Advance Auto Parts Inc.

welcome to the advanced auto parts second quarter 2020 conference call before we begin elizabeth ice lebanon senior vice president communications and investor relations will make a brief statement concerning forward-looking statements that will be discussed on this call please go ahead good morning and thank you for joining us to discuss our second quarter 2020 results

I'm joined by Tom Greco, our President and Chief Executive Officer, and Jeff Sheppard, 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 remarks today may contain forward-looking statements. All statements, other than statements of historical fact, are forward-looking statements, including... but not limited to, statements regarding our initiatives, plans, projections, and future performance. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information about factors that could cause actual results to differ can be found under the captions forward-looking statements and risk factors in our most recent annual report on Form 10-K and subsequent filings made with the Commission. Now let me turn the call over to Tom Greco.

Good morning to everyone joining us today. Before we get to the specifics of our quarter, I want to start with an acknowledgment to our advanced team members and independent partners. They've shown incredible perseverance and support for each other and for our customers over the past few months. Never has the term essential business meant so much to us. Throughout Q2, our team members responded to the pandemic with an exemplary level of customer care. At the same time, our entire organization responded with a remarkable level of speed and agility. Every week, we hear stories from both customers and team members on how Advance has helped keep America on the road during this crisis. along with commendations on the safeguards we've put in place to protect them while in our stores. Our sincere thanks and appreciation goes out to every single AAP team member and CarQuest independent partner who delivered the strong performance we're about to review. Since the onset of COVID-19, we established three overarching priorities. First, prioritize the health and safety of our team members and customers. Second, preserve cash and protect the P&L during the crisis. And third, prepare to be stronger following the crisis. At the beginning of the pandemic, we set up a team dedicated to the health and safety of our team members and customers. This cross-functional team organized daily stand-up calls throughout our organization, which allowed us to respond with a tremendous sense of urgency to help keep people safe and healthy. As examples, we installed plexiglass care shields in our stores in a matter of weeks. We institutionalized entirely new standard operating procedures across our stores and D.C. networks. Our technology team enabled work remote capabilities for corporate functions and for our field team. We significantly increased communication through virtual town halls and regular video updates. And importantly, we provided enhanced compensation and benefits on top of our industry-leading Fuel the Frontline stock compensation program to help our team members during this time. Health and safety has been a top priority for the leadership team here at Advance over the past few years. While none of us wanted COVID-19, the foundational processes that were put in place prior to COVID were instrumental in enabling us to not only respond to the global crisis, but to provide outstanding customer support within it. As a result of our health and safety focus, we're very pleased that AAP has been well below the national average infection rate for COVID-19. We remain laser focused on taking the necessary steps to enable our team members to feel safe coming to work and to ensure our customers feel safe shopping in our stores, which is more important than ever right now. When we provided our quarter-to-date results during our Q1 call, we indicated that our sales results had sequentially improved every week during the first four weeks of Q2. As you saw in our results this morning, our sales momentum continued for the remainder of the quarter. Our sales grew 7.3% to $2.5 billion compared to the prior year. Comparable store sales increased by 7.5%, the highest quarterly growth rate in close to 10 years. Our adjusted operating income increased by 42% to $279 million, and our adjusted operating income margin rate increased 274 basis points to 11.2%, while free cash flow in the quarter was up 60%. Nearly all regions had positive comparable store sales, with the Gulf Coast, Central, and Appalachia regions posting strong double-digit growth. The Northeast, Mid-Atlantic, and West Coast regions, which were more impacted by the pandemic, significantly trailed our other regions. In fact, we had an extremely wide distribution of performance geographically. with over 2,000 basis points separating the highest and lowest growth regions. As you've heard from others, our professional business was more negatively impacted by COVID-19 than DIY in the quarter. This was primarily due to the temporary closure of garages across North America. In addition, we have a disproportionate amount of our professional business in the Northeast, Mid-Atlantic, and West Coast. These regions represent over 30% of our pro sales and they were all well behind the rest of the country in terms of their professional growth rate. However, as the quarter progressed and stay at home orders began to lift, we saw sequential improvement in our professional business each period. In the final four weeks of Q2, pro sales were up mid single digits. During the quarter, we continue to support our professional customers, including the rollout of our enhanced MotoLogic platform. This repair and diagnostic tool was built from the ground up by industry and technology experts and provides access to complete, unedited OEM information. Since 2018, 3,700 new vehicles and 14 million-plus articles have been added, Our most recent upgrade includes enhancing modal visuals, which allows technicians to share repair animations. This helps them explain services to customers in person, by text, or email. Also in Q2, we signed up a record number of new TechNet customers, as we crossed 11,500 TechNets in total. Our independent car quest WorldPack, and Carplus Canada businesses also recovered nicely as the quarter progressed. Throughout the quarter, we responded quickly to the needs of our professional customers and put new tools in place for our sales team to be successful regardless of current challenges. This includes contact pre-delivery, instructor-led virtual training for shop owners, and expansion of selling capabilities, enabling our sales team to better meet the needs of our professional customers. We believe the work we've done to be there for our professional customers at a time of great need has set us apart. Our DIY omnichannel performance was meaningfully stronger than our DIFM business throughout the second quarter. This was driven by both external and internal factors. An overarching macroeconomic factor is whether consumers are repairing or maintaining their vehicles, they are much more focused on saving money during challenging times. This generally means fewer new vehicle sales, an aging fleet, and more DIY jobs. In addition, the stimulus checks from the FAIRS Act, as well as extended unemployment benefits in Q2, provided incremental discretionary income, which we believe contributed to our DIY sales performance. Since our DIY momentum has continued into Q3, we believe there are other external factors driving DIY beyond stimulus. First, many consumers were continuing to spend more time at home and had more time to work on their vehicles. Secondly, we believe that due to COVID-19, people were less apt to use public transportation. This includes ridesharing, buses, trains, and subways. It also includes air travel, which was down significantly in the quarter. Airline leisure travel was at times replaced by a road trip in a personal vehicle. In total, mass transportation indices were well below a year ago, all quarter. Meanwhile, personal vehicle miles driven climbed throughout Q2, according to Apple and Google Mobility. Finally, according to our research, many of the large box retailers, including online retailers, prioritized staples along with food and beverages in Q2. This resulted in long-tail items such as auto parts to be deprioritized, which temporarily opened a door. We believe external factors represented the majority of the surge we experienced in DIY. While we cannot speculate on the longer-term impact of these macroeconomic or COVID-related variables, we do believe from past experience that DIY typically performs better during recessionary environments as consumers try to save money and keep their vehicles longer. Additionally, as our economy continues to reopen, we believe there's still an understandable concern surrounding public transportation and mass gathering. We remain committed to providing a safe shopping experience through our suite of advanced same-day options. As more and more consumers are relying on personal vehicles, they are choosing contact-free options like advanced same-day curbside or advanced same-day delivery. While we clearly have strong momentum in DIY, it's important to reiterate that there are still many unknowns surrounding COVID-19. In addition to external factors, our internal initiatives for DIY gained traction in Q2. First, we successfully launched Die Hard on July 2nd nationwide. Although it's not a meaningful growth driver in the quarter, The first week of selling Die Hard was a momentous celebration and a galvanizing event for our team. The launch involved coordination across every aspect of our business. Normally, the advanced executive team would be doing store tours during a launch like this. While we would have preferred to do in-person store tours, this was simply not possible during this time. Therefore, we adapted and conducted a combination