O'Reilly Automotive Q1 Earnings Call Transcript

123jump.com Staff
29 Jun, 2010
New York City

Sales rose 10% to $1.28 million and net income rose 55% to $97.5 million or 70 cents a share. Gross profit was 48.3% of sales for the quarter versus 46.6% in the prior year. Operating margin for the quarter was extremely strong 13.2% of sales. An improvement of 342 basis points over the prior year.

O''Reilly Automotive, Inc. ((ORLY))
Q1 2010 Earnings Call Transcript
April 29, 2010 11:00 a.m. ET

Executives

Thomas G. McFall – Executive Vice President - Finance and Chief Financial Officer
Gregory L. Henslee – Co-President and Chief Executive Officer
Ted F. Wise – Co-President and Chief Operating Officer

Analysts

Tony Cristello – BB&T Capital Markets
Alan Rifkin – Bank of America/Merrill Lynch
Stephen Chick – FBR Capital Markets
Dan Wewer – Raymond James & Associates
William Truelove – UBS
Scot Ciccarelli – RBC Capital Markets
Mark Becks – Longbow Research
Christopher Horvers – J.P. Morgan
Michael Lasser – Barclays Capital

Presentation

Operator

Good morning. My name is Lisa and I will be your conference Operator today. At this time, I’d like to welcome everyone to the O''Reilly Automotive fourth -- first quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. McFall, you may begin your conference.

Thomas G. McFall

Thank you, Lisa. Good morning everyone and welcome to our conference call. Before I introduce Greg Henslee, our CEO, I''d like to read a brief statement. The company claims the 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 statements discuss among other things, expected growth, store develop, integration and expansion strategy, business strategies, future revenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions that are not guarantees of future benefit 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-K for the year ended December 31, 2009 for more details.

At this time I would like to introduce Greg Henslee.

Gregory L. Henslee

Thanks, Tom. Good morning everyone and welcome to our first quarter conference call. Participating on the call with me on the call 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 would like to start off again by saying thanks to all our dedicated team members who work so hard each and every day to make sure our loyal customers receive the very best service in our business. This past quarter was and outstanding quarter for Team O''Reilly. And I want to recognize each and every one of you for the great job you''re doing taking care of our customers and systematically working us through the integration of CSK.

Clearly, we have a very bright future ahead of us as we complete this integration and focus on expansion and executing our dual market strategy coast-to-coast. Congratulations to all of you on a great performance in the first quarter.

Looking back to our fourth quarter conference call, it''s clear that we underestimated the amount of demand that was pent-up as a result of the relatively soft sales our industry experienced for much of the winter. As I mentioned on the call, we attributed the softness in the fourth quarter to the continued strain the economic conditions in the U.S. has placed on consumer budgets.

We believe this is amplified during the holiday season, as many spend there discretionary cash on gifts and holiday activities, and deferred spending on auto repairs that didn''t need absolute immediate attention.

Comparable store sales are always difficult to forecast. And we have once again proven that sales trends can change relatively quickly. As you know, we were forecasting consolidated comparable store sales in the 2% to 4% range for the first quarter. As it turned out, early spring weather arrived in many markets and sales in the last half of the quarter accelerated dramatically and we were able to generate a robust 6.9% growth in consolidated comparable store sales for the quarter on top of comparable store sales -- a comparable store sales increase of 5.7% in the first quarter of 2009.

As previously mentioned, the fourth quarter of last year was the last time we''re going to disclose the details of our comparable store sales by store type. From this point forward, we plan to provide only our consolidated total company comparable store sales performance. However, I do want to reflect and add some color to our comp store sales performance for the quarter.

The stronger trends we saw in the last half of the quarter were present in the majority of our markets across the country. We saw better retail traffic in our stores and our installer business picked up significantly.

Again, I relate some portion of this strong increase in business to maintenance and repairs that were deferred last winter and with the early spring weather in many markets, we benefited from this pent-up demand. It would be very difficult for us to forecast the expectation that sales will continue for the full second quarter at the strong pace we saw in the last half of the first quarter.

However, we do anticipate continued solid business trends. We are off to a good start to the quarter in April, and as a result, are providing guidance of comparable store sales in the range of 4% to 6% for both the second quarter and for the year. We''ll continue to update our annual guidance quarterly as we progress through this year.

July 11, 2010 will be the second anniversary of our purchase of CSK. As you know, following the purchase we put in place a aggressive plan to implement our distribution model in the western half of the country, which establishes the foundation for us to execute our dual market strategy.

We also put in place an aggressive plan to convert the inventories and store layouts to fit our model. Many team members have worked extremely hard to execute this plan. And I am very happy to announce that we are completing the integration plan on time and we are seeing very positive performance results as our efforts and investments gain traction.

The CSK stores as a whole have generated a positive comparable store sales each full quarter that we have owned them. And in the first quarter, we continue to see good business trends.

The fully converted Checker stores in the central part of the Country, which were the first to be converted, are performing extremely well. We''ve also seen a solid improvements in the performance of the Murray stores that, given the economy in these markets, especially in Michigan, these stores continue to lag the other stores.

In the western half of the country, it is very clear that we have a lot of opportunity to grow our business as we establish our company as a capable partner to the commercial customers in each market. These stores have done very well and are incrementally taking advantage of the additional parts availability afforded them by our distribution expansion in the West.

Even the stores that are still on CSK''s systems and distribution model are doing much better as a result of better access to inventory, more competitive pricing, and our team''s focus on providing great customer service. Ted will be reviewing our integration plan in detail in a moment, but in general I want to convey that we remain very enthusiastic about the opportunity we have to grow same-store sales in the acquired CSK stores.

Many of the markets in which these acquired stores do business generate an incredible amount of auto parts sales. And the level of CSK''s under-performance due to the lack of inventory availability and non-competitive pricing is clearly apparent. As we stated before, we put a lot of effort into correcting this.

We reset our pricing over a year ago, and over time, the perception consumers have of our competitive price position will continue to improve. The same thing applies to inventory availability.

