領先汽車配件 (AAP) 2012 Q2 法說會逐字稿

Welcome to the Advance Auto Parts second-quarter 2012 conference call.

Today's conference is being recorded.

If you have any objections, please disconnect at this time.

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 and 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 December 31, 2011, on file with the Securities and Exchange Commission.

The Company intends these forward-looking statements to speak only at the time of this conference call and does not undertake to update or revise them as more information becomes available.

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 third-quarter earnings release is scheduled for November 8, 2012 before market open.

And our quarterly conference call is scheduled for the morning of Thursday, November 8, 2012.

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 President and Chief Executive Officer.

Darren?

Thanks, Joshua.

Good morning, everyone.

Thanks for joining us and welcome to our second-quarter conference call.

Before I begin, I'd like to thank our 54,000 team members for their hard work and diligence as they navigated us through a challenging quarter.

As you have seen in our earnings release this morning, our second fiscal quarter reflected a near-term slowdown within the industry and in our results.

Today I thought it would be helpful to provide some context and perspective on the drivers of the slowdown.

As we anticipated, our second quarter faced weak consumer demand in both DIY and commercial.

With significant slowdown in our cold-weather markets principally located within the Northeast and Great Lakes regions of the US.

From a consumer perspective, gas prices continued to weigh on demand.

The average gas price increased nearly $0.10 a gallon over the first quarter of this year.

The good news is, the current outlook is for gas to be lower the rest of the year.

The macro environment continues to be stressed with high unemployment and low consumer confidence, which has constrained consumer spending.

This was evident across retail and reflective of our business as consumers were only willing to spend the absolute minimum amount on failure-related parts, and were willing to defer maintenance purchases.

This slowdown in both failure and maintenance spending impacted both DIY and commercial and led to a deceleration in sales growth versus the first quarter.

The principal driver in the deceleration was a sequential quarter-to-quarter decline in the average ticket, while our transaction growth was down modestly.

In the non cold-weather markets, we saw transaction growth from Q1 to Q2 accelerate in the low single-digits.

The overall Company transaction growth in commercial still remained positive in the low single-digits from a comparable store perspective.

The average ticket decline reflects a combination of mix of products sold and our pricing position in the second quarter.

The industry is experiencing the impact of lower inflation in some key seasonal categories like air-conditioning and the absence of escalating oil prices and the impact on the oil change special programs.

In addition, there are pockets where the consumer is trading down in select categories in pursuit of savings.

Finally, while price promotions are not having an immediate positive impact on the top line, we believe it will positively contribute to our growth in the future.

From a geographical perspective, we saw different results throughout the regions of the Company, with the greatest deceleration in our cold-weather markets, again, especially in the Northeast and the Great Lakes regions.

Our performance in those two markets is reflective of the milder weather conditions during the first quarter, which impacted hard parts and pulled the business forward from the second quarter.

Our comparable store sales declined mid single-digits in these regions of the country, including our Autopart International stores within those geographies.

Conversely, we saw acceleration from the first quarter to the second quarter in our stores located in the western half of the US.

Our comparable store sales continue to grow positively and were up low single digits in our western geographies, where only 10% of our stores are located, as they continue to be less impacted by severe fluctuations in weather.

As a result of the declining ticket and lower DIY transaction counts, our comp store sales decreased 2.7% which was at the low end of our outlook for the quarter.

Additionally, our operating income decreased $19.7 million to $169.2 million in the quarter.

This was in line with our outlook for the quarter.

Despite achieving our previously-shared range of outcomes, we are not satisfied with our performance during the quarter.

Yet, we remain encouraged by the fundamentals of our industry, and have specific action plans to improve our performance for the balance of the year.

As such, we continue to focus on growing commercial and competing for the right to serve our customers.

The last few years have been focused on gaining a level of fundamental or basic competitiveness by implementing the table stakes of the commercial business.

Which simply meant investing in the industry's best parts pros, sales team, delivery trucks and parts availability.

We continue to focus our efforts in those areas but realize the next level will require us to move from being fundamentally better to providing our customers with even greater levels of reliable service, increased delivery speed and superior availability.

As a result, we continue to move forward with the insourcing of our commercial credit function, the opening of our new DC with daily replenishment capabilities, rolling out our B2B e-commerce platforms, electronic parts catalog, and diagnostic tools for our commercial customers.

These key initiatives will fuel our growth over the next several years and allow us to aggressively grow in commercial.

Our field and sales teams are more focused than ever at running the business with excellence.

Kevin will provide you with an update on our progress in the opening of our DC and other operations update.

As we start our third quarter, and look to the back half of the year, we continue to anticipate sluggish consumer demand and choppiness in our business performance.

I want to stress we view this as a moment of uneveness versus a longer-term downward trend in the industry or our performance.

In the upcoming quarter, and possibly for the balance of the year, we anticipate we will continue to see lower transaction counts driven by DIY.

Partially offset by slight improvements in our average ticket.

