Zaheed Mawani - Vice President, Finance Planning, Analysis and Investor Relations Darren R. Jackson - Chief Executive Officer & Director George E. Sherman - President Michael A. Norona - Executive Vice President and Chief Financial Officer Bill Carter - Senior Vice President, Business Development and Integration Charles E.

Tyson - EVP-Merchandising, Marketing & Supply Chain.

Gregory S. Melich - Evercore ISI Michael Louis Lasser - UBS Securities LLC Seth M. Basham - Wedbush Securities, Inc. Matthew Jeremy Fassler - Goldman Sachs & Co. Robert Higginbotham - SunTrust Robinson Humphrey, Inc. Dan R. Wewer - Raymond James & Associates, Inc. Christopher M. Horvers - JPMorgan Securities LLC.

Welcome to the Advance Auto Parts First Quarter 2015 Conference Call. Before we begin, Zaheed Mawani, VP of Investor Relations, will make a brief statement concerning forward-looking statements that will be made on this call..

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

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

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

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

The company intends these forward-looking statements to speak only as of the time of this conference call and does not undertake to update or revise them as more information becomes available. Now, let me turn the call over to Darren Jackson, our Chief Executive Officer.

Darren?.

Thanks, Zaheed. Good morning, everyone. Welcome to our first quarter conference call. Joining me on the call today is our President, Sherman, who will update you on our business operations including our integration activities; and Mike Norona, our Chief Financial Officer, and Mike will update you on our financial performance.

Entering 2015, and year two of our integration, we remain very confident in the growth, earnings and service potential of this combination. We are well positioned in the commercial business, DIY, import, domestic, independent and online channels with approximately 60% of our business in the fastest-growing commercial segment.

The 2015 enterprise priorities remain unchanged from 2014. They are, just to remind you, relentlessly improving our base business, execution, and successfully delivering the year-two integration objectives. We are building on last year's progress and continue to be confident that the steps we took positioned us well.

As a reminder, the notable successes in 2014 included naming our go-forward leadership team, aligning our cultures, while improving our inventory availability principally through the cross-sourcing. We also completed our supplier negotiations and defined our go-forward product brand structure.

We successfully entered Dallas, leveraging the Carquest backbone. And finally, we delivered on the synergy and financial expectations for the year. Through the first quarter of this year, the cultural assimilation remains very strong.

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

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

In addition to that, aligning our systems and distribution work; this also includes moving to a common foundation for products, pricing, customer process, support centers, pay and benefits, and the store and field leadership structure. This significant work is underway and is an integral step into leveraging the full potential of this acquisition.

It will and has resulted in broad-based change, a number of new learning curves and some temporary disruptions to our business. We completed critical integration deliverables in the quarter and expected some impact to the business; however, the degree of impact on the base business, honestly, was greater than we anticipated.

Consequently, our first quarter performance was lower than we expected. Overall, our sales grew 2.3% to just over $3 billion. The comparable sales were up 0.7% led by commercial growth with our DIY business declining modestly. Earnings per share on a comparable basis grew 6.2% in the quarter on top of last year's 35.5% growth.

Now, our industry fundamentals remain positive including vehicles in operation, gas prices, miles-driven and steadily improving economy. The industry benefits are not equally distributed across the country.

Specifically our northeastern and upper Midwest markets meaningfully underperformed our expectations in Q1, principally driven by weather and some of the West Coast port slowdown. Despite the integration workload and some weather-impacted areas, we have continued to grow our sales and our profits.

The integration efforts I referenced earlier had a larger impact on our core commercial business in the quarter as it experienced a sequential slowdown from Q4 of last year. Our commercial business has been consistently performing at the high end or above the high end of the market growth of 3% to 5%.

In our first quarter, we were closer to the low end of that range. Our sales and operations teams are intensely focused on leading the business and our customers through these changes to get this part of our business back in rhythm and we will. Our fourth quarter call, I outlined five key integration priorities that we were focused on this year.

Later George will provide more details and a status update shortly. Together, these five key priorities support the overarching objective of aligning the two companies to a common foundation.

