Advance Auto Parts Inc.

Welcome to the Advanced Auto Parts Third Quarter 2020 Conference Call. Before we begin, Elizabeth Eisleben, Senior Vice President, Communications and 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 Third Quarter 2020 results. I'm joined by Tom Greco, our President and Chief Executive Officer, and Jeff Shepherd, 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 captioned 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, everyone. And allow me to start by thanking each of our advanced team members and CarQuest independent partners for their tireless efforts to delight and serve our customers. Our entire team face challenges every single week throughout Q3. And I'm reminded daily that our role in supporting essential workers has never been more important to our success. We've been operating with three overarching priorities during the COVID-19 pandemic. First, prioritize the health, safety, and well-being of our team members and customers. Second, preserve cash and protect the P&L during the crisis. And third, prepare to be even stronger following the crisis. We made progress on each of these objectives in the quarter. Our dedicated leadership team remains focused on the health and safety of our team members and customers, regularly cascading safety protocols and updating our playbooks for the pandemic. This includes health checks for all team members instituted company-wide in Q3. We also provided cooling fabric masks in the summer to address heat concerns while ensuring our team members had face protection. Our communications team keeps visibility high through virtual town halls and regular video updates to ensure team member engagement. We're also benchmarking and working collaboratively with industry and professional organizations to continuously improve our response to this rapidly changing environment. Bottom line, we remain vigilant to protect our team members and to ensure that our customers have a safe and positive experience in our stores. Turning to Q3 results, our net sales grew 9.9% to $2.5 billion compared to the prior year, and we delivered comparable sales growth of 10.2%. This is our strongest quarterly performance in 15 years. Adjusted operating income increased by approximately 33% to $272 million, and our adjusted operating income margin rate increased 183 basis points to 10.7%. As you'll hear from Jeff, we also strengthened our cash and liquidity position throughout the quarter, highlighted by our quarterly free cash flow improvement of 95%. Recently, we saw positive comp sales across every region, with the Gulf Coast, Central, and Southeast posting strong double-digit comp growth. Our Northeast, Mid-Atlantic, and West regions, while still positive mid to high single digits, were below our overall comp growth in the quarter. As we noted in Q2, there remains a wide gap between our highest and lowest performing regions, although this narrowed in Q3 to approximately 900 basis points on average between the six regions I just mentioned. The good news is that the Northeast, which is our largest region, had the most improvement of any region in the quarter versus Q2. As we examine the broader oil parts industry and total retail data, the performance of these lower growth geographies has been more impacted by COVID-19 and is consistent with our internal results. On a category basis, we saw sales strength in batteries, as well as continued growth in appearance and optics that began in Q2 when stay-at-home orders were implemented. While there are many puts and takes in Q3, we believe the net benefit for the industry was driven by three primary external demand drivers. First, there are economic drivers. Due to the uncertainty of the macroeconomic climate and increased unemployment, there have been fewer new vehicle sales and more used vehicle sales. This results in an aging fleet, which is good for both DIY and ultimately pro. Secondly, there are COVID-related factors. As we've discussed before, we believe consumers have an understandable fear of using mass transportation, creating a heightened emphasis and reliance on personal vehicles. In some cases, people are working from home and have time on their hands to do their own DIY maintenance and repairs. Finally, it's our belief that when motorists have DIY needs in this environment, they prefer to shop in smaller boxes. In our stores, they can feel safe, get the trusted advice they need, and get back on the road quickly so they can do the job well. Of course, some of the benefit from these external factors is offset by the reduction in miles driven, which is an important demand driver for our industry. When this begins to recover, we expect it will provide a tailwind for the industry. We believe the majority of our accelerated top-line growth in the quarter, and in particular the strong DIY performance, is due to these external factors. Our industry has historically performed well during challenging economic times. Considering prior periods when the economy was challenged, DIY is generally an early beneficiary, followed relatively quickly by pro-recovery. Looking more closely at our Pearl business, we delivered mid-single-digit net sales growth in Q3, following a decline in Q2 due to the temporary closure of garages across North America. In Q3, our machine learning platform, Dynamic Assortment, enabled