Advance Auto Parts Inc.

Welcome to the Advanced Auto Parts Fourth Quarter 2018 Conference Call. Before we begin, Elizabeth Eisleben, Vice President, Investor Relations, will make a brief statement concerning four looking statements that will be discussed on this call.

Good morning, and thank you for joining us to discuss our fourth quarter and full year 2018 results. I'm joined by Tom Greco, our President and Chief Executive Officer, and Jeff Shepard, our Executive Vice President, Chief Financial Officer, Controller, and Chief Accounting Officer. Following their prepared remarks, we will turn our attention to answering your questions. Before we begin, please be advised that our comments today may include forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. While actual results may differ materially from those projected in such statements due to a number of risks and uncertainties, which are described in the risk factor sections in the company's filings with the Securities and Exchange Commission, we maintain no duty to update forward-looking statements made. Additionally, our comments today include certain non-GAAP financial measures. We believe providing these measures helps investors gain a more complete understanding of our results and is consistent with how management views our financial results. Please refer to our quarterly press release and accompanying financial statements issued today for additional detail regarding the forward-looking statements and reconciliations of these non-GAAP financial measures to the most comparable GAAP measures referenced in today's call. The content of this call will be governed by the information contained in our earnings release and related financial statements. Now, let me turn the call over to Tom Greco.

Thanks, Elizabeth. Good morning, and thank you for joining us today to discuss our fourth quarter and full year 2018 results. This was an exciting year for Advance, and I want to personally thank the entire Advance team and our network of CarQuest independents for their unwavering commitment, focus, and dedication to deliver meaningful progress toward our long-term strategic objectives throughout the year. In the fourth quarter, net sales increased 3.3% to $2.1 billion, and comparable store sales were up 3.4%. Our adjusted operating income margin of 6% increased 45 basis points compared to the prior year quarter, and our adjusted earnings per share increased 51.9% to $1.17%. Regarding our full year 2018 performance, our net sales increased 2.2% to $9.6 billion, and we delivered a 2.3% increase in comparable store sales, our strongest annual growth rate since the acquisition of GPI. Adjusted operating income margin increased 51 basis points year over year to 7.8%, and our free cash flow was $617 million, an increase of $206 million year over year. Jeff will speak to our financial results for the quarter and the full year in more detail shortly. The continuous improvement we delivered throughout 2018 would not have been possible without our more than 70,000 team members truly living our cultural beliefs every day and reinforcing our mission, passion for customers, passion for yes. The hard work we've completed to date is building the foundation we need to win over the long term. Specifically in the fourth quarter, I'm very pleased with the consistent balance improvement throughout AAP on nearly every metric. Both our north and south divisions delivered positive comp sales with geographical growth led by our mid-Atlantic, Carolinas, Gulf Coast, Appalachian, and northeast regions. From a category perspective, we saw strong sales in brakes, engine management, oil and filters, and undercar. As we discussed last quarter, we're seeing meaningful improvements in key metrics across the enterprise, driving growth in both our professional and DIY businesses. In the fourth quarter, for the first time in recent history, our DIY business outcompt the professional business as our omni-channel initiatives continue to strengthen our customer value proposition and for DIYers. Turning to professional, we delivered growth across all professional businesses in both the fourth quarter and full year 2018, led by growth in WorldPack and our CarQuest independents. We remain focused on our commitment to deliver a best-in-class experience for our professional customers. With this objective front and center, we're building new capabilities to strengthen our partnerships with customers. ensuring future success for both their business and AAP. For example, with the launch of our unified professional portal My Advance in August, we're integrating multiple formally disparate online tools in a one-stop shop. This includes our advanced pro catalog, e-services suite, training resources, customer support, and many other value-added tools for professional customers. As a result, Usage of this platform increased over 50% in Q4. This unique advanced tool differentiates us from our competitors and provides a single location for our industry-leading product assortment as well as training and business solution advice. Expanding on our DIY omnichannel performance, we made significant investments in our online engagement and fulfillment platforms to further enhance the customer experience. We improved customer engagement by increasing page load speed streamlining search capabilities, and increasing customizations based on customers' vehicles and search inputs. We're also leveraging