領先汽車配件 (AAP) 2009 Q1 法說會逐字稿

Welcome to the Advance Auto Parts first quarter 2009 conference call.

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

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

Certain statements made during this conference call will contain forward-looking statements that incorporate assumptions based on information currently available to the Company.

Any statements that are not related to historical facts are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are subject to risks, uncertainties and assumptions, including those listed from time to time in the Company's annual report on Form 10-K and its other filings with the SEC.

If any of these risks or uncertainties materialize, or if the underlying assumptions prove incorrect, the Company's actual results may differ materially from the anticipated results discussed in these forward-looking statements.

The Company intends these forward-looking statements to speak only at 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.

For planning purposes, our second quarter earnings release is scheduled for Wednesday, August 12, 2009, after market close and our quarterly conference call is scheduled for the morning of Thursday, August 13, 2009.

To be notified of the dates of the future earnings release, you can sign up through the Investor Relations section on our Website.

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

Now let me turn the call over to Darren Jackson, our CEO, who will be followed by Jim Wade, President; Kevin Freeland, Chief Operating Officer; and Mike Norona, Executive Vice President and Chief Financial Officer.

Darren?

Thanks, Judd.

Good morning, everyone and welcome to our first quarter conference call.

I'd like to begin by congratulating the team on a great quarter and a great start to 2009.

Our terrific results were driven by the efforts of our 49,000 team members.

A year ago, we began a turnaround and transformation story.

Chapter one of our story focused on the customer, defining our four key strategies and revitalizing the core values at Advance.

Fiscal 2009 is the second chapter of our transformation story and it builds on chapter one with a focus on enabling and empowering a great team.

Our committment and focus on the customer, team members and our four strategies are playing out in our results and the material investments to transform our business.

Our confidence in our team members and their results allow us to move forward at an accelerated rate.

To do this, we must lead change, drive the business and reinforce the values of the Company, which are to inspire, serve and grow.

And as of today, I will share with you where we stand in our journey and our progress on our four strategies.

To date, our strategic progress is in line with our high expectations, yet we have exceeded our expected financial outcomes.

Our commercial acceleration and availability excellent strategies have yielded significant gains in the quarter and the last 12 months.

Strategically and financially, the commercial sales growth and the gross margin have been outstanding.

Our DIY transformation and superior experience strategies are building momentum as well.

Candidly, we are thrilled with the first quarter results in our DIY business but we need to be honest that the economic environment put some wind in our sales, literally.

We are very encouraged about what the future holds for our superior experience strategy as we look out over the balance of the year and the foreseeable future.

Collectively, our strong start to 2009, coupled with the economic landscape, is guiding us to accelerate investments to enable a customer focused sales culture, which will fuel our future growth and strengthen the foundation of our business.

Overall, this year will resemble last year in terms of investment profile and pace.

And we will continue to balance our investments in areas that will yield immediate return and others focused on future returns.

Looking out, we will begin to leverage these investments as we turn the corner on 2010.

There are countless areas of the business that I'm excited about that are not readily apparent in the press release.

These include our continued improvement in our customer satisfaction scores, our meaningful market share gains in commercial and the uptick in our DIY share gain.

The completion of our second team calibration survey, the 83% of our stores that had positive comparable sales growth in the quarter and the fact that we had nearly a dozen general managers on track to earn $100,000 this year under our new incentive compensation plan, which pays for profitable sales growth.

Collectively, our focus on growth, profitability, the customer and team members allowed us to increase sales 10.3% in the quarter, on a comp store sales increase of 8.2%.

While delivering bottom line earnings per share growth of 19%, excluding the $0.04 impact of store divestitures.

This is on top of a 21% EPS increase last year during the first quarter.

Jim, Kevin and Mike will cover the details of our strategic and financial results.

Turning to the economy.

The economic environment continues to be a mixed blessing.

We continue to be deeply concerned for many of our fellow Americans, customers, family members, on account of the current economic crisis and confidence and the 25 year high unemployment rate.

However, our industry and our role as a Company continue to be important to meet the needs of our customers in these times.

There is no doubt the trauma in this economic environment is showing up in our business and we are benefiting from it.

Our entire industry has been benefiting from the tide rolling in on DIY.

If the tide rolls back out, the situation will be more challenging to navigate.

However, we are focused on achieving consistent performance whether the economy is in trauma or in great economic times.

To that end, my top three priorities in 2009 start with our team members and their ability to lead change, build great teams and turn potential into excellence.

The changes we've made to our pay and rewards program are accelerating our success.

In addition, we are seeing results from our steps we are taking in customer satisfaction improve results as well.

Collectively, the revitalization of our values, the transparent to uncomplicated focus on our strategy and how we manage and develop our team in good times; is making a big difference as well.

And I believe we are only scratching the surface on the potential of our Company and our team members.

As we continue to build great teams, I'm excited about the promotion of Sarah Powell as General Counsel.

And the new leaders that have recently joined our Company, including Tami Kozikowski, as our Chief Development Officer; and Scott Bauhofer, as our e-commerce leader.

These continued leadership changes are allowing us to spur innovation and increase the speed of getting strategy focused initiatives to market.

The team's focus on profitable sales growth and living our values continues to guide us individually and collectively in this transformation journey.

I'd like to close with an example of what great looks like in our stores.

Sarah House is the General Manager our store in Greenwood, Mississippi.

This store defined greatness in 2008 and it's now driving double digit comps in both commercial and DIY, as well as maintaining above average customer satisfaction scores for both commercial and DIY.

District Manager, Willie Brown shared with me that this store has a true passion for customer service and for growing the business.

He describes the store as setting the operational excellence standards.

Sarah truly believes in the strategic direction of the Company and rallies her team to take care of their customers, most of whom they know by name.

Reggie Flowers, the commercial parts pro, another member of this store team, is a dynamic leader who serves his customers extraordinarily well.

This team has achieved a true partnership between the DIY and commercial teems, resulting in a total store team being dedicated to and focused on taking care of their customers and their results reflect that.

Congratulations, team, on a job well done.

Now, I'd like to turn the call over to Jim Wade to provide a progress update on our commercial acceleration and DIY transformation strategies.

