Advance Auto Parts, Inc. (NYSE:AAP) Q1 2023 Earnings Call Transcript

Advance Auto Parts, Inc. (NYSE:AAP) Q1 2023 Earnings Call Transcript May 31, 2023

Advance Auto Parts, Inc. beats earnings expectations. Reported EPS is $3.57, expectations were $2.57.

Operator: Welcome to the Advance Auto Parts First Quarter 2023 Conference Call. Before we begin, Elisabeth Eisleben, Senior Vice President of Communications and Investor Relations, will make a brief statement concerning forward-looking statements that will be discussed on this call.

Elisabeth Eisleben: Good morning, and thank you for joining us to discuss our Q1 2023 results. I’m joined by Tom Greco, President and Chief Executive Officer; and Jeff Shepherd, Executive Vice President and Chief Financial Officer. Following their prepared remarks, we will turn our attention to answering your questions. Before we begin, please be advised that remarks today will contain forward-looking statements. All statements other than statements of historical facts are forward-looking statements, including but not limited to, statements regarding our initiatives, plans, projections, future performance, and leadership transition. Actual results could differ materially from those projected or implied by the forward-looking statements.

Additional information about factors that could cause actual results to differ can be found under the captions Forward-Looking Statements and Risk Factors in our most recent Form 10-K and subsequent filings made with the commission. Now let me turn the call over to Tom Greco.

Tom Greco: Thanks, Elisabeth, and good morning everyone. I’d like to start by thanking our entire team for their relentless focus on serving our customers. The dedication of our frontline team members has been a hallmark of the company for many years and we’re grateful for their ongoing commitment. I’ll review a couple of themes today and provide an update on our performance in the first quarter and outlook for the balance of the year. First, we’re putting the customer and our team members first in every decision we make. While our financial results in the first quarter were well below our expectations and there is still work to be done, our customer-focused investments in parts availability and price competitiveness resulted in improvements across key relevant performance indicators.

We’re executing our plan to drive continued improvement in our transactions with Pro customers highlighted by increased parts availability, sustaining competitive price targets, and improved execution across the board. Secondly, as we look to the outlook for the balance of the year, we expect the competitive environment in the Pro channel to remain very challenging. As you saw in our release, we are reducing our annual guidance based on the shortfall we experienced in Q1 and our updated balance of year outlook. Additionally, we believe it’s prudent to enhance financial flexibility and we’ve made the difficult decision to reduce our quarterly cash dividend. We remain committed to executing against our key initiatives to drive top line growth and improve operational performance.

In terms of our top line, Q1 net sales increased 1.3%, while comparable store sales decreased 0.4%. New stores contributed to net sales growth in the quarter, inclusive of the 21 stores and branches we opened in Q1. We saw net sales growth in both DIY omnichannel and DIFM, with DIY omnichannel slightly outperforming DIFM driven by a double-digit sales increase in our e-commerce business. In terms of cadence, we believe that lower tax refunds pressured our business in March. From a category perspective, motor oil and brakes led the way as a milder winter impacted cold weather category sales in some of our geographies, particularly in some of our northern geographies. On a regional basis, our sales growth was led by the West. Overall, both net and comp sales growth were below our expectations for the quarter, driven primarily by our professional business.

As I mentioned, we saw improvements in the KPIs we track to measure parts availability. In collaboration with our vendor partners, our supply chain fill rates improved in the quarter. In terms of availability, our on-hand rates improved by approximately 50 basis points in the quarter. In terms of competitive pricing, we’ve talked in the past that based on our research, the most important criteria for an installer to make choices above their part supplier starts with availability, followed by consistency of delivery and relationship. Pricing has historically been the third or fourth criteria for an installer. However, if the gap between our price and competitors becomes too wide, price becomes a bigger factor. Last year, we saw a relative price position within Pro climb to unacceptable levels as a result of changing competitive dynamics surrounding price-related investments.

We’ve done considerable work testing different price points across categories and geographies to determine the best approach to drive increased transactions and growth in our Pro business. This work helped us refine price targets for each category relative to competition, be it a traditional competitor or a wholesale distributor. As a result of improved availability, along with the investments we made within Pro to achieve competitive price targets by category, we saw improved performance in both transactions and units relative to the fourth quarter. This was more than offset by less year-over-year growth in average selling price relative to the fourth quarter. In order to sustain our targeted competitive price position in Q1, we had less price realization in implant, which put substantially higher pressure on our product margin rate.

Our gross margin rate declined 162 basis points, with the single biggest shortfall versus expectations being less than planned price realization within product margin. Separately, we also experienced a mixed headwind within product margin, which Jeff will explain in more detail shortly. These two primary headwinds within gross margin more than offset the benefits we saw from both channel and own brand mix. In terms of SG&A, we incurred a headwind associated with the prior year adjustments which Jeff will discuss further. The combination of gross margin and SG&A deleverage resulted in an operating margin decline of 339 basis points in the quarter. As we look to the back half of 2023, we’re urgently focused on operational improvement. On the top line, we’re continuing to drive our DIY omnichannel business behind the strength of DieHard, our Speed Perks loyalty platform, and strong growth in our e-commerce business.

