領先汽車配件 (AAP) 2002 Q2 法說會逐字稿

Welcome to the Advance Auto Parts second quarter conference call. Just as a reminder, participants are in a listen only mode. Before we begin, Eric Margolin, the company senior vice-president and general counsel, will make a brief statement concerning forward looking statements that will be made on this call.

You may go ahead, sir.

Thank you. Good morning.

Certain statements that will be made during this conference call will contain forward looking statements that incorporate assumptions based on information currently available to the company. These statements discuss, among other things, expected growth, store development and expansion strategy, business strategies, future revenues and future performance. These forward looking statements are subject to risks, uncertainties, and assumptions including but not limited to competitive pressures, demand for the company's products, the market for auto parts, the economy in general, inflation, consumer debt levels, the weather and other risk factors listed from time to time in the company's filings with the Securities and Exchange Commission. Due to changing conditions, should any one or more of these risk factors materialize or any of the underlying assumptions prove incorrect, the actual results may materially differ from anticipated results described in these forward looking statements.

It gives me great pleasure to now turn the call over to Larry Castellani, our chief executive officer. Larry?

Thanks, Eric.

Good morning, and welcome to our second quarter 2002 conference call. With me in morning is Jim Waite [phonetic], our chief financial officer, David Reid, our executive vice president, chief operating officer, and Jeff Gray, our senior vice-president and controller.

Once again, our team members produced strong results during the second quarter. Earnings per share before integration expenses an extraordinary item grew 57 percent to 77 cents on 49 cents last year, and we achieved same store sales of 5 percent on top of 6.8 last year. Along with the solid same store sales and earnings per share growth, other achievements included continuing to successfully integrate Discount Auto Parts, the acquisition of 55 Track Auto Parts stores which closed on July 26, 2002. We achieved a 220 basis points increase on operating margins integration expenses, and we also prepaid approximately 112 million in debt during the quarter and 189 million since the beginning of the year.

During the quarter we successfully achieved our three key goals, which are to expand our operating margins, use our free cash flow to reduce our debt, and to successfully integrate Discount Auto Parts. We will continue to focus on these goals as we go forward. But before I elaborate on these goals, as well as other initiatives I'd like to hand the call over to Jim Waite who will review our second quarter and year to date results.

Jim?

Thank you, Larry.

Good morning. We are excited about the strong performance that was produced by our team members in the second quarter. During the second quarter total sales rose 30.5 percent to 792.7 million compared to last year's 607.5 million. We experienced strong growth in our retail segment where sales grew 32.1 percent to 774.9 million compared to last year's 586.8 million. As you recall, the retail segment includes both our DIY and our commercial or DIFM sales. Sales from our Western Auto wholesale dealer network continue their expected contraction with a year over year decline of 13.9 percent to 17.8 million. Same store sales grew in the second quarter on top of 6.8 percent in the same quarter last year and increase in customer count generated approximately two-thirds in same store sales with the remainder coming from increase in average ticket.

We are excited that more customers are choosing Advance for their automotive needs and increasing market share in operating where we're operating store. As you may recall, same store sales in the first four weeks of the quarter were flat due to cool wet weather as well as tough comparisons. As we expected the remainder of the quarter saw strong comps approximately 7 percent generating an overall increase it of 5 percent for the quarter. Year to date same store sales growth of 6.5 percent compared to 6.2 percent for the first half of last year. We remain comfortable with mid single digits same store sales growth for the remainder of 2002 and the start of the third quarter confirms that expectation is achievable. For the quarter DIY same store sales rose over 5 percent and commercial comps are approximately 4 percent.