of in-person and virtual tours across the country. The good news is we got to a lot of stores very quickly, and every general manager we spoke to was incredibly excited about the potential of Diehard. While it's too early to quantify the impact of Diehard, we believe this iconic brand will be a long-term differentiator for us. Secondly, we made a decision in the early stages of the pandemic to prioritize advanced same-day messaging in our advertising over previously planned brand awareness campaigns. The advanced same-day advertising was both timely and relevant. Going forward, we'll continue to build the awareness of the advanced brand, partnering with Team Penske, NASCAR, and with the Indy 500 this upcoming weekend. Third, our SpeedPress loyalty program sustained continued momentum as the number of active members grew to more than 13.5 million, an increase of nearly 30% year over year. We're also seeing growth on customers graduating to higher tiers within the program, along with improved in retention rates. Finally, our DIY execution continues to improve. In addition to the national launch of advanced same-day delivery, we've strengthened the front-end user experience of our online platform, which led to improved traffic and higher conversion rates. Our in-store execution also improved with strong ticket count growth, along with notable gains in units per transaction and sales per ticket. As a result of both external and internal factors, we delivered double-digit growth in DIY Omnichannel throughout Q2. To close out the top line, and as we said in our press release, we've continued to see strong sales through the first five weeks of Q3. As we turned to profitability, we made progress on each of the four pillars of margin expansion in the quarter. In terms of sales and profit per store, we had very strong sales per store in the quarter. On a rate basis, our SG&A per store was down materially. Certainly, we benefited from top-line growth. However, our productivity tools are also helping. Utilizing our new scheduling and task management tool, our field team has done an excellent job managing hours despite a challenging and evolving environment. With that said, we took several actions in the quarter reflective of the unique operating environment, such as a reduction of certain labor and costs related to the softer professional business. As our business continues to normalize, including the mix, we expect to add certain expenses back. In terms of supply chain, improved execution and standardization in our distribution centers enabled us to leverage supply chain in the quarter. As we called out in our Q1 earnings release, we did need to delay or pause some important initiatives due to COVID-19. As an update, and given the strength of our business, several of these key initiatives are now back up and running. Frostbender Replenishment, which will integrate the supply chains within Advance and PowerQuest, is on track to deliver the original savings we planned in Q3 2021. This is slightly delayed from our original timeline, primarily due to factors related to COVID-19. Our Single Warehouse Management System, or WMS, initiative was officially paused during the quarter. We've restarted this work and revised the timelines for WMS, which includes prioritizing our largest VCs. We expect to complete our WMS implementation in these large VCs by the end of 2021. We believe this will enable us to realize the vast majority of the plan savings in 2022. In terms of category management, we continue to work with suppliers on material cost optimization and own brand expansion. We also began the implementation of a new pricing platform and expect over time this new tool will enhance our price management capabilities. Our next step is to begin the implementation of market-based or local pricing strategies, which is something we cannot do efficiently today. Finally, in addition to leveraging store labor in the quarter, we continue to execute our SG&A productivity agenda. This includes the integration of back-office accounting as we consolidate four ERP systems to one. We also saw significant savings in travel expenses after pausing travel across the company. While we believe there will likely be some savings associated with reduced travel longer term, it will not be at the level we saw in Q2. Our focus on health and safety also continues to drive cost savings in SG&A. In Q2, we once again reduced our recordable incident rate, which has resulted in a 27% reduction for the first half of 2020. Our collision frequency rate has also improved with a year-to-date reduction of 13%. Before I turn it over to Jeff, and based on current events happening across the U.S., I want to reinforce our commitment to inclusion and diversity. We're witnessing immense civil unrest across the country in recent months. These events are reinforcing the importance of our cultural beliefs at events. Our cultural beliefs are part of how we think and how we act at events, regardless of level or title. Our champion inclusion cultural belief is highlighted by the statement, I embrace diversity of people, thoughts, skills, and styles to deliver results. It's never been more apparent to my leadership team that we need to step up on our commitment to champion inclusion even more. This includes standing up against intolerance and racism, conducting business with integrity, and interacting with all people in a respectful manner. We recently launched an initiative we call Advancing Black Pathways. This is focused on creating real change in three primary areas, culture, careers, and communities. We look forward to seeing further progress in this important element of our culture as the initiative develops. In summary, Q2 was a strong quarter, and we could not be prouder of how our field team members took care of our customers during a difficult time. In spite of the challenges we faced from COVID-19, our advanced leadership team also stepped up as evidenced by significant increases in our communication and employee engagement scores in our most recent Pulse survey. While we're pleased with our second quarter results, uncertainty remains in terms of how the pandemic will impact consumer behavior and our business. Regardless, we remain focused on executing our strategy while updating the value and prioritization of our long-term projects in this new environment. Most importantly, we will continue to prioritize the health and safety of our customers and team members for the balance of years. while leveraging our industry-leading portfolio, which now proudly includes DieHard. With that, I'll turn it over to Jeff for details on our financial performance. Thank you, Tom, and good morning, everyone. We're certainly in an unprecedented time right now, and I truly hope that you and your families have stayed well during the past several months. Before diving into our Q2 results, I want to thank our team members for all we have accomplished over the last several months. It's a result of their dedication that we're extremely pleased with what we delivered in the second quarter. In Q2, our adjusted gross profit was approximately $1.1 billion, which was an increase of nearly 9% compared to Q2 of the prior year. Adjusted gross profit margin improved 57 basis points year-over-year to 43.9%, driven by favorable channel mix and supply chain efficiencies. These were partially offset by inventory-related costs due to a significant decrease in inventory driven by an increase in customer demand. Our adjusted SG&A was approximately $818 million in Q2, nearly flat compared to Q2 2019. Adjusted SG&A as a percent of net sales improved 217 basis points compared to the prior year. primarily driven by cost controls being implemented in response to the pandemic in late Q1. These include reductions in labor costs as we leveraged store labor while reducing medical claims. Further, we saw savings from lower delivery expenses to pro customers in the front half of the quarter before professional sales began to recover. Additionally, we saw favorability in travel and a reduction in insurance expenses. These cost savings were partially offset by investment in marketing expenses associated with the launch of our advanced same-day campaign and the Die Hard brand in the quarter. Support contracts related to IT solutions we have implemented since Q2 2019 were also a slight headwind in Q2. In addition, we incurred $15 million in COVID-19 expenses in the quarter, which partially offset the cost savings we delivered in the quarter. Our COVID-19 expenses were a combination of two things. First, we are incurring ongoing costs as we provide cleaning supplies, gloves, masks, and hand sanitizer to our stores, DCs, and corporate locations. In addition, we incurred some one-time expenses, such as installing plexiglass barriers in our stores. Secondly, we continue to invest in team member compensation and benefits in the quarter. Adjusted operating income in Q2 was $279 million, which improved 42% compared to the prior year quarter. Our adjusted OI margin rate improved 274 basis points to 11.2% in the quarter. Adjusted diluted EPS was $2.92, an increase of 46%. Free cash flow in the quarter was $380 million, a 60% increase compared to $237 million in Q2 2019. Year-to-date, free cash flow was $308 million compared to $381 million during the same period in 2019. As a reminder of our capital allocation priorities, we remain committed to maintain our investment grade rating, invest in the business, return excess cash to shareholders. Consistent with these priorities, we've taken several actions. First, we repaid the $500 million previously borrowed under our revolving credit facilities. In addition, yesterday we provided notice to the trustee of our intention to redeem the $300 million, 4.5% notes due in 2022. These actions will help us return our leverage ratio to pre-COVID levels. Secondly, the prom mentioned We restarted several projects that we expect to enable margin expansion that has been paused or delayed due to COVID-19.