In terms of Pro, we’re focused on improving top line sales and driving gross profit dollars. This is highlighted by a back-to-basics approach and a heightened focus on execution across the board. The first big driver here involves further optimization of our inventory and parts availability to improve on-hand rates. In some cases, we plan to sell through owned inventory at discounted rates to transition to new higher-margin alternatives. The second driver involves our plans to sustain competitive price targets to ensure we close the sale. On the margin front, we’ve talked about strategic sourcing within category management in the past. We’re now taking a much more holistic approach, starting with the latest customer and category insights and updating the role of each category within our business.

We then apply a very disciplined approach to determine sourcing, distribution, shelf space, pricing, and promotion. Our category management process involves the engagement of our strategic suppliers with an overarching goal of accelerating our mutual sales growth and margin expansion. We’re addressing opportunities here on a category-by-category basis, with continued work planned balance of year and into 2024. In addition, we also executed a corporate restructuring in the first quarter, which will provide savings balance of year within SG&A. In terms of our balance of year outlook, we continue to be mindful of macroeconomic uncertainty and potential pressure on consumers. For our industry, the primary drivers of demand remain positive, including an increase in car park and aging fleet, and a modest increase in miles driven compared with one year ago.

Our overarching goal for the balance of the year remains to improve operational execution to regain top line sales momentum, particularly in the professional sales channel. Regaining our share of wallet with existing customers has been challenging. However, we’re elevating our focus on parts availability, sustaining competitive price targets, and improving field execution. Jeff will cover more details surrounding our revised guidance later in the call. But given what we’ve experienced year-to-date, we expect that sustaining our competitive price targets by category will require higher than planned price investments in Pro, and we factored this into our full-year guide. Before turning the call over to Jeff, I want to talk briefly about the newly expanded role of our independent Board Chair, Gene Lee, and provide a quick update on the CEO search process.

As you saw in our release this morning, Gene is now serving as Interim Executive Chair and will be providing additional operational oversight and support to our management team during this time. I look forward to working with Gene and continuing to leverage his experience as we work to deliver operational improvement in the business, while helping to ensure a seamless CEO transition. With respect to the CEO search, following a very thorough vetting and selection process, we’ve retained a leading independent search firm to assist with this work. Our succession committee is comprised of board members with significant experience in retail, automotive, industrial, and multi-unit operations. The committee is evaluating internal and external candidates and remains committed to identifying a candidate who is exceptionally fit for the role.

With that, I’ll now turn the call over to Jeff to review our first quarter financials in more detail and provide our outlook for the full year. Jeff?

Jeff Shepherd: Thanks, Tom, and good morning. I want to reiterate our gratitude for our team members and the ongoing commitment to putting our customers first while navigating a difficult quarter. In Q1, net sales of $3.4 billion increased 1.3% compared with Q1 2022, driven by new store openings. Comparable store sales decreased 0.4%. Gross profit margin was 43% compared with 44.6% in Q1 2022. In terms of gross margin, we experienced headwinds associated with targeted price investments, which were above expectations due to the current competitive landscape. It’s important to point out that as we remain committed to maintaining the competitive price targets we’ve established and have now attained in key categories, we were unable to price to cover product costs in the quarter.

Product costs were up mid-single digits compared with the prior year, which exceeded our year-over-year price realization. In addition, unfavorable product mix and increased supply chain costs also contributed to gross margin deleverage. In terms of product mix, we routinely see variations, which can be influenced by several factors, including macroeconomic conditions and weather. As you know, we had a milder winter in the quarter, which impacted battery and wiper sales in Q1. This, coupled with an increase in motor oil, which carries a lower margin rate had an unfavorable impact on product margin. While we had channel and owned brand mix tailwinds, product mix headwinds more than offset these benefits. The combination of inflationary costs in our new DCs in California and Toronto, as well as lower-than-expected sales resulted in supply chain deleverage.

This more than offset productivity gains from our supply chain initiatives. SG&A in the quarter was $1.4 billion compared with $1.3 billion the previous year. As a percent of net sales, Q1 2023 was higher than planned due to the softer top line and was 40.4% compared with 38.6% in the prior year. We incurred approximately $17 million in SG&A costs in the first quarter. As a result of management’s review, it was determined these amounts were paid in 2021 and 2022, but not correctly expensed in those years. We’ve concluded these costs were not material to prior years and therefore, we recognize the adjustment in Q1. In addition, our SG&A deleverage was also due to inflationary headwinds associated with labor and benefit-related expenses. We incurred costs associated with new store openings, which were partially offset by a reduction in start-up costs we incurred in 2022 related to our California expansion.

Our Q1 operating income was $90 million compared with $203.3 million in the previous year. On a rate basis, Q1 was 2.6% compared with 6% in the previous year. Diluted earnings per share was $0.72 compared with $2.26 in the previous year. Q1 capital expenditures were $85 million compared with $114 million in the previous year. The year-over-year reduction was primarily attributable to the completion of certain IT-related investments from the prior year and lower new store and branch openings in Q1 2023. Free cash flow was an outflow of $468 million in the quarter, with the largest contributor being the timing of payables. As you saw in our release this morning and as Tom mentioned, the Board made the difficult decision to reduce our cash dividend to $0.25 this quarter.

