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Advance Auto Parts, Inc. (NYSE:AAP)

Q2 2014 Earnings Conference Call

August 14, 2014 10:00 AM ET

Executives

Zaheed Mawani - IR

Darren Jackson - CEO

George Sherman - President

Mike Norona - CFO

Analysts

Gary Balter - Credit Suisse

Greg Melich - ISI Group

Matthew Fassler - Goldman Sachs

Dan Wewer - Raymond James

Simeon Gutman - Morgan Stanley

Scott Ciccarelli - RBC

Michael Lasser - UBS

Seth Basham - Wedbush Securities

Operator

Welcome to the Advance Auto Parts Second Quarter 2014 Conference Call. (Operator Instructions) This conference is being recorded. If you have any objections, you may disconnect at this time. Before we begin, Zaheed Mawani, Director of Investor Relations, will make a brief statement concerning forward-looking statements that will be made on this call.

Zaheed Mawani

Good morning. And thank you for joining us on today's call. I'd like to remind you that our comments today contain forward-looking statements we intend to be covered by, and we claim the protection under, the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements address future events, developments or results and typically use words such as believe, anticipate, expect, intend, will, plan, forecast, outlook or estimate and are subject to risks, uncertainties and assumptions that may cause our results to differ materially.

Our comments today will also include certain non-GAAP measures, including certain financial measures reported on a comparable basis to exclude impacts of cost that were incurred in fiscal 2014, in connection with the integration of General Parts International and BWP Distributors.

Please refer to our earnings 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.

For planning purposes, our third quarter 2014 earnings release is scheduled for November 6, before market open and our quarterly conference call is scheduled for the morning of Thursday, November 6, 2014. 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 Darren Jackson, our Chief Executive Officer. Darren?

Darren Jackson

Thank you, Zaheed. Good morning, everyone. Thank you for joining us, and welcome to our second quarter conference call. I'd like to start off by thanking all of our team members for their continuing commitment to better serve our customers which resulted in a very good Q2 performance. Joining me on the call today is our President, George Sherman, who will update you in our business operations; and Mike Norona, our Chief Financial Officer, who will update you on our financials.

We are pleased with the operating results from our second quarter as we continue to build on our momentum from our first quarter performance. Overall we are on track in terms of the base business objective, integration milestones and our financial performance. Our team members remain focused on our 3 key outcomes and continue to drive improvements into the business. These base business improvements, along with our ongoing benefits from favorable winter weather, enabled another strong quarter.

Our total sales grew 51.5% in the quarter compared to the second quarter of 2013, primarily as a result of the acquisition of General Parts and our comparable store sales increase of 2.6% in the quarter. Our second quarter comparable cash earnings per share of $2.08 was an increase of 30% versus our second quarter last year, driven by both the acquisition of General Parts and the improving base business result.

Despite the relatively cooler start to the summer season, we delivered strong comparable store sales gain in our commercial business, while our DIY business was essentially flat driven by lower sales and seasonal categories versus our first quarter. The sequential acceleration in our commercial business was led by our Northeast, Great Lakes and mid-South regions. We experienced increases in both traffic and ticket led by strong sales gains and right control, climate control and the breaks category.

Further, our momentum continued with national accounts which delivered double digit growth within the quarter. Overall, our comp trends were relatively stable throughout the quarter with some moderation experienced towards the end of the quarter. Consumer confidence continues to trend slowly in a right direction. The combination of relatively stable fuel prices and improving employment condition raise the ground work for optimism with the consumer. However, we are still guarded in our view of the consumer given spending constraints in the lower and middle income customers.

During the quarter, both our gross profit rate and comparable SG&A rate declined. Gross profit rate declined 505 basis points to 45.2%. The SG&A rate improved on a comparable basis 358 basis points to 34%. Again, this was primarily due to the acquisition of General Parts and was in line with our expectation. Mike will be discussing the financials in more detail shortly.

We are encouraged with the progress of our key priorities. Looking at our base business, our results built on a momentum coming out of the first quarter, our commercial sales improvements drove our growth. The business remains on track with our profitability goals, including our focus on expense control, including solid progress on our cost of our initiatives. Our customer service focus remains top of mind. Our DIY and commercial mystery shops are providing key insights to improve the quality and consistency of our service. The outcome is building deeper relationships with our customer through improving our execution and customer experience.

Turning to our integration, we remain on track against our plan. We are now moving from the planning into the execution phases. The cross-sourcing initiative continues to deliver positive result as we leverage our leading inventory availability. We continued our expansion of our WORLDPAC access with another 600 Advance stores in the quarter. We also announced the consolidation of 100 CARQUEST stores into Advance stores beginning in August and completing by the end of 2014. These consolidations will allow the combined store to have increased inventory coverage and team member support to serve our customers better.

