領先汽車配件 (AAP) 2015 Q1 法說會逐字稿

Welcome to the Advance Auto Parts first-quarter 2015 conference call.

(Operator Instructions)

Before we begin, Zaheed Mawani, VP of Investor Relations, will make a brief statement concerning forward-looking statements that will be made on this call.

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

I would like to remind you that our comments today contain forward-looking statements 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 belief, 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.

Our comments today will also include certain non-GAAP measures, including certain financial measures reported on a comparable basis to exclude the impacts of cost in connection with the integration of General Parts International and BWP Distributors.

Please refer to our earnings press release and accompanying financial statements issued today for important information and additional detail regarding these forward-looking statements and the reconciliation of the non-GAAP measures referenced in today's call.

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.

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

Darren?

Thanks, Zaheed.

Good morning, everyone.

Welcome to our first-quarter conference call.

Joining me on the call today is our President, George Sherman, who will update you on our business operations including our integration activities, and Mike Norona, our Chief Financial Officer.

And Mike will update you on our financial performance.

Entering 2015 and year two of our integration, we remain very confident in the growth, earnings, and service potential of this combination.

We are well-positioned in the commercial business, DIY, import, domestic, independent, and online channels with approximately 60% of our business in the fastest-growing commercial segment.

The 2015 enterprise priorities remain unchanged from 2014.

They are, just to remind you, relentlessly improving our base business, execution, and successfully delivering the year-two integration objectives.

We are building on last year's progress and continue to be confident that the steps we took positioned us well.

As a reminder the notable successes in 2014 included naming our go-forward leadership team, aligning our cultures while improving our inventory availability, principally through the cross-sourcing.

We also completed our supplier negotiations and defined our go-forward product brand structure.

We successfully entered Dallas, leveraging the Carquest backbone.

And finally, we delivered on the synergy and financial expectations for the year.

Through the first quarter of this year, the cultural assimilation remains very strong.

The cross-sourcing availability continues to drive the business and the growth drivers, principally with the WorldPac business, the Canadian business, and our Dallas markets are exceeding expectations.

In 2015, the required next step in the Company's integration is the Company's people, processes, systems, and capabilities are to form a common foundation.

In addition to that, aligning our systems and distribution work, this also includes moving to a common foundation for products, pricing, customer process, support centers, pay and benefits, and the store and field leadership structure.

Significant work is underway and is an integral step into leveraging the full potential of this acquisition.

It will and has resulted in broad-based change, a number of new learning curves, and some temporary disruptions to our business.

We completed critical integration deliverables in the quarter and expected some impact to the business.

However, the degree of impact on the base business honestly was greater than we anticipated.

Consequently our first-quarter performance was lower than we expected.

Overall our sales grew 2.3% to just over $3 billion.

The comparable sales were up 0.7%, led by commercial growth with our DIY business declining modestly.

Earnings per share on a comparable basis grew 6.2% in the quarter on top of last year's 35.5% growth.

Now our industry fundamentals remain positive, including vehicles in operation, gas prices, miles driven, and steadily improving economy.

The industry benefits are not equally distributed across the country.

Specifically our Northeastern and Upper Midwest markets meaningfully underperformed our expectations in Q1, principally driven by weather and some of the West Coast port slowdown.

Despite the integration workload in some weather-impacted areas, we have continued to grow our sales and our profits.

The integration efforts I referenced earlier had a larger impact on our core commercial business in the quarter as it experienced a sequential slowdown from Q4 of last year.

Our commercial business has been consistently performing at the high end or above the high end of the market growth of 3% to 5%.

In our first quarter we were closer to the low end of that range.

Our sales and operations teams are intensely focused on leading the business and our customers through these changes to get this part of our business back in rhythm, and we will.

Our fourth quarter call, I outlined five key integration priorities that we were focused on this year.

Later George will provide more details and a status update shortly.

Together these five key priorities support the overarching objective of aligning its companies to a common foundation.

This significant just table-stakes work is required in order to minimize the confusion with customers and position the combined Company to operate more efficiently and ultimately generate the highest value from this combination.

As a Company, we made a decision to drive key integration activities aggressively from the start.

We believe moving faster with things like the organization and product integration will get us to a desired end state and the results sooner than a piecemeal approach.

I previously noted that our 2015 integration priorities were entering a more complex phase, as I called it.

Certainly it is expected, given we are undertaking the largest and most diversified integration project in the industry's history.

Although the core business integration work is driving change and short-term volatility in the base business, this volatility will pass and the long-term potential remains strong.

I will conclude my prepared remarks by reiterating our ongoing confidence in the potential of the combined businesses and the opportunity to grow the Company in the long term in size and scale and achieve our next target of 12% comparable operating margins by the end of 2017.

Last year we focused on executing our integration plan with few unforeseen challenges.

A year later, the long-term potential remains the same and we are encountering impacts of change from the integration.

It is a reminder that neither results nor change unfold in a linear fashion.

While our results this quarter did not meet our high expectations, we expect the business to steadily improve, which is the case so far in the second quarter.

Q1 was a new high point of integration change and we expect to start seeing our team settling into a sales and operating rhythms going forward.

We also remain grounded that we still have sizable amount of integration work ahead of us and we continue to expect some unevenness in the business this year.

In consideration of this, Mike will review this with you and also provide you with a revised annual outlook.

I want to finish by sincerely thanking our 74,000 team members for their remarkable commitment in supporting the changes to position our business for an outstanding future.

Now I'd like to turn the call over to George Sherman, our President.

George?

Thanks, Darren.

Good morning, everyone.

First I, too, would like to thank all of our team members for their contribution to customer service in the quarter and putting their focus and energy in giving our customer commitments while stretching to complete many of our integration tasks.

With my prepared remarks this morning, I'll provide commentary on our first quarter base business performance together with a progress update on our integration priorities.

As we've mentioned in the past, Advance is on a path of continuous improvement and consistent execution, and we've made tangible progress.

