領先汽車配件 (AAP) 2005 Q2 法說會逐字稿

Welcome to the Advance Auto Parts second-quarter 2005 earnings conference call.

Before we begin Adam Bergman, Vice President of Investor Relations will make a brief statement concerning forward-looking statements that will be made on this call.

Good morning.

Certain statements contained in this conference call are forward-looking statements as that statement is used in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements address future events, developments or results and typically use words such as believe, anticipate, expect, intend, plan, forecast, outlook or estimate.

These statements discuss, among other things, expected growth and future performance including comparable store sales, sales per store, operating margin, free cash flow, return on invested capital, inventory growth and earnings per share for third quarter, fourth quarter and fiscal year 2005.

These forward-looking statements are subject to risks, uncertainties and assumptions including but not limited to competitive pressures, demand for the Company's product, the market for auto parts, the economy in general, inflation, consumer debt levels, the weather and other factors disclosed in the Company's 10-K for the fiscal year ended January 1, 2005 on file with the Securities and Exchange Commission.

Actual results may differ materially 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 can be found in our press release and 8-K filing which are available on our website at www.AdvanceAutoParts.com.

Before I turn the call over to our President and CEO, Mike Coppola, let me briefly highlight a change we'll be making or future quarterly releases.

Beginning next quarter we will issue our earnings press release on the same morning as our conference call to better synchronize the timing of these two related events.

We will continue holding our earnings conference call at 8 AM Eastern time with the earnings release being distributed earlier the same morning.

For planning purposes our third-quarter release and conference call are both scheduled for the morning of Thursday, November 3, 2005.

To be notified of the dates of future earnings reports you can sign up through the Investor Relations section of our website.

On a separate matter, we look forward to seeing you at our annual investor conference next Wednesday in Charlotte.

For those of you who are not able to attend, we will be webcasting management's presentations and the question-and-answer session live next Wednesday and on a replay basis thereafter.

If you are planning to attend, please be sure you've registered with us so we have an accurate headcount.

And if you'd like more information about the event, please contact Susie Mason at 540-561-8451.

With that I'd like to now turn the call over to Mike Coppola.

Good morning.

Welcome to our second-quarter conference call.

Joining me today are Jim Wade, our EBP of business development and Jeff Gray our CFO.

Let me first begin by thanking our team for their outstanding performance.

In particular I'd like to highlight our store operations group led by Paul Klasing and our four SVP's of operations for driving excellent improvements in store standards and for our third consecutive quarter of 9% or better same-store sales growth.

I am very pleased to report that as a result of executing a number of our new initiatives that our sales momentum continues.

As evidenced by our 9% same-store sales increase for the quarter on top of the 5% in last year's second quarter, with such solid top-line results we were able to leverage many of our fixed costs while continuing to invest further for our future success and drive robust bottom-line performance.

I'm also pleased that we saw both gross margin and SG&A improvement.

For the quarter we achieved earnings per diluted share of $0.90.

This is a 28.6 increase in EPS compared to the $0.70 we earned in the same quarter last year.

These results confirm that our initiative to drive sales and profitability are working and we continue to gain market share while growing our profitability.

We believe we are very well-positioned to continue our strong growth.

In a few minutes Jim will review our sales results in greater detail; he will also elaborate on our recently announced acquisition of Lappen Auto Supply in the Greater Boston area.

We took an opportunity that gives us instant scale in a strategically important metro market.

We continue to focus on four key goals -- one, raising average sales per stores; secondly, expanding operating margins; third, generating strong free cash flow; and fourth, increasing our ROIC.

Most of you on the call are familiar with a host of merchandising initiatives that are helping drive footsteps into our stores and more purchases to our cash registers.

In the interest of time I won't review in great detail some of the high initiatives -- high level initiatives we've implemented such as category management, but we'll be glad to answer any questions you have about these programs which continue to help us deliver the products our customers want in the stores where they're needed.

Frankly, category management isn't really an initiative any longer.

Instead it's become ingrained in our culture and our way of doing business as Advance focuses on being a merchant driven organization.

I'd like to spend most of my time this morning discussing some of the new programs and initiatives that have been rolled out to our stores lately.

For example, direct importing.

We are always looking for ways to drive better values for our customers.

In the past we've talked about a number of proprietary brands such as Joe's Garage, Mechanic's Choice, Endurance and Professional's Favorite.

These brands among others are part and parcel of our direct sourcing approach.

When we can go to the Orient or elsewhere and have product manufactured directly for us at a significant savings relative to the national brand we will do so.

Of course our approach is to put quality first, so we'll only import items that meet our demanding expectations for durability and performance.

Factory direct ordering, or FDO, this program officially launched last week.

We will build our offering by year-end to approximately 250,000 SKUs that customers will now be able to order at our stores directly from the manufacturer, everything from accessories to hard parts.

We've rolled out a special in store fixture to help promote this new program.

Local purchasing or LPO.

LPO enables our stores to locally order over 350,000 SKUs directly from local suppliers.

This program will help us to be in stock more often on items that we don't stock in our distribution network enabling us to better service -- provide better service to both our DIY customers and especially our time sensitive commercial customers.