Thank you, Darren and good morning.

I'd also like to congratulate our store team, our commercial sales force and our support teams on a great quarter.

This morning, I'll update you on our progress with our commercial acceleration and DIY transformation strategies.

Through our commercial acceleration strategy, we're continuing to increase our sales and gain market share in the first quarter, which we believe shows that our strategy is working.

With only about 3% market share, there continues to be much more room for our growth.

This was our fifth consecutive quarter of double digit growth in commercial, with a 17.5% increase in comp store sales for the quarter.

This increase was on top of a 10.6% comp sales increase in the first quarter of last year.

As a result of commercial comp growth, our commercial sales mix increased over 30% for the first time ever.

I also want to recognize our team for the strong growth in commercial gross margin percentage during the quarter.

You are proving we can drive strong sales and margin by focusing on parts and providing great service.

We remain fully committed to aggressively growing the commercial business and to continue to achieve double digit comps throughout 2009.

Last quarter, I shared our focus areas that are leading our acceleration in our commercial business.

We're continuing to make progress in these focused areas.

We continue to aggressively invest in parts pros, trucks and drivers in our stores and our markets with the greatest potential and with a proven track record of performance.

We've identified our full potential commercial sales for each store, which is the base from which these investment decisions are made.

These investments are providing our team the resources to drive strong sales performance by serving our customers better.

We continue to focus on building the basics of great customer service at each store.

We're leveraging the increased parts availability that we continue to add and the addition of key brands that we made over the past year.

We are focusing on quick and consistent delivery to our garage customers and building a foundation of knowledgeable team members who understand our commercial customers' needs and are focused on serving them better than anyone else.

We're measuring our progress and improving customer service through our customer traction scores, which I'll discuss in a few minutes.

Finally, we're continuing to revolutionize our commercial sales force.

We're building our team with additional talent to supplement our strong existing talent base.

We've added several new commercial sales leaders during the first quarter who have management experience with best-in-class sales and distribution companies and are customer focused with exceptional leadership and team building skills.

We continue to expand our sales force of commercial account managers, by selectively adding new positions where it's clear we need more sales coverage to reach the many customer opportunities that exist.

We're also providing them more tools that help us acquire new customers and increase our share of our existing customers' purchases.

A milestone in that regard -- in regard to tools, to make our team more effective, is the successful implementation of a Company-wide relationship management system during the first quarter.

I'd also like to recognize the Autopart International team for another strong 10.6% comp store sales increase this quarter.

AI continues to expand its business rapidly with its successful entry into the Baltimore/Washington market.

We're also continuing to grow our sales, between AI and Advance stores, as the two companies are leveraging each others parts availability strength.

This quarter, we also opened our first AI store in the same building as an existing Advance store.

We plan to continue this model, allowing us to better meet our customers' needs by increasing our parts availability, while leveraging our opportunity costs by utilizing square footage that was previously not this productive.

Turning now to our DIY transformation, the first quarter was a key point for our team with DIY comp sales.

Our team delivered a solid 4.4% positive comp after several quarters of negative DIY results.

This was a 550 basis point improvement from the fourth quarter.

As an indication of the breadth of the improvement, we're pleased to report that 74% of our stores posted positive DIY comps for the quarter.

This combination of solid DIY comps and double digit commercial comps, produces a strong growth model.

It's evident that our industry as a whole realized better DIY results this quarter, as consumers are saving money by maintaining their existing vehicles rather than replacing them.

However, the industry data indicates that our team did increase DIY sales at a faster rate than the market during the quarter, which we believe is a very positive sign as we look forward.

Even with the increased sales we saw this quarter, our data shows us that we still have a tremendous opportunity in DIY to fulfill the needs of the customers who are walking through our doors each day.

In our business, almost all customers come to the store wanting to fill a need or find a solution to their problems.

They want to make a purchase.

We still have to do a better job through our service and parts availability initiatives of converting those needs to sales.

Taking a longer term view of DIY, we're working hard to transform it into a sustainable growth engine in any economy.

We're building a capability that's best-in-class in understanding, managing and optimizing the experience of our customers.

Through our DIY transformation, we're striving to turn Advance into a distinctive and differentiated brand.

We'll be arming the organization with actionable customer insights to build our growth and we're continuing to use our peer-to-peer partnership and our new team members systems to achieve more consistent Company-wide results.

Last year, we launched an ongoing Company-wide customer satisfaction survey.

With this tool, each of our stores knows the rating its DIY and its commercial customers have given the store for the level of service they are receiving.

Basically, we're measuring our success of a number of customers who gave that store a score of 9 or 10 on a scale of 1 to 10 for customer service.

We believe these customer traction scores are making our entire Company more customer focused and will be a key driver of our growth going forward.

As we analyze our customer traction scores, over 70% of our DIY customers are rating us with a 9 or a 10.

Although there's room for significant improvement, that story is increasing as we learn from the surveys and the distribution of stores is relatively tight.

In regard to commercial, and even with five consecutive quarters of double digit comp sales growth, slightly over 60% of our commercial customers are rating us a 9 or a 10 and the distribution of scores is broader, meaning our customer experience is not as consistent as we want.

Although we're not satisfied with our current commercial customer scores, we're excited about the huge opportunity that is shown by these numbers.

As we continue to make investments in commercial and work hard to better operationalize our value proposition in our stores, we'll differentiate our customer service, our customer churn rate will decrease and our growth will continue.

Switching to new store development.

In the first quarter, we opened 46 stores, including 11 by Autopart International, towards a goal of 75 new Advance stores and 30 AI stores in 2009.

We also closed nine stores and relocated three.

Our total store count at the end of the quarter was 3,405, including 135 AI stores.

Mike will share more information about the store closings that are part of the plan we announced during our fourth quarter release, as well as the financial impact of those closings.

In closing, thanks again to our team for what you're doing each day.

You serve our customers and drive our results.

We continue to be pleased with our commercial results and are certainly encouraged by the significant improvement in our DIY results during the first quarter.

Now, I'd like to turn the call over to Kevin to review our availability excellence and superior experience strategies.

Thanks, Jim and good morning.

I'd also like to congratulate the team on a great quarter.

