Prabhakar Vaidyanathan - Vice President of Finance, Corporate Treasurer and Head of Investor Relations Tom Greco - President and Chief Executive Officer Tom Okray - Executive Vice President and Chief Financial Officer Bob Cushing - Executive Vice President for Professional Mike Broderick - Senior Vice President Merchandising and Operations Support Leslie Keating - Executive Vice President Supply Chain Strategy and Transformation.

Simeon Gutman - Morgan Stanley Seth Sigman - Credit Suisse Scot Ciccarelli - RBC Capital Markets Mike Baker - Deutsche Bank Matt Fassler - Goldman Sachs Michael Lasser - UBS Christopher Horvers - J. P.

Morgan Seth Basham - Wedbush Securities Steve Forbes - Guggenheim Securities David Bellinger - Oppenheimer & Company Dan Wewer - Raymond James Carolina Jolly - Gabelli and Company Matt Mcclintock - Barclays Daniel Imbro - Stephens Chris Bottiglieri - Wolfe Research.

Welcome to the Advance Auto Parts’ Second Quarter 2017 Conference Call. Before we begin, Prabhakar Vaidyanathan, 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 to discuss our second quarter results.

I'm joined this morning by Tom Greco, our President and CEO; Tom Okray, our Executive Vice President and Chief Financial Officer; Bob Cushing, our Executive Vice President for Professional, Mike Broderick, Senior Vice President Merchandising and Operations Support and Leslie Keating, Executive Vice President Supply Chain Strategy and Transformation.

Tom Greco and Tom Okray will open the call with prepared remarks regarding the quarter, and Bob, Mike and Leslie will join them to answer questions for the Q&A portion of the call.

Before we begin, be advised that our comments today include statements that are not historical facts, and maybe deem forward-looking statements within the meaning of the Private Securities Litigation Reform act of 1995.

Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, which are described in the Company's filings with Securities and Exchange Commission. Our comments today will also include certain non-GAAP measures.

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 content of this earnings call will be governed by the information contained in our earnings press release and related financial statements. Now, let me turn over the call to Tom Greco..

Thanks, Prabhakar, and good morning. Let's dive right in. In Q2, we narrowed our historical competitive growth gap versus peers by registering a slight sales increase of 0.3% with comp sales flat versus prior year. This represented sequential comp sales improvement once again when compared with the combined Q4 plus Q1 timeframe.

As we indicated on our Q1 call, we’ve been looking at Q4 and Q1 combined due to a couple of factors that made it logical to do so. These results reinforce that we’re strengthening our customer proposition for both DIY and professional customers.

We’re encouraged by our performance relative to the industry as we’ve consistently narrowed the comp sales gap over the past year. Turning to operating income. Our adjusted operating margin rate came in at 8.6% with adjusted EPS of $1.58. On a year-over-year basis, this was 214 basis points less versus the same period last year.

It's important to note that this rate includes 26 basis points from non-cash P&L headwinds related to reduction in inventory.

As we’ll discuss in detail later, we think it's very important for you to understand this and for us to make sure we’re transparent as the non-cash P&L headwinds will continue as we keep reducing our inventory through good business decisions.

Excluding the non-cash impact of the inventory reduction of the adjusted operating income would have been $207.3 million or 9.2% margin, a decline of 188 basis points on a year-over-year basis.

Therefore, our Q2 operating margin performance versus prior year was primarily driven by investments in the customer; and as I mentioned, the non-cash P&L impact of our inventory optimization efforts. As stated previously, we have a tremendous opportunity to improve profitability.

That said, before we achieve that objective, we need to strengthen the team and make necessary investments to support our customers and front line team members. What we understand this increases cost in the short-term and puts pressure on operating margins, we remain confident, these decisions are in the best long-term interest of our shareholders.

The investment in the front line is necessary to stabilize and grow the business. The plans to execute productivity and transformation needed to strengthen team first in order to refine the plans to execute. We're still in the early phases of our turnaround.

And as noted before, the historic lack of investment in the customer needed to be rectified; we lack the coherent strategy; our frontline turnover was unacceptable; our technology platforms were segregated and difficult to navigate; and our supply chain infrastructure was duplicative and salient.

All of this created a suboptimal experience for both customers and team members, and was the primary reason our top line underperformed versus our competitive set by a wide margin for years. Simply put, we were an easy share donor for our competitors. Our new team has been acutely focused on changing this.

Our focused investments have consistently enables us to narrow the gap over the past 52 weeks, demonstrating that our elevated focus on the customer is driving desired outcomes.

While we’re narrowing the competitive gap versus peers, which gives us tremendous confidence in our investment, we also recognize the short-term headwind the industry is facing, and have factored this into our full year guidance. You saw our fiscal 2017 guidance revision in our press release today.

Our revised full year guidance ranges from down three sales comp on the low-end to down one comp on the high-end. With regard to sales. There is little doubt the industry experienced a short-term drag on sales in the first half of 2017. This has been widely reported in both public company releases and syndicated data.

While we don’t think the softness indicative of a longer term trend, we do believe it's now prudent for us to plan for this softer industry backdrop to persist into the second half of 2017.

As a result, we’re moderating our growth expectations for 2017, as we do not believe a lost step the first half sales softness in the back half nor do we believe industry growth rates will snap back to historical levels in half two. We attribute the temporary industry softness to three primary factors.

First, economic uncertainty for low income consumers; the most measurable dimension here is the year-over-year increase in gas prices, which has lead to a lower increase in miles driven in 2017 versus prior year relative to the increases we saw in both 2015 and 2016.