us to have the right part in the right place and improve availability. This enabled both assortment and close rate improvements as lookups and demand surged. We also deployed new customer delivery software for WOLPAC, ADVANCE, and CarQuest, which includes real-time updates and notifications for all users. In addition, our pro customers were very appreciative of the continued interactive virtual classroom training we provided through our CarQuest Technical Institute. This included the ability for pro customers to extend the training content to all technicians within their repair shops. On our MotoLogic platform, we continue to enhance our technical service bulletins and also deploy this valuable tool in CarQuest Canada. These tools, in addition to our sustained focus on improving the overall experience for pro customers, enable us to further grow our TechNet base during Q3 as we cross the 12,000 customer mark. In addition, our Car Quest independent team had another strong quarter and has now converted 36 new stores to the Car Quest family year-to-date. Once again, we know this has been a difficult time for professional shops, and we believe the work we've done to be there for professional customers when they need us most has set us apart. Moving on to DIY Omnichannel, we delivered another quarter of double-digit net sales growth in Q3. These results were driven by the external drivers discussed earlier, coupled with our DIY growth initiatives. Our growth initiatives are primarily focused on increasing share of wallets with existing DIYers, while attracting new DIY customers. Based on the syndicated data available to us, we drove meaningful share gains throughout the quarter. Our DIY initiatives start with DieHard. While we believe DieHard is benefiting our performance in all channels, we can clearly see improvements in our DIY battery share behind our launch. In October, we introduced our DieHard is Back campaign. This advertising launched with a two-minute film on October 18th during the Fox NFL Game of the Week. This integrated campaign featuring Bruce Willis has already generated over 2 billion impressions and more than 1,200 earned media placements. We believe our marketing plans will drive continued support during the winter months when batteries fail and customers need a reliable solution. we think we have significant room to grow Diehard in the battery segment. Secondly, we continue to focus on building awareness for the advanced brand to attract new customers and drive traffic. In addition to leveraging more effective advertising, including Diehard, we're strengthening our digital engagement with DIYers when they visit our website or download our app. few three highlights include the continued growth of our advanced same-day suite of services and strong momentum and consumer response to the launch of our mobile app earlier this year. These and other initiatives helped drive strong double-digit sales growth in e-commerce for the quarter. Third, we continue to see year-over-year growth in active Speed Perk members since the rollout of our new program in the summer of 2019. Importantly, We're seeing a steady increase in members graduating to the elite and VIP levels. Our graduation rates improved by more than 20% year-over-year, reflecting important share of wallet gains with heavy DIYers. We're leveraging first-party data gathered through this program to deliver a personalized experience for our customers. Finally, we remain focused on execution across the board. We did an excellent job with the diehard launch overall and saw year-over-year net promoter score improvement across all channels. In summary, our top line performed well in the third quarter driven by the factors just discussed. So far in Q4 through the first four weeks, comp sales remained positive across all channels in the mid-single-digit range. As a reminder, Q4 tends to be our most volatile quarter each year, primarily due to fluctuations in weather. In addition, we remain sensitive to potential volatility from other external factors in the current environment, particularly those related to the future spread of COVID and the possibility of heightened stay-at-home orders in the near term. Much more within our control is the execution of our four pillars of margin expansion, as we demonstrated in Q3. Starting with our first pillar, our top line growth during Q3 contributed towards sales per store improvement versus the previous year. Additionally, on a rate basis, our SG&A per store improved year over year. We're managing store payroll with greater effectiveness as a result of a my-day scheduling tool. Our team continues to plan payroll conservatively in the current environment, balancing customer service and cost very closely. In terms of supply chain, we're making progress with our cross-banner replenishment, or CBR, initiative. We've completed nearly one-third of our original plan, which redirects stores to a more freight logical distribution center and reduces stem models across our network. We're already beginning to see savings from the stores that have been completed as a result of reduced miles. We're on track to complete approximately 40% of our identified stores by the end of the year. with completion and full run rate expected to be realized by Q4 2021. Importantly, our team has found further opportunities for improvement