We will be in a stronger position to growth our combined business volume in that consolidated store. The commitment to enhance capabilities and simplify the support structure included announcing the closure of our Minneapolis office as we rationalized our corporate centers down to two. Roanoke, Virginia our existing support center and Raleigh, North Carolina which is the former CARQUEST headquarter. The relocation of the Minnesota office will transition over the next 12 months and we are pleased that all of our senior leaders have chosen to relocate with their families and continued to be a part of the Advance team.

Additionally, we completed plans for Advance stores to enter the Dallas market beginning in Q3. The Advance branded stores in this market will utilize the CARQUEST distribution center that already has daily delivering capabilities. This is an example of our new combined capabilities that will allow us to accelerate our based business as we grow our presence and established a base store in our Dallas market. Importantly, as a result of all the hard work of our integration teams in the quarter, I am pleased to see say we remain on track to achieve our 2014 synergy and integration cost commitments.

Overall we are satisfied with our outcome in the second quarter and first half of the year as a combined company. I continue to be encouraged by progress we are making with our operational execution, foundationally we’re getting better and are focused on continuous improvement and delivering consistency quarter-to-quarter, I’m very proud of the entire team for delivering a solid first half of the year and remaining focused on the based business outcomes. Our integration process today continues to be on planned and is early proved point demonstrating we have strong starting point organizationally underpinned the diversity of experienced team and the outstanding leaders coming together to successfully integrate this company.

Our growth and profitability is on track. Our second quarter comparable results generated a 30% comparable cash EPS growth, another step in the right direction. Looking ahead despite the moderate start to the summer reason, we remain positive about the back half of the year and continue to be encouraged by the momentum and sustained execution of our team. I would like close once again by thanking all of our team members for their tremendous hard work and a good start to the first half of the year.

I will now turn the call over to George Sherman. George?

George Sherman

Thanks, Darren, and good morning everyone. First, I too would like to thank all of our team members for their contributions to customer service in the quarter and doing all the right things to show our customers that we put them first. At the heart of executional excellence is customer service and our team members drove our success this quarter to their commitment to the customer.

With my prepared remarks this morning, I'll provide a view on our second quarter business performance followed by a business update including our key priorities within the quarter.

Looking at sales, we're pleased with our performance in the second quarter, as the team delivered a comp store sales outcome of 2.6%, a sequential acceleration of 310 basis points on a 2-year basis.

Our positive sales performance was once again attributable to solid execution by our field, merchant and supply chain teams, combined with a continued momentum from customer demand that carried over from the first quarter. Overall, we are satisfied with our sales performance in the second quarter and we’re progressing against our goal of continuous improvement and more consistent comp sales outcomes. We are certainly moving in the right direction.

As a result of the acquisition, our newly combined commercial mix now stands at 57%, with our Commercial Business continuing to show consistent growth. We generated solid comp acceleration in our Commercial Business, with the Northeast market leading the way followed by our Great Lakes and Mid-South Markets with our commercial business benefiting overall from transaction and ticket growth in the quarter.

Our B2B business continues to perform very well with approximately 40% growth in the second quarter versus the previous year. Additionally, I would like to call out the early yet strong progress we’re marking with our CTI program. We launched CTI with Advance in late April and to date already have approximately 700 shops signed up. To put this in the prospective, Advance trained approximately 500 shops all last year.

CARQUEST Technical Institute will continue to be a differentiator for us and help our customer grow their business. Looking at our DIY business as referenced earlier, our DIY performance was essentially flat. We saw slightly lower demand this quarter in category such as batteries and antifreeze versus our first quarter when the winter demand for those categories was at its peak. Offsetting the lower demand was a sequential acceleration in our dollars per transaction from our first quarter and consistent strong growth from our B2C channel.

As I previously mentioned and we will continue to stress, we’re focused on 3 outcomes sales, great customer service and profitability. I touched earlier about our focus to consistently drive a better sales comp. I can tell you that we now have a very healthy intolerance for poor sales day. We are building the expectation of winning and embedding the good behaviors of urgency and accountability that underpin consistent sales outcome.

We are relentlessly focused on maintaining our team member training. It’s about building our muscle at the counter and measuring ourselves at how well can engage with our customers. We’ve been able to talk to our customers about their projects; can understand what they are looking for. It’s about building a competency and confidence in our team members in the customer respectively.

We are clearly beginning to see the benefits of our training investments as they begin to drive outcomes validated by our customer feedback. Our move to a more fuel-centric organization has put more control in the hands of our stores, giving more responsibility to our leaders that are closest to the customer.

We’ve previously mentioned relying upon our local leadership to make decision such as labor decisions. We are always seeing a benefit of that to improvements in our overall cost of an hour. We’re also engaging our few leadership and decisions related to our real estate planning and help source strategies driving more ownership locally and in turn our team continues to be more engaged in outcome focus.

Turning to our integration, I'll build on Darren’s comment and share a few additional insights from an operational perspective. As mentioned our integration efforts are underway and we’re processing as expected. We’ve had some very good early wins and I think it’s a very comparable list would be our retention outcomes.

