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Executives

Ray Arthur - Chief Financial Officer

Mike Odell - Chief Executive Officer

Scott A. Webb - Sr. VP of Merchandising & Marketing

Analysts

Jeff Blaeser - Morgan Joseph & Co.

Bret Jordan - Avondale Partners

Sean Haydon – Yield Capital

Anthony Cristello - BB&T Capital Markets

Brian Lester – The Abernathy Group

Stephen Chick – FBR Capital Markets

Greg Malik – Morgan Stanley

The Pep Boys – Manny, Moe & Jack (PBY) F2Q09 Earnings Call September 9, 2009 8:30 AM ET

Operator

Welcome to The Pep Boys second quarter 2009 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host Mr. Ray Arthur, Executive Vice President and Chief Financial Officer of Pep Boys.

Ray Arthur

Good morning and thank you for participating in Pep Boy's second quarter fiscal year 2009 conference call. On the call with me today are: Mike Odell, Chief Executive Officer of the company; Scott Webb, SVP Merchandising and Marketing; and our Vice President and Corporate Controller, Sanjay Sood.

The format of the call is similar to those done by Pep Boys in the past. First Mike will provide opening comments regarding our results and priorities then I will review the second quarter of 2009 financial performance, balance sheet and cash flows. We will then turn the call over to the operator to moderate a question and answer session and we plan on ending the call no later than 9:30 a.m. Eastern Time.

Before we begin, I’d like to remind everyone that this conference call is governed by the language at the bottom of our press release concerning forward-looking statements, as well as SEC Regulation FD. In compliance with these regulations, we are Web casting the conference call on www.investorcalendar.com. For anyone on the Web cast who does not have the financial statements, you can access them on our Web site at PepBoys.com.

I will now turn the call over to Mike Odell, our Chief Executive Officer.

Mike Odell

Good morning and thank you for joining us today. We are now six quarters into our three-year plan to turnaround Pep Boys and we remain on track. Our vision is to be the automotive solutions provider of choice for the value-oriented customer, and I want to start by thanking the Pep Boys' team in our stores, distribution centers, and support center for the progress we've made in earning our customers' trust on a more consistent basis, for returning us to profitability, and for beginning to establish the foundation for our future growth.

As we have said before, 2009 is a year of positive change and building for the future, following the disruptive change that was required in 2008. And 2010 is the year we expect to complete most of the foundational work in our turnaround.

We still have more hard work ahead of us but it's nice to see two quarters of results from our work so far. I continue to be very pleased with the level of pride we see returning to our organization as our associates embrace and drive forward with our vision and strategies. Our people are the heart and soul of our business and they are proud of our return to core automotive.

Our operating profit was $18.7 million in the second quarter of 2009, as compared to $11.9 million in the second quarter of 2008. 2008's operating income also included $4.1 million in gains from asset sales.

So there is an $11.0 million improvement in operating profit before gains, which I characterize as service and commercial revenue growth, offset by a sales decline in retail accessories and complimentary product, as well as modest improvement in overall margin rate and significantly lower expenses. Basically, the trends that we discussed on our last call in June continued for the balance of the quarter.

For the first half, operating profit was $40.0 million in 2009 as compared to $26.0 million in 2008. 2008's operating profit also included $9.6 million in gains from asset sales.

So that leads to a $23.4 million year-to-date improvement in operating income before gains, which is also characterized by service and commercial revenue growth, offset by a sales decline in retail accessories and complementary product, as well as modest improvement in overall margin rate and significantly lower expenses as planned.

To remind everyone, there are three key strategies that underpin our vision. The first and primary strategy is to lead with our service business and to grow by adding service and tire centers. The second is to create a differentiated retail experience by creating the automotive superstore. And the third is to leverage our automotive superstores and our service and tire centers to provide the most complete offering for our commercial customers.

And we are executing this plan to transform Pep Boys into the automotive solutions provider of choice for the value-oriented customer. We want to be the one place that has, and does, everything automotive.

We have been very pleased with all aspects of our service business, except for tire sales. Service center customer account was up 3.2% during the second quarter, while service center comparable store revenue was up 2.3%. Maintenance and repair services were up nicely above customer count and revenues across all categories. We had double-digit increases in maintenance services, alignments, and ride control and high single-digit increases in brakes, starting and charging, and engine performance. This trend is due to our marketing programs, store execution, and favorable industry trends.

