領先汽車配件 (AAP) 2010 Q1 法說會逐字稿

Welcome to the Advance Auto Parts first quarter 2010 conference call.

Before we begin, Joshua Moore, Director, Finance and Performance Management, 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.

I would like to remind you that our comments today contain forward-looking statements subject to risks and uncertainties that may cause our results to differ materially.

We intend any forward-looking statements to be covered by and we claim the protection under the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements address future events, developments or results, and typically use words such as believe, anticipate, expect, intend, will, plan, forecast, outlook, or estimate, and are subject to risks and uncertainties and assumptions including competitive pressures, demand for the Company's products, the market for auto parts, the economy in general, uncertain credit markets, consumer debt levels, dependence on foreign suppliers, the weather and other factors disclosed in the Company's Form 10-K for fiscal year ended January 2, 2010 on file with the Securities and Exchange Commission.

The reconciliation of any non-GAAP financial measures mentioned on the call with corresponding GAAP measures are described in our earnings release and our SEC filings, which can be found on our website at advanceautoparts.com.

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.

For planning purposes, our second quarter earnings release is scheduled for Wednesday, August 11, 2010, after market close, and our quarterly conference call is scheduled for the morning of Thursday, August 12, 2010.

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

Darren?

Thanks, Joshua.

Good morning, everyone.

Welcome to our first quarter conference call.

First, I would like to thank our 50,000 team members for their hard work in getting us off to a great start in 2010.

The team has positioned us for another great year, both on the top line, and the bottom line through a commitment to superior service and simply every day heroics.

A combination of strong market conditions and successful execution of our key initiatives drove an 8.7% increase in total sales, and a two-year comp store sales of 15.9%.

We also expended our gross profit rate by 93 basis points, and we generated double-digit operating income growth during the quarter.

I am encouraged by our continued improvement in our overall customer satisfaction scores, while recording a record level 15.9% return on invested capital.

Collectively the strategic and financial progress is evident in our customer experience, bottom-line results, and our new investment-grade rating.

As you recall, fourth quarter demand and sales had moderated, causing our financial results to be below expectations.

This was due in part to our strategic investments.

However, our assumption was that these investments would help position us for a strong start to 2010, and they did.

Our first quarter of 2010 was one where we outperformed both our financial and strategic objectives.

We are realistic that three-quarters of the year is ahead of us, so we remain focused on our commitment to drive material outcomes with a select group of high-impact operating initiatives.

To date, we are pleased with the progress of those initiatives, including the rollout of our new commercial program, which is now in roughly 50% of our stores and the success of our customer-oriented sales training.

We continue to make progress on our demand-driven labor model, and we work to continually improve our order accuracy.

Our global sourcing capability has ramped up, and we continue to strengthen our marketing program.

Jim, Kevin, and Mike will provide updates on some of these initiatives later on the call.

We are off to a good start in the second quarter.

We continue to see positive trends in our industry, with the strengthening of our commercial customers as a result of dealing closing.

Additionally, increases in both the average age of vehicles and in miles driven aid the trends.

These positive signs in our industry combined with our sharper focus on fewer priorities, lead us to be upbeat about our outlook for 2010 and beyond.

At Advance our goal is to have leading customer experience in our industry and to create customers for life.

We will get this done with great values, great team, and great character.

Here is an example of what great looks like.

I would like to recognize District Manager Gary Cox for his role in leading our Company.

In mid-2009, Gary assumed responsibility for a very challenging market in Texas.

Gary's unlimited optimism and coaching his team turned around the market from negative double-digit comps early on, to generating positive double-digit comps by the end of the year.

Through execution of our improved sales and distribution processes, Gary's district saw an increase of almost 10% in overall transactions, and an additional 8% increase in average ticket.

Gary was recognized as the District Manager of the year in 2009, and maintains top scores for team engagement and customer satisfaction.

With Gary, it is all about his team, his peers, and the values of Advance Auto Parts.

Thank you, Gary, for leading by example.

We have a focused agenda to accelerate our growth and profitability, and we remain committed to our four key strategies, commercial acceleration, DIY transformation, availability excellence and superior experience.

I am encouraged with our strong start to 2010, and we are on pace for another successful year.

Now I would like to turn the call over to Jim Wade, our President, to provide a progress update on our commercial and DIY business, along with store operations.

Thank you, Darren, and good morning.

I want to congratulate our entire team for a great start to the year.

I will review our sales growth and provide an update on our commercial and DIY strategies.

Our total comp sales grew by 7.7% in the first quarter compared to 8.2% during the same quarter last year.

That was our strongest two-year comp performance in recent history.

Our 7.7% comp increase was driven by both an increase in our customer average, and in our transaction counts.

As Darren mentioned, we saw a sequential improvement in the performance of the total market from the fourth quarter of 2009 to the first quarter of 2010.

Our business benefited from this, and our teams responded well by focusing on providing great customer service to every customer who visited or called us.

As a result of our team members, each of our three geographic areas generated strong positive comps in DIY and double-digit comps in commercial, which marks our ninth consecutive quarter of double-digit commercial comps in our Advance Auto Parts stores.

Commercial now represents 33% of our total sales, moving us closer to our goal of 50% over time, and truly becoming a more fully integrated service model.

With our accelerated growth, we continue to gain significant market share in commercial during the quarter, but we have a long runway ahead of us with less than 5% market share in the $40 billion commercial market.

On our last conference call, we reviewed our commercial initiatives and our key focuses for 2010.

I want to give you a quick update on the status of those initiatives.

Our commercial initiatives focused on what our customers tell us is most important to them, have the part I need and deliver it to me quickly and accurately every time.