Second, a temporary trough in vehicles in the age and maintenance suit-spot resulting from a substantial decline in new car sales in the 2008-2009 recession; eventually, this reverse as new car sales accelerated double digits for three straight years starting in 2010 and experience strong mid single digit growth for the succeeding years after that.

As a result, we expect meaningful improvement for industry growth in the future.

Finally, it pains me to say this, but weather played a role in the first half of the year, as two consecutive mild winters, combined with the spring and summer that was cooler than last year, impacted certain categories like shocks and struts under car, as well as air conditioning.

Growth rates for these categories were down low single-digits in Q2, and given that summer is almost over, we don't expect categories like AC to recover lost sales balance of year.

In addition, the industry had a record breaking finish last year because of an unusually cold December, which places us with a known difficult compare at the end of the year. All of this has been factored into our sales guidance. Of course these weather impacts even themselves over the long term, but they may not even themselves out this fiscal year.

If we look, historically, such short term volatility is not unusual.

In any given year from 2000 to 2016, the industry experienced variability in growth rates year-to-year; yet overall, the market has grown with a CAGR of 3.5% over that 16 year period; based on our analysis, car park has the highest correlation with auto parts sales of any variable we’ve studied; given current estimates for car park over the next five years, we see the current 2017 headwinds for the industry as temporary.

Taking all of this into account, while we're projecting temporary softness for the industry balance of year, we're forecasting roughly 3% sales growth for the industry over the next few years with healthy underlying demand. In addition, we believe we'll be shared gainers and so shared contributors based on our actions over time.

We continue to take aggressive steps to fundamentally change the business. However, we believe it'll take time for us to fully realize the benefits of our actions. I'll elaborate on this shortly.

In the near term, while we're moderating our expectations for growth this year, we're accelerating our planned inventory reduction efforts to improve free cash flow. We have more inventory than we need and plan to reduce it in a thoughtful and disciplined fashion.

In Q2, we were encouraged that we reduced inventory without impacting sales, and we're pulling forward our inventory reduction efforts ahead of what was originally scheduled in our five year plan to improve free cash flow.

As a result, we expect our balance of year profitability to be impacted by; first, higher deleverage related to the change in the comp guidance; second, ahead of schedule inventory reductions that will drive a non-cash P&L headwind from inventory reduction. Let me explain the non-cash P&L impact of inventory reduction.

The Company has purchased inventory at higher costs in the past, which are reflected in the balance sheet on a LIFO basis. In addition, under accounting rules, certain supply chain costs associated with inventory have been capitalized.

As the Company reduces inventory, these costs move from the balance sheet and generate a non-cash negative impact to gross margin. As we continue to reduce inventory, it will improve cash flow but there'll continue to be a significant non-cash negative impact to gross margin.

It's important to understand this; as it is clearly good business to reduce unnecessary inventory and we want to make sure the non-cash accounting effect on margin doesn't drive bad business decisions.

The third factor impacting balance of year profitability is necessary investments in the customer, our front line team members and organizational talent, to ensure long term sustainable growth. As we move to Q4, these investments get more than offset by productivity initiatives we have in play.

The change in the comp outlook is the single biggest driver of the change in guidance. Additionally, while inventory reduction positions the Company for improved free cash flow, it's expected to drive a non-cash P&L headwind in 2017. Tom Okray will provide more color on the financial shortly.

But before that, I'm very excited to provide more details on Phase 2 of our transformation plan. We shared our objectives for Phase 2 on our transformation plan on our Q1 call. They were; first, elevate focus on the customer; second, drive productivity; and third, attract and develop talent. Let's start with the customer and driving growth.

For professional, it's foundational that we have the right part in the right place at the right time. We’ve had substantial early success with lead market initiatives to improve our value proposition. Importantly, we proven we can significantly improve our value proposition. And when we do so, it directly drives performance.

First, a brief update on our availability transformation, or AT, for short. We’ve implemented AT in approximately 400 stores; at the core of availability transformation is a radically different approach to assortment and delivery. This is resonating with our customers.

Sales are performing around 5 points better in AT test stores versus controlled stores. We are expanding AT to another 600 stores, by Q4. AT has shown us that we can satisfy the customer with better service, better availability and less inventory. Secondly, many of our professional customers order through our digital platform.

We’ve recently introduced a new B2B platform, called Advance Pro to over 1,000 customers. We expect thousands of additional customers to move to this exciting platform balance of year. Advance Pro also includes our new enterprise catalog, called Apacs.

The Advance Pro B2B platform integrates with a wide array of shock management tools used by our professional customers and provide enhanced search capability and repair job details, as well as labor and fluid specifications. Our early testing of Advance Pro is very positive and our customers love it.

We’re also rolling out a new enterprise catalog Apacs internally to team members. We’ve already rolled this out to 3,300 Advanced stores. Today, Apacs is providing increased speed and functionality. Ultimately, Apacs will give team members visibility to parts across the enterprise in one place.

This will save time and make it easier and faster to access all the parts that AAP has, regardless of whether it was sourced from Advanced, Carquest or Worldpac. We expect these actions to be completed and in place by Q4. Another professional initiative currently in test is Worldquest.

Worldquest is a standalone professional-only model, which leverages our current technology to source parts across Advanced, Carquest and Worldpac. Worldquest provides an enterprise-wide portfolio of OEM and replacement products for professional customers under one roof with one stop ordering and delivery.

This takes some of the best elements of Worldpac and Advanced, and combines them with the full enterprise catalog to provide the best of the best solution for professional customers.

We’ve been piloting this new model for a few months and its driving significant growth and capturing market share by acquiring new customers and selling more parts to the customers we have. We’re very excited about AT, Advanced Pro, Apacs and Worldquest, and expect these initiatives will improve first call status.

