Welcome to the Advanced Auto Parts Second Quarter 2015 Conference Call. Your lines have been placed on listen only until the question and answer session of today's call. This conference is being recorded. If you have any objections, you may disconnect at this time. Before we begin, Zaheed Mawani, Vice President 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. 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 and are subject to risks, uncertainties and assumptions that may cause our results to differ materially. Our comments today will also include certain non GAAP measures, including certain financial measures reported on a comparable basis to exclude impacts of costs in connection with the integration of General Parts International. 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, Sahid. Good morning, everyone.
Welcome to our Q2 conference call. Joining me on the call today is our President, George Sherman, who will update you on our business operations, including our integration activities and Mike Norona, our Chief Financial Officer, who will update you on our financial performance. We are 18 months into our integration and our confidence in the growth, earnings and service potential of this combination remains very strong. The 2015 enterprise priorities continue to be improving our base business execution and successfully delivering the year 2 integration objectives. Through the first half of this year, we have been focused on aligning our teams, processes, systems and capabilities to a common foundation.
Overall, the base business execution and the integration remain on track and our results for the quarter were in line with expectations. In the quarter, our sales grew 1% to $2,370,000,000 The comparable sales were up 1% led by commercial with our DIY business sequentially improving. Earnings per share on a comparable basis grew 9.1% in the quarter on top of last year's 30% growth. Industry fundamentals continue to remain positive, including vehicles in operation, gas prices, miles driven and a steadily improving economy. Regionally, the results are not equally distributed across the country.
We saw solid performance in Canada, the Northeast, the Southeast, including the Florida market. Conversely, our upper Midwest markets underperformed in the quarter, principally driven by weather, while our Puerto Rico market experienced softness as a result of the economic uncertainty. Also, our sales growth from our import focused branches of Worldpac and AutoPart International continued to deliver strong total results. We continue to work through the 5 key integration priorities outlined on our previous calls. George will provide more details and a status update shortly.
Overall, I am pleased with the progress we made during the quarter with the integration activities. As expected, the integration work continues to have a more concentrated temporary impact on our core commercial business. We are better balancing the extra demands resulting in a better Q2 performance. In the second quarter, our core AAP commercial business sequentially improved. However, our Carquest commercial
our Carquest commercial sales continued to
see some softness. The volume of integration work will subside and we expect our commercial business will in time return to delivering comps consistently at the high end or above the high end of the market. Our DIY business improved sequentially approaching flat for the quarter as the teams continue to execute our DIY initiatives. In addition to the current demands of the business, we experienced a fire in our Roanoke support center this quarter. I want to recognize the teams for quickly reestablishing operations to ensure we did not experience any material downtime.
Overall, our 2nd quarter results were in line with our tempered expectations as we anticipated some carryover of the Q1 integration activities into this quarter. That said, the business improved steadily as our teams took additional steps towards settling into our sales and operating routines. Looking at the back half, we expect incremental progression in our business and we'll continue to meter our efforts to ensure our organization stays focused on serving our customers and delivering on our outcomes. The key outcomes we measure success by are sales, service and profit. We continue to be aggressively focused on accelerating all three of these.
On our last call, we outlined our target to deliver comparable operating profit of 12% by the end of 2017. Now being well into a multiyear integration, we have learned a lot. The biggest takeaway is the need to eliminate or simplify our work and deliver what matters most to our customers. With this focus, we see an opportunity to achieve 12% faster and have challenged ourselves now to get there by the end of 2016. This is not about adding new things, but rather pulling forward elements of the plan that were earmarked for 2017.
While achieving 12% is not a final destination or full potential of our business, it is the next milestone. I am confident our organization will deliver on this goal. George and Mike will also provide more specifics and discuss our key initiatives during their remarks. I want to finish by sincerely thanking our team members for their remarkable commitment and 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?
Thanks, Darren, and good morning, everyone. First, I'd like to echo Darren's comments and thank all our team members for their contribution to customer service in the quarter and putting their focus and energy into meeting our customer commitments. With my prepared remarks this morning, I'll provide commentary on our 2nd quarter base business performance together with a progress update on our integration priorities. Entering Q2, despite the heavier integration work, we experienced sequential improvement in the business as our team has started settling into normal business rhythms. While a comp of 1.3% in constant currency is not what we normally aspire to, it is progression we expected from Q1.
We are nearly 1 period into our Q3 and I'm encouraged by the continued progress in our business. Turning to our commercial business. As Dara mentioned, our core commercial business continues to face a larger proportion of integration related change, namely in people and products, but showed steady improvement versus Q1. There continue to be many encouraging signs including our Canadian comps growing double digits in constant currency, our strategic account growth and the continuing strong performance of our Texas market where we're utilizing key elements of our combined resources. With respect to our key customer segments, our TechNet customer marketing program membership has grown to a record level of 7,000 members, with overall sales growth continuing in the double digits year to date.
