領先汽車配件 (AAP) 2010 Q3 法說會逐字稿

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

Before we begin, Joshua Moore, Director Finance, 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'd like to remind you that our comments today contain forward-looking statements we intend to be covered by and we claim the production under the Safe Harbor Provisions for forward-looking statements contained in the Private Securities Litigation Reform Act 1995.

Forward-looking statements address future events, developments or results, and typically use words such as believes, anticipates, expects, intend, will, plan, forecast, outlook, or estimate and are subject to risks, uncertainties and assumptions that may cause our results to differ materially, including competitive pressures, demand for the Company's products, the economy in general, consumer debt levels, dependence on foreign suppliers, the weather and other factors disclosed in the Company's 10-K for the fiscal year ended January 2, 2010, on file with the Securities and Exchange Commission.

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.

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

For planning purposes our fourth quarter earnings release is scheduled for Wednesday, February 9, 2010, after market close and our quarterly conference call is scheduled for the morning of Thursday, February 10, 2010.

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

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

Now let me turn the call over to Darren Jackson, our Chief Executive Officer.

Darren.

Thanks, Joshua.

Good morning, everyone.

Welcome to our third quarter conference call.

First, I'd like to thank our nearly 51,000 team members for delivering another record performance during our third quarter of 2010.

Our positive momentum continues to build and we continue to focus on what matters most to our customers.

Our passion around serving our customers and growing our business has enabled us to capitalize on a strong industry fundamentals and consumer demand for auto parts.

Our team members are doing a fantastic job executing our strategies resulting in a 9.9% increase in comparable store sales during the quarter, our largest quarterly increase in five years.

We continue to increase our profitability by growing our gross profit rate 110 basis points during the quarter which helped drive another quarter of double digit operating income growth.

Our operating income jumped 31% in the quarter compared to a year ago.

The favorable market conditions and successful execution of our key initiatives drove an 11.4% increase in total sales.

Store sales productivity reached a record $1.7 million per store on a trailing four quarter basis.

I am encouraged by the overall customer satisfaction scores as we strive to differentiate ourselves by leading in service and providing superior availability to our customers.

Collectively, the strategic and financial progress is evident in our customer experience and our bottom line results.

The past 11 quarters have been squarely focused on becoming more competitive.

We have embarked upon a journey to accelerate our commercial business which has realized 11 consecutive quarters of double digit gains in comparable store sales.

Our performance in commercial is the direct result of our investment to better serve our customers through the additions of parts pros, delivery trucks, the right brands and a national salesforce.

At the same time, we needed to become more competitive in terms of merchandising and supply chain in order to provide our customers with the right products at the right time.

Additionally, our operational focus is due in part to our increased efficiency and productivity.

For example, inventory upgrades are no longer event driven but rather simply part of our fueling the business.

This work has allowed us to serve our customers better and at the same time we have expanded our gross profit rate more than 300 basis points since 2007.

Through our DIY and experience strategies we have been able to reignite our DIY business and improve the in-store experience delivered to our customers as evidenced by the growth in our customer satisfaction scores over the last several quarters.

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

Our team is the most important factor in advance of success.

Our highly engaged team members have a passion for serving our customers.

We continue to assess engagement of our team members through our team calibration survey and we recently completed our second survey of the year.

I continue to be pleased that those scores are at record levels across the Company which underpin our strong results in 2010.

We are excited about what we see in 2011 as we begin the next phase of our plan.

We will continue to strengthen our business through our focus on team members and customers while prioritizing differentiation through service and availability.

Differentiation will require going to the next level of effectiveness on several key initiatives that have previously rolled out.

The key initiatives include global sourcing, our eCommerce platforms for both DIY and commercial, and our demand driven labor model, and our commercial customer growth and retention programs.

These core capabilities continue to make a difference with customers and to our bottom line.

We will further intensify our work around service and availability while delivering on value propositions that are driving these terrific results.

We remain committed to the development of our team members, as I have said before, our team and the total collaboration of our team is the most important factor in our goal to lead the industry in service.

I would like to take a moment to recognize a member of our team who is truly a collaborative leader who is dedicating to serving our customers better than anyone else.

District Manager Ryan Crawford in Arkansas has always been a hands-on model of how to give wow customer service internally and externally.

He constantly connects with every team member and gets to know them personally seeking to understand what they expect from their advanced career.

He is a true mentor to his entire team and is a proactive coach in terms of collaboration.

Ryan is always a leader in training and execution measurements but always takes extra time and concern in making sure the team member translates new material into action.

As Ryan leads the performance of the stores, customer satisfaction scores, as well as team calibration scores have consistently gained momentum and are increasing.

These increases are directly tied to his leadership style and the example that he sets for his teams.

Ryan also possesses high personal standards and is an example of a leader who is living the advance values and who truly understands our focus on service as we raise the bar on our committment to our customers and further grow the development of our team.

Thanks, Ryan, and keep up the good work.

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

Jim.

Thank you, Darren, and good morning.

I want to add my congratulations and thanks to our entire team for another record quarter.

We appreciate our team's committment to providing great customer service and earning their business one customer at a time by living our Company values.

This quarter is the continuation of the plans we have laid out for you in the past few quarters.

Our team did a great job executing those plans as well as capitalizing on the strong industry fundamentals to produce strong results during the quarter.

Our total comp store sales grew by 9.9% in the third quarter compared to 4.7% during the same quarter last year.

Again, this quarter we're pleased to achieve an increase in both the number of customer transactions as well as the average size of each transaction.

Each of our geographic areas produce positive comps in DIY and double digit comps in commercial resulting in a very consistent performance across our Company.

This marks our 11th consecutive quarter of double digit commercial comps in our Advance Auto Parts stores.

Commercial now represents 34% of our total sales.

Also, our DIY business produced strong growth and achieved our sixth quarter of positive DIY comps in the last seven quarters with solid positive comps each quarter this year.

In total we continue to gain market share during the quarter.