Salvage yard body parts.

During the second quarter we began a rollout of a new salvage parts sourcing program providing approximately 650,000 SKUs to customers on a special order basis.

These include parts such as replacement bumpers, body panels and light assemblies.

Through this program we are now offering our customers the ability to repair vehicles that have had a fender bender or otherwise need salvage parts.

This program is now in all stores and is especially attractive from a working capital standpoint because we have no inventory investment associated with it.

These various initiatives, direct sourcing, FDO, LPO, salvage body parts and others, are focused on taking product that would otherwise be deep in our supply chain and putting it closer to our customers to drive customer satisfaction and sales.

Aside from our merchandising initiatives, our work toward being a premier operator of retail stores is a never-ending job.

Our store indices in-stock level continues to be a key focus area or us and we are achieving very strong levels of performance on these metrics on a consistent basis.

Again, it's all about being in stock on the particular items the customer wants, so ensuring our shelves are full is one of the most effective ways we can better serve our customers.

We also know the best way to improve various aspects of store operations is to measure them and rate our stores' performance.

Today in addition to in-stock percentage we measure countless other elements of each store's operations including cycle counts, shrink, labor effectiveness, the number of ASE certified team members and many, many other metrics.

As mentioned in our last call, we had a record number of applicants for the spring ASE exam and those results are now in.

Congratulations to all of our team members who passed this rigorous test.

I am pleased and very proud to say that we have a record level of ACE certified team members per store and are committed to growing these numbers even further.

Many customers recognize that the ASE certification means expert device.

Our ASE certified team members have both superior parts knowledge and the customer's confidence that they'll diagnose their needs correctly.

We'll continue to set the bar successively higher for all the metrics we measure to ensure Advance is best in class both in our eyes and in our customers.

We continue to see excellent results from our 20 ton format stores.

Many of you have seen these stores which look very, very different from a typical auto parts store.

Our comprehensive approach to remake our stores both inside and out has resulted in bright, attractive and eye-catching stores that customers increasingly are choosing to shop.

At the end of the second quarter approximately half our chain is operating with this new format.

We will continue converting our stores to the 20 ton format over the next several years until all stores are converted.

Our market by market conversion approach continues to produce strong sales increases in the first year post completion and our class of 2005 new stores is on track to produce a record level of new store performance.

In the past we've talked about investing in high ROI projects including test equipment to help us reduce our battery warranty expense.

This is an excellent example of how category management is helping us.

Our partnership with our vendors in this case led us to recognize that our battery defect rate was higher than industry average and set us on the track of identifying ways to improve it.

I'm very pleased to report that through the use of this program and our team's disciplined execution we achieved a record low battery defect percent in the second quarter.

The consistent execution of our commercial program is still driving very robust comps.

We continue to add delivery programs in stores where we see potential to serve commercial customers.

Jim will talk more about the success of our commercial business which we attribute to a very focused strategy.

We're arming our commercial sales team with the tools they need to target the right customers and exceed those customers' expectations for service, quality and competitive prices.

We foresee our approach continuing to produce double-digit comp increases into the future.

Our focus on making our supply chain more responsive is helping us ensure we have the right parts our customers need in a cost-effective manner.

As many of you know, we opened our eighth distribution center last quarter near Allentown, Pennsylvania.

Thanks to Roy Martin and our logistics team, this facility has ramped up more smoothly than any DC we've ever opened and is now supporting over 250 stores, improving our service levels while minimizing the cost to reach stores in the Northeast.

Our existing DC network gives us ample capacity for the next several years and we expect our logistics area to be a source of margin improvement for the foreseeable future.

The implementation (ph) of our initiatives our industry dynamics are strong.

With more vehicles on the road than ever being driven further than number conditions are ripe for auto parts wear and failure.

These trends have been in place for several years now.

We continue to grow our share within a growing market.

The combination of this industry tailwind and our Company specific initiatives gives us continued confidence that we will drive annual earnings per share growth of 20% or more for the next several years led by attaining our goal of 11% to 12% operating margin by 2007.

We will achieve this goal by remaining disciplined, investing or the long-term, and staying committed to operational excellence.

We are confident in our ability to achieve our goals and our Board of Directors affirmed its confidence with its approval of a three for two stock split to stockholders of record as of Friday, September 9th.

We expect these additional shares to be distributed on Friday, September 23rd, and our stock will begin trading on a post split basis on Monday, September 26th.

We are reiterating our guidance for the third quarter of $0.78 to $0.83 for earnings per diluted share on a pre-split basis or $0.52 to $0.55 after the pending three for two split which would represent a 15% to 22% increase in EPS over last year's third quarter.

From a sales perspective we were hurt last year by four hurricanes hitting the Southeast.

As we cycle last year's 3% comp increase, we are expecting a strong comp quarter.

With these first three weeks of this quarter we have seen solid sales trends.

Keep in mind that we will be slightly more difficult margin comparisons as a result of mix caused by last year's cool weather and hurricane impact.

In addition, we manage variable SG&A expenses unusually tightly because of the hurricanes in last year's third quarter.

