Welcome to the O’Reilly Automotive, Inc. second quarter earnings conference call. My name is Daniel, and I’ll be your operator for today’s call. At this time, all participants are in a listen-only mode. During today’s call, prepared comments will be presented, followed by a 30-minute question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Tom McFall. Mr. McFall, you may begin.
Thank you, Daniel. Good morning, everyone, thank you for joining us today for our second quarter 2014 conference call to discuss our earnings results and our outlook for the full year. Before we begin this morning, I’d like to remind everyone that our comments today contain certain forward-looking statements, we intend to be covered by and we claim the protection under the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You can identify these statements by forward-looking words such as expect, believe, anticipate, should, plan, intend, estimate, project, will, or similar words. The company’s actual results could differ materially from any forward-looking statements due to several important factors described in the company’s latest annual report on Form 10-K for the year ended December 31st, 2013, other recent SEC filings.
The company assumes no obligation to update any forward-looking statements during this call. At this time, I’d like to introduce Greg Henslee.
Thanks, Tom. Good morning, everyone, 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 Chief Financial Officer, Jeff Shaw, our Executive Vice President of Store Operations and Sales. Ted Wise, our Executive Vice President of Expansion, David O’Reilly, our Executive Chairman, are also present. It is once again my pleasure to congratulate Team O’Reilly on another excellent performance in the second quarter to thank each member of our team for their unwavering commitment to our company’s culture of providing excellent levels of customer service to each and every one of our valued customers.
The sales momentum we experienced in the first quarter carried forward into the second quarter as the wear and tear on vehicles caused by the harsh winter weather contributed to demand for our products, resulting in a robust 5.1% comparable store sales increase, exceeding our guidance expectations of 2%-4%. Our ability to deliver this strong comparable store sales performance on top of a very robust 6.5% increase in comparable store sales from the second quarter of last year is a testament to our team’s commitment to serving our customers. In total, we increased sales 7.7% to $1.8 billion. We are especially proud of our team’s ability to grow sales profitably as we improved our operating profit by 94 basis points to 18.2%, which is a record second-quarter operating margin.
As a result of our team’s relentless focus on excellent customer service and expense management over the long term, we generated a 21% increase in earnings per share in the second quarter, which represents our 22nd consecutive quarter of EPS growth of 15% or greater. As we discussed on our last call, we expected the harsh winter weather would provide a tailwind in the second quarter as repairs were made to fix the excessive wear and tear on vehicles driven on weather-damaged roads. We definitely saw this play out in our northern and eastern markets, where undercar categories such as brakes, ride control, driveline, and chassis performed very well.
Our comparable store sales performance was consistent throughout most of the second quarter. We did see trends soften somewhat at the end of the quarter, as we have yet to see the typical stretch of extreme heat and the associated seasonal demand in categories like temperature control and cooling. In addition, the drought in the western half of the country has not been favorable. Our sales performance to our professional customers was again the bigger driver of our comparable store sales growth as we continue to grow this business more rapidly chain-wide in both existing and expansion markets. Our DIY business was also a very strong contributor to the growth in the second quarter. We are pleased with the market share gains we are realizing on this side of the business. Average ticket continues to be the more meaningful driver of our comparable store sales growth.
As we’ve seen now for the past several quarters, inflation on an individual SKU-by-SKU basis was flat and did not significantly impact average ticket in the second quarter. The trend in average ticket growth continues to be the result of increased parts complexity and cost of repairs. During this quarter, this trend was further driven by the high mix of undercar repairs, which typically are more costly and result in a higher ticket. Now I’d like to move on and provide a little more color on our guidance for the third quarter and full year. We are increasing our full-year comparable store sales guidance to a range of 3.5%-5.5% to reflect the outperformance we delivered in the first half of the year. For the third quarter, we are setting our comparable store sales guidance at a range of 3%-5%.
At the midpoint of this range, our expected two-year comparable store sales stack is 8.6%, which is below the second quarter two-year stack of 11.6% but in line with our year-to-date two-year stack of 9.3% through June. In establishing our sales guidance for the third quarter, we expect to see a continuation of the current strong business trends and a solid demand, partly driven by damage done to steering, suspension, and ride control components during the harsh winter. We remain cautious in our outlook for categories typically driven by extreme summer heat, such as air conditioning, refrigerant, and cooling, as temperatures have remained relatively mild, even chilly in some areas so far in the third quarter. From a macroeconomic standpoint, we are encouraged by modest gains in miles driven as unemployment very gradually improves.