As the program has grown, it's become clear that TechNet could assist our customers not just with diagnostic support, but with training, marketing as well as a variety of programs to help them save money and grow their businesses. TechNet is also experiencing record program retention rates. These results were a great example of the commercial sales team recruiting solid new members that find value in the program's marketing, training, business management and other key components of the program. Turning to our DIY business, the SpeedPerks loyalty program continues to grow and we've now surpassed the 6,000,000 member mark, so about 60% of our 2015 member acquisition goal. We couldn't be more pleased with this outcome.
We're beginning to build critical mass and have now also successfully integrated Speed Perks into our online shopping experience that will allow us to leverage the online channel to drive more members and provide customers with an online earn and redeem capability. Speed purchase is central to our repositioning strategy to serve the heavy DIYer and the early results are encouraging. For example, from some of the data that we've analyzed from Q1, over 80% of identified customers joining our heavy DIYers. So over indexing with both the right kind of customers as well as the right kind of parts with hard parts showing particular strength. Turning to our integration, we've now completed our 2nd quarter of the heavier lifting aspects of the integration.
Our Q1 saw a high point of disruptions with a combination of a significant number of integration work streams. While we continue to expect some level of integration related disruption throughout the year, we saw a decline in the disruption in Q2 and expect it will continue to moderate each subsequent quarter. With that in mind, I'd like to share a status update with you across the 5 key focus areas. First, our support center consolidation is virtually complete. Our Minneapolis office is now closed and those team members moving to Raleigh have completed their moves.
Also the team member moves between Roanoke and Raleigh have also been substantially completed. 2nd, our field operations and sales teams are 6 months into their new roles or territories. While there are certainly still reasons of sales underperformance as teams continue to settle in, we are generally pleased with the progress given the magnitude of the integration change. The markets that experienced the most disruption are all improving in terms of sales strength. Additionally, the sales growth gap between customers that experienced a relationship change and those that did not continues to close.
3rd, turning to our store consolidation, conversion and relocation work. In the Q2, we successfully completed 68 store integration projects across 3 markets and those one is expected.
The back half of the
year is slated for 200 total projects among conversions, consolidations, closures and relocations. That's a slightly lower number than we indicated last quarter because we've shifted about 20 relocations into 20 16, which enables us to avoid touching the store twice. The program will continue to be executed by market and in Q3 we will complete 3 more markets. Execution in these markets is already underway and initial indications how the performance will be similar to what we've seen to date. The 4th priority is our product changeovers.
We continue to execute the product and pricing alignment work. The product relabel work is now largely complete. On the replacement front, we continue to replace product lines and expect to have this completed by late in Q4 or early in Q1 of 2016. Results from the product conversions continue to meet expectations as our customers tell us they are very happy with our lineup of brands. Inevitably, there are also some instances where we no longer carry certain brands, which a few customers have been loyal to for years.
And we are actively engaged in retaining those customers who are replacing their business. Our commercial price alignment work is effectively complete. As we discussed last quarter, the price alignment positions us properly in the market. And while the impact of price movement is immediate, the fact is it will just take some time to drive sales and unit velocity to make up for the impact where we decrease prices. All in, our product and price alignment work continues to be on track.
Our 5th key priority focuses on our systems and supply chain integration efforts. As mentioned previously, we are focused on migrating to a and we are on pace with our development efforts. We should be in pilot in Q1 of 2016 with a rollout to follow as we indicated last quarter. This is also an enabler to aligning our supply chain systems and we remain on track to begin the integration of the Carquest and advanced DC networks by the middle of next year. Turning now to our efforts to expand our daily delivery program.
At the end of the quarter, we had 7 77 Advanced Auto Parts stores being serviced daily, an increase of 77 over the Q1 and that moves us closer to our year end goal of 1,000 stores. I'm pleased with our overall progress on this front. Our focus on base business execution and successfully completing and leveraging the integration has our team focused on our next profitability goal of 12% comparable operating profit. As Dara mentioned, we are stepping up the target timeline from 2017 to 20 16. The acceleration is healthy because it requires action now to take things out of the business that are adding complexity and fragmenting the store team's focus.
Intensifying and simplifying base business execution has several components, but it starts with sales. And that means consistently delivering on our sales and service objectives. You've heard me talk about how we've been driving consistency into our sales execution and we've undertaken a range of initiatives as a significantly to significantly improve our sales culture. Moving from a corporate led company to a field focused organization, simplifying our operations for those things that matter most to our customers, empowering our field and store teams to make local decisions in service of the customer and moving the business from activity based to outcomes based. Our steady climb to improving sales, service and profits requires us to have a heightened focus on these activities, while clearing obstacles to allow our Field and Store teams to stay focused on the delivery of the outcomes.
We continue to take actions toward making our business more cost efficient and accelerating our transition to a field led organization. Servicing the customer is the number one deliverable for our field and we need to provide our stores with the ability to make that happen without additional workload and distractions. While well intended, our corporate support center is pitching faster than our stores can catch. Consequently, in order to drive greater organizational effectiveness and in turn enhance our field focus, we made the tough but necessary decisions to cut non essential work out of our corporate support center and have eliminated roles that were not considered core as we look to narrow the focus and reduce workload for our stores. This work will be largely completed in August.