CSK had developed the reputation of not having robust hard part inventories. We have corrected this, and our marketing and advertising efforts are now geared toward giving customers a reason to give us a chance to prove that we are the best choice when it comes to helping them with their automotive needs. We feel we''ve come a long way on these fronts, but still have a long way to go.

In reviewing our first quarter sales performance, we would be remiss not to mention the continued solid performance at the core O''Reilly stores. We have a very strong team in our core markets and we are very pleased with the performance of our core stores.

One of the early concerns among analysts and investors with the acquisition CSK was that we could potentially lose focus and market share in our core markets. And with almost two years of CSK ownership under our belt, I can assure you, as reflected in our performance, that our core stores continued to perform extremely well.

The strong comparable store sales were generated during the quarter leverage our expenses nicely and coupled with the significant improvement in gross margin, we are not able to sustain as a result of the buying synergies we have experienced as part of the CSK acquisition. We are very pleased with the 13.2% operating margin we were able to generate. This operating margin is the highest first-quarter margin we have generated since going public in 1993.

Tom will be reviewing our financials in more detail in a moment, but I just want to express that we''re very encouraged that the solid start we''ve had to 2010. As planned, acquisition of CSK is proving to have been a very good investment for our company and we are very excited about what the future will bring as we continue to establish our presence in the markets that are relatively new to us.

As an industry, while a more robust economy would certainly be helpful, we feel we continue to benefit from the growth of the average age of vehicles on the road n the U.S. as new car and truck sales have decreased. We feel that many consumers have established a new perception of how far a vehicle can be safely driven, and we expect, for years to come, autos will be given at higher and higher mileages than the past.

The higher mileage vehicles obviously require more maintenance. We also see a lot of opportunity for continued growth as our industry continues to consolidate. At the end of this year we will have opened 150 net new stores, but we''ll still have the distribution capacity in existing facilities to add approximately 500 stores, using our existing distribution methods.

So, we won''t need to add any additional distribution capacity to support our new store growth until approximately late 2013 or 2014. We are also working as diligently as ever to continue to improve our levels of customer service and operating efficiencies. We have several initiatives currently underway to ensure we maintain our industry-leading customer service levels.

These include point-of-sale system improvements, parts cataloging enhancements, inventory management system improvements, and better productivity management in our distribution centers, just to name a few. As I''ve mentioned, we are very encouraged by the strong start we have had this year and are looking forward to the continued solid performance throughout the year as we work through the final chapters of the CSK integration.

I will now turn the call over to Ted Wise.

Ted F. Wise

Thanks, Greg, and good morning everyone. Like Greg, I would like to begin by saying a quick thank you to Team O''Reilly for the fantastic sales and profit performance we are here to discuss this morning. Through our team''s commitment to great customer service, and execution of our dual market sales programs, we continue to expand our market share.

The 10% topline growth and a 6.9%, comp sales performance is truly remarkable. So, once again, thanks to all of our team members throughout the Organization for your contribution last quarter.

In regard to our new store growth in the first quarter, we finished with a net 48 new locations, bringing us to a total of 3469 stores. Our expansion plans for new stores this year is 150 locations, so we are in excellent shape on our schedule. We continue to share and balance the time of our installation teams between new store installations and performing front-floor resets on CSK stores out West.

Our real estate grew as aggressively working new store expansion around our core O''Reilly markets as well as the new West Coast states. As a result of the slower economy, we are finding good signs for future expansion at reasonable rates. In regard to the CSK stores, we have completed individual store and market assessments and have developed a stay, or relocation strategy for all stores.

We have also identified our potential expansion opportunities in the undeveloped markets, and growth in new markets. Opening stores with our dual market plan with the expanded product offering and daily distribution service to the store, opened up new markets that would not have fit the CSK retail sales plan.

Now, for a brief overview of our store expansion for first quarter. Once again, the great state of Texas led our growth in the first quarter with seven new stores, which brings us to 528 Texas stores that are serviced from our distribution centers located in Houston, Dallas, and Lubbock.

Following Texas, North Carolina and South Carolina contributed five stores each. And rounding out our growth in the southeast part of the Country, we added three new stores in Virginia. There are also five new stores in Ohio and three new stores in Michigan that are being serviced from our recently converted Murray''s distribution center in Detroit. Indiana, Florida, and Tennessee all contributed three stores each. The remaining 12 new stores are spread out in eight more states, and includes our first new store in California.

To summarize, our store expansion involves seventeen different states which, as I have mentioned in the past, gives us the ability to be more selective and have better planning and execution in rolling out our new stores. In the first quarter, we also moved five older stores to new locations and had 12 major start renovation projects going on.

In addition to our normal new store growth, we made good progress on phase two of our CSK conversion on the West Coast. Our installation teams performed ninety CSK store resets to the O''Reilly retail format. As you may recall, these are resets at the front display area and do not typically involve the back room, since the hard parts inventory changeovers were completed throughout most of the last year.

These front-floor resets are also independent from the computer system conversions. This is totally different from how he handled the major projects in the first phase of the changeover of the Murray stores and the midwest Checker stores, which were total inventory lifts, new computer systems, and store resets all at the same time. Needless to say, it is much less disruptive to the business, allowing the store to stay open during all the work and maintaining a high level of customer service.

As I mentioned, the hard part line changeovers are for the most part finished, and the product department is working on the final phase of the front -floor line evaluations and changeovers. As these out-front lines are reviewed, new planogram changes and product line upgrades are being rolled out to the stores, and by the end of this year all stores will have a fresh grated planogram retail mix.

We we''ll continue to step up the pace on the store resets scheduled throughout the remainder of the year and plan on having all CSK store reset and the O''Reilly interior decor and image package installed during the next 12 months.

Now to outline the DC openings and the conversions schedule, which also includes our store computer conversions. The West Coast schedule began with the opening of our new 388,000 square-foot Seattle DC last December and the following conversions of the 193 Schuck stores, to daily data replenishment, and the insulation of the new O''Reilly computer system.

As a reminder, the store computer conversions does not involve any inventory or physical changes to the store. It is basically changing the store computer and going to O''Reilly POS and store operations system.