However, in the second half of the year we will continue to roll out our new commercial program.

And make investments and focus our efforts in the following areas.

Improving our availability through the addition of new and converted Hub stores and inventory upgrades.

These availability investments will translate into roughly $60 million of increased parts inventory.

We are increasing our traffic driving advertising to stem the decline in transactions and increase the number of customers that visit our stores.

We continue to grow our commercial sales force and anticipate growing our team by roughly 5%.

And finally, we will continue to maximize our in-store labor to meet our customers' needs and provide superior customer service.

We expect but cannot guarantee that the hot summer and more normalized winter weather will provide a lift as we enter the back half of the year.

However, we remain cautious with our outlook as our current trend suggests that our comp store sales will be constrained.

This view of our business is reflected in the outlook Mike will share a little later.

Internally, we are working with a sense of urgency and taking steps to drive a better outcome than our trend suggests.

Our efforts and our focus remain on generating positive comps for the balance of the year.

In closing, I want to share a story of how team members Alex Moore and Chris Webb recently showed what living our values looks like.

Alex, from our store in Christiansburg, Virginia stayed well after closing one night to help a family who was stranded while driving from Connecticut to Florida.

Their alternator and radiator had failed and their car battery was dead.

Chris, an instructional designer on our training team at the support center, who was passing by at 10.30 at night on his way home, saw the car in the parking lot and stopped to offer his help.

Alex and Chris stayed well after midnight, helping our customers get back on the road again in their time of need.

I would like to recognize and thank Alex and Chris for their compassion and their focus on service for the decisions they made to help create an Advance customer for life.

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

Kevin?

Thanks, Darren, and good morning.

I'd also like to thank the team for their hard work during the second quarter.

I'll provide updates on the work that occurred during the quarter.

As well as update you on our initiatives to support our superior availability strategy and new store growth.

As Darren mentioned, our soft performance during the quarter does not overshadow the long-term fundamentals of both our business and industry.

Our focus on increasing breadth and depth of our in-market product assortment and availability remains, and will continue to aggressively move forward with the availability initiatives we laid out at the beginning of the year.

Those initiatives include the expansion of our Hub network; the continuous upgrade of our parts inventory at our non-Hub stores; the opening of our new DC; and the continued growth and roll-out of our B2C and B2B e-commerce platforms, commercial diagnostic tool and our electronic product catalog.

Hub's inventory upgrades continue to be a vital component to our availability strategy, as it allows us to provide superior end market parts availability.

Due to the aging fleet of vehicles, both maintenance and failure parts have increased in order of importance for our DIY and commercial customers.

We continue to expect the demand for these products to increase as the average age of vehicles increase despite the current slowdown in demand due to unseasonably warm weather.

As a result, we continue to increase the number of Hubs through new store expansion and upgrade of existing stores, which have the space and are strategically positioned to operate as a Hub.

At the end of our second quarter our total Hub count was 320 versus 288 in the second quarter of last year.

Additionally, we upgraded the inventory in 231 non-Hub stores during the quarter.

As I mentioned, increasing our parts availability is critical to our success and growth.

However, we have been working to ensure to free up capital to fund other parts of our business.

As such, we continue to expand our accounts payable to inventory ratio which increased roughly 784 basis points from 75.1% at the end of second quarter last year to 82.9%.

As a direct result, we have reduced our owned inventory by 31.3%, or $163.4 million, from $521.6 million to $358.2 million.

As previously stated, our new Remington, Indiana distribution center was slated to start receiving product in the second quarter and I'm delighted that we successfully achieved that milestone.

Work is now underway to schedule the first outbound shipments in mid-September.

We will ship product to our stores in phases, ramping up to 400 stores next year.

We are also excited about our ability to provide improved availability by providing daily replenishment to over 200 stores next year.

Essentially adding this new capability will allow us to provide greater coverage to the cars in the market and the customers we serve.

We continue to focus on growing our business through our expanded penetration of our B2B capabilities to our commercial customers, as well as through successful new store openings.

During the second quarter we opened 10 stores, including 3 Autopart International stores.

Year to date we have opened 35 stores, including 6 Autopart International stores.

As of July 14, 2012 our total store count was 3,692, including 203 Autopart International stores.

We remain on pace to open approximately 120 to 140 stores this year.

Our gross profit rate increased 16 basis points to 49.9 versus 49.7 during the second quarter of 2011.

The increase was primarily driven by improvements in shrink and supply chain expenses due to labor productivity and lower fuel costs.

Partially offset by increased promotional activity and a higher mix of commercial sales.

Year to date, our gross profit rate was 50.0, a 14 point basis decline over the same period in fiscal 2011.

Again, I'd like to thank the team for their hard work during this challenging environment.

We remain confident in the priorities we have laid out and our teams are working diligently to ensure our focus does not get diluted.

And that we execute our initiatives and the fundamentals of our business flawlessly.

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

Thanks, Kevin, and good morning, everyone.

