Good morning. My name is Carly, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2010 Third Quarter Earnings Release Conference Call. Thank you. Mr.
McFaul, you may begin your conference.
Thank you, Carleen. Good morning, everyone, and welcome to the O'Reilly conference call. Before I introduce Greg 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. These statements can be identified by forward looking words such as expect, believe, anticipate, should, plan, intend, estimate, project, will or similar words.
In addition, statements contained within this conference call that are not historical facts are forward looking statements such as statements discussing, among other things, expected growth, store development, integration and expansion strategy, business strategies, future revenues and future performance. These forward looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions, including but not limited to competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our ability to hire and retain qualified employees, risks associated with the integration of acquired businesses, including the acquisition of CSK Auto Corporation, weather, terrorist activities, war and the threat of war. Actual results may materially differ from anticipated results described or implied in these forward looking statements. Please refer to the Risk Factors section of the company's Form 10 ks for the year ended December 31, 2009 for more details.
At this time, I'd like to introduce Greg Hensley. Thanks, Tom. Good morning, everyone, and welcome to our Q3 conference call. Participating on the call with
me this morning is, of course, Tom McFall, our Chief Financial Officer and Ted Wise, our Chief Operating Officer. David O'Reilly, our Executive Chairman is also present. I'd like to start off by once again congratulating team O'Reilly on the outstanding results. Our performance across all markets in the Q3 was very strong and we should all be proud of our performance so far this year. Especially impressive is the continued outstanding performance of the core O'Reilly stores.
We've asked many of our more tenured team members to take on the task of attending the CSK conversions and spend the 1st couple of weeks after conversion training the converted store team members. Even with these distractions, our core stores have continued to gain market share and post very impressive comparable store sales gains. At the same time, the work that we put into these conversions is clearly bearing fruit as we continue to gain market share in the converted stores. The strong comparable store sales that we've been able to achieve in the converted stores have been a team effort and every team O'Reilly member should be very proud of the success we are having with these conversions. Our outstanding sales performance is the direct result of the incredible customer service levels we provide at each of our locations, and I want to thank you for your commitment to providing the best customer service in our industry and to the continued success of our company.
Before moving on to discussion of our operational performance during the quarter, I want to comment on the $5,900,000 reserve we accrued in the 3rd quarter to fund settlement of the legacy CSK Department of Justice issue. As discussed during our 2nd quarter earnings release, this investigation is related to the alleged wrongdoing at CSK Auto in 2006 prior. As most of you know, we did not purchase the company until July of 2,008.
Part of
our due diligence process prior to this purchase was, of course, evaluating the exposure the company could have related to the alleged issues. After extensive work, we reached the conclusion that the actions of the Department of Justice and the Securities Exchange Commission would most likely stop short of penalizing or charging CSK based on the level of cooperation with the SEC and the DOJ, the merits of our acquisition, prior actions by the SEC and DOJ, our track record of solid management, SOX compliance, along with many other factors. As expected, in March of 2 1009, the SEC determined to close the matter with respect to CSK without fine or penalty. With respect to the DOJ investigation, O'Reilly has continued to cooperate with and engage in discussions with the DOJ to resolve CSK's legacy accounting issues and we have now reached an agreement in principle with the DOJ. Subject to final documentation, the DOJ, CSK and O'Reilly will enter into a non prosecution agreement and the company will pay a one time monetary penalty in the amount of $20,900,000 As you may recall, we reserved $15,000,000 for this matter during our Q2 this year and the additional $5,900,000 reserve that we made this past quarter will resolve the matter.
Now on to our quarterly performance. We're very pleased with our performance during the Q3. Business remained strong coming out of the Q2 and was steady at a solid rate throughout the quarter. These solid trends exist in pretty much all our markets across the U. S.
And yielded a strong comparable store sales increase of 11.1% for the quarter on top of the 5.3% increase we had last year. Our continued strong comp performance can be attributed to several factors, but the key contributor is very solid execution across all our markets. Our store operations and distribution teams are very simply doing an outstanding job providing incredibly high levels of customer service. This coupled with the ongoing effort we make in all stores to carry the right product assortment at competitive prices as well as the investments that we've made in our Western distribution capability has put us in a good position. At the same time, our industry clearly continues to benefit from the tailwinds that have been present for some time now.
The average age of vehicles driven in the U. S. Continues to increase as new vehicle sales install, fuel prices have been relatively steady for some time now and miles driven are back to solid incremental increases. And to a lesser degree, the dealership closures have redirected some of the service work that was being performed at the dealers to aftermarket shops. In the Q3, all the factors I've mentioned both internal and external coupled with favorable summer weather conditions culminated into a very good sales environment for our company.
We're very pleased with our comparable store sales performance on both sides of our business, DIY and commercial. Yet, as has been the case for some time now, our commercial sales continue to grow faster than our DIY sales as we have enhanced our capabilities in the historic CSK markets. To this point in the Q4, we're very pleased with our sales performance. However, Q4 is always a difficult quarter to forecast comparable store sales. As winter rolls in, sales can be lumpy from week to week and with unemployment still over 9%, I think it's reasonable to anticipate some slowdown in our business over the holiday season as consumers use their limited discretionary income for holiday activities.