However, when you layer on the integration that touches many parts of the organization, and namely customer-facing parts such as our field and sales teams, it's clearly not business as usual.

The multi-year integration plan will have a few peaks, and Q1 was at a high point with many simultaneous work streams being executed.

We expected our business would see some impact; however, it was more than we anticipated and led to sales outcomes that were below what we expect and aspired to deliver with a comp of 0.7%.

I'll discuss the integration impact and status in more detail shortly.

Turning to our commercial business, as Darren mentioned, our core commercial business faced the most change and experienced the greatest amount of variability.

The overall industry is benefiting from the macro benefits improving consumer confidence and those are all net positives.

Offsetting the industry tailwinds beyond the integration was weather impacts we experienced in our core markets as we contended with high degrees of sales variability and lost sales days due to weather-related store closures.

With respect to our key customer segments, our TechNet commercial partnership programs are designed to help our customers improve their service and grow their business.

We grew our TechNet program in the quarter high single digits year-over-year and now have over 6,500 members.

Additionally the vast majority of our strategic account business also grew at close to the same rate.

Our B to B penetration continues to be a strategic priority and we continued our progress with meaningful growth in the quarter.

Turning to our DIY business.

In 2015 we expect to improve our DIY business, underpinned by three initiatives.

First our Speed Perks loyalty program.

We've rolled that program out to all Advance stores with the Carquest stores scheduled to receive it by approximately the end of Q2.

The objective this year is about achieving scale through member acquisition.

That translates to a year-end target of about 10 million members.

We are on pace with over 4 million members at the end of Q1.

The early indicators relative to increased frequency and basket-size improvement from members in Q1 are meeting our expectations.

The second initiative is renewed emphasis in investments in marketing toward DIY customers with focus on the heavy DIYer or the car guy.

We like what we're seeing with our initial customer response, with sustained awareness from advertising ramps over time and we're tracking results closely.

Lastly, we continue to invest in our store key members through training initiatives that deliver a great customer experience.

We're also working to improve the consistency and simplification of our DIY marketing and how it shows up in our stores to make the customer experience simple and clear.

Overall I'm satisfied with the progress we made in Q1 with DIY and the steps we're taking against our objective.

Turning to our integration.

We are now into the second full year of integrating General Parts.

This year is focused on aligning to a common foundation.

The integration activities put pressure on the core capacity of the business in the quarter, and we expected that to be the case.

And frankly, it is the only way to move forward and get the teams through the changes as quickly as possible and stay focused on the end-state outcomes.

With that in mind, I'd like to share a status update with you on the core integration activities we're undertaking this year stratified across five focus areas.

First, our store support center consolidation is essentially complete.

During the second half of last year and through the first quarter, we've made the required decisions and worked through the changes to ensure we have all team members operating in their go-forward roles by the end of Q1.

The team members group moving between Roanoke to Raleigh will be fully complete after the school year, and the Minnesota office is set to close in July.

It was important to get all this done so new team members can begin ramping up the required learning curves as quickly as possible and improving operational execution throughout the year.

Second, our field operations and sales team integration is complete.

In Q1 we integrated our field teams across 33 regions in order to build the structure with singular leadership across both brands.

We consider this work absolutely essential and a part of the integration that we needed to address with speed and conviction.

Our history with acquisitions tells us that unifying teams with aligned goals, career tracks, and rewards allows team members certainty in their role in the go-forward organization.

The cultural overlay between our teams has been positive from the start and that certainly continues.

Restructuring our field sales teams is something we needed to do both for our team and our customers.

An aligned sales team prevents redundant sales calls and shows an aligned face to our business across the Advance and Carquest brands.

As with any field structure change of that magnitude, we experienced disruption both internally in changing reporting structures and externally in sales reps and the customer relationship shifts.

We're now emerging from the high point in the learning curve and the focus is now back squarely on sustainable performance rhythms.

Third, now turning to our consolidation conversion and relocation work, when we updated you last, we had completed our early consolidation program for the first 100 stores which were predominantly those lowest performing stores in the chain.

In the quarter, we converted the stores served by our Dallas distribution center, which includes the Dallas and Houston markets.

We are very pleased with the team member, customer, and financial results.

What is most rewarding is the ability to be successful with these conversions in a market that is so highly competitive.

We'll next be executing this program in stores served by three distribution centers in Q2 in Salt Lake City, San Antonio, and Bangor, Maine.

This next wave is approximately 70 stores.

In the back half of 2015, we expect to move at a run rate of 110 to 115 stores consolidated or converted per quarter starting in Q3.

The program is projected to run until mid-2017 when the Carquest chain will be fully converted.

Overall, we continue to be on-schedule with our plan.

Notably, unlike retail store conversions which can be simpler for both customers and our team members, our conversions and consolidations impact how our commercial customer does business day to day.

The consolidations affect commercial customers differently and require more effort and agility around the process to make sure we are not only executing the mechanics of the transition but retaining the customers through the process and getting them quickly back to normal operating routines.

We also successfully completed the consolidation of approximately 40 Autopart International stores in Florida in Q1 with the acquisition process to drive more efficiency and better profit outcomes.

These consolidations have gone well and we're very pleased with the sales and profit performance.

The fourth priority is our product changeovers.

We began the work in late Q4 of aligning the products, the brands, and the pricing between the Carquest and Advance stores.

This program has two components, product relabels and product replacing.

We've completed 90% of the relabel program as of the end of Q1.

This involved key member capacity and focus, including independent store owners and distribution center team members touching over 20 million pieces of merchandise.

We also completed the additional phases of replacing complete product lines.

That's more difficult work since it involves sweeping product back to a central facility, setting new planograms, and bringing in the new product.

That requires execution at the supplier, supply chain, and store levels and is inherently more complicated.

In pursuit of building the best house of brands in the industry, it also involved teaching our teams to sell brands they may have competed with in the past.

