領先汽車配件 (AAP) 2011 Q2 法說會逐字稿

Welcome to the Advance Auto Parts second quarter 2011 conference call.

Before we begin, Joshua Moore, Director of Finance and Investor Relations will make a brief statement concerning forward-looking statements that will be made on this call.

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

I'd like to remind you that our comments today contain forward-looking statements we intend 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, 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, business interruptions and other factors disclosed in the Company's 10-K for the fiscal year ended January 1, 2011 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 in our website at AdvanceAutoParts.com.

For planning purposes, our third quarter earnings release is scheduled for Wednesday, November 9, 2011, after market close.

And our quarterly conference call is scheduled for the morning of Thursday, November 10, 2011.

To be notified of 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 1 year.

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

Darren?

Thanks, Joshua.

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

I'd like to thank our 52,000 Advance team members for delivering an outstanding performance in the second quarter, through their dedication and service to our customers.

We are pleased with our second quarter results that include our commercial sales growing at double digit comp rates and our DIY business showing incremental improvements from our first quarter.

Both combined to generate a 2.5% comparable store sales gain in the quarter.

Our external measures for customer satisfaction continued their upward trends for both our commercial and DIY businesses.

Selectively, our service and operations focus is reflected in our 66 basis point improvement and our operating income rate which rose to 12.8% for the quarter, as well as our earnings per share which grew 26% to $1.46 during the quarter.

These results are very encouraging, despite a consumer environment filled with economic uncertainty.

Our expectations reflect the current reality of a more challenging economic landscape, including escalating gas prices that are over $1 per gallon higher than a year ago, miles driven trending downward, and a clear slowdown in the industry growth rate versus the record pace last year.

The counterbalance to the economic pressure is the continued aging of the vehicle fleet which stands at 10.5 years, lower new car sales and pent-up deferred maintenance costs that have more than offset the economic obstacles.

It is important to say our teams have done a terrific job retooling our operations and financial plans without compromising our strategic investments which has allowed us to be successful in the current economic environment.

Our ability to balance solid execution in the short-term with our efforts to evolve our operating model to differentiate in the long term is a delicate one, especially when the strategic and financial commitments are to achieve record levels.

Our team is on track to deliver both.

Strategically, we remain committed to accelerating the commercial business through our wave rollout process, building world class capabilities including [poolable] sourcing and pricing, aggressively expanding our eCommerce platform for both B-to-C, and B-to-B, strengthening our distribution capabilities and providing the best in market availability through our hub expansion and custom mix rollout and igniting our promise, Service Is Our Best Part.

Financially we are on track to grow our commercial comp store sales by double digits for the fourth year in a row.

Our 240 basis point improvement in our operating income rate and 420 basis point improvement in our ROIC over the past 3 years reflects the strength of the industry but more directly, the systematic approach and determination of the Advance team.

Looking at the balance of the year, I am pleased with our start to the third quarter, yet I remain cautious for the reasons I mentioned earlier regarding the economic stress coupled with the record comparisons to last year.

That being said, my confidence in our team's ability to deliver on expectations through excellent customer service while controlling our costs are high.

Strategically, we will continue to prioritize service leadership through accelerating our commercial growth by investing in talented team members with a passion to serve and we expect to benefit from delivery and B-to-B capabilities that will allow us to fulfill our customers' needs with speed, reliability, and consistency.

Leading in service also means growing our DIY business, by insuring we have a foundational service and operational excellence at every store.

We are committed to igniting service with tools that increase customer engagement, team member productivity, while providing a great buying experience.

Additionally, we will continue to maintain our focus on providing superior availability.

Simply said, our goal is to be the best position to provide our customers the products they both need and want to complete their job.

This means continuing to invest in the appropriate breadth and depth of inventory and evolving our supply chain to manage demand effectively and efficiently.

Superior availability will continue to leverage our merchandise capabilities and extensive in market supply chain network to insure we have not only the quantity of products but the quality at the right store at the right time.

Our strategic and financial progress will not be linear or spreadsheet perfect.

The record results we achieved since 2008 and the winding road to get there remind us of that.

As such our focus remains on building on the momentum of the past 3 years and positioning our Company for long term sustainable growth and profitability while serving our customers better than anyone else.

Our record second quarter results are another positive step in the journey.

Before I close, I want to provide an extraordinary example of a team and a team member of Advance Auto Parts that represents Service Is Our Best Part.

The why customers choose Advance Auto Parts.

At the heart of service is great people, Advance team members.

Last month, I traveled to Princeton, Indiana to be with our team at Store 5004, which is lead by our Store Manager Eric Dunlop, and District Leader Ernie Lease.

My visit was one of the most difficult and inspiring days that I have had since joining Advance Auto Parts.

I was there for the services of Crystal McDuffy, a 23-year-old mobile parts pro that was lost in the line of duty on a routine delivery.

Words cannot describe the pain of her loss.

I met with customers, family, and team members.

I was inspired by the care, the joy, and the genuine life Crystal radiated to everyone she came in contact with.

Eric Dunlop and the greater team surrounded Crystal's family with support, care, and compassion.