The point-of-sale orientation and systems training is handled at the store by sending seasoned, experienced O''Reilly team members from the core O''Reilly store who worked side-by-side with the manager and team members during the conversions, and then they stay at the store for at least one week following the conversions.

Following Seattle, our new Marino Valley 408,000 square foot distribution center in Southern California opened in January 2010, and the store computer can system conversions for the 238 surrounding Kragen stores were completed. Then in the middle of March 2010, we opened a 225,000 square-foot distribution center in Denver, Colorado, servicing the surrounding eighty-four stores, and these stores are now finished with their computer conversion systems.

Next on the schedule in May 2010 is the opening of our 205,000 square-foot Salt Lake City distribution center, which will service the eighty-six stores that will follow the same computer version schedule. Then we will have a short breather until September 2010 when we move our existing Dixon DC to a new 525,000 square-foot DC in nearby Stockton, California. This DC will service the surrounding 274 Kragen stores that, again. will start their computer system conversion at that time.

To finish the DC and store conversions, we will return to Phoenix the first week in November 2010 and convert the CSK distribution center over to the O''Reilly system and begin transition to a data replenishment at the store level. This will include converting the 151 Checker stores to O''Reilly computer systems at the same time the DC converts. So by the end of November 2010, we will have completed all the store computer system conversions, installed five new distribution centers, converted the existing CSK distribution centers to O''Reilly systems, and the stores will all be receiving daily stock order replenishment.

This is an amazing accomplishment and has required a lot of hard work and great planning to have executed these tasks in so short a time. As I mentioned, the store resets will be progressing throughout the year and while most of them will be finished by the end of this year, there will be a small group of stores to finish resetting in the first half of next year.

We are also well underway with our signed conversions to O''Reilly Auto Parts, and we will project rebranding all stores to be completed by early next year. Now in regard to the business development on the West Coast, our stores continue to gain sales traction on both the retail and installer side of the business.

A key factor in growing our sales has been the increased hard parts selection at the store level. The store inventories have also been supported by a hub and spoke systems that have set routes throughout the store groups.

Also, as new distribution centers open, and area stores begin receiving nightly replenishment, they also will have special order availability of the broad SKUs at the distribution center overnight, or in the case when the store is in the immediate area, they have same-day access to the distribution centers inventory.

In addition to having the right inventory, our market competitive pricing is in place and beginning to change the perceptions that customers had developed of the CSK store inventory and pricing model. It took CSK years to establish these customers’ perception, and although we feel good about the sales trend and traffic customer, changing these perceptions will take a while.

We definitely feel there is a lot of additional opportunity ahead of us as we continue to convert the stores and establish the O''Reilly name in these markets. Now, on the installer side of the business, we are seeing great results from our consistent sales call and developing customer relationships over this last year.

Our territory sales managers and in-store sales specialists are in front of the customers, selling the O''Reilly program of quality parts, competitive pricing, and most important, great service. We have improved service levels with additional trucks and staffing our first call installer counters with experienced parts professionals. No different than changing the perception of the retail customer, we still have a lot of work to do and lots of opportunity ahead of us as we establish the O''Reilly brand and win the wholesale customers business.

Improving our sales skills, product knowledge, and overall service levels of our store sales teams, will be the key to growing our business. As the stores go on the O''Reilly computer systems, our O''Reilly LMS, or Learning Management System, and all the O''Reilly training programs are available to our store teams.

CSK did not have a computer based training system, and this addition is being well accepted and will be a great tool increasing our parts knowledge and providing better customer service level. Our store operations and sales teams continue to grow stronger and become more effective O''Reilly leaders as they fully comprehend or programs and they see the results of implementing them.

We are very fortunate to have had so many quality team members in the CSK stores that are willing to adopt the O''Reilly culture and become part of the new West Coast O''Reilly management team. We continue to evaluate our staffing requirements that are required to manage these stores and will continue to add district managers, territory sales managers, and other field positions critical to the controls and management of our store operations in sales.

It is very exciting to think that much of the task oriented work of the changes we were making that occupied so much of our teams time in these stores is behind us. And we now have more time to totally concentrate on servicing our customer and growing the sale and profits in these stores. With that, I will turn it over to Tom.

Thomas G. McFall

Thanks, Ted. Now well move onto the numbers.

For the quarter, sales increased $116 million, 10% over the prior year, to $1.28 billion. The increase was attributable to a$78 million increase in comp store sales, a $35 million increase in non-comp new store sales, and a $3 million increase in non-comp non-store sales.

For the quarter, both ticket average and ticket count contributed to our comparable store sales increase, but the majority of the comp increase was driven by the comp ticket count. For 2010, we are increasing our total revenue guidance to $5.2 billion to $5.3 billion, which is a $100 million increase from our previous guidance.

Gross profit was 48.3% of sales for the quarter versus 46.6% in the prior year. The 167 basis point improvement was driven by the acquisition buying synergies which were not in the comparable 2009 period.

As you will recall, the majority of the new vendor deals were signed at the end of the first quarter and beginning of the second quarter of 2009. As a result, this will be the last significant non- comparable quarter for buying synergies.

For 2010, we continue to estimate gross profit as a percent of sales will be 48.1% to 48.4%. Where we end up in this range will be driven largely by how successful we are at adding commercial sales in the acquired stores, as commercial sales carry a lower gross profit percentage.

Based on our performance in the first quarter, we would anticipate being in the lower end of this range. SG&A for the quarter was 35.1% of sales versus 36.9% in the prior year. The leverage on SG&A was a result of the strong comparable store sales.

On a per store basis, SG&A per store was up approximately 1% which allowed for strong leverage on 6.9% comparable store sales. For 2010, we are not expecting SG&A dollars per store to be slightly up from 2009 as we see opportunity to more aggressively invest in store SG&A to drive sales.

We anticipate the total SG&A for 2010 will increase approximately 4.5% over the prior year. Operating margin for the quarter was extremely strong, 13.2% of sales. An improvement of 342 basis points over the prior year. This large -- excuse me, this large improvement is a result of full year run rate of buying synergies, strong comp sales and tight expense controls.

