Advance Auto Parts, Inc. (AAP) Q2 2007 Earnings Report, Transcript and Summary

Welcome to the Advance Auto Parts Second Quarter 2007 Conference Call. All participants have been placed on a listen-only mode until the question and answer session. [Operator Instructions]. Today's call is being recorded. If you have any objections, you may disconnect at this time. Before we begin, Eric Margolin, Senior Vice President and General Counsel 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. Certain statements contained in this conference call are forward-looking statements as that term is used in the Private Securities Litigation Reform Act of 1995. Forward-looking statements discuss among other things expected growth and future performance including new store openings, remodels and relocations, comparable store sales, sales per store, gross margin, SG&A expenses, operating margin, return on invested capital, free cash flow, accounts payable ratio, capital expenditures, tax rate and earnings per share for the third quarter and fiscal year 2007. These forward-looking statements are subject to risks, uncertainties and assumptions including those disclosed in the company's 10-K for the fiscal year ended December 30, 2006 on file with the Securities and Exchange Commission. Actual results may differ materially from anticipated results described in these forward-looking statements. 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. Our results can be found in our press release and 8-K filing which are available on our website at www.advanceautoparts.com. For planning purposes, our third quarter earnings release is scheduled for Wednesday, October 31, 2007 after market close and our quarterly conference call is scheduled for the morning of Thursday, November 1, 2007. 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 1 year. Now let me turn the call over to Jack Brouillard, our Chairman, President and CEO who will be followed by Jim Wade, EVP of Business Development and Jill Livesay, SVP, Controller. Jill will be filling in this morning for Michael Moore, EVP and CFO who is unable to attend today's call due to a death in his family. Also joining us today on the call will be Elwyn Murray, EVP, Merchandising, Supply Chain and Technology. Jack?

Good morning and welcome to our second quarter conference call. Over the past three months, I have had the opportunity to work closely with our management team as well as to visit our stores and distribution facilities and speak with many of our dedicated team members. I believe our team has made significant progress in this short period of time in taking the steps to position us to strengthen our business as we go forward. I want to give you an overview of our second quarter results and outline the steps we are taking to improve our sales, our earnings and return on capital. In the second quarter, we saw a continuation of the disappointing sales trends we experienced in the first quarter. Comp store sales grew by 1.3%. As Jim will discuss later, our comp sales results were stronger excluding our Florida and the Gulf Coast stores. Gross margin grew by 51 basis points, which was less than the growth in the first quarter and in line with our expectations. SG&A deleveraged by 41 basis points as a result of our low 1.3% comp store sales increase. Earnings per diluted share grew $8.5 to 60... 8.5% to $0.64. Our guidance had been for comp store sales growth in the low single-digit range and earnings per share in the range of $0.65 to $0.69. Second quarter results included costs of $0.01 per share related to the CEO transition and other severance costs. I want to discuss the steps we are taking to improve our performance. As I mentioned on our last call, our recent strategy review confirmed that we must return to the basics of being a parts store to reinvigorate our sales growth. The in-depth customer research on both DIY and commercial customers provided us good insight and background for our action plans. We believe the following key initiatives are critical to growing our sales. First, we are improving our parts availability to better meet the needs of our core customer segments. We have developed and are implementing a plan to increase parts availability in our stores. We believe this will drive improvement in both our DIY and commercial sales. The plan is focused on greater late model and foreign vehicle coverage as well as being more aggressive in getting parts into our stores and closer to our customers. We have used input from our store managers and our parts professionals as well as internal and external data to make our decisions. Some of this increase in coverage is already in the process of being distributed to our stores and most will be completed before year end. Jill will discuss the impact of these decisions on our inventory investment. At the same time that we are increasing parts availability, we have implemented an aggressive program to free up dollars invested in less productive inventory to fund a portion of this investment. Also, to increase our parts availability and inventory productivity over the longer term, we have reprioritized our information technology projects to improve our custom mix, our merchandising and inventory management tools. Second, we are increasing our commercial focus to take greater advantage of the full potential of the large and growing commercial market. We believe that over the last few quarters, we have missed meaningful opportunities to drive our commercial sales and as a result our comp growth in this area has slowed. While 5% to 6% comps are respectable, we believe they fall short of our potential in this area. Increased parts availability will be a component of this improvement. However, we are taking a look at everything we are doing in this area to increase our commercial sales growth. Our commercial research as well as our continued learnings from Autopart International give us more insight on how to further grow this business. We are looking at store staffing and training, compensation structures, truck utilization and many other areas to optimize our structure for further commercial growth. You will be hearing more about this over the next several quarters. Third, we are changing our previous focus on the front room. As part of our ongoing business review, we have begun to improve the efficiency of our work on the sales floor or front room portion of our stores. Among other things, we are streamlining our front room assortments where applicable and reducing the frequency of tasks such as planogram changes. This wok in improving efficiency and sales productivity will continue throughout the remainder of the year. In addition to growing our sales, we will make more progress on reducing our SG&A and improving our return on invested capital throughout our company by realigning our investments to the customer segments that provide us the greatest opportunity of return. To have a meaningful impact, we must make structural changes in how we operate instead of just marginal reductions through business as usual. Over the past several weeks, we have made decisions in a number of areas that will reduce certain SG&A expenses by more than $20 million in the second half of 2007 and over $50 million in 2008 and that will reduce CapEx investment by $20 million in the second half of 2007 and over $65 million in 2008. Some of those decisions are as follows. We announced yesterday a reduction in our field and store support center of 250 positions including 175 field positions and 75 budgeted and open positions which are now closed. I want o emphasize that none of these positions are in our stores. We are assisting this group of team members to transition to the next step in their careers and we want to thank them for their service to the company. We will reduce our new store growth in 2007 to 190 to 200 stores and in 2008 to 140 to 150 Advance Auto Parts and Autopart International stores. We are also anticipating relocating 20 stores in 2008 compared to 35 in 2007. We believe this is a prudent step for us to take while we work on getting our comp sales growth restarted, improving our operating results and further refining our new store operating model. We have halted our 2010 store remodel program because our research showed our customers are not giving us credit for this significant investment and our recent sales show it is not delivering the expected results. We will be reevaluating our go forward remodel plans. We will of course continue to perform routine store maintenance. Our store base is in very good shape overall. In fact, over 2700 stores or 87% of our store base has been opened, relocated or remodeled since 1999. We have discontinued our Advance TV network in our stores. Again, through our customer research, we have determined that our customers did not give us credit for this substantial investment. We have eliminated certain advertising expenditures that we determined were not productive in driving our sales. We are testing and measuring other portions including our print advertising program, and the results of those tests will drive our advertising decisions for 2008. We have evaluated all of our planned CapEx investments in logistics, IT and every other support area of the company and have eliminated those investments that did not demonstrate an acceptable return and realigned all others to support our go forward strategy. These are just a few of the areas where we have made decisions to reduce and redirect expense and capital and this is the beginning of a more cost conscious and return-oriented culture in our company. We already have under way the evaluation of the next structural expense reductions that will be needed to refit our company to support the findings from our strategy review. We will share them with you over the coming quarters. Some areas we are looking at include the productivity of our field and commercial transportation expenses, reducing our store occupancy costs, lowering our non-merchandising purchasing costs and many other key areas. We believe the steps we are taking to drive sales and reduce expenses are positioning us much better to support a more effective strategy as we go forward. As Jill will discuss further, we will see the positive impact of the expense reduction in the third and fourth quarters. We believe we'll see some impact from the sales drivers over these next two quarters, but we expect it to be minimal in the short term. Internally, it will take us most of this time period to implement our initiatives and externally, the economic headwinds may continue to be a negative for sales growth for the remainder of the year. We believe high gas prices have reduced our customers' ability to pay for needed repairs and have increased maintenance deferrals. We anticipate that over time customers will adjust their budgets and we will see a benefit when this deferred maintenance is performed. Now I would like to turn the call over to Jim and Jill who will review further our second quarter results and our guidance for the remainder of the year. Jim?