As Darren discussed, our industry fundamentals are as strong as they've been in many years and we believe they will continue to be for some time as vehicles continue to age, miles driven remains stable or grows, and economic conditions reinforce the need for consumers to stretch their dollars.

Although the impact to weather is normally neutral over a quarter or a year, the sustained heat this summer was certainly a contributor to our sales strength.

We always anticipate more uncertainty due to the volatile nature of the fourth quarter resulting from a shift in consumer spending patterns and competing demands of holiday shopping.

As we discussed last quarter we're now in a stage of transformation where the pace of new initiatives as slowed.

We're asking our store teams to focus on fully implementing and executing the key initiatives that will enable us to provide better customer service which is the key to our success.

Our initiatives remain on schedule and are focused on doing fewer things but doing them better is resulting in more consistent execution, strong sales growth and the highest sales per store in our industry.

We continue to invest in our store teams to enable and provide great customer service to both our DIY and commercial customers.

Over the last two quarters we've successfully implemented the first two phases of customer driven staffing in our stores.

These new staffing tools have been well received by our store teams and we've achieved significant increases in sales by reallocating our existing labor dollars to better align scheduling with our customer shopping ordering patterns.

We've also completed the most team member training in our stores this year than ever before.

This training is focused on both improving selling skills and enhancing product knowledge, which is enabling our team to better meet our customers' needs.

We'll continue to develop and refine additional staffing tools and build on our training and team member development focus in 2011.

Our commercial growth continues to be strong and is supported by the investments we made in parts pros, trucks drivers and parts availability, the ramp up of productivity by large investment and salesforce and related tools over the past couple years, our focus on growing our relationships with those customers that we can serve best and with which we mutually have the most potential when we partner together and improved operational excellence in our stores so we can consistently get orders delivered quickly and accurately.

Two areas that Kevin will discuss further continue to be fundamental to our strong sales growth.

The increase in parts availability that enables us to do better, delivery of the customer experience, and our new eCommerce tools which are bringing more DIY customers to our stores and making it easier for our commercial customers to do business with us.

We are in the early stages of both initiatives and we look forward to their contribution in 2011.

With these initiatives the positive industry fundamentals and the positive feedback from our customers we are excited about our ability to achieve double digit growth in our commercial business and continue to grow our DIY business as we look forward.

Lastly we continue to reach new customers and grow our sales through successful new store openings.

During the third quarter, we opened 43 stores, including 10 Autopart International stores.

As of the end of the third quarter our total store count was 3,540 including 191 Autopart International stores.

In closing, thanks again to our talented team members for another successful quarter and for achieving those results through a committment to leading inspire teams and providing great customer service.

Now I'd like to turn the call over to Kevin Freeland, our Chief Operating Officer.

Thanks, Jim, and good morning.

I'd also like to congratulate the team for a strong third quarter.

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

During the third quarter, our gross profit rate increased 110 basis points versus the third quarter of last year.

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

We continue to be pleased with the strides that have made improving gross profit rate which has increased 300 basis points on a two-year basis.

Through our custom mix rollout we completed approximately 179 upgrades 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.

As a result of our improved availability, the comp store sales of hard parts continues to outpace that of our total comp sales and is increasing as a percent of total revenue versus the third quarter of last year.

Additionally, we continue to improve category margin rate performance in hard parts.

Our sales and margins in accessories are also improved during the quarter and continue to benefit from our new global sourcing capability.

In total, global sourcing continues to have positive impact on gross margin in the third quarter; however, we are far from realizing our potential in this capacity.

In the third quarter we continue to improve parts availability through our hub transportation service and cost improvements and increased our availability through the addition of seven hub stores.

Our delivery hub network is at 168, providing multiple deliveries a day to over 2200 stores in addition to our 31 PDQs.

Year-to-date, our DC productivity improvements have increased 12% over last year due to continued focus on labor standards and productivity initiatives.

Our adjusted accounts payable to inventory ratio of 71% increased significantly from 61.1% at the end of third quarter last year.

Our increase in the AP ratio continues to be driven by more favorable payment terms, supply chain financing, and the timing of inventory purchases.

Our own inventory decreased by nearly $112 million versus last year.

The customer perception of product availability continues to increase and exceed our internal expectations.

This increased perception is a direct result of our continued focus in committment to provide superior availability to both our DIY and commercial customers.

As we look forward we will continue to expand our availability through focus on increasing our overall brand assortment and leverage our expanding sourcing capabilities.

We will continue to increase the amount of in market inventory by maximizing the storage capacity of our stores, hubs, and PDQs, combined with our effort to expand our hub network.

Through this work our inventory levels and inventory per store will increase; however, we remain focused on reducing our owned inventory through continued expansion of our AP ratio.

We're pleased with the progress of our DIY eCommerce platform with continual increases in all key metrics, traffic, conversion rates, and sales.

We are proceeding with the rollout of our business-to-business eCommerce capabilities which will be completed in December.

We're excited about our B2B capability as it will enable our commercial customers to experience Advance in the manner in which they prefer, either online or over the phone.

Additionally, it will allow us to become more competitive and do business with more and larger bay garage customers.

In the third quarter, AI's revenue grew 22.9% driven by the net addition of 40 stores over the past 12 months and a positive comp sales performance in the quarter.

AI opened 10 new stores during the quarter bringing their total store count to 191.

Year-to-date, we've opened a total of 35 new AI stores and anticipate the opening of three to five more stores in the fourth quarter.

Overall, our third quarter was very successful on our team and I'm thrilled by the strategic and financial progress we've made as we focus on providing superior availability.

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'd like to start by thanking all of our talented team members for the strategic progress and fantastic financial results we delivered during the third quarter.

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

One -- provide financial highlights of our third quarter performance; two -- provide an update on the key financial dimensions of our transformation; three -- link our third quarter performance to the balance of 2010 and share some insights into how we are thinking about 2011.