For the same quarter last year DIY comps were approximately 6 percent and commercial comps are approximately 10 percent. Year to date DIY comps were approximately 7 percent compared to about four and a half percent last year and commercial comps were about four and a half percent year to date compared to almost 15 percent last year. Last year's stronger commercial comps were primarily the result of adding additional programs as well as increasing the number of delivery trucks in several stores during that period. In 2002 we've added 41 net new commercial programs as planned, primarily in the Discount Auto Parts stores. Currently we have a total of 1411 programs with 1240 Advance stores, including the converted discount stores and 171 at the Discount Auto Parts stores. Our focus in commercial continues to remain primarily on increasing sales and profits in existing programs. the sales at our Discount Auto Parts stores are also solid during the quarter producing same store sales gain of 3.7 percent. This compares to 1.8 percent in the same quarter of 2001. These sales gains in the second quarter were achieved during the height of the merchandise conversion process which will be completed in September. Just as a reminder, the Discount Auto Parts same store sales gains are not included in our reported comps, since they've been owned for less than a year. These stores will be added to the comparable store sales base after 13 completed accounting periods or during the 13th period of this current fiscal year. We'll continue to report these results separately until that time so you'll be able to track their progress as we go through the year. the stores in overlapping markets will be closed stores due to discount acquisition continues to experience same store sales gains of over 20 percent. However, on a total comping basis [inaudible] store sales by less than 1 percent. During the second quarter we opened 11 new stores and closed 23 stores including nine related to the Discount Auto Parts acquisition resulting in an ending store count of 2,367. Year to date we've opened 28 new stores and closed 145 stores including 128 related to the discount acquisition. There will only be a few more closures related to the discount acquisitions as we go forward. We plan to open approximately 110 stores this year in existing markets which includes the recently announced Track Auto Parts [inaudible] acquisition. We also have a strong new store development pipeline as we move into 2003. We still an at this time anticipate opening 100 to 125 stores in 2003. the Track Auto Parts acquisition is an exciting opportunity for us to quickly penetrate the metro Washington, D.C. market. On July 22nd, we with given bankruptcy court approval to assume the leases on 255 stores, 48 of these stores are in the Washington DMA, 5 are in Baltimore, and two are in Richmond. The acquisition closed on July 26th. The total purchase consideration was the assumption of a lease, $4 million for fixtures, and up to 12 million for inventory. As we have stated in many of our other presentations, we believe we've demonstrated our strong acquisition and integration experience and this experience was the key to our receiving bankruptcy court approval. The Track stores will be systematically turned over to us in groups of approximately 5 per week. Once we've taken possession of each group of stores we'll close them for about two weeks to totally convert each store to Advance auto parts including merchandise, systems, remodel and signage. by the end of this year, all of these stores will have been converted. the Washington metro market is a very challenging market to gain a foot^hold given the limited amount in high price of real estate locations available. Because of this issue Washington is right now an under served market. Our public competitors have only about 33 stores in the metro market today. Not only is the market underserved, but these 55 Track stores have had a history of strong sales. In fact, they achieved in aggregate higher average sales per store in the year 2000 than Advance's company averaged. These results achieved before they declared bankruptcy in July of last year. Now wrapping up stores our new stores continue to open at a higher sales level than in the past. Our new hurdle rates and discipline store development program are driving improvements in invested capital. Our gross margin rose 170 basis points to 44 percent for the second quarter compared to last year's 42.3 percent. Retail gross margin which excludes our wholesale dealer network was 44.6 percent compared to 43.2 percent last year. Gross margin improved primarily due to purchasing synergies and efficiencies realized as part of the discount acquisition and positive shift in product mix. Year could date our gross margins have risen 120 basis points to 43.7 percent from 42.5 percent last year. We anticipate gross margins for the remainder of 2002 to be in line with or slightly higher than the second quarter.

SG and A before integration expenses declined 60 basis points to 35.8 percent. We achieved leverage primarily in our corporate overhead and occupancy expenses for the quarter. Year to date SG and A before integration expenses declined 110 basis points to 36.8 percent from 37.9 percent last year. Total integration expense for the discount stores for 2002 was originally budgeted for 40 million. During the second quarter we converted 54 stores and the out of state markets and continue to merchandise conversion in the Florida market resulting in 7.6 million of integration expenses. In the first quarter we incurred 10.6 million total of 18.2 million year to date. We remain comfortable no more than $40 million in integration expense will be incurred in 2002, and we anticipate that the total may be slightly below the original estimate due to the comps combined efforts of the Advance and Discount team to effectively manage all cost as we go through this integration process. Operating margins for the second quarter before integration expense rose 220 basis points to 8.2 percent due to solid same store sales growth, increasing gross margins and leveraging of our SG and A expenses. On a year to date basis operating margins before integration expense also rose 220 basis points to 6.9 percent from 4.7 percent last year. We continue to work towards marrying the operating margin gap to best in class comparison.

Operating income for the second quarter before integration expense rose 78.3 percent to 64.9 million. Including integration expense, operating income rose 57.4 percent to 57.2 million. On a year to date basis operating income before integration expense rose 98.8 percent to 123.8 million. Including integration expense operating income rose 69.6 percent to 105.6 million year to date. EBITDA is as adjusted rose 63.1 percent before integration expense in the second quarter to 86.8 million and increased 70.8 percent to 173.4 million year to date. Interest expense rose to 19.1 million from the second quarter from 13.4 million in the same quarter last year as a result of the Discount Auto Parts acquisition offset partially by a lower average debt level than anticipated as well as lower interest rates. The tax rate for the quarter was 38.8 percent and we anticipate this approximate tax rate for the remainder of the year.