As a result, we now expect our full year 2020 capital spending will be a minimum of $250 million. In Q2, our capital expenditures were $57 million, which was an increase of $7 million compared to prior years. Third,

With respect to our priority to return excess cash to shareholders, we're pleased to maintain a 25-cent dividend per share for Q3.

In addition, we've lifted the temporary suspension of our share repurchase program and will remain opportunistic in our balanced approach to returning excess cash to shareholders.

In summary, we deliver strong operating results and strengthen our balance sheet this quarter. we remain diligent in managing our liquidity and executing our plan to win in the marketplace while expanding margins. With that, let's open the call to address your questions. Operator?

Thank you. At this time, if you'd like to ask a question, press star 1 on your telephone. To retry a question, press the palm key. Please limit yourself to one question and one follow-up. And your first question comes from the line of Michael Lassara with UBS. Please go ahead.

Good morning. Thanks a lot for taking my question. As you look at it, how is your market share in both DIY and DISM as you try and adjust for business mix and geographic exposure? And as part of that, Tom, do you think that the customers in the DISM segment you are levered to might be losing share within those markets?

Hey, good morning, Michael. First of all, we absolutely gained share in the quarter. We can see from the syndicated data that inside of DIY we gained share. And on Pro, we just look at what's been reported and we compare it to what we delivered, and we feel very confident that we gained share in DIFM also. So you have to keep in mind that this is a pretty fragmented industry. In a $150 billion segment, the big four players have $40 to $45 billion in sales, so roughly a third of the business. So is it conceivable in the middle of a global pandemic that large-scale players that have about a third of the business can take share from, you know, the smaller-scale players that are two-thirds? I think we just showed that that's the case. You know, obviously we've got capabilities that smaller players just don't have, you know, a great online portal, omni-channel capability there. We can turn on a dime and do curbside delivery or contact-free delivery. Our supply chains are robust. So, you know, we're confident that we gain share in the quarter, and I think it's, as you've been seeing, the larger players are going to be doing well in a quarter like this.