artificial intelligence and machine learning tools to improve our online attachment selling as well as product assortment. The significant investments we're making in our website are enabling improved customer confidence and that they are getting the right part for the job. If they buy online and pick up in-store, Our knowledgeable team members are available to provide trusted advice to our customers and ensure they have the complete and correct parts to get the job done. Aligned with our omnichannel focus, we're excited about the progress we've made with our recently announced Walmart partnership, which will significantly extend our reach to DIY customers and help drive market share growth for AAP. We've appointed a senior leader to lead the partnership, And we're building a talented team to work together with our Walmart partners to launch and grow this business. We're off to a strong start with the AAP and Walmart team members working well together and focused on delivering a compelling value proposition for DIYers. We're on track to begin rolling out our plans in the first half of this year. This will include the launch of a broad assortment of our industry-leading parts. Customers will be able to have the parts shipped to their home in the first phase of the rollout, while phase two will enable buy online and pick up today in an advanced store. Finally, last year we introduced three key elements of our end-to-end supply chain and footprint optimization strategy. First, a market-by-market approach to drive share. Second, repurposing our in-market store and asset base. and third, optimizing our distribution centers. Overall, I'm pleased with the progress we've made to improve our footprint over the last year. We're improving share performance through a market-by-market approach, which in 2018 included 14 new WorldPAC branch openings. We expect to continue this momentum in 2019 to further strengthen our customer value proposition and gain share. In addition, We closed and consolidated 101 stores during 2018. Consistent with previous quarters, we're approaching store closures very differently than in the past. Most importantly, our team is laser-focused on retaining our top-performing team members and ensuring that we maintain sales through the transfer to other AAP locations. Regarding optimizing our distribution centers, I'm pleased with our team's successful execution in closing our Gallman and San Antonio distribution centers in 2018. We're in the process of closing our Columbia, South Carolina distribution center and are on track to complete this in the first half of 2019. We're thrilled with Ruben Sloan joining our leadership team as we continue to make progress on supply chain. While we have significant opportunities to improve supply chain executions, we did increase transparency and collaboration between supply chain and other functions such as store operations and merchandising. We also rolled out new tools and technology in the fourth quarter, including our delivery dashboard, which leverages telematics and improves accuracy and reliability of pro-delivery for our customers. In summary, I'm confident in the supply chain team's ability to further improve execution in 2019 and deliver on our long-term goals, including the optimization of our entire distribution network. Finally, I'm pleased to report we published our inaugural Corporate Sustainability and Social Report in December and posted it on our website. This report highlights our progress in three primary areas within our ESG agenda, people, planet, and community. Once again, we made progress on people and culture in 2018 as we further increased diversity representation in leadership roles. We continue to invest in frontline team members through our Fuel the Frontline incentive program with more than 15,000 grants to date. Fuel the Frontline remains a unique program within our industry and broader retail. There's no question that this has been a driver of increased retention of our top performers in key store operations positions. We also appointed a world-class environmental health and safety leader, Mike Miller. Mike's built a talented team and launched several safety initiatives driving meaningful improvements, including a 10% reduction in the number of reportable incidents and an additional 13% reduction in our collision frequency rate. In terms of environmental, we reduced our greenhouse gas emissions by 7%. Long term, we expect our environmental health and safety agenda will drive significant productivity. In terms of community, we elevated our involvement in our communities by playing leadership roles in national organizations such as JDRF, the American Heart Association, and Building Homes for Heroes, an organization who constructs new homes for veterans and their families returning to the U.S. While we've delivered progress in each of these critical areas to date, we recognize we have a responsibility to do more. I look forward to continuing our momentum and sharing future updates on these efforts. In summary, performance improvements across the enterprise in 2018 translated to accelerated growth. As we've said previously, we continue to be encouraged by the improving macro indicators for the auto parts industry. and are confident in our ability to deliver top-line growth, margin expansion, and strong cash flow in 2019. With that, I'll turn it over to Jeff for details on our financial performance and our 2019 outlook.