Our average consumer has been under pressure for a long time as a result of the slow recovery, and we would not anticipate this pressure to significantly abate in the near term, particularly as consumers face a headwind from gas prices, which appear to be holding at an elevated level above $3.60 per gallon on average. We remain very confident in the long-term outlook for our industry, as we expect to see better engineered and manufactured vehicles stay on the road longer. Moving on from the top line, we are pleased to deliver gross margin of 51.5%, a 64-basis point improvement over the prior year. On a sequential basis, the second quarter margin improved 68 basis points over the first quarter. This sequential improvement was driven by a significantly lower headwind impact from LIFO accounting, which Tom will discuss in more detail later in the call.
This impact was partially offset by the favorable mix benefit we experienced in the first quarter. For the full year, we are leaving our gross margin guidance unchanged at a range of 50.9%-51.4%. As in past quarters, this guidance assumes expected continued limited selling price inflation and rational industry pricing. Thanks to the dedication of our 67,000 team members, we continued our strong momentum from the first quarter into the second quarter, and we are well-positioned to deliver another outstanding year in 2014. Through our hard work and commitment to providing outstanding customer service levels, we continued to gain market share, generating an increase in comparable store sales of 5.1%.
More importantly, we translated top-line market share gains into profitable growth, increasing our operating profit by 94 basis points to an all-time second quarter high operating margin of 18.2% and an EPS increase of 21% over the prior year to $1.91. We remain confident in the long-term drivers in the automotive aftermarket and, most importantly, in our team's ability to execute better than anyone else in our business and to profitably grow market share. Based on our continued confidence in year-to-date results, we are increasing our full-year operating profit guidance from a range of 17%-17.4% to a range of 17.1%-17.5%. We are also increasing our EPS guidance for the full year to a range of $7-$7.10, which includes shares repurchased through yesterday. Again, I would like to thank Team O’Reilly for the outstanding second quarter performance. Great job, everyone.
I'll now turn the call over to Jeff.
Thanks, Greg. Good morning, everyone. I'd like to begin today by echoing Greg's comments on the dedication of Team O'Reilly. Because of the hard work and commitment of each of our store and DC team members, we were able to once again produce results that exceeded our expectations. During the first quarter, our team battled the elements to keep our stores open under very harsh conditions with the sole purpose of taking care of our customers when they needed us to be there for them. That level of commitment continued in the second quarter as we were once again there for our customers as they worked to repair the wear and tear to their vehicles resulting from the extreme winter weather.
O'Reilly's long-term success is the direct result of our team's relentless focus on providing consistent top-notch customer service daily to every customer who calls or walks into our stores. We cannot thank our team enough for their continued contributions and commitment to providing the highest level of customer service in the industry. I'd like to take a few minutes to add some color to our operational results for the second quarter, including the progress of our distribution expansion activities and our new store expansion. Starting with SG&A, we were able to leverage our expenses by 30 basis points in the second quarter due to our strong comp performance. As Greg mentioned, our team generated a 5.1% increase in comparable store sales during the second quarter, which was on top of a very strong 6.5% increase during the second quarter last year.
Average SG&A per store increased 2.4% during the second quarter, which was higher than our expectations and was the result of higher-than-expected team member cost and negative outcomes on certain litigation that is inherent to the normal course of our business. We're very proud of our ability to relentlessly control expenses over the long term, but under no circumstances will we sacrifice our customer service. I know I sound like a broken record on this, but our ability to consistently provide top-notch customer service is critical to our long-term success. We manage our store staffing levels to control expenses with adjustments to support current business fluctuations, but just as importantly, we staff our stores to provide them with the tools they need to grow their business in the future.
This long-term perspective on store staffing levels has been instrumental to our past success and is critical to our ongoing future profitable growth. As we look forward to the second half of the year, we would expect that our average SG&A per store would not increase at the same level as the first half of the year. However, due to our higher-than-planned results in the first half of the year, we now expect that full-year average SG&A per store will increase by approximately 2%. Before I provide an update on our distribution expansion projects, I'd like to congratulate our DC team for their continued ability to provide the best parts availability in the aftermarket.
Our knowledgeable and dedicated store teams work tirelessly to provide our customers with top-notch service, and our DC team works relentlessly to ensure our stores are properly stocked and have same-day or overnight access to all of the parts our stores need to take care of our customers. I cannot stress enough the vital role that our robust regional tiered distribution system plays in our long-term success. Nightly store replenishment and same-day or overnight access to over 145,000 hard-to-find parts is critical to providing unsurpassed levels of customer service and is a key driver of our comparable store growth, which has consistently led our industry. Along with the support of over 270 strategically located hub stores, our comprehensive distribution system provides our stores with the access to inventory necessary for continued success, and I want to thank our DC team for their ongoing hard work.