As you can tell, Bob Cushing is leveraging the same industry leading tools he built at Worldpac, and he is raising the bar on execution across the entire AAP professional organizational. Shifting to DIY omnichannel.

We’re building new capabilities to integrate physical and digital assets to ensure a seamless omnichannel experience across all customer touch-points. We're refocused on our customer and we want to satisfy customer needs and desires for parts and service in the manner that is most desirable for DIY customers.

We’ve charged Mike Broderick who has both the 25 years in the parts business to do with DIY what Bob is doing with professional; completely leverage all of AAP’s assets across the enterprise to accelerate DIY growth. We’re offering DIY-ers a choice in how they shop, while ensuring a consistent experience every time, both in-store and online.

To enable a dramatically improved customer experience, we're investing in technology, and it’s working. Our growth B2C online significantly accelerated in Q2 almost immediately after we put more focus behind it.

Mike is working closely with our new SVP marketing, Yogi Jasnani, to drive full integration of our digital and physical assets to deliver an omnichannel experience that is compelling and consistent.

We want our customers to get the best of online, while enjoying the convenience and satisfaction of our knowledge and store base for pick-up, exchange or delivery. This includes leveraging our Speed Perks loyalty program with millions of Speed Perks members; we already have an identifiable audience who we can engage and improve loyalty.

We're also very excited about the launch of our enhanced Web site later this month. We've made significant improvements to our new Web site. We expect a much faster and more frictionless experience to drive Web site traffic, conversion and of course sales.

We’ll be relentless in improving the DIY omnichannel customer experience in our stores, on desktop and on mobile devices, including an exciting launch of our app in the second half of the year.

I thought a lot about the tools we're implementing to better serve our customers, but let me spend a few moments addressing our actions with frontline team members in our stores. Our stores operate as a DIY store fronts for the DIY omnichannel experience, as well as delivering notes for professional.

Without question, our stores and frontline team members are incredibly important for our business. The investments we've made in our team members behind fuel the frontline have enable us to both narrow the competitive growth gap over the past year and dramatically reduced customer facing employee turnover.

As proof, our turnover was down between 15% and 30% on key customer facing positions in Q2 depending on the role. At the same time, our work force is responding with improved execution against KPIs, which is a critical element to drive performance.

We're now focusing our team members on a narrower set of metrics, and making progress on the consistency of the in-store experience for our customers. Finally, our entire leadership team is really excited about a significant body of work; transforming our supply chain from end-to-end.

We're planning to integrate our supply chain across the enterprise, which will enable a step change in parts availability, customer service and order to delivery time. At end state, we expect to have a multilevel supply chain that optimizes the role of every node and every square foot of our network based on customer needs.

The future network will improve professional customer availability, better support our DIY strategy and enable more ecommerce delivery options. We expect to optimize our physical footprint by market to create fulfillment and replenishment nodes to best serve the customer and meet the Company's market presence goals by DMA.

While the end-to-end supply chain work will drive availability and growth, we also expect end-to-end to significantly reduce cost and inventory as we better leverage AAP's assets.

This will include a comprehensive optimization exercise that evaluates roof tops, fleet, last mile delivery, transportation, product returned, replenishment, inventory positioning and many other costs and effectiveness variables in ways we have simply not looked at them before.

End-to-end supply chain is expected to leverage all the assets of all AAP banners. Now, let's talk productivity more broadly. As a reminder, our productivity agenda is comprised of three big buckets; material costs, supply chain and ZBB.

On material costs, we've conducted a comprehensive category reviews on approximately 40% of our core product categories in 2017. This involves full product teardowns and developing a category strategy. While material cost negotiations are not new to AAP, our approach is very different than in the past.

These discussions are fact based and include rigorous market research and an elevated focus on building strategic partnerships. In supply chain, we've previously discussed the benefits from leveraging scale as we consolidated our last mile delivery fleet under one provider. These benefits will begin to be realized in the back half.

We're also leveraging scale with the transportation center of excellence to manage transportation across AAP banners. Here, we're finding significant opportunities to better leverage existing routes, reduce miles and optimize assets, while providing improved service.

We're also implementing new technology to dynamically route demand, dispatch drivers and optimize service, while improving asset utilization. On ZBB, we're embracing frugality as a fundamental cultural shift that will remove unnecessary costs from our P&L. As an example, we announced the field and corporate restructuring in late June.

This changes how work gets done throughout the Company. As part of this initiative, we used customer insights and market analytics to restructure our field organization from 34 to 12 regions. We streamlined our professional sales team and aligned them with store operations. We optimize multiple and disparate call centers to become more efficient.

We’re deploying new technology to drive efficiency. In summary, we continue to look for ways to simplify our business by integrating functions across banners and streamlining core business processes, while we build new capabilities. A second example of ZBB is price match override.

This is an opportunity to improve pricing discipline in our stores on professional. Here we’ve taken a much more analytical approach to price match override. We’re focused on improving gross margin rates by providing new analytical tools to assist our team members in optimizing price matching activity.

Of course, none of this can happen without world class leadership and talent. And we’ve assembled a leadership team that has a combination of deep experience and knowledge in the parts business with leaders who bring significant new capabilities from outside our industry.

We believe these are critical for future growth; new capabilities, like insights in analytics, a transformational approach to supply chain, consumer marketing, online retail and importantly, technology.

Both our growth and productivity initiatives require execution and the world class leadership team we’ve assembled, along with thousands of dedicated team members and independent operators in the AAP family, bring a high level of intensity to the execution of our transformation plan.

