O

123jump.com Staff
23 Feb, 2010
New York City

The auto parts retailer sales increased 5% to $1.17 billion in the quarter. Net quarterly income surged 68% to $72 million helped by strong same-stores sales growth and improved margins. Earnings per share rose to 52 cents from 32 cents the prior-year quarter.

O’Reilly Automotive, Inc. ((ORLY))
Q4 2009 Earnings Call Transcript
February 18, 2010 11:00 a.m. ET

Executives

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

Analysts

Matthew Gardner – Credit Suisse
Scot Ciccarelli – RBC Capital Markets
Adam Sindler – Deutsche Bank
Alan Rifkin – Bank of America/Merrill Lynch
Anthony Cristello – BB&T Capital Markets
Michael Lasser – Barclays Capital
Matthew Fassler – Goldman Sachs
Mike Montagna – Morgan Stanley
Scott Stember – Sidoti & Company
Colin McGranahan – Sanford Bernstein

Operator

Good morning. My name is Mandy and I will be your conference operator today. At this time, I would like to welcome everyone to the O’Reilly 2009 Annual Earnings Release 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 at that time, please 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. Tom McFall, sir, you may begin.

Thomas G. McFall

Thank you, Mandy. Good morning, everyone and welcome to our conference call. Before I introduce Greg Henslee, our CEO, I’d like to read a brief statement. The company claims the protections of the Safe Harbor for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by forward-looking words such as expect, belief, 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, discussing among other things expected growth, store developments, integration and expansion strategies, business strategies, future revenues and future performance. These forward-looking statements are based on estimates, projections, beliefs and assumptions that are not guarantees of future events and results. Such statements are subject to risks, uncertainties and assumptions including but not limited to competition, product demand, the market for auto parts, the economy in general, inflation, consumer debt levels, governmental approvals, our ability to hire and retain qualified employees, risks associated with the integration of acquired businesses including the acquisition of CSK Automotive Inc., weather, terrorists 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 company’s Form 10-K for the year ended December 31, 2008 for more details. At this time, I’d like to introduce Greg Henslee.

Gregory L. Henslee

Good morning, everyone and welcome to our fourth quarter conference call. Participating on the call with me this morning is, of course Tom McFall, our Chief Financial Officer; and Ted Wise, our Chief Operating Officer; David O’Reilly, our Executive Chairman is also present.

I would like to start off by thanking all of our dedicated team members who work so hard each and everyday to make sure our loyal customers receive the very best service in our business. All the way from our company headquarters, distribution centers, regional offices and most importantly, our stores, our dedication to making customer service our top priority is clearly evident.

All of you to be commended on all the solid results we generated in 2009 and I know we are all looking forward to continuing the growth of our company as we work to make 2010 other great year. It’s now been a little over a year and half since we began the process of integrating CSK with O’Reilly.

During this relatively short period of time, we feel we have accomplished a lot and are clearly on pace with the integration plan that we put in place directly following the acquisition. At the end of 2009, we had integrated many of that headquarters function. We negotiated most of our supplier agreement, changed over and enhanced most of the product offering in the CSK stores, completely changed over a 185 stores in the center of the country.

We merged Minneapolis Distribution Center into the O’Reilly Distribution Center in Brooklyn Park, converted the Detroit Distribution Center to O’Reilly systems and material handing, converted the Detroit Murray Stores to our systems, opened the Seattle Distribution Center, converted a 141 of the 193 stores that are supplied by Seattle to our systems along with a long list of other accomplishments necessary to integrate CSK with O’Reilly.

Since the course of the year, we completed the remaining system conversions in the stores supplied out of Seattle. We opened our Moreno Valley California Distribution Center on January 18 and have since started converting the computer system and have converted 148 stores supplied by Moreno Valley and have just 90 to go to complete the complete Moreno Valley distribution area.

These distribution center openings along with the subsequent store system conversions are the most important step in our integration process. As we have outlined before, the 185 stores that were converted in the center of country, which included the Minnesota, Montana, West Texas and New Mexico Checker Stores along with the Chicago Murray stores were very disruptive.

These complete changeovers involve closing the stores for a week on average or moving the stores’ existing inventory, resetting the store layout, installing a new inventory along with new computer systems, operational procedures and every thing else that goes along with an O’Reilly store. We basically turn these into O’Reilly stores in one-week time. This process again was very disruptive to the operation of the business.

The conversions that we are currently doing are now left are simply computer system and procedural conversions. These conversions do not require us to close the store and are not nearly as disruptive as the changeovers that were done in the center of the country. We are progressing with these changeovers at a rate of 30 stores per week and are being completed as we open our new western distribution centers.

To complete these, we send a tenured O’Reilly team member to each of the stores to be converted on Saturday, the four of the stores planned to conversion. This team member’s job is to connect the computer terminals, get the system up and running and physically attend the data conversion which builds the inventory, customer and accounting files necessary to do business on O’Reilly systems. These conversions take place after the close of business each Saturday night and we have a very qualified conversion and support staff here in Springfield that run these conversions each weekend.

On Sunday morning, the stores open on O’Reilly systems and are connected to their new servicing DC. The team members of the store would have previously had training on how to use our point of sale system and the tenured O’Reilly team member access the trainer for the first week of business and stays there at the store for this first week.

We then have a second trainer come in the following Saturday to spend another week with the store to make sure the store manager and team members not only have complete training on making point of sale transactions, but also on all the various daily routine functions and procedures. So far these conversions have gone very well and we are pleased with the result we are seeing.

We remain very confident in our ability to complete the conversions according to the schedule we set as part of our integration plan. As most of you know, this plan of ours is putting a much more robust distribution network in place in the western half of the country. This network basically emulates the network we have in place in the core O’Reilly markets and when completed all of our stores will get the level of distribution, service and support that it has allowed our company to prosper in both at do-it-yourself business and as a preferred supplier and business partner to commercial customers in the core O’Reilly markets.

Once we complete Moreno Valley, we’ll proceed with the opening of our Denver, Colorado distribution center in March then the opening of Salt Lake City in May to relocation of our Dixon, California distribution center to Stockton, California, in late August and then the final step of these conversions will be the system conversion of our Phoenix distribution center along with the 151 stores supplied by Phoenix which is currently planned for December 6.