We have now completed investments in additional parts pros, trucks and drivers in approximately one-half of our stores with commercial programs.

These stores continue to produce comp sales increases significantly higher than our double-digit Company average.

These investments will continue to fuel our growth in 2010 as we look towards extending those investments to the entire chain over time.

Also as we continue to learn more about the potential of each store in each market, we're investing in high-performing stores in 2010 by reallocating previous investments where we see the opportunity to increase productivity.

Our investments in parts availability are continuing and Kevin will update you on our progress.

As I visit our stores, our teams are thrilled with our increasing ability to get the right parts in each store based on the specific vehicles in their markets.

This availability continues to be a fundamental driver of our commercial growth.

Raising the overall operational consistency of service to our commercial customers is also a key focus in 2010.

We believe this is key to increasing the retention of our existing customers, while expanding our customer base.

Another step in this direction is our new online ordering system which Kevin will update you on.

After increasing our commercial sales force by 45% in 2009, we're focussed in 2010 on increasing the productivity of our sales force by developing deeper relationships with our existing customers and developing relationships with our potential new customers.

The combination of our dedicated sales force, visiting our customers and our store teams providing consistently great service is a strong driver of growth.

In addition to strong sales growth, we're very pleased that our commercial customer satisfaction scores have continued to increase in 2010 over significant increases last year.

Ultimately, how our customers feel about our service is the best predictor of our future growth.

Our focus in 2010 is on those stores where our customers have given us our lowest customer satisfaction ratings.

As we build our strong commercial brand, we expect every store to provide exceptional service consistently.

As we said on our last call, we continue to believe we have the potential to grow this business in double digits for the 2010 year.

Now turning to DIY, we saw strong growth in our DIY business and achieved our fourth quarter of positive DIY comps in the last five quarters.

We believe our strong DIY results were driven by the success of our initiatives, as well as a stronger overall DIY market.

We believe the cold and snowy winter, deferred maintenance, and an overall increase in consumer spending factored into our first quarter DIY results as well.

As I did with commercial, I want to give you a quick update on our DIY initiatives and where we're focused in 2010.

Our DIY initiatives focus on what our customers tell us is most important, friendly and knowledgeable people who can solve our problems, are available when I need them, and have the part I need when I need it.

The parts availability initiatives I've described in regard to commercial apply equally with DIY.

We're continuing to increase our availability in 2010.

To ensure our customers have team members available when needed, we're improving the staffing of our stores based on a demand-driven model.

The upgrades in our staffing (inaudible) will continue to be rolled out during the year, and are being enthusiastically embraced by our store teams.

We have increased the quality and effectiveness of our training and development programs for our team members.

This includes our onboarding program for new hires, General Manager development, product knowledge and related problem solving skills, and basic customer greeting and sales skills for all of our team members.

This is a key focus across our Company in 2010 and is critical us to meeting the needs of our customers.

The launch of our new [B-to-C] website last fall is now providing us additional DIY sales but probably more importantly many customers are visiting our site before making the decision to visit a store to make a purchase.

The lack of an E-commerce presence combined with decreased new-store openings, and increased store closures last year contributed to our inconsistent growth relative to the overall market.

We belief E-commerce will be a strong sales driver for us in the future.

During our fourth quarter conference call, we discussed our marketing strategies to increase the number of customers who come to our stores.

We continue to refine our approach to better target both our highest potential customers and our underserved customer segments.

This new, more targeted approach has allowed us to more than double our marketing effectiveness while keeping our overall marketing spend roughly in line with last year.

Our primarily sponsorship with Monster Jam, which we announced in the fourth quarter, is now in full swing and is being received well by our customers as well as our team members.

We're very pleased with the returns and progress of our marketing initiatives.

Our customer satisfaction ratings for our DIY customers also continue at a high level.

With these scores and with the initiatives that we're focused on, we're excited about our ability to grow our DIY business while continuing to aggressively grow our commercial business.

Wrapping up with new store growth, during the first quarter we opened 43 stores, including 11 Auto Part International stores, while closing one store.

As of the end of the first quarter, our total store count was 3,462 including 167 Auto Part International stores.

I want to wrap up by just again thanking our team for a great first quarter.

Your commitment to leading inspired teams and providing great customer service continues to produce our strong sales and profit growth.

We look forward to the remainder of 2010.

Now I would like to turn the call to Kevin Freeland, our Chief Operating Officer, to review our availability [excellence] strategy.

Thanks, Jim, and good morning.

I would also like to congratulate the team for a strong start to 2010.

I'll take a moment to highlight a few of our many accomplishments during the quarter, as well as update you on our initiatives to strengthen our gross profit rate and improve our product availability.

During the first quarter, our gross profit rate increased 93 basis points versus the first quarter of last year.

This increase was on top of a 133-basis-point increase during the same quarter in 2009.

Our first quarter improvement was driven by increases in both front room and back room categories, resulting from the rollout of our custom mix and price optimization strategy, the strengthening of our merchandising capabilities, and the impact of our rapidly growing global sourcing capabilities.

Through our custom mix rollout, we have upgraded inventories at more than 470 stores during the quarter.

This strategy allows us to improve our end-market availability of parts and accessories, and drives improvements in both sales lift and margin performance.

During the quarter, sale of hard parts grew at double-digit rate, and increased roughly 100 basis points as a percent of total revenue versus the first quarter of 2009.

This increase in sales mix for hard parts and improvement in category margin rate was a strong contributor to our 93-basis-point expansion in total gross profit rate.

Additionally, we continued to grow sales and expand our margins in accessories, which have benefited greatly from our new global-sourcing capabilities.

