Advance Auto Parts, Inc. Q1 2008 Earnings Call Transcript

May.16.08 | About: Advance Auto (AAP)

Advance Auto Parts, Inc. (NYSE:AAP)

Q1 2008 Earnings Call

May 16, 2008 8:00 am ET

Executives

Judd Nystrom – Vice President Finance and Investor Relations

Darren Jackson – President, Chief Executive Officer

Elwyn Murray – Executive Vice President Development Officer DIY

Jim Wade – Executive Vice President Customer Development Officer Commercial

Mike Norona – Executive Vice President, Chief Financial Officer

Kevin Freeland – Executive Vice President Supply Chain and Information Technology

Analysts

David Cumberland – Robert W. Baird

Peter Benedict – Wachovia

Dan Wewer – Raymond James

Colin McGranahan – Sanford Bernstein

William Keller – FTN Midwest

Tony Cristello – BB&T Capital Markets

Seth Basham – Credit Suisse

Operator

Welcome to the Advance Auto Parts first quarter 2008 conference call. (Operator instructions) Before we begin, Judd Nystrom, Vice President Finance and Investor Relations will make a brief statement concerning forward-looking statements that will be made on this call.

Judd Nystrom

Good morning and thank you for joining us on today’s call. Certain statements made during this conference call will contain forward-looking statements that incorporate assumptions based on information current available to the company. Any statements that are not related to historical facts are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are subject to risks, uncertainties and assumptions, including those listed from time to time in the company’s annual report on form 10-K and its other filings with the Securities and Exchange Commission. If any of these risks or uncertainties materialize or if any of the underlying assumptions prove incorrect, the company’s actual results may differ materially from the anticipated results discussed in these forward-looking statements.

The company intends these forward-looking statements to speak only as of the time of this conference call and does not undertake to update or revise them as more information becomes available. Our results can be found in the press release and 8-K filings which are available on our website at www.AdvanceAutoParts.com.

For planning purposes our second quarter earnings release is scheduled for Wednesday, August 6 after the market close and our quarter conference call is scheduled for the morning of Thursday, August 7. To be notified of future dates of earnings reports you can sign up through the investor relations section on our website. Finally, a replay of this call will be available on our website for one year.

Now let me turn the call over to Darren Jackson our President and CEO who will be followed by Elwyn Murray, EVP Customer Development Officer DIY, Jim Wade, EVP Customer Development Officer Commercial and finally Mike Norona, EVP and CFO. Darren.

Darren Jackson

Thanks Judd. Good morning everyone and welcome to our first quarter conference call of 2008. I’m happy to update you on the progress we’ve made on our turnaround during the first quarter. Specifically, I plan to share my observations on the strategy evolution, the leadership changes and provide some tangible examples of progress in our turnaround plan.

Finally I plan a real life example of what our company will act like and look like when our turnaround strategies take hold throughout Advance. I wanted to start by personally thanking our Advance and AI team members for their terrific work in Q1 which resulted in a 21% increase in our earnings per share.

The top line sales were in line with our expectations while the bottom line was above our plan. The starting point of the results began with the parts sum at last year where we learned directly from our team members on how to accelerate commercial sales. Our 10.6% commercial comparable store sales gain in the quarter was driven by the work and the other steps we took to support our team members as we focused on growing commercial sales.

Similarly, our improvement in our cost structure resulted from last year’s efforts. Finally, our team is driven to win in this challenging economic environment. This play to win attitude put us over the top in the first quarter. I’m encouraged by our first quarter results.

I’m also realistic that turnarounds by definition will have ups and downs. In Q1 our financial results ran ahead of plan while strategic results were on plan. The 100 plus days of our AAP turnaround is on track from my perspective. The goals in the first 100 days included listening, learning and leading.

We made material progress in focusing the organization on our four turnaround strategies, specifically, commercial acceleration, DIY transformation, availability excellence and superior experience. The truth is, these strategies are an outgrowth of our core values of Advance and the input of our team members.

The tangible results are just beginning to emerge. For example, commercial comps are accelerating and new brands, including MOOG, Wagner and Remy are arriving on our shelves. The inventory upgrades continued to surgically enhance our parts availability. Lastly, our employee turnover has improved significantly this year for our store teams, supply chain and at our corporate office.

Practically we were in the formative stages of our transformation with considerable systemic and sustaining change ahead of us. I’m very excited about the leadership changes that we made this past quarter.

The addition of our new CFO Mike Norona who will be the catalyst responsible for our growth stewardship, the formation of the commercial team led by Jim Wade and the DIY transformation led by Elwyn Murray, availability excellence led by Kevin Freeland, superior experience led by Ken Wirth and Mike Marolt, merchandising led by Charles Tyson and financial services led by Kevin Tobin.

I’m also pleased to announce the addition of Donna Broome, Senior Vice President of Commercial Sales. I am confident the organizational changes will enable us to shift gears and close the gap between Advance and our competitors. They reflect the commitment to moving from words to action, from acknowledging to committing to change.

I am confident this team of leaders will make it personal and possible for the entire team to succeed. The strategies are focused on what matters most, the customer. We will need to educate, engage and enable our team to build the capabilities to execute the strategy, starting with commercial acceleration.

We have reorganized the company to have a fully dedicated commercial team led by Jim Wade. The premium brands which are critical to meeting the customer needs of commercial customers are now part of the mix and we will begin to evaluate and adjust our store labor models to reflect the commercial customer needs.

Turning to the DIY transformation, we have started a 100 day intense business review with a strategic partner under Elwyn Murray to gain quick hits, including attachment selling. We need to jump start our front room with new category development, an appeal with “keep the wheels turning” brand campaign.