Given our recent performance and balance of the year outlook, we believe it’s prudent to retain financial flexibility. Given the factors discussed, we are updating our full year guidance to include net sales of $11.2 billion to $11.3 billion, comparable store sales of negative 1% to flat, GAAP operating income margin of 5% to 5.3%, income tax rate of 24% to 25%, diluted earnings per share of $6 to $6.50, capital expenditures of $250 million to $300 million, a range of $200 million to $300 million in free cash flow and 40 to 60 new store and branch openings. With that, let’s open it up for questions. Operator?

Q&A Session

Operator: Thank you. And our first question is from Elizabeth Suzuki from Bank of America. Elizabeth, please go ahead. Your line is open.

Elizabeth Suzuki: Great. Thank you. Just on the competitive environment, you noted that you expect competition in Pro to remain challenging. I mean, do you think that competition is mostly coming from the large chains? Or are the smaller independents getting more competitive too as the supply chain leases up and they’re able to get more product as well?

Tom Greco: Hi, good morning, Liz. I think it’s a combination of the two. I mean, we measure the relative price indices against the industry. And obviously, we also measure it against our direct to close-in competitors, but we predicate our pricing strategy off of the industry more broadly. So really, those two are both looked at, but the primary driver for us is the industry, because, as you know, the Pro business is highly fragmented and there’s a lot of business out there. It’s a $100 billion category, so we look at the whole thing.

Elizabeth Suzuki: Great. And then Tom, you had also mentioned in your prepared remarks that you talked about plans to sell through some of your owned brand inventory to replace with better product. I mean, is the implication there that the owned brands didn’t meet the demands of your customers in terms of quality or features? And are you pausing expansion in owned brands?

Tom Greco: Yes. Let me correct that. We have owned inventory, which is essentially inventory that we’ve already paid for, it’s not necessarily owned brand. We’re essentially transitioning from one brand to another in a couple of big categories, and that’s what we’re talking about here. For the most part, we are actually transitioning into higher-margin owned brands, so I know that’s a little confusing. But this is largely about expediting the process to move out of inventory that is essentially moving out of our system and into higher-margin owned brands.

Elizabeth Suzuki: Got it. Thank you for clarifying that.

Operator: The next question comes from Chris Horvers from JPMorgan. Chris, your line is open, please go ahead.

Chris Horvers: Thanks. Good morning. So just at a high level, narrating this, you cut your operating margin by 280 basis points. So is that essentially 250 on the gross margin line and the balance on SG&A given the lower outlook? And then within that gross margin, is that all price investment that’s driving that difference?

Tom Greco: Yes, Chris. Let me give you some context on what happened in the quarter and how we’re thinking about balance of the year, and then I’ll let Jeff sort of tie it off. In terms of the sales, I mean, DIY was generally in line with our expectations. We were down low single digits in transactions, up mid-single digits in average ticket. We posted a positive comp generally in line. As you know, in Pro, the goal was to invest in inventory and make sure that our competitive price index was in line with where we had targeted. We want to drive our units. We want to drive transactions. We’re trying to increase our share of wallet with our existing customers get back to where we were. We’re actually making good progress on improving units and transactions.

In the quarter, we improved. We were down low single digits in transactions in the quarter, but that was a nice improvement from where we were at the end of last year, so we’re getting more jobs with our installers. The challenge is two-fold. We’re not getting enough lift yet, so it is taking longer to recover share of wallet with our existing customers. That’s been the biggest issue that we faced so far this year. We’re going to stay at it. It is taking longer than we’d like, though. And then in terms of our average ticket in Pro, it was up low single digits, which is significantly below how we plan that business. And as we look forward, that’s going to be a big P&L headwind for the year. So I’ll let Jeff tie it out from there.

Jeff Shepherd: Yes. In terms of the split between margin and SG&A, Chris, the best way to think about it, if you look at the balance of the year, kind of midpoint of the guide for last year, we’re expecting deleverage in both gross margin, as well as SG&A relatively split. I mean, there could be some variability there, but that’s why we’re sort of thinking about the balance of the year. And just to put a bow on that, we do think the second quarter will be the most deleverage, and then we’ll see improvement in the back half.

Chris Horvers: And so, that’s a good segue to the follow-up. So as you think about price and availability is — are you — have the price investments been made and now we’re sort of annualizing through that? And is there any LIFO dynamic there? Then on the availability side, you did add a lot of inventory. So is availability where you want it? Or are we also trying to figure out, right, we have the inventory, but is there a question of it’s just not in the right location?