I'll briefly highlight our initiatives to improve our gross profit rate, as well as key focus areas and investments that will continue to drive long term value.

During the first quarter, our gross profit rate increased 133 basis points versus last year.

This improvement was primarily due to continued investments in our new pricing capabilities, merchandising capabilities, parts availability.

And combined with changes to better align team member incentive, resulting in better store execution.

One of the investments we made last year was related to price optimization.

We continued to rollout our new price optimization process, which has favorably impacted our gross profit rates in first quarter.

Our retail price optimization strategy has been implemented across a majority of the front room categories.

We have adjusted prices on key items throughout Q1 to be more competitive within our most impactful categories.

The optimization of these categories contributed to our gross profit rate increase during the first quarter.

In Q4, we announced a significant change in how we manage the end of life inventory cycle.

In the past, we devoted our return privileges to parts for early model cars with greater than a five year supply.

In an effort to significantly improve the inventory productivity, we have discontinued replenishment on all early model parts with two to four years of supply and have tightened our policy of obsolescence to greater than four years of supply.

This policy change enables us to free up shelf space in our stores to ensure the right parts are in stock.

During the quarter, approximately $6.5 million of slow moving inventory was disposed of and our goal is approximately $18 million to $20 million by the end of second quarter.

This will not have any impact on our 2009 financials, since the inventory adjustment that was made during the fourth quarter of 2008.

As we optimize our assortments in parts through our new custom mix process and in the front room business, we are identifying both overstocks of basic inventory, as well as identifying unproductive inventory.

We are working aggressively to remove this product from our store assortments in 2009, utilizing both markdown strategies and our vendor return privileges.

Another initiative we have underway is the implementation of our core merchandising system.

I am pleased with our progress thus far.

We are currently on track for our initial implementation, which begins in the second half of 2009 and will be completed in early 2010.

As previously stated, we anticipate that we will begin to realize the benefits of the new system and begin to see improved category performance as a result of the new capability investments.

We are also moving to develop a true direct importing program and believe our opportunities in this area are great.

We opened our Asia sourcing operation and the hiring of our team members is nearly complete.

We expect our global sourcing operation will provide significant margin improvements and allow us to increase the speed to market with products that are more focused on what our customers want and need.

We are also leveraging the success and experience of Autopart International.

We are working to increase our synergy with AI to leverage their experience and sourcing they have developed over the last 15 to 20 years.

We believe these synergies will prove to be a competitive advantage for us.

Now, I'd like to update on the progress of our availability excellence and superior experience strategies.

Availability excellence enables us to serve our customers better than anyone else by redefining the standard with breadth, depth and speed of delivery of parts.

During the quarter, we added two PDQ's, or parts delivered quickly, and 21 local area warehouses, along with increased store delivery services; to provide a wider assortment of parts same day for our customers.

These facilities, combined with the added delivery service, should increase our availability to provide parts to our stores within a two hour window.

In concert with our new custom mix capability and a record setting 309 inventory upgrades in the quarter, we are setting the standard for availability in our industry.

In addition to the investments, we also continue to identify opportunities to drive efficiencies.

During the quarter, we implemented engineered standards for order selection within three of our eight distribution centers.

This initiative enables us to improve labor productivity in our main distribution centers and reduce distribution expenses over time.

Labor performance is steadily increasing, consistent with our expectations.

Turning to information technology, we're investing in IT in support of our business strategy.

In conjunction with the shut down of the partsamerica.com site in February, we launched an online catalog site and began to build a team of experienced e-commerce professionals.

Our goal is to launch a world class e-commerce site in the near future that will support our multi-channel strategy and serve our customers better than anyone else.

During the quarter, after careful research and consideration, we decided to outsource the Company's corporate purchasing and expense accounts payable functions to IBM, a nationally recognized provider of source-to-pay services.

This change only impacts the purchases of goods not for resale.

By outsourcing these areas, we'll be able to focus resources on achieving our key strategies.

Provide savings opportunities by leveraging IBM's buying power during vendor negotiations.

Gain access to IBM's global expertise and best practices for both sourcing and expense accounts payable.

And improve processes and organizational capabilities with both procurement and account payable policies.

This transition will be complete in fourth quarter.

Advance will continue to internally manage the purchase and payments of all merchandise sold in our stores.

Our superior experience strategy enables us to serve our customers better than anyone else by consistently providing legendary customer service through a relentless focus on execution.

Superior experience translates that goal into the specific activities that our team members must perform in order to unlock their full potential, drive significant customer satisfaction improvement, while ultimately accelerating sales growth.

During the first quarter, we began an initiative designed to introduce new strategies and operating changes into the stores in a scalable and repeatable method that ensures consistent and sustained operating performance.

This new implementation factory will launch several key programs that will be rolled out in Q2 and Q3.

In closing, I continue to be encouraged with the progress we are making as a result of our investments in availability excellence and superior experience.

In the future, I look forward to sharing the benefits of these initiatives as a result of the investments that we're making.

Now, let me turn the call over to Mike to review our financial results.

Thanks, Kevin and good morning, everyone.

I would like to start by personally thanking all of our talented and dedicated team members for the results we achieved this quarter.

What is impressive is that, despite being in the early stages of our turnaround, our team members continue to find ways to take care of customers, lead change and deliver strong financial results.

I plan to cover the following topics with you this morning.

One, provide some financial highlights of our 2009 first quarter.

Two, share the specific investments that are driving our sales and profit gains and how they are impacting our cost structure.

And three, share what we see for the balance of the year.

Turning to our first quarter.

Our results include a change in accounting principle for freight and other handling costs associated with transferring merchandising from LAW's and PDQ's to our retail stores, from recording such costs as SG&A, to recording those costs in gross profit.

This change, which had no impact to operating income or cash flows, more accurately reflects the nature of the expense.

It also makes our results more comparable to our competitors.

Going forward, our results will be reported under this new accounting principle and we have retrospectively adjusted all prior periods related to cost of sales and SG&A.

The impact for the first quarter of 2009 was a reclass of 112 basis points out of SG&A and into gross profit.

Our results also include $0.04 per diluted share of expenses related to our incremental store divestiture plan, previously announced in our 2008 fourth quarter release.

