領先汽車配件 (AAP) 2006 Q1 法說會逐字稿

Welcome to the Advance Auto Parts first-quarter 2006 earnings conference call.

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

Mr. Bergman, you may proceed, sir.

Thank you.

Good morning and thank you for joining us on today's call.

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 new store openings, remodels and relocations, comparable store sales, sales per store, operating margin, free cash flow, stock option expense, capital expenditures, tax rate, share count, cash dividends and earnings per share for the second quarter and fiscal year 2006.

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; dependency on foreign suppliers; acts of terrorism and other factors disclosed in the Company's 10-K for fiscal year ended December 31, 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.

Please keep in mind that all per share figures referenced in today's press release and conference call reflect the Company's three for two stock split that was effective September 26, 2005.

For planning purposes our second-quarter earnings release and conference call are both scheduled for the morning of Thursday, August 10, 2006.

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

Joining me on the conference call today are Mike Coppola, our Chairman President and CEO;

Jim Wade, Executive Vice President of Business Development; and Michael Moore, our Chief Financial Officer.

The four of us will be traveling later today; we will answer as many of your questions as possible on this call and return any follow-up calls as soon as possible.

If we miss your call while we're traveling we will call you back at the earliest possible opportunity.

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

Good morning and welcome to our first-quarter conference call.

Let me begin this morning by saying that our first-quarter sales met the low end of our mid single-digit comp guidance.

Our first-quarter comps ran 3.9% on top of a strong 9.2% in last year's first quarter.

While the two-year trend is consistent with our long-term average, I'm very disappointed our sales weren't stronger.

As a result our earnings also came in at the low end of our guidance.

I want to reassure you that our focus continues to be on driving strong top and bottom line results by differentiating Advance as the premier retailer in the automotive aftermarket.

I would like to provide some color on why the quarter came in the way it did and, more importantly, what we're doing about it and how Advance is well-positioned for the future.

We believe that the economic environment in the first quarter was quite unfavorable, especially compared to last year.

Rising energy prices, higher interest rates and higher required credit card payments are likely reducing discretionary income for our lower and middle income customers.

Customers may defer certain maintenance, choose good parts rather than our better or best parts or pull back on discretionary products we sell.

In addition, an unseasonally warm winter and cool spring, especially in three of our primary areas, the Northeast, Southeast and Upper Midwest, reduced the need for replacement automotive parts particularly compared to last year's first-quarter.

Buyer analysis, below trend sales of winter merchandise compared to last year cost us directly at least 1 full comp point for the quarter.

Our commercial business has proven to be somewhat less susceptible to macro factors and it remains solid on plan.

DIFM customers tend to be in a higher income demographic and therefore less affected by macroeconomic pressures.

We continue to execute a very disciplined commercial model and I believe we are well-positioned for further growth in this area for the foreseeable future.

As our commercial business has grown to be a more significant contributor it and helps balance our results.

Our DIY business fell short of plan for the quarter producing a 0.5% comp, validating our view that macro factors hurt the low income DIY customer disproportionately.

Of course, none of us here at Advance are satisfied with these results.

Our team now is working even harder and I'm very proud of them.

Importantly, people tell us our stores are best in class, our in-stock percentage is at an all-time high, and our average transaction size is also at record levels.

That tells me when customers shop with us we're doing a good job satisfying them.

One of our most significant opportunities to drive sales is to get more customers into our store so that we can delight them.

This involves virtually every area of our Company because numerous small factors drive whether a customer shops with us or goes elsewhere.

Our number one focus and objective is to drive sales and customer satisfaction and that's why we're working even harder to have more compelling advertising; brighter, cleaner, neater stores; having stores in more convenient locations; merchandise that's better presented and properly priced; and key members that genuinely greet every customer when they walk in the door or call us on the phone.

We are part of the consumer solution to high gas prices.

We can teach them how to improve their gas mileage and save money by doing projects themselves.

This should provide additional future tailwind to our sales.

In addition, many of you know we offer a variety of free services -- for example, free battery and wiper installation -- which we have had in place for a long time.

We are more proactively reaching out now to our customers to let them know about these services and ask if we can lend them a hand.

Our recently introduced special order center is a strategic competitive advantage, allowing us to say 'yes' to our customers so that no customer ever walks out of one of our stores empty handed.

Other customer service enhancements include an upgrade to our APAL price lookup and POS system.

That is making us even more user-friendly for our customers and store team.

For example, we can now seamlessly check availability, confirm shipment and process special order product for our customers right on our APAL system, helping us to more easily drive top line sales.

APAL continues to be a significant competitive advantage for us, allowing us to look up parts for a customer and ring up their purchases on a common system, while also offering graphics to help the customer confirm that the product they want is the product they get.

It's a great innovative tool that keeps getting better.

We launched a system that enhances our commercial tier pricing by dynamically adjusting commercial customers discounts based on their buying history.

This optimizes both our sales and margin.

We also are in the process of implementing eScheduling which automates and enhances our existing MPT labor planning tool. eScheduling will give our stores and field management a more efficient and more effective way to schedule and monitor labor scheduling down to the individual store level.