The backbone of the strategy, our turnaround strategy is availability excellence. We have engaged a strategic partner to reengineer our supply chain and network capabilities, space management discipline and leverage the ecommerce platform under the direction of Kevin Freeland.

Finally a key differentiator, superior experience, Ken Wirth and Mike Marolt will lead the rollout of the customer employee satisfaction initiative. In addition, they are charged with reawakening and revitalizing our trademark of legendary customer service built on a foundation of operational excellence.

So what gives me hope and confidence as we continue the turnaround path? It is a team member like Regional Vice President Frank Miller. Frank, who has led a team from negative comp store sales last year, producing some of the highest comps in the company. Frank was a fairly new RVP last year who decided along with his team to turnaround their business by being best in class.

He was inspired by his winning colleagues and sought out the guidance and assistance from them. Now he’s inspiring them. So how did Frank do it? Frank will be the first to tell you that credit goes to the team. They developed the plans and strategies very similar to what the entire company is embracing today.

They aggressively addressed the commercial opportunities, focused on improving the DIY experience through legendary customer service and developed ways to empower the team. Frank did not make any excuses for the team’s previous results. They simply focused on changing those results and now this team is one of the best turnaround stories in the company.

Frank and his team were focused on the company’s values and use them to guide every step of the journey. By doing so they went from trailing to exceeding within a year. And perhaps the most compelling part of this story is that if you ask Frank about his success, he will tell you there is still more work to do.

The energy and results for this team are contagious and they are spreading. Thanks for letting me share this story with you. Frank, thanks again for a job well done. This story is the story of the future of Advance. Now I’d like to turn it over to Elwyn.

Elwyn Murray

Thank you Darren and good morning. In my time with you I would like to cover three things. First, I will reorient you to how we see the DIY space today. Second, I will share the definition and objectives of our DIY turnaround and transformation plan. Third and finally, I will provide an update on a number of initiatives we have underway now in order to reverse our DIY comp trends.

As we have discussed before, we see the DIY industry growing at approximately 1% per year. It is a highly consolidated industry with the top seven players making up 66% of the market. New store growth is exceeding industry growth, leading to negative comps among major competitors.

Customer traffic has shown single digit declines over the last several years and while partially offset by increasing sales per transaction has resulted in negative comp trends. All of this information tells us that DIY is in need of a major overhaul. The check engine light has been burning in DIY for several years now and it’s time that we answered the call.

I’m very excited about the opportunity to lead our DIY turnaround and transformation and will now provide more insight regarding what this means to us and how we are pursuing this work. We have purposefully both included both the words turnaround and transformation in the definition of our DIY opportunity as there are things we are doing now and over the next 12 months to improve the customer experience and begin turning around our current trends.

Additionally, we are focused on transforming the DIY space over the next 12-36 months by identifying and developing distinct value propositions intended to ignite demand by meeting and anticipating changing customer needs in the medium and longer term. Our objectives of this transformation are three fold.

First, to attract and win more than our fair share of high priority customer segments, such as traditionalist, light users, Hispanics and new segments that are not in the space today. In order to achieve this we are focused on creating and delivering distinct value propositions to most of these attractive segments.

Second, to capture the most from customers who visit our stores by maximizing every opportunity we have to serve, solve and sell them what they need in order to be successful with their respective projects.

Third, to create nothing short of Advance Auto Parts fanatics who will return frequently and promote Advance to others. We will do this by defining what great customer service is at Advance and developing our team in order to achieve this on a consistent basis. We will measure out transformation success three ways.

First, by increasing average DIY sales per store by 15% through increased traffic, improved conversion rates and large average transaction size driven largely by higher attachment rates. Second, by achieving market share leadership in the markets where we compete. Our aim will be to over-index with our targeted segments.

And third, by achieving top quartile customer satisfaction and loyalty scores for retail comparisons. Finally, I will provide an overview of a number of initiatives that we have underway now in order to turnaround our DIY trends.

We know what DIYers want, convenient locations, parts availability, knowledgeable in store service and quality parts at competitive prices. While Advance performs well with price oriented DIYers, we underperform with the attractive traditionalist customers who care most about parts availability and parts quality.

We also underperform with light user customers who care most about convenient locations and in store service. We also have a significant opportunity to improve our business with the emerging Spanish speaking Hispanic population. We know we must improve our parts availability, product quality, in store service, team member parts knowledge and bilingual staffing in order to meet the needs of these attractive segments.

To respond to this demand and meet our customer’s needs, we have a number of strategies underway, including the following. We continue to improve our parts availability by expanding the breadth of our in store assortment as well as reengineering our supply chain to vastly improve our end market parts coverage.

In the first quarter we introduced an incremental $45 million of hard parts and foresee the net addition of an incremental $125 million for the full year 2008. Also, we continue our pursuit of the highest quality brands with recent additions to our offering, including MOOG chassis and Wagner brakes.

The addition of these brands enhances our ability to serve important customer segments within the do-it-yourself and commercial markets. We are intensifying our focus and efforts around attachment selling. More specifically, we are actively developing tools to ensure that our team members are equipped and incented to sell the complete solution so that our customers have everything they need in order to succeed.

We continue our focus on enhancing parts knowledge. In the first quarter we completed a benchmarking study of parts knowledge within our stores and determined by category where we are strong and where we have opportunity to improve. We also identified the most frequently asked questions from our customers and determined by category where parts knowledge is most predictive of sales growth.

We are actively deploying training efforts to improve parts knowledge in the areas that matter most. We continue our efforts to simplify our sales floor by rationalizing categories and SKUs while creating room to both increase our hard parts in store holding power and expand our product offering to capture more of the car and driver experience.