This significant just table stakes work is required in order to minimize the confusion with customers and position the combined company to operate more efficiently, and ultimately generate the highest value from this combination. As a company, we made a decision to drive key integration activities aggressively from the start.

We believe moving faster with things like the organization and product integration will get us to a desired end state and the results sooner than a piecemeal approach. I previously noted that our 2015 integration priorities were entering a more complex phase, as I called it.

Certainly, it is expected given we are undertaking the largest and most diversified integration project in the industry's history. Although the core business integration work is driving change in short-term volatility in the base business, this volatility will pass and the long-term potential remains strong.

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

Last year, we focused on executing our integration plan with few unforeseen challenges. A year later, the long-term potential remains the same and we are encountering impacts of change from the integration. It is a reminder that neither results nor change unfold in a linear fashion.

While results this quarter did not meet our high expectations, we expect the business to steadily improve, which is the case so far in the second quarter. Q1 was a new high point of integration change and we expect to start seeing our team settling into a sales and operating rhythms going forward.

We also remain grounded that we still have sizable amount of integration work ahead of us and we continue to expect some unevenness in the business this year. In consideration of this, Mike will review this with you and also provide you with a revised annual outlook.

I want to finish by sincerely thanking our 74,000 team members for their remarkable commitment in supporting the changes to position our business for an outstanding future. Now, I'd like to turn the call over to George Sherman, our President.

George?.

first, migrating and rationalizing the two sets of enterprise systems over to one go-forward platform; second, continue with the Carquest legacy systems; and finally, whenever you bring a set of systems that were designed for a private company under a public company umbrella, it requires additional work to get the systems the same place as Advance is from a functionality and compliance standpoint.

We're taking a measured approach to this complex work ensuring that we focus on high-value areas for our team and customer first. Last year, we were able to complete several systems projects as planned to support the product changeover work, store conversion work, our organization conversion work, and financial compliance requirements.

The next phase of our work is focused on getting the Carquest stores, Advance stores and both e-commerce platforms on to a common Carquest-based product catalog. This is the most valuable element of customer experience and is the value-creating element of the store system by allowing Advance to offer the industry's deepest catalog.

We're doing the back-end work this year and expect to migrate the change to that common catalog in 2016. The third major segment of systems integration is the work of connecting the Carquest and Advance distribution centers and stores systems into one integrated supply chain.

That work is also well underway and we expect to begin the process of converting the supply chains in the middle of next year. Concurrent with the systems work is our ongoing expansion of daily delivery in the legacy Advance network. At the end of the quarter, we have 700 Advance stores being serviced daily.

We expect to have approximately 1,000 Advance stores being serviced daily by the end of the year. Our best estimate today is, we'll be nearing completion of the entire chain on daily delivery by the end of 2017. Once the supply chain systems work is completed, we can then finish the consolidation of the back end financial systems.

By definition, that'll occur last. And at this point, we expect to be able to complete that work in late 2017. Lastly, before I close, I'd like to take a moment to share some insights as we focus on pushing forward our growth agenda as a combined company. A few comments on the major ones.

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

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

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

In closing, what I'd like to convey is that, we are in the midst of an operationally taxing integration year, and while there have been some challenges, some more than we anticipated and others that we've yet to tackle, those challenges are simply part of this process and should not be interpreted in any other way.

The parts of our organization that are not in the midst of integration change are delivering with strength. We remain absolutely confident in executing against the plan and by the future we see for our company as we work to integrating this acquisition and positioning Advance for growth and industry leadership.

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

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

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

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

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

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

As a reminder, and unless otherwise specified, Advance will present its financials and supporting commentary on a consolidated enterprise basis, and would also discuss results on a comparable basis which excludes the impacts of one-time integration expenses and amortization of intangible assets both related to the acquisition of General Parts.

Our financial results were below our expectation in our first quarter of 2015, primarily driven by our integration activities. We expected the heavier integration efforts to impact our financial performance in 2015.

However, the combination of both the volume of change and the areas of the business that were impacted had a greater financial impact than we anticipated at the beginning of the year. The changes had the most impact on our commercial sales. Despite the softness, we were able to grow our profit rate and deliver on our synergy expectations.