This will help us be even more effective in adjusting store labor up and down with sales trends.

We provided training sessions on many of these initiatives at our biennial store managers’ conference which was held this past March.

It was a great opportunity to bring all of our store managers and field managers together to update them all on the additional tools at their disposal and to get everyone motivated to drive further improvement in sales and profitability.

You couldn't imagine a more enthusiastic group of 4000 individuals focused on satisfying our customers.

This year theme, We Are Advance, stressed that everything we do affects the perception of the Advance brand, whether it's the cleanliness of the store, a smiling face behind the counter, a store manager that motivates his store team through coaching and development, or our willingness to go above and beyond the call of duty to assist the customer.

All of these drive what customers think of Advance.

The team left with terrific tools to bring back to their stores as well as the recognition that both individually and collectively each of us represents the Advance brand.

For the quarter we delivered earnings per diluted share of $0.68 compared to the $0.63 in the same quarter last year.

With sales at the low-end of our expectations our earnings also came in at the low-end of expectations.

Keep in mind that our results for the current year reflect the new stock option accounting rules which reduced operating margin by approximately 36 basis points and EPS by $0.03 for the quarter.

In terms of gross margin, we continue to see significant opportunities to improve our gross margin rate and we expect to show steady improvement for the year.

Direct importing offers one such opportunity.

Today direct importing comprises a low single-digit percentage of our mix.

Over time we see that rising as overseas suppliers improve the quality of their goods and provide us with more compelling product offerings.

Logistics efficiencies also provide us with an ongoing opportunity to improve our gross margin.

We have seen consistent improvements in this area over the past several years, yet still have room to improve further.

For example, we are reengineering our distribution facilities to make them more efficient.

As well, as we continue to grow we are leveraging the capacity of our existing facilities.

Now I'd like to spend a few moments on SG&A.

As we've indicated in the past, we are consciously choosing to spend SG&A dollars on high return projects and will continue to do so.

With that said, in other SG&A areas I believe we should have reacted faster and with more urgency to the sales trends in the first quarter.

We've pared back on a number of expenses and have deferred hiring for certain store support center positions, but we should have done more earlier.

Let me assure you, our organization is even more intently focused to distinguish between SG&A to drive sales or profitability and nonessential SG&A.

SG&A investments that drive sales and customer satisfaction include many of the projects we have undertaken in recent years such as remodeling our stores to our 2010 format, adding commercial programs and relocating stores to more prime locations.

These SG&A investments produce excellent financial returns over time as these investments mature.

As for nonessential SG&A, in early 2006 we continued to build on the success of our 2020 project to help us identify opportunities to further reduce nonessential spending and inefficiencies throughout our organization -- areas where we can save money while at the same time not affect our ability to serve customers and generate sales.

As a result of expanding this work, we have assembled a list of approximately 30 additional high-priority areas where we can reduce SG&A while improving efficiency.

And we have begun implementing many of these.

Over a two-year period we believe that these initiatives can reduce our SG&A run rate by an additional 100 basis points.

These improvements are key to helping us achieve our 11 to 12% operating margin target by 2008.

Keep in mind that many individually small ideas that affect our stores translate into tremendous savings.

With over 2900 stores our savings multiplication factor is significant.

Examples of some of these recently identified opportunities include simplifying our end of day processes at store level and savings in areas like telecommunications and expanding our energy management program.

We'll report back to you on our progress in future quarters.

Suffice it to say, we see tremendous opportunity to improve SG&A over the short, intermediate and long-term.

With that said, we remain committed to spending SG&A dollars that drive enhanced sales, profitability or customer satisfaction.

Our philosophy is the best way to drive improved SG&A performance is to leverage top line growth.

In short, we have made improvements in our gross margin and SG&A over the past five years.

We still have many areas where we are funding additional opportunities.

Turning briefly to our industry dynamics;

I think it's important to note that even with higher gas prices thus far in 2006, miles driven have grown and are up about 1.8% year-to-date.

This confirms our view that most miles being driven in the country are of a nondiscretionary nature.

And as more miles are put on vehicles, the parts of those vehicles undergo predictable wear and tear, eventually leading vehicle owners to our stores for parts, service and advice.

So maintenance deferred and tough economic times will eventually come our way.

More cars on the road than ever before that are on average older than ever and being driven further than ever is providing a consistent tailwind to our industry.

In addition, SUVs and pick-up trucks comprise the majority of the vehicles purchased and those vehicles take more expensive replacement parts than a comparable passenger car.

Everything I've talked about in my remarks this morning ultimately are aimed at achieving one or more of the four key financial goals -- one, raising average sales per store, which currently we're at 1.567 million, a 20% increase since 2002; secondly, expanding operating margins where we have improved each year for the last five years and continue to target 11 to 12% by 2008; generating strong free cash flow; and forth, increasing our ROIC by deploying our capital in shareholder friendly ways.

Due to the macro economic conditions affecting our customers, we project comp store sales for the year to be in the range of 3 to 5%.

For the year we continue to target earnings per diluted share to be in the range of $2.37 to $2.47 which includes approximately $0.12 of stock option expense.

For comparative purposes 2005 EPS of $2.13 do not include $0.09 of pro forma stock option expense.

