Advance Auto Parts Inc.

Welcome to the Advance Auto Parts fourth quarter 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 Q4 and full year 2020 results, as well as our 2021 outlook that we highlighted in our earnings release this morning. 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 teacher performance. Actual results could differ materially from those projected or implied by the forward-looking statement. Additional information about factors that could cause actual results to differ can be found under the captions, forward-looking statement, 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.

Thank you, Elizabeth, and good morning to all of you joining us today. I hope you and your families are healthy and safe amid all that we've endured over the past 12 months. Here at Advance, we're incredibly grateful for the way our entire team persevered. When the reality of COVID-19 descended on our communities in March of 2020, we found ways across AAP to meet new, unfamiliar challenges with innovation and agility. I'd like to thank all of our team members as well as our independent partners for their commitment to safely serve our customers. As an essential business, their efforts have been critical to keep America moving during a time of great need. As you've heard from us throughout this pandemic, we remain focused on three overarching priorities. First, protect 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. Our results in Q4 and for the full year demonstrate that our unwavering focus on these priorities has enabled meaningful progress towards our long-term goals. From the beginning, we've invested in compensation for our frontline and distribution center team members enhanced benefits, cleaning, personal protective equipment, and innovative ways to serve our customers. This helped ensure that our team members and customers feel safe coming into work and to shop. Our store and distribution center team members continuously stepped up throughout the year, and they are the true heroes for us. In spite of many obstacles for our team, we saw significant improvements in organizational health, and increased engagement scores throughout the year. Fundamentally, we're building trust in the advanced brand at an enduring time for the world and one that our team members and customers will always remember. We're confident our COVID-19 related investments, which we believe will subside over time, are strengthening our employment brand, our customer brand, and our corporate reputation for the long term. In Q4, we delivered comparable store sales growth of 4.7% and margin expansion of 17 basis points. This includes an 82 basis point headwind related to COVID-19. Adjusted diluted EPS improvement of 14% to $1.87, including a 22 cent headwind related to COVID-19. For the full year, we delivered top-line growth resulting in record net sales of $10.1 billion, adjusted operating income improvement of 4.1% to $827.3 million, including a $60 million headwind related to COVID-19. Record adjusted diluted EPS of $8.51 including a 66 stem headwind related to COVID-19. And we also returned $515 million to shareholders through share repurchases and our continued quarterly cash dividend. Jeff will cover more of the details of our financials shortly, but first let's review our operational performance. COVID-19 related factors continue to affect channel performance in Q4 across our industry. DIY omnichannel led the way as it has since Q2. It's well documented that consumers are spending more of their time at home, likely contributing to the shift in discretionary spending from services to goods. Given economic uncertainty and elevated unemployment, many consumers are choosing lower cost options for vehicle repairs and maintenance, benefiting our DIY omnichannel business. Our professional business continued to recover with positive comp sales in both Q3 and Q4. Miles driven remained below prior year, in particular for higher income workers working remotely who generally take their cars to pro shops. This has limited growth in certain professional sales channels and in key categories like brakes. Geographically, all of our eight regions posted positive comps in the quarter. led by our southernmost regions, including both the southeast and southwest. Meanwhile, our mid-Atlantic and northeast regions remain below our reported growth rate. As previously discussed, large urban markets in these regions have been more impacted by COVID-19, with the most significant decline in miles driven. The good news is that while there remains a gap between our highest and lowest performing regions, that spread continues to narrow. We're cautiously optimistic this will further narrow in Q1 based on improving trends and more favorable winter weather early in the year. As we highlighted in our earnings release this morning, through the first four weeks of Q1, our comp sales were trending in the low double-digit range. with strength across both DIY and professional. With respect to categories, DieHard is driving record battery sales and led our growth in Q4. In addition, appearance chemicals remain strong, a trend that began with the stay-at-home orders