We are confident that we will work through the required operational phases of our integration and deliver the compelling financial value of our combination with GPI. Turning to sales. Our first quarter net sales increased 2.3% to $3.04 billion compared to our first quarter of 2014.

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

We also experienced more pronounced variability in our commercial sales, where, in some cases, we saw greater than a 300 basis point gap in our commercial sales comps in places where we shifted customer relationships versus where we had no changes. This variability is part of the change and we expect it to be short term.

Comp sales were also partially affected by unfavorable weather across some of our Great Lakes and Northeast markets. As a reminder, General Parts company-owned locations are included in our comp sales calculation beginning in February 2015. Sales to our independent customers are not part of our comp calculation. Turning to gross profit.

Our gross profit rate dollars in the first quarter increased 3% to $1.39 billion from $1.35 billion in our first quarter of 2014. Our gross profit rate of 45.9% was up 31 basis points compared to first quarter of 2014.

This year-over-year rate increase was due to 45 basis points of achieved merchandise cost synergies partially offset by cost from our new Hartford, Connecticut DC that opened in late 2014. Turning to SG&A. Our comparable SG&A rate was 35.7% in the quarter, which improved 26 basis points compared to our first quarter of 2014.

This year-over-year improvement was the result of achieved cost synergies and lower incentive compensation partially offset by slightly higher advertising expenses related to our DIY business. All in, first quarter comparable cash EPS was $2.39, up 6.2% on top of last year's 35.5%.

As a reminder, in our first quarter, last year, we had a $0.05 EPS impact in one-time favorable tax audit settlements. Our first quarter operating income dollars on a comparable basis increased 8.4% to $308.3 million and our operating income rate increased 57 basis points over the same period last year to 10.1%.

Included in our operating income was $24 million in net incremental acquisition synergies. We are pleased that we continue to deliver against our synergy expectations. Operating cash flow increased approximately 26% to $102.2 million in the first quarter versus $81.1 million during the same period last year.

Free cash flow increased to $45.2 million in the first quarter versus $20.6 million during the same period last year. Our AP ratio for the quarter was 76.5% versus 75.9% last year. At the end of the first quarter, we had roughly $1.61 billion of debt on our balance sheet, and our adjusted debt-to-EBITDAR was 2.7 times.

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

We continue to measure the performance of our business and prioritize our investments to achieve growth, profit, and value creation. Our growth engine is our commercial business, which is driven by the growth of new and existing customers.

We also see a opportunity to organically grow stores to over 6,000 locations, which include doubling the size of Worldpac and growing our independent business. Additionally, we expect our loyalty program, which targets the heavy DIY'er, will drive more consistent DIY comp performance through increased frequency and a stronger sales mix of hard parts.

Turning to profit. We see an opportunity to grow our comparable operating income rate to 12% by the end of 2017. As context, our combined post-acquisition comparable operating income rate was 9.1%, reflecting the acquisition of a lower-margin commercial-heavy business.

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

This puts us on track against our next profit objective of achieving a 12% rate. This is realistic given it considers the rebalancing of the gross margin profile of our now more commercially weighted business that has a different commercial customer, including national accounts, government, paint and an independent business.

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

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

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

With respect to value creation, the acquisition of GPI continues to provide us with a compelling opportunity to drive shareholder returns through incremental earnings and cash flow. In addition to improving our operating performance, an equally compelling opportunity exists with our balance sheet.

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

The outcome of this work will result in a lower inventory investment with greater SKU availability, along with continued progress on our vendor terms, both of which will show up in an improved AP ratio. Also we're on pace to get back to our targeted level of 2.5 times and maintain our investment grade ratings.

Once achieved, we will revert back to our previous capital allocation strategies to drive shareholder value, which includes investing in our business and deploying our share buyback program. Turning to the balance of the year.

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

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

It's prudent to build in the earnings miss we experienced in our first quarter and factor in some continued integration headwinds into our results, primarily impacting our commercial sales. We now expect our annual comparable store sales to be at the low end of the previously communicated low single-digits range.