We believe our targets are reasonable based on our expectations for operating margin improvement for the balance of the year, though we will need sales to accelerate in order to achieve the high end of our guidance.

For the second quarter we are targeting EPS in the range of $0.65 to $0.68 inclusive of approximately $0.03 of stock option expense.

EPS of $0.60 in the second quarter 2005 do not include $0.02 of stock option expense.

Our guidance is predicated on 3 to 5% comp assumptions on top of the 9% achieved in last year's second quarter.

For the first three weeks of the current quarter comps are running consistent with our first-quarter's performance.

Now I'd like to turn the call over to Jim to review our sales and store growth in greater detail.

Jim?

Thank you, Mike, and good morning.

I'll start by reviewing in more detail the sales results achieved by our team in the first quarter.

Our total sales rose 10.7% compared to last year's first quarter.

This reflects 3.9% comps and approximately 9% square footage growth.

Our DIY comps grew 0.5% over a 5.1% increase in the last year's quarter while our commercial comps increased a very healthy 16.3% against 27.2% last year.

We saw good growth in average transaction size on both sides of our business.

DIY customer count was our biggest opportunity.

As Mike mentioned, we believe our customers are impacted by higher energy prices, as well, there's a lack of normal winter weather, especially in the Northeast, Southeast and Upper Midwest.

On the commercial side of our business where we expect to surpass the $1.1 billion mark in annual sales this year, but still hold less than 2% marketshare, we continue to grow solidly.

We're growing this business the right way by catering to parts-oriented customers and by being very disciplined with respect to customer service levels and margins.

And our 16.3% commercial comps met our expectations for the quarter reflective of the double-digit growth we believe is achievable for the foreseeable future.

During the quarter we added 112 new commercial programs to our stores, approximately half of which were in new stores, bringing the total number of Advance stores with commercial programs to 2304.

For the quarter our commercial sales as a percent of our total sales was 25% including Auto Part International.

For Advance stores commercial was 23.6% of sales compared to 20.6% in the same quarter last year.

Today about 81% of our Advance stores have commercial programs compared to 75% at the same time last year.

We can continue to target commercial programs in 85% or more of our stores over time.

Meanwhile, within the stores that have commercial programs, we've seen hundreds of opportunities to add additional delivery trucks to better support and grow existing programs.

During the first quarter we opened 58 new stores, a record first-quarter performance for us. 54 of these stores opened as Advance Auto Parts and four opened as Auto Part International.

This compares to 26 new stores opened in the first quarter of last year.

We also closed three stores in the quarter.

Due to our strong pipeline of new stores and the huge opportunities we see to add stores in our existing markets we're raising our guidance for new stores for 2006 to 185 to 195 stores from our previous guidance of 170 to 180 stores.

As you may recall, we acquired Auto Part International in September of 2005 and we view its commercial business as complementary to our own.

AI has competitive strengths in sourcing parts for foreign makes and models and Advance and AI's buyers have been sharing knowledge and identifying ways in which each of our companies can benefit from the other's sourcing arrangements.

We've been extremely pleased with what we've been able to accomplish thus far and see continued opportunity for both companies to buy merchandise better than either of us currently do.

From a real estate standpoint, prior to its acquisition AI was growing at a rate of two or three new stores per year.

We believe the market for AI's products supports a faster rollout pace and the AI team opened four new stores in the first quarter.

We're in the process of determining what level of growth is sustainable for AI before articulating a go-forward goal.

Suffice it to say that we certainly see opportunities for AI's nearly 100% commercial business to provide additional legs to the strong commercial growth Advance has produced over the last several years.

We'll update you further on AI's progress in the quarters ahead.

Also we want to congratulate Roger Patkin and the AI team for what they've already accomplished with their accelerated growth.

We continue to pursue our goal to have the newest, freshest store base in the industry with our new store growth and our aggressive remodel and relocation programs.

During the first quarter we remodeled 65 Advance stores to our 2010 format.

At the end of the quarter we had a total of 1661 stores with the 2010 format or about 58% of our Advance stores.

These bright, new looking stores provide a significant point of differentiation to the consumer relative to competitors.

We remain on target to achieve our goal of 200 to 225 remodels in 2006.

With these remodels along with new stores and relocations, approximately two-thirds of our stores will have this format by the end of 2006.

We'll continue remodeling our stores until the entire chain features the 2010 format.

During the quarter we also relocated 11 stores and we continue to target 50 or more relocations of existing stores this year.

By reopening these stores as new freestanding locations annually we're taking about 2% of our stores that have limited upside potential and repositioning them with significant opportunity for continued growth.

With this activity we ended the quarter with 2861 Advance Auto Parts stores and 66 Auto Part International stores for a total store count of 2927 stores.

With our planned growth we'll surpass the 3000 store mark in 2006.

Now let me turn the call over to Michael Moore to review our financial results.

Thanks, Jim, and good morning.

Let me turn to our first-quarter financial statements.

For the first quarter gross margin was 47.8%, equal to last year's rate.

Two items on the gross margin line are worth expanding on.

First, last year's first-quarter gross margin rate was up 137 basis points versus the prior year.