last April. Across our professional business, our team continues to leverage our industry-leading assortment of national brands, OE parts, and owned brands, For pro customers, there's nothing more important than having the right part in the right place at the right time. To enable this, we continue to strengthen our dynamic assortment tool, which is now live in all our corporate stores and more than 700 independent locations that have opted in. This machine learning platform has enabled significant improvements in product availability, helping to drive over a 60 basis point improvement in Q4 close rates. In addition, we continue to make enhancements to our online portal, MyAdvance. The ease of access and wide array of resources available now includes features like virtual training, which has been essential during the pandemic. The resources we provide through our CarQuest and WorldPAC technical institutes allow our pro customers, including all technicians within their shop, to attend interactive virtual training. Additionally, we continue to update our comprehensive catalog of technical service bulletins through our MotoLogic platform. We believe pro customers are recognizing and appreciating our investments to improve parts quality, product availability, delivery speed, and the digital experience, resulting in higher enterprise pro online sales and share of wallet. These actions have also enabled growth of our TechNet customer base, with approximately 1,400 new tech nodes added in 2020. Finally, we continued increasing our CarQuest independent locations in 2020, welcoming 50 new stores. Our independence remained a valuable component of our overall strategy, and our team remains focused on further expansion. Moving on to DIY Omnichannel, we gain share in every region and across most categories in both Q4 and for the full year based on the syndicated data available to us. We believe our share gains are the result of our focus in four areas. First, the launch of DieHard. Second, building awareness in regard of advance through differentiation. Third, improving customer loyalty through speed perks. And fourth, improving store execution. Starting with Die Hard, despite the challenges of the pandemic, our team successfully launched Die Hard as planned and executed a marketing plan unlike anything we've ever done before at AAP. Our Die Hard is Back campaign featuring Bruce Willis let consumers know that the iconic Die Hard brand was back and they could now buy DieHard at advance and car price. This campaign is already improving top of mind and unaided awareness for DieHard. Our Speed Perks program is an important tool to drive customer loyalty. Our team continues to invest in personalization for Speed Perks members, driving higher engagement, long-term loyalty, and increased share of wallet. In 2020, we grew our VIP members those with an annual spend of $250 to $500 by nearly 15%. And our elite members, those with annual spend of more than $500 by more than 20%. To wrap up the discussion on DIY Omnichannel, we continue to see improvement from our initiatives, including our net promoter scores. This gives us confidence that we're on the right track to sustain sales and share momentum in 2021. Moving on to an update of our four pillars of margin expansion, I'll begin with sales and profit per store. As a reminder, following three consecutive years of declining sales per store, we finished 2017 at approximately $1.5 million per store. Over the last three years, we've been optimizing our footprint, including the closure of 273 underperforming stores. Our sales per store have now grown for three consecutive years, and we finished 2020 at nearly $1.7 million per store. We're also executing a focused agenda to leverage payroll while reducing shrink, returns, and defectives to drive for-wall profit per store improvement. In addition, the ongoing focus on team members is enabling us to attract the very best parts people and to reduce turnover Our team members are a differentiator for advanced, and four years ago, we made a commitment to dramatically improve retention. Continued investment in our unique Fuel the Frontline program, with more than 22,000 stock grants awarded since inception, is creating an ownership culture. In the current environment, with an increased competition for talent, we're reducing store turnover and enhancing our employment brand. We now have three straight years of comp sales growth and the closure of underperforming stores behind us. We're excited to announce that we plan to expand our store base and geographic footprint this year and expect to open 50 to 100 new stores. Our second margin expansion pillar is supply chain. While we paused our cross-manner replenishment and warehouse management system initiatives early in 2020, Our team found ways to innovate and make progress on this productivity opportunity later in the year. The expansion of cross-banner replenishment is on track with the timing we communicated in November, as we finished the year with just over 40% of the originally planned stores completed. We're on track to complete the originally planned stores and DCs by the end of Q3 2021. and the