Crystal and the Princeton team are a humble and meaningful reminder that service begins with extraordinary people.

Crystal, Eric, and Princeton, Indiana are an inspiring reminder that Service and Our People Are the Best Part.

Now, I'd like to turn the call over to Jim Wade, our President, to discuss our service leadership strategy.

Thank you, Darren, and good morning.

I'll start again by thanking and congratulating our team for the sales and profit results we are reporting this morning.

Their hard work in leading and inspiring our teams and serving their customers better than anyone else produced our improved results for the second quarter.

Our total comp store sales grew by 2.5% in the second quarter compared to 5.8% during the same quarter last year.

We saw an improvement in both our DIY and commercial sales trends over the first quarter.

Overall the comp increase was primarily due to an increase in average transaction size.

We saw a rebound in the Northeast and mid-Atlantic regions where we were impacted most by weather in the first quarter.

We're encouraged by these results and see many positive signs that we can continue to build on our momentum as we've gotten off to a solid start in the third quarter.

The overall market remains mixed but certainly remains positive over the longer term, with vehicle population continuous to age and will continue to age for many years to come, as a result of the slowdown of new vehicles coming into the market.

The unemployment rate and higher powered gas prices are currently challenging consumer spending and driving habits and causing consumers to again defer maintenance but that maintenance will eventually have to be done as it has in the past.

Our commercial sales returned to double digit comps in the second quarter after a very slight dip in the single digits in the first quarter.

This resumed our record of double digit comps 13 in the last 14 quarters in our Advance stores.

We continue to outperform the market and gain significant market share in this growing business.

Commercial represented 37.2% of our total sales in the second quarter.

We still see tremendous opportunities to grow commercial and to gain market share.

While we've seen some improvements in DIY, we still have opportunities despite the tough economic environment.

We've made changes that will both drive more customers to our stores and better serve them during the second half of the year.

In both DIY and commercial, our sales growth will be driven by our continued emphasis on operational and service excellence at every store and by the progress we made with greater parts availability while leveraging the investments we've made over the last several years along with selective investments going forward.

As a reminder our focus on operational and service excellence is aligned with our goal of serving our customers with dependable and fast service consistently in every store every day.

We believe this focus certainly is contributing to our sequential improvement in sales results.

Early in the year we increased the number of district leaders and sales force to enable them to spend more time serving our customers and coaching their teams.

This created some short-term disruption as both those teams experience changes in the stores they lead and the customers they served.

That change is now behind us and our team is building momentum.

We have shared with you over the last several quarters our work to continue to strengthen our store staffing model.

Our work has been focused on having the right people at the right time to align with the traffic patterns of both our DIY and commercial customers and we're seeing tremendous results from this work.

Through our focus on training and development to solve our customers' problems, we now have the most ASE Certified team members ever in our stores.

During the quarter we saw substantial increases in our measurements that tell us how well we're doing at having the right quantity and quality of staffing coverage each day of the week in each store and we reached new levels of productivity as well as achieved significant leverage in our labor investment over the last year.

With these improvements we're now investing in specific stores and markets where we see opportunities to accelerate our sales growth.

In regard to new store openings during the second quarter we opened 28 stores and closed 1 store.

Year-to-date we've opened 65 stores.

As of the end of our second quarter our total store count was 3,627 including 203 Auto Part International stores.

In closing I'd again like to thank our team as we serve our customers through our promise of Service Is Our Best Part.

Now I'd like to turn the call over to Kevin Freeland, our Chief Operating Officer to discuss out superior availability strategy.

Thanks, Jim and good morning.

I'd also like to thank the team for their hard work in the second 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 support our superior availability strategy.

Availability has been a key strategy for us over the past 3 years and is high on the list of what our customers tell us they expect of us.

Furthermore when we have the products our customers want at the store, our customer conversion rates are in excess of 90%; however when we have to pick up the product somewhere else, resulting in longer delivery times, this drops considerably.

Since Q1 of last year we've been aggressively working to forward our position in inventory in the failure and maintenance categories and position ourselves to meet the demands of the customer and lead the industry in availability.

As a result, we've worked aggressively to add to our number of hub stores which sits at 253 today including 14 that were open during second quarter and over 77 opened year-to-date.

We've also greatly increased the number of inventory upgrades at store level in order to maximize our storage capacity.

During the second quarter we upgraded inventory at 266 stores and 652 year-to-date.

In addition to our efforts to increase the quantity of product availability for our customers since 2008, we have been working aggressively to insure we have the right brands, quality of parts, and the right assortment in the right store.

The quality of our offerings has never been better.

Our inventory position increased since second quarter of last year and we ended the second quarter of fiscal 2011 up 15.1%, down from 21.3% increase of inventory in Q1.

Our in stock levels were up 130 basis points over last year setting a record high.

As confirmation of the effectiveness of these investments in an independent industry survey placed Advance at the Number 1 position for product availability.

We believe we can continue to lead in availability with less overall inventory.

We anticipate ending the year with inventory levels in the low double digits above last year and to end Q1 of next year with inventory levels below Q1 of this year.