Additionally we continue price alignment work between brands and have aligned approximately 80% of product pricing to commercial customers between Carquest and Advance stores.

The outcome is to have one consistent set of prices in all stores across the chain.

Naturally we have some customer reaction as we move pricing.

Certainly in the cases where we lower pricing, that impact is immediate.

Again, the required increase in unit velocity that's needed to compensate for the price decrease is not.

We've been satisfied with the overall outcome and while it's likely had a negative impact on both our comps and earnings in the quarter, we know this work positions us correctly in the market for the long term and it had to be done.

Our fifth key priority focuses on our systems and supply chain integration efforts.

Looking at systems first, we have completed a significant amount of due diligence on what is understandably a complex part of this integration.

The complexity arises largely from three areas.

First, migrating and rationalizing the two sets of enterprise systems over to one go-forward platform.

Second, contending with the Carquest legacy systems.

And finally, whenever you bring in a set of systems that were designed for a private company under a public company umbrella, it requires additional work to get the systems to the same place as Advance is from a functionality and compliance standpoint.

We're taking a measured approach to this complex work, ensuring that we focus on high value areas for our team and customer first.

Last year we were able to complete several systems projects as planned to support the product changeover work, store conversion work, our organization conversion work, and financial compliance requirements.

The next phase of our work is focused on getting the Carquest stores, Advance stores, and both e-commerce platforms onto a common Carquest base product catalog.

This is the most valuable element of the customer experience and is the value-creating element of the store system by (technical difficulty) Advance to offer the industry's deepest catalog.

We're doing the back-end work this year and expect to migrate the change of that common catalog in 2016.

The third major segment of systems integration is the work of connecting the Carquest and Advance distribution centers and store systems into one integrated supply chain.

That work is also underway and we expect to begin the process of converting the supply chains in the middle of next year.

Concurrent with this systems work is our ongoing expansion of daily delivery in the legacy Advance network.

At the end of the quarter we had 700 Advance stores being serviced daily.

We expect to have approximately 1,000 Advance stores being serviced daily by the end of the year.

Our best estimate today is we'll be nearing completion of the entire chain on daily delivery by the end of 2017.

Once the supply chain systems' work is completed we can then finish the consolidation of the back-end financial systems.

By definition that will occur last, and at this point we expect to be able to complete that work in late 2017.

Lastly, before I close, I'd like to take a moment to share some insights as we focus on pushing forward our growth agenda as a combined Company.

A few comments on the major ones.

WorldPac continues to execute its growth plan at or above expectations, and we continue to invest in that business and its growth including the planned opening of 12 new branches this year.

Carquest Canada completed the majority of the product changes last year and had no field organizational integration activities and is now driving solid double-digit growth in local currency for the Carquest Canada business.

Finally, while not the core focus of the acquisition, we see solid DIY growth in stores where we installed the Advance DIY capabilities as part of the store conversions.

In closing, what I'd like to convey is that we're in the midst of an operationally taxing integration year.

And while there have been some challenges, some more than we anticipated and others that we have yet to tackle, those challenges are simply part of this process and should not be interpreted in any other way.

The parts of our organization that are not in the midst of integration change are delivering with strength.

We remain absolutely confident in executing against the plan, and by the future we see for our Company as we work to integrating this acquisition and positioning Advance for growth and industry leadership.

While I've gone into detail to give you a better context on what some of the challenges around the integration look like, make no mistake, we are moving forward every day and are absolutely confident in our ability to execute this work while building upon our core business.

Despite facing the toughest quarter of integration, we grew sales for the sixth quarter in a row.

As aspects of the integration move to complete status where we see the majority of certain tasks behind us, there will certainly be a sustained period of execution focus to ensure that we maximize the value of the work that we've done and continue to emerge as a top commercial competitor.

Now I'd like to turn the call over to Mike Norona, our Chief Financial Officer.

Thanks, George, and good morning, everyone.

I'd like to start by thanking all of our talented team members for their commitment to serving our customers during the quarter while also navigating the change driven by our integration efforts.

In my remarks today, I plan to review the financial highlights from our first quarter of 2015 and provide some insights on the remainder of the year.

As a reminder, and unless otherwise specified, Advance will present its financials and supporting commentary on a consolidated enterprise basis.

And we'll also discuss results on a comparable basis which excludes the impacts of one-time integration expenses and amortization of intangible assets, both related to the acquisition of General Parts.

Our financial results were below our expectations in our first quarter of 2015, primarily driven by our integration activities.

We expected the heavier integration efforts to impact our financial performance in 2015.

However, the combination of both the volume of change and the areas of the business that were impacted had a greater financial impact than we anticipated at the beginning of the year.

The changes had the most impact on our commercial sales.

Despite the softness, we were able to grow our profit rate and deliver on our synergy expectations.

We are confident that we will work through the required operational phases of our integration and deliver the compelling financial value of our combination with GPI.

Turning to sales, our first quarter net sales increased 2.3% to $3.04 billion compared to our first quarter of 2014.

This sales growth was principally driven by the addition of new stores, our comparable store sales increase of 0.7%, which was led by the growth of our commercial business, a 40 basis point sequential improvement in our DIY business from Q4 2014, offset by a net 21 basis point foreign currency impact.

We also experienced more pronounced variability in our commercial sales where, in some cases, we saw greater than a 300 basis point gap in our commercial sales comps and places where we shifted customer relationships versus where we had no changes.

This variability is part of the change and we expect it to be short term.

Comp sales were also partially affected by unfavorable weather across some of our Great Lakes and Northeast markets.

As a reminder, General Parts Company-owned locations are included in our comp sales calculations beginning in February 2015.

Sales to our independent customers are not part of our comp calculation.

Turning to gross profit.

Our gross profit rate dollars in the first quarter increased 3% to $1.39 billion from $1.35 billion in our first quarter of 2014.

Our gross profit rate of 45.9% was up 31 basis points compared to first quarter of 2014.

