Welcome to the O'Reilly Automotive Incorporated Third Quarter Earnings Release Conference Call. My name is Ellen and I will be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. I will now turn the call over to Tom McFall.
Tom, you may begin.
Thank you, Ellen. Good morning, everyone, and welcome to our conference call. Before I introduce Craig Hensley, our CEO, we have a brief statement. The company claims the protection of the Safe Harbor for forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these statements by forward looking words such as expect, believe, anticipate, should, plan, intend, estimate, project, will or similar words.
In addition, statements contained within the earnings release and on this conference call that are not historical facts are forward looking statements, such as statements discussing among other things, expected growth, store development, integration and expansion strategy, business strategies, future revenues and future performance. These forward looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions, including but not limited to competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental regulations, the company's increased debt levels, credit ratings and the public debt, the company's ability to hire and retain qualified employees, risks associated with the performance 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 Factors section of the Annual Report on Form 10 ks for the year ended December 31, 2012 for additional factors that could materially affect the company's financial performance.
These forward looking statements speak only as of the date they were made and the company undertakes no obligation to publicly update any forward looking statements whether as a result of new information, future events or otherwise, except as required by law. At this time, I'd like to introduce Craig Hensley.
Thanks, Tom. Good morning, everyone, and welcome to the O'Reilly Auto Parts Q3 conference call. Participating on the call with me this morning is, of course, Tom McFall, our Chief Financial Officer and Jeff Shaw, our Executive Vice President of Store Operations and Sales. David O'Reilly, our Executive Chairman and Ted Wise, our Executive Vice President of Expansion are also present. It is once again my great pleasure to congratulate team O'Reilly on another profitable record breaking quarter.
And I want to thank each and every one of our dedicated team members for their unwavering commitment to providing the highest level of customer service in our industry. At the beginning of the quarter, we set the bar high with comparable store sales expectations of 4% to 6%, which was on top of a 3 year stacked comp comparison of 17.2%. Through your efforts and hard work, we generated an industry leading 4.6% increase in comparable store sales for the quarter. We should all be very proud of our ability to consistently outpace the industry in comparable store sales growth, especially in the midst of ongoing difficult macroeconomic conditions. In total, we grew sales for the quarter by 8% and because of our team's relentless focus on profitable growth and expense management, we generated a record quarterly operating margin of 17.4%, driving a 28% increase in earnings per share to $1.69 This represents our 19th consecutive quarter of adjusted earnings per share growth of 15% or greater.
Our team remains committed to providing consistent, excellent customer service in each of our stores every day as we continue to focus on executing our proven business model of serving both retail and professional service provider customers. I could not be more proud of the great job our team does serving our customers. And I would like to again thank all of team O'Reilly for driving our record breaking results this past quarter. I would now like to take a few minutes to provide some color around our sales performance for the quarter. Business was fairly consistent throughout the quarter, adjusted for the Sunday benefit we had in July.
And we were on track to finish the quarter at the midpoint of our 4% to 6% guidance range until the end of the quarter. September finished slightly softer than we had anticipated, primarily driven by the anniversary of aggressive prior year advertising and promotional activity and resulted in a 4.6% increase in comparable store sales for the quarter, just slightly below the midpoint of our expected range. While the cadence of our prior year promotional activity was a small headwind to our comp growth for the quarter, it was one of the factors that supported our 59 basis point improvement in gross margin for the period. The core O'Reilly and acquired markets contributed equally to our comp store sales growth for the quarter. The strength of the core O'Reilly comp this quarter as compared to the acquired markets is primarily the result of the much more difficult prior year comparisons in the acquired markets.
However, going forward, we expect that the acquired markets will provide a larger portion of our comparable store sales growth as we continue to capitalize on the tremendous opportunities to gain share in these markets. Both the DIY and professional business contributed to our growth for the quarter, although more from the professional side as we continue to see that side of our business growing more robustly chain wide. The rapid growth of the professional business in the acquired markets continued during the quarter. However, our core O'Reilly stores also posted very strong growth on the professional side
of the business. That
said, we continue to remain confident in our ability to gain share on the DIY side of our business over time, driven by the initiatives we have in place and the opportunities created by changes in the overall industry. We will continue to focus on executing our proven dual market strategy in all of our stores across the country and we are well positioned to continue to gain market share on both sides of our business. Average ticket continued to be a stronger contributor to our comparable store sales increase driven by the complexity of vehicle repairs, pricing management and our overall business mix. However, ticket count was also a contributor during the quarter. As we've seen over the last several years, the quality of vehicles on the road continues to improve and these vehicles have become more and more complex.
These higher quality, better engineered vehicles require less frequent repairs. However, when repairs are needed, they continue to become more costly contributing to the growth in our average ticket size. Again, as we have seen all year, inflation was not a significant driver of our average ticket growth for the quarter. We also continue to see a shift in the mix of our total business into more costly hard parts categories, primarily driven by the growth of the professional service provider business contributing to the growth in our average ticket size. Ticket count comps continued to be strongly driven by increases in our professional sales led by our acquired markets and more than offset the pressure we experienced in DIY transaction counts.
As we look at our sales performance on a category by category basis, the lack of extreme heat during the summer had a definite negative impact on hot weather categories like temperature control and refrigerants. However, we continue to see strong demand in many of our key hard part repair and maintenance categories such as brakes, driveline, suspension and ride control. On a regional basis, we saw fairly consistent results across the country. We remain confident in the drivers we see for demand and continued growth in our industry. However, we believe the American consumer continues to be pressured from the persistently difficult macroeconomic conditions we have seen over the last several years.
