領先汽車配件 (AAP) 2006 Q4 法說會逐字稿

Welcome to the Q4 2006 Advance Auto Parts Welcome to the Advance Auto Parts fourth quarter 2006 earnings conference call.

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

Thank you for joining us on today's call.

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

Forward-looking statements discuss, among other things, expected growth in future performance including new store openings, remodels and relocations, comparable store sales, sales per store, gross margin, SG&A, operating margin, return on invested capital, free cash flow, accounts payable ratio, capital expenditures, tax rate and earnings per share for the first quarter and fiscal year 2007.

These forward-looking statements the subject to risks, uncertainties, and assumptions, including those disclosed in the Company's 10K for the fiscal year ended December 31, 2005 and the 10Q for fiscal quarter ending October 7, 2006 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 8K filing, which are available on our website at www.advanceautoparts.com.

For planning purposes, our first quarter earnings release and conference call are both scheduled for the morning of Thursday, May 17, 2007.

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

Finally, a replay of this call will be available on our website for one year.

With that, let me now turn the call over to Mike Coppola, our Chairman, President, and CEO, who will be followed by Jim Wade, EVP of Business Development, and Michael Moore, EVP and Chief Financial Officer.

Welcome to our fourth quarter conference call.

There is no doubt that 2006 was a challenging year for us.

Our financial results did not live up to expectations.

While I believe Advance made many significant strides toward improving things by customer service and store execution in 2006, we know we can't confuse effort with results.

We must achieve better results in 2007, and I would like to thank our team members for embracing this challenge.

Rather than begin by reviewing our fourth quarter results, which you can find in our press release, I would like to talk to you today about some of the significant actions we are taking to improve our performance going forward.

The macro economic issues affecting our lower income customers should be moderating.

Yet, for the first six weeks of '07, our comp store sales growth is running in the low single digits in line with our trend of the past three quarters.

Why hasn't our business picked up despite this?

From mix of business standpoint, we continue to see strength in non-discretionary categories such as batteries, but the mild start to winter hurt our sales on a number of hard parts categories.

Now, with the blast of cold winter weather over the past several weeks, our recent results have been stronger.

Business has picked up as of late, but we believe it is prudent to remain conservative in expectations until we see better results on a more consistent basis.

From a sales standpoint these past few weeks have been reminiscent of the past two years.

During that time, our business saw significant stretches of both above trend growth and below trend growth.

In light of such significant swings and change, you would expect us to take a step back and reassess our opportunities and we are doing exactly that.

We are using both internal and external resources to help us do so and do a deep dive on the growth potential of our business in the customer segments that are most important to us, among other things.

We expect the knowledge gained from this research will help us serve our customer segments that may be under-served today, as well as help us refine our strategy going forward.

It will also help us better allocate our resources to various growth opportunities more appropriately.

While that process takes place, we also know we must take actions today to improve profitability and return on capital, especially in the soft sales environment and if that persists.

Let me speak to some of the high-level actions we're taking in 2007 to enhance our results.

One initiative is a lower cost remodel format that will increase our return during a more challenging sales environment.

We have re-evaluated our current remodel scope from the customer's perspective, to validate which elements produce good returns and where we have opportunities in order to reduce the scope of these projects.

Going forward, you will still see the bright, Advance, 2010 look inside and out, but we are reducing the amount we are spending on changing fixtures and elements of the store that are less visible to the customer.

With our new approach, we believe we can achieve sales improvements from remodeling while reducing our remodel CapEx by up to 40%.

We are also temporarily planning to open fewer new stores and relocations in '07 until we complete our reassessment to determine how we can best allocate our capital going forward.

We also continue to be more economical at the corporate level.

At year end 2006, for example, our corporate staff support headcount was 4% less than it was a year ago, despite supporting 7% more stores.

This reflects just some of the efficiency enhancing measures we put in place in 2006 including fully consolidating our customer contact center operations in Roanoke and replacing open positions on a selective basis only.

Frankly I am disappointed that our SG&A results in the fourth quarter were not better.

A good part of our operating income shortfall relates to one specific area, our workman's compensation and auto liability claims.

This still continues to represent a key opportunity area for us in 2007.

We have put in place a number of new safety programs, and along with a new structure and a new approach in our management department, I am confident we will make headway and show leverage on this line item this year.

Michael Moore will discuss our insurance programs further in his remarks.

These, and other initiatives we are working on, are helping us take costs out of our business.

Previously we indicated we could leverage SG&A in 2007 on a comp range of 3 to 4%.

Based on both our internal work and the business review process, we are re-examining all areas of the business to identify opportunities to leverage SG&A at an even lower level of comps.

Of course, comp growth is a great assist in dragging SG&A leverage, and I believe our advertising, marketing and merchandising programs for 2007 are our most compelling ever.

These include our annual Buy One, Get One Free Sale that ran last month, and many other exciting campaigns that are designed to drive greater brand recognition with our customers and more footsteps into our stores.

While we are doing this, we are doing this while continuing to improve our gross margin.

So we are not sacrificing profitability to drive customer traffic.

