Advance Auto Parts' (AAP) Tom Greco on Q3 2016 Results - Earnings Call Transcript

| About: Advance Auto (AAP)

Advance Auto Parts, Inc. (NYSE:AAP)

Q3 2016 Earnings Conference Call

November 14, 2016 05:00 PM ET

Executives

Zaheed Mawani - IR

Tom Greco - President & CEO

Tom Okray - EVP & CFO

Bob Cushing - EVP of Professional Sales

Analysts

Michael Lasser - UBS

Simeon Gutman - Morgan Stanley

Matt Fassler - Goldman Sachs

Bret Jordan - Jefferies & Company

Mike Baker - Deutsche Bank

Brian Nagel - Oppenheimer & Company

Dan Wewer - Raymond James & Associates

Chris Horvers - JPMorgan

Scot Ciccarelli - RBC Capital Markets

Chris Bottiglieri - Wolfe Research

Alan Rifkin - BTIG

Craig Kennison - Robert W. Baird & Company

Jamie Alexander - Redmond Asset Management

Seth Basham - Wedbush Securities

Jack Balos - Focus Research

Denise Chai - Bank of America, Merrill Lynch

Adam Leba - Luna Sales

Mike Montani - Evercore ISI

Zaheed Mawani

Thank you. Thank you, everyone. Good evening, I'm Zaheed Mawani, and I run Investor Relations. Welcome to the AAP combined earnings and strategic business plan update meeting. We're very excited to be here today and share this update with you over the next couple of hours.

Before we begin, I'd like to remind you that our comments today contain forward-looking statements. Please refer to our earnings release that we issued today for more details as it relates to our third quarter.

We have a great agenda for you today. So we're going to get into a third-quarter recap, and then we will go right into strategic plan highlights, followed by a question-and-answer session. And then afterwards, we will be serving light refreshments, and members of the management team will be here for introductions and discussion. Okay, with that, let's get started.

And I'm going to turn it over to Tom Greco, our President and CEO, to get us going. Tom?

Tom Greco

Well, thanks, Zaheed, and good evening, everyone. We're really thrilled to see all of you here today. I'd like to welcome all of you to our event, both those of you here in the audience, as well as those of you joining us on the webcast. We greatly appreciate your interest in our business, and we're very excited to share our progress with you today. We'll start by providing a brief recap of the third-quarter results, and then we'll transition to an overview of our strategic business plan. We've been developing this over the past several months. With that, let's get right into it.

Our comp-store performance in Q3 was down 1% as our initiatives to improve top-line performance began to have an impact. While we delivered sequential improvement versus previous quarters, let me be clear. We will be relentless in our pursuit of positive comp sales.

In terms of profitability, our adjusted operated margin rate of 9.7% and adjusted EPS of $1.73 were impacted by three primary drivers, all of which we called out during our Q2 call. First, we made investments in the quarter to better-serve our customers. Secondly, we took deliberate actions to reduce inventory levels versus Q2, which resulted in cost headwinds. Going forward, we'll continue to bring our inventory levels down without disrupting our customers. And third, we faced higher supply chain operating expenses in the quarter, including our planned transition from 5X to 3X delivery frequency in selected markets.

As for our top-line performance, while it's still early, we're encouraged by our sales improvement, as the heightened focus on execution translated to improved input metrics and ultimately sales. We remain relentlessly focused on execution and we're going to make investments in customer service and availability to align our entire organization around the customer and around gaining market share.

To date, our investments have driven sales performance at a faster rate than expected. On our Q2 call, we called out back-half investments in three areas in availability, in customer service and in our front-line organizations. All three of these investments have been promising. In terms of availability, we have a number of initiatives underway that test different ways of positioning our inventory, of assorting parts and of delivering parts to our customers. These tests are being conducted throughout our network. The initiatives all have the same end-game get the right part in the right place at the right time consistently, reliably and predictably.

As we work to improve availability, we're working to do so at less cost and with more availability. We're testing these initiatives in multiple phases and we're applying some of the learnings to our base business. So far, we like many aspects of what we're seeing and we plan to roll out these initiatives in 2017. We also see elements of our test that we can leverage in the future, and we'll discuss the progress we're making on availability later when we review our strategic business plan.

In terms of investments in our customers, we're equally encouraged. This includes investments in availability, in store labor and in a front-line incentive program. These investments enable our front-line team to compete at the absolute highest level and position them to win with our customers. In particular, the incentive program we launched has been extremely well-received by our field team, and almost immediately has had a step-function impact on reducing turnover in all front-line roles. Our field team is fired up and they're increasing their focus on what matters most to our valued customers.

In summary, we're encouraged by the investments we've made in availability in our customers, and in our front-line team. On a regional basis, we saw comp sales improvement in every region in the country. While performance in the Northeast and Great Lakes still lagged our overall business, it improved as our actions to improve performance in some of our more challenged distribution centers paid off. Our teams in these regions are excited about the changes as we're giving them the chance to say yes to our customers more often.

To sum up Q3, we're encouraged by the progress we're making and the momentum that is building behind our efforts. That said, we still have a significant amount of work to do to dramatically change the trajectory of our business. Accordingly, we're maintaining a very disciplined approach to improving customer service, as it's absolutely vital that we get this right for the long term. We're focused on delivering consistent sales and profit improvement over the long term, not just the next quarter. We'll continue to sharpen our focus on execution, improve availability, and deliver on the needs of our customers as we execute our strategy.

I'll be back up shortly to provide an update on our strategic plan. But before I do, it's my absolute pleasure to introduce Tom Okray to give a brief third-quarter update on our financial and operational highlights. Tom brings more than 25 years of experience in finance, operations and supply chain to AAP. Most recently, he served as VP, Finance, Global Customer Fulfillment at Amazon, where he was the finance lead overseeing the optimization of all key elements of Amazon's global fulfillment network. In addition, Tom spent over 20 years at General Motors in finance and supply chain-related roles. He was most recently responsible for overseeing more than 120 billion in annual expenses and 8 billion in CapEx as CFO, Global Product Development, Purchasing and Supply Chain.

Tom is absolutely passionate about winning in the marketplace and he's laser-focused on what matters most to our customers. He knows what it takes to win in the digital world and he's bringing an entirely new dimension to our thinking as we navigate the future. We're thrilled to be joined by Tom, given his unique background and deep operating experience, as we write the next chapter of growth for AAP. Tom?

Tom Okray

Thanks, Tom, and good evening, everyone. Before I begin my prepared remarks, I just want to briefly share how thrilled I am to be a part of the AAP team. I joined the organization at a very exciting time, as we refocus the Company on our most important priority, the customer. We will work to improve our service levels, our overall execution, and without a doubt, our operating and financial performance. I also want to thank Mike Norona for assisting with my transition and our third quarter financial close. Total sales for the third quarter decreased 2% to $2.25 billion, principally driven by our comp-store sales decline of 1%, store closures, and Carquest consolidations. The declines were partially offset by growth at Worldpac, store conversions and new stores.

Our gross profit rate decline of 104 basis points was primarily driven by higher supply chain expenses and headwinds associated with reducing inventory. Our adjusted SG&A rate was essentially flat year over year, driven by continued cost-reduction initiatives, partially offset by investments in delighting our customer. All in, our third-quarter adjusted operating income came in at $217.6 million. Adjusted operating margin decreased 95 basis points over the same period last year, to 9.7%. Operating cash flow through the third quarter was $409.4 million versus $520.1 million last year, primarily driven by an increase in inventory versus last year, and lower sales. While we have not provided an annual EPS outlook, we'd like to give some context on how we're thinking about the balance of the year.

We're encouraged by our sales improvement in Q3. However, it's early and we have a lot of work to do. Additionally, as you may know, our fourth quarter is our lowest volume and most volatile quarter of the fiscal year. We expect continued headwinds in our operating margin rate, similar to what we experienced in the third quarter, as we continue to invest in our customers, our inventory, and optimize our supply chain network. That wraps up our third quarter recap. We're going to transition to discussing elements of our strategic business plan.

With that, I'll turn it over to Tom Greco.

Tom Greco

Thanks, Tom. So at this point, we're going to transition to the strategic business plan. This plan has been several months in the making, and we couldn't be more excited about our prospects for the future. Our plan is deeply rooted in focused consumer and customer research for both DIY customers and professional customers. Our goal is to dramatically improve performance across the board through a step-change in customer service. Please understand, we'd like to share as much of our plan as we possibly can with you. At the same time, we feel it's in our best interest of all concerned that we're careful on just how much we share about our plan, for competitive reasons. Also understand that if you're left wanting for more details, we've spent considerable time analyzing the pros and cons of doing so, and we've concluded that it's not in our or shareholders' best interest to do so. That said, we've got a very compelling plan to capitalize on the enormous growth opportunity that we have at AAP. And we're excited to share our plans to deliver improved results and shareholder value.

Before we get started, I know this might be the first time we're getting to know each other. There's some new people in new positions at Advance and for some of you, this includes me. Stepping back, and with the benefit of my first six months in the role, along with close to 30 years of experience at PepsiCo and Frito-Lay, I'm confident we're in a great position to capitalize on the opportunity ahead. Many of the ingredients for success that I enjoyed at PepsiCo are transferable here: Constructing a demand driven growth agenda that's rooted in customer and consumer insights. Transforming the supply chain to build new capabilities and drive productivity and empowering the front-line organization to drive execution and operating improvement.