I'd like to start by thanking all of our talented and dedicated team members for their commitment to serving our customers as we navigated through a challenging second quarter.

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

One, provide some financial highlights from our second quarter of 2012.

Two, put our second quarter and year-to-date results into context with our expectations and key financial dimensions we used to measure our performance.

And, three, provide some insights on the remainder of 2012.

During our first-quarter earnings call, we shared that we were tempering our second-quarter expectations given our slow start to the quarter.

We ended up coming in at the lower end of the outlook range we shared for the quarter.

We believe our softness is a function of the tough economic environment that is taking a toll on our customers, as evidenced in our maintenance categories and the lingering impacts of this year's milder winter.

This latter point is evidenced by the significant softness we experience in our cold weather market, such as the Northeast and Great Lakes areas.

This softness drove weakness in both our DIY and commercial businesses and our Autopart International stores.

While we are disappointed with our second-quarter performance, we also know our relative underperformance can be partially explained by the fact we have more stores in colder-weather markets.

For our second quarter, our total sales decreased 1.3% to nearly $1.5 billion, driven by a comp store sales decrease of 2.7%, partially offset by the net addition of 65 new stores over the past 12 months.

Year to date our total sales increased 1.2% to $3.4 billion and our comp store sales are flat.

As Kevin mentioned, our second-quarter gross profit rate increased 16 basis points to 49.9% versus 49.7% in the second quarter of 2011.

The increase was primarily driven by improvements in shrink and supply chain expenses due to the labor productivity and lower fuel costs.

Partially offset by promotional activity and a higher mix of commercial sales.

Our commercial mix represented 38% of our 2012 sales versus 37.2% in 2011.

Year to date our gross profit rate decreased 14 basis points to 50% versus 50.2% over the same period last year.

Our SG&A rate of 38.3% increased 135 basis points versus the second quarter of 2011 primarily due to expense deleverage as a result of our 2.7% comp store sales decline, and the planned shift of expenses from first to second quarter, partially offset by lower year-over-year incentive compensation expenses.

Year to date our SG&A rate decreased 56 basis points to 38.5% versus 39.1% over the same period last year.

All-in, our second-quarter operating income dollars decreased 10.4%.

And our operating income rate decreased 119 basis points to 11.6%.

Primarily driven by the planned SG&A shift from first to second quarter and the SG&A deleverage from the lower comp sales.

While our diluted earnings per share decreased 8.2% to $1.34 versus $1.46 last year, roughly $0.08 was due to the SG&A shift.

The planned shift in expenses, which was previously communicated during our first quarter conference call, was driven by our annual general managers meeting and some strategic investments.

Through the first half of 2012 our operating income dollars increased 5% to $393.8 million.

And our diluted EPS increased 12.5% to $3.14.

Year to date free cash flow was $265.4 million, down 7.6% over the same period last year.

The decrease was driven by increased accounts payable as a result of the insourcing of our commercial credit program and lower deferred income taxes due to the lapse of certain corporate tax legislation offset partially by continued reductions in our owned inventory.

As Kevin mentioned, our owned inventory decreased 31.3% from second quarter 2011 driven by our continued efforts to increase our accounts payable to inventory ratio, which now stands at 82.9% versus 75.1% in the second quarter of 2011.

We are maintaining our previously-communicated annual free cash flow outlook to still be a minimum $400 million, which includes our previously-communicated increase in accounts receivable of $80 million to $100 million for the full year from insourcing our commercial credit program.

We are excited about this new capability, as it will allow us to provide a higher level of customer service to our existing commercial customers, help fuel our commercial growth as we increase our credit penetration with customers, and allow us to build deeper relationships with our customers at lower costs.

At the end of the second quarter, we had $448.6 million of cash and $600 million of long-term debt on our balance sheet.

Our adjusted debt to EBITDAR ratio was 2.1 times, which is well below our previously-stated ceiling of 2.5 times.

Our average diluted share count was 74 million shares at the end of the second quarter.

While we are not meeting our expectations as we go through this soft period, we remain confident with the solid industry fundamentals, the commercial market opportunity and our team's ability to improve our performance.

We continue to measure our performance through the financial dimensions of growth, profit and value creation.

As we have consistently communicated, we prioritize growth as our primary use of capital to increase shareholder value, which includes growing our business through our strategic investments, our operational performance, and looking for future growth opportunities or strategic capabilities that capitalize on the market growth opportunity.

While we see growth as our primary focus to increase shareholder value, we will continue to use share buybacks opportunistically.

At the end of our second quarter we have roughly $500 million left on our share repurchases authorization.

While there will be moments in time where investors will attempt to read into our share repurchase activity, we want to remind investors that we take a long-term disciplined approach to share repurchases.

And we measure our success over years and not over quarters.

We continue to maintain this same disciplined approach with respect to share repurchases, which is focused on creating long-term value, not short-term earnings.