As well, this quarter we will continue investing, as we have in the first two quarters, for the long-term.

We will also be anniversarying the logistics improvements made a year ago.

Finally, because of stock price appreciation and significant option exercises, we expect our weighted average share count to be higher than it was in the first or second quarters.

For the fourth quarter we are initiating guidance in a range of $0.50 to $0.54 or earnings per diluted share on a pre split basis or $0.33 to $0.36 after the pending three for two split, which would represent a 16% to 26% increase compared to last year's first quarter.

In the fourth quarter we will be up against our best sales comparison from last year when we produced a 9.7% comp increase.

Again, keep in mind that we are up against tougher merger comparisons in the back half of the year.

For the second half of the year we expect comps to be in the range of 7% to 8% with comparisons being easier in the third quarter and of course more challenging in the fourth.

Based on the upside of our first-half results we are raising our guidance for the 2005 year to a range of $3.12 to $3.18 per diluted share on a pre split basis or $2.08 to $2.12 after the pending three for two split.

This would represent an increase of 25% to 28% for the year.

We continue to see opportunities to improve our gross margin percentage and leverage our SG&A expenses while continuing to invest for the future resulting in another year of healthy operating margin improvement.

In summary, we continue to make solid progress toward our four key goals -- raise average sales per store which are at a record level and are approaching industry leading; expanding our operating margins, which continues to climb toward our goal of 11% to 12% by 2007; generate strong free cash flow, 13% higher in this year's first half compared to the same period last year; and increase our ROIC which we have accomplished by driving superior returns on the capital we've invested to grow our business.

And we continue to see significant opportunities to improve these metrics in the years ahead.

Now let me turn the call over to Jim.

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

Let me now review in more detail the sales results achieved by our team in the second quarter.

As Mike described, our strong sales continue to reflect the combination of solid industry fundamentals and the strong results from the key initiatives we're implementing.

Our sales rose 12.6% compared to last year's second quarter.

Comparable store sales increased 9% over a 5% increase for the same quarter last year.

For the first half of the year sales rose 12.3% on a comparable store sales increase of 9.1%.

We saw solid increases in both DIY and commercial in the second quarter with DIY producing 4.9% comps while commercial had another very strong quarter with a 27.1% comp.

For the first half of the year DIY comps were 5% while commercial comps were 27.2%.

During the quarter both higher customer count and increased average transaction contributed to our comps.

Also, we experienced solid comps and market share increases across all areas of our Company in the quarter.

We remain focused on our core business of auto parts and accessories to drive our same-store sales growth and no merchandise categories contributed significantly to this quarter's sales increase.

We believe the primary driver of our DIY increases for the quarter was the continued and consistent execution of the initiative that Mike described earlier and we're now starting to see their benefits accelerate.

Our sales building initiatives are benefiting both comp and new stores performance.

New store productivity is at a record high.

Also our average annual sales for all of our stores on a trailing 12 month basis now exceeds $1.5 million for the first time in our history.

As we've discussed in previous quarters, we believe the tremendous results in our commercial program are due to the disciplined execution of our commercial plan.

We are very focused on the customers that fit our model as opposed to letting our customers cherry pick us.

By that we are primarily targeting independent garages and service stations that specialize in vehicle repairs.

These customers generally don't stock their own parts inventory and rely on commercial vendors like Advance to meet their needs for parts like break pads, starters, hoses and belts.

We're equally aware of which types of customers not to target -- garages that are too distant from our store for example or customers that desire only low margin commodity items.

Through this focus we've built a very rapidly growing and strongly profitable commercial business.

We provide a very compelling value proposition to our customers through a combination of a huge customized assortment of product to need the diverse needs of different customers -- quality parts with an emphasis on the brands they trust; a knowledgeable team, as Mike mentioned, more ASE certified professionals; excellent service including efficient delivery to commercial accounts; and of course competitive prices.

During the quarter we added 71 new commercial programs to our stores, approximately half from new stores, bringing the total number of stores with commercial programs to 2,072.

Today nearly 77% of our stores have commercial delivery programs compared to 70% at the same time last year.

Our commercial sales as a percent to our total sales was 20.9% for the quarter compared to 18% in the same quarter last year.

We continue to expect double-digit comps in our commercial business for the foreseeable future as our existing programs move up the maturity curve and we have more programs.

On a trailing 12-month basis we've now surpassed the $800 million mark for commercial sales and we now believe we'll exceed our goal of $1 billion in commercial sales in 2007.

We believe we have tremendous potential in each of our markets to grow our share of the commercial business very profitably as we look for opportunities to deploy our capital.

Keep in mind that as strong as we've grown this business over the past several years, we still command less than 2% market share in what's still a highly fragmented industry.

From a macro perspective let me address our view of the automotive industry today.

Many of you know that various automotive manufacturers and stimulated new vehicle sales through employee pricing promotions over the past month or two.

While we're keeping an eye on it, at this point we don't believe these aggressive pricing efforts temper the very positive industry dynamics that Mike discussed earlier.

We believe consumers are benefiting through lower prices on vehicles they likely would have purchased anyway.