Since we completed our debt agreement at bond offering in the fall of last year our financial strength and overall creditworthiness continues to grow. In June Standard and Poors raised our corporate credit rating and Moody's raised our outlook to positive. Because of our improved financial position and strong free cash flow, we repurchased approximately 37 million of our bond and we refinanced our 305 million tranche B loan with our more favorable 25 million tranche C loan. Because of these transactions, we've lowered our future interest expense and also recorded an after tax extraordinary loss from the extinguishment of debt of 7.6 million in the quarter. Approximately 57 percent of the 7.6 million is related to the writeoff of unamortized deferred loan fees and related financing fees on credit facilities. About 43 percent is unamortized discounts and loan fees as well as premiums paid to repurchase the bonds. Net income before integration expense on the extraordinary item rose approximately 100 percent in the quarter to 28.2 million. After integration expense net income rose 66.8 percent to 23.6 million. Including the debt extinguishment charges net income rose 12.9 percent to 15.9 million. year to date net income increased 164 percent to 4747 [47.6 million before the extraordinary item and rose 102 percent to 36.4 million including integration expenses. After integration expenses and the extraordinary item net income rose 55.8 percent to 28 million. Earnings per diluted share before integration expense and the extraordinary item rose 57 percent to 77 cents compared to 49 cents per diluted share last year. Including integration expenses earnings per share rose 30.6 percent to 64 cents per share. After integration expense and the extraordinary loss earnings per share were 44 cents declining 10.2 percent. year to date earnings per share before integration expense and the extraordinary item rose 111 percent to a dollar 33. Including integration expense earnings per share rose 61.9 percent to a dollar and two cents. After integration expenses and the extraordinary item earnings per share rose 25.4 percent to 79 cents. Overall the subject of earnings per share I'd like to quickly address the issue of accounting for stock options. In 2001 and 2002 the stock option grants approved by our board of directors and stockholders have ranged from 1.2 percent to 1.5 percent of shares outstanding. If we expense all of our stock option grants, earnings per share in fiscal 2002 would be reduce bid only approximately five cents a share using the Black Scholl's [phonetic] options pricing model. If we expense only our 2002 stock options grant earnings per share would be reduced by 2 cents per share. We have followed the disclosure requirements of the statement of financial accounting standards number 123 in accounting for stock options as we previously disclosed in our 2001 financial statements. We are fully prepared to change our methodology for accounting for stock options once final rules are issued. As always, we want to assure that our stockholders have all the best information available to them.

Let me now review the key components of our balance sheet. Our cash position increased $21 million from year-end to 39.5 million. From the end of the first quarter the cash balance declined 25.7 million as we brought down our cash balances to prepaid debt. Our total capex for the quarter was 20.2 million including 10.4 million of integration capex. Capex year to date was 46.6 million including 17.2 million of integration capex. We remain current with our previous guidance for capex of no more than 1 $15 million for the year of which approximately 40 million relates to the integration of Discount Auto Parts. Net inventory which is inventory less payables was up 26.3 percent to 489.5 million compared to a sale gain of 30.5 percent. Our accounts payable to inventory ratio 154.4 percent. This compares with favorably to 58.8 percent for the comparable quarter last year. We continue to not anticipate the accounts payable inventory ratio will be approximately 48 percent at year-end compared to 43.7 percent at the end of 2001. the year-end ratio is consistently lower than the second quarter due to the seasonably weaker fourth quarter. Inventory at quarter end was 1,074 million up 36.2 percent compared to this quarter last year. Our inventory grew fast they are than sales for the quarter and slightly more than we would like through the merchandise conversion process. However, we are confor thable that our inventory growth rate will be less than year over year sales growth [inaudible] once the inventory has been complete. Net debt decreased 238.1 million from year-end to 734.3 million at the end of the second quarter. We generated 75.1 million in free cash flow during the quarter and 144.7 million year to date. As in every year the first half of our fiscal year is the most seasonably strong for cash generation. Towards the fourth quarter it will be a slight cash net user. That being said we're raising our free cash flow estimate to 100 to 110 million for the year from 90 to 100 million previously. Our return on invested capital rose 12 percent on a trailing 12-month basis, increasing from 10.6 percent in fiscal 2001. We continue to focus on enhancing operating results, reducing our debt levels and effectively managing our working capital. Due to the strength of our results this quarter as well as lower interest expense, we are raising our earnings per share guidance for 2002 to a range of $2.53 to $2.60 before integration expense and the extraordinary item, compared to $1.31 in 2001. We haven't previously given guidance for the third and fourth quarter of 2002 and we'd like to take that opportunity to do so as well. For the third quarter we believe we can achieve earnings per share of 82 cents to 86 cents, this would result in a comparable increase of 55 percent to 62 percent compared to the actual second quarter increase of 57 percent. For the fourth quarter we expect to achieve earnings per share of 38 to 42 cents per share. This increase in guidance for the remainder of the year is coming primarily from the full recognition of interest savings from the refinancing and bond buy back. As we have said before, we believe we can achieve a 25 percent increase in earnings per share in 2003. We'll provide additional details on our 2003 expectations on our third quarter conference call.

Now let me turn the call over to Dave Reid who will update you on the Discount Auto Parts integration as well as our commercial program.

Thanks, Jim.

As you've heard, the integration of the Discount Auto Parts stores is progressing well. and as we mentioned before, we have a two-pronged integration process. One for those stores out of the state of Florida, including Georgia, Alabama, Mississippi, Louisiana, South Carolina and the Pensacola market of Florida. And one for the Florida stores are what we call the in-state stores. By the end of the second quarter we had converted 108 of 165 stores in the out of state markets and it's important to note that the entire out of state integration plan will be completed by mid November of this year. In the in state markets, we have completed approximately 75 percent of the merchandise conversion which we are rolling out by category. This will be completed by the end of the third quarter. Before the end of August, we will begin the integration of our store systems in the in state markets. the POS conversion of POS systems conversion is expected to be completed by year-end. Now let me take just a few minutes to talk about our commercial program.