We are pleased with our talent of retention at our stores, the sale teams in the field and key leadership positions. And the spirit of retention, the same thing has been through with our independent customers, as we continue to focus on their business outcomes and helping them continue to grow their business profitably. Overall we are very pleased for the retention of our independent customers.

Our second source initiative continues to show our team some proof points of what this partnership can be. Where we have locations in similar geographies, Advance and CARQUEST stores can source from each other. We also now have a total of 800 Advance in AI stores cross-sourcing with WORLDPAC. We continue to build local scale and drive efficiencies within our network, but more importantly, being able to say yes more often to our customers.

The integration of our merchandizing teams is in progress as we make our way towards centralizing our merchandizing capability and rally. Once complete, we will have our merchandizing organizational center of excellence in the team that we will be more efficient and effective. In the midst of this change, I'd like to say how proud I am of our team that continues to execute day and day out and deliver the best business outcomes and ensure our stores are not missing a beat.

Lastly, I’d just like to say how excited we are to have entered the Dallas market just six months integration by capitalizing on a CARQUEST distribution center, store systems, POS systems and processes in many cases as we open our Advance footprint. And enter new high potential DMAs using our combined enterprise capabilities and assets.

Moving on, I want to update you on our supply chain initiatives. We’ve been methodically progressing against our supply chain objectives. We continue to progress our daily delivery capability for approximately 550 Advance stores now receiving daily delivery from our Remington, Lakeland and Kutztown distribution centers, with a majority of CARQUEST store also receiving daily delivery of the 34 CARQUEST TCs.

Second, we continue to drive improvements of end market availability to our hub store strategy. Due in a quarter we added 5 hub stores to a combination of new stores and upgrades of existing stores, including the opening of our first Canadian hub in Ontario. At the end of quarter our hub store count was 410, an overall increase of 56 from the second quarter last year.

Third, as we look at inventory, our inventory growth was up over 60% year-over-year in the second quarter from early due to the General Parts acquisition. Inventory upgrades increase of new stores in hub stores. Inventory levels were slightly higher versus our first quarter as a result of new stores added during the quarter.

We continue to be focused on our goal of having superior availability the deepest assortment and investment in our strategy to get the parts closes the customer. Looking at our new store growth during the quarter, we open 28 new Advance AI and CARQUEST stores and close 15 stores including plan consolidations of 11 BWP stores bringing the total company operator to store account to 5,289.

We also added one WORLDPAC branch in the quarter bringing our total branch count to 106. We are progressing as expected and continue to pace on these new openings to be in line with our guidance of between a 120 and 140 new store this fiscal year. As I close our remarks today, I’d like to share how proud I am of the entire team. The base business improvement are contributing to our outcomes and laying the groundwork for an operating model that strives for and delivers consistent outcomes.

Our integration program is progressing nicely, we are fully integrated our leadership teams and we could not have asked for a better cultural consistencies between this things coming together. While we are satisfied with the execution momentum in our recent performance in the third two quarter, we are by no means content. Looking to the back half of the year, as we remain positive in our outlook and we will continue to stay focus on our plan showing patience when required, and accelerating when we see opportunities to serve our customer better than anyone else.

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

Mike Norona

Thanks, George, and good morning, everyone. I'd like to start by thanking all of talented and dedicated team members for their commitment to serving our customer in the quarter and helping our company again deliver strong financial performance in our second quarter.

I plan to cover the following topics with you this morning. One, provide some financial highlights from our second quarter of 2014. Two, put our second quarter results into context with our expectations and key financial priorities that we use to measure our performance. And three, provide some insights on the remainder of 2014.

Before I begin my remarks about the quarter, I would like to remind everyone and unless other specified Advance will presents its financials and supporting commentary on a consolidated enterprise basis and I will discuss results on a comparable basis which excludes the impacts of one-time integration expenses related to the acquisition of both General Parts and BWP along with any amounts related to the amortization of intangible assets resulting from the acquisition of General Parts.

As mentioned on our first quarter call, we begin the work of integrating the Company and initiating the purchase accounting assessment including the preliminary valuation of the balance sheet and conformity of the accounting policy. In the first quarter, we referred to a conformity reclassification of approximately 70 basis points of supply chain cost from SG&A to gross profit and provided a preliminary estimate of the impact to the remaining quarters to be approximately the same 70 basis points. As we progressed through our assessment, we determined the impact of the supply chain re-class to be closer to approximately 85 basis points. This updated assessment of approximately 85 basis points applies to both the second quarter and to the remaining quarters of 2014.

Moving onto our second quarter operating results, we are pleased to report a second quarter comparable cash EPS of $2.08, a 30% increase from our second quarter of 2013. The second quarter results reflect a continuation of the sales momentum from our first quarter included in our comparable cash EPS result in the quarter with $0.09 in synergy realization.

On a GAAP basis, our second quarter EPS was $1.89, which included $0.08 of intangible asset amortization associated with the acquisition of General Parts, $0.08 of one-time integration expenses and cost to achieve synergies related to the integration of General Parts and $0.02 in onetime costs associated with the integration of BWP.