And there may be some marketshare shifts taking place with the aggressively priced makes and models winning at the expense of less sharply priced vehicles.

Keep in mind, too, that many of our core customers are in a lower middle income demographic and usually don't react on impulse to promotional activities on new vehicles.

Instead, they are typically the secondary or tertiary owner of the vehicle they drive.

So the new vehicle sales that GM, Ford and Chrysler are simulating are coming from consumers who can afford to buy a brand new car.

These new cars aren't often replaced -- are often replacing relatively young vehicles that may not even be in the high repair cycle yet.

So the number of vehicles in the six-year-old and older range remains at a record high today and these are the vehicles that are in our sweet spot.

This is the time in a vehicle's life when a number of parts and systems need to be replaced or repaired.

Moving on to our inventory investment.

During the quarter our sales grew by 12.6% while inventory grew by 11.6%.

Due to the strong comp in the quarter we were able to leverage our inventory growth nicely.

Over the 2005 year we still expect to continue to grow sales at a slightly faster pace than inventory.

Meanwhile we continue prudently use our capital to invest in inventory primarily by focusing on positioning parts closer to our customers by expanding the number of stores with carrying an extended mix of parts.

We believe this initiative is enhancing our brand in the eyes of the consumer because we have the right parts available at the right time for customers.

As Mike mentioned earlier, we believe we are well on our way to having the newest, freshest store base in the industry as we continue to open new stores and aggressively remodel and relocate our stores to our 2010 format.

We believe the capital we're investing in this area is a key driver of our strong sales growth and profitability and will continue to be in the years to come.

During the quarter we open 36 new stores and closed three stores bringing our total store count to 2,708.

For the first half of the year we've open 52 stores and closed six.

For the year we continue to expect to open 150 to 175 new stores which will result in 6% to 7% square footage growth for the year, an acceleration compared to last year.

Based on our recent acquisition of 19 Lappen Auto Supply stores in the Greater Boston area, we believe we will reach the higher end of this new store owning target for the year.

We have the infrastructure in place to continue delivering this level of higher new store growth for the foreseeable future.

Lappen, as we previously announced, gives us substantial density in an important metro market where it's a challenge to find quality real estate.

Their stores are well-run and well staffed and we very much welcome their team to Advance.

We expect to convert Lappen's 19 stores to the Advance 2010 format over the coming months and we believe the combination of our two company's strengths will maximize our share of this important market.

Keep in mind that we acquired Lappen after second quarter ended so it had no impact on the results detailed in today's press release.

Lappen is an excellent example of the tremendous opportunity that we see to invest in additional stores within our existing market.

Tuck-in opportunities like Lappen remain available and we evaluate these carefully as we make build verses buy assessments.

With that said, organic growth remains our key focus.

We believe new store growth is an optimal use of our capital, especially as our new stores sales continue to accelerate to a run rate of well over $1.1 million, up from 900,000 in 2001 and $1 million in 2003.

Our enhanced site selection process, our 2010 format, our national advertising campaign, and our opening of stores primarily in existing markets are the key drivers of the continued higher productivity and rates of return on our new stores.

During the quarter we also relocated 13 stores and 32 for the first half of the year.

For the full year we remain on track to relocate at least 50 stores or approximately 2% of our store base.

Store relocations remain a key part of our program to upgrade our store base and, with this high level of annual relocation activity, we ensure our stores are optimally located as our markets grow and change.

We are handsomely rewarded when we invest to reposition a store to a superior location.

Our 2010 market remodel program continues to be on plan and produce strong results.

For the first half of the year we've remodeled a combined 119 Advance and former discount stores.

We currently have just 35 Florida stores remaining to be converted and they will be completed before the end of 2005.

At the end of the quarter we had a total of 1,333 stores with the 2010 format.

As Mike mentioned, we now have approximately half our chain operating with this 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 remodeled stores continue to produce on average a sustainable double-digit sales increase as we convert by market and we believe our increasingly vibrant young store base will be a key driver of our sales growth for many years to come.

Now let me turn the call over to Jeff Gray who will review our financial results.

Thanks, Jim, and good morning.

Let may continue by discussing the remaining lines of our income statement as well as go into more details on our balance sheet and cash-flow statement.

For the second quarter our gross margin increased to 47.1% compared to 46.5% last year.

Our gross margin performance continues to driven by our category management and supply chain initiatives.

Our new distribution center in Pennsylvania which opened in March continues to be a source of cost improvement through the optimization of ton miles to our stores in the Northeast.

During the second quarter our SG&A expenses improved to 36.1% from 36.4% last year as we managed our expenses while continuing to invest in our business for the long-term.

We experienced positive leverage on labor and benefits as a result of our strong comp store sales.

During the quarter our team optimized our payroll investment to ensure our stores were staffed to provide appropriate customer service.

The strength of the quarter did result in team member incentives being higher than planned as many of our stores exceeded their plan for the quarter.

As expected, we continued to experience higher self-insurance and fuel costs during the quarter.

Operating margins rose to 11% compared to 10% in last year's quarter.

This is the highest operating margin percentage we have achieved in our public history.