Thanks, Tom, and good morning, everyone. I want to begin by thanking the entire Advanced team for their dedication throughout 2018. In Q4, the team's discipline enabled meaningful improvements across the business, our adjusted gross profit was $930 million, an increase of 6.4% from the prior year quarter. On a rate basis, our adjusted gross profit margin of 44.2% improved by 127 basis points from the prior year quarter. The drivers of this increase were the result of productivity initiatives, including MCO, inventory efforts to better position existing inventory throughout our supply chain, and reduced shrink. These improvements were partially offset by commodity and tariff headwinds versus the prior year quarter. The good news is we've seen minimal impact on units as a result of commodity and tariff-related cost increases. And to date, we've been successful passing on any increases through pricing actions. We continue to work closely with our supplier partners to negotiate pricing and minimize impacts to our customers. Our adjusted SG&A was $802 million in the fourth quarter. an increase of $43 million year over year. As a percentage of net sales, our adjusted SG&A increased by 82 basis points to 38.1%. The majority of this increase was driven by higher bonus expense, which we expect to normalize in 2019. We also increased spending related to our new marketing campaign, including an acceleration of digital capabilities. Additionally, Our last-mile delivery expenses were higher due to increased fuel and transportation expenses, which include increased costs related to cross-banner visibility. While this capability is clearly enabling stronger top-line performance, we have significant opportunity to improve efficiencies. And finally, third-party services and contract fees were higher in the quarter, directly correlated to the increased capital spend. These headwinds were partially offset by further reduction in our insurance and claims expenses due to improved safety performance, as well as lower rent and occupancy costs. Adjusted operating income in the fourth quarter was $127 million, an 11.7% increase from the fourth quarter of 2017. Our adjusted operating income margin increased 45 basis points to 6% in the quarter. Consistent with the quarterly ramp in capital spending throughout 2018, our capex in Q4 was $89 million, bringing our full year spend to $194 million. More than 65% of Q4 spend was related to information technology and supply chain projects. Our IT initiatives include critical system investment, addressing long-standing integration opportunities and lack of capabilities. We've officially started the integration of all banners and moved to a single payroll system on January 1st. Our finance team also launched our ERP project to integrate our back office systems, which will happen over the next two years. As Ruben and his team worked to improve existing supply chain operations, we invested in network upgrades, including wireless access and handheld scanners to improve accuracy and efficiencies within the distribution centers. For the full year 2018, net sales were $9,581,000,000, an increase of 2.2% compared to 2017. And comp sales were 2.3%, a significant improvement over our 2017 performance. Adjusted gross profit for the year increased 3.5% to $4.2 billion. And adjusted gross profit margin increased 53 basis points to 44.1%. Adjusted SG&A for the year increased 2.3% to $3.5 billion. On a rate basis, our full-year adjusted SG&A was 36.3%, which was flat year-over-year and in line with previously discussed expectations. We delivered a 9.3% increase in adjusted operating income for the full year to $750.2 million. Adjusted operating income margin was 7.8%. an increase of 51 basis points. Full-year operating cash flow increased by $210 million to $811 million, and free cash flow improved by $206 million to $617 million. Because of several factors, we increased inventory more than originally planned in 2018, resulting in free cash flows slightly below our November projections. The primary drivers for the increase year over year, in addition to higher sales, were first, as we are beginning to implement dynamic assortment, we found some gaps in our current coverage. Consistent with our commitment to putting the customer first, we increased inventory purchases in Q4 to mitigate these gaps and potential risks to the successful rollout of dynamic assortment in Q1. Dynamic assortment will significantly improve how we forward deploy inventory and and expect that when fully implemented, will enable higher terms. Second, as sales trended higher, we were focused on improving store in-stocks, resulting in higher purchases to ensure replenishment capabilities throughout our supply chain. Third is related to 14 new WorldPAC branches that were opened in 2018, as well as purchases to support planned openings in the first quarter of 2019. With all that said, we remain committed to optimizing our inventory over the next several years while maintaining our customer-first focus and improving our assortment across the enterprise. Our disciplined approach to managing cash and delivering on our capital allocation priorities this year resulted in an AP ratio of 72.7% to end 2018, an improvement of 329 basis points year over year. In addition to this notable progress, we delivered a 13.8% return on invested capital, which was a 90 basis point improvement compared to the prior year. In line with our financial priorities to maintain an investment-grade rating, invest in the business, and opportunistically return capital to shareholders, we repurchased $153 million worth of advanced stock during the fourth quarter. We're confident in our ability to generate cash flow from the business and committed to the opportunistic return of cash to shareholders. As such, subsequent to year-end, we repurchased $127 million worth of advanced stock at an average price of $159.65. Our guidance and forecasts do not include any additional repurchases at this time. Additionally, last month we announced the early redemption of our $300 million 2020 notes using available cash on hand. We're confident in our ability to generate cash flow from the business and drive shareholder value while keeping to our financial priorities. We are pleased with what we were able to deliver in both the fourth quarter and full year, but recognize that we still have work to do to capitalize on the significant opportunity ahead. As we continue the disciplined execution of our strategic objectives in 2019, we're confident we will deliver further improvements this year. In 2019, we expect to deliver net sales of $9.65 to $9.8 billion, with comparable store sales in the range of 1% to 2.5%. We expect adjusted operating income margin expansion in a range of 20 to 60 basis points, which includes operating expenses related to a continued rampant investment in IT, supply chain, and marketing, in a range of $80 to $120 million in 2019. We estimate our CapEx in the range of $250 million to $300 million this year, of which more than two-thirds is focused on technology, e-commerce, and supply chain investments. In line with our continuing transformation agenda in 2019, we estimate integration and transformation expenses of $80 to $100 million this year, which includes approximately $15 million related to further optimization of our store footprint. Our 2019 tax rate is expected to be 24 to 26%. Finally, we remain disciplined in our cash management and focus on improving cash flow. For 2019, we expect to deliver minimum free cash flow of $650 million. In summary, from a financial perspective, We're pleased with where we ended 2018, but as Tom said, we need to continue our momentum and remain laser focused on flawless execution in the short term while making the appropriate investments in both CapEx and OpEx to deliver our long-term objectives. We're optimistic about 2019 and look forward to sharing future successes as we continue executing our strategic plan. With that, let's open it up to addressing your questions. Operator?