Additionally, as part of our broader work to review our profitability across our store base, we are looking at those stores that are chronic underperformers and take up a disproportionate amount of our field leaders' time. It is not acceptable to have inefficient assets in the business that are consistently underperforming or unprofitable and candidly we'll have to make some difficult choices. While our assessments are still ongoing, we've made the initial decision to close a number of stores and Mike will provide further detail. We will be continuing with our assessments and examining performance across our store base and where necessary adjusting our footprint accordingly. Base business execution will in part be driven by supply chain capabilities.
A key driver of sales acceleration is inventory availability and having the right part at the right time. We are enabling that through the expansion of our daily delivery program. I provided you with an update earlier on how we are progressing on that front. As savings offset to our ongoing investment toward daily delivery expansion, I've challenged the team to lean into initiatives that will simplify our supply chain structure, but also improve the efficiency and take costs out of our overall supply chain capability. We have also fortified our supply chain senior leadership team over the past year and are confident in our ability to execute against these priorities.
Finally, in conjunction with our integration work, we are looking to narrow our IT priorities to the vital few that drive the largest impact on our base business results. We have a very experienced new CIO in place since December of 2014 and have invested the time to develop our future systems roadmap. These are long term components, but also key near term areas of focus and opportunities to drive greater efficiency from our IT program and enhance those core capabilities that our stores leverage to serve our customers. In closing, the first half of twenty fifteen has certainly introduced challenges to our business, some expected, some unforeseen as we work through the complex phases of the largest integration in our industry. Q2 was a step in the right direction as we focus on our base business, acceleration in our commercial business and improving our DIY performance.
We are focused on execution and driving the key initiatives to achieve our 12% comparable operating profit goal by 2016, which has galvanized the organization and amplified the conviction we have to realize the full potential of this company. I'd like to turn the call over to Mike Norona, our Chief Financial Officer.
Thanks, George. Good morning, everyone. I'd like to also start by thanking all of our talented team members for their commitment to serving our customers in our Q2. In my remarks today, I plan to review the financial highlights from our Q2, share some details on our progress toward our 12% comparable operating profit target and provide insights on the remainder of the year. Moving into our Q2 operating results, we delivered comparable cash EPS of $2.27 which included $0.03 of unfavorable impact from foreign currency.
This was a 9.1% increase from our Q2 of 2014 and in line with our overall expectations. Included in our comparable cash EPS was $14,100,000 in incremental synergy realization. On a GAAP basis, our 2nd quarter EPS was $2.03 which included $9,800,000 of intangible asset amortization associated with the acquisition of General Parts and $18,600,000 of one time integration expenses primarily related to the integration of General Parts. Turning to sales. Our 2nd quarter net sales increased 1% to $2,370,000,000 compared to our Q2 of 2014.
The sales growth was principally driven by the addition of new stores and a comparable sales same store sales increase of 1%, partially offset by changes in our independent store count. Our comparable store sales was led by our commercial business together with a sequential improvement in our DIY business in Q1, offset by a net 34 basis point impact from foreign currency. Our gross profit rate of 45.9% was up 64 basis points compared to Q2 of 2014. The gross profit rate improvement was primarily the result of lower product acquisition costs inclusive of the company's ongoing merchandise cost synergy savings. Our comparable SG and A rate was 33.8% in the quarter, which improved 22 basis points compared to the Q2 of 2014.
This year over year improvement was the result of lower insurance costs and lower administrative costs, driven by synergy savings and partially offset by expense deleverage as a result of low comparable store sales growth. All in, our 2nd quarter operating income dollars on a comparable basis increased 8.7% to $285,500,000 and our operating income rate increased 85 basis points over the same period last year to 12%. Our 2nd quarter comparable cash EPS was $2.27 up 9.1% on top of last year's 30% increase. Operating cash flow increased approximately 3.2 percent to $330,800,000 through the Q2 versus the same period last year. Free cash flow increased to $216,300,000 through the Q2 versus $214,300,000 during the same period last year.
Our AP ratio for the quarter of 77.1 percent was essentially flat versus 77.6% last year, driven by improved vendor terms offset by transitional inventory growth resulting from our product integration work and by our accelerated Worldpac growth. At the end of the Q2, we had approximately $1,460,000,000 of debt on our balance sheet and our adjusted debt to EBITDAR was 2.6 times. During the quarter, we paid down approximately $157,000,000 of debt and are progressing as planned to get back below the 2.5 times leverage ratio and maintain our strong investment grade ratings. On our last call, we outlined getting to 12 operating profit required delivering the balance of our $160,000,000 in cost synergies, an additional 100 basis points of cost reductions and approximately 30 basis points of gross margin improvement. George outlined the operational actions we are taking to get to the 12% goal.
I will highlight how those actions will translate to our financials. While some of these cost reductions were contemplated in our original synergy assumptions, we are taking out more than originally anticipated to get an additional 100 basis points out. We expect to realize the majority of these cost reductions and margin enhancements in 2016. We are going beyond our original G and A work to further simplify our administrative cost structures. To this end, as George noted, we recently completed a meaningful headcount reduction across our corporate support centers.