Without question, I see the application of each of these learnings here at Advance. In fact, there's more opportunity to drive growth and productivity at AAP than any role that I've ever had. We'll discuss the opportunities that we see going forward throughout the presentation.

It's also my pleasure today to introduce Bob Cushing, right there in the middle of the slide. Bob recently assumed the newly created role of Executive Vice President, Professional Sales, where he will oversee all of the Company's professional sales operation, including Advance, Carquest, Autopart International, and of course, Worldpac. Today we're rebranding what was formerly known as our commercial business, to professional. Professional is a name that our customers prefer and as a result, that's the name we're going to use going forward.

Bob is perfectly suited to head up this business. He's an exceptionally talented industry veteran, with over 30 years of experience in the industry, and he's been the driving force behind the tremendous growth and market-leading position that Worldpac enjoys today. Importantly, Bob is very competitive. You're going to see that today. He's going to be relentless in driving outcomes, and he'll expect nothing less than the best as he instills a high-performing culture and makes sure we execute to win in the marketplace. In addition to Bob, later in the presentation, we'll hear once again from Tom with a discussion on how our strategy translates to an outlook to the future.

So let's get started. I'd like to begin with what we'd like you to take away from today's event. First, we operate in a terrific industry. It's large and growing, with attractive dynamics across the board. Secondly, AAP has a very compelling market position, including industry-leading assets, tools, and capabilities for us to leverage. Third, we have a tremendous opportunity to drive growth and margin expansion. But to do so, we need to implement real change not just a change in operations, but a real change in culture. We have to focus on the customer first and begin our journey for everything we do with how we can provide the best possible service for our customers. And fourth, we're already executing a clear, focused agenda to drive change. Fifth, overseeing this effort is an aggressive leadership team that's fully aligned around our plan. In summary, one can only conclude that AAP represents a compelling investment, with tremendous opportunity to deliver shareholder value.

So let's start with the fact that we compete in $135 billion industry that's experienced strong growth for several years, and we see no end in sight. Industry forecasts predict consistent growth over the next five years, led by professional. For certain, the industry continues to benefit from an increase in vehicles in operation, an increase in average age of vehicles, an increase in older vehicles, and an increase in average miles driven per year. These industry fundamentals will drive strong growth for the industry for years to come.

In addition to industry fundamentals, AAP is well positioned to gain market share. We have many advantages, including a Company owned professional business, an extensive North American footprint of fulfillment centers and stores, and the leading distributors of import parts. Clearly we have the assets to succeed and accelerate growth, but to do so, we need to better utilize those assets to our advantage. Without question, AAP has a substantial market share opportunity. We're also keenly aware of evolving industry trends, including ecommerce, technology, electrification, urbanization, ride sharing and autonomous vehicles. As a result, we're excited by the opportunities of today and the opportunities of tomorrow, as we construct our strategic growth agenda.

With disruption comes opportunity. Whatever we do, we must delight the customer. Everything we do starts and stops with the customer. In building our plan, we knew we had to develop a deep and visceral understanding of the customer, and deliver on their needs. Over the last few months, we've conducted the most significant piece of research our Company has ever undertaken. We spent a tremendous amount of time to understand what delights both professional customers and DIY customers.

Of course, ultimately, we must turn those insights into actions. Our professional customers are looking for high quality parts at the time we promise them. We understand this opportunity, and its unquestionably achievable for AAP. The DIYer needs vary widely by vehicle history, repair complexity and their level of expertise. This requires a very focused agenda for our team members. Armed with these insights, we've developed a strategy and a series of initiatives to delight both professional customers and DIY customers. The initiatives are focused on making sure we have the right part in the right place at the right time, and creating a better overall experience for all of our customers.

This leads to the big planks of our agenda. First, building an advantaged supply chain is the cornerstone of our efforts, as we improve availability, delivery consistency and speed, to delight our customers. Secondly, in professional, we're building a dramatic improvement in the customer experience at every single touch point, as we ramp up sales and service capabilities.

Next, in DIY, we're planning changes to improve the in store experience and drive loyalty, as well as a re invention of our online experience. Fourth, our growth agenda will be supported by a robust and ongoing productivity engine that will enable us to expand margins and fuel our growth for years to come. At the center of all of this, of course, is our talent and our culture, which will support and facilitate our ability to execute each initiative.

Let's begin with supply chain. A robust and highly functioning supply chain is absolutely foundational to our success. To achieve this, we plan to leverage our existing supply chain assets. The key in constructing an advantaged supply chain is to build new capabilities to improve availability, delivery consistency and speed, and drive growth, while removing unnecessary costs. I'm highly confident we can achieve this at AAP. We have a very strong asset base in terms of square-footage, inventory and delivery trucks, but they are not optimized today. We will optimize our assets to delight our customers. We've been conducting numerous test-and-learn initiatives over the past few months. In our business, having the right part at the right time is essential. It's table steaks for competing in the industry. As a matter of fact, a few years ago, the Worldpac team actually trademarked the tag line -- the right part at the right time. Our test-and-learn markets are delivering very positive results. This includes a significant increase in, in-market parts availability, a significant decrease in order-to-delivery time, and overall reduction in inventory and days on hand -- all while increasing availability.

Our customers are taking notice, and I quote: whatever you guys are doing, it's working for me. I get parts quicker. Cars spend less time on the lifts, so I get more jobs done. The bottom line here is that our changes are leading to increased sales, lower costs, lower inventory levels, and higher customer satisfaction. In addition to our test- and-learn initiatives, we have an opportunity to streamline our supply chain network and systems. This simplification of our supply chain enables us to get the Advance and Carquest supply chain and network fully integrated. This provides three primary benefits. First, streamlining our supply chain improves product availability. Secondly, it drives significant productivity by reducing spend miles from DC to store. And third, it simplifies our systems and processes by enabling seamless inventory transfer throughout the value chain, which is a huge benefit for our team members and independent partners. Therefore, what we formerly referred to as our integration plan, is now fully embedded in our ongoing strategic business plan. As such, we're no longer going to be discussing progress on integration. We're one Company now, and everyone is focused on the customer. Bottom line, there's no longer discussion about integration, but more about how do we use our supply chain assets better, and rethinking the system to better fulfill customer demand, and more efficiently get more parts closer to more customers.

Now, turning to our professional growth opportunity, we're ramping up sales and customer service capabilities big time. And I'd like to invite Bob Cushing to review our exciting plans for professional customers.

Bob Cushing

Thank you, Tom. It's a pleasure to be with you here today. This is an exciting time to be with AAP. In my early observations, I have recognized the tremendous opportunities that exist today to accelerate our growth. In my new role, I'll drive improved performance across the enterprise by leveraging my experience and our proven capabilities, highly coveted by our customers. My goal is to completely transform our customer sales and service model, both online and in person, on the professional side of our business. I will be highly focused on improving the overall customer experience to dramatically improve our first call and first click capability.

As I've looked across AAP, I've found many assets that are totally under leveraged. So it all starts with attractive brand portfolio. And our customers have spoken. They want high quality

branded parts to service their customers. And our research confirmed that AAP's parts assortment consistently delivered against this objective, more than any other supplier. While we're pleased with the result, we will continue to work diligently to delight our customers.

Additionally, over the past 40 years, we have developed an industry leading selection of private-label products to meet the needs of our professional customer. AAP's private-label brands support our multi brand strategy, which is what's preferred by our professional customer. So when you look, we start with the significant growth opportunity from a solid base of domestic vehicles in operation. And importantly for our customers, we're ahead of the curve on the growing import opportunity. The vehicle import market share is expected to grow dramatically, as it has over the past 15 years. This will provide a tremendous growth opportunity for AAP across these higher enterprise. We have the import expertise with Worldpac and Autopart International, we've delivered this, and basically built the leading import program for the past 40 years.

Another asset we can leverage better is our training. Our customers want professional training to help grow and improve the profitability and grow their business. Their technicians need advanced technical training, to meet the demands of diagnosing and repairing today's and tomorrow's vehicles. We already have two great tools today. We have the Carquest Technical Institute, and we have the Worldpac Training Institute, which is focused on the import side, again, the opportunity I just described. Together, the Carquest and Worldpac training institutes provides the professional customer the most comprehensive training curriculum in the industry. And it's only available at AAP.

In today's digital world, serving professional customers has to start with an industry leading online experience. And we have a great online asset at Worldpac today. In the research that we conducted, our online experience was rated best-in-class by our customers. This performance was also recognized by Frost & Sullivan research, which found automotive technicians rank Worldpac as the best program distributor. With a comprehensive line of quality products, easy-to-use online system which is speed-dial, outstanding salespeople, competitive pricing, dependable delivery and consistent product availability. I could not more proud of the team for this accomplishment. But as we look forward, the only way we'll leverage this great suite of assets is to put the customer first always. This has been really important to me my entire career, listening to customers, responding to them and providing them what they need: High-quality product assortment, Delivery service that's fast and consistent, Technology to drive growth and ease of doing business, providing our customers with an industry leading catalog, a sales team dedicated to delighting the customer, and training to enable our customers to grow their business.