Thank you, Jack, and good morning. I'll provide a further breakdown of our sales and store growth for the second quarter and then Jill will discuss gross margin, SG&A as well as the balance sheet and cash flow. As Jack mentioned, our comp store sales came in at the low end of our guidance at 1.3% compared to 1.2% last year. During the quarter, our sales challenges were consistent with what we had experienced in the first quarter. We did see some signs that we thought indicated strengthening at the beginning of the quarter, but as we entered the summer season, there was no consistent trend over the remainder of the quarter. On a geographic basis, sales continue to be stronger in the North and Midwest and weaker in Florida and the Gulf Coast market. Certainly, a portion of the weakness in Florida and the Gulf Coast relates to the cycling of the post-hurricane sales surge. However, as that is now cycled, we have not seen significant improvement and the overall economic trends in these markets appear not to have strengthened yet. Just as a comparison, our comps excluding Florida and the Gulf Coast were 2.8% in the second quarter. During the second quarter, our DIY comps were a negative point 0.1% compared to a negative 1% last year. Our commercial comps were 5.8% over 9.1% last year. This comp was consistent with the first quarter. As Jack mentioned, we are in the process of refocusing on getting our commercial comps back to a double-digit run rate we had previously achieved. Commercial sales including AI represented 26.1% of our total sales. For the quarter, our total commercial sales were $305.2 million, an 11.5% increase over last year. Commercial is a faster growing segment of the auto aftermarket, and we believe it can continue to become a larger portion of that business. During the quarter, we added 32 new commercial programs, most of which were on our new stores, bringing the total number of Advance stores with commercial programs to 2525. Today, about 82% of our Advance stores have commercial programs, the same percentage as last year. Autopart International continued to grow with an additional 13 stores so far in 2007, bringing their total store count to 100. AI celebrated recently the opening of their 100th store with another new store in New Jersey as well as their 50th year in business. For the first quarter, AI contributed $33.9 million in sales. In the second quarter, we opened 43 new stores. 38 of these new stores opened as Advance Auto Parts and 5 as Autopart International. year-to-date, we have opened 113 new stores, 100 of Advance and 13 of AI. We closed 6 stores in the quarter and 8 year-to-date. Our new store productivity remained comparable to last year. In line with our plans to open 140 to 150 new stores in 2008, we have reduced our planned openings to 190 to 200 stores for 2007. We had previously indicated 200 to 210 new stores in 2007. This represents an approximate 6% rate of growth in 2007 and 4.5% in 2008. In 2007 and 2008, we anticipate all of our new stores will open within our existing 40 state footprint. We have also remodeled 61 stores year-to-date. The reduced scope [ph] remodels we started earlier this year significantly reduced our costs. However, not enough time has passed to measure the sales results and ROI from these remodels. As a result, we are halting the remodel program until we have had time to evaluate how we can achieve a higher return on invested capital and better align the program with the findings from our customer research. We have allocated sufficient CapEx in our budget for 2007 and 2008 to maintain our stores on a regular basis during this period. year-to-date, we have relocated 19 stores and foresee approximately 35 relocations in 2007. As Jack mentioned, we anticipate approximately 20 relocations in 2008 as we further evaluate how to increase the return on these investments. Included in our next round of CapEx and SG&A targets is a complete review of our occupancy cost. We believe the findings from our strategy review provide us a significant opportunity to reduce the occupancy cost for our new stores through building and site cost reductions. With our real estate activity in 2007, we ended the quarter with 3087 Advance Auto Part stores and 100 Autopart International stores for a total store count of 3187 stores. Now let me turn the call over to Jill to review our financial result.