This year-over-year rate increase was due to 45 basis points of achieved merchandise cost synergies, partially offset by costs from our new Hartford, Connecticut, DC that opened in late 2014.

Turning to SG&A.

Our comparable SG&A rate was 35.7% in the quarter, which improved 26 basis points compared to our first quarter of 2014.

This year-over-year improvement was the result of achieved cost synergies and lower incentive compensation, partially offset by slightly higher advertising expenses related to our DIY business.

All-in, first quarter comparable cash EPS was $2.39, up 6.2% on top of last year's 35.5% increase.

As a reminder, in our first quarter last year we had a $0.05 EPS impact in one-time favorable tax audit settlements.

Our first quarter operating income dollars on a comparable basis increased 8.4% to $308.3 million, and our operating income rate increased 57 basis points over the same period last year to 10.1%.

Included in our operating income was $24 million in net incremental acquisition synergies.

We are pleased that we continue to deliver against our synergy expectations.

Operating cash flow increased approximately 26% to $102.2 million in the first quarter versus $81.1 million during the same period last year.

Free cash flow increased to $45.2 million in the first quarter versus $20.6 million during the same period last year.

Our AP ratio for the quarter was 76.5% versus 75.9% last year.

At the end of the first quarter, we had roughly $1.61 billion of debt on our balance sheet and our adjusted debt to EBITDAR was 2.7 times.

During the quarter, we paid down approximately $26.6 million of debt and are progressing as planned to pay down debt with our free cash flow to get back below the 2.5 times leverage ratio and maintain our investment grade ratings.

We continue to measure the performance of our business and prioritize our investments to achieve growth, profit, and value creation.

Our growth engine is our commercial business which is driven by the growth of new and existing customers.

We also see opportunity to organically grow stores to over 6,000 locations which include doubling the size of WorldPac and growing our independent business.

Additionally we expect our loyalty program, which targets the heavy DIYer, will drive more consistent DIY comp performance through increased frequency and a stronger sales mix of our parts.

Turning to profit.

We see an opportunity to grow our comparable operating income rate to 12% by the end of 2017.

As context, our combined post-acquisition comparable operating income rate was 9.1%, reflecting the acquisition of a lower margin commercial heavy business.

In 2014, through improvements in operational execution, together with our achieved year-one synergies, we closed out our first year as a combined Company with an operating income rate of 9.9%, which was approximately an 80 basis point improvement from the post-acquisition starting point.

This puts us on track against our next profit objective of achieving a 12% rate.

This is realistic, given it considers the rebalancing of the gross margin profile of our now more commercially weighted business that has a different commercial customer, including national accounts, government, paint, and an independent business.

Part of getting to 12% lies in delivering the $160 million in cost synergies previously outlined and also includes modest profit rate improvements as we move to daily delivery, optimize our current supply chain network, and through our merchandising capabilities such as global sourcing.

We also must take approximately 100 basis points out of our cost structure as we transition to a lower gross margin commercial weighted business.

The key drivers will be reducing our G&A profile in our support centers, lowering system costs as we eliminate duplicate systems as part of our integration efforts, and reducing variability across our store portfolio in both profitability and productivity.

With respect to value creation, the acquisition of GPI continues to provide us with a compelling opportunity to drive shareholder returns through incremental earnings and cash flow.

In addition to improving our operating performance, an equally compelling opportunity exists with our balance sheet.

We expect to deliver measurable working capital benefits from our supply chain and IT systems integration work driven principally through our daily replenishment expansion, optimizing our combined supply chain network, and moving to one set of systems and processes.

The outcome of this work will result in a lower inventory investment with greater SKU availability, along with continued progress on our vendor terms, both of which will show up in an improved AP ratio.

Also, we're on pace to get back to our targeted level (technical difficulty) 2.5 times and maintain our investment grade ratings.

Once achieved, we will revert back to our previous capital allocation strategy to drive shareholder value, which includes investing in our business and deploying our share buyback program.

Turning to the balance of the year.

We do expect to see continued short-term business volatility from our integration activities, given these changes were sequenced throughout the first quarter and our teams were still working through the changes as we exited the quarter.

The duration of the change is difficult to predict, given the reality that change takes time as there is an acceptance and learning curve our teams are working through.

It's prudent to build in the earnings miss we experienced in our first quarter and factor in some continued integration headwinds into our results, primarily impacting our commercial sales.

We now expect our annual comparable store sales to be at the low end of the previously communicated low single-digits range.

As a result, we are revising our full-year comparable cash EPS outlook down to $8.10 to $8.30.

As part of this outlook, we expect our share count to be 73.7 million shares, our tax rate to be in the range of 37.5% to 38%, and our interest expense to be approximately $64 million.

We are confident in our team's ability to execute and our revised full-year outlook reflects our best view of the short-term change impacts from the integration.

Our 2015 synergy estimates remain unchanged at $45 million to $55 million for the full year.

In closing, our first quarter of 2015 was more challenging than we anticipated, given the degree of change that impacted our teams from the integration.

That said, these changes were required to move to one common foundation that will enable us to deliver the full potential of our combination with GPI, and we are confident in our team's ability to navigate through this change.

We're also encouraged by the strong performance from those parts of the business that were not impacted by our integration work, which shows we are on the right path.

I would like to finish by thanking our team members once again for their tremendous and tireless efforts in the first quarter and for what they do every day to serve our customers, inspire our team members, and grow our Company.

Operator, we are ready for questions.

Thank you.

(Operator Instructions)

Our first question comes from Greg Melich with Evercore ISI.

Thank you.

Your line is open.

Hi, thanks.

Had a couple questions.

Mike, I think you mentioned synergies, $24 million of net acquisition synergies.

Is that a cumulative figure including last year's first quarter, or how should we think about that number?

And then I had a follow-up.

That's an incremental number, Greg.