While this can have a tendency to frustrate short-term shareholders, this philosophy has allowed us to purchase over 41% of the Company at an average price of roughly $43 since 2004.

Turning to profit, we continue to improve our profitability, which is reflected in our operating income per store and our trailing four-quarter operating income rate of 11%, which is up 100 basis points from 10% during the second quarter last year.

We have been able to invest in both commercial and availability, while preserving our in-store service levels by maintaining the same levels of labor hours in our stores.

We have been able to fund these investments by managing our cost structure through our continued focus to build a more efficient, competitive and profitable operating model.

As we look at value creation, we continue to maintain our disciplined approach to capital, which is reflected in our return on invested capital of 19.9%, which increased 140 basis points over the second quarter of last year.

Our ROIC has increased over 600 basis points over the past four years.

We are also pleased with our 82.9% AP ratio, which continues to lower our owned inventory.

And we believe we can get our AP ratio to 100% over time.

Turning to the balance of the year.

While we are not satisfied with our second-quarter performance, we believe that the long-term industry dynamics are solid and our commitment is unwavering to continuing our strategic investments at the same pace as we originally planned, which are focused on commercial, availability, supply chain and e-commerce.

These are foundational to our future growth and thus we will not slow or change the timing of them.

That said, our business trends continue to be soft, with the challenging consumer environment.

This, coupled with industry growth decelerating, and more challenging second half of 2012, comp sales compares, particularly in the fourth quarter, which historically has been our most volatile quarter, require us to take a more prudent approach to our annual outlook.

As a result, we now expect our annual comp store sales to be flat to slightly down for 2012.

We continue to expect our gross profit rate will improve modestly for the full year, as previously shared in our outlook.

We will make the appropriate adjustments in our variable expenses, with the change comp outlook.

And will maintain our disciplined focus on managing our discretionary administrative support costs.

As a result, we now expect our SG&A per store will be down 1% to 2% for 2012.

With these changes, we now anticipate our fiscal 2012 EPS to be in the range of $5.25 to $5.35 per share.

In closing, I would like to thank our talented team members again for their resolve and focus to serve our customers during our challenging second quarter.

We have confidence in our team, as they have shown many times that when faced with adversity, they always respond with character, resiliency, and competitive spirit.

We expect to rise to the challenge to improve our performance.

Operator, we are now ready for questions.

(Operator instructions)

Gary Balter with Credit Suisse.

My question relates to, obviously, the results.

When you analyze what's going on, obviously your numbers -- everybody slowed down in the sector.

And Darren you talked about that.

But if you look at the disadvantage that you have because of the fact that your delivery -- you mentioned you're going to have the delivery center working soon.

But what's the disadvantage caused by that?

Have you adjusted labor hours at the store that's maybe hurt you?

Why do you feel you lost momentum in commercial, because that looks like it was negative?

How do you address those?

And what are you doing to deal with those on a near-term and long-term basis?

Thank you.

Yes, Gary, absolutely the right question.

Maybe a little bit of context.

When we looked at our overall commercial business in the second quarter, as we said, when we looked through it and asked the question -- are we still driving the business as measured by transactions -- our transactions across the Company were up low single digits.

As a matter of fact, in many, if not all, of our non weather-affected markets, they were up better than mid single digits.

And so, when I look at the health of being out there, are we delivering the parts, are the teams making the sales calls, are we improving in terms of our relationships with customers, I think transactions are a better proxy.

What we see then is that we saw a lot of pressure on ticket.

And we are seeing a little bit of tradedown in the categories.

In my comments, and you can look across the industry, we have some great customers up in the Northeast.

One of them a public company.

We saw those same challenges in the weather-affected parts of the business.

Principally in our maintenance categories, and that includes categories like brakes.

When we get down to the next fundamental question, you said we are expanding our Hub network, we are doing daily replenishment.

Maybe a way to answer that question is that we have 315 Hub stores today.

Those are big commercial programs for us.

Many of those well over $2 million in terms of their productivity.

And what we are finding is that as we go across the country, we use those Hubs to supplement some of the local stores in terms of their availability.

And if we could flip a magic wand and convert all of our DCs to daily replenishment, we would.

But in lieu of that, what we have been doing over the course of several years is just slowly marching up our hard parts SKU count at the local store level and at the Hubs.

So we still see an opportunity in the existing network.

And we still have some of the largest stores in the industry.

Not by thousands of square feet but certainly hundreds.

To continue to add hard parts at the local level, we know when we have the hard part at the local store, our close rates are darn near 100%.

And so when we said we are going to invest $60 million in the back half in Hubs and local stores, what we are essentially doing is saying we are going to add thousands of hard part SKUs to those local stores across the network.

Hubs aren't ideal but by themselves they are a great return.

Our first replenishment facility comes online later this fall.

We have inked our second replenishment facility.

And over the course of several years now, what we have done is, through a balance of custom mix technology by store, and actually getting rid of what we would say some of the slow-moving product, we feel like we are in certainly an improving position each year.