In the first quarter, we continued to make significant progress in increasing our availability through the addition of two PDQs, or Part Delivered Quickly warehouses, in three hub stores.

The two new PDQs are providing increased service to over 200 stores, and brings our total number of PDQs to 29.

Additionally, our delivery hub network is now at 157, providing multiple deliveries per day to over 2,100 stores.

Despite the significant investments in PDQs, the associated transportation expense, and the increased number of hubs, our supply chain costs are down versus last year.

This is primarily due to our ability to improve our overall supply chain productivity.

I'm encouraged that our E-commerce site continues to go so well.

Based on our current trend, we believe our E-commerce business will materially contribute to our DIY business in 2010.

We launched a test of our new business-to-business site in Q4, and expect a rollout nationally during 2010.

Ultimately, our combined E-commerce platform should prove to be a significant growth engine for us in the future.

Our adjusted accounts payable inventory ratio of 68.9% is at an all-time high, and compares to 59.8% at the end of first quarter last year.

This significant achievement was primarily driven by more favorable payment terms and the timing of inventory purchases.

We are on pace to achieve our long-term goals and expect to see a continued year-over-year improvement in 2010.

In the first quarter, AI's revenue grew 18%, driven by strong comp-sales performance, and the net addition of 32 stores over the past 12 months.

AI opened 11 new stores during the quarter, bringing their total store count to 167.

We continued to move at a measured pace to expand AI footprint by accelerating new-store growth in new markets, namely Florida, and generate synergies through supply-chain integration.

Overall our first quarter was very successful for our team, and I'm thrilled by the strategic and financial progress we have made through our availability excellence strategy.

Now let me turn the call over to our Chief Financial Officer, Mike Norona, to review our financial results.

Thanks, Kevin.

And good morning, everyone.

I would like to start by thanking all of our talented and dedicated team members for the strategic progress and fantastic financial results we delivered during the first quarter.

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

One, provide some financial highlights of our 2010 first quarter performance.

Two, provide an update on the key financial dimensions of our transformation.

And three, link our first quarter performance to the balance of 2010.

Before I comment on our financial results, I would like to point out that as of this quarter, we will only provide consolidated comparable store sales results versus breaking out DIY and commercial comp sales.

This change in policy better aligns with our focus on growing our four-walls sales by transforming Advance into an integrated service model providing parts and accessories to both DIY and commercial customers.

In addition, this change is consistent with how our industry reports their comparable-store sales.

I will also remind you that 2009 includes the impact of store divestitures, which decreased diluted EPS by $0.04 during the first quarter of last year.

I will speak about our year-over-year results versus 2009 on a comparable operating basis, excluding the impact of the 2009 store divestitures, as that provides a more transparent and relevant comparison.

We have provided GAAP financials, as well as comparable operating results in our earnings release.

Turning to our first quarter, earnings per diluted share of $1.19 was $0.17 favorable to last year, representing a 17% increase in EPS, excluding the $0.04 impact of store divestitures.

This was on top of last year's 19% EPS increase.

On a GAAP basis, EPS was $0.21 favorable to last year.

Some highlights for the first quarter include a 7.7% comp-store sales increase, which was fueled by strong positive comps in DIY, and our ninth consecutive quarter of double-digit gains in commercial.

This was on top of an 8.2% comp during the same period last year, which represented our most challenging quarterly comp-store sales comparison.

During the first quarter, our gross profit rate increased 93 basis points versus last year, primarily due to continued investments in pricing, merchandising capabilities, parts availability, and an increase in direct sourcing.

The 93-basis-point increase was on top of a 133-basis-point gross profit rate improvement during the first quarter 2009.

Our SG&A rate during the quarter increased 68 basis points, excluding the impact of store divestitures.

The 68-basis-point increase was driven by the annualization of last year's commercial investments in over 500 stores, E-commerce, and strategic capabilities, such as global sourcing.

This was partially offset by leverage on occupancy expenses as a result of our 7.7 % comp-store sales increase.

Overall SG&A dollar growth was in line with what we expected and what we communicated on our fourth quarter conference call after adjusting for the higher variable expenses as a result of the better than expected comp-store sales growth.

On an SG&A per-store basis, more than 75% of the dollar growth was driven by 2009 expense annualization, and by variable expenses, while less than 25% of the growth in SG&A dollars per store was driven by new investments.

Free cash flow for the quarter was $262.9 million, which represents a 31% increase over last year.

This increase of $61.5 million was primarily driven by improvements in inventory management, a record high accounts payable ratio of 68.9%, and our strong operational performance, which increased net income.

As a result of our strong free cash flow, we were able to repurchase approximately 6.9 million shares of our stock, or 7% of our shares outstanding for $287.7 million at an average share price of $41.62.

We now have $212.3 million remaining under our $500 million share repurchase authorization.

We have previously stated that we would be opportunistic with share repurchases based on valuation, and given we trade at a surprising 20% EBITDA multiple discount to our peers, we felt the timing was right to repurchase our shares given our view of the future.

We believe in our Company's ability to create long-term shareholder value and this repurchase shows our confidence.

On April 29, we announced the closing of our $300 million senior unsecured notes offering with a 5.75% coupon due in 2020.

This transaction was important for Advance, as it provides us a more stable long-term capital structure that aligns with our growth strategy and allows us to further diversify our debt to stakeholders.

With these funds, we plan to fully repay our $200 million term loan set to expire in October 2011, and the $75 million [aborings] on our revolving credit facility.

This will also enable us to increase funding for supply chain financing as some banks will allocate capacity to supply chain financing to offset the reduction in bank debt.

We believe that this will help accelerate our ability to improve our AP ratio over time.