Tire sales, however, were softer than we planned. The macro driver for tire sales is miles driven. A reduction in miles driven leads to a reduction in tire wear. Thirteen consecutive months of declines in miles driven ended in March with a slight increase in April, a slight decrease in May, and a 2% increase in June. As miles driven continues to stabilize we expect tire sales to recover.

We generally run with the industry with not promoting our sales with TV and radio, and we run ahead of the industry during promotional periods. And we have seen some improvement in tire sales in this quarter.

As we look to become the low-cost alternative to dealerships for complete automotive service, we continue to invest in high-quality technicians and master technicians, technical training, late model parts coverage, and the latest equipment. We recently installed advanced engine performance and diagnostic equipment in 380 of our stores and will complete the roll out chain-wide during the fourth quarter of this year.

It's been very exciting to our team to be able to say yes to more customers as a result of our improved capabilities and that will only get better as the percentage of vehicles on the road with the advanced technologies increases.

We are also currently in the process of converting our installers to express service technicians focused delivering fast, expert oil changes and fast, expert tire services. 29 minutes or less for oil changes and 59 minutes or less for most tire services.

These changes include process changes, new equipment for some stores, training, and a shift to performance-based pay. The chain is rolling out market-by-market. Improving the speed with which we perform oil changes had increased our maintenance service customer count by double digits in the markets where we have already rolled it out. As we continue to enhance our service capabilities and continue to source our parts directly from the manufacturers, we can confidently deliver, as our ads say, Pep Boys does everything for less.

So far this year we have opened six new service and tire centers, three in Southern California and three in the Northeast. It's still very early but two are currently running ahead of projections, three are running in line with projections, and one is running behind projections. So in balance, they are performing as planned.

We are still on track to open approximately 15 new service and tire centers this year and we are building the pipeline to do 20 to 40 next year, with our focus on locations in Southern California, the Northeast corridor, and Chicago that can be serviced by existing supercenters.

Annual revenues for these service and tire centers again are estimated to be from $1.0 million to $1.5 million per location and we are expecting EBITDA of approximately $150,000 to $250,000 per year per location. The cost per leased location, including working capital, is about $450,000 to $550,000.

We are also looking at small chains that would give us improved density in existing markets.

Our strategy for our retail business is to win in the trade areas around our stores, primarily because of our assortment, having the highest level of replacement parts coverage, and the broadest range of maintenance, performance, and niche products, plus installation.

Our retail business was down 6% during the second quarter. The core automotive portion of the business was about flat for the third quarter in a row due to improved parts coverage and favorable industry trends. The accessories and complimentary portion of the business was down 15.6% due to the difficult sales environment for discretionary products.

Complimentary product sales were also hurt by our inability to sell certain power support vehicles due to a dispute with the EPA that we hope to settle this quarter.

We are still comfortable with our shift in advertising mix from primarily retail center print ads to service center TV and radio promotions and we did recently add DIY oil changes to the TV and radio promotions with good results.

Business has been good for our commercial business, up 6% in total during the second quarter and up 4% on a comparable store basis. And the mix of business has been good as well, leading to improved margins. Most of the revenue increase came from increased customer count and we have been improving the quality of our commercial teams. That plus improved parts coverage and favorable industry trends are what have been driving our commercial business.

We added commercial operations to eight more of our supercenters during the second quarter, bringing us to 446 out of 561 of our retail stores, and we plan to open 10 more in each of the next six quarters.

During this third quarter we will also roll out the performance-based pay program for our commercial sales managers that we have been testing.

Our rewards program is off to an excellent start and continues to build momentum, as we now have $2.3 million customers signed up. Our rewards program is designed not only to drive repeat business with retail and service customers, but also to drive cross-shopping of retail customers to relevant service offers and service customers to relevant retail offers. And all customers enjoy benefits like discounted towing service, free flat repair, free tire rotation, free check-engine light diagnostic, and free brake inspection, all of which are driving more customer count. And most importantly, we are now gathering data with which to better understand and to serve our retail customers.

We have increased the number of SKUs available for next-day delivery from our NDDC from 25,000 to 45,000 and we now have 12 superhubs to increase the number of SKUs available same day in the market. 10 more superhubs will be added to existing supercenters over the next nine months as it is our intention to have the highest level of replacement parts coverage.

Our speed shop in Los Angeles is meeting our expectations and our second one in Lancaster, PA, will soft-open in October with a big grand opening in the spring. The speed shop with its own space and dedicated experts is a destination for car and truck enthusiasts. And again, our objective is to create a differentiated retail experience that becomes a destination, not just for the surrounding neighborhood but for the surrounding community, as we do intend to have the broadest range of maintenance, performance, and niche products.