Like I said, these conversions are going very well and we’re clearly not seeing the disruption in business that we’re seeing with the complete changeovers that we completed in the center of the country. Now, on to our fourth quarter performance. As I mentioned on our third quarter conference call, primarily for competitive reasons, the fourth quarter is the last quarter we planned to disclose the level of comparable stores sales detail that we have been disclosing since the third quarter of 2008.

We planned to go back to reporting our company’s total comparable store sales performance as a single consolidated comparison with our 2010 reporting. I know most of you read on our press release last night that during the fourth quarter we generated consolidated comparable store sales of 2.7%.

Our guidance estimate in our third quarter earnings release was consolidated comparable store sales in the 2% to 4% range, so we were within our range, but slightly below the midpoint of our guidance due to a drop in our comparable store sales performance in December. This was partly due to the tough comparisons we had from December of last year and partly due to the macroeconomic factors that we assume applied more pressure during the Christmas holiday with consumer spending more of their discretionary income and available credit on the holidays.

Comps in the first quarter are on a solid trend and we think we’ll see continued incremental improvements as the year progresses. And we’re able to take advantage of our distribution infrastructure in the western states. The store on O’Reilly system generated comparable store sales of 2.4% on top of the 6.2% comp increase they generated in fourth quarter last year.

Considering the relatively tough comparisons, we are reasonably pleased with the performance of the stores on O’Reilly systems. The obvious exception to that comment would of course be the 141 converted Murray stores, which had a comp stores sales decrease of 11%. Included in these stores are the Detroit area stores, these stores operate in one of the challenging economies in the country with unemployment almost three times than national rate.

It’s hard to be pleased with the comp performance of these stores that as we have explained before, they are in a state of transition and are moving to a more sustainable business model comprised of a healthy mix of both retail and commercial business focused on auto parts and supplies as opposed to the substantial amount of non-automotive products these stores had previously been selling.

Many of the core hard parts categories are performing well in these stores as we drive this transition and as we continue to establish ourselves as an outstanding auto parts stores for the do-it-yourself customers and as a great business partner and supplier to the commercial accounts in the Chicago and Detroit areas. Over time, we will see significant improvement in the performance of these stores.

The 123 converted Checker stores located primarily in the upper Midwest, Texas and New Mexico are performing well. The business model in these stores was more similar to that of O’Reilly and we are doing a good job in these stores -- in these markets establishing relationship with commercial customers and starting to build the size of business. The Checker store conversions in the center of the country generated an impressive 8.5 comparable store sales growth for the quarter.

The Western Stores operating on CSK systems generated 3.5% comparable store sales. Please keep in mind as you consider our Western CSK store performance that the 5.2% comp we generated in these stores during the third quarter was comparing to a 4.3% decrease in comps in the prior year. The 3.5% comp we generated in the fourth quarter was comparing to an 80 basis points positive comp in the prior year, so the positive sales trend we have been on in these stores continues.

We remain very confident and excited about the opportunities we have to grow market share on both sides of our business in the western states. And we are looking forward to the complete rollout of our distribution capabilities as we continue with the execution of our CSK integration plan.

Generally speaking, we are very pleased with our performance at this point with the integration of CSK. It’s clearly represented a significant challenge and we still have a long ways to go to complete the integration but the pieces are coming together very well.

Our team has worked very hard to execute our integration plan and our vendors have been very supportive of the integration. I think the outstanding vendor support we’ve received is clearly exemplified in the improvements we have seen in our gross margin. We ended the year with a 48% gross margin compared to a 45.5% in 2008, a 250 basis point improvement.

Tom will be giving specific gross margin guidance in a moment, but generally we expect to be able to maintain these higher gross margin levels. And our company will benefit nicely as we work to leverage our fixed costs by implementing our dual market strategy allowing us to grow our sales in many markets in which we deal CSK with underperforming. At the end of the year -- we ended the year with an 11.1% operating margin, well on our way to getting our operating margin back to pre-CSK levels and beyond.

Having made many of the capital investments that needed to be made in order to enable the CSK stores execute our dual-market strategy, we are looking forward to getting back to positive cash flow generation this year. Again, Tom will be reviewing all our financials in detail in a moment.

Just looking at our business from a very high level for a moment, the tailwinds for our industry continue to be the increasing average age of vehicles in operation due to the improved engineering of newer vehicles and the decreases we’ve seen in new car and truck sales.

The potential for continued increases in the number of vehicles on the road as the U.S. population continues to grow, the closing of OED dealerships which potentially puts some of the service that was being done at dealerships into the automotive aftermarket and for us continued consolidation of the industry. At last count, the top ten chains in the U.S. represented only 42% as the total part stores and with many of our larger competitors modifying their business models to try and execute modified versions of a dual market strategy, we expect many of the weaker stores and small chains will fall under increased pressure creating more expansion opportunities for companies like ours to see opportunity for continued growth.

The headwinds are obviously the general economic condition in the U.S. with unemployment hovering around 10% increased fuel prices. For example, at the end of 2009 we showed the average price per gallon of gas at over 260 per gallon compared to $1.64 at the end of 2008, an almost 60% increase.

This obviously takes more money out of our customer’s pockets and has proven over time can put pressure on the total miles driven in the U.S. However, we see a lot of opportunity and over time we feel we can become a significant factor in the supply of parts to commercial customers in the Western U.S. and at the same time feel we can improve our penetration on the Do-it-Yourself side of the business in all the markets we serve.

All 45,000 members of team O’Reilly are working hard to make those things happen. And we are looking forward to a successful 2010 as we work towards completing the integration of CSK and making O’Reilly an auto parts brands that will be easily recognized from coast to coast. I’ll now turn the call over to Ted Wise for some additional comments.

Ted F. Wise

Thanks, Greg and good morning everyone. Before discussing CSK integration, I would like to quickly review our fourth quarter expansion and summarize our growth for last year. By design, we ended the year by installing 10 new stores in the fourth quarter. This enabled us to redirect much of the stores installation department in our field team attention to plan and start the store resets in the west.