This note offering will result in incremental interest expense given our existing swaps, which we entered into three years ago, do not expire until October 2011.

I will quantify this interest impact for 2010 later in my remarks.

In April, we were upgraded to investment grade status by Standard & Poor's.

This was an important milestone and accomplishment for our Company, and we are particularly proud of this upgrade because we believe it is an independent assessment validating our strong operational and financial performance, solid operating cash flows, and strong financial metrics.

As you know, we had been working diligently to provide the investments necessary to accelerate the growth of Advance while ensuring we generate solid returns on these investments.

We have publicly committed to grow both our top line, and bottom line while strengthening our balance sheet to ensure we have a strong foundation to grow well into the future.

We remain committed to maintaining our investment-grade metrics and managing our rent-adjusted leverage ratio to a maximum 2.5 times.

At the end of the first quarter, our leverage ratio was 2.2 times.

As we have previously shared, our strategies position the Company to accelerate growth, improve profitability and drive shareholder value.

These three dimensions will continue to be how we measure the path ahead and our performance thus far shows we are trending in the right direction.

Turning to growth, we are pleased with the 4% improvement we have made in sales per square foot on a trailing four-quarter basis through our first quarter 2010.

In addition, we continue to lead the industry in sales per store, which has grown to approximately $1.6 million, representing a 4% increase on a comparable trailing four-quarter basis.

Turning to profit, we are pleased with the 93-basis-point gross profit rate expansion in our first quarter, and our 226-basis-point increase on a two-year basis.

We expect the investments we have made in our capabilities and infrastructure will drive continued operating income expansion through further gross profit, expansion, and more moderate SG&A dollar growth.

Turning to value creation, we are pleased with our 31% increase in free cash flow in our first quarter, and improvements in our balance sheet driven by effective working capital and inventory management.

We continue to demonstrate our ability to generate strong incremental returns on our investments as evidenced by our ROIC, which at the end of the first quarter was 15.9%, representing a 130-basis-point increase from last year.

Looking ahead, we expect to leverage this strong financial platform we have built along with our recent upgrade by S&P into continued growth in economic profit.

For the balance of the year, we are on track to open approximately 150 new stores for both Advance and Auto Part International brand, and we remain on plan with respect to our investments to grow our commercial business and to improve our DIY sales performance.

We are pleased with the strong start as the market performed higher than we expected, and our execution was solid.

While we are optimistic for the full year, we remain pragmatic and do not anticipate that the two-year trends will continue at this Q1 pace.

We remain focused on delivering and executing on our original plans for this year that we shared with you on our fourth call and that were built into our 2010 outlook.

During our fourth quarter earnings release, we provided an annual outlook which included an estimated 2010 operating EPS range of $3.20 to $3.40 per share.

This annual outlook was based on operating performance only, and did not include share repurchases or the impact of the recent notes offering.

The favorable impact of our share repurchases partially offset by the recent notes offering will add a net incremental benefit of approximately $0.14 to our full-year EPS of which we realize $0.04 in our first quarter results.

In closing, we are very pleased with our strong start to 2010.

As Darren mentioned, we remain committed and focused on our four strategies that are allowing us to build a differentiated service model to serve both our DIY and commercial customers.

We are encouraged by our investment-grade status, and will be working aggressively to ensure we maximize the benefits associated with this.

Again, I would like to thank all of our talented team members who are passionately leading us through our transformation and who have truly helped our Company reach new heights.

Operator, we are now ready for questions.

Thank you.

(Operator instructions).

Our first question today is from Dan Wewer with Raymond James.

Your line is now open.

Thanks.

You had noted that your commercial market share continues to increase, I recognize that you are not breaking out your do-it-yourself performance, but in looking at your growth can you determine whether or not you grew market share in the do-it-yourself market channel?

Yes, this is Jim.

In total, I think as we look at our overall market share we're pleased with where we are, and as you commented in the commercial area with the growth, we're seeing significant share increases.

I think the -- when you look at the DIY share, we're still cycling some of the things related to us.

Opening fewer new stores and closing stores last year that to a greater extent then certainly our competitors.

We're working on it, we haven't cycled through that yet.

I think the most positive indicator we have in that regard, though, is as we've looked at market share, our existing stores are actually gaining share and gaining productivity which I think goes to the health of our business, and the health of the initiatives that we're rolling out.

And, Jim, related to that, I believe a year or so ago you used to give a figure that about 10% of your store base was generating sales per square foot of under $100.

I think about 10% were in excess of $300, but in looking at those underperforming stores, do you have any sense as to what part of the store base that represents today?

Do you know, Jim?

Yes, this is Judd.

Mike referenced in -- last year that our performance of the bottom 10% was below $100 per square foot, and the performance of our top 10% was above $350 a square foot.

That still holds true.

With some of the 10% that fell in that category is actually just new stores.

So we have new stores that we opened that are starting to grow their average volume up.

Some of the stores that were underperforming actually were part of our store divestiture program last year, and we closed those stores, of which there were 45 in total closed.

Yes, you would say by virtually all of the stores we took out last year in the store-divestiture program, we're below that $100 a foot mark or darn close.

So the water line (inaudible) is no longer 10%, it's something less than that.

We can follow up on that, but that was one of the principal focuses in terms of last year, cleaning that up, and what the related cash flow drag that went with those stores.

Okay.

Great.

Thank you.

You're welcome.

Thank you.

Our next question is is from Tony Cristello with BB&T Capital Markets.

Your line is now open.

Thank you.

Good morning, gentlemen.

Hi, Tony.

It was noted in the commentary that the increased growth in SG&A per store was 75% related to 2009 annualization, and then the variable portion about 25% from new investments.