Tom Greco: Sure. Well, first of all, on the — I’ll start with availability, because Jeff can connect price a little bit after I talk. But we’re always going to want to have improved availability. We are making good progress there. Our on-hand rates are up, our supplier flow rates are up, our fill rates from the DCs to the stores are up, so good progress on availability in terms of our on-hand rates, still room to improve there, but clearly, we’re improving there. In terms of price, as I said with the earlier question, we have a targeted price index versus the industry by category. And to answer your question directly, we are where we need to be there. It is resulting in less price realization than we planned, but we are at the targeted index now.

Jeff Shepherd: Right. And we’re planning on that being a competitive dynamic through the balance of the year, so that is factored into the revised guidance. In terms of impact from LIFO, we’re not anticipating anything significant there. We talked about inflation being up mid-single digits. We’re expecting some moderation over the balance of the year. However, the LIFO, we think, will be a slight benefit.

Chris Horvers: Slight benefit for the year, but it was a headwind in 1Q?

Jeff Shepherd: That was a benefit in 1Q, very small, $7 million.

Chris Horvers: Got it. Okay. Thanks very much.

Tom Greco: Thank you.

Operator: The next question comes from Simeon Gutman from Morgan Stanley. Simeon, your line is open. Please go ahead.

Simeon Gutman: Good morning, everyone. In the prepared remarks, it somewhat painted a picture of like a very competitive price-driven backdrop. Curious if you can discuss — has, especially commercial resorted to, I don’t want to say any price war, but it sounds a little different than the way the other competitors described it. Are you seeing price matching? Is it coming from the big chains? Is it coming from the independents? Can you discuss that competitiveness a little more, please?

Tom Greco: Good morning, Simeon. I think it’s consistent with what I said earlier. I mean, we were establishing our price targets based on what we see every week in the industry in each category, and we react to that. I mean, we’ve got a very strong team in strategic pricing. They look at our unit lift in each of the categories in terms of how we would perform at different levels, and we’ve got a very clear idea of where we need to be in order to deliver unit improvement and secure more jobs. So they established those targets for each category, and when we see that move, and again, that’s at an industry level. We don’t measure — we look at individual competitors that are close in, but it’s really more at the industry level that we drive our pricing strategy off of, so I think it’s a combination of the two.

Simeon Gutman: And can you give any sense for how much of the gross margin impact is due to the acceleration of moving some lines out of your network versus the price investments?

Jeff Shepherd: It’s primarily the price investment. I mean, that has been the single biggest factor. We aren’t able to cover inflation with price, and that was by far the biggest driver.

Simeon Gutman: Got it. Okay. Thank you.

Operator: The next question comes from Bret Jordan from Jefferies. Bret, your line is open. Please go ahead.

Bret Jordan: Hi, good morning, guys.

Tom Greco: Good morning.

Jeff Shepherd: Good morning, Bret.

Bret Jordan: Could you talk about the repercussions of the debt to EBITDAR now being at 3x? Is this going to require sort of a more funded working capital level? And I guess, what does it do to your, I guess, inventory balances and cost of goods?

Jeff Shepherd: Yes. I mean, we’re looking to make the necessary investments within working capital to ensure we have the right availability. We’ve made substantial improvement in that. In the first quarter, you’ll see our free cash flow. When you look at the details, our inventory is up $100 million. We think we have some further investments to go, but we think that will be largely completed by the end of this quarter, so we’re confident that we can get those investments in and start producing the cash from making those investments. We watch our ratios very closely. It’s elevated, and we believe that to be temporary as the availability improves our transactions, and we improved the cash flow.

Bret Jordan: Okay. Your accounts payable, I think we’re in the 70s as a percentage of inventory. Is that number probably heading lower here as we go into a sort of into this 3-plus debt to EBITDAR ratio?

Jeff Shepherd: No. We think we’ll see some slight improvement over the course of the year. We had some sizable planned payments in the first quarter associated with our payables, so that will start to flatten out over the balance of the year. And so, we’ll see some slight improvement.

Bret Jordan: Okay. And then a question on commercial. I mean, obviously, could you maybe give us some color as to what percent of your commercial business is national accounts? And then obviously, one of your big national accounts did an RFP in the first quarter that I think maybe took some business away from you. How do we reconcile that with this phase of price investment you think that given the fact that you’re calling out lower pricing that RFPs like that would be going towards you as opposed to a way?

Tom Greco: Sure. Well, obviously, we look at the different channels within Pro, Bret, as you know. So our — we don’t break out exactly how big our majors are, but our strategic accounts are very important to us. We believe we’ll see to the direct question you mentioned on the RFP as we get into the back half of 2023, we’ll see improvement there just across our national account base in general, for a variety of reasons. Most of the progress we’ve made so far has come up and down the street, which I’m pleased about. So we’re going to continue to drive our up and down the street business, secure more jobs, increase our share of wallet, our field team is highly focused on driving execution in the field and got a pretty still playbook.

We’re going to make progress on availability and we’re going to sustain our CPI. And with that, we expect to improve transactions, units, and drive share of wallet. So as we get into the back half on Pro, we expect improvement on the strategic side and also a continued progress up and down the street.

Bret Jordan: Okay. A part of that first question, — on the payables and free cash, I guess, your free cash guide, given the fact that we’re probably have to fund a bit more working capital, is your confidence in that guidance tied to lower CapEx or store opening expense? I guess, you look at the puts and takes of cash flow.