full run rate of savings will come beginning in Q4 2021. In addition, the implementation of our new warehouse management system, or WMS, continued in Q4. We converted our fourth DC by year end as planned, and we're on track to complete our largest buildings this year. We believe we can capture roughly 75% of the savings from this initiative in 2022. Moving on to category management, the expansion of our own brand assortment is a key component. This includes an increase of CarQuest's branded assortment in engine management and undercar. CarQuest has an excellent reputation with installers, and new products have been very well received by both pro customers and CarQuest independents. In 2020, we also launched our strategic pricing initiative to enhance our capabilities while incorporating customer decision journey insights into price and discount decision making. Finally, our fourth pillar of margin expansion involves reducing and better leveraging SG&A. The successful execution of our field restructure, back office consolidations, and safety initiatives benefited SG&A in the quarter and will enable further improvement in margin expansion going forward. As we called out in November, SG&A was elevated in Q4 primarily due to COVID-19-related expenses and other factors that Jeff will detail shortly. To summarize, we're now in execution mode on our key growth and margin expansion initiatives. Our mission is passion for customers, passion for yes, with the goal of serving them with care and speed. We've made many necessary changes at AAP in recent years. But one thing that has not changed is the content knowledge, the passion, and the commitment of our team members and independent partners. Our actions have strengthened advance, enabling us to compete more vigorously. Finally, we're very excited to share our third sustainability and social responsibility report next month. and we'll be providing a strategic update of our long-term plans on April 20th. With that, I'll pass the call to Jeff to discuss our financial results in greater detail, as well as our 2021 guidance. Thanks, Tom, and good morning. I, too, would like to begin by expressing my gratitude to all our team members for the extraordinary focus and effort throughout 2020, despite the unprecedented times. our entire team adjusted, adapted, and continued to execute our priorities. In Q4, our net sales of $2.4 billion increased 12%. Adjusted gross profit margin expanded 192 basis points to 45.9%, driven primarily by inventory-related items, cost and price improvements, as well as supply chain leverage. As our primary focus throughout the year was on the health and safety of our team members and customers, we temporarily paused our physical inventory counts earlier this year. When we resumed these in Q4, our actual shrink rates were far better than we had anticipated. This resulted in a benefit in inventory-related costs due to a reduction in the reserve to reflect the positive result. LIFO-related impacts were a tailwind this quarter versus prior year. This will be the last quarter we include the LIFO impacts in our adjusted financial results, and we will begin reporting in Q1 2021, excluding any benefits or expenses from LIFO in our adjusted financial measures. We believe this adjustment creates a more accurate picture of our operational results and is more in line with industry practices. Our Q4 adjusted FG&A expense was $913.5 million. On a rate basis, this represented 38.6% in net sales compared to 36.9% in the fourth quarter of 2019. The single biggest driver of this increase was $19 million in COVID-related costs directly attributable to the unanticipated spike in case rates. We also incurred higher Q4 medical claims as a result of lower claims during the prior quarters. In addition, our short-term incentive compensation for both field and corporate team members was higher than prior year. Separately, we invested behind the launch of the Die Hard is Bad campaign. We also incurred lease termination costs related to the ongoing optimization of our real estate footprint. We believe the expected investments in Die Hard and Lease Optimization will result in top and bottom line improvements Despite higher SG&A expenses, adjusted operating income increased 14.6% in Q4 to $171.8 million. On a rate basis, our adjusted OI margin expanded by 17 basis points. Finally, our adjusted diluted earnings per share was $1.87, up 14% from prior year, despite a 22 cent impact in the quarter from COVID expenses. For the full year, which includes an additional week versus 2019, we delivered record net sales of $10.1 billion, which increased 4.1%. The 53rd week added approximately $158 million to sales. Our adjusted gross profit increased 5% year over year, and adjusted gross profit margin expanded 38 basis points. Adjusted SG&A expense for full year 2020 increased 5.2% from 2019 results. This is primarily the result of COVID-related expenses discussed earlier, as well as the 53rd week. We estimate the additional week resulted in a headwind of approximately 1.5% to our SG&A costs in the year. Our adjusted operating income increased 4.1% to $827.3 million, and our OI margin was 8.2%, flat