Thanks Jim and good morning. Let me begin with our reported earnings. Earnings per diluted share were $0.64, which was slightly below our earnings guidance of $0.65 to $0.69 per share. Our earnings guidance did not include costs of $0.01 per share related to the CEO transition and other severance costs. For the quarter, gross margin was 48.1%, a 51 basis point improvement over last year. This reflects improved procurement costs and lower logistics expense. As part of our improved procurement costs, LIFO was a $3.3 million credit in this year's quarter compared to a $5.6 million credit in last year's quarter. Going forward, we expect modest LIFO credits in most quarters as we benefit from lower costs in most product categories. Turing now to SG&A. Our SG&A expense rate for the quarter rose 41 basis points compared to last year. This increase was primarily due to a 50 basis point increase in fixed expenses as a result of low comp sales and expenses of $1.5 million or 13 basis points related to the CEO transition and other severance costs. These items were partially offset by savings in other expense lines. With the expense reductions Jack outlined, we expect to leverage SG&A in the second half of the year. The SG&A leverage in the second half before severance and asset write offs of $6.4 million or 57 basis points. With the expense reductions we have made thus far and further reductions under review, we believe we can leverage SG&A on less than a 3% comp going forward. Interest expense net of interest income was $6.9 million in the quarter compared to $8.8 million last year, primarily due to lower borrowing rates and higher cash balances this year compared to last year. Approximately 65% of our debt is hedged to fixed rates and our current borrowing cost is just over 6% at today's rate. Our second quarter income tax rate was 38.3% as compared to 38.1% last year. Going forward, we expect our tax rate to be in the range of 38.4% to 38.6%. In terms of the key components our balance sheet and our cash flow statement, for the quarter, inventory increased 8.9% on a sale increase of 5.6%, in line with our performance in the first quarter. The rate of inventory growth was greater than the sales growth due to one, expanded parts assortments in selected stores; two, second quarter sales coming in below expectations and three, an inventory build in the new AI distribution center during its opening. In the third and forth quarter, we will be making investments in parts availability. We expect to offset a portion of this investment by increase the productivity of our existing inventory, rebalancing inventory on selected categories and selected stores. As a result of this parts availability initiative, we expect that inventory will grow somewhat faster than sales in the second half of the year, but the spread between inventory growth and sales growth will be less than in the second quarter. Our accounts payable to inventory ratio was 57.1% compared to 57% last year. We continue to see opportunity to grow our AP ratio. On the cash flow statement, our CapEx was $39.8 million for the quarter and $115.7 million year-to-date, lower than the $54.1 million and $132 million spent last year respectively. As Jack discussed, we are taking a number of steps to reduce our capital spending and improve our return on invested capital. We now estimate capital expenditures for 2007 to be $230 million to $240 million as compared to our previous estimate of $250 million to $270 million. This estimate includes approximately $25 million for our 9th distribution center in Indiana. As a result of fewer new store openings in 2007 and 2008, we have delayed the opening of our next distribution center from mid-2008 until the beginning of 2009, which will help our SG&A leverage in 2008. With the reduction in CapEx, we expect free cash flow to grow by more than 80% in 2007 to a range of $150 million to $170 million for the year. This is an increase from our prior guidance of $125 million to $145 million. In the second quarter, we repurchased 95,000 shares. So far in the third quarter, we have repurchased an additional 890,000 shares. In addition, the Board of Directors yesterday approved a $500 million share repurchase program which replaces the $300 million share repurchase program which is nearly completed. As we have said before, we expect to continue to return capital to shareholders through dividends and share repurchases. Share repurchases specifically are a key part of our capital allocation strategy, and as we look at the returns on investments within the business as compared to investments in our stock at its current price range, we find share repurchases to be very attractive. In terms of updated guidance, for comp store sales we are assuming negative 2% to flat in the third quarter and flat to 2% in the fourth quarter. We are basing our guidance on the assumption that a challenging macroeconomic environment will continue throughout the balance of the year, and because of the implementation timeframe, our sales building initiatives will positively impact second half sales to a limited degree. For the second half, we expect minimal improvements in gross margin percent as we work through the inventory and merchandising initiatives we have discussed. Also, we expect to start leveraging SG&A in the second half as a result of expense initiatives we have implemented. We expect earnings per diluted share in the third quarter to be $0.53 to $0.57 and for the year to be in the range of $2.24 to $2.32. Included in the third quarter guidance and 2007 year guidance is approximately $0.04 in severance costs and asset write offs associated with the reduction in workforce and halting of our Advance TV network. We believe that all of the steps we are taking certainly position us to improve sales, reduce SG&A and improve return on invested capital going forward. Now I would like to turn the call back over to Jack.