During the quarter, as you've heard, we achieved a same store sales increase of 4 percent and as the quarter progressed our sales did accelerate. We have added 41 net new programs year to date, mostly as a result of the integration process of discount. We have also realized programs in various markets to ensure we are serving our targeted customers well. We continue to focus on expanding our customer base by building strong relationships with our customers. Over the past year we have refined our focus to emphasize on the quality of our sales rather than just the quantity, to maximize the profitability of each commercial program. with that emphasis in mind, we believe the future sales and profitability of our commercial business will accelerate. Over the next several months when we have the opportunity to focus on growing the Discount Auto Parts commercial business which represents only about 7 percent of their sales as compared to [inaudible] only 15 percent at the Advance Auto Parts stores. with our expanded hard parts selection and our store systems, we believe the Discount Auto Parts stores have tremendous opportunity to expand customer penetration once our programs have been fully rolled out in these stores.

Now let me turn the call back over to Larry.

Thanks, David.

The remainder of the call I'd like to talk to you about the strength of the after market, some of our new marketing and merchandising initiatives, and other updates. the after market continues to show a plus growth. In fact, in 2001 the market grew 3.6 percent to 103 billion from 98 billion in 2000. [inaudible] to highest levels at 9.3 years. In 2000, there were over 123 million vehicles over six years old. to sum up, there are more older vehicles being driven more miles per year needing more parts than ever before. In looking at the after market, it's important to note that this industry does well in good times and bad. Consumer sentiment has no impact on whether or not a person buys a starter or battery or replace one that just broke. Americans have to keep their vehicles work. They have to go to work, they have to take their children to school. Most our customers work on their vehicles out of economic necessity. Because their average hourly wage is less than $20 per hour and their take home average hourly wage is usually less than $15, it's extremely difficult for them to pay someone 40 to $60 per hour to work on their car. Nevertheless, needless to say, we value our customers and their ability to roll up their sleeves and tackle a repair job. That's the reason we offer them a good value as well and advise them on how to complete the repair project effectively. We believe that the DIY after market will continue to be strong given the ingenuity [inaudible] and increasing number of vehicles coming into the high repair cycle. As for the DIFM market, we believe that we have great potential to expand our penetration into that sector by continuing to focus on serving our professional installer customers better. to strengthen the after market as well as our team's hard work, dedication and focus, gives us increased confidence that we can increase our operating margin and close the gap compared to best in class. On a year date basis, we picked up 220 basis points and given our strong performance in the first two quarters, we anticipate achieving operating margins for the year of 7.0 to 7.1 percent. Beyond this year, we have articulated that we see at least another 400 basis points of opportunity. That opportunity exists in approximately 200 basis points of further SG and A leverage, and approximately 200 basis points of gross margin expansion. We believe the gross margin expansion will come from approximately 40 basis points of purchasing efficiencies and savings, 60 basis points of enhanced supply chain initiatives, and approximately 100 basis points from a marketing and merchandising initiatives which we are continuing with our present roll out. This includes our efforts in category management and enhanced store buying reviews.

During the past few months, some of our shareholders have asked us about insider sales. Please note that none of the officers of our company have sold any shares. Similarly, our larger shareholders, Raymond Spalding and Sears, have not sold any shares since the secondary offering. Raymond Spalding and Sears have a long track record of exiting their investments in an organized way. It's our expectations that if the [inaudible] decide to money ties some or all of their investment in Advance, they will do so in an organized way.

This year we filed our 10(q). We did this 13 days in Advance of the due date so we could also file our officers' certification on August 14th. Although we were not required to file until August 27, we chose to file early in order to assure our shareholders we stand behind our filings. We like to assure our shareholders that we have in place strong financial controls. We monitor and review our results on a daily, weekly, and quarterly basis. Our financial team is strong, led by Jim Waite and Jeff Gray. All of us are proud of long history of honesty and integrity with which our team has bill the company and served our customers and shareholders. During the second quarter we launched our team member stock purchase program. Each full-time employee has been with us at least one month before the start of a calendar quarter is eligible to participate in the plan. We've experienced solid participation in the program and we're pleased that our team members want to be share holders in the company that they're helping to build. All in all, the second quarter was a strong quarter for Advance Auto Parts with strong increases in revenue and operating income. We will continue to focus on managing our operating expenses, thereby leading to a continued growth in margins as we go forward. Last and but not least we are on track in integrating Discount Auto Parts as you heard from David and by the end of the year all we will have to do is rebrand the stores in Florida. Mean while we will reap the benefits of the advanced merchandise mix and leading edge store system. We look forward to more progress in the third quarter.

Thank you for your participation on this call this morning. And now, Operator, we'd like to ask you to please poll for questions. 00:42:27

At this time if you would like to ask a question, please press star then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key.

Your first question comes from Hollanderies kin with Lehman Brothers.

Congratulations, gentlemen, on an outstanding quarter. a couple of questions. Larry or Jim, can you maybe provide the inventory levels, maybe on a per store basis where they stand today versus last year as both [inaudible] stores and the core Advance stores?

Alan, I can address that. I don't have the specific numbers in front of me, but I can tell you, I think where we stand in regard to that. At the Advance Auto Parts stores, the inventory at the end of the second quarter first over is basically in line with where it was last year. There hasn't been any significant change at all. In the discount stores, it's a little higher than last year although not very much as we're adding some SKU's as we remerchandise the stores. Where we do have more inventory this year than last year is in the distribution center. When you look at our numbers at the end of the second quarter compared to last year, as I've said in my comments, we're - we had inventory a little bit higher than our sales increased, little bit higher than we'd like, but it's in the distribution centers as we made sure we went through the integration process that we maintained a solid order bill and with it being in the distribution center, that's the easiest place going forward to liquidate that as we go through the rest of the year. So we remain very comfortable that as we do that, we'll show inventory growth below the sales growth by the end of the year.