As you may recall our fiscal 2009 results included the impact of store divestitures which decreased dilutive earnings per share by $0.04 during the third quarter 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 provide a GAAP financial results as well as comparable operating results and our earnings release.

Overall, we are very pleased with our strong third quarter results as we continued to reach new heights and achieve new milestones in our Company's history.

Starting with our earnings, our third quarter earnings per diluted share of $1.03 were $0.34 favorable to last year representing a 49% increase in EPS excluding the $0.04 impact of store divestitures last year.

This was on top of last years 19% EPS increase.

On a GAAP basis, EPS increased 59% or $0.38 over 2009 third quarter results.

Our comp store sales increased 9.9% during the third quarter which was driven by strong DIY performance and our 11th consecutive quarter of double digit comp sales gains in commercial.

This was on top of a 4.7% comp during the same period last year representing a 14.6% two-year comp store sales increase.

Our gross profit rate increased 110 basis points versus last year and continues to be driven by improved merchandising and pricing capabilities, improved parts availability, and supply chain efficiencies.

The 110 basis point increase was on top of 190 basis point gross profit rate improvement during the third quarter of 2009.

Our SG&A rate during the quarter decreased 50 basis points excluding the impact of store divestitures last year.

The 50 basis point decrease was driven by strong comparable store sales which resulted in leverage of fixed costs and the decelerated pace of net incremental spending on the Company's strategic capabilities partially offset by incremental advertising and increased incentive compensation.

Our operating income increased 32% versus the third quarter last year and our operating income rate increased 160 basis points during the third quarter.

Free cash flow through the third quarter was $467.8 million which represents a $53.8 million increase over last year.

This increase was primarily due to our strong growth in net income and reduced net owned inventory.

Our Accounts Payable to inventory ratio increased to 71% from 61.1% last year as part of our continued focus efforts to reduce our net owned inventory.

Overall, we are pleased with our top and bottom line performance which is being driven by strong industry dynamics, previous strategic investments and superior execution by all of our team members.

We continue to position the Company to decelerate the pace of SG&A per store dollar growth which will position us to leverage expenses at lower comp sales levels in the future.

Our performance through our third quarter as well as our performance over the past three years reinforces our committment to accelerate growth, improve profitability, and drive shareholder value.

We will continue to measure our performance based on these three dimensions.

Our progress over the past few years clearly shows we are on the right path.

Our committment to growing our business is reflected in our year-to-date 7.8% increase in comp store sales and our industry leading sales per store which on a trailing four quarter basis grew 5% to $1.7 million.

Our ability to grow our profitability is marked by consistent and continued gross profit expansion and an increased operating income rate which grew 110 basis points and 160 basis points respectively during the quarter.

On a two year basis, our gross profit rate and operating margin has expanded by 300 basis points and 240 basis points respectively.

As we look at our ability to drive shareholder value, we are pleased with our 220 basis point increase in ROIC to 17.3%, a 38% increase in economic profit added over the past 12 months and our year-to-date record free cash flow of $467.8 million.

This strong performance across-the-board gives us confidence in the strategic choices we have made to greatly increase our operating performance and shareholder value.

Our performance is also being recognized externally with our recent upgrade by Moody's to investment grade.

This upgrade coupled with our previous upgrade by S & P now brings us to full investment grade status.

Getting to full investment grade is the direct result of the positive impact our team members are making on growing our business and when combined with our strong balance sheet provides us a strong financial platform to continue to grow and extract further value in areas such as supply chain financing.

Next I'd like to link our third quarter performance to what we see for the balance of the year as well as provide some insights on 2011.

As we previously shared, we do not expect the same level of overperformance in our fourth quarter.

The fourth quarter is our most volatile quarter given the seasonality shift in the timing of consumer spending and the tradeoffs consumers make during the holiday shopping season.

We also estimate we will have a $0.10 to $0.12 headwind in our expenses in the fourth quarter primarily due to incentive compensation resulting from our strong year-to-date performance compared to our soft fourth quarter last year combined with the deliberate decision to pull forward some 2011 expenses in commercial and availability into our fourth quarter.

This will better position us to carry our momentum into 2011.

With our strong third quarter performance and taking these expense headwinds in the fourth quarter into account, we are increasing our fiscal 2010 annual EPS outlook to be in the range of $3.80 to $3.90.

Turning to 2011, we expect industry dynamics to remain favorable which gives us confidence to continue to invest in the customer and team member facing parts of our business to drive growth.

We anticipate continued top line growth driven by double digit commercial comps and continued new store growth that will be at least 2010 levels.

We expect our availability will continue to generate value through reductions in owned inventory and continued gross profit expansion; however, at more modest levels than 2010.

Turning to our cost structure we expect we will continue to invest in the business in areas such as commercial, parts availability and eCommerce.

That said, we expect our SG&A dollar growth to decelerate in 2011 as we somewhat offset this investment spend with productivity enhancements in areas such as labor management and operational efficiencies.

This will position the Company to leverage SG&A at lower sales comp levels in 2011.

Given the momentum in our operational performance, disciplined approach to capital management and strong industry trends, we expect capital spending to increase in 2011 primarily in the areas of availability and store systems.

We believe this investment profile best positions the Company to build a differentiated service model that delivers on our long term financial objectives.

We look forward to sharing with you a more robust 2011 annual outlook during our fourth quarter conference call.

In closing, we are very pleased with our strong third quarter and year-to-date operational and financial performance.

Our strategic choices along with our execution and favorable industry trends continue to fuel our growth and provide us a solid foundation to continue to grow from and differentiate our business in the eyes of our customers.

Again, I would like to thank all of our talented team members for their meaningful contributions and record setting performance through our third quarter.

Operator, we are now ready for questions.

(Operator Instructions) Our first question comes from Gary Balter from Credit Suisse.

You may ask your question.

Thank you.

First of all, Darren, congratulations.

You've done such a super job since joining the Company.

Thanks, Gary.