In fact, we have shown strong year over year improvement in gross margin, having improved in every year in our history as a public company.

Over the stretch of time, our gross margin has grown by nearly 400 basis points and our uninterrupted string of annual gross margin gain stretches back well into our pre-public history.

At the same time we are also improving our price competitiveness.

Improved procurement costs and logistic efficiencies, for example, compared to last year also helped us in our fourth quarter results.

Going forward, we continue to see opportunity to improve our gross margins.

Direct importing provides us with the ability to source product overseas at more favorable prices, both for us and for our customers.

As well, category management processes continue to reveal opportunities where we can work with our vendors to improve our sales, our competitiveness, and our gross margin percent.

While our grade of gross margin gains in the future probably won't be as great as they've been over the past five years, we continue to see opportunities to steadily improve our gross margins for the foreseeable future as well as improve our price competitiveness.

Let me turn to our guidance.

Our guidance is based on a low single digit comp increase, which is where we are running, as I said, for the first six weeks of the quarter.

We expect to achieve modest gross margin improvement and much less SG&A de-leverage than we had in the fourth quarter.

Accordingly, we are targeting first quarter EPS to be in the range of $0.68 to $0.72.

Last year's first quarter was relatively strong because it was our best comp quarter of the year.

For the 2007 fiscal year, our guidance is also based on a low single digit comparable store sales increase.

We continue to see opportunities to improve our gross margin and if our comps are in the upper half of our guidance range, we would also expect to see SG&A leverage for the year.

Accordingly, we are targeting full year EPS, with a range of $2.38 to $2.48, representing year-over-year growth of 10% to 15%.

With ease in comparisons after the first quarter, there is reason to believe our sales will be more robust, but we're going to take a conservative approach, especially with expenses in CapEx until we see our sales trend return.

As always, we remain committed to developing our team to help us achieve our four key financial goals.

We are certainly disappointed with our progress towards these four goals in 2006 but we continue to work hard to derive better results in the future.

Our first key goal is raising our average sales per store.

This was a bright spot in '06 with Advance having become the industry leader with an average sales per store of $1.55 million.

With that said, we have a long way to go before we meet our potential on this metric.

This is always our first focus.

And we have a number of new advertising, marketing, and merchandising plans that give us enthusiasm about our ability to make further inroads in this area.

Second is growing our operating margin.

Obviously, we took a step backward in this metric in '06 with about half of the deterioration coming from non-comparable stock option expense and the other half owing to a loss of leverage on lower than planned comp store sales.

Third is growing our free cash flow.

We achieved slight year-over-year growth in free cash flow, but fell short of our expectations.

We are targeting stronger growth in '07, which Michael Moore will speak to.

And fourth is improving our ROIC.

This also took us a slight step back in 2006.

But where our efforts to improve returns on remodels and commercial programs should yield improvements in 2007.

Though we did not achieve our objectives in 2006, these four metrics remain at the forefront of our organization.

In fact, they are the benchmarks for our incentive compensation plan.

So our bonus eligible team members know exactly how important these metrics are.

I believe we have the people, the systems, the processes in place to make good progress in these areas and we are focused on driving improvement in 2007 and beyond.

With that, I would like to turn the call over to Jim.

Good morning.

I will review our growth plans and also provide some further insight into our business review that Mike mentioned earlier.

I will begin with our commercial business which is the fastest-growing segment on the auto aftermarket and is becoming a larger portion of our business as well.

Many of you probably saw our press release in December when we eclipsed the $1 billion mark in annual commercial sales in our Advance Auto Parts stores.

For the quarter, our commercial sales, including Autopart International, represented 25.4% of our total sales.

For the year, our total commercial sales, including AI, were approximately $1.16 billion.

That is a 24% increase over 2005.

During the quarter we added 41 new commercial programs, most of which were in new stores, bringing the total number of Advance stores with commercial programs to 2,439.

Commercial made up 23.2% of sales in our Advance stores, compared to 21.8% in the same quarter last year.

Today about 81% of our Advance stores have commercial programs, compared to 78% in the same time last year.

We are approaching our goal of having commercial programs in 85% or more of our stores over time.

With commercial programs in more than 2400 stores, our density across our 40 state footprint provides a strong advantage for our commercial customers because we can deliver parts to them quickly, which is a key driver of commercial sales.

We are the third largest industry player in commercial, but as we approach our goal of 85% or more of our stores having programs, we continue to see significant opportunity to grow our commercial business.

Many of our programs have been added over the last five years and historically, these programs have shown the most growth.

Our commercial growth also requires less SG&A investment going forward, as it principally consists of leveraging existing investments with fewer startup costs for new programs.

We can maximize sales and profits by shifting commercial delivery vehicles or other commercial resources to locations where they can be most productive.

Autopart International also continues to grow.

We significantly accelerated AIs new store growth rate in 2006, having opened 25 new stores during the fiscal year, bringing their store count to 87.

For the fourth quarter, AI contributed $25.4 million of our total sales.

In 2006, the AI team proved it could open new stores at an accelerated pace.