Okay. Just a couple more questions if I may. You're now saying the integration expenses will be no more than $40 million whereas only a quarter ago you were saying it would approach the 40. Should we conclude from that that the efficiency by which you're converting the stores is actually increasing at the converted stores?

I think that's a valid statement, Alan. I think what happens as we've gone through integrations in the past, what always happens is as we start the integrations and work through the individual steps that had to be done, the efficiency with which our team performs always increases because of the prior experience as well as the routine we get into as we convert stores. So I think we're seeing that again, I think as we go through the rest of the year we'll continue to see that.

Okay. and just one more if I may. with respect to the [inaudible] program, how many stores have now on that program versus last year at this same time?

We're almost at 700 stores as our current number in total.

Okay. Thank you very much. Congratulations.

Alan, thank you.

Your next question comes from Gary Baulter [phonetic] with CFSB.

Two questions, if we can. One is you made a comment about you're comfortable with third quarter comps, and given what we've seen which is no rain and a lot of heat, could we infer from that that you're comfortable the high end at least at the current time, third quarter comps?

Gary, I think that we'd like to just stay with what we said before, mid single digit comps as we anticipated.

You don't want to add any color on it?

No, I think we have to be right up front and blunt about what we're going through. We would like to be optimistic, but wishful thinking is just not a good business plan and with everything that's going on in the economy, we think it's important to stay with the guidance that we gave prior to.

Two more things on that. One is what do you see - let's assume the consumer slows down as we're seeing - obviously we're not seeing from your business, and during the streak that we're seeing from other retailers. Historically what has been the impact on your business from a consumer slow down?

Historically, and you look back over a long trended period of time, you can see where there has been some softening, but nothing dramatic and I think it really goes back to the core aspect of the business. And I said earlier in my remarks, Gary, our customers just don't consider a dead battery or a dead starter a discretionary purchase. [inaudible] retail we're not fashion, we're not jewelry, we're business where our people work on their cars out of necessity and it's next to their home or their apartment in most cases it's I the single biggest investment they have and it's something that they just continue to make these catastrophic failure purchases from our stores. We might see a little bit of softening in the front room and some discretionary purchases, but the primary part of our business in hard parts does very, very well and as a result you'll see our company, if you look back at our comps and the long, over the last five years or even prior to, take a look back in the '70s and '80s when we still enjoyed very strong high single digit comps during recessionary periods.

And then the last thing, could you give us the average volume at the DAP stores that are now remaining? Because I would assume you closed them at lower volume stores.

Yeah, Gary, I'll address that again without a specific number. I can tell you, yes, we have the stores that we close at discount were the lowest volume stores primarily outside the state of Florida where we closed the store and move moved a lot of that business to the Advance surviving stores in the same area. As far as the remainder of the stores concerned, there are sales per store would fill still be less than Advance's average sales per store. That's where, as I said before, we see a major opportunity to grow those going forward?

We should be thinking like a 1-1, 1-2 bid number?

Toward the higher end of that number.

Okay. Thank you very much.

Thanks, Gary.

Your next question comes from Peter Caruso with Merrill Lynch.

Good morning. You mentioned on the call that the increase in customer transactions accounted for about two-thirds of the comp. You can you clarify with that the adjusted statement for the Advance stores and if so can you give us some feel on the increase in customer transactions that you've seen so far at the Discount Auto Parts chain.

Yes. I'll be happy to do that. The results that we're seeing from the discount stores are not significantly different. In both cases the larger part is coming from customer count increases as well as customer average increases. We talked about before in the discount stores as we go forward, we see a significant opportunity to increase the customer average there. They have especially in Florida some good customer counts, but their customer average which which think is driven primarily by not having as much parts mix as we're now adding is lower than Advance and we would anticipate going forward seeing that customer average grow faster than the Advance customer average.

Okay. Secondly, has the pricing environment in commodities and front end merchandise remained relatively stable? And if you looked at your comp, are you getting comp from the front end as well as from the sale of parts?

It's with the good balance across the board, Peter. And the only thing I could add to that is just a continuation of more - the same kind of pricing rationalization we've seen earlier in the year appears to be continuing through the back half of the year.

Okay. and then lastly, the gross margin that you booked in the quarter is not sensitive to having taken any volume purchase rebates that would require you to hit some sort of same store sale level in the second half of the year?

No, it is not. And I will say in the second quarter of this year the trade discount related income that went into gross margin was no hire eras percentage of sales than last year's second quarter.

Great. Thank you. Good luck for the next quarter.

Thank you.

Your next question comes from Rob Schwartz with J.L. Advisors.

Hi, congratulations on a great finish of the quarter.

Thank you, Rob.

A couple of quick questions. First of all, gross margin up 170 basis points; what particularly is contributing to that? I know last time we spoke about, you know, contracts with your vendors and seeing improving terms there. and while you expected most of the benefits in 2003, is it fair to assume you're receiving some benefits earlier than expected?