As an example, we introduce navigation systems in the first quarter and now offer these devices in 1,000 of our stores and we look to grow our credibility in this space. We continue our efforts to effectively reach and serve the emerging Hispanic population. In 2008 we dramatically improved the quality of our marketing message tailored to Hispanic customers and increased the magnitude of our spend five times our 2007 levels in order to reach this important customer segment.

Additionally, we increased our bilingual staffing levels by 16% in the first quarter of 2008 compared to Q1 2007 and still see much room for improvement here. We officially launched our “keep the wheels turning” branding strategy in the first quarter and continue to be pleased with the response we are getting from customers and team members.

We will continue to evolve our messaging under this campaign and feel positive about the platform we have created. Tax rebate payments from the 2008 Economic Stimulus Act began reaching consumers this month and will continue until mid to late July. In order to maximize the sales opportunity for Advance, we have produced and are running special radio, television and online creative messages starting in May to entice customers to spend their rebate at Advance.

Our message is focused on encouraging customers to use their stimulus checks to protect their four wheel investment by spending their rebate checks on those automotive projects or discretionary purchases that have been delayed out of economic necessity. In addition to the outbound messaging there will be in store signage communicating to customers that their tax rebate will go further if invested in their vehicle at Advance.

Lastly we are in the early stages of creating visibility to customer satisfaction and team member engagement metrics. We are engaging a third party provider to start serving our customers and team members in the coming months. For our customers, we will be learning about the level of customer service they currently receive at our stores, defining what great looks like and developing our team to achieve higher loyalty scores with our customers.

For our team members, we will be focused on how engaged and satisfied they are with their workplace. We know a highly engaged workforce aligned with a clear and common objective in our case to provide legendary customer service will create superior customer experiences, loyalty and thus increase profits.

We are encouraged with the progress we are making with these initiatives as well as others not mentioned and see much room to improve within each of them. In conclusion, we will continue to accelerate execution of near term actions in order to reverse our current DIY trends.

We anticipate solidifying our DIY transformation plan over the next 100 days and will provide further updates in coming calls. Now, I would like to turn the call over to Jim.

Jim Wade

Thank you Elwyn and good morning. I’m pleased to be leading the acceleration of our commercial business as we grow it from less than 3% market share today to a much greater share of the market over the next several years. Also, I’ve never been more excited about our company’s future because we’re reinvigorating it based on our values around our team and our customers that make our customer successful over its long history.

We have a great opportunity ahead of us and we control our own destiny in both our DIY and commercial businesses. Before I get too far into the details of where we’re going, I wanted to congratulate our entire store and commercial teams on their 10.6% increase in commercial comp in the first quarter.

As you may remember, we committed ourselves to getting back to double digit growth about this time last year. Since then our team has increased the commercial comp consecutively each quarter. In addition to the solid comp, all our key commercial metrics improved, including higher average transaction, increased customer count, higher gross margin percent, increased productivity of our parts pros and delivery fleet and a higher balance of part sales.

I’d also like to thank the auto part international team for a strong first quarter in sales and profitability as both their original base of stores as well as the new stores they’ve opened in the last two years performed well. Overall they produced a 14.2% comp for the quarter.

As we look forward, we know we have the opportunity to further accelerate our commercial business and take it to a much higher percent of our total sales over the next several years while increasing our profitability as we lever the investments we’ve already made and will be making.

We’re pleased but not satisfied with the first quarter commercial results because we know that that as we provide our team more tools to serve our customers better, they’ll capture more business. We’ll achieve this by building best in class capabilities that can differentiate how we serve the commercial customer.

To achieve this objective, we’ve dedicated the full time and energy of some of our best team members and formed a commercial organization that is focused 100% on growing our commercial business. This team covers all key areas, including the sales force, customer management, merchandising, human resources, marketing, finance, IT and real estate.

We’re also excited that Donna Broome is joining our team as Senior Vice President of Commercial Sales. With her experience leading a sales force of over 1,000 and achieving revenues of over $3 billion at Grainger and her 15 years of sales leadership with Xerox, she’ll lead our commercial sales force to achieve the full potential that we see for this business.

As we’ve covered in our previous calls, we’ve done extensive research to identify how commercial customers make their purchasing decisions as well as determining where we rank in each of those key attributes. Our commercial customers rank us high in delivery time, which is at the top of the list of expectations they have for their parts supplier.

Our investment in over 3,300 densely located stores in 40 states puts us very close to our garage customers and allows us to meet and exceed their expectations for delivery time. Our commercial customers have told us we need greater parts availability as well as more brands that are most highly rated by garages.

As Elwyn discussed, we’re well on our way to addressing both of these opportunities but we expect to further build upon the strength significantly in the months and years to come. Delivering on our DIY strategies will also have a positive impact on our commercial business because the customer needs are aligned in so many ways.

Our customers have also told us we need to increase our parts knowledge in our stores. We’re working very hard to provide our already strong store teams more opportunities to increase their parts knowledge through continued improvements in store systems and more training.

From a customer standpoint, our existing commercial customers index higher towards smaller independent garages with one to three service bays relative to the total garage population. Our future growth is dependent upon continuing to meet these customer needs while further building our customer base with large independent garages along with national accounts.

Additionally, we will continue to build our business around the basics. We’ll grow sales with the top customers that we’ve targeted in each store because we know it’s not about how many customers we have but instead the quality of the relationship with our core customers.

We’ll build relationships with garages located closest to our stores. We know that with our large store base we can out service customers if we focus on garages in a tight radius of our stores. And we’ll build customer satisfaction by strengthening our investment in parts pros while leveraging our large delivery fleet.

Over the coming months, our commercial organization will continue to strengthen our capabilities around the key attributes that drive customer purchasing decisions. We’ll also be formalizing our customer management tools and the tracking of key sales, profit and customer satisfaction metrics, all of which will be necessary to further accelerate our commercial growth.