compared to prior year. Adjusting for the $60 million in COVID costs, our adjusted operating income margin expanded 59 basis points. Our full year 2020 adjusted diluted earnings per share was $8.51, which is a new record for Advance and includes a headwind of 66 cents related to COVID costs. We estimate the impact of the 53rd week with a tailwind and approximately $20 million to our adjusted operating income, and a benefit of approximately 23 cents to our reported adjusted EPS for the year. Our capital expenditures in Q4 were $75 million for a total investment of $268 million for the year, and in line with our previously stated expectations. As we've noted, some of the critical transformation investments we expected to make in 2020 will pause for a portion of the year. As a result, we expect our capital spending will increase this year compared to 2020. Our free cash flow for the year was a record $702 million compared to $597 million in 2019. This increase was driven by several factors, including the efforts we have made to improve working capital. We made meaningful progress on our AP ratio in 2020. delivering 300 basis points of improvement and ended the year at 80.2%. This, in addition to a $76 million tailwind associated with the CARES Act, resulted in a significant improvement in our cash conversion cycle. Our strong cash flow generation allowed us to continue our share repurchase activity in Q4. For the year, we repurchased more than $458 million of advanced stock, and including our quarterly cash dividend, we returned $515 million to shareholders. Our team remained disciplined throughout 2020 to ensure adequate liquidity, protect the P&L during the pandemic, and strengthen our balance sheet. This resulted in meaningful improvement in our cash position, resulting in $835 million in cash on hand at year end. Further demonstrating our confidence in the long-term strength of our business and commitment to return cash to shareholders in a balanced approach, utilizing both share repurchases and dividends, our board recently approved a continued payment of our quarterly cash dividend. Turning to 2021, while uncertainty remains in the current environment, we believe that we can continue to carry the momentum we have seen in the back half of 2020 forward. As the economy continues to recover and with our planned new store openings, we expect to deliver increased net sales and additional margin expansion. Importantly, we expect Miles Driven to continue improving throughout 2021, which should enable year-over-year growth in our pro business. We're encouraged by trends through the first four weeks of 2021. With strength across our DIY omnichannel and pro business, we delivered double-digit comparable sales growth to start the year. We recognize the importance of transparency, and based on what we know today, this morning we introduced our 2021 outlook. Despite continued uncertainty, we're pleased to provide our 2021 guidance. Based on the assumptions we outlined in our earnings release, our 2021 guidance includes net sales in the range of $10.1 to $10.3 billion, Comparable store sales growth of 1% to 3%. Adjusted operating income margin rate of 8.7% to 8.9%, which includes margin expansion of 60 to 80 basis points as compared to the 2020 adjusted operating income margin, excluding the $20.1 million benefit from the 53rd week. Income tax rate of 24% to 26%. Capital expenditures of $275 to $325 million, and a minimum of $600 million of free cash flow. Finally, as Tom mentioned, following several years of closing underperforming stores and focusing on the improvement of operations across our footprint, we're excited to begin actively growing our store base and expanding existing and new geographies. For the first time in four years, we're guiding to new store openings of 50 to 100 locations. I once again would like to thank the tremendous efforts of our team members in meeting the challenges of COVID-19 while still executing our strategic plan. We look forward to sharing more on those plans in the investor presentation we'll publish in April. Now, let's open the call for your questions. Operator? Certainly. At this time, I'd like to remind everyone, in order to ask a question, please press star 1 on your telephone keypad. To withdraw your question, press the pound key. We'd like to remind everyone, In order to allow everyone an opportunity, please limit yourself to one question and one follow-up. Michael Lasser with UBS, your line is open. Good morning. Thanks a lot for taking my question. If we take the midpoint of your operating margin guidance for this year, it implies that you'll have achieved around 30 basis points of annual margin expansion between 2019 and 2021. recognizing that there's some COVID costs in there, but why wouldn't there be more margin expansion given the investments you've made, the store closures, and the year has started off strong with double-digit comps so far this year? And if you could also talk about the flow of margins over the course of this year, it would be very helpful. Thank you. Good morning, Michael. First of all, we're very excited about the start of the year. In terms of the overall