If you remember last year we did a little bit over $8 million and this year we're a little bit over $32 million, and that is a net number.

So we should think of the $24 million as being halfway through to the $45 million you expect for this year?

Yes.

The way to think about that, Greg, if you think about last year, our synergies built.

So in the first half of the year last year we had about 30% of our synergies and they built throughout the year.

This year it's going to be the opposite, it's going to be a flip.

Roughly 75% of our synergies will happen in the first half of the year and then the last 25%, just because they'll be annualizing the bigger numbers from last year.

Got it.

And then second question is could you remind us how many distribution centers you now have for each business, or now it's one business, but we started with GPI and Advance.

And how the plan is of integrating those and how many you expect to have as you move forward on that integration?

Yes, Greg.

Good morning.

So in total we're at 44 today.

We've completed our logistics network study that's going to inform us on where we're going to end up from an integration perspective.

Where we are in the journey right now is we are going to do a significant amount of upgrade work on a large number of the Carquest DCs to prepare the capacity for the expansion of our conversions.

And in the second quarter we'll be in a position to start announcing where we're going to be (technical difficulty).

We obviously have a lot of work to do in different markets and that's when we'll come back and give you greater insights in terms of total count.

So this year is about fixing up the ones we have to make them as optimal and then we decide which ones to close next year?

Is that a fair way to think about it?

That's exactly right.

Thanks.

I'll let someone else have a shot.

Thank you.

Our next question comes from Michael Lasser with UBS.

Good morning.

Thanks a lot for taking my question.

As you get into some of these more complex parts of the integration, are you finding anything that's changing your longer term view or causing you to change direction?

So perhaps you're realizing that some of the systems from either legacy organization just may not be up to speed and you're going to go through a big change management process anyway, so why not take this as an opportunity to bring everything up to the state-of-the-art?

Michael, good morning, it's George.

I'll start with that one and turn it over to Bill Carter who is running our integration.

We are very committed to powering through the conversions and the consolidations.

And I think if you look at conversions as a starting point that's relatively straightforward work.

We've done it in the past.

We have a core competency around it.

We've liked the DIY outcome that's come with much of that work.

The consolidations are inherently more complicated, but again I think with the BWP acquisition, we learned how to do a consolidation quite well.

Little bit more taxing, little bit more time consuming, but we have to keep on working through this.

We've not seen anything that would cause us to dramatically change any of the schedules.

That's correct.

Both from a store standpoint and a product standpoint, you heard George mention the progress we're making.

We continue to be on track.

I think the second part of your question is are you learning stuff through the integration that's causing you to change.

I would say we learn every week.

We learn every month.

And we make tweaks.

We're not radically changing the long-term integration plans by any stretch of the imagination, but we continue to improve it over time.

One example that George mentioned on the call is we recognized the value of getting to our common catalog sooner rather than later so that our availability across the network can be similar across platforms.

So we're prioritizing that as something that's a value-creating engine for the team member and the customer.

That was a learning that we probably had three or four months ago as we were doing our due diligence and have adjusted accordingly to prioritize that as something we're bringing to the front from a value creation and common foundation standpoint.

I'd also say, Michael, that we're not changing the process but we're certainly iterating the process.

Every consolidation we get a bit better.

For instance, if a Carquest store is moving into an Advance store and that base of business that they're bringing along with them requires some parts that were not in the assortment of the Advance store, we're being more expeditious in moving that over.

Maybe last case.

Michael, with your last question is why not get everything to state-of-the-art?

That would be hard.

But there will be a handful of things that will be state-of-the-art by 2017.

Our catalog will be state-of-the-art by 2017 and we'll start to experience some of those benefits as early as the beginning of next year.

Our supply chain in terms of daily replenishment by the end of 2017 will -- the 5X delivery across the nation will be state-of-the-art.

So there's more examples, so we're trying to balance this, as George said, in terms of the team's ability to kind of work through the change, things that we have to power through versus piecemeal.

And we're keeping an eye on the things that are critical to the customer relationship that should be state-of-the-art by the time we get through this in 2017.

Okay.

That's super helpful.

I guess what we're all trying to figure out is just with all the pieces you have in place and what you're learning, there's nothing to suggest that you won't be able to close or at least narrow the margin gap that AP currently has with some of its peers over time.

So there's nothing that's really changing the longer term.

And then as part of that, when should we expect that some of the recent integration hiccups are going to be less impactful and just the business will perform more in line with the market?

Thank you so much.

Hey, Michael.

George again.

I don't think we see anything that would cause us to change any margin expectations.

As far as the work and what's behind us and what's ahead, I tried to give some detail on this and I'll give a bit more.

I think if you look at the actual work that's been done, we've tried to move to a common foundation between the two companies.

And when we say that, we mean product/brand alignment, pricing, process, getting the store support centers consolidated, getting our store leadership teams consolidated in the field, and then beginning some of the early consolidation and conversion and relocation work.

If you look at that, I think the product label part of this is largely behind us.

So again, that was very physically intensive, it's touching 20 million pieces of merchandise and it's essentially close to done.

So we're emerging there.

If you look at the product replacement, that work is still ahead of us category by category.

As far as pricing, we're nearly complete.

Most of the pricing unification has happened and it certainly has in the major product lines.

I call the work ahead of us some of the cleanup work, odds and ends, but the major lines have now been changed.

That's a big change for us.

If you're in the field and you're working with customers and the pricing is different between an Advance store and a Carquest store and you're beginning to bring your customer base together, that leads to questions, obviously, on why someone's getting a lower price than someone else.

And then I think when the work is done, as you can imagine, one of two things has to happen.

If we raise prices, holding the line on unit velocity; and if we lower prices, it is getting the unit lift that we need to pay back for the pricing investment that we made.

So we're making progress there and I think we're emerging from that portion of it as well.

The support centers are -- the work is done.

Now, bringing the teams up to speed, ramping them up in terms of their handle on their new positions remains something that takes a bit of time.