With this in mind, we're going to leave our comparable store sales forecast at 4% to 6% for the quarter, which would lead us to completing the full year with comps in the range of 7% to 8%. Adjusting for the non recurring $5,900,000 expense item I mentioned, we generated a 14.4% operating margin for the quarter. This is an all time high quarterly operating margin for our company since going public in 1993, beating the record we set in Q2 of this year by 20 basis points. The increased level of profitability is the direct result of the commitment all our team members have made to the profitability of our company through diligent management of our gross margin and relentless expense control, while continuing to robustly grow market share. We're very pleased with our efforts on all fronts to grow our profits as we incrementally work to complete the integration of CSK.
We're now in our 28th month of the CSK integration work that began with the acquisition in July of 2,008. And I'm very pleased to announce that we're right on schedule with the plan we put in place directly following the acquisition. We've now completed the distribution expansion in the western half of the country with O'Reilly Distribution Centers now operating in Seattle, Moreno Valley, California, Denver, Salt Lake City and Stockton, California. Stockton was our most recent opening and our team has simply done an excellent job at moving our operations from Dixon, California to a larger facility in Stockton and in completing the system conversions of the 274 stores that are supplied by the new distribution center. We're now in the process of closing down the facility in Dixon, but still have some duplicate inventory to work through and will do so over the next few months.
This duplicate inventory is one of the contributors to the inventory growth we had in the Q3. The final leg of the distribution and system conversions will be completed on November 7 with the system conversion of the Phoenix distribution center and simultaneous conversion of the 151 stores that are supplied by that distribution center. On that date, all our stores and DCs will be operating on the same systems and we'll be able to retire the legacy CSK systems that are being used in the unconverted stores. We'll also be able to focus more of our efforts on execution of our business strategy in all the converted stores, which will lead to continued in gaining back the DIY auto parts market share these stores have sacrificed over the years and the growth of our commercial programs. With respect to the Phoenix DC conversion, I want to reassure everyone that we're very confident in our ability to perform a single weekend conversion of this size.
We've done it before and have been doing conversions most weekends at a rate of 20 to 40 stores for some time now. In 1998, we converted all of the 180 high low stores we purchased in Texas and Louisiana in 1 night. And in April 2,009, we converted the CSK Detroit DC and 79 supported stores in one night. Both of these conversions were accomplished without service disruptions to the stores as we have a lot of experience with these types of system conversions. Following completion of the system conversions, we'll finish the last leg of the integration by completing the remaining store resets, renovation work and rebranding.
Ted will be reviewing this in detail in a moment, but I just want to reemphasize that we're on schedule with our plan and are very satisfied with the performance of our converted stores and new distribution centers. A lot has changed in a relatively short period of time for our team members in the acquired stores, and we're very proud of the jobs our teams in both converted and unconverted stores have done adapting our culture values and our dual market strategy. Generally speaking, and as I've expressed through the integration, we're very enthused about what the future holds for our company. We very simply have a huge opportunity to expand our ability to execute our dual market strategy in many new markets and we now have ourselves in a position to do that. At the same time, we have several initiatives underway to improve our operations, profitability and market penetration in all markets.
Things like the implementation of retail price optimization software, enhanced e commerce capabilities, incremental improvements to our inventory management systems and enhancements to our point of sale system content, just to name a few of the initiatives that we currently have underway. We also feel that the industry tailwind we've had for some time now could be long lasting as consumers permanently change their behavior and gain comfort with driving well maintained vehicles at higher mileages. Again, congratulations to all of team O'Reilly on the outstanding third quarter results. I'll now turn the call over to Ted Wise.
Thanks, Greg. Good morning, everyone. To start, I would like to also thank our nearly 49,000 O'Reilly team members for the absolutely outstanding results in our Q3. Without question, the general conditions for the auto parts business have been good. However, for our team to produce 11% comps defines the superior level of service we are giving our customers and the market share gain we are experiencing across the core O'Reilly stores as well as our new conversion stores out west.
Also, our 14.4% operating margin last quarter demonstrates our team's ability to effectively manage both our expenses and gross profit. Most amazing, these results parallel the work of various projects involving CSK to O'Reilly store conversions and installations of our new distribution centers. We are proud of our teams above and beyond commitment to take care of our normal business, while managing the integration of CSK into our company. We are anxiously looking forward to next year when we have the many tasks of the conversion behind us, all the support in place on the West Coast and our entire team can be 100% focused on growing our sales. Before commenting on our progress and the conversion work on the West Coast, I will quickly summarize our new store expansion for the Q3.
We ended the quarter with 3,511 stores, a net gain of 44 new stores. This brings us up to 115 stores year to date and on schedule to end the year at 150 new stores. Again, an incredible accomplishment for our store expansion and installation team members considering the additional workload involving the West Coast conversion and reset work that we'll outline in a minute. Also, we performed 11 major store renovations and relocated 4 stores into new locations. In regard to our area of expansion, the stores were in 15 different states.
