank you, Terry. Good morning everyone and welcome to our conference call. Before I introduce Greg Henslee, our CEO, I’d like to read a brief statement. The company claims the protections of the Safe Harbor for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by forward-looking words such as expect, believe, anticipate, should, plan, intend, estimate, project, will or similar words. In addition, statements contained within this press release that are not historical facts are forward-looking statements. Such as the statements discussing among other things expected growth, store developments, integration and expansion, business strategies, future revenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions that are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions including, but not limited to competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our ability to hire and retain qualified employees, risks associated with the integration of acquired businesses, weather, terrorist activities, war and the threat of war. Actual results may materially differ from anticipated results described or implied in these forward-looking statements. Please refer to the risk factor section of the company’s Form 10-K for the year ended December 31, 2008 for more details. At this time, I’d like to introduce Greg Henslee.

[Greg Henslee:]

Good morning, everyone and welcome to our third quarter conference call. Participating on the call with me this morning is, of course Tom McFall, our Chief Financial Officer; and Ted Wise, our Chief Operating Officer; David O’Reilly, our Executive Chairman is also present. It’s now been a little over 15 months since we closed on our acquisition of CSK Auto and went about the task of integrating the two companies. Clearly, this has been a huge undertaking considering the pure scope of the work that has been done and is yet to be done to complete this integration. I’m extremely proud of the spirit, in which our management team has approached this large task and I’m very pleased with our results so far. All the way from consolidating corporate headquarters functions to showing our new customers in the western half of the country, what O’Reilly Auto Parts is all about, I think our team has done a great job getting combined company off to a great start. At the same time, we’re very fortunate to have such a solid team driving our business in the core O’Reilly markets. We’ve not missed a beat in our core markets as we’ve gone about the process of combining the two companies, and I think that speaks volumes to the quality of our core team and to the commitment our team members make to our culture values and to ensuring our company’s success and I want to congratulate all 44,000 members of team O’Reilly for the great job they’ve done in the third quarter. We continue to try and disclose as much information as we think is reasonable considering the competitive environment with regard to the components of our comparable store sales. Similar to the disclosure of our second quarter performance, we again want to speak to each of the components that contributed to our 5.3% consolidated comp store sales growth during the third quarter. We plan to disclose each of these components again when we report our fourth quarter and year end performance in February of next year. However, we plan to go back to reporting our company’s total comparable store sales performance as a single consolidated comparison with our 2010 reporting. Business during the third quarter generally remained very steady throughout the period. Continuing the trend, we’ve experienced throughout the year, and that steady trend has continued to this point in the fourth quarter. The stores that are on the O’Reilly point of sales system generated a 5.3% increase in comparable store sales. I’ll break the O’Reilly system generated comp down into the following three components

[Ted Wise:]