Thank you. My second question is, you outlined some delays in the initiatives that were going to drive the margin inflection in 2021 but there's also some factors that are probably trending better than what you anticipated so as you net those out are you do you believe that the magnitude and the timing of the margin expansion that you previously outlined for 2021 will be consistent with what you had previously expected or should we as we look out forward start to recalibrate lower our expectations for next year thank you very much

Well, obviously, there's a tremendous amount of uncertainty right now, whether it's the shape of the recovery, the impact of COVID. We've got an election coming up. So we're still working through our update, if you will, of our strategic plan, which will be a three-year plan when we discuss it later on in the year and into 2021. You're right. There's been impact to each one of the margin expansion initiatives that we have. At this point, we're not in a position to comment specifically on where we're going to be in 2021. It's obviously very early at this stage, but we feel very good about the progress that's being made, whether it's in sales and profit per store, where we had a very strong quarter You know, the team did a really, really good job managing payroll in the quarter. We're looking a little bit differently at our fleet, if you will, as we go forward given the changes in the real estate environment and construction costs. You know, supply chain we referenced in the prepared remarks. We still feel very good about our ability to expand margins through supply chain. We're rolling up, you know, our own brand portfolio, which will drive margins. And in SG&A, we had a very strong quarter. Those initiatives are moving very well and, in fact, you know, ahead of our expectations. So, you know, there's puts and takes in there, but I think it's a little early to speculate on 2021. Thank you.

And your next question comes from the line of Seth Sigmund with Credit Suisse. Please go ahead.

Good morning. This is Kieran McGrath for Seth Sigmund. Congrats on the great quarter. Two questions from me. Firstly, you discussed DOI strength continuing quarter days. Does that tell you that stimulus was a smaller piece of the elevated DOI demand in the first half? And related, Do you now think that that elevated demand is more durable than your initial expectations?

I'm sorry, Kieran, can you repeat the first question? I'm not sure I understood everything.

Just regarding the strong quarter-of-the-date DOI trends, obviously stimulus has now expired. So does that inform you that the stimulus will be a smaller piece of that elevated demand in the first half, and then related, is that elevated demand now more durable, in your opinion, than your initial expectations?

Well, I think the – I guess there's a lot of factors in there. I do think that we obviously benefited from stimulus and unemployment benefits, but we know that in the back half we're going to get less benefit from that. That said, you know, the strength has continued, as we indicated. You know, when you've got a challenged economy and when you have COVID, there's a number of things that work in our favor. You know, we know we're going to have less new vehicle sales. That means an aging fleet. That means more repairs. means more DIY work. You know, we know that people are going to avoid mass transportation. We hear a lot about, you know, the car is a safe place for people right now. So they're choosing to, you know, use a personal vehicle. There's some people that are buying cars because of that that have not used and did not have a vehicle before. They're buying a used vehicle to get around when they had been doing nothing but ride-sharing. So that's going to help us. And the fact that people have time on their hands to do projects and are spending less on travel, entertainment, and those types of things also benefits us. So I think there are some macroeconomic factors involved. related to the environment and to COVID that benefit us. And then, you know, we do have a lot of confidence in our internal drivers. I mean, Diehard is launching. Our field team is very, very excited about it. Our marketing plans are kicking in. We're into our second year of sleepers. So, yeah, we believe, regardless of the environment, you know, we'll have strength in DIY in the back half.

Great. Thank you. And then, secondly, Regarding your category performance, was that relatively broad-based or was it led by maintenance and appearance? And then what do you see in failure categories on the back of the miles-driven trends that you discussed? Thank you.

Yeah, sure. Good question. I mean, there is, you know, some impact on the categories that really rely on miles-driven. If you talk about things like brakes, to a lesser extent under car, chassis. You know, as the economy started to open back up, I mean, in the early part of the quarter, we were soft in those categories, particularly on the professional side. But we gained momentum throughout the quarter, and now we're in the mid-single-digit land growth rate in those categories. So the categories that are very reliant on miles driven, we've seen an improvement in the last couple of months. On failure, this intermittent driving that's going on obviously benefits certain categories for us, be that, you know, batteries or fuel pumps. There's others where we're seeing, you know, very, very strong growth. AC bounced back nicely in recent weeks. It was obviously quite warm in our geography, so that came on very strong. And as you've heard from others, appearance, wash and wax, very, very strong performance, and that's also sustained. So, you know, you've got the normal dynamics around, you know, miles driven and its relationship to the category I don't think is as relevant. It doesn't correlate as highly as we're seeing, you know, strength in certain categories that really aren't depending on miles driven. Thank you.

And your next question comes from the line of Elizabeth Suzuki with Bank of America. Please go ahead.

Great. Thank you. You know, just following up on a previous question, I guess looking at the cost reductions that were made in the quarter, I mean, it sounds like a lot of it was labor expense that will likely come back as the sales environment is more favorable. But, you know, at the same time, you had longer-term cost savings initiatives that were delayed. So as we think about just the remainder of the year, we expect labor costs to come back, but then longer-term you get the benefits of the larger initiatives over the next, you know, two, three years.

Yeah, sure. Liz, this is Jeff. So, you know, we had obviously a number of, you know, cost initiatives that we put in place at the end of the first quarter. They did start to manifest themselves, obviously, in the second quarter. And you hit on the main things. You know, the payroll was a big driver. Professional delivery, you know, that segment was huge. slower in recovering, we were able to see benefits there. And we saw benefits associated with costs we can control, like travel. And then we saw benefits in areas like medical, because a lot of our team members are deferring elective procedures and even checkups. So as we look to the back half of the year, I think there's potential headwinds. There are some continued tailwinds. And then there's some that could go either way. So, you know, as professional recovers, you know, we are going to have additional professional labor. You know, we've got to deliver that part to the customer, and that just requires additional labor hours, driving, and costs associated with that. We are going to continue to invest in our marketing in the back half. You know, we've launched that both for Die Hard as well as our Same Day. And it's something we believe in, which should, you know, obviously drive revenue. But, you know, that's something we want to invest in. And then, you know, the CapEx, the projects that we're starting, that we're restarting, that were paused, there's obviously OpEx related to that. And we're going to continue to make those investments. And then, obviously, the COVID costs. We're going to continue to prioritize people over profit. Having said that, we think there are some tailwinds as well. We're going to continue to control things like travel. And store payroll is another area we believe that we can continue to leverage. And, you know, we've got our... labor tool that's been put in place and we're seeing a lot of benefit from that. While we think there's going to be some additional labor associated on the professional side, we think we can continue to control payroll. Then there's a question mark with medical. Medical could continue to be a tailwind, but it could also be a headwind if back half team members are going to be more comfortable going into the doctor's office to get checkups or start to do elective procedures. So those are sort of the costs that we're looking at in the back half. You know, obviously, you know, we're still in the pandemic. There's still a lot of uncertainties, which is part of the reason why we don't have any guidance out there right now.