As a result, we are revising our full-year comparable cash EPS outlook down to $8.10 to $8.30. As part of this outlook, we expect our share count to be 73.7 million shares, our tax rate to be in the range of 37.5% to 38%, and our interest expense to be approximately $64 million.

We are confident in our team's ability to execute and our revised full-year outlook reflects our best view of the short-term change impacts from the integration. Our 2015 synergy estimates remain unchanged at $45 million to $55 million for the full year.

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

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

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

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

Thank you. And our first question comes from Greg Melich with Evercore ISI. Thank you. Your line is open..

Hi. Thanks. I had a couple questions. Mike, I think you've mentioned synergies, $24 million of net acquisition synergies. Is that a cumulative figure including last year's first quarter or how should we think about that number? And then I had a follow-up..

That's an incremental number, Greg. If you remember last year, we did a little bit over $8 million. And this year, we're a little bit over $32 million. And that is a net number..

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

Yeah. The way to think about that, Greg, if you think about last year, our synergies built. So in the first half of the year, last year, we had about 30% of our synergies and they've built throughout the year.

This year, it's going to be the opposite – it's going to be the flip, roughly 75% of our synergies will happen in the first half of the year, and then the last 25%, just because they'll be annualizing the bigger numbers from last year..

Got it.

And then second question is, could you remind us how many distribution centers you now have for each business, or now it's one business but how we started with GPI and Advance? And how the plan of integrating these and how many you expect to have as you move forward on that integration?.

Yeah, Greg. Good morning. So in total, we're at 44 centers today. We've completed a logistics network study that's going to inform us on where we're going to end up from an integration perspective.

Where we are on the journey right now is, we are going to do a significant amount of upgrade work on a large number of the Carquest DCs to prepare the capacity for the expansion of our conversions. And in the second quarter we'll be in a position to start announcing where we're going to be with (35:21).

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

So this year is about fixing up the ones we have to make them as optimal and then we decide which ones to close next year? Is that a fair way to think about it?.

That's exactly right..

Great. Thanks. I'll let someone else have a shot..

Thank you. Our next question comes from Michael Lasser with UBS..

Good morning. Thanks a lot for taking my question.

As you get into some of these more complex marketing integration, are you finding anything that's changing your longer-term view or causing you to change direction? So perhaps you're realizing that some of the systems from either legacy organization just may not be up to speed and you're going to go through a big change in management process anyways, so why not take this as an opportunity to bring everything up to the state-of-the-art?.

Michael, good morning. It's George. I'll start with that one and turn it over to Bill Carter, who is running our integration. We are very committed to powering through the conversions and the consolidations. And I think if you look at conversions as a starting point, that's relatively straightforward work. We've done it in the past.

We have a core competency around it. We like the DIY outcome that has come with much of that work. The consolidations are inherently more complicated. But, again, I think with the BWP acquisition, we learned how to do a consolidation quite well. A little bit more taxing, a little bit more time-consuming, but we have to keep on working through this.

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

That's correct both from a store standpoint and a product standpoint. You heard George mention the progress we're making and we continue to be on track. I think the second part of your question is, are you learning stuff through the integration that's causing you to change. I'd say we learn every week, we learn every month, and we make tweaks.

We're not radically changing the long-term integration plan by any stretch of the imagination, but we continue to improve it over time. One example that George mentioned on the call is, we recognize the value of giving to our common catalogs sooner rather than later. So that our availability across the network can be similar across platforms.

So we're prioritizing that as something that's a value-creating engine for the team member and the customer. And that was a learning that we probably had three or four months ago, as we were doing our due diligence and have adjusted accordingly.

To prioritize that is something we're bringing to the front from a value creation and common foundation standpoint..

I'd also say, Michael, that we're not changing the process but we're certainly iterating the process. So every consolidation, we get a bit better.

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

Correct..

Yeah. Maybe last case. Michael, your last question is why not get everything to state-of-the-art. That would be hard. But there will be a handful of things that will be state-of-the-art by 2017. Our catalog will be state-of-the-art by 2017 and we'll start to experience some of those benefits as early as the beginning of next year.

Our supply chain, in terms of daily replenishment, by the end of 2017, will – the 5x delivery across the nation will be state-of-the-art. So there's more examples.