That compares to our historical average annual increase of 50 to 70 basis points.

As margin comparisons ease for the balance of 2006 we anticipate gross margin rate improvement in each of the remaining quarters.

Secondly, we recognized a $2.9 million LIFO credit in the first quarter compared to a $4.2 million credit last year.

This difference unfavorably impacted gross margin by 12 basis points compared to last year.

Now turning to SG&A, our SG&A expense rate for the quarter rose 48 basis points compared to last year.

The increase in SG&A was due to stock option expense of 36 basis points and our store managers' conference held every two years that represented over a 30 basis point increase from last year.

The conference is a multimillion dollar expense, but one that we expect to generate at pay back many times that amount through the motivation and training of our store managers.

In addition, unplanned expenses related to the resolution of certain legal matters and property damage costs increased SG&A by about 20 basis points in the quarter.

One of the reasons I joined Advance is to help drive nonessential SG&A out of the business.

I, with the rest of the executive team, am committed to do that.

In the quarter there were several areas of expense that we leveraged versus last year including incentive compensation and maintenance and repairs.

We are reviewing all expense lines for the balance of 2006 and we have aggressively reduced selective expenses in non sales related areas.

Examples of these include -- reductions in corporate overhead such as deferring the addition of new positions and selectively not replacing open positions; telecommunications expense; supplies; maintenance and repairs; and professional services.

Also, our store labor planning tool enables our store organization to tightly manage store payroll by store by week relative to each store's sales trend.

Operating margin was 9.1% or 48 basis points less than last year due to the noncomparable stock option expense and other items previously discussed.

Clearly some of these other items, such as the store managers' conference and the unplanned legal and property damage costs, are specific to the first quarter.

We expect to see operating margin improvement for the full year as we have for each of the past five years.

We continue to believe that our 11 to 12% operating margin target by 2008 is achievable.

Interest expense net of interest income was $9.5 million in the quarter versus $8.6 million last year due to higher interest rates.

We have in place interest rate swaps that effectively fix our interest rate exposure on approximately 40% of our debt.

The remaining 60% of our debt is subject to higher interest cost.

We view this relatively low-cost debt as appropriate in our overall capital structure.

We continue to amortize about $32 million of principal per year resulting in improved debt to capitalization ratios.

Our total debt at quarter end was $430.6 million and our debt to total capitalization ratio was 31.4% versus 37.8% a year ago, an improvement of 6.4 percentage points.

Our first-quarter income tax rate was 36.6% compared to 38.5% last year.

In the first quarter we recorded a $1.8 million tax benefit related to the favorable resolution of certain tax contingencies.

Going forward we continue to expect our tax rate to be in the 38 to 38.2% range.

On an after-tax basis this tax benefit essentially offsets the 20 basis points of unplanned legal and property damage cost.

During the quarter we repurchased approximately 1.3 million shares of our stock for $53 million under our share repurchase program leaving $188 million remaining on our current $300 million repurchase authorization.

Subsequent to quarter end we have repurchased approximately 1 million shares for $39 million.

Since inception of our first buyback program in August 2004 we have repurchased over 11 million shares for a total of approximately $300 million.

In April we paid our first quarterly cash dividend and yesterday the Board of Directors declared a regular cash dividend of $0.06 per share to be paid to stockholders of record as of June 23rd.

Our dividend and share repurchase programs enable us to return to our stockholders a portion of our free cash flow.

In terms of the key components of our balance sheet and our cash-flow statement, we ended the quarter in a solid inventory position and did a good job managing inventory in a tough sales environment.

Inventory increased 8.5% on a sales increase of 10.7%.

Our accounts payable to inventory ratio was 57.9%, slightly less than last year's 59%.

Last year's first-quarter AP ratio reflected an inventory buildup for the opening of our Northeast distribution center which increased our ratio over and above our normal rate.

With that said we continue to expect steady year-over-year improvement in our accounts payable to inventory ratio in spite of the growth in our direct sourcing initiatives and Auto Part International's lower AP ratio driven by its higher direct source mix.

We will achieve enhanced AP to inventory levels primarily through growth in our vendor financing program.

This program currently has $125.4 million outstanding, a $30 million increase compared to last year.

CapEx for the quarter was $78 million as it compared to $60 million last year, primarily reflecting our record number of store openings.

For 2006 we continue to expect CapEx to be in the range of 260 to $280 million.

We estimate free cash flow, which we define as operating cash flow plus vendor financed AP, less capital expenditures to be in the range of 140 to $150 million in 2006.

In 2006 we are returning the majority of our free cash flow to stockholders through share repurchases and dividends.

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

Thanks, Michael.

Before we open the floor to questions this morning we would like to reiterate our commitment to growing our top line.

Growing our DIY business is our top priority.

Also we remain committed to improving gross margin and SG&A and we have implemented a number of specific initiatives to drive further improvement in these metrics.

We are committed to accomplish this rain or shine, high energy prices or low.

Despite a first quarter that was not up to our usual standards, I believe Advance is doing the right things to manage our business with great intensity on a day-to-day basis as well as growing stronger future results.