But I'll be honest, is it ideal?

It's not ideal in terms -- ideal is closer to a daily replenishment model.

But we certainly have tools.

And we certainly are focused on not worrying about what we can't control but what we can in terms of adding to that availability.

As to labor hours, in the first half of the year our labor hours were up, just modestly on a per-store basis.

So it's not a case that we pulled back.

We made a little bit of a bet in the second quarter, a little bit, on pricing.

And a little bit in terms of traffic driving.

And my takeaway is that when we start to snap back in some of those cold-weather markets, they should start behaving more like some of our non weather-affected markets.

Which really gives us -- I don't know if the word is hope, but confidence that the business will come back overall.

I think what you heard on our call is that we see the back half -- and our teams are absolutely focused on our internal targets and plans to drive positive comp store sales.

That is absolutely the expectation here.

And we are also realistic that we see trends in terms of that hot weather that we just experienced.

It generally positions us well and the benefits of that come when it gets cold, principally in places like batteries, first and foremost.

So we are trying to both send a message that we are being balanced in terms of what we see immediately in the consumers.

But more importantly in the short term, give us a little cold weather in those cold weather markets, I'm certain we will see some of those businesses absolutely snap back.

And it doesn't change the fundamental thesis of our industry of 240 million cars on the road.

They are out there.

And the consumer, from our point of view, are making choices today where they are just stretching it out a little bit longer, principally in the maintenance categories, in order to manage their checkbook a little bit better.

Thank you.

And just for my follow-up and I won't ask -- Mike scared us off from asking the buyback question so I'll stick to something else.

I'll leave it to somebody else on that one.

All three of you said the weather has had an impact.

A few years ago business wasn't that strong, and then all of a sudden all this deferred maintenance started getting spent on and comps picked up a lot for everybody.

Do you think we are just past that stage where the deferred maintenance caught up and this is more normal?

Or do you think the weather really is the difference right now?

Yes, you're right, Gary, back in 2008 I remember having one of these conference calls.

And it was ourselves and the industry, we were all shaking our head.

It was essentially flat comps for the industry, even down in a couple of places.

And then 180 days later we were all high-fiving because the comps were closer to 10.

I think if you look at some of the AAI data and other data, it says the deferred maintenance bill out there at any one point in time is not less than $60 billion.

So it's still a big number that sits out there in those vehicles for us.

So I think it's certainly out there.

I think the way the consumer is managing their dollars right now is that -- and we've talked about this time and time again -- that gas price, from our vantage point, I think it's every $0.01 move is $1 billion of discretionary income.

As that comes down, and we can see it in some of our markets, where there's a little more gas price relief, those tend to be markets that are doing a little bit better.

And as you said, and I'll reinforce that, we have markets where, quite frankly, the difference -- and these aren't small markets -- from the Northeast to parts of the South are literally 15 points difference in terms of how they are performing.

And so I don't think the economies are that different between the two markets, for sure.

But I certainly pin back to, in those markets.

And competitively they are comparable, too.

So I do think we have a little bit of a stretch-out period going on in some markets.

And in other markets that were less impacted, they are behaving the way we expected them to behave.

Greg Melich with ISI Group.

Two questions.

First on the sales trend, Darren, clearly the focus is getting those comps back to positive.

And you listed how, the things you are doing.

But also the guidance infers that it's negative in the back half.

Could you just give us some insight as to how it's been since the end of the quarter?

I assume it's still negative but maybe better than you actually were in the second quarter.

And you mentioned in your release, the second part of that, that the last period of the quarter was better.

Could you just describe what that period was?

Yes.

A couple of things, Greg, to your direct question.

Since the beginning of the quarter it's been a little choppy.

And so, what I can see, and we've talked about this in the remarks, this is true, our final period, which cuts off about mid-July, our comps absolutely turn positive in the final period.

And that was low single digit.

Low, low single digit.

But they turned positive, which was a turnaround from what we experienced early in the quarter.

And if you said what was driving it, certainly we all saw the heat come back into the market.

That helped drive some of the seasonal categories.

And we got that lift.

The thing that tends to benefit from that, as you know, is you take air-conditioning, that was a principal driver.

It didn't help as much this year because we saw that was one of the categories, from an inflation point of view, that was literally down 50% this year.

So, in some cases we could have been up 38% in units but still down 12 in comps because the inflation effect went against us this year.

And we saw a little bit of that in the ticket.

But all that being said, I think the read you should take away from that, when we bounce back to, I would say, more seasonal trends -- and in many of our markets it went beyond seasonal trend, it was just plain warmer than it ever has been -- the business reacted appropriately.

When we look to the back half of the year, and what we can see is that our confidence, we are no good at predicting the weather, I'll just tell you that.

But what we are good at predicting is if we have more normalized weather patterns, the heat that we just experienced will certainly manifest itself in some of our stronger categories of business.

Whether that sits in the starters, alternators and battery categories.