Turning to sales, our second quarter net sales increased 51.5% to $2.35 billion compared to our second quarter of 2013. This sales growth was principally driven by the acquisition of General Parts, our comparable same-store sales increase of 2.6% and the addition of new stores. For comparison purposes only, net sales for General Parts in our second quarter after adjusting for selling days and holidays this year versus last year increased approximately 3.8% to $737.1 million based on 82 days this year versus 90 days last year. Our positive same-stores sales were driven by our commercial growth and strong execution from our field and supply chain teams. Year-to-date, our total sales increased 49.2% to $5.3 billion.

Turning to gross profit, our gross profit dollars in the second quarter increased 36.3% to $1.06 billion from $779 million in our second quarter of 2013. Our gross profit rate of 45.2% was down 505 basis points compared to the second quarter of 2013. This year-over-year rate decline was primarily due to the acquisition of General Parts resulting in a higher mix of commercial sales that has a lower gross profit rate. Including in our gross profit results this quarter is the approximate 85 basis points conformity impact that I mentioned earlier which was partially offset by 35 basis points of synergy savings in the quarter. Year-to-date, our gross profit rate decreased 472 basis points to 45.4% versus 50.1% over the same period of last year as a result of the General Parts acquisitions.

Turning to SG&A, our comparable SG&A rate was 34% in the quarter which was done 358 basis points compared to our second quarter of 2013. This year-over-year rate decline was a result of the acquired General Parts business having a lower SG&A cost. SG&A also reflects the approximate 85 basis points of conformity impact mentioned earlier and cost leverage from our 2.6% comp stores sales increased partially offset by higher incentive compensation due to our better sales performance.

Year-to-date our comparable SG&A rate decrease 373 basis points to 35.1% versus 38.9% over the same period last year, again principally due to the General Parts acquisition. All in our second quarter operating income dollars on a comparable basis increased 34% to $262.7 million and our operating income rate decreased to 146 basis points over the same period last year to 11.2% primarily as a result of the acquisition of General Parts. Year-to-date the Company’s comparable operating income rate was 10.3% versus 11.3% during the same period last year.

Operating cash flow through the second quarter was $320.6 million versus $310.1 million in the prior year. Free cash flow through the second quarter improved to $214.3 million versus $198.2 million in the prior year. Our AP ratio for the quarter was 77.6% versus 85.1% last year. This decline was expected due to the acquisition of General Parts and is previously shared, we see continued opportunities to improve our AP ratio as a combined company. At the end of the second quarter, we had roughly $1.87 billion of debt on our balance sheet and our adjusted debt-to-EBITDAR was 2.9 times and was in line with our expectations.

During the quarter, we paid down approximately $200 million of debt and remained focus on our commitment to quickly 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 financial performance of our business and prioritize our investments to achieve growth, profit and value creation. Our growth engine continues to be our commercial business which delivered solid growth in the second quarter, helping us deliver our third consecutive quarter of positive comps. As George mentioned, we are investing in several key areas to improve our service and business performance to maintain our growth momentum.

Turning to profit, we are pleased with our 34% comparable operating income dollar growth versus the previous year and the 11.2% comparable operating income rate that we achieved in our second quarter. We see continued opportunities to improve our profitability as measured by operating income dollar growth through consistent sales growth, leveraging our size and scale and improving our cost efficiency. We also remain on track to achieve our year one cost synergies of $45 million to $55 million on our way to achieving the total expected cost synergies of a $160 million over the next three years. With respect to value creation, the acquisition of General Parts provides us a compelling opportunity to drive shareholders returns through incremental earnings and strong cash flows.

We saw this in our second quarter with a 30% increase in our comparable cash EPS. We continue to be focused on improving our free cash flow through our disciplined capital deployment, consistent operating results and working capital management primarily in the areas of inventory management and AP ratio. We are pleased with the progress we made in these areas in the quarter. Our focus on free cash flow is enabling us to pay down our debt to get back to our previously stated leveraging ceiling of 2.5 times by the end of 2015. Once our debt is paid down, we will continue to optimize our capital structure to maximize shareholder value.

Turning to the balance of the year, we are pleased with our outcomes during the first half of 2014 and the momentum we have built heading into the back half of the year. I would like now to share two updates to our 2014 full year outlook. First, based on the sales comp performance in the first half of the year, we expect our full year comp store sales to be in the low single digit. Also, as we shared in our press release, we have raised our full year annual consolidated comparable cash EPS outlook to now be in the range of $7.50 to $7.60. Despite the moderate start to the summer selling season, we are building momentum as a combined company and maintain a positive outlook for the back half of the year given our ongoing base business improvements, integration progress and steady industry fundamentals.