The fourth quarter expansion included three stores in North Carolina, three stores in Ohio, three stores in Wisconsin and one store in South Carolina and one store in Virginia. We also relocated two stores into new buildings which brought us up to 14 relocations for the year.

We completed 21 store renovations in the fourth quarter for a total of 53 store renovations last year. And as I mentioned in the last part of the year, our installation team has completed 27 stores reset in the Checker and Kragen Stores in the western state. New stores expansion for the year reached our 150 store goal and covered 25 of our 28 stores we operate in.

As planned to support our new distribution center in Greensboro this year, North Carolina led the growth to 29 new stores, Ohio had 21 stores, Texas continued to contribute good markets with 16 new stores, Georgia had 12 stores, South Carolina and Wisconsin ended up with 11 new stores and our growth continues into Florida with eight new stores. Tennessee had seven stores. The remaining 35 stores were spread out in 17 additional states.

As I have mentioned in the past the geographic coverage of our distribution centers allow us to more effectively and strategically plan and execute our store growth. While the majority of our growth is focused towards supporting the newer distribution centers like Greensboro and Indianapolis, we continue to seek out and find good store growth opportunities within our more mature markets.

Our continued expansion into markets like Texas, Arkansas and Missouri provide additional leverage in our distribution centers, our field management team and our overall corporate infrastructure. The execution of our dual market sales plan to both the DIY customer and the professional customers gives us the opportunity for an O’Reilly store growth in many small but very profitable markets that fall when they are on nightly distribution model.

Since we are in the middle of the CSK conversion, we have decided to set our goal for new store growth next year at 150 installations. There are few new stores planned for the West Coast this coming year.

The expansion will continue to be more concentrated in the Eastern states serviced out at Greensboro and Atlanta as well as the Ohio Valley state serviced out at the NDDC and our recently converted Detroit distribution center.

I would like to take this opportunity to recognize the great job that the corporate departments and the teams in the field have done in planning, installing and staffing our new store expansion, especially considering they had also been very involved in the CSK acquisition and the integration plans.

Now for some additional remarks on the CSK store and distribution center conversions. As Greg outlined in his comments, the computer conversions in the stores and the expansion of the distribution centers is moving forward according to plan. Last spring, the Detroit distribution center was converted to start servicing the 79 converted Murray stores in the Detroit area. It also played an important role in supporting and supplying our new stores in Ohio, in Michigan this year.

The remaining converted Murray stores in Chicago moved to our Indianapolis DC. And our distribution centers in Lubbock, Minneapolis and Billings began supplying the other 123 converted Checker stores. As you may recall, this first group of Murray and Checker stores involve complete inventory list, resets of the front display floor, new computer installations and going to our daily inventory replenishment. We have now finished installing interior O’Reilly packages in all these stores and with the exception of a couple of stores, all the exterior signage has been converted to the O’Reilly brand.

Now, moving to the west. The Seattle DC was opened in November and as Greg described, 193 stores Kragen had been converted over to a lot of computer system. Our Moreno Valley DC opened last month and will follow the same conversion schedule for the 238 Kragen stores that we did in Seattle of approximately 30 stores per weekend.

And then in March, we will reopen a new distribution center in Denver and begin the conversion of the 84 Checker stores in that market. In May, we have opened the distribution center in Salt Lake City and followed with the 86 Checker store conversion. And then in August we returned to California to move our current distribution center in Dixon into a brand new 520 square foot building in Stockton. This will allow us to complete the conversion of the remaining 276 stores, again following a 30-store per week schedule.

Then in early December, the last piece in the puzzle will be converted to the system in our Phoenix distribution center and the last Checker stores in Arizona, New Mexico will be converted. This will be last conversion in the change. The store conversions will take place on the same weekend. The end result will be all CHK DCs and all CHK stores will be fully converted to O’Reilly system and the O’Reilly distribution model by the end of 2010.

Our entire team has done a great job of planning and executing the conversion process in both the DCs and the stores. These conversions especially with the tight schedule we are working within would not be possible without the contribution of literally thousands of team members in the core O’Reilly stores going to the CSK conversion stores for weeks at a time to help install and train. It is very rewarding to see our core O’Reilly team members work side by side with our new West Coast team as we implement our systems and our goal dual market business strategy.

Our store installation teams have started to reset of the front floors in the West Coast stores, which is entirely different and independent of the computer conversion schedule. Depending on the scope of the project, we will be able to do around 30 store projects per week.

Immediately following the resets of the store fixtures and a new plan grant, each store will have interior remodel work done and new O’Reilly interior to cope that is installed. The planning and the permitting for new O’Reilly signs to re-brand the stores is well underway in the West Coast.

Our goal is to have the store re-branding completed by the middle of next year as well as any interior upgrade and maintenance needed. Now to add a few comments regarding the progress and the growth of our business at west, with the exception of this few front room lines left to be converted the product line upgrade and hard part additions are finished.

We have very good coverage in all stores that is supported by larger inventory and strategically placed hub stores. Of course, as the new DC is opened we gained the advantage of having over 100,000 skews available each night and some time during the day with the store close to the DC.

Our DIY pricing has been adjusted to be more competitive in each market and our retail advertising which includes print and radio is focusing on the increase product availability and more competitive prices along with continue to educate the customer on the transition to the O’Reilly brand. The co-branding is done very well, which helped us to decided re-brand store to O’Reilly soon than what we have originally planned.

In regard to the installer side of our business, the inventory upgrade have been important in rolling our business along with improving our service levels and providing great delivery service to our professional customers. Our sales team consisting of full time territory sales managers and store sales specialist are very focused on developing sound relationships with our professional customers.

We are very pleased with how the new O’Reilly team members in the conversion CSK Stores have taken the new O’Reilly programs and are executing the dual market sales strategy in their markets. We are also very confident we will continue to have strong sales results and gain market share as the stores convert to our computer systems and have better inventory availability with the new distribution centers.

Now, I would like to briefly take a few comments to discuss our O’Reilly manager’s conference that was held last month in Nashville at the Grand Ole Opry Hotel Convention Center. There were over 4500 O’Reilly management and sales team members from our stores, distribution centers and corporate offices.