Okay, now back to the specific distribution expansion projects. Our newest distribution center in Lakeland, Florida, continues to ramp up nicely and is now providing nightly service to 87 stores, up from 76 stores in April. As I mentioned last quarter, it takes time for a new greenfield DC to build the critical mass of stores that is necessary to operate at maximum efficiency and optimal productivity. Our Florida DC team is focused on daily improvements, and we're very pleased with the early productivity results we've seen so far. More importantly, we're excited about our ability to provide enhanced service levels to our stores in the growing Florida markets, and we continue to view Florida as a market where we can open a large number of successful stores.
I'd also like to mention that our Lakeland DC team is very excited to host our Analyst Day next month and is looking forward to showing off their beautiful new facility. I'm proud to say that our distribution projects in Naperville, Illinois, and Devens, Massachusetts, are progressing well and remain on track to begin operations during the back half of this year. As we previously mentioned, the Naperville DC is a new greenfield facility and is needed to better penetrate the large and competitive Chicagoland market and to free up growth capacity in our northern Midwest DCs. When our Devens DC opens, we'll relocate all the operations from our existing DC in Lewiston, Maine, to this new facility and will immediately service our 56 stores in the upper Northeast.
Just as important, this larger state-of-the-art facility will provide us with the capacity necessary to expand in those markets, beginning with new store openings next year. We're very excited about the opportunities for enhanced customer service our current distribution projects will provide, and we look forward to their completion in the coming months. I'd like to finish up today with an update on our store expansion for the first half of 2014 and our plan to finish up the year. In the second quarter, we opened 41 net new stores across 17 states. This brings us up to 91 net new stores year-to-date across 28 different states and just shy of 50% of our planned 200 net new store openings for the year.
As we mentioned on last quarter's call, the harsh winter weather pushed several of our store opening projects back, but we're confident in our ability to hit our target of 200 net new openings this year, with a good number of the remaining openings occurring during the third quarter. Not surprisingly, Florida leads the pack with the largest number of new stores so far this year at 14, followed by Texas with 10, and California with nine. As I mentioned earlier, the Florida markets present great expansion opportunities for us, and California is a huge market which offers great backfill potential as our dual market strategy continues to gain traction. In Texas, our operations teams continue to execute our model very well as that market continues to expand year after year. The remaining openings are spread throughout 25 other states.
We remain very pleased with the success of our new store openings, and we attribute this success to our ability to be very selective in our new store site selection process, as well as our ability to develop and train outstanding teams of professional parts people who are eager and ready to provide consistent, top-notch customer service in every new store. Our robust distribution infrastructure has capacity from coast to coast, allowing us to choose optimal sites in any market with the confidence that the new store team will have all of the support necessary to be successful. Now, before I turn the call over to Tom, I would once again like to congratulate and thank our store and distribution teams for another record-breaking quarter. Your commitment to providing consistent, top-notch service to all of our customers each and every day continues to be the key to our long-term success.
I'll now turn the call over to Tom.
Thanks, Jeff. We'll take a closer look at our results and provide updates to our guidance. Comparable store sales for the second quarter increased 5.1%, which exceeded our guidance of 2%-4% as we benefited from the strong demand in undercar categories as customers repaired vehicles damaged during the severe winter. For the quarter, sales increased to $132 million, comprised of an $86 million increase in comp store sales, a $45 million increase in non-comp store sales, a $2 million increase in non-comp non-store sales, and a $1 million decrease from closed stores. This strong sales performance, combined with solid expense control, resulted in a 21% increase in diluted earnings per share to $1.91, which exceeded the top end of our second quarter guidance range by $0.08. I'd like to update you on gross margin and the impact LIFO accounting had on our margins.
As we discussed on our last three calls, our success at reducing our acquisition costs over time has exhausted our LIFO reserve, with the result that additional cost decreases create one-time non-cash headwinds to gross margin as we adjust our existing inventory on hand to the lower cost. During the second quarter, our gross margin of 51.5% included a LIFO headwind of $3.4 million as we continued to be successful in reducing acquisition costs. Looking at the third quarter, we expect to see a similar LIFO headwind as we saw in the second quarter. We expect a comparable gross margin percentage in the third quarter as we achieved in the second quarter. Our full-year gross margin guidance range remains unchanged at 50.9%-51.4% and includes the expected LIFO headwinds in the third quarter, but none in the fourth quarter.
Our effective tax rate for the quarter was 36.7% of pre-tax income and benefited from $2 million more than we expected in job tax credits. For the full year, we now expect our effective tax rate to be approximately 36.6%. Moving to the balance sheet, inventory per store at the end of the second quarter was $579,000 versus $570,000 at the beginning of the year. This increase is consistent with the seasonality of our business, and we continue to expect inventory per store to be flat for the full year as our teams diligently add the right inventory, leverage our existing investment, and minimize non-productive inventory. At the end of the second quarter, our AP to inventory ratio was 93.5%, representing an improvement of 690 basis points from the end of 2013.