margin expansion, our long-term goal is to dramatically accelerate our margins, as you know. We're pretty excited that we're going to share an update with you on our long-term plans on April the 20th. 2020 was our third consecutive year of comp sales and operating income growth. And we have said, as you highlighted, that 2021 and beyond is going to have a significant acceleration of margin expansion, and it's going to come from a number of areas that we've talked about before. So we're going to talk more about that on April the 20th. I mean, I think the biggest factor in which you described is the COVID-related cost that we still have embedded in our annual guide this year. And that remains an unknown at this point. We still have some uncertainty out there regarding that. COVID-related costs, and we saw that late in the year. It spiked significantly as infection rates across the country went up, and we remain very focused on accelerating margin expansion. Once that comes out, as we said, at $60 million for the full year, that'll be a big number for us to expand our margins with. Okay. And my followers, Tom, you have the advantage of having more exposure to markets that were hit harder in 2020, as well as exposure to recovery in the professional market, which has been slower to improve thus far. So as you think about 2021, compared to your peers, how much of a gap are you expecting that your sales should improve more than the industry this year Now, admittedly, you're recognizing that you've got to do a one-to-three comp, but that seems pretty modest in light of these benefits that you'll have, especially relative to the rest of the industry. Well, for sure, we definitely saw that difference last year. You know, if you look at the miles driven, which is the most, you know, one of the significant drivers of demand in our industry, miles driven were down the most in the northeast and mid-Atlantic regions. The southeast and southwest were down the least. And then on the other hand, from a channel perspective, we know that DIY will perform pro. So both of those things, we start to laugh in April and May. And we do expect the Northeast and Mid-Atlantic to come back strong. It's obviously, once again, a function of how quickly the economy returns to those markets, how quickly people start to return back to work. But there is an expectation that those markets will outperform and that pro will outperform DIY this year. So we feel we're very, very well positioned in that regard. And, you know, we're going to watch it very closely. We've looked at the full year, the laps for each geography and each channel. And we feel very good about how we're positioned to take advantage of that, you know, resurgence in demand in the Mid-Atlantic, the Northeast, and our professional business. Okay, thank you very much, and good luck. Thanks. Seth Figman with Credit Suisse. Your line is open. Hey, good morning, everybody. Thanks for taking the question. I wanted to just follow up on that guidance for the full year, for next year. Jeff, on the 8.7 to 8.9 EBIT margin, I assume that excludes the impact from LIFO. Can you just confirm whether LIFO is expected to be a headwind or a tailwind in 21? And just so we're all comparing apples to apples, if you exclude the LIFO benefit in 20, are we looking at EBIT margin 20? and 20 more like 8%, so effectively you're guiding 70 to 90 basis points of expansion. I just wanted to confirm those numbers. Yeah, sure. First of all, we did exclude LIFO from the guidance that we provided in 2021. So, you know, we had that as a slight headwind as we were modeling it, but it's not in the AOP that we put out or the guidance that we put out today. And then you're right, as it relates to 2020, you would have to back out that $14 million that we had in favorability in LIFO in 2020. So that gets you closer to an eight on a 52-week basis. Okay, great. So effectively guiding a little bit more than that improvement. Okay. And then just on the gross margin, if we look at the drivers this quarter, LIFA was a factor. But can you just help us better understand some of the fundamental drivers that are supporting this improvement? And sort of within that guidance we just talked about, what are you assuming for gross margin and sort of the phasing of the benefits related to supply chain and some of the other initiatives? Thank you. Yeah, sure. You know, our initiatives are really beginning to take shape. So as it relates to category management, for example, we saw improvements in both product costs as well as improvements in price. And then we once again leveraged supply chain as the initiatives, you know, around cross-banner replenishment are continuing to remove costs, and we're taking advantage of that. So in addition to shrink and the LIFO, as you just called out, You know, the channel mix was also positive, although I will tell you that that was offset by product mix, which is related to categories such as brakes, wipers, and lighting, similar to what we saw in the third quarter. Now, looking forward into the guidance into 21, it's a lot of those same initiatives. And those are the reasons that gross margin is going to be the