The key drivers for long term demand in our industry remain unchanged. The total fleet of vehicles on the road continues to grow aided by a recovering rate of new vehicle sales and flat vehicle scrappage rates. As a result of better engineering and manufacturing, vehicles remain on the road and in service for longer periods of time and undergo more routine maintenance and repair cycles resulting in a historically high average vehicle age of over 11 years and continuing to expand the upper end of the vehicle age range of our core customer or sweet spot. While we remain confident in the long term fundamentals of the industry, we remain cautious in the short term concerning the economic headwinds our customers face. Through August of this year, total miles driven in the U.
S. Were relatively flat, hampered by unemployment of over 7%. While this does reflect an improving trend, this rate is still persistently high by historical standards. We also believe that the average consumer remains very cautious and continues to worry about economic uncertainties such as the impact of healthcare reform and the impact the governmental shutdown had on the economic recovery in the U. S.
We expect the solid business trends we experienced in the last 4 quarters to continue. But in light of the macroeconomic pressures and more difficult comparisons we face as we annualize the improved business trends that started in the Q4 of last year, we are setting our Q4 comparable store sales guidance at a range of 3% to 5%. Thus far in October, business has been solid and we are trending within that range. As we look back at the Q4 of 2012, October November were strong months with the year finishing a little softer in December. For the full year, we are tightening up our comp guidance range from 3% to 5% to 3.5 to 4.5% based on having 3 quarters of actual results in our books.
The midpoint of our Titan full year range is at 4% unchanged from the midpoint we established at the beginning of this year. Moving on from the top line, sequentially gross margin was relatively flat with the Q2. These results are better than we had anticipated when we hosted our Q2 conference call in July as gains on product mix and the cadence of our promotional activities in the current year compared to last year offset headwinds in the current period resulting from our LIFO inventory accounting. Tom will discuss the impact of LIFO accounting on our gross margin results in more detail in a few minutes. But from a high level, as we renegotiate our key supplier agreements over the next few quarters, we will face some short pressure short term pressure on gross margins.
But these better negotiated product acquisition costs will benefit us as we turn the product going forward. On a year over year basis, gross margin improved 59 basis points. The improvement was driven by product mix, improved acquisition costs and year over year differences in the aggressiveness of promotional activity. These benefits were partially offset by the LIFO impact and the headwinds from capitalized distribution costs related to last year's store level inventory build initiative. Looking ahead, sequentially into the Q4 as we compare to the Q3, we expect to see continued pressure from capitalized distribution costs related to last year's inventory build and increased pressure from LIFO accounting.
On a year over year basis, we expect that improved acquisition costs will offset these headwinds resulting in a 4th quarter gross margin percentage comparable to the Q4 of 2012. Based on these expectations and our year to date results, we are narrowing our full year gross margin guidance from a range of 50.3% to 50.7% to a range of 50.5% to 50.7% of sales. Our outlook for sales and gross margin Our outlook for sales and gross margin results are predicated on market pricing
remaining rational and inflation falling below normal ranges. I would
like to wrap up my comments today by quickly updating you on the status of our VIP acquisition as well as the status of our loyalty card program rollout. All of the VIP store layouts have been reset and the new interior decor packages in place and both interior and exterior signs have been changed to the O'Reilly logo. We have the majority of the backroom hard parts inventories and approximately half of the front room inventories changed over to the O'Reilly product lines. The final physical changes to the exteriors of the buildings will occur next year and the timing will be based primarily on weather conditions. The business in these northeastern markets is very cyclical in nature with the extreme winter months representing the lowest top line volume months of the year.
Our goal is to have the store inventories completely changed over and our programs in place to capitalize on the strong spring selling season in these markets and we are on track to meet that goal. We also have some exciting news regarding our plans for growth in the Northeast that Jeff will discuss in a moment. As we've said in the past, the acquisition of VIP will not have a significant impact on our results in 2013. However, it provides a springboard for our growth in the Northeast and we remain excited about the opportunities to grow our brand in these new markets. I'm also very pleased to announce the successful rollout of our loyalty card program in all of our stores at the beginning of October with over 1,000,000 members already signed up.
Our program will allow us to increase our retail customer engagement and direct market special offers to our retail customers as part of our continuing efforts to grow our retail market share and build brand recognition. We're excited about the initial results of the program and are very optimistic about the opportunities this program will provide as we continue to improve the overall shopping experience for our retail customers. I want to finish up today by reiterating our strong belief in the long term drivers of demand in our industry. We remain steadfast in our long term commitment to executing our proven strategy of serving both retail and professional service provider customers by providing unsurpassed consistently high levels of customer service in all of our stores every day. We are confident in our ability to continue to gain market share while also delivering profitable results.
I would like to again thank all members of team O'Reilly for your hard work and the commitment you've made to our continued success. Congratulations on another record breaking quarter. I'll now turn the call over to Jeff Shaw. Thanks, Greg, and good morning, everyone. I'd like to echo Greg's remarks and thank team O'Reilly for their hard work in delivering strong results against high expectations.
Your dedication to providing consistent top notch customer service drove our industry leading comparable store sales growth and record operating margin. Again, thank you for your continued efforts to make O'Reilly the market leader in customer service. I'd like to begin today by talking about some exciting distribution center expansion. As Greg alluded to earlier, we now have our plan in place to add significant distribution capacity in the Northeast by relocating our acquired DC in Lewiston, Maine to a facility in Devons, Massachusetts. We purchased an existing facility in Devons, which is a western suburb of Boston and plan to relocate our Lewiston, Maine facility, then begin service out of this new location in the back half of twenty fourteen.