Yes, we did roll with the renegotiation of our contracts with the vendors. Bear in mind that we did have contracts prior to discount that did not lapse until we got further into this year. So 2003 would really be our first full year run rate with all the negotiated programs with our suppliers. We saw very good balance in margin improvement, front room and back room, and again we spent an awful lot of time on price checking and looking at every area of opportunity. But bear in mind, Rob, we price our goods and services to maximize contribution yield. So some of the items that we price, we price for traffic draw, some for margin enhancement and some for what they do and representing add on sales.

Great. Thanks. And secondly, regarding your interest expense, can you briefly just run through when you renegotiated it, your credit agreement a month or two ago, can you discuss the change in interest rates for that tranche?

Sure. As you recall, when we put it together, the financing that we had in place for the discount acwhich circumstances it was last September, October of 2001 when the conditions for financing were certainly as favorable as they've become. and at the same time our creditworthiness has improved substantially as well. So the biggest single change that occurred we were paying [inaudible] plus 300 basis points with a floor of 4 percent on our tranche B loans. We were able to renegotiate primarily with the same lenders as we had before a new package that gives us a live work plus 2 and I a half percent with no floor. I think it was a substantial change that was a reflection of both the market that we were working in as well as our creditworthiness that has changed since last year.

That's great. That was on approximately 300 million of debt?

250.

Great. Thanks, guys. Congratulations again.

Thank you.

Your next question comes from jack bill owes with mid wood securities.

Hi. I have a question on Discount Auto Parts stores. You said you converted 108 out of I guess 165. How many Discount Auto Parts stores are there currently and how many stores remain to be converted?

There are a couple of approximately 546 stores total of which we've converted 108. and again as I've explained, we primarily look at these groups of stores in and out of state so the out of state group is a total of 165 stores to be converted and the balance would be in Florida. and we'll be moving into Florida in the fourth quarter beginning to convert physically the actual building.

What's been the experience in terms of sales gains for the Discount Auto Parts stores that were converted first?

Jack, this is Jim. For the stores, as I've said in the notes, the stores that are in the overlap markets that we converted, we're saying sales of over 20 percent increases. For the discount stores that we're converting to Advance and all other markets, they're running - that are within our plan or slightly ahead of our plan as we had projected out for the year and I think we're starting to meet our expectations there.

I think that the 3.7 percent comp that was reported for the stores in the second quarter, wasn't that negatively impacted by some rainy weather in June in Florida?

I think overall for the quarter it probably basically balanced itself out. There was a period of time in the - for really two or three weeks if not more in Florida where there was really a lot of rain that affected the business. But when you look at the entire quarter, I don't know that was an overall significantly negative pack factor.

Okay . I guess what I'm getting at I would expect that Discount Auto Parts comp store sales for the third quarter should be in the middle comp - middle single digit range?

Well, what we've said in our previous guidance is we had budge fed and anticipated low single digit comps in the discount stores for the entire year of 2002 and and I think what you'll see in the third quarter is that there is some significant positives in that the merchandise integration process is almost done . I think clearly there will be some positive effects from having that in place. At the same time we're now in the system conversion process in the stores we're changing the POS system and the electronics parts catalog. So we had to change the direction that we've given, but we certainly feel very comfortable what we're seeing in other stores as we are going through the integration.

Just one last question regarding Track Auto. With the conversion for Track Auto stores, what condition are they in compared to Discount Auto Parts? And also are you paying rent on the Track Auto stores prior to their opening?

I'll answer both of those questions. The first one, I'll answer your second question first. We are not paying rent on those stores until we take them. The way we have set up the conversion plan is that track continues to operate those stores until we take as I said approximately five per week. When we take the five, we'll take responsibility for them and start paying the rent. But prior to that we don't have any obligation for rent or any other expense of operating the stores. As far as the condition is concerned, first of all as I said they're good solid real estate locations in a market that's difficult to get real estate at a reasonable price. So the base from which we can operate is very good. As I also mentioned, the sales in the past have been very solid and strong. They have not been as good in the last year or so because track has been in bankruptcy as a result the order fill has not been where it needs to be and the in stock position in the stores has not been what we'd like to see. I think I would add to that as well, having been in those markets over the last several weeks, there's a lot of good people in those stores. and with the proper inventory levels and the Advance name and the Advance branding and the benefits that comes with - I think there's huge pore tension in that market.

So the conversion of two weeks in terms of converting it to Advance auto parts stores will be similar tasks as you would for Discount Auto Parts stores?

Jack, when we take ownership of those stores, unlike discount we're going to close the store for two days - two weeks, I'm sorry, and do a complete renovation at that time.

Like a new store.

Consider it taking the store dark and us taking over a vacant building and converting it look a new store.

Okay. Thank you very much.

Good enough. Thank you, jack.

Your next question comes from Renee Shaw with Morgan Stanley.

Hi, a couple questions. On the inventory levels, do you expect, given you're about 75 percent due to merchandise mix inventories to grow slower than sales in the third quarter or for the full year? And second can you talk about the payable inventory ratio how high you think that can get since that improved this quarter? And just finally on new store openings, could you talk about some of the target markets that you're looking at? Thanks.