I'll ask "it's a big picture" question and decide how much detail you want to go into.

But you have some very strong initiatives that you address at the beginning, the sourcing, the labor scheduling, et cetera.

The question we get from our side always is, where are they in that?

Like, so in other words, how much investment has been made in sourcing and where are they in the payback on that?

Kind of what inning are we in?

Is it possible for you to take a few of the major initiatives, and kind of address that in terms of where are you in terms of investment versus payback in some of those?

Yes, Gary.

I'm happy to do that.

Why don't I do this.

I'll have Kevin talk about global sourcing.

I'll have Tami talk about labor.

And I'll have Jim talk about our commercial wave program.

B ecause when I look out to next year, I look at those three programs, and they will be a disproportion at amount of the initiatives that we continue to lean into in terms of driving outcomes that are showing up in this quarter, but they will carry over into next year for sure.

Yes, Gary, this is Kevin.

In terms of the global sourcing, if you're describing where are we in the game, we're very early in the game.

It was a single digit percent of the receipts that we brought in as a Company this year, and this was our first full year moving into that direction.

That program will grow dramatically in the early years and it's quite frankly unknowable how far that can expand.

We could look at our Autopart International subsidiary where very nearly all of the products come in private label.

And I doubt seriously that that's a prudent strategy for us, that I would say at this stage.

The issues that we're dealing with are predominantly how to scale it and how to scale it quickly.

So I'd say for the next several years those numbers will go up pretty sharply.

Jim, do you want to talk about commercial waves?

Sure.

Gary, in terms of store count across our Company, we're around half way through our process of investing in our stores to accelerate our commercial growth.

Having said that, we're more than half way in terms of investment, primarily because of a couple reasons.

One being, as we've done our investments, we're becoming more efficient as we go.

So it's not taking us as large an investment as we go to our next group of stores each time.

In addition to that, some of the things that started out as part of our acceleration in specific stores has become applied across the entire Company already, in terms of being able to do that without the process of investing in specific stores.

So as we look at it overall, we're somewhere north of half way through the process.

Tami, labor?

Hi, Gary, it's Tami.

Hi.

So I would say we're probably about two-thirds of the way through the labor initiatives.

I think we've talked in the past the first phase was moving labor within the same-store, within the same box.

Just to get it to the right day and the right day of the week and time of the date when our customers were there.

The next step really moved it between stores to get it to the stores that needed it most.

And then the next phase really, we've got some tests in different ways of measuring that traffic, and when the customers are there.

And we have some technology to invest in.

It's not huge investment, but just to support the systems.

Yes, Gary.

And maybe I would finish up with two other thoughts, that the other big initiative that I reflect on is our eCommerce rollout.

I mean, we literally just got in the game this year.

By the end of the year, I think we will have enabled virtually all of our stores just to do basic B to B eCommerce.

What we've seen in our B to C site is, I think it's roughly 70% of those orders are being picked up in store.

And I just think that's part of where the world's going.

And I think we're second inning, if not the first inning in terms of eCommerce.

I think as I look out, one of the things I think about too, is that when we got started, we put a lot of energy in terms of building merchandise capabilities and supply chain.

And we're reaping those benefits.

Last year we put a lot of energy into, I would say, getting into the store portfolio, and re-racking the store portfolio.

One of the things that's just happening, is business is so darn good.

What we're realizing, is that we will make probably a bigger push in the availability area, as Mike said in his comments, as we look out.

Because as we continue to learn about availability and custom mix, we see big opportunities there.

The other thing that we're seeing, particularly that's revitalizing our DIY business, and I don't think we can understate it, is the training efforts have ramped up considerably.

And, matter of fact, in this fourth quarter, we will pull forward more of those training efforts, because as we look across the Company, our internal language is DM ops excellence.

And we've begun that process across the Company.

And I think that there is big, big opportunity for us as we become more consistent in execution.

That's great.

Just one quick follow-up, and that's real helpful segment by segment.

Are you in somewhat of a positive virtual circle, where you talked about availability.

As your payables increase, your actual net cost of putting more inventory in actually is lower, so it leaves you more opportunity to test adding more availability, and same with that drive sales.

Is that one of the ways we should be thinking about it?

Yes, Gary, this is Kevin.

I'd say a couple of things.

First off the custom mix has materially improved the quality of inventory in our stores, which is improving the productivity.

We also worked on the, what we refer to as, non-working inventory, or essentially the slow moving inventory and have materially reduced that quantity, and have created a program that makes it unlikely that increases in inventory would bear much risk.

Despite that, as we look at our key competitors go through financials and compare companies, we have as much as a double digit deficit in dollars of inventory per square foot against other major competitors.

So there's an ability for us to physically hold additional inventory beyond what we do today.

So what you saw in the quarter, is sales were up 11%.

Inventory went up 11%.

And essentially what we're able to do, is add both the quality and now quantity of inventory.

And yet despite the 11% increase in inventory, our total owned inventory went down 17%.

So we improved availability, and threw off $112 million in cash.

We actually survey our end customers on their perception of availability, both commercial accounts and retail customers, and it shot up markedly in the quarter, compared to the year before.

So we believe that that is a strategy of the future, and in fact, we'll be continuing to essentially improve availability and the perception of it with time.

Thank you.

The next question comes from Alan Rifkin with Banc of America.

You may ask your question.

Yes.

Thank you very much.

With the investments that you've made on the commercial side of the business, can you maybe describe for us what are the levels of revenues and operating income and penetration, in stores where you have the commercial programs set up relative to the corporate average?

And does your continued belief that you can grow commercial by double digit, is that belief predicated on further rollout of commercial programs to stores that don't have it today?

Or do you think that that will come from increased benefits at already existing stores that have the program?

Alan, this is Jim.

As far as how we look at the break down of commercial comps in our business, the stores that we've invested in directly as part of our acceleration, are growing faster than the stores that are not.