Is that 75% more related to the timing of when those investments were made in 2009?

Or is there something else that we should sort of point to?

No, you are exactly right, Tony.

The -- your -- the numbers that I quoted in my remarks, roughly 75% of our growth in dollars were due to annualization, primarily driven by commercial, and areas like dot-com.

And let me give you an example.

We did over 500 stores last year after Q1 that are now annualizing and last year we had one person in dot-com, at this time last year.

Now we have almost 50.

So it's primarily the annualization, and then the other piece of it is the variable expenses from the higher sales that we drove.

Okay.

And just as a follow-up then, if you look at the 25% related to new investments, is there a way that you could then tie that 25% of new investment in terms of then how your overall progress is on ongoing initiatives?

Are you 25%?

50%?

75% of the way through that?

I mean, is there a way you can point to saying, hey, we now have only, contributing 25% to new, but we're 50% of the way through in terms of progress made?

Yes, sorry, this is Jim.

I'll answer at least part of that question.

I think as we look at the investments, we talked about in our previous comments in regard to the commercial [weigh] process, an example, we crossed the halfway mark in those investments.

And we're at a point now where we're starting to look at the productivity of those investments, and making sure we are having them in the right stores as we're planning to over time extent them through the entire organization.

But in regard to a lot of the initiatives that are being executed in the field, we're in a phase now where there's not very many new investments.

We're really focused on the operational excellence around the investments we have rolled out.

We talked about things like the staffing programs and some of the other things we're doing at the field level.

So we're moving from pint where there was lots of new investments that we were making to one we were really focused on driving productivity of those investments.

And Tony, this is Kevin, two other major categories, would be -- Mike just mentioned on E-commerce, I -- we have put it -- essentially the resources in to be able to develop a B-to-B and B-to-C sites, and you are seeing the costs of those.

They are rapidly scaling at this point from a sales perspective, but essentially consistent in terms of an SG&A perspective.

The same would be true on global sourcing.

We have put in what would be the infrastructure required to support that, and you are seeing the reflection of that in the SG&A, but those programs are growing at a dramatic rate.

And, Tony, I guess I want to reiterate what we said at the beginning of the year, everything that Jim just said and Kevin just said goes back to exactly what we said at the beginning of the year, and that story hasn't changed at all in terms of our investment profile for this year.

Okay.

Great.

Very helpful.

Thank you.

Thank you.

Our next question is from Gary Balter with Credit Suisse.

Your line is now open.

Thank you.

Congratulations on just a great quarter.

Thanks, Gary.

Question on the payables.

You now have investment grades for the Company, and we have watched Auto Zone use that benefit in working with suppliers to get up to close to 100% financing on the payables side.

And you had a nice jump this quarter.

What should we be thinking about from a cash flow perspective going forward?

Yes, I won't take you out any further this year, Gary.

But I will talk a little bit about our AP ratio.

We're very pleased with the progress we have made.

If you remember last year we jumped that from about 57% to 61%.

What I said at -- in our Q4 call is we believe we can see that same kind of increase this year, roughly.

We think we're going to end it around the 65% range.

The 68.9% was just an outstanding quarter for us, and a tremendous accomplishment to the team members that are working in our merchandising group partnered with our finance team.

Investment grade, you hit the nail on the head, one of the benefits of investment grade is when you actually get the opportunity to get more funds and at cheaper rates, and that has increased our capacity within -- that we're building for the supply chain financing program.

And then in partnership with Kevin Freeland and his merchandising group, they are working closely with the vendors, and looking for all of the opportunities, but we see a great pathway to continue to grow our AP ratio.

In the short term, we believe we're going to get to 65% this year.

And out further, we see a lot more opportunity, and it's not out of the realm to get to 70%, to get to 75%, and we feel real positive about that.

Uh-huh.

You probably covered some of this on the call, and I apologize, I stepped out for one minute, but the price optimization, as you've rolled that out have you found anywhere you have had to somewhat roll it back, or vice versa, or you have actually a lot more opportunity within certain categories than you thought?

Yes, Gary, this is Kevin.

The predominance of what you are seeing reflected in the margins that we've produced over the last several years is on the DIY side, and in the front room.

We have two programs in there, but if the products are insensitive to price moves, it is driven by the price optimization.

If it's sensitive to price moves, it's essentially benchmarked off of our key competitors, so we're in the enviable position that we are, essentially priced to market on all of those sensitive areas, which we had not been in the past, and seeing increased gross margin on the balance of the business.

What we're looking at forward is throughout the course of this year, we're rolling out that capability now to the parts portion of the DIY business, and we aspire in future quarters and in future periods to move what we're learning to the commercial side of the business.

Thank you very much.

Thanks, Gary.

Thank you.

Our next question is question is from Matthew Fassler with Goldman Sachs.

Your line is now open.

Good morning.

Thanks a lot, and good morning.

Hey, Matt.

Hey.

My first question is a follow-up, I guess to the SG&A question.

You gave that 75%/25% breakout, the 75% being a combination of annualization of last year's investments and incentive compensation.

Could you break out within that 75%, the role of annualization versus variable expenses?

Yes, I'll give you just a ballpark.

On the total, just on the total, the variable of the growth was roughly 40% of the growth.

So I think if you look at the dollars, it was about $70 million over last year.

40% -- and you can do the math on the rest.

And presumably you had some -- some variable baked into your plan for the quarter, though not as much as you ultimately booked given your strong performance?

That's right.

That's right.

Okay.

And then the second -- my follow-up, I guess --

Matt, can I just build on something you said.

You mentioned incentive comp.