Switching to new store development, in the first quarter we opened 30 Advance stores and four Auto Part International stores as planned toward our target of 115 stores for the year. We also closed four Advance stores and relocated three.

Our average new store sales in the first quarter exceeded our results for the same quarter last year. We’re continuing to identify significant opportunities to reduce our new store occupancy costs over time by 10-20%. We’re proceeding with finding store locations that will maximize both our convenience to our DIY customers while minimizing our delivery times to our garage customers.

These locations don’t typically need to be main on main to achieve our customer’s desire for convenience and speed of delivery. As we move away from more expensive corner, our site costs are significantly reduced. We’ve also made a number of changes to our building specifications which will further reduce costs.

Over the last six months we’ve tested smaller prototype buildings and different store layouts to optimize parts availability and sales floor needs. In mid 2008 we will begin rolling out our 6,000 square foot prototype as we open stores in many of our markets in place of our current 7,000 square foot prototype.

I’ll close by saying that we look forward to providing further updates on our commercial acceleration and store growth over the quarters to come. Now let me turn the call over to Mike to review our financial results.

Mike Norona

Thanks Jim and good morning. I also would like to personally congratulate and recognize our talented and dedicated team members who positively and passionately impacted our business to deliver the results we saw this quarter. I plan to cover the following topics with you this morning.

One, provide an overview of our quarter one results. Two, connect our strategic priorities with our financial measures. And three, provide visibility to some other actions we have taken to improve our long term financial performance.

Turning to the first quarter, total revenue increased 4% to $1.53 billion compared with revenue of $1.47 billion in the first quarter last year. This revenue increase reflected the net addition of 141 new stores in the past 12 months and a comp sales increase of 0.6% on top of a 0.7% increase last year.

The comp store sales was comprised of a 10.6% increase in commercial sales, including Auto Part International, offset by a 3% decrease in DIY sales. This compares to a 4.2% increase in commercial and a 0.5% decrease in DIY in the first quarter last year. Commercial sales including Auto Part International represented 29% of our total sales compared to 26% last year.

For the quarter, our total commercial sales including Auto Part International were $438.7 million, a 14.4% increase over last year. Consistent with the prior year, 82% of our Advance stores had commercial programs. Clearly our commercial teams are leading our company with these fantastic growth numbers, despite a tough economic environment.

Our gross profit rate was 48.7% in the first quarter as compared to 48.3% last year which reflects a 39 basis point improvement. The 39 basis point improvement was driven by lower supply chain and logistics costs combined with more effective pricing.

SG&A expenses were 39.3% of sales compared to 39.1% last year. This increase of 11 basis points was driven by deleverage due to modest comp sales and increased incentive compensation. These increases were almost entirely offset by cost reduction initiatives that were initiated during the second half of fiscal 2007.

Interest expense net of interest income was $12.3 million in the quarter compared to $10.9 million last year. Our current borrowing cost is approximately 5%. Earnings per share increased 21% to $0.86 for the quarter as compared to $0.71 for the first quarter last year.

This 21% EPS increase was primarily driven by a 7% increase in operating income and approximately 13 million shares repurchased over the past year. This is the first quarter in which our quarterly EPS has increased over 20% in over two years.

As previously announced, the company repurchased approximately 4.6 million shares during the first quarter at an average price of $34.04 for a total expenditure of $155 million. In comparison, the company repurchased 8.3 million shares and 3.7 million shares in fiscal 2007 and fiscal 2006 respectively.

As announced in our release, the Board authorized a $250 million share repurchase program. This new authorization replaces the company’s $500 million share repurchase program authorized in August 2007 which has $105 million remaining. We plan to buy back shares on an opportunistic basis.

Let me now comment on a few items on our balance sheet and cash flows. For the quarter, inventory increased 4% which matched our sales increase of 4%. The increase in inventory was driven by our parts availability initiative which was somewhat offset by our focused plan to improve inventory productivity.

Inventory per store was flat as compared to prior year. As you can see, we’ve been funding the majority of our parts availability initiative through some inventory reduction initiatives. In Q1, our accounts payable to inventory ratio was 58.6% compared to 57% last year.

Our capital expenditures were $58.9 million for the quarter. This compares to $75.9 million last year or a reduction of $17 million driven by a decrease in store development as well as timing associated with the construction of a new distribution center. Overall our free cash flow increased in the first quarter to $150.5 million, an increase of $45.4 million compared to last year’s first quarter which was higher than we expected.

Looking forward, we now expect our free cash flow to decrease more than we anticipate for the balance of the year based on decisions we made during the first quarter to make additional investments in inventory throughout the balance of the year.

To put our first quarter results into context, our sales results came in on plan and our bottom line results exceeded plan. This was primarily driven by the growth in our commercial business, improvements in gross margin, better SG&A leverage versus last year and our share buybacks.

In other words, our results were primarily driven by actions we initiated last year and fulfilled this year. These results provide us a clue of how important the actions we take today are to the financial results we deliver in the future. They are also a motivating force for our team as we undertake the exciting and challenging turnaround action we shared with you today.

Now I’d like to connect the financial results to our strategic priorities. As you have heard, we have kicked off four strategic priorities and each one of those is in a different stage of evolution. Our commercial strategy is furthest along because it started last year and it did impact first quarter results with its 10.6% comp sales increase and it’s 14.4% total sales increase.

It is also highlighting the importance of how focusing on the customer can drive our business. The other three strategies are at varying stages of evolution and had a less material impact on our first quarter results. As we have mentioned on this call, we are in the early stages of our strategy work and turnaround.