And they are doing a considerably higher sales per store in commercial in those stores as well.

So the impact of the investments has accelerated both the comp growth, as well as taking those stores to a higher -- significantly higher level of sales than others.

Having said that, we're very pleased with the growth rates that we're seeing in stores that we haven't made as much direct investment.

And I think we're seeing that because a lot of the things that we're doing Company wide with availability, with the salesforce, with a lot of other things that are improving our commercial business overall.

So that's a look at how we think about the sales.

We're also pleased with the progress we're making with margins in commercial.

We are getting more efficient with our investments, as I mentioned before.

And that's translating into accelerated improvements in our margins that our additional commercial business is making as well.

As we look forward to the future, and our comfort level is continuing to grow with the commercial business significantly, it comes from a couple things.

I think there's just so much opportunities still in the commercial business overall.

We still have, as we talked before, a very low share in total.

And when we look at our customers, and our level of share of wallet of our customers compared to the total, we just have lots of upside.

As far as where is that coming from?

We'll continue to add commercial programs when we open new stores.

But we don't see any significant increase in the number of programs in existing stores.

We're at about, I think 90% of our stores have commercial.

And we wouldn't anticipate that to change much at all.

So, as we continue to invest specifically in stores, as we see the impact of the initiatives that we've already put in place over the last two or three years, and just the opportunity in the market, that's where we get our comfort level to see a continuation of 11 quarters of great comps that we've seen already.

Okay.

Thank you.

Alan, it's Mike.

Just, I think Jim captured it well.

We don't share out specifics of how we're doing around our program, but I'll give you this frame.

You know, I think over the last 11 quarters, we've proven we can grow comps.

And in the more recent quarters, we're starting to see glimpses of improvements in our controllable profit, as we kind of balance our ability to grow through comps and profitability.

And when we start to look at our commercial sales per program, and productivity of that, that's growing year-over-year.

We're starting to see productivity improvements in things like our salesforce in our trucks.

So we're pleased with our commercial.

And that's important for us, because we see that as an important part of our growth.

Okay.

And one follow-up if I may, for Darren.

Darren, on the global sourcing initiative.

With there being so much opportunity ahead for you, and with this certainly being a considerable driver to gross margins in the future, can you maybe share with us how you're going to go about managing the inherent greater risk associated with global sourcing, particularly as it relates to rising input costs coming out of various countries in Southeast Asia?

You want to talk about that, Charles?

Yes.

I think there are a couple things.

So we're looking at global sourcing from a global perspective, by the way of bringing in product from Mexico, Korea or China.

Many of our products that are coming from, that come from importers in the past, are coming from China.

So as commodity prices arise, we see generally that the market price will go across the industry.

And so, the inherent benefit of becoming more vertical in Asia, will drive that competitive advantage to us.

And that's something that we look at from a commodity perspective every quarter, to understand what that impact might look like.

Charles, you would add that Alan, to build on it, is that we think about a global sourcing capability.

We're not locked on to global sourcing.

Exclusively means China.

So we have pieces of our business, and we're building relationships that we can source from Mexico.

We're looking at things in Vietnam.

We're understanding how the market might evolve in India.

So I think you have to think about it.

And the way we think about it, is that this stuff tends to move over time.

And we have to build a team that has the capability to work in many different markets.

But partly the reasons that you mentioned, and quite frankly, as those other markets evolve, you can end up getting better product, or different quality product, by actually being able to be adept, and work within those different markets.

Thank you.

Our next question comes from Kate McShane with Citi.

You may ask your question.

Hi, thank you.

Good morning.

Hi, Kate.

Good morning.

Can you break down what the biggest drivers were of the bigger basket that you highlighted in your comments?

Is it coming from higher discretionary purchases or something else?

And how much of your growth was from traffic versus conversion?

The reason why I ask is, I would imagine conversion is improving faster because of your labor effort.

But wanted to see if that was something coming through already, or something that will be more to come.

You guys jump in.

So Kate, a couple things.

So in the quarter, clearly, traffic was a big driver.

So was ticket.

And ticket was principally driven by mix in the quarter.

Weather is clearly helping us.

And you know what?

When we look at things like our AC business and our battery business, batteries have a higher ticket.

That certainly helped us in the quarter.

Conversion rates, per se, I would say this, is that we continue to work to get better measures on true conversion.

We can see our traffic, or our transactions, clearly picked up, versus a year ago in Q3.

I think it was that combination of, we can see this building traffic pattern.

And it tends to be in the failure categories, not in the discretionary categories.

Clearly the weather related categories helped us in the quarter.

And what gives us confidence as we go into next year, you can actually go back in time, I think it was about 2005, where we all enjoyed a pretty good year.

And that tended to be more discretionary driven.

Clearly what's happening in the marketplace is cars are -- average age of cars are heading towards 11 years.

And you figure that two-thirds of the cars that are seven years old or older, the average mileage on those cars is north of 100,000 miles an hour.

And clearly what we're seeing, is those failure related categories, and the focus of our availability efforts to make sure that we continue to grow in terms of our availability, give us a lot of optimism as we look to the future.

That's really helpful.

Thank you.

And then my second question is on eCommerce.

I wondered if you could just update us, now that DIY has been up and running for a little while.

I think that before that time, eCommerce accounted for less than 1% of your sales.

And as we move into 2011 with the B to B launch, how much do you think eCommerce is going to compose in the first year of this initiative?

Yes, Kate.

This is Kevin.

We don't break out eCommerce as a separate segment.

What I can tell you is, I would break the businesses out between the retail business versus the commercial business.

On the retail side, we actually benchmark ourselves in terms of traffic and the publicly available conversion rates to our main competitors.

But we're fairing nicely at this stage.

We have surpassed most of the people that would be in the segment, and are just delighted with where we sit in terms of the traffic.

We're getting to our site compared to our competitors, and how many of those sales we're able to close.

We can also see that a far more significant impact, is the number of people that are on the site, and are choosing to just essentially go to the store without making a sale.