Thanks Jill. In closing, I would like to again thank our team members for their commitment over this past quarter as we make some difficult but necessary decisions. In the lifecycle of every company, there are times when there are growing pains that we must go through to unleash the next cycle of our growth. I believe this is one of those times and the changes we are making now come at the cost, but will allow us to turn our attention to achieving our full potential as we go forward. I look forward to seeing you all in my travels over the next few months. We are now ready for questions. Operator? Question And Answer

Thank you. [Operator Instructions]. Our first question today is from Tony Cristello. You may ask your question and please state your company name. Anthony Cristello - BB&T Capital Markets: Hi, BB&T. Good morning. I guess one of the questions I had is when you talk about the guidance, and I think Jill alluded to SG&A leverage in the second half, but yet you are taking earnings estimates down by a dime and that's reflective also of probably $0.11 or so in SG&A savings. I am just trying to understand is the revenue, the deterioration there, I mean it seems like that's either a bit extreme and certainly not as consistent with what others are seeing. And is there something else that's... you talked about the initiatives on the hard part side of the business. I mean is that actually hurting you from a sales perspective at least until the end of this year?

Well thanks for the question Tony. I'll start off and I'll let the rest of the team come in as needed. The main driver of where we have placed our guidance is the sales environment that we are in right now, and we hope that it improves beyond what we are seeing right now. But you could view us as being conservative, but this is the reality that we see right now that it's been difficult to generate any sustained comp sales momentum. Now this week, as many of you are experiencing and seeing on the news, it's quite hot this week and we are comping significantly better this week. But at the point in time when we had to deliver the guidance, the concern we have is that while we feel very good about many of the initiatives and that they well in fact give us traction over time, the external environment weighs more heavily in the near term than the ability of these initiatives to give us traction. So while we are going to get those SG&A savings, the concern we have is the external environment and what the sales momentum will be. Anthony Cristello - BB&T Capital Markets: It would seem, though, if your sales are going to be comping flat to minus 2 and you are still getting leverage, I guess I am just... is the DIY business really that bad? I mean are you comping like a minus 1 or worse on the DIY side and are you comping minus 10 in the state of Florida right now?

Maybe Jim can add a little color to it.

Tony, I think what we are seeing currently, as Jack said, through these first three weeks, the comps in both areas, both DIY and commercial were a little less than what we have been running in the second quarter, and that's the basis for the direction on the guidance. The other thing you will likely see that Jill mentioned in her comments as well in the third and fourth quarter is probably less gross margin percent improvement as we make all the changes in the implementation of these initiatives from pushing out more parts and the related cost of doing that and those kind of things. So that's an area that we are probably not as optimistic over the second half of the year as we were before, not because anything fundamentally has changed, but because of the activity that's going to be going on in those two quarters. Anthony Cristello - BB&T Capital Markets: Okay. Just one follow up and I'll ask someone else to take over. How much of the sort of initiative to improve parts availability, do you have like a cost in total of what you see that aside from what you think you can do internally, just from mixing things around?

Hey Tony, this is Elwyn Murray. We have obviously increased our intensity and our focus on parts availability at a much greater level, particularly since May. We had some energy going on prior to that, but I would say that in the back half of the year, we were literally introducing 2 to 3 times what we would have introduced on a regular run rate when it came to inventory related specifically to parts. As you are probably well aware, there are lead times required in this industry in particular with hard parts. So it will take us a bit longer to get some traction on that, but we are very encouraged about the significant emphasis and amount of parts inventory that we are going to be able to get into our stores in the back half of the year. Anthony Cristello - BB&T Capital Markets: Okay. All right, thanks.

Thank you. Jeff Sonnek, you may ask your question and please state your company name. Jeffrey Sonnek - Friedman, Billings, Ramsey & Co., Inc.: Thank you. FBR. Just back to this parts availability theme. If you are cutting advertising spend, and this is not completely clear how you are doing that, but I mean how do you communicate to the customer if they are only shopping your three times a year and exactly what they are going to find in advance or why they should shop your store versus one of your competitors?