To drive our growth and productivity work, we first needed to invest in talent, which temporarily increased overhead before we could remove other cost. It is this talent that now needs to drive the savings we’ve developed from our productivity agenda. A few of these leaders have joined me on the call today.

In addition to proven industry leaders, like Bob Cushing who is building upon the success in Worldpac and expanding its mandate across all professional, we’ve added new individuals, like Mike Broderick and Leslie Keating.

Mike brings significant industry experience as our chief merchant; and has recently assumed responsibility for store operations which includes all the staff related functions, which enable our field teams to succeed.

In this role, Mike will spearhead our efforts in driving down acquisition cost, improve gross margin and accelerate productivity in store operations. Ahead of supply chain strategy and transformation, Leslie is leading the end-to-end supply chain transformation work described earlier.

She has an outstanding track record in delighting the customer and delivering continuous improvement in productivity. And in a moment, I'll turn the call over to Tom Okray, who brings terrific industry experience in automotive and online retail.

Tom has been instrumental in dramatically upgrading his team, and is relentlessly focused on driving growth and margin expansion. These are just a few of the world class leaders committed to executing a bold and exciting transformation plan for AAP. In summary, we’re in quarter three of a five year transformation plan.

Our unwavering focus on the customer and the investments we’re making to improve the customer experience is driving real improvement and narrowing the historical performance gap versus the industry.

In addition, during the back half of 2017, we begin to execute the productivity agenda we’ve constructed to drive long-term growth, margin expansion and free cash flow improvement. The opportunity ahead for AAP is truly unique within our space, and could not be more exciting. With that, I'll pass it over to Tom Okray..

Thanks, Tom and good morning, everyone. In Q2, we delivered $2.26 billion in net sales, a 0.3% increase versus prior year. This growth was lead primarily by professional, which has been our initial focus during the transformation. Gross profit margin came in at 43.9%, 91 bps lower versus the prior year.

Of which 26 bps was related to the non-cash impact of the inventory reduction. Exuding the non-cash impact of the year-over-year inventory reduction, the Company's gross profit margin decreased 65 basis points.

We are calling out this non-cash inventory headwind as we believe it is important for the shareholder to understand that our decision to lower inventory is a good cash flow decision, and we're not going to let the non-cash hit earnings inhabit what is clearly a good business decision.

With respect to inventory, in Q1 and Q2, we delivered two consecutive quarters of reduction on a year-over-year basis. This is the first time the Company achieved this since 2009. Further, the inventory reduction in Q2 of roughly $120 million was the largest quarterly inventory reduction that we've had since at least 2005.

It is important to note that we achieved the Q2 inventory reduction while growing sales. Our intent is to continue to reduce inventory going forward to set the Company up for strong free cash flow in the future. While absolutely the right thing to do, these actions will continue to be a non-cash P&L headwind.

Keep in mind these inventory related headwinds are non-cash. Let me explain further. To reiterate Tom's previous comments, the Company has purchased inventory at higher cost in the past, which are reflected in the balance sheet on a LIFO basis.

In addition, under accounting rules, certain supply chain costs associated with inventory have been capitalized. As the Company reduced the inventory, these costs move from the balance sheet and generated a non-cash negative impact to gross margin.

As we continue to reduce inventory, it will improve cash flow, but there will continue to be a non-cash negative impact to gross margin.

The remaining 65 bps was driven by approximately 35 bps related to an increase in supply chain cost, 50 bps from unfavorable mix and commodity headwinds offset by approximately 25 bps of favorable material cost performance. Adjusted SG&A came in at 35.2% of revenue, a 123 bp increase versus prior year.

The increase was primarily driven by roughly 93 bps related to investing in the customer and growing AAP talent. More specifically, customer service hours along with investments in talent through fuel the frontline and a new leadership talent we've attracted to AAP.

In addition, we had increased employee related cost for medical and insurance that contributed 30 bps. As we have previously mentioned, in Q2, we are lapping significant cuts from prior management. This was a major driver of our adjusted SG&A increase year-over-year. This lap will continue into Q3.

Going forward, as a part of our productivity initiatives, we will optimize these investments while being thoughtful to not impact the customer. While we acknowledge that our adjusted SG&A costs are up, we needed to reinvest in the customer, stabilize our frontline and grow our talent base.

This investment and leadership talent will not only drive and execute the productivity initiatives but also change the culture of AAP. Consequently, costs went up before they are going to go down. We will continue to aggressively drive productivity in the second half of this fiscal year.

It should be noted that in fiscal year '17, the majority of the productivity will be reflected in improvement in gross margin versus adjusted SG&A.

Having said that, adjusted SG&A will decline in absolute dollars as we go through the remainder of the year; more specifically, we expect to end Q4 at least $25 million lower than Q2; of course, the adjusted SG&A margin impact will be dependent on our growth rate.

As noted previously, gross margins will face a non-cash P&L headwind from our inventory reduction initiative. In summary, our Q2 adjusted operating income came in at $195.5 million with adjusted operating margins down 214 basis points over the same period last year to 8.6%.

Excluding the non-cash impact of the inventory reduction, the adjusted operating income would have been $207.3 million or 9.2% margin, a decline of a 188 basis points on a year-over-year basis. Turning to cash flow. Our free cash flow more than doubled through Q2 versus prior year, and operating cash flow was up 28% through Q2 versus prior year.

The details of our revised 2017 guidance are reflected in our press release from this morning, but let me provide some additional color on key elements.

Given the half of the year is behind us and considering both current industry sales environment, as well as the ramp time of actions we are taking to flow through to the P&L, we believe it is not prudent to revise our 2017 guidance.