Turning to phasing in the back half of 2014, we continue to be on pace to deliver against our first year cost synergy expectations, however we expect the balance of our cost synergies this year to be weighted more towards the fourth quarter. In closing, we are satisfied with our performance in the quarter in the first half of the year. Our focus is still squarely set on two key priorities of delivering on our base business outcomes and successfully integrating General Parts. We continue to be pleased with the improvements our teams continue to make each quarter with our execution in the spirit of driving consistent sales, services and profit outcomes. The integration is progressing as expected with the team delivering the early quick wins and plan synergy benefits.

I want to once again thank our over 74,000 talented team members for what they do each and every day to serve our customers, inspire our team and grow our great company. Operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). The first question today is from Gary Balter with Credit Suisse.

Gary Balter - Credit Suisse

Rather than ask a question that builds on the good stuff going on, I'll ask the tough question. What's not working? You have a whole game plan, and you have an awful lot going on in terms of WORLDPAC AI integration, testing Dallas. It's all the cost savings that Mike talked about. What are the areas that you're finding are a little bit more challenging, and how are you dealing with those?

Darren Jackson

Hi, Gary, this is Darren. So, I would say couple of things, what’s keeping me awake at night right now is that we just haven’t had a bump in the night that’s to be honest I would say the places that are most complex for us and predicting these type of acquisition is systems. Lining up the systems are going to be complicated. We have had some quick wins on systems but as I look out I think that’s an area that most companies as ourselves underestimated some of the complexity that’s not going to keep us from achieving our synergy or achieving our targets but I see that as an area where we are going to have to double down more efforts as a company. I would say the second one is, we said this is a script. The planning process even building out the process steps, I think as a company we are pretty good at that now moving into the execution part of the integration work. And that is the things we talked about the 100 store conversions, the supply chain work.

We are moving, essentially we are touching three corporate offices that’s a lot of moving part to be honest and so it is going to take our entire team even doubling down that more in terms of our focus with the team members to keep up powering through this work. That’s the only way can do this just power through it. So as we’re into the back half of this year next year. There are just going to be little ups and downs with the execution type of work but today we haven’t had a bump in the night what we can see the complexity is really aligned in this system in terms of somewhat we originally planned and probably more importantly the work right now is entering execution and that just by its nature tends to be more up and down.

Gary Balter - Credit Suisse

I had a follow-up -- or not a last follow-up. But you've mentioned a few times the slowdown in July, the more recent period of time. Anything other than what you're seeing seasonally that would concern you in terms of either pricing or maybe end roads that are happening in Florida from O'Reilly? Or do you think it's very much seasonal?

Charles Tyson

Yes, Gary, it’s Charles. I mean primarily we’re seeing it from a seasonal perspective. We had a very strong Q1 in our battery business and we’re seeing some slowing there. When you wake up in Raleigh at 58 degrees when it’s only 90 AC business. So some of the seasonal businesses are impacting it. But we aren’t doing anything from a pricing perspective that would drive any concern from in terms of how that’s impacting the trend on the business. And we got good core continuing growth on the car business and our break business and we continue to see great strength going in Q3.

George Sherman

Gary, it’s George I would add to that. We saw strong commercial comp performance in our commercial business throughout the entirety of the quarter. We saw some slowing toward the end in the heat-related DIY categories that you would expect, so that underlying strength in commercial gives us confidence for the remainder of the year.

Operator

Thank you. The next question is from Greg Melich with ISI Group.

Greg Melich - ISI Group

Thanks. I wanted to get into the synergies a little bit, just to understand how you're on path. It seems, if I back out the $0.09, it's about $10 million or $11 million of synergies at the EBIT level. Mike, is what you were suggesting that we're still going to get to the $50 million-ish, but maybe the third-quarter looks like the second-quarter and then we have a big step up in the fourth-quarter?

Mike Norona

Yes, Hi, Greg. Yes, that’s exactly right. I mean we delivered little over a $11 million in synergies in the second quarter about $8 million in the first quarter and we’re pleased with that. We are right on top. I think you saw we took our outlook up. I think as we gained more confidences there, and as George said, we feel more confident and coming end at the high end of the synergies that said the phasing is going to be more weighted towards the fourth quarter. So I would think kind of about one-third, two-thirds for the balance of the year. The remaining synergies will kind of fall third quarter fourth quarter in that one-third, two-third.

Greg Melich - ISI Group

Got it. And then a follow-up. I think, Darren, in your comments, you talked about the 100 CARQUEST consolidations into Advance stores. And that they could be in a strong position to grow the actual combined sales of the stores when you consolidate. Is that just saying that the sales loss from a closure are less than you expected? Or you actually think that when you put them together you end up with a bigger pie, and that's not just 80% or 90% that you keep?

George Sherman

Greg, it’s George. We think it is close due to the ladder first of all we’re confident in our ability to retain sales by consolidating the stores we believe they were building us stronger commercial capability store by stores that’s going to enable us got and gain more sales.

Greg Melich - ISI Group

So on the commercial side, do you have any evidence of a dozen stores where this has actually worked and you end up with more commercial sales?