The new DC will be approximately 370,000 square feet, will have the capacity to service 280 stores and will be key to our continued growth in the Northeast markets. We knew when we acquired the VIP stores that we'd need a larger facility to support the growth in the existing store base as well as to robustly grow in the Northeast and the new Devon's facility will deliver that capacity while also leveraging some of its fixed costs from day 1 as it supports the 56 acquired VIP locations. Our real estate group has been actively identifying side zones throughout the Northeast this year and is currently in the process of negotiations for potential new store openings in these markets beginning in early 2015. Our focus for the acquired VIP stores over the next year will be to complete the inventory changeovers, complete the refurbishing of the interior of the stores and roll out our commercial programs. In addition, we continue to train the store teams on our processes and procedures, but most importantly, we're instilling the O'Reilly culture of providing consistent top notch customer service to every customer who calls or walks in our store.
We remain very excited about our opportunity to expand in the Northeast and the new facility in Devon's will provide the springboard we need for this expansion. With the addition of the Devons DC, we now have 3 active DC projects in the pipeline. As we discussed on last quarter's call, we have a new DC scheduled to open in early 2014 in Lakeland, Florida to support our rapid growth in the Central and Southern Florida. This is a 390,000 square foot facility capable of serving 300 stores. We're also working on a new 360,000 square foot DC in Naperville, Illinois that's scheduled to open in the second half of twenty fourteen.
This DC will be capable of serving up to 250 stores and will support the vast Chicagoland market as well as free up capacity in several of our Midwestern DC. 3 concurrent new DC projects is a big task. However, our DC operations teams are seasoned veterans and have the proven ability to manage multiple projects simultaneously. If you recall, as part of our CSK acquisition and integration between July 2008 November 2010, we successfully opened 4 new greenfield DCs, relocated 1 DC and converted 2 existing DCs. In addition, we opened a new greenfield DC on the East Coast in North Carolina in 2,009 as well as relocated our Kansas City DC to a larger facility in 2,009.
Being able to efficiently and successfully build and open just one DC can represent a challenging undertaking, but our ability to manage multiple projects and successfully bring several full service 5 night a week delivery DCs online in a short period of time without service interruptions has been a critical factor in the outstanding service we provide to customers in existing and new markets. The success of these projects is a direct result of the meticulous planning and the flawless execution by our DC operations teams led by Greg Johnson, our Senior VP of Distribution Operations and Larry Ellis, our Vice President of Distribution Operations who combined have over 68 years of experience in our industry. Greg and Larry lead an experienced and talented team and we're highly confident we'll be able to replicate our past successes with the current DC projects. Our robust regional tiered distribution network offers multiple same day deliveries to over 85% of our store base and 5 night a week replenishment to every store in the continental U. S.
For 56 years, we've understood the importance of providing a consistently high level of parts availability to customers is the key to long term success and we're confident in our ability to continue our tradition of top notch service in every new market we enter. I'd like to shift gears a little and talk about our new store growth. We opened 48 net new stores in the Q3 and we're on track to hit our goal of 190 net new stores in 2013. Our store openings were again led by the Florida, Ohio and Texas markets. We continue to be pleased with the performance of our new stores and based on that success, we plan to increase our new store openings to 200 in 2014.
We expect to open stores in approximately 34 states next year as we continue to identify great opportunities across all of the markets we serve and have the capacity throughout our distribution network. Our growth next year will consist of openings in existing, new and acquired markets. Existing markets such as Texas continue to offer robust economies and growing populations and we have very seasoned store and DC teams in these existing markets to support this growth. Greenfield markets such as Florida will also see significant growth in 2014 and will be supported by our new DC in Central Florida. In addition, we plan to enter our 43rd state next year with openings in Pennsylvania.
Finally, with our dual market strategy firmly in place, we'll grow in our Western acquired markets next year. California alone has significant backfill opportunities and we also plan to open new stores in Oregon, Utah, Arizona and Washington in 2014.
Now I'd like to take
a minute to talk about some of our operating numbers. We leveraged SG and A 36 basis points during the Q3 driven by solid comparable store sales of 4.6% and our relentless focus on expense control. Year to date, we leveraged SG and A 8 basis points, which is slightly above our expectations of being flat at this point in the year. Our SG and A dollar spend was in line with our expectations. Year to date, average SG and A per store has increased approximately 75 basis points and we expect that rate to continue in the Q4.
I'd like to finish up today by recapping the highlights from our recent store operations leadership meeting. Each year in the late summer, we bring our regional managers together in one room to discuss business strategy and ways to continue to perpetuate our model as well as replicating the O'Reilly culture in all of our new markets. The theme every year is very simple. How do we continue to deliver that consistent top notch customer service in every store every day? We focused on the fundamental concepts of execution in every store, identifying and developing strong leaders and internally building our bench of future store and district managers to support our growth, as well as creating strong and cohesive store teams.
These are the very same concepts that have made us successful for the past 56 years and are the keys to our future success. Our regional managers left the meeting fired up ready to replicate the knowledge and the training they received with each of their district managers who will in turn replicate the training with each of their 4,135 store managers across all of our markets. We remain well positioned to continue our track record of profitable growth supported by 61,000 team members dedicated to delivering unsurpassed levels of service to each one of our customers every day. I would once again like to thank our store and DC operations teams for their hard work and dedication and want to congratulate them on another very successful and profitable quarter. Now I'll turn the call over to Tom.