Wisconsin and Ohio had 7 stores each, Texas and Indiana received 6 stores, and Michigan and North Carolina had 4 stores each. The remaining stores were spread out primarily in the South and Southeast states. As I mentioned, our installation schedule calls for another 35 stores in the Q4 for a net 150 new stores in 2010. Our new store expansion plan for 2011 will be 170 new stores. Considering the amount of conversion and reset work on the West Coast that will spill over into the 1st part of next year, we will have a very busy and productive year ahead of us.
Our real estate team continues to evaluate the conversion store leases and develop the stay and relocation strategy for our store group out West. We will also start a more aggressive new store growth plan in the West now that the new distribution centers are open the stores are operating under the O'Reilly system and brand. Now to overview our conversion progress for last quarter. In the 2nd week of September, we officially opened our new 520,000 square foot distribution center in Stockton, California. As Greg mentioned, it was actually a move from the smaller CSK distribution center in Dixon, California.
This allowed us to start the computer conversions for the 274 Kratian stores, primarily in the surrounding markets at a rate of approximately 40 stores per week. In addition to receiving new store computers and POS system, the stores began nightly stock replenishment and daily access to the additional DC inventory coverage. To date, this was not only the largest distribution center we opened, but also the largest group of stores to convert. We are now finished with the project and in process of shutting down the old Dixon DC and redistributing the inventory to our surrounding distribution centers. The last phase of the distribution and store conversions will take place on November 7.
When we convert the existing CSK Phoenix DC over to O'Reilly warehouse system and convert the 151 surrounding stores to O'Reilly systems. Unlike the other conversions, as Greg mentioned, all 151 stores will convert over the same week and time. This allows us to be totally off of the CSK computer systems by end of the year and start all distribution centers and stores under one reporting system in 20 11. The installation of 5 new distribution centers, conversion of 2 CSK distribution centers to O'Reilly systems, the conversion to nightly replenishment and installation of new store systems in all 1299 CSK stores will have been completed in approximately 2.5 years. This is an outstanding accomplishment that has involved a great deal of planning and execution across all areas of our company.
We're also making good progress on the store resets. We're also making good progress on the store resets and now that the stores are finished with the computer conversions, more stores will be available to put on the reset schedule. We have completed almost all the individual store layout plans and have the new plans into the city for permits. We completed resets for over 130 stores last quarter and we'll do an additional 190 stores in the Q4. Our goal is to finish the store resets by the end of the Q1 of next year, the exception being a small group of resolution stores and some that may still be pending permitting issues.
Immediately following the store resets to the O'Reilly floor plans, the interior decor package necessary remodel work follows. Our plan calls for all interior decor and related work to be finished following the resets in the first half of next year. In regard to the actual backroom merchandise changeovers and the new retail planograms, this work has been ongoing independently of the physical resets. Backroom hard parts changeovers were completed by mid year and we are 80% completed without frontline changeovers with a balance to be scheduled in November, December and January. At that time, the stores will have the O'Reilly product mix both hard parts and new retail planograms, even though a small group of stores will still have the old CSK store layout.
Our co branding advertising plan for CSK and O'Reilly brand has been going on for almost 2 years and has paved the way for changing the exterior signs. This task is well underway and so far we have completed sign conversions to the O'Reilly brand in approximately half of our stores. An additional 180 stores will be installed as soon as the signs are received by the installing sign company. And the balance of the sign surveys for the stores will have been completed, bids sent out to sign companies and plans into the city. We expect to have the rebranding completed by the end of Q1.
Again, there may be a small number of resolution stores and perhaps a group of stores that still has permitting issues that will go into the Q2. Following the signed conversions, we are evaluating the rest of exterior store in regard to paint and other image upgrades that may be needed and the appropriate work will be scheduled as soon as possible. To summarize the store conversion task and projected completion schedule, All computer systems and nightly replenishment will be finished by the end of this year. All inventory hard parts upgrades were finished this year. All out front planograms finished by this coming January.
Store resets finished in the Q1, O'Reilly sign change outs finished in the Q1 and the interior decor and exterior work completed in the Q2 of next year. Our store operations and sales teams are developing well as they become more familiar with the O'Reilly product lines, computer system and all the aspects of our dual marketing plan. Our team members have been very receptive to the conversion task, introduction of the new POS system, the new store operational procedures and the physical resets going on in the stores. Most importantly, we are seeing a good sales improvement as we transition the stores traffic from a more pure oil and accessories sales mix to include more hard parts to both the retail and professional installer customer. Improved store inventories and the access to additional inventory coverage at the hub and distribution center has and is playing a key role in growing our retail and installer business.
Market driven pricing is also helping us gain new customers as the customers realize that we are competitive now. An important goal of our print and radio advertising has been to build the O'Reilly image of having better parts coverage at everyday low prices. The better inventory and better pricing has gained momentum as the stores are reset to the O'Reilly format and O'Reilly exterior signs go up. On the professional sales side, we are very focused on building strong and experienced teams at the store that will result in higher service levels. As stores convert to O'Reilly systems, we're opening up more stores to delivery and implementing 1st call installer service counters to better service the professional customer.