Currently, we estimate that the full year incremental store divestiture will result in a $0.15 to $0.22 charge to EPS, with the majority of the expenses occurring during the second and third quarters.

As previously stated, these costs are not included in our 2009 annual outlook.

Our first quarter financial results significantly exceeded our expectations, driven by an 8.2% comp store sales increase, combined with a strong gross profit rate improvement versus prior year as a result of our continued investments.

Our earnings per diluted share of $0.98, included a $0.04 charge related to store divestitures, which as previously shared, was not part of our 2009 annual outlook.

Excluding the impact of the store divestitures, our earnings per share of $1.02 increased 19% on top of a 21% increase in EPS last year.

Some highlights for the first quarter include an 8.2% comp store sales increase, comprised of a 17.5% increase in commercial and a 4.4% increase in DIY.

Please note, that the impact of the calendar shift as a result of the 53rd week in fiscal year 2008 added approximately 1% to our total comp store sales in Q1.

The impact of the calendar shift will reverse and be a head wind to our comp store sales during the back half of 2009.

Our commercial comp was comprised of an 18.3% increase in Advance stores and a 10.6% increase from Autopart International.

On the DIY side, we delivered a 5.5% sequential improvement from Q4, driven by a higher customer average and increased traffic, as measured by transactions.

Quite frankly, we did not anticipate this dramatic increase, with every area in our Company posting positive DIY comp sales.

All in, our revenue grew at 10.3% versus the remainder of the total market growth of 4%.

Clearly, our strong top line performance exceeded expectations and resulted in significant market share gains.

During the first quarter, our gross profit increased 133 basis points versus last year, primarily due to more effective pricing and better store execution.

We are beginning to realize the benefits from the investments we've made over the past year and during the quarter, in terms of both our pricing and merchandising capabilities.

These capabilities are allowing us to be more targeted with respect to our commercial and retail pricing strategies and better positioned from a cost standpoint.

Additionally, our store team members have responded remarkably to our new incentive structure.

We are very pleased with our margin improvements.

Our SG&A rate increased 142 basis points and was driven by higher incentive compensation, store divestiture expenses and continued strategic capability investments to improve the Company's gross profit rate and accelerate the commercial business.

The higher incentive compensation and store divestiture expenses drove over 100 basis points of the increase during the quarter.

These increases were partially offset by occupancy and advertising expense leverage, as a result of the Company's 8.2% comparable store sales increase.

Despite the SG&A increase, our operating margin increased 25 basis points during the first quarter, after removing the impact of the incremental store divestitures.

We previously shared that 2009 would be another year marked by investments required as part of our turnaround and this played out in our first quarter SG&A line.

I will share more on our SG&A investments later in my remarks.

Free cash flow for the quarter was $201.4 million or a 34% increase over prior year's first quarter, primarily driven by an increase in net income, a decrease in owned inventory and the timing of tax payments.

With this free cash flow, we paid down $176.1 million of debt during the quarter.

Our accounts payable to inventory ratio increased to 59.8% from 57.2% at year-end 2008 and from 58.6% at the end of first quarter last year.

Inventory only grew 3.9% from last year's first quarter, compared to sales growth of 10.3%.

Our rent adjusted leverage ratio at the end of first quarter was 2.4 times, which was in line with our internal target.

From a capital structure perspective, we are managing the business to a maximum adjusted debt to EBITDAR leverage ratio of 2.5 times, with capitalized rent of 6 times.

We think this is prudent given the environment and we are comfortable that we can continue to invest in our growth strategies to reach our full potential, while also balancing the interests of debt and equity stakeholders.

To put our first quarter results into perspective, we are pleased with our fifth consecutive double digit commercial comp sales growth, our first positive DIY comp in 12 quarters and the gross profit rate improvement, which all resulted in strong earnings growth.

We are also happy with the free cash flow we generated and the fact that we continue to strengthen our balance sheet.

Naturally, SG&A growth is not what we are striving for longer term but it's not a surprise given our investment priorities and our terrific first quarter results.

Now, I would like to share with you the specific investments we are making to accelerate growth and improve our operating performance in the future and how they are impacting our SG&A per store performance gauge.

During Q1, our comparable SG&A per store increased to $607,000 per store from $590,000 per store in the fourth quarter.

The increase in SG&A per store can be placed into three buckets.

First, key investments we made last year and continue to make, that we are beginning to see benefits from.

Examples include inventory upgrades, commercial resource investments, pricing effectiveness and physical inventories.

All of which, impacted our improved commercial comps and margin improvements this quarter.

Secondly, investments we have recently made that have been dilutive due to the timing and payback horizon of the investment.

Examples include our merchandising system, fleet outsourcing, goods not for resale outsourcing, global sourcing, engineered standards, building commercial sales force, recently investments in PDQ's and LAW's and store divestitures.

All of these investments will have strong financial returns, yet were dilutive this quarter.

Lastly, investments we made in the current quarter that delivered an immediate financial return.

There is no better example of this than the structural change we made to our incentive system to pay on growth rather than budget.

In times of growth like we experienced in our first quarter, our bonus expense will be linear, especially, when you are transforming from a capped program.

However, our teams now have unlimited upside to accelerate growth.

These are examples of why we have said 2009 will resemble last year in terms of our investment profile and pace.

And also why we are seeing deleverage in our SG&A.

Spending always comes ahead of returns and we are simply playing catch up in terms of some of the key capabilities and investments needed to transform and differentiate our business.

This will have a tendency to frustrate those who look at our SG&A on a shorter term horizon.

However, our solid first quarter results, including our strong commercial comp, improved margin rate improvement, and DIY share gain; provide direct evidence that the investments we started last year were in the right areas, even though those investments burdened our SG&A last year.

As we peer through the lens of our four strategies, we also believe our current performance is only a mile marker to what we believe is our full potential.

We believe our four gauges continue to be the right barometers to measure our performance but naturally, they will not move in tandem.

We have prioritized growth and returns to be leading indicators, as measured by sales per square foot and ROIC.

SG&A per store will be more of a lagging indicator, given the timing of benefits.

Looking ahead, I would like to remind you that the stimulus checks during our second quarter last year benefited our top line approximately 2%.