Thanks, Jeff. Now we'll take a closer look at our results and add some color to our guidance. Comparable store sales for the quarter increased 4.6% on top of prior year's comps of 1.3%. 3rd quarter comps came in within our range despite the lack of extreme temperatures, which created a headwind for our results in weather related categories as Greg previously discussed. For the quarter, sales increased to $126,000,000 comprised a $72,000,000 increase in comp store sales, a $52,000,000 increase in non comp store sales, a $3,000,000 increase in non comp non store sales and $1,000,000 decrease from closed stores.
As Greg mentioned, we're setting our 4th quarter comparable store sales guidance at 3% to 5%, which is in line with our internal expectations created at the beginning of the year. We're adjusting our comparable store sales guidance for the full year 2013 to a 3.5% to 4.5% increase in comparable store sales, which is simply narrowing our previous guidance as comp sales for the 1st 3 quarters have been within our expectations. Our full year total sales guidance remains unchanged at $6,600,000,000 to $6,700,000,000 As Greg discussed, our gross margin results exceeded our expectations for the 3rd quarter despite headwinds resulting from LIFO inventory accounting. I'd like to provide a little more color on what we've seen on this front and what we're expecting over the next few quarters. As a result of our incrementally better purchasing power over time, our product acquisition costs have outpaced inflation and resulted in the reduction of our LIFO reserve to a calculated LIFO debit.
We have elected the conservative approach and have not and will not record the LIFO debit, which would have the effect of writing up our inventory value beyond replacement cost. To the extent we have received and expect to continue to receive acquisition cost improvements, while in a 0 LIFO reserve balance, we have temporary one time hits to gross margin to adjust our existing on hand inventory to the new lower acquisition costs. I want to strongly emphasize that these are non cash short term headwinds, which will be quickly offset by the long term gains as the acquisition cost improvements generate increased point of sale margins ongoing. As a result, we expect these LIFO charges to be a meaningful headwind in the Q4 of this year and the Q1 of 2014. After that period, we expect the quarterly impacts from acquisition cost reductions will be largely mitigated by the improved gross margins generated by the deals we are currently putting in place.
As Greg previously mentioned, we expect the impacts of the LIFO accounting and capitalized distribution costs to create pressure on our sequential margin in the 4th quarter. But on a year over year basis, we're expecting Q4 gross margins to be comparable to last year as a result of the acquisition cost improvements. As a result, we're tightening our full year gross margin guidance to 50.5% to 50.7%. Although we will not give full year 2014 guidance until our next conference call, we do expect the pressure from the expected LIFO charge in the Q1 of 2014 to result in approximately flat year over year gross margins in the Q1 of next year. Operating profit as a percent of sales for the quarter was 17.4%, which was a 94 basis point improvement over the prior year and represents an all time high quarterly operating margin.
For the 1st 9 months of 2013, operating profit as a percent of sales improved 79 basis points to 16.9 percent of sales. Based on our strong year to date results, we're raising our full year operating profit as a percent of sales guidance to 16.2% to 16.5 percent, up from our previous guidance of 16% to 16.4%. Diluted earnings per share for the Q3 was $1.69 per share, which represents an increase of 28% over $1.32 per share in the Q3 of 2012. For the 1st 9 months, diluted earnings per share was $4.63 per share, which represents an increase of 29%. Our Q3 and year to date EPS benefited from tax rates of 35.3% and 36.5% of pretax income respectively versus rates of 37.3% and 37.9% for the 3rd quarter and first 9 months of 2012 respectively.
The Q3 of 2013 benefited from job credits in excess of expectations versus the Q3 of the prior year, which was negatively impacted by adjustments for certain tax audits. Based on our year to date results, we now expect a full year tax rate of approximately 36.8 percent of pre tax income for 2013. For the Q4, we're establishing diluted earnings per share guidance of $1.27 to $1.31 Based on our above planned results in the Q3 and additional shares repurchased since our last call, for the full year we're raising our guidance from $5.79 to $5.89 per share to $5.91 to $5.95 per share. As a reminder, our diluted earnings per share guidance for both the Q4 and full year take into account the shares repurchased through yesterday, but do not reflect the impact of any potential future share repurchases. Moving to the balance sheet.
Our average inventory per store at the end of the Q3 was $572,000 up 1% from $567,000 at the end of the Q3 of 2012 and in line with our per store inventory at the end of 2012. We continue to project inventory per store to be flat in 2013 as we continue to identify opportunities to redeploy our existing investment in a more productive inventory. Capital expenditures for the 1st 9 months of 2013 were $300,000,000 The purchase of the Devons, Massachusetts distribution center brings us in line with our year to date expectations after being slightly below our plan in the first half of the year. With continued development of now 3 distribution center projects in the Q4 including the Lakeland, Florida and Naperville, Illinois facilities in addition to Devons, we'd expect to be in the upper end of our previous CapEx guidance range. So we're tightening that guidance range to $395,000,000 to $415,000,000 At the end of the 3rd quarter, our AP to inventory ratio was 87.8%, up from 84.4% at the end of the Q3 of 2012 and 84.7% at the end of 2012.