driver for our margin growth when we look at 21 compared to 20. So the strategic pricing, we've got it in place. We're starting to implement that. We're already starting to see early results. And, you know, similar to the category management, we're changing over into private label, and we're going to start to see the impact of that early on and then throughout the year. So it's those initiatives that are in place where we're taking the actions now, and we're going to see that benefit going into 21, and those are going to be the drivers that lead our gross margin. Very helpful. Thank you very much. Chris Horvath with J.P. Morgan. Your line is open. Thanks. Good morning, everybody. So I guess a couple questions on cadence. How are you thinking about overall sensor sales cadence over the year and any additional detail on how you're thinking about pro versus DIY? Hey, good morning, Chris. You know, the cadence is much more volatile than historic, right? You know, we're going to be laughing a minus 9 in the first quarter, and then we go to a 7 plus and a plus 10, and then there's variation across the channels and there's variation across the geographies. So we've done a tremendous amount of work on this to try and understand what to expect for the year. Clearly, the first quarter will be very strong. We highlighted a low double-digit growth quarter to date, and that's prior to the widespread shutdowns that happened late period three and into period four. The second quarter, you'll recall the professional business was still challenged, DIY surged. You know, that we're factoring in, et cetera. So, you know, think about looking at the two-year numbers. I mean, that's what we're looking at closely, obviously, is the two-year numbers to kind of factor out the volatility of last year. But even there, you know, you've got to put some judgment against it. But we obviously expect to get off to a great start and build on the momentum. You know, we're excited about the way the year has started off. And, you know, we're going to continue to build from here. Got it. And then similar question on the margin. Given that the supply chain and WMS completes over the year, at least the supply chain and then WMS, does the gross margin expansion weight more to the back half? The inverse of that is the SG&A or SG&A dollars were flat in the first half, but up very high in the back half. So is there some inverse going on between gross margin and SG&A over the year? There will likely be some, Chris. You know, the gross margin, to your point, we continue to see improvements. You know, cross-banner replenishment is a great example of that. You know, as you take out those STEM miles, you get that savings immediately. We'll be completed with the first set of stores that were identified in the end of the third quarter, so you get that full run rate. in the fourth quarter. So we'll continue to see that improvement throughout the year. You know, SG&A, again, that's a little bit more tricky just with the COVID costs that almost all of them are in SG&A. That one's a little bit more difficult to predict. You know, certainly we saw a surge here late in the year and then early into 21. But, you know, as we said, we are modeling less COVID costs in 21 as compared to 20, you know, when that happens remains to be seen. And then we will be lapping some difficult dollars in SG&A in the second and third quarter around payroll. So we had We were taking hours out. We were reducing time. We were closing early. And we're going to be returning to normal, ideally. And we'll have full store hours, which requires the store labor, requires the training. It requires the normal replenishment and stocking and all the other types of things that we had to pause in the second and third quarter. So you're going to get some volatility throughout the year. Got it. Thanks very much. Seth Basham with Redbush Securities. Your line is open. Thanks a lot, and good morning. My question first is around the fourth quarter inventory shrink. Did you call out how much shrink helped those margins in the fourth quarter? We didn't call out the number. It was a significant number, which is why we wanted to call it out. It's a bit of an anomaly. Normally, what happens is we do these physical inventory counts throughout the year. And what that does is it informs what we call our shrink rate, which then drives the type of reserve that you need on your balance sheet for the estimated shrink that's out there. Because we were pausing that, as I just mentioned, in the second and third quarter, we had to catch all that up in the fourth quarter. It was a positive adjustment, but it took, you know, what we probably would have recognized in the second and third quarter and pushed it all into the fourth quarter. So, you know, on balance, we still saw improvement on a year-over-year basis. We just saw that, you know, primarily in the fourth quarter. And we're going to continue to, our efforts around shrink, we're very pleased with the results, although it was, all came in the fourth quarter. We're going to continue with those standard operating procedures and hope to get further benefits and shrink going into 2021.