I am convinced that our team's focus, discipline and drive will continue to make us an industry leader.

We are now ready for questions.

Operator?

(OPERATOR INSTRUCTIONS).

Tony Cristello, BB&T Capital Markets.

Good morning, everyone.

A couple questions.

First, the guidance for the 3 to 5% comp, is that inclusive -- or what assumptions are you using in terms of the effect of the consumer and gas prices?

And you noted that comps to date were sort of at the same run rate as what you saw in the first quarter, and I'm also wondering the significant rainfall that you've experienced in the Northeast, is that reflected in that number as well?

Tony, we're going to have rain in some areas and sun in other areas.

And we really try to build in those exceptions that we get all the time.

The bottom line is we're just looking at what our current run rate is, what the macro economic environment is and believe that that's probably the rate we're going to run it for the rest of the year.

Okay.

You talked about initiatives to sort of improve your G&A and manage the business and get some leverage there.

And I'm just wondering, on the commercial side of the business product returns are sort of a drag in general on profitability.

And understandably in an infancy stage you can typically have more product returns as you're trying to win business.

And I'm just trying to understand, is that an area that you can see more efficiency with and where are you now in terms of a return rate and has that improved since you accelerated your business on the commercial side?

First of all, that's an issue for us in DIY as well as commercial.

For various reasons, which we have put a lot of work into understanding, customers do tend to return a high percentage of merchandise.

With that said, in recognizing that as part of our strategic plan we've developed an initiative we haven't talked much about called Keep the Product Sold, Sold.

And we are studying reasons for the returns and on an ongoing basis putting in remedial factors to reduce that return rate.

Not that we've made great progress, but we've certainly made some progress with that over the last couple of years.

APAL, of course, is another big assist to that and we are working with our stores to make sure they show the pictures and graphics that we have on our system to our DIY customers to help validate that they do have the right part.

We also work with our commercial installers when we take the call to ensure that they're giving us the right model, the right engine specification or VIN number to help us minimize getting them the wrong part and having it to have to come back to us.

So there clearly is an opportunity to improve efficiencies there?

Absolutely.

Okay, and one last question.

From our conversations with a lot of the installers in the industry there certainly has been a shift toward a lot more of the maintenance type services which reflect a lower usage of hard parts in that type of repair.

And I'm wondering how has that impacted your commercial business in terms of product mix and what should we think about going forward?

Tony, again, our commercial business, as you can see, remains very strong.

We've got solid double-digit comps as we've projected.

And as we look at our mix, our balance of sales is staying pretty consistent, in fact maybe even growing slightly in the parts area.

Are you seeing more parts or are you providing even more of the chemical type products to some of the maybe smaller installers that may not be carrying stock inventories?

We really do not go after driving our sales with chemicals and motor oil.

We sell them to our good hard parts customers and we're continuing to do that.

And as I said, our balance of sales or mix of parts continues to be very strong.

Okay, great.

Thank you.

David Cumberland, Robert W. Baird.

Good morning.

You've noted weather in the quarter of Q1 being unfavorable.

Can you talk specifically about what you saw since the Q4 report in mid-February in weeks seven to sixteen?

Was it a lag of winter type whether in that period that was the biggest factor?

Tony, again, I think that everybody has seen what's been going on with the whether this year in particular.

We obviously recognize, I think everyone does, that we had a very warm winter in January and February and conversely we ended up with a cooler spring in March and April.

With that said, weather is only a partial factor of our business.

We also feel that the macroeconomic issues have also provided a drag on our business.

And on a two-year run rate, as we said in the call last year, we felt pretty comfortable with where we were running and obviously that two-year run rate fell off with softer comps in the back half of the quarter than we originally guided in the call last call.

And then can you provide a few more details on the unplanned costs, the timing of those within the quarter?

Were those not factored in to the Q1 guidance provided in February?

One example is we had a store burn the last week of the quarter in Waco, Texas, which obviously was certainly not planned for nor expected, which caused a hit.

And we had some other legal matters that we're really not at liberty to discuss that were not anticipated in the quarter.

Thanks.

And last question.

On last quarter's call you talked about incentives for store associates to move customers up to premium products.

How's that going?

Does that remain an area of focus?

That area continues to be a strong area of focus.

We are rotating product mix in and out of that program.

It's motivated our team members -- we returned hundreds of thousands of dollars in incentive payments to our team and think that's part of what's helped us maintain and grow our gross margin percent as well as over time our sales base.

Thank you.

Bill Sims, Citigroup.

Good morning.

With the LIFO credit and difficult comps to bear in mind, what else was the main driver of the unfavorable drag on gross margin?

Is it retail mix is the next largest component or was it any commercial pressure we should see?

There's really not particular commercial pressure.

Our commercial margin and its share of business remains consistent.

I think that certainly when you look at commercial mixing a little stronger than DIY that created some downward pressure.

And the mix of goods we just sold this year was a little softer.

But again, recall that we were significantly over last year by -- I think last year we had 137 basis points, we had an extraordinarily strong quarter with favorable mix as well as this LIFO credit hurt us another few basis points this year as well.

All right.

Thank you very much.

Matthew Fassler, Goldman Sachs.