The year to date increase is better than expected, primarily due to incremental gains in terms we've realized with our suppliers. While we do expect our ratio to come down somewhat in the Q4 due to the seasonal timing of payments, we now expect to end the year slightly above our earlier expectations of flat with the end of 2012. For the quarter, free cash flow declined to $158,000,000 versus $276,000,000 in 2012. This decline was caused solely by the dramatic improvements we made in our net inventory investment throughout 2012, driven by the rapid growth in our vendor financing program. On a full year basis, we're expecting the improved outlook on our AP to inventory ratio, partially offset by a CapEx spend closer to the top end of our range and slightly higher deferred tax payments related to previous tax depreciation accelerations to drive free cash flow to the high side of our previous guidance.
As a result, we're narrowing our guidance range to $470,000,000 to $500,000,000 Next, I'll provide an update on our share repurchase program. As we've discussed several times since the inception of our repurchase program, we continue to believe the best use of our cash is to reinvest back into our business. But we continue to view buybacks as an effective use of excess available cash and we'll continue to opportunistically execute the program moving forward. During the Q3, we repurchased 1,500,000 shares for an aggregate cost of $185,000,000 at an average price of $120.71 per share. Subsequent to the end of the Q3 and through the date of this earnings release, we repurchased approximately 200,000 shares at an average price of $125.74 bringing our cumulative year to date share repurchases to 6,800,000 shares at an average price of $105.69 Our cumulative share repurchases since the inception of our program in January of 2011 through yesterday were 38,900,000 shares at an average price of $80.77 As an update, we currently have $360,000,000 remaining under our current Board approved share repurchase authorization.
At the end of the Q3, our adjusted debt to adjusted EBITDA was 1.94 times. As we discussed in the Q2 earnings call, we still intend to move prudently toward our long term target leverage range of 2 to 2.25 times and we've expected at the beginning of the year to have entered that range, but our strong 2013 eBuy results still have it slightly below our target. We remain confident that our established target leverage range represents the appropriate capital structure for our company we will continue to incrementally move toward entering that range. However, as I've discussed in the past, but it bears repeating now, we are extremely committed to adhering to our targeted leverage cap, so that we can maintain or improve our investment grade ratings as this is a critical factor in maintaining the success of our vendor financing program. Before we turn the call over to the operator to take your questions, I'd like to take this opportunity to thank all of our store, DC and headquarter team members for their hard work and commitment to our company's success.
Your commitment to providing the best customer service in the industry is the driving force behind our continued outstanding financial performance and I want to express our gratitude for the dedication you show every day. At this time, I'd like to ask Ellen, the operator to return to the line and we'll be happy to answer your questions. Ellen?
Thank you. We will now begin the question and answer session. Our first question comes from Scot Ciccarelli with RBC Capital Markets. Please go ahead.
Hey, guys. Scot Ciccarelli. Two questions. The first is, what kind of impact are you expecting from the LIFO in the Q4 and Q1? Said another way, what would gross margins look like excluding the LIFO impact?
And then since I'm sure somebody else will ask it, if I don't, can you guys just talk about what you're thinking regarding Advances' recent acquisition announcement the other day in terms of any additional challenges or opportunities that that may provide? Thanks.
Okay. Well, I'll take the second question and I'll defer the LIFO question to Tom. I'll answer first. On Advances acquisition of GPI, we basically have read all the information you have, of course. And us being in the business, we know probably a little bit more about those companies from a competitive standpoint than you do.
So we of course looking at it from our side see the opportunities that could be created just as our competitors see opportunities when we acquire companies to take advantage of the distraction and the work that has to be done to integrate those companies. So we'll of course be working to do what any good competitor would do and that is to try and gain market share as they work to bring those companies together. There's still a lot of known as far as what they'll do with the brands and whether the Carquest and Advanced stores will be integrating together or they'll continue to operate those in the same market separately. So there's a lot yet to be seen. But we of course see the opportunities that we have to take advantage of potential market share gains as they work through that acquisition.
Scott, on the second part of your question, we would expect absent the LIFO charge to see a relatively consistent gross margin percentage with the Q3 in the Q4.
So flat sequentially. Got it. All right. Thanks a lot gentlemen.
Okay. Thanks Scott.
The next question comes from Mike Baker with Deutsche Bank. Please go ahead.
Hi. Thanks, guys. Can you hear me okay?
We can. Yes.
Great. Okay. So I wanted to just ask, I had 2 questions. 1 on the West with CSK. Can you tell us what where are you in terms of the DIY BIFM mix in those stores?
And then I guess then where are you company wide? Just sort of frame how far you are in through that process has been what 4 or 5 years and you still say you have room to go. So just sort of contextualize that? And then same type of question on the benefits of renegotiating with your vendors. How far along are you in that process?
How much how much benefit do you have to go there? Thanks.
Okay. On the CSK product mix, our company as a whole, we're about 42 professional and 58 percent DIY. CSK is more DIY oriented still. They would still they would be more in the 66%, 34% range something like that. So we continue to work to gain market share on the professional side out there and that becomes a bigger part of our mix.
As we've talked about, we continue to do a little better DIY out there. So we're growing both sides of the business, but the commercial business grows significantly faster than the rest of the business. And then Tom you want to take the remainder?
Sure. On the timing of deals, we expect to have some pretty big deals get re upped here in the Q4 and the Q1, which is why we're calling off the LIFO charge. After that, we'd expect to be on a pace to be back to more incremental gains.
Okay. Thanks. If I could just follow-up on that CSK, so 6,634 in terms of DIFM, what can that DIFM get to? Does it ever I don't think it ever gets to the fifty-fifty, right? But if you could talk about where you think it could get to?
Thanks.
