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.