But I think those major elements are behind us.

The product lift is still ahead, no question about that.

There will be some more work around that.

A little bit of pricing work needs to be done yet and then, obviously, the conversions and consolidations will go on for well over a year-and-a-half, two years.

This was helpful.

Thank you so much.

Thank you.

Our next question comes from Seth Basham with Wedbush Securities.

Good morning, and thank you for taking my question.

My first question is around the cadence of the impact from some of the integration changes that you're making.

I understand that they're temporary and primarily in Q1.

But as you've gone through the first month of the second quarter, have you seen the impact lessen and does that give you confidence that you ought to be able to hit your new targets for 2015?

Yes, Seth, it does.

And I think there are markets where either the change has been limited or the change has abated.

If you look at our Canadian business, again, they did this work last year.

Their product replacement is well behind them.

They've activated on it and they're running nice, solid double-digit results in local currency.

If you look at our Autopart International business, they've been protected from most of this change and are continuing to run very nice growth.

WorldPac is just growing and is completely isolated from this change and is running nice single-digit growth.

Where we went into Dallas/Fort Worth on the go-forward systems, we have seen very good results in a very competitive market.

Where we've begun to -- where we did the work early -- and, Seth, we did the BWP work well ahead of this -- that was the biggest concentration of Carquest business in the Northeast.

So, much of that work's behind us and we like the way that we've emerged into Q2 with our Northeastern business, and the intensity of the change management is far less of a factor there.

That's helpful.

So the earnings revision for the year is primarily related to the miss in the first quarter as well as some pressure in the second quarter with very little change to the second-half vision?

Yes, that's a way to think about it.

It's always -- I think George really articulated well.

All those things didn't happen at the same time in the first quarter, so some of the change happened throughout the quarter.

So we were still navigating to the change.

I think that's a way to think about it, Seth.

It's always difficult to predict the exact level of change and the learning curve that the teams are going through.

But the way to think about the outlook is we built in the miss in the first quarter.

We've lowered our sales for the balance of the year.

We went to the low end of our previous range.

If you think of a low single digits in kind of that one to three range, we think we're going to be in the low end of the range and I think that reflects what you just shared.

So that's kind of how we thought about the outcome.

We'll look at the change as is it the product brand work, is it the pricing work, is it the process work, is it the corporate work?

And I think it's an amalgamation.

It's all those things.

And as I said, some of that is behind us now, so we see this abating through the course of the year.

Very helpful.

Last question from me.

The DIY business, it seems like you made some progress there.

Can you comment as to whether or not the comps in DIY were stronger in the first quarter than the fourth quarter?

Yes, we said they sequentially improved 40 basis points, Seth.

I missed that.

Thank you very much.

(Multiple speakers)

Thank you.

Our next question comes from Matthew Fassler with Goldman Sachs.

Thanks a lot and good morning.

Two quick questions.

I'll ask them both up at once.

First of all, as you think about the impact of the loyalty program, you spoke about its impact on sales.

Can you talk about how that tends to impact margin and how you expect the margin impact to progress as that program ramps?

And then, secondly, if you could just update us if you haven't already done so on the sales impact or the sales recapture rate that you're seeing as you close -- as you continue to consolidate some stores.

Let me start off with the Speed Perks program and then Charles Tyson will add some comments as well.

I think we've been satisfied with every aspect of Speed Perks.

To have a membership well over 4 million here early into Q2 and 4 million at the end of Q1, we think that we're onto something pretty good here.

We think that the program is distinctive and is the best in the industry.

It has been a win for us in terms of all the financial fundamentals.

The sales lift has been good.

The transaction growth has been good.

We're seeing a bounce-back effect.

And as you think about -- understanding that sales work, is there -- just to make sure that we model it correctly, is there some give-back on gross margin?

Obviously the gross profit dollars have to be doing well for you to like what you see.

But does the margin rate come down and does that build or is there a cadence to that?

Matthew, it's Charles.

There is an impact from a gross margin rate.

Obviously the impact on sales and the growth we're seeing from that customer segment that have joined the Speed Perks program has a very positive growth punch and dollar impact.

From a pro forma perspective when we piloted this, we're exceeding our expectations from the pro forma that we set for ourselves for this year.

Great.

This is Bill.

Just to answer the question on the consolidation results.

As George mentioned in his comments, we completed the early consolidation program as of the end of last year.

That was focused on the 100 lowest-performing, low-profit stores of Carquest.

We are pleased with those profit and sales results from those and we recaptured about 60% to 80% of the revenue that was associated in those Carquest stores.

Obviously some variability based on markets and how well we executed.

As we move into the broader consolidations associated with the market conversion plan that George outlined, we expect consolidation performance to improve and be at the higher end of that range versus the lower end of that range as we work with programs that are bigger and stronger in nature to start with and we do more meticulous planning of the customer transitions as part of the larger consolidations.

That's where we're performing at this point.

That's great.

Thank you so much.

Just as a reminder, Bill, 60% to 80% is in the commercial part of the business.

And holistically, if you include DIY, understanding that DIY is kind of tiny for the certainly the Carquest stores you're closing.

It's not a meaningful figure.

It generally disburses.

And especially for those, it absolutely disburses.

It wouldn't change that number appreciably.

Got it.

Thank you.

Thank you.

Our next question comes from Robert Higginbotham with SunTrust.

Thanks.

Good morning.

Was hoping to get a little more color on what really surprised you in your integration process.

Was it really that things were taking longer or were just tougher to execute?

Or was there a piece of there being a sharper reaction, if you will, from your customer base?

And one thing I'm trying to get at is to the extent you lost some share through these changes, did you expect to get that back, call it, immediately once you're done with those changes?

Or do you think you'll have to work harder, if you will, to win that business back?

This is George.

I'll start off with that and ask Bill Carter to make some comments as well.

I think if you look at the work -- again, I think if there's something that made an impression, it would be the cumulative effect.