Yes. I don't think it will get to fifty-fifty just because some of the locations that we're in out there are more retail inclined locations. But it can probably get, I don't know, I would be guessing because we're trying to grow both of them as much as we can. But we might get it to the 45, 55 range someday. But again, that's yet to be seen.
It depends a lot on just the what happens in our industry relative to the amount of DIY business and hold the amount of the DuPont business. I think everyone agrees that right now the DuPont business is growing a little more robustly than the DIY business. So it may be that we reach a point that we're not able to get our DIY business to be that much of our mix out there or maintain that much of a mix out there. But we'll see. Our new form business is strong and growing and we just have to see where it ends at.
Okay. Yeah, perfect. Thank you very much. Appreciate it. You bet.
The next question comes from Gregory Melich with ISI Group. Please go ahead.
Thanks. Just wanted to get a little more color on
that DIY versus do it for me relative performance. You said that both were positive. Was that outperformance that do it for me seems to have regularly did that widen in the quarter? Or is it pretty much what it's been running? And then I had a follow-up on the purchasing.
You're referring to the company as a whole? Yes. Yes. No, it stayed pretty well, no, it narrowed a little bit. No, I'm sorry, it widened a little bit with compared to last quarter.
It's a little bit wider this quarter. We had one less Sunday, which is a good number for the professional side and less good for the DIY side. So excluding that sort of day shift, do you think the GAAP has stayed whatever sort of 600 bps? Well, we're not going to comment on the 600 bps. Okay.
But that will be my answer. So the on purchasing, Tom, could you give us a
little more color on why now on the extra traction on the purchasing? Are there particular categories that you're resetting? And how is inflation looking on the flip side in terms of sell through, if there is any? Yes. Tom may have some comments on this.
So we're simply going back through our major vendors, primarily hard parts vendors. And post the CSK acquisition and the expiration of some of the agreements that we had post acquisition and just kind of reworking those deals and resetting those deals to reflect our planned growth on the East Coast and the rest of the country. And that's kind of what we're working through. So these are deals that will benefit us and our manufacturers as we assure them business and growth into the future and put us in a position to work to do on the East Coast what we've not yet done and have been able to do in the Central and the Western part of
the country. On the inflation side, when we look at sale prices year over year excluding mix, we're well below historical averages for inflation, which I think have been noted other places within the industry. Still positive, but well below history? Fairly positive. Okay.
All right. Thanks a lot.
Okay. Thanks, Greg.
Thank you. The next question comes from Matthew Fessler with Goldman Sachs. Please go ahead.
Thanks so much and good morning. I'd like to focus my question on traffic and ticket where you did give us some color, but to think about the traffic and ticket trends within each of DIY and commercial for you please?
Okay. When we look at traffic on DIY, it's been pressured over a long period of time due to the changes in vehicles and the frequency of repair. Last quarter, we had one of our best DIY traffic counts in a while and that slowed this quarter. So there continues to be pressure. Again, we had one less Sunday, which is good for the professional side of the business and more challenging for the DIY side of the business, but it did slow.
On the do it for me side of the business, we continued to gain share both in our existing markets and even more robustly in the acquired markets. So those ticket counts are increases are more than offsetting the DIY pressure.
And is there if you look at the ticket on the DIY side, I guess you sort of talked about an industry wide trend of fewer repairs, but of larger magnitude. Is that playing out on the DIY side of the business as well?
We see that on both sides of the business, yes.
Great. And then just quickly by the way a follow-up. I know you said inflation was not really a factor. I'm asking that really as it relates to comp rather than gross margin and the whole LIFO theme. As you look forward to 2014, as you look at raw material costs and other factors, any anticipation of the impact that you would expect for inflation?
For the foreseeable future, we don't see a catalyst out there that's going to drive our acquisition costs higher and sale prices higher. So we're not expecting to see for the foreseeable future comps driven as much by inflation as we've seen in the past.
Okay. Great. Thanks so much guys.
Thanks, Matt.
The next question comes from Simeon Gutman with Credit Suisse. Please go ahead.
Thanks. So just looking at Q3 and relative to Q2 and Tom you said that DIY was a little slow or slower. Can you talk about whether that's just industry macro weather or was it market share that you could identify?
I think we would say that it would just be more macro and maybe not so much industry related, but I would relate it more to the fact that the DIY customers are typically customers that are many of them work on their own cars because they are economically incentivized to do that. They really can't afford to have their car worked on. So they try to do some of the jobs themselves. And I think some of the things that have happened of late with the governmental shutdown and those kinds of things, must maybe not having quite as hot weather as what we would have typically had in the summertime. Those things probably put a little bit of pressure on the DIY.
I think that from an industry standpoint that everyone agrees that the do it for me business is growing a little bit faster than the DIY business just as a result of the complexity of vehicles and the expertise that it takes to do some of the drivability type repairs. And we would expect that trend to continue into the future. Okay.
And then a follow-up. I think I got the relationship right that the gross margin benefited from being a little less promotional this year. Can you just talk about the trade off there? And is this an intention? Is this a posture you plan on going forward?
And do you think had you been a little more promotional on a tougher take, you could have gotten better comps and just thinking about the return there?
Yes. It's really just a timing thing. We plan our promotions based on a variety of things including the timing with vendors related to their preference on oil change specials and some of those kinds of things. The primary difference here is just some pretty aggressive oil change specials we had running during that period last year that we didn't have running at the same time this year. Really nothing has changed, but it did have an impact and it was a positive from a gross margin perspective and probably did put some pressure on sales during the quarter.
And definitely as we look at it from a category by category basis, those categories that we were promoting last year didn't perform nearly as well from a sales standpoint towards the end of the period as they performed last year. But they, of course, performed much better from a gross margin perspective. So, it's just typical promotions. Nothing has changed with the way we do it, strictly a timing thing.
The next question comes from Chris Horvers with JPMorgan. Please go ahead.
Thanks. Good morning, guys. I wanted
to follow-up on that one as well. I mean, you mentioned, it sounds like you really believe that the promotional change is what drove some of the slower trends into the end of the quarter. I mean is there anything that you've seen in around the government shutdown leading in coming out that would suggest that there was an impact, probably temporary, but there was an impact. And commercial versus DIY, was there a difference in those businesses as well related to that?
Yes. Here's what I would say, Chris. Our DIY business definitely slowed down towards the end of the quarter more pretty dramatically. And we related it directly to the difference in the promotional activity that we were running last year in those categories that we were promoting. At the same time, this whole government shutdown and the bickering that's been going on in Washington was going on.
And I think as informed as most people are these days because of the news agencies and smartphones and all that kind of stuff. I think it creates uncertainty, especially when people are living paycheck to paycheck and we're talking about defaulting on our sovereign debt and all the things that are discussed on TV and news agencies. So a lot of people don't really understand. They just think it's bad and can't be good for them. And then also the impending health care debate and whether or not people are going to have to spend the money next year to have health care in order to abide by the law and what that means and what's going to happen with their employer sponsored healthcare when many are delaying their open enrollment because they are trying to figure out how to do this and what's the right thing to do and they want to be competitive with other companies when it comes to the healthcare.
Yet all of us are having to burden a little more expense. So there's just a lot of uncertainties I think that also contribute to DIY softness. So far this quarter, we have seen our DIY business doing better and our overall business has been solid as I said. So I think the government saying, hey, we're going to get along for a while here and try to work this out. I think that has helped calm some nerves and things are maybe a little more back to normal.
Perfect. And then, 2 more quick follow ups. As you think about sort of what sort of weather backdrop are you expecting in the Q4? It's been pretty shaky over the past couple of years. Do you think that as you see the outlook, do you think it's going to be more favorable this year?
Let me answer that. Okay. You go ahead. When we come up with our guidance, we'll look at pricing trends and we'll look at our business trends. We always project weather to be normal.
Okay. Fair enough. And then last question, just as you build inventory for these new DCs from a assuming that you're buying cheaper, is that part of the reason why you'll have a gross margin tailwind as the year progresses next year?
The new DCs really won't have a significant impact on our gross margin. We'll have a little bit of headwind when they first open as they're not as efficient, although we're spreading it off across a large base. So that's the distribution cost standpoint. When we look at gross margin tailwinds next year, although we haven't given guidance, When we get beyond signing up some of the last few big deals we have and the impacts from our LIFO, when those subside, we're going to see that pressure released and we'd expect to see higher margins in the back half of the year. And it really doesn't relate back to DCs or DC openings.
We really try to focus our deals with our suppliers on how much product we're going to move over a period of time.
I guess I was just I always thought with LIFO that if you are buying you're basically going to be flat inventory year to year right now. But as you step up presumably inventory growth year over year that ends up being you're buying lower that ends up being a benefit in the LIFO calculation?
It won't impact our LIFO calculation as much as our capitalized distribution costs for more inventory and that helps offset the value, the cost. Unicap is a recognition of the value of putting more salable inventory in place in those costs you burden. So it really doesn't run through LIFO.
Okay. Understood. Thank you. Thanks.
The next question comes from Dan Weimer with Raymond James. Please go ahead.
Thanks. Greg, just following up on inflation, you noted that it's going to run below normal range,
I believe, is what
you said in your prepared comments. What was the normal range? As I recall, it was around 2%, correct me if I'm wrong. And then curious as to why the inflation rate is less? It's my understanding it's not just what's happening with copper and steel prices that parts are more technologically sophisticated than they used to be.
Therefore, the engineering costs are higher and that's contributed to that used to work inflation rate. So why would that not have continued?
Yes. Well, I think at some point it most likely will continue. Our historic rate has been more in the 1% to 2% range, 1.5% something like that. We're expecting it to be pretty flat. I think part of that is driven by commodities as oil prices have increased and we're not seeing as much of that of late and other commodities too, antifreezes and things like that.
I think over time, we do move back into more of an inflationary environment. But as we continue to grow and some other companies have continued to grow, we all buy well. It's harder, I think, for manufacturers to pass price increases through to these larger companies that operate very efficiently from a supply chain perspective. And we just went through a period and we expect to continue to go through a period in the upcoming year where we wouldn't expect there to be as much inflation unless something were to happen that drove commodity prices up and then we might see some.
And then as a follow-up question, back when you bought CSK operating margins in the core business were running about 12%. As I recall CSK's operating margins were around 5%. And now we're looking at the combined organization somewhere between a 16% 17% operating margin. So you could make a case there's been about 1,000 basis points of synergies coming out of CSK. When you look at where you exceeded the initial forecast from 5 years ago with the integration, was it mainly in product acquisition cost?
Yes, a big part of this product acquisition cost for sure. We've and a lot of that's due to a lot of factors. One, just the size and the buying power we have, a lot of its efficiencies that we have created in supply chain from a just a supply standpoint, buying through vendors here in the U. S, but buying more product from overseas manufacturers and things like that. But yes, it has exceeded what we thought it would be and the majority of the synergy has come through improved gross margin.
But Dan, what I would add to that is CSK's operating margin of 5% was they were working pretty hard to keep that number down. So a lot of it is operational execution. So they should not have been at 5%. Should they have been at the 12% that we were at? There's some differences in leases and things like that.
Part of getting their 5% up to 12% is just executing the business better.
Right. Yes.
Great. Thank you. Thanks.
The next question comes from Daniel Hopkin with William Blair and Company. Please go ahead.
Good morning. Just I guess another question related to CSK. If you could you talk about sort of core versus converted stores at this point, sales productivity, how those compare and where you see I guess my math suggests they're pretty comparable at this point in terms of sales per store or sales per square foot. Where could you see, if I'm right about that, where could the converted stores get to over time given that you're particularly growing the commercial business? That's my first question.
Okay. Well, to some degree comparing the core O'Reilly stores to the CSK stores is a little bit comparing apples to oranges because of the as the company was a young company and expanding, we expanded into a lot of rural markets that really never have the top line potential that many of the metro stores that we put in as a more mature company at Core O'Reilly and the CSK was in when we bought them. So CSK has the potential to have the majority what was CSK has the potential to have the majority of their stores at a pretty high top line and more comparable with the metro stores that CorO'Reilly has. If we compare the metro stores at Coral O'Reilly to the CSK metro stores, the Coral O'Reilly store still outperformed the CSK stores. There's still a lot of upside on the CSK.
The Coral O'Reilly stores are as a whole are dragged down a little bit by the rural stores that we operate. They just don't have that top line potential. So, core O'Reilly would still be probably a little higher in those metro stores, but we were working to get our CSK stores up to that level. And then in some cases, we'll surpass Port O'Reilly because we're in some really good markets out west that have a lot of market potential and we're just in the process of gaining that performing market share and we still have a lot of room
to go.
Okay, great. And then as it relates to just back yet another question on the gross margin. So when you talk about the deals that signing near term between now and let's say Q1, the impact there that is the unit cap in other words just increased capitalized distribution costs that's the drag from that?
No. We got a little we had a combined question back a few questions ago. There's 2 issues there. These new deals are going to be a pressure on us from a LIFO accounting standpoint and create short term margin as we write all our inventory down to those new deal prices. The other issue was a question on new DCs and we'll see a higher capitalized distribution cost next year, which is recognition for all these DCs we're going to put in place an additional inventory we'll have in salable position and that will be a net zero on gross margin as the capitalization of those values offsets the increased cost of new DCs.
Okay. So and in summary, you're looking for flattish year over year gross margin in the Q4 and the Q1 because of the, I guess, benefit from improved product acquisition costs over time?
Yes. The short term pain for the long term gain, yes.
Okay. Thank you very much.
Thanks.
The next question is from Michael Lasser with UBS. Please go ahead.
Michael, are you there?
Your line is open, Michael. We'll take the next question. We have Jack Bellows with Focus Research. Please go ahead.
Hi. I was wondering when you took over CSK, did you have some distractions that benefit your competition the way you might expect to happen with Advanced Auto Parts?
Well, that's a good question,
Jack. I'd like to say, no, we didn't. But I can tell you that when you do something like this, it takes a lot of energy and it takes a lot of focus from the not only a top management of the company, but the field team members that you put in place to do that. What we did during the CSK acquisition is we really relied on our field operations management to run the core O'Reilly stores and keep things headed the right direction. I think they did a great job.
But there's it always takes a lot of energy out of the top management of the company to absorb the kind of acquisitions that we did with CSK and that Advance is working on integrating with GPI. So the answer would be, yes, sure, it takes some you do the best you can to avoid it materializing in market share loss. But there's certainly that possibility that exists with any acquisition of that size.
Okay. But I assume that you were still able to pretty well service your commercial accounts.
Yes. We were we kept our eye on the ball and all the things that really what you try to do Jack is you try to make the stores that are in operation that are operating and servicing customers, you try to make it a non issue for them. You make it something that they read about in our newsletters and our communications, but you make it something that doesn't impact them. Where it can become distracting is where you're trying to maybe adapt the business to the changing market conditions, something that competitors doing. There's just not quite as much focus on that from a top management standpoint as there would be if you weren't integrating a company.
So that would be generally where I'm coming from.
Okay. One last question. Regarding SG and A, which was down for the entire company, I think there was a comment made that SG and A per store was up 0.75. Can you explain that difference?
Did you say
that? The increase in SG and A on a we leveraged total SG and A, but if we look at raw dollars, the growth was 0.75% per store, which is what we're expecting for the full year.
In other words, you went up 0.75 per store in an upward direction despite the entire company being down?
Oh, percentage. We're talking about dollar the 0.7 is dollar increase per store, Jack.
Oh, I'm sorry. I thought it was a percentage. Okay. That's good. Thank you very much.
Yeah. Thanks, Jack.
We have reached our allotted time for questions. I will now turn the call back over to Greg Hensley for closing remarks.
Okay. Thank you, Alan. I'd like to once again thank everyone, every member of Team O'Reilly for their hard work and their dedication to our ongoing success. You've proven time and time again that the relentless focus on providing consistent excellent customer service is the key to our long term profitable growth. We remain committed to executing our proven business model in every existing and new markets that we enter.
We are confident that we will continue to gain market share by focusing on satisfying each customer who calls or walks into our stores. Thanks to everyone for their time today and we look forward to reporting our 2013 Q4 and full year results in early February. Thanks.
Thank you. Ladies and gentlemen, this concludes the O'Reilly Automotive Incorporated Third