We have also added dedicated sales and installation technicians for 12-volt products like electronics, remote starters, and towing harnesses in 20 stores, as we intend to be the leading installer of automotive after-market products.

Our intent is to transform our supercenters into automotive superstores so that whenever customers think about automotive products and services of any kind, they think of Pep Boys. We do everything and we have everything for less. Meanwhile, our supercenters will be feeding parts to our service and tire centers and help our commercial business to provide the most complete offering for our commercial customers.

On a macro level, lower gas prices, aging vehicles, closing dealerships, and service shops continue to be favorable to us. The reduction in miles driven has been unfavorable to us, especially with respect to tires, but the decline in miles driven has moderated and our May after-market industry tire sales are expected to stabilize later this year.

Tight consumer spending continues to be unfavorable for sales of the discretionary products on our sales floor, so our focus in on driving sales in service, commercial, and the DIY core.

The impact of Cash for Clunkers is minor for us. New car sales can eat into repairs of old cars but we haven't seen that yet. But sales of cars, whether new or used, drives our accessories sales and sales trends for this category have improved a bit so far in the third quarter.

As you can tell from my comments, we are pleased with our progress but we still have work to do. 2008 was a year of disruptive but necessary change, 2009 is a year of building for the future, and we expect 2010 to be a year of optimizing our performance. And as we do that, we are moving towards our future of consolidating the automotive service industry and becoming the automotive solutions provider of choice for value-oriented customers.

I will now turn the call over to Ray to review our financials.

Ray Arthur

This morning I will begin with a general overview of our results and then provide detail on a GAAP as well as a line-of-business basis. Please see the last page of our press release for line-of-business format statements. I will also review relevant balance sheet and cash flow data.

On an overview perspective service labor revenue and our commercial business sales increased 5.2% and 6.0% respectively and our core automotive sales were relatively flat. We continue to experience soft demand in discretionary categories with sales down 16% as a result of our second quarter comp store sales decline by 2.3% overall compared with the second quarter of the prior year.

The difficult macroeconomic environment continues to negatively impact sales in our discretionary product categories with the decline accelerating in the second quarter when compared to the first quarter of fiscal 2009 as consumers continue to defer spending, while sales of non-discretionary service and hard parts have improved from recent trends.

We believe that the steep decline in new car sales over the last year and a half has, and will continue to generate additional service revenues and hard part sales as consumers will ultimately spend more maintaining and repairing their aging vehicles. In part offsetting this trend is miles driven, which has declined for the 13th straight month in March. And as you know, when miles driven are down, so is wear-and-tear on each vehicles tires and parts.

However, the decline in miles driven has moderated and we actually saw increases in April and June, as Mike indicated, as compared to the previous year, which is very encouraging. However, it should be noted that miles driven are still significantly below 2007 levels.

On a GAAP basis, net earnings from continuing operations for the second quarter of 2009 improved to $7.9 million, or $0.15 per share, versus earnings of $5.8 million, or $0.11 per share, for the same period last year. The prior year included a $4.1 million pre-tax gain from the disposition of assets, primarily due to the sale-leaseback transactions completed in the second quarter of 2008 and a one-time $2.2 million tax benefit resulting from the recording of a deferred tax asset due to a state tax law change.

Consolidated revenue for the second quarter of 2009 was $488.9 million, an $11.1 million reduction from the revenue of $500.0 million reported last year. The 2.2% reduction resulted from the decline in comparable revenue of 2.3%. Notable is 22% of the comparable revenue decline is due to $2.4 million less in sales of those non-core merchandise categories that we substantially exit as part of our strategic transformation and a $15.3 million, or 16% decline, in other discretionary product sales.

Core parts sales were flat to the prior year and service revenue improved by $4.9 million, or 5.3% while commercial sales increased $3.1 million, or 6% over the prior year. This is basically the last quarter where sales of product that we have exited will impact our comps.

Total gross profit dollars for the second quarter of 2009 declined to $128.2 million from $130.4 million recorded in the prior year. Gross profit, which is fully loaded with occupancy costs, warehousing, and service payroll, remained relatively flat as a percentage of sales, at 26.2% as compared to the prior year.

The decline in gross profit margin for merchandise sales of 60 basis points, to 29.7% in the second quarter of 2009, from 30.3% in the prior year, was primarily due to a decline in product margins as a result of increased product promotions and an overall change in product mix, which was partially offset by lower warehousing and occupancy costs as a percentage of sales.