Jeff Shepherd: Yes, we took a comprehensive look at all of that, and you’ll see we did reduce the number of planned new store openings this year. We’ve reduced our estimate for capital expenditures. So all of that has been contemplated, and we’re going to continue to assess that throughout the year.

Bret Jordan: Okay, great. Thank you.

Operator: The next question comes from Greg Melich from Evercore ISI. Greg, your line is open. Please go ahead.

Greg Melich: Thanks. I wanted to just quantify a little bit more on inflation, what it was in the first quarter in both DIY and Pro? It sounds like it was low single digit, maybe mid-single, and then what’s your expectation for the rest of the year, the cadence of that?

Tom Greco: You’re talking about costs, Greg? Or are you talking about –

Greg Melich: top line.

Tom Greco: Yes. Top line, that’s what I thought, yes. So yes, we saw mid-single digits on DIY in terms of average ticket and we saw low single digits on Pro, which the Pro number was well below how we planned it, so that’s kind of where it came in.

Greg Melich: And then the guidance, the cadence for the rest of the year, should we expect that to go all to low single digits or near flat?

Jeff Shepherd: Guidance would be near flat.

Tom Greco: Yes. I mean, we’re anticipating that the competitive environment in Pro is similar for the balance of the year, and that’s why we’re making the single biggest driver of our guidance revision is that.

Greg Melich: Got it. Okay. And then just the follow-up is, are we — I know you’re bringing inventory back and get fill rates back is still a key primary way to get back share. Is inventory now, I guess, was up 5% year-on-year? Is that back where it wants to be? Or do you still need to have some inventory investment?

Jeff Shepherd: We’re largely there. Well, we’ve got — we have a little bit more investment we think we need to make that we believe will be completed in the second quarter and at that point, we think the working capital or inventory investments will be largely completed.

Greg Melich: Got it. And then my last follow-up was just a little more color on the SG&A in terms of, I know there you were up — you had the $17 million, but the other drivers you said wage inflation. Could you just give us a little more color on those and how they’re trending?

Jeff Shepherd: Yes, wage inflation was the biggest factor, again, mid-single digits, so couple that with the top line and that’s pretty difficult to get leverage there. We also did see deleverage in our newly opened stores, where we’re moving through these phases of last year’s preopening costs. Now we’re moving into open stores, and where we get natural deleverage there as we build the revenue, we’re still seeing deleverage. That was offset by preopening costs that we had last year, so it’s sort of shifting that, but those were the big drivers.

Greg Melich: Got it. Thanks, and good luck.

Tom Greco: Thanks, Greg.

Operator: The next question comes from Scot Ciccarelli from Truist. Scot, your line is open. Please go ahead.

Scot Ciccarelli: Good morning, guys. A follow-up question on the balance sheet. So I know you mentioned there were some timing issues, but vendors in this industry are well known for being very sensitive to the performance of their customers. And so, I guess the question is, are some of your vendors starting to change terms or maybe are your payment terms on private goods different than or shorter than branded goods? Because if we just had timing differences, I guess, I would think the AP ratio would improve a little bit more than what you suggested.

Jeff Shepherd: Well, there haven’t been any significant changes in terms. Really, the timings associated with the investments we started to make in the back half of the year, and those invoices are coming due in the first quarter, and we largely anticipated that. So it wasn’t a significant surprise to us. And as I said, it will even out over the balance of the year, and we’ll see improvement in the AP ratio as the year goes on.

Scot Ciccarelli: So if inventory is going to continue to go up then you would expect AP to increase more than whatever increase is still happening on the inventory side?

Jeff Shepherd: Yes. Well, ideally, we start to sell through that inventory, and that will also help our AP ratio, but yes, that’s — the way to think about it.

Scot Ciccarelli: Understood. Thank you.

Jeff Shepherd: Thanks.

Operator: The next question comes from Steven Forbes from Guggenheim Partners. Steven, your line is open. Please go ahead.

Steven Forbes: Good morning. Maybe just to start with a quick follow-up on a prior comment. As I think you mentioned you expect the most deleverage on EBIT margin in the second quarter, so can you just expand on what’s driving that? Is it comp compares? Or is there something in the margin profile that we should be aware of that you’re cycling as well?

Jeff Shepherd: Yes. I mean, part of it is inflation in terms of we expect that to moderate more in the back half than in the first half, so we’re dealing with that. And then it’s really just finishing up the availability once we get that availability where we wanted more improvement in sales in the back half than as compared to the second quarter.

Steven Forbes: And then just a quick follow-up. If we think back to the Analyst Day, the transformation margin expansion timeline exhibit, and so forth, can you just talk about whether we’re sort of progressing against that timeline or if any of these changes in the capital expenditure profile of the business or investment agenda has impacted that timeline for the supply chain transformation in any such way?