While the seasonality of our business yields a higher AP to inventory percentage in the second and third quarters, 93.5% exceeded our expectations. We will give some of this gain back by the end of the year as sales and replenishment volumes seasonally decrease, but based on the current support we're getting from our vendors, we now expect our AP to inventory percentage to be slightly above 90% at the end of the year. Year-to-date capital expenditures were $195 million. This is slightly behind where we thought we'd be at this point in the year, but we still expect our 2014 CapEx to be within the range of $390 million-$420 million. This leads us to free cash flow, which was $461 million for the first six months of the year versus $263 million in the prior year.
The increase was driven by higher income, slower growth of trade receivables, and a better net inventory position. Based on above-plan income and our increased year-end AP to inventory expectations, we are raising our full-year free cash flow guidance to $625 million-$675 million. Moving on to debt. We finished the second quarter with an adjusted debt to EBITDA ratio of 1.81 times. We continue to believe our targeted leverage range of two to two and a quarter times reflects our optimal capital structure, we will move into this range when additional borrowings will not create significant negative carry. Over the long term, we will be extremely prudent in managing our debt levels to ensure we maintain our investment-grade rating, continue a robust vendor financing program, and have the flexibility to support opportunistic acquisitions.
We continue to execute our share repurchase program, from the beginning of the year through the date of this press release, we repurchased 2.6 million shares of our stock at an average cost of $149.07 per share for a total investment of $389 million. We continue to view our buyback program as an effective means of returning available cash to our shareholders after we take advantage of opportunities to invest in our business at a high rate of return. We will prudently execute our program with an emphasis on maximizing long-term returns for shareholders. For the third quarter, we're establishing diluted earnings per share guidance of $1.91-$1.95. Based on our above-plan results in the first half of the year, and additional shares repurchased since our last call, for the full year, we're raising our guidance to $7-$7.10 per share.
As a reminder, our diluted earnings per share guidance for both the third quarter and the full year take into account the shares repurchased through yesterday but do not reflect the impact of any potential future share repurchases. Finally, I'd like to thank the entire O'Reilly Team for their continued dedication to the company's success. As Greg and Jeff mentioned earlier, your hard work and commitment to providing unsurpassed levels of customer service is the reason for our record-breaking results. This concludes our prepared comments. At this time, I'd like to ask Daniel, the operator, to return to the line, and we'll be happy to answer your calls. Excuse me. Questions.
Thank you. We will now begin the question and answer session. It's a 30-minute question and answer session. If you have a question, please press star then one on your touch tone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Please limit your questions to one question and one follow-up question, please. Once again, if you do have a question, please press star then one on your touch tone phone. Our first question comes from Seth Basham from Wedbush Securities. Seth, please go ahead.
Good morning.
Good morning.
Congrats on a great quarter. My question revolves around first trends to date. It seems like trends slowed a little bit in June you spoke to. How is July trending to date?
It's doing fine. We spoke to June being a little softer than the first two months of the quarter, it wasn't like a cliff or anything. It was just the softest month of the quarter. July, we're doing fine.
It's within your guidance range of 3%-5% for the quarter?
Yes.
Got you. Secondly, as we think about some of the new DCs you're opening, Lakeland recently opened and then a couple more on track for later this year. Can you give us a sense what kind of lift you're seeing from those 87 stores in Florida with the overnight service there, or service from that Lakeland DC and what should we expect from Naperville?
Well, Florida's a new market for us, at least Central and Southern Florida is a new market for us, and we're doing very well down there. I think it goes without saying, as you've implied, Seth, that stores that are supported by a distribution center have the ability to better penetrate a market than stores that are supported by a hub or maybe without the support of either a hub or a distribution center on a same-day basis. To be frank, the Southeast and the Northeast being some of our newest markets and being markets that are affected to some degree by weather. More than anything, just the fact they're newer stores and they're supported in the South by a new DC are some of our best performing markets.
We would expect to do much better in Chicago and then again in the far Northeast where we have the VIP stores once we have a larger DC and more access to SKUs. Right now the stores that we have converted as part of the VIP acquisition are supported by a distribution center that does not have the number of SKUs that we would typically put into a DC because of space constraints. We'll be in a much better position up there once we do that. Yeah, they're performing well and we would expect the Chicago stores to perform well. I don't really have a number for you. They'll perform better with the DC than they do without.
Got it. Thanks so much.
Thank you.
The following question comes from Matthew Fassler from Goldman Sachs. Matthew, please go ahead.
Thanks so much. Good morning. My first question relates to gross margin. Thanks a lot for the clarity on LIFO. Appreciate it. If you think beyond LIFO and you think about the intrinsic drivers of margin in the business, I know you had started to talk about coming upon the five-year anniversary of the CSK deal and some of the vendor renegotiations that were going to commence along with that. Can you give us a sense as to the status of some of the longer-term margin drivers and how you see those playing out, gross margin drivers that is, how you see those playing out over the second half of the year and then into 2015?