Thanks, Greg. Good morning, everyone and again, thanks for joining this morning’s conference call. Well, at the end of third quarter, we increased our store count to 3,415 stores. This was an increase of 32 new stores, giving us a total of 140 new stores so far for this year. This excludes four store closures announced as part of a group of 18 overlapping core CSK stores that we identified to be closed and consolidated. The remaining 14 stores will be consolidated in the near future. As you can see, we are well ahead of our expansion goal for 150 new stores in 2009, which allows us to redirect more of our store installation teams to work on the store resets in the western CSK stores. Now I’ll give you a brief overview of our new store expansion activity by state. North Carolina led the growth with five stores last quarter, Tennessee and Wisconsin followed with four new stores each and Ohio had three new stores. The remaining 16 stores were opened in 12 different states. As far as leading expansion state year-to-date, North Carolina again opened 26 stores, Ohio 17 stores, Texas 16 stores, Georgia 12 stores and Wisconsin nine stores. Now in addition to the 32 new stores last quarter, we also relocated three stores to new prototype buildings and completed 13 major store renovations in the core O’Reilly group. Of course we also finished the remaining 54 Murray’s store conversions in the quarter. As a reminder, this completes the Phase I of the CSK changeover involving the 123 Checker Stores in the upper Midwest states, New Mexico and South Texas, as well as the 141 Murray’s stores in the Chicago and Detroit markets. As we enter into the second phase of the conversion, our installation teams are moving to the western states to address the resets of the remaining CSK stores. I want to take this opportunity to, again thank our store operation teams for the outstanding jobs in accomplishing these Phase I changeovers during this past year, as well as installing the 140 new stores, 40store renovations and 13 store relocations in the existing core O’Reilly markets. Now on the distribution side, in August, we moved our Kansas City distribution centre into a new 2000 square foot building along with upgrading warehouse management system, which will improve productivity and allow us to grow more stores out of Kansas City market. Our most recent new distribution center installed in Greensboro, North Carolina in May, continues to ramp up in sales and productivity as we add new stores in surrounding market areas. After the addition of our four new distribution centers in the western states next year, we will operate from 23 locations providing nightly service to our stores in 38 states. Based on our distribution capacity, we are in good shape to continue expanding into new market throughout the states we currently operate in. The West Coast store conversions begin with the opening of the new Seattle distribution center on November the 9, this includes the changeover of 194 Schucks stores that will be changing out computer systems and we will be converting at a rate of approximately 30 stores each week to our nightly stock replenishment system. The Moreno Valley distribution center in Southern California is scheduled to open on January the 18 and will support the transition of the 239 Kragen stores. Denver distribution will open on March the 15 and support 85 Checker stores and the Salt Lake City DC will open May the 17 to support 87 Checker stores. That leaves the two existing CSK distribution centers located indicated in Dixon, California and Phoenix, Arizona. After additional evaluation of the Dixon DC, it became apparent that we needed a larger facility for the current 276 stores and future growth and since the property didn’t allow for expansion, the decision was made to move to a new 520,000 square foot distribution center located in Stockton, California and this move will take place next September. Stockton will then be able to handle the conversion of the 276 Kragen stores in the center and northern part of California and then to finish, the Phoenix DC conversion and the last 151 Checker stores will convert systems in November of next year. The opening of our new western distribution capacity is an exciting time for our company and we are looking forward to providing our customers greatly increased levels of service as we rollout our POS system to co-insight with the new distribution centers. The final stage of the store conversions, which include are the out front resets and remodels and in the final exterior sign change will start following each distribution opening and the store conversion of systems. These are underway now and will continue throughout next year. On conversion goal is to be completely finish and operating under the O’Reilly brand by the end of the first quarter of 2011. These stores will continue to grow stronger as we move forward with each of the changeover phase including our store, system conversions, nightly distribution, front room resets, and interior decor work and then finally replacing the exterior signage. In the core CSK stores, most of the heavy lifting and the huge task of changing over the hard parts lines and additions is almost finished and now with improved inventory levels, increased hub store support and the new market driven pricing. We are helping our stores service new customers both retail and installer. The co-branding and our print advertising and our radio advertising, is sending out the message of more parts and lower prices to our customers. We are very pleased with the level of enthusiasm and commitment from our new team members as they perform the changeover projects and learn all aspects of the O’Reilly sales plan. The task of performing installer sales entitlement as been finished in all CSK markets and we are very focused on training and improving the level of parts knowledge of the store team member. In addition our district managers are recruiting and staffing our stores with additional parts professionals that are needed to continue the effective rollout of our first call installer program to the additional stores. We continue the evaluation and expansion of our sales teams and our store leadership teams to mirror the O’Reilly model, which provides the time needed to focus on integration task, develop installer, customer relationships and build store teams that will grow sales and profits. Also as the stores go to the O’Reilly systems, we will begin the transition in our stores to our team incentive pay plan and our store manager sales and profit commission plan. Our compensation plans have been very successful and a key ingredient in growing our sales and profits by rewarding our store teams and our managers for providing outstanding customer service. As you might expect, we’re proud of this past quarter’s results and like Greg, I would also like to recognize and give credit to our hard working and dedicated team members, as well as all of our customers that support us with their business. This level of sales and profit growth is a result of a very coordinated effort from an entire team, including corporate support, distribution and sales and store operations. All focused on giving great customer service. The continued balance of our DIY and our installer sales growth reflects the ongoing effectiveness of our dual market sales strategy. While the core O’Reilly 6.8% comps is outstanding the CSK store comps of 5.2% in the last quarter is most encouraging and a very strong and positive indicator of the growth we can expect to experience as we continue to execute our business plan in the stores. I will now turn the call back over to Tom McFall. Thanks.