So now it is our time to shift into high gear. We will knit together and leverage best practices across all of AAP's professional business going forward. I know there are better ways to integrate our supply chain. I know we can leverage our catalog and technology to create a better online experience. And for certain, we will build a more robust sales and customer service culture at AAP. And by the way, we're already doing it. In fact, we just solidified a multi-year agreement with one of the largest customers, who is really pleased with the new am AAP approach.

And I quote the customer: we chose Advance professional based upon their overall enterprise value. The combination of product coverage, local availability, technician training, technology, as well as competitive pricing, made them the right choice both now and into the future. They have a proven track record of great customer service and consistent execution across a large geographic area, which makes them the right strategic partner for the business. The entire AAP team could not be more excited about taking our professional sales to the next level. And we know there's a significant market share opportunity for us as we execute our plan. And we will deliver it.

At this point, I'll kick it back to Tom. Thank you.

Tom Greco

Okay. So now you see why we're so excited about professional. Now I'm going to talk DIY. And we're a little l further along in our journey to accelerate professional than we are in DIY. While we continue to strengthen the DIY plan, we're already seeing signs of improvement in our DIY sales, as we really get focused on the customer. Just like inside professional, our DIY success begins with putting the customer first in everything that we do. We have to build trust, confidence and loyalty with DIYers all over the country. We leveraged some custom, significant research we conducted with DIY customers, and our plan is to delight them at every touch point.

Across the board, we're improving parts availability, we're building engagement platforms that drive traffic, we're ensuring a consistent in-store experience to drive frequency, we're focusing our training on priority segments to build knowledge and capability. And we're revamping our Speed Perks loyalty program. We're also increasing our investment in mobile and digital to seamlessly connect the online and in-store experience, all of which have the common goal of gaining market share. First, we plan to grow our customer base. We've analyzed our business over the past several years, and we have a very clear idea what's been driving our challenges with traffic and sales growth inside of DIY.

Some of the factors driving the decisions on how DIYers choose an auto parts retailer include vehicle history, repair complexity, and their level of expertise. From this, we've identified priority segments where we're confident we have a right to succeed. Meeting the needs of these customers will require thoughtful planning around labor, training and marketing. We're excited about attracting new customers to AAP with targeted marketing and a wider array of services. Next, we'll drive frequency with existing customers. Speed Perks is entering its third full year. To date, we haven't been leveraging the scale of this program as well as we should and will going forward. Our plan is to build customer loyalty with Speed Perks. We now have millions of Speed Perks members, which gives us a deeper understanding of their lifetime value. We're learning more and more about how these customers want to be engaged. And we're building momentum around new ways to cultivate a much stronger relationship with these customers by leveraging insights and analytics around their individual needs and behaviors. Just one additional trip per year by each Speed Perks member results in a tremendous growth number for AAP.

Finally, winning in DIY requires us to improve the overall experience for our customers, both in-store and online. Critically important to achieving this goal is to address the basics of the business. We have to raise our standards on execution. This includes ramping up discipline inside the store, and re-dedicating ourselves to a consistent and exceptional customer experience every single time. We also must ensure that we serve our customers when and how they want to be served, which means elevating our online experience. The end result will be a much better experience for DIYers in every interaction they have with AAP in person, over the phone or online enabling us to build customer trust, confidence and loyalty. Our customers have been telling us that we're making progress in DIY. In the past few months, we've seen an increase in the number of complimentary letters from DIYers all over the country. To read just one: your manager and his staff were so nice and so helpful in what was for me a very stressful situation. His actions have made me an Advance Auto Parts customer for life.

In summary, our team is energized to better-serve the DIYer. And just like in professional, there's a significant market share opportunity in DIY with improved execution. Between the transformation of our supply chain, building out new capabilities in professional, and improving the overall experience for DIYers, we're very bullish on our ability to sequentially accelerate our top-line performance going forward, just like we did in Q3 of this year.

Now, let's talk productivity. Accelerated productivity will fund our journey. In order to sustain investment in growth, a robust productivity engine is absolutely essential. We've gone up and down every single cost line in the entire enterprise to construct our productivity plan. It spans six major categories and will contribute meaningfully to profit growth.

The categories we've targeted are: distribute, ship, run as it pertains to stores, deliver, sell, and support. Please note that while we're removing unnecessary costs, we're also driving new capabilities and investing in long-term growth creation. Our current productivity build delivers 500 million in cost reduction over five years. To be clear, this is a gross number. Some of this will be used to fund our growth and transformation initiatives, so not all of this will flow directly to the bottom line. You'll see the impact of the re-investment of our productivity savings in improving operating margin over the period of the plan.

Our productivity agenda includes three important areas of focus. First, zero-based budgeting, where we're eliminating waste and standardizing our approach to cost control. Secondly, as I mentioned earlier, we plan to streamline our supply chain to drive both effectiveness and efficiency. Simplifying, optimizing and fully leveraging our existing asset base yields big savings in our plan. Finally, we've initiated a substantial piece of work on material input costs. As part of this, we'll leverage procurement and value engineering to round out the big planks of our agenda.

Bottom line, we're entering 2017 with a very high level of confidence in our productivity pipeline. In addition, we're very much looking forward to having Tom Okray provide his perspective, given his extensive experience in large organizations where productivity and cost management play a central role.

Finally, I'd like to touch on talent, culture and capability. Across the organization, you can expect us to be maniacally focused on growing talent, evolving our culture and growing new capabilities. Specifically, we'll grow talent by developing much more robust leadership development programs for our existing leaders. We're also promoting talented leaders who know the parts business cold, and have the capability to do more.

And importantly, we've done a great deal of work on evolving the culture of the Company. This includes building a culture which is obsessively focused on the customer, and one with an exceedingly high level of accountability of ownership and drive for results. Related to this, our leadership team has spent time looking at incentives and ways to empower all of our team members to act like owners. As an example turnover. We put a tremendous focus on reducing turnover, and I'm pleased to inform you that we were down significantly in Q3 versus previous year in each of the key roles in the field.

Finally, we're defining the new capabilities we need across the entire enterprise. Where we lack the talent internally, we're going outside to find people who have industry leading capabilities that we can leverage. And we've already hired several people from outside of AAP that are bringing an entirely new dimension to our thinking as we prepare for the future.

In summary, over the next five years, our plan delivers sequential top line sales improvement, $500 million in gross productivity, substantial margin expansion, and world class talent, culture and capabilities, which will future fit AAP for years to come.

Now it's my pleasure to invite Tom back to the stage to give you a high level view of how our plan translates to an outlook.

Tom Okray

Thanks, Tom. The opportunities Tom and Bob discussed to deliver improved results are familiar to me. I'm used to putting the customer first always. And I know we can drive accelerated sales growth and margin expansion included in our plan.

Turning to the financial impact of our plan, for 2017, we will deliver positive sales comp growth and a modest increase in operating margin. By 2021, our plan delivers mid single digit comp sales and at least 500 basis points of margin expansion.

As Tom previously discussed, we're building a platform to enable sustainable growth and operating leverage. To achieve that goal, we've worked backwards from the customer, and balanced our efforts to achieve growth, reduce costs and efficiencies throughout the organization. Importantly, we're also focused on delivering shareholder value. We will deliver strong operating performance, which will generate strong cash flow improvement.

Further, we have tremendous focus on working capital. This includes optimizing our inventory and our payables, which will result in a dramatic improvement in AP ratio. Our strong cash flow generation, combined with a balanced capital allocation plan, enables us to invest in new capabilities such as digital, and growth, such as new market development. We will apply disciplined rigor around driving strong returns and efficient use of capital, as measured by ROIC. We look to return excess cash to shareholders while maintaining our investment grade rating, with a bias towards share repurchases. Together, we have a tremendous opportunity to leverage the largest asset base in the industry to drive shareholder value. I couldn't be more excited about the future of the Company.

And with that, I'd like to ask Tom and Bob to return to the podium. We will take some questions. Zaheed, can you lead us?

Question-and-Answer Session

Operator

[Operator Instructions]

Unidentified Analyst

[Technical Difficulty] Great, first six months -- I guess the biggest follow-up I'd have on this is, if you think about that longer-term goal, getting the 500 basis points of improvement, mid single-digit margins, what do you think is the biggest constraint, if you will, to actually getting there? You've listed a lot of great opportunities. But as you're looking at it, what is the biggest hurdle? Is it the supply chain? Is it getting the culture to move faster? I'd love to hear in your words. And Tom, as a follow-up, just what's -- any CapEx budgetary things we should be thinking about as part of that five year plan?

Tom Greco

I think the big one for me is the customer obsession piece that has to permeate the entire organization. It's something that has been lacking, okay? And we have to get that much deeper embedded into the organization, so that every single team member is out there really doing whatever it takes to provide the best service we can provide to our customers. And we're working very hard at building that culture. We've taken some steps to really elevate and lift up examples of people who were doing that. Because we do have people doing that throughout the organization, but it's not as consistent as we'd like. And that's -- if I could wave a wand and change one thing tomorrow, it would be that. But that's the biggest opportunity area, I think, in terms of getting to where we need to go.

Tom Okray

The way we're looking at CapEx over the plan is basically in line with what we've historically spent. That's our input at this point. Absolute dollars right now.

