領先汽車配件 (AAP) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the Advance Auto Parts' second quarter 2004 conference call.

Before we begin Eric Margolin, the Company's Senior Vice President and General Counsel, will make a brief statement concerning forward-looking statements that will be made on the call.

Mr. Margolin, you may begin 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 discussed, among other things, expected growth, store development and expansion strategy, business strategies, future revenues and future performance including our future free cash flow and earnings per share.

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 if any of the underlying assumptions prove incorrect, the actual results may materially differ from anticipated results described in these forward-looking statements.

The company intends these forward-looking statements to speak only as of the time of this conference call and does not undertake to update or revise them as more information becomes available.

Our results, including a complete reconciliation of our GAAP to comparable results for 2003, can be found in our press release and 8-K filing and are available on our website at www.AdvanceAutoParts.com.

I will now turn the call over to Larry Castellani, our Chairman and Chief Executive Officer.

Thanks Eric.

Good morning and welcome to our second quarter conference call.

During our second quarter we achieved record revenue and earnings, as well as industry-leading comparable store sales gain of five percent.

We believe our investments and initiatives to grow our topline and enhance our brand awareness are generating solid results.

During the quarter, we achieved earnings per diluted share of 70 cents, a 16.7 increase versus comparable earnings per diluted share last year, and our earnings were within our guidance range of 69 to 72 cents.

Nonetheless, we are not satisfied with these results.

On this call we would like to outline our strategies and determination to produce strong long-term results.

During the prior two quarters and the first eight weeks of the second quarter, we produced strong comparable store sales gains in the 7 percent range which gave us the opportunity to continue to invest in the business to gain market share.

During the last four weeks of the second quarter, when our comps were in the low single digit range, we did not adjust our investing pending determination of any longer-term trend change.

We prudently stayed the course and continued to invest in our initiatives to grow our topline and brand awareness.

We believe that this strategy is generating results as we have produced approximately 3.5 percent comp store sales gains during the first three weeks of the third-quarter.

At Advance Auto Parts, we continue to invest and manage the business for the long-term.

Our greatest opportunity is to increase the average sales in each of our stores and leverage our fixed expenses.

In order to meet our long-term goals we will not overreact to short-term sales fluctuations.

However, we have taken steps to prudently manage our expenses to a lower level until we return to a stronger comp run rate.

We're focused on the long-term in the investments we have made in our merchandising and marketing initiatives, as well as in our in-store systems, which will give us traction to continue to gain market share in 2004 and beyond.

Before we discuss our guidance and opportunities for the remainder of the year and beyond, I would like to touch on the highlights of the quarter.

Sales rose 9.8 percent and comp store sales grew 5 percent.

Gross margins expanded 62 basis points as we benefited from our category management initiatives and continued supply chain leverage.

Our operating margins rose 32 basis points to 10 percent, we would like the point out that this is our first quarter of double-digit operating margins.

Earnings per diluted share increased 16.7 percent to 70 cents from our comparable earnings per diluted share of 60 cents last year.

As Jim will elaborate further in this call, we see the sales results for the last four weeks of the second quarter as an opportunity to speed up the implementation of an initiative which we began at the end of the first quarter.

We're calling it the 2020 initiative because it focuses our entire team on driving efficiencies throughout our organization to further leverage our expenses and raise productivity.

Our entire team is involved.

We have already identified and are evaluating over 300 opportunities that have the potential to help us drive sales and enhance our productivity.

We remain as positive about our industry dynamics as we have ever been.

The average age of a vehicle continues to increase and there are more older vehicles on the road than there have ever been in the past.

Vehicles are staying on the road longer because of the enhanced quality especially related to interiors and exteriors.

But all parts fail and need to be replaced, especially our core selling items including batteries, starters, alternators and water pumps, as well as belts and hoses.

Our core DIY customers work on their vehicles out of economic (technical difficulty) necessity.

These customers have to keep their vehicles running to get to work, the grocery store and to continue on with their daily lives.

Their vehicles are a critical part of their lives and we do not see that changing.

Even if our core customers put off preventive maintenance repair applications such as a new brake job, that deferred repair job will become a failure at some point in the future.

We believe that we will benefit from the pent-up demand as we progress through the remainder of the year.

Due to solid dynamics in our industry and our initiatives to grow our business, we continue to believe that we will meet our operating margin goal of 11 percent or more by the end of 2007.

We will meet this goal by staying the course we have laid out investing for the long-term as well as managing our business to prevailing trends.

Our initiatives are helping us gain market share.

These initiatives include category management, our 2010 store format, APAL, our proprietary electronic parts catalog and MPT our store labor scheduling system.

We believe that we have built the foundation to continue to gain share for the remainder of 2004 and beyond, as well as to continue to produce solid EPS growth.