And they're able to do research.

They're able to figure out whether or not we have the part that they need, in a convenient setting of their own home.

On the B to B side.

We have not yet fully rolled out the program to all stores, won't have that done until late next month.

And I would say at this stage, it's difficult to be able to tell where that program will go, because of the fact that in the last few months we've been rolling it out to hundreds of stores a week.

The growth rate is -- we're setting records literally every single day.

And I think as we get out into spring of next year, we'll get a better sense of how large that program will be, and how quickly it grows.

One thing that we have seen is, obviously there's a material amount of the business, that is people choosing to order over online, in lieu of over the phone.

But a material fraction of it is turning out to be incremental business from customers that we were unable to serve in the past because they prefer to shop online.

Thank you.

Thank you.

Thank you.

Our next question comes from Matthew Fassler with Goldman Sachs.

You may ask your question.

Thanks so much.

And good morning to everybody.

Good morning, Matt.

My questions relate to SG&A.

It's a question and then a follow-up.

First of all, in the past couple quarters, you give us very helpful break down of the composition of expense growth, or growth and expenses per store, as it related to some of the long run investment initiatives, and some of the shorter term efforts that related perhaps to incentive compensation.

Would you be able to do that for the third quarter?

Yes, I'd love to, Matt.

Thanks.

And I was a little bit worried about getting shut out on this call.

So thanks for asking a question.

So a break down.

I'll give you high level frame first.

And I'll give you some specifics.

About 80% of our SG&A growth in the quarter was driven by our variable expenses.

Our NSOs will open up more stores this year, and annualization on previous investment.

So that's the majority of where the growth came from.

You know, we're pleased as I look specifically in Q3.

We're pleased with our 50 basis points of leverage without divestitures, and 106 basis points with divestitures.

And our spending profile was in line with what we said all year.

I think for the year that I shared with you, that our spending this year would decelerate over last year.

We've seen that.

We said that our SG&A per store last year grew at 8%.

This year we said it'd be above the high end of mid single digits.

That's exactly where it's tracking, and that's where I anticipate it's going to track for the rest of the year.

And then some of the key drivers around that, that happened in the quarter, were advertising.

I think we told you in Q2, that we'd spend a little bit more advertising because of timing.

And also what I would tell you on advertising, is our advertising in 2009, so last year, was down over 2008.

So now we're getting back to more normalized levels, and we're really pleased with the returns that we're seeing in advertising, to drive consideration based on our improved analytics and CRM capabilities.

And then the other one was incentive comp.

We have a model that pays on growth.

So in times when we grow -- so a 9.9 comp over a 4.7 last year, we're going to see a little bit of deleveraging in our incentive programs.

What I would tell you, is the program is driving more storage growing this year, over last year sequentially.

So we're really pleased of what that program is driving for us.

So that's what I would tell you about the quarter.

And you heard it in my remarks, around Q4.

Again, we're not changing our principles that we outlined at the beginning of the year.

But because of the seasonality of our business, with Q4 being our most volatile quarter, and Q1 actually, we're anticipating being a stronger quarter, we want to position ourselves.

So we pulled forward a few investments, one in commercial ways, that Jim talked about earlier, just to position us to make sure we go into next year strong.

And the other one in availability.

And then the last thing is, is you'll remember last year, we had a soft fourth quarter, which impacted our annual programs last year, as we turned back a little bit of bonus in Q4.

We don't anticipate that same level of softness in this Q4.

So, that's really what's driving the $0.10 to $0.12 that I gave you for Q4 outlook.

And just to make sure, Mike, do you have appropriate share of voice on this call, a couple part follow-up.

The $0.10-$0.12 is sort of incremental to what base?

And then just an early look at 2011.

You talked about leveraging on a lower comp.

It seems like you've got several hundred basis points of truly variable SG&A, that you put in 2010 as a function of investment and performance.

Is that an SG&A growth rate that could come down very substantially, year on year as you look from 2010 to 2011?

Well, I'm not going to get too specific.

I kind of gave you a frame.

I'll answer your second question first.

I think what we said, is this year we leverage at lower comp levels than we did last year.

Last year, I'd say we were leveraging SG&A at double digits.

This year through the third quarter, we're doing roughly a 7.8 comp, and our SG&A rate is up roughly 10 basis points.

So we're almost flat on roughly an 8-8.5 comp.

So we're pleased that we did what we said we were going to do.

I anticipate next year, as we start to look at the yield on our total SG&A.

Tami talked a little bit about the opportunities we have in labor, Jim talked about us getting more productive in commercial, I mentioned that we're getting more productive with our advertising spend.

That gives us confidence that we'll be able to leverage at lower comp levels next year.

Got it.

Thank you so much.

Thank you.

Our next question comes from Scot Ciccarelli with RBC Capital Markets.

You may ask your question.

Hey guys.

How are you?

And I don't know if this is a Darren question or a Mike question, but I guess it's a little bit of a follow-up to Matt.

You talked about this degree of seasonality.

Darren, it's something you mentioned during your last quarter.

I guess the question is, what kind of impact do you think that will have in terms of your relative to your current run rate?

Whether you're looking at two year stacks, three year stacks, however we should be thinking about it?

What kind of impact do you think this change in consumer buying patterns will have on the fourth quarter, in terms of a sales run rate?

Scot, here's the way I'd answer that.

Is that, I'm not going to forecast December or Thanksgiving through the end of the year for you.

But -- and I know you did some work on it.

And I actually agree that there's a change in seasonality.

I think we all were on the call after the fourth quarter last year, in the industry, explaining why there was such a fall off in Q4.

Not just in terms of our business, but the industry in total.

And what we saw, is that there was higher spending in other parts of retail.

Usually what we've seen -- if I go back three years ago now I think, Jim.

We literally saw a moment, where the day after Thanksgiving, we saw a full 600 basis point decline in our sales rate, as people just headed for the malls, and headed for other parts of the business.