Despite the rapid growth in inventory, our owned inventory per store decreased 1% due to our work to increase our Accounts Payable to inventory ratio which now stands at 75.1%, up roughly 300 basis points from the second quarter of 2010.

We continue to make great strides in our efforts to expand this program by working strategically with our vendor partners to form strong and mutually beneficial partnerships.

The combination of rapid expansion of this program and the deceleration of our inventory growth should lead to further reductions in our owned inventory in the quarters ahead.

Turning to gross profit, our margins declined 72 basis points to an overall rate of 49.7%.

This decline was driven by several factors.

The first factor was that our strong shrink performance of the last 2 years reversed.

Jim and his team have been working diligently to prioritize the processes to insure we get back to our strong levels of asset protection.

Additionally, our supply chain costs continue to be a headwind as a result of increased fuel prices and increased hub deliveries.

We were also negatively affected by inflationary pressures during the quarter, combined with an elevated level of price competition in the marketplace.

A confirmation of the wisdom of our aggressive price action was an independent industry survey placing Advance in the lead in the perception of DIY prices.

Partially offsetting these headwinds were a continued improvement in the DC productivity and continued benefits from our merchandising and pricing capabilities.

For the balance of the year, we continued to expect our gross profit rate to be constrained driven by increased supply chain expenses relative to higher fuel costs and hub investments.

Additionally, shrink will be a headwind as we work aggressively to get back to our previous levels of performance.

Finally, we will balance our price changes in response to high commodity price inflation while maintaining our unwavering commitment to be competitive in the eyes of our consumer.

Our B-to-C and B-to-B eCommerce platforms continue to perform above our expectations.

In the quarter we launched our new Business-to-Business platform which now sits on the same platform as our Business-to-Consumer side.

Our B-to-B customers have given us very positive feedback on the enhanced selection, content, navigation, search and site performance.

Sales growth improved markedly post-launch.

We continue to be pleased with the strategic progress we made and remain focused on strengthening our ability to serve our customers better than anyone else while continuing to improve our productivity.

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 and dedicated team members for their contributions to the financial outcomes we delivered during our second quarter of 2011.

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

1 - provide some financial highlights from our second quarter of 2011; 2 - put our second quarter results into context with the key financial dimensions that we use to measure our performance; and 3 - share with you what we see for the remainder of 2011 and beyond.

During the second quarter our revenue increased 4.4% driven by 130 net new stores over the past 12 months and a comparable store sales increase of 2.5% which was on top of a 5.8% comp sales increase last year.

Our second quarter also marks our 13 out of the last 14 quarters of double digit commercial comp sales growth in our Advance stores.

Auto Part International also delivered a solid second quarter.

As Kevin mentioned our gross profit rate in the second quarter was 49.7% versus 50.4% in the second quarter last year or a decrease of 72 basis points.

The decline versus prior year was driven by increased shrink as a result of short-term execution and operational challenges in managing our accelerated pace to lead in inventory availability, increased supply chain expenses due to investments in hubs and higher fuel costs, inflation this year compared to last year, and the increased mix of commercial.

The margin decrease was partially offset by our continued improvements in merchandising and pricing capabilities.

Year-to-date, our gross profit rate increased 10 basis points to 50.2%.

While we expected a gross profit rate decline during the second quarter, the decrease was slightly larger than we expected due to the higher shrink.

We have developed a very strong track record of managing shrink over the past few years and we have confidence that we will get this back in line over the next few quarters.

Turning to our cost structure.

Our SG&A rate was 37% during the second quarter versus 38.3% during the second quarter of 2010.

This 138 basis point decrease was primarily due to the reduced incentive comp as a result of a lower comp store sales growth, benefits from our new variable customer driven labor model which includes the anniversary of investment rollout expenses, as well as a significant decrease in support costs from our operating model work.

Partially offsetting this were increased investments in areas such as commercial, eCommerce, global sourcing, and store systems.

I will share more on both gross profit and SG&A expenses later in my remarks.

All in, our operating income grew 10.1% over our OI rate -- sorry and our OI rate increased 66 basis points to 12.8% on top of 121 basis point improvement last year.

Our diluted EPS increased 26% to $1.46 versus $1.16 last year.

Year-to-date our diluted EPS is up 19.2% on top of last year's 21.9% comparable EPS increase.

Free cash flow through the second quarter was $287.3 million versus $407.6 million last year.

The decrease in free cash flow was driven primarily by the change in owned inventory this year-to-date versus last year and higher capital expenditures.

Our Accounts Payable to inventory ratio increased 300 basis points to 75.1% as of the second quarter of 2011 from 72.1% versus the same period last year as part of our continued efforts to reduce our net owned inventory.

During our second quarter, we repurchased 4 million shares of our stock for $239.7 million at an average price of $60.31 per share.

Through the second quarter we have repurchased approximately 8.2 million shares of stock at a cost of $509.7 million or an average price of $62.07 per share.

These repurchases reflect our view of our valuation and our internal confidence in our Company's ability to grow profitability and to create long term shareholder value.

As we stated in our press release, the Company's Board of Directors authorized a new $300 million share repurchase program.