We are, however, adjusting our earnings per share guidance on the assumption that comparable store sales gains will be in the three to four percent range for the remainder of the year.

We want you to know that we are not adjusting our internal sales goals and objectives.

We continue to strive for mid single digit comp growth but we have adjusted our expense structure to the lowest sales level.

This translates into anticipated earnings per share range in the third quarter of 68 to 71 cents in place of the previous guidance of 70 cents to 73 cents.

We are also initiating guidance of 42 cents to 46 cents for the fourth quarter of '04.

For 2004 fiscal year we anticipate producing earnings per diluted share of $2.48 to $2.55, which reflect current sales trends in second quarter results.

The top end of this guidance range matches our initial earnings per share guidance we gave prior to the beginning of the year.

One way to measure any business is the strength of the Company's cash flow.

Year-to-date, we've generated 122.4 million in free cash flow.

Due to the confidence of our management team and Board of Directors, that we will continue to produce strong results and free cash flow.

The Board has authorized a $200 million stock buyback program to be implemented over a two-year program.

We've established our criteria for this plan and we are fully prepared to go out in the market and start buying back shares.

Our strong financial position provides us the opportunity to derive shareholder value by investing in our business as well as buying back our shares at attractive valuations.

At today's stock price, we could buy back approximately 8 percent of our shares with this authorization.

As I have said before, we will continue to get good at getting better by executing on our initiatives to drive sales productivity and enhance operating performance.

Our key goals for 2004 and beyond remain the same and they are to (1) raise average sales per store; (2) expand operating margins; (3) generate strong free cash flow; and (4) increase ROIC.

Now I would like to turn the call to Jim Wade, our President, who will review with you our operating initiatives and results.

Jim.

Thank you Larry and good morning to all of you on the call.

During the second quarter, our sales rose 9.8 percent due to comparable store sales increase of 5 percent plus the new -- the sales from our new stores.

The majority of our increase in comparable store sales came from an increase in average ticket.

Our team continued to increase our DIY average ticket by executing on our initiatives including category management and (indiscernible).

On the commercial side we are also grow our average ticket as we continue to build stronger relationships with all of our commercial customers.

We continue to focus our full attention on our core business of parts and accessories to drive our same-store sales growth and we believe that by focusing on our core productlines we will continue to focus -- continue to grow our business consistently in 2004 and beyond.

The few non-core items in our stores had a negligible effect on our comps.

Our DIY comps for the quarter were 1.8 percent, that was below the run rate we've seen in the past two quarters.

The lower comps we saw in the last four weeks of the quarter came in the form of less traffic from our DIY customers.

As Larry mentioned earlier, we believe the fundamentals of our industry and our business remains as strong as ever.

We certainly don't pretend to economists, but based on recently released economic data that we have all seen, overall consumer spending slowed in the second quarter.

At the same time, job growth and consumer confidence is up, and through the first quarter miles driven were up even with higher gas prices.

Over a period of time we will all be able to determine the true causes of the decreased spending and how much came from weather or other reasons.

We have seen these types of short-term sales fluctuations happen over the years and certainly don't believe these results are any indication of a change in the underlying dynamics of our industry.

We're pleased, as Larry said, to report that comps since the quarter ended have strengthened back to approximately 3.5 percent, but they are not yet back to the run rate we've previously experienced.

As a result we are up prudently adjusting our comparable store sales guidance to a range of 3 to 4 percent for the third and fourth quarters and we are managing our expenses based on that assumption.

When we see our sales further strengthen, we will be fully prepared to maximize that opportunity.

Our commercial team once again achieved strong results in the second quarter, and produced a 22.3 percent comp.

Throughout the second quarter our commercial business remain strong.

Year-to-date, we produced a 20.6 percent commercial comp.

We believe the tremendous result in our commercial program are due to several key reasons.

We have enhanced our tools for identifying new customers and stores in each of our markets that meet our commercial model.

We can say yes, we have that part, to our customers more often due to our logistics network that provides fast access to a large variety of parts, to our customers in each of our markets.

We are reaching out to more new customers as well as continuing to develop our relationship with our existing customers through our commercial sales team.

We're generating more and more satisfied customers with our high level of service and speed of delivery.

We believe that focusing on serving our customers better than anyone else will give us the opportunity to continue to strongly grow our commercial business for many years to come.

We also continue to add commercial programs.

In fact, in the second quarter we added 109 programs to our stores, bringing the total number of stores with commercial programs to 1,809.

Today approximately 70 percent of our stores have commercial programs compared to 60 percent at the end of the second quarter last year.

We continue to expect to produce double-digit comparable store sales gains in our commercial business as our existing programs move up the maturity curve and we identify opportunities to add more programs.