The AI team also successfully their new distribution center in Massachusetts, which provides them the capacity to serve up to 300 stores on a very efficient basis.

Going forward, our goal was to continue ramping up AI store openings and potential acquisitions over time.

However, since this is a smaller company that is working to get bigger, faster, it will be more successful if we let their progress in hiring and developing new team members and expanding their brands to new markets, govern the rate at which they can grow.

A strength of the AI model is that occupancy cost, CapEx investments, and the time it takes to open a new store are very low because AI stores are located in low-cost warehouse type facilities that are relatively easy to locate and inexpensive to retrofit.

So we have more flexibility with the rate at which it opens stores.

Shifting back to Advance now, we had another strong year in 2006 with our store development program not only through our new store growth but also through our remodel and relocation programs.

Our new store productivity in the fourth quarter remained steady, though on a reported basis was adversely impacted by Autopart International, having an additional week of sales in last year's fourth quarter, and by lower sales in some of our other non-comp categories.

We continue to expect new stores in their first full year of operation to generate approximately 70% of an average store's volume.

During the fourth quarter, we opened 53 new stores bringing us to 215 for the year which was at the high end of our guidance. 46 of these new stores opened as the Advance Auto Parts, and seven opened as Autopart International.

We didn't close any stores in the quarter and closed five for the year.

Our pipeline of new stores is strong as we began 2007.

However, at this time, as we're taking a more conservative approach to store openings as we go into 2007, as Mike mentioned we currently anticipate we will open 200 to 210 new stores through a combination of Advance and AI stores.

This represents a 6.5% rate of growth, down from about 7.5% last year.

That slower growth rate translates into less CapEx and less SG&A for our new stores.

In 2007 we anticipate all of our new stores will open within our existing 40 state footprint.

At the end of the year we had a total of 1956 stores with the 2010 format, or about 65% of our total stores.

As Mike mentioned, we've reviewed our remodel program scope and identified opportunities to reduce the investment.

In addition, with two thirds of our stores now operating as 2010 stores, we'll not need to remodel as aggressively in 2007.

We believe we can take advantage of our positioning by being more selective.

For example, rather than remodel every store in the market, we'll assess which stores will benefit most from a remodel and not necessarily remodel newer stores in a market.

In 2007 we expect to remodel approximately 150 stores, down from the 189 we remodeled in 2006.

We foresee approximately 35 relocations in 2007 compared to 47 this past year.

This plan will benefit CapEx, SG&A and return on capital.

Through a combination of a lower cost remodel program and being more conservative with new store openings and relocations, CapEx for store development will be down in 2007 compared to 2006.

With our real estate activity in 2006, we ended the year with 2,995 Advance Auto Part stores, and 87 Autopart International stores for a total store count of 3,082.

Our comprehensive Business Review is helping us to assess how we approach retail and commercial and which customer segments matter most, which in turn is helping us to prioritize our uses of capital.

As our review progresses further, and we reach other decision points about the business, we plan to communicate more with you in the quarters ahead.

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

Good morning.

Let me begin with our income statement.

For the quarter, gross margin was 47.1%, a 40 basis point improvement over last year.

This reflects improved procurement costs and a lower logistics expense.

In the quarter, LIFO was a $1 million credit.

Turning to SG&A, our SG&A expense rate for the quarter rose 140 basis points compared to last year.

Non-comparable stock option expense represented 45 basis points of the increase.

De-leverage on fixed expenses, due to low comp sales represented a 70 basis point increase.

Increases in self insurance programs represented a 75 basis point increase.

We leveraged our remaining SG&A lines by 50 basis points.

The higher costs for self insurance programs was primarily due to increases in workers' compensation and auto liability costs.

Our costs have largely increased due to the rapid growth of our commercial delivery programs and the increased cost of workers' compensation claims.

We expect increases in auto liability to moderate due to less new commercial delivery programs added to existing stores going forward.

Also, as a result of new safety programs we initiated in 2006, we're seeing a reduction in the frequency of new accidents, but it will take time to favorably impact our actuarial estimates and reduce our expense.

As a result of improved expense discipline throughout the organization, we leveraged a number of other expense lines including travel, hiring, moving, supplies, communications, professional services, and alarm monitoring expense.

In addition, we had lower bonus expense this year as compared to last year.

With all of that said, we de-leveraged SG&A in the quarter to a lesser degree than in the third quarter.

In fact, fourth quarter represented the slowest rate of SG&A growth on a per store basis in several years.

Only .6% adjusted for comparable treatment of stock options.

Due to reduced expense levels we expect a modest level of SG&A growth per store going forward.

Looking forward to 2007 there are a number of programs that will require less investment.

As Jim mentioned, our commercial growth will primarily consist of leveraging existing delivery programs.

In addition, the cost per store and the number of remodels will decline, both of which will favorably impact SG&A.

And we are planning to open and relocate fewer stores in 2007 than we did in 2006.

We expect the combination of one, less new relocated and remodeled stores; two, fewer new commercial delivery programs; three, expected improvements in expense lines that de-leveraged in 2006, namely workers' compensation and auto liability; and four, other expense reductions to enable us to leverage SG&A on comp increases of 3% to 4% going forward.