That said, we are optimistic in our growth and profitability profile, based on our Q1 results and we remain committed to the strategic objectives and investment profile we shared with you last quarter.

Additionally, we will increase our investment spending in key strategic areas, including commercial trucks, parts pros, and drivers, as well as areas such as global sourcing and e-commerce.

Our proven results, coupled with our low market share, demand that we move faster.

With these changes we now expect each 1% increase incomparable store sales will add approximately $0.05 in EPS on an annual basis.

Our previously shared 10 basis point improvement sensitivity in operating margin is still expected to add approximately $0.03 of EPS.

These sensitivities do not include our store divestiture costs.

In closing, we are pleased with the financial results we delivered this quarter.

They contain clues that we are on the right pathway to reach our full potential and are also a reminder that we are still in the investment cycle of our turnaround.

We remain cautiously optimistic about the economic environment and the impact it is having on our valued customers.

Most importantly, we are proud of our dedicated team members who delivered fantastic first quarter results and who are passionately leading our turnaround.

We are now ready for questions.

Operator?

Thank you.

(Operator Instructions) Tony Cristello, you may ask your question and please state your company name.

Thank you.

BB&T Capital Markets.

Good morning gentlemen.

Good morning Tony.

One question, the first question I have is, when you look at the level of spend, should we think that this, given the fact that comps have accelerated to some degree, that the level of spend or SG&A per store, as you noted, will accelerate through the balance of the year?

And then, at some point and I don't know, maybe you can provide clarity on that, when will we see that level of spend per store start to release, flatten out or decelerate?

Hi, Tony, it's Mike Norona.

Well, first of all I want to give you a little context for Q1.

We were up against our toughest compares, if you remember and I think we said that in our Q4 outlook.

We did say also that we're going to continue to spend and invest in our strategic capabilities for the back half of the year.

That said, the compares get a little bit easier as we go through the back half of the year.

So, implying that the level of spend starts to decelerate as you enter the back half of the year.

And as we enter the first part of next year, if you -- an 8% same-store sales number should indeed provide at least breakeven or perhaps some leverage rather than deleverage.

Is that a good way to look at it?

Yes, Tony, it is.

So let me just give you a simple example is that -- I'm doing this from memory.

My recollection is in the first quarter of last year, Mike, it was like a 10 basis point leverage on SG&A.

Well last year, if you went to the first quarter and went down into our merchandise organization and had everybody raise their hand that were part of the global sourcing team, that would have been one or two people.

Today it probably numbers closer to 20.

Our e-commerce team was one or two people and that number is closer to 20 today.

And if you look at the other merchandise capabilities that are clearly benefiting our margin today, whether it's the pricing teams, whether it's our IOM, that didn't exist in the first quarter of last year.

And so, if you think about it, we have been -- in the first quarter of last year in many places, we were still doing the edits.

And we began to build the capability spend throughout the second, third and fourth quarters.

You can look at our commercial sales team and I'm looking at you, Donna, between the first quarter of last year and the fourth quarter, what are we up to 100 team members in that space?

Yes.

And so to Mike's point, they all don't have a return in the moment but they're all working towards.

And that's what I'd have people focused on is that; Are we actually getting the returns in the places that we targeted?

Are we getting it in commercial sales?

Are we getting it in the gross margin rate?

What we said in the script, we're building momentum in superior experience, in the DIY transformation.

And you know what?

We're probably a little bit further behind in terms of our investment.

And you know what?

We're probably seeing, in some cases, some of the benefits, whether it's in shrink or whether it's our DIY trend.

But we're trying to think about it in terms of; Are the capabilities getting the returns, in the spaces that we're making the investments, in time periods that make sense?

And so, I'm actually not troubled at all by our SG&A spend.

And I think to your point, it levels out and we had some catch up to do and we had some editing to do.

But in the places that we targeted returns, I couldn't be happier.

Okay, great.

Thanks guys.

Thank you.

Our next question is from Stephen Chick.

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

Hi, thanks, FBR.

Hi, Steve.

Hi, how are you?

Good.

Congratulations on a good quarter here.

Two questions.

First, is related to sales.

And when you set guidance for the year for DIY, I think actually being negative, it was after your fourth quarter on that conference call, which was I think February 19 or so.

And I think Mike, frankly, said that DIY exceeded your expectations.

So I'm wondering, if you could -- that implies I think that things accelerated as the quarter went on.

But I was wondering if you could speak to that trend, the intraquarter sales trend?

And if you could mention how things have continued as we've kind of progressed here into the second quarter?

And then, my follow-up question is related to commercial but I'll ask that, actually, after you -- if you could give an answer to the first one.

If that's alright.

Yes.

Why don't I frame it and then Jim, maybe you can add a little bit.

Is that, Steve, back in February, I think you actually have to go back to the fourth quarter when we had the sequential change from Q3 to Q4 in our DIY.

We weren't quite positive coming through the fourth quarter.

And I would tell you that in the first quarter, it was in, I think we said, literally we ended up with some wind in our sales.

I'd call it an elevator ride.

That we got on the elevator and DIY clicked up much higher than we had expected.

And what we learned last year, between Q2 and Q3, is sometimes it's a head fake.

We had great business in Q2 of last year.

Q3 fell back the other way.

And I would say throughout the quarter, there were some different calendar shifts throughout the quarter but by and large, the quarter, as we got into March, April and so was pretty consistent.

And I think you don't have to look any further than the economic environment to know that people are choosing to, as Kevin Freeland says, in-source more of that work.

And on the commercial side, I think our efforts are showing up in terms of just the investments we're making.

Because our market share gains there are more material and distinct based upon what we're doing.

So I think collectively, the whole industry is benefiting from the DIY tide rolling in.

And you know what?

I think it's -- you guys write about it all the time.

The environment is going to continue to help those trends for the foreseeable future.

Do you have anything to add, Jim?

No.

The only thing I would add, I think when you compare the first quarter to prior quarters for DIY specifically, we saw our traffic trend improve.

And that ties back to the consumers looking to repair their own vehicles and start to shop in our stores more.