Okay, great. Thank you. And your next question comes from one of Simeon Gutman with Morgan Family. Please go ahead.

Thanks. Good morning, everyone. I wanted to start with a question on some of the DCs that you've begun to standardize. Can you talk about the sales and margin performance around those DCs or the areas in which they serve? I think some of them may have been impacted just because of COVID and some of the Northeast. I'm curious, since it's a building block of the transformation, how it's progressing, and are you seeing real change as a stepping stone to margins?

Hey, good morning, Simeon. For sure, out of the gate, we were really happy with what we were getting from the implementation of the new warehouse management system. The fill rates improved. The DC that we did was much more organized. The people there were trained and very excited about what was done. It was a material difference, I think, between what was there before. Obviously, the impact of COVID has been significant throughout all of our DCs and in our stores. It's made it difficult to hire people. It's a challenging environment right now. If you have an infection in the D.C., there's obviously things that we have to go through. We have to quarantine people. So I think it's a difficult time to really benchmark the success of the warehouse management system at this point. As we're starting to ramp back up and get people hired in our buildings, we just went through this yesterday, We are seeing progress and improvement on fill rates and how quickly we put things away and all of the things that go with running a DC successfully. So the short answer is we're highly optimistic that the warehouse management system implementation will enable a much more structured labor management system for our buildings and standardize our buildings and allow us to drive productivity You know, during the last several months, it was difficult to realize some of those benefits.

Okay. Thanks for that. And then my follow-up is related to a couple initiatives in the do-it-yourself side. I think marketing was on the cusp of changing and being enhanced, and then the diehard battery, and I apologize if some of this was asked already, but curious where you are on these two initiatives and how you manage in this environment.

Sure. I mean, the marketing we repurpose from, you know, essentially a, you know, branded campaign to really lift up Advance, the name Advance. We've talked a lot about the low relative awareness of the Advance brand. And, you know, we remain committed to that. That said, you know, as COVID hit and, you know, speed and urgency of getting parts became paramount, we repurposed that advertising to the Rally Cry campaign that we've been running. which is advanced same-day, and that has worked extremely well. It really drives home the speed and convenience and trusted advice that we can provide to our customers. It allows us to lift up advanced same-day curbside, so if somebody wants to come into our store and just wait in their car, we can walk the battery out, install it, and they don't even have to get out of their car. Advanced same-day delivery, I think we're the only people in the industry doing that at this point, has been very successful for us. And it's driven our pickup and store business as well. So, you know, we're happy with the way that campaign went. That said, we're remaining committed to, you know, driving awareness of the advanced brand. In terms of DieHard, we couldn't be more excited about DieHard. I mean, we mentioned in our prepared remarks that we went out and did virtual market tours. We were in a lot of stores very quickly. We saw our execution against it. Our team members are so excited about this brand. You know, they've lived with it their whole lives in some cases. In some cases, a team member remembers when they were five years old and they went out and they bought their first battery. It was a diehard battery. So we've got a tremendous amount of energy and enthusiasm around it. The marketing plans are coming together for the fall. But we dialed the execution on this. I already credit our field team. We wanted to launch it that July 4th weekend, and we stuck the landing on that. The execution looks fantastic coast-to-coast on Diehard. So more to come there, Simeon, but, you know, off to a great start, and we executed it well, and now we've got to really get the pull going so we can drive people into our stores.

Okay. Thanks for that, Tom.

And your next question comes from Linus. Scott Sicarelli with RBC Capital Market. Please go ahead.

Good morning, guys. So based on the flat comp that you had in the first four weeks of the quarter, it looks like comps had to be up kind of 10% to 11% or so in the last eight weeks of the quarter. So, Tom, when you talk about strong sales continuing so far in three years, does that mean we're still running at a double-digit rate?

Yeah, we're not going to give specific numbers, Scott, for it. But, I mean, obviously we did end up running double digits those last couple of periods, and we've continued to see strength into the third quarter, which we feel good about. So the category remains strong, you know, for some of the reasons I mentioned earlier. So we feel good about it. Got it. Okay.

And then when you talked about the 2,000 basis point gap across some of the geographies, I'm assuming that was kind of full quarter commentary. But should we assume there's been a fairly meaningful narrowing in that performance gap in kind of July and August so far, just as consumer mobility has continued to improve? Are you still seeing the gap that wide? Yeah, good question.

We are seeing it narrow. And we commented on, you know, the Northeast, the Mid-Atlantic specifically, where, you know, we've seen the most significant impact of COVID, and particularly on the pro side, by the way. DIY, we're doing better there. But even there, you know, you've got that differential that we're talking about, but it has narrowed. As time has gone on, and we are optimistic that we'll continue to narrow. It's just, you know, the people up in the Northeast and mid-Atlantic have been just less mobile. And, you know, our overall performance up there has lagged. I mean, the center of the country was very, very strong, you know, throughout the entire quarter, both on pro and DIY. Mid-Atlantic and the Northeast challenged significantly. West Coast, we did well on DIY. Pro was more challenged on the West Coast for us. So that's kind of the geographic performance, but we are seeing a narrowing, which is good for us. Got it. Very helpful. Thanks, guys.