The conference program involved both operations and sales training, which was customized to the individual store divisions. In addition to the O’Reilly training sessions, our vendors held a product show, as well as a number of key in-depth product training seminars for our team.

Our general sessions were designed to recognize our high achievers as well as to discuss the challenges and opportunities ahead of our company and the role that each of us play in achieving our sales and profit goal. This is also the first time that our new West Coast store managers attended the conference and proved to be a huge benefit in helping them feel more part of the team and see up close what the O’Reilly culture is all about.

Our management sales teams left Nashville very enthusiastically about the opportunities ahead of us and with an increased level of determination to gain market share this year in their individual markets. To finish my comments, I would like to thank our 45,000 O’Reilly team members for their hard work and their commitment to help make this a very successful year for the company.

This success has been based on a true team effort and contribution. Many of our team members were part of the CSK conversion stores. Others were very involved in the actual conversion and planning and execution. And core O’Reilly stores and distribution center team members stayed totally focused on growing our core O’Reilly business. Judging from our company’s performance, everyone did an outstanding job and again, I would like to thank everyone for that job last year. With that, I’ll turn it over to Tom.

Thomas G. McFall

Thanks, Ted. Now we’ll move on to the numbers. For the quarter, sales increased $59 million, 5% over the prior year to $1.17 billion. The increase was attributable to a $30 million increase in comp store sales, a $31 million increase in non-comp new store sales, flat sales and non-comp non-store sales and a $2 million decrease in stores merged and closed in 2008. For the year, sales increased $1.27 billion, 36% over the prior year to $4.85 billion.

The increase was attributable to $189 million increase in comp store sales, a $145 million increase in non-comp new store sales, a $4 million increase in non-comp non-store sales, $935 million in CSK sales for the period when we did not own CSK in the comparative period in 2008, which was January 1st through July 11th and the $2 million decrease in stores merged and closed in 2008.

For 2010, we estimate our total revenue will be between $5.1 billion and $5.2 billion. Moving on to gross profit, gross profit was 48.5% of sales for the quarter versus 46.2% the prior year. The improvement was driven by the improved product acquisition costs negotiated with vendors based on our increased post-acquisition purchasing levels.

For 2010, we have to make gross profit as a percent of sales, will be 48.1% to 48.4% of sales. And inherent in this range, is $25 million of incremental buying synergies we will see primarily in the first quarter, offset in part by decreased distribution costs associated with the ramp up of the efficiencies at our new distribution centers and pressure on the gross margin as a larger mix of the total business is done on a commercial side, which carries a lower gross margin percentage.

Where we end up in the range, will be driven largely by how successful we are at adding commercial sales in the converted stores, which will put pressure on the gross margin percent sales, but will be incremental to gross margin dollars per store which is our focus. SG&A for the quarter was 37.8% of sales, versus 39.0% in the prior year. Excluding acquisition-related charges, SG&A was 37.7% of sales versus 37.9% in the prior year.

Leverage on SG&A came from increased sales per store. On a per store basis excluding adjustments, SG&A dollars were up slightly from the fourth quarter of 2008. That slight increase is comprised of decreases in headquarters, advertising and general store expenses, offset by increases in store payroll related to the cost of store conversions and the cost of launching additional commercial programs in converted stores.

For 2010, we expect SG&A dollars per store to be slightly down. We’ll continue to invest significant dollars in store conversions, training and new commercial programs, but we expect this to be fully offset by increased synergies on headquarters and advertising and increased sales driven by our store investments made in 2009.

Operating margin for the quarter was 10.7% of sales, an improvement of 345 basis points over the prior year. Excluding acquisition adjustments, the quarterly operating margin increased 244 basis points. For 2009, operating margin was 11.1% of sales and is quickly closing in on our pre-acquisition LTM operating margin of 11.8% for the period ended June 2008.

We were very encouraged on the rapid progress we have made in returning our operating margin to pre-acquisition levels, in such a relatively short period of time. We expect our operating margins for 2010 to exceed the pre-acquisition operating margins.

A little bit about interest. Net interest expense for the quarter was $11 million, which was $2 million less than the prior year on lower LIBOR, offset in part by higher debt levels. For 2010, we expect net interest expense of $41million to $43 million based on lower average debt levels. This estimate is also subject to unforeseen changes in LIBOR levels to the extent our debt is not swapped to fixed rate.

The tax provision for the quarter was 38.0% of pre-tax income as opposed – excuse me – as compared to 37.7% in the prior year. The fourth quarter results were favorable to our third quarter guidance due to the favorable resolution of certain tax issues. For 2010, we expect our tax rate as a percent of pre-tax income to be 38.0% to 38.4%, as compared to 38.1% for all of 2009.

Where we fall within this range, will be dependent on resolution of open-tax year audits that occurred during the year. Adjusted diluted earnings per share for the quarter was $0.52 per share, which represents an increase of 41% over the fourth quarter of 2008. For the year adjusted diluted earnings per share was $2.26, a 38% increase over the prior year.

Now, moving on to the balance sheet. The average inventory per store at the end of the year was $559,000, which was a 17% increase from the prior year average of $478,000. The increase was in the CSK stores, as the core O’Reilly stores average inventory approximated historical levels. The increase was a result of changeovers of CSK stores, which added a much wider breadth of SKUs available at each store, combined with the CSK stores systems -- excuse me -- combined with the stores on the CSK System, receiving only one stock order a week which necessitates more stocking depth.

In 2009, we intentionally flooded the CSK stores with hard parts, to get them back in our hard parts business. In 2010, we are focused on refining the inventory mix at the CSK stores and as the new distribution centers come online, we’ll be able to reduce the stocking depth at the CSK stores.

Based on these 2010 initiatives, we expect only to increase our total investment slightly in 2010, despite opening a 150 new stores and adding three distribution centers. Our reserve for LIFO at the end of the quarter was $8.7 million, which was a decrease of $4.1 million in the previous quarter. This change in our last buy to LIFO inventory reserve did not have material impact on gross margin for the quarter.