So we're trying to balance this, as George said, in terms of the team's ability to kind of work through the change, things that we have to power through versus piecemeal, and we're keeping an eye on the things that are critical to the customer relationship that should be state-of-the-art by the time we get through this in 2017..

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

So there's nothing that's really changing in the longer term? And then, as part of that, when should we expect that – some of the recent integration hiccups are going to be less impactful and the business will perform more in line with the market? Thank you so much..

Hey, Michael. It's George again. I don't think we see anything that would cause us to change any margin expectations. As far as the work and what's behind us and what's ahead, I tried to give some detail on this and I'll give a bit more.

I think if you look at the actual work that's been done, we've tried to move to a common foundation between the two companies and we see that – we mean product brand alignment, pricing, process, getting the store support centers consolidated, getting our store leadership teams consolidated in the field, and then beginning some of the early consolidation, conversion and relocation work.

If you look at that, I think the product label part of this is largely behind us. So again, that was very physically intensive. It's touching 20 million pieces of merchandise and it's essentially close to done. So we're emerging there. If you look at the product replacement, that work is still ahead of us category by category.

As far as pricing, we're nearly complete. Most of the pricing unification has happened, and it certainly has in the major product lines. I call the work ahead of us some of the clean-up work odds and ends, but the major lines have now been changed. That's a big change for us.

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

And then, I think, when the work is done, as you can imagine, one of two things has to happen. If we raise price, it's holding line on unit velocity. And then if we lower prices, it is getting the unit lift that we need to pay back for the pricing investment that we make. So we're making progress there.

And I think we're emerging from that portion of it as well. The support centers are – the work is done. Now, bringing the teams up to speed, ramping them up in terms of just their handle on their new positions remain something that takes a bit of time. But I think those major elements are behind us.

The product lift is still ahead, no question about that. There'll be some more work around that. A little bit of pricing work needs to be done yet. And then, obviously, the conversions, consolidations will go on for well over a year and a half, two years..

This was helpful. Thank you so much..

Yeah..

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

Good morning and thank you for taking my question. My first question is around the cadence of the impact from some of the integration changes that you're making. I understand that they're temporary and primarily in Q1.

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

Yes, Seth. It does. And I think there are markets where either the change has been limited or the change has abated. If you look at our Canadian business, again, they did this work last year. Their product replacement is well behind them, they've activated on it, and they're running nice solid double-digit results in local currency.

If you look at Autopart International business, they've been protected from most of this change and are continuing to run very nice growth. Worldpac is just growing and is completely isolated from this change and is running nice single-digit growth.

Where we went into Dallas/Fort Worth on the go-forward systems, we have seen very good results in a very competitive market where we've begun to – where we did the work early, and, Seth, we did the BWP work well ahead of this. That was the biggest concentration of Carquest business in the Northeast.

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

That's helpful.

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

Yeah, that's a way to think about it. It's always – I think George really articulated well. All those things didn't happen at the same time in the first quarter. So some of the change happened throughout the quarter, so we're still navigating through the change. So I think that's a way to think about it, Seth.

It's always difficult to predict the exact level of change and the learning curve that the teams are going through, but a way to think about the outlook is we've built in the miss in the first quarter. We have lowered our sales for the balance of the year. We went to the low end of our previous range.

If you think of a low-single digits in kind that 1% to 3% range, we think we're going to be in the low end of the range and I think that reflects what you just shared. So that's kind of how we thought about (44:54).

But I would look at the change as, is it the product brand work? Is it the pricing work? Is it the process work? Is it the corporate work? And I think it's an amalgamation. It's all those things. And as I said, some of that is behind us now. So we see this abating during the course of the year..

Very helpful. Last question for me. The DIY business, it seems like you made some progress there.

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

Yeah. We said they sequentially improved 40 basis points, Seth..

Great. I missed that. Thank you very much..

Yeah..

Thank you. Our next question comes from Matthew Fassler with Goldman Sachs..

Thanks a lot and good morning. Two quick questions. I'll ask them both up at once. First of all, as you think about the impact of the loyalty program, you spoke about its impact on sales.