We have much work to do in building out the details of our strategic plans and financial roadmaps, including investments required, turns expected, risk profile and timing. As those become available, we will share them with you appropriately. As you also heard on this call, we do have some early insights into each of our strategies to tell us we are focused on the right four areas.

In order to measure the financial progress of our turnaround, we have identified four gauges of success. We believe these gauges provide a transparent and all encompassing view of our four strategic priorities and will be a barometer of our progress. These four gauges were shared with you in our press release.

The first gauge is sales per square foot, it tells us, are we growing and optimizing. The second gauge is SG&A per store. That is, are we leveraging the investments we have made in our stores and will continue to make in opening new stores. The third gauge is operating income per team member or said different profit per employee. This gauge measures our productivity.

We have 45,000 talented team members coming to work every day to do their best work and make our company a better place to serve customers and for employees to work. The final gauge is return on invested capital. This is, are we getting the appropriate returns on the investments we are making. This gauge is important given the future investments required for our turnaround in areas such as IT, supply chain and stores.

As we look at these gauges today, we lag the industry and the market leader in all four. This is unacceptable. We have a real opportunity to take these metrics, turn them into insights and drive actions through the work we are doing in our four strategies. Our expectation is that we will get all four of these gauges to at or above the industry average.

Longer term, we will look to lead our industry in these measures. As we continue to build the roadmaps of our strategies, we look forward to sharing more with you on our gauges.

Finally, the company provides an annual outlook at the beginning of the year only which was an EPS of $2.55. However, as previously released, a 1% increase in comp sales adds approximately $0.10 in diluted EPS and a 10 basis point improvement in operating margins adds approximately $0.03 of incremental diluted EPS.

We are pleased with our first quarter results but remain cautiously optimistic given the current economic headwinds and the fact that three quarters remain in our fiscal year. We also do not expect our results to be linear given we are still in the early stages of some of our strategic work and don’t have full visibility to the cost or investment profiles.

We may also choose to accelerate investments if we determine it is better for the long term. An example of this is some of the decisions we made in our first quarter to increase our inventory for the balance of the year. Additionally, our turnaround approach entails an in depth assessment of all parts of our business, including our operating model, store profitability and processes.

Correspondingly, this may create some short term earnings volatility as we position the company to increase the long term value. We will continue to instill discipline and be prudent as we make these decisions. In closing, we are excited about the long term prospects given our renewed focus on the customer. We believe we are focused on the right strategies and are confident our team members will lead us as these strategies evolve.

We also are realistic and know that in any turnaround, there is significant work and are committed to transforming our company to ensure our turnaround is successful. We are now ready for questions. Operator.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from David Cumberland – Robert W. Baird.

David Cumberland – Robert W. Baird

Can you elaborate on the gross margin improvement related to effective pricing? Was that in the DIY or the commercial side and anything else you can add on that?

Mike Norona

From a gross margin perspective, there were two drivers of our gross margin, one was our supply chain and logistics costs and two was our pricing strategies. And I would tell you about 80% of it came from our supply chain and logistics distribution costs.

Elwyn Murray

I’ll share a little perspective from a category point of view on where we saw some nice margin improvement. First of all, the increase in balance of sale of our hard parts which are higher margin as you know was certainly beneficial to the margin. Secondly, we saw some nice increases in higher margin chemical or additive categories as people look to extend their fuel efficiency, fuel additives, fuel injector cleaners, things of that nature were certainly positive for us.

And also as we see folks delaying repair and trying to extend performance, things like stop leaks and other again high margin categories have done very well for us. I would also highlight that while commercial sales have certainly grown and overall commercial gross margin is certainly lower than DIY gross margin, we are making some nice progress with solidifying our commercial gross margin and selling our entire value proposition if you well in commercial versus simply dropping prices.

As we look at our price indices which we monitor for parts as well as our sales floor, both are consistent with our recent past and where we want to be. And I guess lastly I would just comment that our category management team led by Charles Tyson and Scott [Phelps] continued to do a nice job leading and seeking cost of goods reduction opportunities for us and will continue to do that.

David Cumberland – Robert W. Baird

On the addition of brands, you called out adding a few recently, do you feel like you still have more parts brands that you need to add, particularly on the commercial side?

Elwyn Murray

I would say that the addition of MOOG and Wagner were really the final two pieces of the puzzle as far as we see it. There are some other opportunities but those were the two most significant and large and we’re very excited to have those in our stable.

Operator

Your next question comes from Peter Benedict – Wachovia.

Peter Benedict – Wachovia

Last quarter I think you mentioned that Florida had been a drag about 50 basis points in the overall business, any update on how the trends are down in that region?

Darren Jackson

I don’t think we’ve seen any real systemic changes in the balance of how the regions are playing. The one thing that is interesting though is that if you look at our commercial business, that’s not true, we’ve seen strength in our commercial business across all of our regions.

And it’s probably safe to say even a little stronger in the Southeast. So the way I would think about it is when we look at the balance of sales altogether, you can still clearly see where some of the pockets of challenges are economically, whether it’s because of the housing market, whether it’s because of gas prices.

But when you climb underneath and look at where we’re applying efforts against our strategy, even in places like Florida and the Southeast, you can see that it’s working. So we feel good about the fact that we’re doing something different and gaining some market share, even in places where it’s economically a little bit more challenging.

Peter Benedict – Wachovia

I know you guys have added some new brands here, have you seen any customer migration, maybe down to private label, to lower price points given the macro environment, is that evident at all, different from the last couple quarters, any comment there?

Darren Jackson

What we can continue to see in the numbers is that in the discretionary items, so let’s just pick one, like tools, that’s going to be DIY side, that continues to be just a little more challenging. And what we call more the non-discretionary parts related categories we continue to see strength in places, just pick brakes, pick batteries, those businesses tend to be just fine. Now as to the actual mix and price points, Elwyn.