Accounts payable of $818 million was 42.8% of inventory, as compared to 46.9% in the prior year. Our AP to inventory ratio at the end of 2008, benefited from special extended dating on changeover orders. In 2010, we expect our AP to inventory ratio will continue to be under pressure as we work excess inventory out of and through the system.

Capital expenditures were $98 million for the quarter, bringing the year-to-date total to $415 million, which was within our estimate of a 2009 CapEx spend of $400 million to $420 million we discussed on our third quarter call. For 2010, we anticipate capital expenditures will be $400 million to $440 million, as we complete our DC projects and continue to invest heavily in store conversions.

Excluding conversion CapEx, maintenance CapEx in our 150 new stores would be approximately in the $250 million range. Depreciation and amortization for the quarter was $37 million and a $148 million respectively. For 2010, we expect depreciation and amortization to be $154 million to $159 million.

Moving on to debt, total borrowings were $791 million at the end of December, this year, compared $733 million at the end of 2008. The increased debt of $58 million has been used to fund new store growth at the core O’Reilly stores and a conversion investment, including both CapEx and net inventory of the acquired CSK stores. However, the majority of these investments have been covered by internally generated cash flow.

For the year, we have increased our debt outstanding on our ABL by $65 million. However, because of the increases in our borrowing base, availability under the revolver has actually increased slightly to $445 million, providing us with ample available credit.

For 2010, we expect to reduce our total outstanding borrowings by a $150 million to $200 million. Included in this reduction, is our planned redemption of a $100 million legacy CSK convertible notes in December. Our plan is to fund this with our existing ABL, which will still allow us significant financial flexibility.

Now, for some other financial information. Cash flow from operating activities for the quarter was a use of $4 million versus a positive $9 million in the prior year. Both numbers reflect the seasonal nature of our cash flows from operating activities.

For the year, cash flow from operating activities decreased $13 million to $285 million, driven by the higher income, offset by our large investment in net inventory. For the year, free cash flow was the use of a $130 million as we invested heavily in inventory and CapEx for the DC expansion and store conversions.

We expect free cash flow to swing to a positive $120 million to $150 million in 2010 as we continue again to invest heavily in CapEx, but do not have a significant investment in that inventory. Stock option expense for the quarter was $3.2 million compared to $2.5 million in the prior year and the year-to-date stock option expense was $13.5 million, compared to $8 million in the prior year, with the increase being driven by the options issued in connection with the CSK acquisition.

For 2010, we expect stock option expense to be approximately $16 million. Let me finish by recapping our overall guidance. For the first quarter, our comparable store sales guidance is 2% to 4% and for the year, our comparable store sales guidance increases to 3% to 5% as we see the positive impact of more converted CSK stores.

Our GAAP diluted earnings per share guidance for the first quarter is from $0.56 to $0.60 on a 139.5 million shares and our adjusted GAAP diluted earnings per share guidance for the full year is from $2.50 to $2.56 on 140.3 million shares. At this time, I’d like to ask Mandy, our Operator to come back and we’ll be happy to answer questions. Mandy?

Question-and-Answer Session

Operator

Yes, sir. At this time, I would like to remind everyone, in order to ask a question press star then the number one on your telephone keypad and due to today’s limitation on time, please limit your questions to one and one follow-up question. Again, that is star then the number one to ask a question. We will now take our first question from the line of Gary Balter with Credit Suisse.

Matthew Gardner – Credit Suisse

It’s actually Matt Gardner. A couple questions on the conversion process. As we think about the evolution of the performance of those converted stores as you roll them out. Can we use Checker’s – the Checker’s progression, as sort of what you think the normal run-rate would be? And seeing -- going back a couple quarters, they started out negative, then they sort of got back into positive range two quarters out and now you’re up 8.5. How sort of atypical is that for most of the converted stores as they roll out?

Ted F. Wise

As we said, the stores that we converted in the center of the country are much different than a pure conversion standpoint. Although the ultimate result, we feel would be very similar. I think the comparison there would be that in the stores in the center of the country, we saw pretty significant dips in performance that were the result of closing the store for a week as we did the conversion. And then just the shock of training, all the products being relocated in the store, just a very disruptive process that caused the sales to be soft and for the stores not to comp very well for a maybe a four week period or maybe longer than that in some cases. We won’t see the downturn in sales to the degree that we did in the center of the country stores, in the western stores that I think the end result will be similar and that varies by market. We have more opportunity in some markets than others obviously. But I don’t think it would be unreasonable to ultimately expect performance comparable to what we’re seeing now in the Checker stores.

Matthew Gardner – Credit Suisse

Okay. As you’ve done the Schuck’s stores over the last -- sort of the last couple months since November, any surprises there positive or negative?

Ted F. Wise

No. We knew when we did the Schuck’s stores, when we did, that we were going to be comparing to an unusual weather period in Seattle last year, where we had a huge snowstorm that drove a lot of tire chain sales and other things that you wouldn’t normally sell. From a sales trim perspective, we were happy with the lack of disruption in the Seattle converted stores and have been pleased with the conversion progress not only in Seattle, but also the performance of the stores in Southern California that are being converted to be supplied out of Moreno Valley.

Matthew Gardner – Credit Suisse

Okay. Just on the SG&A front. You’ve got the guidance on a per store basis, I guess should be up slightly versus 2009. How do we think about how the spending evolves throughout the quarter? Is there any lumpiness to SG&A spend related to the DCs as they roll out? When do you start to see some of the elevated SG&A spend start to drop off as you get past the conversion process? Is it a late 2010 event? Is it going to come in 2011?

Thomas G. McFall

This is Tom. First thing I’d like to say, is in my prepared comments on distribution costs, I inadvertently said that we’re going to see a decrease in distribution costs. Of course, that is incorrect. We expect to see as a percent of sales an increase this year as we open new DCs that are not efficient. Now, let me move on to your specific question. Distribution costs will be -- are included in gross margin. But as we open more DCs and we have more DCs that aren’t fully efficient, there’ll be more of a drag in the end of the year. But our distribution teams will work quickly to get the training done that needs to happen, so get them efficient again. When we look at SG&A, on a regional basis SG&A will be very lumpy but on total, because we’re doing about the same number of conversions each month, we’d expect it to be relatively consistent across the year, with the exception of our normal seasonality which lines up with stronger sales in the second and third quarter.