Now, what's a little different this year, than say three years ago, and I talked about this earlier too, depending on whose numbers you believe.

But by the time you get to January of this year, we'll be closer to 11 years old, in terms of cars, than 10 years old.

And those miles keep racking up.

In the type of selling that was happening three years ago had more of a discretionary nature to it.

And today, it has a much more non-discretionary nature to it.

So there may be a little more durability this year, because you just don't have a choice.

Because quite frankly, you can't get to the mall, because your car broke down.

And so I still believe there is a shift.

We can see it in every payroll cycle, in terms of how consumers are spending it.

And we can see it in the tax return cycle for sure, in terms of how business picks up.

And so, I don't think those structural environmental things, in terms of unemployment and how the consumer is squeezing the dollar, has changed.

I just think that they may be getting crowded out.

We may get a little more play, because of the non-discretionary nature of the mix that's selling today.

Got it.

Thanks a lot guys.

Thank you.

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

You may ask your question.

Thank you.

Good morning.

Hi, Tony.

I guess one of the questions that I wanted to ask and follow-up on, was in the prepared remarks, you talked about 168 hub stores with delivery to 2200 stores.

I'm assuming you targeted the stores that you saw the most opportunity from a parts availability standpoint.

Can you maybe give us a little color on the other 1300 stores that are out there?

And do you have an equal opportunity with them from a parts availability standpoint?

Or is there something different you view those stores as?

Yes, Tony, this is Kevin.

We're not completed yet, in terms of the full hub rollout strategy.

But much like the commercial programs, we are clearly on the back half of the investment cycle.

As we looked at opportunities, essentially what we're doing is, we're leveraging existing real estate to serve densely packed stores with extended assortments in a hub store.

And as we move through the list of opportunities, eventually we begin to move into stores that are more sparse, and where the opportunity is either non-existent, or is a diminished opportunity.

That all said, we still see additional opportunities going forward.

And I would say that there should be still material activity adding hubs through 2011.

Okay.

And one of the benefits that perhaps sometimes is understated of the parts availability, is what its impact is on the DIY side?

And can you maybe give a little bit more color about the training efforts for DIY?

And we've talked a lot about commercial in 2011, but how you're positioning DIY heading into next year?

That's my follow-up.

Thank you.

Tony, this is Jim.

I'll touch base on the training part of the question and the rest can join in.

We really, this past 12-18 months, we really looked back and recommitted ourselves to training our team, and helping our team be in a better position to serve our customers and solve their problems in the stores.

So I mentioned in my remarks, that in 2010, we did more training than I think we've ever done as a Company.

And that's both in terms of just teaching product knowledge and helping better understand the product that we sell, as well as selling skills and how to solve our customers problems.

And that will be a committment to us as we look into 2011.

And that is a factor in our DIY growth.

And we think we're starting to see some of the impact of that effort, both in terms of our sales, and how our customers perceive our ability to take better care of them.

Hello.

This is Greg.

One thing I would add, is that we are improving our ability to kind of clearly communicate with our teams, what a great customer experience looks like, how to really fully leverage superior availability.

And actually, we're instituting a process that allows us to assess, kind of their improvement on a routine basis.

And we've done that in a number of stores in a number of districts.

And we're excited about how that kind of training and focus on service excellence is leading to better leverage of our availability improvements.

And the other thing I would say around availability, is that in DIY, the customer need, it's a need base, not a want base category.

And in this environment, the needs they have typically, speak to repair, and tend to be pretty urgent.

And our availability strategy of getting parts closer, more approximate to our stores, and improving our ability to leverage our network through service experiences, is the strategy that we're embarking on.

And we're seeing great success with that.

Tony, this is Kevin.

I'd put one last point in there, which is, we measure customer perception of availability.

And there is a stark difference between the improvements and the perception on the commercial side, versus the DIY side.

And it's the same inventory.

We believe that the disproportionate improvement on the commercial side, is basically the fact they buy from us every week.

A DIY customer comes in dramatically less often.

And it will take a while for them to figure out what we've done, and have their expectations catch up with our current reality.

So the improvements we've had in availability, are more immediately showing up on the commercial side, and bode well for growth on the DIY side down the road.

Thank you.

The next question comes from Dan Wewer with Raymond James.

You may ask your question.

Thanks.

Darren, I guess a year, year and a half ago you began telling investors that the companies focus was to grow market share in commercial, which you obviously have achieved.

And to hold market share in do-it-yourself, recognize that do-it-yourself has dropped about 35% to 40% of the addressable market within the industry, but still it's a lot of dollars.

At what point do you begin to maybe alter the focus a bit, and look to actually begin growing share in do-it-yourself?

It looks like on these numbers, you may have accomplished that in this most recent quarter.

Yes.

That's a great question, Dan.

So here is what I'd say, is that when we got started on commercial, and I think I had talked about this maybe a few calls back, is that we had to disproportionately dial up our focus, our communication, our share expectations.

And, oh, by the way, we had 3% share.

And I think we've come a long way in three years, and I think we're all the way up to 4.5% share.

So there's still, I would say a heavily weighted focus on what the share opportunity is.

And we're going to continue with the waves, the B to B rollout, the availability and maintain that focus.

But what I would say has changed, is that many of the things that were episodic in getting to those commercial share gains, are now becoming more routine in our business.

And I even see it in the third quarter of this year.

So our commercial wave stores absolutely lead the chain in growth, but our balance of the chain did double digit too.

And partly it's a double digit because availability is more natural for us in the custom mix process.

Labor is more natural for us in the customer driven labor.

So there's a way to achieve gains by actually building in the way we do business.

Rhythmically, versus episodically.

I will tell you in the last year, this past year, we have reasserted our focus in DIY.

We're seeing it principally in the parts and battery business.

Without getting into the specifics of the comp number, its got to be our best comp in five years, if not longer.