And as we look forward, I think there are positives and negatives to that; tail winds, gas prices are continuing to be down, head winds, the stimulus package from last year fell in the second quarter.

So we're up against some somewhat tougher comparisons.

But certainly, overall, we remain positive with what we're seeing.

Pleased with where we are but we are cautious, taking into account those factors.

Okay.

And then, my second question on commercial is, obviously, the commercial strength is encouraging.

And we're getting some feedback and I wanted to ask you this but there's been some feedback that garages are asking a little more about price and a little more value conscientious.

And I'm wondering if the strength that you're seeing in commercial is -- can you speak to if that's driven by lower price point, type hard parts inventory or if you're also seeing a gain in some of the higher tier, closer to OE quality like inventory as well?

Can you speak to that?

Yes.

I can speak to that and anyone else can join in as well.

The way we're going to market in commercial is emphasizing our ability to serve the customer and have the parts they need and have the brands they need.

And be able to get the part there quickly to them.

And have team members that can help facilitate that process.

And that's how we're seeing our growth.

And we mentioned in the call, that we in the first quarter, actually, saw some significant 150 basis point, actually, increase in the commercial gross margin percent.

And that's clearly going to the service value proposition and the parts balance of sale that we're seeing.

And that's how we're going to market and that's how we'll continue to do so.

So, there probably is, in some cases, some additional price sensitivity at some garages, depending on where they're located and what type of specific customers they may have.

But we haven't seen anything significantly different and we certainly haven't changed how we're going to market.

Okay, thank you.

Thank you.

Our next question is from Scot Ciccarelli.

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

Hi, guys, RBC.

How are you?

We're good, Scott.

Excellent.

Obviously, the first quarter turned out pretty good and particularly, on the sales side.

But I'm also going to assume that you're not planning for 78% comps for the balance of the year.

Now, assuming this assumption is correct, how quickly could you guys pull back on SG&A spend if you chose to and by how much?

Can you frame that for us at all, Darren or Mike?

Yes Let me frame it.

First of all, we're making -- there's two buckets of spend that we have.

One, is we're building new capabilities.

And if the market slowed down a little bit, I don't know if we would slowdown that spending and building new capabilities.

And the best example I can think of is the merchandising system.

It's a capability today that we don't have, we need to have and we're going to need it in the future.

And I think that's important.

Commercial, you can see from our commercial comps we're investing in our commercial business and we're seeing fruits of that.

If all of a sudden there was a change in the market, we have levers that we can pull.

However, right now, we're thinking -- we're building structural parts of our business and that's where the majority of our SG&A is going.

And building on something Darren said, as I look at our SG&A, most of it is, if not all of it, is being invested directly in the customer facing parts of our business.

And I think that will position us well to do well.

And I think in Darren's remarks, in our business we want to do well when the market is -- when the economy is good and when the economy is bad.

And if you don't invest in your business in times like this, you won't have those options.

So I think good companies find ways to grow in good economies and bad economies.

Maybe the last thing I would add is, we've been sharing with you and we get a lot of questions strictly on SG&A.

And one of the things that I want to point you to is SG&A typically, when you spend $1, you're looking to get a return.

And I think I outlined in my remarks that the timing of the returns usually will have SG&A as a lagging indicator.

So one of the things that I look at it as our four gauges, is we've prioritized our growth, as measured by sales per square foot; and our returns, as measured by return on invested capital to be leading indicators.

And if you look at our business, from Q4 to Q1, our ROIC went up from 14 to 14.6.

So, we're getting the returns.

And I can tell you, we got a lot more discipline in our business before we're investing $1 to make sure we're getting the return.

The timing sometimes lags and then, you can see what happened in our sales per square foot.

Scot, I would just build on Mike's point that look, if the rest of the year is an 8% comp, we'd be absolutely thrilled.

And I'm not speaking out of school that 90 days ago or 120 days ago, we had a view of the business and our view is more optimistic today.

And we are recalibrating our business, as you can see from our release, to a higher set of expectations.

There's no doubt about that.

And the other thing to think about, Mike remind me, if you back out our store divestitures our SG&A is up 100 basis points?

Yes, 98 basis points.

2/3 of that incentive comp.

And the wonderful thing about incentive comp, I'm thrilled for our team members, specifically our general managers, a dozen of which are on track for $100,000 total cash comp this year.

If the business isn't working, we don't have 2/3 of the SG&A going up because of incentive comp.

And so, most of the investment, it's about parts pros, hours in our store, those things that are touching the customer.

So I think when you kind of break out; Where is the SG&A going?

That's how I look at it.

Is that; Is it going towards those things that are going help us sustain that top line growth, sustain that margin improvement, and by the way, reward the people that are driving the business?

And this quarter couldn't have come out better, from my perspective.

And you know what?

I'll say it again, I am not overly troubled.

And you know what?

I'm actually thrilled that we're seeing those investments show up in those places we expected to get the returns.

Very helpful.

Thanks guys.

Thank you.

Our next question is from Gregory Melich.

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

Hi, it's Greg Melich with Morgan Stanley.

Good morning, everyone.

Hi, Greg.

Hi.

So, Darren, just to close on that is SG&A point.

This is clearly a year of investment.

You're getting the early return but the 14% year-over-year dollar growth or if you look at it on a sort of annualizing on a per store basis, at $300 million, that is something we should expect to see come down into '10 and '11?

Yes, I think it's most exaggerated in this first quarter, Greg, for the things that we talked about.

That last year in the first quarter, that was probably the peak of the edit.

And this year, we are anniversarying many of the things I talked about earlier.

And in fact, Greg, we planned to deleverage in the first part of this year, I think we said that in our remarks in Q4.

Got you.

All right, so the comp you would need in the back half to leverage, if it was 8% in the first quarter, it would be 5% in the second half or something like that?

Well, you'll do the math in your spreadsheet.

But it's -- you know what?

You can see because of our investment profile last year, the math would shake out that it's certainly considerably less than 8%.

Right.

And then second, is in the past few quarters, you talked about the custom mix tests and how they've done well in certain stores.

You didn't mention it in your remarks.

Could you give us an update there as to how many stores you've really gone into that custom mix and how some of these systems may be impacting it?

Yes, Greg, this is Kevin.