Yes, I'll take that. We have all heard the expression that half the money we spend on adverting is wasted. The trouble is we don't know which half. And we are doing some pretty deep work there to determine what is effective in what we spend on advertising and what isn't. And from that, we are identifying the vehicles that we think are going to be critical to deliver our message. I will say that we want to deliver that message when we are poised to deliver for the customer. So as we think about certainly '08 and into the fourth quarter of this year, getting these parts in the right locations, we are certainly thinking about how we are going to craft our message in and what medium we are going to use to communicate it. So that will be a key part of it.

It's a good question, and the work we are doing in reducing the advertising, I don't think had much bearing on telling the customers about our parts availability. The TV network and the store really addressed only the people who are already in the store, and we are finding that we have opportunities in the print side which was really not driving that business either. Jeffrey Sonnek - Friedman, Billings, Ramsey & Co., Inc.: Do you care to quantify or help us think about these expense savings and maybe how... and maybe an order of magnitude where advertising falls versus these headcounts reductions etcetera?

The biggest impact in the advertising area for this $50 million of cuts for next year was around the Advance TV. And that was one of the bigger items within the list, and I think to quantify that, it's $7 million to $8 million on an annual basis. The remainder of the items were all equal to or lower than that number, and that was the only significant large number that came out of the advertising by itself. Jeffrey Sonnek - Friedman, Billings, Ramsey & Co., Inc.: Great. Good luck. Thanks.

Thank you.

Thank you. Matthew Fassler, you may ask your question and please state you company name.

Thanks a lot, Goldman Sachs and good morning.

Good morning.

I would like to ask two questions. I guess first of all, to what degree as you look at the sales deceleration you are experiencing, while the macro environment is tough, some of your competitors have spoke to essentially in line sales trends quarter to date. To what degree, through timing or through the area of weakness, have you been able to essentially tie the slow down to potential disruptions from steps that you have taken to make changes in the business?

That's a great question. We ask ourselves that every day, every week because you always wonder how much of it is external to you and how much of it is what you may be doing or not doing inside the business. There may be an argument that there is a bit... we have had a CEO change and as always, there is always some potential disruption with that. But I still think if I weighted out the factors and as we look at it and we discuss it and look at the data, it is largely external. And we operate in a variety of geographies, but some different... concentrations are different at O'Reilly and other places. Commercial is 25% of our business and that's been better than the DIY. The stores are being well maintained and well led and well executed, and again this week it's turned hot and our business is quite good this week. So it's not to say that we don't ask that very, very same question continually, but I can't see major areas we are "doing it ourselves".

Got you. I guess my second question is sort of a management question. There has been significant management transition, and I guess my question Jack is are... is the company looking, if you will, for a permanent CEO, and you don't have an interim title, the implication had been that this was in essence going to be an interim transitional role for you and there is no discussion there. So if you could give us a sense as to what the game plan is there.

Well, we continue to have our search process for a permanent CEO in that I am in fact Interim CEO. Russell Reynolds is working with us closely on the search and it's tracking on progress, and beyond that, I can't say much more, but we are optimistic that we'll have a successful completion to the search.

I guess the follow up to that is the changes that you are making are pretty significant, so how have you essentially weighed the magnitude of the changes that you want to make to the business versus the fact that you will probably have a successor at some point who will probably want to put their own stamp on the business? How have you... have you decided what the appropriate level of change is?

Well we ask ourselves that question, and we have been thoughtful and deliberate I think in terms of the things we have done up to now and then the next set of initiatives are also being treated the same way. We think they are consistent with not only the strategy work that we have done recently, but also in line with just good business practices. When I look at an SG&A that's higher than it should be, I don't think we have the luxury... I think whoever the new CEO is is going to have to address that. So we think we are addressing it in a way that would not be adverse to the decisions a new CEO would make.

Got you. Thank you so much.

Thank you. Danielle Fox, you may ask your question and please state your company name.

Thanks. Good morning. Danielle Fox, Merrill Lynch. I have a few questions. First, I was wondering if, as part of the strategic review, you have made or contemplated any changes to the compensation structure either at the manager or the store associate level.

That's all under evaluation at this point. I can't give you any details, but we are very open to developing new scenarios and testing them and see if they are good for the business and for our team members. And that revolves around new ways to incent sales and the like, Danielle.

Okay, thanks. And then I was wondering also if you could just be a little bit more specific about the sources of gross margin expansion this quarter and where you see some... Jim, I think you mentioned you expect a moderation over the next couple of quarters. You pointed to improvements in logistics and procurement, but if you could just be a little bit more specific about what you are seeing and whether pricing is contributing at all to the gross margin expansion?

Hi Danielle, this is Elwyn. We have enjoyed 400 basis points of improvement in our gross margin over the past five years. And while we continue to expect further progress there, particularly as we continue to work with cost of goods reduction side, we certainly want to ensure that we are priced right and where we need to be in the marketplace on the parts of the business that matter most. So under my leadership, we are going to be pushing for the cost of goods and ensuring that we are where we need to be in the market. And again, given the rapid growth we have enjoyed over the last five years, we just think that rate of growth may slow a little, but we continue to see progress there expected.

Okay. So it's primarily a function of comparisons?

Yes.