Our full-year guidance implies a similar level of operating margin improvement for the year.

Interest expense net of interest income was 6.5 million in the quarter, up over the prior year due to higher interest rates and higher average outstanding debt levels.

Our tax rate for the quarter was 37.8% compared to 38.5% in the first quarter.

This reduced rate reflects a change in certain state tax rates and our ongoing tax planning.

As a result we now anticipate our tax rate to be approximately 38.3% for the remainder of the year.

Earnings from diluted share from continuing operations were $0.90, a 28.6% increase compared to $0.70 in last year's quarter.

For the first half of the year sales rose 12.3%, operating income expanded from 8.9% in last year's first half to 10.2% this year.

And diluted earnings per share of $1.84 is a 34% increase -- 34% higher than the $1.37 in last year's first half.

For the balance of the year our guidance is based on diluted share count of approximately 74.5 million compared to 73.6 million shares in the second quarter as a result of stock options already exercised.

In terms of the key components of our balance sheet and cash-flow statement, our inventory rose 11.6% year-over-year on a 12.6% sales increase resulting in improved inventory productivity.

Our Accounts Payable inventory ratio improved to 57.6% compared to 56.3% last year.

Our vendor financing program currently has 120.8 million outstanding and accounted for the majority of the increase in its ratio.

We continue to expect year-over-year improvement in the Accounts Payable inventory ratio has been moved to the balance of the year driven by continued growth in our vendor financing program.

Our total debt at the end of the quarter was 454 million and our debt to cap ratio was 34.3% which compares to 30.6% a year ago.

CapEx for the quarter was 60.3 million as compared to 55.1 million last year.

We now expect CapEx to be in a range of 200 to 220 million for the physical 2005 year.

These investments reflect our acceleration of square footage, increasing ownership of selected new stores and acceleration in our remodeling and relocation programs and continued investments to drive our sales and profitability and our recently announced acquisition of Lappen Auto Parts.

Free cash flow year-to-date is 138 million compared to 122.4 million in the comparable period last year due to the strength of our business and continued improvements in our working capital management.

Adjusting for our new CapEx guidance and the recent acquisition, we expect free cash flow to be in the range of 150 to 160 million for the year.

At the end of the quarter our cash balances stood at 176 million, significantly higher than the year ago.

In terms of using our cash, our strategy continues to be investing back into our business subject to our 15% after-tax hurdle rate.

If we exhaust those opportunities and there's still additional free cash flow, then we will look to deploy it in the most optimal way to increase shareholder value.

We continue to evaluate smaller private company acquisitions as we believe the current risk reward profile for these opportunities to more attractive than other public opportunities.

At our Board meeting yesterday the Board of Directors granted a new authorization for a 300 million stock repurchase program.

This replaces the $200 million authorization which was essentially completed over the past year having repurchased approximately 4.7 million shares at an average price just over $40.

The Company's financial flexibility is enabling us to accelerate our growth, invest in our business and return capital to shareholders.

Opportunistic share repurchases are among the ways we are driving higher return on capital.

Again, as Adam noted earlier, our results are available in our press release and 8-K filing and can be found on our website at www.AdvanceAutoParts.com.

Now I'd like to turn the call back over to Mike.

Thanks, Jeff.

Before we open the floor to questions this morning, we would like to reiterate our commitment to meeting our long-term goal of driving our annual earnings per share 20% or more for the next several years.

We will accomplish this task by investing to grow our sales per store and improving our operating margins by leveraging our gross margin and SG&A expenses.

I would also like to again congratulate our entire team at the store support center, in our logistics network as well as in the field for their continued support in driving Advance to be best in class.

We are now ready for questions.

Operator?

(OPERATOR INSTRUCTIONS).

Danielle Fox, Merrill Lynch.

I have a couple of questions about the gross margin.

Could you just outline some of the things that changed between the first and second quarter?

I know when you reported the first quarter you mentioned that a number of the things that drove the really large gross margin expansion wouldn't be repeated.

Can you tell us what helped in the first quarter that didn't help in the second quarter?

And what else might be changing over the course of the remainder of the year?

Well, Danielle, I think as we -- and you just stated also -- is as we mentioned in the first-quarter call, we had unusually low margin in 2004 and unusually high margin in 2005.

Basically the reason for the unusually high margin in 2005 were a number of factors as we outlined.

We were significantly affected by the weather that moved our mix to a much more profitable makeup of product.

We also had some very significant improvements in our logistics network that we began really in the fourth quarter of 2005 which really started paying big dividends in the first and second quarters of this year, but will moderate as we go throughout the year in the third and fourth quarter as well.

And then you mentioned a number of things that would help both the gross margin and the SG&A, leverage, when you think about that 11% to 12% goal for 2007, which line item do you see as the bigger contributor?

Is it the gross margin or the SG&A leverage when you look at for your long-term margin goals?

Again, I think the real key is what happens in total.

And it depends on the circumstances in the quarter -- we're affected by weather, we're affected by mix, we're affected by the economy, we're affected by our commercial mix and we're really looking to manage the business to the total so some will come from gross margin as it has in the past and some will come from SG&A and it will depend on the circumstances we face as we move toward 2007.