I don't think there's any one aspect of it that was more complicated than we thought, and I think we're well in control of every aspect of the integration.

It's hard work.

I would call the combination the one that has made things a bit more complicated.

A lot of things falling into place at the same time -- pricing changes, product changes.

Any time you do a product replacement, you're relying on execution at multiple levels, including the suppliers.

We've had a couple of instances there where it hasn't been the best first impression of a new part coming on board because of the in-stock condition at the time.

I think when you look at the pricing work, again, it's a multi-phase challenge.

It's not just getting the pricing unified, it's getting the activation around that new price once it's done and that takes time, getting the sales team out there into the shop to communicate that.

It's no one single thing.

It's the combination of all of them blending at the same time.

It's a combination of -- to answer your question specifically, Rob, nothing took longer than we expected.

I think it was just tougher when it all added up in Q1, change for our team and, as George mentioned, change due to some of the product and pricing changes through the team and the customer work-throughs.

So it was more the amalgamation of them than any particular thing sticking out as a surprise.

Parts of it were terrific.

So if I can go back to the cultural overlay and the field alignment, we asked our teams to go to 33 regions across the country and we combined leadership.

Some of our regional vice presidents come from Carquest, some of them come from Advance.

They initially spoke a bit of a different language in terms of how they focused around the business and that, one quarter later, has meshed together very, very well.

Okay.

That's helpful.

And in terms of winning back some of the business -- granted you're still growing commercial, but winning back some of the share that you presumably lost, do you expect that to happen automatically or will you have to do something incremental to get that back?

I think while some of the change has been tough -- and let's talk about the product brand alignment.

Uniformly we like where we're going.

So when the work is done and when the work is behind us and we have this new house of brands that we think is terrific, our team's behind it, our customer's behind it and we're very confident that we'll win back.

And we've experienced this in previous integrations when we did BWP and we had things disrupted.

The share came back over time, within a year usually, but not instantaneously.

It's not going to come back next week.

So we feel good about the recovery.

The dip wasn't nearly as bad as what occurred in some of the previous ones.

But that share comes back, we regain that share with customers, and we do it over a reasonable period of time.

Got it.

That's very helpful.

My second question is really on your general pricing strategy.

Historically it seems like you've been pretty aggressive in the marketplace in commercial.

As you harmonize pricing, is that a fair way of thinking about how you're currently going to market?

Does price become less of a point of competition as you increase daily delivery and now have bigger muscle as a bigger enterprise?

Yes, I think that's absolutely the case.

When we looked at the pricing continuum, as you'd expect, Advance was on the more competitive side and Carquest was on the higher side.

We struck a point where we felt it was the right pricing strategy for the kind of commercial business that we're going to emerge as and that we've become.

And that includes 5X delivery benefits, that includes a lot of the commercial know-how coming from Carquest, that includes the Carquest training institute, that includes our TechNet programs, banner programs that have come out of this partnership.

Got it.

Great.

Thank you.

Thank you.

Our next question comes from Dan Wewer with Raymond James.

Thanks.

Can you talk about the perspective of your commercial customer, what they saw differently from Advance and Carquest in the last quarter that resulted in the market share in your commercial channel, I guess, weakening a bit?

Was it a disruption in your in-stock capabilities, your ability to hot- shot a part within 30 minutes?

Was it a change in the salesman covering their account?

If you can give us some clarity on that.

Sure, I'd be glad to.

And I'll give it to you from the perspective of if you were a district manager for, say, Carquest and some of the change that's happening right now.

Those customers working with that team will have seen some product changes.

Clearly there have been changes in filters and in belts and in chassis and in gaskets and in batteries.

So brands that you've been used to selling for many years, you're now in some cases selling a new one and in all cases going forward you will be.

So it's bringing the customer along on that journey and just showing and demonstrating the quality of the part.

And I start off right there.

I think the pricing part of it has been an impact as well where there's some interim period of time where, again, in a market Carquest and Advance have two different prices.

And then we have a new one going forward.

So for those Carquest customers, they're very often seeing lower pricing, and again we have to activate and sell more when that happens.

But that's a change.

Some of the systems tend to change for our team along the way.

We try to make that as transparent as possible and protect our customers from change.

So from a B to B standpoint, they're using the same systems that they always have.

I think those are the major changes.

And we have changed some of our sales territories and that's another part of it, where we did not want to have a customer have an Advance commercial account manager come knocking on the door and then the Carquest commercial account manager came knocking on the door 10 minutes later.

That appears to be disorganized and it's confusing for a customer and we've changed that.

So we have built new sales territories with a single representative representing both brands in some cases.

But every customer has one commercial account manager only, not multiple.

So in some cases it's a new face; in others it's the same.

Following up on the previous question, I don't understand if a commercial customer is now, let's say, doing more business with O'Reilly or more business with NAPA and perhaps Advance or Carquest dropped down the first-call list.

If they're getting a good experience with your competitor, why are they going to toggle back to Advance two or three quarters down the road?

Well, I think we'll have converted all of our brand work.

We'll have all of our availability and all of our brands lined up, our pricing lined up.

I'll remind you some of those relationships go back for years and years.

So there might be a period of time where part of our integration is showing up in a commercial shop, but we've been with these folks for a long, long time and that matters.

Dan, this is Darren.

So part of the indicators I look at -- because I think that's a fantastic question, is that when we look at our strategic and national accounts, our growth slowed a bit in the quarter, but you know what?

The ones that have been leading the way continue to lead the way.

So whether that's CarMax or whether that's DriveTime or others, we feel really good about that.

When I peer into the Carquest network, their banner programs, we grew that business in the quarter 7%.

So those tend to be some of the large bay installers.

And then we grew the TechNet customer specifically.

There's only 6,500 of them, but we grew those double digits in the quarter as well.

And those tend to be a leading indicator of the best relationships.