The 13.2% first quarter operating margin represent the highest first quarter operating margin we have had as a public company and one of the highest quarters of all time. For the full year, we expect our operating margin to be in the mid-12% range.

Net interest expense for the quarter was $11 million, which was $1 million less than the prior year on lower average interest rates. For 2010, we expect net interest expense to be $39 million to $42 million, based on lower average debt levels.

This estimate is also subject to unforeseen changes in LIBOR levels in the extent our debt is not swapped for fixed rates. The tax provision for the quarter was 38.5% of pretax income, which was flat with the prior year.

For 2010, we expect our tax rate as a percent of pretax income to be 38.0% to 38.4%, where we fall within the range will be dependant on resolution of open text year audit that occurred during the year. Diluted earnings per share for the first quarter was $0.70 per share, which represents a 52% increase over the first quarter of 2009.

Now, we''ll move on to the balance sheet. The average inventory per store at the end of the quarter was $549,000, which was a 13% increase over the prior year average of $487,000. This increase is a result of significantly increasing the hard parts SKUs stocked in the acquired stores and the addition of the Western DCs to support our dual market strategy.

In 2010, we are focused on refining the inventory mix at CSK stores and as the new DCs come online, we will be able to reduce the stocking definite to CSK stores. Based on these 2010 initiatives, we expect to only increase our inventory investment slightly in 2010 despite opening 150 new stores and three new DCs.

Through the first quarter, we added 48 net new stores, but reduced our total inventory by $10 million, which equates to a 2% reduction in the average inventory per store. Our reserve for LIFO at the end of the quarter was $13.1 million, which was an increase of $4.4 million from the previous quarter. This change in our last buy to LIFO reserve did not have a material impact on gross material margin for the quarter.

Accounts Payable of $795 million was 41.8% of inventory as compared to 46.8% in the prior year. Our AP to inventory ratio at the end of the first quarter of 2009 benefited from special extended dating on changeover orders. That said, in 2010, we expect our AP to inventory ratio will continue to be under pressure as we work excess inventories through and out of the system.

Capital expenditures were $91 million for the quarter. For 2010 we continue to estimate capital expenditures will be in the range of $400 million to $440 million as we complete our DC projects and continue to invest heavily in store conversions. Depreciation and Amortization for the quarter was $40 million. For 2010 it to continue to expect depreciation and amortization to be one of $154 million to $159 million.

Total borrowings at the end of the quarter were $703 million compared to $791 million at the end of Q1 2009. Also at the end of the quarter we had $531 million of availability under our ABL facility.

For 2010, we expect to reduce our total outstanding borrowings by $170 million to $220 million. Included in this reduction is our planned redemption of $100 million legacy CSK convertible note in December 2010.

Our plan is to fund this with our existing ABLs which will still allow us significant financial flexibility. Now for some other financial information. Cash flow from operating activities for the quarter was $171 million, an increase of $84 million over the first quarter of 2009.

The improvement was driven by higher net income and deferred taxes and the lower increase in net inventory investment in comparison to the first quarter of 2009. For the quarter, free cash flow was $80 million versus the use of $65 million in the first quarter of 2009.

Improvement of $145 million was driven by the previously mentioned increase cash flow from operations and a $60 million decreased in capital expenditures. We now expect free cash flow to be $140 million to $160 million in 2010, as we again invest heavily in CapEx, but do not have the significant increase in the investment in that inventory.

Stock option expense for the quarter was $3.6 million, compared to $3.3 million in the prior year. The increase is driven by our year-over-year increase in stock price. For 2010, we continue to expect stock option expense to be approximately $16 million.

To recap our overall guidance, for the second quarter our comparable store sales guidance is 4% to 6%. And for the year we are increasing our comparable store sales guidance from an increase of 3% to 5% to an increase of 4% to 6%.

Our GAAP diluted earnings per share guidance for the second quarter is from $0.70 to $0.74 on 140.6 million shares. And we are raising our GAAP diluted EPS guidance for the full year to a range of $2.65 to $2.75 on 140.7 million shares. At this time, I do like to ask Lisa, the Operator, to come back and we would be happy to answer your questions. Lisa?

Question-and-Answer Session

Operator

At this call, I’d like to remind everyone, in order to ask a question, please press star then the number one on your telephone keypad. Please note to limit your questions to one question and one follow-up question. We''ll pause for just a moment to compile the Q&A roster. Your first question comes from Tony Cristello with BB&T Capital Markets.

Tony Cristello – BB&T Capital Markets

Thanks. Good morning, gentlemen.

Gregory L. Henslee

Good morning, Tony.

Tony Cristello – BB&T Capital Markets

Greg, you had mentioned in your prepared remarks some initiatives that you''re talking about, whether it''s a POS or parts cataloging, or inventory or productivity enhances our measurements at the DC level. I''m just wondering if you could give us a little bit more color, sort of what''s the timeline on those? Are those things that are already underway? And sort of what''s sort of behind the launch of some of these initiatives right now?

Gregory L. Henslee

These things really aren''t anything new, Tony. For -- This is my 26th year here, and David''s here and he''s lived with the business his whole life. We have constantly evolved really everything we do. Point-of-sale, catalog, the way we manage productivity, and things like that.

Today with technology being what it is, there is so much opportunity to incrementally improve the function of our POS, the content that we make available to our parts specialists, just the whole interaction experience with our customers in general. And then also just continuing to improve the way that we manage inventories, measure productivity, in our distribution centers, you know, incent our distribution team members to be as productive as they can be and so forth.

So we have teams in our IT department and operational departments that manage these projects that we work on, ongoing. Some of these are things that we implement in pieces, and some of the improvements that we''re making will be implemented this year. For instance, the way that we handle what would be considered a minor thing to many, but it''s a major thing when it comes to running a store, is the way you deal with sales tax, for instance, when it has to installer customers.

You know, a lot of installer customers want to not pay tax if they billed their customer for tax. And state law in most states allows us not to build an for tax, but they require tax on certain items. Making that as automated as it can possibly be enhances our POS system. Another example would be making just sure that we have pictures of all of our products. And those pictures are available from different views of the product, so if we don''t have it in stock we can match it up at the counter and make sure we order the right part. And things like that are implemented incrementally.