We also believe the strength in commercial is a reflection of our team's successful execution of our internal initiatives and not any indication of any change in the industry.

Again we want to thank our entire commercial and store teams for producing these strong commercial results.

While I'm talking about sales I also want to touch on inventory as well.

During the second quarter our sales grew by 9.8 percent and our inventory grew by 10.2 percent.

Considering the lower than planned sales in the last four weeks of the quarter, we are comfortable with this level of growth.

We continue to freely invest in inventory primarily by focusing on positioning parts closer to our customers by expanding the number of stores which carry an extended mix of SKUs.

We believe this initiative will further enhance our brand in the eyes of the consumer because we have the right part available for customers when they need it.

As we move through the remainder of the year we expect our inventory growth to support our long-term objectives and to grow at a slightly higher pace than our sales growth at the 3 to 4 percent comp level.

We continue to open new stores and aggressively remodel and relocate our stores to our 2010 format.

During the second quarter we opened 31 new stores and closed one bringing our total store count to 2,583.

Year to date we have opened 51 new stores as planned and closed seven underperforming stores.

Our new stores continue to open with record sales.

As we reported before our average stores opened one year now have a 1.1 million sales run rate, up from 900,000 in 2001.

Our enhanced site selection process, augmented by our 2010 format, our national advertising campaign, and our opening of stores in existing markets, gives us confidence that we can hit our long-term targets for substantially improved average store sales volumes.

We remain on track to open 125 to 135 stores in 2004, and close 10 to 15 stores resulting in an expansion of our square footage of 4 to 5 percent.

We continue to open these new stores primarily in our existing underpenetrated markets where we leverage our advertising, our distribution and sales support teams and take advantage of our growing brand recognition to gain market share.

As we move into 2005, we expect to accelerate our square footage growth to 6 to 7 percent.

We have tremendous opportunities to further penetrate our existing markets where we believe we can open more than 1,500 stores and continue to gain our market share.

During the second quarter, we relocated six stores and year to date we have relocated 11 stores.

In 2004 we anticipate relocating approximately 40 stores as we continue to upgrade our store locations.

Our 2010 market remodel program continues to produce strong results.

Since 2003, we have remodeled Richmond, Virginia;

Charlotte, North Carolina;

Nashville, Tennessee; and most recently San Antonio and Austin, Texas.

During 2004 we will remodel over 100 existing Advance Auto Parts stores on a market-by-market basis.

We also continue to move southward in the State of Florida with our remodeling of over 100 of the former Discount Auto Parts stores to the 2010 format.

We currently have just 148 of the 394 Florida stores remaining to convert this year in 2005.

These stores are being remodeled market-by-market at the rate of about two to three stores per week.

At the end of our second quarter, we had 928 stores with this new format.

By the end of 2004, we plan to have over 1,100 stores with the 2010 store format, with the remainder of the chain being totally converted over the next several years at a rate of approximately 200 to 250 stores per year.

Our 2010 stores continue to produce, on average, a sustainable double-digit comp increase and we believe it's going to be a key driver of our sales growth for many years to come.

As Larry mentioned earlier, we also introduced a new initiative called 2020 to our leadership team at the end of the first quarter.

The objective of this initiative is to focus our team on increasing our profitability by identifying opportunities to leverage our expenses while aggressively growing our sales.

This initiative includes all areas of our company and each of our team members.

Since this introduction, our team has already identified over 300 opportunities to increase our productivity and each is being reviewed for possible implementation.

In some cases these initiatives are being implemented immediately and in another cases they will take more time to plan, test and communicate, but they will start to have a positive effect on our results before the year is over.

This initiative will be ongoing and will keep our team focused on productively growing sales and maximizing our results.

The one thing these initiatives all have in common is that they are being generated by our team and will result in a better run and more profitable company.

As this initiative continues we will further update you on how it will help us leverage our SG&A.

Now let me turn the call over to Jeff Gray, our Senior Vice President and Chief Financial Officer, who will review our financial results.

Thanks Jim and good morning.

I will continue by discussing the remaining lines of our income statement as well as go into more details of our balance sheet and cash flow statement.

Our gross margin expanded 62 basis points in the second quarter to 46.5 percent, compared to 45.9 percent last year.

Our category management initiatives and continued leverage from increased efficiencies in our supply chain positively impacted gross margin.

Going forward, we continue to have opportunities to enhance our gross margin through our category management process, as well as continue improved efficiencies in our supply chain.

During the quarter, we had a LIFO credit of 2.3 million due to negotiated price reductions from certain vendors.

In the second quarter last year, we had a $1.2 million LIFO debit, however we want to emphasize again that with consistent application of LIFO, gross margins are comparable from year-to-year.