We essentially, are rolling out custom mix in two ways.

We mentioned there were 309 inventory upgrades in the quarter.

And our inventory upgrades are total store upgrades using the custom mix tool.

So at this point, inclusive of fourth quarter, we're approaching 500 of our stores that have been completely converted.

Additionally, we as we update our planograms, which is about 1.5 year long process to update all of the sections behind the counter, each and every one is updated using the new custom mix tool.

So, we are approximately 1/6 of the way through that conversion as well.

Great.

And what's the sort of time frame?

Is this the pace where you'd expect to go so that you'd be done in a couple years with this or is the cadence still accelerating in terms of stores you can convert?

I think you'll see the majority of the impact of that program by about this time next year.

We won't be completed but we will be substantially through all the stores and all of the planogram resets.

That's great.

Thanks.

Thank you.

Our next question is from Colin McGranahan.

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

Good morning.

It's Sanford Bernstein.

Hi, Colin.

Good morning guys.

Two questions, first one to kick this SG&A horse one more time.

I was hoping you would ask an SG&A question, Colin.

just so I understand it, I think you'd said probably about 75 basis points of the deleverage was on incentive comp.

So maybe you could just describe the structure of that program a little bit more so we understand how it works?

And it would be helpful to me, obviously, an 8% comp was fantastic.

But still seems odd that your incentive comp would ramp to such a degree that you'd delever 75 basis points at an 8% comp.

So clearly, it's really structured to the upside of the growth.

So a little bit of help on how it works and how it's structured I think would help clarify that for me.

That's first question.

And then secondly, just on gross margin, if you could provide a little bit more clarity on some of the drivers of gross margin?

What your average price increase was?

How much was rate versus mix?

How much was shrink.

And attachments, which I know has been a focus, did that contribute to gross margin and was that part of the incentive comp as well?

Yes, maybe we can take you through SKU profitability too, Colin.

So, Colin, I'll kick it off and then I'll pass it to Kevin on margin.

So, to give you a little background on our bonus, previously in the past -- so let me back up on the numbers.

So SG&A, up 98 basis points, once you adjust out the divestitures and the supply chain reclass.

And of that, about 70% was incentive compensation.

And about 70% of that number was field and stores, so our field organization.

And what happens, is we've actually changed our program.

Previously, we paid off a budget.

So whether you were growing your business or not, if you were budgeted to grow your business or not, we would pay you, whether you hit your budget or not.

And that's pretty common in the industry.

We made a structural change to our bonus program that now we pay off sales growth.

And so, if you're growing your sales, then that's how we pay.

If you're not growing your sales you don't get paid.

We also have two bumpers to make sure we maintain our profitability.

One is a margin bumper and one is a labor bumper.

So in time -- so what you saw, is when you move from a static fixed program, to one based on growth and you have a knock out quarter where you deliver an 8.2% comp; you're gong to see more of a linear relationship.

One of the numbers that I look at is; What of our incentive comp are we paying as a percentage of our incremental gross margin?

So, we're spending less this year in incentive compensation, as a percentage of our incremental gross margin dollars, than we did last year.

And it's a significant, it's by about 10 percentage points.

And then Colin, in terms of the gross margin improvement, it's a broad based set of initiatives and investments that are producing that gain.

As I mentioned in my statements, we have launched a price optimization program, which is looking at the nature of the price sensitivity of all of the products in the front room.

And carefully selecting what prices to set, all the way down to local market levels.

And that was a material impact.

Secondarily, we have launched a category management process that is very carefully going through and determining in a good, better, best strategy how we lay out our assortments in an attempt to favor the stepping up of customers into the best products that we offer.

Obviously, the commercial customers are much more sensitive and appreciative of that and that has been helped by the growth in the commercial area.

We're also working with our store personnel to maintain more of the margin at point-of-sale.

And if anything, from how they manage the commercial pricing programs, as well as maintaining the integrity of our inventory and reduction in overall shrink in our stores.

As we move into the back half of the year, we've also stated that as the core merchandising system comes online, the first benefits that we'll see are enhanced margins.

And the global sourcing capabilities that are coming online.

we'll begin in the fourth quarter to see the enhanced margins from directly sourced products.

Thank you.

Our next question is from Matthew Fassler.

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

Thanks a lot.

Goldman Sachs.

Not to disappoint, there is an SG&A follow-up and then one on gross margin as well.

Actually, I'll keep them both on SG&A.

As you think about your expense growth, you just broke out in further detail from us the explicit growth associated with incentive.

But I would also imagine that there's some variable comp associated with volume, labor.

I'm not sure how variable your advertising is, based on the inflows that you're seeing.

So, your SG&A per store, SG&A per foot was up somewhere between 9% and 10%, which was a pretty big acceleration from last year, up 2.5% range.

About 2 percentage points of that growth was incentive comp.

So, if we eliminate that for the moment, you still saw acceleration in growth and expenses per foot kind of mid single digits.

Is there a piece of that that is variable along with sales or is all of that increase essentially structural and aimed at the longer run investments that you've described today?

No, there's a chunk of it, certainly, Matt, that's variable.

The simple thing to think about is that we have been pouring in parts pro hours.

We have been pouring in driver hours.

We have been pouring in commercial salespeople.

And with the businesses, we're rebalancing back to a little bit of making sure we're there to staff DIY.

I think we would have said last year and we're certainly seeing this in some of our market share gains that; You know what?

We've probably starved DIY a little bit last year in places.

We've put some of that back into the business because the customer experience was demanding pieces of that.

And similar to Mike's earlier comments, we can pour in additional parts pro hours, driver hours.

We can pour in commercial sales managers.

But the payback isn't measured in 30 day increments.

In some cases, where the demand is and the relationships are, there are certainly -- when we're pouring in trucks, ultimately, those trucks don't pay back in 30 day increments or even 90 day increments.

But what we're learning to do, in a variable type of way, is better manage the truck fleet throughout the Company.

So, if we're not getting a return in one place, we can move it in another place.

And you can think about that as moving your variable expenses around too.

And so, I think when we step back and look at those buckets, yes, there's incentive comp.

80% of the SG&A investment is going towards customer facing activities.