This new authorization replaces the Company's $500 million share repurchase program authorized in February 2011 which had $112 million remaining.

Strategically, we continue to position the Company for growth and improved profitability.

Our performance in our second quarter and over the past 3 years shows we are on the right path and reinforces our commitment to accelerate growth, improve profitability, and drive shareholder value.

We continue to measure our performance based on these 3 dimensions.

Our commitment to growing our business is reflected by another quarter of double digit commercial comparable store sales growth.

Our commercial sales per program have grown to $618,000 and over the past 3 years has grown from $425,000 which represents a 45% increase.

Our ability to grow profitability is marked by a 66 basis point improvement in our second quarter operating income rate to 12.8%.

Over the past 3 years, we have seen our operating income rate continue to improve and we remain committed to increasing this to 12% over the next few years.

We have also seen our earnings per share grow over 20% compounded annual growth rate over the past 3 years.

Turning to shareholder value.

We continue to maintain our disciplined approach to capital as reflected in our return on invested capital which is now at 18.5% or 200 basis points over the second quarter last year and represents a 420 basis point improvement over the past 3 years.

We are also pleased with our 75.1% AP ratio and continue to see opportunities to improve our AP ratio to reduce our owned inventory.

Our owned inventory progress is allowing us to lead the industry in inventory per store at $577,000 which is a deliberate part of our superior availability strategy.

We are also pleased with the progress we made reducing our inventory growth to 15.1% in Q2 over the prior year from the 21.3% growth from Q1.

Our availability and quality of our inventory have never been better and it positions us well to meet our customers' expectations.

Looking forward, our improvement from our first quarter, the favorable industry dynamics and our internal momentum give us confidence in our ability to continue to grow and improve our profitability.

As Darren highlighted, in our press release we are encouraged by our solid start to our third quarter.

While our comparisons are more challenging in the second half of 2011, we believe that the investments that we have made in areas such as commercial, advertising, supply chain, eCommerce, and global sourcing combined with the investments we will make during the second half positions us to deliver on our annual 2011 EPS outlook.

We continue to make progress on our goal to achieve 12% operating margins over the next 2 to 3 years.

With a large portion of our capabilities built and the growth momentum we have in areas like commercial, we are confident in our ability to get there.

Over those 2 to 3 years, we expect the drivers to get to 12% will primarily come through a more competitive cost structure and modest gross profit expansion from where we are today.

As we look out from a gross profit perspective, we are delighted by the significant improvements we've made in our gross profit rate over the past 3 years and believe that the structural drivers from areas such as global sourcing, future supply chain efficiencies, availability and merchandising capabilities remain intact and have a modest upside potential longer term.

These structural drivers will help offset the continued accelerated growth of our commercial business as well as inflationary and competitive pressures.

That said, in the near term, we continue to expect our gross profit rate will be constrained for the balance of the year driven by supply chain deleverage as a result of the increased investments due to the addition of over 80 hub stores versus last year and higher fuel prices.

Additionally, the timing of price changes will also constrain our gross profit rate as we respond to increased inflationary pressures while balancing our competitiveness.

We also see headwinds related to shrink as we refocus our efforts to regain our discipline and processes with respect to our availability initiatives in the short-term.

Previously we have said that our gross profit would show a modest increase in 2011.

Given the headwinds, we now expect our full year gross profit rate to decline modestly in 2011.

Turning to our cost structure.

We previously shared that we began the work in 2010 to identify opportunities within our operating model to build a more efficient, sustainable and cost competitive structure to deliver our service model.

This work identified a number of opportunities for productivity enhancements, reduced variability across our store performance and reductions in support costs furthest away from the customer.

As you can see in our second quarter results, we started to see progress from our operating model work such as increased productivity from areas such as labor and our commercial programs, reduced variability in store cost outliers and decreased support and discretionary expenses that are furthest away from the customer in areas such as consulting fees, travel and supplies.

We are very pleased with the momentum we are building around a more competitive cost structure and continue to be on track to deliver our flat to 2% SG&A per store growth outlook for fiscal 2011.

Most importantly, and included in our operating model work is taking out costs furthest away from the customer that we can continue to invest in customer facing areas such as commercial, eCommerce, and reinvigorating our DIY business.

We will continue to make investments in these areas to grow our business including back half investments in areas such as commercial.

These back half investments are included in our SG&A per store outlook.

In closing, we remain confident, focused and committed to growing our business by delivering on our service promise and improving our profit model, and our second quarter results show we are on the right path.

We also could not be more proud of our talented team members for the results they delivered in our second quarter and who continue to propel us towards our full potential.

Operator?

We are now ready for questions.

(Operator Instructions) Dan Wewer, Raymond James.

So in the first quarter when same-store sales were up 1.5%, you had noted they probably should have been up around 5% but the shortfall was probably evenly split between weather challenges on the East Coast as well as some of the Company specific disruptions.

So we've increased sequentially about 1 percentage point from the first quarter.

Do you think that was primarily the reversal and the weather challenges and that perhaps the disruptions from change in the coverage of your District Manager responsibilities probably had less of a negative impact than you thought?

Yes, Dan.