And then something specifically that we''re implemented over the next couple of months, is what we call a labor management system in our distribution centers that basically kind of sets standards for productivity in the distribution center based on the layout of the DC, where the products are located, the amount of time it takes to stop or pick a product, and then were putting in place an incentive program for our distribution team members to be as productive as they can be. And will start that here in the next couple of months in Detroit.

Tony Cristello – BB&T Capital Markets

And I guess just on a follow-up, when you think about the POS, is their anything that you''ve been lacking in terms of your ability to sell through to -- and I''m assuming this is more of a DIY approach, I know that the Hispanic community has been sort of a big target for DIY, especially right now. Is this something that might draw incremental sales? And this is a benefit that could be added to what''s going on with the West Coast and the conversions at CSK?

Gregory L. Henslee

I don''t think that we would be doing anything that would add measurable incremental sales. I think that every improvement we make, we make because we feel like it''s the best thing to do for the business. That improves our competitive position. And improves just the customer interaction. But I don''t think anything that we''re doing right now would create a measurable benefit beyond the benefit that we get from having robust POS systems that we have in place today.

Tony Cristello – BB&T Capital Markets

Okay. Perfect. Thank you.

Gregory L. Henslee

Thanks.

Operator

Your next question comes from Alan Rifkin with Banc of America.

Alan Rifkin – Bank of America/Merrill Lynch

Thank you very much. Congratulations, gentlemen.

Gregory L. Henslee

Thanks, Alan.

Alan Rifkin – Bank of America/Merrill Lynch

Your SG&A leverages is obviously quite admirable despite costs in the quarter that are not being capitalized but expensed as a result of the conversion process. How much in your opinion did this impact the SG&A great in Q1? And would it be reasonable to expect that these costs go away at the end of 2010 altogether?

Gregory L. Henslee

I''ll make a comment and then Tom might have more detail. In the scope of our overall SG&A, as you said, there are many of the conversion expenses, or payroll dollars that are expensed as opposed to amortized. I don''t think it creates a material difference in our SG&A.

Tom, you may have a comment on that.

Thomas G. McFall

Alan, we''re not going to break of our SG&A separately, but when we look at 2009, we spent a lot of dollars that went through store payroll to reset back rooms. And this year, to the extent that the store personnel are helping on the front end and doing front reset, and then all the training time for the conversions, we are incurring a similar amount of expense. And it''s a number that we are looking forward to not spending next year and spending it on items that really drive sales.

When we look at, as we talked about before, when we look at the O''Reilly efficiency at the store level and the CSK efficiency, part of it is how many sales they are doing and a lot of it is this conversion process. But we continue to have an opportunity to better leverage our payroll at the CSK -- in the CSK markets, and on the O''Reilly side, the store payroll was tremendously leveraged this quarter and they did a fantastic job.

Alan Rifkin – Bank of America/Merrill Lynch

Okay. Thank you.

And a follow-up if I may, Greg, you made a point of saying, and rightfully so, in the quarter you achieved a record high EBIT margin of 13.2. If w go back and we look at 2005, when you reached the peak on an annual basis of 12.5%, your EBIT margins in that year''s first quarter were only 11.5%.

So you''ve exceeded that number by 170 basis points. As we think about the opportunities for this Company long-term, beyond 2010, can we kind of draw parallels between the EBIT margin beat this quarter versus back then and what the long-term opportunities maybe for a rally to achieve EBIT margins?

Gregory L. Henslee

Well, I would hate to say that we could incrementally build a annual model based on the beginning point being the difference between what we generated this first quarter and the first quarter of 2005. That was the first full year that I was CEO of the company. I remember the year will, but I don''t really remember how the quarters broke out.

But what I would say, Alan, is that as we have these strong comp quarters, I -- we are in a great position to leverage our costs. And our store team focuses very intently on managing payroll, which is our single largest expense. As we complete these conversions, and as we become more productive in the Western stores and our team members get more proficient on our POS, their sales per month increase, we will become more productive.

And yes, I think that over time we''ve got a great opportunity to continue to set records from a operating margins standpoint for the Company. The extent, and I guess the time in which it takes to accomplish that, is dependent on our incremental comp stores sales growth and our ability to leverage that, which I feel very good about.

Alan Rifkin – Bank of America/Merrill Lynch

Thank you very much.

Gregory L. Henslee

Okay. Thank you, Alan.

Operator

Your next question comes from Stephen Chick with FBR Capital Markets.

Stephen Chick – FBR Capital Markets

Hi, thanks. Good quarter.

Gregory L. Henslee

Thank you, Steve.

Stephen Chick – FBR Capital Markets

I guess maybe, you know, for Ted, the -- if you look at the growth you''re seeing in the converted stores, I guess, can you clarify if the installer commercial businesses growing faster than retail? And then, you know, secondly, as you are ramping the commercial business and you look at -- I don''t know if it''s NPD data or if you look at market specific data, can you tell, you know, where the market share may be coming from? Is it coming from three steppers or some of the regional folks or maybe even some of the larger incumbents that might be in that market?

Ted F. Wise

Steve, you know, we don''t break out the retail and the wholesale growth. But I would say they are very, very close to each other. A lot of the wholesale volume is just now starting to be material because of the distribution centers, the nightly service, we''ve got all of the traditional product lines in place and the hub and spoke system is working good. Again, there''s a lot of strong competitors on the West Coast, and it''s taken us a while to develop the relationships and again now, we totally have the tools in place. So again, they are growing about the same.

We anticipate the wholesale business will be much better this coming year because of the tools we have, and the fact that it takes more than just a few sales calls to build a relationship. In regard to the competitors out there, it''s -- on the West Coast, it''s basically a two-step market. There''s a lot of under car, small warehouses. They are regional. They have strengths and they have weaknesses. They''ve got good inventories, but not necessarily broad inventories, and they don''t have as good a replenishment frequency as we do.