As Mike mentioned earlier, we are working to identify opportunities to leverage SG&A at even lower comp levels.

For first quarter 2007, assuming a low, single digit increase, we expect SG&A to de-leverage to a much lesser degree than it did in the fourth quarter.

In the first quarter there are two items that are favorable, compared to first quarter 2006.

Last year our store managers conference, held every two years, represented 30 basis points and the resolution of certain legal matters and property damage costs represented 20 basis points.

However, in the first quarter we expect incentive compensation to partially offset the benefit of these two items.

Our team is focused on leveraging SG&A going forward.

I am committed to lead the organization to improve SG&A performance in the future.

Interest expense, net of interest income, was $7 million in the quarter compared to $7.2 million last year.

Our recent refinancing, which reduced our borrowing rate, is saving us approximately $600,000 in interest expense on a quarterly basis.

Offsetting that, we have approximately $50 million more of net debt outstanding now than we did a year ago.

In the first quarter, which is a 16 week quarter, we expect interest expense to be approximately $12 million, and to be $8 to $9 million in each of our remaining 12 week quarters.

Approximately half of our debts is hedged to fixed rates and our current borrowing rate is just over 6% at today's rates.

Our fourth quarter income tax rate was 38.0%, in line with our guidance.

Going forward, however, we expect our 2007 tax rate to be in the 38.2% to 38.4% range.

We expect the adoption of FIN48, uncertain tax positions, which takes effect in the first quarter, will slightly increase our effective tax rate.

In first quarter 2006, our effective tax rate was 36.6%, which included a $1.8 million tax benefit related to the favorable resolution of certain tax contingencies.

This favorably impacted EPS by nearly $0.2 per share in last year's first quarter.

In terms of the key components of our balance sheet and our cash flow statement, we ended the quarter in solid inventory position and managed our inventory in line with sales.

For the year, Inventory increased 7% on a sales increase of 8.2%.

We expect inventory to continue to grow at or slightly less than the rate of sales growth.

At the end of the fourth quarter we took early receipt of some merchandise in return for very favorable pricing.

Adjusting for these purchases, inventory would have grown 6%.

Our accounts payable to inventory ratio was 53.2% compared to 54.8% last year.

This is largely a function of slowing our rate of inventory purchases to reflect the soft sales environment.

We continue to see opportunity grow our AP ratio.

We recently refinanced our credit facility, which lowered the discount rate on our vendor finance program, making it more attractive to our vendor base.

We would therefore expect to see our vendor financed AP balance to grow in 2007.

On the cash flow statement, our CAPEX in 2006 was $259 million as compared to $216 million in 2005.

This reflects more new stores and remodels as compared to last year, more owned versus leased stores and greater investments in IT and logistics.

As Jim mentioned earlier, we're taking a number of steps to reduce capital spending and improve our return on capital.

With fewer new, relocated and remodeled stores planned in 2007 as compared to 2006 and our lower cost per store remodel, we expect 2007 CapEx to be in the range of $250 to $270 million.

This estimate includes approximately $30 million for a new distribution center in Remington, Indiana that we announced earlier this week.

This facility should open in mid-2008.

Excluding planned facility -- planned expenditures for this new facility, CapEx will be down from 2006.

Given this level of capital expenditures we expect free cash flow to be in the range of $125 to $145 million for the year.

In 2007 we anticipate returning a portion of that free cash flow back to stockholders through dividends and share repurchases.

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

Needless to say, falling gas prices should help our customers and certainly our costs.

We believe there is pent up demand for maintenance that customers have deferred.

Together, these ought to be a strong combination.

Although we're disappointed that 2007 got off to a slow start, cold weather is now taking a toll on automotive parts, and this gives us confidence in a brighter sales environment.

As I said, we're not going to assume a sustained snap back in sales.

Instead, we're going to take a conservative approach and hold the reins on CapEx, and SG&A.

We're committed to achieving better SG&A performance in 2007.

When sales return over a consistent period of time, we'll reassess our opportunities where we can reinvest to keep the top line growing.

But for now we're not taking that for granted and we're managing expenses accordingly.

With that said, even with tighter expense controls, we are continuing to grow in a disciplined, methodical manner with a keen eye on returns.

Our four key financial goals remain constant for us while we're taking fresh approaches to how we can best achieve progress toward them.

Our comprehensive business review is identifying more opportunities where we can better optimize our business.

In closing, I'd like to take this opportunity to thank our team for all the extra effort they put into 2006 and thank them in advance for bringing an even more aggressive focus for 2007.

We are now ready for questions.

[ OPERATOR INSTRUCTIONS ] First question is from Tony Cristello.

You may ask your question and please state your company name.

BB&T Capital Markets.

Good morning.

I am just wondering, Mike, if you can maybe -- when you look at your growth that you're giving for this year, the 10% to 15%, it is obviously lower than the long term growth that you gave a couple months ago.

What is the -- as the floors reset, is that simply a function of you ratcheting back on stores and being more conservative in your outlook?