Okay. And then just the final question is just a little bit more strategic. After sort of executing on the plan that you laid out, I wonder what you see as sort of Advance Auto Part's major points of differentiation competitively. You talked about cutting headcount, ad spend and modeling activity and adding parts to drive the commercial business. That sounds somewhat similar to what your chief competitor is doing today. So what do you see as major points of differentiation once you've successfully executed on the plan?

Yes, this is Elwyn. I will answer that and say part of the reason it sounds like our chief competitor's, because those are the dimensions that matter most in this business. And so we are convinced after the strategy work we have done on things like parts availability, nozzle [ph] parts, pros and individuals in our stores, parts quality, convenience and speed of delivery are all the things that matter most. So while we have arguably fixated on the front room or areas that haven't meant as much, we feel like we are at a position where clearly we need to redirect our energy towards these areas that do. Parts availability, I would say our challenge there is to bring ourselves up to par with, and then we are looking at developing the infrastructure and systems that allow us to make that ultimately a competitive advantage.

We have in addition, as you well know, strong market share number one and number two position in many of our markets, and we intend to maintain that point of view. Another dimension, we have got a very high talent group of people that are working for our customers in our stores, and we continue to feel that we are going to build on that strength that we have and that a point of differentiation long term will be our people.

Thank you very much.

Thank you. Gary Balter, you may ask your question and please state your company name.

Good morning. It's Seth Basham for Gary. A couple of quick questions. Just in terms of how you are planning your new store growth going forward, you mentioned you still plan on growing in our existing markets. But are there certain states or certain geographies where you are going to be carrying back that growth more than others?

This is Jim. Seth, not really in terms of carrying back in specific areas. I think our mix for a number of years has been continuing to fill in and reinforce some of our core markets and then expand further into the North and out through the Midwest including places like Texas where we have added quite a few stores; Chicago, we have added quite a few stores. So what we have done as we look at 140 to 150 stores is just look at all the projects we have in the pipeline and look at what our plans are going to be for next year and adjust where it's appropriate. But you would not see a significant change in the strategy in any of the markets that we are in.

Understood. And then we think it's a great step in the right direction in terms of all the cost cuts to lower the leverage bar. You mentioned that you expect to leverage on a 3% or lower comp going forward. Can you be more specific? Are we talking more about a 1% to 2% comp that you could gain leverage on next year?

I think we'll be able to talk more about that as we go through the next quarter, as Jack talked about. We have made some good progress in a relatively short period of time. We have some significant opportunities left in some of the areas that we talked about including occupancy costs and transportation and non-merchandise procurement and a number of other areas. We'll have a better understanding of the quantification of those numbers as we work through the next few months and will be in a much better shape when we are at the point of making 2008 guidance. But clearly, our objective is to lower that point below 3% at which we need to beat it to be able to leverage our expenses.

Very good. Thank you guys and good luck.

Thanks.

Thank you. Bill Sim, you may ask your question and please state your company name.

Thank you, Citigroup. Good morning. I have two questions. The first question is a follow up to Danielle's question on gross margins. When I look at the gross margin improvement, did you have to give up much in the way of payable terms during the quarter in order to improve procurement cost? And then what impact, if that is so, what impact will this have on your gross margins going forward? Will you see a drag as you give it back?

We did not give up any significant payable terms during the quarter to grow our margin this quarter.

Jill, can you comment on your drop in payables then, what was driving that relative to inventory?

The overall drop in payables is just a function of the payment as the terms come due. There is nothing... no significant changes in our strategy with accounts payable.

It was the same as last year.

Right. 57.1% was our AP ratio this year compared to 57% last year.

Okay. My second question is surrounding the Florida market. I believe you haven't opened stores in Florida for the last several years, at least not any significant stores. Given the challenges you have in Florida that don't appear to be going away any time soon, is there any thought in terms of reevaluating your Florida real estate portfolio and potentially either selling owned stores and taking the cash or doing some thing to decrease potential cannibalization you have seen in those markets?

Our strategy over the last several years, Bill, in Florida is to continue to in fill the state. Obviously, we have well over 400 stores in the market and we have also relocated a number of stores in the state as we've had the opportunity to do that. And that basically will continue to be our strategy. The market, the Florida market is a very solid market. We expect that's going to be the case forever and we'll be looking to continue to solidify our position there. And we have good locations, we have a great market share and we are going to continue to work to grow on that. So it will be a continuation of what we have done over the last several years.

I think you have to figure that all the time Florida resets itself and comes back for a number of factors. And while we wish we were comping at a greater rate in Florida, it's still a very highly profitable market for us.

Okay. And one more follow-up question regarding your repurchase authorization. Can you give us an idea of timing of the repurchase plan as well as source of funds? Is it purely out of free cash flow or do you have any incentive to generate a new leverage in the balance sheet?

This is Jim. As Jill discussed, we started ramping up our repurchases in the last few weeks here as the stock price clearly, as a company, we think is attractive. We have certainly strong cash flow to purchase stock at the appropriate time. We also have plenty of other liquidity if we chose to use that as well. So we'll continue to evaluate and make the decision as we go, but I think the $500 million authorization that the Board approve is an indication of the value that they see here, and certainly we have the resources to fulfill that and we have demonstrated over the last couple of years some pretty significant repurchases as well when we do it opportunistically.