Zaheed Mawani

Great; why don't we go to the back of the room, Michael?

Michael Lasser

Good evening. It's Michael Lasser from UBS. Two questions. First, Tom, how do you bridge the fact that AAP's operating profit per employee is about almost half the rate of the peers, and how do you bridge that to your plan and your customer focus to get that? And second part of the question is, how do you gain the market share that you've lost, back?

Tom Greco

Sure. Well, first of all, the differential between ourselves and our peers is really around some of the things that we just talked about. I do know, we're not fully leveraging our current asset base across the board. The entirety of our infrastructure can be better-optimized, better-leveraged, and we're taking the steps we need to achieve that goal. So that's a multiyear journey, but we're going to do it in a very disciplined fashion without disrupting our customers. We're not going to knee-jerk, we're not going to rush it. But there's ways that we have already identified to better-leverage the existing asset base that we have, and essentially get to those types of margins that we aspire to.

And then your second, remind me on the second question? Yes, I think we're very focused on driving at what the customer wants. The input metrics that we've identified for our organization have been narrowed significantly. So the number of things our field organization is focused on is down to a much more manageable list. And I think that our cadence, which we go through every week to look at how we're performing against those key input metrics that are customer facing are resulting in, relatively speaking, improved sales performance. And you know, in terms of the customers, getting the customers back, I think we're already getting customers back. We track how many customers we sell to every single week. So I know the absolute number of professional customers we're selling to by week, and we know exactly where our opportunities are. And we're getting the customers back we need to get back.

Zaheed Mawani

Thank you. Simeon, we'll go with you.

Simeon Gutman

Thanks. Tom, I think the first conference call, we talked about some of the issues being more process driven than infrastructure. Curious a lot of the presentation talked about that. Curious if you can update some thoughts on it? And then, Tom, you answered that question about CapEx, saying it's going to be constant. Does that mean we'll either see new stores come back into the mix, or does that constant mean maybe new stores slow down and you put some more investment back into infrastructure? One more and one follow-up. As we often hear, you have the parts in the system, but you're touching it more to get it to the customer. Is that an observation that's fair, and how do you fix that?

Tom Greco

Maybe if I could, Simeon, I'll combine your first and third question. Because I do think how we were getting parts to the customer was not optimal. So we have tested a number of different ways of inventory positioning, of assorting parts, and of how we deliver to the customer. And all of those have been factored into our strategic business plan. Some of them we've just kind of lifted and shifted right away, and moved them to our base business. But we're not going to comment specifically on the things that we're rolling out. But part of the goal is to reduce touches. Obviously we don't want to touch parts; we want to reduce the number of times we touch parts in every part of the supply chain, inside the DC, how many times we touch it on the way to the customer, how many times it gets touched in the store. Touches are bad in a supply chain, so our goal is to reduce touches. But we wanted to do that in a way that enables more availability, and that's the trick that we're trying to balance with.

Zaheed Mawani

We'll come over here to Matt.

Tom Okray

Did you want to me to get the CapEx question?

Zaheed Mawani

Oh, pardon me. Yes.

Tom Okray

Just to finish up? The main buckets of CapEx will be renovation of the existing stores, IT, as well as looking at potentially opening new stores as we get the flywheel going and start gaining market share.

Matt Fassler

Good afternoon. It's Matt Fassler from Goldman Sachs. I guess this one's for Tom Greco. You spoke about culture and the change in the selling culture at the organization. How does one go about doing that? How are you energizing the team and directing the team in that regard? And then if we could also tie that to any changes you're making in incentive comp, how you're managing to thread the needle of presumably making that compensation better-aligned with productivity while still keeping that level of motivation as strong as it has been?

Tom Greco

Good question, Matt. For us, those customer-facing employees are just so critical. Our general managers, our district managers, our commercial parts pros, our commercial account managers, those are the people that face customers every single day out there in the marketplace. Six months ago, candidly, we had a very difficult time retaining people. You probably are well-aware of the fact that we were losing people to competitors. We took some steps to address that through incentives, by lifting up the importance of those roles, listening to those people. We brought a general management council into place to essentially help us forge our agenda.

We're spending a lot of time looking at turnover rates by geography, by district, throughout the country. So we've made a lot of progress. I mentioned in the prepared remarks, our turnover rate is down across the board in each of those four roles, dramatically. It was up significantly, and now it's down year on year. And we're going to continue to pay attention to that, because we know that if we can get continuity and we can get our people trained and skilled and knowledgeable, and really loving coming into work every day, that's going to make a difference over time. So it really is about the tools we're providing them, the training we're providing to them and the incentives. And we have to enable them to compete at the highest level in the marketplace. And that's what we're doing.

Zaheed Mawani

Great. We'll go over here to Bret.

Bret Jordan

Thanks. Bret Jordan with Jefferies. A question on the supply chain. I think you talked about the number one being, the number one of on your focus list. At what point are we going to have distribution centers on a common IT system? And is it still the thought to rewrite the legacy program and use it as the overlay? And then the follow-up question on that is, the inventory levels, I think at the end of the second quarter, you talked about maybe taking several hundred million dollars out of that balance. Would we expect that to happen around the same time you get a common IT backbone?

Tom Greco

So thanks, Bret. First of all, the whole initiative around streamlining the supply chain is that we're going to look across our entire infrastructure and optimize the assets that we have. Part of that, of course, is to get to a single supply chain stack, so that we have distribution centers that can communicate with stores on either network. So that, we have a very deliberate plan to roll that out. We have a timeline. We know when we're going to get it completed. Part of that is to get to a single information technology system, so that's a much easier system for us to work with.

We're also looking across the entirety of our supply chain to include Worldpac, Canada, Autopart International, all of those represents elements of a North American supply chain, which ultimately we want to get to. So we're pretty excited about the streamlining supply chain. There's a big productivity driver in our strategic business plan. It's a big simplifier for our people, because they don't have to deal with the multiple processes, and it's going to helps us with availability.

On your second question, which was surrounding our catalog, we've got Bob here, who -- maybe you can talk to this a little bit, Bob, on the catalog. But we're excited about having Bob oversee the entirety of our professional business. We've never done that before. We've always looked at it somewhat vertically. Advance, Carquest, Autopart International, Worldpac, we want to make sure that we make it as easy as possible for our customers to access all of those really -- the broad lineup of parts that we have. Bob, can you maybe talk a little bit about it?

Bob Cushing

Yes, so Worldpac has built, for the last 40 years, the industry-leading OE catalog. And back in 2004 when Worldpac was acquired by GPI, we were working with them collaboratively to build their after-market catalog. Now we have this opportunity to bring them both together, to have the best possible customer experience. It's an exciting time, and we will no doubt have the leading catalog in the industry, I'm pretty certain of it.

Bret Jordan

So second quarter next year, one catalog for all of AAP?

Bob Cushing

It will be in 2017.

Bret Jordan

Okay, good enough.

Zaheed Mawani

Okay. What we're going to do now is just transition and take a call from a participant on the phone, and then we'll come back to in the room. So if you're on the phone and you're ready, please go ahead with your question.

Operator

Our next question comes from Mike Baker from Deutsche Bank. Your line is now open.

Mike Baker

Hi. Can you guys hear me okay? Hello, can you hear me?

Tom Greco

Yes.

Mike Baker

Okay, good. Sorry, just wanted to make sure. All right, so one industry question and then one Company-specific question. On the industry, you talked about more vehicles age 11 or older, or vehicles aging. I'm wondering what you guys see as the sweet spot of vehicle maintenance? Is there some age that vehicles get tooled at the market rate vehicles for you? And of course, there's probably some age when they sort of come into your sweet spot. What do you think the right cohort or bucket is to look at? And how do you see the number of vehicles in that bucket trending? That's the industry question.

And then I'll ask the Company-specific question at the same time, and then I'll listen. So the margin progression, 500 basis points essentially over five years, but you said slight improvement in 2017. So it's really 500 basis points between 2018 and 2021. Can you give us more help or color on the cadence there? Is it still going to ramp up in 2018 or '19, or is it going to be very back-end loaded? Thanks.

Tom Greco

Okay. I had a little trouble hearing there, Mike, but I'll do my best. On the first question, which was a sweet spot, it's really five years-plus. That's really the sweet spot for our business. So that's why we like the fact that there was 17.5 million vehicles sold over the past 12 months. That gives us an outlook for the next five years. We know that when those vehicles come around five years from now, that's when we'll start to really see a ramp-up in sales for us. On the second question, do you want to take that?

Tom Okray

Sure, I'll take that. First of all, let's step back. We're not satisfied with our operating margin that we have in Q3, and we're not satisfied saying modest improvement in 2017. But we're building a foundation here for the future. We're going to put the customer first. We're going to invest in the customer. We're going to optimize the supply chain and we're going to reduce our inventory. We're not going to cut corners. At this point in time, we're not going to give a glide path of what the timeline looks like to get to the at least 500 basis points margin improvement by 2021. Perhaps more color when we're back talking in February.

Mike Baker

Okay, I appreciate it. I'll turn it over to somewhere else.