During the second quarter our SG&A increased 30 basis points to 36.4 percent from our comparable results of 36.1 percent last year which excluded integration expenses of 2.9 million.

This increase reflects our continued advertising investment and higher medical costs driven by inflation in the health care sector, and as Larry mentioned, our continued investments in our long-term growth initiatives.

Last year, our GAAP SG&A percentage was 36.5 percent and on a year-to-date basis SG&A was 37.5 percent and flat with last year's comparable results.

GAAP SG&A was 37.8 percent last year.

As Larry and Jim mentioned, we have adjusted our expenses for the balance of 2004 based on a 3 to 4 percent comparable store sales level which we anticipate will produce negative leverage of SG&A expenses of approximately 20 to 40 basis points for Q3 and Q4.

These projections reflect continued investments to drive the business including remodels, new commercial programs and initiatives to increase our inventory availability as well as continue anticipated higher medical costs.

As we enter the third quarter, we begin to anniversary the increased level of advertising and plan to maintain this increased level as a percent of sales going forward.

We believe that this investment has increased our brand and is important to building our long-term brand awareness.

Our customers are gaining confidence in us and know that for the best parts, people and prices, we're ready in advance.

Our operating margins rose 32 basis points during the second quarter to 10 percent versus last year's 9.7 percent on a comparable basis.

Last year our GAAP operating margins which included integration expense was 9.4 percent.

Year to date, operating margin increased 8.9 percent or 39 basis points from last year's 8.5 percent on a comparable basis.

Last year, our GAAP operating margins which included integration expense was 8.2 percent.

Our interest expense declined to 4.5 million in the second quarter compared to 7 million last year.

During the quarter we continued paid down debt and enjoyed the benefits and overall lower debt level versus last year.

Our tax rate for the quarter and year to date was 38.5 percent and we anticipate that approximate tax rate for the remainder of 2004.

Earnings per diluted share rose 16.7 percent to 70 cents in the second quarter versus our comparable earnings per diluted share of 60 cents for the second quarter of last year.

In 2003, our GAAP earnings per diluted share were 58 cents and included 2 cents of integration expenses.

I will now review the key components of our balance sheet and cash flow statement.

CapEx for the second quarter was 55.1 million, up to due to the purchasing of the land and building of our distribution center in the Northeast and we remain on scheduled to open this facility in the spring of 2005.

Year to date, our capital expenditures were 87.1 million.

We continue to project that our capital expenditures for 2004 will be approximately 180 million which includes $50 million for the Northeast distribution center.

Our net inventory, which is inventory less Accounts Payable, increased only 6.4 percent to 519 million versus a 9.8 percent increase in sales, as our Accounts Payable inventory ratio rose to 56.3 percent from 54.8 percent last year.

These results include our vendor financing program that was launched at the beginning of the year and has been broken out separately on the balance sheet as Financed Vendor Accounts Payable.

The program has continued to grow and it currently has 40.2 million outstanding, up from 32.5 million at the end of the first quarter.

Under our current banking agreements we have the opportunity to take this program up to 50 million this year and 100 million next year.

We are evaluating opportunities to further expand this program given its strong ramp up.

Year today, will produced 122.4 million in free cash flow and paid down 110 million in debt.

We continue to feel confident that we will achieve 130 million of free cash flow target for 2004.

Although we are very close to our free cash flow target for 2004, please keep in mind the seasonal nature of our working capital needs as well as the planned 93 million in capital expenditures for the remainder of the year.

Our total long-term debt at the end of the quarter was down to 335 million compared to almost 1 billion at the end of 2001, and our debt-to-cap ratio was 30.6 percent.

Due to the strength of our balance sheet and strong free cash flow, we feel confident that we have the opportunity to continue to increase our investments to grow our business as well as to buy back our stock at attractive valuations.

In the near-term we anticipate using free cash flow and availability under our credit agreement to buy back shares.

We currently have 87 million available in fiscal 2004 for share repurchase under our existing credit agreement.

We are also evaluating the opportunity to modify our existing credit agreement to provide us the flexibility to further accelerate the share purchase program, if we so choose.

As a reminder, in regards to the guidance Larry provided, when putting together your fourth quarter models you need to take into consideration the fourth quarter of 2003 included an additional week producing approximately 7 cents in diluted earnings per share.

Our fourth quarter guidance of 42 to 46 cents translates into a 10.5 percent to 21.1 percent increase over last year's diluted earnings per share from continuing operations.

Additionally, the guidance that Larry provided does not include the impact of a share purchase program nor any costs associated with modifying our credit agreement.