And just one final housekeeping question.

What was the other income that was the million dollars in other income?

Danielle, this is Jeff.

It's primarily interest income earned on our short-term investments.

Thank you very much.

Alan Rifkin, Lehman Brothers.

A couple questions if I may.

Mike, you mentioned that with respect to the 2010 reformat (indiscernible) 2005 achieved record performance.

Is there something inherent about this class that really separates them from the rest or do you think that some of the improvements that you've made in the program can be applied towards the remaining 50% of the program -- 50% of the stores that haven't been converted yet?

Well, I don't think we said that the 2010 class was especially strong.

I think the comment you may be thinking of was that our new stores have been doing much better partly because of the fact they're 2010 stores and obviously due to other reasons.

Certainly we're very happy with our 2010 store program.

We do see a double-digit increase the first year and then stronger comps than typically we would have found going forward.

Okay.

And with respect to the DC that was added in Allentown, can you maybe just shed a little color, Mike, as to how in your opinion that's improved your in-stock level?

And can some of the efficiencies of this latest DC be applied towards the other seven that may improve your margins going forward?

Absolutely, Alan.

Obviously we had a very strong need for a distribution center in the Northeast through our acquisitions of both the Parts America as well as Discount Auto Parts.

We ended up with DC's where obviously they were at in those days and we've been rationalizing those locations.

We were getting very tight on capacity in a number of our DC's particularly in our Blue Hills, Virginia DC and our Delaware, Ohio DC.

This new DC in Allentown took a lot of pressure off those facilities in particular, helped make them more efficient as well as improved our transportation cost by moving the product much closer to where our stores are located.

Okay.

And one last question if I may.

Jim, I think you said that the latest crop of year-one stores are producing revenues in that first year of 1.5 million.

That's certainly well north of the 900,000 a few years ago and even the latest number of 1.1.

Do you think that that's possibly a new pro forma number going forward as all new stores that you're going to be added will be of the 2010 format?

Alan, let me clarify the comment I made.

We continue to see our new store productivity to increase; our new stores are doing more volume this year than last year.

But the $1.5 million number that I mentioned is the average of all of our stores that Advance operates today.

And my comment was that this is the first time in our history that we now have an average sales volume per store of all of our stores that now exceeds over 1.5 million.

Okay.

Thank you, Jim.

Thanks for that clarification.

Okay, thank you.

Matthew Fassler, Goldman Sachs.

Good morning.

I've got two questions.

First of all, on the expense front you continue to show pretty sharp increases in expenses for store in expenses per square foot in the neighborhood of 6%.

And you spoke to your very aggressive control of those expenses incentive compensation that you saw.

What kind of expense growth would you anticipate going forward?

And given that you seem to have reasonably good control over your expense growth, what kind of comps do you need to leverage?

Matthew, I think that that's a multidimensional question you're asking.

I think the real bottom line is we're looking to manage our SG&A expense number to achieve leverage year-over-year on a consistent basis as well as invest appropriately where we have the opportunity and have the ammunition to invest for the long-term.

Certainly we love to see sales per square foot increase and expenses per square foot increase and the real key is we've got to look at it on a percentage of sales basis.

So from a go-forward standpoint, I think the answer is very much the same -- we're going to continue to work to leverage no matter what level we're at from a comp sales base and invest appropriately as we get some higher comp levels that gives us more ammunition to invest more for the future.

And so, say when you're up against tougher compares and perhaps the comps moderate from the high single digit levels that you're seeing, is it feasible that you'd be able to leverage expenses in that kind of environment?

Yes, I believe certainly we can manage them more aggressively and I think that was very clearly demonstrated in last year's third quarter when we faced a big impact from gasoline prices as well as for hurricanes.

I think we did a commendable job and our team rallied to the cause and we managed our expenses aggressively and achieved very strong results.

And just a second question on the commercial business.

Looking at the number of commercial programs you operate today versus the number you operated a year ago, it looks like the commercial sales per commercial store in the program did experience somewhat accelerated growth during the quarter.

Is that an accurate read on your commercial performance?

Did the true commercial comp, if you will, actually pick up a bit?

Matthew, this is Jim.

We believe that is correct.

I think what you're seeing there is that we're buying that more and more customers are out there that we can service very efficiently and very profitably and we have a lot of programs that are very early in the maturity curb so we should expect to see the existing program that we've rolled out over the last two or three years continue to show very solid growth for certainly the foreseeable future.

Great, thanks so much.

David Cumberland, Robert W. Baird.

On a couple of the newer initiatives, factory ordering and the salvaged body parts business, how different are these programs from programs available at competitors and, more specifically, what types of delivery times are you expecting?

David, this is Mike.

Again, some of these programs are available to a number of our competitors and some have the same vendors that we're dealing with, some have different vendors.

Again, in most cases it's within two to five days where the product is shipped either UPS our FedEx from the vendors.

I think the real key here is that it certainly helps us from a proactive standpoint with a number of competitors and from a defensive standpoint from some other competitors.

But either way will help build our comp sales going forward.