I think the difference between a strong positive in the second half and a more challenging business trend, like we are experiencing in the first half, is literally if we find our way back to the more normalized patterns.

Great.

And the second question in terms of capital allocation.

You guys are running with more cash than ever before.

And I think I heard in your comments you mentioning a second daily replenishment facility.

I'm wondering, are you considering another new DC, like Remington?

Or is there some other spending there?

We've seen some acquisitions like Quaker City that came up.

How are you thinking about allocating that cash?

Or is that the new level you need to run at, given the commercial credit program?

Yes.

So three things, Greg, you're right.

We are at an all-time high, a high level of cash.

I did say that.

As we look out, we've penciled a new agreement for a second daily replenishment center.

I'd like to actually not get into the details of where it is, for competitive reasons.

But everything that we see certainly says that to further build on the momentum we've built in the last four years, we are taking the next steps competitively in the commercial segment.

And we believe that is where the future is.

Mike did talk about commercial credit for years.

It was just lower on the priority list.

We had that outsourced to a third-party bank that was principally a retail bank.

What we know is that we are going to spend $100 million, which is comparable to our competitors, to bring it into the business.

We feel that by bringing that in, we are going to actually be able to provide a better level of customer service.

More importantly, only about half of our business is done on commercial credit today, which is a fraction of where the industry is, or even AI.

So we think it's not only a great customer service tool, but it also is a sales-generation tool for many of our customers that, quite frankly, could benefit from that credit, particularly in difficult times.

So that's two.

As we look to next year, our store count -- and we have purposely, and I think I've said this before -- is challenging some of our comps relative to others in the competitive set.

We have slowed store growth to about 100 stores a year.

We will be 125 this year.

Next year that number will be closer to 200.

And the bright spot of our performance this year has really been this class of new stores.

So we have been spending time re-architecting the store model to be a more commercially-driven store model, a much lower cost model for us in terms of the cost to build it and where we place it.

As we go into next year, we see a great opportunity to begin to up the store count in terms of many of the markets that we see, in part because of the commercial potential.

And four years later we feel like we have a commercially-oriented new store program that is worth investing more dollars into, for sure.

Michael Lasser with UBS.

On the distribution center, is there any way you could quantify the potential benefit that you might see on the sales side as that facility comes online?

Yes.

Michael, this is Kevin.

Essentially the center will totally service over 400 stores.

And approximately half of those will be within a range close enough to the facility to receive daily replenishment.

We do actually have quite a bit of work on what the lift will be.

And it's a good change as it improves the availability of those stores.

Quite frankly, in a fleet of 3,700 stores, changing 200 to a better availability will have somewhat of a modest impact on the overall Company.

Yet, as that program rolls out, there would be a more pronounced impact on the Company as a whole.

That's helpful.

And then my second question is, what is the appetite to potentially take your leverage ratio beyond the 2.5 times guardrail.

If you saw opportunities either on the acquisition front or the ability to accelerate the pace of new distribution center openings to really improve the positioning of the business over the long term?

Yes, it's Mike.

We have at this particular point in time no appetite to take our adjusted debt-to-EBITDA ratio above 2.5 times.

And we believe actually we can grow our business and do the things that Darren talked about and Kevin talked about, and operate our business and grow our business.

And make the investments in our strategic initiatives, and keep within that.

But at this particular time we have no plans to do that.

Yes.

And Mike, you would say that, you asked a question about our daily replenishment centers.

Maybe to put that a little bit more into context, in order to make those things happen you have to replace warehouse management systems, and that's complete.

We've got to open the first one and honestly work the bugs out.

These are complex centers.

We are excited about what we see right now in terms of how that center is operating in terms of the phase that we are in.

And I would say this, that we have absolutely capital and cash, that if that proves to be what we believe it will prove to be, we are not constrained, both in terms of dollars and leverage ratio to go a lot faster on that.

What we are doing, and we think it's responsible, is that we certainly want to work the bugs out on it.

Because if you speed in this area and the supply chain pays the price, 3,600 stores pay the price.

And so you shouldn't read anything into our comments that we will be timid in terms of our ability to invest in the business.

Provided, and I'm confident the teams will figure this out, we get the results.

Dan Wewer with Raymond James.

Mike, maybe just a little bit more direct on the buyback issue.

I understand your response on looking for reinvestment opportunities.

I understand that you use a conservative DCF model to determine when to buy back shares.

But we are also looking at the Company running with $400 million more cash than a year ago.

Stock's off about 27% from its peak.

Free cash flow yield is up to about 10% now.

The bottom line is, what are we waiting for?

Dan, the good news is, you listened to our pre-remarks and you understand our philosophy hasn't changed.

That our first priority with capital -- and Darren said it -- is to invest in growing the business.

And, quite frankly, that's where we prioritize.

And, quite frankly, we are not growing at our level of expectation at this particular point in time.

So the balance of the year we are focused on reversing the trends.

We are going to continue to invest in the business and generate positive comps.