Again, as we noted earlier, our results including a complete reconciliation of our GAAP and comparable results for 2003, are available on our press release, 8-K filing and can be found on our website at www.AdvanceAutoParts.com.

Now I would like to turn the call back over to Larry.

Thanks Jeff.

A few weeks ago, Darren Jackson, Chief Financial Officer of Best Buy, joined our Board of Directors and will serve on our audit committee.

His background in finance, accounting and retail will augment our already strong and independent Board.

We look forward to his many contributions.

Before we open up the floor to questions this morning, we would like to reiterate our commitment to meet our long-term goal of getting to 11 to 12 percent operating margins in 2007.

We will accomplish this task by continuing to find opportunities to serve our customers better and more effectively.

Needless to say, we cannot achieve this goal without a dedicated and talented team.

I would like to personally thank each and every one of them for their hard-work and determination to serve our customers better than anyone.

Thank you team.

We look forward to sharing our team's accomplishments with you on future calls.

Operator, will you please pool for questions?

(OPERATOR INSTRUCTIONS).

Alan Rifkin with Lehman Brothers.

Thank you very much.

Hello gentleman.

Couple of questions.

In kind of dissecting your guidance for the second half, if you were proactively going to address your expense structure and you're still planning for a 3 to 4 comp in the second half, can you maybe just provide a little more color as to why, even with that comp, you're still seeing negative leverage on the SG&A line?

Alan, I think it is just safe to say that we believe investing for the long-term is the prudent thing to do.

We are in the midst of doing certain things, from IT to rolling out a stronger efforts in our commercial, the remodeling program, the relocation program.

We're still right on track and we're not going to change our goals to open up the new distribution on the Northeast in the early part of '05.

There are just so many initiatives we are in place with now.

We believe it is the prudent thing to do and take a reasonably responsible risk relative to growing our business long-term and growing the comp that can come as a result of it.

So Larry, you do think like in hindsight looking back on the second quarter, any sort quantification as to how much you believe weather hurt you?

I know you said earlier in the call that you did not believe higher gas prices were crimping your business.

Do you believe that it is mostly weather-related or is there something deeper with respect to the consumer that you are seeing in your business?

Alan, I think Jim said it best, we're not going to try to be economists and I know there's a lot of things going on.

We've heard a lot of different remarks from different retailers.

We can't control that part of the universe around us, but we know that car parts, SUVs like pickup truck parts, are not like fine wine.

They don't get better with time.

They all fail eventually to some degree.

There will be pent-up demand.

We believe that is going to come back.

But what has caused the sudden fall off in the last few weeks of the second quarter, I think is a combination of all of the above that has been reported by many retailers across the board.

How long that is going to continue, we can't tell you.

We can only tell you what we are focused on and what we have covered in our call today.

Please bear in mind though Alan, we have seen this before.

This is not new to us in the company.

It is not new to us in the industry.

We've been through this many, many times and we have seen it come back and we can recite times in 2001, and we had 2003 that had the same problems in different periods or different quarters.

But over time it comes back.

Eventually the weather abates, eventually people get used to whatever gas prices there are, and people just continue to drive.

The vehicle is something that people consider a necessity in their everyday life.

We believe that over time, I cannot tell you the week that is going to be, but this will abate and our DIY comps, as well as our commercial comps, will just continue to go back to historical levels.

One more question if I may Larry.

Obviously, the weakness is more so on the retail side of the business.

Are you contemplating any new marketing strategies or advertising programs to kind of target that customer in the second half of the year?

We think just refining the plan that we have in place is the best way to optimize the investments we have already made or are in the process of making.

Clearly our targeted Hispanic advertising, and many of the things that we have got in place right now Alan, in the lifecycle of the initiatives that we're working on, we are in early stages of them and for us to be suddenly changing course isn't good for our customers nor our team members.

We have laid out a very long term strategy structure, execution plan for the company.

It is not as if we are not flexible.

As we indicated on the call, we are making prudent adjustments delivered within the numbers that we gave in the guidance we gave on the call.

But we do think we are in this for the long-term and that we're doing the prudent things to maximize the long-term investments in the Company.

Bear in mind Alan, the number one upside that this Company has is raising the sales productivity of every one of our stores.

Thank you very much Larry.

Bill Sims with Smith Barney - Citigroup.

Good morning.

You've done a phenomenal job growing your commercial comps in such a tough environment, but as we start cycling into and expanding new stores into existing markets are we going to see the percentage of the total commercial program as well the (indiscernible) stores start to decelerate and have less of a role on the overall business?

We see the opportunity long-term to continue to grow our commercial business consistently.

I mentioned in my comments that we have grown our number of stores from 60 percent to 70 percent that have programs.

We will never be at 100 percent but we will be significantly north of where we are today.