Can you talk about how that tends to impact margin and how you expect the margin impact to progress as that program ramps? And then, secondly, if you could just update us if you haven't already done so, on the sales impact, on the sales recapture rate that you're seeing as you close, as you continue to consolidate some stores..

Yeah, Matthew, sorry go ahead..

Yeah, Matt, let me start off with the Speed Perks program and then Charles Tyson will add some comments as well. I think we've been satisfied with every aspect of Speed Perks. They have a membership of well over 4 million here early in Q2 and 4 million at the end of Q1. We think that we're on with something pretty good here.

We think that the program is distinctive and is the best in the industry. It has been a win for us in terms of all the financial fundamentals. The sales lift has been good, the transaction growth has been good, we're seeing a bounce-back effect..

And as you think about – understand that sales work – is there, just to make sure that we model it correctly. Is there some give back on gross margin? Obviously, the gross profit dollars have to be doing well for you to like what you see.

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

Yeah. Matthew, its Charles. Yeah, there is an impact from a gross margin rate. Obviously, the impact on sales and the growth we're seeing from that customer segment that have joined the Speed Perks program has a very positive gross margin dollar impact.

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

Great..

And, Matt, just this is Bill. Just to answer the question on the consolidation results. As George mentioned in his comments, we completed the early consolidation program as of the end of last year. That was focused on the 100 lowest-performing low-profit stores of Carquest. We are pleased with those profit and sales results from those.

And we recaptured about 60% to 80% of the revenue that was associated in those Carquest stores, obviously some variability based on markets and how well we executed.

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

So that's where we're performing at this point..

Thank you so much..

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

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

Yeah. It's not a meaningful figure. It generally disperses. And especially for those, it absolutely disperses. So it wouldn't change that number appreciably..

Got it. Thank you..

Thank you. Our next question comes from Robert Higginbotham with SunTrust..

Thanks. Good morning. I was hoping to get a little more color on what really surprised you in your integration process.

Was it really that things were taking longer or were just tougher to execute, or was there a piece of there being a sharper reaction, if you will, from your customer base? And one thing I'm trying to get at is to the extent that you lost some share through these changes, do you expect to get that back, call it, immediately once you're done with those changes or you think you'll have to work harder, if you will, to win that business back?.

Yeah, it's George. I'll start off with that and ask Bill Carter to make some comments as well. I think if you look at the work, again, I think if there's something that made an impression, it would be the cumulative effect.

I don't think there's any one aspect of it that was more complicated than what we thought, and I think we're well in control of every aspect of the integration. It's hard work. I would call the combination, the one that has made things a bit more complicated. A lot of things falling into place at the same time, pricing changes, product changes.

Any time we do a product replacement, you're relying on execution at multiple levels including the suppliers. We've had a couple of instances where it hasn't been the best first impression of a new part coming onboard because of the in-stock condition at the time. I think when you look at the pricing work, again it's a multi-phase challenge.

It's not just getting the pricing unified; it's getting the activation around that new price once it's done. And that takes time, getting the sales team out there into the shop to communicate that. So it's no one single thing; it's the combination of all of them landing at the same time..

It's the combination of the, to answer your question specifically, Robert, nothing took longer than we expected. I think it was just tougher when it all added up in Q1, change for our team, and as George mentioned change due to some of the product and pricing changes that the team and the customer worked through.

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

And on the customer reaction..

Parts of it were terrific. So if I can go back to the cultural overlay and the field alignment, we asked our teams to go to 33 regions across the country and we combined (51:17) of our regional vice presidents come from Carquest, some of them come from Advance.

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

Okay. That's helpful.

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

I think while some of the change has been tough, and let's talk about the product brand alignment. Uniformly, we like where we're going. So when the work is done and when the work is behind us and we have this new house of brands that we think is terrific, our team is behind it, our customer is behind it, and we're very confident that we'll win back..

And we've experienced this in previous integrations when we did BWP and we had things disruptive. This year, it came back over time. Within a year, usually, but not instantaneously. It's not going to come back next week. So we feel good about the recovery. It definitely wasn't nearly as bad as what occurred in some of the previous ones.