than initially modeled, which includes additional stores that can be included following the completion of the first phase. In addition to CBR, our Single Warehouse Management System implementation, or WMS, is also well underway after a temporary pause due to the pandemic. Our team mobilized to adjust our plans, which now includes virtual implementation capabilities. We're installing the new WMS starting with our 11 largest DCs, of which we expect four to be completed this year. Based on what we know today, we expect to finish the entire WMS implementation by the end of 2022. With that said, we'll realize savings as each additional DC is completed. In terms of category management, we made progress in Q3 on own brand expansion. We expect to finish 2020 with a significant increase in own brand SKUs and to further enhance our SKU mix next year. Our margin rate on own brand SKUs is meaningfully higher than comparable applications in their respective categories. This will enable further growth in margin rate in the years to come. Separately, our new strategic pricing tool is beginning to enable both profit dollar and margin rate improvement through pricing initiatives rolled out in the quarter. Finally, SG&A productivity continues to be a source of margin expansion. First, we made progress on the consolidation of disparate back office systems, which is our largest area of opportunity within SG&A. In Q3, this was highlighted by progress on our finance ERP implementation. In addition, we continued with the integration of WorldPAC and Auto Part International. We also continued to address opportunities to optimize our organizational structure, including support contracts and professional fees. Consistent with this, we made the decision to consolidate our field structure from two divisions to one in May. In early October, we further streamlined our field structure from 12 to eight regions. We believe that these moves enable us to serve our customers with even greater effectiveness, efficiency, and flexibility. The recent field changes also enabled us to bolster certain areas in our corporate support center with seasoned field operators. As an example, we frequently discuss the importance of diversity and inclusion and its inextricable link to our business strategy. As part of this, we welcomed Dina Lamar, having served as our RVP of the Great Lakes region for the past three years, to our leadership team as our new VP and Chief Inclusion and Diversity Officer. Dina has a deep field leadership background in retail, both inside and outside of a band, and her leadership and enthusiasm for building a high-performing, diverse workforce made her an ideal candidate for this role. A second area of opportunity within SG&A is rent. Based on the current environment, we're thoughtfully evaluating our real estate footprint, including office space. This involves negotiating with landlords for concessions on low-return properties, and in some cases, exiting the property altogether. We've engaged a third party to help with this and expect it may result in some short-term cost headwinds in Q4. Specifically, buying out leases that are unproductive where we determine the building is no longer necessary. Third, we have a dedicated team reviewing the existing plans we have for every single line item within SG&A. They're assessing the productivity we had planned pre-COVID and also capturing key learnings we've had during COVID. This team is recommending areas of refinement and further opportunity as we move forward. For example, during COVID, we limited company-wide travel, which will continue for the balance of the year. Going forward, we intend to leverage virtual options and do not plan to return to pre-COVID levels of travel. Another area of opportunity is further reduction in our insurance and claims expenses. Here, we continue to make progress on our lost time injury rate. LTIR represents our most severe accident and was 33% lower than the prior year. In addition, our sustained focus in Q3 resulted in a reduction in collision frequency rates of 13% versus the prior year. Our advanced driver program and SmartDrive event-based video coaching is also being rolled out, which we believe will help us further reduce our collision frequency rate. In summary, we continue to believe that margin expansion is a significant opportunity for advance to drive total shareholder return, and we remain focused on the initiatives we have in place pre-COVID for the four pillars of margin expansion. While executing these previously established plans, we're also closely monitoring the current and future environment to identify new productivity opportunities to drive total shareholder return. Before I turn it over to Jeff, I'd like to recognize the impressive results our team members and generous customers delivered in our American Heart Association campaign. Following a successful campaign last year, I could not be prouder of our team's efforts this year to raise $1.4 million, which was a 38% increase compared to last year. We delivered this record-setting campaign while providing exceptional customer service and remaining relentless on the execution of our long-term plan. In closing, our third quarter results were another step in the right direction. Despite uncertainty that remains in the current environment, we remain focused on executing our