And we built up, or I should say the Carquest team has built up, a lot of great equity in terms of those relationships.

Now we did see a little bit of a pullback on the Advance side.

Some of that weather always evens out.

But I think when we move the salespeople -- you know what?

What happened is we are not able to give as much attention as we're going through the process, and what we have to focus on and what we're monitoring is that quarter in and quarter out, Mike talked about a 300 basis point volatility in terms of touching customers.

So each period we've seen that volatility come down a little bit.

And what is it is that we're touching customers again on a consistent basis.

And so that's how you win people back, and then you augment it, as we've said, with getting the pricing right, the product brands, and the consistency.

And just a real quick question for Mike.

On your 12% operating margin goal for 2017 you talked about 100 basis points of cost reductions, I guess that equates to about $100 million.

Is that going to be back-loaded primarily to 2017, or would you expect to achieve some of that $100 million savings either late this year or in 2016?

The way to think about it, Dan, is we really started that once we put this acquisition together.

Our operating margins were at 9.1% last year.

We did some work on our costs.

This year we're doing some work on the costs.

And I think you're right, it will start to accelerate into next year and then we'll probably see the biggest change hit us in 2017.

And I think we've talked about our costs before as we move to a lower cost -- lower commercial model, we see opportunities at our support centers to take costs and make ourselves more efficient in those areas.

IT is an area, as we get rid of duplicate systems there's a big opportunity.

And then as we improve the profitability and productivity and the variability across our store base.

We think those are big opportunities and it's work that -- it will be very planful.

It will be very thoughtful.

And then part of also getting to 12% is keeping our sales goal and growing the comps.

So that's another important dimension.

Thank you.

Thank you.

Thank you.

And our final question today comes from Chris Horvers of JPMorgan.

Thanks, and good morning.

So a question asked, maybe asked prior but a little differently this time.

I'm trying to dial in the impact of the integration impact on the Carquest commercial business versus the heritage AAP commercials.

On Carquest there was a lot of concern that the business had decelerated all year in 2014 and worries that something was breaking there in the integration.

And then the heritage AAP commercial did very well last year.

So maybe can you share some insights on Carquest and the heritage AAP and maybe highlight regions that didn't have as much change impact and how those businesses performed and what the lift you're seeing from daily delivery and heritage AAP?

I think if you look at, Chris, the change for the Carquest commercial business, I highlight one thing.

They're the beneficiary of a pricing benefit.

So certainly we're seeing that happen.

And again that activation piece of getting the unit velocity back is not immediate.

So if you look at where that's happening, more often than not lower pricing is happening in the Carquest network, they're having to go catch up, get the velocity to drive the dollars above where it was before.

There really aren't many markets in the country where there's (technical difficulty) change to Carquest.

The best indicator of that would be the BWP business.

And again, as Bill said, there's a trough initially, but we certainly see ourselves come out of it and build upon the business.

In the 5X markets, we've been very pleased with the lift, and the most recent work that we've done was Lakeland, Florida, to get north Florida on the daily delivery.

Very happy with our outcomes in Florida.

And then, of course, we have a new Hartford, Connecticut, facility that is at about 160 stores now and beginning to ramp up more and more, bringing daily delivery to the northeast.

And we're happy with those results too, and especially the way that just recently with a lot of the change behind us in the northeast, that market we're pleased with.

So the daily delivery lift is basically as you've rolled more DCs in more stores, it's been consistent with your prior experiences?

That's correct.

Obviously, as George said, we've been very happy with the impact in our Lakeland facility and our teams have done a wonderful job in executing that without any interruption of service to our customers.

And we're beginning to see that flow through into our new Hartford facility, and we will complete more of that work as we move through the year this year.

Probably the most -- the clearest example we have is what's gone on in Canada, right, team?

They went through a first, littlest change, double-digits comps.

I know the competitive set's different, but there's some pretty good competitors up there as well and the team's doing a great job.

WorldPac continues just a -- it's a very nice business, growing above our early expectations.

They're doing a nice job.

And the BWP market, certainly less change there and they're a leading indicator too.

We just have to power through it.

We've got to finish through the things, we've got to power through, and we've got to manage to the integration plan that we set out there.

I'll also say that our Dallas/Fort Worth market opening has been a great example too.

We're very happy with the results in Dallas/Fort Worth and how we entered a new market, and we used something close to what the go-forward model will look like.

We used a Carquest distribution center.

It is on daily delivery.

We opened up super hubs geographically spaced across the DFW metroplex.

We've got a combined team.

There will be some change still in those markets.

It's not entirely on the go-forward plan, but it opened up well and certainly we like the outcome there.

And so two quick follow-ups.

So, A, what did your -- what was the first-quarter earnings below your internal expectations?

And, B, what do you attribute the improvement in the DIY business to, because the compares are actually tougher.

So was this actually the loyalty card helping?

Thanks.

I'll hit the first one and then I'll let George hit the second one.

It's real simple.

It was on the top line.

We said it.

The change that George put through, discussed, and we believe those are shorter-term impacts, they had an impact on our field teams.

And it primarily came through on our commercial sales.

That was really our shortfall.

I think we were pleased with some of the things.

Really pleased with our synergy work and what we did there, and so we're building momentum there.

But really showed up on the commercial sales side.

On the DIY side, I think the single biggest change was the Speed Perks program.

Again very, very happy with the membership base that's being built.

I'd also add that we changed our marketing strategy.

And you'll see a shift in our marketing mix more toward TV.

And on TV you'll see it in places where car guys tend to watch TV.

So a car-related show on Velocity TV, a Nascar broadcast.

And we're getting very, very good feedback on that and I think it certainly highlights what's different about our loyalty program.

At this time, I would turn the call back over to Zaheed Mawani for any final comments.

Thanks, Lisa, and thanks to everyone for participating on our first- quarter earnings conference call.

That concludes our call.

Thank you.

That concludes our call today.

You may now disconnect.

Thank you for joining us.