So we have opportunities to add a lot more programs yet.

But just as importantly, the programs that we have out there are relatively young still.

We have added a lot over the past year, 18 months.

They are early in the maturity curve, they are going to continue to grow.

We have a great team in place to drive the commercial business, both at the corporate level as well as the commercial and store level.

And as we work through and look at the future we have our plan laid out which will continue to allow us to grow that commercial business at a very significant pace and do it across our entire company.

Thank you.

One quick follow-up question.

If the areas of the country that were not experiencing poor weather over the past quarter, can you give us any color about how those comps were trending relative to the Company plan?

We don't give out by region, but yes, we have seen some difference.

There's no question about that, but we prefer for competitive reasons not to break out the comps in different regions of the country.

Thank you Larry.

Danielle Fox with Merrill Lynch.

Good morning.

A couple of questions.

First, are planned spending levels for the second half higher now than they were at the beginning of the year?

No, Danielle, our planned spending levels are not.

As we said on the call we're adjusting our spending levels in line with the 3 to 4 percent comp guidance that we gave.

Having said that, we do intend to continue as we have talked about to invest in some of our long-term growth initiatives that were already planned for the back half of the year and we're going to continue to do that, although we are adjusted prudently some of our other controllable expenses relative to the new comp guidance.

I guess what I'm trying to understand is a 3 to 4 percent comp on the back half would put you at roughly a mid single digit (technical difficulty) comp store the full year which is in line with your prior guidance.

So, I am wondering why you tweaked down the estimate for the full year?

Is it that you needed mid single digit (technical difficulty) comps every single quarter?

The answer to that would be yes.

So, is 5 percent plus the level at which you should achieve leverage (technical difficulty) you think about the occasional (technical difficulty) upside to the model in the back half?

In the 4 to 5 percent range.

4 to 5 percent.

Correct, and as we said earlier in the call, we will prudently evaluate this on a week-to-week basis.

There is no question that we did not reign in some controllable expenses when the sudden fall-off came.

But clearly as we go through the back of the year we will be very intensely watching all of our controllable expenses so that we can maximize the opportunities at hand and the fall-through to profit.

But on the other hand, we are with reasonably aggressive direction, encouraging our people to take the opportunity that is out there right now to grow market share in every state that we are in.

Just a final question on the free cash flow outlook.

You mentioned that your (technical difficulty) planning estimate.

I was wondering, was that in your (technical difficulty) guidance for free cash flow?

And if not, is there an (technical difficulty) benefit somewhere else on (technical difficulty).

Danielle, you were cutting in and out.

Can you run that by us one more time?

It's very difficult to hear you.

Sorry about that.

You reiterated your free cash flow target of $130 million for this year.

You're making some incremental investments in inventory.

I'm wondering if that was in your initial plan or if there are offsets somewhere else where you're seeing benefits.

Just as a detail, are you including the vendor financing that is treated as a long-term liability in your working capital calculation for free cash flow target?

The answer to that is, yes, Danielle.

It does include the inventory investments but they were already in our initial plan, and we are including the vendor financing program as a working capital initiative internally.

Thanks very much.

Dex Blassett (ph) with Gates Capital Management.

I just had a lot of questions.

I understand that you are including, I guess you're including the full 50 of the program, the vendor financing?

Yes, we anticipate to fully fund that and have that up by the end of year as we move to the back half of the year.

Okay.

Then if I look at the calculation from your calculation of 122.4, it looks like you're also including property sales in that free cash flow number?

Yes we are.

We're doing cash flow from operations less investing activities which is the CapEx minus the sale of excess profit.

Do you contemplate -- I forgot how many more do you have to sell this year?

We will continue to periodically sell some excess real estate.

We've done that consistently.

Most of the real estate that we have that we have sold is property that was acquired as part of the discount auto parts acquisition or one of the other acquisitions, and as we sell those they do flow through the cash flow, but that has been fairly consistent over the last year or so.

So, if I assume double the first half, that would be a good estimate?

It probably would be relatively close.

In the ballpark, yes.

Okay.

Thank you.

Michael Weisberg with ING Investment Management.

Good morning.

Can you help me with a couple of things?

The comp guidance for the second half, what is the implications for the DIY business in the second half?

Should we assume similar comps through the second quarter or any improvement?

What is embedded in the guidance?

Continuation of our existing trend, basically.

Which would be you the -- you commented about a 2 percent DIY comp, something like that?

Yes, in that range.

So a 2 percent comp, okay.

You have some unusual advertising expenses this year, which you talked about, that sort of bring you up to a new level.

Beyond this year what kind of comp guidance, comps do have to generate in total in order to be sort of, to be neutral in terms of SG&A leverage?

In the 4 to 5 percent range, Michael.