I think the majority of it to be honest is our teams settling into their new roles and the DLs.

We knew we wouldn't solve it in a quarter.

And when we look at regionality, and in the first quarter we said regionality was about a 1.5 points of the outcome.

When we look at regionality this year, maybe a simple way to think about it is that 90% of our stores are East of the Mississippi, 10% of our stores are West of the Mississippi.

When we look at the industry data, the industry in total, what we can see is if you take DIY East of the Mississippi, the industry versus West of the Mississippi the industry, the East lagged the West by roughly 250 basis points in DIY.

So what we're still seeing and that's just -- you say you can't change who your parents are and you can't change the fact that 90% of our stores are East of the Mississippi and we're still seeing some of that regionality impact in terms of the concentration of our stores.

Now in the commercial business, it's same-same.

There's very little difference East of the Mississippi or West of the Mississippi and as we said in our prepared remarks what we can see is the commercial business as an industry remains very strong.

The DIY business has slowed and it has slowed particularly East of the Mississippi relative to West of the Mississippi.

So if you map it out, we still have a drag in our overall numbers as a result of some of that regionally, but what we are seeing and that's part of our comments in terms certainly as we come into the third quarter as the teams are settling into their jobs, as the commercial CAMs which I think were up 50 year-to-date versus a year ago, they settle into those relationships that's helped propel commercial growth and certainly has helped with our DL structure, allow us more time in stores to work with our teams.

Okay, and then just as a follow-up for Kevin, on your payables to inventory rate, it increased modestly year-over-year about 3 percentage points.

In past meetings you talked about eventually taking your payables to 100% of inventories.

What will be needed to accelerate at the pace of that improvement?

Is it just simply slowing the race of your gross inventory investment?

Two things.

You're correct.

Essentially the net number is we have days of supply of inventory and days of payables and essentially what we had in this quarter was that the rise in debt payable days was being constrained by a 15% increase in overall inventory which is increasing the days of total inventory.

As we roll forward, that delta year-over-year in days of inventory will moderate by the end of the year and quite frankly reverse as you get into first quarter.

Additionally we are improving programs, vendor by vendor, week by week as we move forward and I think those numbers most notably as you get out of the first quarter of next year will reflect a sizeable and nice improvement in the AP ratio.

Gary Balter, Credit Suisse.

Thank you it's Gary and Simeon.

I'll start and Simeon will ask a follow-up.

First of all, nice quarter Darren.

The question that we get a lot and maybe you can address it on the call is your comps were better but they're still running a little bit behind the competitors and one of the concerns seems to be that in all this labor shuffling that you've done with some of the new programs that perhaps you've actually pulled out too much labor from the stores and that's having an impact especially in the DIY business.

Could you address that?

Yes, Gary, I can.

So we went through the quarter this year -- Well actually the beginning of the year, we have been executing on a plan that we actually developed last year.

So last year we went through a holistic review of our cost structure and it's no secret you can just do the SG&A per store and you can see that our SG&A per store is higher but I'll remind everyone our sales at the end of this quarter per store was about $1.7 million on a trailing 12 basis, so near at the top of the industry too.

As we looked across the cost structure and even the SG&A leverage we saw this quarter, a big chunk of that came out of support center cost, professional fees and a lot of the great work they did last year to identify where we can make those cost cuts.

And we made some edits in terms of our store operating model and the truth is, is that over time, whether we had a $5 million store or whether we had a $1.2 million store we had similar Management structures and it was a hard decision but we edited it out and I would say more appropriately sized those Management structures for the volumes of those stores.

What we didn't do is then double back and cut the hours and so what we do is store by store, we do a build up in terms of the hours per store based on the transactions that they do.

What we did do is variablize some of the cost structure across our store operating model and that's part of what sits in the numbers.

Did we edit some hours and store operations and AGMs and did we probably lose a little bit of sales on the top line because of it?

I'm certain we lost some.

Overall these are not easy processes but ultimately, the way we think about it looking out, we continue to invest in our labor capabilities in terms of our own internal language of CDL trying to make sure that we're putting the hours to the right stores at the right time in terms of transaction and activity.

We'll take another step as we go into next year in terms of tools for that labor model but this is part of that process where ultimately, we edited in 1 place as I say to the teams, we reinvested in other places like the growth of a 20% of our DL ranks in training and development, 50% or a 50 person increase in our CAMs and also adding to our NPPs and as we look to the back half of the year, we will continue to do our commercial wave process which is adding hours back to our stores and locations where we see commercial demands, so it's not as easy as I said.

We can't make it spreadsheet perfect but what our ultimate goal is that we need to continue to evolve our operating model consistent with the strategic direction of our Company.

The follow-up for Mike, if it's okay?

The gross margin and SG&A, thanks for the color for the back half of the year.

Maybe can you get a little bit more granular and help us think about the progression, on shrink does that mean you have to take a couple steps back to make additional progress or should we see the gross margin contraction moderate sequentially and then how should we think about the SG&A dollar growth?

Does it stay sub 1% for the rest of the year?

I'll take you up.

Maybe I'll talk about gross profit first.