Additionally, we are executing broad based reductions across all our non selling functional areas and discretionary costs within our support teams across the enterprise. We estimate the savings generated through these headcount reductions and other G and A cost reduction initiatives will reduce our costs by approximately 45 to 55 basis points on an annualized basis with the vast majority of the savings to be realized in 2016. Note that savings realized from actions taken in 2015 are already included in our most current 2015 annual outlook. Additionally, the one time cost resulting from the recent headcount support center reduction is already included in our most recent full year 2015 estimate for one time costs. As George shared, we have taken steps to improve our productivity and profit contribution across our store base with our ongoing performance management discipline and efforts to simplify our store operations.
While performance management will improve many of our outlier stores, closing stores is required on the chronic underperforming and unprofitable stores. As part of our ongoing assessment of consistent recurring outliers, we are now applying a higher threshold of performance acceptability. And while this work is not yet complete, we have made the initial decision to close 50 of our poorest performing stores by the end of 2015 that were not originally anticipated. This is in line with our focus on minimizing focus on minimizing distractions and removing layers of low returning costs and focus on our highest returning activities. The one time costs associated with these additional closures are estimated to be between $16,000,000 $20,000,000 and will be incremental to our original 2015 full year outlook for one time costs.
We will share more details on any further closures as we continue our work. All in, we estimate the annualized benefits from improving our store profitability and productivity through performance management, operating efficiencies and store closures is estimated to deliver expense leverage of approximately 45 basis points to 55 basis points in 2016. Lastly, as I mentioned earlier, we expect to continue expanding our gross margin rate. We expect to leverage our size and scale to drive incremental net gross margin expansion ex synergies through improved purchasing, growth of our private label program and our global sourcing initiatives. We also expect benefits driven from supply chain initiatives longer term led by our daily delivery program expansion.
Shorter term, we expect to offset the incremental costs and investments to expand our daily delivery through initiatives such as greater efficiencies across our transportation program and improvements in supply chain productivity. Additionally, on supply chain, we have largely completed our distribution network go forward plan and roadmap. However, we are still working through the financial implications and complexities of the acquired Carquest distribution network, including working through matters with distribution center landlords. We will provide you more details as we finalize this work. In addition to improving our operating performance, a material opportunity exists to improve our working capital.
We continue to see opportunities to improve our AP ratio through better terms and improved inventory management as we progress through the product 2015 and get back to a sustained leverage ceiling of 2.5 times and maintain our strong investment grade rating. Once achieved, we revert back to our previous capital allocation strategy to drive shareholder value, which includes investing in our business and deploying our share buyback program. Turning to the back half of the year, we are maintaining our annual outlook that we shared with you on our Q1 2015 earnings call, which includes delivering a full year comparable cash EPS outlook of $8.10 to $8.30 As shared earlier in my remarks, we are now we now expect one time costs to increase $16,000,000 to $20,000,000 for the additional 50 store closures. This increases our 2015 full year estimate for one time costs from our original outlook of $75,000,000 to $85,000,000 to now be between $91,000,000 $105,000,000 In closing, our 2nd quarter results were in line with our original expectations as we made progress in our base business and integration. We remain optimistic and focused on driving our commercial sales growth, steadily improving our DIY business and executing on our actions to achieve our 12 operating profit target.
I would like to finish by thanking our team members once again for what they do every day to serve our customers, inspire our team members and grow our company. Operator, we are now ready for questions.
Thank you. We will now begin the question and answer session. Our first question comes from Mr. Seth Basham of Wedbush Securities. Sir, your line is open.
Thank you and good morning.
Hi, Seth. Hi, Seth.
My first question is just a clarification of 2015 guidance. I want to make sure that some of the extra savings that you guys are now talking about were included in the 2015 outlook previously. Hey Seth, it's Mike. Yes, yes we were. If you look at our guidance for the year, it's 820 dollars kind of in I'll pick the middle of that range we gave of $8.10 to $8.30 So use $8.20 And then that included about $20,000,000 of Hartford annualization from last year and acceleration of Worldpac.
So if you adjust for that, you get an increase in EPS of around 10 point somewhere between 10% and 11%. And then if you take the midpoint of the synergies that we planned this year, that explains about half of it, if you use the midpoint of 45% to 55%, which means the base business was increasing. So we actually assumed that we would improve our base business. And those things that we talked about in our script in terms of improving our SG and A and some of the other aspects of the improvements are part of that improvement in the base business this year. So the answer is yes.
Got it. That's helpful. And then as a follow-up, just thinking a bit about the DIY business, you mentioned sequential improvement. Can you point to whether or not we saw positive comps from that business yet? And what the drivers of improvement are?
How you expect it to trend going forward?
Yes, Seth. This is Darren. So in my prepared remarks, I said the DIY business approached flat. So it's been the best DIY performance that we've probably had in nearly 1.5 years. And the drivers are what George outlined.