Darren Jackson

Well, we do Gary in terms of BWP, so that’s what we talk about before. We got try before we buy and I’d say what you have to think about it is that difference for DIY than this commercial. So when we consolidate something those stores had some DIY business a lot of that DIY business doesn’t necessarily transfer on the street. The commercial business as a twofold impact, George is right, what we’re seeing as we’re holding onto the team member, that’s important. There is better inventory availability in the consolidated store and what happens is that the existing store base ends up then because you can provide a better service level. You just have better coverage and so that’s what we’re seeing. What we saw I would say in the BWP process, as we got better at perfecting it, what we’re seeing in George you tell me -- I think we’re just a few stores into the 100 at this point.

George Sherman

Yes, we’re two stores in. We converted one at the end of July and one yesterday. We are just getting started.

Operator

Thank you. The next question is from Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs

My question relates primarily to revenue. You talked about the pro-business gaining momentum, despite a lack of weather tailwinds. Can you talk about the degree to which that relates to revenue synergies associated with the transaction? And related to that, you talked about the expansion of WORLDPAC access and being able to bring some of that product to your Advance customers. Any quantification or qualitative or quantitative rundown of how that has actually progressed?

George Sherman

Yes, Matt, it’s George. We certainly think it help and it certainly allowed us to leverage some market strength. So it really is getting the -- yes as you know with the commercial customer, it doesn’t matter if it’s a 2005 F150 or 1970 Chevelle, we have got to have the part and get to yes quickly on that question when it’s asked. So, it helped us now it is not in our comp and maybe Mike will build on this a bit both intercompany, cross-store sales are back out of our comp and that reflected in here but it certainly is building a better capability for us, a better commercial capacity for us and we think a very good parts authority at the local level.

Darren Jackson

Maybe building on that a couple of other things, Matt, is that we are very early but there are hundreds not thousands at this point in terms of advanced stores that have sold TECH-NET relationships and those TECH-NET relationships as we talked about one of the benefits from car class is that where Advance lacked is that a some of the traditional programs that the traditional players had TECH-NET being one of them. And so we are starting to see initial traction in terms of TECH-NET we are seeing traction in terms of the CTI, the CARQUEST Technical Institute Investments.

What we are also seeing is that we ended up, we have just a lot of terrific national accounts including CarMax, we’re able to provide better coverage, so CARQUEST couldn’t reach certain national accounts because they simply didn’t have the store and we do, that’s one of the benefits we are seeing in terms of better coverage in the commercial space. Probably the most fundamental thing that we are seeing is at a local level the CARQUEST team, the Advance teams and I would say that’s expecting my expectations, are working together nearly seamlessly. It’s really been terrific and pleasant surprise culturally and when we are working together, the customer benefits.

Operator

Thank you. The next question is from Dan Wewer with Raymond James.

Dan Wewer - Raymond James

Thank you. Darren, there are a lot of terrific things that took place in the second-quarter. But one trend that I'm not real excited about is the 60% increase in inventory only generated a 36% increase in gross profit dollars. So I was curious as to where you are in your product line reviews and eliminating redundant SKUs between the CARQUEST and Advance organizations. And how you think that inventory growth may change during the balance of the year.

Darren Jackson

Dan, I think I appreciate you are asking a tough question. I would say the way we have guided the teams early on is that we have used an approach that says let’s get it integrate it first and optimize it second. The integration, the way we prioritize that is make sure that customer service levels do not experience any degradation that they only get better. And so a choice that we have to make in the inventory side of it is that we could go into optimization and as I said earlier part of that will require systems work. And so, we made a deliberate decision early on in terms of hubs, super hubs and level of investment plus an inventory coming on for Hartford that in all cases early on in this acquisition we want customers.

The independent customers are core customers who experienced the benefit of the service level, recognizing that the good news about this inventory, it’s not fashion, it doesn’t go out of style. And that the teams as they come together in Raleigh and work as one team, we will have a runway to maximize what I will call the balance between service level and getting the inventory dollars out. There is no doubt that there is a big value pool in terms of absolute inventory for us but in the early days we don’t want that to come at the expense of customer service. Charles, anything you would add?

Charles Tyson

As we look at the work that we are doing inside the AAP network to Darren’s point, we are waiting for some systems integration across both brands. We see moderation in the AAP inventory as we move through the balance of this year and that is work of the team to continue to drive out. We finished the product integration planning work and now we are going into that phase and the beginning of consolidations we are looking at the rationalization of inventory between both brands and as we start to going to our DC conversion strategy into next year we will start to see where we drive simplification for the assortment that will have impact on the overall inventory. But I want to reiterate that, we won’t do that at compromising service levels. As we grow in the commercial space, the expectation of our commercial customer is very high around superior availability and that teams have been in-charge and doing a good job in driving that superior availability protection into the market as well as looking at where we have unproductive inventory that we can better utilize either out of the network, in partnership with our vendors or elsewhere through the networking consolidation. Mike, do you want to add anything?