Brian Nagel

Hi, it's Brian Nagel from Oppenheimer. So Tom Greco, a question for you. If we step back and look at this plan, the 500 basis point goal of operating margin is impressive, and gets you much closer to your competitors. So, I guess the question is, as you've studied the business now and you're not the first to attempt to drive higher operating margins here at AAP. What were the mistakes made previously? And how does your plan differ from maybe some of the prior efforts to do this?

Tom Greco

Okay, thanks, Brian. Obviously hindsight is 2020, and I think mine is as good as anyone else. But I'll comment briefly on what I think is different about our plan. First of all, I will say that I think our plan is dramatically different than we've seen previously, in terms of what I've looked at. I would say there's a couple of big ones.

The first one is that we are obsessed with the customer. Everybody on this stage is obsessed with the customer. We are going to drive that deep into the organization. We may have said we were obsessed with the customer in the past, but I think there's a lot of evidence that would say that we were not obsessed with the customer in the past. And that's probably job one, is to drive that, as I mentioned earlier, deep into the organization, ensure that it's a filter that we put every single decision that we make through the entire Company.

Secondly, we really didn't have a cohesive strategy, that I could gather, over the last several years. That caused us to make significant shifts in direction frequently over time. And when you're shifting a large organization of 75,000 people, it gets very difficult to get any kind of momentum around the agenda.

Third, when you have that going on, it really starts to compromise the execution. Because you're trying different things, and different priorities take a different level of energy at any given point in time. I can tell you, the number of things we were measuring was significant. The number of input metrics we were trying to accomplish was a very long list, and it did vary quarter in, quarter out.

So that, over time, reduces the amount of accountability that people inside the organization have to deliver against those goals, and it starts to compromise the overall ability to get things done and to achieve the margin expansion goals that were outlined. I think those are the big things that I would observe. Customer service is going to be or obsession with the customer, really, going forward, is our agenda. We have a cohesive strategy now. We're going to be focused on operating metrics and execution that are required to deliver against that. We do have to build the culture of the organization to be really focused on not just the customer, but to have a very high level of accountability, of ownership and drive for results. And that will be different going forward.

Brian Nagel

Thank you.

Zaheed Mawani

Okay, we'll come over here.

Dan Wewer

Dan Wewer, Raymond James. Tom, can you give an update on your thoughts about Carquest consolidations going forward? A few conference calls ago you expressed some dissatisfaction with the revenues that you were giving up. And then the second.

Operator

[Operator Instructions]

Tom Greco

[Technical Difficulty] conversions, the relocations, the openings, the closings, all of those things. And I'm an insights and analytics person. I want to really go deep on the metrics. What we said we were going to achieve with those goals, what we actually achieved -- we look back over the timeframe that they were initiated and we weren't comfortable, candidly, with what the performance of the consolidations were in that timeframe. So we dramatically reduced them by about a third, based on what we originally planned at the time of the deal itself. And I feel really good about that decision, because we're going to be able to drive market share. We're going to be able to retain employees. We've got some great people that work on the Carquest side of the business, on the independents and the corporate side; so that, I feel great about. The conversions -- I will tell you, I was in one last week -- that has worked well. Because you're essentially adding DIY to what was formerly an entirely professional operation. And so we see obviously increased traffic associated with that. We're driving comp sales in that store. We're getting more professional business. So the conversions have been much more successful overall. So you'll see us actually accelerating some of the conversions to get more DIY business on that side. As for our goals, again, we're going to focus on the customer. You saw our market share -- its single-digits. There's a lot of food on the table for us to grow. We have $10 billion in sales in a $135 billion market. We feel very good about our ability to gain market share overall in that timeframe. Obviously we don't ignore our competition. We look at it market by market. But our belief is that staying absolutely laser-focused on what's important to the customer is going to ultimately enable us to gain market share.

Zaheed Mawani

Great. We'll come right over here to Chris.

Chris Horvers

Chris Horvers JPMorgan. I have a few questions here. The $500 million in sales productivity, how much of that is sales-dependent? We've had some companies that I follow sort of talk about productivity metrics, and it's really not cost out, it's more just leverage. So how much of that is straight cost-out opportunity? And how would you break that out between cost of goods opportunity versus the expense opportunity? And then I have a follow-up question.

Tom Greco

So first of all, none of it is sales-dependent. I don't look at it that way. I'm looking for cost-out, period. So when we look at our productivity agenda, we're looking at waste opportunities that do not impact the customer. So my definition of productivity is, same sales, lower cost. So we don't need four-comp or three-comp, or anything like that to achieve that productivity goal. That cost is coming out. And we've identified each of the buckets that we believe it can come out in, and we're going to continue to focus on that. That will be an ongoing journey for us over the life of the strategic business plan. How much of it is -- what were you saying?

Chris Horvers

Cost of goods versus…

Tom Greco

Yes, there's obviously -- we had the three buckets, so that material cost optimization really does reflect some cost of goods. But it's obviously stilted more towards straight productivity in some of the operating lines that we have inside the P&L. We're not going to give a specific number, but it's definitely more on the straight productivity.

Chris Horvers

Okay. And then what drove the improvement in comps during the quarter, going from a minus 4 to minus 1? Can you talk about how much availability improved during the quarter? How much would you attribute to lower turnover? And then how much would you attribute to sort of stopping the confusion that was going on in the organization? And then finally, any comment on cadence during the quarter would be great.

Tom Greco

Sure. Well, first of all, we mentioned, right or wrong, we kind of landed on a small list of input metrics not too long after I got to AAP. And we said to the organization: we are not changing these. Even if they weren't perfect, we were not going to change those input metrics. We're going to look at them every single week, and we're going to go very deep, as opposed to this kind of wide swath, one week, we're going to look at this, some other week, we're going to look at something else. We're looking at the same small list of metrics. I can tell you that not every one of them, but several of them have shown significant improvement, quarter-to-quarter, so Q1 to Q2 to Q3. Some important ones that are customer facing ones, order-to-delivery time is one of them. Turnover, I mentioned earlier. We've got pockets of the organization where our fill rate and distribution centers is improving, and that one, we've got pockets where it's not. But we've narrowed the input metrics down significantly. People know what we're going to be talking about. You used the word distraction. I think that we've basically said this is what we're going to be focused on. And I'm really proud of our field team, because they've really responded to that agenda, and they're really driving against it, and that has really helped us. We're not going to comment on how our sales went through the quarter. Really excited about how Q3 ended up relative to Q2.

Zaheed Mawani

Great. We'll just come over here to Scot.

Scot Ciccarelli

Thank you. Hi. Scot Ciccarelli, RBC. Follow-up on Chris's question, just so I understand your comment, Tom. If you're really talking about 500 million in productivity, or let's call it cost saves, shouldn't that translate into something higher because of the sales leverage that you guys would expect from a mid single-digit comp? I'm trying to reconcile the two.

Tom Greco

So translate into more margin expansion, is that your question, Scot?

Scot Ciccarelli

Yes.

Tom Greco

Yes, well, again, we're trying to future-fit the Company for the long term. So we're going to continue to invest back in the customer to enable us to grow for many years. So it's not just about the five year plan. We've got a five year plan. We feel really good about it. We like the way that our sales is going to unfold, and we're very confident in that productivity pipeline. But we also are expecting that we're going to have to continue to invest in the business to drive growth over time. Because there's a lot going on inside the industry, and there's a lot of unknowns in the next five years that we have to be thoughtful with.

Scot Ciccarelli

Okay. And then a follow-up, actually for Bob. Given the success at Worldpac, what would be the top three changes you'd like to implement at the professional business as you take over the whole commercial operation or professional operation at Advance?

Bob Cushing

Well, I said earlier in the prepared remarks about, again, providing our customers what they value most. And so they want to have a quality brand portfolio, fast and consistent to the market every single day. We have to run that business every single day. So that's a critical one. We also want to end up making sure that we end up taking the catalog and having the catalog readily available to the customer. Which means we're basically integrating and having two catalogs there to serve it up. And of course, having the technology to basically make sure that we provide to our customers the best possible experience, to get the right part at the right time. So technology, catalog, right part at the right time. Those are critical, and that's what our customers value most.

Zaheed Mawani

Great. We'll come over here to Chris.

Chris Bottiglieri

Hi, thanks a lot. Chris Bottiglieri, Wolfe Research. Quick question, if you're able to. Can you give us some context on how you're, as I look at it, you have five disparate businesses that you're looking to homogenize. Give us the context for how each segment has performed on a comp basis over margins over the last couple years? Like, just what you're dealing with today, and kind of how you look to bridge that toward your mid single-digit comp growth?

Tom Greco

We're not going to comment on the specific comp sales for individual businesses. But we have seen certainly across the enterprise improvement in the third quarter, and we feel really good about that. Obviously, they're coming from different places, to your question, Chris. Bob's Worldpac has been performing at a high level for quite some time, but other parts of the business have been struggling. So we're very mindful of where everything is positioned, but we did see improvement in the third quarter virtually across the board.

Chris Bottiglieri

And then one brief follow-up. You think about your value proposition moving forward, what's embedded in your comp outlook versus the market growth obviously implies you're going to suddenly take a lot of share. So when you think about the competitive set, what really differentiates AAP from your peers? Like what are your value drivers that are going to allow you personally to grow faster than everybody else? Like, what do you do different and better?