So, again, now that we have the distribution centers in place and we have our inventory levels where they should be, we''ll continue to make progress on taking market share in that regard. A lot of it is tied to the personnel we have at the store. And again, as we mature our programs out there, we are going to be able to attract and recruit a higher level professional parts person away from these more traditional two-step type competitors.

And when that starts happening, you hire one or two in a market, and then two or three more and pretty soon the profile of your installer service specialists change to where you basically have experienced parts people on the ISS counter. And not to say that we don''t have a lot today, it''s just that as we roll out more installer stores, from retailed installer, we will have to add the experience levels to grow the business. And that''s a work in progress and we''re making good headway in that regard today.

Gregory L. Henslee

And Steve, this is Greg. One thing I might add to that is that, one, in this particular quarter, and I know, Ted, you''re talking more on a twelve month back basis, and also by region we had similar retail and wholesale growth. For the consolidated Company, our -- like Ted said, we don''t disclose the business mix difference, but our commercial business continues to be a little bit stronger than our retail business on a whole basis.

And then as far as defining where that business comes from, that''s -- as Ted said, that''s really difficult for us to do. But I can tell you the categories in which we continue to grow business are the hard parts category, the application parts, the non-discretionary stuff, chassis parts, ignition parts, belts and hoses, things like that are performing extremely well. The discretionary display area merchandise, is not growing nearly as fast and some of those categories are company negative.

Stephen Chick – FBR Capital Markets

Okay. That''s helpful. And the second question, if I could, Greg, we have seen other retailers who have made comments about kind of, April so far, with the pent-up sales demand that we saw in March, that kind of maybe indicated that April has been just a little -- started off a little at a slower rate of growth than where the March quarter ended. So I was wondering if you could give us a little more granularity and clarity on how solid is a solid in terms of the start to the second quarter for sales?

Gregory L. Henslee

Steve, but I would say is that March was an outstanding month for us as proven -- I know you guys back into what our March was based on what we said on February 20, 2010. And the math is going to lead you to the conclusion that we had really strong sales in March. April has been a good month so far.

I would say that maybe it has slowed down slightly, but it''s still a very, very good start to the quarter and were comfortable with the guidance we gave up 4% to 6% for the quarter, again not knowing what the rest of the quarter will bring, the having confidence in the trend of business since the middle of February.

Stephen Chick – FBR Capital Markets

Okay. Thanks, guys.

Gregory L. Henslee

Okay. Thanks, Steve.

Operator

Your question comes from Dan Wewer with Raymond James.

Dan Wewer – Raymond James & Associates

Thanks. Greg, I wanted to follow up on your comments about the change in the pricing strategy at CSK. As I recall, you took your everyday prices down about 4% to 5%. But in turn, the Company was less reliant on the different types of promotions they were running. So, were you initially seeing the sales not respond to the reduction in pricing given that you''re do-it-yourself customers in those stores are only in those stores once or twice a year and are not cognizant of the changes taking place?

Gregory L. Henslee

Well, we have incrementally seen transactions increase, but at the same time we have seen our ticket average come down a little bit as a result of the price changes that we''ve made. Our perception is, and again, this is just a perception based on having been in this business most of our lives, is that it takes a long time for consumers in the hard parts business to realize that you are more price competitive than what you were the month before, or maybe even the year before in some cases. It takes a long time to establish those perceptions. We feel like we''ve incrementally gained traction with that.

And our marketing and advertising efforts to drive traffic into the stores as the customers come into by an oil change or whatever it is they might be buying, if they price something else and then check one of our competitors, they find out that we''re now competitive, whereas we have had the perception all along that many of the customers that came into the CSK store came in because they were given a coupon. They came in because they had an ad in their hand, and they bought typically just those items.

And if the priced something else, CSK proved to them that they weren''t price competitive with our primary retail competitors. I think that the changes that we''ve made incrementally ramp from a traction standpoint as customers become more accustomed to the fact that we are competitive now, and then as they have reason to check us, based on past experiences, they find out that our prices truly are competitive. And I think that that momentum builds, and it''s a reputation that takes time to correct.

Dan Wewer – Raymond James & Associates

Are you trying to say that the sales benefits were probably less in the quarter just ended than it will be later?

Gregory L. Henslee

That''s exactly what I''m saying.

Dan Wewer – Raymond James & Associates

Okay.

Ted F. Wise

Dan, this is Ted. Also I might add that when we adjusted our prices but it was through a certain amount of time that we were able to roll out a lot of our private label lines, too. So while we had a little bit lower prices on what they carried, it was most of last year, it was just a line of at a time that we rolled out inventory of more competitive private label product, which has been a big help in growing the retail business.

Dan Wewer – Raymond James & Associates

And Tom, I just wanted to make sure I understood your comment about inventories at year end. Were you indicating that you expect year end inventories to be equal to or less than the $1.9 billion that you had at the end of FY ''09?

Thomas G. McFall

We expect it to be up slightly, but not through the process of fine-tuning our mix at CSK, we won''t see the growth we normally would see from 150 stores.

Dan Wewer – Raymond James & Associates

So the total inventory dollars would be up slightly, the inventory per store be less, I guess?

Thomas G. McFall

Correct.

Dan Wewer – Raymond James & Associates

Okay. Thank you.

Gregory L. Henslee

Thanks, Dan.

Operator

Your next question comes from William Truelove with UBS.

William Truelove – UBS

Hi, great quarter, guys.

Gregory L. Henslee

Thank you.

William Truelove – UBS

In terms of the -- I know you''re not breaking out the sales growth pace between the old CSK and O''Reilly, obviously, but can you talk a little bit about the commercial sales at CSK? You said they''re growing maybe is slightly better, but wasn''t the percentage of sales at the old CSKs around 10% commercial? And it still roughly around there or has that changed materially since the conversions?

Gregory L. Henslee

That''s incrementally change. It''s increased some. If you look back over the past twelve months, CSK by itself, the commercial business has grown better than the retail business. And that''s an ebb and flow thing from week to week, quarter to quarter for the consolidated Company. Generally, our trend has been over the past couple of years that our commercial business has grown a little better than our DIY business.