Mike Norona

Dan, I wanted to connect two things, first of all we expect the inventory growth to moderate as we get throughout the year. We are also focused on reducing our owned inventory. I think that’s important to drive our cash flow and then I wanted to connect your point around the gross profit rate. We are actually right on plan with respect to our gross profit rate and maybe let me remind you at the beginning of the year we said, took 2013, we blended the companies together and said that the gross profit rate for 2013 would be somewhere in the 45.5% to 46% gross profit rate and that didn’t include synergy. But you do the math on a year-to-date basis we’re tracking at 45.4% a back out about 30 basis point synergies that take about 45.1. And then the add back to supply chain re-class and we’re close to 46, we’re almost right at -- we’re right in the range we say that the gross it would be modestly up to share. So we’re tracking right at where we said we would be.

Dan Wewer - Raymond James

Great. Well, that's certainly a lengthy question or answer to my question. Just as a real quick follow-up, when you're talking about closing and consolidating a CARQUEST store into Advance, and that potentially the combined commercial revenues could be more than 100% from where they were running prior due to better parts availability. What does the inventory growth look like in that combined CARQUEST Advance location?

Mike Norona

It’s going to vary, based on markets, some of market potential. And if you look at our Southern markets and as we looked at inventory we see gaps where actually have inventory. There are other markets where the inventory actually will be flat and so on average when I look at the first grouping of stores that we’re doing today the inventories is just moderately up and that’s based on the geography whether stores are the benefit those stores can take by adding superior availability into those stores.

Operator

Thank you. The next question is from Simeon Gutman with Morgan Stanley.

Simeon Gutman - Morgan Stanley

Thanks, good morning. Just one follow-up on inventory, and then my main question. Would you say that Advance or CARQUEST , either of the companies, has a superior ability to forecast either the fleet or the breakage within a market? And then that will help you improve just the inventory allotment per store in general.

Darren Jackson

Simeon, this is Darren. So in forecasting the inventory around this really top before we have the custom mix tool it’s not rocket science in terms of vehicles and operational around the store. And we’ve been using that for years now, I think that tool further help us in the CARQUEST forecasted and inventory, I think where we an advantage beyond this is, and CARQUEST had this advantages that what WORLDPAC allows us to do WORLDPAC is selling a lot of more rate model coverage vehicles and so they are getting a better sense early on in the cycle, principally around the import vehicles which we’ve said, I have really taken an over in terms of the growth and some of the car pack the last several years. And that will better in form our overall mix of inventory principally in the import space and principally in late model coverage. And we tend to think is that is, a benefit that is still ahead of us. Today, we respond to that benefit by income WORLDPAC and the future which you could see and what we could see in CARQUEST is that ideally what you’re doing is a portion of that product putting it in your own DC. That's a much more profitable transaction when you got to just deliver it out of your own network.

Simeon Gutman - Morgan Stanley

Okay. And then my main question is on the industry and the tone of business. A couple of suppliers talked about weather-related replacement activity and that there are still pockets of pent-up demand. And you mentioned end of the month was a little soft. So from your vantage points, and I guess this is the age-old question, is do we root for hot weather now the rest of this season? And do we see that pent-up demand? Or now do we roll back into the winter and hope for extreme cold? How much of this is still to come, and does this roll forward to next year at this point?

Darren Jackson

Simeon, weather always evens out. That’s what I would say. What we root for, internally we don’t spend our time looking around the weather, a few of you spend their time think that the team has to get to get out there and take market share, what you have to do is every customer of you, you got to serve them better than anybody else what we do internally as we train we team. We have put an enormous amount of training matter of fact AAIA will recognize us as the best training group this year. And that’s what we committed to, the weather is going to up and down. Bad thing will even out, that what showed up in our guidance at the beginning of the year when we set low single comps. We anticipated weather would help us. We anticipated that usually there is the other side of it and so I think we’ve build the set of responsible plans that reflect to that. And to our team we want to just stay focus on going out there and getting share, just serving customer better than anybody else.

Operator

Thank you. The next question is from Scott Ciccarelli with RBC.

Scott Ciccarelli - RBC

Hello. Quick clarification -- hopefully quick -- and then a question. Your comments on the GPI sales growth in the quarter, up 3.8%; that's on a per day sales basis and that’s kind of true apple-to-apples run rate?

Mike Norona

Yes. That’s exactly right.

Scott Ciccarelli - RBC

Got it, thank you. And then you talked about some of the experiences that you had with the BWP consolidations. And let's call it the north of 100% kind of retention because of the additional market share. Given your fixed cost infrastructure, can you give us an idea of the impact that has on the profitability of that store?

Darren Jackson

Hey, Scott this is Darren. So a couple of things. Think about it in overall store, we’re able to better leverage probably about two thirds of the payroll in that store, because it’s essentially what we’re transferring is a combination of the few counter people and we’re transferring a few drivers down to that store, so it has a very nice flow through in terms of the fixed cost and we get to leave the fix cost of the close location behind. I want to make just make this point quickly as you would say that I wouldn’t want people running off and writing down 100 plus percent on every store because in some of those consolidation, the other factor you have to take in as that if they’re a mile away we’re in real good shape. If they’re multiple miles away, we do lose a higher percentage of that business because we’re just further from the shops. So what we’re seeing is we’re very pleased with the transfer that we’re seeing, we’re seeing places that we’re getting plus 100%, but we’re also seeing places that are coming in underneath. Principally there is distance involved too.