Well, our renegotiations with vendors are pretty much complete and we're happy with the results. Obviously, our gross margin improved significantly as you know, as part of the CSK acquisition of some of the deals that were made. As we've anniversaried those deals, we're happy with the position we're in now and as a growing and we think a successful company. We're a company that suppliers want to have in their camp. We feel like we'll continue to have incremental gains, although we wouldn't expect our gross margin to continue to grow much in the coming years by a large extent. It'll be maybe small incremental gains, but nothing like what we've seen in the last couple of years, I would guess. Tom, you may have some additional comments on that.
Yeah. We're starting to anniversary some of those deals. When you look at the impact of LIFO, we have a number of big deals that happened in the third and fourth quarter last year, first quarter this year. We haven't lapped those deals. Once we do, we would expect to get back to a more normal gross margin growth rate in the 10-30 basis points a year.
Tom, just following up on that and thinking about the cadence of renegotiation by category and vendor, which you guys have visibility to, and also the pace of inventory turnover, which varies a lot by category but on the whole is I guess about two times a year. At what point does that really start to make its way through the P&L for maximum impact? Is it late this year? Is it early 2015 that you start to see them all kind of marshal their impact on the margin?
Because we're on LIFO and we utilize last buy, we see the reduction in cost across dollar inventory day one. That second day, the first part you sell, you're selling at a lower cost. It's not based on turns. Mathematically, we need to turn the inventory one time to offset that first write down. Sequentially, the margins improve right away.
Got it. Very briefly following up on SG&A, I know there was a small litigation item that probably distorted the numbers a little bit. Variable expense would you say there is relative to the base guidance that you gave, relative to your sales guidance, such that if sales are a little bit better, maybe the expense is in shop for bonus comp or what have you?
When we look at these litigation items outside of normal, because we have some, we were $2 million or $3 million higher this quarter than we would be on an average run rate.
Got it. Thank you so much.
The following question comes from Gregory Melich from ISI Group. Greg, please go ahead.
Hi, thanks. I just wanted a quick follow-up on the gross margins and then touch on SG&A. If you look at the second half, it was helpful to know about the LIFO there. Are there any uniqueness in terms of the new distribution centers coming online that could be impacting gross margin in the next couple of quarters as well that we should be aware of? I had a follow-up.
The effect of the new DCs coming online will be minimal and I don't think will be noticed in our gross margin. They're levered pretty well, and we have some offset from our Indianapolis distribution center, which is really beyond capacity and not operating as efficiently as it should be and will benefit from the offload of some of the stores, so we wouldn't expect that to be a factor in the second half.
Great. On SG&A per store, I guess it was up about 2.5%. How should we expect that to play out in the second half? Is this a good run rate, or was there something tweaking that in a certain direction?
Well, we've been above 2% in the first half of the year. Our guidance is to be 2% for the full year, so we should run a little less than 2% in the third and fourth quarter.
Is there anything special around that, or is it just the weather early in the year added more costs?
We're relatively close. These are relatively small percentages. The beginning of the year obviously had some payroll and maintenance costs associated with all the cold weather and utility costs. There's nothing that sticks out as a real issue in the second quarter, and we should be pretty close to plan in the third and fourth quarters.
Tom, on AP to inventory, you said part of the free cash flow increase included a new number for that, a new target. Do you have a number you can give us?
Slightly above 90.
Okay. Thanks a lot. Good luck, guys.
Yep. Thanks, Greg.
The following question comes from Alan Rifkin from Barclays. Alan, please go ahead.
Thank you very much. Greg, you mentioned that the winter weather continued to be a tailwind in the quarter. I was wondering if perhaps you could quantify what the benefit was, and when do you expect this tailwind to exhaust itself?
Alan, I wouldn't really be able to quantify it. I can tell you that the categories that we would most apparently see as categories that would benefit from the harsh winter that we had were some of our best performing categories. I mentioned some of those, but they're chassis, ride control, driveline, brakes. Automotive batteries did real well, which are sensitive to weather extremes. It was a factor. To quantify it, I don't know what we would have done had we not had the weather, but these are the categories that are a big part of our business. We expect to perform well in those categories ongoing, and our comp percentage is driven by our success in these categories. The portion of our performance here that's incremental related to the weather is hard to determine.
I think that when we have weather extremes, there are some things that people have fixed right away. When you've got maybe a tie rod end coming loose and your car won't pass state inspection as a result of being jarred around on rough roads, that has to be fixed right away. Things like shock absorbers, ride control that may fail earlier than normal because of being driven on bad roads, those are not something you have to replace right away, but you eventually will because the ride of the car changes and the handling of the car changes. There's some ongoing benefit, but it'll start waning as we go through the summer. Again, it's hard to determine how much of it was related to the weather and how much of it is just pent-up demand and just the solid aspects of the business that we're in.