We're expanding our territory sales management team, making more sales calls and developing stronger customer relationships with a wider group of both large and small customers. As we now transition from the CSK to O'Reilly brand and along with the improved inventory, market driven pricing and higher service levels in the stores, we feel our relationship and business with a professional customer will continue to grow for years to come. Bill Riley culture is growing stronger every day in our new stores on the West Coast. Our team members are very happy to have the conversions and the inventory changes behind them and moving forward so rapidly with
the interior resets and exterior sign changes. They are
excited to be full and exterior sign changes. They are excited to be fully integrated in the O'Reilly systems and procedures and looking forward to continue building our business. The core O'Reilly managers and team members that have spent time helping with the conversions and training at these stores have done a great job in expanding our O'Reilly culture as well as training in the O'Reilly procedures. We are now operating as one team moving forward. With this, I'll turn the call back over to Tom.
Thanks, Ted. Now, we'll move on to the numbers. For the quarter, sales increased to $168,000,000 13% over the prior year to $1,430,000,000 The increase was attributable to $136,000,000 increase in comp store sales, a $30,000,000 increase in non comp store sales and a $2,000,000 increase in non comp non store sales. For the quarter, ticket average and ticket count contributed equally to our comparable store sales increase. The increase in ticket average continues to be driven mainly by mix as sales of hard parts, which typically carry a higher ticket accounted for a larger portion of the overall sales volume.
For 2010, we're increasing our total revenue guidance to a range of $5,300,000,000 to $5,400,000,000 Gross profit was 48.6 percent of sales for the quarter versus 48 point 5% in the prior year. The 10 basis point improvement was driven by improved acquisition costs and improved shrink at the converted stores. These improvements were in part offset by deleverage on the distribution costs, which is a result of the new DCs coming online and consistent with our expectations. Year to date gross profit stands at 48.6 percent of sales and for the full fiscal year, we expect gross profit to be approximately 48.5 percent of sales. SG and A for the quarter was 34.3% of sales versus 36.7% in the prior year.
The leverage on SG and A was the direct result of strong comparable store sales. On a per store basis, SG and A per store is up 2.6%, which allowed for strong leverage on 11.1% increase in comp store sales. Year to date SG and A improved 200 basis points as a result of strong sales and expense control. For the full year, we expect SG and A dollars per store to be up slightly from 2,009 as we continue to see opportunities to more aggressively invest in store SG and A to drive strong sales results. We anticipate that total SG and A for 20.10 will increase approximately 5% to 5.5% over the prior year.
Adjusted operating margin for the quarter, which excludes the impact of the legacy CSK DOJ matter discussed by Greg earlier, was extremely strong at 14.4 percent of sales, an improvement of 2 50 basis points over the prior year. This large improvement was a result of strong comp sales and tight expense control and represents a record quarterly operating margin. For the full year, we expect our adjusted operating margin to come in at 13% to 13.5 percent of sales. Net interest expense for the quarter was $10,000,000 which was better than prior year by $1,000,000 due to lower borrowings in part by higher rates as a result of our outstanding interest rate swaps. For 2010, we expect net interest expense to be approximately $40,000,000 The tax provision for the quarter and year to date was 38.7 percent and 39.7 percent of pre tax income respectively.
The tax rate was negatively impacted by the charge related to the legacy CSK DOJ matter, which we currently do not anticipate to be tax deductible. Excluding this one time charge, the quarterly rate was 37.6 percent and the year to date rate was 38.2 percent of pre tax income, which were both flat to the prior year. For 20 10, we expect our tax rate as a percent of pre tax income to be approximately 39.5 percent. Included in this estimate is the 120 basis point one time increase related to the non tax deductible reserve to settle the legacy CSK DOJ issue. Adjusted diluted earnings per share for the Q3 was $0.86 per share, which represents an increase of 37% over the Q3 of 2 1009.
For the year, adjusted EPS of $2.37 increased 39% over the prior year. Moving on to the balance sheet, the average inventory per store at the end of the quarter was $565,000 which represents a 4% increase over the prior year average of $543,000 This increase is a result of our continuing effort to add hard parts coverage to the stores duplicative inventory as new DCs come online. Since the beginning of the year, we've added 100 net new stores, 4 new DCs with one to close when we relocate to the Stockton DC. As a result, our total inventories increased $85,000,000 We remain focused on refining the inventory mix at the CSK stores and leveraging the new DCs to reduce the stocking depth at the Western stores. We expect our total inventory levels will not increase significantly through the end of the year despite adding approximately 35 new stores in the 4th quarter.
Our reserve for LIFO at the end of the quarter was 24 $1,000,000 which was an increase of $1,000,000 over the previous quarter. This change in our last buy to LIFO reserve did not have a material impact on gross margin for the quarter. Accounts payable of $943,000,000 was 47 0.2 percent of inventory as compared to 47.9 percent in the prior year. We continue to work hard at increasing our AP to inventory ratio by improving our inventory productivity and improving terms with vendors. The capital expenditures were $94,000,000 for the quarter bringing our year to date CapEx up to $276,000,000 versus $317,000,000 for the comparable period of 2,009.