Service gross profit margin improved to 12.3% in the second quarter of 2009, from 7.4% in the prior year, due to increased sales leading to spreading absorption of fixed expenses such as occupancy costs, including rent, utilities, taxes, and the fixed component of labor costs.

Selling, general, and administrative expenses declined by $13.1 million, or 10.7%, to $109.5 million for the second quarter of 2009 compared with expenses of $122.6 million for the prior year. As a percentage of sales, the expense rate decline to 22.4% from 24.5% for the same period last year, primarily due to lower legal and professional service fees, lower payroll and related costs, lower store selling expenses such as supplies and fuel costs for our commercial fleet, and lower media expenses.

Net gains from disposition of assets decreased by $4.1 million in the second quarter of 2009 as compared to the prior year. The prior-year first quarter included the recognition of gains resulting from our sale-leaseback transactions and there were no material transactions in the current year.

Interest expense for the second quarter of 2009 remained relatively flat to the prior year at $6.5 million. The prior year did include a $600,000 gain from the retirement of debt.

For the first half of 2009 net earnings from continuing operations improved to $18.9 million, or $0.36 per share, as compared to $11.0 million, or $0.21 per share, in the prior year.

The current year included a $6.2 million pre-tax gain from the retirement of debt, whereas the prior year included a $3.5 million pre-tax gain from retirement of debt, a $9.6 million pre-tax gain on sale from asset dispositions, primarily due to sale-leaseback transactions, and a one-time $2.2 million tax benefit resulting from reporting of a deferred tax asset.

Now I will cover the service center, retail, and commercial business on a line-of-business basis for the second quarter of 2009.

Our service center business, which includes tire and merchandise sales, as well as service labor generated through our service phase, reported revenue of $229.5 million in the second quarter of 2009 versus $224.2 million last year.

Comparable revenue increased by 2.3% in the second quarter of 2009 compared to a decrease of 1.9% in the same period last year. As mentioned earlier, despite the tough macroeconomic conditions, which continue to impact discretionary sales, non-discretionary spending on service and hard parts improved in 2009 from prior-year trends. We believe the continued decline in new car sales has contributed to an increase in the age of the U.S. vehicle fleet, which is requiring an increasing consumer spending on maintenance repairs.

Another positive trend we see is the increase in miles driven in the past few months as compared to the declining trend of the prior 13 months as well as a decline in gasoline prices from peak levels last year.

Service center gross profit increased to $57.4 million for the second quarter of 2009 compared to $52.1 million last year. Gross profit as a percentage of revenue improved to 25% in the second quarter of 2009 from 23.2% in the prior year. The improvement over the prior year was due to increased service labor revenues and spreading absorption of fixed costs over these additional revenues.

The retail and commercial business generated sales of $259.4 million for the second quarter of 2009 compared to $275.9 million for the same period last year. The 2009 second quarter results reflect a $2.4 million reduction of non-core product sales that we've deemphasized. Retail sales were also negatively impacted by the difficult sales environment for discretionary products, which declined by $15.3 million, or 16%, as compared to the prior year, in part due to our inability to sell certain power sports equipment due to an EPA dispute that Mike mentioned earlier and we hope to resolve this quarter.

Core part sales were relatively flat to the prior year while commercial sales increased by $3.1 million, or 6%, over the prior year.

From a gross profit perspective, the retail and commercial business reported gross profits of $70.7 million for the second quarter of 2009 versus $78.4 million for the same period last year. Gross profit as a percentage of sales decreased by 110 basis points for the second quarter of 2009 as compared to the prior year, primarily due to the decline in product gross margins due to product promotions and overall change in mix to more commercial sales and due to the deleveraging impact of reduced sales on fixed costs. Fixed costs are comprised primarily of occupancy costs, including rent and utilities.

I will now turn over to the balance sheet. Cash balances increased by $500,000 to $21.9 million from $21.3 million at the end of the prior year. Accounts receivable declined by $7.0 million to $21.8 million, primarily due to improved collection of vendor support funds.

Inventory at the end of the second quarter was $548.8 million, a decline of $16.1 million from the $564.9 million at the end of last year. The decrease in the current year resulted from more disciplined inventory management, including reduced seasonal inventory purchases, reduced lead times, and safety stocks.

Property and equipment net declined by $21.3 million to $719.0 million, primarily due to depreciation outpacing capital improvements and asset acquisitions. At the end of the quarter we owned 242 properties, including our headquarters, four of our distribution centers, and many of our stores. As we previously indicated, we believe we have substantial unrecognized gains built into these properties, even considering a decline in the overall real estate markets.