Tom Greco

Well, first of all, I'll ask Bob to talk a little about professional, and maybe I'll handle DIY, because we do see them as extremely different businesses. I think that is part of the opportunity that we may have had in the past, when we were sort of blending the two of those together. And through the research that we've conducted, it was extremely clear that we had to get much sharper and crisper on our proposition to DIYers without watering it down with: well, gee, what about professional side of the business, how are we going to handle that. With the DIYer, which, obviously we showed the chart earlier, it's a $50 billion business. We do expect the segment to grow. We've got a lot of insight around what are the segments that are going to grow inside of DIY.

We're focused on the segments where we're confident we can win. We're going to engineer our training, our marketing, our labor model, all towards those priority segments, and really converging the investment levels that we have inside of DIY. Which is a re-purposing of the money that we have today towards those priority segments. And then leveraging Speed Perks as a loyalty program. Which we got up and running, we've got a lot of members who joined us, and we've got an opportunity to engage them very differently than we have in the past. And we're building a plan to go do that. So I think it's the overall value proposition will be quite different than it was in the past. And again, we are seeing some progress on that, because in the quarter, we saw a nice pop on the DIY side in addition to our overall business. Would you like to talk about professional, Bob, please?

Bob Cushing

Yes, so on the professional side, when I look at it from the standpoint of our footprint, we have the leading footprint in North America. And so when I look at that and our capabilities there, with the assets that we have available, when I look at the assets that we have and all these different business units and the years of experience serving the professional customer. Knowing exactly what drives their business, what drives their growth, what I know we have on the portfolio side, what I know we have on the technology side, what I know we have on dig digital driver side, we have all of those capabilities. And now for the first time, we're able to harness all of the business units and the assets and resources there towards bringing the best experience to the customer. And this is the first time we've had that opportunity. And again, we're almost three years into the AAP acquisition of General Parts, and this is the first time we're able to bring that level of higher customer service that we're going to provide to the professional customer. And all of those will drive our particular sales and growth opportunities, and accelerate it as we bring more and more of those assets to the field, to the customer, and win that business every single day.

Zaheed Mawani

Great. Let's go over here to Alan.

Alan Rifkin

Thank you very much. Alan Rifkin with BTIG. How are you?

Tom Greco

Good.

Alan Rifkin

I believe you said in your prepared remarks there would be no more reporting on integration. Yet almost three years after the acquisition, we had a $0.12 charge in the quarter. Can we take your statement that there will be no more putting on integration to mean that going forward, there won't be any more below-the-line charges?

Tom Okray

No, that wasn't the context of the comment. The comment was related to -- we're not going to focus on the customer, we're going to focus on our core business. We're not going to talk about the integration. We will still have an ongoing charge from operating income down to adjusted operating income.

Alan Rifkin

Any idea when these charges may cease? Will it be sometime in 2017, or do you foresee the charges going even further than that?

Tom Okray

At this point in time, we're not going to comment on how long the charges will go.

Alan Rifkin

Okay. And just hypothetically, if, let's say there's an industry turn-town and sales don't meet your modest positive comps for next year. What point do you start to maybe take a more draconian view on perhaps closing a few distribution centers and/or closing some stores? Or is that not on the drawing board, even if you hypothetically don't meet your plan next year?

Tom Greco

Well, first of all, we're excited about our comp prospects for next year, very excited about it. Secondly, we do believe that there's an opportunity to streamline our supply chain which is not draconian. It's really an opportunity to be smarter about leveraging our existing assets. If you think, Alan, about the different parts of the business that have come together over time through acquisition, we actually have a pretty impressive footprint. We just have treated them very vertically, as opposed to horizontally, is what I would say. And you're going to see us look for opportunities to better-integrate the entirety of our supply chain assets, DCs, over-the-road, our store delivery fleet which the stores, the Worldpac branches. We've got a lot of different assets that are out there that have handled things in a very siloed fashion, and we see opportunities to better-integrate those. And that may mean, over time, we're going to be able to leverage those assets in a better way.

Alan Rifkin

Okay. One more if I may. You mentioned that the DIY business is obviously lagging professional, which obviously, there are industry headwinds which result in everyone seeing similar trends as that. But just to break that down a little bit further, are you seeing the relative weakness on both the Carquest side, as well as the legacy stores? Or is it more skewed towards one versus the other?

Tom Greco

Well, I mean, obviously Advance has a much stronger DIY business than Carquest. Carquest was built on professional. In fact, we actually have the founder of Advance here; Nick Toddman has joined with us today. So, wonderful to have Nick be with us. They really built this tremendous business for the DIYer originally, and then separately, Carquest built their business with a focus on the professional customers. So, I mean typically, the Advance store has a much higher DIY base, and it's much more institutional there's much more institutional knowledge, I would say, on the Advance side of the business, for DIYers. I'm looking forward to touring some stores with Nick to get his opinion on how we're doing, which he gives us when he sees us all the time. But it's a fun business. It's a great side of the business. They've got people who want to fix their vehicles and really we've got some exciting things we believe we can do to bring that level of focus back to the DIY side of the business next year, that I'm not going to speak about here. But we're excited about our plans there.

Alan Rifkin

Thank you, Tom.

Zaheed Mawani

And just right now we're just going to shift back to a caller on the phone. Please go ahead with your question.

Operator

Our next question will come from Craig Kennison from Baird. Your line is now open.

Craig Kennison

Good evening, thanks for taking my question. What does your plan or what does your research show with respect to the threat from Amazon? Are there any opportunities to partner? And of course, I'm especially interested on the view from Tom Okray, given his background with that organization.

Tom Okray

It's a very interesting question. But I'm here to tell you that we're obsessed with the customer. We're aware of the competition, but we're obsessed with the customer. And that's what we're going to focus on. We know if we do the right things for the customer, then that will take care of itself.

Zaheed Mawani

Great. Next question on the phone, please.

Operator

Our next question comes from Jamie Alexander from Redmond Asset Management. Your line is now open.

Jamie Alexander

Yes, this is kind of a follow up on the prior analyst's question. What are the changes that you foresee in the industry over the next five years?

Tom Greco

So I think it was what are the changes in the industry in the next five years.

Jamie Alexander

Yes, you said it was a rapidly changing industry?

Tom Greco

Yes, obviously we continue to see the growth on the professional side. All of the work that we've done is saying that the professional side is going to outperform. I think we showed in our charts that it's we're talking mid single digit growth on professional. As more and more people enter the ownership stages of their vehicles and they're not fixing them themselves, they're going to take it to one of our hundreds of thousands of customers that are out there that repair vehicles across the nation. And we're excited about that because we feel we're very well positioned in that space.

Bob showed the chart on imports. We've got a strong domestic base of business with our customers. But if you look five years going forward, we expect imports to grow at about 20%. So again, we feel very good about that, in that we're well positioned with the strength of the business that Bob has built with Worldpac in the next five years to help us really get after that opportunity.

Some of the other things we showed are very much on our mind. None of them are kind of five year items, whether you talk about the electrification, you talk about autonomous vehicles, you talk about some of those larger macro shifts-- we don't see them impacting our core business in the next five years. In the next 10 or 15 years, they become bigger factors. So we're going to definitely pay attention to what's going on there. And as I said in our prepared remarks, we want to be -- with disruption comes opportunity. We want to be part of that opportunity and look for growth vectors that may not exist today in our base business.

Zaheed Mawani

We're going to shift back into the room, and maybe we'll come over here, please, Theresa?

Unidentified Analyst

I had two questions. One, just on cash flow; can you just quantify and maybe share some specifics on what you guys think is the gross opportunity in terms of the working capital that could be currently released, and that's stuck on the balance sheet? And then second is just, as you think about balancing share repurchases with maintaining investment-grade ratings with agencies, is there a target leverage ratio that we can think about for modeling?

Tom Okray

Well, let's start out with the working capital. Stepping back, we all believe that we have too much inventory. No question about that. And as Tom mentioned in his remarks, we are thoughtfully looking at bringing that down without impacting the customer, for sure. What we want to do is look at the metric of our AP ratio. We believe that's the best way of looking at how we're performing. So that means optimizing obviously the payables and the inventory level, with most of the work coming in the denominator. I think we were at 73.4% this quarter. Our peers are much higher than that, and we couldn't be more excited about getting up to the levels of our peer group over the five-year period; which obviously will unlock a tremendous amount of cash on a $4 billion-plus inventory level. And then your second question?

Unidentified Analyst

Was just, is there a target leverage ratio, like three times adjusted debt?

Tom Okray

Yes, we're going to maintain our 2.5 times leverage ratio.

Unidentified Analyst

So as you guys grow EBITDA and release cash from the balance sheet, should we assume that the excess cash gets used to repurchase stock?

Tom Okray

Our first priority will be delighting the customer and investing back in the business. Our second priority will be maintaining our investment-grade rating with the 2.5 leverage ratio. And then our third bucket will be returning cash to the shareholders.

Zaheed Mawani

Thank you. Let's go over in the front row here to Seth.

Seth Basham

Seth Basham from Wedbush. My question is on the store labor model. What have you observed over the last six months, Tom, on the labor model, and how do you change it going forward? There are a lot of shifting roles and responsibilities between DIY and DIFM, and the incentive structure obviously has been up for consideration. Can you give us some observations?