And you are right, last year, we deleveraged incentive comp as we put the new bonus program in.

However, this year we actually saw a little bit of deleverage in terms of our incentive compensation.

Sorry, leverage.

We saw leverage.

So the dollars were up, but as a percent to sales you're saying they were down to some degree?

They were modestly down, yes.

Got it.

Okay.

My follow-up is just a quick checkup on two programs that you updated us on, one was custom mix and the other was enhancements to commercial, and I think Kevin gave us the number of stores, maybe Kevin and Jim gave us the number of stores that were added to each of those programs.

Could you now update us on what percentage of the chain, or what percentage of the ultimate number of stores that are going to get these programs have had them introduced and kind of how much there is to go for each of these initiatives?

Yes.

Matt, I'll take the custom mix side of it.

The custom mix tool is essentially evolving in its logic, and we're continuing to find opportunities to grow sales and to improve inventory turnover through those enhancements.

So you could essentially say that in its first incarnation, we have largely canvassed the chain, but as the enhancements are coming online, you'll see us continuing to report rolling this out further across the chain, and having an additional positive impact on the Company.

And Jim can walk you through the commercial changes.

Yes, that's -- Matt, I mentioned earlier in regard to the investments in the commercial programs, we're halfway through the investments across the chain.

I think right now about 89% of our stores have commercial programs.

We don't see that changing significantly, but over time, we'll continue to upgrade the remainder of the stores.

In the meantime, investments like the sales force, for example, we mentioned in our comments that we increased the sales force significantly last year, about 45%.

This year, we have -- we're close to where we need to be in that regard, we're not making additional investments in people, but we're making investments in being able to increase the tools they have and increase the productivity of our visits and those kind of things.

So across the chain, the stores are benefiting from different commercial investments that we have made, certainly the parts availability piece has been huge to our commercial growth, and as Kevin mentioned, that continues as well.

Great.

Thank you so much, guys.

You're welcome.

Thank you.

Our next question is from David Schick with Stifel Nicolaus.

Your line is now open.

Hi, good morning.

Hi.

The question would be on the -- on the direct sourcing, single sourcing, you mentioned it last in your order of gross margin drivers, but you mentioned it as significant in accessories.

I just wanted to first clarify, was that a proportional mention in gross margin?

So is it the smallest of those -- just those that you drove -- that you talked about?

Yes, David.

The -- the answer the -- if you look at the -- the size of that program, and the, what we have learned as we have begun shopping those programs, is that it is a -- it has been a nice improvement in the quarter, but the lion's share of that story is yet to be told.

We are scaling that as rapidly as is prudent, but that's -- that's a program that's going to take years to fully materialize.

Okay.

That was essentially my question.

It's very early innings, is what I was trying to get at.

For that.

And then just a follow-up on DIY, was there any big discrepancies between geographies, given some of the weather that played out?

One of the things we're pleased about in the first quarter, our team, as we talked about earlier, our team did a great job with the additional customer count we saw, and we had significant increases across the areas and not a significant difference between the areas.

That's great.

Thanks very much.

Okay.

Thank you.

Our next question is from Colin McGranahan with Bernstein.

Your line is now open.

Thank you.

Just wanted to come back to commercial sales firstly, in the fourth quarter, you talked about how you felt you had done a great job acquiring new customers, but maybe not as great of job keeping them.

Hoping you could maybe talk a little bit about some of those earlier markets that you made investments in?

How the trend looked between the fourth quarter and the first quarter, and what changes you made as you went back in and refocused on those markets, and how that played out?

Yes, I think -- we're in -- we're in a process there that we're making good progress on, but we have work to do.

We said that, I think, in our previous calls.

We -- over the last couple of years, we put a lot of the basics in place, and that's what we're focusing on, the basics of what our customers are asking from us, having the part, fast delivery, the accuracy, those kind of things.

And we have seen some obviously significant sales growth opportunities and [costs] over the last couple of years, and as we continue to progress through this -- the whole commercial acceleration strategy, certainly a big part of our focus right now is on better identifying who our best customers are, ensuring that we're continuing to grow the business with those customers.

We certainly have learned a lot as we have continued to rollout additional markets through the last two years, and we're seeing -- we're seeing progress, but I think that's one of our big opportunities going forward, is continuing to reduce the number of customers that might be buying less from us than last year, and that will be a key driver of our commercial sales growth as we go forward.

Okay.

And then just a follow-up for Mike.

I think I must have missed it.

But what was the commercial comp again?

Oh, some things never change.

Well, is commercial an important strategy for the business?

Yes, it is.

Yes, it is.

(Inaudible) variance between your commercial comp and your DIY comp?

Hey, Colin?

--

And less disclosure about a very significant strategy in improvement for shareholders and I just say, as an advocate for investors, I think it's not really helpful when you're not providing the disclosure on what's an important strategy for the business where there's a significant variance between the two businesses that you operate in.

Yes, Colin, thank you very much for that comment.

And a couple of things.

The past two years we have been working to build a integrated service model.

And commercial is a key driver of our growth.

Make no mistake about that.

And I think Jim, in his remarks, made it very clear that we are very pleased with our strong and our ninth consecutive double-digit growth in commercial.

That said, what we have done is really just align what we have done with our comps with industry practices.

So I think we've become consistent --

Industry practices?

Yes, and also -- I'm also supporting what you said is, we have strong commercial comps.

But who's industry practices?

Auto Zone gives us commercial dollars every quarter.

Yes, and we give you the percentage of that business, Colin, and you can calculate the dollars.

Okay.

It's your decision, but maybe worth revisiting.

Thank you.

Thanks.

Thank you.