You need 4 to 5 to be sort of neutral.

Below that you deleverage it, above that you improve?

I think we will be providing additional guidance certainly on the 2005 year on our next call in more detailed, but it is directly related to what how, as Larry said, how aggressively we invest in the business and how we manage that mix.

In today's world in terms of what we're investing, it's in that 4 to 5 percent range.

What is the implications of accelerated commercial growth relative to DIY in terms of your margins?

I'm trying to remember how the commercial business stacks up versus DIY in terms of SG&A and gross margins?

In the gross margin area of the commercial business it is just slightly lower than the total business, the DIY business, and we have seen that continue to be the case.

As Jeff reported, our gross margins grew strongly in the second quarter even with the growth in commercial, so I think our team is managing through that very well.

From an SG&A standpoint, the commercial business is incremental for us because as we add programs and grow the business, the fixed costs of the business are in place and we have an opportunity to add more store -- volume to the stores without having a significant change in fixed costs.

Having said that, we have aggressively ramped up our commercial programs and when we roll out commercial programs there is some incremental net effect from an expense standpoint as we do that.

But, as the programs are in place and they mature they are very accretive to our business.

Does that mean that the total operating margin contribution is the same or higher as the DIY business when you factor in the leverage?

Yes.

Great.

Did I hear you say, Larry or Jeff, that the 2010 stores are comping double-digits?

Where we do the major market conversion, that is correct.

Okay.

Because you already, what, a third or more of the stores in the 2010 program?

We have over 900 in the program currently.

Keep in mind that that 900 we got to in three ways.

We have remodeled a lot of stores, we also have opened all of our new stores for the last couple of years with that format, as well as relocation.

So it is sort of, in the major markets you did a first-year benefit of a double-digit comp?

Yes, we remodel an entire market and the process we go through is, we remodel every store in a market, we take a look at our entire operation in that market, and then we re-grand open the market and when we do that, we have seen a sustainable double-digit comp increase and that continues.

It is not a one year thing that goes away.

It raises our base in that market for us to build on as we go-forward.

I see.

That's great.

You guys did a good job on this call in a tough environment.

Thank you Michael.

Bear in mind that those are the issues that we hopefully clarified on the call relative to the investments we are making in the company because clearly at the time we remodel the stores, relocate the stores, convert the stores or have the conversion in a major DMA (ph), we certainly don't get the return back in the quarter that we do it in.

But over time, it makes '05, '06, '07 certainly become our friend.

Great.

Thanks a lot.

Thanks Michael.

Ken Forman (ph) with Omega Advisors.

Good morning.

Larry, what is the timing on the -- for the store buybacks?

And I have a second question please.

Sure.

I'm going to let Jeff handle the (indiscernible) exactly what we're doing with the stock buyback.

He is leading the effort.

Ken, as I spoke about in my comments, we currently have 87 million available to us under our current facilities and would anticipate, given the attractive valuation of our stock, trying to get that program up and started sooner than later.

So we are moving forward with that and would like to take advantage of what we proceed to be attractive valuations today and we have up to 87 million available to us.

And as I said earlier, we're looking potentially at modifying our credit agreement to allow us to even further accelerate that in the back half.

Great.

Thank you.

The second question, how should we think about the long-term EBIT margins?

You stipulated the long term target of 11 percent to 12 percent.

And how we should conceptually think about the next year?

Again, we've had no change in our long-term plans, our goals and objectives.

I think we are still working our long-term strategy and anticipate being in the 11 percent to 12 percent range in 2007.

What we think, Ken, is we have consistently grown the operating margins every year and our intent from the beginning was to do that in such a way that it was sustainable and gave us the base from which to grow the next year.

We will go, again, in a more specific discussion about 2005 on our next call.

But as Larry said, we're on track and fully anticipate continuing to grow that margin and reach that objective.

Thank you.

One thing that I would like to just say in addition to both Jeff and Jim's remarks, please bear in mind that the initiatives that we covered during the course of a call, category management, I don't want to go through them all again, but bear in mind we're in the early innings of those initiatives.

I think that you will see why our team shares the enthusiasm for the long-term future of our company as we work through the investments we're making today.

Thank you.

Thank you.

Jack Bellows (ph) with Midwood (ph) Research.

First I have a question for Jeff and that is, you have an idea in terms of a stronger seasonal week, how much additional sales you got in terms of the percentage gain in sales because of that week for the quarter?

Could you just repeat that again?

Are you talking about the fourth quarter?

I'm talking about the second quarter which ended a week later than last year.

So you have -- that additional week, I think was seasonally stronger than the same -- you want to compare the exact same weeks versus a year ago.

Jack, this is the same conversation we had in the first quarter call, in that our comps are being calculated on the --.