And then on the custom mix program, where do you stand on that as a percentage of stores and what are your plans for the next phase of the program?

Custom mix really is not a program that applies specifically to individual stores.

As we refer to it, it covers the whole organization.

Stores are affected differently by the product, but the same process applies across all of our stores.

We began that program, if you recall, in September so we're getting pretty close to analyzing the first set of reviews of our categories and we will begin this year again in September, October reviewing a number of those categories with a little bit more robust analytical set of tools which we think can help us continue to fine-tune our mix year-over-year category by category.

Great, thank you.

Scott Ciccarelli, RBC Capital Markets.

A couple questions.

First, I know Mike, you've termed rising gas prices as a headwind for your business.

I guess the question is, is there any way to quantify what kind of impact there's been or as we see oil prices continue to move upward, how should we think about that impact on your business going forward?

I think as the year has progressed, last year certainly when gas prices had a huge increase toward the end of our second quarter we and the retail industry in general felt some pressure.

I think it's very clear that to a degree the consumer adjusted to those increases and the effect became very moderate if any at all.

Certainly we're seeing accelerated gasoline prices today and we feel that there is some negative effect on our business.

However, as you can see by our strong comps, we believe a number of initiatives that we've put in place have more than compensated for that headwind.

Okay, fair enough.

And then I guess the second question is probably for Jeff.

As your debt levels have been -- I guess as interest rate have risen, I should say, and your share count creeps up, how should we think about where you're going to pool your cash generation after you invest in your business?

As we set in the past, the business continues to generate a healthy free cash flow and we're looking first and foremost to opportunistically reinvest that in the business to grow our business for the long-term.

I think the $300 million authorization the Board made yesterday we'll continue to use as we have in the past and look opportunistically out there at our stock.

And if you look back at what we did a year ago and enabled it to purchase approximately 200 million of our stock for just over $40, I think we'll continue to look at it opportunistically in the marketplace.

But we want to continue to reinvest in the business.

I think that we still have a very effective cost structure in place from a debt perspective even though variable rates have gone up a little bit, I will refer to you that we have hedged that and fixed that through swaps.

Roughly 40% some of our over all debt is fixed.

So we're not as subject to the volatility in the rate as the original 100% variable debt structure we have in place.

So I think we'll continue to look at it opportunistically.

Again, we want to continue to grow the business for the long-term.

So between the debt paydown and stock buy back we're going to continue to see a balance?

Yes, I don't think that we're at this point think it's an appropriate -- any additional leverage or deleverage on the balance sheet would be appropriate at this point given the relatively low cost of the debt relative to the cost of the equity out there.

Fair enough.

Thanks a lot.

Jack Belos (ph), Midwood Research.

You had mentioned that the average sales per store is now around 1.5 million and I was wondering what the history now is in terms of discount stores -- what their average sale per store is, and I'm trying to remember what it started at when you first made the acquisition?

This is Jim.

If you remember back when we bought Discount Auto Parts, they were around $1 million per store range and we said then that we were going to do a number of things which we've all executed to get those sales of those stores up over the next several years and that certainly has occurred and is occurring.

We have a tremendous team in Florida headed by Curt Schumacher that has led that effort and we continue to see solid growth in those markets both on the DIY side and commercial side and we fully anticipate that that's going to continue for the foreseeable future.

We don't give out specific numbers by area or region of our company, but as we said back when we bought Discount, those stores certainly will achieve and potentially exceed our company average over time.

They might beat the average over time?

Excuse me?

I'm sorry.

You said they might beat the Company average over time?

Yes.

How many years is that?

We can't give a specific time frame but, Jack, we see very positive things for the state and we think that will continue.

Because of the jump in commercial business to almost 21% versus 18% of sales, to what degree would that have had a negative impact on the gross margin mix?

Well, Jack, it does have some effect of negative as well as effects in the ramp up period.

Our SG&A over time, of course we believe it will help leverage our SG&A.

But again, it's been pretty consistent over the last six quarters that effect so you really analyze it year-over-year as well.

At the margin wouldn't there be a net negative impact because you have a higher percentage of sales there?

Yes, but it's not a significant number, Jack.

Okay.

And Jeff, what is the LIFO adjustment for this year's third quarter compared to last year?

We had basically a flat LIFO charge during the second quarter of this year.

I think it was 2.3 million LIFO credit last year during the second quarter.

Okay.

Thank you very much.

John Tomlinson, Prudential Equity Group.

I'm sorry, I might have this is question.

But for Jim I guess it's specific.

Can you talk about maybe the operating margins and some more of your more mature commercial stores then the margin in some of the newer stores?

And how much to the operating margin improvement will that ramp up of that commercial business contribute to the 11% to 12% margin expectation that you have for 2007?

This is Jim.

The way we look at the commercial business is that it's an increase in sales of each of the stores that are out there and there's a very profitable flowthrough of the profit from those sales because we don't have to make significant investments in either expense or capital to drive that business.

So as we've said before, the commercial business complements our retail business in such a way that it raises our total sales per store which allows us to increase our operating profit both in terms of percentage and dollars which then contributes to achieving our goal of 11% to 12% operating margins overall.