long-term strategy. With that, I'll turn it over to Jeff for details on our financial performance. Thank you, Tom, and good morning, everyone. I want to reiterate Tom's thanks to our team members for their dedication and hard work, not only this past quarter, but since the pandemic began. We have been extremely diligent in ensuring safety measures are in place throughout the enterprise. At the same time, our team members have risen to the challenge. The positive print we released today would not have been possible without them. In Q3, our adjusted gross profit was approximately $1.1 billion. This was an increase of 11% compared to Q3 of the prior year. Adjusted gross profit margin rate improved 50 basis points year over year to 44.4%, driven by favorable pricing actions and supply chain efficiencies. These improvements, coupled with channel mix, were slightly offset by unfavorable product mix and headwinds associated with shrink and defective. It's also important to note But while we experienced tailwinds associated with LIFO, these tailwinds were offset by capitalized supply chain costs, resulting in no net impact from the inventory-related costs and benefits both in the quarter and compared to the prior year. Our adjusted SG&A was approximately $857 million in Q3, an increase of 5.8% compared to Q3 of 2019. Adjusted SG&As of percent of net sales improved by 133 basis points compared to the prior year, primarily driven by an improved payroll and rent leverage, reduction in travel, and our continued focus on safety, leading to a reduction in insurance claims, as Tom had mentioned. These cost savings were partially offset by an increase in support contracts related to our transformation initiatives. In addition, Our COVID expenses for the quarter were approximately $9 million. The majority of these expenses are related to ongoing costs, such as cleaning supplies, gloves and masks, and enhanced fixed-day benefits during the pandemic. We expect to incur these costs for the foreseeable future. Adjusted operating income in Q3 was $272 million, which improved 32.6% compared to the prior year quarter. Our adjusted OI margin rate improved 183 basis points to 10.7% in the quarter. Adjusted diluted EPS was $2.81, an increase of 34%. Year-to-date free cash flow was $616.6 million, compared to $539.3 million during the same period in 2019. Driven by strong top line results, improved working capital, and a deferral of federal payroll tax. In Q3, our capital expenditures were $52.5 million, which was a decrease of $5.3 million compared to the prior year. In line with our financial priorities, during the quarter, we completed the early redemption of our 2022 notes and tendered approximately 57% of our 2023 notes, both of which carry a 4.5% coupon rate. This was completed using both cash on hand as well as proceeds from the $350 million 1.75% note issued during the quarter. Our disciplined approach to managing our balance sheet has allowed us to take advantage of the current low interest rate environment, resulting in a stronger debt maturity profile and improved leverage ratios. we believe our debt financing initiatives have further safeguarded the business for the future. Our disciplined approach to managing cash resulted in an AP ratio of 80.8%, which is the highest we've achieved since the GTI acquisition. We remain confident in our ability to generate meaningful cash from the business and to opportunistically return cash to shareholders. As we discussed last quarter, We lifted the temporary suspension of our share repurchase program, and during the quarter, we repurchased nearly $110 million of advanced stock at an average price of approximately $153 per share. This, combined with the continued payment of the $0.25 quarterly cash dividend per share approved by our board, further demonstrates our confidence in the long-term strength of our business. Given the continued uncertainty around the impact of COVID-19 and the current economic situation, we will not be providing guidance for the balance of the year. Traditionally, Q4 has been our most volatile quarter, with weather having a meaningful impact on results. In addition, there are a couple of factors impacting SG&A to consider in Q4. First, we have known incremental costs compared to the prior year related to COVID-19 expenses. As Tom mentioned, there will be costs associated with buying out unproductive leases. Third, we are investing in the Die Hard and Back marketing campaign. We also want to remind you that our fourth quarter this year includes a 53rd week. With the exception of comparable store sales, we encourage you to include the impact of these factors in your modeling. Finally, we are updating our strategic business plan informed by our best estimates and assumptions of the environment. Our plan is to finalize this in early 2021 and provide you with an update after our Q4 earnings release. We expect to finalize the date in the near future and look forward to sharing additional details with you. In conclusion, we are pleased with the results of the quarter and believe that we have positioned ourselves positively for the remainder of 2020. We know that we cannot predict what this winter will bring, but we remain committed to top line growth, margin expansion, and managing our liquidity. With that, let's open the call to address your question. Operator?