Tom Greco

I think obviously we made some adjustments to our labor model in the latter part of last year that I think we may have rushed a little bit in terms of the execution of that -- which is an opportunity for us going forward. I mean, we want to make sure -- when you're talking about something as important as your store labor, which faces customers, it requires a tremendous amount of analytics up front, rigorous testing, proven methodologies, then you roll it out. So what I observed was, we weren't really approaching it that way, and so we had to sort of reverse course on some of the things that we did. And early on, it's been very well received by our field organization. You have to listen to what our region vice presidents, our district managers, our general managers in the stores, are telling us. And as I went around, I mean, I try to spend as much time in the stores as I can. And I do take a lot of notes, and I listen to them when they tell me: this is not driving my comps. It gives you the allusion of profitability, because you're reducing costs and you're really just getting customers angry, and they don't come back to your store, and then it's just a bit of a vicious circle.

So we've been very thoughtful about our labor model. I think we've made a lot of progress on better aligning our hours to the demand, both on the DIY side and on the commercial side. And we'll continue to do that. We've got to make sure that we can service the customer with all of the things that they want, whether it's parking lot services or delivery frequency or when they want the part, we've do to have the labor there to fulfill the demand. And we've made pretty significant changes, I would say, in how we're approaching that.

Seth Basham

That's helpful. And just as a follow-up, if there are more changes to come, what's the timeline for them? Are we talking about another year, or are we pretty much at status quo?

Tom Greco

For labor particularly? Yes, no, I mean, the changes that we've initiated are fairly positive right now on labor. We're going to continue to refine them. We certainly reserve the right to do better. But I'm pleased with the results that we've had so far on our labor model.

Seth Basham

Thanks.

Zaheed Mawani

Great. We'll just come right over here to Jack.

Jack Balos

Jack Balos, Focus Research. We were originally told a while ago that the integration of Carquest would be completed in 2017. Is that still correct?

Tom Greco

Yes, that's a similar question Jack, was it, yes, to what we had earlier. We've basically stepped back on the original goals that were outlined, and integrated them into the broader strategic business plan. We're very comfortable with the five year outlook, and we're going to do it in a way, the full integration in a way that's not disruptive. And I want to make sure that as we bring the supply chains together as we integrate the systems and do all the things that were part of that plan, that we do it in a way that's going to be flawlessly executed. So that timeline is different than we originally communicated. The new timeline is different.

Zaheed Mawani

Great. Maybe we'll -- hey, Theresa, can we just come to the front row here, to Denise? Thank you.

Denise Chai

Thank you. Denise Chai from Bank of America Merrill Lynch. How are you thinking about new store growth over the next five years? And will there be any more store closures?

Tom Greco

We've got our plans. We're not going to comment specifically on what the aggregate number is. But we do start to move in a much more positive direction, let's just say. When you take the aggregation of store openings, store closures, consolidations, conversions, relocations all of those start to turn positive for us in the five year horizon. And they haven't been, as you probably have seen, in the last three years.

Denise Chai

Okay, thanks. And then a follow-up on AI. You're closing some stores in Florida. What's the strategy for AI?

Bob Cushing

So with AI, we're working closely with them and collaborating on a holistic professional strategy across the entire, and they're, of course, included in all that. They have a pretty robust footprint out there today, and we're going to leverage that within the holistic professional strategy that we're building today. They're part of it as well, as obviously Worldpac, Advance and Carquest.

Zaheed Mawani

Thanks. We'll just go over there to John.

Unidentified Analyst

Hi, thank you for taking my question. I just wanted the follow up on the five-year plan. You described it as at least 500 bps of margin expansion. Do you have line of sight to an outcome that's better than that? And what would drive the difference between 500 bps and whatever that might be?

Tom Greco

Well, obviously we've got the five-year plan modeled. More sales would drive a better outcome than we currently have modeled, I think is the easiest way to answer that question.

Unidentified Analyst

And is it possible that you could hit 500 bps sooner than five years?

Tom Greco

I'm not going to respond to that. We're aggressively pursuing the margin opportunities as rapidly as we can. And if it comes earlier, that's fantastic. But again, we're making sure that we focus on the customer. And we're going to make sure that we invest where we need to, to provide the customer with the service they need to build long-term relationships with both professional customers and DIY customers. Which, that's the wild card in there, is really keeping the engine moving to drive the top line.

Unidentified Analyst

And just last one, on incentives. Do you plan to reorganize the incentive structure in some way to hit those numbers? And how do you envision that playing out?

Tom Greco

Yes, we definitely have plans on the incentive structure. We're not going to comment on that in here. I think we'll be in a better position in February to provide that to you, because we're still in the final stages of refinement. But we are looking very closely at incentives, really, across the board.

Bret Jordan

And, Bret Jordan, Jefferies, quick follow-up. On the AP inventory, Tom, you were saying you thought you could reach your peers' levels. And maybe this question is for Bob. Does Worldpac have the leverage against the vendors to get to 100%, or north of 100% accounts payable to inventory? Or is the OE vendor base less likely to take the extended payables? I guess, do you really think 100%-plus is a target, or does your supply chain differ from theirs?

Bob Cushing

Yes, I think you do have to, you hit the nail on the head. You have to adjust for the dynamic on Worldpac on that. So then it starts to get into how much is the mix of Worldpac? And as we're talking in the five-year window, is it 100? Is it 90? At this point in time, we're just swagging. But we want to get the industry leaded, obviously adjusting for the Worldpac payables dynamic.

Zaheed Mawani

Thank you. Theresa, we'll just come over here.

Adam Leba

Hi, thanks. It's Adam Leba from Luna Sales. Just getting back to the cash flow question. And I haven't modeled it out, but if I'm thinking forward on all the levers in the business, if you're able to grow mid single-digits, you'll have plenty of money to keep your rating to feed the business and to buy back stock. And I guess the possibility of getting a tax windfall is higher now than it was a week ago. So if you have more cash than you need, I guess the long-winded way of getting the question is, how do I think about, or how are your repurchases paired against your view of intrinsic value of the stock?

Tom Okray

I think we're weighing into a very hypothetical question in terms of value of the stock versus potential repurchases. Clearly I gave you the order it's going to be. Number one, invest in the business. Number two, maintain our ratings. Number three, repurchase stock. Obviously we'll also look for any investments out there that can help fulfill the customer in terms of acquisitions, those types of things. But I don't want to get into speculation of where the stock value is in terms of repurchases.

Zaheed Mawani

Let's go back over to the back row, please.

Unidentified Analyst

Just a question on the supply chain, because it does feel like the Holy Grail for this industry, to make sure you have the parts when and where you need them. I had always had the impression that the legacy AAP DCs maybe weren't perfect that's kind of why you built Remington, sort of as a test. But that they weren't prefect for the professional customer. Maybe the Carquest, they had a lot of DCs, but they also were a little bit inefficient or maybe not perfect for the professional customer. Do you -- it sounds like you're happy with the supply chain as is, and you can kind of make it work. But if you had to redo the system, would you do it differently?

Tom Greco

That's obviously a very difficult question. We did greenfield the solution. We looked at what a greenfield solution would look like. But then of course, you have to overlay -- I've got capital in the ground today with this asset base. And the piloting did reveal that there was more elegant ways to get the right part in the right place at the right time than perhaps we had looked at in the past. And knowing what we have, our distribution center network, our super hubs, our hubs, our store network -- we have a great asset base. I just want to kind of reinforce that, just utilizing that asset base differently than we'd used it in the past, is how we're thinking about it. So we'll continue to look for opportunities to improve it over time, but we feel great about the asset base that we have. We do feel there's an opportunity to streamline, as I mentioned earlier. But how would with we have done it differently? That's a tough question. I do know what we have today is fantastic, and Bob is all over it, as it pertains to professional customers. He's going to be tapping into every single one of those distribution centers, to get parts closer to the customer. And we're excited about the streamlining, because that's going to bring parts closer to the customer, just in and of itself.

Zaheed Mawani

We'll just come over here to Mike. Thank you.

Mike Montani

Thanks a lot, Mike Montani with Evercore ISI. Just wanted to ask, when the comp moved from negative 4 to negative 1, Tom, can you maybe share a little bit of the traffic and ticket progression there?

And then also DIY versus DIFM? And then to follow up on that, the mid single-digit comps that you all have guided to, what kind of assumptions does that involve for DIY versus DIFM? And also, how much pricing is there versus transaction volume?

Tom Greco

Okay, well, we're not going to break out the DIFM-DIY split. I can tell you that we did improve proportionately in both of them. Professional has been outperforming DIY for us, and it outperformed in the quarter. So we're going to continue to drive at both of those businesses very differently. And missed your second question.

Mike Montani

Just in terms of the mid single-digit comp outlook longer term, maybe can you help us build to that in terms of volume versus pricing?

Tom Greco

Yes, I mean, we're really focused on units growth. A part we measure it I want to know units. Pricing is nice, but we want to grow our business by getting more customers. We want those customers to buy more parts from us over the course of 52 weeks, over the course of five years. So making sure that we, on the professional side, as Bob indicated, we've got a great lineup, a high quality parts lineup. We think we've got a very strong lineup of parts there. We've got to deliver them at the time we promised to our customer. But we want them to buy more individual units from us. And that's why Bob and I have been spending a tremendous amount of time with our customers to really figure that part out. So you'll see us very focused on unit growth. Ultimately, we're going to look at pricing, but we're going to do it smartly. We're not going to take pricing so that we start losing customers. The idea is to drive more customers and have more customers buy more parts from us.