Elwyn Murray

We honestly haven’t seen a significant shift. Our private label or house brands have maintained a steady position without a significant upswing.

Operator

Your next question comes from Dan Wewer – Raymond James.

Dan Wewer – Raymond James

You had noted that gross margin rates and commercial have solidified and then further accompanied you had a very nice increase in gross margin rate despite very strong sales in commercial. Darren are we at the point where gross margins in the commercial segment are no longer at a disadvantage to the DIY category?

Darren Jackson

From your lips to God’s ears. So no, structurally the commercial business compared to DIY is lower. And candidly as we look ahead, we think systemically that will always, should never say always but will continue to be the case.

But I think as we work through building the relationships with our customers and build let’s say the basket that we’re moving with some of our better customers and the mix of product, what we did see in the quarter, if you just look at commercial margin this year versus last year, it’s fair to say they were up just a little bit.

But, because of the growth in the commercial business in relation to DIY, on the overall company margin, clearly it puts some pressure on the overall company margin. And the good news is through our capabilities in pricing and the good news is in terms of the teams working hard to take some costs out of the logistics part of the pipeline, we’re able to save money and offset that.

And that’s the best of all worlds because our customers end up getting the pricing they’re looking for, we’re taking costs out of the back of the house and allows us going forward in terms of the profile of our margin to figure out ways on how to keep building on that momentum.

Dan Wewer – Raymond James

In past quarters in the discussion on the changing real estate strategy, Advance noted they may give less attention to the main on main locations and increase the emphasis on the best locations for your commercial customers. How do we square that with the goal of increasing your DIY sales per store 15?

Jim Wade

I think they align well. First of all I would say that our real estate team is making some very good progress in regard to taking a broader view of real estate locations and we’re starting to see some positive impacts already in terms of our occupancy costs.

But as we look at our business going forward and we’re looking at where does the site make the most sense to be convenient to both our DIY customer and our garage customer, I think those align well and can reinforce each other as we get the right parts in the stores and have that optimal location. So we don’t see it as a challenge but see it as really an opportunity to align two businesses better.

Darren Jackson

I would add to that it affords the opportunity to potentially in fill more around the [allied] markets and wrap up more of the profit pool.

Operator

Your next question comes from Colin McGranahan – Sanford Bernstein.

Colin McGranahan – Sanford Bernstein

I wanted to dig in a little bit more into the commercial growth, was hoping you could break down that 10.8% comp a little bit just in terms of change in average order volume versus new customers, price versus units to the degree that makes sense and then new programs and how much benefit you had in the comp from new programs and the maturation of those programs versus existing sales programs. Just trying to get a little better sense of where the acceleration is coming from.

Jim Wade

From the standpoint of where did the comp come from, we were pleased to see both our customer count and our average transaction increase. When you look at the two pieces of that, the customer count increase was a little higher than the average transaction increase.

As far as price versus units, I think again that basically addresses that, we didn’t see any significant change in pricing strategy during the quarter so it was more about selling more parts which is beneficial to all those metrics that we look at.

We really didn’t add any new commercial programs in the quarter of any significance at all, other than just the new stores that we opened last year coming into the comp through the normal process. So when you look at the 10% increase, new locations would only be in stores that we’ve opened the past year that went into the comp during the normal course of business.

Colin McGranahan – Sanford Bernstein

Second question on inventory, $125 million increase in hard parts, what are you looking at in terms of net because I know you are taking out some of the slower moving inventory.

Kevin Freeland

There’s two impacts there. We have the new MOOG and Warner program that came in that will lift inventories for the year and as well we’re doing the inventory upgrades of $125 million at the same time we’re analyzing slow moving products and working to set up returns through our vendors. I believe the total growth in inventory over the growth in sales is expected to be in the $60-$70 million this year.

Colin McGranahan – Sanford Bernstein

For Mike, I understand you just give guidance at the beginning of the year and once a year and the volatility given the turnaround in the environment, trying to get a sense of how much better 1Q was in the bottom line than your initial forecast, because if anything it looks like the compares through the year get easier from here, certainly on the gross margin line and to some degree on the top line as well.

Mike Norona

First of all, as you know we’ve shared the guidance of $2.55 and we’ve also kind of given you a grid of a 1% comp equates to about $0.10 and a 10 basis point in operating margin is equivalent to $0.03. And I would tell you, although we slightly came in better than our plans in the first quarter, as I look at the balance of the year, that grid still holds very true. So I would tell you that we feel good about the guidance we gave at the beginning of the year and as we see the rest of the year playing out.

Colin McGranahan – Sanford Bernstein

Do you plan to update that in the second or third quarter or are you going to stick with that $2.55?

Mike Norona

We don’t plan to, I think what we shared with you is this company is focused on the longer term and growing value. The only time I would see us making any more statements is if we saw any material differences and at this particularly juncture we don’t.

Colin McGranahan – Sanford Bernstein

The DIY sales increase of 15% per store, it seems like a pretty optimistic goal as it would put your sales per store in the $1.7 to $1.75 million range, it doesn’t look like really anyone does that kind of revenue per box today, so just trying to get a sense of where that 15% increase per store is rooted.

Elwyn Murray

It is a fair question and it is a lofty goal. We do about $1.1 million a year today in DIY and 15% growth if you will over the three to five year window I’m describing gets you to $1.25. So obviously that’s going to require turning around what are currently negative trends and getting that to the positive side.

Over the course of that three to five year, you’re still talking about low single digit growth and we recognize it’s going to require both some stop the bleeding with immediate controllable actions but also some transformational thinking around the space in general and that’s the work that I’m going to be leading over the next 100 days.

Operator

Your next question comes from William Keller – FTN Midwest.