Mike Norona

And Scot, I think our focus. We always want to improve our profitability. We don’t think about it. We’re not going to start reporting out on stores, but the big value there is when we consolidate we get a better pool of inventory, we can improve our service levels. We get better delivery, more trucks serving the customers. So we really focused on the top line two of those consolidations.

Operator

Thank you. The next question is from Michael Lasser with UBS.

Michael Lasser - UBS

Good morning. Thanks a lot for taking my question. I wanted to connect some of the points you made on the gross margin side. You mentioned that the gross margin was down, due primarily to the inclusion of General Parts. And then it sounds like it was also due to the reclassification. Was there anything else in there that caused the gross margin pressure that you would highlight?

Darren Jackson

No, there were three big drivers. They were two primarily that took down and one that actually helped it. The two that took it down of the two you mentioned and one that helped they’re actually our synergies, so primarily driven by our purchasing synergies. But those are with the three big drivers.

Michael Lasser - UBS

Okay. And then on the performance of the GPI businesses, it seems like you're talking a lot about the benefit that the legacy Advance stores are seeing as a result of the integration. But it seems like the GPI businesses also accelerated a bit from the first to the second quarter. Maybe you can discuss what's happening, what benefits those segments are seeing from the combination as well. Or is there something else going on there?

Darren Jackson

I think they’re very much the same like in many cases. Just as Advance is benefiting from the inventory position of CARQUEST so too as CARQUEST from Advance, so on a market-by-market basis, they are experiencing better inventory availability. I also think just at a culture level the team is pretty fired up about integration. Gary mentioned this, when you think about integration and he gave the example of systems being one of those things that’s kind of you hit a period where it's a longer drawn out project you go through, the one that probably gives us the most in terms of successful integration of this cultural overlay which has been fantastic. So I think the teams are aggressive out there on the CARQUEST side, but they too see better market availability.

George Sherman

And I think the other thing I would add to that is we were pleased with the CARQUEST growth in terms of our Canadian business was strong, independent business strong, wolf pack business was strong. And I think the word we would use we’re seeing steady improvement and momentum.

Operator

Thank you. Our final question today comes from Seth Basham with Wedbush Securities.

Seth Basham - Wedbush Securities

My question revolves around the base business, which we haven't spoken too much about on the Q&A here. Could you give us an update on some of the key metrics that you're tracking in terms of customer satisfaction scores, training completed, attachment sales, rates, et cetera?

Darren Jackson

Yes, sure, Seth, really all the above. I think if you look at the DIY business and Gary really said this. We can’t control weather but we can control what the interaction looks like between a customer and our team when they walk in the stores and that really he has focused around that heavy duty DIY and selling the entire project to them and that really was the impedance behind automotive systems training.

We are pleased with how that’s progressed. It is a very comprehensive 18 module training program. It takes some time. It’s difficult. It’s meant to be that way. But we track completion rate on that one and we’re pleased with that’s moving along. We also look at the individual interaction with the customer and whether or not we sold the entire project.

On the customer service side, we look at a number of metrics one of which is likely to recommend and are very-very pleased with the outcome there that’s been strong and it has remained strong for a couple of quarters now.

And then we’re also beginning to have more of a focus around commercial customer feedback, really talking to our best customers, doing an anonymous survey and just kind of getting feedback on the core components of the great relationship and how we’re helping them to grow their business. That’s very new for that’s off to a very nice start as well. So those really I mean we’re going to be a field led customer centric organization and metrics like that are at the heart of that.

Seth Basham - Wedbush Securities

That's great. It seems like you have some real momentum there. As you think about your comp performance for the last couple quarters and the progress you're making with these initiatives internally, how much of that comp lift that you've seen do you think has been driven by some of these initiatives relative to the benefits you see from weather, et cetera?

Darren Jackson

Yes, I mean Scott, I think a large part of it, the weather is out there and it works both ways and we know that. What we like about the sequential comp improvement is that we see our core commercial business getting stronger and stronger along the way and we think we control that. We think that’s execution. We think that’s the evolution of the commercial value prop. We think it’s better in-field execution by our teams and in fact we think it’s better confidence among our team.

Operator

Thank you. I would now like to turn the call over to Zaheed Mawani for any final comments.

Zaheed Mawani

Thank you, Wendy. And thanks to our audience for participating in our second quarter earnings conference call. If you have additional questions, please call me at 952-715-5097. Reporters, please contact Shelly Whitaker at 540-561-8452. That concludes our call.

Operator

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

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Source: Advance Auto Parts' (AAP) CEO Darren Jackson on Q2 2014 Results - Earnings Call Transcript
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