Matthew Gardner – Credit Suisse

And then just lastly on the gross margin line, if we go back to the second quarter, I think the guidance that you had for the back half of the year, gross margin backed off a little bit. The gross margin would come down a little bit related to commodity costs and I think we ended up actually being above what the 2Q run-rate was. I am just curious as to what do you think -- what was the incremental driver of the stronger gross margins as we went into the back half of the year?

Thomas G. McFall

What we see -- obviously, a lot of it has to do with finishing up deals with major vendors and getting the accounting right. But what we also see is, when we have slower sales in the fourth and first quarter, driven by fewer commodity weather items, it hurts our top line but helps the gross margin percentage because those products tend to not carry the as high gross margin percentage.

Operator

Your next question is from Scot Ciccarelli with RBC Capital Market.

Scot Ciccarelli – RBC Capital Markets

Two questions. First of all, Can you just talk little bit about the competitive dynamics, especially on the commercial side that the western CSK stores are going to encounter as you ramp up that commercial business?

Ted F. Wise

Sure. Well, there’s plenty of competitors out there as there are in every market. There’s several smaller chains out there that do a good job in commercial. There’s several what we call, two step operations that basically exist just to service commercial customers and they are all tough competitors. We take them one at a time by market, evaluate their strategy, pricing, inventory, the service levels they are able to provide and come up with a combination for us, it allow us to incrementally develop relationships with customers and start working to take our fair share of the market.

Scot Ciccarelli – RBC Capital Markets

Okay. That’s helpful. And then, just a clarification on the guidance, I think this time last year you basically guided 2009 to about $1.85 and yet you ended up around $2.25. Can you guys just kind of give a little bit more description, a little bit more color on how you’re thinking about the outlook for 2010? Thanks.

Gregory L. Henslee

Well, I’ll make a few comments and if Tom wants to make some comments, he may have some additional comments that, what I would say is that as we look to 2010, it’s hard to look forward in a year that the U.S. economy and consumers continue to be under the pressure they’re under and be real aggressive from a sales standpoint.

Now, at the same time, we’re very enthused about the opportunity that we have in the western U.S., with the implementation of our business model that will come to fruition this year as we open our distribution centers. We’re hopeful that our comparable store sales and resulting earnings are better than what we would expect but again, that’s yet to be seen.

The other factor is just purely from an expense standpoint, there’s a lot of work to do to do these conversions and there’s a lot of expense related to these conversions and that’s baked in to our guidance. Now certainly, we leverage any expense with great sales. But I think that our sales guidance is reasonable and their resulting earnings would be reasonable based on that.

Thomas G. McFall

Scot, the two things I would add is, obviously, we’re very excited about our results for 2009, a very good year. A couple of items in relation to being so much higher above our initial guidance would be, one, we were successful through a lot of hard work from our merchandising staff and our field teams by changing over products earlier and pushing up the synergy dollars in 2009. We have a pretty good handle on where margin is going to be this year within a much narrower band.

The second piece would be when we did the 2009 guidance, LIBOR rates have bounced around quite a bit for the couple months previous to that and that provided some tail wind for us too. LIBOR rates can’t go much lower than they are now.

Operator

Again as a reminder, please limit your questions to one and one follow-up question. Your next question is from the line of Mike Baker with Deutsche Bank.

Thomas G. McFall

Mike, good morning.

Adam Sindler – Deutsche Bank

Hi, this is actually Adam, in for Mike. Good morning. Two questions if I may. You talked a little bit about the difficult comparisons in December last year kind of impacting the comp. I was hoping you could maybe discuss some other sort of factors in the quarter, one of them being miles driven that you discussed down versus the second and third quarters of the year. But then also there was a competitor on the other day discussing how they felt that they were not in the competitive position in the front half of the year, kind of changed their pricing in the back half of the year.

And then we saw another competitor this morning, who also was a little bit light on the top line. Wondering if you could maybe reconcile some of those comments for us and how you look at the fourth quarter, really what was the major driver of comps at the low end there?

Thomas G. McFall

Well, what we saw in the fourth quarter was that we had a relatively strong third quarter. Fourth quarter started off strong. December business from a comp store sales perspective softened some on tough comparisons. And we had a good December last year, 2007, we had a soft December. We related the softer comps comparing to 2008, of course, to the fact that the consumers have been under a lot of pressure, gas prices were up over 2008. And that there wasn’t as much discretionary spending as what there would be and what there was available was being used as much as possible holiday gifts and things like that.

From a competitive standpoint, we’ve heard the same things that you have heard about the things our two competitors said. And the earlier mention, of course, they went through a process I think of adjusting their pricing and I think they are more competitive than they were before.

Retail, I don’t think we’ve seen that on the commercial side. I don’t know to what degree that affects us. We would be limited on the other competitor from an exposure standpoint to just the eastern half of the country but we really haven’t seen a material effect from that at this point. It’s hard to measure that of course. We work hard to keep our prices competitive and we never feel that we’ve gotten ourselves to a point where we’re just done.

I mean, it’s a weekly process, a daily process. There is a team here that works on maintaining competitive retail prices and competitive prices for our repair shop partners and that’s never a completed process. And there’s never a time that we shop a complete line and some of our competitors haven’t changed their prices. So, we wouldn’t have, I don’t think notice a significant change with the change in the strategy or the adjustments to some our competitors that they would make.

Adam Sindler – Deutsche Bank

And just one quick followup, if I may. The thousand West Coast stores; I believe we are using estimates of $1.3 million per store broken down by about $1.1 million retail, $200,000 commercial. Has that changed at all significantly during this process changing out products? Or is that a …

Gregory L. Henslee

I think that’s a pretty close point on average. The commercial business right now is growing pretty well in those stores, so over some period of time, the commercial business will grow. We don’t expect the retail business of course, to decline. We expect to grow that too, the commercial business right is growing faster than the retail business.

Operator

Your next question is from the line of Alan Rifkin with Bank of America/Merrill Lynch.