Okay. Thank you. Just to follow up, if I may. You've talked about the opportunities in Florida, and certainly, we're in agreement with you. If you look at Florida together with California, those are certainly two of the more lucrative states in the country. Obviously, you have more experience operating in the state of California since the CSK acquisition. If we were to drill a little deeper, and if you compare and contrast California specifically to Florida, what is your assessment in terms of the opportunities in Florida relative to California? Is it as good? Is it even better?
Well, I don't think we'll ever have as many stores in Florida as we have in California, just because of the size-
Right
of the populations and stuff. It's really good. Florida has been a state that has been one of our best new store opening states that we've had in a while, and we're really happy with how our stores have done down there and happy how they've done once we opened the Lakeland distribution center. I would rank it right up there. Last quarter, California and Florida led our new store openings, and we're happy with the performance of the stores in both those states. When we came into California, CSK already had those stores almost up to what we did average in most states across the country. We really didn't see it from the ground up like we are in Florida. We're really impressed with Florida as to how quickly we're getting to what we would expect to do in a store.
In California, we've incrementally grown beyond what CSK has done. It would be hard to compare the two because there's differences in both. Rents are obviously higher in California, so you have to do more volume per store. Wages tend to be a little higher in California, so you have to do more volume per store. Litigation in California, there's a lot of rules in California that don't exist in some states, so you have to be wary of that. On balance, we like Florida a lot, but we do a ton of business in California, so they're both good states for us.
Are the commercial opportunities in Florida greater than the commercial opportunities in California?
The only difference that I would be able to point out, Alan, would be is that in Florida you have what I think would be an older population that would be less likely to work on their own cars. I think it's just a mix of business. I think the commercial business is really strong down there. I think in California you would have more people that would be apt to work on their own cars. The DIY business is probably a little stronger than what it is in Florida.
Okay, thank you. That certainly makes sense. Thanks, Greg.
Thanks, Alan.
The following question comes from Michael Lasser from UBS. Mike, please go ahead.
Good morning. Thanks a lot for taking my question. Greg, when would you normally transition from some of the hot weather products to more fall related merchandise? At some point, the lack of hot weather won't matter as much. At what point do you get there?
You start getting there like September and October in most markets. It varies on geography, of course, but generally you make that transition after school starts. In our business, we see a little bit of a dip in the shops that we supply, see a little bit of a dip in business when school starts because people start spending money on school supplies and getting their kids ready for school and stuff that, in many cases, they don't plan to spend, but then they do because they need to. They'll delay some repairs and other things that they need to do. Typically, once someone makes it to the point that school's starting with something that they can avoid fixing, like an air conditioner or something, they may just hold on and wait to fix it next spring.
It would push forward, and then we would transition into doing more fall and prep for winter type stuff.
During those months, weather becomes less of an influencer on the business. Is that fair to say?
I think that's fair to say.
The other question is, we'll soon get to the point where the cars that were sold in 2008 become a bigger portion of the seven-year-old vehicles. Typically, what categories are first sold into a car when they reach this sweet spot of the aftermarket? I ask that because the weather benefits fading, the smaller cohorts become a bigger portion of the total. There's going to be a lot of debate in the next 6 months of the industry to the extent that trends remain below where they were in the first half of the year. Is it because of the weather or is it because of the change in the vehicle population? I guess what I'm trying to frame is, if there are some impacts from smaller cohorts to seven-year-old vehicles, where will you see it first and what are you going to be watching for?
Thank you.
Mike, We're talking about six, seven-year-old vehicles. That age of a car would typically, I know it varies by geography and by individual, but let's say it's a 100,000-mile vehicle. What you're going to have is brake failures, some chassis part failure. The cars today that are so closely monitored by a computer that has multiple sensors that detect all these different things, you may start having problems with some of those sensors. The check engine light comes on and can cause some drivability problems. You start having some of those things. Primarily, I think what we would watch would be brakes, chassis, ignition, emission. Cars at that age need tuneups and so forth. Belts and hoses, timing belts, especially on cars that have belt driven camshafts. That's about the point that the belt gets replaced. We'll watch those.
I said, right now, those categories seem to be doing pretty well, it's hard to quantify what's weather and what's just normal maintenance. Tom, do you have something to add?