And your next question comes from the line of Michael Montagna with Evercore. Please go ahead.

Hey, good morning. Thanks for taking the question. Just wanted to focus on two things. One was top line and then a margin follow-up. So just specifically as it relates to the top line, was just hoping for some extra clarification in color around, you know, the pro side. Was that positive during the quarter? And then anything you can share, Tom, in terms of, you know, traffic count versus ticket size, you know, for DIY and DIFM. And then I just had the margin follow-up after that.

Yeah, first of all, on Pro, we were down slightly in the quarter, you know, overall. I think on ticket and traffic, very, very strong ticket performance. On DIY, dollars per ticket, very strong. In terms of Pro, we measure accounts, right, Michael, on Pro, like how many accounts are we servicing. In April and into early May, that number dropped significantly. It was down 30%, you know, for a couple of weeks there as the garages were closed and some of these markets were, you know, shelter in place and very shut down. As the quarter progressed, the number of accounts we were sort of thinking came back, back, back, and right up through the end of the quarter, we started to approach year-ago levels. We're still slightly negative, but approaching year-ago levels. But our dollars per account surged. So, you know, you're seeing some consolidation there a little bit. But overall, our pro business has recovered week in, week out since this thing started. And we're optimistic about that.

Okay, great. And then just on the margin front. kind of a two-parter, but one is on SG&A dollars. Jeff had some significant puts and takes there, but if you think about the back half, can you kind of continue SG&A dollars to be more or less flattish with last year, even if the volumes remain strong? What should we think about there? And then secondly, on the gross margin front, just wanted to see what kind of inflation you all are experiencing, and if you feel you can get it through Because, as I recall, there's significant tailwinds from cycling the Speed Perks 2.0 launch as well as supply chain leverage into 3Q that should be good for gross margin. Yeah, sure. Let me start with the SG&A.

As I said on a previous question, we certainly have some headwinds and we have some tailwinds. And if you kind of tick back through those, you know, the headwinds are controllable. We have marketing, but if we need to scale it back, we can scale it back. You know, the only one you really can is COVID. I mean, we're going to spend what it takes to protect our people and protect our customers. If pro labor doesn't continue to trend the way it has been, you know, we're not going to have drivers in the store if there's no parts to deliver. And then on the tailwind side, obviously, travel and payroll in a store, I feel really confident we can continue to leverage that, not to mention the awareness that we're going to get from the marketing and the impact that we're going to get from diehard that we really didn't see much in the second quarter. And then medical, again, could go either way. In terms of gross margin, inflation was relatively low in the quarter. I think we were right around 2%, maybe slightly under. And you're right, in the back half, there's two things we're going to be lapping. You touched on one of them in terms of fee perks and then also the full impact of the tariffs. So on a year-over-year basis, we should be able to see some benefit there, assuming we don't get anything in the back half associated with elections or anything else. So, yes, certainly some opportunity.

Thank you, and good luck.

And your next question comes from the line of Danielle Ambrose with Stevens, Inc. Please go ahead.

Hey, good morning, guys. Morning. Tom, can you update us on the status of the independent car quest locations? Obviously, they're leveraged towards the DIFM market, which is underperformed. I know you added a few, but just any material change in the health of the independent landscape you're seeing, especially maybe August 2021, here today as we've seen the PPP funding kind of run out in late July. Any change you're seeing out there in that landscape? Well, first of all, it is changing. There's no question about that. But we grew in the quarter with our independents. We're really excited about that. I'd like to commend them. I mean, they did a phenomenal job amid tremendous challenges. I think the team really banded together, the independents themselves, our field team, our pro team that supported them. We acted really fast, and a lot of our independent partners were able to just take all of the things we were doing inside of Advance to keep their team members safe, leverage the PPP loans. They were able to roll out curbside delivery in conjunction with our AAP stores, which allowed them to provide essential parts and services to their communities. You know, I think more and more, you know, we're able to move faster to enable our independents to do the things that they need to do to win in the marketplace, and that's why the CarQuest program is growing. So we feel very good about the progress that's been made there, and they have a strong quarter, actually, so we feel good about it, Daniel. That's great. That's helpful. And then, Jeff, maybe one on gross margins as a follow-up. You know, we're hearing from transportation companies – especially truckload and LTL, rates are beginning to move a lot higher due to limited capacity. Can you remind us how much of your freight is exposed to third-party freight rates or contract rates, and then how you're expecting that to maybe impact gross margins in the back half?

Maybe as a follow-up to the last question on gross margins.

Yeah, and we haven't broken out our third-party transportation, but we certainly do have exposure. A portion of it is third-party, a portion of it we do have internal. So we do have exposure to it, but we haven't seen a significant amount of inflation here in the second quarter. It doesn't mean we won't get it in the back half, but what we've seen here in Q2 has been basically immaterial. Yeah, thanks.

And your next question comes from the line of Zach Fadum with Wells Fargo. Please go ahead.

Hey, good morning. On the do it for me, you mentioned performance was down slightly in the quarter. Curious if this was consistent across, you know, all the varying professional customer or commercial customer types and whether you saw any, you know, disparities across kind of mom and pop garages or regional chains.

Well, the way we measure that, Zach, is obviously we have our large strategic customers. We have our TechNet customers. We have the all other. You know, what I can tell you is all of them have been bouncing back. As we mentioned, in our most recent four-week period, which kind of is mid-June to mid-July, you know, we were up very nicely, you know, in our professional business overall. And that really was across the board. You know, our strategic accounts are coming back. You know, our TechNet probably led the way. It did lead the way in the quarter. We added additional TechNets, and our base TechNet customers performed very well in the quarter. And even the all-other segment in the last four weeks, we grew. So it was really a function of that first big change when COVID impacted the country in April when, you know, there was just people closed down and it was – pretty uniform across our channels within professional. And then as the country began to open back up, you know, we saw it improve. And Dave's experienced similar things to us. We looked at the geographic performance, and I talked to the CEOs of these companies. We do the benchmarking. Everybody struggled in the Mid-Atlantic and the Northeast. Everybody had a huge, you know, growth rate in the center of the country. So that's really what was going on. And I do think over time, as we said before, the large strategic accounts are going to continue to grow at an accelerated growth rate. And, you know, where they have the scale, they're going to leverage that scale.