[Tom McFall:]

Thanks Ted. Now we’ll take a more in depth look at the numbers. Sales increased $147 million, 13% over prior year to $1.26 billion for the quarter. The increase was attributable to a $51 million increase in comp store sales a $37million increase in non-comp new store sales, a $3 million increase in non-comp non-store sales and $56 million in CSK sales for the period we did not all CSK in Q3 of 2008, which was July 1 through the 11. At the time we purchased CSK their operating margin was very low and as a result including July 1 to July 11, 2008 in the third quarter of 2008 would not have a significant impact on the EPS for that quarter. For the year we estimate our total revenue will be approximately $4.85 billion. Gross profit was 48.5% of sales for the quarter, versus 45.6% in the third quarter of 2008. The improvement was driven by product, acquisition costs negotiated with vendors based on our increased post acquisition purchasing levels. For the third quarter, gross profit increased 28 basis points over the second quarter of 2009, this increased was driven by our continued alignment of product offerings, across the chain and improved distribution efficiency resulting from the completion of the CleanSweep store product lifts. On our last call, we estimated the buying related synergies would realize in 2009would be between $60 million and $65 million. We now feel, we’ll achieve the upper end of that range primarily based on the rapid rate of product alignment. We continue to be confident with our total annual estimate of $90 million merchandised acquisition cost savings starting in 2010 and ongoing thereafter. For the year, we estimate our gross margin as a percent of sales will be approximately 47.9%. SG&A for the quarter was 36.7% of sales versus 37.3% in the prior year. The decrease in the prior year was due to our efforts to reduce duplicative and non-needed expenses from the CSK SG&A infrastructure and lower fuel costs, offset in part by higher investments and store payroll to accomplish the ongoing line conversions and build the commercial business. The 38 basis point increase in SG&A as percent of sales from the second quarter of 2009 to the third quarter was a result of some increase in energy costs, which impacts are based on utility expenses as well as further investment in store payroll at CSK implemented to grow the commercial business. We continue to very closely monitor our investment in the expansion of CSK commercial business and given the acceleration of comps that the CSK and converted Checker stores during the quarter we are beginning to see solid results. Operating margin for the quarter was 11.9%, an improvement every 350 basis points over the prior year. The LTM operating margin as of the end of the third quarter was 10.3% of sales and is quickly closing in on our pre-acquisition LTM operating margin of 11.8% for the period ended June 2008. As we previously stated, we expect our operating margins post acquisition to exceed the pre-acquisition operating margins once the integration is complete. Net interest expense for the quarter was $11 million, which was flat with the prior year and slightly higher debt levels, lower LIBOR and fact that the debt was outstanding for the full third quarter in 2009. We expect 2009 net interest expense to be $44 million to $46 million-dollars. The tax provision for the quarter was 37.4% of pretax income as compared to 41.8% in the prior year. Prior year rate, included a one-time charge related to the change in tax liabilities related to the acquisition, excluding that one-time charge, last year’s third quarter tax rate was also 37.4% of pretax income. We expect the full year tax rate to be 38.2% to 38.4% of pretax income. Adjusted EPS for the third quarter was $0.63 per share, which represents a 58% increase over the adjusted EPS in the third quarter of 2008. For the year, adjusted EPS was $1.74, a 37% increase over the prior year. The only remaining acquisition charge we expect to record is the amortization of trade names and trademarks recorded as part of the purchase price allocation. We’ll amortize the remaining value over the next year as we convert all the stores to O’Reilly brand. For the year, the impact of this non-cash charge will be reduction to GAAP EPS of $0.03. Now move on to the balance sheet. The average inventory per store at the end of the quarter was $543,000, which was a 17% increase from the average first store inventory of $463,000 as of last September. The increase was the result, we acquired CSK stores inventories been below the store core O’Reilly inventory levels as of September of 2008, combined with the additional inventories currently in the system related to store conversions, product changeovers and inventory beginning to be stocked in the Seattle DC. We anticipate at the end of the line conversion process, store conversions and DC ramp up the chain wide inventory per store will be similar to pre-acquisition O’Reilly levels. Our reserve for LIFO at the end of the quarter was $12.8 million, which was a decrease of $15.6 million, which was a decrease of $15.6 million from the previous quarter. This significant decrease in our reserve to adjust last buy inventory to LIFO over the last two quarters is consistent with the significant product acquisition price decreases negotiated with our vendors. Accounts payable of $889 million was 47.9% of inventory, as compared to 49.9% in the prior year. Our AP to inventory ratio is negatively impacted by the additional inventory in the system related to the expense of line changeover profits and the elimination of a major consignment program with one of our venders. Moving onto capital expenditures, CapEx was $86 million for the quarter, bringing the year-to-date total to $317 million and we are maintaining our estimate for the ‘09 CapEx spend to be $400 million to $429 million. Depreciation and amortization for the quarter was $37million and we anticipate full year depreciation and amortization to be approximately $150 million. For some debt numbers, total borrowings were $704 million at the end of September, this year compared to $665 million at the end of the third quarter of 2008. The increase net of $38 million was used to fund new store growth at core O’Reilly and the conversion investment including both CapEx and net inventory at the acquired CSK stores. However, the majority of these investments have been covered by internally generated cash flow. For the year, we have decreased our debt outstanding by $29 million and currently have $538 million of available borrowing capacity under our ABL facility. As we enter our season of higher working capital needs and we continue to invest in CapEx for the CSK conversion, we anticipate our debt levels will increase during the fourth quarter. We currently estimate our new debt balances will be between $730 million and $750 million at the end of year, which means our borrowings, will be essentially flat with the end of 2008. Now for some other financial information, cash flow from operating activities for the quarter was $136 million versus $74 million in the prior year. The increase in a quarter was driven by higher net income after deferred income taxes. Year-to-date cash flow from operating activities was $289 million, which was flat with the prior year. Higher net income after deferred taxes and depreciation will fully offset by higher level of net inventory investment required for the CSK line conversion process. Stock option expense for quarter was $3.3 million, compared to $2.6 million in the prior year and year-to-date stock option expense was $10.2 million compared to $5.5 million in the prior year. Both increases were driven by the options issued in connection with the CSK acquisition. To recap our guidance, for the fourth quarter our comparable store sales guidance for O’Reilly and converted stores is 2% to 4%. As we faced tougher comparison incur some drag from the stores that will convert in the fourth quarter, as the conversion process initially creates some headwinds related to training issues. The CSK comp guidance is 3% to 5% as we continue to see solid results from our selection and the consolidated comp guidance is 2% to 4%. Our GAAP EPS guidance for the third quarter is from $0.47 to $0.51 on the 139.6 million shares. Our GAAP EPS guidance for the full year is $2.18 to $2.22 on 138 million shares. At this time, I’d like to ask Terry, the operator to comeback. We’d be happy to answer your questions. Terry.