For 2010, we expect our CapEx 10, we expect our CapEx
to range from $375,000,000 to
$400,000,000 As discussed in our last conference call, approximately $40,000,000 of CapEx we plan to spend this year will be deferred into the first half of twenty 10 based on adjustments and timing to a portion of the front end CSK conversions. Depreciation and amortization for the quarter was $41,000,000 For 2010, we expect depreciation and amortization to be $160,000,000 to $165,000,000 versus $148,000,000 in 2,009. Total borrowings at the end of the quarter were $431,000,000 compared to $704,000,000 at the end of Q3, 2009. During the quarter, we elected to permanently retire the FILO tranche of our ABL facility, which lowered our maximum borrowings to 1.07 $5,000,000,000 The $125,000,000 tranche carried an interest rate premium of 125 bps. Even with the elimination of the FILO tranche, we had $674,000,000 of availability at the end of the quarter.
For 10, we expect to reduce our total outstanding borrowings by $325,000,000 to $350,000,000 As noted in our press release on October 1, the legacy CSK convertible notes remain exchangeable so until the end of Q4. To date, dollars 11,000,000 of the notes have been surrendered for exchange. To the extent any notes remain outstanding, we continue to intend to call the notes in December. Our plan is to fund this with our existing ABL, which will still allow significant financial flexibility. Now for some other financial information.
Cash flow from operating activities for the quarter was $237,000,000 an increase of 101,000,000 dollars over the Q3 of 2009. For the year, cash flow from operating activities has increased 105 percent to $593,000,000 The improvement was driven by significant decrease in net inventory investment, higher net income, and the timing of payments of other liabilities. For the quarter, free cash flow was $143,000,000 versus $50,000,000 in the Q3 of 2009. Year to date free cash flow was 316,000,000 versus a use of 28,000,000 in the 1st 9 months of 2,009. The improvement was driven by the previously mentioned increase in cash flow from operations and a $41,000,000 decrease in capital expenditures.
We now free cash flow to be $250,000,000 to $275,000,000 in 2010 and we use any additional free cash flow to further reduce our outstanding debt. Stock option expense for the quarter was $3,800,000,000 compared to $3,300,000 in the prior year. The increase was driven by the year over year increase in our stock price. For 2010, we continue to see approximately $15,000,000 versus $13,000,000 in 2,009. Now to recap our our overall guidance.
For the Q3, our comparable store sales guidance is 4% to 6%. For the year, we are raising our comparable store sales guidance to an increase of 7% to 8%. Our GAAP diluted earnings per share guidance for the 4th quarter is from $0.56 to $0.60 on 142,300,000 shares. For the year, our EPS guidance is $2.79 to $2.83 per share on 141,400,000 shares. On an adjusted basis, excluding the 2nd and third quarter charges, our guidance for the full year EPS on a diluted basis is a range from $2.94 to $2.98 At
this time, I'd like to
ask Karleen, the operator to come back and we'll be happy to answer your questions.
Hey, guys. Scot Ciccarelli.
Hey, Scot.
Look, I know you guys don't break out CSK specifically anymore, but is there any color you could provide or a way to think about the impact that the commercial sales growth at the CSK stores has had on the overall company?
Well, as I've talked about for some time now, Scott, we were not going to break out our sales in a secular way like we had been. It was confusing to many, and it was just one of those things that for competitive reasons and other reasons we decided not to do. But I will tell you that the CSK commercial program is contributing significantly to our performance. And the converted stores, in general, our oldest converted stores are our best performing comp stores. So I think from there, what I'm implying is that the conversions are working and that the commercial business is the majority of the gain that we're seeing in comps in the converted stores and that the longer the store has been converted, the more traction that they get.
And given the growth that we've seen in the commercial side, have we kind of reached a gross margin peak given the margin delta between commercial and DIY?
Yes, I think so. The more as we continue to grow the commercial business, we'll continue to put some pressure on our gross margin. But we have a lot of mitigating factors in our company that we work on to maintain our gross margin.
Okay, great.
Thanks a lot, guys. Okay, thank you.
Your next question comes from the line of Brian Nagel with Oppenheimer.
Hi. Good morning. Good morning. Congratulations on another very nice quarter.
Thank you very much.
The first question I have is, if you just look at the sales line and you guys articulated in your prepared comments a lot of the drivers of sales, but there was mean as I look at your sales and I characterize it went from good and actually great in the Q2 to really great in the Q3. There was an acceleration if you look on a 2 year basis on your comps. Is there anything you saw that could explain that this acceleration we've seen over the last few months in the business?
Well, there's a lot of positive factors, all the macro factors that we talk about. But then also for the past or at least in the Q3, we had what I would consider to be almost ideal weather conditions to drive some demand on summer products like temperature control products and batteries and things like that. And then just those other macro factors are meaningful. And those factors have with the cars having more miles on them, the cars being a little older on average than what they were and people having made the decision to drive those cars for even longer than maybe they originally planned when the recession started. I think those factors are just continuing to build, but I do think we had some benefit in the Q3 of just an unusually warm and dry summer in most markets, which was good for us.
Okay. Very good. Then the follow-up question, longer term in nature, you commented in your prepared remarks that and you've said this before, but you've commented that you look at trends that you believe they may be longer lasting. We talked a lot about the macro environment and obviously a lot of the very significant changes you made in your model with the integration of CSK. But is there something you're seeing specifically with maybe customer data, etcetera, that gives you the confidence that this is more than a cyclical type phenomenon, it's more of a structural type shift in the business?