Thank you very much. Good luck.

Thank you. Our next question is from Jack Balis. You may ask your question and please state your company name.

Focus Research. I would like to ask you about the 250 positions that were eliminated and whether there was any change in the field in terms of, for example, district managers, the stores and where the eliminations have occurred.

Well, again, the 250 positions, 75 of which were open positions that we have decided not to fill. The positions in the field, roughly 100 of the positions of the 175 relate to the cessation of the remodel program. And then there were some reductions in the line management in the field in terms of regional and district positions. We still feel we maintain excellent coverage in the field and there were in the headquarters here in Roanoke about 31 positions that were eliminated.

Okay. In terms looking at more incentive compensation, would that include as others have done, compensating your commercial sales people at the store level on a commission basis?

That's something we are looking at along with other things. We haven't come to any firm decision, and probably if we have 2 or 3 scenarios, we'll run them in a portion of the company for a period of time and see the impact. But you raise a good point.

What was the decline in Florida comps?

Jack, we don't give specific numbers for specific regions. But as I said, the comp, taking out the Florida and the Gulf Coast regions was about 2.8% for the quarter. So you can work yourself back into a number that helps quantify that to some extent probably.

Okay. One last thing regarding store expansion, and that is, Jim, I think that everyone agrees that I think you said historically over and over that business and the industry does come back. So you've had... industry has had two soft years and '06 and '07. Don't you believe that by '08, deferred demand will come back and the industry should benefit from that? And if so, shouldn't you have more new stores to take advantage of that trend?

Well I think there is probably 2 or 3 points there. One is certainly, we do believe that, as Jack talked about, that there is some deferred maintenance going on that is going to come back over time because it ultimately has to be done. The second is all the things that we've outlined in regard to the initiatives that we are undertaking, I think clearly historically, are the ones that have caused us to see our business come back when we successfully implement those decisions. In terms of how that affects the store expansion, I think that a lot of the things that we are doing will allow our new stores that we will be opening to be more effective as we go forward, both in terms of how they are merchandised as well as the occupancy cost and other factors that influence their performance. So 140 to 150 stores are still a lot of stores, and we think that a year from now, as we make the changes that we are making that we'll be in a better position to have better performing new stores and with that, would certainly see the opportunity over time to open more than what we are going to open in 2008.

Thank you.

Thank you. [Operator Instructions]. Our next question is from Rick Weinhart. You may ask your question and please state your company name.

Hi, thanks. Good morning. BMO Capital Markets. I had a couple of questions. One, do you perhaps have what the comp was excluding Florida and the Gulf states for the first quarter, or maybe if you could just clarify what kind of an impact we had between first and second quarter?

It was about the same numbers in both quarters. The comp in the second quarter excluding Florida and the Gulf Coast was slightly higher than the first, but not significantly different.

Okay. And the weakness that has led you to take the comp numbers down a little bit here, was that geographically dispersed or was that also kind of centered in that area?

It's broader than... it's Florida continuing on the trends that Jim has talked about and across a broader geography. The start of the third quarter was weaker than we hoped it would be. That led us to the guidance we gave.

Okay, thank you. And my last question, on the sales boost that you are hoping to get from the expanded parts selection, what are you basing that on? Is this based on data related to customers that have essentially walked out because you didn't have the part you tracked at or is this based on some additional market share gains related to kind of increasing traffic?

This is Elwyn. It's based on a number of things, not the least of which is input from our parts pros where we have gathered a lot of insight from them on what's missing in the market. Obviously, we have data sources that allow us to see what late model and particularly where import coverage is needed in different markets. Likewise, what are the brands that we aren't in that we need to be to be credible with our commercial customers. So we are doing a lot of that. Additionally, we have the capability to perform what effectively we call a lost sales function in our store level, so literally in 3100 stores, we are able to capture sales that were missed on parts. And I am certainly making that a priority with our merchants to utilize that information to make further decisions. So there are a number of things that are serving as good inputs to improve our parts availability. And based on some of the early indicators, we are seeing results there. I would tell you that the terms on these incremental parts are not at the highest level because naturally we carry many of the basic items. But they are extremely high margin as you know and they are enabling us to gain additional business and with that additional parts being sold in addition to the parts that we are introducing. So we are optimistic about this and this is a strategic focus of ours certainly for the near term, but I think a capability that needs to be enhanced tremendously for the long term as well to make it not only on par with but a competitive advantage for us.

Elwyn, just a follow up on that. Are you actively going to be advertising this expanded selection to your commercial customers?

We are working with our marketing group to formulate communication at the right time. Naturally, I want to have some news and some thing both can see before we start communicating it. And that is taking us some lead time as indicated earlier, but as we think about the 1st of '08, we want to be poised to communicate what we are doing.

Okay, thanks very much.

Thank you.

Thank you. Ryan Rentria [ph], you may ask your question and please state your company name.