In regard to the first part of your question, our operating margins of our stores in areas where we have a greater market share, as we've talked about before, typically are higher than operating margins of stores we've just opened or are recently going into market.

So again, we see that as an opportunity going forward as we continue to open more stores in markets where we don't have the marketshare yet today that we'd like to in terms of numbers of stores which will drive our operating margins in those markets.

I guess just to clarify, maybe there will be a greater margin opportunity as some of those commercial programs ramp up to maturity since you're not adding the expense that you have as you increase the penetration over the past year so significantly.

Is that a fair way to look at it?

Absolutely, that's a true statement.

When we first put a commercial program into a store obviously its profitability is not what it's going to be once that program matures over a period of time.

I had mentioned earlier, we have a tremendous number of commercial programs that are very early in their maturity stage because of the growth in programs over the last two or three years and clearly that will be a contributor towards our increased operating margins as those programs continue to mature.

So as the commercial comps maybe slow just because of the tough comparisons over the next couple of year, wouldn't you see more of that fall to the bottom-line just because of the higher volumes?

Is that a good way to look at it?

I think generally that's the case. think we fully anticipate double-digit comps in commercial going forward, so we see strong growth in commercial.

As our number of new programs may not be quite at the same rate of pace as they have in the last two or three years, the growth in the existing programs we think will be very solid.

And to your point, as we grow the sales per store averages of commercial, that becomes more profitable business.

That's all ahead.

Thanks a lot and congratulations, guys.

Steve Mortimer, Wellington Management.

Congratulations.

One more thing, Jeff, on the LIFO credit.

Did you mean when it was flat year-to-year that you didn't have a LIFO credit this year or that it was the same amount as last year's LIFO credit?

It was flat meaning that we didn't have a LIFO credit nor charge during the quarter.

Okay.

And does that indicate any sort of change in the pricing out there of auto parts or anything like that?

No, it's just a fluctuation of the mix and the inventory and things that we took some price increases, some price decreases, but the inflation for the quarter was flat.

Okay.

And following I guess the strong Q1 gross margin that you had, would you expect a resumption of the seasonality in gross margins where Q3 is usually up sequentially from Q2 and then it's down a little bit in Q4?

No, we wouldn't expect any change in the seasonality nature of our margin.

As Mike talked about earlier, obviously we had a couple of reasons for the strength of the first quarter year-over-year based on the reasons Mike talked about and mix changes and some of the logistics changes.

And as we continue to move to the back half of the year, obviously we're expecting a more normalized mix.

And as we anniversary some of those logistics supply chain benefits that we started last year it will start to moderate down a little bit and you won't see quite the strength you saw in the first quarter.

Okay.

And then last quarter on the call you said that when you initiated the Q3 guidance that you'd expect your strongest comp of the year to be in Q3.

Would you still expect that to be the case?

Yes.

Thanks very much.

Rick Weinhart, Harris Nesbitt.

A couple questions if I could.

One, you talked about growing the number of stores with expanded part selection.

I'm wondering if you can quantify that at all or maybe put it on a timeline where we are in that process?

Rick, this is Jim.

I'll take the question.

We don't -- I don't know that we can quote an exact number.

I'll talk to about the process and we look on a market by market basis at how best we can get the most merchandise the closest to our customers while continuing to leverage our inventory investment.

And what that consists of is more parts either in all of our stores in a market or more parts in what we call our local area warehouse stores which service our other stores in those markets or more parts in just certain stores in a market.

So it's a market by market process that's driven by our folks out in the field, our operations team and in each case we look at the investment in that market we're going to need to make relative to the expected results -- returns from an internal rate of return standpoint.

It's an ongoing process that we've been doing for a number of years.

Certainly we've focused on it more in the last two to three years, but we'll continue to see that happen by market as we go forward.

Okay, thanks.

And on the distribution cost, if we could dig into that a little bit.

Would you say now that assuming that you don't have any major geographic increases in your store base, are you comfortable currently with the number of DC's, the number of warehouses, or do you foresee the need for increases or perhaps additional rationalization in some areas still?

We think the rationalization is pretty well complete.

This is Mike, by the way.

Certainly as we continue to grow our store counts, sometime in the future we'll need to have another DC, but for the next two or three years we think we're in pretty good shape.

But the positive news of course, when we do add a DC it tends to help us because it helps rationalize our transportation cost.

Okay, thanks for that, Mike.

And last question.

On the salvage parts announcement, you talked about collision parts, but I'm wondering if -- or specifically anyway, does this include also replacement parts that you may already carry in the store -- that we would be able to get on a used basis?

Basically our program is more products that we currently do not carry.

So we are looking particularly to sell and it's not part of our program -- hard parts such as starters or alternators (multiple speakers) body parts.

So there's no cannibalization possible in this case?

That's our philosophy, yes.

Thanks very much.

Thank you, sir.

Ladies and gentlemen, this does conclude the question-and-answer portion of today's call.

We thank you for your participation in today's conference.

This does conclude your presentation and you may now disconnect.

Have a wonderful day.