Or is there something else you are seeing that is causing you to be a little bit more -- or reduce that assumption?

It is pretty obvious, the way we started the first quarter, that that is a concern for us.

We feel comfortable with where we thought the rest of the year would be and our ability to achieve that.

Just our expected trends in the first quarter we think causes us to be -- to be prudent for us to lower that starting growth rate.

When you look at getting more leverage from, say, a sub 3% comp, are there -- how do you pare back even to a greater extent or have you identified some areas that you think you can -- above the ones that you noted, to get to a 3% flex point?

It seems like you would start to dig deep.

Are you talking about layoffs?

Have you incurred any layoffs at the corporate level, and how is morale with the employees?

I think morale in our organization continues to be strong.

I think our team believes they are still riding the right horse and our future is very bright for us.

I think a number of our long term team members have seen these periods, periodically over the history of this organization, and there have been tough years, and just as much as there have been tough years there have been great years, and bouncebacks continue to happen.

So I think from a morale standpoint, we are fine.

What we basically did is we did build some growth in investments into our plans for '07.

We were going to add some positions at headquarters in some areas, and we just curtailed those right now.

We took another look at our advertising to see if we could make that more efficient.

We just went back and looked at every cost, based on the lower sales environment and tweaked that down to allow us to leverage SG&A at a lower level than the 3% we talked about.

Did you have any layoffs in the quarter?

No.

We did adjust, when we say this quarter, no.

Last quarter, I think we did mention and we referred to it again, we had a call center down in Lakeland, Florida, in the old DAP distribution center, which we did consolidate to Roanoke.

We did place many of those people, if not the majority of those people, either here in Roanoke or back into our stores in Florida.

What can we expect in terms of costs related to the opening of your new DC for '08?

What will we incur in '07?

We will spend approximately $30 million in CapEx in 2007 on behalf of the new distribution center.

There will be no P&L impact because it will not be operational until 2008.

Thanks.

The next question is from David Cumberland.

Are we still on?

One moment.

Are we still on?

Mr. Cumberland, you may go ahead.

Can you hear me now?

Yes.

Thanks, with Robert Baird.

First question, when did you start the process of assessing the capital allocation in customer segments and when might you give more specifics on that?

This is Jim.

We started looking at our capital allocations certainly throughout 2006, but in terms of the in-depth business review, we started that in the early part of the fourth quarter, looking at each of the different aspects of our business -- the DIY and commercial, customer research, customer segments.

We would anticipate that most of that work will be done by the early part of the second quarter of 2007.

Thanks.

And then, maybe for Mike, you talked about new marketing and merchandising plans for the year.

Can you elaborate on that?

I think, David, for competitive reasons, we obviously don't want to talk about everything we're doing.

We're looking to refresh our approach with our print media, electronic media.

Last year, recall, we did things like the wiper blades, 25% off sales, where we put a concerted marketing effort together to focus all our marketing and merchandising efforts into that promotion.

We kicked the year off with a BOGO sale, as we typically do.

We ran a 10 for $10 sale this period.

We're just looking for new and interesting ways to create interest in our stores and bring in more footsteps.

My last question, for Michael, you mentioned higher incentive compensation in Q1 '07.

If you hit your plan for the year, how much would incentive compensation increase in basis points versus '06?

If we hit the high end of our guidance, incentive compensation would de-leverage by about 45 basis points, for the year.

Our next question is from Jack Baylose.

Focus Research.

Mike, you mentioned that recent results were stronger.

I was also wondering if there were differences in regional results depending on weather.

Yes.

We have said our recent results are stronger.

I am not sure where you are at today, but it is probably snowy and cold.

We get mixed results from where that weather hits and when it hits.

We obviously had a severe ice storm in the Southwest.

That affected us negatively in the first period.

You don't get a boost in sales from ice storms.

On the other hand, the Northeast with the heavy snow has been fairly strong for us.

In the Southeast we have had a little bit of rain.

We do get some differences.

But we are seeing overall strength.

In other words, in the month of February, you're seeing stronger strength.

The last couple weeks.

In terms of comparisons going forward, as you know, in the first quarter of '06, your commercial delivery was up, but you were comparing with the first quarter of '07, was up 16.4.

Then it goes down to 9.1 in the second quarter of '06, and 8.7 in the third quarter of '06, as well as having negative comps in retail during those two quarters as well.

It just seems you are being ultraconservative when you are suggesting your first quarter comps experience for '07 currently is going to continue for the remainder of the year.

Given that you have so much easier comps, wouldn't you expect some pick-up going forward?

Jack, I think we did when we did the plan for '07, but obviously, and we said it over and over again in the call, we just think at this time it is much more prudent for us to plan with a lower comp growth rate to manage our expenses at that rate, and to set our expectations for Wall Street and our investors for that rate.

Certainly we're looking for upside, but right now we don't have enough confidence in the consistency of our top line sales to be any more aggressive.

You had mentioned you have some old-timers.

I suppose Jim Wade would be an old timer now? 12 or 13 years?