[Operator:]

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

[Greg Henslee:]

Good morning Gary.

[Gary Balter:]

Hi. Yes, sorry. It was on mute.

[Greg Henslee:]

Good morning.

[Gary Balter:]

First of all, a very strong quarter; could you walk us through, you kind of talked about Murray’s and the problems of Murray’s and how you’re dealing with it? So essentially are we looking at two more quarters of pretty strong negative comps and then you think you get back to positives or you turn it to positives or is this an ongoing problem?

[Greg Henslee:]

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

[Gary Balter:]

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

[Tom McFall:]

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

[Ted Wise:]

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

[Gary Balter:]

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

[Tom McFall:]

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

[Operator:]

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

[Colin McGranahan:]

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

[Tom McFall:]

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

[Colin McGranahan:]

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

[Tom McFall:]

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

[Colin McGranahan:]

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

[Tom McFall:]

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

[Operator:]

Your next question comes from Scott Stember with Sidoti.

[Scott Stember:]

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

[Greg Henslee:]

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

[Scott Stember:]

To that point about commercial doing a little better have you heard any anecdotal proof from some of your installer customers that the declining dealership base in the country is actually beginning to have an impact, a positive impact on business?

[Greg Henslee:]

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

[Scott Stember:]

That’s all I have. Thanks.

[Operator:]

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

[Dan Wewer:]

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

[Tom McFall:]

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

[Dan Wewer:]

But it is correct that the reduction and the LIFO reserve benefited the gap gross margin rate by 130 blips approximately during the quarter?

[Tom McFall:]

No, that’s not correct.