Now, we have been able to maintain positive comps store sales growth in both categories, but generally speaking, the commercial business for us is growing faster than the DIY. For CSK, we have a lot of opportunity on the commercial side, and CSK is an entity by itself, the commercial business is doing better, of course, than the retail business.

William Truelove – UBS

Multiples better than the retail business, or just moderately better?

Gregory L. Henslee

Well, it''s doing better. I wouldn''t give a definition on how much better, but it''s doing, I''ll say moderately better.

William Truelove – UBS

Sure. And then one follow-up to that is, you talk about hiring commercial reps, adding them to the marketplace. Would you say that your pace of hiring sales reps is going to be very aggressive near-term or is it going to be more moderate? Because as you may know, one of your competitors went out and hired a whole bunch of sales reps, and it has some disruptive effects on the SG&A expense ratio. So, how do you try and balance that too? What do you think the pace of hiring will be?

Gregory L. Henslee

Well, we''re very, very diligent stewards of our expense. And if we''re going to do anything that got our SG&A out of pace with our ability to grow sales, we would build that into our forecasts and tell everyone we were going to do that. That''s not the plan. Our plan is we add these outside sales people -- which CSK had many in place that were kind of built into their expense model just as we have as core O''Reilly. We continue to add them as we grow the sales, but we will not get our expense ahead of the sales growth.

William Truelove – UBS

Wonderful. Thank you so very much for answering my questions.

Gregory L. Henslee

You bet. Thank you.

Operator

Your next question comes from Scot Ciccarelli with RBC Capital.

Scot Ciccarelli – RBC Capital Markets

Hi, guys. Scot Ciccarelli.

Gregory L. Henslee

Hi Scot.

Scot Ciccarelli – RBC Capital Markets

Kind of a follow-up on the previous question. You do have better inventory levels and replenishments that contemplates a lot of these CSK stores. I guess the question I think a lot of people are kind of trying to figure out right now is, have you learned anything about the business that will keep a typical CSK storefront generating a comparable amount of commercial sales as what you traditionally been able to generate through an average O''Reilly store?

Gregory L. Henslee

Well, what I would say Scot, is that the average CSK store should grow into doing something very similar to what we''ve been able to do with the O''Reilly stores. There''s a big variance in the O''Reilly stores with -- if you compare rural markets to more metro markets. But, we generally have been able, at core O''Reilly, to keep the balance at approximately 50/50.

Again, not by intent necessarily, but just by trying to do as much business on both sides as we can. In the western CSK stores, there are some stores, I would say approximately 10% of the stores, that are in locations that aren''t necessarily conducive, or as conducive as we would like them to be, to doing a large amount of wholesale commercial business. Those stores most like you will never get to a 50/50 mix. But the remainder of the stores over time we believe can do as much wholesale business as the O''Reilly stores do on average and our efforts are to work to build that.

Ted F. Wise

Scot, this is Ted. In LA and some of those real dense population areas, the store count is, you know, pretty heavy, and they''re so close together that sometimes it just doesn''t make sense to run wholesale business out of stores that are 1.5 miles apart when you can actually service the installer better from one larger store, bigger inventory, more trucks. So there will continue to be a small number of stores that will be more retail -- primarily retail. But again, that''s a very small percentage of them.

Scot Ciccarelli – RBC Capital Markets

It should be applicable to say, 90% of the store base?

Ted F. Wise

Yes.

Scot Ciccarelli – RBC Capital Markets

Okay. Great. Thanks, guys.

Gregory L. Henslee

Okay. Thanks, Scot.

Operator

Your next question comes from Mark Becks of Longbow Research.

Mark Becks – Longbow Research

Hey, congrats on the great quarter.

Gregory L. Henslee

Thank you.

Mark Becks – Longbow Research

You mentioned the pent-up demand. I wonder if you guys thought this was more about a 1Q tailwind or you think that can kind of play out for the remainder of the year?

Gregory L. Henslee

Well, I say -- I made that comment in complete speculation because we have no way to measure pent-up demand. We''ve all been in the business a long time, and we have seen periods when economic pressures placed on consumers result in comp store sales growth that is not as robust as we would like it to be. Generally, directly following those periods, you will have pretty robust sales as people take care of the things that maybe they have deferred. So I think that with the winter weather that we had in many markets, I think prevented people from working in their driveways on vehicles, on the DIY side. I think that caused some release of pent-up demand in the springtime.

I think the economy in general over the past couple of years has caused people to try and defer as many things as they could that didn''t absolutely have to be repaired. So I think that''s more of maybe a slow release of pent-up demand as people''s individual financial situations improve with a growing economy. So I think you see some benefit of it over a longer period of time. But I feel like we had an immediate benefit when the spring weather got here from some of the things that had been deferred over the winter and some catch up from some things that maybe weren''t done during the pre-holiday season as discretionary income was spent on more holiday activity type of things.

Again, that''s all speculation on my part based on my experience in the business. But I -- my observation would be that demand for parts right now has been strong based on the older vehicles and -- being driven on the road, and some release of the pent-up demand that we feel like has kind of has accrued over the past year or two.

Mark Becks – Longbow Research

Great. And just as a follow-up, I was hoping you might be able to dig into gross margins a bit and quantify if there was any sort of pressure you may have seen from the distribution costs with the new DCs ramping up. Thanks.

Gregory L. Henslee

We spoke at about, that our DC costs as a percent of sales will be up this year as we bring DCs online and get staff trained. Those costs were higher than what they had been previous -- in the previous quarter, but within what our expectations were. Obviously, when we do a big sales number like this, we always get a lot of leverage on the fixed costs of our DCs. So that wasn''t a big impact. And when we look at total dollar spend, it was within our expectations and the cost of the DCs rolling on has -- our DC ops group does a great job of planning and managing, and the results have been as we expected.

Mark Becks – Longbow Research

Just to kind of follow-up on the gross margin side, there wasn''t a material impact with the increased transportation of stores with the two new DCs?

Thomas G. McFall

It was with our expectations.

Mark Becks – Longbow Research

Got you. Thanks so much.

Gregory L. Henslee

Okay. Thank you.

Operator

Your next question comes from Christopher Horvers with J.P. Morgan.