And to Kevin's earlier point, there's still structural things behind the scenes, where; You know what?

We still haven't seen global sourcing, some of the e-commerce, that's still to come.

And then, my second question relates to the out years, 2010 and beyond.

Clearly, there's several percentage points of SG&A growth, that we're going to see, related to some of the investments you've discussed at length.

As you think about next year, would you envision those investments essentially continuing?

Would you expect the investment dollars to come down or would the investment dollars increase year-on-year 2009 levels?

Yes, I think I said in the script, that with a reasonable sales environment next year, just reasonable, we would expect to see, as we turn the corner on 2010, is 2010 to be a year of leverage.

And I think if you go back, our story didn't change it.

That this year, what we saw is more of the investment profiles similar to last year.

And to be honest, coming through the first quarter, recognizing there is just a structural change in demand, we are going faster and we are investing more.

And those places that are getting more of the investment are principally in the commercial acceleration strategy.

Yes, let me just build on that point.

So I think next year, as Darren said, you're going to see leverage.

But one of the things we're going to want to do for you is link the dollars we're spending and the returns we're getting.

So, where did we spend dollars last year?

Merchandising and commercial.

Where are we starting to see this year?

So I would expect next year, the dollars we're spending this year, Kevin, some of the things that I mentioned in my remarks that diluted a lot of our outsourcing, our fleet, our GNFR.

I would expect next year, we would be talking about the savings we're getting from those initiatives.

But I also don't want to set -- we're a growing Company and I anticipate that if there's good options and good investments to make, that have good returns, we'll make those.

But what I'll want to do is break out for you where we've invested and what returns we're getting.

And then, what returns we expect in the future.

Thank you.

Our final question today comes from Chris Horvers.

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

Thanks.

Chris Horvers, J.P.

Morgan.

Good morning.

Hi, Chris.

So, I wanted to focus not on spending, at least not with the first question, more on the DIY side.

Darren, you had talked about maybe not having the right opening price points in 4Q, maybe too DIFM focused, not at the right inventory.

What do you think allowed the elevator to shoot up or the light switch to turn on so quickly in, what sounds like maybe, March?

We hired Greg Johnson.

(Laughter) Greg is sitting in the room with us, so I had to say that.

I'll give you my perspective and then Jim can.

And part of what I'll link back to too is that I think, as the economy unfolded and again, Chris, appreciate, we're able to see more broadly through our market share service, that this is turned on across the market.

So, I'd love to stand in front of you and say it's just everything that we're doing.

The market structurally is more attractive and I don't think we've seen the market this attractive in, certainly, better part of the year if not longer.

That's one.

But I don't want to -- the other thing that I've failed to highlight and it goes back to a year ago, as we began the journey in our merchandising teams, whether it's Charles Tyson and his team; You know what?

There's just a different approach to coming to market in DIY as well.

It's much more fact-based, there's much more thought going into the mix, there's benefits from custom mix.

And that merchandising, where we were clearly giving up market share last year throughout every quarter of the year, we turned the corner this year, as we look at our first quarter numbers.

And we're picking up market share again.

And that, when I look at picking up market share, I ask myself; Are they directly related to the team members we're investing in and the capabilities?

And maybe Jim and Kevin can give you a few other sound bites in terms of specifically what's happening in DIY.

Yes, this is Jim.

I think we're in the very early stages of really strengthening and building some of the key capabilities that can help us ensure that DIY can grow, regardless of what is going on with the economy.

And we touched on that a little bit in our remarks.

But some of the things that Darren mentioned, certainly the social system changes with the bonus plans, I think made a difference in our team.

The increased availability that we're putting in the stores through the custom mix.

Some of the targeted marketing that we started at the beginning of this year, is helping to drive traffic into our stores.

And then, once we get the customers there, we have the opportunity to sell them more.

So there's a lot of work going on that is headed by Greg Johnson and certainly, with Charles Tyson and the others in the merchandise area.

But we see some significant opportunities to build on our DIY model.

Focus first and foremost on the basics of serving the customers that are walking in our stores, converting those to sales.

And we see a lot of positive opportunity around all of that.

In the first quarter, a lot of those things started to take hold.

As well, as Darren said, the challenges in the economy gave us an opportunity to serve our DIY customers better, at a time when they need to maximize the use of their dollars.

And Chris, just a final comment.

We made a move last year to set up a merchandising staff for our front rooms in Minneapolis.

And in DIY, the share gains actually came in the front room categories.

And just highly complimentary of that team's efforts and energies.

But just to reiterate things that had been said, it was the approach that they have in category management, the way that they approached pricing and promotion and improved merchandising and availability of products.

Okay.

And then any -- is there any -- do you see any regional data on where you took the most or least market share?

And then finally, as you talk about the stimulus checks, when did you really start to see this lift last year in the second quarter?

And I think a lot of them were mailed in May.

Are you starting to see some of the headwind from those tough comparison?

Thank you.

Yes, I would say regionally, Chris, certainly on a total market share basis and that really is commercial in DIY, I think every region had material gains in the quarter, principally driven by commercial.

I don't remember the -- commercial is easy to think about.

I don't remember the break outs in the DIY business.

But in order for us to get a total market share gain, you're going to have to have strength in our core southeast market.

You're going to have to have strength in some of our northeast markets and some of the Great Lake markets too.

But collectively, there's not one that really says it's disproportionately leading or lagging, is my memory.

And we had positive growth in all of the markets.

All markets.

And the headwinds, Mike?

Yes, I would tell you that we started to see -- the stimulus hit us last year-end of May, end of June.

What I would tell you is we're off to a good start in Q2.

It's still early.

The stimulus is going to be a head wind but I want to remind you that we also, I think, had $4 gas prices last year.

So that could offset that but it's still early.

Thank you.

At this time, there are no further questions.

I will turn the call back to management for any final comments.

Thank you, Wendy.

And thanks to our audience for participating on our first quarter earnings conference call.

If you have additional questions, please call Joshua Moore at 952-715-5076.

Reporters, please contact Shelly Whitaker at 540-561-8452.

That concludes our call.

Thank you.

That concludes our call today.

You may now disconnect.

Thank you for joining us.