Got it. That's helpful. And then on the gross margin line, again, how much of the 60 basis point expansion would you attribute to DIY mix? And, you know, how would you quantify that relative to the impact of other factors like LIFO and the supply chain leverage?

Yeah, so basically in rank order, there are two major drivers to the gross margin expansion. The first actually being supply chain. We leverage both in rate and dollars on a year-over-year basis. And then the second item would be the mix that you're referring to. And then that was offset by what we call inventory-related, which was largely – you think of it in terms of volume. Because we took the inventory down so substantially, those capitalized supply chain costs worked their way through the P&L. The LIFO impact for the quarter was a little over $3 million. So year over year, we actually saw that as a tailwind, but it was a $3 million hit in the second quarter. Got it.

That's helpful. Appreciate the time, guys. Thanks, Zach.

And your next question comes from the line of breath, Jordan, with Jeffries. Please go ahead.

Hey, good morning, guys. Morning. Morning. Hey, as you look at Duralast, sorry, at the diehard with six weeks, I guess, of history,

How has the performance of the battery category been with that new brand?

I mean, if you compare it to what you were doing maybe with AutoCraft in the prior year in July, do you see anything that you can sort of measure the success with? And I guess as you think about the Diehard brand for product extension, are you going to keep that in battery or is that rolling out to broader categories? Well, first of all, you've heard from others that batteries perform very well in the second quarter period for some of the reasons that we mentioned earlier. And that was, you know, fortuitous for us because, obviously, we were in the middle of a transition. And we wanted to sell through all of those auto craft batteries. But that was a massive undertaking for us. So, I mean, it enabled a very smooth transition, as I mentioned. Every store in the country was full with Die Hard in early July. You know, we can see the share numbers. We like the share numbers a lot. in batteries. And, you know, we're optimistic that, you know, Gaillard's going to sustain that momentum. So I think it's early to comment on the performance of it. But there's no question that, you know, we are very bullish on our ability to drive market share gains in batteries in the back half of the year. In terms of what we're going to do with the brand, more to come there. We want to be very thoughtful and deliberate about Die Hard. You think about the big things that we're focused on there. We have to win in batteries. That's kind of job number one. We want to make sure that we're doing the job there. and not kind of moving on to something else before we've established ourselves within batteries. But beyond that, there's a lot of extension opportunities that we're discussing, but you're not going to see a lot there, you know, over the next couple of months. I mean, right now we're focused on dialing the execution of the battery launch. you know, marketing it flawlessly, making sure DLI consumers know that the only place they can get it is at an advanced auto parts. And, you know, our pro customers, we've got programs that we're launching there as well. And our team members, you know, we want to make sure that our team members are, you know, really, really clear on the benefits and the features associated with iHeart. So that's kind of the current focus is on really dialing the battery and launching the back half of the year. Okay. And then a quick question. You mentioned that you gained market share in the quarter. I guess, do you have a feeling for where the shake-it share gains may have come from?

I mean, you did comment some other online and non-traditional auto retailers de-emphasized the category, or was it from smaller independents who were just sort of stressed with, you know, pre-K or PPP funding?

Yeah, I think it's a combination of both from what we can see, Brett. You know, there's limited information that you can see the true online performance, but when we look at, you know, share of buyers or some of the growth rates that you can get, you know, surrounding the online players, we can see those gains. And, you know, when we see our performance versus rest of the market, you know, we have to assume that some of those gains came from some smaller players also, which is not as clear to us, right? You can't see specifics there. You just see us versus rest of the market. But I think it's a combination of both of those two. Great.

Thank you.

And your next question comes from the line of Seth Bashan with Redbush Securities. Please go ahead.

Thanks a lot, and good morning. My first question is just surrounding the effect of the pressure on miles driven and whether or not you're seeing declines in failure and maintenance categories directly tied to miles driven, particularly in the regions where miles driven have remained the weakest, such as the Mid-Atlantic and Northeast. Can you provide a little bit more color there?

Yeah, honestly, Steph, it's impacted more the brakes, undercar, chassis categories. And, again, I mentioned earlier that that was early in the quarter. So we saw, as miles driven, dropped to minus 40 and minus 50, right, which was kind of the April numbers. and in particular in the geographies you mentioned, we definitely saw a slowdown in breaks and to a lesser extent under car chassis. But that gained momentum as the quarter went along. And by the time we got to the end of the quarter and into the third quarter, and this is largely a professional comment, by the way, you know, we were able to see that number come up, and we're now growing the single digits in those categories. In the failure-related, particularly batteries, when you've got intermittent driving, you're basically increasing the likelihood of failure. So that has actually helped us, and sales are up very strong in those categories. And we mentioned appearance and accessories. which, you know, people just have time on their hands. They're washing their own cars. They're detailing their own cars. They're not buying a new car. They're buying a used car that they want to work on and do some things. So they're doing the things that, you know, people who have time on their hands are doing right now. So DIY is a great time for DIY because people have time on their hands. and they're going to do things with that time other than just sit around the house and get outside and do the things that people love to do. So, you know, miles driven is normally a very high correlation of performance in the category, but we're not seeing that same relationship that we've historically seen.

That's really helpful. And then secondly, on cross-banner distribution, I know you've delayed some of the expected changes and benefits, but for DCs where you have implemented it so far, can you provide a little bit of an update as to types of improved margin or improved performance that you're seeing?