I mean, we're real pleased with the Speed Perks program and the loyalty program and we continue to build that membership. It's over $6,000,000 The other things that we have put a fair amount of time and energy in to, we talked about our omnichannel capabilities. We like that business in terms of the synergy we're seeing in terms of moving traffic into the store. And then some of the marketing efforts are paying off in some of the key markets. And we're starting to see some of the benefits that we haven't seen in years
as we open new
stores and new next several years as we start to push stores out West, that will be several years as we start to push stores out West, that will be part of it.
Got it. Thank you very much and good luck.
Thank you.
Our next question comes from Mr. Scot Ciccarelli of RBC Capital Markets. Sir, your line is open.
Thank you. Good morning, guys. You've previously mentioned that you needed some improved comp growth to get to your 12% EBIT target in 2017. So I guess the question is, what are you guys assuming your comps need to be in 2016 to reach that 12% target? And just to be clear, this is 12% for the full year in 2016 and not a run rate by the end of 2016, correct?
Hey, Scott, it's George. You're correct. It is the full year for 2016 that we're targeting toward. We previously guided our comps to be in the low single digits. We're sticking with that.
I mentioned in my remarks that we're pleased with the start that we've had to Q3 and that also remains the fact. If you look at the 12% work, I think it's a combination of a couple of activities that we've talked about in the past. First of all, 18 months into the integration, we were always going to look at headcount synergy. 18 months into the integration, we're looking market by market. So as we look at our consolidation conversion and relocation work, it became natural over time to begin to look at the Advance stores as part of that as well.
And the same business rationale that we would have for consolidating a Carquest store or closing a Carquest store applies to an Advance Auto Parts store as well. So call that kind of an evolution of that activity. And then we stated that we were going to look for some cost out of our business and that was going to help guide us to 12%. We found ways to accelerate that. So while looking at the synergy headcount, we looked deeper.
We looked at ways to simplify the business for our teams. We looked at taking layers out of our corporate structure that would allow us to stop sending so much change to our stores and put more control around that. Combination of all those things just led us to believe that we could get there considerably faster.
Yes. And as to the sales Scott, I'd say it's pretty straightforward. We do need to see the sales
continue to make their upward progression.
We're not going to jerk the wheel here. As progression. We're not going to jerk the wheel here. As George and his team have been essentially clearing the decks of activities for our store, this progression DIY got better last quarter. It got better this quarter.
We expect it to get better next quarter. Our commercial business and our AAP stores got better this quarter. We have some work to do in our Carquest legacy stores. They will get better. They have probably the brunt of the intensity of the integration change.
So we're not planning on quantum leap in the comp store sales to get there. But we are planning on this progression into this methodical focus to get there over the next 6 quarters. Excellent. Thanks a lot guys.
The next question comes from Simeon Gutman of Morgan Stanley. Your line is open.
Thanks. Good morning. Hi, Simeon Gutman. My first question is, it was I mean, just last quarter, the outlook was lowered and we mentioned 12% for 2017. My question is why raise the bar now?
It wouldn't have better progression maybe to beat along the way next year. And that sort of begs a follow-up of 12% wouldn't seem like a stopping point to your point, Darren. I'm just curious about your thoughts, just why now?
Well, I mean, I'll start off with the why say 12%, because we think we have a clear pathway there. So again, as we began the work and as we the sales have to continue to grow, We've said they would. But as the integration begins to abate more and more quarter by quarter, we know that the primary effect of the integration has been on the commercial business. We'll see the commercial business strengthen along the way. We also find some significant cost and opportunity across the board that we now feel very strongly that we can achieve this number and we'll do so in the 6 quarter period to get there.
12% is simply the next step along the way. So we're saying it because we have a clear pathway. We're not in any way shape or mirror implying that that is what we're capable of doing. We actually believe we're capable of doing more than that.
Okay. And my follow-up, thinking about share gains and top line growth versus margin, the industry is clearly strong right now and there's a lot of top line opportunity for your business, Worldpac cross selling and some of the better availability. So how do you balance the opportunity for market share gains with this margin target that you laid out there? Could that margin focus cause you to miss some opportunities on the top line or prevent you from going after some?
Yes. Sameer, I'd frame it this way is you're right. The market out there is very strong. If you think about our growth drivers and you mentioned it on
the call
Worldpac Worldpac is a business that to be honest we're just not touching them. We will open another distribution center for World PAC in the Q4. They've opened 6 locations, 6 branches so far this year. They'll finish with 12. Bob and his team continue to be missioned with grow that business profitably and as quickly as you can without affecting the base business, because you can take a business and grow it too fast and disrupt the base business is 1.
Continue to focus on new markets in terms of other growth opportunities, but do it in the right way. And we've targeted Texas in terms of growing our new store base out there and other parts out West, keep taking advantage of those new markets. In the core, I think as George has alluded to, each quarter, I think George you call it quieting the integration. How do we quiet the integration in a way that we continue to make steady progress on DIY, steady progress on the core commercial and really help the teams that are suffering the brunt of the integration in terms of product and people continue to make their path forward in terms of normal selling routines.