Considering our first half comp performance, as well as the outlook we have for overall industry growth in the back half, we have revised our full year comp expectations to now be between down 3% and down 1%. Turning to operating profit.

We have revised our adjusted OI margin expectations to be between 200 bps and 300 bps decrease versus prior year; the primary driver of the change is the leverage of fixed costs associated with the lower comp expectation; also contributing to the change is a 75 bps headwind related to non-cash expenses from reducing our inventory significantly more than we planned at the beginning of the year.

Excluding the impact of the non-cash expenses from the inventory reduction, the adjusted operating income margin expectation would be 125 bps to 225 bps decrease versus prior year. Finally, on free cash flow. We now we to deliver a minimum of $300 million in free cash flow in fiscal year 2017.

The change versus our prior $400 million free cash flow forecast is primarily driven by the change in our net income expectations, partially offset by the benefits from our increased inventory reduction effort. While below our initial guidance, the $300 million in free cash flow is a significant improvement from prior year performance.

With that, let's open it up to questions.

Operator?.

Thank you. We will now be conducting a question-and-answer session [Operator Instructions]. Our first question is from Simeon Gutman of Morgan Stanley. Please go ahead..

Tom, you mentioned when in the last couple of quarters that you don’t expect the turnaround to be linear. And I don’t think the market expected that either. And there’s arguably a lot of room here for improvement for top line and margin.

But based on the original guide, it seems like the organization may have been unfamiliar with some of the investments that needed to turn the business around.

How do we get confidence now that management understands the magnitude and depth of investments required?.

First of all, I think the big thing that the guide reflects is adapting to the environment that we’re competing in right now. When we entered the year, as you recall, we finished the year strong. We had basically a three comp in the fourth quarter that the industry was performing at a different level than we’ve seen in the front half of the year.

And as we outlined in our prepared remarks, the front half of the year has been softer for the whole industry. And I think you’ve seen that reflected in the earnings reports, from people in our industry, from the NPD data, and for all the reasons that we indicated in our prepared remarks.

We feel that we have to adapt this current environment in the back half of the year. That said, going forward, this is a healthy industry and we’re very confident in the outlook for the industry overall based on the car park and all the variables that are associated with that.

So I think the guide is more a reflection of the current environment, and we saw real opportunity to pull forward some of the key initiatives that we actually had in our strategic plan earlier in the year.

And most notably was the -- for the inventory reduction effort, which we’re very pleased that we were able to take that on and take the inventory down well, still registering a narrowing of the comp sales gap versus our competition.

We’re very happy with the fact that we’re able to take the inventory down and drive sales performance in that same environment..

So I guess as a follow up to that, is that implying that internally that, I guess the progression of the business is similar to how you thought about it? Or are there things that require greater investment than you initially laid-out? And then just thinking as a second part to that, thinking about timing of improvement, it sounds like now for this year its maybe fourth quarter.

But should there be improvement in 2018? Should the business begin to bounce back, or is it -- does it get it pushed out further even to 2019?.

Back to the first part of your question, I mean we entered the year thinking that the industry will perform at historical 3% to 4% growth rate. And as per NPD data or anything else we see, we’re not at that rate. So that was really the big driver there. And so that’s why we’ve had to rethink the environment.

Going forward, we certainly expect the significant improvement in '18 over '17..

[Operator Instructions] And with that our next question is from Seth Sigman with Credit Suisse. Please go ahead. .

A couple of follow up questions, I guess first against the weaker industry backdrop as you highlighted Tom. As you make improvements to availability in service, what are you doing to drive awareness in that type of environment? And specifically on price, if we do assume that industry growth remains constrained here in the near-term.

Do you feel like you need to change your pricing strategy sharp enough potentially to drive more awareness of some of those improvements that you’re making?.

Well, first of all, on availability, Seth. We’re really focused on executing against the fundamental customer promise that we have, and that starts with the right part in the right place. So that’s what the availability transformation is all about.

And taking our advantage brand portfolio, our assortment management tools and really leveraging those to make sure we have the right part in the right place. Of course, we’ve got to have it at the right time as well. So we're working really hard on improving our order to delivery time to our customers.

We're in the process to installing telematics in all of our vehicles and that enables us the link, the order time through, whether it's over the phone or through one of our catalog platforms to the order to delivery time and make sure that we're measuring that and continuously improving there.

The third leg of the stool is the value proposition itself, and that’s about having well trained knowledgeable professionals, making sure that we're looking at pricing, but pricing is really the third most important variable to our professional customers, based on all of the work we've done. We’ve got to make sure we’ve got the availability right.

We’ve got to make sure we get it to them as quickly as possible. And yes, we’ve got to be competitive on price. But we're very-very focused on making sure we’ve got the right part in the right place, and getting it to the customers at the right time..

In terms of the higher investments here; so the integration and transformation expenses of $100 million to $150 million, which I think is up from $30 million to $35 million.

Could you walk us through the buckets that are incremental to be original plan? And what is gross margin versus SG&A?.

Well, first of all, there is three big things that are in those expense lines; the first is obviously the restructuring that we did, which is the big undertaking that we had in the second quarter.

And I'm really pleased that we're able to make that change in our entire field organization and we've actually kept on the momentum of the business as we exited the quarter. So we made a really big change. There was a restructuring charge that’s embedded in there, that’s the first thing.

The second thing is we did engage an outside firm to help us in the transformation effort itself. We really didn’t have all of the capabilities we needed in-house, so we have to engage an outside firm to get us kick-started on the transformation effort.

And the third is we actually sold our corporate aircraft, or in the process of selling our corporate aircraft. So those are the three things that are in that bucket..