Thank you. Ladies and gentlemen, if you wish to ask a question at this time, please press star, then 1, or your touch-tone telephone. If your question has been answered or you wish to move yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from Simeon Goodman with Morgan Stanley. Your line is open.

Hi, guys. This is Zeon Siu. I'm for Simeon. So guidance sounds maybe a little bit conservative, and you've talked about mid-teens even margins over time, which would represent significant gains from here, you know, a range of 20 to 60 is encouraging. But we were just kind of wondering, is the journey maybe going to take a little bit longer to reach over time, or should we expect faster progress at some point soon?

Well, good morning. We feel pretty good about the progress we made in 2018 in driving top-line growth and expanding margins at the same time. This is something that the old AAP had difficulty with, and we're happy that we were able to do both last year. The productivity focus in 2018 drove margin expansion in 2018, and we feel that the material cost optimization, supply chain productivity, and zero-based budgeting will continue to help us with the productivity. There are some offsetting investments in 2019 which will limit margin expansion, and we feel these investments are critical to our success, and they're going to really differentiate us over the long term. They'll do one of two things. They'll either unlock future cost savings or drive top-line growth. And in our prepared remarks, you heard Jeff talk about a range of $80 million to $120 million of op-ed investment in 2019. That by itself is around a full point of margin expansion in 2019 that we're reinvesting back in the business in order to drive long-term growth. They're focused in three areas, the OpEx investments. First of all, technology and e-commerce. Secondly, in our people, primarily in supply chain. And third, in marketing. And I'm happy to go deeper into each of these areas, but the net of it is, in 2019 will drive significant productivity and expand margins and drive our top-line growth while making important necessary investments to drive the long-term growth of the company.

Thank you. And then just to follow up on that, can you just remind us where the biggest upside will come from, you know, longer term? What's the biggest kind of opportunity? Is it inefficiency on the margins or more of the sales productivity?

Well, we obviously have both. I mean, we think we can drive shareholder value through a combination of performing at or above the rate of growth of the industry, which is very healthy right now in that 3% range. And we also believe we can drive significant margin expansion. So both of those play a key role in the overall trajectory of our financials.

Okay. Thank you.

Thank you. Our next question comes from Chris Horvath with J.P. Morgan. Your line is open.

Thanks. Good morning, guys. Can you talk about the margin guides for this year? How should we be thinking about the cadence? Do you think it's going to be more front half versus back half weighted? You'd have to annualize some investments and expenses from last year, this past year as well. And in terms of the components, how should we think about gross margin leverage versus SG&A?

Yeah, hey, good morning, Chris. You know, we think overall for the year, you know, the margin is going to be, we're going to see, you know, steady improvement throughout the year. In terms of the margin breakdown between SG&A and gross margin, you know, we think we're going to be flat on a rate basis on our SG&A. So as you recall, in 2018, we came in at 36.3%. And right now we're modeling with those OpEx investments that we talked about, in both prepared remarks and the color we just gave on the previous question, that that will keep us flat on a rate basis. So that's the way we're thinking about it.

Understood. And then in terms of the share repurchase opportunity, you know, can you sort of square up how you think about that use of free cash flow? You have the debt pay down coming, $300 million in the first quarter. How do you think about the opportunity for share repurchases in 2019?

Yeah, and just to remind you, our capital allocation priorities have remained unchanged from 2018, which is to maintain that investment grade rating, reinvest in the business. You know, we talked about the increase in the capital expenditures we expect in 2019, which is going to be a range of $250 to $300 million. And then opportunistically repurchasing shares or giving excess cash back to our shareholders. You know, since we had our revised repurchase plan, we repurchased $400 million worth of shares, and we're going to continue to be opportunistic with that. We don't have anything in our guidance currently, but we're going to continue to be opportunistic and look at those opportunities to return excess cash to our shareholders.

Understood. And then in the last question, You know, Tom, can you talk about how you're thinking about the supply chain integration? You have multiple phases, I think three phases going on currently. How do you think about the time to complete those different supply chain projects? Thank you.