I'm not talking about the comps, I'm talking about total sales?

Total sales.

Yes, the total sales are being calculated on obviously the fiscal 12 weeks this year compared to the fiscal 12 weeks last year.

And if you're talking about the mismatched weeks in terms of the 53rd week delaying everything this year a week, the impact of that would be less than 1 percent.

Less than 1 percent.

Because I think it was more than 1 percent in the second quarter.

Yes.

Okay, so it's a little bit less than 1 percent?

Yes.

I wonder if you could clarify again, in the second quarter you were up 30 basis points in SG&A on a 5 percent comp.

Is that primarily all due to the additional advertising expense or is it some other things?

The answer to that is no.

Jack, simply put, we did not do as a good job as we had the opportunity to do to reign in some of our expenses.

We have a commitment of resolve and accountability on the part of our operational team that the things that effect us the most, payroll in the stores, in the DC's and the like in our supply chain.

We could have done, we could have clearly done a better job of managing some of that.

Bear in mind, and again, I will be the first to admit that we fell on our face, not backwards.

We are going into our peak selling season, and it was a rather abrupt change in the comp run rate and we were slow in making the appropriate adjustments.

Okay.

In your comp store base, do you have an idea of what percentage of the stores that are in your comp store calculation base, would be 2010 stores?

Jack, we don't have that number in front of us.

If Jeff perhaps you could get back to Jack and make that a follow-up.

We don't have that number in front of us Jack.

I don't want to guess.

Just one last thing in terms of the economic environment.

Wal-Mart was up, Wal-Mart stores about 3 percent comp for the quarter, and they are forecasting about the same thing going forward in their third-quarter and probably a good portion of the benefit was that the do a lot of business in food.

So since you sort of share the Wal-Mart lower income customers in DIY, wouldn't you say that is affecting your business somewhat?

Jack, I think we do share from a social economic standpoint, much of the same customer base, no question about that.

On the other hand, the demand for the products they're selling versus ours is a bit different in so much as the ratio of our sales that are from catastrophic failure.

Okay.

But I think it is possible for people in lower income brackets who are being impacted by higher inflation to do as you say which is defer purchase for a while.

To some extent that can be done, yes, and we've seen that many times over the years, and we can recite times where we have seen it for weeks.

We have seen it because of weather, we've seen it because of economy for a quarter or for a longer period of time.

But over time you see what our numbers have been and you know the kind of strong comps this company has generated over the last five or seven years.

In our business that repair still needs to be done even though it may have been deferred for a period of time.

Right.

Thank you.

(OPERATOR INSTRUCTIONS)

We have time for one more question, operator.

Armando Lopez with Morgan Stanley.

Good morning.

Just a quick question.

We're starting to hear some rumblings, with raw material prices increasing, about vendors raising prices.

I was just wondering if you could maybe comment on what you're seeing and if prices do go up, how easy is it or how flexible is it to pass those increases onto the consumer?

We have not seen anything of any significance come through.

Our team is doing a great job of working with our suppliers and as Jeff had mentioned in his comments, we're still seeing LIFO credits which in effect means overall our pricing is still improving.

If there were to be significant changes in commodity prices, certainly we would still feel good about meeting our gross margin objectives in that regard, as well.

Okay.

With respect to gross margins, how much more opportunity is there?

Is, I guess, the category management in China the main driver still?

Category management at large.

I would not attribute it to China by any stretch of the imagination.

It's a process by which we're working very close with our vendors in the development of specific (indiscernible) numbers and contribution yield numbers by category, by productline.

We're changing productlines, changing suppliers.

We are in the very early stages of maturity rate of this.

This is something that will go on for years.

You saw the improvement that we had, the 62 basis points, in the last quarter.

We believe that it's going to be a fundamental driver to enhancing our gross margins, but more importantly, enabling us to drive the topline.

Okay.

Thank you.

Operator, one more question, I think we have time for.

Alfred Lockwood with Roxbury Capital Management.

You mentioned that the noncore items in the store hurt the DIY comp more than your basic product I guess.

Can you elaborate on that?

We didn't, I don't think we said that.

Our comments were that we're consistently sticking to our core business, which is auto parts and accessories and any noncore items in our stores had a negligible effect on our comps in total.

Okay, I must have misheard you.

It's very important you realize that our comps that we are seeing and have been seeing are coming from our core business.

If you go in our stores, you'll see that laid out in our marketing and merchandising initiatives.

Everything that we're doing is driving the core aspects of our business.

Very good.

Thanks.

Thank you.

I would like to take opportunity to thank you very much for participating on our call today.

Ladies and gentlemen, this concludes your conference call.

You may now disconnect.

Good day.