Accounts payable, including the trade payable program, decreased to $225.6 million from $244.3 million at the end of the previous fiscal year. The AP to inventory ratio declined to 41.1% from 43.2%, primarily due to the reduction in replenishment ordering.

Total debt, net of cash, decreased by $45.0 million from year end 2008, primarily due to the repurchase of $17.0 million of the company's outstanding senior subordinated notes and a repayment of $22.3 million of loans outstanding under our revolving credit facility. The bonds were repurchased at a pre-tax gain of approximately $6.2 million and were reflected in interest expense in the first quarter of 2009.

Lastly, let me turn to cash flow. We generated free cash flow, defined as cash flow from operations less investing activities, of $66.5 million in the first half of 2009 and after paying a dividend of $3.2 million, repaying amounts outstanding under our revolving credit facility and trade payable program, combined with the bond repurchase noted earlier, the company generated $500,000 in cash in the first half of the current year.

Respectively, we have no significant debt maturities until 2013. We expect capital expenditures to be approximately $50.0 million for the full year here, which includes the additional of 15 service and tire centers. We do not see any other significant cash needs other than normal operating cash flow in the near term.

With that, I will now turn the call over to begin the question and answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeff Blaeser - Morgan Joseph & Co.

Jeff Blaeser - Morgan Joseph & Co.

On the operating cost side, how sustainable do you think these current levels are and what impact do you see from this expansion as well as were any of the cuts that you previously announced workforce reduction, marketing, short term in nature that could potentially escalate down the line?

Mike Odell

The biggest parts of the cuts would be the marketing and the payroll. And I would really term it, actually, instead of cuts I would call it a repositioning. We have shifted our from being very extensive on the pre-print to drive the accessory business and the discretionary spending and shifted that basically into the service business and recently have added on the TV and radio to support the retail, as well.

So we're comfortable with the shift that we've made in the marketing. I wouldn't say that we cut the print and it's cause of decrease in sales as much as we've shifted the emphasis in the direction of the company, and recognizing that what was being driven by the pre-print, you know, it's important but it's not the key to our future. The key to our future is the service and the hard part side of the business.

And the payroll side, a lot of that, the products that we were selling, there is incremental costs to that as well. I mean, it really was shifting our model and that's why we are getting out of this, de-emphasizing this product because yes there were sales and yes there were margins, but it had a lot of other expenses associated with it.

Ray Arthur

And you will probably see that as kind of a run rate. It's not as if those savings are going to disappear in Q3 and Q4. And there are—Mike certainly indicated the biggest are in marketing and payroll, but there are significant cuts in other areas that are not quite as large but that will be sustained. So the savings that you see in the quarter, there will be probably some more savings in Q3 and Q4.

Mike Odell

And in terms of the service folks, most of the costs associated with those, and by the way, we're calling them service and tire centers in our comments because that would be the customer views, so I have shifted to calling them service and tire centers. And most of the costs for those are really inside the stores, and therefore part of the economics I was sharing. We have a little bit of overhead to add relative to kind of real estate and development but those are fairly modest expenses that are required to support them at this point in time.

Jeff Blaeser - Morgan Joseph & Co.

And add on, when you mention the marketing, do you think the shift to the service side has had any impact on the retail sales? You have certainly identified the discretionary as being the major contributor to the negative comp.

And also, on the tire side, I believe that traditionally does have a negative impact, you know, add on sales are particularly attractive when tires sales are higher. Is that still the fact, and could that be boosted, as you mentioned tire sales could improve in the back half?

Mike Odell

Yes, when I look at the second quarter, really the only thing that kind of bugs me was the performance of our tire business. It was weaker than what we had planned and if the tire business had been stronger it would have been a blow-out quarter. Like I said, tire sales have already improved here in the third quarter so I'm feeling better.

In terms of the other question, my guess is regarding the effect on retail of the marketing spend. Again, you've got so many marketing dollars and you've just got to decide where you're going to play. And we had been spending those marketing dollars on kind of the extra side and we shifted those marketing dollars to be focused on the core.

And I'm really pleased with the customer count that we're seeing in service. And when we started to add the DIY oil change to the TV and radio, you know, we didn't want to do that initially because we didn't want to make too confusing a message for the customer, but now they've seen the tire events enough and we felt like we could add on to the commercial within the same time frame without confusing the customer, and we saw a lift in the retail, in the core side of retail, as well as the accessory side of retail, when we started to advertise that as well.