Our next question today is from Alan Rifkin with Bank of America.

Your line is now open.

Yes, thank you very much.

Question for Jim on the commercial sales force.

Jim, any sort of color that you can provide, like number of accounts per salesperson that you have added?

And how does that compare to the corporate average?

Basically just trying to see the efficiency in which some of these new salespeople have been successful at signing up incremental accounts?

We don't want to get into that level of detail in terms of the specifics.

I will tell you that the sales force is a critical component of our overall commercial growth.

I think when you look at commercial, the -- it's got to be a combination of a talented sales force that's going out there, and continuing to develop relationships with existing customers, and focusing on the key places where we can go to get new customers that best meet our model.

And just -- and then at the store level, being able to continue to build that operational consistency that every time the customer calls, we're able to, first of all, have the part, and be able to get it there to them quickly and accurately.

So it's an overall plan.

We certainly internally track lots of metrics about the number of visits, and which customers we're focused on, and all of those kind of things with the sales force, and we're pleased with the sales force, the job they have done this past year, and they are a key part of why we have such a strong commercial comp again this quarter.

Okay.

Jim, in terms of your goal to take the 33% presently up to 50% of corporate revenues over the longer term, is that predicated more so on an increase in average ticket from existing commercial customers or is that predicated more so on additional accounts?

Yes, obviously it will be both.

We still have a tremendous opportunity to gain additional share, wallet from our existing customers , and it's -- when you look at where can you make the biggest impact the fastest it's continuing to grow that business with our existing customers.

And we have the tools today to know which customers have the greatest potential and those kind of things.

At the same time, we are, and will continue to target new customers in the markets around our stores, and that will be a key component of our growth as well over

Okay.

Thank you very much.

Thank you.

Thank you.

Our next question from Scot Ciccarelli with RBC Capital Markets.

Your line is now open.

Good morning, guys.

Hi, Scot.

Can you guys talk about changes in conversion rates, and maybe the gap that we have between the top 10% to 20% of your base and the bottom 10% to 20% of your base?

It seems to me this has been a primary focus, and what I'm trying to figure out is how large is that gap, number one, and, number two, the improvement that we have seen at least in the DIY area here, how much of that is by converting more of the traffic versus getting incremental footsteps in the door?

When you look at the first quarter, we saw increases in both our transaction count as well as the average transaction sales to those customers, and when we look underneath that we're doing a lot of things to measure conversion across our stores.

We have introduced a lot of new tools in stores to help us measure what our conversion level is, so we can at least have an overall understanding of the progress we're making.

The key things that we have touched on is, in terms of just driving that conversion, once we have the customers in the stores, obviously, making sure we have the parts, and Kevin talked about what we're doing in that regard.

Getting the right team members at the right time in the stores so that we know what our customer traffic is in each store and staff accordingly.

I think we have made substantial progress in that this year so far and we'll continue to do so.

Making sure that the team in the stores have the training and development to ensure they can solve the problems of the customers.

So we have identified, generally, what our conversion opportunity is.

We have identified what the key places we can focus on to increase that conversion, and then that's what -- the initiatives that we have, that are helping us grow the DIY business.

Can you get, Jim, or Kevin, can you give me an idea regarding what is that gap between -- let's call it the top performing stores and the bottom performing stores?

Yes, Scot, this is Darren.

To today we have traffic counters in several hundred stores.

I will tell you this.

We have been in an R&D proof of concept on that, and that data has to stabilize a little bit, and I'm not uncomfortable sharing with you, but I can tell you top and bottom.

So like everybody else in the industry what we can see is transaction counts.

And what we do have is feedback from our stores, and I will tell you that this is the best transaction increase that we have seen in terms of, principally driven by footsteps since I've been here.

And we probably have to go back a couple of years at the Company to see the level of footstep increase that we saw in the store.

What I can't do is tell you conversion rate went from 88 to 90 in the quarter on the top and the bottom at this point.

We hope to do that at some point, we're just not convinced that spending that money at this point before we can get clarity that we're getting real good traffic counts makes sense.

Okay.

Thanks a lot, guys.

Yes.

Thank you.

Our next question is from Mark Becks with Longbow Research.

Your line is now open.

Hi, thanks for taking my question.

Yes.

You mentioned occupancy levered in the quarter.

I was hoping where you might be able to quantify where payroll came in at or at least kind of talk about any sort of benefits you're seeing from the demand driven model at this point?

Yes, maybe I'll start and then Jim or [Tammy] you can --.

We were actually very pleased with our labor productivity in the quarter.

In terms of -- one of our largest expenses that sits on our operating statement is labor, and as we have said, we have added a lot of labor, primarily investments in commercial, and that's where we have seen a lot of the leverage.

However, as Jim mentioned earlier, our existing stores are performing very well, and one of the thing that I was pleased at during the quarter is the leverage we saw based on the plans we set with the higher sales.

So Jim, you want --

Yes, I think -- the only thing I would just add that as we saw the increased sales go through the quarter, the team was able to deploy the labor in the right places and enable us to do that additional volume with just very little investment in labor at all, and I think a big part of that was being able to have it at the right place, and take advantage of some of the initiatives that we're focused on.

Okay.

Great.

And I know you don't want to provide any particular quantitative numbers behind the comps, but I was hoping you might be able to give a little bit of color on within commercial and DIY what sort of difference you are seeing with the DIFM program, the variance between stores that have gone through that conversion?

And then also within DIY, what sort of benefit you are getting from the E-com?

Yes, as far as the commercial is concerned, again, not giving you specifics, we said in the call that there is a significant difference between the two groups of stores.

Ones that have gone through it, and ones that haven't.