Sure, Chris. Well, Ruben Sloan, as you know, came in in the fourth quarter, and Ruben was on our board. You know, he's brought a – a new dimension to our thinking. He was very familiar with what we were doing. I think he's really building momentum to ramp up execution in our supply chain. He's focused on a very rigorous standardization of the core processes. So it's important to note that I feel really good about the progress we're making on the execution, just the basic blocking and tackling within our supply chain. The three big elements of our supply chain strategy haven't changed, to your point. The first one is building a market-by-market DMA plan. And I think, you know, we've completed a thorough review of every market in the country. We plan to leverage really the entire enterprise's supply chain infrastructure. The goal here is to drive share, obviously, expand our margins, drive cash flow for each market based on the size of the opportunity going forward within our existing footprint. Secondly, you've heard us talk about DC optimization. We have more DCs than we need. We're in the process of executing a pretty disciplined plan to optimize the network. We completed the closures of our Goldman in San Antonio, DC at the end of 2018, and we're on track to close our Columbia, South Carolina, DC during the first half of 2019, and you'll see us continue this optimization work going forward. Finally, in terms of our in-store, In-market store and asset optimization, this is also well underway, and it's performing very well. Here we look at the entirety of the in-market asset base, including advanced and car quest VCs, advanced super hubs and hubs, world pack branches, auto part international stores, and, of course, our advanced and car quest stores, both corporate and independent. And once we're clear on what the entirety of this asset base is and how to best assort and connect these assets, we then look to optimize. And with this as a backdrop, we did a great job executing store closures last year. We're exceeding the goals we established across the board. And in 2018, we closed and consolidated 101 stores and opened about 14 WorldPack branches. So we plan to take a similar approach in 2019. and I feel really good about how we're executing, and I'm confident it's going to get better under Ruben's leadership. Thank you.

Thank you. Our next question comes from Michael Lesser with UBS. Your line is open.

Good morning. Thanks a lot for taking my question. As you look out over the longer run, do you expect the DIY and DIFM business to be more similar in terms of growth rate? Why do you think what drove the difference this quarter?

Well, first of all, from an industry standpoint, Michael, we expect professionals to outperform DIY. The industry leading indicators are really strong this year, as you know. You know, the big ones that we found, GDP being positive, the car park is going to go up, vehicle miles driven is growing. And then, of course, vehicles in the sweet spot is the big one that we're seeing growth this year. We'll be up a couple of points this year on vehicles in the sweet spot. Of course, that's vehicles in that 6- to 11-year-old population. And that's a real positive for the industry overall. That number, as you know, was down in 2017 and then roughly flat last year. So we're seeing a positive trend in the vehicles in the sweet spot, and that tends to benefit the professional side a little bit more. Obviously, with cars getting more complicated, that benefits the professional side. So we expect professionals to grow a little bit above the rate of growth of DIY, call it 4% to 5%. and DIY in the low single-digit range. All that said, we're really pleased with the performance of our DIY business in the most recent quarter. It is the first time, as we said in our prepared remarks, that DIY out-comped our professional business. You know, our advertising, Think Ahead, Think Advance, helped us for sure. Our field team is executing well in the stores. We're driving units per transaction, and obviously the omni-channel effort is helping us. So, All of those things are helping our internal performance on DIY. On a macro level, though, we would expect professionals to perform higher than DIY over time, and that's how we've modeled our own business as well.

To start the quarter, the weather's been really funky. Can you give us some sense in how the business has performed quarter to date?

We feel great about where we are year to date. Obviously, it's winter, and it's been volatile. The tax refunds are a little bit late, but we clearly like our performance on a year-to-date basis. And I really like the progress on our execution. If you consider, you know, our professional business, we're seeing our close rate go up. You know, our cross-banner sourcing continues to gain momentum. On the DIY omni-channel side, we continue to drive awareness through think ahead, think advanced. We've seen a nice uptick there. And then, you know, we're getting better at managing the cost side of things as well. So all of those things are positive for us on a quarter-to-day basis. Thank you so much.

Thank you. Our next question comes from Scott Ciccarelli with RBC Capital Markets. Your line is open.

Good morning, guys. Scott Ciccarelli. Question about the incremental OPEX you guys outlined. Do you envision the investments that you highlighted – as really just a 2019 event, or is it recognition that you need to continue to invest in the business to position it where you want it to be over the longer term?

Let me start, and I'll kick it over to Jeff to talk about the longer term. But first of all, in 19, there's a couple of areas that we're investing in, Scott. If you talk about technology and e-commerce, that's by far the biggest investment that we're making. It's over half. examples here are largely integration related. So getting to one payroll system, getting to one back office system, getting to a single warehouse management system. These are large technology related platforms that we're implementing across the enterprise and really simplify the business and reduce complexity in our cost base. In these cases, we have IT OpEx expense in 2019 without the commensurate cost takeouts as we design and implement the new systems. So we fully expect to remove these costs sometime in the future, obviously when we're able to retire the old way of doing things, whether that's our payroll or our ERP system. Secondly, in terms of people, you'll recall we had a crisis in terms of turnover in our frontline organization and store operations a couple years ago. We've now addressed that. Our turnover is down. And this year we're making a similar wage investment in our supply chain team to do the very same thing in our distribution centers to drive the turnover down there. And then third, in marketing, We've been building our brand both in DIY and professional. I talked about the advertising campaign. As we continue to see the marketing campaign drive our comps and obviously lift our sales growth above the industry average, we're going to continue to invest. If we don't like the returns there, we can certainly meter it back. But these three areas represent the vast majority of our OpEx investment in 2019. And I'll let Jeff talk a little bit about the future.