Thank you. Our next question is from Scot Ciccarelli of RBC Capital Markets. Please go ahead..

Tom, I was hoping you could help us understand, how much -- specifically how much of OI change is due to the comp change versus incremental investments. I guess, this a bit of a follow-up on Simeon’s question.

But just trying to understand what's the deleverage impact versus what's things are costing more than anticipated?.

Let me take that one. First of all, I'd like to talk about how excited we are about our productivity agenda. And as we talked about in Q1, most of this would hit in the back half of the year. I mean, specifically, 80% of our productivity plan is coming in the back half of the year and the majority of that is coming in Q4. So that is really on track.

Let me give you a specific example. If you're talking about material cost performance, we said in our prepared remarks, we've been for 40% of our categories, and so not even half. And of those 40% with the negotiations that are ongoing, those are going to hit primarily in the back half of the year. Obviously, we're going to continue to ramp up as well.

And that's consistent with the other areas of the P&L as well, whether it's the restructuring activities, or the supply chain work that we're doing. So the majority of the OI drag coming to your question is related to the top-line, the deleverage..

Thank you. Our next question is from Mike Baker of Deutsche Bank. Please go ahead..

Couple of follow-ups; one, I'd like to talk about the $750 million in cost savings you talked about last quarter. And I think at the time you'd said its non-sales dependent. So we haven't seen you’re investing. But any insight into the confidence in that number and when we start to see that show up in the operating margin.

And then I guess the second follow-up, you just said that you expect the productivity to really hit in the fourth quarter.

Can you help on the margin differential in the third quarter versus the fourth quarter in terms of the year-over-year decline that we should expect?.

Well, first of all, I couldn't be more excited and more confident about the $750 million over four years. I'll just reiterate what we said on the previous quarter's call. I mean with bringing in the leadership team, we're finding more-and-more each day.

Having said that, we are going to continue to invest in the things that are important; the customer for sure; building out the leadership team below Tom's direct team.

As it relates to the back half of the year, we expect that we will have Q4 margins be above prior year's margins, excluding the inventory -- the non-cash inventory reduction that we see. With respect to breaking out Q3 and Q4, I'm not going to go into that at this time..

Thank you. The next question is from Matt Fassler of Goldman Sachs. Please go ahead..

I'm trying to understand the trajectory of investment versus harvesting. This is a business that I think you all believe for a long time has a margin target well above historical levels. And that will come under higher sales or lower expenses.

It seems like the costs arising at a rate that would outpace even a solid sales gain in terms of the trajectory of the margin.

So at what point do you think you net out to the -- at least the influx to the cost structure and consequently to margins starting to stable margin expansion, and then obviously the sales will be what they will be?.

Let me come back to the $750 million. I mean we’re -- fact that that a big number, obviously. We are on track to achieve it, as Tom said. We know exactly when we’re going to get the $750 million. We know the growth. We know the net and we know how we’re investing back. We’re not communicating details on how that’s going to unfold at this time.

Obviously, we’re going to continue to hone that and at the appropriate time, we’ll let you know exactly how that’s going to unfold..

Thank you. Our next question is from Michael Lasser of UBS. Please go ahead..

It seems like the rest of this year is going to be one of transition for your P&L. So can you help frame what's probable for next year, especially in light of the multiyear cost savings that you’ve previously laid out.

So as we think about next year, you no longer are going to see the drag or potentially no longer going to see the drag from inventory reduction activities. And then can we layer on $150 million or so the pro rata $750 million savings program.

I mean that you could realistically see 150 to 200 basis points of margin expansion next year, even if your sales remained flattish or slightly positive.

And what could stand in the way of that expectation, what would drive down side to that?.

First of all, I would like to talk a little bit about the inventory. I mean we’re extremely pleased with what we were able to do this quarter. We took inventory down as we said in prepared remarks by about $120 million.

That’s the largest quarterly inventory reduction that the Company has seen since 2005, and the first time since 2009, that we put together back-to-back quarters on a year-over-year basis where we’ve had a reduction. Simply put, we are going to continue this aggressive inventory reduction.

As we said in the prepared remarks, it's just simply the right thing to do to set the Company up to be able to generate cash.

We are prepared to take the non-cash hit to earnings free cash flow; for the 28 weeks ending in Q2 is up 104%; net cash from operating activities up 28%; our cash and cash equivalent balances at $257 million is a 145% higher than Q2 of the prior year. So we’re going to continue on the inventory reduction. It's the right thing to do for the business.

We will have guardrails up to make sure we don’t impact sales, just like we did this quarter. So to get -- answer your question is, will that continue into '18, absolutely. We’re not going to give guidance or comment on '18 right now, but that will continue to be an initiative we pursue in '18..

Thank you. The next question is from Christopher Horvers with J. P. Morgan. Please go ahead..

So a couple of detail questions. Can you share your thoughts on comp cadence in the back half? Should we look at the stacks as 3Q maybe down low singles and 4Q down mid singles, so we net down to that minus 3, which appears to be which you’re implying at the midpoint.

And then can you remind us of what the non-cash impact was in the first quarter, so we can back into what you’re embedding in the back half for that gross margin pressure. And finally, you mentioned the guide partly reflects the current sales environment, so presumably that slower.

What gives you the confidence that this presumed slowdown is not related to some of the field changes that you've made. Can you point to market share, recent market share trends, what do you think the industry growing and so forth? Thank you..

There is a lot there, Chris. So I’ll take the sales question and I’ll flip the non-cash question over to Tom. We're not going to comment on the cadence between Q3 and Q4. We’ve step back on the overall outlook for the industry, and set our best estimate as we sit here today on what we think the industry is growing to grow.