William Keller – FTN Midwest

To get back to gross margin you mentioned that the bulk of the improvement was on the lower supply chain and logistics cost. Can you give you a little bit more detail about that given the fuel costs and energy costs right now?

Kevin Freeland

One, we actually hedge our fuel purchases on the major portion which is the outbound supply chain between our distribution centers and our stores and it accounts for about 80% of the fuel that we use. So that essentially, the changes in fuel have had a smaller impact on that portion of the supply chain than you would expect.

Secondarily, again to comments that Mike made earlier in the call, there were a series of changes that were initiated last year to improve productivity in the distribution centers and what you’re seeing is the impact of those programs this year.

William Keller – FTN Midwest

You talked about the inventory increase for fiscal 08 and in the first quarter it looked like working capital came down a bit. I’m wondering if that’s a onetime thing that’ll be offset through the rest of the year or if we can kind of count on that relationship holding for the next few quarters?

Mike Norona

What I would tell you I think Kevin previously answered the inventory question, I think the change that we see is the additional increases in inventory due to the MOOG and Wagner and the parts availability initiative. So, that’s all we see at this particular juncture.

William Keller – FTN Midwest

Right but in the first quarter, working capital came down, I’m wondering if that was, if there’s something, a onetime thing in the first quarter, an anomaly of some sort or if that trend of working capital improvement may continue here for the next few quarters.

Darren Jackson

What I’d do is I’d break it into two pieces. One, in the short term, you’re right. Our improvements in working capital and free cash flow, I think our free cash flow was up 43% in the first quarter. We exceeded a little bit of our expectations in the first quarter certainly in terms of free cash flow and in our working capital management.

What you’ll see is some pressure in the next couple quarters because MOOG and Wagner are just beginning to flow and just getting the inventory on the shelves is going to put some pressure in terms of our working capital investment. That being said, as we look out longer term, we are just in the day one or two in terms of getting into the longer term work that we’ll be doing in our supply chain.

Our longer term work in terms of our space disciplines in the front room and the back room, day one or two in terms of looking at the overall mix in some of the other turn opportunities that we have.

So longer term we absolutely see opportunities to keep improving the working capital but I think shorter term and I think Elwyn said it with MOOG and Wagner that we’ve kind of locked on in, probably, I don’t know, certainly not the final two but the two big two that we’re looking to put into our mix of inventory.

Operator

Your next question comes from Tony Cristello – BB&T Capital Markets.

Tony Cristello – BB&T Capital Markets

Darren there’s a tremendous number of initiatives underway and it appears that the majority are geared toward helping the top line growth and overall productivity. Is it fair to assume that most of the cost save initiatives have already been implements and with the goal of now leveraging fixed cost with greater productivity and if that is the case, how much is needs to be accomplished is dependent on your ongoing systems implementations.

Darren Jackson

In any business today you’re never done trying to improve productivity, both on the top line and in the cost structure. It just seemed to make a lot of sense to us is that the right place to get started with, whether you look at our sales per square foot, our profit per team member, the state of our DIY business that our energy was best positioned to start growing this business again.

Because when we start growing this business again, a lot of good things happen culturally, a lot of good things happen for our team members in terms of job opportunities and a lot of things happen in terms of creating the environment that we want here at Advance and it’s an environment we enjoyed for many years before I ever got here.

And inevitably as a part of just responsible stewardship, there will be cost things that as we get into re-architecting the business model, we’re going to have to continue to be vigilant in terms of finding not just those incremental opportunities in terms of changing our cost structure, but ones that allow us to step change part of that.

So organizationally, we’ve been purposeful to position the company to go grow again because we know how to grow and we know what that environment will do for our culture and I was purposeful in my language to say, and we have to get back to the operational excellence that we used to enjoy as a company not so many years ago.

And by way of example, we have shrink results in our stores, some of those things run at 0.3 and some of them run well over 1. That’s unacceptable to have that type of variation. And so we’ve got a lot of those type of examples in our company that over the course of the next several years and that doesn’t mean everything is going to take forever, but that we have to just get after in terms of some of the basics around operational excellence.

Tony Cristello – BB&T Capital Markets

Would you say that the initiatives on the commercial or the DIY, one is more dependent on being accomplished through systems or is there enough to do right now without relying too heavily on the $30-$40 million you have planned this year, the capital spend you have geared towards systems initiatives.

Darren Jackson

The way to think about it is two frames. One, when you think about the DIY business, what Elwyn, underneath some of the transformation he talked about quick hits. And those are basic things.

So it’s attachment selling and we know today and we’re working on tools today, we just launched earlier this week attachment selling scorecards that allow our team members to better see are we helping our customers get all of the things they need, the total solution for whether it’s getting that bake job done or whether it’s getting that tune up job.

So every day in every store we can now see tools that allow us to see top to bottom in the company who’s doing the best job of selling the complete solution or the total job to our customer. Today, I’d be honest with you, our weekend scheduling is not where it needs to be and those are things in a DIY environment, if we can strike the right balance of getting the right team members in front of customers on the day that they’re out there, there’s a lot of business in just the basics in order to get that done.

I’m very excited about, we’ve started the first, we’re on the 30 days Elwyn and Mike in terms of, we’ve picked 30 stores where we’re beginning to understand customer satisfaction feedback and employee team member feedback as to what we can do different.

We’ve got a DIY summit coming in early June where we’re going to bring 20 or 30 of our team members to Roanoke, just like we did with the Parts summit last year and I can’t emphasize enough, last year this team did terrific work engaging our team members in the Parts area and our 10.6% comp today has a lot to do with the people that were on the front line giving us the feedback as to what we did differently.