And buybacks don't create sales.

I think the most important thing is, we believe that investing in the business and growing our business is what creates long-term value.

And buybacks also show our confidence in doing that.

And we've done them over the last few years.

Since 2004 we bought back about 41% of the Company at an average price of $43.

So we think that has created good value.

However, it doesn't create sales.

And I think the most important thing is, is that, we get the question a lot, we are focused on creating long-term value, not short-term earnings.

And we also take it very seriously about what we are going to do with the cash.

I think to Greg's question, and to some of the questions earlier, what you're going to do with the cash, we typically don't talk about that.

We don't talk about buybacks before we do them.

We don't talk about other things before we do them.

But just know this management team takes very seriously what we do with the cash.

And whatever we do do with that cash, we will make sure that we get a good return and we drive long-term value.

Okay.

And then just a question about Carquest, Darren.

It's speculation that its ownership may change hands.

Can you remind us the difference in Carquest's position in the commercial market relative to Advance and AI?

And also if there are certain potential buyers that would create more of an issue, more of a headwind for Advance than other potential buyers?

Yes.

Dan, I'm going to just start first.

First of all, we don't comment on specific opportunities that may exist out in the marketplace.

And, Darren, if you want to give a few insights to his question around comparisons.

Yes.

Dan, both your questions are understandable, and I understand why you're asking them.

And I would say this -- the following.

The market right now, as you know, there was another public company that was out there for sale that was sold and then put back.

So there are things shifting in the marketplace right now.

Part of that is that, who knows.

I couldn't speculate at this point whether Carquest gets sold or not, or it doesn't get sold.

I can't speculate who buys them or who doesn't buy them.

The most recent evidence we do have is one of the companies in our industry got sold and then it was unsold.

And so I think we will have to watch how that plays out versus, at this point, us speculating as to what the outcome will be.

There's no doubt that, as you know, and you've watched this industry longer than most, this is a B2B WD model and that may be attractive to some, and it may not be attractive to some.

So, instead of trying to lead you down a path of speculation, I think we will all sit back and see how that unfolds over time.

Matt Fassler from Goldman Sachs.

I have one follow-up on capital allocation and then another on traffic.

First of all, on capital, you spoke about reinvesting in the business.

If you think about the level of CapEx for this year, but also the prospective level of CapEx going forward given expansion and any other reinvestment that you're contemplating, should we think about height in aggregate capital expenditures from your prior run rate or prior thought process?

Matt, I think what we've said in our outlook is that we are going to be spending this year $275 million to $300 million.

And we still believe we are going to be in that range.

The big areas that we are investing in capital this year, obviously, first and foremost, in terms of growth is our NSOs.

So that's one big pocket.

And then maintenance that goes into maintaining those.

The second pocket is supply chain.

Kevin has been really clear around.

And we are very excited about the Remington facility and the daily replenishment test that we are going to be doing.

I think it's going to be a fantastic opportunity.

And the first one's always more expensive, so that's a big part of our capital.

And then the third area, obviously, is IT and our systems.

Kevin's talked about some of our electronic parts catalog.

And that's going to be a fantastic tool for our teams and our stores to enable them to serve our customers faster.

So those are the three big pockets.

Darren did talk about, as we look out, we haven't given an outlook for the out years, but just be clear we are going to continue to invest in commercial.

We are going to continue to invest in availability.

We are going to continue to invest in supply chain.

And we are going to continue to invest in those parts that will grow our business.

But I can't comment at this particular point in time as to whether we are going to increase that.

But we are comfortable with the capital at this particular juncture.

I was going to say, if you look back two years ago it was roughly a $200 million run rate.

We have taken it up.

Last year, it was $300 million, again this year.

Principally it's supply train driven.

Next year you can infer from our comments taking our store count from 125 to closer to 200, that will drive it up.

And the other thing that we've been spending capital on, quite frankly, is our acquisition of Motologic and DriverSide.

And the other piece of capital, though, that runs through working capital is commercial credit.

And so, again, we are trying to stay on strategy.

And, unfortunately, strategy and financial results and 90-day windows or 180-day windows, as we are trying to take that next step in terms of capabilities, daily replenishment, commercial credit, diagnostic tools.

In the fall of this year we will begin the process of our new electronic parts catalog being rolled out to our stores, in order to enable the commercial sales, as well as the retail hard part sales to be able to be affected in a more customer-friendly but more team member-friendly way.

And those all sit in the capital bucket.

Usually about the back half of this year we get even more precise as to what the dollars are.

So I agree with Mike, we are not going to give you a forecast now.

But we are in that in between period where many of the larger investments that are positioned to grow, I would say, are positioned in commercial with larger bays and larger customers, we're in that transition to the capabilities.

I think we just started it in July with internal credit on our own books.

We will start in October of this year shipping daily replenishment.

We wish it would go faster, and the teams are working their tails off to make it go faster.

As that comes through, it informs just how fast we can go.