And Simeon, the moves that we made so far and the ones that we referred to in our script are G and A heavy as light. So we are not going to try to get our way there by affecting sales capability. That absolutely has to remain strong for us. In fact, we need to try to find ways to do more and more for the sales portion of it. And I actually think the G and A cuts encourage sales.
And Simeon, the other piece of that is the stores that we closed help us both the chronic underperformers are delivering negative comps. When you close those stores that actually helps us on the top line. And actually they're delivering negative profit. It actually helps us on the bottom line. So as George said and I think it's an important point, this 12% is linked top line growth and bottom line improvement.
And let me add, when you close stores that are underperforming, you're also helping out the S once again. So how does that play out for a district manager? An underperforming store is much like any performance management issue. You spend a disproportionate amount of time and effort trying to fix that store, resuscitate that store and maybe that's not even possible. So this frees up the time and the bandwidth for our district managers to go encourage the best performing stores and move along the middle performing stores.
Thanks.
Our next question comes from Mr. Greg Melich of Evercore ISI. Sir, your line is open.
Open. Hi, thanks. I wanted to get a little bit more about the real incremental store closures. Could you give us more it sounds like they were just poorly performing stores. Were they geographically in a certain area or were they bringing cash or what were the metrics used to actually pick those 50?
We looked at the 4 wall profitability of the stores, Greg, and I think that really drove the answer. They're geographically spread. I think when you have a chain the size of ours, 5,300 stores, over time, demographics shift, business shifts, and I think that's simply the case with these stores. So they've been around for a while. They began to decline.
Their comps were going down. Their operating income was going down. And this is just the right decision for us to make. So and I wouldn't suggest that we're finished. It's an ongoing process.
We should always be looking at the performance of our stores and we should always be paring away those that are weaker.
Got it. And then on the capital allocation, I think Mike you mentioned that once you get the debt paid down, get down to under 2 and a half times debt to EBITDAR, that you go back to the traditional capital allocation strategy. Could you remind us of what that is? And then also, if I remember correctly, it tended to bounce around between maybe 1.8 times and 2.4 times debt to EBITDAR. Could you just remind us what that was and how you look at it now?
Yes. So the answer is yes. We'll go back to our previous capital allocation. And that was always investing in the business first and then our share buyback program. We always had to open to buy.
Currently, we have an open to buy. We've made a commitment to the rating agencies that will be below our 2.5 times and that's what we're committed to. And then the other thing I'd remind you of, we recently got an upgrade from Moody's. I think that those are all positive. That doesn't change the commitments we've made.
We're going to keep under our 2.5 and then we'll use our share buyback as we've used it historically.
Great. Thanks. Yes.
Our next question comes from Mr. Dan Weaver of Raymond James. Sir, your line is open.
Thanks. George, I want to follow-up on your comments about the Carquest stores generating commercial comps a little less than expected. Is that primarily reflecting their lower pricing or the price of realignment that you referred to and not yet generating higher revenues? Or do you think it was perhaps the loss of some of that brands such as Wix and Gates that's impacting their performance?
Again, I think you hit the primary one. When you look at the pricing strategy work that was done and we got to what we consider to be competitive pricing in the commercial business across the country, the majority of the price decrease work went toward the Carquest stores, which were historically higher in price. As we said that price change is immediate, the velocity growth is not. So it takes a bit of time to get the word out to go from customer to customer and begin to get the realization that there is a more competitive price in the market before we begin to see that sales lift. So I think we attribute the majority of it to that.
I also wanted to follow-up on your comments about do it yourself comps getting close to flat. And it sounds like you're off to a good start with the loyalty program. But it looks like there's one other initiative the company hasn't yet implemented to drive do it yourself revenues and that's an expanded private label program. Is your private label penetration still in the low 20% rate? And if so, do you see a need to bump it up to the level that AutoZone and O'Reilly are currently running to achieve similar type
of do it yourself productivity?
Hey, Dan, this is Charles. Good morning. Hi, John. We've been working on our private label development program now for 4 years. And when you look at the expansion of the Carquest program across our whole network, today we sit as a combined company at 47%.
So we've made significant progress improving our private label penetration.
So in the advanced stores, 47% of the cost of goods sold is now private label
or My company, we're not breaking it out between AAP and Carquest. When we look at the combined stores, if you start to walk through the AAP stores, you'll start to see a fairly significant penetration of the Carquest private label brand sitting in our base business. And as we roll through the product changeovers this year and the lift and replace, you'll continue to see the Carquest penetration improve in the AAP buildings.
Just if I could add just one more follow-up then. Is that private label product from Carquest desirable for the do it yourself customer who I typically think is looking for that opening price point?
So as we lean into our heavy DIY program, particularly with our Speed Pugs program, we're seeing very good adoption of the Carquest brand to those heavy DIYs. So they want both a value brand, which we've seen historically that we've driven on the AP side, but we're seeing very good take up with the quality of the Carquest private label across multiple categories there. Okay. Thank you.
Our next question comes from Michael Lasser of UBS. Sir, your line is open.