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

Got it. That's very helpful. And my second question is really on your general pricing strategy. Historically, it seems like you've been pretty aggressive in the marketplace in commercial.

As you harmonize pricing, is that a fair way of thinking about how you're currently going to market? Does price become less of a point of competition as you increase daily delivery and now have bigger muscle as a bigger enterprise?.

Yeah, I think that's absolutely the case. When we looked at the pricing continuum, as you'd expect, Advance was on the more competitive side and Carquest was on the higher side. We struck a point where we felt it was the right pricing strategy for the kind of commercial business that we are going to emerge as and that we've become.

And that includes 5x delivery benefits. That includes a lot of the commercial know-how coming from Carquest that includes the Carquest Training Institute, that includes our TECH-NET programs, banner programs that have come out of this partnership..

Got it. Great. Thank you..

Thank you. Our next question comes from Dan Wewer with Raymond James..

Hi. Thanks.

Can you talk about the perspective of your commercial customer, what they saw differently from Advance and Carquest in the last quarter that resulted in the market share in your commercial channel I guess weakening a bit? Was it a disruption in your in-stock capabilities, your ability to hotshot a part within 30 minutes? Was it a change in the salesmen covering their account? If you can give us some clarity on that..

Sure. I'd be glad to, and I'll kind of give it to you from the perspective of if you were a district manager for, say, Carquest and some of the change that's happening right now. Those customers working with that team will have seen some product changes.

Clearly, there have been changes in filters and in belts and in chassis and in gaskets and in batteries. So brands that you've been used to selling for many years, you're now in some cases selling a new one, and in all cases going forward you will be.

So it's bringing the customer along on that journey and just showing and demonstrating the quality of the part, and I'd start it off right there. I think the pricing part of it has been an impact as well where there is some interim period of time where again in a market Carquest and Advance have two different prices.

And then we have a new one going forward. So for those Carquest customers, they're very often seeing lower pricing. And again, we have to activate and sell more when that happens, but that's a change. Some of the systems tend to change for our team along the way. We try to make that as transparent as possible and protect our customers from change.

So from a B2B standpoint, they're using the same systems that they always have. So I think those are the major changes.

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

That appears to be disorganized and is confusing for the customer, and we've changed that. So we have built new sales territories with a single representative representing both brands in some cases. But every customer has one commercial account manager only, not multiple. So in some cases, it's a new phase; in others, it's the same..

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

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

Well, I think we'll have converted all of our brand work. We'll have all of our availability in all of our brands lined up, our pricing lined up. I'll remind you, some of those of relationships go back for years and years.

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

Yeah, Dan. This is Darren.

So part of the indicators I look at – because I think that's a fantastic question is that when we look at our strategic and national accounts, our growth slowed a little bit in the quarter, but you know what? The ones that had been leading the way continue to lead the way, so whether that's CarMax or whether that's DriveTime or others, we feel really good about that.

When I peer into the Carquest network, their banner programs, we grew that business in the quarter 7%, so those tend to be some of the large bay installers, and then we grew the TECH-NET customers specifically. Now there's only 6,500 of them, but we grew those double-digits in the quarter as well.

And those tend to be a leading indicator of the best relationships and we built up – or I should say, the Carquest team has built up a lot of great equity in terms of those relationships. Now, we did see a little bit of a pullback on the Advance side to some of that, weather always events out.

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

So each period, we've seen that volatility come down a little bit. And what is it? Is that we're touching customers again on a consistent basis. And so, that's how you win people back and then you augment it, as we've said, with getting the pricing right, the product brands and the consistency..

And just a real quick question for Mike, on your 12% operating margin goal for 2017, you talked about 100 basis points of cost reductions. I guess that equates to about $100 million.

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

Yeah. The way to think about it, Dan, is we really started that once we put this acquisition together. Our operating margins were at 9.1%. Last year, we did some work on our costs. This year, we're doing some work on the costs. And I think you're right.

It will start to accelerate into next year and then we'll probably see the biggest change hit us in 2017. I think we've talked about our cost before as we move to a lower cost, lower commercial model. We see opportunities at our support centers to take costs and make ourselves more efficient in those areas.