And where we see that growth is clearly in the parts side of the business, and the battery side of the business, and the efforts in terms of eCommerce, the efforts in terms of the training.

We have no intention to see DIY share.

I think just the math tells you, it's hard to grow the share at the rate that we have share gain opportunity in commercial.

But our efforts this year, is to have the team come back together, and as we go into FY 2011.

Not to think about it as an either/or, but to think about it as an integrated service and availability opportunity.

I think Kevin's points are right on in terms of getting credit for those investments, whether they're availability or service.

Take a little more time in terms of [the immediacy].

But this is about as excited I have been in my three years about our DIY opportunity, than as I look back.

So you think we're at a tipping point where the share gain should begin to grow?

I absolutely believe we're at a tipping point in terms of DIY, because we're better positioned in terms of the tools and our focus on the training and availability, but I do want to -- it's again, just math, Dan.

Our share gain opportunities in commercial, just by function of as you said in the beginning, size of market, and where we're already penetrating DIY, commercial will continue to lead the way.

And we have not changed our story in terms of getting to a more balanced 50/50 model as we look out.

And then, just as a quick follow-up.

And thinking about the seasonality of your business, and the seasonal earnings contribution.

The fourth quarter guidance from the Company implies about a $0.50 to $0.60 per share EPS drop off from your third quarter results.

So we went back and looked at the last five years.

And there's never been a period where the sequential earnings decline has been more than $0.30 a share, and that was last year.

So even baking in the extra expenses in 4Q, there appears to be a very healthy dose of conservatism built in.

Hi, Dan.

It's Mike.

I don't necessarily agree with you on the conservatism part.

We try not to predict.

We're not good predictors.

I think we're better operators.

What we do, and I think Darren said it.

I mean, fourth quarter typically is our most volatile quarter.

We saw it last year, I think we hung up a $0.39 EPS number.

As I look out with the outlook we gave, we're very comfortable.

We're off to a start in Q4 that's very consistent with the outlook we gave.

The $0.10 to $0.12 are real, when we compare ourselves to last year.

And as I look out in Q4, if we hit the numbers that we expect ourselves to hit, I think we're going to see nice growth out from an OI perspective, and nice growth from an EPS perspective, that we're comfortable with.

And I think Darren said, that quarter typically is our lowest volume quarter.

So I think some of your math is just picking up on that being a low volume quarter for us.

Well, we hope you're right, Dan.

What we try to do candidly, and we've been signaling all year, that we're not so good at predicting the fourth quarter.

I don't think we've gotten it right in the last three years.

We've either been under or over.

We provided the $0.10 to $0.12 because we didn't think that people may have remembered last year's bonus turnback.

And we did make a decision candidly in this business.

The Christmas season for us, comes in the first quarter.

And so we made some decisions that will constrain earnings a little bit as it relates to preparing for the commercial waves, getting the training out there.

We're making some eCommerce investments in this fourth quarter in order to continue to build awareness.

And we just think that we believe in the structural dynamics of the business, and I think that's just putting a little more pressure on the fourth quarter.

You're going to come up with your own estimates, as is everybody on the call.

We just wanted to be transparent as to what's in our thinking.

And we'll get together in a little over 90 days, and we'll see how it turns out.

But those are the ingredients we see.

And Dan, last thing is, we try not to manage the business on a quarterly basis too.

We're really pleased with how the year is shaping up.

And as Darren says, we want to position next year to be even better.

Thank you.

Our final question comes from Gregory Melich with ISI.

You may ask your question.

Hi.

Thanks.

And great job guys.

So two areas.

Darren, you brought up the W word of weather.

So I'm going to give you a chance to sort of put a frame work around that.

If you look at those categories like batteries, hoses, some other things that are typically weather sensitive.

Can you give us an idea, is it a couple hundred bips of comp that you think may have been helped?

And then I had a follow-up.

So Greg, I would say this.

No doubt that weather helped us.

Could it be up to a couple hundred basis points?

Sure it could be.

So when we look at the chemicals business, the AC business, the battery business.

You know what?

You know, it's -- global warming is helping.

There is no doubt about it.

But that being said, when we come around on these numbers again, the other thing that's even more important to the numbers, is structurally what's going on with the age of the vehicle?

And the other pieces of the business?

And that's what we see in the makeup of the sales.

Because those things are as much a reflection, and they may have accelerated a little bit.

But the core opportunity is still the same in terms of that age of vehicle fleet, and the other related failure categories as we look out.

Great.

And then the second question is maybe a bit big picture.

The square footage growth -- you've been putting up 140-150 a year, but then you took out some stores last year.

As you see this sort of step function in terms of age of vehicle changing, what are your thought process in terms of accelerating the current store base?

Or is it really still about improving the productivity out of the assets you have, as you think forward a few years?

Yes, if we look forward a few years, you know what?

Should we be all the way to the West Coast as we look out over the long term?

Yes, we should.

As we look out in terms of total numbers of stores, I couldn't tell you whether the -- I know it's not less than 4,000, and it could approach 5,000 stores.

And we continue to look at those maps.

But we are still very focused on the fact, that in terms of the share of wallet story, Greg, our math continues to tell us that in terms of the average opportunity by store, that there's an average opportunity to do $2.5 million a box.

And think about that as aspirationaly.

And I think we're at $1.7 million today.

So there is a lot of productivity and profitability.

And as you listen to today's call, our efforts continue to be how we're building in those capabilities, in order to realize on that potential over time.

And so, whether it's $1.2 million per box we see in commercial, we're doing roughly $1.1 million a box today in DIY.

We expect that to grow.

But what I think as an organization, that the way I've thought about it is that, if you can build the best consumer value proposition and the best business model, you can go anywhere.

And so, we think that we're still on the right balance of growth and productivity.

Thank you.

At this time I'll turn the call back to management for any final comments.

Thank you Shirley.

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

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

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

And that concludes our call.

Thank you.

That concludes our call today.

You may now disconnect.

Thank you for joining us.