Michael, what I'd add to that is during the short term, quarter to quarter, the weather impacts our business, and it's noticeable in certain categories driven by what type of weather events we have. When we look at the car population with 240 billion plus cars and trucks, changes in the population occur slowly over time. Those changes, when you look back over a long period of time, are identifiable. On a quarter-to-quarter basis, the change of a 240 million vehicle population, it's hard to track specific items related to that. Quarterly, we'll talk about weather long term, that change in vehicle population, the engineering of the vehicles has the biggest long-term impact, but it's hard to identify on a quarter-by-quarter basis.
That's super helpful. Thank you so much.
Thanks, Mike.
The following question comes from Michael Baker from Deutsche Bank. Mike, please go ahead.
Hi. Just curious, did your back half comp outlook change at all based on what you're seeing in June? I know you raised the full year, that's because of what you've seen year to date. Wondering. Change your back half outlook at all?
No, we changed our full year to reflect what we've accomplished so far this year, but our back half outlook remained the same.
Okay. This little bit of a slowdown in June doesn't change your outlook. Okay, thanks. Always curious if you could talk about the % of your business that is from DIY versus DIFM currently, and sort of break that down, if you can still do it, how that breaks down from the acquired CSK stores versus the stores that you didn't acquire.
Yeah. Right now we're about 42/58. 42 do it for me, 58 DIY. We really don't break down the CSK versus O’Reilly mix. The CSK mix on the do it for me business has incrementally grown as we've been effective gaining market share out there, but we really don't give the mix numbers for the different parts.
Well, how about this. I assume that the CSK stores still are under index to DIFM, is there still an opportunity for that to increase more so than in other stores?
Yeah, they under index compared to the core O’Reilly stores and our new stores. There is more opportunity out there for us to continue to increase our do it for me business. We have a lot of good competitors out there that are doing a lot of business on the do it for me side, we see that as an opportunity for us to incrementally work to gain market share in a profitable way.
Right. Okay. Thanks. Appreciate it.
Okay. You bet. Thanks, Mike.
The following question comes from Simeon Gutman from Morgan Stanley. Simeon, please go ahead.
Thanks. Good morning.
Good morning.
Greg and Tom, going back to the secular outlook, I know we talked a little bit about, it sounded like Tom, it's a slower moving process than some of the numbers look, but curious what your outlook is. How do you feel, and what do you think we should think about that sweet spot of the fleet shrinking next year? Should industry growth continue despite some of those headwinds? It sounds like it should, but just wanted to get your thoughts.
Simeon, what I'd say, and Tom may have some comments too, but we're not that concerned with the change in the vehicle population age relative to the recession that we went through because of the size of the vehicle population and also the age of the vehicle population, having so many cars that are older and beyond what was previously considered the sweet spot, and I guess maybe still is today, that are still on the road at high mileages. I know I've said this probably too many times to different analysts, but there are cars being driven today at mileages that just have not been seen by us in the past because of the quality of the drivetrains and the bodies and the interiors and all these things that might have previously caused people to trade or scrap a car.
Today, cars just have the ability to stay on the road a lot longer. I just think our industry is in for a good run as we continue to benefit from these cars that have been built over the last 10, 15 years that are of incredibly high quality when it comes to drivetrains and bodies and interiors and so forth, and that the automotive aftermarket is in a good position as a result of that. Of course, we have to consider the vehicle population to some degree, but we don't pay a whole lot of attention to that part of it. The way we look at it is there's a lot of market share out there to gain, and when we have our internal meetings here, we don't spend much time on vehicle population.
We spend time on how much market share we have that we can gain that our competitors are currently doing, and I think we have a lot of opportunity out there. Tom?
I'm sorry, Tom.
From a macro standpoint for our industry looking into next year, we don't think that 2008's low SAR number is going to have a huge impact, just because of the continuing age that vehicles can stay on the road and the size of the population. From a macro standpoint, when we look forward for the next 18 months, the biggest driver is going to be the health of the consumer and what happens with miles driven and how many people go back to work and start commuting to work and what that adds to the potential for parts failure. From an overall profitability standpoint, when we look at the top line, we have run the last couple of years without much inflation.
We'd like to see not a lot of inflation, but a little bit of inflation to help drive higher top-line sales and more gross margin dollars to offset the increases in cost you see. That's an item that could also have an impact on comps for the industry.
Is the age of vehicles that you're servicing, to the best you can track it, is that changing in any way that gives you more or less confidence in the outlook?
It's hard to track, of course, because many parts fit different vehicles, so you have to track it based on the lookup, assuming that the part was always looked up electronically. We do track that. Yeah, as the vehicle population gets older, yeah, we're selling more parts for older vehicles, for sure.
I think you see that in the SKU count for ourselves and what you need to be competitive in this industry. The SKU count continues to rise because new vehicles are coming with new SKUs and old vehicles are staying in the fleet longer, and you have to keep those SKUs on hand.
Okay. My follow-up regarding inflation, Tom. Is there any early signs of cost creep from the supplier side that you can look down the road and maybe get some inflation?