Ray Arthur

And if you break down core, I mean parts are up. So it's really that discretionary type of spending where consumers just aren't letting their dollars go at this point.

Mike Odell

It's a judgment call but we just decided we're not going to spend the money.

Operator

Your next question comes from Bret Jordan - Avondale Partners.

Bret Jordan - Avondale Partners

A couple of quick follow-up on that discretionary category. Can you give us a feeling, just from a capital commitment, of dollars in inventory tied to what you consider the non-core line?

And then a little bit more quantification around the impact of the power sports business, on that $15.3 million decline year-over-year.

Ray Arthur

The power sports business is hard to delineate how much of it is deferred consumer spending. There is about $3.0 million or $5.0 million in sales that we could not make because—

Mike Odell

That was the overall reduction in the power sports category was about $5.0 million.

Ray Arthur

And of that, there are SKUs that we can't sell because of the EPA dispute. It's somewhere between $3.0 million to $4.0 million.

Mike Odell

Ask the inventory question again.

Bret Jordan - Avondale Partners

If you were to look at your $550.0-odd million in inventory, how much of you consider invested in the discretionary category, as you evolve more toward hard parts and less toward air compressors, where is the capital commitment to non-discretionary?

Mike Odell

Accessories and the complimentary products is probably about 40% of our inventory. That is not an exact number.

Bret Jordan - Avondale Partners

Have you seen any benefit on the near-term dealership closures? I mean, we're clearly evolving through that process, but do you see much pick up there?

Mike Odell

It's one of those things that it's so fragmented it's hard to quantify but I would have to say that it's a benefit out there.

Bret Jordan - Avondale Partners

As you talk about Q3, seeing some tire improvement, are you seeing any improvement on the discretionary purchase? Is there any bias towards getting back into performance or appearance products later in the summer?

Mike Odell

More on the appearance, on like seat covers and steering wheel covers. Basically we've seen about a 5 point improvement in our sales trend in service and in the DIY businesses. And then commercial has continued on the pace that it's been sustaining for several quarters now.

Operator

Your next question comes from Sean Haydon – Yield Capital.

Sean Haydon – Yield Capital

Could you quantify the substantial benefits unrealized from the property zoned?

Ray Arthur

The benefits in terms of unrecognized gains?

Sean Haydon – Yield Capital

Yes.

Ray Arthur

What I can tell you is what we've said before. Previously we had indicated we thought we had about $1.3 billion in unrecognized gain related to those properties. We subsequently did $300.0 million worth of sales-leasebacks. So that would imply, if you were to do the math, that there's somewhere around $1.0 billion. Now that's pre-real estate decline. So you would have to factor in some amount of real estate decline into that to come up with a revised value. We have not done that at this point. But we still believe, even with the reductions in the real estate markets, that we have still a substantial amount of unrecognized gain in those properties.

It's really a source of liquidity for us should we need to pursue it.

Operator

Your next question comes from Anthony Cristello - BB&T Capital Markets.

Anthony Cristello - BB&T Capital Markets

When you look at these sort of spokes stores that you're opening up, can you categorize the maturity curve that you're expecting to see at those stores. And if I'm looking at those stores, can you give a little bit of a prototype, are they going to be traditional mix in the system, what we see at your service side, or are we going to see more of a tire mix, or more of a general maintenance mix?

Mike Odell

It's hard to predict the curve. We're expecting that it will take a year. I said that two are ahead of projections because they are already getting close to the run rate. The three that are one track are, like I said, we think that by the end of the year or sometime within the year they'll be at their run rate. And then we've got the one that's just out of the gate slow.

In terms of the mix, it looks like it's very similar to our existing service centers. We thought that the tires might be a little bit lighter but they haven't been. They've been about the normal mix.

Ray Arthur

But it still is early and we've indicated that we're only opening 15 this year so that we really make sure that all our economics pan out the way we think they're going to. So right now it's very early in that most of the service spokes that we've now got, we opened during this quarter.

Mike Odell

And there is a grand opening but it's not a significant budget that goes toward the grand opening, because we want to see how they do when they first open. And so for instance, the one that we say is behind, that one will get a little bit heavier in terms of the marketing investment to get it on track whereas the ones that are already hitting the run rate, we don't need to spend a whole lot on getting them going.

Anthony Cristello - BB&T Capital Markets

Have you seen any competitive pricing or reaction as you have been opening those stores?

Mike Odell

No.