Tom Greco: Sure. Well, first of all, a lot has changed since the day we made that presentation, and the biggest thing is the competitive environment in Pro. And so, our objective is to regain momentum in our Professional business, that’s our largest business. It’s vitally important for the company. We are getting back on our front foot on the top line in Pro. We’re going to improve our availability. We’ve got to be where we need to be on the pricing and raising the bar on execution. So relative to what we discussed there, we are continuing to execute all of the margin expansion initiatives that we laid out. This is a new dynamic that we’re dealing with, and we’re going to address it directly.

Steven Forbes: Thank you. Best of luck.

Tom Greco: Thank you.

Operator: The next question comes from from UBS. Henry, your line is open. Please go ahead.

Michael Lasser: This is Michael Lasser from UBS. Good morning. Thanks so much for taking my question. Tom, so you’re well into the transformation that you started many years ago. And yet, it does seem like everything is taking a step back between margins, free cash flow generation, you needed to cut the guidance, cut CapEx. Why is this all happening now? Is it something that’s internally catalyzed or more externally catalyzed?

Tom Greco: Yes. I think it’s similar to the last question, Mike. I think it is external. I mean, obviously, the dynamic has changed on the Pro side. You would say that, that’s probably been ongoing here for the last 1.5 years anyway, and that’s a fair comment. We are addressing that competitive dynamic. I think, I’ve got a very strong resilient team here at Advance. We’ve built a great team, both in the corporate office and in the field. We faced adversity before, and we’ve overcome. And I have no doubt that we’ll overcome the challenges we face today. But we’ve got to address what’s in front of us right now, and that’s about driving operational improvement and regaining share of wallet with our Pro customers. Now we are going to continue to execute against the things that we believe will continue to improve our business that were part of the transformation timelines that we’ve discussed.

Michael Lasser: And Tom, are you seeing the challenges in your Pro business across both the legacy Advance and Carquest businesses, as well as Worldpac? Maybe a way to address that question, is can you give us a sense for how Worldpac performed in the quarter?

Tom Greco: Yes, Worldpac is doing fine. I mean, the multiyear stacks on Worldpac look terrific, so we continue to perform very well at Worldpac. Our challenges on Pro are isolated largely to the Advance Pro business.

Michael Lasser: Thank you very much, and good luck.

Tom Greco: Thank you.

Operator: The next question comes from Bobby Griffin from Raymond James. Bobby, your line is open. Please go ahead.

Mitch Ingles: Hi, everyone. This is Mitch Ingles on for Bobby. My first question is, if the competitive landscape in the Pro segment continues to be challenging and passing through price increases is not an option, what strategies or actions do you have or need to implement in order to rebuild and improve the gross margin in your Pro business?

Tom Greco: Yes, good morning. It’s — we talked a little bit about in the script about our category management process. I think that’s the single biggest opportunity that we have. It involves a pretty comprehensive proceeds category, where we’re essentially looking at sourcing shelf space, all of the things that are part of category management and will work collaboratively with our supplier partners to mutually drive sales and profit. I mean, I think it’s really important that both of us benefit from it, but that would be the single biggest driver. Supply chain remains an opportunity. Our new Chief Supply Chain Officer is getting really good momentum with his team. There’ll still be further opportunities there as well.

Mitch Ingles: Got it. Thanks, Tom. And on that subject, can you elaborate on what the supply chain headwinds were in the quarter that led to the deleverage? And what steps are taken to mitigate these going forward? And you previously mentioned on the last call about some of the consolidation opportunities in the supply chain, so any updates there? Thank you.

Jeff Shepherd: Yes. I mean, the primary deleverage point was the wage inflation that we saw for our labor in the distribution centers. We also had some deleverage of our newer DCs as we get them up to capacity, so we’ll naturally get improvement there as we get the distribution centers serving a full slate of stores. It’s a bit of an iterative process where you bring a number of stores online. It starts at a lower number until it works up to its full capacity. And once it does that, we’ll get much better leverage there, but those are the two big ones. And I’ll turn it over to Tom on the consolidation part of the question.

Tom Greco: Yes. So what we talked about is that our long-term vision for Pro is really to leverage the entirety of our enterprise assets and provide a superior customer experience. As you know, the pro margins are lower than the DIY margins, which results in natural channel mix headwind, so we’re testing variations of how we might better leverage the entirety of our enterprise assets. We talked about Toronto in our last call. We’re seeing good progress up there, and we see that as an opportunity. There’s still work to be done to optimize it, but we believe there’s potential to go further there. And the end-state goal is pretty simple, superior customer experience, accelerate the Pro growth ,while expanding margins and potentially reduce inventory, so more to come there.

Operator: The next question comes from Seth Sigman from Barclays. Seth, your line is open. Please go ahead.

Seth Sigman: Hi, good morning, everybody. So my question is mainly on investments. It does seem like there is more of a message today of investing to drive higher sales productivity, which I think is still the biggest gap versus your peers, and I think that’s both a retail issue and a professional issue. So the question is really beyond just price, are there other areas that you may still need to lean into incrementally from an investment perspective thinking about store investments, labor, et cetera? And could those investments potentially extend into next year?