Not much gray hair, though. (MULTIPLE SPEAKERS) You've got the least gray hair in the room.

Maybe Jim can answer this question.

What's been your experience, in terms of a bounce back, when the industry has had period of softness?

Like, for example, last year, I can remember a time when there were fewer miles driven, maybe going back 15, 20 years in the history of the industry.

I don't expect that to happen again.

There will probably be an increase in miles driven as there has been recently in '07.

I am wondering, Jim, based on your experience, after you've been through a soft patch in the industry, how many months in the future do you then start to see the deferred maintenance rebound show up in sales?

I think it varies from year to year, depending on what the circumstances are, and what the causes of the slowdown is.

And I think traditionally, this industry sees less slowdowns or upturns.

It's more consistent than most of retail.

But having said that, there are times when business is stronger or weaker.

But I think the thing we keep coming back to, and talking about, is that ultimately, with our type of customer, the need to repair their cars, that business does come back.

As Mike said, the key is when do we see that business consistent enough in terms of strength to feel better about providing more optimistic guidance as we go forward.

And I think the important thing here, as Mike said, is to ensure we're seeing consistent improvements in sales and until we do that, manage the business conservatively.

History has certainly shown us over and over that business in this industry does come back and we fully believe that will be the case.

So, if it does come back, you can ramp up and take advantage of it.

Yes, I believe that's -- in almost any type of business, if we manage our business conservatively, when sales are tougher, when we do see sales pick-up, that gives us the opportunity to leverage better and take advantage of it, as well as being prepared to invest where it makes sense.

It was mentioned that you're going to have lower remodeling costs on the 2010 stores going forward.

Would that also affect the new store costs as well?

It will in some cases.

As far as the remodels are concerned, the key things we continue to focus on there is to make sure we do accomplish the rebranding to the 2010 look and also the refreshing of the stores, but not spend quite as much structurally in changes or in replacement and resetting fixtures.

Having said that, we are looking at every cost in our new store program as well.

We have identified some savings that are the same as the types of savings that we're going to get on our remodel programs.

And in other cases, we're looking at other types of costs that go into our new stores that we can address.

But I feel comfortable that we are going to be able to achieve some savings on new store programs as well.

Will that include the fixturing cost too?

Potentially some, but not nearly -- in a new store, obviously, we're putting all new fixtures in.

In a remodeled store we have the option of how many new fixtures -- how many replacement fixtures we put in.

The fixture costs primarily will be on the remodel, in terms of savings.

Well, Jim, I hope as business ramps up, with your experience, you can get the other guys to be a little more optimistic as well. [laughter] Thank you.

Next question is from Matt Fassler.

Goldman Sachs.

Thanks a lot and good morning.

I'd like to start out by digging a little deeper into the capital allocation discussion.

You have had some very modest adjustments in rate of store growth and remodels.

And Jim, you intimated that this review is something that remains underway and gets done by the outset of the second quarter.

What are some of the bigger picture conclusions that you think might result from this analysis and the range of actions that we could see as an outcome?

We're really not at the point where we can talk about significant outcomes yet.

And I think, even internally here, we are trying to ensure that we go through the entire process and make sure we have a good strong fact base and then from there make decisions.

But again, the types of things we're looking and is, first and foremost, updating all of our customer research.

We are going back and doing extensive research with both DIY and commercial customers, understanding how they see their purchasing decisions today, certainly compared to research we have done in the past, looking at the different segments of the business as far as how customers break down.

And then from there, starting to look at how do we maximize performance both from a sales and margin standpoint, as well as SG&A leverage and return on capital?

As we finish out the process, the intent is to be more clearly aligned with how we can best drive the business and invest our capital.

We will certainly talk more about that as we get closer to the end.

But we are just not at a point yet to start to come away with conclusions, internally to any great extent, and certainly not to the point where we're comfortable talking publicly yet.

Because what you are talking about sounds more like an operations review than a capital structure review.

Are you thinking about things like buy-backs or more significant changes to the rate of store growth as a result of this?

I think it's an internal review of our business and the findings from that will tell us how best to allocate the capital based on the return that we get.

I don't know if I answered your question exactly or not.

It is fair enough.

Capital allocation will be a clear result of this, but it's coming from what we learn about customers and how best we can use the capital to drive the business.

Got you.

A couple of follow-ups on the financial front.

To Michael Moore, the workmen's comp and auto liability issue, you talked about a 75 basis point hit.

Has this been a problem all year or is this the first time you are seeing impact of this magnitude on the P&L from these line items?

This is probably a higher magnitude than the year, but it has been an issue throughout the year for us.

But we -- as I said in my remarks, our number of incidents are declining.

We expect to see, over time, that that expense will come back.

In fact, the total debt expense in 2007, we expect to be able to leverage.

Was there a change in carrier or accident experience or something like that, this quarter that led to the pop?

There was no change in carrier.

We conduct an -- or have an actuarial study done twice a year, and that study looks at all past claims, or incidents from prior years, and the cost per incident increased.

On the new space productivity front, Jim, you mentioned some other non-comp items, I think beyond the core Advance stores, and the extra week a year ago from AI that distorted the calculation.