Having said that, the ones that haven't also showed strong growth.

And I think what we have seen as we have rolled out the investments is we have seen an accelerated comp growth in those stores.

That's leading to a significantly higher average sales per store in commercial -- in those commercial [weight] stores, and as we go back and continue to do those investments, we have the same opportunity in the stores that haven't gotten investments yet.

But the point I would make is even with the strong comp growth in the stores that received investments, we're seeing strong growth in those other stores as well based on where they are in the growth curve.

Uh-huh.

Yes, Mark, in terms of the E-commerce investments, the E-commerce business, we view as it being broke out in two different places.

How does it drive customers into our stores?

And how do we transact on the site?

The predominant impact, we believe, is actually driving customers to our stores, and the single-most common thing that someone does after spending time on a site and researching products is to request directions to a nearby store.

So we believe that that's something that we'll never fully be able to quantify, but as the prime impact of the site.

That all said, we set expectations for the year on the [B-to-C] side that would be a dramatic improvement over what we have had historically seen and we are materially above those numbers.

On the [B-to-B] side, we are early in that deployment, and the percentage increases are obviously coming off of a small base, but are surprising, and we're delighted as to what that is going to look like as it rolls out across the rest of the year.

All right.

Thanks, and best of luck.

Thank you.

Thank you.

Our next question is from Kate McShane with Citi Investment Research.

Your line is now open.

Hi, good morning.

Hi, Kate.

Besides the weather impact on comps this quarter, is there anything that you anticipate will be different between this quarter and the following quarters, just because you're going up against much easier comps than you did in the quarter last year?

Hi, Kate, this is Darren.

I think that's a great question.

We think about that a lot.

I think we were here last year, talking about a great first quarter too and the need to just accelerate all of the investments, and to be candid, I think it was a little bit of a head fake.

And when I think about the balance of the year, the thing that is different this year is we remain focused on those initial investments we talked about and driving it deeper into the organization, in part because we're trying to assess this part of the seasonality of the business changing.

In terms of what we saw in the fourth quarter was both a little bit of moderation in our business and others, what we saw earlier, and there's only a few of us who have reported is clearly a pickup.

Partly weather-related.

Partly seasonality in terms of how the consumer is architected financially these days.

So I think our view is that clearly there are things in the industry, and I'll tell you one that we're now going to anniversary some better gas prices as we go into the second and third quarter, which is helpful.

We see miles driven picking up again, so we think that that's good.

We can see the impact.

Can't give you the specific math on some of the dealer closings that are out there.

The average age of cars, all bode well for industry specific.

And I think in the end weather evens out, it absolutely evens out over the course of the year.

What may be changing and shifting a little bit is some of the seasonality in the business between periods like Q4 and Q1.

We'll be a lot smarter 90 days from now to understand that seasonality question, too, based upon how things are unfolding.

That's helpful.

Thank you.

And then my follow-up question is on DIFM, and I think the last time you spoke with us, Darren, you had said that DIFM sales per store was around $500,000.

Has been there any notable change to this number?

Yes, Mike, do you have the specific number?

Yes, we are -- we hate to give exactly numbers out, but we are in the range of $530,000 to $540,000 now.

And I think the last time we were just in the high 400s, so we continue to make progress on the average.

And, again, that's on the average.

The actual stores that we are touching are significantly above that.

So we see a lot of opportunity.

And, again, it ties back to our investments.

We have invested ahead, and we believe that we're going to see continued sequential improvement in that metric.

Yes.

Thank you.

Yes.

Thank you.

Thank you.

Our final question today is from William Truelove with UBS.

Your line is now open.

Hi.

Great quarter by the way.

Thank you.

I had a question about commercial, again.

In terms of the commercial, the growth there, is it really coming from -- how much is coming from new commercial accounts relative to, say, the order size at the existing customers that you have is my first question.

My second question goes to, when you broke down the SG&A growth, the 75%, the annualization, the 25%, the increased investments, the variable expense with higher sales, how does that compare with the deleveraging that would happen to your rent?

So if you get higher sales going forward, is going it to be a neutral basis offset with the rent leverage, or our how should we think about that?

Thanks.

Those are my two questions.

On the first question regarding commercial, when you look back over our business the last few years, there are a lot of customers we were doing business with that -- some of which we were doing a lot -- quite a few more we weren't doing very much of, so when you look at where is that increase coming from, the largest a part is coming from existing customers.

But those existing customers may not have been spending much with us a year or two ago, but we did have the relationship.

So as we've added the investments in the parts, we're able to grow that share significantly faster.

Can you ask the second question?

We want to make sure we understand it.

Yes, so the second question.

When you broke down the SG&A growth, you said 75%, the annualization of 2009.

I get that.

Then the 25% of the increase was related to variable expenses associated with higher sales.

So what I was trying to figure out is as sales go up, usually -- obviously you are leveraging rent, but then you seem to have a deleveraging of your new expenses, so for the remainder of this year, as sales grow, of this 25% kind of additional amount, is it going to be -- what is the balance between a rent leverage versus this additional expense leverage?

Yes, let me clarify, because I don't think -- you may have misunderstood what we said.

What we said this year, and it played out in the quarter, is that 75% of our growth this year will be in variable and annualization.

And that played out in the quarter.

So -- so said differently, of the $70 million that we grew, roughly 75% a tad over, was variable and annualization.

The 25% is in new investments, i.e., commercial, growing dot-com, global sourcing.

My apologies, and you're right, I did write it down wrong.

Thanks, Bill.

Thank you.

That's all the time we have for questions.

I would like to now turn the call back to management for any final comments.

Thank you, operator.

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

If you have additional questions, please call me 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.