IT is an area as we get rid of duplicate systems. It's a big opportunity. And then, as we improve the profitability and productivity and the variability across our store base. So we think those are big opportunities and its work that – it will be very planful. It will be very thoughtful.

And then part of also getting to 12% is keeping our sales going and growing the comps. So that's another important dimension..

Right. Great. Thank you..

Thank you..

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

Thanks and good morning. So question asked – maybe asked prior, but a little differently this time. So, I'm trying to dial in the impact of the integration impact on the Carquest commercial business versus the heritage AAP commercial.

On Carquest, there was a lot of concern that the business had decelerated all year in 2014 and worries that something was breaking there on the integration. And then, heritage AAP commercial did very well last year.

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

Yeah. I think if you look at, Chris, the change for the Carquest commercial business, I highlight one thing, the beneficiary of a pricing benefit. So, certainly, we're seeing that happen and, again, that activation piece of getting the unit velocity back is not immediate.

So if you look at where that's happening more often than not, lower pricing is happening in the Carquest network. They're having to go catch up, get the velocity to drive the dollars above where it was before. There really aren't many markets in the country where there is change to Carquest. The best indicator of that would be the BWP business.

And again, as Bill said, there is a trough initially, but we certainly see ourselves come out of it and build upon the business. In the 5x markets, we've been very pleased with the lift and the most recent work that we've done was Lakeland, Florida to get the North Florida on the daily delivery. Very happy with our outcomes in Florida.

And then, of course, we have a new Hartford, Connecticut facility that is at about 160 stores now and beginning to ramp up more and more, bringing daily delivery to the Northeast. And we're happy with those results too. And especially the way that just recently with a lot of the change behind us in the Northeast, that market we're pleased with..

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

Yeah. That's correct. Obviously, as George said, we've been very happy with the impact in our Lakeland facility. And our team did a wonderful job in executing that without any interruption of service to our customers. And we're beginning to see that flow through into our new Hartford facility.

And we will complete more of that work as we move through the year this year..

Yeah. Probably the most, the clearest example we have is what's going on in Canada, right team? They went through a first, littlest changed, double-digit comps. And all the competitive set's different, but there are some pretty good competitors up there as well and the team is doing a great job.

Worldpac continues just, it's a very nice business, growing above our early expectations, so they're doing a nice job. And the BWP market, certainly, less change there and they're a leading indicator to, yeah. We just have to power through it.

And so we got to finish through the things we got to power through, and we got to manage to the integration plan that we set out there..

And I'll also say that our Dallas/Fort Worth market opening has been a great example, so we're very happy with the results in Dallas/Fort Worth and how we entered a new market. And we used something close to what the go-forward model will look like. We used the Carquest distribution center. It is on daily delivery.

We opened up super hubs geographically spaced across the DFW Metroplex. We've got a combined team. There will be some change still in those markets. It's not entirely on the go-forward plan, but it opened up well and certainly we like the outcome there..

And so two quick follow-ups. So A, what did your – what was the first quarter earnings below your internal expectations? And B, what do you attribute the improvement in the DIY business to because the compares are actually tougher. So was this actually the loyalty card helping? Thanks..

Yeah. I'll hit the first one, and I'll let Darren get the second one. I mean it's real simple. It was on the top line. We said it. The change that George put through – discussed, we believe those are shorter-term impacts. They had an impact on our field teams. And it impacted – and it primarily came through on our commercial sales.

So that was really our shortfall. I think we were pleased with some of the things. Really pleased with our synergy work and what we did there. And so we're building momentum there, but really it showed up on the commercial sales side..

On the DIY side, I think the single biggest change was the Speed Perks program; again, very happy with the membership base that's being built. I'll also add that we changed our marketing strategy and you'll see a shift in our marketing mix more toward TV.

And on TV, you'll see them in places where car guys tend to watch TV, so a car-related show on Velocity TV, a NASCAR broadcast, and we're getting very, very good feedback on that and I think it certainly highlights what's different about our loyalty program..

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

Thanks, Lisa, and thanks to everyone for participating on our first quarter earnings conference call. That concludes our call. Thank you..

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