We feel great about our sales momentum. We're competing now. We're earning new business. We use to be a share donor consistently every time we reported earnings releases. We’re now starting to win business. Bob Cushing is doing a terrific job rallying our professional sales team together. On the industry front, we know there is ups and downs.

I mean, we’ve looked at this over many years and it's really difficult to predict any given year what it's going to look like. But if you look over time, this is a 3.5% growth industry and that’s what we expect, going forward.

We're pleased that we're narrowing the competitive gap, and we did narrow the competitive gap in the second quarter and we did narrow it after we made those field changes. So we're not -- we don’t feel like the changes that we made are impacting our performance.

And we're going to continue to give our field team the tool they need to win, and that’s essentially the idea. We made the changes while we were introducing new tools, new technology to our field team. And to that end, we feel both the efficiency and the effectiveness of our sales organization has been improved versus where it was.

I’ll put the non-cash over to Tom..

With respect to the Q1 question on the non-cash inventory related, it was 49 bps unfavorable..

Thank you. The next question is from Seth Basham of Wedbush Securities. Please go ahead..

My question is around leverage. You guys are at 2.9 times adjusted debt EBITDA and then in second quarter you guys implied that you’ll probably be little bit weaker in that going forward.

Do you expect that you’ll maintain your investment grade credit rating?.

We do. We've had discussions with both Moody’s and S&P, and have taken them through our plan and we're comfortable with that. We're committed to get back to the 2.5 leverage ratio that we have talked about previously. In the current environment, it will be under pressure for the short-term.

But we're comfortable and committed to get back to that, and we anticipate that the rating agencies will see that favorably..

Thank you. Our next question is from Bret Jordan of Jefferies. Please go ahead..

On the second quarter, could you talk about regional performance dispersion and maybe what you think the market grew in those regions.

Do you think you close the performance gap, but still lost some share in the second quarter?.

Well, first of all, we feel very, very positive about the changes up your way, Bret. The north part of the country performed much better. If you remember, last year, we really struggled up there, if we look across our new regions. And let me just say, we went from 34 to 12 regions. These 12 regions that we have now are huge jobs.

We've got great leadership in these jobs. We've made the changes, not just from a productivity standpoint. We think the effectiveness of these new regions is going to be much stronger.

In the old world, I’ll just take Florida as next example; we would have had four people essentially leading our business in Florida; it was very difficult to compete with local competitors when you have four people that want to do different things; you got entrenched competitors down there that major in categories like AC; now we can go into Florida with a very aggressive plan and have a very nuanced approach to competing down there.

But in the quarter, I mean, if I look across the new 12 regions that we have, the Northeast, obviously, improved nicely versus where it has been in Q1; the Great Lakes, the Central, which for us gives in that Ohio area; and then Mid Atlantic. So those were the big winners in the quarter.

And I really feel that that group rallied around the change; they also rallied around the distribution centers that we have up in that area, which made some significant improvement in fill rates and all of the key metrics that we look at. So that's a bit of a snapshot..

Thank you. The next question is from Steve Forbes of Guggenheim Securities. Please go ahead..

I wanted to focus on the regional work structure, changes that you highlighted. So I know you just commented on it. But can you expand on how these changes have impacted the store ops or structure? And I guess, how confident are you that you have the correct level of regional oversight now under a leaner structure, given the importance of the touches.

So as we try to digest what it means for operations throughout the business, I mean how often -- what have been the average number of stores that our VP is going to oversee now, and what is the expectation for the line of sight as you think about the evolution here in digesting these changes internally?.

Well, first of all, we spent a lot of time making sure that this structure was going to make sense long term for the Company and enable us to really get at some of the opportunities that we have in some of these local geographies.

Again, we just didn't have the perspective to bring back share to Raleigh, to get at some of the local opportunities and compete at the highest level in these geographies. So starting with the top, these new 12 regions that we have are much -- they're bigger jobs.

Yes, they have more stores but we have put an infrastructure underneath them that enables them to run the business effectively. So we're not concerned about that. And the overall change in trajectory that we've seen since we made the structural change we haven't seen a big change in the performance in the Company. So we manage the change very well..

Thank you. Our next question is from Brian Nagel of Oppenheimer. Please go ahead..

This is David Bellinger on for Brian. So you mentioned there the comps for the quarter essentially flat on an easier comparison here.

Can you give us some more detail, by category? And within that, are there any specific trends that you see that are indicative of really standout from the weakness in the car park, or is that more of just a broad based slowdown?.

First of all, we did see a nice uptick in some big categories in the second quarter; batteries, oil, brakes were the most notable ones, softness in cooling, okay, which we saw in the second quarter and honestly we’re continuing to see in the third quarter as we called out in our prepared remarks. Those are the big most notable category performers..

Thank you. Our next question is from Dan Wewer of Raymond James. Please go ahead..

Tom, I want to follow-up on the leverage issue. So when you’re speaking with Moody’s and S&P, you discussed with outlook that the adjusted debt EBITDA rate approximate 3 turns for the next two or four quarters. And are you saying that they -- so that’s okay, the investment grade rating is not in jeopardy.

Did I understand that answer correctly?.

We’re in discussions with S&P and Moody’s on an ongoing basis. They are very happy with the cash that we’re generating; we’re generating a significant amount of cash versus previous year. We’re very upfront about where we see our leverage ratio going. And I don’t want to comment for them.

But to-date, we have had very positive reception from both S&P and Moody’s..

Thank you. Our next question is from Carolina Jolly of Gabelli and Company. Please go ahead..