Alan Rifkin – Bank of America/Merrill Lynch

Thank you very much. Greg, now that the accelerated conversion of about 30 stores a week is well underway, can you possibly shed some color on the performance of the stores in the weeks immediately following a conversion? And then also from an expense standpoint are you becoming more efficient in the conversion process?

Gregory L. Henslee

Well, first just the performance of the stores following conversion. There is two ways of looking at it. One, you have to look at just the sales trend the store was on and then two, you have to look at the comparisons that they are up against, so you don’t get fooled by just the comp percentage that we may see. As I mentioned earlier, when we converted the Seattle stores, we started that process. I think it was November 9 and we had eight stores in the first week and then we moved to 30 and then we had a couple holidays in there.

Those stores were, we knew, were coming up on an unusual winter storm that they had last year that caused a real high spike in sales in those stores last year. So, we knew we had comparison issues. In looking at those stores sales trend, the stores stayed pretty much on track and we didn’t see much disruption from the conversion. Certainly that first day, two days you have training issues, you’re not as fast at point of sale but these conversions really just aren’t as disruptive as the ones which is in the center of the country. In Southern California, now that we’ve got some of the Moreno Valley stores under our belt, what we’re seeing and again, business changes day-to-day, week to week based on a lot of different factors but we’re not seeing much change in the comp trend in those stores as they convert. They continue to operate very well under very normal weather in Southern California. There very seldom a weather event in Southern California as you know and Ted you may…

Ted F. Wise

Yes, Alan, I might add on the store expense side. Last year was a very task-oriented year for all the CSK stores and the thousand stores on the west coast. There was a lot of busy work as far as product changeovers and in place preparing for the computer conversions, the training. And what we believe, we’ll see after they go on our system, the stores become more efficient. We’ll leverage our payroll better through sales growth obviously but also being able to implement our scheduling system on our computers in the store and fine tune our payroll cost on the West Coast this year.

Thomas G. McFall

And Alan, just to make sure we answered the second part of your question on our ability to become more efficient in the actually conversion, there really isn’t much to gain there. What we spend the put a tenured core O’Reilly team member on a plane, travel him out there, the travel expenses, their payroll being out there. In the busier stores, you might have two that do this at the same time to make sure there is plenty of training help for the store. There is really is not much we can do to optimize that other than make sure we benefit from it as much as we can at the store being trained. So, there’s really not much to gain there.

Our opportunity, as Ted said, is to just operate these stores more efficiently, which we’re working towards through the ways we manage payroll and the way we manage what we call a wage pyramid in the store, to make sure that we have team members that are entry level, team members that are in the middle of the wage range, that are good parts specialists and then of course, the management of the store.

Alan Rifkin – Bank of America/Merrill Lynch

And one followup, Greg, if I may. With respect to these 141 Murray stores, we certainly get a lot of questions from investors with respect to these stores and even though it only represents by our estimate, 2% to 3% of your revenues, are your still committed to these stores and are these Murray stores still in fact profitable?

Gregory L. Henslee

They are profitable. As a whole, we’re very committed to them. We have got one of our best operations guys up there running those, the divisional VP that is responsible for those, is a very tenured O’Reilly management member. He spends a lot of time in Detroit, a lot of time in Chicago. We’re of course doing better in Chicago than we are in Detroit. Detroit is a very challenging economy. We’re taking these stores through a very significant transition. These stores were very different than an O’Reilly auto parts store. We focus on hard parts, application parts, automotive only merchandise, being a great supplier to the, I’ll call it, the medium to heavy do-it-yourself and to commercial customers.

And these stores were stores, they carried a lot of -- they had a lot of automotive coverage of course, not nearly to the degree that we would, but they had many ancillary products and non-automotive products that they would run promotions on at aggressive prices to bring traffic in to the store and by taking those out, we’ve put ourselves in a comparison position to where we don’t compare very well from a sales standpoint. But on a by category basis, several of our hard parts categories are performing very well. And we’re very committed to turning these into very profitable auto parts stores over time and being a dominant factor in Chicago and Detroit.

Thomas G. McFall

Alan, this is Tom, What I would add to that is, because the Murray stores were selling a lot of non-core products, previous to conversion, their averages were higher than the company average because of those extra products. So when we look at the comp gross margin dollars in those stores, it’s significantly better than the comp sales because a lot of those ancillary products did not carry very good gross margins.

Operator

Your next question -- your next question is from the line of Tony Cristello with BB&T Capital Markets.

Anthony Cristello – BB&T Capital Markets

Good morning, gentlemen.

Gregory L. Henslee

Good morning, Tony.

Anthony Cristello – BB&T Capital Markets

I guess I have a question on, now that the Seattle distribution center is up and you got that market going, could you provide a little bit more color or detail on how you approach growing the commercial side, now that you have sort of the replenishment up and what you’re doing in that market to try and win new business?

Gregory L. Henslee

Ted, do you want to speak to that?

Ted F. Wise

Tony, actually, most of the infrastructure has been put in place. We started last year as far as looking at the staffing models in the store, realizing that we were going to have a better hard parts selection, first of all, very soon, immediately. But then as we opened the DCs, we had the next layer of supply. So we started building stronger teams in the store from a, we call him ISS installer service specialists, improving the hard parts mix, evaluating the territories around the stores and building new territories for more accounts.

Their model was to call on a lot of the large accounts, but they overlooked a lot of the small shops around the store. So we’ve sort of reengineered how they made sales calls, increased the number of TSMs and like I said, progress it’s a work in progress of implementing new installer service centers in the stores, we call them first call centers and just consistency and building relationships at the installer level and it’s working. And we feel like the additional inventory now, particularly some of the brands that we had added towards the end of the year, last year.

In the last one, for instance, was like wick filters, we just changed over which is a more traditional line of oil filters and air filters. So we’re really in good shape from a product standpoint obviously with the new DCs, couldn’t be in better shape with the supply chain. And we’ll just continue to make consistent calls and give great customer service level. Dial into the competitive pricing, which there’s different competitors in different markets, so you have to be competitive if you’re going to get the business.

And just grow the business, which is -- it’s a process, it doesn’t happen overnight, because it’s so relationship based. And quite honestly, the Seattle area had a pretty good foundation to grow from. They had proportionately, probably a better installer mix of business, than what a lot of the Kragen and Checker stores did.