Yeah, we're right on the number in terms of the productivity we expect in the buildings that we've made the changes to. So we feel very good about that. You know, we're continuing to roll it out. We delayed it. I mean, it was a difficult quarter. You know, you're running through a you know, all the challenges that we were facing. Our e-commerce business surged significantly in the quarter. We had COVID incidents in our distribution centers, which caused us to have to slow it down, which we didn't want to do, but we had to. So we're not going to realize the full benefits until the third quarter of 2021, as we indicated in our prepared remarks, which moved it back about a quarter. But In the buildings and the stores where we've made the change, you're just taking stem miles straight out. So it's just great stem mile savings. You know, as fuel costs fluctuate, that's going to fluctuate. But overall, it's on track with the client productivity we expect. Thanks a lot, and good luck.

And your next question comes from one of Kate McShane with Goldman Sachs. Please go ahead. Hi, thank you for taking my question. This is Shawnee Luther on behalf of Kate McShane. In terms of thinking about COVID-related costs, and you guys mentioned that you incurred $15 million of COVID costs in 2Q, and part of it was one-time expenses like plexiglass, etc. How should we think about this expense going forward?

Yeah, it's a tough one, obviously, to predict. We're going to continue to pay whatever we need to to keep our people safe. We had $16 million in the first quarter. We had $15 million in the second quarter. So one could say that is a run rate. We did have some one-time costs, but we had that in the first quarter as well. So the question really becomes, is there a third quarter one-time cost, or is there a fourth quarter one-time cost? remains to be seen. You know, like we said in some of our comments, you know, we put in the plexiglass, we continue with sanitation, masks, temperature taking, and then we did some support directly to our team members in the form of, you know, some one-time compensation. So, you know, that's sort of the dynamics of the first half of the year. A little bit difficult to predict what's going to happen in the second half of the year, but we're certainly going to, you know, make sure we keep our people safe.

That is very helpful. Thank you. And if I could get a quick follow-up. In terms of your inventory down slightly in the quarter, how should we think about the back half outlook for inventory, and are there any issues, you know, in sort of sourcing and supply chain globally at this point, or everything pretty seamless right now?

Yeah, in terms of sourcing, you know, we've been very successful in working with our supplier partners across the globe. in terms of getting the SKUs that we need. We have some in stocks that are a little bit lower in some of our slower velocity SKUs, but we intend to get that back on track in the second half of the year. So we're not anticipating any significant investments or any significant decreases in the back half as we sit here today. Again, if we get another surge, it could drive down our inventory. But right now, we're well-stocked, we're well-prepared, and we're going to keep working through that through the back half of the year to ensure we can get the customers the parts they need.

Todd, thank you. And your next question comes from the line of David Dillinger with Wolf Research. Please go ahead.

Hey, good morning, and thanks for taking the questions. Maybe just somewhat of a follow-up on the last question. Given the volatility in sales trends and the strong pickup off the lows in late April, have you sort of come across any supply constraints, especially within the world pack business? Is that something we could see coming to play more towards the later stages of the year? We haven't, David. I mean, we obviously are managing this daily. We get an update that's comprehensive every Monday and every Friday. It lets us know where we are. It has been challenging because there has been a significant surge in demand and you've got suppliers and manufacturers out there that are scrambling to source. We're well positioned. Our WorldPAC team does a terrific job sourcing the parts that they get that are somewhat unique. A very long tail of OE parts and private label parts that they have, branded parts that they have. We haven't had anything specific that we would say we're in any way disadvantaged. You know, I think we're actually very well positioned versus the rest of the market. Got it, got it. And I just want to follow up in terms of online. So online growth has been significant lately in the DIY channel. What are you seeing from a competitive standpoint now that this category seems to be getting more traction online? Have you seen any other players get more aggressive in the space? And, you know, how are you addressing this? Yeah, I mean, the big key here, David, is to make sure, I mean, obviously we've had some new customers come to Advance in the last several months, and we've talked a lot about that over the last few months. How do we make sure if somebody walks into our store for the first time or goes to our online portal for the first time that we keep that customer? And obviously, Speed Perks is the vehicle to do that. We're very happy with the loyalty program that we have. We were very focused on that in the past 12 months. We indicated that the number of people year on year was up 30%. We also know that we're graduating people that were in Speed Perks to the higher tiers. We had a 24% increase in graduation rates in the quarter. So somebody who was a club member is now a VIP or an elite. So that tells us that that person is increasing their share of wallet with advance. which is very, very important in this timeframe. You don't want it to be a one and done. You want it to make it sticky, right? And we know that our average dollars per member is up significantly. So that tells us we're driving share of wallets. That's kind of how we look at it to make sure that these online purchases that they're making with us are translated into a great customer experience, whether that's online on our app, by the way, which we launched in the quarter, or in our store. And I feel that we're making good progress there. There's a tremendous amount of runway there. We've now got that first-party data. We've got an email. We're able to personalize our offers. So, you know, obviously other online players are going to do what they do, but our ability to know the category and provide the subject matter expertise and content knowledge that we have, along with the trusted advice and the speed and convenience of our stores, we feel we're well positioned to compete in that world. Very good. Thank you very much. Appreciate it.

And there are no further questions at this time. I will send the call back. Sorry. Over to Tom for closing remarks.

Well, thanks again for joining us today. And as you heard, we delivered strong results in Q2, and we're very optimistic about the second half of 2020. During this unprecedented time we're all enduring, I'm incredibly proud of how our team has come together to serve our customers with care and speed while protecting the health and safety of all of our team members. I'm confident that the actions we're taking will allow us to continue building on this positive momentum for advance and enable meaningful top-line growth, margin expansion, and significant cash flow generation. We look forward to talking to you again in November. Thanks again for your continued support, and please stay safe.

This concludes today's conference call. You may now disconnect.