Yeah, sure. And just in terms of you know, that detail that Tom just provided, some of those clearly have, you know, longer tails than others, but we do think this type of investment we're going to see not only in 2019 but also in the 2020, and then we would expect these to normalize after that.

Got it. Okay, very helpful. And then just a housekeeping item, can you tell us what the impact of inflation was in the fourth quarter?

Yes, about two points on a per-unit basis, Scott. Got it. Okay. Thanks, guys.

Thank you. Our next question comes from Dan Weaver with Raymond James. Your line is open.

Thanks. The first question I have relates to transformation charges. How many additional years beyond 2019? will you continue to set up a line item for this? And does it continue until the company reaches that 14%, 15% EBIT rate?

Yeah. Hey, Dan. In terms of the transformation, you are seeing it start to ramp down. But, again, as we continue with the integration we just talked about on some of the previous questions, we're certainly going to see it in 2019, and I would expect to continue to see it into 2020. You know, after that, I think it would be fairly de minimis at that point.

So then a second question, you talked about the acceleration in your do-it-yourself revenues exceeding commercial. I know that you seem to be a little more aggressive with the 20% off promotions on your e-commerce offer. Can you talk about what that's contributed to your do-it-yourself sales growth?

Well, we're certainly seeing strong growth in our e-commerce business. About 70% of the transactions, whether they're DIY, online, or retail, Dan, start on a mobile device now. So you really have to be there for the customer when they're doing their initial searches and investigating what they need to do for the job. So we're very excited about that. We've made a lot of progress improving the quality of our website, the page load speeds, all of those key variables. And it's going to be an omni-channel effort. That whole journey involves online search each time. So we're going to continue to drive our online business. We're going to continue to drive our retail business. When the customer gets there, we're going to make sure they have all the parts they need. It's essentially adapting to really leveraging our asset base, including our online assets and our physical assets in the stores.

Doug, you sound really excited about the Walmart partnership. Can you discuss how that benefits your guidance for 2019 for sales and for operating margin rates?

Yeah, well, first of all, you know, the guide itself, you know, we believe this is going to be a great year for the industry and for AAP. So, you know, clearly, you know, we want to see an acceleration of our performance versus last year. Walmart, the initiatives that we have for Walmart, as we said in our prepared remarks, really kick in, you know, towards the back end of this year. There's a couple of phases. You know, the first phase is really to put a broader assortment of parts onto the Walmart website for ship-to-home purposes. And then the second phase is to get really stand-up, what we call pick-up today, where the customer can enter into the Walmart website. It'll be a branded online presence that we'll have there on the Walmart website, and they'll be able to pick up the part in an advanced store, and that'll be towards the back end. So there isn't A lot of incremental sales contemplated, Dan, in that sales guide. You know, we believe that will be all upside to the sales guide we have.

Okay. Thank you.

Thank you. Our next question comes from Brian Nagel with Oppenheimer. Your line is open.

Hi. Good morning. Thanks for taking my question. Congrats on a nice year. I've got maybe a couple questions. First off, just from a bigger picture perspective, you know, Your comments here and then obviously a lot of indicators throughout the industry have suggested a nice and improving tailwind within the business. If that happens and you're looking at your turnaround or your efforts, do you have an opportunity to accelerate your efforts or would you more or less let the tailwind from a sales perspective fall to the bottom line?

Well, it's a good question, Brian. I mean, clearly, there's a high fixed cost base that we have that incremental sales helps us a lot. So we're going to make sure that we're making the investments we need to make for the long term. As we said a few minutes ago, there are a couple of areas that we feel we have to address. And eventually those costs come out in pretty big chunks. If you think about, you know, getting to a single payroll system, we currently have four. We've moved to a new payroll system. We need to retire those old systems. Getting to a single ERP system, we currently have four of those. We want to get to a single system there and retire those systems. So all of the investments we're making this year in the technology space largely pertain to the simplification and the integration of the company. on the other side of the coin, we're driving the top line. The top line is very important. We want to be competitive in the marketplace. We want to strengthen our customer value proposition, whether that's on the professional side or on the DIY side. And there are some things that we're doing there to drive our business. We believe that the things that we're doing are making us much more relevant. I think if you look at the back half of last year at our actual performance, it was strong relative to the industry, and that's the goal on an ongoing basis. So, you know, we're going to continue to drive the top line hard. To the extent that we exceed the sales guide that we've provided this year, we'll make those decisions as they come. But, you know, clearly the industry backdrop is very good. We feel very good about where we are on a year-to-date basis, and we're going to continue to make those decisions as they come along.

That's very helpful. The second question I had is, You had mentioned in the prepared comments that the dynamic assortments in your efforts on inventory. So with that, a couple questions. One, is inventory where it needs to be now or should we expect to see a continued build from here? And then second, is there a way to look at this effort and maybe parse out just in and of itself how much that has held back sales? So to the extent that we get inventories into a better position, That, again, alone should be a driver of sales?

Well, first of all, you know, we clearly see opportunities to continue to optimize and reduce our inventory. You know, there's a couple of things that we're doing there, Brian. We plan to start the implementation of cross-banner replenishment between CarQuest and Advanced in the back half of 2019. So essentially, when that's completed, we'll be able to ship parts from legacy advanced distribution centers to legacy CarQuest stores and vice versa. Obviously, this will enable us to reduce stem miles and further optimize inventory throughout our DC network. Secondly, we're also integrating the WorldPak and AutoPart International supply chains, and those two supply chains are starting to come together. We're assorting together. Bob Cushing is leading all that work. So you think about those first two big work streams, cross-center replenishment and advancement, CarQuest, and then, of course, WorldPacketAI. As those two big initiatives are completed, we're moving from four supply chains down to two. So that should help us reduce inventory. Now, you mentioned dynamic assortment. What we're learning there, And I think you know this. We've evolved from the old way of assorting, which we used to call probability to sell, to a new way of sorting that is founded in machine learning tools called dynamic assortment. And this is showing us that we can actually increase our turns throughout the supply chain by replacing slow-turning SKUs with more relevant faster-turning SKUs. you know, pretty basic stuff. But we're very excited about the early returns on dynamic assortment, and you're going to continue to see us optimize our inventory going forward. And I think, you know, your point about have our sales been held back a little bit because of our inventory assortment, I think the answer to that question is yes. You know, because as we make these changes, we're seeing the close rate go up. So just by, you know, essentially using the dynamic assortment tool that we have you know, changing out the assortment we have in a category like spark plugs or anything else, we're definitely seeing the close rate improve. So we see opportunities there.

All right. I appreciate all the color. Thank you.

Thank you. Our next question comes from Seth Basham with Wet Bush Securities. Your line is open.

Thanks a lot, and good morning. My first question is around the comp trends in the fourth quarter. Could you give us a little bit more color as to the degree of outperformance of DIY relative to DIFM? Was it, you know, 20, 30 basis points, or was it 200 or 300 basis points?

Yeah, it was pretty slight, Seth. You know, we don't break that up specifically, as you know, but it was slightly higher. You know, the trends through the quarter were similar to what you've heard from others. You know, our period, 11 and 12, which is essentially October, November, was strong, and December slightly positive. So, you know, not as strong as November and but slightly positive in December. So, you know, but the comparative of DIY and pro was relatively similar.

That's helpful. And as you think about the drivers behind that inflection of DIY outcomping pro, was it more the market, weather, et cetera, or was it more around some of your initiatives with advertising or something else?

Well, we definitely feel we're performing better in DIY on the channel than we had been. Obviously, we do see some syndicated data on that topic that would corroborate that. I do think that we're executing better in the stores. I think that the advertising health, we see the awareness numbers. They went up nicely. They're still way too low in our view, but the awareness numbers did go up behind the new advertising numbers. Our buy online, pick up in store execution is improving. All of those things are factors. I think our relative performance is stronger in DIY and I think that's why we're performing better.

Got it. Just one last housekeeping question. You mentioned the impact of inflation in the fourth quarter, but what is it embedded in your guidance for comps in 2019?

It's similar to what we said. On a per unit basis, it's It's a couple of points, obviously, that, you know, there's still some uncertainty there, Seth, surrounding tariffs. But, you know, based on what we see today, that's what we have in there. Thanks a lot, and good luck.

Thank you. Thank you. Our next question comes from Brett Jordan with Jefferies. Your line is open.

Hi, good morning. Yeah, on that inflation question. On the inflation question, I guess it sort of seems that maybe we're expecting a couple of points of inflation in 2019, and that's you expect inflation to represent the majority of your comp and you're not really seeing a lot of unit pickup, or maybe some better color on that. Well, you know, I mean, again, I think, Brad, you know, our guide itself is in line with our full year performance last year. I can tell you that everybody in the company is focused on exceeding that sales guide. We think it's going to be a strong year for the industry and for Advance for all the reasons that I've said. I think from our standpoint, we're building our fixed cost base around the sales guide as we did last year. Our goal is to exceed that sales guide. And all we're trying to do is make sure that we're able to deliver the overall financials of the company. So the goal is to beat the sales guide. Okay. And then a question on the Walmart relationship. Is picking up at Walmart not going to be an option? Are you either going to ship to home or pick up at Advance? At some point, we do plan to have it available to pick up at Walmart. We're rooting this entire partnership in the customer, and what the customer wants is what we're going to do. So we're going to make it as easy as possible for the customer. Obviously, we do believe that the convenience of coming into an advanced store is an advantage, along with the trusted advice that our employees can provide. But, you know, Walmart's been a terrific partner on this. And, you know, they've got a great leadership team. We're excited to work collaboratively with them. We've got one of our top people, Nicole Jeffries, is working on this initiative. She's dedicated to the partnership. She's building out the plans. And I know the Walmart team is very excited about it. So more to come. Where do you see that relationship going? impact on margin being in 2019? Obviously, you've got some costs built into the development as well as maybe some revenue share with Walmart, but have you sort of carved out how much that might cost you on the front end? We haven't broken that out, Brett. I mean, obviously, we're going to do this in a thoughtful way and do it in a way that has a positive impact on our overall financials.

Okay, great. Thank you.

Thank you. Our next question comes from Chris Botteglieri with Wolf Research. Your line is open.

Hi, thanks for taking the question. So I'm hoping that you could update us on the material cost savings, you know, how far along are you in that process? And then as we think about kind of the impact of inflation, you know, in 2019, how do those conversations change in this type of environment? Would you still expect to get those benefits?

Yeah, sure, Chris. You know, in terms of the material cost, I think, you know, one of the things as we go through this cycle, you know, I'll call it phase one, we're probably about 80% of the way through these material cost categories, but it doesn't really stop there. You know, we're going to be going back and revisiting categories. The first round, we really focused heavily on AAPCQ. As we go back to certain vendors, we're now incorporating WorldPack and AI. So it's an ongoing negotiation. Certainly with the uncertainties around tariffs and other commodity headwinds, you know, we continue to work closely with our vendor partners. So, you know, we've talked about inflation in 2019, and it's something that we're actively working on with our supplier partners.

Gotcha. And then is there a way to quantify what the LIFO reserve was this quarter and what the impact on the gross margin was? Like given the inflation we're seeing, how should we think about that in 2019?

Yeah, yeah. Yeah, that's something we saw in the fourth quarter here was actually a headwind. You'll see when we publish our 10-K here later on today, it was about a $15 million headwind. But, again, we were able to more than offset that with other actions, including productivity measures. So while it was a headwind, to your point, with the increasing costs, the commodities, the tariffs, we were able to more than offset that. That's impressive. Thank you.

Thank you. Our next question comes from Seth Sigmund with Credit Suisse. Your line is open.

Thanks. Hey, guys. Good morning. I wanted to talk a little bit about cross-banner visibility and just the progress there. Any indication on how much that may be helping the comps currently and how you see that ramping? And then on the cost side, I know that's had some negative implications in the short term. If you could quantify the impact in the fourth quarter and then just the potential for greater efficiencies next year, that would be helpful. Thank you.

Sure. Well, it's a big factor, you know, in terms of our comp improvement. You know, when you consider – let me break it down this way. If you look at our 2018 comp and you compare it to our 2017 comp, we improved by about 430 basis points. You know, we think that at least half of that is related to overall industry improvement if you think about the comparison to our primary competitors. So what's remaining, there's about, you know, 100 or 200-odd, 205 points or whatever that number is. All of that is around three big things, cross-banner visibility, our DIY performance, and then just general execution. So we would attribute about 80 BIPs to cross-banner visibility. and it's a very strong gaining momentum initiative that we have inside the company. Very excited about it, and our team is very excited about it. The cost to optimize it, it's relatively small, but it does cause us to drive around a little bit more than we'd like to to get the part, and we're going to continue to work at that.

Okay, thank you. And then on the gross margin outlook, which I think is implied to be up 20 to 60 bps for the year, can you just walk us through some of the key drivers of that? I think you touched a little bit on the material cost reductions, but Maybe specific on the supply chain, which has been a headwind, a lot going on there as you start to close some distribution centers. Any more color on how to think about that as a headwind or potentially less of a headwind in 2019?

Yeah, I think actually you touched on a number of those. In terms of supply chain, in fact, in the fourth quarter, it was relatively flat on a rate basis as we're lapping those two distribution centers that we opened last year. So we're overcoming some of those headwinds with the initiatives that we've been talking about in terms of supply chain. We hope to get some productivity out of that. Obviously, there's some investment that comes along with it, but we think we can get some productivity there. Material cost optimization, to your point, is going to be ongoing. We're still confident we can see improvements there. And then other productivity measures, including strength and better managing our slower-moving inventory, As we continue to use things like dynamic assortment, we think this is going to help us get more efficient and will drive those 20 to 60 basis points of improvement. Great. Thanks very much.

Thank you. And I'm currently showing no further questions at this time. I'll turn the call back over to Tom Greco for closing remarks.

Well, thanks to all of you for joining us. We've completed our second year now in our transformation agenda, and my leadership team and I, are extremely proud of the team's execution in 2018 and their continued focus to begin 2019. So as you've heard today, the diligent efforts and strategic investments we made over the past two years are beginning to bear fruit in our improving results. And while we have a lot of work ahead in our transformation journey, I'm confident we're on the right path with the right plan, and we have the best team members in the industry to help us capitalize on the significant opportunity ahead for AAP. We look forward to discussing our first quarter results in May. Thank you.

Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.