Anthony Cristello - BB&T Capital Markets

As we enter, now, sort of the seasonally stronger period for tire, October, November.

Ray Arthur

Seasonally [inaudible]?

Anthony Cristello - BB&T Capital Markets

Well, from a consumer standpoint, going into the winter months, typically are stronger purchase periods, correct?

Mike Odell

Actually, summer drive time would be the strongest.

Anthony Cristello - BB&T Capital Markets

Really? You have more traction than in October, November period?

Mike Odell

Yes, people are driving more in the summer, going on trips and stuff. It doesn’t fall off that much but it's not going to pick up in the third or fourth quarter.

Anthony Cristello - BB&T Capital Markets

So there's nothing from a promotional standpoint that you're looking at as the winter months approach?

Mike Odell

Daylight savings time, CMB scene, we're still going to continue with our tire promotions.

Ray Arthur

Every day is a tire day at Pep Boys.

Anthony Cristello - BB&T Capital Markets

When you look at the trends in the business, miles driven you talked a little about seeing some improvement. What really—

Mike Odell

I would call miles driven a stabilization versus an improvement. Basically we had 13 months where it just kept dropping, dropping, and dropping. And now I think we've kind of found the low. I don't know that miles driven is to recover to where it was, but it has at least stabilized.

Ray Arthur

And like I said in my remarks, we're well below 2007 levels of miles driven right now.

Anthony Cristello - BB&T Capital Markets

Is your business positioned that you need to get back to 2007 levels to see the benefit?

Mike Odell

No.

Ray Arthur

But we'll see benefits. Like I said, the implication from my standpoint is that at some point miles driven will probably slowly recover towards those old levels and so it will probably be a slow improving trend over the next year, maybe longer.

Anthony Cristello - BB&T Capital Markets

In your prepared remarks you noted that 2009 is building for the future and 2010 is going to be the year of optimizing to performance. Is the optimization predicated on further macro or further trend improvement?

Mike Odell

No, when I talk about operational turnaround, the things that I consider still a work in process more or less, we are not consistent enough store-by-store in terms of execution, we haven't developed a culture of trust to the level that we aspire for. We are just putting out the performance-based pay. We did it earlier for the service advisors but it's just starting this quarter really and next quarter for the express service technicians. It's just happening this quarter for the commercial teams. Our marketing is going to continue to evolve to tell more story around trust in automotive superstore. The speed shop, we've got one done, the second one going, plans for more, more super hubs. The Web isn't up and running the way we want it. I don't want to overwhelm you and go through all the details but there's still things that we're working on that to me are foundational to our business.

And that's why I've continued to call it a three-year turnaround, because we're on the path, and again, these are positive changes so that when they hit the stores they are well received and they have a favorable impact. And we've been pacing it so that we can make sure that we execute well and that the team is ready to absorb the changes that will continue to come.

But again, I view them as positive changes this year and then fine-tuning and optimizing our performance next year. That's why I characterized it as a three-year turnaround.

Anthony Cristello - BB&T Capital Markets

Could you give us the number of what tire sales were actually down in the quarter and what are they running now into this quarter.

Ray Arthur

We don't provide that level of detail.

Operator

Your next question comes from Brian Lester – The Abernathy Group.

Brian Lester – The Abernathy Group

Can you help us understand a little more thoroughly the game plan with respect to real estate owned since it's such a significant portion of your business. It represents a reasonable majority of the assets the company owns, and how it modifies that. There was progress being made, it seemed, in 2007 and 2008 and then that's abruptly stopped, but understanding that the market is the market, where are your plans going in the future to amortize that?

Ray Arthur

I think there was a window of opportunity this year, previously, that would provide us with cap rates that were attractive enough to make amortization[?] of those properties worthwhile. Our current debt is investment grade cheap debt. It's 7.5%, it's low covenant. So we don't have a great need for capital right now. We ended the quarter with basically zero drawn on our revolver. That being the case, the only real expenditures we see going forward, beyond our normal capex, which is being funded through operations, is additional service spokes, and to our potential acquisition should we find one.

Depending on those needs, we may need to assess capital. We certainly have a lot available under our revolver which we can use. But should we need more capital above and beyond that, we can monetize our real estate at this point. But cap rates are now in the 10% range and for us to give up 7.5% to go and incur 10% debt, without a significant use in the near term, just doesn't make a lot of sense for us.