Anthony Cristello – BB&T Capital Markets

So, would you categorize that market as a better market than what you would see going into Greensboro and building out commercial?

Ted F. Wise

It’s a bigger market. You take a Greensboro, for example, versus Seattle and Portland, so yes, there’s more installer business. It’s probably more fragmented with two steppers. So I’d say it’s a stronger market just from a pure population count and car count.

Operator

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

Michael Lasser – Barclays Capital

Thanks a lot. It’s Michael Lasser from Barclays Capital.

Gregory L. Henslee

Hi, Michael.

Michael Lasser – Barclays Capital

How are you? Since it seems like this will be a big year for investing and conversion process, can you perhaps quantify some of those costs, so we can have a better sense of what the longer term margin outlook might be once you’ll be done absorbing these expenses and I’ll fit in a quick follow-up, is there any impact on the gross margin from the excess inventory investment that you made in the CSK stores?

Thomas G. McFall

I’ll answer both of those. From a margin standpoint, where we get to an operating margin is going to be driven by where we can build the commercial business in the total average store sales to leverage both the payroll that we’ve put in from a commercial standpoint and the high fixed cost of CSK.

We’re not prepared at this point to quantify what our payroll percentage is, but after this year, we have a significant opportunity to get better on leveraging payroll. And there’s a decent discrepancy between the core O’Reilly payroll percentage and what we are running at CSK now is which is kind of what you would expect.

The second question on inventory – the answer to that is no. The margin that we’ve driven is based on the products that we sell. And converting or really reducing our inventory I call it right sizing our inventory this year will not have a material impact on our gross margin percentages.

Operator

Your next question is from the line of Matthew Fassler with Goldman Sachs.

Matthew Fassler – Goldman Sachs

Hi, good morning. Just a couple of follow-ups here, I know that you disclosed the Schuck’s numbers alongside the core O’Reilly numbers. And just to make sure I understand what the core, I guess, pre-acquisition O’Reilly stores had done from your discussion during the call, it sounds like the Schuck’s numbers are probably under some pressure given the compare such that the core O’Reilly stores probably did a little bit better than the combined number that you disclosed in the release?

Thomas G. McFall

That’s correct.

Matthew Fassler – Goldman Sachs

Is that materially better like half a point, a point something like that or in any of that?

Thomas G. McFall

I would consider it not material and not to the extent that you described it.

Matthew Fassler – Goldman Sachs

Got you. Okay. And then secondly, if you could discuss when during the year you think the inventory growth rate will see an inflection point? Clearly, it sounds like by year end, I think you are into meeting inventory might actually be down or at least pretty close to flat. When do you think you start to work those numbers down?

Gregory L. Henslee

We’re working on it right now. And I think we’ll see progress depending on what we’ve done here in the next 40 days or so. We may see some progress in the first quarter. I think by the end of the year. You would again see some -- there is a slight increase as we open new stores and distribution centers. We’ll see a dip before then, going back up to slight increases at the end of the year.

Operator

Your next question is from the line of Gregory Melich with Morgan Stanley.

Michael Montagna – Morgan Stanley

Hey, guys. This is Mike in for Greg. Just, wanted to ask two quick questions, one was really with respect to synergies now. And Tom, I think you alluded there’s still some pretty good opportunities on the COGS side from purchasing. Can your just refresh us? Is that a still sort of a 70/30 split between COGS versus SG&A and some of the other opportunities you have in payroll that you just mentioned?

Thomas G. McFall

In our prepared comments, we pointed to $25 million of incremental buying synergies this year. When you look at our run-rate of gross margin last year, you can see when our major deals got done, our acquisition costs got diffused, so most of that will fall in the first quarter.

From a headquarters SG&A synergies, purely synergies standpoint, we have opportunities this year and part of that is going to be offset by investing in district managers. And TSMs, as Ted discussed earlier, to really get the feel of the operational support they need to go out and grow the business.

Mike Montagna – Morgan Stanley

Great. And then just quickly as a follow-up, on the comp side, obviously, some deceleration from the 5-3 to the 2-7. Just looking at a very high level, wondering if you can quantify, first, maybe on a traffic and ticket basis, what might have de-accelerated a bit? Was it more just traffic or just pricing pressure on ticket? And secondarily, DIY versus DIFM, if you could give us a feel for where you shake out.

Gregory L. Henslee

Yes. Well, our DIFM business is growing a little bit better than what our DIY business is. Ticket count in average I think we’re both, if you compare to the third quarter, both would be affected a little bit. Is that correct, Tom?

Thomas G. McFall

That’s correct.

Gregory L. Henslee

I think to add to kind of add to the comment, I made earlier about consumers just being under pressure and the holiday season putting already strapped consumers under more pressure. I think was manifested for us in a slightly lower ticket average. And then of course, just some decreased traffic as compared to the third quarter.

Operator

Your next question is from the line of Scott Stember with Sidoti & Company.

Scott Stember – Sidoti & Company

Afternoon. Just one question. When you look at your guidance next year, what are you assuming will be the commercial to retail mix to CSK stores on the West coast?

Gregory L. Henslee

I think that we’re going to be hesitant to answer that question. Obviously, on the West Coast we would expect to grow the commercial business faster than the DIY business based on just penetration.

Ted F. Wise

Yes. If we were 85/15, out there now or something like that, we would expect something like that we would expect the commercial business to grow faster in the year at more of a -- I don’t know maybe -- a slight improvement towards the do-it-for-me growing a little faster. But inherent within that is we want to as Greg commented, we want to grow and there is potential out there to grow the DIY side of the business and CSK has given up a lot of market share over time.

Gregory L. Henslee

Yes. For the first time over several years, CSK from a retail standpoint has got a hard parts inventory competitive pricing, which we should see some nice growth from that. It won’t happen overnight. It’s going to take a while to kind of remake the image of their availability and competitive pricing for the retail but it will happen slowly and surely.

Ted F. Wise

And incrementally, most likely Scott, we’ll get to 80/20, 75/25. In what time that happens is a little bit of an unknown now.