Let me take the new stores. All of our new stores, as we've said before and I'd just like to reiterate, all of our new stores are in our existing [inaudible] in the states we operate in now. It is not our intent in the foreseeable future to be spring boarding into new states or drastic new marketing areas. We have plenty of room to fill in the marketing areas that we're in right now. There's plenty room for us to continue opening new stores in Florida [inaudible] and we're starting construction on new stores in Florida. So we've got plenty of room for the foreseeable future to continue to open new stores and dense up DMA's where we are poorly represented. So for the time being in the foreseeable future we will not be going into new states. Jim?

Renee, as far as the inventory is concerned, we anticipate being back in line with our sales growth by the end of the third quarter. and as I've said in our remarks, we still feel that by the end of the year we'll be growing sales at a rate faster than our inventory. As far as the payables to inventory ratio, also mention in my remarks that at the end of the year we should be at 48 percent accounts payable ratio compared to 43.7 last year. and as I've said, the our year-end set to fall at the end of December is a [inaudible] weaker time frame for us our account ratio is less than it is in the middle of the summer but it will also at the same time be significantly higher than it was at the end of last year. Lastly, I think our single biggest opportunity to increase the accounts payable to inventory ratio going forward is to increase our inventory terms which is going to come back to a lot of the [inaudible] we are working on in term of custom mix and category management and a number of other things that we anticipate driving sales faster than inventory growth as we go forward.

Great. Thanks a lot.

Thank you.

Your next question comes from Nafar Nazeem [phonetic] with J.P. Morgan.

Hi. It's actually Carla Casello [phonetic] J.P. Morgan. I'm wondering about competition for the commercial business. Are you seeing any pick up work? We've heard of of a number of players starting to increase their focus on that business.

I think that we recognize that as well and I think that our plan as Jim and David articulated to you, something we're very comfortable with. We have plenty of room to continue right sizing our programs taking advantage of the close in location. Please bear in mind when it does come to the commercial program, the two things that really matter most is availability and time. and we think that we can really fine tune that expertise with the locations that are close to our stores and continue to refine our product mix so we have the right product and getting it to the commercial account and that hot shot half hour that they really request and require. Balancing that with the expense ratio to support that kind of program is something we're working diligently to refine. As Jim indicated, we're not rolling out hundreds of programs or hundreds of trucks, but rather, as David indicated, a reallocating the trucks, drivers, and product mix to support those programs so we can get good density and increase our rate of return and profitability on a buy program basis.

So you're not seeing any increase in price competition as players enter that market?

We believe that the rationalization in pricing that I indicated earlier carries through to the commercial end of the business as well.

Okay. I'm also - if you have any insight into the trend in DIY versus D I S M. I would assume that that could be a risk if the - we're seeing greater sales of new cars lately instead of used cars and if that hurts the DIY market, I'm curious.

We don't think so. I think the thing you have to realize is when somebody buys a new car and they trade-in a used car, it doesn't matter if that used car is two years old or six years old, the car is not going to the scrap yard. I think it's important to not only look at new cars the way you do, but you should also look at the scrappage rate. That's what's important to us. More vehicles are out there today than there ever was before and I think that when you look at that continued growing rate, according to the U.S. Department of Commerce and the 123 and 124 million registered vehicles out there today versus 1991 when there was a considerably less number than that, the thing that drives that is the scrappage rate versus new cars coming out. So we just see more vehicles out there. I indicated earlier the huge increase in cars that are six years old and our customers' willingness to maintain those cars on a going forward basis. But clearly when somebody buys a new car, the vehicle that they're trading in is not going to the scrap heat, it's going into the secondary market. Many people buy those vehicles turn right around, put batteries in them, put shocks on them, have to do the belts and hoses to maintain them and oftentimes it's break time and things like that. That's when they fall right into being our core customer.

Okay. Great. I one other question. We've noticed it seems like increased auto parts sections at Wal-Mart super centers and I'm wondering if that's a new force of competition for you or has that been an ongoing dynamic?

26 percent of our SKU's not our sales or tonnage, but about 26 percent of our SKU's are sold in other classes of trade, we're growing our market share against these other classes of trade as well as the market share growth we're making with our core competitors.

Okay. Great. Thank you.

Thank you very much.

Your next question comes from Stephanie Rogers with B.N.P. Merriman [phonetic].

Hello, gentlemen. Thank you for the best news I've had in a couple of weeks.

Thank you for participating in our call.

Absolutely. I have a question about the Track stores. Why did they file for bankruptcy?

You know, as we presented in the past in our different group meetings, I think that - I'd like to go back and focus on one fundamental point and that's the fact that in this industry, size matters. It's no different than why and how we acquire the [inaudible] stores. It's very difficult for a player of that size to have the kind of economy of scale from a purchasing standpoint, from a logistics standpoint, the whole supply chain is very expensive for them. They certainly don't have the IT support to find the parts in the system. and what they do have, they don't have the advertising or the field team to support it as well. It's the kind of leverage best in class the top three or five retailers in this sector that can disproportionately take advantage and leverage that on a go forward basis and give the customer better availability, better value, better service and in the commercial end of the business which track did not participate in, having the right part in the right place and doing it quickly makes all the difference in the world. So I don't think there is any one thing that drove them into bankruptcy. I think it's just the aspect of the cost of doing business today and the efficiencies that go with the size and scale that we're able to accomplish that they couldn't.