Mike Montani

Then just a DIY versus DIFM do you need DIY to be up low single digits to the mid singles, or can you do it even if it's flat?

Tom Greco

No, professional's going to carry the load. I think you probably know, about 60% of our business is professional today. The category is growing at a disproportionate rate. We expect that will outperform the industry, so you can do the math. We're calling 3, 4, 5, something like that, for professional at the industry level. So for us to gain share, as Bob indicated, we have to be higher than that. And that's the goal.

Mike Montani

Just the last one I had, for Tom also. Is the buyback pace. Can you tell us what kind of a comp you would need to see in order to get more aggressive there? Or how are you thinking about buying back the stock?

Tom Okray

Ideally we'd have a consistency and a buyback process. But again, its way early days to start talking about buyback schedule.

Zaheed Mawani

Great. Matt, you have a follow up?

Matt Fassler

Thanks a lot. It's Matt Fassler from Goldman Sachs with a quick follow up. I'm curious, now that each of you is a few months into weeks to months into your respective roles, what kind of tools you have to understand market share trends? And with that in mind, as you entered this meeting with a nice revenue beat versus what the street was anticipating, how much of the acceleration, if you will, do you think was a function of improvement in the market, I guess, on a geographically adjusted basis, versus the efficacy of some of the efforts that you've spoken about tonight? Thank you.

Tom Greco

Well, first of all, we have the industry related market share tools that are out there. We do use those. I wish we had more, but I use what's available. So we see that once a period. I see it Wednesday this week, for the purposes of the most recent period. And we've been watching it very closely, and we watch it by geography, we watch it by category, all of the things that you would expect there. And we have seen, I would say, relatively uniform improvements on it. I mean, you've got pluses and minuses, as you always will. But we've seen the sequential improvement come fairly uniformly. Share, yes.

Zaheed Mawani

We've got a follow up here from Chris.

Chris Horvers

Thanks. Chris Horvers, JPMorgan, with a follow up. Understand you don't want to share a lot of details on sort of what the supply chain looks like in the vision. But can you give a sense of what you're dealing with, and I guess, how much low hanging fruit or how much hard work is ahead? Can you talk about what the experience was in the Northeast in some of the DCs that went to daily delivery, what you did to unwind them, and what it looks like now in those DCs?

Tom Greco

Great question, Chris, I mean, I went up there fairly early on, because we were really struggling; I think May, something like that, May or June, I went to a couple of the facilities we have up there. What we did is, we tried to impose a bit of a cookie-cutter approach to those distribution centers. And they really weren't engineered to do it. We had more stores than we should have assigned to them, at a delivery frequency that was very difficult for them to execute flawlessly. And that created a very chaotic environment in the distribution center. We weren't able to fill orders properly; there was accuracy issues. Yes, we were delivering 5X to the stores, but if you ask the general managers of those stores, they would have said: please stop doing this. Because we were just -- it was a bit of a Lucy Show-type thing going on. We just had stuff coming in and out, and in and out. And we weren't getting the right part to the right place at the right time. So we essentially unwound that. We went to 3X in those distribution centers. We got into a much better cadence with the stores. We executed our first one in August.

Then we went in September, in the second one. We've now done all of them. So there's transition costs that we've incurred in the last couple of -- in the third quarter -- and will incur in the fourth quarter, by the way, as you move to this new system. And we're seeing much better fill rates, like significantly better, much better accuracy, and the general managers are much happier, and they're selling more. So it just goes back to, the customer wants the right part in the right place at the right time. The customer doesn't say: hello, have you got 5X? They say: have you got the right part? And when we're able to fulfill that part, regardless of how we got it there, that's what they're looking for. So I was in both of those facilities in -- what's this, October -- I was in there in October; totally different place. There's not stuff all over the place. We've got clean aisles. I can see down the aisles. That's kind of important to me in a distribution center. I don't want to see stuff laying on the loading docks. I mean, I tip my hat to the teams in those DCs, because they've really worked at it very hard. And as a result, our customers are much happier.

Zaheed Mawani

We have a follow-up from Michael.

Michael Lasser

Tom, you mentioned the $500 million savings that you're going to achieve over the next five years is not going to be customer-facing. Can you give us more detail on the non-customer-facing activities that are inefficient at this point? Is it mostly supply chain? Is it corporate? I think helping to at least provide a little more detail will help bridge the expectations there.

Tom Greco

Well, first of all, I'd call out zero-based budgeting, Michael, and I do have some experience with that. I love it. It's a terrific opportunity to really standardize how costs are managed across the organization. And I would consider what we have in there a AAA bond. It's really about getting horizontal views of all of the costs that you have across the enterprise, as opposed to each cost center manager managing their costs in more of a vertical fashion, and us saying: gee, can you do better? It isn't a do-better exercise, it's a change-the-physics exercise. We're not managing those costs the same way anymore, and we're asking people to look at the costs in ways they haven't been looked at before. So those costs, we've got a very clear idea. Tom is running the control tower. We're very clear on where those costs are coming out. They're across the P&L, Michael, so I can't call out specific things. They're really throughout the entire P&L.

The supply chain obviously is a big area of opportunity. We just talked about one here, 5X to 3X. You deliver parts three times a week instead of five times a week, it costs less. And unless you have a really good effectiveness reason for doing it, which we didn't in that case, when we go from 5X to 3X, we save a lot of money. So we're going to continue to look for those types of opportunities. But it's those types of things where, as I said earlier, the cost is coming out. It's not volume dependent or revenue dependent.

Zaheed Mawani

We have a follow-up from Chris there.

Chris Bottiglieri

Thanks a lot. Chris Wolfe Research. Just a quick question. What was the tradeoff from going from 5X to 3X? Is there anything you are losing? Are you losing some of those hard to find SKUs? And then separately, how often are you servicing the hub stores and super hubs? How often do those get replenished?

Tom Greco

What do you mean by the trade-off?

Chris Bottiglieri

I mean, why did the previous management team go to 5X in the first place? Was it just a bad decision? Was there any kind of benefit? I'm just trying to see why this all didn't happen sooner.

Tom Greco

I think it falls into the camp of my earlier answer. I don't know that there was a lot of rigorous analytics done. I don't know that we looked at the DC itself, and how many dock doors they had, and how many stores they were servicing, and delivery frequency. We just felt that, that was a solution that could work everywhere, and it doesn't. That's kind of the short version on that one.

Chris Bottiglieri

What about the mega hubs, super hubs? How often are those serviced right now?

Tom Greco

It varies. It varies by market. We have different cadence for super hubs and hubs throughout the network, as we do for stores.

Chris Bottiglieri

Okay. And sorry, one underlying question, and then I promise, I'm done. For the imports, can you just talk about where that fits in relative to your core AAP stores? Are you servicing like Toyotas, like that level of imports at those stores, or are they doing just strictly domestic? And then kind of where does that all fit in with AI and Worldpac?

Bob Cushing

Was the question the mix of the parts?

Chris Bottiglieri

When you think about the catalog, where does the core AAP store leave off in terms of what types of vehicles they service? What additional types, I would imagine Worldpac is not serving too many Audis and BMWs, they are probably dong more Hyundais. And can you just talk about the SKU mix and how it fits together?

Bob Cushing

Yes, again, we look at it market by market, looking at the VIOs, the vehicles in operation there. And we're seeing a good mix of all makes, all models, at the store level. And importantly, because many of the stores have access to the Worldpac assortment, we're measuring all that activity, and then basically working with the merchandising team to push those parts closer to the store, so they will get is closer to the customer without having to have that extra touch.

We're seeing, again, a good cross-section of parts there, mostly Asian versus high end European which of course is a Worldpac. But I would say for the most part, domestic, Asian and certainly some European, Volkswagen, some Audi, and so forth. But it's a good mix. But importantly, when you go to the market there, we're going to the customer with the answer of: we have all of it, all makes, all models, across the entire enterprise, and we're bringing that closer to the customer. So as that develops and evolves, we'll continue to build the inventory to support that activity market by market, capturing all the look-ups on the online, which we do at Worldpac today, and certainly capturing all the call-ins as well. That's going to be dynamic inventory. Whatever the calls are out there for the customer development side, we're going to have the part closer to the customer.

Chris Bottiglieri

Thank you.

Zaheed Mawani

Okay, well, good. That looks like that concludes our Q&A session. Thank you very much. And Tom, I'll, Tom's going to wrap up.

Tom Greco

Okay, so I really appreciate everybody coming this evening, and the interest you have in our business. I'd just wrap it up by saying, we absolutely believe that AAP is a very compelling investment opportunity. The industry is performing well. We're in a compelling market position, we feel. There's a tremendous opportunity for us to drive growth and margin expansion. I think you've seen that the team is executing a pretty focused agenda going forward. We're aligned around the plan. So, big opportunity to drive substantial shareholder value, and that's our commitment to you. So thanks for coming tonight.

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