So what we said for the back half, well what we said for the year is that we now expect for it to be down versus what we said before for the year it was modestly up and the drivers of that is we have deliberately and we said at the beginning of the year, are re-architecting our supply chain.

That is the largest driver and the great news is in the out years that's going to give us great efficiency.

That's why we're doing it but in these years when we're investing so that's a big driver.

The other driver will be inflation, some level of inflation and that's made up of fuel costs and then commodity pricing and Charles can talk a little bit about that and that's volatile.

In this uncertain environment right now we've been watching those things move around, so there's some volatility there.

So with that, it becomes harder to predict and then shrink, and that was over the last couple years and we said in our remarks that we're extremely proud of our progress we've made in shrink and we believe we lead the industry in terms of our shrink performance.

That said we set some high expectations and we fell a little bit short.

We got a little bit away from our execution and operational practices and the good news is that's something we're in full control of but that will take us a little bit, so that will be a little bit of a headwind.

So the way I would think about overall gross profit to the balance of the year is if we're traveling currently up 10 basis points on a year-to-date basis, we anticipate on being down so probably you'd expect to see this -- similar kinds of declines that we saw in the second quarter and again, that's not predicting.

I'm just saying it's going to be closer to what you saw in Q2 than when you saw it in Q1 in terms of a decline.

And then in terms of SG&A, we're extremely proud of the progress we made, Darren talked a little bit about that we started the work last year on our Op model work and really it's premised on the fact of growth and if you remember in the first 3 years we talked about we were spending dollars and the other side of the entry as we were building capabilities and you were watching our growth and you were watching our margin expand.

I'd say the similar thing is we're taking costs furthest away from the customer, things like discretionary expenses and professional services, travel, things that the customer doesn't value.

That's enabling us to put those dollars back into the growth parts of our business and Darren talked about it commercial, eServices, global sourcing.

So we anticipate that, that trajectory that we saw in Q2 is going to continue to the back half of the year.

And as Darren said, we expect to continue to see productivity on things like our labor.

Another stat is our commercial programs are the dollars that we pull out of each commercial program, the productivity improved.

I think we're at $618,000 per store.

We're 11% more productive than last year and 45% more productive on a three year basis so as we get more productive, as we take out costs furthest away from the customer, we anticipate that our SG&A will continue to grow at a slower rate and I think I said it in my remarks, I'm not going to give you a number but we feel comfortable that we're still going to hit the flat to 2% SG&A growth for the year.

Greg Melich, ISI Group.

Just to follow-up on the SG&A improvement in how they layer in an execution, both of you I think, talked about the portion that's in the support center and the headquarters versus the stores.

Where are you now in terms of executing on taking those costs out both at the store level and at the headquarters?

Are we 100% done now, it flows through?

Are we 60% done or did the second quarter because of timing actually have a little bit more improvement than you thought because it sounds like you made a lot of gains in the second quarter but with SG&A still flat to up 2% per store, that you expect that actually to pick up a little bit for the rest of the year?

Yes, so Greg, I think the way, I don't know if that work will ever be over for us.

We're always going to look to build a competitive business model.

I would say we're in the early innings and what -- the early innings may mean that you're going to take the costs out furthest away from the customer, that may not last as long.

Actually getting costs out of things that are less productive and moving them into more productive I think that will go on for a foreseeable period of time but we did the work last year.

We don't provide anything beyond this year and we're comfortable with the outlook that we've shared with you previously, but we see over the last couple of years we've built up our costs, we have the highest costs in the industry and I think that our goal is to make sure those costs are as productive as they can be and I think the work is continuing to make sure that we take the unproductive costs out so I still think we're in the early innings of that work.

Yes Mike, you would also say -- Hi Greg, this is Darren.

I don't see us being the cost leader in the industry.

I agree with Mike that there's perpetual work and there's more work in the near term for sure to continue to work on that cost structure and like our margin story that didn't unfold in a year, I think it will unfold over the next several years in terms of striking that right balance between productivity and growth and service levels.

So we see an opportunity in many of our stores right now to be honest that there's still investments to make because the service levels and growth opportunities are still high that's why.

And principally they will sit in wave stores but they also sit in other markets.

The other example I would give that might not be as clear is that in our supply chain today, we talk about the headwinds that we're facing from investments.

We've had headwinds in supply chain for the 3 years that the team has been running that and we've been able to offset those headwinds with gains from those capabilities.

We have probably our largest single investment in CapEx happening right now in our supply chain that's pointed us towards a much more efficient cost efficient model that isn't going to land in our P&L this year.

We'll start to see glimpses of it probably 1 year to 1.5 years out but these things take time in terms of the changing things structurally versus just changing things on a temporary basis.

So there is still pieces out there in terms of the long term cost structure that will show up in the margin that our headwinds today for sure benefits tomorrow as we look out over the horizon.

And in our SG&A structure, just found if you do it 10% across-the-board that's not the right way to approach it so systematically approaching it and doing it at a pace where you're both able to insure growth service levels and productivity is the path that we're on.

If I could follow-up quickly on the buyback pace, you did over $600 million last year, the business appears to at least generate $400 million plus of free cash flow if you're getting the working capital improvement.