What are the other items that create noise in that line item -- or that calculation?

The things that don't go into our comp calculations are what we call bulk sales, sales that we make throughout the quarter or the year that fluctuate from year to year.

As you recall, our Puerto Rico business doesn't go into our comp sales.

We're doing some things differently there that is impacting a little bit the total amount of volume we are seeing there.

It is those kinds of things.

The point we wanted to make sure we made, because we know people calculate this out, is that our underlying new store productivity is still solid.

Finally, on incentive compensation, Michael, you talked about a 45 basis point hit, if you get to the high end of your guidance.

Just to make sure incentive compensation wouldn't stand in the way of your making that $2.48 EPS, in the event that sale and other things got there, that would be after consideration of the incentives comp.

Yes.

Our people out there earn their bonus on that.

Fair enough.

Next question is from Gary Balter.

Please state your company name.

It's Gary Balter and Seth Basham from Credit Suisse.

Maybe I'll start and then I'll let Seth ask a question.

Going back on, just following up on what Matt just asked, one of his 40 questions, if you looked at workers comp and the auto liability, how much of that reflected possibly changing the rates of reserve versus actual incidents?

When you looked at it, were you just under-reserved based on previous experience and some of this was a catch-up so we shouldn't expect as much next year?

As I say, we have an actuarial study done twice a year, and what that study looks at is prior years claims, and they apply a development factor.

What the actuarial study told us is that we needed to increase the severity of claims, both for prior years and current year.

It was both a combination of current year and prior year.

In that regard --

It's increased cost on behalf of prior claims.

Some of it in a way is a catch-up.

You could look at it that way.

That is positive.

Mr. Coppola, we have heard some stuff on pricing, that you're getting a bit more aggressive, and you alluded to it in an answer to a previous question.

Do you discuss what you're doing on pricing?

I didn't say we're getting more aggressive, Gary.

The real key is that we continue to improve our price competitiveness, despite us having the ability to increase gross margin simultaneously.

The real issue is, and probably the best way of looking at it is, we continue to buy better, due to scale, due to size, due to direct importing, due to category management.

We are taking much of that cost savings, or a good portion of that cost savings, and giving it back to our customers with lower retails, and picking up our main gross margin improvement from things like logistics, those kinds of expenses that we were earning through improving our efficiencies.

You are not seeing -- you are not starting any price battle.

Absolutely not.

Absolutely not.

On that whole private label and the push to sourcing, do you worry that you're moving too far in one direction?

Could that be having any impact on the brands you are changing and some of the direct importing, whether that's the weaker part of the sales?

We have, obviously.

Our parts department branding has not changed.

It is fundamentally the same.

We may have tweaked it actually a little bit higher to a brand name orientation.

It's where we had the private label existing that we're going to direct imports, the customers see the same box.

Most of our direct import activity the last couple of years have been in categories in the front room, that were of non-descript brands.

We did not discontinue one true branded item for a direct import.

I think we have done a pretty good job marketing and developing brands like Professional's Favorite, Mirage, Auto Express, Joe's Garage, Mechanic's Choice.

Where, really, we had a menagerie of brands, we've gotten, I think, more clarity with the customer that we look more branded than we were when we didn't have these direct import supported brands.

Just on that point, Mike, can you update us on the percentage of your sales from private label and from direct importing?

We are pushing the higher end of the range.

We've talked in the 20 to 25% range, we're getting closer to the 25.

But again, that is not a goal or a target, that is something the customers drive by their purchasing activity.

And direct importing?

Our direct importing is about 5% of our business, slightly less.

Completely direct.

Yes.

Direct sourcing.

Next question is from Bill Sims.

Please state your company name.

Good morning, it's Citigroup.

Mike, of the 2007 look into the comp guidance you provided, can you give a rough break down between commercial and retail?

Should we expect a similar rate of growth as what we saw in the fourth quarter?

I think that would be the proper assumption, that there will be a rate of growth in both.

I think commercial might be a little softer than we saw in the fourth quarter, but we expect DIY to be a little bit higher.

And one of your, maybe not direct competitors, Monroe Muffler, had some very positive things to say on the industry, and you're the first auto part retailer to come out and provide more muted guidance.

How do you think your two industries differ from a consumer perspective?

Again, they are heavily oriented toward commercial, and I think their positive commentary was -- the last two weeks of December were very strong for them.

They were not for us, so there is certainly a dichotomy of results.

But I think the things we are hearing from our installer customers, that their business has been soft throughout, not only December, but also in January.

And then, last question, just from a store labor perspective, you've maintained in the past that you would not cut store labor as you cut expenses throughout the organization.

Do you hold true to that in the fourth quarter?

And should we expect the same in '07?

We believe we did and we are managing our labor to what we think are reasonably conservative forecasts.

Obviously, as we go into spring selling season, we will continue to ramp up labor week over week.

We may be a little slower in adding the labor in to assure that we continue with our leverage.

We have a tool called MPT which we've talked about many times, and we're using that to manage our labor.