Tom Greco: Yes. Good question, Seth. And you’re absolutely right. I mean, the single biggest difference between our peers and ourselves is that. They have significantly higher throughput in their boxes, so we believe we’re making — we’re obviously talking about availability. That’s an inventory investment and making sure we get more parts closer to the customer. But beyond that, we’ve already made substantial investments in our people through our field of frontline stock ownership program, so that’s a big one that we’ve already made. We’re going to continue to look for ways to drive our e-commerce business, which has been very successful. In terms of DIY, we’re actually pleased with our performance there and our relative performance. We’ve really got to get this Pro business and share of wallet within our Pro business back to where it needs to be. And from there, obviously, we’ll drive our sales per store and obviously, profit per store.

Seth Sigman: Okay, thank you. And then just to follow up on the price investments specifically. Can you help us frame how off your pricing has been relative to peers and perhaps the scope of the changes that you’re making, looking at the percent of the assortment, maybe the depth of the changes? And then stepping back, if you think about how some of your competitors have sharpened prices over the last two years, that’s also been combined with other improvements, right, in stock availability, service, some of which you’ve already talked about. But I guess, ultimately, what gives you the confidence today? I understand the gap in performance, but what gives you the confidence today to make those big changes? Thank you.

Tom Greco: Yes, we’ve seen really good progress in many of our stores and many of our categories with the actions we’re taking. We got to just continue to do what we’ve been talking about on the call, which is a kind of a back-to-basics approach of improving our availability, making sure our competitive price indices are there, and raising the bar on execution. So where we have that in place at, we’re seeing really, really strong performance, and we just need to replicate that further across the chain.

Seth Sigman: Can you just help us with the scope of the changes, maybe looking at how much of the assortment you’re actually changing?

Tom Greco: Well, we’re not changing the assortment. We’re improving availability, right? I mean, we’re increasing what we call our assortment rates and our on-hand rates. So what is designed to go into a store, 22,000 SKUs in an Auto Parts store, what do we want in the back room, so we’re improving the quality and composition of the assortment in the back room. And when we do that, we see significant improvement in our sales. I mean, the most important thing in our business, as you hear from all of us, is availability, so that’s the number 1 driver. And of course, you mentioned the investments from others, that happened over the last two years, so we’ve had to essentially replicate that investment this year in terms of making sure that we’re in line with where we need to be on competitive price by category.

Operator: The next question comes from Zach Fadem from Wells Fargo. Zach, your line is open. Please go ahead.

Zach Fadem: Hi, good morning. Tom, following up on the last question, comparing you to your peers, curious if you could talk to the structural or infrastructure differences that you believe may be having an impact that drives the lower throughput and thus the need for higher investment? And then specifically looking at your commercial business, curious to what extent the execution improvement can narrow the gap versus just having a structural difference?

Tom Greco: Yes. I mean, I think infrastructure-wise, we have the assets we need to compete. I mean, we’ve got, obviously, a large Pro business. It is different than our peers, given that we have the Worldpac business, which is fully integrated. We’ve got the Advance business. We put all of the large buildings that we can have Auto Parts in, we have over 500 of those. So we’re doing a much better job leveraging the entirety of the enterprise assets and there’s still room for improvement in that area. In terms of execution, we’re going to continue to make sure that we’re building the relationships that we have with our Pro customers. We’re making the number of sales calls we need to make with our account managers that are out there.

Bob Cushing has terrific relationships with the large strategic accounts that are going to continue to grow at outsized rates over the next several years, so we have a lot of things that we can leverage on the Pro side of the house to drive growth going forward.

Zach Fadem: Got it. And then, Jeff, a two-part question for you. First one, following up on the Q2 commentary, is there any guidepost that you can give us on magnitude with respect to Q2 comps where you’re tracking today and maybe gross margin versus SG&A? And then second, you mentioned doing a corporate restructuring in Q1. Can you help us understand the cost impact in Q1 and then expected savings and productivity for the rest of the year?

Jeff Shepherd: Yes, I’ll start with the second one first. The cost in the quarter was relatively low. It was low single-digit millions, so it was not a significant investment. We haven’t broken out the savings in the balance of the year, but we — it is sizable, and we factored that into the revised guidance. It’s something we can quite easily track. And so far, we’re measuring up against our expectations. So from that standpoint, we feel pretty good. In terms of second quarter, again, we expect deleverage both in gross margin and SG&A, probably be more in gross margin than it will SG&A, but we do expect it to be a fairly significant deleverage in the second quarter.

Zach Fadem: Got you. Appreciate the color guys.

Operator: The next question comes from David Bellinger from Roth Capital Partners. David, your line is open. Please go ahead.

David Bellinger: Hi, good morning. Thanks for the question. Going back to the DIFM price gaps, so with the changes you’ve now made, are those gaps largely closed versus your direct competitors? Are you going even further and taking price below other market participants in order to recapture some of the share that’s been lost over the past year or so?

Tom Greco: Well, first of all, David, we are where we need to be. Obviously, it is market by market, so we look at it high share market, low share market. Those types of things will influence where we target by market. But in general, we are where we need to be. And that’s what’s factored into the full year guide because that — where we need to be is significantly lower than we had planned from a price realization standpoint, so that’s where we are.