Good morning.

First question.

You did give us some color on the beginning of the second quarter.

And if the second half of Q1 was a bit stronger than the average and your other part of Q2 was sort of in line with the first-quarter's average that would imply a little bit of deceleration.

Any view on what might be driving that?

Do you think it's the gas price issue kicking in or any other factors that you can identify?

I'm not saying we had a deceleration or acceleration.

We've got a pretty steady run rate in that mid single-digit 3 to 5 level.

And again we talk about gasoline prices, but I think you've got to recognize that fuel and energy prices that affect the low income customers, those of you who have natural gas in their customers know what took place this past winter.

Despite it being a warm winter, natural gas took a lot of money out of the low income customers' pockets in addition to gasoline and other energy-related costs.

And that's certainly from a standpoint of time of year the natural gas issue went away.

But gasoline, as you all know that own a car and fill your tank, is taking a lot of money out of the economy right now.

Certainly over time we think that negates itself and I think it's proven over and over that that happens as the customers adjust.

As we annualize and reduce that accelerated run rate I think that will have less of an impact on us and all of low income retail.

Understood.

Secondly, Mike, I'd like to follow-up on expenses if we could.

Digging a little deeper with just two questions.

The first is as you look at your mix of SG&A, can you give us a sense as to how much you'd characterize -- what piece of the expense base you'd characterize as nonselling.

And then secondly, can you give us a sense of how you did on the store labor line?

It sounds like there was an effort through scheduling to optimize that a bit more.

Were you able to average that this quarter and if not do you think that's a possibility kind of later in the year as the expense controls kick in?

We didn't get a lot of leverage out of store payroll, nor did we attempt to, and we think that's an important factor for us.

And again, we are managing our store labor very diligently and continue to put a lot of emphasis on new programs and processes to reduce store labor.

We look at obviously SG&A expense in many ways.

Certainly there's probably nothing we do that doesn't have some impact on sales, but certainly a lot of things don't.

We're looking at travel, we're looking at meetings, we're looking at energy usage and proactively expanding our energy management program that in that case certainly has no impact whatsoever on sales.

Understood, thank you very much.

Jack Balif, Midwood Research.

You had mentioned in the press release that you're working on a large number of sales enhancing initiatives.

I was wondering if you could elaborate on that.

And also one part of it which you mentioned, which is more compelling advertising, could you elaborate on that and other sales enhancing initiatives?

Jack, again, I think we've iterated many of those from the 2010 remodels to our special orders center to improving our in-stock. better execution at store level, taking better care of the customer.

Although our team does a great job, we think we can still get better there and will continue to work on those kinds of things.

As far as advertising, I think that we have changed our advertising a bit, I think as we mentioned earlier, to focus on a couple particular areas and currently we are focusing on communicating to our customers the differentiation that we have with the availability of product through our special order centers rather than just more on general brand building.

Okay.

In terms of your comp store expectations going forward, do you still expect the DIY portion of that to be in the less than 1% comp?

Jack, again, it really depends on where things end up.

You've got to look at our mix.

We're certainly looking for DIY comps to accelerate from a 0.5 level, that is an abnormally low number.

And I think if you look over the last three years in particular, we have had very healthy growth in our DIY comp rate.

And I suspect when things return to normal we'll get back on that trend line.

Okay.

And the additional new store expansion phase, is that going to result in some new store expansion expense above and beyond what you're originally planning?

Jack, this is Jim.

It will result in some expense certainly, but we think it's the right thing to do and that's certainly factored into the guidance that we've provided for the year.

Our team has worked really hard over the last year or so continuing to build up our store pipeline and open more stores earlier in the year and the believe the benefits of getting them open and getting them open earlier will benefit us as we get later into the third and fourth quarter and certainly position us better for next year and beyond.

Okay.

My last question is in terms of discretionary merchandise mix versus let's say nondiscretionary hard parts, do you have a rough idea as to what portion of your sales are in those categories?

Again, Jack, as we've talked many times, there's a crossover affect and a part that fails completely is obviously nondiscretionary, a part that wears even though it's nondiscretionary, over time short-term customers can tend to postpone some of those purchases.

So I think we're really seeing the effect across our parts area as well as our accessory area that people are deferring some expenditures on goods that they don't absolutely need right now.

What portion of your sales with the accessories?

I don't know if we really talked about that, but again, it depends on how you define accessories.

It's probably about 20 to 25% of our sales.

Okay, thank you very much.

Alan Rifkin, Lehman Brothers.

Mike, you mentioned that there were no less than 30 additional high-priority areas for you to improve on the SG&A, and you talked about opportunities over the shorter term into medium-term and longer-term.

Can you maybe provide just a little bit more color on what specific initiatives over the shorter term, let's say within the next six to nine months, that you think you can lever SG&A by?

Again, I think it would probably be most appropriate as we execute then to tell you the results, but I'll talk to a few.

Our energy management program for example, we piloted about 700 or 800 stores two years ago and we looked at the results this last year and found great success there and we are currently in the process of rolling those systems out to 1000 more of our stores as we speak.

In the next few weeks we'll start having more of those go into our stores.