By the same token, we have done things that we have taken work out of the stores, and through MPT have removed that labor, because it is not necessary anymore.

We've referred to, for example, a few times, our closing process, we have now put that into place, and we're saving 15 minutes a day times two team members in every one of our stores.

They just get home earlier, and we don't pay that extra half hour per day per store.

So that labor certainly has come out of the store.

Thank you very much.

Our next question is from Alan Rifkin.

Please state your company name.

It's Alan Rifkin with Lehman Brothers.

Few questions, if I may.

Looking at a post mortem here at 2006, and looking at the weakness relative to your plans for the existing stores, where specifically, if any area did it really lie?

Was it within a class of new store openings?

Was it possibly geographical?

Was it particular to the 2010s, or relos?

Could you maybe just provide a little bit more color along those lines?

I think on an overall basis, what we saw last year is the different categories, whether it be existing stores, new stores, or remodels, the results were not as strong as what we had seen in the prior year.

It was not geographically centered, or new stores versus existing or remodels or anything specific.

It was across the company, a lower sales level than we would have liked to have achieved.

Second question, your decision to invest in your store base at a slightly more conservative rate, this year versus last, do you have any empirical evidence so far, even if it's fourth quarter alone, that would lead you to believe this lower investment will actually produce higher ROIC results?

We are in the process of doing some testing of that currently.

Again, the intent is -- we talked about before, is from the customer standpoint, they are going to look at a remodel and they're going to see the new 2010 look as they have in the past, and they're also going to see a refreshed look of the store.

And the costs that we're taking out are costs that we don't think will impact the response from the customers.

So, like everything else, we measure, we look at and we understand the impact, and that's the process we're going through currently.

But we feel as comfortable as we can at this point that we can still achieve the benefits at this lower cost.

Jim, as a follow-up to that, the targeted goal to reduce by 40% the remodel expenses, should we be thinking that any remodel going forward will be, what, about $80,000 to $90,000 per remodel?

Is that a good number at this point?

Alan, yes.

Currently we spend a little more than $150,000 in CapEx per remodel and we expect that to be under $100,000 going forward.

In the area that you mentioned.

One last question, so Gary doesn't pick on me.

If you hit your plan in 2007, at low single digit comps, let's say, what proportion of your targeted expense savings would you say you could realize, irrespective of what the comp is, as opposed to how much is really predicated on you producing that comp?

In other words, of the targeted expense savings, how much is fixed, and how much is really variable?

When we talk the target expense savings, we're really talking more the fixed type expenses or when we say fixed, traditional expenses that we spend.

It's not, per say, store payroll that we're talking about.

What we have really done is taking -- structurally taken expense out of the business.

Alarm monitoring expense, communications expense.

That is savings we are going to achieve, irrespective of what sales are, in terms of dollar savings.

Michael, any idea what that would collectively roll up to in terms of targeted expense savings?

Or is that difficult to --

I don't think I can respond to that quantitatively.

Thank you very much.

Good luck.

Our final question is from Scott Ciccarelli.

RBC.

Two questions.

The first is -- has to do with the store labor.

Obviously it is your biggest expense bucket, if you will.

Is there a point where you actually start to scale back store labor?

I know you've been hesitant to do it, because you're expecting a snap back.

But is there a point where we actually start to make structural changes to the in-store labor model?

I think that's what I referred to earlier.

We are very committed to providing the labor we need to take care of our customers first and do the work that is necessary second.

Where we are looking is what we call, what work is necessary, how much planogram work we do, how many point of purchase signs we put up, how we, from an SOP standpoint, do many processes, and where we can reduce the workload, we are taking the labor out, because it's not necessary.

We focus first on what it takes from a transaction standpoint to service the customers that come in our stores, manage the work, and obviously we're going to look to take some of the work out of the business structurally, as you say.

It sounds like you're not really going to change the in-store labor model outside of the extras, the closing and that kind of stuff, the customer facing activities.

The model is based on service and workload.

And we're trying to reduce the workload wherever we can, by being more efficient or more prudent in what we are doing so that the model is the same, the process is the same, and when there's less work to do, we have less hours in the store.

The other question is, it looks like implicit in your guidance, you do expect comps to improve, at least very slightly, during the course of the year.

Is that a function of optics, just easing comparisons or is there contemplated an actual acceleration in the sales trends, if you will, during the course of the year?

Scott, the only thing I can say to you is we are looking to be conservative.

Certainly, there is some easing coming up.

We also have a little more optimism, but until we see consistency of that run rate, we're going be very conservative in what we are saying.

I understand that.

I guess my question is, contemplating the guidance that you provided to us, is there an actual improvement in the sales trend that you are looking for?

Is that implicit in the numbers that you provided us?

Both, the easing of the comps, and a little better, more optimistic view of the future.

One other thing, our first quarter was our best quarter last year.

As we go into Q2 through 4, where we had then a 1-2 to 1-6 comp range, those quarters are a bit easier to anniversary.

Thanks a lot.

Thanks.

Appreciate it, guys.

Thank you.

That concludes our call for today.

Thank you for joining us, you may now disconnect.