I know that turns it around a little bit this year, but I assume that the back half will continue to have a slower pace just given that seasonally is not when you get as much cash coming in the door or how are you thinking about it?

Is it just managing to that 2.5 times debt to EBITDAR?

Yes, I mean, I think you start there.

We're committed to keeping within our investment grade and making sure we maintain on our leverage ratio and we said it in our remarks.

We trade at a significant discount and the other side of that entry is this Management team has a very large confidence in our team members and in our ability to continue to create value and we never comment on what we're going to buy going forward but we won't hesitate to continue to buy back our stock and at the end of the day, that's always the last thing we think about.

We've piled a lot of dollars into this business and built up capabilities and you've seen it in our growth and you've seen it in our margin expansion and if there are opportunities to put dollars into continue to grow our business that's what we look for first and then our buyback is kind of how we think about it what's kind of left.

We typically don't comment, Greg but we bought back about 10% of our sales again this year on top of the 13.6% we bought back last year and we're pleased that we're getting it and we're a little perplexed on our value to be honest with you.

Matthew Fassler, Goldman Sachs.

My first question relates to pricing.

You intimated that you had made some adjustments over the course of the quarter and that there are lots of moving pieces as it related to input costs and also to competitive dynamics.

If you could give us a sense as to the nature of those adjustments, were they on commodity items, or were they up and down the mix of the business and what kind of impact you think they had to your top line and to your margin rate?

Yes, Matt, this is Kevin.

We've seen a pretty significant dose of inflation come through and it's gone through our entire industry.

It's anchored on commodities so it's products like what sits underneath our products like lead, steel, oil, and has generally lead to price inflation at retail.

That said, there has also been competitive pressure across the industry as the entire industry is seeing those increases at a time when the pace of growth of the industry is more modest than it was last year.

Those conspired to put pressure on us and we have excellent systems to know what the competitive and prevailing price of products are in the marketplace, so we stayed with a strategy that we've been on for many years of maintaining our competitiveness and essentially got impacted in the squeeze.

I do not know inflationary impacts as we go forward.

Obviously there's an awful lot going on in the world these days that would suggest uncertainty but what I can tell you is the way that we approach things which is we are going to maintain our competitive position in pricing and maintain the programs that we have through global sourcing and price optimization to maintain the margins as high as we can.

Great, and my second question relates to inventory.

As you exited the first quarter inventory was up a good deal.

You sounded somewhat dissatisfied at the time of the levels of those inventory and a bit concerned with the consequences of those levels for margin going forward.

As we're a quarter further in you seem more contented with inventory levels so if you could just talk to us how the inventory increased relative to sales relates to some of the programs you spoke about, be it in stock, the parts availability and others and whether in fact there has been or will be any consequences to margin from the overage that you had a quarter ago.

Yes, a couple things.

One, we overshot the runway in first quarter beyond our own expectations and had undershot the runway the year before, so we were if you went back a full year ago we had a great first quarter and ended the quarter lower in inventory than our desire and we made the opposite correction and adjustment this past year.

Those investments are in our Part business.

It's a reflection of inventory upgrades, hub expansions, and quite frankly, additional inventory in safety stock beyond what we'd perceived was needed.

We're pleased to say that the things that we look at which is the customer perception of availability are high and competitively in a wonderful place.

If we look at in stocks, they have never been higher.

That said, we don't believe that it was necessary to have that significant increase in inventory to maintain those positions and that became true at the end of this quarter.

We're not up 21%.

We're up 15% and yet we're hitting all of the numbers that we aspire to hit and those numbers will be on their way down in the quarters ahead as we maintain the goal which is product availability for our customer with the most prudent investment of inventory that we can have, so I think you'll see that moderate for the next several quarters.

And consequences for gross is, I think you had alluded to some perhaps last quarter, did that pan out?

I'm sorry say that again?

Consequences to gross margin rate as you work through that be it for mark downs which I wouldn't imagine would be a big deal or leverage of any kind of fixed costs over the inventory base?

Yes, we model out the sale of our products over long periods of time and basically, as the fleet of cars hit the road, they begin to fail as the out years occur, it builds to a peak and then moderates down but it occurs over about a 10 year horizon, so unlike a business that would be apparel or high technology products, the rate of obsolescence is very, very slow in our industry.

So generally this was not a risk to margins or a risk of obsolescence, it was more of a getting ahead of ourselves in availability and we are selling off that inventory and getting back to a more preferred position over a period of several quarters.

Kate McShane, Citi Investment Research.

If I could just follow-up on the last question.

How much success did you have during the quarter in passing some of these higher prices through, and are you trying to pass through 100% of the cost increases that you're seeing and in regards to the price competition what are the categories where you're seeing the most pressure?

Yes, essentially our ability to pass the price increases through is generally good in this industry.

This is not a highly price sensitive industry and it has been, the majority of the inflation that we've seen then ends up reflecting in the prices that we charge.

That said, I would say that as is obvious, the increases in prices that we're getting caused by inflation are happening at a higher rate at this point than we're successfully able to pass them on through.