So what we are doing is opportunistically, if we see small deals with cap rates are in the 7.5% range, we'll explore those. And there are those that are out there, but not on a large scale. So to the extent we see those, we tend to take advantage of them and then use those funds to finance our expansion plans and/or to opportunistically take out debt when it's trading at levels that make it very attractive to us. As you know, during the quarter we took out $17.0 million of debt for about $11.0 million. It's hard not to think about doing that when you've got sources of liquidity.

But right now I think we view it, all that owned property is dry powder. And it's one of the great things about Pep Boys is we have an incredibly strong balance sheet and we can access that property for liquidity, should it become necessary. But we just completed the renewal of over $300.0 million revolver at terms that were very favorable, to at least what everybody else was getting in the market, with a five-year term. So it's one way of saying we just don't at this point believe we need to go and monetize those other assets.

And the last thing I want to add to there, too, is the real estate market right now isn't the best. So we have the luxury of waiting until things get better as well.

Operator

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

Stephen Chick – FBR Capital Markets

Last quarter you had talked about your DIY performance relative to the industry and with the core automotive portion of retail sales staying flat, I'm wondering if you look at NPD-like data, and it actually seems like it might be decent relative to what we've seen out of some others, so can you speak to on the DIY side of the business where your trends are relative to the market for the quarter.

Scott A. Webb

As far as our NPD share goes along application parts, we actually are growing share in those application categories. And in our accessory and non-application categories, there are some pushes and pulls. As you probably might expect from accessory categories, we wildly overshare the market because of our broad assortment. So as other competitors pick up new items that we have had for a year or two, it sort of ebbs and flows a bit.

But the story line there is we are growing share in our application parts business.

Stephen Chick – FBR Capital Markets

And did I hear correctly that heading here into the third quarter that the DIY business got 500 basis points better?

Mike Odell

Again, this is not a forecast for the quarter, this is just how we're doing quarter to date, trends have improved by about 5 points. And just to clarify my other comments, tires were down last quarter and they are up so far this quarter. So that's got a lot to do with why we feel better about the third quarter.

Stephen Chick – FBR Capital Markets

For the quarter, DIY versus commercial split, commercial I think you said was 4% comp.

Ray Arthur

Yes, 4% comp, 6% total.

Stephen Chick – FBR Capital Markets

And the DIY portion?

Mike Odell

We quoted that accessories and complimentary was down 15.6 and that DIY core was about flat, north of flat. And you blend those two together and it gets you to a negative 8.8.

Operator

Your next question comes from Greg Malik – Morgan Stanley.

Greg Malik – Morgan Stanley

Could you give us a sense if deflation or disinflation had an impact on the quarter in terms of the comps?

Mike Odell

There is pricing pressure. I think that's like everywhere in the world these days. Obviously we try to hold price as best we can, but I would say that there was definitely pricing pressure in the quarter that we just left.

Greg Malik – Morgan Stanley

Do you care to quantify how that may have been incremental? I mean, was that worse than in the first quarter or was it similar to the first quarter?

Mike Odell

I would say it was a little bit tighter in the second quarter than the first quarter. I think the overall industry has done pretty well in terms of trying to maintain pricing and not get into wars with one another. But I think particularly with tires, because the industry has been suffering, that pricing on tires has been—you've got to stay on top of it. And it's a big tick.

Greg Malik – Morgan Stanley

So just to make that clear, tighter means that it was a little bit?

Mike Odell

More competitive pressure.

Greg Malik – Morgan Stanley

And there's been a lot of talk about potential for tariffs, imported tires from China. If that were to occur under the current proposals, what would that mean for you?

Mike Odell

It's hard to predict exactly. I think the whole notion is a little crazy because you're just going to shift production to other countries. It doesn't necessarily mean it's going to shift into the U.S. there's a limit to how much capacity the U.S. has to begin with.

Scott A. Webb

I would say that I feel good about our position in terms of our sourcing. We have a couple of great suppliers that have North America production. So we feel like we're good.

Mike Odell

It may actually be hurting some of our competitors more than it will hurt us. I don't think it helps anybody but it will hurt others, I think more.

Greg Malik – Morgan Stanley

So it's not good, but competitively, you feel well positioned.

Mike Odell

Correct.

Operator

This concludes our Q&A session.

Mike Odell

I think those last couple, I was glad to be able to clarify some of the sales comments so hopefully everybody has good feel for the color. And again, I just want to close with thanking our associates for the progress that we've made, restating that I'm pleased with the progress that we've made but we are incomplete and still feel very good about our future. And feel good about the second quarter that we just closed. To break it down, it was quite a big improvement in profitability.

Operator

This concludes today’s conference call.

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