And then it will get translated into dollars and projects for the team going forward.

And just as a follow-up, I assure you that I ask you this question in the spirit of your intro with long-term focus in mind.

The last big buyback push from the Company was late 2010, early 2011.

You bought back a lot of stock in the low to mid 60s.

And you've been smarter than most about thinking about intrinsic value and picking the right spots.

Is there any reason to think that your view of the intrinsic value of the business has changed over the last 12 to 18 months, as we think about at what levels this might be too good of an investment for you to pass up?

No, Matt, not at all.

Peter Keith with Piper Jaffray.

This is actually Jon on for Peter.

You guys have done a great job stabilizing shrink now this quarter.

And it just turned into a benefit.

Based on what you lost in shrink in the last three quarters of last year, do you think you're going to be able to recapture that in the second half of this year?

Yes, it's Mike.

Yes, I want to really compliment our teams on what we've done with our shrink trends.

And the answer to that is yes.

Our trajectory that we were on last year was going in the wrong direction.

We have reversed that.

And we are going to get back.

And by the end of this year we will be almost to those levels that we were at prior to our decline.

Okay.

Great.

And then as my follow-up, as we think about your Remington distribution center, and the margin impacts for both the remainder of fiscal 2012 and then going into fiscal 2013, should we be assuming a drag to margin now, continue to assume a drag to margin in the second half and margin expansion in 2013?

This is Kevin.

We've had leverage, essentially, coming from the supply chain this year.

And it's through predominantly efficiencies that we have been driving through the centers and some smart decisions that we made on forward purchases of fuel.

As we turn the distribution center on, obviously the investments that we have made begin to depreciate.

We will begin to operate the facility.

But the actual operating costs of the facility are lower than any of our other centers.

So it's actually a significant change in the way that we are operating the level of automation that we have put into the center.

So essentially we get a headwind and a tailwind at the same time.

I think when it's all said and done, we see a relatively muted impact of that from a margin perspective.

And predominantly what we will see is an impact on sales.

Bret Jordan with BB&T Capital Markets.

Just a quick question.

In the prepared remarks you talked about your pricing position in the second quarter.

I guess my question is really what the promotional environment is looking like right now and whether the comment was a positive or negative pricing position relative to peers?

Yes, this is Kevin.

We essentially keep our ear to the ground on DIY and commercial prices every day of the week.

And we try to manage in a very tight range of plus or minus 1% of the prevailing prices in the market.

And we are benchmarking all of our key competitors.

As we got into the second quarter, in that plus or minus 1% range, to be honest, we have managed to the low end of that range purposely.

As we were hitting tough sales, we wanted to make sure that it was not being driven by being improperly priced in the market.

And it would be our intention to stay in that position until such point as the sales turn around.

So I think what you're seeing in our numbers, is in fact, what you would likely see in the quarters ahead.

Okay.

And one follow-up.

On the commercial pricing, as a couple of these large players become a bigger piece of your commercial business, is there price deflation as they wield that clout?

Are you seeing some compression in commercial pricing through those contracts?

Bret, to build on Kevin's point, but specifically to answer that one, as you build more national accounts, of course, those come with both lower margin rates.

But the truth is, they come with greater consistency and growth in the margin dollars for sure.

So as we grow that, there will be, and there has been for four straight years, just more pressure in our business inherently because commercial gross margins are lower.

And I think just to put an exclamation point or a period on your other question.

When we look at our performance in Q1 and Q2 in terms of the deceleration in our business, what we really saw is that, if you broke it down into two things, nearly 75% of the deceleration in our comps came from ticket.

And in that ticket, you can see both the combination of -- and you would expect this from us -- that we saw lower transactions.

We certainly went out and, I would say, used more promotional vehicles in terms of radio and in terms of direct mail in order to drive traffic in our stores.

That's what you do in these times.

And what we also saw is a consumer trading down in certain categories of the business.

I think that reflects some of the economics.

And so, as we look out, we continue to just manage and assess that balance between driving the promotional activities, traffic into our stores, traffic to the commercial accounts.

And that balance with ticket in the back half of the year.

And you know what?

That's how you go back and just fight to get the business back.

As you look at -- and this is not really a third question, I guess -- responding to that, as you look at your online pricing, which is pretty aggressive, is that compounding the ticket compression because people are buying online but picking up in store?

And they're getting what is running a 20% discount from the online ticket?

This is Kevin.

We do have a more promotional stance online.

And it's more similar to what we do through our direct mail program, so those two are relatively aligned.

The honest answer is, while that business has grown very large percentages over the past several years, it is a very small part of our business today.

And not large enough to materially move the Company's gross margin.

Thank you.

Thank you.

At this time I'll turn the call back over to Joshua.

Thank you, Shirley.

And thanks to our team for participating in our second-quarter earnings conference call.

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

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

Thanks again to our audience and that concludes our call.

Thank you.

This does conclude today's conference.

We thank you for your participation.

At this time you may disconnect your lines.