And the second question regarding that region, are you going to have any price flexibility in that area since it's so difficult to get an inroad? Are you going to be able to charge higher prices? Margins in those stores will be better?

We have different pricing zones. It's something we have to look at on an individual basis and we're looking at maximizing our pricing zones on a value orientation and where we can get the best contribution deal. I think you also have to bear am mind there are higher expenses associated with the D.C. market as well. the rents are higher, the shrinks are higher, cost of labor, cost of doing business overall is a little bit heighter and we have to balance that with our margins and our promotional activity, but it's something I have to tell you we're very excited about.

Thank you very much.

Thank you.

Your next question comes from Steve Kartrat [phonetic] with Berman Capital.

Hi. This is actually Christina Henry with with Berman Capital. I had two questions. The first one is while you achieve SG and A leverage in this quarter, it was less than had been achieved year to date. I was wondering why it was such strong sales there would be less SG and A leverage. [why with such strong sales]

I think there are a couple reasons for that. One is in the first quarter we had almost an 8 percent comp, this quarter we had a 5. So we are the type of business that has a fair amount of fixed cost and when we do run even higher comps than we did this quarter we have the ability to leverage more. But secondly, we are seeing leveraging in a lot of categories in our P and L, and I think we anticipated Larry said in his comments that we can leverage a lot more going forward. We're not happy today where we are with SG and A and it's a matter of attacking each individual line and making sure we're growing those lines at a rate that are reducing those lines at a rate much less than our sales growth.

You can rest assured that we've identified that opportunity and it's a very important part of our L TB. and as we go forward implementing our long term plan and budgeting process for '03 we see that as a significant opportunity, as I indicated in my remarks.

Uh-huh, okay. Thank you. And the other question that I had was what would you estimate to be the pretax flow through on comps above the 2 to 3 percent range?

I don't know that there's a real simple answer to that question. I think, clearly, looking at actual numbers, if you look at the first quarter and second quarter where we ran in the first quarter almost 8 percent comps, at that level there is not much additional expense incurred to generate the sales. If the sales are being generated at the same margin level at the expense line there is just not very much expense associated with it. So when there is a substantial flow through of 25 percent or more, it depends on how the additional comp is getting - is coming and what expenses or margin effect it has to get there. But substantial ability to leverage our business as we have higher comps.

Thank you very much.

Your last question comes from Susan Jensen with Lehman Brothers.

Finally. Let me add my congratulations to a great quarter as well.

Thank you.

Larry, going back to something you said in your initial remarks, I'd just like to follow-up a little bit on your longer term gross margin increase of 200 basis points. Part of that is going to come out or I guess the largest part is going to come out of the marketing and [inaudible] your category management. How are you doing on that so far? I know you've made great progress, but can you give us any specifics?

I think it's safe to say that since we wrote an entire marketing program last year, started implemented at the end of last year, it's based around category management. There's certainly no rocket science to what we're doing. It's nothing more than the best in class marketing merchandising, performance measures, [inaudible] one year foot contribution yield by category and the like that are being rolled out. Huh-uh know part of this is IT, part of it is personnel development, part of it is the implementation of the higher and turn^over rates of return that we have for the different categories. It's an ongoing process. Please know that it's not something that we have a time line that says we're finished. These line enhancements and category review programs, big part of the development of our people. Has an awful lot to do with how we buy our product, promote our product. We're moving along going through the stores. We've done this through probably 30 percent of our mix implemented at store level. We've got an awful lot more to do and as we do it and go through the rest of the store front room and back room, when we come back and do what we did the last part of last year and start it all over again after annualize the dates of the roll outs of those first categories.

Great. Are there any particular categories that you've had enormous success with or any categories that conversely you've been disappointed with as you [inaudible]?

Some of each. We don't disclose by particular category what we're doing well in or not. We know that our core business doesn't change from year to year. You know how important batteries and hard parts are in this business. And you also know some of the fashionallable trends that we've introduced into our front room [Fashionable]. We're doing very well with a lot of these new categories. Conversionly perhaps we over^did some of the other. I think we had very keen eye on what's working and what isn't working. We have to balance that with Jim's remarks relative to the inventory buildup that we had and on a go forward basis we have to leverage our sales against better inventory turn as well.

Great. Thank you very much. and my congratulations to you.

Thank you for participating on the call.

I would now like to turn the call back over to management for closing remarks.

Well, we're very proud of our progress to date. We are pleased [inaudible] we don't confuse effort with results. We've reached a new plateau, but clearly looking at the top of the mountain as best in class, we know where we have to go. We know what we have to do to get there. We have the deepest resolve to make it become reality and we certainly appreciate your support and participation with our company as we go forward with it and I'd like to close just by saying that we really believe we have - this company has a long runway ahead of it and great legs understand it and we're very excited about our future. Thank you very much for participating today.

Ladies and gentlemen, that concludes our conference call for today. You may all disconnect and thank you for participating.