The close of date process, some of it is apply usage, some of it is payroll expense, some that's going to need systems revisions.

Where we can turn some things off we're going to turn them off which will give us some short-term gain.

And where we need to do some IT support to help the system accommodate that, that will be a little bit longer-term.

But we have looked at with great intensity of every process we do in every area of our organization and are looking for opportunities to improve.

We're in the process of implementing PeopleSoft for example in our -- a further development of PeopleSoft, an upgraded version in our accounting department.

And again, with that process I'm sure we'll find a lot of efficiencies as well.

Okay.

And with respect to the direct importing, you mentioned that it was only a low single-digit proportion of your mix.

Where do you envision that going over the next year or two ideally?

I think it's going to continue to grow.

Part of the issue of course is the capability of the suppliers there to produce quality parts.

And we have selectively not bought some product from China yet because we just don't feel they can produce the quality that we're looking for.

But our team just got back a few weeks ago and I think over time you'll see that number double and triple, but again, the timing is going to depend on what takes place with the capability of the suppliers there.

And one last question if I may.

You're still backing the full year $2.37 to $2.47 even though you came in at the low end of your guidance for Q1, which obviously puts a little bit more pressure for you to make up a small part of the difference in quarters two through four.

As you're taking your comp assumption down by a point on both the low and the high end what incrementally has changed in your thinking with respect to improvements on the operating margin line for the remainder of this year that gives you the comfort with still hitting that guidance even though the sales number is lower?

Part of our problem in the first quarter were a few of these unplanned issues that we don't expect to repeat themselves as we go forward.

We do have some other issues that we know are going to be positive to us coming forward, but more importantly and overall, we're looking at how we can better merchandise to improve our margin and have put in plans to do just that.

We as well have taken a very aggressive stance toward expense management that we began halfway through the first quarter that we think will pay dividends as we go out through the year.

Okay, thanks and congratulations on your appointment as Chairman.

Thank you very much, Alan.

Rick Weinhart, Harris Nesbitt.

A couple questions.

First, on the comp guidance, I believe you mentioned that in first quarter weather was about a 1 percentage point impact on the comp line?

Yes, we believe that on a direct basis, yes.

So if we back that out, you were roughly running at about a 5% comp in the first quarter.

And looking at your comparisons going forward versus last year, they don't get demonstrably worse, in fact, by the fourth quarter they look to be a little bit easier.

So it sounds like you're being a little bit conservative perhaps on the comp guidance or are there other factors that I'm not taking into account here other than comparisons in trends and weather and so forth?

With the macroeconomic situation I think we are being a bit conservative in that guidance in the 3 to 5% range but as well as realistic based on those issues.

And again, we're working to plan our expenses in that range which, should we have some upside would convert to the bottom line, but also protect us if things get a little bit softer.

And on the expenses, going forward now based on what you're forecasting, is there a level of comp that you can give where you feel like you'll start to leverage those expenses?

Again, we give the same answer, and we're not trying to be unclear in this, but we really need to continue to look at where it makes sense to invest SG and where it doesn't.

And typically when we have stronger sales we'll invest more in the SG&A -- some of these initiatives that affect SG&A that help our business for the long-term.

But certainly we'd like to see mid single-digit comps and I think that over time that's a healthy range that will give us enough ammunition to leverage comps as well as continue to invest.

Okay.

And this question perhaps --

-- with SG&A rather and continue to invest.

Right, okay.

And then perhaps this question is for Jim on the AI business.

Can you talk a little bit about the performance of that business in the quarter?

And it sounds like you haven't put together all of the details on the expansion for that division?

But perhaps you can talk about whether acquisitions might play a role in that as well or if you're looking purely at organic growth?

Our first priority, as we've talked a little bit about in the past, is we made the acquisition in September of last year and taking the time to have the two organizations work together and see what opportunities that we see that we can take advantage of.

And certainly, as I mentioned, they fall in both the category of sourcing expertise that AI has that they have developed because of their foreign car parts history that goes back so far.

And then secondly, looking for opportunities to grow the business over time and help it become a bigger portion of our commercial business in total.

And that's really what's been going on.

The progress we made so far has been very solid.

We've opened the first four stores in the quarter that I talked about.

And we're looking and seeing how the Company is able to grow and how quickly they're able to grow and we're putting in place the infrastructure that allows us to do that.

So that's what's keeping us from getting any more specific about the future yet until we get a better feel for what we are able to commit to.

Certainly down the road as we look out further we see the opportunity for both organic growth as well as complementary types of acquisitions that AI could allow us to participate in that we might not be able to in today's world just as Advance Auto Parts retail stores.

And in terms of performance, we've been very pleased with what the team there has accomplished so far and we're mixing the opportunity to grow the business and invest in the infrastructure it's going to take to grow it while at the same time maintaining a healthy profitability.

In relation to how you're interacting with the Advance Auto Parts stores, do you have any details on how different the customer base is or where you're drawing those sales from?

Sure.

I think it comes down to in summary that the commercial business is just still extremely fragmented and in markets in the Northeast, New England that both Advance Auto Parts stores and Auto Part International stores are having locations today -- there's so much business out there that both can go after.