And, you know what, we don’t have DIY figured out so we’re going to get some of those very team members in our building, giving us their best advice as to what we need to do differently. Similarly in the commercial space, we have a lot of those opportunities that are right now in terms of going out to the business, MOOG and Wagner are terrific additions, we’re thrilled to have them as partners and growing that business.

But you know what, getting out there and getting our commercial parts pros, the tools that they need, putting delivery trucks in spaces that we don’t have them today, having a little confidence that we should be going after demand as opposed to what we’re getting today is part of where we need to go as well.

So we’re not sitting around waiting for some IT system to show up or some terrific, and I know we’ll get terrific work out of the supply chain and the other teams, but there are things right in front of us that are part of what we’re going after.

And to be real honest, those things will get us partly down the field looking at the business differently with leaders like Donna Broome who will bring sales force tools, training, leadership that we don’t have today to make our team members better to help support them are things that longer term will have sustaining and systemic change in the business.

Operator

Your last question comes from Seth Basham – Credit Suisse.

Seth Basham – Credit Suisse

It’s Seth Basham and Gary Balter. First, was there a LIFO credit or charge in the quarter?

Judd Nystrom

What you’ll see is we highlighted the material drivers from a gross profit standpoint and you’ll see that in our press releases where as Mike indicated, 80% of it was supply chain and logistics and 20% of it was pricing. The actual net impact of LIFO and a bunch of other things actually was immaterial in the quarter.

Seth Basham – Credit Suisse

As it relates to gross margin, I think in your last quarterly conference call you talked about expectation for modest gross margin improvement over the course of 2008. We saw a pretty good improvement off a relatively tough comparison there. So as you think about the balance of the year, would you expect this type of improvement to continue or would you expect it to come down?

And in the context of answering that question, can you remind us really to your fuel purchase hedging. At what price is that hedged and is that throughout the year?

Darren Jackson

On the margin you’re going to have to wait Seth, we’re going to pull out the crystal ball.

Elwyn Murray

Let me go back to maybe what we said at the beginning of the year and I’ll parlay it forward. I think at the beginning of the year we came out of Q4 fairly soft and we forecast out through the year at a zero comp and hence we gave you the number.

I think at that time we said we anticipated on a zero comp, we anticipated our margins to be up modestly and our SG&A to be down due to a lower comp. Now we come out of Q1 and our comps are a little higher than we expected, our margins are a little higher than we expected and our SG&A came in around where we thought it would be.

As look at the balance of the year, I think those comments still hold and I think one of the reasons we give you that grid, that 1% comp increase, $0.10 and $0.03 is equivalent to 10 basis points improvement in margin is to help you and guide you. But right now, we see those similar trends, those trends continuing as we originally laid out.

Kevin Freeland

Essentially what we do is there’s two major fuels costs for the company that the transportation from the DCs to the stores and then the fleet of trucks that we have bringing the product to our commercial customers. What we actually hedge is the diesel for the outbound trucks and it’s not something that we have disclosed or intend to disclose in the future, but it locked in the prevailing prices at the end of last year.

We built the budget, set expectations of our earnings based on those assumptions and so on the outbound costs, we’re largely insulated from price moves and it’s something we have done for years.

Seth Basham – Credit Suisse

On the inventory investments, some of your competitors have taken a long period of time than you have to decide what inventory to invest in to serve the commercial customer and make parts more available. You’re making a pretty big investment throughout 2008, just trying to get a sense of what gives you the confidence that you are making the right decisions on what categories to invest in?

Elwyn Murray

One thing I will say is you know from really May of 07 through December of last year we got very aggressive and Darren has mentioned some of the feedback from our Parts summit, we acted on a lot of the input from our team. One of the beauties of that was it got a jump start, it was not a perfect science, but what we did do is sit on top of that entire experience with our test and learn, test and control lab store type of science.

And we’re able to determine from those roughly 500 stores that we touched where the biggest winners were and why. So we’ve been able to refine that and so as we look at the remaining if you will 2,500 stores, we know precisely where we want to go for the biggest bang and are deploying aggressively against that this year.

So some great learning came out of the action we took last year, not to mention the action we took last year we felt was accretive, we’re just going to the most profitable opportunities now quickly.

Mike Norona

Just to clarify, a big part of that inventory increase that we didn’t anticipate would be the addition of MOOG and Wagner, it’s a brand new vendor that is going to play an important part in our future. Whenever you bring a new vendor on side there is an upfront investment to build up your inventory. So that’s a big portion of the increase we see.

Seth Basham – Credit Suisse

You talked about four key financial metrics you’re aiming to be a leader in. As you look at your real estate portfolio as it currently stands, would that be limiting to you achieving that goal of being a leader in those metrics?

Jim Wade

I would just say we certainly have to take into account how much real estate we own versus our direct competitors in some of the metrics. But other than that I don’t think there’s anything that prohibits us from getting where we want to be.

Darren Jackson

Wouldn’t you also, what I would add to that is that one of the things that we learned again just paying attention to the customer feedback, when you think about our commercial garages, the thing that’s number one on their list is speed of delivery. And through our real estate strategy and granted it was DIY motivated, but it turns out that some of those main and main locations position us very well with some very important garages as we look across a lot of the markets we participate in.

So our advantage in terms of speed of delivery really emanates from that real estate strategy and as we go forward we’re going to have to continue to balance as we add the new stores, how do we take advantage of that and then how do we build on that as we’ve talked about with getting the right parts availability for those very same customers.

Operator

I would now like to turn the call back to management for any closing comments.

Judd Nystrom

Thank you operator and thanks for our audience for participating in our first quarter earnings conference call. If you have additional questions, please call me, Judd Nystrom at 540-561-8450. Reporters please contact Shelly Whitaker at 540-561-8452. That concludes our call, thank you.

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