Through the end of the year, our expectation is that on a SKU by SKU sale basis, we're not going to see inflation.
Okay, thanks.
Our following question comes from Aram Rubinson from Wolfe Research. Aram, please go ahead.
Aram, are you there? Operator, we might go to the next question.
Sure. Our next question comes from Christopher Horvers from JP Morgan. Chris, please go ahead.
Thanks, guys. I also want to follow up on the gross margins. When you think about that 10-30 basis points outlook over the longer term, what's the driver? How much of that is buying synergies versus leverage on distribution centers that you're putting in versus, I guess, company-specific pricing type strategies?
Those are the three buckets it comes from. It depends on the year. We're going to try to chip away on all fronts. We do have quite a few newer distribution centers and, as the stores and those distribution centers reach higher volumes, we'd expect to see more efficiencies. We would expect to see some price optimization opportunities, especially when retails start to move a little bit, which they haven't really moved much in quite some time. I think the third leg of that is acquisition cost, and although we've gotten most of our benefit from that here recently, we continue to expect to continue to find incremental gains.
Pretty balanced, sounds like.
Yep.
Yep. Just to clarify on the LIFO, as you lap the LIFO pressures later this year and early into next year, do we get that back, or how does that play out?
I would think of it more of an absence of the headwind.
Absence.
Yeah. When we look at it, we talked about it earlier, we take that hit all up front. Then from the next part, we sell at the lower cost. On a going-forward basis, we make a higher POS margin on that part. Sequentially, when we look at the quarters, that better pricing is factored into the gross margin.
Understood. Then finally, can you just remind us on the compares last year? I seem to recall there was a heat snap in early July and the business started to pick up, but then it moderated back down. How did your third-quarter comparisons, how did they play out?
Third quarter last year, July was the best month of the quarter.
Any degree or any qualitative comment as to how much?
No, it wasn't a huge difference, but July was definitely the better part of the quarter, and then we ended the quarter with the softest month of the quarter.
Perfect. Thanks very much.
Yeah, thank you.
Our next question comes from Liang Tsang from Morningstar. Liang, please go ahead.
Good morning, and thanks for taking my questions. Looking more granularly into your commercial performance, could you discuss how your small business accounts are performing versus some of your larger accounts? When you enter into a new market like Florida, which customer base do you start off with?
The national accounts we have, we would have existing relationships and existing pricing set up, so we would be ready to do business with them. We would start off with them pretty quickly. Our focus is typically on just the up and down the street shops that exist, and we typically open a store and do a market blitz to make sure that all the shops knew we were open and what we were about, what kind of services we provide, and we would set up accounts and so forth. It's a mix of both, and it depends a lot on the particular market and who exists in those markets. Most shops are doing pretty well this year. The pickup in demand as a result of the weather, I think that shops across the board are doing pretty well.
You never get all of a customer's business, so it's hard to know for sure how each one's doing in total. I saw Monro reported this morning, and I think their comps, they were hoping they would be a little higher than what they were. Some shops, especially the national chains that sell tires, and this may be the case with Monro too, where tire deflation has caused some pressure on the top line. That may be a factor for them, too. From a parts supply standpoint, I would consider them pretty equal, and I think most shops are doing pretty well.
When you enter into a new market, now that you have this national reach, do you have some of your larger account customers asking for you to come into Florida, for instance? You mentioned that the Florida business is picking up faster. Could that be contributing to it?
Well, we put a lot of focus on having relationships and doing business with national accounts.
Typically, we call on them rather than them asking us to be their supplier, because really in the U.S., there are no underserved markets when it comes to auto parts these days. When you go into a new market, you have to go in and take the business from someone who's supplying them now.
Yeah, we work hard to have relationships with national accounts. In Florida, we have some. I'm unaware of that being a major factor in our success down there, and I would say that probably at least as big, if not bigger factor, is just our efforts up and down the street to develop relationships with shops, independently owned shops, maybe small chains of shops, and sell them parts and provide services to them.
That's very helpful. Thank you, and good luck on your next quarter.
Well, thank you.
Thank you. We have now reached our allotted time for questions. Greg Henslee, I'll turn it over back to you.
Thanks, Daniel. We would like to conclude our call today by again thanking the entire O’Reilly team. We've once again proven that committing ourselves to the O’Reilly culture values and taking great care of every customer are the keys to our record-breaking results. We continue to believe in the long-term demand drivers for our industry and are very proud of our second quarter results and accomplishments, and we are very confident in our ability to continue to successfully and profitably execute our proven growth model and to gain market share from coast to coast. I would like to thank everyone for joining our call today. We hope to see many of you at our Analyst Day in August, and we look forward to reporting our third quarter 2014 results in October. Thank you.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.