Mine’s just pretty simple, when I look long term and I understand that there are a lot of practices into getting there.

I'm just trying to understand the difference between your take you to inventory or ratio and your competitors, and what kind of -- how do you get to that ratio of 80% that goes from 90 to 100 [indiscernible] your competitors are currently producing?.

The first thing we do is optimize and drawdown our inventory. We’ve said that we’ve got far too much inventory. It's something that we’ve been talking about since we first put out the strategic business plan; we put rigorous activities in place; we need twice a month in a cash council talking about not only inventory but also [APNAR].

You have to understand that as we’re starting this inventory drawdown that it's driven by curtailing buying. And so, therefore, it's going to take some time for the accounts payable to catch up with that. So the AP ratio will be a lagging measurement, but it will kick-in, I would say around the end of fiscal year '18.

And then we’ll be on a trajectory, both from a cash perspective and in AP ratio perspective, to be very competitive with our peers..

Our next question is from Matt Mcclintock with Barclays. Please go ahead..

First, just a clarification question; Apacs, did I hear right that you said that you would have visibility across the enterprise for parts by Q4? Or is that expected to be much later than Q4?.

Right now, we rolled that catalog Apacs in over 3,200 stores, and also advantaged from, which is powered by Apacs. So just rolled down nationwide, it was over thousand customers on it.

So importantly, we will be piloting out a full course banner sourcing capability within those platforms, and those platforms were necessary with that architect who’ll be able to do that.

So it’s a two quarter event and the team is extremely excited about it, and we certainly have seen it already with what we did with Worldquest on what the results were and how customers view that. So I think overall Q4 is the plan, and we accept that to happen for sure..

And Matt I’ll just add to what Bob just said. I mean we're so excited about this rollout. I mean you think about, currently, our team members are looking up parts on multiple, in multiple places throughout the catalog that we have. And this enables them to have essentially a one stop shop for parts across the enterprise.

We’ve got a terrific portfolio of parts across AAP, and that’s the idea with Apacs is to simplify the job for our people, make it easier for them to find parts and that way we can serve our customers better than ever..

Thank you. Our next question is from Ben Bienvenu of Stephens. Please go ahead..

This is Daniel Imbro for Ben, thanks for taking my questions. When you think about the critical factors for driving sustainably positive comps long-term, I would think that includes better suit of service, higher parts scalability.

What percentage of your stores posses those characteristic today? And then those that don’t, what’s your assessment of how far these stores are from having performance metrics that meet your targets? Thanks..

You broke up a little bit there.

Can you repeat the question?.

So thinking about driving positive comps longer terms.

What percentage of your stores posses those necessary characteristics today? And then those that don’t, what is your assessment of like how far those stores are from having those performance metrics meet your target?.

First of all, we've narrowed the performance metrics pretty significantly for the stores themselves. You are always going to have a distribution when you’ve got thousands of stores, you’ve got some stores that are at the top that are performing at extremely high level and you’ve got stores at the bottom.

In our case, we have a very unique position in the industry; relative to others that are competing that have got very strong executional capabilities that they’ve had for many years. We're building out those capabilities overall. So we're trying to pick-up the whole bell curve and move it to the right.

And that means better availability inside our entire network, that means fast order to delivery time, and that means improved training capability of the professionals in those stores. So I think our agenda here is to improve the entire enterprise. We obviously manage the lower performing stores on a weekly basis.

I get a look at every single -- one of our key metrics, by store, by district, by region, every Monday we go through it in our operating committee meeting. So we’ll manage the performance.

But the agenda we have to do, what you said which is to sustainably drive comp improvement, is one of essentially taking the entire customer value proposition we have and improving it overall..

Thank you. The next question is from Chris Bottiglieri of Wolfe Research. Please go ahead..

Can you segment the inventory non-cash charges like what -- maybe write-downs on new agreements, LIFO headwinds and then lastly capitalize supply chain costs. I know you had some issues last year the previous [indiscernible] taking inventory up, and then maybe across that makes changes in back half of 2018..

Chris, it's no write-downs. It’s the other two that you mentioned. It's quite simply the capitalizing the supply chain costs, taking those capitalized cost and moving them from the balance sheet to the income statement, as well as the treatment related to the LIFO debit that we've got on our balance sheet in the declining cost environment.

It's those two that make up the difference..

Is there a point where you get through that, or is it just that you continue to take that inventory just going to be a perpetual headwind until inventory grows again?.

No, that's correct. We've got a rather large LIFO debit on our balance sheet and in a declining material cost environment as we draw down inventory that will be a headwind to P&L. I mean it's important to note that as inventory is growing, it was a tailwind to P&L. For seven years, the Company was growing inventory much greater than sales.

And if I go back to the question they had in Q1, there was a 22 bp benefit in Q1 of the prior year related to the increase in inventory. So yes, it's going to be a headwind as we continue to draw down inventory; but again, it's non-cash, it's the right thing to do.

Once we get to an optimized level and churn starts kicking in, we get our payables in order. You will see a dramatic improvement in both cash flow and supply chain performance that it'll enable..

Thank you. We have no further questions at this time. I would like to turn the conference back over to management for closing remarks..

So as you heard today, we've got a lot of detailed work going on and we look forward to continue to update you on our progress, moving forward. We knew this wasn't going to turn around overnight, we knew that from the very beginning. And at the same time, we're moving rapidly to set the business up to compete at the highest level for the long term.

We now have an outstanding leadership team in place that can do the job. So we'd like to conclude our call by thanking all the team members and independent operators across the AAP family for their efforts to better serve customers this quarter. And thanks for joining us today..

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation..