Advance Auto Parts Inc.

Welcome to the Advanced Out-of-Parts First Quarter 2019 Conference Call. Before we begin, Elizabeth Eisleben, Vice President, Investor Relations, will make a brief statement concerning forward-looking statements that will be discussed on this call.

Good morning, and thank you for joining us to discuss our First Quarter 2019 results. I'm joined by Tom Greco, our President and Chief Executive Officer, and Jeff Shepard, our 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 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 details 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, everyone, and thank you for joining us today as we review our first quarter 2019. I'd like to begin with recognizing our more than 70,000 dedicated advanced team members and our superb network of CarQuest independents. Their unwavering commitment to say yes to our customers enabled Advanced to deliver progress in Q1 while making necessary investments to solidify the achievement of our long-term strategic goals. In the first quarter, net sales increased 2.7%. to $3 billion, and comparable store sales were also up 2.7%. Our adjusted operating income margin of 8.3% increased 46 basis points compared to the prior year quarter, and our adjusted diluted earnings per share increased 17.1% to $2.46. In a few moments, Jeff will speak to the details of our financial results However, I wanted to share some highlights from our Q1 performance first. In the first quarter, we delivered broad-based positive comp sales, with the highest growth coming from our Midwest, Mid-Atlantic, Appalachia, Carolinas, and Central regions. From a category perspective, we saw strong growth in brakes, motor oil, and batteries. In the first quarter, we experienced some weather-related volatility, primarily in the DIY segment. This is not unusual in this timeframe. At the same time, we're pleased that our comparable store sales were positive in both DIY retail and professional in Q1. In addition, our e-commerce team delivered meaningful growth throughout the quarter. We achieved this while delivering our fourth consecutive quarter of positive comp sales and an improvement on our two-year stock versus Q4. Our professional business was strong throughout the quarter. We believe that improving industry fundamentals are benefiting our professional business. We're seeing increased adoption and utilization of our unified front-end portal, MyAdvance, with our professional customers, which we expect will drive meaningful growth for both existing and new customers. As a reminder, MyAdvance is a one-stop shop of our full suite of tools for professional customers to build their business, including our new enterprise catalog, Advance Pro. Advance Pro has now been extended to fully support our CarQuest locations, bringing all the benefits of Advance Pro to more professional customers, as we've now enabled our independents to leverage many of the catalog features we've rolled out in our company-owned stores. Additionally, we recently expanded our TechNet program. TechNet is a business solutions partnership program designed to help independently owned repair facilities grow their business and develop customer loyalty while maintaining their own identities and serving their local communities. The enhancements will help us grow this network of more than 9,800 TechNet shops across the U.S. and Canada. Enhancements were created with direct input and requests from existing TechNet partners. We're committed to being the trusted first call for all of our customers and continue to leverage feedback from our professional field team, TarQuest independents, and TechNet customers to ensure they have the tools they need to succeed. In addition to investments we're making for professional customers, we're also cognizant of how DIY customer shopping patterns are evolving. We invested in key DIY platforms in Q1, including moving key capabilities to the cloud, enhancing our customers' digital experience, increasing site speed, and improving shipping capabilities. We also made several back-end investments, such as updating SKU availability and accessibility on our website. On the marketing side, we're making progress on elevating the advanced brand and are pleased with the rollout of our new campaign, Think Ahead, Think Advanced. Since launching the campaign, we've seen an increase in both purchase consideration and increases in website traffic, with year-on-year increases outpacing the vast majority of all retailers. Importantly, we've also seen continuous improvement in the overall awareness and brand recognition of advance through recent brand tracker surveys, which are the highest we've seen since we began tracking these metrics in the first quarter of 2017. In fact, our top-of-mind awareness scores improved both sequentially and year-over-year. This improvement is a direct result of our strategic focus on our omni-channel and an ongoing investment priority of our transformation. Finally, to round out our top-line growth initiatives, we're rolling out new tools for our frontline team members to make their daily tasks easier and allow them to focus on what really matters, serving and delighting our customers. One of our most important initiatives is our next-gen store network, updating outdated technology throughout our stores. Several of our legacy systems and capabilities create delays and frustration for our frontline team members when they're not able to easily view or rapidly toggle between necessary tools such as our catalog, delivery dashboards, and training modules. Our next-gen network significantly increases speed and reliability, including a new connected phone system that allows us to serve customers better than ever. As one example, our team members can look up parts much faster, with an average 85% improvement in the speed of catalog lookups, ultimately providing faster and more reliable service for our customers. Our next-gen network is an example of our focus on reducing non-value-added tasks. Unfortunately, our team members are spending an inordinate amount of time on these tasks, which takes them away from customer-facing value-added work. We're working to reduce these tasks throughout the enterprise, and as an example, in our stores we recently launched MyDay, a tool that groups several modules to manage and direct the administrative and back office work in our stores. Since early in Q1, our GMs report that they're reducing administrative work hours and can dedicate more time to customer-facing sales and team member training in their stores. We expect these investments will not only improve productivity in our stores and our customer support centers, we're also confident these initiatives will reduce turnover rates as we make it easier for all our team members to do their job. We continue to make excellent progress on improved retention, and in the first quarter, we reduced turnover by approximately 15% amongst our core four frontline team members. Our goal in 2019 is to reduce turnover in each of our core four frontline roles for the third consecutive year, as advanced finance builds a reputation of being the very best place to work for great parts people. As we drive sales at or above the industry's average, we're equally focused on our unique opportunity to expand margins in four key areas. First, in terms of improving sales and profit per store and our footprint optimization strategy, we remained consistent in our approach to store closures and consolidations in the first quarter. In line with this commitment, during the quarter, we closed and consolidated 38 stores while reducing the cost of our overall rent obligation as we right-sized our asset base. With our improved approach to store closures and consolidations, our overall rate of professional sales retention has consistently exceeded both historical and planned retention, and our field team is doing great work to retain top talent while working with our large network of stores to place team members. We've also had some significant wins on lease negotiations and have been successful in meaningfully reducing our lease liabilities. All of these factors will continue contributing to improved cash flow for AAP. In parallel, we also continue to look market by market for opportunities to drive growth. We're pleased with our execution of openings during the quarter, which included three new retail stores and three WorldPAC branches. We're also very excited to welcome 20 new independently-owned CarQuest locations that joined the Advanced family in the first quarter. we'll continue to look for opportunities to optimize our footprint and drive our sales and profit per store to targeted levels. Second, in terms of supply chain, we're focused on the long-term optimization of our distribution center footprint as we improve execution day in and day out. With respect to Q1, we made progress on our critical cross-banner replenishment initiative, which will enable us to ship parts from our legacy red DCs to legacy blue stores, and similarly with our blue DCs and red stores. This is a significant unlock that will reduce stem miles and improve customer service. Once fully implemented, we expect to improve product availability, drive inventory turns, and deliver significant cost productivity. In terms of execution, improving performance is primarily focused on standardization and what we describe as running common in terms of processes across all DCs. For a variety of reasons, including systems, we do not do this today. I remain confident in the supply chain team's ability to transform and integrate our supply chain while improving execution in 2019. Our third margin expansion opportunity is category management. where we're making progress in our ongoing material cost optimization efforts, development of private label, and strategic pricing. Finally, we remain focused on every single line within SG&A, once again leveraging store labor amid wage inflation, driving reductions in rent through our store footprint optimization efforts, while reducing insurance and workers' comp-related costs with our dedicated focus on the safety of our team members. In terms of safety, we're seeing meaningful improvements in our incident rates, which is translating to the P&L. We're committed to further improvement as we continue executing on our detailed health and safety agenda. Overall, our operating margins improved again this quarter. That said, we know we still have a material opportunity ahead and continue to focus on ensuring the customer is first in everything we do. With this disciplined execution, we're confident we'll drive revenue growth and margin expansion. Before turning over to Jeff, I want to thank him for his commitment to ensuring the financial success of Advance by serving in dual roles over the past year while we conducted an extensive search for the best candidate to succeed him in his controller and chief accounting officer role. After a thorough search, I'm pleased to announce that Andrew Page joined the Advanced Team as our Senior Vice President, Controller, and Chief Accounting Officer last week. Andrew brings over 25 years of broad-based accounting experience with him, most recently as Senior Vice President and Chief Accounting Officer for Under Armour, and we're thrilled to have him on the Advanced Team. With that, I'll turn it over to Jeff for details on our financial performance.

Thanks, Tom, and good morning, everyone. I want to begin by welcoming Andrew to the advanced team. I'm confident that his experience will be a great addition to our finance organization and help deliver our finance vision to drive customer and shareholder value through a world-class finance team. I'd also like to thank the entire advanced team for their continued efforts in Q1, which enabled another quarter of positive results. In Q1, our adjusted gross profit was $1.3 billion. an increase of 3.6% from the prior year quarter. On a rate basis, our adjusted gross profit margin of 44.6% improved by 37 basis points from the prior year quarter, driven by improved pricing that more than offset cost headwinds were incurring, together with continued improvement in our inventory management throughout the enterprise. These gross margin benefits were partially offset by planned investments in supply chain wages as we're focused on reducing turnover and improving execution throughout our distribution centers. In addition, our margin expansion was partially offset by an increase in shrink as our distribution centers have made significant progress in backlog tasks. Despite the headwinds, I'm confident our actions are building a foundation for much improved DC performance. The improved reclamation process will improve our level of service and inventory accuracy. Related to improving inventory assortment and availability, we continue the deployment of our top 25 categories using dynamic assortment in the first quarter. We've seen a meaningful increase in incremental sales since the initial launch, and we continue to roll out this program. We plan to complete the rollout to all stores by the end of 2019 and will expand the categories included. Our adjusted SG&A was $1.1 billion in the first quarter, an increase of $26 million year over year. The primary drivers of this increase were due to minimum wage and planned merit increases, professional services related to our IT and e-commerce investments, and a year over year increase in fuel and transportation expenses related to the utilization of our cross-banner visibility. However, on a rate basis, Our adjusted SG&A improved by eight basis points compared to the prior year quarter to 36.4%. We were once again able to leverage store labor as a percent of net sales in Q1. Additionally, as safety continues to be a top priority for ADVANCE, I'm pleased with the continued expense reductions directly correlated to our lower incident rates and claims. Adjusted operating income in Q1 was $243.6 million, an 8.7% increase from Q1 2018. Our adjusted operating income margin increased 46 basis points to 8.3% in the quarter. Adjusted EPS for the quarter increased 17% to $2.46. This excludes the one-time cost related to the early redemption of our bonds that would have come due in 2020. In terms of capital spending, we invested $61 million in capital projects in Q1 compared to $34 million in the same period of the prior year. Our largest investments were information technology related as we remain focused on the complete back office integration throughout ADVANCE. Related to our capital spending, the investments made have had corresponding operating expenses that are in line with our expectations in the quarter. We anticipate that we will continue to ramp up capital investments throughout 2019, focusing on information technology, supply chain, and e-commerce. As part of our ongoing efforts managing our working capital, we continue to make progress on our AP ratio. Notably, our AP ratio for the quarter was 74%, an increase of approximately 550 basis points compared to the prior year quarter. This improvement, together with our disciplined working capital improvements, helped enable another strong quarter of free cash flow growth. In Q1, our free cash flow was $143 million, which increased nearly 20% compared to the prior year quarter. As we previously discussed during our call in February, In the quarter, we completed the early redemption of our $300 million bonds due in May of 2020. In line with our financial priorities, we are pleased that our leverage ratio of 2.1 times is now at the lowest point since the GPI acquisition. Additionally, to our focus on cash flow and disciplined approach to capital allocation, we returned over $130 million in share repurchases and dividends during the quarter. Our team's unrelenting focus has enabled a solid balance sheet that provides us financial flexibility and security. I'm confident our ability to generate meaningful cash flow combined with the strength of our balance sheet will differentiate Advance and create financial stability regardless of economic trends that may impact the industry. We believe that the fundamentals we set in place for the quarter are crucial, and we will continue to focus on meeting our goals for the balance of 2019. With that, let's open it up to addressing your questions. Operator?

Thank you. Ladies and gentlemen, if you have a question at this time, please press star then 1 on 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 Michael Lather of UBS. Your line is now open.

Good morning. Thanks a lot for taking my question. Tom, your comparisons are going to get a lot tougher in the next couple of quarters. We just rolled through the two years back. It suggests you'll see some negative comps. How are you going to be able to sustain this low to mid-pandemic comp rate that you experienced over the last quarter?

Hey, well, good morning, Michael. We feel pretty good about where we're situated for the year. The input metrics that we track to drive comp improvement are working well for us. We look at them every single week and, in some cases, daily. So when we look at UPT, our primary econ metrics, our loyalty program, which is Speed Perks, we're excited about some refinements we've made there that we're rolling out. On the pro side, dynamic assortment is helping with our stock rate and close rate. So we really track the input metrics, and as we see those input metrics translate to sales improvement, we're confident that we continue to build on the two-year stack that we put up in the first quarter. And that's kind of how we plan the year. Obviously, we're starting to lap growth. And we're excited about that. We want to continue to drive growth and have comp sales at or above the industry average. And overall, we're pleased with the fact that both pro and DIY grew in the first quarter, and that's the goal for the rest of the year.

That's helpful. My follow-up question is, you achieved good gross margin expansion in the first quarter, but the pace of expansion moderated from what we've seen over the last few quarters. That, coupled with one of your competitors reporting a similar trend yesterday, has started to raise the question, is the auto parts retail sector in peak gross margin? Can you comment specifically on that topic and then what the outlook for advanced gross margin is from here on out?

Yeah, sure, Mike. You know, We've had a number of initiatives that we've had in place for a while. Our material cost optimization is something that's ongoing. We're always looking for ways to minimize costs. We're working very collaboratively with our supply partners in terms of minimizing those costs. We obviously saw some evidence of that this quarter. We think that can continue. We work with them day in and day out. We've been through the various categories and AATCQ, and we're continuing to do that as we work through with AI and WorldPAC. So, you know, we look at that. Obviously, when we look at our assortment, we look at private label. That's another area that we're addressing. So for us in particular, we think we have a number of areas that we can focus on to continue to drive costs down and keep our margins where they're at or better.

So just to clarify, we shouldn't assume that price transparency is starting to creep in the industry and everyone's having to promote a little bit more to drive sales?

I wouldn't necessarily assume that, Michael. We've been consistent in terms of how we look at the business that Really, especially on the professional side, product availability is king. And then you've obviously got other factors in there, the relationship we have with our customers. Obviously, you've got to be competitive on price, but there's other levers that are more important. We're looking at pricing very closely in addition to what Jeff said. I mean, the material cost optimization work is excellent that Mike Broderick and his team are leading. We do feel we have a disproportionate opportunity to grow our private label business relative to others maybe. We have a lower starting point. But we've got to look strategically across our business at pricing. And where it makes sense, we're going to, you know, be more intense and more competitive. And in other places, we see opportunities to expand margins. So we've got a tremendous opportunity to grow gross margins, and that's a big part of our long-term plan.

Thank you very much.

Thank you. And our next question comes from Chris Harmers of J.P. Morgan. Your line is now open.

Thanks. Good morning, guys. Good morning, Chris. A couple questions. So on the investment side, can you talk about how much investments were put in in the first quarter? I think you talked about roughly 100 basis points of investment. of investment pressure over the year. How much did you put in in the first quarter? And then laterally, can you also talk about how you think about the growth rate of SG&A dollars or perhaps leverage over the balance of the year, sort of the cadence, how you're thinking about that?

Yeah, sure. As it relates to the investments, Chris, as a reminder, we indicated the $80 million to $120 million of what we're calling OpEx investments back into the business. And that's a combination of technology-related people and marketing. And we're very much on track. We've reinvested that, and it's going to continue to ramp during the year. But we're very much in line with that guidance that we provided you.

And then in terms of, like, how you think about just the overall, say – SG&A leverage. I think on the last call you talked about sort of steady improvement over the year from a leverage perspective on SG&A.

Yeah. If you remember, we talked about our SG&A to be consistent with what we saw in 2018. We finished the year at 36.3%, and we anticipate we'll be in line with that in 2019. Got it.

And then, you know, Just broadly, you talked about improvement in two-year stacks in the comp, DIY, and commercial up. How did the stacks, say, shake out on the DIY and commercial front? You didn't mention Northeast as an outperforming region. Was that an area that you saw more of sort of underperformance relatively on the DIY side?

Well, we called out the top performing regions. We have 12 of them. And honestly, we grew everywhere. We were happy with our overall comp performance. The Northeast was a little bit behind, not significantly behind. Actually, it was close to being in the top five, if you will, Chris. But overall, we continue to be happy with our business up there.

And then the DIY versus commercial, any comments on stacks in the first quarter relative to 4Q?

Yeah, both of them grew on a two-year stack basis. And as we said, both DIY and pro grew. Pro outperformed DIY by a little bit. I mean, this has been a couple quarters in a row where we've been relatively close. There isn't a huge outperformance in aggregate. The professional business is coming together under Bob Cushing. We're kind of packaging our entire lineup under the professional banner, which we call Advanced Professional. And then, obviously, DIY Omnichannel, we're integrating the online experience with the in-store experience, and that's performing well. So relatively close, but professional outperformed DIY in the quarter. Excellent. Best of luck, guys. Thanks. Thank you.

Thank you. And our next question comes from Brett Jordan of Jeffrey's. Your line is now open.

Hey, good morning, guys. Good morning, Brett. Could you give us an update as to where we are in the Walmart partnership and the Yami Channel initiative?

Sure. We're very excited about this one, Brett. We're very much on track with what we've talked about. We're building an automotive specialty store on Walmart.com where our customers will have access to our parts, accessories, maintenance items, et cetera, in addition to Walmart's other offerings. And we're really working together on delivering a differentiated experience. We believe we can bring speed, convenience, and trusted advice together. to the large number of DIY customers who are already going to Walmart.com every day. We're on track to get started in the front half. We'll build the capabilities for the year. I don't expect this to be a big factor in the second half because we want to make sure that the customer proposition is absolutely best in class at each stage of our rollout. We meet on this every week. And it's something that we're very aligned with the Walmart team on. So going well and more to come.

Okay, great. Then a follow-up as far as the progress in closing some distribution infrastructure. Any experiences you've had as far as converting systems and maybe fill rates in stores where you're seeing some DC shutdowns?

Yeah, I think we've hardened that process, Brad. You know, we've now closed three buildings. We're now looking at how we can further optimize our existing DCs, and that includes our cross-manner replenishment initiative, which we've spoken about. We're now making daily replenishment deliveries to a group of CarQuest stores from an advanced DC. And within this pilot, we're still in the learning phase, but we expect to be completed that by the summer. Separately, we've got a pilot that's replenishing an advanced store from a CarQuest DC. So the plan here is to take what we've learned from these pilots and really scale them to other DC store combinations later in the year and into 2020. So, you know, we're getting the process down. When we point a store at a new distribution center, we're making sure that we don't lose any momentum. And the intent there is to do it in such a way that the catching DC is ready to go when we point that store at the catching DC. So we haven't seen any deterioration in fill rates. I mean, we've finished up the three. I think we finished up the most recent one in the first quarter this year. And we're excited about it. There's a tremendous opportunity for us to take cost out with this initiative.

Great. Thank you.

Appreciate it. Thank you. And our next question comes from Mike Baker of Deutsche Bank. Your line is now open.

Thank you. I just wanted to ask you about trends throughout the first quarter. Were you impacted by tax refunds at all? How did that impact February and what has happened since then? This is a particularly long quarter for you guys. And I guess you mentioned the weather impact, so I'm wondering if you could quantify that.

Yeah, first of all, Mike, on tax refunds, you know, we looked at the scans by week. You know, we get the syndicated data from NPD, and we did see a bit of a lag there, but it did come back as the quarter ended, so it really wasn't a factor for us at all. And whether it was volatile, it always is in the first quarter. I would say that You know, generally, you know, some of these seasons straddle quarters for us, whether it's winter between Q4 and Q1, or even now, as you think about the spring selling season, it was a little warmer in April this year than it was last year. It's been a little cooler to start off May. So the spring selling season has been somewhat elongated in that regard. But I wouldn't say there was any material impact on the first quarter results for us.

Okay. And then I guess related to that and really to follow up on Chris's question, so you comped at 2.7, which is above your full year guidance of 1 to 2.5. So that either suggests that, you know, you decelerate through the year or there's upside to that guidance. So in your opinion, which is more likely and do you expect to comp positively in all four quarters?

That's certainly the plan is to come positively in all four quarters. You know, we do have more difficult laps in the back half of the year. We're confident in our full year guide. Our goal, obviously, is to be at or above the industry average. So, you know, clearly we're focused on beating the number. But that said, you know, we're sticking with our full year guide, and we're confident we'll achieve that.

And one more related to that. Was the first quarter 2.7? How was that in line with your internal plan?

Yeah, it was slightly lower than our internal plan for the quarter. But, you know, as we look at the full year, you know, we did front end load the plan. That's what we like to do here to make sure that we make it difficult to start the year. And we remain confident in the full year guide.

Okay. I appreciate all the color. Thank you.

Thank you. And our next question comes from Seth Basham with Western Securities. Your line is now open.

Thanks a lot, and good morning. My question is around cross-banner replenishment. You gave a little bit more color, but I was wondering if you could be more specific as to when you expect to have the chain up and running fully on cross-banner replenishment. Is it 2020 or 2021 then?

Yeah, sure, Seth. Yeah, very exciting initiative for us. I appreciate the question. We're using – Ruben Sloan is leading this work. We've got some special software that we're using that allows us to be much more freight logical in our design of our system. You know, we have all the assets we need to succeed. We've got 50-plus distribution centers, as you know, and many of them are positioned in urban markets like a Chicago, a Dallas, etc., and they operate in a silo today. So we'll be able to use those DCs very differently. When you think about Dallas, Texas, we've got a blue DC sitting in Dallas. We've got a whole bunch of stores there, but we don't ship them from Dallas. We ship them from Houston, actually. So as we stand all this up, it's going to really help not just our cost, but our availability and our speed to get our product to our stores. The plan is to get at these DC store combinations in the back half of this year. We see it continuing through 20. It might bleed into the front half of 21. You know, we're going to be very careful about this change, obviously, as we have been with our DC closures to date. We want to make sure that we're executing flawlessly and we're not disrupting the customer. So the plan is to essentially start the ball rolling in the back half of this year. Next year will be a busy year as we transfer stores to new DCs. And, again, it might drift into the front half of 21, but we'll be realizing the full benefits of the savings and the availability improvements by that time frame.

Really helpful, Collin. And then, secondly, a follow-up just around gross margins this quarter. Jeff, was there any LIFO benefit or charge to the quarter?

Yeah, there was a LIFO charge this quarter of $26 million. That was largely more than offset by changes in our supply chain costs that we were capitalizing on the balance sheet. So what we call our inventory-related costs were de minimis this quarter, and that's consistent with the year-over-year quarter as well.

Okay, and a little bit more color around the adjustment of the humane gross margin this quarter with outer period adjustments.

Yeah, sure. You know, that was something as we were closing our books, we came across it. It really relates to prior years as we were going through and looking at some of the processes we had around matching some of our invoices with a lot of really small invoices that have added up over the years. Should have run through the inventory as far back as 2014. So none of that relates to 2019, which is why we wanted to call it up separately.

Fair enough. Thank you.

Thank you. And our next question comes from Simeon Gutman of Morgan Stanley. Your line is now open.

Good morning, everyone. My question, it's sort of a follow-up on a few questions regarding the rest of the year and sales. So you were outperforming the peer group for a bunch of quarters. Now it's somewhat underperformed in the first quarter. You do have tougher comparisons now in the back half. So can I ask it in this way? If you look at the initiatives around sales for this year versus ones that were in place last year, are they more incremental? Are they more marginal? Or are any of the initiatives you're working on should result in like a step change to the sales over time or, you know, thinking about distribution longer term? That's the next layer that's going to unlock, you know, better throughput.

That's a great question, Simeon. I mean, I think, you know, look, we're obviously very cognizant of where we're situated. We're pleased that we're competing in a very healthy industry that's growing. That's something you're hearing from everyone, you know, very excited about. the prospects for 19 and beyond as that vehicles in the sweet spot continues to grow. You know, our agenda is a complex one, as you know. I mean, we're primarily focused on delighting our customers and improving execution to drive sales growth, but we're also very focused on delivering margin expansion, profitability, and cash flow. So we're taking a balanced approach to executing our strategy and We're going to continue to drive at the initiatives that I spoke about earlier to drive more top line. Of course, we'd like to have more sales and we want to be gaining share, and we're balancing that with the need to deliver the P&L overall. I think in terms of specific initiatives, I'm probably most excited about the launch of our Speed Perch Loyalty Program in the back half of this year. That should help us with DIY significantly. We're focused on our most loyal customers. We've had a pilot market in place for a couple of periods now that we're beginning to scale. We see some big upside there. Obviously, online continues to perform extremely well. And I think Bob Cushing... On the professional side, we're seeing significant momentum in our two-year stacks there as we kind of package together our overall offering. You know, you've got cross-manner visibility now in place. My Advance is working well for us. We're seeing increased adoption of our Advance Pro catalog, more online ordering. So there's a lot going on, and we're trying to balance everything that we're doing in a way that we continue to execute flawlessly.

Got it. My follow-up is on distribution. You just laid out the time frame for, I guess, progress over time and some of the big changes. You increased pay. You mentioned that last quarter. Can you talk about – I don't think it would have the same impact that if you increase pay at a store, you might see better productivity. Can you talk about what that change is meaning to the distribution center, I guess, maybe through turnover, and is productivity improving from those changes alone?

Yeah, for sure. First of all, there's nothing more important than our team members. I want to emphasize that to our success. We're focused on attracting the very best people that we can. And we knew there was going to be higher wages this year in 2019. We reviewed our exposure to each DMA. I think, as you know, Simeon, we've made a big investment in our frontline team members in the store, stores themselves through our unique Fuel the Frontline stock ownership program, which is now in its third full year. We also substantially improved our 401K platform that is available to everyone. So we're making sure that we're helping our team members with even retirement planning, if you will. In the DCs, Ruben felt pretty strongly that a wage increase in the DCs would help reduce turnover. And I've been quite surprised at how rapidly that's impacted our turnover in the DCs. We've seen a pretty significant drop very quickly. And it has helped us. I mean, it's helped us with the fill rates, the reliability, the accuracy, and also we've taken several days off our reclamation in the D.C. So I think overall it's helping our execution, and I know Ruben's very committed to standardization and really getting – much more commonality across our buildings, and I think that will help us also. So clearly when you make a wage investment, there has to be an output metric that you can attribute to the investment you're making in wages, and I think we're connecting those dots pretty well.

Okay. Thank you.

Thank you. And our next question comes from Scott Ciccarelli of RBC Capital Markets. Your line is now open.

Good morning, guys. Scott Ciccarelli. So I know it's an ongoing process, but can you guys update us kind of where you are in the process of renegotiating terms and pricing with your vendors?

Yeah, sure. You know, first of all, Scott, I think it's really an iterative process. We're never going to be done. But, you know, when we talked about sort of the first round, we were specifically focused on AAPCQ. We're about 90% there. We've gone through the major categories. We're wrapping that up. But, again, it doesn't stop. We're going to go back and we're going to be looking at WorldPAC and be looking at some of the categories that started over a year ago. And so it's going to be an ongoing process. Like I said earlier, we're working very collaboratively with our supplier partners. And so we expect to continue this process because we look for margin improvement and we look for, you know, strong relationships with our vendors.

Got it. And then follow-up, you know, can you also provide, I know you talked a bit about, you product sales and how that distribution backend is changing. Is it possible to provide some color or range, however you want to describe it, regarding how you think about the contribution margin performance and how that will change as you guys try to optimize the backend?

Can you expand on that a little bit, Scott? I want to make sure I understand your question. Sure.

Yeah, Tom, specifically on the cross-banner sales, cross-banner product sales, my understanding has been that the profit margins on those sales have been relatively modest, and as you guys optimize the supply chain and delivery and distribution part of it, there's an opportunity set for those margins to expand. If you can just kind of help us frame it some way, I think that might be helpful for the group.

Sure. Sure. Well, for sure, we're starting to make progress on that one. You know, we weren't clear on what the impact of cross-manner visibility was going to be when we first rolled it out. I mean, you're making well-packed parts visible. to our advanced customers in that respect and vice versa, et cetera. So now we've got a pretty good handle on, you know, what are the brands that our customers weren't able to get before, but now that they can see a broader array of parts, they're now able to get. So we've been able to map that out, and now we've had meetings DMA by DMA that Ruben is leading, to ensure that we're essentially moving the parts around in market as efficiently as possible. We start to lap this, I think, in the second quarter. We did see our expenses, our transportation in market fleet expenses came down a little bit in the first quarter from where they'd been. So that optimization work is happening. And I think as we get into the second and third quarter, I think it'll be, you know, we'll be in a position to start actually potentially saving some money in those lines. Understood. Okay. Thanks, guys. Thank you.

Thanks. Thank you. And our next question comes from Chris Barclary of Wolf Research. The line is now open.

Hey, thanks for taking the questions. First one is just on leverage. It looks like given the lease accounting changes that you adopted, your leverage metric decreased about a half a turn from that change. So I wanted to, I guess, figure out if that's the way the rating agencies are looking at it and credit investors. And then, like, given the methodology change, should we still rely on the historical two and a half to three turns of leverage under this new methodology, or has that also changed?

Yeah, so obviously I can't speak for the ratings agencies or how they're going to look at this. You know, when we looked at it, the six times rent expense was really a proxy expense. for what we thought an obligation would be. With the new lease accounting standard, we now have that on-balance sheet. We have it quantified, you know, in accordance with a methodology that should be used consistently across the industry. So we just felt like it was a better indicator of what our true obligation was. Now, to be clear, and to your point, the old model, if you want to use the six times rent expense, you're right, we'd be at a 2.6. So we're still very close to our stated objective of 2.5. But we do think the new methodology is better because it's a true reflection of what that obligation is, and you can clearly see that on our balance sheet.

Gotcha. That makes sense. And then big picture question on the supply chain. You had AutoZone yesterday raise their mega hub strategy to 60 to 90 hubs. O'Reilly disclosed for the first time they've secretly had, you know, 80 super hubs. A while back you guys had been experimenting with – I forget what they were called, super hubs or something to that effect – I'm just curious where you stand today on those and if you think your current distribution infrastructure is adequate to compete in today's evolving commercial landscape. Thank you.

Yeah, sure. First of all, I think, honestly, everybody defines these things a little bit differently. The way we look at it is we have 50 million square feet of buildings, and we're going to put the most optimal parts in the closest to the customer locations we can. And that's the exercise that we're going through. I mean, you think about, you know, we have a CarQuest DC that has a lot of parts in it. It's only servicing the Blue Network today. I think we're in a very different starting point than some of our industry peers. And we're looking at optimizing those assets and making sure that we're connecting basically the customer back work that we're doing, which is to really understand on the professional side, job by job, what are the requirements for the parts that they need? which ones require rapid delivery, which ones may be – there might be more of a willingness to wait, if you will. So it's using all of our asset base and working back. I think in that respect, we're taking the assets that we have and optimizing those, and there's plenty of room for us to improve the cost structure of the company as we do that.

Gotcha. And then just like one final follow-up there. I think earlier in the call you had mentioned – that Bob was looking to, or Ruben rather, was looking to standardize the physical layout of the DCs. As I've understood it, the CarQuest DCs were a lot smaller in square footprint, much more of them than your traditional legacy DIY DCs, or however you want to frame those. So I want to get a sense for to what extent you're able to standardize the entirety of your supply chain and how those two legacy infrastructures will complement each other. Thank you.

Yeah, good question, Chris. I mean, I think Ruben's really in execution mode on supply chain. You know, I think you start with just improving basic execution, and we talked about running common. This is a very basic supply chain concept, but for a variety of reasons, mostly systems related, we weren't actually doing this. So getting to a common platform, even though the building might be different in size and shape, you can get to common methods throughout the building, right? That's a very important process for us. I talked about the DC optimization and freight logical. I think the other piece that we're working on is investing in a single warehouse management system to replace legacy systems within Advantage and CarQuest. And this will significantly improve what we call labor management standardization, or LMS. So that's an important priority for us with Ruben. We believe we can get much more common in terms of the processes. You think about people, process technology, people. We're making investments in the people that we have to make sure that we've got the best people working in our DCs. We're routinizing the processes that they have to make their jobs easier, and then we're supporting it with technology. So that's really his agenda in that regard. And, you know, he's making a lot of progress. He's building a great team, and we're excited about the prospects for supply chain, not just in terms of cost optimization, but in terms of availability.

Gotcha. Thanks for all the detail. Appreciate it.

Thank you. And our next question comes from Elizabeth Zuziski of Bank of America. Your line is now open.

Great. Thank you. This may have been asked already, but I just wanted to touch on it. Has there been any material impact on the business or the industry yet from the step-up in tariffs, and what have you guys seen in inflation in the last couple of quarters?

Yeah, sure. So in terms of tariffs, you know, this is something we've been analyzing for a while, both the tariffs that already have taken place last year as well as the potential impact. And, you know, we feel like we've taken the necessary steps to mitigate it. But a couple of things, you know, relative terms, you know, our industry has less exposure to tariffs than most other retail sectors. Obviously, I can't speak for everyone in our industry, but for us, The categories that are impacted are less than 10% of our total direct imports. As it relates to indirect imports, it's a little more difficult, but we think it's in that same range, about 10%, so a total of 20%. To date, we've been able to pass on the impact of tariffs. Given the key categories that have been impacted to date, we haven't seen a material change in unit performance. And that's going back to the tariffs that took place in 2018. And then we've taken several steps to mitigate the impact, including sourcing refinements and working collaboratively with our suppliers. And they're equally motivated to mitigate the impact of the tariffs. You know, we feel like we're positioned competitively as our industry peers are generally in the same position. You know, we've managed through the first rounds. But without a doubt, the 25% of tariffs for this round is a meaningful increase to pass on to our customers. But the industry historically has been able to pass on these increases, particularly on the pro side, where the cost is embedded in the cost of a job. You know, DIY, there's obviously a little more risk. But we feel like we've done everything we can to mitigate the impact, and we'll continue to monitor this very closely.

Okay. And is there any impact from inflation to date or in the last quarter that you can break out for us?

We've seen a little bit of inflation. You know, obviously, labor rates, we continue to see there have been some cost increases, but it's been in line with our expectations, kind of that 2% to 3% range is what we've been seeing. So, you know, nothing out of the ordinary, I would say.

Okay, but in terms of the contribution to comp in the quarter of that 2.7%, was there any skew for skew increase in price?

Yeah, I mean, we did take some pricing actions recently. Again, to offset, because remember, we got the tariffs that took place in the fourth quarter, so we had caught headwinds in the quarter, but that was more than offset by, you know, the pricing and some of our MCO efforts. But, yeah, we did have some price, but, again, nothing significant and obviously didn't have an impact on rates.

Got it. Okay, thank you.

Thank you. And our next question comes from Michael Montani of Evercore ISI. Your line is still open.

Hey, good morning. Thanks for taking the question. I just wanted to build on the last question a little bit. If you were to assume the next $300 billion-plus of imported goods were to get tariffed, would that basically have the effect of doubling the 20% exposure that you all have had from Section 301? Or how should we think about, you know, the potential exposure?

Yeah, and it's Tom, Michael. No, I mean, when we look at it, we looked at the whole, all of the lists, 1, 2, 3, everything that's in there. And that's the number we gave. So, and just a little more color on what Jeff was talking about. I mean, we obviously have been tracking list 1, list 2, list 3. So, those things that have been impacted. we haven't seen a meaningful change in unit movement. Others have been around this industry a lot longer than I have, but they've said consistently, you've heard, that we don't expect this to have an impact. We're very cognizant that 25% is a big number, but we haven't seen an impact to date. So that's obviously something we're going to have to monitor very closely.

Okay, and then within the comp, so the 2.7 that you all reported, can you give some incremental color around what the ticket did versus the traffic in the quarter and how that compares to trend?

Yeah, I mean, it depends on the business, of course, but consistent with previous quarters, you know, we are seeing DIY retail, you know, continues to be challenged on traffic. And, you know, that's something that we're very focused on. You know, we've launched a new advertising campaign. We're seeing improved awareness, you know, top of mind, aided awareness, unaided awareness, all improving. So we feel like we're making progress there. But unfortunately, Michael, that's still a negative number. And then obviously average ticket has been able to offset that. E-commerce is strong on both ends, professional stronger on both. But, you know, DIY retail transactions is the one that we're, you know, we remain concerned about. And, you know, we measure e-commerce transactions, whether it's buy online, pick up in store, or ship to home. So we put the transactions for DIY e-com inside the e-com number. So the DIY retail transactions are pure, you know, somebody walking in the swinging doors.

Okay. And just the last one for me was around, you know, leverage points. So, you know, given the investments of 80 to 120 million, and there's obviously discrete offsets that you have in the cost structure as well, you know, what kind of comps would you all need to kind of lever SG&A into the back half of the year and maybe just bigger picture and You know, you could give us an update on, you know, some of the gross cost savings opportunities over the years. There's been different figures, half a billion, you know, 750 million plus. What kind of a bucket have you realized so far out of that and how much remains, you know, to go?

Sure. Well, I think on the comps, I mean, we obviously constructed our plan, you know, to deliver on the guidance we provided. So, you know, we gave a guide on sales. We gave a guide on margin expansion and embedded in that margin expansion, obviously, we're focused on making the investments that we feel we need to in order to drive the long-term growth of the company, which is you know, in four big areas, and I think we've talked about that. You know, the opportunity that we have is substantial. I think we're quite unique in terms of our overall margin expansion opportunity. I mean, we're growing our sales, and at the same time, you know, we believe we can drive our margins significantly higher. and that's going to come from, you know, improved sales and profit per store, which is a big opportunity for us, supply chain, which we've spoken about, improved category management of the different categories we have, and then reduction in SD&A. When you put all that together, you know, we believe we can close the gap we have with our industry peers pretty significantly over the next several years, and we're going to try and get to our stated goal of mid-teens as rapidly as we can. So that's kind of where it is. We've talked about 19 and 20 having some pretty big investments in order to set up our technology platforms to enable that longer-term outcome. At the same time, we're on track with those initiatives and achieving the milestones we need to to get there.

Thank you, and good luck.

Thank you.

Thank you. And our next question comes from Daniel Imbrow, Stevens Incorporated. Your line is now open.

Hey, good morning. Thanks for taking my questions and thanks for all the color today. Tom, a bit of a follow-up actually on the last few questions. And then the prepared remarks, we've talked a lot about in-store technology as well as some DC technological investments you're making. Can you just help us think about a timeframe? I think you just referenced it a minute ago, but when we should begin to see some of those benefits showing up on the P&L, whether that's through higher sales numbers or through some cost efficiencies in the stores, just what kind of timeframe should we be thinking about before we start seeing the benefits there.

Yeah, good question, Daniel. I mean, first of all, it varies widely, unfortunately. I'll try and give you a better color. When you talk about the technology and e-commerce investments that we're making, it's by far the biggest part of the OpEx investment. It's over half. We've really changed the investment profile of the company. When you think about OpEx or CapEx, you know, we used to invest primarily in new stores, and now we've shifted that investment profile to much more technology and e-commerce based. So, When you're talking about when will we see payback, well, you talk about integration-related items. So getting to a single payroll system, okay, getting to a single back office system, getting to a single warehouse management system. All of those are in-flight. we should start to realize the SG&A benefits associated with those starting next year and then mostly as we get into 21. Because you have to – the problem here, Daniel, is you have to keep the old system operating as you basically sunset – sorry, as you stand up the new system. And in some cases, we're moving our platforms to the cloud, et cetera. So it's a little bit complicated there, but we have very – high level of confidence that we can take the commensurous costs out at some point in time in the future. In addition, we're making big bets in the e-commerce area. So there, you know, you're starting to see more early returns. So, you know, we're getting high growth there. We're getting more people to our websites. We're driving more top-line growth. That's an important part of our overall sales and profit per store input. So that's a bit of a different piece of it. Finally, we're currently installing a next-generation store network across the entire chain. And I can't tell you how excited I am. our team members are about this. I mean, Sri Dantius, our chief technology officer, has rolled this out. We're going in store by store and replacing a very slow legacy system with a much more rapid, much more connected, much more modern point-of-sale system, catalog, and phone. And it's having great success out of the gate. We've done several hundred stores already. We plan to complete that project this year. I would expect that to start realizing benefits, you know, now in the current stores. Obviously, until we get to, you know, 4,000 plus, we won't get the full benefit, but next year we'll get the full benefit of that. So it depends on what you're talking about in terms of these technology platforms and But the idea is to really differentiate ourselves versus our competition with our online experience, be that in professional or in DIY, to make the job easier for our team members in the stores or distribution centers. And, of course, to integrate the company, which is long overdue and something that we're very focused on.

Got it. That's helpful. Thanks. And then a quick follow-up, Jeff, just on capital allocation. Under the new leverage, you noted we're at kind of a multi-year low. But looking at the cash flow statement, I don't think you guys repurchased any shares since the 4Q report. So just wondering if you could update us on your thinking about capital allocation from here as you invest in all these technological and different opportunities, but free cash flow should be improving from here. So any update on that front?

Yeah, sure. And just as a reminder, our capital allocation priorities is we want to maintain our investment grade rating reinvest in the business, and then return excess cash to our shareholders. A couple of things just on the cash return front. We did two things this quarter. First, we did repurchase $127 million worth of stock in the first quarter. We don't have anything else planned right now for the rest of the year, but we continue to look at that. That's obviously very fluid, and we will be opportunistic with that, but there's currently no plans right now. We did buy back debt in the first quarter, so that was another $300 million of debt that we retired early would come due next year. And we're very much on track with our investments that we've been talking about, and we feel confident that we're going to be well within the range of the guidance that we provided last quarter. So we feel like we're doing all of the things that are consistent with our capital allocation priorities, and we're very much on track with everything that we've indicated.

All right. Thanks so much, guys.

Thank you. And, ladies and gentlemen, this does conclude our question and answer session. I would now like to turn the call back over to Tom Greco for any closing remarks.

Well, thanks to all of you for joining us this morning. A couple of quick comments in closing. My team and I look forward to kicking off our second annual American Heart Association fundraising campaign throughout the stores next week. And the AHA, as many of you know, is an organization that's extremely important to all of us. And while I'm proud of the fundraising accomplishments we had last year, we're looking forward to exceeding our campaign goals this year. So look for it in our stores. Heart disease is the number one killer of Americans, and all of us at Advance are committed to help change that statistic. And before I conclude, I want to take a moment to express our sincere gratitude to all our nation's heroes who have served especially those men and women we honor this Memorial Day weekend who paid the ultimate sacrifice for our country. I wish you all a safe, healthy, and happy holiday weekend, and we look forward to discussing our second quarter results with you in August.

Ladies and gentlemen, thank you for participating in today's conference. This includes today's program. You may all disconnect. Everyone have a great day.