If you stand back and look at it over time, time is on our side, and generally, the true cost of the products ultimately is reflected at retail and I think this has more to do with a quarter to quarter impact more so than a long term structural issue.

It is also uncertain at this point with just the global economy what the underlying prices for steel, lead and oil will be so that is not something I'm skilled at predicting at this point.

In terms of the specific categories, where the inflation is coming in as products would have a lot of lead, a lot of steel and a lot of oil, but we don't give specific category breakdowns of what we're seeing in terms of pricing.

Okay, great and then my second question is on the eCommerce business.

Since it's still somewhat a recent event since you re-launched your site.

Are there any significant investments that you have left that's contributing to your SG&A spend for this year?

I think the investment profile that we have in the eCommerce business is likely to be similar ahead of us as it has been behind us.

We are very early in that cycle.

The growth rates that we're seeing are -- we're delighted with and are unusually high.

Some of that is playing catch up for competitors that put eCommerce businesses out years ahead of us but I don't see that as a factor in a growth of SG&A.

It's more of a consistent investment profile in the quarters ahead.

Tony Cristello, BB&T Capital Markets.

I guess what I wanted to dig a little bit more into was the cost side of things.

You talked about the 138 basis points of expense savings or leverage.

I was wondering if you could maybe quantify a little bit the variable component versus the incentive comp versus what your anniversarying and what we should think about sticks versus what may have to come back to drive sales in what's a much more challenging comp environment for the second half of the year?

So Tony, I'm not going to break out the basis points for you, but I'll tell you there were 3 areas that we talked about.

The first one is our incentive comp programs and here is the thing.

We design our incentive compensation programs for growth and this year we grew at 4.4%, last year we grew at 7.2% so you would expect that there are incentive comps across our business including at our SSC were lower than last year so we were able to leverage that in the quarter.

If you ask me, do I hope we leverage that looking forward?

The answer is no, because we want to grow and that's why we designed those programs is to grow.

And then the other components in terms of productivity that we're going to see from our programs previous investments we've made like in commercial.

I talked to you about the productivity we're seeing and the sales per program, we would expect that to continue.

We've made great investments and our teams continue to deliver and bring on new customers and grow our commercial programs and I think Darren said it in his script, this will be our fourth consecutive year of double digit commercial growth.

So we would expect to continue to see more productivity.

I think the biggest owner is building a more cost competitive structure and taking costs out of our business that aren't productive, and I think that's where we're going to see the most amount of progress and we started to see that.

That was a piece of our SG&A leverage.

I don't anticipate we're going to take out 138 basis points every quarter but I would anticipate the largest portion is going to be coming from taking costs that don't matter to our customers and that are not yielding us a good return, so Kevin talked about this a little bit.

When we put dollars into eCommerce we get a good return.

When we put dollars into global sourcing we get a good return and probably our greatest return comes when we put dollars into commercial.

So the whole idea is actually taking dollars out of the non-productive parts of our cost structure and putting them into those areas I talked about, so that's kind of how we're thinking about it and Darren said it and I'll reinforce it is this is going to be a multi-year journey, but we feel pleased with the progress we're making and I couldn't be more proud and I want to say this, with our team.

These ideas aren't coming from the top of house.

These ideas are coming from our 52,000 team members that are giving us ideas on where we can take costs out and moving them into areas that they can help us be more productive.

So I think in the quarter we had 700 ideas that came in through our team members.

So that's not lost on our leadership team, but it's our actual, our team members that are leading this work.

Great, that's helpful and maybe if I could just have 1 follow-up on the shrink and the gross margin.

It seemed like you were doing extremely well and then maybe something happened that you took your eye off the ball whether it's the increased inventory, whether it's some of the shifting going on at the DIY level.

I'm assuming the shrink component was more driven on the front of the store but perhaps maybe that's not the case.

Could you just give a little bit more color on what transpired and what you now have done to sort of fix that problem?

Yes.

So I'm going to go back to what we said.

We're extremely proud of the progress we've made.

In fact, we haven't changed any of our practices, we still do full physicals.

So a lot of our process is how we measure shrink haven't changed at all and I think you named a few of them.

We have a little bit more inventory, we're actually doing some tweaks to our operating model.

I would call those, we not going to use those as excuses.

We're extremely proud of the capability we've built up in our team and it's not 1 person or 2 people, it's our entire field team and our store support teams that have worked in collaboration to actually get to that outcome.

I think what happened is we have a lot of stuff going on and it's like any other business and sometimes when you take your eye off something the results can wander a little bit and that's what's happened.

What we said is we are going to get back to operations, we're going to get back to execution and the good news is this is within our control.

The challenge is, it's not an on/off switch so that's why we said it's going to be over the next few quarters

That's very helpful.

Thanks for your time.

Thank you.

That's all the time we have for questions.

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

Thank you, Wendy, and thanks to our audience for participating in our second quarter earnings conference call.

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

Reporters, please contact Shelley Whittaker at 540-561-8452 and that concludes our call.

Thank you.

Thank you.

That concludes our call today.

You may now disconnect.

Thank you for joining us.