David Bellinger: Okay. And then a follow-up in regard to Professional sales in general. There’s been some concern around certain end customers shifting suppliers. Can you help us understand the breakdown of, I believe, it was a flattish Pro sales comp this quarter. Maybe you can talk about average spend per customer in light of the inflation benefit versus any customer losses that occurred within the Q1 period?

Tom Greco: We are seeing growth in average spend per customer, which is good. It’s not where we’d like it to be. We want it to be higher because we want to recover. The biggest challenge we faced last year was share of wallet with existing customers. I mean we’re now growing customers. The share of wallet is the opportunity that we’re driving at, and we are growing average sales per customer, but it’s not where we like it to be.

David Bellinger: Got it. Thank you, Tom.

Tom Greco: Thank you.

Operator: The next question is from Seth Basham from Wedbush. Seth, your line is open. Please go ahead.

Seth Basham: Thanks a lot. And good morning. My question is also around the pricing environment. As you forecast improved performance on sales for the balance of the year, are you anticipating any competitive reaction pricing-wise?

Tom Greco: Yes. We’ve obviously considered different scenarios, Seth. We do expect it to be very competitive, so Jeff mentioned essentially flat on price realization, which is well below our plan. If that changes to the positive or the negative, we will respond.

Seth Basham: Got it. Understood. And my follow-up question is around private label brand performance. Can you give us some more color on the overall performance for private label brands? You mentioned that you’re still moving in the direction of private label brand or are you having pockets where you’re having to roll back some of that new products because of underperformance?

Tom Greco: On the contrary, I’ve been in a lot of stores over the last several weeks. I’ve met with a lot of customers. People like the quality of our Carquest branded product that we’ve moved to. So we’re very pleased with the products, and we’re continuing to improve the assortment rates in the stores and availability of those products. But clearly, we’ve got a winner in terms of the product quality itself. The return rates are much lower. The manufacturers we have chosen are OE suppliers so very pleased with that.

Jeff Shepherd: And just to add to that, we’re seeing a benefit in the P&L from own brand in terms of both dollars and rate, so it’s executing well. We want to continue to push that product through because it’s a benefit to the P&L as well.

Seth Basham: Thank you.

Operator: The next question is from Michael Baker from D.A. Davidson. Michael, please go ahead. Your line is open.

Michael Baker: Okay. Thanks. So it sounds like you got to where you needed to be in terms of price within the first quarter. Did you see any improvement in your sales trends as you did that or even I think we’re, what, four, five weeks, at least into the second quarter, are customers reacting at all to your — getting closer to the other guys in price? Or if not, how long does that typically take, particularly in an industry where, because everyone said, it’s not really driven by price?

Tom Greco: Yes. Good morning, Mike. We are. Our customers are definitely responding. We moved — I mentioned earlier, we were down mid-single digits on transactions in the fourth quarter. We were down low single digits on transactions in the first quarter, and we expect that to continue to improve. What’s being offset there, if you talk about sales and comp is the average ticket is coming down with that as we continue to drive our units and transactions, we’re seeing average ticket come down.

Michael Baker: And so even with that still coming down, you’re not — it sounds like you’re not going to invest any more in price, at least unless others respond, so how do you intend to then win back share if the pricing is now where you think it needs to be?

Tom Greco: We feel we are — we will win back share because we are seeing improvement as time goes on, on units and transactions. So as our assortment rate and availability improves, we’re seeing improvements there, so we do believe that will continue as the year goes on.

Michael Baker: Okay. Okay. Fair enough. Thank you.

Operator: The next question comes from Brian Nagel from Oppenheimer. Brian, your line is open. Please go ahead.

Unidentified Analyst: This is on for Brian Nagel. Thank you for taking my question. So you mentioned that the structural underpinnings of the sector remained positive in your view. You highlighted the aging fleet, an improving miles driven. Just wanted to ask, have there been any changes to your view of near-term demand trends in the industry at all?

Tom Greco: Not really. I mean, if you look — I mean I know there’s been things written over the last several weeks or so about that. I mean we still see the industry growth at 3% to 5% this year. Based on those, as you said, underlying primary drivers of demand all continuing to improve, you’re still seeing pressure on new car sales. You’re seeing people keeping the vehicles longer that’s typically been very good for our industry, so we see 3% to 5% growth this year.

Unidentified Analyst: Thank you. That’s helpful. Good bye.

Tom Greco: Thank you.

Operator: We have no further questions, so I’ll hand the call back to Tom Greco for any concluding remarks.

Tom Greco: Well, thanks again for joining us this morning. As I shared at the outset of the call, Q1 was challenging and our financial results were well below expectations. We know there’s work to do, and we remain focused on increasing parts availability, sustaining our competitive price targets and improving our field execution. We’re committed to executing our long-term strategy to overcome our recent challenges and ensure that Advance is positioned for future success. We look forward to sharing more in August.

Operator: This concludes today’s call. Thank you very much for your attendance. You may now disconnect your lines.