And the other thing with commercial customers is there's virtually no commercial customer that buys everything from one supplier.

So in many cases we can be complementary in how we provide product to a customer.

But on an overall basis I think the retail stores -- the base of the business is retail.

As a result of that we're servicing and doing a very good job servicing the commercial customers that fit within our retail model and our team does a great job of that and it's a big business.

On the other side AI is almost entirely commercial, so they focus 100% of their efforts on commercial and can meet the needs of more sophisticated customers, the larger independents and some of the other types of customers, to a somewhat greater level than we might be able to with our retail store location.

But in general we complement -- the two models complement each other well and on an overall basis we can capture a significantly bigger portion of the total commercial business.

Okay, great.

Thanks very much.

Gary Balter, Credit Suisse.

Good morning.

It's actually [Seth Bash] in for Gary.

Mike, you've talked about macro factors and impact on your business more than you have in the past.

We're just wondering, is there anything that you see that makes your business less resilient to these macro factors than in the past?

No, I don't think so.

I think the fundamentals of our business, the investments we've made, the initiatives we've executed are all sound and we feel very comfortable with those.

Our marketshare strength from everything we monitor is very strong.

I think why we're a little more concerned here is that these issues have become very big for the lower income customer and it's more than just one, it's not just gasoline, it's home heating fuel, natural gas, it's other expenses that they have to -- the credit card change.

There's just been a lot of things that hit the low income customer this year all in unison.

And I think that's where we've gotten a bit concerned.

By the same token, I think we still feel pretty comfortable with 3 to 5% comps and we believe we're going to make our guidance as we laid out in the first quarter.

And we also know that this stuff comes back over time.

The parts are going to continue to wear, and the deferred part is going to have to be replaced.

And the customer -- these low income customers in particular will adjust, work a couple extra hours, get some over time, get a part-time job in their household to cover some of the incremental expenses and get back on their normal buying pattern.

Okay, understood.

Following on some earlier questions, just in terms of SG&A leverage, I think in the past you had mentioned that you expect to leverage SG&A for the full year.

Is that still to be expected given the lower sales trends?

This is Michael speaking.

I think as a result of our lower sales projection and stock option expense and some headwind items as higher energy costs -- it's going to be challenging to leverage SG&A this year.

But our team is working very hard.

We are looking at all areas, particularly those areas that do not impact the customer and us in the selling support area in the stores and the entire corporate office.

Looking at staffing and all services that we provide, whether we can reduce the scope of service, eliminate an activity, rebid it.

But with a lower sales projection it's going to be challenging to leverage SG&A.

But excluding stock options expense it might be possible?

It would be much more likely.

And then finally on the commercial business, you've talked about your goal of reaching 85% penetration and you're rapidly approaching that target.

When do you expect to get there and what do you expect the impact to do to your comps in the commercial business once you've reached that target?

This is Jim.

What we've said is that 85% or more of our stores will have programs.

And one of the things that we're looking at currently is revisiting again how many of our stores can in fact have commercial that don't have them today.

And as we're doing more commercial we're finding that we can do more and we're finding more and more opportunities to grow it.

So it may be 85, it may be something north of that as we continue to see opportunities.

We're adding programs as we talked about today.

We added over 100 in the first quarter, half of which were new stores, and the other half were really new programs that we added early in the year so we can get the benefit for the entire year.

So we'll continue to see that number gradually increase over this year and next year and probably beyond before we get to that 85% or more number.

We have shown and continue to do in the first quarter very healthy comp increases in the stores that have commercial programs more than a year.

And that's certainly our team's focus and we've looked at it internally on an ongoing basis between what's the comp of existing programs as well as what's the comp of the new stores that are taking commercial programs.

So we continue to see and expect that underlying comp of the commercial stores to be very solid as we go forward.

Great.

Thank you, gentlemen.

Danielle Fox, Merrill Lynch.

I actually have just two quick questions.

First, can you talk about the effect that commodity price fluctuations had on your sales and gross margin in the quarter?

Danielle, from a gross margin standpoint other than the LIFO effect really nothing because in most cases we're able to pass those increases through.

Again, as much as we have commodity price increases in motor oil or in the past ethylene glycol, it affects things like antifreeze and washer solvent.

We've also, as you can tell by our total LIFO number, had deflationary costs in things like hard parts that we continue to leverage our size and scale and direct importing potential to keep those costs going down, so it's negligible either way.

And then the final question was just to clarify, you are raising your store openings but it sounded like you're not changing your CapEx guidance.

Is that right?

We believe that even with the increase in stores we will come in within that existing range?

Has there been any change in the owned versus leased mix of new stores?

No, not significantly.

We anticipate owning approximately 25% of our new stores for the year.

So the decision to open more stores was just a function of more attractive real estate deals and things like that?

Primarily and as well as we continue to be -- we did see a lot of opportunities to open stores in the markets that we're in and take advantage of the strong performance we're seeing in our stores.

And it positions us, we believe, very well for the future as we see these opportunities to get the stores open.

Terrific, thank you.

Ladies and gentlemen, we thank you so much for participating in today's call.

At this time you all may disconnect and have a wonderful day.