Christopher Horvers – J.P. Morgan

Thanks and good morning.

Gregory L. Henslee

Good morning.

Christopher Horvers – J.P. Morgan

A question for you. You said all markets did relatively well. Did you see -- I''m not sure if you commented if you saw more strength in the southeast where you have big exposure and where, perhaps the weather was pretty unseasonably cold and snowy?

Gregory L. Henslee

We had relative strength throughout the Country. And, yes, we were pleased with our performance in our Eastern division. We really were -- the best performing part of our Company were the center Country converted CSK stores. And the rest of the stores were primarily comparable on a division basis and I would say that we were pleased with the Eastern division as well as the remaining division.

Thomas G. McFall

Chris, would point to those stores gaining traction from being converted the longest, having time to develop the commercial business, getting customers back for and having competitive prices and inventory stock than we would put that on geographic or whether.

Gregory L. Henslee

That''s right.

Christopher Horvers – J.P. Morgan

Fair enough. So if we kind of looked at maybe 4Q and 1Q together on a comp basis to try and smooth some of the weather impacts, it sounds like, based on what you''re seeing in traction on the CSK side, even on that, that you''re thinking there''s a potential acceleration even if we took the two quarters from a combined view?

Gregory L. Henslee

Well, I think if you look at the CSK stores that have been converted the longest, they, of course, are accelerating the best. The remaining stores are doing well as a result of the things that I just mentioned with pent-up demand and just the springtime being here and things like that.

Christopher Horvers – J.P. Morgan

And then one final one, as you -- can you maybe quantify how much of the, how much sales you took out these CSK stores a year ago? Was that 8%, 10% from front-room product that is really non-core auto that, that you weren''t -- that basically suppressed your comps last year during the year?

Thomas G. McFall

I don''t think we have that number here. We did take several product lines and some categories out of those stores that we''ve sold through as a closeout product. We replace those sales with hard parts sales. So our hard parts categories are doing very well, while -- and enough that they generate a solid comp when compared to the sales of these other more discretionary products that CSK had kind of gotten into over the last several years prior to us buying them. I don''t know if you had any quantification of that or not.

Gregory L. Henslee

Chris, we never gave any quantification of that. We obviously look at it internally from how much where selling by product line. I can tell you that it was a pretty good headwind as were the changes in average ticket from getting prices right, and as Ted mentioned, adding entry-level products into the mix to the extent that you sell down to those, but it also drives our traffic for having that and being competitive in getting people in the store. So incrementally as we roll through the year, those headwinds will cease to be as stiff as they were last year.

Christopher Horvers – J.P. Morgan

Thank you.

Gregory L. Henslee

Thanks.

Operator

Your final question comes from Michael Lasser with Barclays.

Michael Lasser – Barclays Capital

Good morning. Thanks a lot for taking my question. With the CSK stores shifting to a new compensation structure over the last several quarters that focuses more on the incentive part and a gradual rollout of the distribution centers, is there a risk? And how are you managing the risk of some of these folks over-promising ahead of what the capabilities might be?

Gregory L. Henslee

Now, to the …

Michael Lasser – Barclays Capital

To the commercial customers?

Gregory L. Henslee

Okay. Well, you earn their business one delivery at a time, one day time, one week at a time. And I think we''re pretty careful about what we promise. As a matter of fact, as we originally start really making a push to come into the commercial business, we''re pretty careful because we have learned over the years how hard it is to earn a commercial customers business back once you''ve got it and didn''t do the job you promised you''d do.

So we have been pretty careful in describing what we''re capable of and what we''re not and promising more on the long-term of what we are putting in place and can eventually do. I think we''ve done a good job of managing that and I think the relationships that we are establishing are relationship that we can maintain based on being honest with the customers upfront about what our capabilities were, what they''re becoming, and what they are today in these markets. Ted, I don''t know if you have anything to add to that.

Ted F. Wise

Yes, Michael, we are definitely street smart in that regard and very conservative. We learned a long time ago that you go out and buy business or promise the world or the sky from a service level, and if you mess it up, you will lose a customer. So particularly out there where we had so much going on last year from moving product and just getting the store ready to do business, we were conservative.

A lot of times we would wait to rollout delivery service until we had the right staffing in the store and kind of take it one step at a time. It''s more of a long-term commitment to service. But on the other hand, where we were in a good position with the right people in the store and the right competition, we were very aggressive. So that evaluation process goes on district manager and regional sales manager making a game plan for each individual store.

Michael Lasser – Barclays Capital

And as you look at the vintage of CSK stores that have been converted the longest, are you seeing more growth coming from new customers or more growth coming from customers where you''re moving up the call list?

Gregory L. Henslee

I don''t have a measurement of where the commercial sales come from, because many of these accounts are accounts that were open that you -- they were opened immediately. When we put a store in the commercial business, will try to open accounts with virtually anyone that we would hope to do business with so that when they do give us a call, or they need apart they couldn''t find anywhere else, we are capable of handling the transaction.

So the way we measure, we would measure the growth as increases in existing customers, but also realizing that many of those customers were customers that had been -- had a competitor as a first call for some period of time. So that''s really a hard internal measurement. But my observation would be that generally we have developed relationships with many customers that were not buying from Checker stores in the center part of the country and the western U.S. and that we''re working our way to becoming the first call for those customers. And we''re probably not at the top of the list on as many as we would like to be today, but we''re working our way up the list.

Ted F. Wise

Michael, first of all, CSK''s model was to have fewer customers, maybe a larger volume customers, based on price. We want those customers, but our philosophy is to do business with every customer in the market area. So we''re calling on and have accounts with customers now that the former CSK folks didn''t even know exists. So our customer base is much larger. And to Greg''s point, when they are a new customer, it takes time to earn the business and work your way up on the first call list.

Michael Lasser – Barclays Capital

That''s really helpful. Thank you so much.

Gregory L. Henslee

Thank you, Michael.

Operator

Sir, do you have any closing remarks?

Gregory L. Henslee

Well, I would just say as I mentioned earlier, we are very pleased with our first quarter performance and we are very encouraged by the