Good morning. Thanks a lot for taking my question. The closure of the 50 incremental stores begs topic of what the potential opportunity for missed strategy might be along with how you're thinking about the potential for sales recapture from those 50 closed stores. So how many of the stores across your entire base right now are unprofitable?
Well, we're addressing those within this closure. We're addressing the unprofitable stores within the closure. As for what the total number is, we're still that's ongoing analysis. We'll continue to work on it. We'll always work on it.
But I would add that in some cases, there will be consolidation opportunity as well as part of this. So we don't look at it necessarily as a complete sales loss. We look at it in many cases as profit optimization. And Michael,
the other thing I would add as well is there were 3 dimensions to improving the profitability that we talked about. One is performance management. And whenever you have stores, sometimes there's points and periods of time where stores run a little lower comp or are unprofitable in a certain period of time and those can be solved with performance management or as George said simplifying our operations. And then the 3rd dimension is and that's the last resort of closing stores. So it's those three things that we look at across and all three of them will drive improvement.
So Mike, do we think about the distribution of your stores by profitability as maybe more uneven than the average retailer? So you have a good amount of very profitable stores and then more at the tail of those that are unprofitable?
No. I wouldn't say we have 5,300 company owned stores. And I would say we're no different than a lot of other retailers. You're going to have variability. We just completed an acquisition, so we've got some newer stores to our portfolio.
But I would say we're no different than any other retailers. You get variability and you address those variability and that's what we're doing as part of our efforts.
Okay. And then if we look at the gross margin performance in the Q2, it was up nicely. How much of that was due to the synergies that accrued during the period?
Yes. That was the biggest driver of the improvement in our gross margin.
Okay. Thank you so much.
Yes.
Our next question comes from Matt Fassler of Goldman Sachs. Sir, your line is open.
Thanks a lot. First, just a quick quantitative housekeeping item. Because you didn't have 2016 guidance out there previously, just to clarify, it seems like the acceleration on the margin side is about 50 basis points from the original plan. Is that Mike the right way to think about it?
You know what, we haven't put it out there yet. I think George said it earlier. In Q3, we'll give you a clue like we typically do with how we're thinking about next year and then we'll give you the actual outlook in Q4. I don't want to get into that for next year. But the fact of the matter is for the full year next year, we're expecting to grow on this year and we're expecting the margins to come in at 12%.
Got it. I was just using the 45 basis point to 55 basis point quantification that you gave for some of the expense line items that you item Yes.
We actually gave 2. We gave 45 to 55 for G and A and we also gave $45,000,000 to $55,000,000 in terms of
the closure of our stores.
Got it. So those were 2 different ones. And both of those just to be clear are incremental to your prior thinking?
Yes. Yes.
Okay. Thank you. And then second question
Sorry, Matt. Those are incremental to what we would expect for this year. Some of that was already built into our synergies, but they're incremental to this year.
Got it. Okay. So the acceleration by year, we probably can't pinpoint how much exactly how much you've pushed forward from your prior plan to your new one, not at this point?
Yes. You know what happens Matt is originally when we did our synergy work, you do it based on targets. Now we're getting to your street addresses and that's how we think about it. So they start to blur together. Here's what I how I'd have you think about it.
This year we've given you an outlook for this year for $810,000,000 to $830,000,000 that's how I think about this year. And then next year, we're going to build on that and hit 12% operating profit. That's how you think about it.
And just one more piece of clarity on this quantitative side. It sounds like the acceleration of the 12% is not just pushing up the timing of recognizing synergies that you previously disclosed, but in addition to that some other cost cuts that you discussed on the call. Is that correct?
That is correct, Matt. It reflects a deeper work than the synergy.
Got it. And then just briefly on the qualitative side, you made reference earlier in the call guys to moving to more of a field driven organization. Can you talk about how you implement that? How you deploy that strategy, I guess, on the cultural front, which seems to your point to be an opportunity for the stores?
Yes, Matt. I think it begins with, again, simply beginning to put some significant governance and gatekeeping in place on the communications coming out of the SSC. Governance and gatekeeping in place on the communications coming out of the SSC. It also involves becoming a more better listening organization. So we've already begun to do things like general manager councils that actually have some real consequence to them where a group of just great performers from around the country begin to come in and give us advice on what needs to be done to change the business.
We now run all field changes past the field leadership team or a sampling of the field before we actually go ahead and we make those changes. We give more decision making autonomy to the field senior leadership and ask them to take a bigger role in driving the outcome of our business. We've made a significant effort at trying to just dismantle the bureaucracy of our company. And we have it like any other that when you get big over time, you get some unintended consequences. So beginning to pull that out and just begin to simplify our message to the team and meet it much more on what we say.
This business ownership and accountability for our field team, we've simplified our field structure. We have said certainly that we feel that we need to go to a single selling team in our stores. We've had the historical DIY and commercial split. We know that we need to begin to unify that and operate as one single selling team. So I think there are a number of initiatives ongoing and certainly planned that we've begun to put in place that will begin to drive that kind of behavior.