Well, no, I don't think we have any data that wouldn't be available to you just from a pure macro level. What we see that you don't see obviously is just the types of products that are being bought for the cars. And we do really well on the repair parts, maintenance parts, and in many cases, the kind of parts that higher mileage vehicles take. My observation has been, I think it's the observation of several in our industry is that the cars that have been built over the last 10 or 15 years are generally higher quality cars than what had been built in the years prior. And because of that, the enhancements that were made by the OEs during that time to make the interiors last longer, make the bodies last longer, just make them more comfortable and presentable to drive at higher mileages.
I think that as people have spent some money on maintaining these cars, they'll continue to invest in maintaining them because they're not a car that they don't want to drive. These cars, many of them can be driven at over 200 1,000 miles without having major drivetrain issues, engine transmission differential or transaxle. And because of that, people are willing to maintain the brakes and suspensions and ignition and the drivability components. So I think that what we'll see is that the consumer behavior with regard to trading cars every 3 or 4 years or less than 100,000 miles, that may be long lasting.
Thank you very much and congratulations again.
Thank you.
Your next question comes from the line of Michael Lasser with Barclays. Michael, your line is open.
Good morning. Thanks a lot for taking my question. On the leverage that you've been seeing, so SG and A per store was up 1.4% in the 2nd quarter on 7% comp increase, almost 8% comp increase. It was up 2.6% in the percent in the 3rd quarter on an 11% comp increase. So this 300 basis point should we continue to think about the ratio of SG and A per store increases to comp increases is kind of a one for 3?
Tom, do you want to
take that? Yes. Some of that is going to be a sliding scale on how high or low comps are. As we've talked about previously, especially
on the acquired stores, which have
a high occupancy on the acquired stores, which have a high occupancy cost, which is fixed, we have a tremendous amount of opportunity to leverage those sales with existing expenses. When we started the year, we discussed that SG and A would be relatively flat, not down a little bit. Obviously, that was on a lower comp assumption. We have quite a few variable costs that drive our businesses. We see more customers and but we little bit more amounts of leverage on sales increases, I think that that's going to be a lower number, but we still have opportunity next year to be well above our historic rate.
And this is my follow-up, but next year will the flat SG and A per store if it's in the mid single digit range, does that hold true?
We'll give you guidance on the next call for 2011.
Okay. And then just a broader question, it seems that like part of the message you were articulating earlier this morning and at your recent Analyst Day is that you're nearing the end of some of the heavy lifting on the CSK acquisition and now the focus turns to organic growth and various improvement initiatives such as price optimization, etcetera? And how much opportunity do you think there is to both on the margin and the sales side from some of these initiatives that you're going to now turn to given the renewed focus you'll have?
Well, Michael, we don't really know the full, I guess, untapped availability of some of the things that we have not done yet, although we have done some early tests of things like price optimization and other things. I think it would be premature to a prospective number to what we could do in gross margin due to price optimization or what we can do sales wise to enhance our the optimization or what we can do sales wise to enhance our very solid program we have already with some additional things that we can do with our point of sale systems and e commerce content, and the transaction products and stuff like that. But they'll be positive. There are things that over the last two and a half years, we probably would have already implemented some of these things had we not been so focused and resources tied up on the integration of CSK because they're things that are tested and work well and they've been used by many retailers and they're just opportunities for us now that we're going to have a little bit more time to focus on things we can do to improve our business outside of the integration of CSK.
So we'll continue to report on these things and but we would expect positive results from them based on our early analysis of tests.
All right, cool. Thanks a lot and good luck with the rest of
the year.
Okay. Thanks, Michael.
Your next question comes from the line of Matthew Fassler with Goldman Sachs.
It's actually Stephen Gregory with Mandalay Research. A couple of things, you guys mentioned early in the call that enhance e commerce capabilities is a big initiative of your organization. Can you provide some color as to what you guys are doing regarding that initiative?
Well, there is several things going on with e commerce. We've been managing transactions with our installer customers for years. Before the Internet was prevalent mainstream, we did transactions with our installers via green screen terminals that we would set up. And over time, we've had to Internet based, and now we have systems integrated into the systems that they use that allow Internet based transactions. Our efforts, both on that front and on the retail front, are to improve the content that's available to customers, so they can see more about our products, see more about the availability of products, maybe schedule better the amount of time it's going take for them to get their products on the commercial or get our products on the commercial side.
And really just the things that you see some of the best e commerce retailers doing. Like I said earlier, some of the work that we've been doing on CSK has probably had us a little bit distracted from focusing on some of those things over the past 2.5, 3 years. And we've kind
of gotten back to focusing on some
of these fundamental things that we feel are opportunities for us. But most of them revolve around content and integration into systems that we want to improve.
And then just a follow-up to that. Are you going to be steering people to buy products on your site or are you just more using as an informational source to get people to your stores? And second to that, are you guys building like a mobile commerce or social commerce solution to gain more messaging out there in the marketplace, allow people to go on via an iPhone, etcetera?
Yes. We will at some point implement a mobile apps for we want to do as much e commerce business as we can. So yes, we would steer our customers to buy online, which we've been selling online for quite some time now, both commercial and retail, as I said. But yes, we would steer customers to do that. But we also do very well with our existing buy online, pick up in store or just the inquiries that can take place on the Internet to go to one of our local stores.
And we have enough stores in many markets so that using the Internet to do an inquiry as to whether we have a product, what the price is, what it looks like is enhancement to retail transactions. But sure, we want to do as much as we can online. We're a little bit hand tied when it comes to pricing on the Internet because we certainly don't want to price lower on the Internet than what we price on in our stores for local customers. But we're working on some things there that might improve that situation too.
All right. Thank you very much.
You bet. Thank you.
Your next question comes from the line of Kate McShane with Citi Investments. Hi, good morning.
Good morning.
On the last call, you had said that in the core O'Reilly stores and more established markets, you're trying to grow retail and wholesale in hard parts. Can you tell us where you are with this initiative in the O'Reilly stores and how this falls in the sequence of events you outlined today for the converted CSK stores?
Well, I'll make a couple of comments and then I'll Ted may have some comments that he wants to make to this too. One of the things we talked about early on when we acquired CSK is that it appeared to us that they had given us some of the core auto parts, hard parts business that had been is kind of the foundation for all of our operations. And they've given that up and kind of exchanged it for some of the import nonautomotive accessory type products that we've really not dabbled in. 1, because we just have always done well in auto parts and put our focus in auto parts and 2, we don't feel as confident in the ability to have demand for those products without the support of ongoing large competitive prices. And we've seen ability to be a great hard part supplier at competitive prices, and we've seen much improvement in our hard part sales in those markets, and we'll continue to do that.
And then, of course, to add to that, typically what repair shops and commercial customers buy are these hard parts. So yes, we're doing very well there. But that's our focus is to take these is to continue taking these stores through a transition of this large portion of nonautomotive products over to hard parts. And I feel like we've been successful to this point, but we'll continue to have more success obviously started
by putting inventories in the store. When it obviously started by putting inventories in the store. When we purchased CSK, generally speaking, their backroom inventory was very, very poor on the majority of the stores. I mean, they had some larger stores that did installer business that had good hard parts inventory, but over time they had just swapped accessory and oil business for their parts business. And then also the parts, the hard parts they did have, they weren't competitive and they didn't have a very good selection of house brand, entry level product, good, better, best concept.
So it all starts
with educating the customer
because for many, many
years, their ads, all with educating the customer because for many, many years their ads, all their print, everything that the retail customer saw would indicate that they were more of an accessory house, tool, promotional house, and now we've got to more or less rebrand the company in the eyes of the hardcore DIY customer, the ones that really buy the hard parts that we're the place to go for parts now and that we're competitive, because again, not only did they have very good inventories, what they had, their mindset was that they could be 10%, 15% higher than the competition. So it's all coming along well. Again, it won't happen overnight. They've taken years to build that reputation. It will take us a while to build rebuild the reputation to be a hard
parts store. Okay, great. Thank you. And just as a follow-up to that then, in terms of the inventory then for hard parts at those CSK stores, you're where you want to be at this point?
No. Well, we have plenty of inventory and to the extent that I think we have too much inventory. And I mean, we're working to adjust those inventories incrementally, but we don't want to get too far ahead of ourselves on the adjustments because we still have a lot of untapped potential in those markets. But we put these hard parts inventories out there awful quickly. And we use good systems and information to decide what inventory to put out.
But in some markets, that maybe has a population of customers that maybe wouldn't be as inclined to buy some of the higher priced branded products, we'll be making some adjustments over time in just our assortment of hard parts products to better fit the markets and reduce some of the duplication that we may have in lines now.
And the reason we may be to some degree put too many hard parts out to begin with was because we didn't have our distribution centers in place and they weren't getting nightly delivery service. And now that all the stores are being serviced nightly, we have our hubs in place. To Greg's point, we can selectively go back and fine tune the inventories.
Thank you.
Thank you.
Your next question comes from the line of Alan Rifkin with Bank of America.
Yes. Thank you very much and congratulations gentlemen on an outstanding quarter. Thank you, Alan. Just a couple of questions if I may. Greg, I certainly realize that the oldest Checkers stores that were converted earliest are still performing the best.
But of the various steps in the conversion process between implementing the computer systems and putting the hard parts in the store and the planograms and the resets, what all of which are at various stages, of course, together with the exterior signage, what in your opinion drives the greatest incremental benefit once each of those conversion processes are added to the stores?
Well, clearly, it's having the hard parts. That's the business that we're in. And while our systems facilitate making transactions the way we want to make them, making connections, electronic connections with the commercial customers and sourcing parts, and we feel like our planograms are optimized to do business the way we want to do business retail. And the resets are just something that you have to do in retail to keep your store looking fresh because some of these stores were getting pretty weathered. Clearly, having the parts on the shelf is what makes the most difference.
But improved that as we've owned the company and had better inventories, and we'll continue to put our marketing advertising efforts into exposing that fact to consumers. And I think that's something that gains momentum as customers realize that we're
in the hard parts business. But clearly, that's the most impacting factor. Alan, this is Ted. Another thing that you didn't mention there and particularly on the wholesale side of business, as we address the staffing levels of each of people that can sell the parts, you don't have enough people or the right people, don't have the people that can sell the parts, you don't have enough people or the right people, you don't maximize your sales. So that's an ongoing process that we're working on.
We had a lot of good people to start with and we just need to add more people as our business continues to grow.
And then, Alan, the other factor there is just distribution capability. We put inventory out in the stores initially to help the CSK stores that didn't have good access to distribution and that helped some, but now having overnight access and same day access to many stores to larger inventories is a big help because the average stores you know has a little over 20,000 SKUs and our DCs would have more like 120,000 and that access makes a big difference in our ability to allow, 1, to hire good people and get good people to position that they can be successful, but then also deliver to commercial customers.
Okay. Thank you. And one follow-up, if I and certainly it's understandable that DC costs in the quarter would deleverage and that's a direct result of opening up 5 new DCs in a very short period of time. First of all, would you be able to quantify how much DC costs were delevered? And would it be fair to assume that with Phoenix now opening in just a couple of weeks, is the 3rd you just reported point in time where you're seeing maximum deleverage on the DC and costs?
Tom, do you want to take that? Yes. First,
when we look at the amount of deleverage, it was less than what we would have expected or planned based on the DCs coming online. When we look at where the maximum is, really the issue for us at this time is team training and efficiency of team members. We're confident in our ability to get back to where we've been historically in a percent of sales standpoint. We just have a lot of new team members out there. And as we ramp up these converted stores, our emphasis is on making sure that if anything we're over servicing the stores and over time we'll be able to reduce that.
I would say this quarter was probably our maximum deleverage as the DCs that converted B of the year become more and more efficient.
Thank you all very much.
Thank you, Alan.
Your next question comes from the line of Matthew Fassler with Goldman Sachs.
Thanks a lot. Good morning. Congratulations on a strong quarter. A lot of my questions have been answered, but there's one I want to focus on and that is sort of the seasonality of the 4th quarters. I guess some strange things happened the past 2 years in terms of your sales in Q4 relative to Q3.
As you think about the reality that we're in a somewhat more stable economic environment, do you feel like what transpired last year and the year before was symptomatic of kind of the economic chaos that we had more or less? And do you feel like in a more stable environment you can return to more typical seasonality? And I guess are you making any special plans as it regards the cost structure inventory as you think about your financial planning for Q4?
Well, Matt, we hope that the factors you stated are right. We've experienced erratic sales in the 4th quarter for erratic sales in the Q4 for a longer period of time than just the recession due to holiday spending and the effect that the onset of winter can have and so forth. So we're doing everything that we can to make sure that our Q4 is strong and that the trend that we've that we're on and we've had coming out of the Q3 continues. But as we've seen, we've been surprised before following Thanksgiving when heavy holiday shopping starts and the limited discretionary cash that consumers have starts going elsewhere. So we'll just have to see.
It's always easier for me as it is you to look back at comps and make comments about how they went as opposed to look forward. But we're hoping for the best, but we're trying to plan as reasonable as we can. And to your question about just our resources for the Q4, from an inventory standpoint, we really don't make much of a change there. Our inventories are pretty well set to service the vehicle needs in the areas that they service, and we just don't that many promotional products that we push out seasonally that make a material impact. Now labor or payroll, we certainly do make adjustments to that based on and those adjustments are paid weekly on our staffing system projections that we have out in the stores and they adjust for the business cycles that we have season after season.
So we're in good shape there.
Got it. Thank you so much.
Okay. Thank you, Matt.
Your next question comes from the line of Colin McGranahan with Bernstein.
Good morning. Just a quick question. Do you have a sense of what you think your market share looked like in the quarter? I would assume commercial was up nicely, but any sense DIY versus commercial? What kind of share gains you see?
Well, I think we grew share in both. It's hard to measure the total market to know how much share we gained, but I think we gained share on both sides. Both were good contributors to our growth. The do it for me side, we've clearly taken a lot more share there than we have on the retail side just because we put so much effort into and West stores and the converted Checkers stores here in the center part of the country and the Murray stores. So that's growing.
So yes, we're taking a lot of market share on the commercial side. I'd say some market share retail. Both are performing well, but I don't have a specific market share number for you.
Okay. And then just a quick follow-up. It's not that important, but I'd be curious as to what the justification was from the Justice Department to find O'Reilly shareholders $20,000,000 from actions of previous management?
Well, that's the question I was asking. But there is a really their justification is that their perception is that crimes were committed and that there should be a penalty applied for that. And while our perspective was that there probably wouldn't be a penalty and our advisors felt like there wouldn't be a penalty at the time of the acquisition. It turned out that there was. So, we've now put that behind us and it's history now, but I can yes, of course, the fines apply to CSK.
But I can tell you, I defended our shareholders' position as aggressively as I felt they could be defended. And this is where we ended up after long negotiations. So we're glad to have him behind us.
Okay. Good luck going forward.
Thank you.
And there are no further questions at this time. I would now like to turn the conference back over for closing remarks.
Well, thanks everyone for your attention this morning. We're certainly proud of our performance in the Q3 and you can bet we'll be trying to accomplish great results in the Q4 and we'll look forward to reporting those results to you after the 1st of the year. Thank you very much.
This does conclude today's conference call. Thank you for participating. You may now disconnect.