Hi, Cars Capital. I am just curious, your comp guidance for Q4 is 2 points higher than for Q3 and you said the sales initiatives would have a limited impact and the comparisons about the same. So why is it that you guys are expecting an acceleration in the business in the fourth quarter?

Well, there will be more of the initiatives coming to bear in the fourth quarter, and embedded in that Ryan is also a belief that at some point, the external environment is going to freshen a bit and that there will be more opportunity to do business, but the combination of our own efforts being that much further along and a belief that the external environment is going to improve a bit.

Got you. And I just want to make sure I have this correct, the $50 million in cost reductions in '08 is on top of the $20 million in the second half of this year, so it's an aggregate of 70, is that correct?

No, we should clarify that. The $50 million for 2008 is the impact in 2008; the $20 million in 2007 is the impact in 2007. They are not... you shouldn't add them together.

You should or should not?

Should not add them together.

Got you. Okay, thank you.

Thank you.

Thank you. Nancy Hoch, you may ask your question and please state your company name.

J.P. Morgan. Thank you. Can you just talk a little bit about whether your 11% to 12% operating margin target is still intact? And obviously you are getting a nice jumpstart from the express reductions, but what gets you the rest of the way towards that target?

Well it's a combination of returning to reasonable levels of comp store sales as a result of all of the initiatives that are under way and those that are not yet underway but will be underway. And we are focused on having a more cost cautious culture within the company and the sum total of the things we have been talking about. We still think that target is a reasonable target for us to achieve.

Okay, great. And then you talked about your systems investments and a trade off this year with more emphasis [ph] shifting towards inventory management. Can you talk a little bit about where you are funding those investments from?

Yes, I think as we said in some of the notes, we look at all of our CapEx for 2007 and 2008, and as part of that, have reprioritized some investments, we have eliminated other investments and all of that's reflected in the revised CapEx guidance we have given. The funds are there to do what needs to be done. It's a matter of aligning it with the strategy and ensuring that all the other investments we are going to produce the returns. So that's how we have approached it.

Okay. I guess my question was have you increased the size of the IT bucket or have you... are you deemphasizing some other IT initiatives at this point?

That would be the correct way to... we have not increased, but rather redeployed and ensure that all of our CapEx spending in IT is focused on these initiatives that matter most to our business.

Okay, great. Thank you.

Thank you. Our final question today is from Cid Wilson. You may ask your question and please state your company name. Cid Wilson - Kevin Dann & Partners: Cid Wilson, Kevin Dann & Partners. I want to go a little deeper in terms of your comments regarding some of the missed opportunities on the commercial side. And you mentioned that there were some learning experiences that you got from Autopart International. Can you touch a little more in terms of maybe more detail where you feel those missed opportunities were and touch a [ph] little more on the corrections?

I'll start and then I'll let the team pick up. Some of it is really emphasis, Cid that we were staffing and supporting the DIY side of the business more heavily and in some cases to the detriment of the commercial side of the business in terms of adequate delivery coverage and the parts that we have been mentioning throughout the last two quarters. Anybody else?

The only thing I would ask Cid... this is Jim... that from AI, certainly we have learned more about how to source some of the products we should be sourcing, certainly looking at AI as a model by itself. There has been learnings around staffing and compensation that Jack had touched on a little bit earlier. Certainly, the merchandising, the brands, what kind of brands we should be carrying, a lot of different things that we are looking at. And I think we'll be in a lot better position to talk about more detail in that regard over the next quarter or so. But I think if you look at our history on commercial, we went for a number of years with very strong commercial comps. Certainly, some of that was new programs, but the underlying programs always ran a very solid comp. We haven't seen that same strength in the last year or so, and with the things that we are looking at, our objective and certainly we think the opportunity is to get back to something that's significantly better than what we have seen over the past 12 months in terms of comps on the commercial. Cid Wilson - Kevin Dann & Partners: Okay, got you. And a question regarding just your overall coverage. Is it reasonable to assume that parts was most of the drag on same-store sales? Can you comment on how accessories and chemicals did and are you... and any comments on any pricing pressures in those categories?

Yes, this is Elwyn. I'll comment a little bit with regard to second quarter. Naturally, it's been documented that the quarter was a little cooler than normal. So things like AC refrigerants and accessories, AC parts, we saw some softness there. I would comment that in some categories that I would classify as discretionary, things like interior accessories, seat covers, wheel covers, exterior accessories, car covers, things like that, we experienced some softness there. I would highlight that in some more non-discretionary categories such as batteries, we saw we were solid there. So I think between some of the weather dynamics that have already been well documented, we did see a little softness with some discretionary spending. But the underlying non-discretionary seems relatively solid. Cid Wilson - Kevin Dann & Partners: Okay. And then with regards to free cash flow, you did raise your guidance for free cash flow for this year. And given the amount of reductions that you have for 2008, any thoughts on free cash flow for 2008? I know that you haven't given guidance, but any direction? I mean can we expect free cash flow to accelerate next year and any thoughts there?

As I said, we haven't given guidance yet, obviously, but directionally, we would anticipate that free cash flow next year would be stronger than in 2007.

Thank you. That concludes our call today. You may now disconnect. Thank you for joining us.