And it really begins to shift the decision making weighting more toward the fuel team and away from the corporate team. We know there are things that we think can affect our business that will put an entrepreneurial spirit in the stores. Among those things are how we incent our team. So we're going to pilot and try those things as well. And most of the change in this organization going forward will be led by our field teams, piloted by our fuel teams and rolled out by our fuel teams, not top stone.
Thank you so much.
Our next question comes from Mr. Chris Borvers of JPMorgan. Sir, your line is open.
Hi. It's actually Mark Bex on for Chris. My first question is on the loyalty program and speed perks. Can you give us a sort of idea on the lift that you're seeing? And then also if there's any affiliated gross margin impact or maybe that's just a shift of advertising dollars?
And then I have a follow-up as well.
Yes. Mark, historically, we don't hand out the Lyft numbers. And I'd say the other piece but I would say this is that if you ask us point blank, what's underlying your shift in terms of positive momentum in DIY, it is speed perks. While we're seeing excitement with our team members, When your team members can actually provide something to your customers that they're excited about, provide a benefit to your customers, that's what's driving part of the $6,000,000 memberships that we're seeing today. Is there a margin cost for this?
Of course, it is. It's not material in the scheme of things given DIY margins overall. But there is a small cost to it in the margins that we're seeing.
Okay. And just my second question on the daily delivery and fulfillment. I think you guys are at $777,000,000 now you said and going to $1,000 by year end. Can you guys give us an update on how many of your DCs are actually have the capabilities for daily fulfillment or replenishment? And then how you view that increase going forward?
That would be helpful. Thanks.
Hey, Mark, this is Charles. So today, we've got 3 of our AEP legacy DCs that are doing daily delivery. Of course, all of the Carquest DCs are daily delivery today, which we will continue to make investments in the AAP buildings to build out and complete our 5x delivery across our whole network. We will add capability in the Q4 of this year to enhance moving beyond that 1,000 store number. And we will continue to drive additional capability into converting 3 more of the legacy DCs next year to expand on our 5x capability.
So if I got my numbers right that would only leave another 2 or 3 legacy advanced DCs for daily delivery. Is that correct?
That's correct. That would leave 2 more that we would be working on in 2018 in our current plan.
Perfect. Thanks a lot.
Our final question today comes from Mike Beaker of Deutsche Bank. Sir, your line is open.
Thanks. So a question for George. You said that this Q2 was the 2nd quarter of heavy lifting and then that should dissipate from here. So is there any way to quantify where that disruption occurred in the Q1 and then quantify in the Q2 and what it will look like in the 3rd Q4? Is does it show up in sales, SG and A, margins, etcetera?
Any way to sort of help us quantify what that looks like?
Yes. I mean, I think we would see the intensity of the integration abate sequentially through all 4 quarters of this year. So if you go back to the Q1 of the year, we had changed the field organization. We had changed some selling team responsibilities. Some customers have been realigned among our sales team.
We are at the peak of price changes across getting to one set of prices across both Advanced and Carquest. We are at the peak of the product lift strategy. The relabeling, which is essentially completed now was in full swing during the Q1. So that was kind of the high watermark in terms of all the activities starting in the same place. If you move into Q2, as we finished Q2, again the relabeling work is done.
The product still goes on, but it's become more manageable. Our teams are 6 months more experienced and enrolled than they were when we started this. So the relationships are getting stronger and that impact on the commercial business begins to lessen. That plays forward into Q3 and Q4. So we see Q2 as having been better than Q1 and Q3 is going to be better than Q2 was.
Right. And so understanding that any way to quantify how that might show up in the P and L?
No. I think again we've said that we saw some sequential progress from Q1 to Q2 in sales. Mentioned that we were pleased with the start to Q3. We'd expect that to continue.
And it builds into our annual outlook.
Okay. If I could ask 2 more quick follow ups, because I know we're getting close to 11 here. 1, the 200 consolidations, conversions, etcetera, does that include the new the 50 stores you're talking about today? And then can you sort of break out how many of those will be consolidations versus closures versus conversions etcetera just so we can sort of calculate in our model year end store count?
So this is Bill Carter. The 50th incremental closures that Mike and George mentioned are on top of the 200 that we'll do CCRs that we'll do in the back half of this year. What I'd say in terms of breaking out those 200 in terms of conversion consolidations and what we'll call relocations is if we go back to the bigger picture, we're about a third, a third, a third between conversions consolidations and relocations across the Carquest chain and we're largely sticking with that allocation. We'll do more conversions and consolidations earlier because the relos take a little bit longer to work through the system. So as I look at the 200, it's probably forty-forty-twenty in terms of breaking up, how many of those are conversions versus consolidations versus relocations.
Okay, helpful. One more quick one. You reiterated your low single digit guidance during the Q and A session here. But I think the guidance as of last quarter was the low end of low single digit comp guidance. So are we still thinking low end of the low single digit?
Yes, we are. Okay.
Thank you very much.
At this time, there are no further questions. I will turn the call back to Zaid Mawani for any final comments.
Thank you, Sheryl, and thanks to our audience for participating on our second quarter conference call. That concludes our call. Thank you.
That concludes our call today. You may now disconnect. Thank you for joining us.