[Dan Wewer:]

So, what would that number be?

[Tom McFall:]

It’s a tenth of that.

[Dan Wewer:]

Okay, and then a second quarter, on the pickup in sales at Checkers, is that primarily coming on the commercial side of their business? I know it’s very small to begin with.

[Tom McFall:]

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

[Dan Wewer:]

Okay, great. Thank you.

[Tom McFall:]

Okay. Thank you.

[Operator:]

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

[Tony Cristello:]

Thank you, good morning.

[Tom McFall:]

Good morning, Tony.

[Tony Cristello:]

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

[Tom McFall:]

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

[Tom McFall:]

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

[Tony Cristello:]

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

[Greg Henslee:]

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

[Tony Cristello:]

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

[Tom McFall:]

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

[Operator:]

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

[Mark Mandel:]

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

[Greg Henslee:]

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

[Mark Mandel:]

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

[Greg Henslee:]

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

[Operator:]

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

[Alan Rifkin:]

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

[Greg Henslee:]

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

[Ted Wise:]

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

[Alan Rifkin:]

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

[Tom McFall:]

Hi, Allan, when you look at the change in guidance from our last call to this call, specifically related to the fourth quarter, the increase in EPS estimate is primarily driven by a higher assumption on comp store sale.

[Alan Rifkin:]

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

[Tom McFall:]

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

[Alan Rifkin:]

Okay. Thank you very much.

[Tom McFall:]

Thanks, Allan.

[Operator:]

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

[Matthew Fassler:]

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

[Tom McFall:]

Well, the Checkers were all completed prior to the beginning of the third quarter.

[Matthew Fassler:]

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

[Greg Henslee:]

Yes, we relate a lot of the comp pressure that these stores were under initially to I guess what we would call conversion, really it’s just training. It’s learning the products that we carry, the lines our point of sales system, how to source part, all of those things. So if we wrap all of that stuff and call it as the conversion, then yes, I would say that much of the comp performance in the second quarter for these stores was related to the conversion, but the thing you have to remember is that these stores were coming out of a huge hole. They had a lot of improvement to make, so while the 3.4% I believe decline in the comp store sales in the second quarter, obviously wasn’t desirable. They were improving from where they had come from, because they had underperformed for quite sometime and just to make sure that we don’t implied something that might be misunderstood. Again, these types of conversions are now behind us. We’re not doing any more of these types of conversions. The 1,032 stores that are in the west are a completely different type of conversion. The hard parts that we deploy in the stores are for the most part already in those stores, the team members are used to the products, they’re used to the lines that we carry and the types of products that we have available. The conversions we’ll do there simply re-pointing their distribution to a distribution center that’s kind of replenish them nightly and have more inventories than the DC’s they’ve had and they’re going to that via a new point of sale system that we’ve been told and our observation is that it’s very much robust than the POS system that CSK has been using and then the other piece of the conversion is just the display area enhancements that we’ll do, which is not very disruptive to the stores.

[Ted Wise:]

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

[Operator:]

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

[Michael Lasser:]

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

[Tom McFall:]

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

[Michael Lasser:]

One quick follow-up, Ted made the earlier comment that by virtually being ahead of schedule in the store openings. The company is allocating some more of that labor towards the conversions. Does that change the timing or perhaps the cost of the process at all?

[Tom McFall:]

(Inaudible) let me make a comment. What we’re talking about there are the, have teams that travel and go out and setup our new stores and have helped with these center part of the country conversions. When he is talking about the conversions, we’re not talking about the POS conversions or pointing them to the distribution centers out west as we open them. What we’re talking about is the reset of display fixtures, the interior signage, resets of the parts counters, things like that. These teams, really that part of this process does not tie to the opening of the distribution centers. We really could do that at anytime. His point was that with us being a little bit ahead of schedule, we can get a little bit of a head start on that, more so than what we’d originally planned, but the cost will be exactly the same. We’re estimating that we’ll be completely done with that process of these out front resets and the things that we’ll do to make the stores look like O’Reilly store inside and bid our display plan-o-gram by the end of the first quarter of ‘11.

[Ted Wise:]

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

[Operator:]

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

[Greg Henslee:]

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

[Operator:]

This does conclude today’s call. You may now disconnect.